Noah SmithModify

2025-12-24 17:39:47

Europe has a lot on its plate these days. It’s facing a hostile Russia that has no intention of stopping with Ukraine. It’s dealing with tariffs and various other threats from an unpredictable and hostile Trump administration. And it’s struggling with internal unrest over migration from the Middle East and Central Asia. That would be enough to keep anyone occupied. But on top of all that, Europe is being buffeted by the Second China Shock.

The Second China Shock is another name for the flood of high-tech exports that China has been sending out around the world in the last few years. China’s economy is still suffering from the prolonged effects of the real estate bust that began in late 2021. In response, Xi Jinping’s government has unleashed the most expensive and wide-ranging industrial policy the world has ever seen, promoting high-tech manufacturing across a variety of sectors. Because the economy is in the doldrums, Chinese consumers themselves aren’t able to buy all the stuff that their government is paying Chinese companies to make — electric vehicles, ships, machinery, and so on. So the companies are selling that stuff overseas, anywhere they can, for cut-rate prices.

In Europe, that has manifested as a giant trade deficit with China:

This flood of Chinese exports to Europe is being boosted by several tailwinds. First, China’s currency has gotten cheaper — partly as a result of China’s weak domestic economy, and partly because the government has pushed down the exchange rate in order to pump up exports. Shanghai Macro Strategist writes:

This combination — falling relative prices in China and a weaker currency — has made Chinese goods and services extraordinarily cheap in global terms…A vivid example: a night at the Four Seasons Beijing costs roughly $250, compared with more than $1,160 in New York. The price gap is so extreme that it no longer reflects relative productivity or income levels; it reflects a currency that has become fundamentally undervalued…At these valuations, it is virtually impossible for most countries to compete with Chinese exporters. The current level of the yuan is simply too cheap to support a sustainable rebalancing of global trade.

Here’s a chart showing the yuan’s recent depreciation against the euro:

The second tailwind is Trump’s tariffs. Although Trump has backed off of most of his threats of tariffs on China, some important changes — like the end of the “de minimis” exemption for small packages — have gone into effect. And the threat of tariffs is probably prompting Chinese companies to seek other markets. As a result, Chinese exports to America are falling fast, while the country’s exports to other regions — Europe, Southeast Asia, and Latin America — are booming:

Some people claim that China’s surge of exports to these other countries is actually going indirectly to the U.S. Those people are wrong. As Gerard DiPippo has shown, “transshipment” to America is quite low. China simply found new customers to buy its products. Europe is the most important of those customers.

This means that although Trump’s boneheaded tariffs on allied countries have hurt U.S. manufacturing, his tariffs on China — and his threats of even higher tariffs on China — have partially insulated America from the Second China Shock. Europe as yet has no such insulation.

At this point you may ask: Who cares? China is selling a bounty of useful consumer goods to Europeans at cut-rate prices; why look that gift horse in the mouth? If a store in your neighborhood had a blowout sale, you’d enjoy it, wouldn’t you? And on top of all that, many of China’s fastest-growing exports to the EU — electric cars and such — are “green” technology that Europe has been trying to promote in order to fight climate change.

Given that Europe has so much else to worry about, why shouldn’t it just take the cheap Chinese stuff, enjoy the high-quality cars and the lower carbon emissions, accept deindustrialization, and focus on services instead? That’s basically what The Economist recommended in an article last month:

Indeed, the best hope of consolation for Europe lies not in stopping the China shock, but in weathering it. Manufacturing looms large in politics, but accounts for only 16% of the EU’s GDP, a far lower proportion than services (70%). Even in Germany its share is only 20%. The industries in which China is making inroads—cars, machinery, metals, pharmaceuticals and chemicals—account for more than 10% of the value of industrial activity in only a few European countries, notably the Czech Republic, Germany and Hungary…De-industrialisation, in other words, need not be synonymous with decay.

But as pleasant and easy as this might sound, it would actually be very foolish, for a number of reasons.

First, there’s the military angle. Health care and education and entertainment are nice things to have, but to fight a modern war you need drones, missiles, satellites, ships, planes, and vehicles of all kinds. And with Russia breathing down Europe’s throat, and America no longer a reliable ally, there is a good chance that Europe will soon have to fight a modern war against a high-tech opponent. Russia’s population is smaller than Europe’s, but its economy is now heavily oriented toward military manufacturing. Russian production is also now supported by China, whose companies are selling Russia weapons and even allegedly building weapons in Russia.

In order to resist that threat, Europe will need lots of manufacturing. That doesn’t just mean having European governments purchase ammunition and tanks from defense contractors. It means scaling up Europe’s civilian manufacturing of vehicles, electronics, chemicals, and so on, so that if Russia does start a wider war, Europe can repurpose those civilian industries for large-scale military production. If Europe allows itself to be deindustrialized, its military capabilities will be limited to whatever the government can purchase in peacetime.

The second problem is that Europe’s trade with China is increasingly unbalanced. Europe is not trading services for the flood of electric cars, solar panels, and so on that China is sending. Instead, Europe is writing IOUs. That’s what a trade deficit is — the writing of IOUs in exchange for imports. Robin Harding of the Financial Times recently warned about this unbalanced trade, in an eloquent article entitled “China is making trade impossible”:

There is nothing that China wants to import, nothing it does not believe it can make better and cheaper, nothing for which it wants to rely on foreigners a single day longer than it has to. For now, to be sure, China is still a customer for semiconductors, software, commercial aircraft and the most sophisticated kinds of production machinery. But it is a customer like a resident doctor is a student. China is developing all of these goods. Soon it will make them, and export them, itself…

[I]f China does not want to buy anything from us in trade, then how can we trade with China?…[W]ithout exports, we will eventually run out of ways to pay China for our imports.

A trade deficit is not a gift; it is a loan. That loan must be paid back. The Europeans who take out the loan may be insufficiently long-term in their thinking, effectively borrowing against their own futures to consume in the present. It’s up to government to look out for the prosperity of future generations.

On top of all that, some people think that at extremes of unbalanced trade in high-tech industries, the conventional wisdom that trade is mutually beneficial might break down. Goldman Sachs recently released a report claiming that Chinese exports will actually make Europe poorer!

Greg Ip offers his thoughts in a thread:

Fascinating and important report from Goldman Sachs. They have upgraded long-term GDP of China because of increased exports, but see this as reducing, not increasing, rest of world GDP. Chinese displacement of domestic manufacturing swamps any positives from cheaper goods…

This confirms what I have long suspected: Chinese growth does not “contribute” to global growth except in the purely arithmetic sense. It does not actually create positive feedbacks that lift other countries’ growth. That’s by design...The point of Xi's "dual circulation" is to make the world more dependent on the Chinese industrial supply chain, while making China self-sufficient, that is buying less from the rest of the world. The model is inherently "beggar thy neighbor" (as Goldman notes)[.]

How would this work? Usually, when we think of “beggar-thy-neighbor” trade policies, it’s in the context of recessions; if aggregate demand is scarce, then trade deficits can make it worse. But while China is in a demand-driven growth slowdown right now, Europe is not. So there’s not really a macroeconomic reason to think that Chinese imports are making Europeans poorer.

Instead there must be a microeconomic reason. Obviously, even unbalanced trade is voluntary — Europeans want to write IOUs for Chinese goods — and we generally think that any voluntary trade must benefit both sides, or else they wouldn’t have done it in the first place. Thus, if Chinese imports actually make Europe poorer, it must be through an externality — some kind of negative spillover effect that the Europeans who buy BYD’s cars don’t take into account when they make their purchase.

In a New York Times op-ed back in July, the economists David Autor and Gordon Hanson — who famously coined the term “China Shock” in their research with David Dorn about the effect of Chinese imports back in the 2000s — seem to argue that such an externality exists:

China Shock 2.0…is where China…is aggressively contesting the innovative sectors where the United States has long been the unquestioned leader: aviation, A.I., telecommunications, microprocessors, robotics, nuclear and fusion power, quantum computing, biotech and pharma, solar, batteries. Owning these sectors yields dividends: economic spoils from high profits and high-wage jobs; geopolitical heft from shaping the technological frontier; and military prowess from controlling the battlefield. [emphasis mine]

What might that negative externality be? One possibility is that it’s what economists call a “pecuniary externality” — not a true destruction of value, but an appropriation of economic “rents” from one country to another. Paul Krugman’s New Trade Theory shows how because manufacturing is subject to increasing returns, trade barriers can sometimes reappropriate “rents” to your own country, by allowing your companies to gain scale. In other words, right now, BYD can produce things cheaply because its customer base is really big. If European countries raise trade barriers against BYD cars, their own car companies could gain more scale and become more efficient — and more competitive — by capturing the domestic market, thus transferring some of BYD’s profits to European automakers.

