15 Interviews to Read This Summer

8/19/2019 15 Interviews to Read This Summer

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The Goldman Sachs Group, Inc. Goldman Sachs Global Investment Research

15 interviews to read this summer

From our very first edition four and a half years ago, interviews have been at the core of

Fortnightly Thoughts. Over 91 issues, we have spoken to more than 140 experts including

CEOs/CFOs of global firms, authors, academics and investors. And in response to popular

demand, we’ve rummaged around in our archives and handpicked 15 interviews worth

revisiting this summer. This curated selection is best read at the foot of an old tree to the

soundtrack of breaking waves or clicking crickets.

WORDS OF WISDOM ON…

The rise of EM competition Gordon Orr, Chairman, McKinsey Asia, on China’s hidden innovators

Dr. Andrew Ng, Chief Scientist, Baidu, on Chinese tech keeping pace

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The evolution of nationsStan Druckenmiller, Chairman, Duquesne Family Office, on China’s rebalancing

Prof. James Robinson, of Harvard and co-author of ‘Why Nations Fail’, on success drivers for countries

Joe Studwell, author of ‘How Asia Works’, on the evolution of Asian economies

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The ubiquity of technology

Prof. Raj Rajkumar, of Carnegie Mellon University, on the future of autonomous cars

Paul Brody, ex-Partner, IBM Global Business Services, on the shift to software heavy manufacturing

Tim Bunting, General Partner, Balderton Capital, on the rise of private technology companies

David Epstein, author of ‘The Sports Gene’, on the technification of sports

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The forces shaping consumption

Jeremy Rifkin, author, ‘The Zero Marginal Cost Society’, on the rise of the sharing economy and more

Andrew McAfee, co-author, ‘Race Against the Machine’, on what tech means for jobs

Prof. Michael Sandel, of Harvard and author of ‘What Money Can’t Buy’, on the issues in market societies

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And some timeless insights on investing

Prof. Daniel Kahneman, of Princeton and author of ‘Thinking, Fast and Slow’, on behavioural biases

Howard Marks, Chairman, Oaktree Capital on his investment philosophy

Prof. Bruce Greenwald, of Columbia Business School, on competitive advantages and value investing

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Hugo Scott-Gall

[email protected]

+1 (212) 902 0159Goldman, Sachs & Co.

Sumana Manohar, CFA

[email protected]

+44 (20) 7051 9677Goldman Sachs International

Megha Chaturvedi

[email protected]

+44 (20) 7552 3305Goldman Sachs International

Fortnightly ThoughtsJuly 23, 2015 Special Issue

Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider thisreport as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, seethe Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are notregistered/qualified as research analysts with FINRA in the U.S.


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Goldman Sachs Global Investment Research 2

Fortnightly Thoughts Special Issue

About Gordon Orr

Director and Chairman of McKinsey Asia, and founder of the Chinese-language edition of The McKinsey Quarterly. Previously he was

responsible for establishing McKinsey’s China practice and led the Strategy and Business Technology Practices in Asia.

How has the quality of Chinese production evolved over time?

Chinese manufacturing has absolutely improved in quality. As China has transitioned to become a very largemiddle-income country, its consumers have also become increasingly demanding in terms of product quality.

This has partly contributed to the improving quality of Chinese produced goods. Chinese mid-sized companieshave also learnt lessons from MNCs, given decades of foreign competition in many sectors, and this has

reshaped their mind-set in terms of how they approach multi-national customers. As a result, everything fromR&D to marketing have all improved significantly for many Chinese companies. It’s hard to identify the

nationality of some of these firms by looking at their websites for instance, as they are often in English andhave sophisticated interfaces, very much comparable to the websites of their American and European peers.

Many even sell directly to customers worldwide. And international expansion is becoming possible mostlybecause Chinese companies are increasingly becoming adept at delivering a well-marketed, sleek package ofproducts and technologies.

Which sectors is this most evident in?

Chinese construction equipment manufacturers have been one of the earliest to reap the benefits of the sheersize and growth of the domestic market and they have evolved to become internationally competitive in theirdomain. They are already significant exporters to Africa, and Southeast and Central Asia among other regions.

More recently, many robotic and automation companies are also emerging, clustering around Dongguan.

Water processing is another area within industrials where Chinese firms are active in everything from sewagetreatment plants to reverse osmosis membrane technology. Even in areas like packaging, one of the few

competitors to Tetrapak globally is a Chinese company. There are also many companies in the Shanghai andShenzhen regions which compete aggressively against each other in the B2B industrial domain and I expect

them to become much more visible over time with the ‘through-train’ investment opportunities that are presentnow (‘through-train’ or Shanghai-Hong Kong Stock Connect allows foreign investors to trade Shanghai ‘A’

shares through the Stock Exchange of Hong Kong, and mainlanders to trade eligible Hong Kong shares

through Shanghai Stock Exchange, subject to quotas).

Another area where Chinese brands are becoming increasingly dominant in the local market is the med-tech

industry – local brands account for c.75% market share for coronary stents in China for example. Similarly,domestic firms hold more than 50% market share in orthopaedic and trauma products. Even within pharmaand biotech, Chinese companies are increasingly developing genuinely innovative molecules in partnership

with universities. One can argue that there is an element of ‘being in the right place at the right time’ to theirsuccess, but the main reason that they are being prescribed is that they deliver on the quality front as well.

What is driving this success for Chinese companies?

At some level it was bound to happen as companies climbed up the production curve, but the pace and scaleat which it is occurring is unprecedented and unique to China, and there are a few reasons driving this. Firstly,

we often see that dozens of companies enter a particular subsector in China and only the best ones survive.

So there is definitely some survivorship bias at play when we look at successful Chinese companies.Secondly, they also tend to employ a very rapid improvement cycle approach to production, wherein they firstintroduce a product in the market and then quickly roll out improved versions if the product is well received.

This, I believe, has been a very effective way to expand, especially within industrials.There is also a tipping point that China has reached in terms of improving the R&D output and sophistication.With SOEs reducing the number of people they used to hire from top universities, millions of graduating

engineers and other skilled personnel are entering the private sector and joining start-ups instead. This hascertainly helped.

And finally, the improvement in marketing, particularly in the online space, coupled with the availability of

capital, has allowed many Chinese companies to extend their presence globally. In this context, it is importantto note that the mid-sized Chinese companies that we are talking about never really borrowed at 5% or 6%

interest rates. Rather, these companies borrowed at rates close to 15%. So, the rise in interest headline ratesactually benefits these companies by creating a more even playing field.

With all these factors at play, mid-sized Chinese companies are increasingly trying to break themselves away

from the dependence on other multi-billion Chinese giants for growth and expansion.

Interview with…Gordon Orr

Not only are

western MNCs facing

stiffer competition in

China, but Chinese

companies are also

penetrating other EM

markets… I believe we

will see a rapid growth

in the export of middleincome product

categories from China

to markets like

Malaysia, Thailand,

Indonesia and South

Africa


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Does this means that scale and higher quality are becoming sources of China’s advantage as opposed

to just cost arbitrage?

Absolutely. The relative exchange rates over the last four years made it possible for China to export anythingto North Asia or Europe and even to South Asia to some extent. But the shift in exchange rates have exerted a

significant pressure on Chinese firms to move up the value chain. Many of them realised that B2B firms were

no longer going to buy “cheap and cheerful” products. Chinese exports to India for example have held up aswell as they have, not just because of China’s cost advantage. Rather, it is because the perception that Indianindustrial companies have of Chinese goods has shifted from being “low quality at the cheapest price” to “the

best price for value”.

