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Nicholas R. Lardy always has the data. He has been tracking China’s economy for decades and detailing the country’s growth, reforms and developments in books such as China’s Unfinished Economic Revolution (1998), Markets over Mao: The Rise of Private Business in China (2014) and The State Strikes Back: The End of Economic Reform in China? (2019). After stints at the University of Washington and Yale, Lardy found a home first at the Brookings Institution, and then, in 2003, at the Peterson Institute for International Economics. When others are debating China’s rise and its global influence, Lardy is parsing the figures, painting portraits of the evolution of the country’s economic system. What follows is a lightly edited Q&A about how China’s recovery from Covid-19, despite a trade war and constant bickering with the U.S., has resulted in an even more formidable economic power.

The U.S. has waged a trade war with China for much of the past four years. Have there been winners and losers in this trade battle?

Both countries have lost. U.S. consumers have paid roughly $50 billion in tariffs. The Chinese have [also] had to pay higher prices for goods coming from the United States. The United States has not regained any manufacturing jobs. The U.S. global deficit is bigger than ever. So Trump’s fixation on reducing the deficit has not led to any positive results. 

The surprising thing is that even though both sides have been disadvantaged, the U.S. has probably been more disadvantaged. In 2019, China’s exports to the United States declined at a double digit rate. But China managed to increase its exports to the rest of the world by so much that their [global] exports went up by 5 percent. And that was in the context of extremely weak global trade growth of just 3 percent in 2019. The same thing is true this year. So far, China’s exports are only down about 2 percent. But global exports are down by double digit rates. For the U.S., exports are down 17 percent.¹See the Peterson Institute’s trade graphics here.

So China has actually gained ground during the trade war and the pandemic?

Yes. China’s share of global trade has actually been increasing since the trade war began. Most of their exports are now being produced by private firms. And they seem to have found new markets or been able to expand their sales to existing markets outside of the United States. So they’re running a bit of a trade surplus this year, and that is contributing to China’s economic growth. 

What about the effort to bring jobs back to the U.S., or to discourage American companies from manufacturing in China?

Trump has called for reshoring, and he’s tried to discourage [American] companies from investing in China. But globally, Foreign Direct Investment [or FDI] into China is up in 2020. Globally, Foreign Direct Investment flows are forecast to be down this year by 20 to 30 percent, which is not surprising because the global economy and corporate profits are weak. Companies are cutting back on investment. But they’re not cutting back on investment in China. They’re putting money into China — about the same amount of investment as 2019.

Then there’s this marvelous new story about how much portfolio investment has gone into China over the last few years, and of course, it has been accelerating this year. It’s stocks and bonds. The numbers are truly astounding. I estimate now that U.S. investors hold roughly a little more than $1 trillion dollars in Chinese portfolio investments. Seven or eight years ago, that figure was about $200 billion. So it’s gone up quite a bit. Trump talks about decoupling but in the financial sector it seems like China’s playing a larger role in the global economy. And in the trade sector, its role is also expanding.

The U.S. has put various restrictions on the sales of semiconductors and semiconductor equipment to Huawei and other Chinese firms that have been placed on the U.S. Entity List. Is this beginning to affect American exports of those goods? Or the trade figures?

It will, but hasn’t yet. These [Chinese] companies — the ones like Huawei that are using [micro]chips in their final production — have been stockpiling like mad. They’ve been ordering more than they need. So when they were finally cut off, a month or so ago, they had enough chips to keep going for at least six to eight months. Now the biggest semiconductor manufacturer in China, SMIC [the Semiconductor Manufacturing International Corporation], is being cut off from the equipment and the software that is used to produce semiconductors. And it was just revealed that they have also been stockpiling — ordering massive amounts of equipment. They’ve been accelerating their purchases since the beginning of the year in anticipation that they might be a target for U.S. sanctions. So, for the first three quarters of the year, we’re probably going to find that U.S. exports of those products will be up significantly over where they were in 2019. Once we get the data for October, November and December, the numbers will fall off a cliff.

What are the implications of this?

This is very bad for the U.S. semiconductor industry. It has been a global leader for many years because of very substantial R&D expenditures. But as we cut them off from sales in China, their revenue will fall sharply. Their capital expenditures are likely to fall by as much as $13 billion. The US is likely to lose about 125,000 jobs as a result. And we would expect to see very deep cuts in R&D expenditures by U.S. semiconductor firms. So if that continues for very long, the U.S. could lose its long-standing global leadership position. This is an industry that is crucial for U.S. economic competitiveness and national security. A lot of these advanced chips go into the [U.S.] military. So that’s the story there. Sales have surged from stockpiling. I’m talking about semiconductors and semiconductor manufacturing equipment. But they’re likely to be collapsing as we move through the final months of the year.