Another possibility is that preserving manufacturing increases a country’s innovative capacity. Manufacturing results in “learning by doing” — a kind of research that can’t be done in a lab, but which creates real knowledge and real productivity gains. There may also be a positive externality from having a ton of engineers in a country — what Brad DeLong calls a “community of engineering practice” — because these engineers get together and swap and combine their ideas. This is probably one reason why industrial clusters like Silicon Valley are so unusually productive.

If electric cars are made in China and shipped to Europe, all the innovation will be done in China. A lot of that innovation will be in the form of a bunch of little tricks that can’t easily diffuse to other corporations and other nations; in other words, the benefits will stay in China and make profit for BYD. But if Europe manufactured EVs for itself, most of the engineers who learned those tricks would generate knowledge for Europe.

Benigno et al. (2025) call this the “global financial resource curse”. The authors argue that corporate innovative activity requires corporate profits; if all the profit is being made in China, that will naturally starve Europe of a lot of innovation.

No European consumer who buys a BYD car is thinking about economies of scale or innovative capacity; they just want a car. But the decisions of all of those car-buyers could add up to a loss of scale and innovation for European companies that left all of Europe a bit poorer as a result.

So if Europe fails to fight the Second China Shock — if it embraces the comfortable euthanasia of deindustrialization — it will be militarily weaker in the face of the Russian threat, its international financial position will deteriorate, and it may be economically poorer as a result.

Those are good reasons for Europe to fight the Second China Shock. But how? Unfortunately, as Robin Harding argues, protectionism is going to have to be part of the solution:

The difficult solution [to the Second China Shock] is [for Europe] to become more competitive and find new sources of value…That means more reform, less welfare and less regulation…Even that, however, will not be enough in a world where China offers everything cheaply for export and has no appetite for imports itself…Which leads to the bad solution: protectionism. It is now increasingly hard to see how Europe, in particular, can avoid large-scale protection if it is to retain any industry at all.

This path is so damaging and so fraught it is hard to recommend it…It would mark a further breakdown of the global trade system…Yet when the good options are gone, the bad are all that is left. China is making trade impossible. If it will buy nothing from others but commodities and consumer goods, they must prepare to do the same.

Protectionism, be it with tariffs or non-tariff barriers, is essential in order to de-risk the reindustrialization of Europe. If a German or French company knows that at any moment, China’s massive industrial policy apparatus could swoop into their industry and put them out of business, they’ll be too shy to invest. Trade barriers are important because manufacturing investment is far less daunting behind that sheltering wall.

EU tariffs and other trade restrictions should only be on China — not on any other country (unless it’s doing large-scale transshipment of Chinese-made goods). In fact, Europe can lower trade barriers with more friendly countries in order for these countries’ manufacturing industries to attain large scale. Rush Doshi calls this “allied scale”.

The EU should also pair protection with export subsidies for European manufacturers. Foreign markets are just as important as the European market, and it would be a disaster to lose those. Europe can never match the scale, speed, and tolerance for waste of China’s industrial policy. But sometimes international buyers would rather hedge their bets and buy from Europe instead of onboarding themselves into the Chinese political-economic system. Just the other day, Vietnam decided to partner with Germany’s Siemens to build its high-speed rail, instead of with a Chinese company.

Another idea is to take a page from China’s book, and encourage Chinese companies to set up joint ventures with European companies in order to sell their products into the European market — or even force Chinese companies to do this, with “buy European” rules. If BYD has its car factories in Poland or Hungary, Europeans will be learning how to make electric cars well. Some of that knowledge will eventually diffuse to domestic European companies as well. And if Europe has to fight a total war against Russia, it can just nationalize those factories and use them for military applications.

Finally, Europe should think about taking action on China’s undervalued currency. This is the approach recommended by Brad Setser and Mark Sobel, who argue that pressuring China to allow the yuan to appreciate significantly would defuse a lot of trade tensions. China’s leaders think that Japan suffered economically after a similar agreement in 1985, but the threat of losing the European market might be even scarier.

This all sounds very grim, but on the bright side, EU action against the Second China Shock could be the beginning of a newer, more stable, more balanced, more equitable global economy. Tariffs on Chinese value added would force Chinese companies to move their factories abroad, to Vietnam or Indonesia or other poorer countries, which would help those countries industrialize. They would also accelerate China’s transition to a normal economy, by temporarily increasing involution and forcing China to curb overproduction. And an appreciation of the Chinese currency would make the global financial system more stable.

But in any case, Europe has little choice at this point. It can’t afford to become a deindustrialized, service-intensive backwater — especially not in the face of all the other threats it faces. The Second China Shock must be resisted.

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2025-12-23 04:55:18

According to the Civil Rights Act of 1964, it’s illegal to discriminate against anyone based on race or sex. That includes discrimination against White men. If your company or your nonprofit or your university or your government agency tries to avoid choosing White men for a job position, you have violated American civil rights law. Every year, including under Democratic administrations, the U.S. government brings cases against employers for discriminating against non-Hispanic White people, and it often wins these cases (Example 1, Example 2, Example 3).

But having a law against racial discrimination doesn’t automatically get rid of it. Those cases are hard to win, they take a lot of time and money to prosecute, and a lot of plaintiffs probably don’t even know they can sue. It’s not clear how many Americans even understand that the Civil Rights Act protects White men in the first place.

As an analogy, the U.S. government has been prosecuting anti-Black discrimination pretty vigorously for decades, but at least as of 2015, some still existed. A meta-analysis of field experiments by Quillian et al. (2017) found that employers in the early 2010s were still around 50% more willing to contact a White-seeming applicant for a job than a Black-seeming one:

(As a side note, the authors did find that discrimination against seemingly Hispanic candidates had fallen since the 1970s, and may have vanished entirely by 2015.)

So the law is not all-powerful. If a bunch of organizations in American society decide to discriminate based on race, the government has limited ability to stop them.

In a recent article titled “The Lost Generation”, Jacob Savage makes a convincing case that discrimination against White men rose significantly in America starting in the mid-2010s, and especially after 2020, especially in universities and the entertainment industry. Some excerpts:

The doors seemed to close everywhere and all at once. In 2011, the year I moved to Los Angeles, white men were 48 percent of lower-level TV writers; by 2024, they accounted for just 11.9 percent…White men fell from 39 percent of tenure-track positions in the humanities at Harvard in 2014 to 18 percent in 2023…

In the aftermath of George Floyd’s death…The New York Times solemnly promised “sweeping” reforms—on top of the sweeping reforms it had already promised. The Washington Post declared it would become “the most diverse and inclusive newsroom in the country.” CNN pledged a “sustained commitment” to race coverage, while Bon Appétit confessed that “our mastheads have been far too white for far too long”…

These weren’t empty slogans, either. In 2021, new hires at Condé Nast were just 25 percent male and 49 percent white; at the California Times, parent company of The Los Angeles Times and The San Diego Union-Tribune, they were just 39 percent male and 31 percent white. That year ProPublica hired 66 percent women and 58 percent people of color; at NPR, 78 percent of new hires were people of color.

“For a typical job we’d get a couple hundred applications, probably at least 80 from white guys,” the hiring editor recalled. “It was a given that we weren’t gonna hire the best person… It was jarring how we would talk about excluding white guys.” The pipeline hadn’t changed much—white men were still nearly half the applicants—but they were now filling closer to 10 percent of open positions…

White men may still be 55 percent of Harvard’s Arts & Sciences faculty (down from 63 percent a decade ago), but this is a legacy of Boomer and Gen-X employment patterns. For tenure-track positions—the pipeline for future faculty—white men have gone from 49 percent in 2014 to 27 percent in 2024 (in the humanities, they’ve gone from 39 percent to 21 percent)…At Berkeley, white men were 48.2 percent of faculty applicants in the Physical Sciences—but just 26 percent of hires for assistant professor positions. Since 2018, only 14.6 percent of tenure-track assistant professors hired at Yale have been white American men. In the humanities, that number was just six out of 76 (7.9 percent).

This is only a tiny portion of the article, which runs to 9000 words. These numbers are a smoking gun in terms of racial and gender discrimination, but Savage also documents plenty of examples where institutions were quite open and explicit about their desire to avoid hiring white men. He also talks to some White men who succeeded in the face of this discrimination, and finds that everyone knew the discrimination was in full force.