In the domestic market, some people credit the “buy local” phenomena for the success of Chinese companies,

but I think it only had a modest impact. Being able to match rising consumer expectations has been the key

success factor for Chinese companies. China has an automotive industry that’s churns out 19 million vehiclesa year for example, three quarter of which have some global OEM influence on them, and such competitionhas definitely driven up expectations. So, the fact that local firms responded to the rising expectations of

quality, fit-for-purpose products as China became a middle-income country is definitely central to theirsuccess.

All this has also meant that not only are western MNCs facing stiffer competition in China, but Chinesecompanies are also penetrating other EM markets. The success stories of international expansion by Chinesecompanies are setting examples and they are increasingly willing to compete against MNCs in new markets

just like they found a niche to compete with them at home. I believe we will see a rapid growth in the export ofmiddle income product categories from China to markets like Malaysia, Thailand, Indonesia and South Africa.

Many Chinese companies already view Southeast Asia as a safe backyard to expand internationally. Andsuccess will be a function of whether they are able to deliver Chinese products at much more competitive

prices than exist in these markets currently. Plus, while there have been a modest number of Chineseacquisitions internationally, most of the global expansion is happening organically at this stage. And this furtherreflects that Chinese companies are confident about their capabilities to develop internationally recognised

quality products.

Taking share…Share of Chinese companies in the total sales of top 50 companies in

each sector by sales (based on Datastream universe only)

…by moving up the innovation curvePatent applications per capita versus GDP per capita, 1980 to 2013

Source: Datastream, Goldman Sachs Global Investment Research. Source: WIPO, World Bank.

What are the constraints that Chinese companies face?

In the short term, volatility in the exchange rate certainly affects these companies. But more broadly, attracting

and recruiting high-quality talent remains an issue for them as they expand in foreign markets, especially inareas where they are not well recognized. And this is partly why they are trying to build up their online

presence - to portray themselves as a sophisticated international company, not just to customers, but also topotential recruits. Intellectual property rights-related issues on the other hand are not as common a constraintas a lot of people believe them to be, and most of these Chinese companies actually operate legitimately.

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Germany UK India


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How are DM companies likely to respond to growing Chinese competitors?

Rolling five years forward, investors in DM companies might find themselves surprised by the impact thatChinese competitors can have in a broad range of sectors. It is likely that DM companies will be creating newproducts to compete with Chinese companies, especially in the low- to mid-range segments. We may also see

some acquisitions of Chinese companies that are still at a relatively small scale, but which have the capability

and momentum to grow to their potential value. This will be true in particular if there is an economic slowdownin China, as cheaper asset prices will provide a good entry point to investors. I believe that investors will alsoincreasingly have a more balanced portfolio with companies that compete in the same sector, some of which

would have originated in DMs and some in EMs.

In which sectors are Chinese companies lagging in terms of international competitiveness?

Chinese food and agricultural companies are still lagging to a certain extent, as is the autos industry, where

exports are still quite insignificant if you compare them against absolute volumes. And this is because things

like cars, photocopiers etc., require a complex blend of multiple technologies that are hard to pull together andmaintain an advantage in. And so, it is going to cost Chinese companies a vast amount of money if theydecide to become dominant in these sectors. The semiconductor industry is also quite interesting in this

context. Besides the focus in the five-year plan, the Chinese government has a $40 billion programme todevelop semis domestically. Although the prospects of achieving this are reasonable given that these

subsidies are being distributed in a concentrated fashion across some regions and companies, it is stillimportant to understand that it will be quite hard for Chinese companies to catch up in sectors like semis which

involve a huge learning and experience curve, and the benefits of being in a regional cluster that companieslike Intel, Samsung and TSMC enjoy.

Have things changed in terms of the sophistication and penetration of automation in Chinese

companies?

Yes, the incredibly rapid rise in the cost of labour has really forced companies to focus on automation as ameans to improve efficiency. I think it was broadly underestimated just how quickly companies would respondto rising wages, both through hiring experienced people from MNCs and by using leading edge automation

technology. But the labour-to-capital substitution is now becoming apparent in factories. And increasingly, theautomation technology being used is home-grown, with basic robots being manufactured out of the cluster

around Dongguan. Of course, the lack of a legacy asset base plays an important role in determining howquickly companies embrace technological advancements.

And this applies to many new technologies. Since many Chinese companies are young and don’t have anestablished asset base, the shift towards an online business model, more automation or even 3D printing isnot very expensive (versus their Western peers) and also coming down rapidly given the improvements in

these technologies. That enables rapid innovation, in my view. And that not only applies to companies that usesay, 3D printing to produce goods, but also producers of 3D printers, given the market size and potential rateof adoption in the economy.

But that can also be disruptive to Chinese cities that have been built on labour-intensive models or

around few traditional industries...

Yes, some cities face the ‘Detroit risk’ of being overly dependent on one industry. For instance, some cities inNortheast China are excessively dependent on the steel sector and some in the southern regions have

focused too much on textiles, and they are definitely headed in that direction. Changchun similarly has been

very dependent on a few SOEs in the automotive sector. Further, in many fourth or fifth tier cities which haveone dominant industry, end demand is now flattening as wealthy individuals and talented people are moving tofirst or second tier cities and other wealthier regions. And so, while auto OEMs are still expecting reasonably

healthy single-digit growth in China as a whole this year, most of the growth is coming out of wealthier cities,with fourth/fifth tier cities expected to deliver flat growth at best.

Originally featured in issue 87 on Chinese innovation ( Fortnightly Thoughts: How innovative is China?, April 6, 2015)

…the labour-to-

capital substitution is

now becoming

apparent in factories.

And increasingly, the

automation

technology being

used is home-grown,with basic robots

being manufactured

out of the cluster

around Dongguan


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About Andrew Ng

Chief Scientist at Baidu Inc. in Silicon Valley, Co-founder and Chairman of Coursera and Associate Professor of Computer Science at

Stanford University. Previously, he founded and led the “Google Brain” project which developed massive-scale deep learning algorithms.

What is driving the revival in interest around artificial intelligence worldwide?

The idea of deep learning, which refers to computers simulating the brain to learn from data, has been around

for at least 20 years. However, it was not until the last few years that advancements along Moore’s law and thedevelopment of computing capacity provided the necessary scale to put these deep learning algorithms towork.

Today, companies have access to a huge pool of data from user activities - the webpages that they click on,

the kind of voice searches that they do on their mobile phones etc. And this is allowing deep learningalgorithms to make more accurate predictions. So naturally, a lot of value from deep learning is being created

within the leading tech companies that have access to a lot of data, along with access to capital and theknowhow required to build massive neural networks. In fact, a lot of exciting innovations, particularly in the

software space, are being driven not by start-ups but by large companies as they are the ones which oftenhave better data as well as High Performance Computing technology.

But having said that, constraints in both software and hardware are still limiting what we’re able to do from aresearch perspective, which is why we constantly try to push our limits on both fronts. To draw an analogy, justlike we need both a big engine and plenty of fuel to launch a rocket ship, deep learning requires access to data- which is like a rocket’s fuel - and huge neural networks, which act as the engine. So, while the digitization of

society has been driving up the amount of data or ‘fuel’ that deep learning has access to, we have onlyrecently been able to build bigger ‘engines’ thanks in part to Moore’s law, but also through specific advances

being made by companies like Baidu.

What kind of applications of AI is Baidu interested in?

Until recently, most internet communications have been focused on text. But as we see the transition to mobiledevices, we are also likely to witness a shift away from text-heavy webpages. We believe that within five years,about 50% of web searches could be through speech and images rather than text inquiry. This is why the

ability of computers to understand speech and images will be fundamental to our ability to service users. And

deep learning is by far the best technology for this today. Recently, Baidu announced a breakthrough in

speech recognition using deep learning to achieve substantially better performance compared to current open Application Program Interfaces, especially in noisy environments.

