Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Hello and welcome to another episode of The Odd Laws podcast.
Speaker 2: I'm Joe Wisenthal.
Speaker 3: And I'm Tracy Alloway.
Speaker 2: In this ongoing trade war, I don't know. I guess
Speaker 2: it's a trade war, all the trade headlines. I have
Speaker 2: to say. One of the things I always think about
Speaker 2: is and I write about it, and we reference it.
Speaker 2: The two of us reference it all the time. The
Speaker 2: complexity and the importance of sort of building complex things
Speaker 2: as a marker of a sort of country's capacity for wealth,
Speaker 2: and the sort of complex international trade webs that undergird
Speaker 2: the production of complex things.
Speaker 3: Joe, I know what you think about. It's monkeys and do.
Speaker 2: You think about that?
Speaker 4: Yeah?
Speaker 3: I do think about that.
Speaker 1: Okay.
Speaker 3: The reason I think about monkeys and trees is because
Speaker 3: couple of years ago we had Ricardo Houseman on the
Speaker 3: podcast and he used this metaphor to describe why some
Speaker 3: countries are richer, more economically developed than others. And the
Speaker 3: metaphor was that certain products or industries are like trees
Speaker 3: in a forest, and the firms are like monkeys, and
Speaker 3: so businesses kind of jump from tree to tree, and
Speaker 3: so what you find is if a country gets good
Speaker 3: at one particular product, then the business the monkey will
Speaker 3: jump to the next tree, the next adjacent product, and
Speaker 3: use that experience to build out their offerings. And so
Speaker 3: you tend to see, you know, the more complex economies,
Speaker 3: the bigger forests, the more monkeys swinging from trees are
Speaker 3: indicative of greater advancement and more wealth.
Speaker 2: Right, And this is how you can have a you know,
Speaker 2: a country that at one point specialized in rubber becoming
Speaker 2: a major player in cell phones, or a economy that
Speaker 2: one point made t shirts, which requires some level of
Speaker 2: coordination of supply chains from the thread and the electricity
Speaker 2: to power the looms suddenly become much more advanced any
Speaker 2: number of things. Anyway, I think there's a very powerful idea.
Speaker 2: But when I think about, you know, the idea that Okay,
Speaker 2: now there's this trade barrier between the US and Canada,
Speaker 2: for example, and we have these complex webs of supply
Speaker 2: chains in which goods cross the border multiple times. Do
Speaker 2: we constrain our capacity to do complex things?
Speaker 3: Are the monkeys going to slam headfirst into a trade wad?
Speaker 2: Yeah, it's literally right, Like they're swinging around and they're
Speaker 2: making these webs and densifying and then suddenly they slam
Speaker 2: into a wall in a very real way. What does
Speaker 2: it mean for American wealth if America is sort of
Speaker 2: like constrained.
Speaker 3: Yeah, this ecology of trade, I think it's a very
Speaker 3: valid question.
Speaker 2: Well, I'm very excited back on the podcast that we're
Speaker 2: going to be speaking with Ricardo Housman, professor at the
Speaker 2: Harvard Kennedy School and the founding director of the Harvard
Speaker 2: Growth Lab. So, Professor Housman, thank you so much for
Speaker 2: coming back on Outlaws.
Speaker 4: Thank you for having me. I'm really happy to be back.
Speaker 2: It does not seem like if we're thinking from the
Speaker 2: complexity framework, right, if we're gonna start like putting up nets,
Speaker 2: maybe it's nets, we're gonna start putting up nets in
Speaker 2: the forest between the trees from place it does seem
Speaker 2: harder for the monkeys to swing.
Speaker 4: Well, the way I think about the problem is that
Speaker 4: the complexity that you were talking about in the introduction
Speaker 4: is really the amount of knowledge that you have to
Speaker 4: put together in order to be able to do things.
Speaker 4: And the question is a little bit you know, how
Speaker 4: mobile is that knowledge, how easy it is for you
Speaker 4: to get to that knowledge? And that knowledge takes if
Speaker 4: you want three forms, it takes the form of embodied
Speaker 4: knowledge and tools and materials. So when you buy a cookbook,
Speaker 4: it says if you want to make an omelet, it says,
Speaker 4: you know, take eggs, take milk, take this, take that.
Speaker 4: It doesn't tell you how to make eggs. It doesn't
Speaker 4: tell you how to make milk. You just you just
Speaker 4: buy the eggs, and you don't you disregard all the
Speaker 4: technologies that go into making chickens and to making eggs,
Speaker 4: and to feeding the chickens, and you disregard all of that.
Speaker 4: You just buy the eggs, right, and all the knowledge
Speaker 4: that was embedded in it, it's just in the egg.
Speaker 4: So embodied knowledge is one form of knowledge, and trade
Speaker 4: is one way to get it right. Codified knowledge is
Speaker 4: the knowledge that exists in recipes, formulas, algorithms, do files.
Speaker 4: You know, you just need to have the code and
Speaker 4: follow the instructions if you are and then the third
Speaker 4: form of knowledge is nohow in brains. And the problem
Speaker 4: with knowledge is that there's very little knowledge that fits
Speaker 4: in a brain. So if you want to run a company,
Speaker 4: you need a lot of knowledge. You need knowledge about accounting,
Speaker 4: about finance, about human resource management, about procurement, about production,
Speaker 4: about branding, about marketing, you know about taxes, about contracts.