How have other American export sectors done?

The agricultural sector has done reasonably well, because that’s one of the targets in the Phase One [trade] deal [between Beijing and Washington]. [The intent was] for China to increase its imports, and they have picked up somewhat, but they’re still far below meeting their targets. And their targets are based on 2017 levels. So agriculture sales are a bit above where they were in 2019, but it’s not back to normal. Some people think that China will have a big push to order more agricultural products. They’re buying a lot of corn now, for the first time ever.

You also monitor developments in China’s economy. The pandemic has sapped global growth. How is China’s economy holding up?

The Chinese economy is leading the global recovery. They had a very sharp decline in output in the first quarter, but they managed to get the pandemic almost completely under control within three months. And they started the recovery in the second quarter. On a year-over-year basis, they grew at a little more than 3 percent in the second quarter. In the quarter that just ended — we don’t have the aggregate data yet — but a lot of indicators are that the recovery has strengthened. It was initially concentrated in manufacturing. But we now see that there has been a substantial recovery in services, particularly in retail activity. For example, August was the first month in which the level of retail sales exceeded the level of the same month in 2019. And that makes sense because they have almost no cases of Covid-19. 

According to their figures, nobody has died of Covid-19 since sometime in April. And now the lockdowns are long over. People are regaining confidence. The restaurants and the bars are jam packed. The number of domestic flights now exceeds the level of a year ago. International flights, of course, are still way down, in part because China restricts inbound travel by foreign citizens. But China’s got control of the virus. And if you live in China, why would you want to go to Europe or the United States, or places that still have very high levels of cases. Eight months after the pandemic started, the United States and Europe are still struggling with positivity rates that are in the high single digits, or in some states, even in the low double digits. They had a slight outbreak of the disease in Wuhan, a couple of months ago. Within two weeks, they tested 9 million people. Well, they found 300 asymptomatic cases, which means their positivity rate is 0.003 percent. And on those 300 people, they did extensive contact tracing. And, as you know, China does not go in for self isolation where you promise to stay in. They put you somewhere where you can’t get out! They have basically quashed the virus. So activities that have been slow to recover in the United States that involve face-to-face contact, which is mostly services, travel, restaurants — those are all getting back to normal. China will probably grow by 2 percent, maybe even something close to 3 percent this year, which of course is way below usual but compared to the big declines that are going to be seen in Europe, United States, Japan, and so forth, their recovery is very strong.

They’ll grow by maybe 6 percent next year. By the time 2021 is finished, if they continue to control secondary outbreaks, their economy is likely to be about 10 percent bigger than it was in 2019. The economies of the United States, the UK, Europe, they’re not going to be back to the 2019 level. We will have some recovery in 2021, but it won’t be enough to fully offset the sharp declines that those countries are experiencing this year. China’s going from strength to strength, at least in relative terms. Their share of global trade is expanding rapidly over the last two years, and their share of global output will expand significantly this year and next year.

One of the things you’ve studied is how the state has played a larger role in the market, particularly under Xi Jinping. Has that changed? Is the government intervening more in the markets, and reasserting control over private firms?

They certainly have taken over a couple of dozen companies that are listed on the Shanghai Stock Exchange. The state has become the dominant owner of those companies, and their classification has switched from privately controlled to state controlled. And the state companies continue to get very good access to credit. So China still has a big challenge ahead. It has a misallocation of capital, tilting in favor of state companies, which on average are very inefficient compared to private companies. But as you point out, under Xi Jinping, there’s been a real emphasis on the role of the state. Xi is always talking about the importance of state companies and how they need to be bigger. So that trend continues. The way I would put it is this: Let’s say they could grow at 6 percent next year. That’s way below potential. If they allocate resources more efficiently, they could be growing even more rapidly. They’ve had a strong recovery compared to everybody else. But it has been primarily financed through debt expansion and fiscal deficits. It’s not the result of allowing the private sector to have a greater role and boosting economic growth through higher efficiency.

There were reports of how state companies gained during the pandemic, and companies were repurposed to export PPE (personal protective equipment). Is that true?