I am no lawyer, so don’t take my word for this, but much of what Savage describes seems grossly illegal. Until the Supreme Court’s recent ruling, diversity was an acceptable reason to have racial preferences in university admissions, but to my knowledge it was never an acceptable reason to discriminate in hiring. If anti-discrimination law were easy to enforce, most of these universities and media businesses would be getting slapped with enormous fines (just as many more businesses would have been slapped with fines for discriminating against Black, Hispanic, or Asian people over the years). But anti-discrimination law is very hard to enforce — partly because the burden of proof is so high, partly because people who sue for discrimination risk being personally stigmatized. And so most of the perpetrators are likely to escape scot-free.

Some people have argued that anti-White discrimination is not a big deal, because White men are still doing well as a group. Matt Bruenig has a good post showing that aggregate economic outcomes for White men haven’t really declined in recent years. For example, the percent of young White men who land in the top percentages of the earnings distribution has declined, but only by a small amount:

And the percentage of White men who work in arts and media bounces around, but has stayed around 2.5%:

Bruenig argues that to the extent that it seems that White men are vanishing from various occupations in America, this is due to the shrinking percent of White men in the American population.

Bruenig’s numbers help explain why the problem of discrimination against White men went unnoticed for so long. If you were in an industry or an institution that didn’t have much discrimination against White men, you could look around at wider society and still see White men succeeding at about the same rates as before. For example, I never personally encountered discrimination against White men in grad school — all the White guys I went to grad school with got good jobs, and all the people who ended up with the best jobs were White guys. Nor did I see anything at Stony Brook University or at Bloomberg.

There was thus nothing in my personal life to alert me to the increasing prevalence of discrimination against White men. And as Bruenig notes, the trend hadn’t yet shown up in aggregate statistics. So when I heard a few people start to complain on social media in the 2010s, I didn’t appreciate that anything had changed — especially because the people who complained tended to be the same right-wing types who were complaining about anti-White discrimination in the 2000s and the 1990s. The people who suffered personally from this discrimination — White men in progressive institutions and industries — were the ones who were most afraid to speak up about it.

Nor was I unusual in my slowness to realize that something had shifted. As of 2019, almost no White Americans thought that being White made it harder for them to get ahead, and only a third of Whites said they had ever experienced racial discrimination:

It thus wasn’t until 2020 or 2021, when a flood of credible reporting came out about the new discriminatory trend, and when my friends in the tech industry started to talk openly about it, that I realized that something big had changed.

But Bruenig’s analysis, while praiseworthy for its attention to hard data (unlike much of the discourse around this topic), is not a convincing argument against Savage’s thesis. First of all, the shifts Bruenig documents are small but not trivial — a decrease in the percentage of young White men who make it to the top 10% from 20% to 17% can’t be explained by the shrinking percent of White men in the population. And showing that about the same number of White men work in arts and media over the years doesn’t tell us much about the quality, salary, prestige, or advancement opportunities of the jobs in which they’re working.

The real reason that Bruenig’s analysis shouldn’t mollify us, however, is that we shouldn’t treat aggregate group outcomes as the end-all and be-all of economic fairness.

The capitalist system is remarkably effective at allowing people to succeed in the face of discrimination. Although anti-Black discrimination in audit experiments has remained more or less constant over time, Fryer (2010) shows that in aggregate, anti-Black discrimination explains less and less of the racial gap in outcomes over time — once you control for education levels, racial inequality in the job market went way down in the late 20th and early 21st centuries. And Hsieh et al. (2019) argue convincingly that improved allocation of talent across racial groups has contributed to rising U.S. GDP. Some percent of hiring managers may still be suspicious when they hear a Black-sounding name, but discrimination doesn’t keep Black Americans down nearly as much as it used to.

By the same token, discrimination against White men can be pretty common, especially within certain industries, without keeping White men down as a group. Imagine that instead of quitting because of management changes and a run-in with the Chinese Communist Party, I had been kicked out of Bloomberg for being a White man. I make a lot more money with this Substack than Bloomberg ever paid me. So aggregate income statistics would have actually shown a gain for White men as a group. But I still would have been rightfully resentful, because discrimination would have forced me to go out of my way and take more risks and take a more non-traditional path to success.

(Note: I love Bloomberg, and they never discriminated against me in any way. This example was only for the sake of argument.)

In the same way, lots of American White men may have responded to a wave of discrimination since 2014 by going around the traditional employment system — starting their own businesses, working in non-traditional industries like crypto, and so on. And ultimately, in terms of income, many of them may have turned out fine — so many that the aggregate racial statistics show only a modest change. But those people are still fully justified in being angry at the unfairness of racial discrimination. And even if only a small percentage of White men had their careers destroyed by the wave of discrimination since 2014, that’s still a serious injustice.

This is also why discrimination against White men in academia, the media, or other progressive-dominated spaces is not a remedy for discrimination against Black people and women that still exists in some corners of American society. If half of American industries discriminate against White people and the other half discriminate against Black people, things may balance out at the aggregate group level, but lots of both White and Black Americans will still experience the sting of unfairness from being personally denied jobs they deserve, and from being kept out of the industries they want to work in.

Anti-White and anti-Black discrimination are not like matter and antimatter; they don’t just cancel each other out. An America where every job has racial preferences, and you have to look around for the jobs that favor your race instead of relying on individual merit and trusting the system, would clearly be a dystopia.

Aggregate group outcomes are not enough to make the American system feel fair. If I have my heart set on being a professor but I can’t get an academic job because I’m a White man, the fact that the richest billionaires in America are mostly White men will provide me with exactly zero comfort. People don’t succeed as racial blocs; they succeed as individuals. And fairness has to be provided at the individual level. That’s why laws like the Civil Rights Act of 1964 quite rightly make no reference to aggregate group outcomes. A feeling of individual fairness is what makes our system function.

Notice I said “feeling”. In practice, the widespread perception of fairness is only imperfectly correlated with actual procedural fairness. It’s very hard to tell when you’ve personally been discriminated against, since you only have a sample size of 1. If you get turned down for a job, how do you know how good the other applicants were? If you get fired, how do you know it was because of your race and gender, rather than your job performance, or your cultural fit, or some personal conflict with a coworker? And so on. It’s a difficult signal extraction problem.

Discrimination can’t be eliminated. Instead, our goal should be to preserve trust in the system’s individual fairness. If people believe that the system is unfair, it will drive down trust in institutions and make it harder to provide public goods. One reason the second Trump administration is attacking academic science much more than the first Trump administration did is that Republicans’ trust in scientific institutions fell after 2020:

Some of that was related to Covid, of course, but some was probably due to the increased racial and gender discrimination that Jacob Savage’s article documents. It was not simply a function of right-wing media ginning up hysteria. It was real.

If we want to preserve or rebuild trust in America’s institutions, we have to make the bulk of people believe that those institutions are broadly free of discrimination.

How can that be accomplished? There’s no perfect solution. Even if institutions can be made more race-neutral and gender-neutral, the memory of the period of intense discrimination will persist for a long time. And opportunistic political agitators, amplified by social media, will continue to tell everyone that the system is unfair no matter how much we manage to curb the actual unfairness.

But I think there is one way we can make the system seem more fair, and that’s to aggressively and publicly enforce the law. The Civil Rights Act of 1964 forbids racial discrimination, and in some cases the 14th Amendment does too. So the best solution, I think, is to have lots of high-profile legal victories that make it clear to all Americans that racial and gender discrimination are prohibited in the United States. I wrote about this back in May:

Formal equality under the law does not guarantee actual fairness in society. The law is not all-powerful. But it’s a big loud public signal that says that the system disapproves of unfairness. Therefore, the best remedy for discrimination against White men is simply for White men who feel they’ve been discriminated against to sue, and sue, and sue again.

The alternative to individual fairness under the law is group racial conflict. If Americans decide that individual fairness is dead, and that their interests can only be served by collective racial “power” movements, then we will see the Republican party morph into a White power party, and the Democratic party morph into a “BIPOC” power party.1 Racial bloc politics will be very bad for the country’s future.

America already has good laws that mandate individual fairness. If those laws can be enforced in a very public and unambiguous way, then I think we may still escape the dystopian future of racial conflict and balkanization.

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2025-12-20 17:39:33

Americans are upset about the economy. And what are they upset about? Affordability. On polls about America’s most important problem, the cost of living consistently comes in ahead of other issues like inequality, deficits, wages, and unemployment. Here’s the latest from Echelon Insights:

Trump’s approval rating on inflation is lower than for most other issues:

If you’re an economist, this might strike you as a bit odd, because inflation itself is still fairly low, and around 2.7%:

Alternative measures are even lower.

And real wages — i.e., how much an hour of work can buy for the average worker1 — are rising strongly again, after falling in 2021-22:

Of course, lots of regular people don’t trust official statistics. But regardless of whether they rely on government numbers, people’s own inflation expectations are falling, and yet the percent of Americans who blame high prices for their poor personal finances is still near record highs:

Note that for decades, these two numbers tracked each other very well. But in the years since the pandemic, anger at the cost of living has become unmoored from how much people think the cost of living is actually rising.