Speaker 4: So you need a lot of knowledge. And to bring
Speaker 4: that knowledge together, you need a team of people that
Speaker 4: you need to put together. And complexity comes from, you know,
Speaker 4: the breadth of the team that you have to put together. Now,
Speaker 4: the more you can kind of modify stuff, then you
Speaker 4: don't need to put the brains together because it's all
Speaker 4: in the code. That's one of the things that we
Speaker 4: may talk about artificial intelligence. It makes things in some
Speaker 4: sense simpler because the knowledge is in the machine. It's
Speaker 4: no longer you no longer need a brain to do it. Now,
Speaker 4: what these trade barriers are doing is that they are
Speaker 4: preventing you from, say, buying the eggs right so that
Speaker 4: now you need to know how to do the eggs yourself.
Speaker 4: So in some sense it's making things harder to do.
Speaker 4: As Larry Summers has pointed out, there are about sixty
Speaker 4: times more jobs using steel than job making steel. So
Speaker 4: you know, you protect steel, you're making it easier for
Speaker 4: all those guys that were going to make omelets by
Speaker 4: making now the eggs harder to get. And that's going
Speaker 4: to come at a detriment. You're going to get maybe
Speaker 4: more jobs and steel making in the US, and you're
Speaker 4: going to make all the people who use steel have
Speaker 4: more trouble competing in the domestic market with their products
Speaker 4: and more trouble selling their products abroad because now they're
Speaker 4: buying more expensive eggs, more expensive steel. In this metaphor,
Speaker 4: so in some sense, yes, what you're saying is that
Speaker 4: bread barriers are going to make the ability to put
Speaker 4: things together harder in the US. It's going to incentivize
Speaker 4: some of the things that are being protected, but it's
Speaker 4: going to create difficulties for everybody who you uses those
Speaker 4: things to make other things.
Speaker 3: Is there a way to design tariffs or other protectionist
Speaker 3: trade measures in such a way that you would preserve
Speaker 3: knowledge and I guess preserve access to some of the
Speaker 3: components you need to build out more complex industries.
Speaker 4: I mean, an interesting question is what is the case
Speaker 4: for intervening in the market. Why would you need a policy?
Speaker 4: And then the second question is would trade would tariffs
Speaker 4: be your instrument? Okay, so I would say that economic
Speaker 4: theory gives you at least three good reasons to intervene
Speaker 4: in the market. That might justify something you might want
Speaker 4: to call industrial policy. And then the question is is
Speaker 4: tariff's the right industrial policy because now they're putting tariffs
Speaker 4: on steel and aluminum. They want more still and aluminum
Speaker 4: being made in the US. If you wanted more still
Speaker 4: and aluminum made in the US, what instruments could you
Speaker 4: have used? And its tariffs the right way? Okay, So
Speaker 4: first there is the argument that in order to make something,
Speaker 4: you have to know how to make it. You know,
Speaker 4: it's hard to make things you don't know how to
Speaker 4: make it, and typically when you start something you don't
Speaker 4: you're not particularly good at it, but maybe over time
Speaker 4: you become better at it. There are some learning curves,
Speaker 4: and you want to get into those learning curves. And
Speaker 4: that's a compelling reason maybe to intervene in a relatively
Speaker 4: new industry where you know you haven't yet to figure
Speaker 4: things out, saying maybe like solar panels or batteries, or
Speaker 4: you know something that's relatively new that you still have
Speaker 4: yet to figure out. You wouldn't do it for a
Speaker 4: mature industry like say like electric gas turbines, because you
Speaker 4: know they've optimized that to death and you know there's
Speaker 4: there's no significant breakthroughs for decades now, so still would
Speaker 4: not be the obvious thing that would come to mind. Right,
Speaker 4: it's a nineteenth century chnology, it's an industry that has
Speaker 4: that's quite mature, etc. But you might have a national
Speaker 4: security reasons to protect it or something, but definitely not
Speaker 4: learning curves. By the way, those learning curves, if they
Speaker 4: are like inside the company, if it's something that the
Speaker 4: company is learning and the company owns, markets have been
Speaker 4: super happy to fund that. I mean, markets have funded
Speaker 4: Amazon for decades while the company was losing money because
Speaker 4: they're saying no, no, the company is figuring out how
Speaker 4: to sell stuff on the internet. Eventually, when they do
Speaker 4: figure it out, they will have access to a humongous
Speaker 4: market and that's going to be super valuable. So markets
Speaker 4: supported negative cash flows in Amazon for a very long time.