Well, it’s a combination. When there was a huge demand for PPE, a lot of private companies just switched on their own. They were producing textiles already. Maybe they could make masks without any additional capital investment or hiring new workers. But as China’s been increasing its share of global exports, a lot of it has been PPE equipment. There’s still big demand for it globally. And a significant portion of that demand has been met by private firms. The share of exports by private firms in China has been rising sharply in 2020.  I don’t have much firm-level data to show what’s going on. But my suspicion is a lot of the ramp up in the production of PPE was done by private companies that responded to a change in demand.

There has been a lot of talk lately about the U.S. and China “decoupling.” But is that even possible?

China is deeply integrated into the global economy. A lot of people who talk casually about decoupling don’t really understand the situation on the ground. China is very unusual. In the manufacturing sector, about 25 percent of the output is produced by foreign companies. That’s a much higher share than in Europe. The number for Europe is more like 8–10 percent. In other words, if you went to France, and asked how much production is being undertaken by firms from Germany and Italy and Switzerland, it’d be about 8 percent. In China, it’s 25 percent. That’s been true for a long time. And it’s not changing, because very few [global] companies are leaving China. Many of them are there for [access to] the large domestic market and foreign firms have a large share of that market. Also, China recently allowed the creation of wholly foreign-owned car companies, which had never been allowed. The new Tesla factory [in Shanghai] is 100 percent owned by Tesla. They don’t have a joint venture partner. BMW has now taken a majority share of its joint venture, so it gets much more control. So a very large share of this big automobile market is being supplied by foreign producers. They are not going to move. Daimler recently announced they’re not going to invest any more money in Germany. The market for cars in Germany is going down. They’re putting all their new investment into China. And so you can talk about decoupling casually, but it does not seem to be a tidal wave. 

China is deeply integrated into the global economy. A lot of people who talk casually about decoupling don’t really understand the situation on the ground.

The surveys, particularly of American companies, show that something like 75 percent have not moved and do not plan to move any of their production out of China. About 15 percent say that they might move some of it to Southeast Asia. And only 4 percent say they’re thinking of bringing production back to the United States. So this idea of reshoring is an interesting concept, but on the ground there are advantages of being in China, and it’s no longer [just about] cheap labor. It’s high productivity, the complete supply chains, and the domestic market. We’re going to see a lot of foreign firms continue to operate in China. And China’s liberalizing investment, like in the automobile sector. They’ve substantially reduced the “negative list,” which identifies sectors in which foreign investment is not allowed. So they are recommitting to globalization, and they’re demonstrating that with the kinds of liberalization [moves] I just mentioned. It’s not as open as we’d like it to be, but the direction is very clear. 

What does this mean for multinational corporations? Is China’s market really opening? Isn’t the U.S. threatening to put more sanctions on Chinese firms, which could lead to retaliation on American firms doing business there?

There’s been about $90 billion in foreign investment in China in the first eight months of this year. That is very close to the level for the same period in 2019. Foreign companies operating in China are quite worried, because they see the United States imposing more harsh measures [on Chinese firms] and restricting exports of semiconductors and semiconductor manufacturing equipment. And China doesn’t have an easy way to retaliate. Remember, when Trump started putting on the tariffs, China put tariffs on some things but they couldn’t match one-to-one because their imports from the U.S. are much smaller than U.S. imports from China. In a nanosecond China could shut down Apple, because 40 percent of iPhone sales are in China. It probably has occurred to Apple that they’re vulnerable. But China is not doing that, I think for two reasons. Number one, the company [Foxconn] that makes Apple products in China is the largest private employer in China. It has a million workers. If they shut it down, they could impose huge damage on Apple, but [China] would be accepting very substantial losses themselves. And secondly, they don’t want to go against their own argument that China is still a good place for foreign companies to operate. If Apple was shut down, that would have an enormous impact, because every foreign company would be looking at it and saying, “Well, we could be next. Our operations could just be shut down, overnight.” So for sensible reasons China has avoided retaliation. They’re not going after U.S. companies operating in China. They keep talking about having an entity list like the U.S. They’ve announced what the penalties are, but they haven’t named any firms yet. So you can see, they’re kind of frustrated. The United States has put hundreds, if not thousands, of companies on the Entity List; dozens of subsidiaries of Huawei, and hundreds of subsidiaries of other companies. And China always likes to retaliate in a kind of parallel fashion. But they don’t want to put Apple on an entity list and shut them down. They don’t want to put General Motors on a list and shut them down. Again, General Motors employs a lot of people in China. So it would be a very high profile case. They could say, “We’ll retaliate.” But it would be a high cost strategy.

So, there hasn’t been any multinational corporation exodus from China?