That’s strange, right?

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2025-12-18 15:49:20

In 2004, The Economist predicted that India’s economic growth rate would overtake China’s in two decades. In 2010, in an article called “India’s surprising growth miracle”, they shortened that timeline dramatically, declaring that India might overtake China in terms of GDP growth as early as “2013, if not before”.

In the end, it took two years longer. Since 2015, India has been the world’s fastest-growing major economy, taking the crown from China:

As The Economist noted, this is partly due to India’s more rapid population growth. If we want to look at living standards, we should look at per capita GDP (PPP). Here, India didn’t overtake China until after the pandemic:

India continues to turn in strong growth performances. In the third quarter of this year, it grew at 8.2%, up from 7.8% the previous quarter:

India’s population is growing at a little less than 1% a year, so this roughly corresponds to a per capita growth rate of around 7.2% or 7.3%.

That sort of growth rate is less than South Korea or China managed during their heydays of industrialization. From 1991 to 2013, China’s per capita GDP (PPP) grew at an annualized rate of 9.4%. But 7.2% would still be enough to utterly transform India in just a short space of time.

According to the IMF, India has a per capita GDP (PPP) of $12,101 as of 2025. Thirteen years of growth at 7.2% would bring that to $29,878 — a little higher than where China is today. That’s interesting, because India’s big economic reforms happened in 1991 — twelve years after China’s. Two decades of 7.2% growth would bring India to $48,609 — about as rich as Hungary or Portugal today.

In other words, if India keeps growing as fast as it’s growing right now, it will be a developed country before kids born today are out of college.

Consider even the more modest scenario in which India grows at the same rate it’s been growing over the past decade — about 5.4% in real per capita PPP terms. Fifteen more years of that growth rate would bring India to $26,633 — about where China and Thailand are today. Twenty years, and it would be $34,644 — about the same as Chile.

This is all a big “if”, of course. When I threw out some optimistic growth scenarios on X, I was mercilessly mocked:

But this critique is overdone. Yes, it’s likely that India, like China, and like every other rapidly industrializing country, will experience a slowdown in growth as it gets richer. But growth could also accelerate for a while. China’s growth slowed in the 1990s, but then accelerated in the 2000s after it joined the WTO:

Growth is not always a smooth deceleration; sometimes it goes up for a while. And if Indian policy improves, it could see growth accelerate — or at least remain high as the country gets richer.

And India is still experimenting with policy reforms. Just the other day, it rolled out a major reform of its sclerotic labor laws:

India implemented overhauled labor laws that aim to attract investments and make it easier for companies to do business in the South Asian nation…The laws, grouped in four separate codes, replace archaic legislation and will give flexibility to companies to hire and fire workers, enhance safety standards and extend guaranteed social security benefits…

India’s maze of labor regulations, both at federal and state level, are considered to be rigid and complex, forcing companies to either remain small, employ fewer workers or use capital-intensive methods of production. The latest attempt is expected to make the rules uniform across the country[.]

Among other things, the new law allows women to work night shifts. This has the potential to help address India’s glaringly low female labor force participation rate. Most manufacturing miracles in history started with women migrating from farms to cities to work in labor-intensive light industry (garments, toys, electronics, etc.).1 If India manages to unlock this classic labor resource, it could not only give India a stronger manufacturing base, but also improve the country’s oddly low rate of urbanization.

I don’t mean to claim that this labor law reform will propel India to two decades of 7% growth. By itself, it won’t. But it shows that India’s government is able to push through pro-growth reforms over the objections of incumbent stakeholders. And it shows that the government cares enough about growth to do this.

There’s a theory out there, espoused by A.O. Hirschman back in the 1950s, that economic development creates political support for further development. Once the people of a country realize that rapid economic growth is possible, they may get used to the idea of their living standards increasing noticeably every year. On top of that, many elites become invested in the institutions of growth — owning construction companies, banks, and so on — and thus it’s in their interest for growth to continue.

Basically, this is the idea that Indians are not going to look back at two decades of fairly rapid growth — growth that has brought the country out of desperate poverty into lower-middle-income status — and conclude that this was enough. Instead, they may be willing to do the hard work of overruling vested interests — like the labor groups who resisted the recent labor law changes — in favor of reforms that promise to keep the economic party going.

Which other reforms would be key? For one thing, India needs to reform its financial system in order to help its companies scale up. The country currently has a very high cost of capital, meaning it’s hard for companies to borrow and grow. Fixing bond markets is one idea here, but most countries that experience economic growth “miracles” rely heavily on bank finance instead of on bond markets.

Beyond finance and harnessing rural women’s labor, there’s also probably a lot more India can do to boost their manufacturing sector. In a Noahpinion guest post this summer, Prakash Loungani and Karan Bhasin wrote down some ideas for how to do this:

In a nutshell, their suggestions are:

1. Repeal regulations that specifically stop large manufacturing companies from firing employees

2. Repeal local laws that make it hard to convert agricultural land to industrial use

3. Conduct more trade agreements, e.g. with Europe

4. Reduce red tape for manufacturers

This brings me to another reason I’m bullish on India is that there’s still a huge amount of room for manufacturing to grow. Right now, despite being the world’s fifth-largest manufacturer, India is still a service-intensive economy — manufacturing is only 13% of the country’s GDP. This has led some people to conclude that India just isn’t a country that can make things, and that they should stick to services. But recently there have been some hopeful signs for Indian industry.

For one thing, manufacturing has already been key to India’s rapid growth over the past few years. Menaka Doshi points out that “corporate investment announcements between April [and] September are at a decade high of 15.1 trillion rupees, led by manufacturing firms.” And India’s exports, especially of electronics, are rising:

India clocked the highest goods exports for November in 10 years. Two factors seem to have helped the country counter Trump’s 50% tariff. Buoyant electronics exports, of which Apple iPhones are expected to be the largest chunk. And export diversification, including to China…November trade data…shows India’s exports rose to $38.13 billion — up 19.4% from a year earlier, the biggest jump since June 2022…

Earlier this year, Apple expanded iPhone production in India to fulfill the majority of US demand.

Apple, the world’s best electronics company, is steadily moving more iPhone production to India. That shift, which has been happening since the pandemic, has been helping to drive an Indian electronics export boom:

The boom is still in its infancy, but this just gives it more room to grow. Right now, India’s electronics exports are mostly phones, but this just gives India the opportunity to expand into assembling computers and other electronics.

And while electronics assembly is the lowest part of the value chain, India may be climbing that ladder already. There are also reports that Apple is considering making some of the components of the iPhone in India as well:

Apple is in preliminary talks with some Indian chip manufacturers to assemble and package the component for the iPhone, said people with knowledge of the matter, a move that would mark a key step up in the value chain for vendors to the tech giant…It’s the first time Apple is evaluating the prospect of having certain chips assembled and packaged in India[.]

Components — mostly semiconductors of various sorts — represent the bulk of the value in an iPhone or other piece of modern electronics. Packaging and testing chips is a much higher-value activity than simply slapping components together into a final product.

In fact, India has recently focused on promoting the chip packaging and testing industry, often by soliciting foreign direct investment in the sector. This was how Malaysia became an electronics powerhouse, helping to propel that country to a GDP (PPP) of almost $44,000. It’s a very good strategy for India.

In any case, India just looks like a very promising growth story to me. The country has already been growing at a decently rapid clip, and its income levels are still low enough that it has lots of room to catch up with the technological frontier. It has shown that it still has the political will to push through major reforms, and its manufacturing sector is improving and has plenty of space to grow. It has a huge domestic market that will help its companies achieve scale. It has plenty of elite engineers and such. And due to its democracy and general friendliness, it’s looking like a more attractive production base than China for many multinational companies like Apple.

So what’s the bear case here? What are the key arguments that India can’t grow to become a comfortably upper-middle-income country over the next two decades?

One common idea, expressed by former Singaporean Prime Minister Lee Kuan Yew, is that India will always be held back by internal fragmentation. Lee called India “not a real country”, “32 separate nations”, and “many nations along a British railway line”.

Linguistic fragmentation is certainly a challenge for India. But the country’s regions show no inclination to break away. And federalism can be a strength, too. There was an interesting story in The Economist recently comparing the economic growth models of Indian states Gujarat and Tamil Nadu. Gujarat has focused on building infrastructure, and has pursued capital-intensive industries like chemical manufacturing; Tamil Nadu has focused on improving education and health, and has pursued labor-intensive industries like electronics assembly.