Speaker 4: So you have to argue that these learning curves somehow
Speaker 4: spill over into the value chain, spill over into more
Speaker 4: complicated things to coordinate, and that's why you need some
Speaker 4: kind of action. Sometimes the reason why industries get into
Speaker 4: trouble is that you have chicken and egg problems that
Speaker 4: you know the supplier is not there because you are
Speaker 4: not there and you're not there because the supplier is
Speaker 4: not there. So there's a good equilibrium in which both
Speaker 4: you and your suppliers are there, and there's a bad
Speaker 4: equilibrium in which neither of you is there. So how
Speaker 4: do you go from the val equilibrium where none is
Speaker 4: there to the good equilibrium where both are there. And
Speaker 4: that's a problem that we know how to solve. In
Speaker 4: each one of these cases, caras may not be the
Speaker 4: right instrument. So for example, you know, if you wanted
Speaker 4: the supplier and you to be there, well, maybe the
Speaker 4: garment comes and says, you know, I'm going to give
Speaker 4: a supplier the guarantee that you're going to buy from them,
Speaker 4: and I'm going to give you a guarantee that the
Speaker 4: supplier is going to be there to sell you. So
Speaker 4: you install your plant, he installs this plant, and the
Speaker 4: guarantee expires worthless. So the government can coordinate on the
Speaker 4: good equilibrium. Essentially no money and taxing nobody. A set
Speaker 4: of guarantees would do the trick. If you want the
Speaker 4: firm to learn, I mean, one thing is to have
Speaker 4: these temporary what they call infant protection and the term
Speaker 4: in the literature is infant industry protection. So you take
Speaker 4: an industry at its infancy, and you give it some
Speaker 4: protection until it finds its way, and then you open
Speaker 4: up an alternative to that is you subsidize their capital investment,
Speaker 4: or you guarantee their demand maybe government procurement or something else,
Speaker 4: or you give it a special tax treatment, so you
Speaker 4: have other ways to intervene. The moment you intervene with tariffs,
Speaker 4: you're essentially dumping the cost on the consumers of that industry,
Speaker 4: and the consumers of that industry are going to become
Speaker 4: less competitive, and their size will shrink, and they may
Speaker 4: become vulnerable to other attacks. So it's not the ideal instrument.
Speaker 4: There's an additional reason why it may not be the
Speaker 4: right thing to do. The US is and politically, part
Speaker 4: of all these policy is based on the fact that
Speaker 4: the Midwest did very poorly. The russ Belt did very poorly.
Speaker 4: They lost a lot of manufacturing jobs, and you would
Speaker 4: like jobs to go back to the Midwest. Pittsburgh loss
Speaker 4: it's steal industry. Garandianna lots it's steal industry. Youngstown, Ohio, Cleveland, Detroit,
Speaker 4: et cetera. These cities lost jobs in some industries. Now
Speaker 4: you put the barriers you put tariffs at the national level.
Speaker 4: It doesn't mean that the industries are going to go
Speaker 4: to the Midwest. They may go to write to work
Speaker 4: states in the South. They may go to the Southwest.
Speaker 4: So it's not not your solution to the places at
Speaker 4: your t I have to help those might be better
Speaker 4: dealt with using place based instruments.
Speaker 2: You know, I really like this idea of physical products
Speaker 2: as embedded knowledge, so that if I'm making some recipe
Speaker 2: that calls for eggs, that the eggs that I buy
Speaker 2: are the end result of all the knowledge of the farmers.
Speaker 2: I don't have to have that knowledge myself. It makes
Speaker 2: it simpler process. I was reading a speech recently Ellen Young.
Speaker 2: This speech was given I think in nineteen twenty eight.
Speaker 2: Here's the former president of the London School of Economics,
Speaker 2: and he said, it is generally agreed that Adam Smith,
Speaker 2: when you suggested the division of labor leads to inventions
Speaker 2: because workmen engaged in specialized routine operations come to see
Speaker 2: better ways of accomplishing the same results miss the main point.
Speaker 2: The important thing, of course, is that with the division
Speaker 2: of labor, a group of complex processes is transformed into
Speaker 2: a succession of simpler process. So therefore making something with
Speaker 2: eggs is simpler because someone else doing the simple job
Speaker 2: of making of growing eggs, I'm making the simple job
Speaker 2: of maybe making an omelet or something. Something becomes a
Speaker 2: succession of simpler jobs. But the question I have is,
Speaker 2: does that mean that sort of like sheer market size
Speaker 2: as measured by even by things like population, et cetera,
Speaker 2: become important in these questions because if we're going to
Speaker 2: make complex things, doesn't that on some level require either
Speaker 2: through our population or our friends population, a decent number
Speaker 2: of people who can then do all of these individually
Speaker 2: simple tasks.
Speaker 4: Well, I mean, if that's the reason why value chains
Speaker 4: have become longer, where you just slice it into more modules,
Speaker 4: and then you bring those modules together, and then some OEM,
Speaker 4: some original equipment manufacturer that is putting fifty thousand pieces together,
Speaker 4: and then each one of the fifty thousand pieces, it
Speaker 4: becomes a more manageable task. But some industries require a
Speaker 4: lot of a lot of talent that has to come together.