Further, speech and image recognition abilities are not only critical for the existing lines of businesses, but will

also be increasingly important in the future transformation of the internet. I truly believe that speech recognitionis among the technologies that will mature over the next several years and will potentially change the way we

interact with mobile devices altogether. For instance, currently we tend not to use our phones in noisy placeslike cars. However, once speech recognition becomes more accurate, and moves from say 98% accuracy to a

99.9% accuracy, there will be a transformation in which using mobile phones even in noisy places will becomea natural thing to do. And it will not only change the way we interact with mobile phones, but also how we use

all sorts of technologies, from telling the TV what we want to see, to talking to the thermostat or commandingthe microwave.

So while we realise that understanding text still remains extremely important for a web search engine, voicesearch is rapidly growing as well. And the reason why we are interested in AI is simply that things like image

and speech recognition are likely to be extremely transformative in the future.

When do you expect these technologies to become commercial?

Baidu’s speech recognition is already powered by deep learning, which in the last two years has brought aboutsubstantial gains in performance. So, in some ways it is already commercialized. And what we announced in

December was a complete re-architecting of how deep learning is used, which should open up even moreavenues for gains over the next several years.

But it is important to understand that while the adoptions of these technologies appear to suddenly pick up out

of nowhere, the explosion in penetration is often driven by incremental, steady improvements in the usability ofthese technologies. So, for an insider like me who has been working in this field, the adoption may seem to begrowing slowly and steady. Yet, from the outsider’s perspective, often there will be a point on the demand

curve, where the use of these technologies seems to suddenly explode. It is difficult to know exactly when we

will hit that point, and hopefully it is imminent, but we will have to wait and see.

Interview with…Andrew Ng

Silicon Valley

is still ahead ofChina in many

areas, but there are

definitely many

bright spots where

Beijing is driving

innovation


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Who is most active in the field of AI, is it the start-ups or the dominant tech companies?

Deep learning has become so popular these days that everyone in the tech domain seems to be interested init or working on it in some form or the other. But most of the genuine progress is currently coming out ofclusters around Beijing and California. Baidu was one of the early entrants in the space and it was one of the

first companies to build a new High Performance Computer cluster for deep learning. It also built an internal

deep learning platform that empowered the engineers across the company to try and apply these tools to theirproblems, which unleashed a lot of creativity and brought about new imaginative applications of AI. Google ofcourse, is another notable player with a strong team in this area and Facebook, Netflix, Amazon and Microsoft

have been building their presence in the field of deep learning as well.

While start-ups can be very successful in exploring niches and specialized deep learning applications, I think it

will be very hard for them to challenge big tech giants in areas that require a lot of data or where a clear

economic value is already incentivizing the large players to invest.

Is talent hard to find in this field?

The supply of good deep learning talent and specialists is vastly smaller than the demand. And so, there is

what you can call a talent war going on in the Silicon Valley to hire people with the specialized knowledgerequired in this area. And to an extent, this had made hiring AI talent difficult for all companies in this domain.

However, there are very few genuinely attractive companies that can provide their employees with credible

deep learning labs and also the capital and infrastructure that is critical to pursue advanced AI. In this context,Baidu is committed to provide the best environment for its employees to execute on its mission, which is todevelop AI technologies that impact millions of people, and this is what sets us apart as an attractive employerto people with a similar vision.

Leading from the frontTop patent applicants under Patent Cooperation Treaty (international)

Real interest in Artificial IntelligenceTotal patent grants by the USPTO by field of technology

Source: WIPO. (Note: 2013 instead of 2012 for Tencent; Chinese firms in blue). Note: all ‘*’marked categories relate to data processing; Financial, BusinessPractice includes things like cost/price determination

Source: USPTO.

Has the emergence of new Chinese tech dominators slowed the talent outflow from the country to the

more developed regions of the world?

I genuinely believe that talented individuals increasingly want to move to China to work, and this includes not just the Chinese diaspora of immigrants settled across the world who are choosing to return home, but also

Americans and people of other nationalities that want to spend time working in China.

And often, what differentiates Chinese tech companies like Baidu from other large Silicon Valley firms is thesheer intensity and velocity with which the core internet companies work in China. Despite being a $70-80

billion company, Baidu for example, is able to adopt the behaviour of a small start-up when needed and weregularly make decisions in hours rather than weeks.

Is this also reflective of China’s growing innovativeness, more broadly speaking?

Yes. Ten years ago there was a perception that Chinese companies were copying from American companies,and while it wasn’t 100% true even back then, it certainly isn’t anymore. The picture has changed today and a

lot of things are being invented in China, many of which are yet to be made available in the US. Take Baidu for

example. We were the first to build a GPU (Graphics Processing Unit) cluster using the new generation of HighPerformance Computing hardware and now other companies, many of which are in the US, are following. Wealso pioneered applications of deep learning in advertising and were first in many other areas as well.

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One reason why I think this misconception around the lack of innovation from China exists is that people oftenattribute the first version of what they see to be the original. So, for people living in the US who use the American version of apps for instance, it’s natural to think that the similar app in China is a replica of the

original US one, but often that is not true at all. Take for example the Chinese dating app MoMo, which issometimes referred to as the Chinese version of Tinder, even though in reality MoMo came first. Similarly, the

new “press to talk” feature that just made its way to iOS 8 has almost been a standard in Chinese mobilecommunications for years now.

Of course, Silicon Valley is still ahead of China in many areas, but there are definitely many bright spots where

Beijing is driving innovation. It is also important to note that Chinese tech clusters are often very different fromthe US ones i.e. Silicon Valley. The market forces that affect individual companies are very different in Chinaand so, often Chinese internet companies have to compete in a different manner versus their US peers.

Take the case of Google and Baidu in the early days when they were competing in the Chinese market. Sincethere weren’t many existing Chinese language webpages, Baidu chose a strategy of getting user generatedcontent by proactively setting up information-rich websites with original content (such as PostBar, which is

similar to Reddit) and then indexing all that content.

What happened as a result was that if someone did a search on Google, very often they were directed to one

of Baidu’s properties, and so Baidu could serve the users and keep them in its ecosystem. This is one of thereasons Baidu won market share in China. Even today the Chinese internet ecosystem is in some ways moreand in other ways less developed than the West. This is why Chinese companies behave or compete

differently, or take a different direction when it comes to innovating.

So from the software perspective, Beijing and Silicon Valley have both developed very healthy ecosystems of

innovation and overall Silicon Valley is still a bit ahead, but China is learning very rapidly. Even in the case of

hardware, a lot of innovation is coming out of regions like Shandong, some of which has yet to be madeavailable in other parts of the world including the US. To sum it up, I believe that we are now living in a worldwhere a lot of unique innovation is coming from both sides of the world.

Top 15 websites based on browsing, December 2014

Source: Alexa, UN, World Bank.