But while The Economist pits these models against each other, the truth is that it’s probably good for a country to have both. A complex, diversified economy tends to grow faster than one that focuses on a single narrow range of industries. If India’s states find different paths to success, that could make the Indian economy more resilient in some ways than China, which is currently discovering the downsides of having a strong government that tells every province to make the same things.

Another bear case for India is the idea that China will throttle India’s rise. The reigning industrial powers of the 20th century — the U.S., Europe, Japan, and Korea — were remarkably nice to China during its early industrialization, cheerfully opening their markets to Chinese products and setting up joint ventures to teach Chinese people how to make anything and everything.

But China, the current reigning industrial power, is unlikely to be so nice to India. As expert China-watcher Rush Doshi explains, China’s current leadership wants to monopolize global manufacturing now and for all time. That explains why as Indian electronics manufacturing has ramped up, China has tried to block its engineers from going to India to train their replacements. I wrote a post about this back in March:

But I don’t believe this will cripple India’s growth model. China isn’t the only country that makes things; there are plenty of engineers from South Korea, Japan, Taiwan, the U.S., and Europe who can get Indians started making things. And as Xi Jinping’s regime continues to be repressive, and China’s growth continues to slow, lots of Chinese engineers will find ways to move to a country with more rapid growth and more personal freedom.

My guess is that the most important reason for widespread skepticism about India’s growth prospects is something that most people are too polite to say, except behind the shield of anonymity on a platform like X. A lot of people just don’t believe that Indians, as a people, have what it takes to build a modern high-tech economy. When I express optimism about India’s growth, someone always chimes in to say that Indians have low national IQ:

Let us set aside for a moment the question of whether national IQ studies are reliable. As the more circumspect of the two tweets above notes, cognitive ability and economic success are a two-way street. Though cognitive ability probably does boost growth, the reverse is also true — as countries get richer, they get better nutrition, more schooling, reduced pollution, and air conditioning, all of which contribute to better cognitive performance.

I view these discussions of IQ as a stand-in for something deeper — a suspicion that countries made up of people who aren’t of European or East Asian descent simply aren’t capable of building a wealthy, high-tech society. Although people of Indian descent have succeeded spectacularly in countries from the U.S. to Singapore to the UAE, no country in South Asia has reached upper-middle-income status — India, Pakistan, Sri Lanka, Bangladesh, Nepal, and Bhutan are all still pretty poor. So because none of these countries has done it, a lot of people just assume that none of them can do it.

If you think about it, that assumption doesn’t make a lot of sense. Some country always has to be the first in its region to industrialize. Before Japan beat Russia in a war in 1905, Europeans didn’t think East Asian countries could become modern industrialized powers. And it wasn’t until the success of Japan’s auto and machinery industries in the 1970s that the world came to respect East Asian industrial prowess.

Nowadays, no one thinks it’s odd or unusual if an East Asian country gets rich; in fact, people suspect it. But there had to be a first country in the region to break old stereotypes and assumptions, and that country was Japan.

India is a much bigger country than Japan, which presents a challenge. It seems intuitively harder for a giant country like India to be the first in its region to break the old stereotypes and wow the world. But if you believe economists’ estimates, India is now about as rich a country as Japan was in 1962. The task is not insurmountable.

Call me crazy, but I think India can do it.

Updates

Commenter Jack Lowenstein writes:

As a long time India bull and former professional investor in listed equities there, I would add three points:

1) a positive byproduct of the high cost of capital is that ROEs are also high, and also that because debt capital is scarce, banks remain filters, not funnels. Nor does the Indian government coerce capital into SOEs.

2) fraud and corruption are often posited as negatives for the investment and growth story. However all though these are easy to find, I suggest India’s greater transparency compared to China, as made them less universal.

3) while many countries have great technical universities, I wonder if any have the level of competitive entry as the Indian Institutes of Technology. The nearest equivalent I can think of is French engineering schools.

(1) is an important point; at this early level of development, India needs to worry less about allocating resources and more about mobilizing resources.

(2) is interesting, because there’s some work claiming that China’s type of corruption — like America’s in the late 1800s — gave government officials an unofficial equity stake in development, and therefore encouraged development. It was “corruption”, but the kind of corruption that led to aligned incentives.

Meanwhile, India just passed another big reform package — this one about finance:

[L]awmakers passed a bill this week allowing up to 100% foreign ownership of insurance firms, bolstering an industry long viewed as under-penetrated and capital-starved. Regulators have also overhauled rules for banks, pension funds and capital markets as they aim to shift savings from idle assets such as gold and property toward equities, bonds and long-term investments to finance factories and infrastructure.

All these reforms come as Prime Minister Narendra Modi and his administration want to make India a developed economy by 2047, a goal that requires economic growth of about 8% per year[.]

I’m especially excited about the banking reform, whose goal is creating larger banks while also increasing the number of banks in the country. Of all the reforms in the package, this one seems the most likely to have a major impact.

Note the importance of growth targets in pushing through this reform. If India hadn’t grown at 8% in some recent years, it seems unlikely the government would feel confident in setting 8% as a growth target. This suggests that growth is creating expectations for further growth, which is creating momentum for policy reform.

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2025-12-17 18:04:22

My book, Weeb Economy came out in March, but only in Japanese. Half of the book was a series of translated posts from my blog, so those are already in English. The other half was a new part that I wrote in English and had translated into Japanese by my excellent translator, Kataoka Hirohito. So while I’ll eventually republish the whole book in English, what I can do right now is to publish my English-language first draft as a series of posts on this blog.

The first installment was entitled “I Want the Japanese Future Back!”. In that post, I explained why Japan now finds itself in the position of a developing country, playing catch-up with other countries. This means Japan needs to experiment with bold new strategies and development models, as it did in ages past.

In this second installment, I suggest one such experiment: a huge increase in a kind of investment called greenfield FDI. I discuss:

• How Japan is already benefitting from greenfield FDI in a few places

• Why greenfield FDI (a foreign company building a factory or research center in Japan) is so much more important and useful than other kinds of FDI like mergers and acquisitions

• Why Japan needs to export a lot more to other countries, and how greenfield FDI can help do that

• How Japan can start to welcome more greenfield FDI

• Why Japan is an attractive destination for international investment

The Kumamoto miracle points the way

The semiconductor industry is probably the most important industry in the world. Computer chips are absolutely essential to every high-value product in a modern economy — autos, rockets, appliances, machinery, everything. They’re also of crucial military importance, in an age where precision weaponry rules the battlefield. And they’re of core importance to emerging technologies like AI — whose vast computational resources require enormous data centers — and biotech.

As a result, it’s no wonder that the world’s major economies have been fighting over the semiconductor industry for generations. In the early days, the U.S. and Japan were the clear leaders. Much of the industry involves the design of semiconductors and the production of specialized tools and materials, and in these upstream parts of the industry the U.S. and Japan are still strong. But in the most important downstream part of the process — the actual fabrication of the most advanced chips — both the U.S. and Japan have lost their lead to Taiwan:

Specifically, they have lost their lead to one remarkable Taiwanese company: Taiwan Semiconductor Manufacturing Company. TSMC are essentially the world’s greatest machinists. Other companies design the chips, and other companies create the (incredibly advanced) machine tools that make the chips. What TSMC does is to buy the tools, and then use the tools with incredible ingenuity and efficiency to make someone else’s chips designs into reality. They pioneered this “pure-play foundry” business model, and it has made them rich — and it has allowed Taiwan to outcompete the chipmaking industries of every other country on the planet.

Since the pandemic, the global battle to win semiconductor market share has intensified, due to the advent of AI and to the geopolitical competition between China and the democratic countries. Japan, like many countries, is trying to build its own foundry business, in the form of Rapidus, a joint venture between a bunch of Japanese companies that’s also getting some help from IBM. But — also like in the U.S. there’s also a second, parallel effort afoot. Japan is building chips for TSMC.

In late 2021, TSMC created a Japanese subsidiary called Japan Advanced Semiconductor Manufacturing (JASM), and started building two fabs in Kumamoto prefecture. Sony and Denso pitched in to help. So did the Japanese government, providing billions of dollars in subsidies and offering TSMC logistical assistance in finding local workers and ensuring adequate water and other infrastructure. The first plant was completed very quickly, and opened in February 2024; the second is expected to open in 2025. Now TSMC is considering a third fab in Kumamoto, producing even more advanced chips, to be opened in 2030.

Observers have been impressed with the speed with which the fab was built, comparing it favorably to TSMC’s plant in America, which initially suffered delays. TSMC credited the successful construction to a variety of local supporting institutions — “suppliers, customers, business partners, government and academia.” TSMC’s founder Morris Chang, who once poked fun at Japan for the slow speed of its business dealings, has now become a true believer in the revival of the country’s chip industry. At the opening of the first TSMC plant in Kumamoto, Chang predicted a “renaissance of semiconductors” in Japan.