Speaker 4: And for example, when you go to the do you
Speaker 4: see a film? In the movies, sometimes they put at
Speaker 4: the end of a movie it says the end, but
Speaker 4: it's a misnomer because after they put the end, they
Speaker 4: start showing you the credits, and the credits go on
Speaker 4: for minutes and minutes. You know, there's there's the casting,
Speaker 4: there's the sound effects, there's the visual effects, there's editing,
Speaker 4: director of photography. So you need a whole massive team
Speaker 4: of people that are involved in that in that movie
Speaker 4: making industry. Well, an industry that requires this deep pool
Speaker 4: of differentiated talent tends to locate only in very large cities,
Speaker 4: say like Los Angeles or New York. That's the only
Speaker 4: place where you would you could put together all that
Speaker 4: necessary talent that is required. So industries that require a
Speaker 4: more diverse pool of talent tend to locate themselves in
Speaker 4: bigger cities, and the ones that are kind of simpler,
Speaker 4: lower complexity, they can afford to locate in a smaller
Speaker 4: city because in that smaller city they could probably find
Speaker 4: the more limited diversity of skills that they need. Now,
Speaker 4: one of the things that is a feature of the
Speaker 4: American economy over the last twenty years is that the
Speaker 4: industries that tend to locate in large cities have done
Speaker 4: dramatically better than the industries that tend to locate in
Speaker 4: smaller cities. The industries that tend to locate in smaller cities,
Speaker 4: they tend to demand more land and not that diverse
Speaker 4: labor force. So they're not willing to pay the high
Speaker 4: prices of land of big cities so they can buy
Speaker 4: more land and they don't rely so much on this
Speaker 4: diverse labor force. But the industries that require a deep,
Speaker 4: diverse pool of talent, they are willing to pay the
Speaker 4: higher price of land in larger cities because they don't
Speaker 4: use that much land. So what I would put it
Speaker 4: to you is that part of the drama of the
Speaker 4: US is the fact that there's been this shift in
Speaker 4: demand in favor of the things that happened to be
Speaker 4: done in bigger cities. And by the way, let me
Speaker 4: make a very important point. We just saw the elections
Speaker 4: in Poland, and the elections in Poland meant that, you know,
Speaker 4: the president that won that election is a more called it,
Speaker 4: a more trump like figure, and in fact, his party
Speaker 4: pis he got elected more or less ten years or
Speaker 4: eleven years before Trump, so there was already kind of
Speaker 4: like a Trumpian motivation behind the election of that party.
Speaker 4: They were upset about Trey and globalization, and Europe and
Speaker 4: so on. Now, the interesting thing about Poland is that
Speaker 4: Poland is at the exact opposite experience of the US.
Speaker 4: In terms of trade. Poland has seen rising market share
Speaker 4: across the board in all industries, in agriculture and manufacturing,
Speaker 4: in cars, in machinery, in textiles, they have made out
Speaker 4: like Bandits. Trade has exploded positively in Poland. But the
Speaker 4: thing that has exploded in Poland has benefited these larger
Speaker 4: urban areas and has has heard the smaller, less metropolitan
Speaker 4: parts of the country, and that has generated a political backlafe.
Speaker 3: So even even if the gains have been absolute for
Speaker 3: Poland overall, I guess the relative differences within the country
Speaker 3: are are have become a grievance.
Speaker 4: Yes, let me say one point that we often they
Speaker 4: do not emphasize. No, we often think of countries as
Speaker 4: small open economies. They are small in the sense that
Speaker 4: what they do is not going to change the global economy.
Speaker 4: The US is relatively bigger, but many countries think a
Speaker 4: smaller open economy. When you think of a city, a
Speaker 4: city tends to be an even smaller and even more
Speaker 4: open economy. It's smaller, right, much smaller than the country
Speaker 4: it's in right, and it's more open because it trades
Speaker 4: with not only the rest of the world, but the
Speaker 4: rest of the country, and the labor force can either
Speaker 4: come from the rest of the country or leave to
Speaker 4: the rest of the country. Right, So what tends to
Speaker 4: characterize a city. And you know, for a country, its
Speaker 4: export base is super important. For a city, its export
Speaker 4: base is even more important because a city is less
Speaker 4: self sufficient than a country. A city needs to consume
Speaker 4: a lot of things that it doesn't make. Most cities
Speaker 4: don't make cars, don't make antibiotics, most cities don't make
Speaker 4: X ray machines, they don't make, you know, eggs. So
Speaker 4: all of these things have to be brought in and
Speaker 4: to pay for these things that they want to consume
Speaker 4: in the city, they need to earn money from outside
Speaker 4: the city. They need to export in order to be
Speaker 4: able to import. So the set of export activities in
Speaker 4: a city determines very much the life of the city.
Speaker 4: If those export activities in the city get into trouble,
Speaker 4: then it's not just that those jobs in those exports,
Speaker 4: in thus trees getting, you know, are lost, but those
Speaker 4: workers used to you know, go to the barber, go
Speaker 4: to a grocer go to the dentist. So all those
Speaker 4: jobs in all of these local services also get lost,
Speaker 4: and you get this multiplier local effect and people start
Speaker 4: leaving the city. The moment people start leaving the city,
Speaker 4: their housing prices go down. There's less money to pay
Speaker 4: for education, so the quality of education, the theories, and
Speaker 4: you get all of these negative local effects in the city. Okay,
Speaker 4: that's associated with the export industry of your city getting
Speaker 4: into trouble. So what I'm saying is that the shift
Speaker 4: in demand has it hurt cities. The kinds of industries
Speaker 4: that tend to locate in smaller cities, the kind of
Speaker 4: industries that need less of a deep pool of talent
Speaker 4: and more land. And the current industry is a good example.
Speaker 4: The whole still you skill is a dirty, complicated, large thing.
Speaker 4: So it may hire a lot of workers, but it
Speaker 4: doesn't want to have too many people around them. They
Speaker 4: need a lot of land, so they're not going to
Speaker 4: go to Los Angeles. They're going to go to a
Speaker 4: place where they can acquire a lot of land to
Speaker 4: put their big plant. And it's the fact that the
Speaker 4: export sector of cities in the Midwest, say, got into trouble.
Speaker 4: The fact that the export activities in some parts of
Speaker 4: Poland got into trouble, that they got into this negative
Speaker 4: spiral as people you know, left because they have better opportunities,
Speaker 4: and maybe other parts of the country, in larger cities,
Speaker 4: they leave behind a deteriorating economic and social situation.