Originally featured in issue 87 on Chinese innovation ( Fortnightly Thoughts: How innovative is China?, April 6, 2015)

US UK Germany Spain Japan S.Korea Indonesia India Brazil Russia China

1 Google Google.co.uk Google.de Google.es Yahoo.co.jp Naver.com Google.com Google.co.in Google.com.br Yande x.ru Baidu

2 F acebook F acebook A ma zon.de F acebook Google.co.jp Google.co.kr F acebook Google.com F acebook Vk.com Taobao

3 A ma zon Google.com F acebook Google.com A ma zon.co.jp Google.com Youtube F acebook Google.com Google.ru Qq4 Youtube A ma zon.co.uk Eba y.de Youtube Fc2.com Am az on .co m B lo gs po t Y ou tu be Yo utu be Mail.ru Sina

5 Yahoo Youtube Youtube Amazon.es Youtube Youtube Yahoo Yahoo Uol Google.com Weibo

6 Wikipedia Eba y.co.uk Google.com Live.com Google.com Daum.net Google.co.id Flipkart Globo Youtube Tmall

7 Ebay Bbc.co.uk Wikipedia Yahoo.com Rakuten Fa ce bo ok W or dp re ss W ik ipe di a Y ah oo Ok.ru Hao123

8 Twitter Yahoo.com Web.de Twitter Nicovideo Ppomppu.co.kr Kaskus A mazon.in Live Facebook Sohu

US 9 R edd it W ik ipe di a Y ah oo. co m W ik ipe di a Fac eb oo k Tistory.com Twitter Blogspot Aliexpress Wikipedia 360.cn

Non‐domestic 10 Linke din Live T‐Online.de Marca.com Twitter Gmarket.co.kr K om pas I nd iat im es M erc ado liv re Avito.ru Xinhuanet

Domestic 11 Go.com Twitt er Gmx.ne t Elmundo.e s Livedoor Baidu Detik Snapdeal Adcash Rambler.ru Gmw

12 Imgur Theladbible Bild.de Milanuncios Wikipedia Clien.net Liputan6 L ink edi n W ik ip ed ia L iv ej ou rn al People.com.cn

13 Craiglist Dailymail Spiegel.de Elpais.com Ameblo Donga.com Cliponyu Twi tter Twitter Aliexpress 163.com

14 Tumblr Paypa l Googlea dservic Linke din Dmm.co.jp 11st.co.kr Lazada Jabong Youradexchang Sberbank.ru Soso.com

15 Netflix Link edin Xham ster Aliexpress Naver Blog.me Wikipedia Amazon.com Xvideos Rbc.ru Amazon.cn

% global population 4% 1% 1% 1% 2% 1% 3% 18% 3% 2% 19%

% internet penetration 87% 90% 87% 74% 86% 92% 17% 19% 53% 59% 46%

% global online pop'n 10% 2% 2% 1% 4% 2% 1% 8% 4% 3% 22%


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About Stan Druckenmiller

Chairman and Chief Executive Officer of Duquesne Family Office. He founded Duquesne Capital Management in 1981 and previously

worked at Soros Fund Management, where he served as Lead Portfolio Manager of the Quantum Fund and CIO of Soros

What are the risks of investing in China that are not well understood in your view?

The growth in credit at a time when GDP growth is slowing is a problem for China. And I think this is the 2009

11 stimulus coming back to bite. I understand that it had to be done to fund entrepreneurs and the privatesector, but it’s easier said than done if you’re channeling funds through local government investment vehicles.I’m a believer in markets. A few men sitting around a table and deciding how to allocate capital goes against

everything I’ve ever believed. Not only are they not great at capital allocation, such an exercise also needs todeal with a lack of property rights and corruption. In essence, the frantic stimulus China put together at the end

of 2008 sowed the seeds of slower growth in the future by crowding out more productive investments. Andnow, the system’s building enough leverage and misallocation of resources to warrant risks of a financial crisis,

but the timing of that is still uncertain in my mind. What we’ve seen in China since 2009 is similar to whathappened in the US in 2005, in terms of credit growth outpacing economic growth.

I think ageing demographics is a bigger issue in China than people think. And the problems it creates shouldbe become evident as early as 2016.

You also need to keep in mind that for China to grow and evolve further, it will need to compete with a moreinnovative Korea and now a more competitive Japan. I don’t think China can do that with where its exchangerate is today. I think productivity is a key concern too. And I think that could be one of the reasons why the US

has been so supportive of Abenomics.

People mention lack of infrastructure as a constraint. But when I go over there, it looks like they have a lot ofinfrastructure. It seems ahead of the population, not behind. I see expensive apartments in empty cities that

300 mn rural Chinese are expected to migrate to. That looks very unbalanced to me. Nobody’s ever hadinvestment to GDP at 47%. Japan and Korea peaked at 36%-38%, so as a result I think capacity is way ahead

of demand in some areas in China.

If China slows its fixed asset investment, will that have a knock-on effect for its commodities demand

and thus commodity prices?

When I started in 1976, I was taught by my mentor that when cash flow rises equities go up. But commoditiesare driven by the cost of extraction 90% of the time, and over the long run, technology makes extraction

cheaper, pushing the cost curve down and with it commodity prices. But that hasn’t always worked, if I’dfollowed that advice over the past few decades, I’d be in trouble.

About five years ago, I bought into the peak oil thesis. But then, along comes shale oil and shale technology,reminding me of what my old mentor said 35 years ago. Now I’ve come to think that the oil price is not asvulnerable to China slowing down as it is to ongoing shale supply growth. I regard the ramp up in investment

by China as a 10-year aberration, making the last two years more normal and more representative than theprevious decade.

Diminishing returnsGDP and credit growth in China, 4-quarter moving average

Source: BIS, Datastream.

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1 9 8 8

1 9 8 9

1 9 9 0

1 9 9 1

1 9 9 2

1 9 9 3

1 9 9 4

1 9 9 5

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

2 0 1 5

GDP growth Credit to private sector

Interview with…Stan Druckenmiller

I see

expensive

apartments in empty

cities that 300 mn

rural Chinese are

expected to migrate

to. That looks veryunbalanced to me.


9/53



I do think China is serious about rebalancing, which means infrastructure investment is going to slow. Andobviously, there's been a huge ramp-up in supply around the world in response to the 2009-11 stimulus, whichin my view is a massive misread by the suppliers of these commodities. So that’s not good for commodity

prices. And then you have innovation. Can technology progress in iron ore and copper, the way it has withshale energy? My guess is it will.

If you look at food, there’s now technology that allows seeds to be drought-proof and disease proof. Yes, thereis a demand-supply argument for food prices rising, but the impact of technology on food supply is greater thanyou think. On the other hand, we are using up more and more good arable land to build cities in China and

there is a water problem too.

Do you think we underestimate the role of innovation in resolving these global constraints?

Even with all the progress we have made in technology in the recent past, I think we are only scratching the

surface in terms of innovation. We haven’t seen half of the practical applications of big new technologies yet.

And the cost of these technologies will come down too, whether it’s robotics or driverless cars. That has toprovide a productivity boost.

But there is a downside to technology-driven productivity surges too. There is improved efficiency, but at thecost of fewer jobs. I think the impact of technology on manufacturing jobs is easy to overlook because of the

huge surge in services jobs. But we’re now at a point where the impact of technology is hitting the services

sectors too. And not everyone understands this. I recently brought up the possibility of driverless autotechnology resulting in zero jobs for truck drivers within the next 20 years and there were gasps of disbelieffrom the audience of investors. When I mentioned it to a high-tech company CEO from Silicon Valley a fewdays later, his response was exactly the opposite. The point is that the problem with a tech-driven productivity

surge is that the benefits of that are going to accrue to a smaller, narrower group. Already, computer engineers

have benefitted from computing and the internet a lot more than the broader population.

You could draw similar conclusions on the impact of technology and automation on investing. I believe thatgood investors are successful not because of their IQ, but because they have an investing discipline. But, whatis more disciplined than a machine? A well-researched machine can make many average investors redundant,

leaving behind only the really good human investors with exceptional intuition and skill. And what happens

when machines really take over investing? Do the markets get really efficient? Or will there be competingsystems trying to out do each other? All of this is depressing because there won’t much left to do for humansonce machines start doing more and more.

If machines do everything well, including allocating capital and resources efficiently, can that be deflationary,can that eliminate poverty? I don’t know. It’s hard to be very optimistic if you look at how humans havebehaved historically. All in all, I don’t think robots and greater automation can bring about a utopian world as I

imagined it would as a kid 50 years ago.