And Japan isn’t stopping with TSMC. Micron, an American chip company, is building a fab in Hiroshima, bringing some of its best technology into the country. Samsung is building a semiconductor development center in Yokohama. Both of these investments are being done with significant help from the Japanese government, and involve cooperation with Japanese companies and universities.

These investments by foreign companies aren’t Japan’s only strategy for reviving its semiconductor industry — they coexist alongside homegrown efforts like Rapidus, as well as Japan’s upstream efforts in the chipmaking tool and materials industries. But they represent a crucial addition to the purely indigenous efforts. This is an example of multi-strategy development at work.

But it’s far from the only such example.

A school of AI fish

The artificial intelligence boom is the most important trend in the software industry right now. Whether this remains true in future years remains to be seen, of course, but the capabilities of large language models like ChatGPT, AI art software like Midjourney, and computer vision systems are undeniable. Even if there’s a bubble and bust in the field at some point — as there was with dot-com companies in 2000 — AI is going to be important in the long term.

Japan largely missed out on the internet software boom — the country has no internationally dominant consumer internet giants like Google or Facebook, and its B2B software industry was hampered by Japanese companies’ slowness to adopt IT solutions in past decades. But the AI age is a new dawn, and Japan has another shot at building a powerful software industry.

At the time of this writing, one of the most interesting AI startups in Japan is Sakana AI. Currently, AI applications generally use one large statistical model to generate text, create images, recognize objects, predict the shape of a protein, etc. Sakana tries to instead use groups of smaller models to accomplish the same thing. In addition to being able to do some things better than big models, these groups of smaller models may use much less electric power — an important consideration, when AI’s energy needs are skyrocketing.

Sakana AI has three founders. There’s Llion Jones, originally from Wales, who was one of the authors of the groundbreaking 2017 research paper that discovered the algorithm now used to make LLMs. There’s David Ha, originally from Canada, who was an AI researcher at Google Brain. And there’s Ito Ren, a Japanese former diplomat who was an executive at the e-commerce company Mercari.

The company’s investors are equally international — it includes American venture capital firms like Khosla Ventures, Lux Capital, and New Enterprise Associates, the American semiconductor giant Nvidia, and a large assortment of Japanese banks and technology companies. Sakana’s most recent funding round raised $214 million, and valued the company at $1.5 billion.

That’s not a huge valuation compared to U.S. giants like OpenAI ($150 billion) or Anthropic (possible valuation of $40 billion). But Sakana’s presence has put Japan on the map as a potential hotspot for international AI investment. Nvidia, for example, has declared its intention to create an R&D center in Japan. OpenAI has opened a branch office in Tokyo. Oracle is investing $8 billion over the next decade in AI and cloud computing in Japan. This is in addition, of course, to all the big cloud providers — Amazon, Microsoft, and Google — looking to invest in Japan in order to serve the Japanese market.

Then there’s Spellbrush, a U.S. startup that has a partnership with the AI art and design company Midjourney. Spellbrush uses generative AI to create Japanese-style anime art — one of the most popular and lucrative applications for AI so far. Spellbrush recently opened a branch office in Tokyo’s Akihabara neighborhood.

Japan is still behind the U.S. and China in AI, but investments like these keep it in the game.

It’s important to note that although Sakana AI might succeed, the most likely outcome is that the company will fail. This is true because most startups fail in general, and because in a rapidly changing new industry like AI, the failure rate is likely to be even higher. In fact, the entire AI industry may be headed for a significant bust, like the dotcom crash in 2000.

But this shouldn’t negate the importance of Sakana, or of the Japanese AI boom in general. First of all, though most startups fail, the few that succeed often grow very large and important — venture investing is about accepting many failures in order to find a few huge wins. The investment and attention that Sakana draws to the Japanese AI startup scene will help make sure that some of those successes happen in Japan. Even a general AI bust will likely only be a temporary setback to the industry, as with the dotcom crash and the subsequent recovery.

Second, even failed startups often contribute crucial innovation to a country’s ecosystem. Fairchild Semiconductor wasn’t successful, but it pushed the envelope of semiconductor technology forward, and some of its alumni went on to found Intel. General Magic tried and failed to invent the smartphone in the 1990s, but its alumni went on to help create the iPhone.

And third, Sakana sends a signal that Japan is a viable destination for international investment in the software industry in general, well beyond AI. Japan is generally weak in most areas of IT, including B2B solutions, consumer internet companies, and cloud computing providers. As in semiconductors, a wave of foreign entrepreneurs and foreign funding could help Japan shore up its weak spot in software.

The most important kind of FDI

The chipmaking projects by TSMC, Micron, and Samsung, the U.S. VCs’ investment in Sakana AI, and the branch offices of companies like OpenAI are all examples of foreign direct investment, or FDI. But they’re not the only type, and when people talk about FDI, they often mean something very different. In fact, it’s actually a bit of a confusing term, because it encompasses multiple unrelated categories of investment. FDI includes:

• Cross-border real estate purchases

• Acquiring a foreign company (M&A)

• Building a branch office or factory in a foreign country (“greenfield” investment)

Most writers who advocate for Japan to increase FDI focus on the second of these. They believe that allowing more foreign acquisition of Japanese companies will improve these companies’ productivity by transferring foreign management techniques.

I am agnostic concerning this argument. I recognize that Japan’s policymakers and businesses have many reasons for resisting foreign acquisitions, both as part of the country’s development strategy and part of its social policy. Foreign buyers might downsize Japanese companies by firing large numbers of employees, which would hurt Japan’s corporation-centric social welfare model. They might strip-mine Japanese companies for their technology or other assets and then sell them off as husks of their former selves, as happens all too often with leveraged buyouts in the United States. Or they might simply neglect their Japanese acquisitions until they stagnated.

Instead, my argument is that Japan should focus specifically on increasing and promoting greenfield FDI — foreign companies building their own branch offices and factories in Japan. And in particular, Japan should encourage greenfield platform FDI, in which a foreign company builds factories or offices in Japan in order to create goods and services that are then exported from Japan to a third country. TSMC’s chip fabs in Kumamoto are an example of greenfield platform FDI.

This particular kind of FDI offers a lot of benefits that foreign takeovers don’t. For one thing, greenfield FDI usually directly adds to the economy — when a foreign company builds a factory in Japan, or even just purchases office equipment for a new office, that represents real money that goes directly into Japanese people’s pockets. And greenfield FDI inevitably results in the hiring of more Japanese workers, since someone has to work at the new factory or office branch.

Investment spending and workers’ salaries in turn stimulate the surrounding local economy — already, Kumamoto is experiencing an economic boom. Note that M&A doesn’t necessarily accomplish any of this — it just changes ownership of existing businesses, without requiring any new investment, hiring, or spending on the local economy.

And greenfield FDI is also more likely to be received warmly by the Japanese public. Ito, Tanaka, and Jinji (2023) find that Japanese people feel more positively about greenfield FDI than about foreign acquisitions:

This study empirically examines the determinants of individuals’ attitudes about inward foreign direct investment (FDI) using responses from questionnaire surveys that were originally designed. Individuals’ preferences for inward FDI differ between greenfield investments and mergers and acquisitions (M&A), and people are more likely to have a negative attitude toward M&A than greenfield investments. People with a negative image of the so-called “vulture fund” for foreign capital tend to oppose inward FDI, and this is more pronounced for M&A than greenfield investments.

On top of all this, greenfield platform FDI has a very good economic track record. It has been key to the economic success of a number of developing countries — most notably China, but also Poland and Malaysia.

After China’s entry into the World Trade Organization in 2001, companies from around the world flocked there to set up factories — both to sell their products to a billion newly available Chinese consumers, but also to exploit what at the time were cheap Chinese labor, land, energy, and capital costs, in order to make products for export to the rest of the world. This is known as “platform FDI”.

Poland executed a similar strategy on a smaller scale, becoming a factory floor for European nations — especially Germany — looking for lower costs and more friendly regulation. Malaysia became a center of electronics manufacturing, with investments from the U.S., Singapore, Japan, and elsewhere. In both of these cases, the products of foreign-owned factories were largely sold abroad, since both Poland and Malaysia have relatively small domestic markets. FDI thus helped to make China, Poland, and Malaysia into export powerhouses.

Japan, of course, is in a very different economic situation than China, Poland, or Malaysia were in the 2000s. But it can still learn from their successes. In addition to the direct benefits for investment and employment, greenfield platform FDI offers two main advantages: it can increase a country’s exports, while also facilitating technology transfer. In its current economic situation, Japan could use a whole lot of both of these things.