Speaker 3: I promise not to get to hung up on metaphors
Speaker 3: and monkeys, but I just want to go back to
Speaker 3: the egg analogy for one second. So I understand. You know,
Speaker 3: division of labor expertise can lead to efficiency and app
Speaker 3: gains economically for everyone. However, you know, I'm thinking back
Speaker 3: to when egg prices were very high in the US
Speaker 3: earlier this year, and I joked on this podcast that
Speaker 3: I was going to get my own chickens so that
Speaker 3: I could declare egg independence, egg autarchy and have my
Speaker 3: own supply. Are there not arguments, you know for certain
Speaker 3: things that you would want to have the capacity to
Speaker 3: build those components at home in order to enable you
Speaker 3: to build more complex items.
Speaker 4: Well, no, you would want to make sure that you
Speaker 4: have a diversified source of supply, so that there's a
Speaker 4: problem in Brazil, you can buy from somewhere else. Right,
Speaker 4: So this whole thing about food security that some countries say,
Speaker 4: you know, we need to have food security, so we
Speaker 4: need to produce food in our country at three times
Speaker 4: the international price. Well, I mean that's not food security.
Speaker 4: That's exacerbated risk because you know your country can be
Speaker 4: hit by a drought, by a storm, by et cetera.
Speaker 4: Many things that could destroy your food production. So you're
Speaker 4: going to face much less risk if you have a
Speaker 4: diversified source of materials. And that's one reason why you
Speaker 4: would want to have a good trading relationships with many
Speaker 4: countries because that way, you know, if you get in trouble,
Speaker 4: you can buy from somewhere else. So no, I in general,
Speaker 4: this idea that the price of wheat worldwide goes up,
Speaker 4: that's the reason for you to have your own wheat production.
Speaker 4: That doesn't follow at all. Your wheat production might be
Speaker 4: it might subject you to even more risks than a
Speaker 4: diversified source of wheat from across the world. It's a
Speaker 4: different thing if you're talking militarily, right.
Speaker 3: Yeah, I was going to say, what about something like
Speaker 3: I want to build semiconductors domestically because I think they're
Speaker 3: a very important part of our defense strategy.
Speaker 4: Well, I can perfectly understand that you have an incredible
Speaker 4: concentration of semiconductors in Taiwan, and it's very easy to
Speaker 4: imagine a situation where you no longer have access to
Speaker 4: those semiconductors. So in that case, I can I can
Speaker 4: see the case that would justify things like the Chips Act,
Speaker 4: not necessararily things like tariffs on chips, but because tariffs
Speaker 4: and chips would make all industries that use chips less competitive,
Speaker 4: et cetera. But you know, in creating an encouragement for
Speaker 4: and by the way, convincing TSMC or the Taiwan Semiconductor
Speaker 4: Manufacturing Company, which is the best a foundry in the world,
Speaker 4: to come and see if they can figure out how
Speaker 4: to make it in Arizona. And by the way, it's
Speaker 4: very interesting and it shows you the importance of knowledge
Speaker 4: and know how that sometimes it's very very difficult for
Speaker 4: the same firm that supposedly the firm knows how to
Speaker 4: do something, say Boying knows how to make airplanes in Seattle. Well,
Speaker 4: guess what, making airplanes in South Carolina. Making Boying airplanes
Speaker 4: in South Carolina proved to be much harder than making
Speaker 4: airplanes in Seattle, and transporting the knowledge was a big headache,
Speaker 4: and right now TSMC is facing serious challenges and transporting
Speaker 4: the knowledge to Arizona. So if you put the accent
Speaker 4: on moving the knowledge, things look a little bit different
Speaker 4: than just a discussion about tariffs.
Speaker 2: Yeah, supposedly the yields on the Arizona fabs are quite impressive,
Speaker 2: and they're starting together momentum. Of course, your point is taken,
Speaker 2: but actually this does raise some questions. I mean, you've
Speaker 2: talked about, okay, the importance of diversity of your supply chain.
Speaker 2: To my mind, actually when I hear that, I think, okay,
Speaker 2: there's something legitimate about like anxiety about China specifically, because
Speaker 2: what's happening in manufactured goods is that it's not a
Speaker 2: globally diverse supply chain. It's becoming in many areas a
Speaker 2: China only supply chain. That China's lead in this, that
Speaker 2: its network effects, that it's internal whatever is becoming so
Speaker 2: concentrated in one country for such a big range of
Speaker 2: goods that at least from a non China perspective, it
Speaker 2: feels like from a risk management standpoint, et cetera, that
Speaker 2: there probably is a very good imperative to put forth
Speaker 2: effort towards not necessarily having an American production capacity, but
Speaker 2: a non China production capacity.