If you combine the prospect of fewer jobs with an ageing population, it doesn’t look very good for

many economies...

Apart from India, most of the other major economies have worsening demographics to worry about. It’s a big

problem for the US too, especially given that relative to many other economies, including Japan, its fiscal gapis much wider.

You can look at the US debt stock in a few different ways. The official estimate of the total debt may be US$11tn, but if you include what the Fed has bought (which you should), then the number if closer to US$16 tn. But a

better measure of US debt would include some of the off balance sheet items. Laurence Kotlikoff, who is one

of the top economists in his field of generational accounting, estimates the present value of US debt includingwhat has been promised to senior citizens, adjusted for the projected tax revenues and the fiscal gap, to beabout US$211 tn. That’s staggering.

The US needs to resolve its debt problem politically, otherwise it is headed towards default. I believe theestimates suggest that the US needs to raise all taxes by about 64% in order to be able to support its older

population. That’s raising payroll, capital, dividends and income taxes by 64%. The other option is to cut all

government spending by 40%. Neither one is a viable option and a combination is not easy either. In 20 years,those numbers will become even tougher. The US will need to raise taxes by 75% or cut spending by 46%.

There has been vigourous debate on the veracity of Rogoff and Reinhart’s research on the consequences ofcountries exceeding 90% debt-to-GDP. But it doesn’t take away from the fact that historically, such levels of

indebtedness has resulted in extreme implications. Countries tend to go into a full-blown monetisation or adefault or inflation on average 23 years after they cross the 90% threshold according to their research. So

these debt levels are less relevant for you and me today, but will be extremely crucial for our children. If wecontinue to borrow and spend like we do now, this can become a serious problem in 15 years.

I understood the need for QE1 because the US economy faced a potential meltdown then. But further easing

brings problems of its own, that only come to light with hindsight. All that easing and prolonged negative realinterest rates have gone beyond resolving the core issues the economy faced and has led to re-leveraging. I’m

not worried about inflation as much as misallocation of investment.

Can

technology progress

in iron ore and

copper, the way it

has with shale

energy? My guess isit will


10/53



Another consequence of today’s monetary policy is that the US government is not getting any price signals. Inany other society, at some point in the next 15-20 years, the markets will give a price signal and the politicianswill need to respond. But currently, there is no such impetus for politicians to act. What adds to the problem is

that young Americans don't vote. Old people not only vote, but also have incredibly powerful lobbying groupsbehind them. Entitlements in 1960 were 28% of government outlays, today it is 67%. And the baby boomers

have only now begun to retire. Another debate is that this is a huge reason to accelerate immigration, butcurrent policy is moving in the opposite direction. But even with immigration, the US needs to fix this pay-as-

you-go system or the consequences could be quite drastic.

Do you think investing is becoming harder now with more government intervention and regulation

interfering with market price signals?

It has become harder for me, because the importance of my skills is receding. Part of my advantage, is that my

strength is economic forecasting, but that only works in free markets, when markets are smarter than people.That’s how I started. I watched the stock market, how equities reacted to changes in levels of economic activityand I could understand how price signals worked and how to forecast them. Today, all these price signals are

compromised and I’m seriously questioning whether I have any competitive advantage left.

Ten years ago, if the stock market had done what it has just done now, I could practically guarantee you that

growth was going to accelerate.

Now, it's a possibility, but I would rather say that the market is rigged and people are chasing these assets,without growth necessarily backing confidence. It's not predicting anything the way it used to and that reallymakes me reconsider my ability to generate superior returns. If the most important price in the most importanteconomy in the world is being rigged, and everything else is priced off it, what am I supposed to read into other

price movements?

Originally featured in issue 56 on China’s rising challenges ( Fortnightly Thoughts: The consequences of China’s price discovery , June 13,

2013)

Even with all

the progress we

have made in

technology in therecent past, I think

we are only

scratching the

surface in terms of

innovation. We

haven’t seen half of

the practical

applications of big

new technologies

yet


11/53



About James Robinson

David Florence Professor of Government at Harvard University and co-author of “Why Nations Fail”. Previously he was a Professor in the

Departments of Economics and Political Science at the University of California at Berkeley.

How do you think about the success of nations and what role do institutions play?

When I talk about success, I’m referring to GDP or income per capita, though there are other concepts ofsuccess such as happiness and political freedom. What helps countries grow faster and become economically

successful is innovation, better productivity and better forms of organisations. So, it’s important for a society tomanage and harness the talents, skills, ideas and creativity of its people, which the US, for example, managed

to do in the 19th century, when innovation in the US came from every corner of the social spectrum – the elites,non-elites, farmers and artisans, as early patent records suggest. This was only possible because of its

inclusive institutions, which provided incentives and opportunities to harness society’s potential. The Britishindustrial revolution in the 18th century was a consequence of Britain moving towards inclusive institutions, and

if there is another industrial revolution, it’s more likely that it will happen in the US than anywhere else. We’realready seeing massive innovation taking place in fields such as consumer electronics and biotech in the US.

On the other hand are extractive institutions, which do not allow such innovation. Throughout history, people’sincentives and opportunities have been restricted, as that allowed others in power to take advantage of them.

Take slavery. If we compare how the US and Latin America developed over the last 500 years, one of the

critical factors that explains their divergence is the extent to which Latin America used labour coercion to buildits societies. That was excellent for the people who were extracting rents from the slaves, but that did not allowthe talents of its people to be harnessed for the greater good. This is the fundamental difference between

extractive and inclusive institutions.

What causes a society to move from extractive institutions to inclusive ones?

First, we should remember that both systems tend to be rather persistent. There are lots of feedback loopswhich keep societies extractive or inclusive over long periods. So how do you get a transition from an

extractive to an inclusive society? The first thing is that there’s always a conflict over the organisation ofsociety. A majority may desire a move away from extractive institutions, but the people running the regime

usually have vested interests that stop them from changing the way society is organised. So what’s necessaryis a big redistribution of power.

Now, while we can imagine a situation of gradual changes accumulating for that to happen, the more realistic

scenario is for such a transition to come at a critical juncture, when a shock to the system causesdisequilibrium. And that shock can be triggered by a small event. The Arab Spring started in Tunisia when amarket trader, who was being harassed by the police, tried to kill himself. That somehow solved the collective

action problem for Tunisian society, which was opposed to the regime. So a set of small events canaccumulate into a much larger movement and even spread to other parts of the world. At the same time, a

large shock to the system that leads to a redistribution of political power does not necessarily lead to inclusiveinstitutions. It could just create a different set of extractive ones. That is what seems to be happening in Egyptnow. So it is not a straightforward process.

Do you think that if a society genuinely moves from being extractive to inclusive, then innovation and

creativity will follow and that will lead to sustainable success?

Yes. Of course there will be noise, but if we ignore business cycle dynamics and remain focused on the longrun, inclusive institutions do succeed. There may be macro economic recessions and financial crises like the

ones we have seen in Europe and in the US, but if you look at the long-run growth trend, even the GreatDepression of the 1930s, which was much worse than the current recession, did not affect the Americaneconomy greatly. It was a disaster, with big political consequences even in other parts of the world, but thelong-run trend of economic growth wasn’t affected by that period. This may seem like an outrageous

downplaying of business cycles, but the difference between a rich and a poor country isn’t that one is in aboom and another is in a recession. While macro economic instabilities are real and important, the long-run

growth rate of an economy remains unaffected by these. And that’s why, even now, if we focus on the longterm, we remain optimistic about the US. The innovativeness of its private sector is heavily underestimated.

Do you think that a well-intentioned, benign government can become extractive when it becomes too

big and damage entrepreneurship?