Japan needs exports

Americans often think of Japan as an export powerhouse, because of the international success of brands like Toyota, Honda, Sony, and Panasonic. And during the early days of the postwar miracle, Japan’s bureaucracy did strongly encourage exports, in order to earn precious foreign currency. But in fact, this lingering stereotype is badly mistaken — Japan has never really been an export-oriented economy like Germany or South Korea. It’s a domestically focused economy, more like the United States:

As Chalmers Johnson recounts in MITI and the Japanese Miracle, this inward focus was part of Japan’s development model in the 1960s. MITI found that ensuring cheap bank loans to domestic companies, and promoting competition in the domestic market, was a way to quickly boost Japan’s investment rate and its capital stock. And they found that this approach also ensured an adequate level of exports, since Japanese companies would produce more than they could sell in the domestic market, and export the excess capacity overseas.

Now, Japan finds itself badly in need of exports. The first reason is that exports help increase the value of the yen, making Japanese people richer as a result.

Japan’s currency has weakened dramatically against the dollar and other world currencies. This is partly because of Japan’s low interest rates relative to other rich countries, which is driven by Japan’s low inflation (and probably by a need to keep Japanese government borrowing costs low, in order to make Japan’s very large government debt sustainable).

As a result of the weak yen, Japanese people are finding it increasingly difficult to afford imports. Japan imports most of its food and energy, so the weak yen is increasing the cost of daily life. Japanese companies are having trouble importing the parts and materials they need, as well as energy. The Japanese government has been forced to intervene to prop up the value of the yen. But such interventions can’t last forever, since they require selling off foreign assets — eventually, the government runs out of foreign assets to sell, and the currency crashes even more.

An increase in global demand for Japanese exports can help increase the value of the yen. This is because in order to buy Japanese goods and services, foreigners need to swap their currencies for yen. This increases the demand for the yen, which pushes up its value. The more exports Japan sells, the stronger the yen becomes. Ultimately, Japan’s currency problem probably can’t be fixed by exports alone — financial outflows will have to be addressed as well. But exports help.

The second reason for Japan to focus on exports is that the domestic Japanese market is shrinking. Japan’s population is forecast to fall substantially over the remainder of this century:

Mass immigration may slow this trend, and measures to increase the birth rate may eventually manage to reverse it. But whether that will ever happen is unknown, and even if it does, Japan will not be a major growth market for a long while. This means there is much less incentive for companies — Japanese or foreign — to invest in Japan in order to serve the domestic market than in the past. Less investment also means less spending on R&D, which causes Japan to fall behind technologically.

Exporting can help reduce this problem, or even solve it. The more Japan becomes an attractive platform for export production, the more reason there is for Japanese companies and foreign companies to invest in Japan, including investments in R&D and new technologies. This will help increase productivity.

Finally, the activities required to increase exports may improve productivity. There’s a lot of research on “learning by exporting” — entering foreign markets could teach Japanese engineers, product designers, and managers how to produce things that foreigners want to buy. This could help counter the so-called “Galapagos syndrome” — the tendency of Japanese product standards to drift away from international standards, shrinking the markets available to Japanese companies.

Another way to put this is that exporting allows companies based in Japan — whether domestically owned or foreign-owned — to achieve scale without exacerbating competition that drives down prices.

Greenfield platform FDI — like TSMC’s fabs in Kumamoto or American venture capitalists’ investment in AI startups in Tokyo — can help Japan become more of an export powerhouse. Okubo, Wagner, and Yamada (2017) find that foreign-owned factories in Japan tend to export more — and also to innovate more. Their explanations for the difference have to do with corporate governance and culture, and with the pool of employees that foreign-owned companies are able to hire. They write:

Foreign ownership may play a role in risk-taking choices of companies – such as exporting and innovating – for various reasons. It can provide companies with more information about the outside market, especially in the context of small and medium enterprises. Foreign owners may be keen on getting high returns on investment and may tolerate a higher risk level. Firms with foreign ownership may have greater access to funds. Also, firms that do allow foreign ownership may experience a more open corporate culture than firms that do not, and such open culture may facilitate risk-taking.

The simplest explanation here is that multinational companies — especially those with foreign employees — simply know a lot more about global markets. TSMC knows what kind of computer chips Nvidia and Apple want to buy. Sakana AI’s founders keep in touch with the American AI market, and understand what kind of capabilities U.S. companies want from AI models. And so on.

In other words, greenfield platform FDI is a perfect example of multi-strategy development. It means that instead of coming into Japan to compete with local companies in the Japanese market, foreign companies are helping Japan sell a bunch of new products to a bunch of new overseas customers.

The intangible benefits of FDI

Japan’s low levels of productivity are somewhat of a mystery to researchers. Nakamura, Kaihatsu, and Yagi (2018), a trio of researchers from the Bank of Japan, arrive at the frustrating conclusion that the biggest problem is a lack of “intangible assets” at Japanese companies. These are any non-physical assets — brand reputation, patents, software, long-term customer relationships, management know-how, worker skills, tacit technical know-how, and so on.

This is such an enormously broad and heterogeneous category, and so many of its components are hard to measure, that “intangible assets” basically ends up becoming a label for economists’ ignorance about what makes some companies more valuable than others. For example, Nakamura et al. note that Japanese companies spend quite a lot on R&D, but don’t seem to get nearly as much value for their spending as U.S. companies do.

So the mystery remains a mystery. But even if we don’t quite know what the most important intangible assets are, we still might be able to help companies get more of them. Nakamura et al. suggest a fairly standard, reasonable list of approaches — increasing labor mobility, improving corporate governance, allowing more lagging companies to fail, and improving the venture capital ecosystem. These are all reasonable approaches, and — as we saw above — they’re all things that Japan is already trying to some greater or lesser degree.

But there’s one strategy that seems to be flying a bit under the radar here: FDI. When foreign companies put their factories, offices, and research centers in Japan, they bring many intangible assets with them — foreign management techniques, technical tricks and know-how, connections to customers and suppliers in other countries, and so on. And these can, for the most part, be pretty easily transferred to Japanese companies.

One way, which has been thoroughly documented by researchers, is through interactions with local suppliers. When a company like TSMC puts a semiconductor fab in Japan, one reason is so that it can buy a bunch of specialized tools and components from Japanese suppliers — like the photoresist that Japanese companies are so famous for. This in turn teaches Japanese suppliers what the leading chip companies need and how to best serve them, as well as details about how the best chipmaking tools work. Those kinds of knowledge are both intangible assets.

Another way ideas spread is through job-switching. TSMC’s fab is going to employ a bunch of Japanese workers. Those workers are going to get the chance to learn how to make chips from the very best in the business. If some of them eventually leave to go work at Japanese semiconductor companies, they’ll take all that knowledge with them. This sort of knowledge transfer would have been harder in the old days, when Japan was still under the lifetime employment system. But now, with mid-career hiring on the rise, it’s very likely.

Let’s imagine an example of how this might work. Suppose you’re a Japanese AI researcher at a domestic AI startup. You and your team know a lot about AI models, from reading research papers, from building them yourself, and maybe from going to some conferences overseas. But for some reason your models aren’t quite as good as foreign companies’ models. The foreigners must have a bunch of little tricks they use to make things work better.

Then one day your company hires another researcher who worked at Sakana AI. Your new colleague knows a lot of those tips and tricks for making models work more smoothly, from having worked with some of the top researchers at Sakana. And their time at Sakana also gave them personal connections with a bunch of other researchers overseas, whom you can now call up and ask for help solving your model’s problems.

Congratulations! You’ve just transferred tacit knowledge for free. Your company’s intangible assets have increased.

If this example sounds contrived, consider how many of Japan’s most famous inventions came through interaction with foreigners and absorption of foreign knowledge. Japan’s Canon cooperated with America’s Hewlett Packard in the 1980s to create laser printers. Yamaha created the digital synthesizer with the help of a Stanford engineer named John Chowning. The famous inventor Sasaki Tadashi licensed American patents to help him invent the first commercially viable pocket calculator.

Those are all examples from the book We Were Burning. In other words, in the 20th century, close links between Japan and the U.S. created a vibrant international research community, where ideas flowed back and forth across borders and across companies.

In fact, there’s evidence that this is a consistent pattern when it comes to FDI. Todo (2006) and Kozo (2006) both find that FDI consistently leads to positive productivity spillovers to the country that receives the investment, and that these spillovers are closely related to R&D spending.