There are always companies leaving China. The wage rates have gotten high. They can’t keep up productivity. So they move their inexpensive shoe operations or cheap clothing to Bangladesh. Some companies have been moving out of China for 20 or 25 years, long before we have this kind of bilateral tension between China and the United States. But there are new ones always coming in. In the last four or five years, Foreign Direct Investment into China has been roughly stable. It’s not growing by leaps and bounds. But it’s been in an area of $130 billion to $140 billion a year, which still makes it the second largest recipient of Foreign Direct Investment on the planet. So you have to be a little bit careful and differentiate between what a lot of foreign companies say and what they do. They’re worried and they complain, and things could be better, and China could liberalize faster. But in the case of U.S. multinationals, the vast majority of them are making money. And there are surveys that show for American multinationals operating in China, their profitability in China is higher than in any other foreign location. They don’t want to withdraw. They want to increase their footprint. But they do face a great deal of uncertainty — regulatory uncertainty, exchange rate uncertainty and so forth.

The U.S. has moved to sanction Chinese firms for human rights violations, national security or evading sanctions. But there has also been pressure to delist Chinese firms from the American stock market. Is this the right approach?

It depends on how you measure effectiveness. We are certainly imposing a lot of pain on Huawei, which is one of China’s most successful technology companies. Huawei has annual sales well over $100 billion, the majority of it outside of China. So they’ve been very successful in marketing, not just handsets, but also telecommunications equipment and 5G, probably the highest profile product. Certainly, on a selective basis, we’re imposing some costs. The thing that I object to, and find disheartening, is that there is no effort anywhere in the U.S. administration to recognize or measure what are the costs that we are bearing as a result of these sanctions. It started with the tariffs, and Trump kept saying, contrary to all evidence, that the Chinese were going to pay the tariffs. It’s just like Mexico is going to pay for his wall. The Chinese are not paying the tariffs. The tariffs are being paid by importing firms, and most of it gets passed onto consumers to the tune of about $50 billion so far.

In the tech area, I’ve already mentioned, we can shut down some of these companies potentially. But to do that, we’re going to dramatically hurt Intel, Qualcomm and a raft of other companies that are the dominant players in this market globally. They are doing the R&D that will keep them in the forefront of the global semiconductor industry and maintain our technological edge. I don’t see any evidence that there’s an effort to weigh the costs. And some of these things seem completely politically motivated. We’ve heard no evidence whatsoever about how teenagers using TikTok is a threat to our national security. It’s very hard to understand. So a lot of this seems to be, “We’ll find some high profile, successful Chinese companies and we’ll try to shut them down or hinder them in whatever way we can.” The other more general point is that we have competition with China. The way to compete with China is to increase our research and development; to have a more targeted immigration policy so we can attract talented engineers and scientists from around the world. Federal support for R&D has fallen by about 50 percent since Trump came into office. Federal support for R&D has been the source of many of our most important innovations since World War II. If we want to compete with China, we have to get our own act together, and rebuild our infrastructure and strengthen our R&D. To put it simply, we should compete with China, but we ought to be more on offense and less on defense. We’re not going to win a tech war or an economic war with China, if all of our efforts are focused on trying to prevent their rise. I don’t think it will work.

Despite the trade war and the assault on Chinese firms, it seems that Western financial firms are expanding in China. Are we missing something? I thought China wasn’t opening its market wider to foreign firms.

No, they have followed through [on openings to foreign financial firms]. Although we don’t read about it very often, the Phase One agreement with China, signed earlier this year, did include Chinese commitments to open up their financial sector. And they have completely followed through on that. Many foreign financial firms in securities, insurance, asset management, fund management, ratings and payment systems have gotten licensed. American Express has finally gotten a license. They’ve been knocking on the door for 10 or 15 years. JP Morgan has gotten two or three licenses. Companies that had been required to operate as a minority partner with a Chinese joint venture are now able to increase their ownership and become majority owners. Many of the new licenses have gone to players that are 100 percent foreign-owned. And they relaxed the institutional rules. They’ve made it much easier, for example, for foreign investors to buy Chinese debt, government bonds, corporate bonds. The whole thing has been completely liberalized. A lot of difficulties that made those flows very small in the past have been eliminated. And China looks very attractive. It’s the fastest growing economy in the world. Its currency has appreciated about 5 percent in recent months. And the interest rate on government bonds is 3 percent. 