That could be true. But if you look around the world you’ll find the opposite relationship. For most Latin

American and sub-Saharan countries, the size of the government relative to that of the economy is much

smaller than in Europe, but that’s not necessarily good. Columbia, for example, has a very small state which

lacks the resources to control large parts of the country, to build infrastructure or provide security. On the otherhand, states can definitely become too large and too regulatory, and that can be an impediment to economic

growth as well. While there are lots of interesting variations within the European countries, they are all mostly

inclusive relative to most other societies. For all its faults, the EU does play an enormously important role inimproving the inclusiveness of the institutions of its member countries and those that aspire to join. In theEastern European countries, the EU, at least partially, stimulated reforms in the 1990s, and after that as well,

Interview with…James Robinson

To have

economic growth in

the long run, one

needs to have an

inclusive society,

and inclusive

political institutions

which underpins

inclusive economic

institutions, which

are critical for

incentives and

resource allocation


12/53



which has been good for them. In fact, I think the problems in Greece pre date its accession to the EU and runmuch deeper into the fundamental way that Greek society and politics functions.

This institutional variation within rich countries, even if it is different from that between poor and rich countries,can have interesting sources. For example, while the US appears to have greater incentives and higher

inequality, Scandinavian countries prioritise social insurance and equality, but face lower incentives, at least in

a monetary way. But then, these societies interact and the innovativeness, technological change and ideasspill over from the US to the rest of the world. So, I don’t see any reason why rich countries can’t haveasymmetric situations, with some countries having inequalities, being cut-throat and innovative, and other

countries benefitting from innovation spill-over, which allows them to have more insurance and less inequalityby free-riding on innovation elsewhere.

Can the institutions in inclusive countries become too big or powerful, and eventually hinder

progress?

In my book I give multiple historical examples, one of which is of the robber barons in the late 19th century.They attempted to take over politics in the US, which created a backlash in society and led to the introductionof several political reforms to get them under control. This is a classic example of the private sector and elite

becoming too powerful. In the 1930s, Roosevelt even tried to emasculate the Supreme Court! There were also

times when the central state was trying to override the checks and balances in the US political system. Inshort, there are many groups in society which can set up an extractive society for their benefit if given toomuch power. Venice started with relatively inclusive institutions in the medieval period, but then fell through

coup d’état, and the whole society went from being open and mercantile to closed and extractive. So yes, thathas happened.

Institutions matterGDP per capita versus confidence in national institutions

Source: OECD, World Bank.

Where in the world do you see countries with inclusive institutions beginning to erode?

Different people emphasise different things. There are people who say that some US politicians have too greatan influence on the corporate sector and vice versa for example. There is a famous study by an economist onthe Indonesian President Suharto, which notes that the share prices of certain companies linked with his family

and associates fell sharply each time he had a heart attack, because their profitability was based solely on

public sector favours they received from him. The US is far from that. It is much less corrupt than people claimit is. In Europe, perverse incentives may have been built into the way the EU works, which have made Spainand Greece more extractive over time, but I doubt that Greece was ever very inclusive compared to Germany

or the Scandinavian countries.

How do you see China and India evolving?

To have economic growth in the long run, one needs to have an inclusive society, and inclusive politicalinstitutions which underpin inclusive economic institutions, which are critical for incentives and resource

allocation. Since the agricultural reforms in the 1970s, China has moved a lot towards becoming an inclusiveeconomic society, but the political system has stayed extractive. While it has been possible to generatetransitory economic growth with this model, sustaining that growth will be much harder. This is similar to where

the Soviet Union was.

-$10

$10

$30

$50

$70

$90

$110

35 40 45 50 55 60 65 70 75 80 85

G D P

p e r c a p i t a .

i n ' 0 0 0 s

Confidence in national institutions index

Finland

Denmark

Netherlands

Switz.

Australia

Norway

Canada

UK

Sweden

Austria

S.Africa

France

Ireland

US

Turkey

Poland

Israel

Germany

Japan

Chile

Spain

Italy

Belgium

Greece

Brazil

Russia

PortugalS.Korea

Hungary

Mexico


13/53



When people talk about China overtaking the US, it’s important to remember that 30 years ago, there weresimilar discussions about the Soviet Union overtaking the US, and that did not happen. China has certainlybeen more successful in making its society more inclusive than the Soviet Union was. When Gorbachev tried

to do it, the whole system collapsed under him. The Soviet Union was economically successful for 40 years.But prior to the Russian revolution, people barely produced anything. The government then took a lot of people

out of the rural sector and employed them in factories, which generated huge productivity increases for a longtime and fooled people into thinking this was sustainable growth. Even Argentina was claimed to be as rich as

the US before the First World War. That’s another example of unsustainable growth facilitated by favourablemarket opportunities. That’s why it’s important to study history.

I believe China’s equilibrium remains very transitory, and while it’s difficult to predict the direction in whichChina will go, the current situation is unlikely to persist. Even South Korea in the 1960s and 70s is an example

of extractive growth in some sense, but it managed to make the transition to a much more inclusive political

system, which is why it could sustain growth. North Korea, for example, couldn’t do what China did as itsregime is much less institutionalised. It’s just not confident that it can keep control of society while liberalisingthe economy as China has done.

At some point, when the pressure from the people gets too much, the political institution will clamp down on

economic liberalisation in China. Many academics once wrote that people in the Middle East willingly sacrificedpolitical rights in exchange for subsidies and handouts, but the reality was just that people couldn’t organise

collectively to demand greater political rights and openness in the system. I think the same’s true for China.Growth alone isn’t going to keep people happy. There’s certainly a demand for more political rights, and that

could come out as open conflict. Yes, there’s a chance that a conflict could just lead to a different type ofextractive system. But I think there is a higher likelihood that China converges to become more stable, richer

than it was in the 1970s, but doesn’t try to take over the world as many seem to believe.

In India, there’s been liberalisation and a movement towards political inclusiveness. In fact, the improvedeconomic success of India seems largely correlated with the disintegration of the political dominance of onesingle party. This not only meant more political competition, but that steps like the deregulation of the License

Raj implied higher competition in the economy too. While there are still many dysfunctional and extractive

elements in India’s political system, it has gradually moved towards becoming an inclusive society. Overall,while the growth in India has been much slower than in China, it has been much more sustainable and issupported by the gradually improving nature of institutions. And hence, if asked which of the two countries was

likely to be doing better in 50 years’ time, I will pick India.

Do you think geographical location and the physical attributes of a country have a disproportionateimpact on the success of nations?

No, I don’t think that is true. Africa has low agricultural productivity because it’s never seen a green revolution.

And that’s because of massive predation by governments on farmers, against rural people and rural interests.Nobody uses fertilizers because property rights are weak, and people don’t want to spend money investing in

raising productivity if they’re not going to benefit from it. So it’s not about the climate, it’s about layers ofdysfunctional institutions that keep agricultural productivity low in Africa. Europe once used to be a very

unhealthy place. There was endemic tuberculosis, bubonic plague, cholera, but Europe became muchhealthier because of the fruits of its economic development, and the same will happen in Africa. As theydevelop, they’ll be able to implement the public health measures necessary to eliminate diseases too. They

just need better institutions.

Originally featured in issue 40 on countries’ success drivers ( Fortnightly Thoughts: Where countries succeed companies follow, September20, 2012 )

Overall, while

the growth in Indiahas been much

slower than in

China, it has been

much more

sustainable and is

supported by the

gradually improving

nature of institutions.

And hence, if asked

which of the two

countries was likely

to be doing better in50 years’ time, I will

pick India


14/53



About Joe Studwell

The founding editor of the China Economic Quarterly and a freelance journalist in Asia for over twenty years. He is the author of How Asia

works, The China Dream and Asian Godfathers and has also written for numerous journals

You talk about the three phases of the evolution of a country - agriculture, manufacturing and financial

systems – in your book. Where would you place the different Asian economies on this curve and whohas got it right so far?