Speaker 4: Well, we went through a Japan scare in the nineteen eighties, right,
Speaker 4: And what ended up happening in Japan is that Japan
Speaker 4: kept on progressing and becoming good at everything to a
Speaker 4: point that wages in Japan went top a lot, and
Speaker 4: Japan started to move their industries outside, the phenomenon that
Speaker 4: was called the flying Geese, right, and so Toyota started
Speaker 4: to make cars in Thailand and put things in Korea
Speaker 4: and so on and so forth, and then they went
Speaker 4: into poor states like Vietnam or Indonesia. So what you
Speaker 4: have is that the more advanced manufacturing or the more
Speaker 4: advanced parts of the value chain like R and D design,
Speaker 4: et cetera, are retained in headquarters, and you move the
Speaker 4: more labor intensive, the less skill intensive, the less complex parts,
Speaker 4: the more standardized parts. You moved to a locations that
Speaker 4: pay lower wages, and everybody is better off because for
Speaker 4: those locations, it's a step up for you. It's a
Speaker 4: way to save on labor costs that you cannot afford
Speaker 4: in your country because you want to pay your workers
Speaker 4: very very well, and you can afford to do that
Speaker 4: because you have plenty of jobs for them, and the
Speaker 4: more complex part of the value chain you don't need
Speaker 4: to hire them, and the less complex part part of
Speaker 4: the beligian So there is a world in which this
Speaker 4: is a process. China is getting richer. A lot of
Speaker 4: the things that are being done in China, by the way,
Speaker 4: initially they were done in the coast, and so now
Speaker 4: the coast has become too expensive, they're moving to elsewhere
Speaker 4: in the country and to elsewhere in the region. And
Speaker 4: you know, now there's more production in Vietnam, there's more
Speaker 4: production even in Cambodia. There's more production in poor other
Speaker 4: countries simply because the Chinese worker is now too expensive.
Speaker 4: So there's a world in which this is just part
Speaker 4: of just a repetition of what happened in Japan. But
Speaker 4: let me make an important point. When a production is
Speaker 4: happening elsewhere, it might be happening in a country. A
Speaker 4: good question is where does the knowledge that they're using
Speaker 4: come from? Because what is happening in the world today
Speaker 4: is that the rich countries are becoming more and more
Speaker 4: concentrated in producing knowledge. In order to monetize that knowledge,
Speaker 4: they need to put brick and mortar things that they
Speaker 4: prefer to put them in other parts of the world.
Speaker 4: So Japan, for example, has come up with a lot
Speaker 4: of innovations and a lot of R and D and
Speaker 4: a lot of patents. But the way they monetize their
Speaker 4: patents is not by hiring Japanese workers. That you know,
Speaker 4: Japanese labor forces is declining and so on, and they
Speaker 4: are at full employment. Anyway, they monetize their knowledge by
Speaker 4: deploying that knowledge elsewhere with foreign direct investments and so on.
Speaker 4: And that means that a lot of the of accounting
Speaker 4: of how this process happens is not well captured by
Speaker 4: our standard accounting techniques. For example, if Japan does R
Speaker 4: and D and that improves the productivity of their foreign investment,
Speaker 4: it doesn't show up as higher Japanese productivity. It is
Speaker 4: increasing productivity, but not just not in Japan, in the
Speaker 4: place is where Japan has its plans, and the same
Speaker 4: is happening in the US. If you think of the
Speaker 4: Magnificent Seven, the magnificence and for example Google, when Google
Speaker 4: sort of like this places all the small newspapers of
Speaker 4: the world because all advertising revenue is moving to it's
Speaker 4: moving online, and Google is capturing a good chunk of
Speaker 4: that that doesn't count as a US export because it's
Speaker 4: some subsidiary that Google put in I don't know, in
Speaker 4: South Africa or wherever that is collecting that revenue, and
Speaker 4: that revenue you could count it as a US export,
Speaker 4: but it's not being counted as a US export.
Speaker 2: It turns into the US marketcap exactly.
Speaker 4: It turns into the US into US marketcap. But US
Speaker 4: marketcap is very poorly captured by balance of payment statistics. So,
Speaker 4: for example, if you started the year two thousand, From
Speaker 4: two thousand to the present, according to official statistics, the
Speaker 4: US borrowed sixteen trillion dollars from the rest of the world.
Speaker 4: It ran a cumulative current account deficit of sixteen trillion dollars.
Speaker 4: You'd say, gee, you borrow sixteen trillion dollars. Well, how
Speaker 4: much are you paying for those sixteen trillion dollars. Let's
Speaker 4: say four percent? No, so four percent would be six
Speaker 4: hundred and forty billion dollars in interest payments right on
Speaker 4: the deck you borrowed. Now, if you look at the
Speaker 4: US balance of payments primary income, essentially, the US doesn't
Speaker 4: look like a country that has an external debt. They
Speaker 4: are essentially paying zero. They borrowed sixteen trillion dollars, which
Speaker 4: is say, sixty percent of GDP, and they're essentially not
Speaker 4: paying anything for it. So you would say, well, if
Speaker 4: I can borrow sixty percent of GDP for free, I
Speaker 4: would do that. Well, in some sense, that's what do
Speaker 4: you has done. The way I would like to describe
Speaker 4: it is that US didn't just borrow sixteen trillion dollars.
Speaker 4: It borrowed more like thirty two trillion dollars. It used
Speaker 4: sixteen trillion dollars to cover that official deficit and use
Speaker 4: the other sixteen trillion dollars to mix it with your
Speaker 4: knowledge and invest abroad. And that investment abroad, say Google
Speaker 4: in South Africa, mixed with US knowledge as this huge
Speaker 4: rate of return. So when you borrow thirty two trillion dollars,
Speaker 4: sixteen trillion dollars you borrowed at four percent, but the
Speaker 4: other sixteen trillion dollars you invested at a much higher
Speaker 4: rate of return because it was mobilizing your knowledge. And
Speaker 4: so thirty two trillion, say, you pay four percent over
Speaker 4: thirty two trillion dollars you borrowed, but you make eight
Speaker 4: percent on the sixteen trillion dollars you invest abroad. Well,
Speaker 4: it just turns out that eight percent over sixteen trillion
Speaker 4: dollars is the same as four percent over thirty two
Speaker 4: trillion dollars. You're not really running a deficit. You are
Speaker 4: monetizing your knowledge, but current accounting standards don't capture that.