For 25 major countries around the world, the yield on government bonds is negative. If you can get 3 percent in China and have the possibility of converting your money back into foreign currency at a more favorable rate, then it’s not surprising a lot of money is flowing in. It doesn’t mean investors are putting all their money into Chinese government bonds, but they’re going from a situation in which they had no exposure to Chinese government bonds to one in which they’re beginning to have some exposure. China has a $35 trillion bond market. I believe it’s the second biggest in the world, and foreign investors today only own about 2 percent of the market. It would be much more typical for foreign investors to own 15 percent to 20 percent of a market like that. So this is a number that’s likely to continue to go up. But in the current environment, companies don’t want to talk about this. They don’t want to get on Trump’s radar.

What about Hong Kong as a financial center? After the National Security Law and the pressure to delist Chinese firms in the U.S., what does this mean for global listings and Hong Kong?

US sanctions on Hong Kong as a result of the National Security Law have not yet dented the Hong Kong market. The number and value of initial public offerings has surged in the first three quarters of this year compared to a year ago. And all indications are that Hong Kong’s role as a global financial center will continue to be strong. The role they play in channeling money into China continues to be strong. Lots of Chinese companies are getting listed there. And some of them because the United States is threatening to kick out Chinese companies that are listed in New York. Many of them are now initiating so-called secondary offerings in Hong Kong. And that puts them in a position where they can transfer all of their trading activity to Hong Kong and just shut down in New York. Of course, additional Chinese companies are still listing in New York, but the campaign that’s been launched by the White House and the Treasury Department and the Congress to delist Chinese companies that don’t comply with certain rules is enhancing the role of Hong Kong.

Is there any chance that the U.S. effort to push back against China could backfire, and actually damage American interests?

It’s a real concern. I don’t think it’s 10 years away, I think it’s more like five [years] in some areas. That’s the problem of the current administration in Washington. Their thinking is extremely short term. There’s nobody in the administration that’s visible and bringing any serious thought or analysis of what the medium and longer term implications of this strategy against China are. We heard two nights ago that Trump doesn’t listen to anybody. He just talks over anybody, so you can’t go to him with a reasonable analysis and have him make a more considered decision. There may be some modest short term gains for the United States. But medium and longer term, there are potentially very large losses. The key thing is: there’s no serious analysis of this, and no consideration of what those costs might be to the US. I already mentioned what they might be in the semiconductor space, in terms of the loss of revenue, the loss of jobs. Some companies, like Qualcomm, are selling something like 60 percent of their output to China. So Qualcomm, Intel and other important US technology firms are being very severely disadvantaged by US export restrictions. Now, if it was just a matter of all their stock prices going down because their sales are down, and their profits have collapsed, that’s something we can measure. And maybe that’s not so bad if the goal of the administration is to slow China’s rise. That’s the way they look at it. But what happens next year, or three and five years later, when semiconductor R&D collapses and the US losses its global leadership of the industry? The costs are difficult to measure but could be huge. Now, there’s been legislation introduced in Congress to give financial subsidies to these firms so that they can continue their research and development. So there’s a recognition in some quarters that there would be a cost, and maybe you can offset that cost by putting government money into this. This is very much a second best solution.

If you were advising the next President, what would you say about our relations with China?

Well, the main criticism that [the democratic nominee for President Joe] Biden has made is that we don’t have a coherent strategy for dealing with the rise of China, whether it’s economically, strategically or in any other dimension. We seem to have a bunch of initiatives. Some are reversed from day to day. They’re mutually inconsistent. So the first order of business would be to come up with a comprehensive strategy that would recognize that there are lots of areas where we need to cooperate with China, climate change being perhaps near the top of the list. The current administration doesn’t think climate change is happening. We withdrew from the Paris climate accord, and Trump doesn’t want to recognize there are problems. This would not fit into the thinking of people in this administration. But we need to have some areas of cooperation with China, and climate change would certainly be one. Biden’s team would need to come up with a comprehensive strategy. And gradually, you would see a somewhat different strategy, a less confrontational strategy emerging. But what if Biden went to China and said, “Well, we’re going take off all these enormously restrictive policies that were put in place, and we’re going to let you buy a little bit of this and a little bit of that, maybe we won’t give you our best stuff, but we’ll give you our second best. We’ll still have export controls.” I think China would still think the rational strategy for them would be to push ahead with self sufficiency in critical areas. So you can’t put the toothpaste back into the tube. But something like this will be determined to become more self sufficient. And semiconductors and semiconductor manufacturing equipment and other areas where they’ve been kneecapped now. It’s not going to work to go back [to China] and say, “Oh, we’re sorry about that.” You can’t completely restore the status quo.

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