First of all, it’s important to understand that the major resource of a developing country is its people. So whencountries begin to develop, their aim is to maximise returns from the low-quality human capital that they have.

The three-stage argument, which is largely based on historical observation of countries that have succeeded,is primarily a framework through which this goal can be achieved. The first and extremely important step is to

reform agriculture, which may employ as much as 80% of a poor country’s population. The best way for this tobe done is through a micro-farming approach, i.e., turning agriculture into large scale gardening, where people

spend inordinate amounts on maximising output. This is more effective than large-scale agriculture whenlabour is abundant and very low-cost. This way, by producing six to seven tons of rice per hectare in a countrylike China, instead of two to three in Thailand, despite the latter’s more favourable agronomic conditions, a

country uses all its labour and generates an initial surplus. In East Asia, successful land reform programmes

and micro-farming support systems in Japan, Korea, Taiwan, China and Vietnam generated a 50%-75%

increase in crop output in seven to ten years. These countries saw an enormous increase in yields despiterelatively inferior soil and climatic conditions compared to south East Asian countries like Thailand or the

Philippines where land reform programmes were never successfully implemented.

While such an increase in agricultural output is helpful in itself, it also triggers demand for basic industrial and

consumer products by raising rural incomes. Take Japan after the Meiji restoration, or China in the 1980s: itwas the incremental capital generated across the entire population through agricultural reforms which createdthe initial demand for basic goods that can, and should be produced domestically as part of the industrial

learning process. With increased income, farmers started buying farm equipment and constructing buildings,creating demand for cement, steel and glass among other materials. Unsurprisingly, successful companies like

Great Wall Motors of China and Wanxiang, one of the biggest auto components companies in China today,were both started as agricultural machinery and repair businesses. A strong agricultural economy creates the

best possible foundation for development.

Is this when the manufacturing phase starts?

Yes. Consistently in East Asia the countries that have succeeded have created explicit industrial policies

focused on manufacturing. And several things explain why this succeeded. For one, acquiring knowledge and

a technological capability is the next big priority for countries which have reformed agriculture, and this makeslearning through trade extremely important. It makes a lot of sense to focus on manufacturing as its muchmore freely-traded than services. Moreover, machines really help countries maximise returns on a low-skilled

population as they allow far more value to be extracted than a service-oriented strategy of development can.Manufacturing has a steady learning curve. People can learn on the job while simultaneously adding value for

the employer and earning income. In effect, factories act as secondary schools for developing economies. Inservices, by contrast, you often have to train people up before you can extract any value from them. Think of a

call centre operator or a software code writer. They can’t start from near zero and learn English or softwarecode on the job.

With just 14% of the population in manufacturing, India is an example of the disadvantages of a more service-

sector oriented approach. While it has created some very competitive IT companies globally, the entire IndianIT sector employs just 3 mn people out of a population of 1.2 bn. So, while it may be great for the peopleinvolved in these sectors, the depth of impact that it has on the overall economy is far less than it would have

been if these people were involved in managing manufacturing plants.

Another reason why Japan, Taiwan, Korea and China could successfully transition themselves to becomehuge manufacturers is what I call ‘export discipline’. To ensure that the subsidies and tariff barriers that were

used to nurture manufacturers in these economies did not result in sub-quality goods being produced solely forthe domestic market, any firm that was subsidised by governments was pressured to export. Much of the

pressure was applied by rationing credit, forcing companies to be competitive in the world market and creatinginformation feedback that showed governments whether they were getting a return on the subsidies. It is this

export discipline which separates the industrialisation programmes carried out in the successful countries likeKorea from the ones done in the Philippines, Malaysia, Indonesia and Thailand. The latter states remained in

the tradition of so-called ‘import substitution industrialisation’ which lacks the export discipline and alsoproduced poor returns on industrial policy in Latin America.

Before one starts blaming less successful states, however, it is worth noting that the successful economies are

all contiguous – Japan, Taiwan, Korea, China, Vietnam. There was a transmission of ideas which helped thesenations emerge as manufacturing giants. A big part of their success has been nothing more than transmissioneffects, to use the economists’ term, most of which have their roots in Japan’s breakout performance in the

19th century. Unfortunately, the transmission of ideas broke down in south-east Asia outside of Vietnam.

Interview with…Joe Studwell


15/53



Mahathir Mohamad tried hard to learn the lessons of Japanese and Korean development in Malaysia in the1980s, something I discuss at length in ‘How Asia Works’, but he failed to grasp a couple of the simplestpoints, including the need for export discipline in industrial policy. The two fundamentals that define success in

East Asia have been getting agriculture right and getting an acute focus on manufacturing. The third area isthe policy of financial repression that is used to obtain these objectives. This means that a developing country

needs to mobilise its financial resources and point them at the necessary targets. The easiest mechanism tocontrol is the banking system. Japan and Korea, for example, used central bank rediscounting to manipulate

commercial banks, which were rewarded for lending cheap to exporters and favoured industrial sectors. Chinahas not used much rediscounting, but has built up a huge industrial policy bank in the form of China

Development Bank. The other side of financial repression is capital controls. To be honest, I just cannot seeany argument in favour of not having capital controls to develop an economy. A developing state has to have

discretion over domestic capital in order to run effective policy.

Doesn’t that discourage foreign investment?

China has controlled its capital account very strictly and is only beginning to open it up very, very slowly.

Despite that, it has broken all records for incoming FDI. No, I don’t think that capital controls discourage FDI solong as a developing country has growth and the promise of an interesting new market. On the portfolio

investment front, it’s not surprising that equity investors prefer Anglo-Saxon financial systems, because they’redesigned to reward third-party investors. But it’s also important for investors to have something substantial to

invest in. And so, the fundamental problem for investors is that the policies which produce substantialeconomies like those of Japan, Korea, Taiwan, or China are often profoundly unfriendly to equity investors.

Returns remain appalling in the fastest periods of growth and only come much later, when financialdecompression takes place. So, while it may be upsetting to the equity investor that they can’t generate a

return on the current growth, it’s in their best interest to allow these policies of to build a substantial economy,allowing them to reap returns later.

In the end, I believe that there are at least two kinds of economics, the economics of learning, where you forgoshort-term returns to invest in learning, and the economics of efficiency, which Adam Smith describes as

maximising efficiency and producing short-term results, but without abandoning the economics of learning.

We’ve already witnessed the change of economics in Korea since 1997, because the IMF went in as a resultof the Asian financial crisis and forced substantial change. In Japan, we haven’t seen that change, whichexplains why for two decades Japanese equities have continued to underperform. Despite creating a highly-

competitive economy technologically, Japan failed to understand the need to then move to the economics of

efficiency. Now of course, we are all hoping Mr. Abe is going to liberalise the labour market, break downmonopolies and oligopolies, end remaining policy support and subsidies, and so on. In short, do the AdamSmith thing.

Does China’s size and dominance make it even harder for smaller emerging Asian economies to

follow?

In my view, it's easy to over-emphasize the role of China’s size in its success. Looking around, we seeexamples of small countries that have succeeded: Taiwan, Korea, Sweden, Denmark, Finland, New Zealand

etc. They’ve all done extraordinary things. Developmental success is more about systems and humanorganisation than endowments. And size also creates problems for China, in terms of running effectivedevelopment policy. The main thing that central government officials moan about is that their policies are

constantly ignored in the provinces and that this has high costs – for instance when central government efforts

to close down sub-scale and inefficient industrial capacity are resisted.

What’s next for China?