Speaker 3: Well, this is very This reminds me of the Matrix
Speaker 3: and that scene where they say there is no spoon.
Speaker 3: What if there is no US external deficit? But okay,
Speaker 3: one thing I'm struggling to understand. So you know, you're
Speaker 3: arguing that the US actually has a significant amount of
Speaker 3: knowledge and know how that is mixed up with its
Speaker 3: foreign direct investment, and that doesn't show up in the
Speaker 3: official trade statistics. And I guess one thing I'm kind
Speaker 3: of curious about is and you're arguing that the statistics
Speaker 3: undervalue foreign direct investment. But I would have thought that,
Speaker 3: like foreign direct investment, valuations inherently reflect market expectations. And
Speaker 3: to Joe's point, I'm channeling Joe's love of the efficient
Speaker 3: market's HYPOTHESI here, but they should be captured in market
Speaker 3: cap and things like that. Why do we assume that
Speaker 3: the statistical agencies, the accounting systems systematically mispriced these assets.
Speaker 3: Are they not included anywhere.
Speaker 4: They use book value. When you see the investment abroad,
Speaker 4: they count how many dollars you sent abroad, and then
Speaker 4: they count how much money did you make abroad. And
Speaker 4: when you look at it, the rate of return on
Speaker 4: FBI is double the rate of return on debt in
Speaker 4: the accounts, So they're not counting the firm direct investment
Speaker 4: at the market value. By the way, it's very hard
Speaker 4: to calculate that market value because these are subsidiaries of
Speaker 4: companies that listed the S and P five hundred and say,
Speaker 4: if the price earningserration in the US is twenty six
Speaker 4: or something like that last time I checked, it means
Speaker 4: that they are thinking that all that's money that the
Speaker 4: Magnificent seven are making a broad they multiply by twenty
Speaker 4: six or an even higher number. Right, But that was
Speaker 4: not the accounting was made at book value. So in
Speaker 4: most of these companies there's a huge difference between book
Speaker 4: value and market value.
Speaker 3: Yeah, I was about to say, this is the argument.
Speaker 3: I think We've even done an episode on this about
Speaker 3: stock market valuations and how companies with a large amount
Speaker 3: of intangibles. It's not reflected in book value.
Speaker 4: Right, and that, in my mind is the market's valuation
Speaker 4: of your knowledge exactly. So in a world where knowledge
Speaker 4: is intensive, then book value becomes less of a guide
Speaker 4: on what's actually happening. In a lot of international trade
Speaker 4: statistics is book value because that's what they have to
Speaker 4: make the statistics.
Speaker 2: I think there's a really interesting question. I have one
Speaker 2: last question, and I wasn't expecting to go here, but
Speaker 2: I thought that was so interesting what you were saying
Speaker 2: about Poland and some of the politics not necessarily being
Speaker 2: about the country's overall trading position visa the rest of
Speaker 2: the world, but the internal dynamics of what is happening
Speaker 2: in these countries, where the booms are happening in cities,
Speaker 2: and how that is a function to some extent of experts.
Speaker 2: But I'm curious. One of the things that people bemoan
Speaker 2: about the current environment in the United States and probably
Speaker 2: elsewhere is that cities are no longer a good place
Speaker 2: for upward mobility. That you can't be poor or middle
Speaker 2: class that move to a city and find a job
Speaker 2: and move up the career ladder in the same way
Speaker 2: you could when cities were more centers of hard industrial activity.
Speaker 2: And I'm curious when you talk about the types of
Speaker 2: companies that locate in big cities versus the type of
Speaker 2: companies that locate in smaller cities, et cetera. Are the
Speaker 2: type of companies that locate in big cities not as
Speaker 2: conducive inherently towards upward mobility because there's just so much
Speaker 2: talent required just to get in the door anywhere at
Speaker 2: these firms.
Speaker 4: No, I think that the problem of big cities in
Speaker 4: the US is the fact that they have regulated urban
Speaker 4: space in such a way that housing supply is very inelastic,
Speaker 4: so as people try to move to a city, housing
Speaker 4: prices go up until it's unaffordable to move into a city.
Speaker 4: That if cities had a more elastic supply of housing,
Speaker 4: a more elastic supply of urban space, this dynamic would
Speaker 4: help generate more opportunities in those cities and would help
Speaker 4: maybe raise the price of labor in the cities where
Speaker 4: people are leaving, because now they've become scarcer and people
Speaker 4: would be willing to pay more for them. So that's
Speaker 4: why you're seeing so much growth in cities like Boiseaira
Speaker 4: or or Salt Lake City, or cities in Texas, Visa
Speaker 4: these cities in California and having incredibly inelastic supply of housing.
Speaker 4: So I would put there that, you know, on a
Speaker 4: more inclusive policy involves urban development that allows for that
Speaker 4: inclusion to happen.
Speaker 2: Ricardo Houseman, So great chatting with you. Always extremely thought provocative,
Speaker 2: always takes us down avenues that I don't expect. Really
Speaker 2: appreciate you coming back on outlause.
Speaker 3: Yeah, that was great.