Observers of the Japanese economy have noted with dismay how it seems to be losing human contact with other developed economies. Few Japanese people study abroad these days, and those that do tend to go only for a very short period of time. The number of Japanese young people who want to work abroad has diminished. Collaboration between Japanese scientists and their foreign counterparts has decreased, contributing to a decline in Japan’s high-quality research output. Even as the international research community has grown larger, Japan has been pulling away from it.

Greenfield FDI can help counter that increasing insularity, by bringing foreign researchers and managers into Japan, where Japanese people can absorb their knowledge without leaving the country.

Japan is welcoming the right kind of FDI, but it can do more

Why has greenfield FDI in Japan traditionally been very small? In the early days of its postwar miracle, Japan restricted all kinds of FDI for protectionist reasons, in order to reserve the domestic market for Japanese companies that were still in their early growth stages. This was a typical policy for the time, and not dissimilar from the “infant industry” protections used by the U.S. in its early development.

From the late 1960s through the early 1970s, Japan significantly liberalized its restrictions on FDI. There were still many institutional barriers to foreign acquisitions, mostly resulting from a combination of Japan’s financial and corporate governance systems, and from cultural resistance. But although foreign companies should, in theory, have had an easier time doing greenfield M&A from the 1970s onward, few took the plunge. There are lots of possible reasons for this — force of habit, regulatory differences between countries, cultural differences, and a general stereotype of Japan as a protectionist economy. But the most important reason was probably that unlike countries like China, Poland, or Malaysia, Japan simply didn’t try to actively encourage foreign companies to use it as a production base.

Since 2003, though, the situation has slowly changed. Former Prime Minister Koizumi Junichiro called for more FDI into Japan. Regulations were eased a bit, and tax incentives were put in place. These efforts were minor and halting at first, but have gathered strength over time. Targets have become much more ambitious — in 2023 the government set a goal of attracting 100 trillion yen of FDI (about $690 billion as of this writing) by 2030. Politicians now talk regularly about the need to boost FDI. Immigration laws have been changed to make it much easier for skilled professionals to get permanent residency. There is a new Council for the Promotion of Foreign Direct Investment in Japan, and various other government efforts to attract FDI.

And amazingly, the plan seems to be working. In 2022, net FDI inflows to Japan were very slightly greater as a proportion of the economy than in either China or South Korea:

And encouragingly, greenfield FDI seems to be powering this rise. The number of inbound M&A deals has held steady, while greenfield projects have soared:

And since the semiconductor industry is powering this rise, it’s likely that a significant amount of this will result in exports.

But although this is good progress, Japan could do a lot more on the FDI front. First of all, 1.1% of GDP per year is a big improvement, but it’s not really big enough to be transformational — Poland gets over 5%, France gets 3.8%, and the U.S. gets 1.5%.

Second, most of Japan’s greenfield FDI is in one single industry — semiconductors. If Japan could attract similar levels of investment in other sectors, it would be insured against a sudden downturn in the chip industry, and it would have the chance to build up its technological muscle along a wider front. There are plenty of other high-value industries where Japan could be a high-tech, low-cost production platform — aerospace, biopharma, batteries, and electronics being four obvious examples.

In other words, Kumamoto, Sakana AI, and the other examples above are an important proof of concept for a golden age of Japanese FDI, but they should be only the beginning.

Why do foreigners invest in Japan?

Traditionally, the reason a few foreigners wanted to invest in Japan — either through greenfield investments or M&A — was to tap the large and lucrative Japanese market. That motivation still remains to some extent, but it’s growing weaker every day. But there are a number of reasons Japan is increasingly attractive as an export platform. Understanding these reasons is absolutely crucial for Japanese government officials and businesspeople who want to attract more FDI — if you’re selling something, you must understand why your customers want to buy it.

The most obvious selling point is the weak yen. A cheap Japanese currency makes anything produced in Japan more competitive in world markets. On top of that, decades of stagnant real wages have a silver lining — they’ve made Japan’s skilled workforce look relatively cheap. A third strong point is Japan’s deep network of high-quality suppliers.

There’s also the national security angle. As China’s foreign policy has become more aggressive, the U.S. and other developed nations have begun to try to move them out of China. The U.S. government calls this “friendshoring”, while companies call it “de-risking”, but the principle is the same — no one wants to be caught dependent on Chinese manufacturers for critical high-tech products if a war breaks out. Japan is an obvious alternative production base — it’s smaller and more expensive than China, but infinitely more secure. And unlike China, Japan will not use espionage to steal foreign companies’ intellectual property.

Even Germany, which has traditionally been more willing than other Western countries to invest in China, is beginning to get nervous; a significant number of German companies are looking to switch to Japan. And the U.S. Department of Defense is planning to develop advanced weapons in Japan, as well as manufacturing more traditional munitions there.

Yet another advantage — which Japanese people may not fully appreciate, since they’ve never had to deal with the alternative — is Japan’s efficient government. In many Western countries, environmental review laws and other poorly crafted regulations have turned land use into a nightmare — projects that pass all relevant environmental and safety regulations still have to endure years of lawsuits and court-enforced paperwork, making it hellishly expensive and time-consuming to build factories. The U.S., the UK, and other anglophone countries, which rely on the courts to adjudicate environmental regulation, have become especially hostile to development.

Japan’s more sensible and efficient system, which relies more on bureaucrats than on the court system, preserves some role for community input, but allows construction projects to be approved in a timely manner. Japan’s willingness to build, meanwhile, has left it with plenty of high-quality infrastructure — and the ability to create more quickly to suit the needs of foreign investors if necessary.

But there’s one more huge reason that foreigners want to invest in Japan, which could ultimately be more important than all the rest combined. And it’s a factor that, in my experience, very few Japanese people — including the government officials tasked with promoting FDI — yet appreciate.

The key is that people around the world really love Japan, and want to live there.

(In Part III, I’ll explain why so many people in the world want to live and work in Japan — and how Japan can leverage this soft power to supercharge its FDI sector.)

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2025-12-15 18:48:22

Today at a Christmas party I had an interesting and productive discussion about AI safety. I almost can’t believe I just typed those words — having an interesting and productive discussion about AI safety is something I never expected to do. It’s not just that I don’t work in AI myself — it’s that the big question of “What happens if we invent a superintelligent godlike AI?” seems, at first blush, to be utterly unknowable. It’s like if ants sat around five million years ago asking what humans — who didn’t even exist at that point — might do to their anthills in 2025.

Essentially every conversation I’ve heard on this topic involves people who think about AI safety all day wringing their hands and saying some variant of “OMG, but superintelligent AI will be so SMART, what if it KILLS US ALL?”. It’s not that I think those people are silly; it’s just that I don’t feel like I have a lot to add to that discussion. Yes, it’s conceivable that a super-smart AI might kill us all. I’ve seen the Terminator movies. I don’t know any laws of the Universe that prove this won’t happen.

One response you can have to this is to conclude that because superintelligent AI might kill us all, that we should make very, very sure that no one ever invents it. This is the thesis of If Anyone Builds It, Everyone Dies, by Eliezer Yudkowsky and Nate Soares:

This sort of reminds me of Gregory Benford’s famous admonition to “Never do anything for the first time.” You can make arguments for unforeseen catastrophic consequences for lots of different technologies. Nuclear weapons might kill us all of course, but so might synthetic biology or genetic engineering. Social media or other media technologies might collapse our societies. Video games might entrance us into virtual lives so that we never reproduce. In fact, it’s quite possible that universal literacy and reduced child mortality have already condemned humanity to dwindle comfortably into nothingness, with no artificial superintelligence required.

Personally, I do think that being so afraid of existential risk that you never invent new technologies is probably a suboptimal way for an intelligent species like ours to spend our time in this Universe. It’s certainly a boring way for us to spend our time; imagine if we had been so afraid that agriculture would kill us that we remained hunter-gatherers forever? My instinct says we should see how far technology can take us, instead of choosing to stagnate and remain mere animals.

But yes, OK, a superintelligent techno-god might kill us all. We can’t really know what it would want to do, or what it might be capable of doing. So if you really really want to be absolutely sure that no superintelligent techno-god will ever kill us all, then your best bet is probably to just arrest and imprison anyone who tries to make anything even remotely resembling a superintelligent techno-god. This is the approach of the Turing Cops in Neuromancer, the most famous cyberpunk novel.

And yet today at the Christmas party, against my better judgment, some people who think about AI safety for a living roped me into a serious discussion about their field of research. And to my utter astonishment, they actually thought I had some novel and interesting things to say.

If I can impress AI safety researchers with my thoughts on AI safety, I might as well write them up in a blog post. First, I’ll explain why I’m not very afraid that superintelligent AI will destroy humanity, and suggest some things I think we could do to minimize the risk that it will. And then I’ll explain what actually scares me about AI.

Stoner kids, Singapore, and French forests

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