China’s shadow banking system has seen rapid growth and the country needs a lot more investment to

generate an incremental dollar of GDP than before. The government gets this and realises that financing mustbe more efficient. However, while money has to be increasingly allocated by the market going forward, the

government is still struggling to keep its industrial strategy in place. So we’re entering a period of financialdecompression in which financial system risk increases. There are parallels in Japan in the 1970s and 80s,

and Korea or Taiwan in the 1980s. With capital controls in place I don’t see short-term risk. The recent panicabout China’s outlook was overdone and I think markets are realising this. What concerns me more is that nowis the time the government should be seeking to make real progress on institutional reform – in everything from

the judicial system to education to political pluralism. But I don’t see any evidence this is going to happen. So Isuspect that China will roll forward through another investment cycle, albeit with reduced growth, before really

running up to the limits of its existing growth strategy in a decade or so. I don’t think China is going to fall off acliff short term, but nor have I ever thought it would set any records for qualitative performance in economic

development. China’s clout comes from its 1.3 bn population, not because it does development better.

I suspect that

China will roll

forward through

another investment

cycle, albeit with

reduced growth,

before really running

up to the limits of its

existing growth

strategy in a decade

or so.


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Can China disrupt large Western firms?

For me, big companies are more important than big countries, and developing these big companies istherefore extremely important. I agree with the argument that high levels of concentration can make it harderfor EM companies to gain global competitiveness.

But, on the other hand, the acquisition of IP is probably easier today than it has ever been. So there areswings and roundabouts. Overall I think it is perfectly possible for EM firms to disrupt Western ones. As to theextent to which China will do this, we must be patient. So far we’ve really only seen Huawei make the grade.

But I would expect other firms to do so in the next decade, so long as the central government can maintainmacro-economic stability and avoid financial crises. Even today, becoming a global leader takes time. In thenext few years we’ll see a firm like Great Wall Motors launch a major assault on world markets, we will see

what Lenovo is really capable of, we will see if any of the Chinese new energy businesses can become a world

leader.

Chinese firms, then, can disrupt Western ones, although in some businesses the heavy role of state firms isproblematic. State ownership is not always disastrous, but it’s very hard to find examples of where it works inconsumer-facing businesses. In China’s auto industry for instance, the continued presence of the state auto-

makers and their joint ventures makes life for the private ones – like Great Wall – much more difficult than it

need be.

What is your view of Japan in this context?

Japan’s an extraordinary country which made all the intellectual breakthroughs in East Asia with respect to the

means to economic development, including the first land reforms in 1873. In the 19th century the Japanesewent around the world on long journeys to see how stuff worked and talked to as many people as possible in

order to understand it. They were the society that brought rapid development to East Asia. Despite thisdemonstrated capacity for change, however, Japan has become stuck in a rut because of failure to change.

It’s just extraordinary that a country which produced such path-breaking developmental performance in the 19th century, and again after World War II, could do so little to avoid the malaise that it went through for the past 20years. So will Japan make the necessary changes? Much will depend on the extent to which Mr. Abe can play

the role of the outsider. He doesn’t really have outsider credentials, so one fears that key structural changes,particularly to the labour market, will not be delivered. But he has certainly had a very positive effect on

morale.

Originally featured in issue 62 on dominance ( Fortnightly Thoughts: Concentrating on dominance, September 26, 2013)


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About Prof. Raj Rajkumar

Professor in the Department of Electrical and Computer Engineering and Co-director of the General Motors-Carnegie Mellon Autonomous

Driving Collaborative Research Lab. He is the CEO of Ottomatika, Inc., and previously worked at IBM T.J. Watson Research Labs

When do you expect to see completely autonomous vehicles on roads? What are the key milestones

between now and then?

I expect completely driverless cars to be feasible only in the 2020s, and even then it will first be offered in

some developed countries, where the infrastructure is more advanced and traffic rules are generally obeyed. Autonomous vehicles will take longer to appear in developing economies because: (a) their driving etiquettetends to be very aggressive with very thin error margins, and (b) higher costs will initially be a deterrent.

These issues will likely continue in the 2020s too. We can also expect that some rich, developed city-states orsmall countries like Singapore or Qatar, which are forward-looking in terms of adapting cutting-edge

technologies, to become earlier adopters.

In terms of milestones, there are two very different ongoing paradigms. The first is the so-called “Holy Grail”approach exemplified currently by companies like Google, which has been experimenting on fully autonomousvehicles. Here the milestone is really one capability - the vehicle will be able to drive to its destination all by

itself. But, another approach is the paradigm of incremental automation adopted by today’s carmakers. Most if

not all car companies expect a human to be part of the driving process for quite some time to come. Even ifthe human is not necessarily driving, manufacturers expect a human driver to be present in the driver’s seat,engage and take over control from the self-driving mode as and when necessary. That is still an advance from

cruise control, where right now, the driver gives up control over the accelerator pedal, but still operates thebrake and steering wheel. Most importantly, the driver has the responsibility of cancelling cruise control and

taking back full control when there is a vehicle driving at a lower speed ahead.

So, in this second paradigm, the first milestone - and it’s very imminent - is an autopilot capability on thehighway, allowing drivers to engage in a driving mode where the vehicle steers, brakes and accelerates in the

current lane. The next development is a highway pilot capability with lane changes, where the vehicle can alsochange lanes to pass a slow-moving vehicle in its lane. Another milestone is a self-parking feature, with yet

another being traffic jam assist (TJA) capability where the vehicle drives itself while in a traffic jam. When thetraffic jam clears the human needs to take back control. Production cars available for purchase will reach

these milestones in the next three to five years. My belief is that by the time vehicles become completelyautonomous, people would hardly notice it because they would have slowly, but steadily, given up control for

most of the driving functions before that final step.

Does transportation infrastructure like roads and traffic lights need to change to facilitate the

development of this technology?

It is very unlikely that infrastructure will change broadly enough to accommodate this technology in theforeseeable future. As such, autonomous vehicles are being built on the assumption that there will be no

special infrastructure for driverless cars. That being said, infrastructural enhancements would be extremelybeneficial for self-driving cars.

A wireless communication device which can be added to traffic lights can transmit the location and current

status of the traffic light to a receiver implanted in a vehicle, allowing a self-driving car to react appropriately.Similarly, this wireless system can also facilitate vehicle-to-vehicle (V2V) and other vehicle-to-infrastructure(V2I) communications. For example, a car can communicate to the traffic light about where it is going, so that

the traffic light can adjust its timing, turn green and let a car pass when there is no traffic in other directions.

This should significantly reduce delays and pollution. Furthermore, such technologies will become available onsmartphones to enable vehicle-to-pedestrian (V2P) communications, automatically alerting vehicles andpedestrians, when a pedestrian is crossing the street. It must be borne in mind that the cost of upgrading traffic

lights involves significant inertia.

Fortunately, these communication technologies exist today, and cars will be able to dynamically plan routesand co-ordinate with other vehicles. However, changes in infrastructure will only happen incrementally. We are

beginning to see mandates in the US, in Europe and in Japan to implement the wireless technology. Starting inabout 2017 or 2018, the US government is expected to require that all newly manufactured vehicles carry this

technology. But even so, given the whopping 250 million cars that can operate in the US and assuming thatroughly 15 million new cars are sold every year, it would take 16 to 17 years to replace the current fleet of

cars. So, it will take time.

What are the societal and economic benefits of self-driving vehicles?

Every year an estimated 1.2 million people die and hundreds of millions of people get injured due toautomotive accidents, taking a huge toll on society, both emotionally and economically. Imagine the potentialbenefits if we could take human error, which accounts for more than 90 percent of these accidents, out of the

equation. Unlike people who are prone to distraction, computers are not and they will be able to drive a lotsafer. Another value-add of autonomous vehicles would be an improvement in productivity.

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15 Interviews to Read This Summer