Speaker 4: Thank you, Ricardo, Thank you for having me.
Speaker 2: Really like every time, like I mean every time. We've
Speaker 2: always spoken to Ricardo twice, but I feel like every
Speaker 2: time I talk to him, there's like a bunch of
Speaker 2: ideas that are going to stick in my head for
Speaker 2: a long time I'll be chewing on. In this one,
Speaker 2: it's this idea that like official trade statistics don't capture
Speaker 2: the fact that market value of this trade and which
Speaker 2: you could see in the stock market trading in the
Speaker 2: United States is much higher than what just sort of
Speaker 2: like what is captured in the activity. I'm really intrigued
Speaker 2: by this idea.
Speaker 3: On board with that idea, but I kind of wonder
Speaker 3: how far you can stretch it, and like can you
Speaker 3: stretch it all the way to actually, the US doesn't
Speaker 3: have an external deficit, or could you stretch it all
Speaker 3: the way to the idea that like, okay, well China
Speaker 3: needs to like worry about accruing liabilities from importing US expertise, Like.
Speaker 2: Yeah, I don't know what we need. Is a debate
Speaker 2: between Ricardo and Brad. Sets are ups because one of
Speaker 2: the dimensions. Look, one of the counter arguments to some
Speaker 2: of this stuff would be that there are actual flows,
Speaker 2: because the entity that might be set up in South
Speaker 2: Africa by a US multinational might pay licensing fees back
Speaker 2: so the home country for the right to use the
Speaker 2: Google name and so forth. Obviously, Brad talks a lot
Speaker 2: about this in the context I mean, he talks a
Speaker 2: lot about this actually in the context of software. But
Speaker 2: there is some you know. The fact is is that
Speaker 2: like Microsoft is gigantic and so even, and there's you know,
Speaker 2: these companies that are trillions in trillions of dollars and
Speaker 2: have huge footholds all around the world, and whether they're
Speaker 2: accruing value to America in a way that doesn't show
Speaker 2: up strictly in trade statistics strikes me as an important
Speaker 2: load to continue to mind.
Speaker 3: Well, that's the other thing I was going to say,
Speaker 3: which is, you see this debate in markets quite a lot,
Speaker 3: and the difficulty in analyzing intangibles is it's hard, right,
Speaker 3: Like how do you put a price on things like
Speaker 3: brand value or soft power and stuff like that, And
Speaker 3: so you get these arguments over. Okay, well, book value
Speaker 3: doesn't include intangibles, but you know, maybe it should. But
Speaker 3: if it should, then how do you avoid the problem
Speaker 3: of over inflating because you think that this brand value
Speaker 3: is really good and it's difficult to actually measure.
Speaker 2: Also, it doesn't matter what our trade statistics say if
Speaker 2: we can't make things critical for national security, Like to
Speaker 2: your point, whatever you say, oh, we don't really run
Speaker 2: any sort of trade issues, except if you don't actually
Speaker 2: have the physical capacity to make important things that are
Speaker 2: necessary for having a sovereign nation, then it kind of
Speaker 2: doesn't matter, doesn't You could run surplus and it wouldn't matter.
Speaker 3: I reject the idea that I need to have a
Speaker 3: diversified supply chain of eggs. I'm going full on egg autarchy.
Speaker 2: But here's the thing, Tracy, Like, you could do egg autarchy,
Speaker 2: but God forbid, Like some wolves get in there like
Speaker 2: you do still have the option of going to the
Speaker 2: grocery store, right, So like, even if you know it's like.
Speaker 3: See, then I just need a diversified supply of new chickens.
Speaker 2: It's like that pulp song about the Greek girl at
Speaker 2: the thirst for knowledge. It's like you'll never know what
Speaker 2: it's like because you always have the option to go
Speaker 2: to the grocery stores.
Speaker 4: You know.
Speaker 2: It's like you can't actually replicate true autarchy knowing in
Speaker 2: your head that you have that backup.
Speaker 4: Yeah, that's true.
Speaker 3: That's a good point.
Speaker 2: Yeah, that was a good one, wasn't it.
Speaker 3: That was very good. Okay, I think all right, shall
Speaker 3: we leave it there? Yeah, this has been another episode
Speaker 3: of the Authoughts podcast. I'm Tracy Alloway. You can follow
Speaker 3: me at Tracy Alloway and I'm Jill Wise.
Speaker 2: Oh, you can follow me at the Stalwart. Follow our
Speaker 2: producers Kerman Rodriguez at Kerman armand dash Ol Bennett at
Speaker 2: Dashbot and Kelbrooks at Kelbrooks from our Odd Lots content.
Speaker 2: Go to bloomberg dot com slash od Lots with a
Speaker 2: daily newsletter and all of our episodes, and you can
Speaker 2: chat about all of these topics. Twenty four to seven
Speaker 2: in our discord Discord dot gg slash out.
Speaker 3: Lots and if you enjoy odd Lots, if you like
Speaker 3: it when we talk about monkeys swinging from trees or
Speaker 3: egg autarchy, then please leave us a positive review on
Speaker 3: your favorite podcast platform. And remember, if you are a
Speaker 3: Bloomberg subscriber, you can listen to all of our episodes
Speaker 3: absolutely ad free. All you need to do is find
Speaker 3: the Bloomberg channel on Apple Podcasts and follow the instructions there.
Speaker 3: Thanks for listening. Eight