How a young venture capitalist stays confident about China's future despite challenges

This is a partial, lightly edited transcript highlighting some of the most interesting discussions in our last podcast episode with Johnny Zou, the Head of Primavera Venture Partners春华创投.

Johnny has a unique background. He worked at elite financial institutions and had impeccable Western training. At the same time, he is known to express views about China that may be considered a little unorthodox in his industry. At Primavera, Johnny mainly focuses on investments in AI, medical technology, cloud, shared economy, and cross-border opportunities. Johnny holds a Bachelor of Arts in History from Yale University and a Master of Science in Economic History from the London School of Economics. Johnny is also a fellow Sub-stacker, and he writes at one of my favorite Chinese-language substacks

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On “Total Factor Productivity” and “New Product Forces”

Robert: Hi Johnny, I read every article you write on your Substack

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. You've been writing quite regularly. And I also start to see some common themes among your different articles. You often say that China's regulators have done a major mistake since at least the 09 crisis that effectively made what you call the total factor productivity stagnate for almost a decade. Please explain in more detail to our audience which mistakes you think they are.

Do you think it's possible for China to avoid such a mistake if it was done again? Or is it inevitable? Or is there some way to mitigate this?

Johnny: To start with, I didn't make up the numbers for the so called total factor productivity's contribution towards economic growth.Actually, this whole concept was actually published by the People's Bank of China in 2021 because they did a review of China's economic growth since 1978's reform. And the outcome of this study is quite striking. Basically since 1978 total factor productivity before 2008 played a major role in China's economic growth.

So just for the listeners who don't really know this concept, total factor productivity is actually very simple. It means that any sort of growth that comes outside of population growth and capital growth. Prior to 2008, the contribution of total factor productivity towards China's growth is like 40%. And actually the early 2000s is the heyday, for our overall productivity which contributed to about 45 percent of our growth. But since 08 this percentage has gone down significantly. Initially, it's like a third, like 33%. But in recent years, you've seen numbers lower than 30%. And the overall average for 2013 through 2020 is actually 25%.

So what is the impact of that? It means that something in the economy is quite inefficient and the reason is because of policymaking. If you look at this from a retrospective angle, we did make a major mistake in 08 trying to prop up the entire economy using huge fiscal stimulus because as a result of that the capital growth is staggering and that has been evidenced by the balance sheet expansion of the People's Bank of China, which basically quadrupled since 2008.

The result is that the capital efficiency of our economy has gone down. It's a very simple sort of economics 101. Once you have a lot of capital within a single system, the return on capital will go down just because of the sheer supply of capital and because the demand growth won't be exponential by anyhow.

So I think as a result of the decline of the economy's productivity, now we are just paying the dues for this sluggish productivity growth. And because of multiple reasons, because of COVID, because of geopolitics, and because of China's internal leverage cycle, the capital supply of our entire economy has just gone down significantly compared to the 2010s era. As a result of that, our economic growth also became a little bit sluggish compared to 5 to 10 years ago.

So I think that's really from a retrospective angle, it's a major mistake. But I wouldn't say that if we were having a time machine and going back in time that we could fix it.

I think it's mainly because of three reasons. The primary reason is that we were so married back then in the China-US relationship. That's a strategic relationship that we believe that China and the U.S. can coexist forever. And so because of the 2008 financial crisis and China being the largest holder of U.S. treasuries, we felt like if we didn’t really stimulate our economy so as to expand the global economy, then we'll have a major impact towards this relationship as well as the global economy. So that's the fundamental belief of the leadership back then. And I think it's very hard to really change that view because, in 2008, I don't think there's anyone really calling that China's is the biggest enemy of the US, or like a strategic competitor.

Number two is I think the previous 30 years of China's economic leadership have been very married to Western economics and western values.

So when a huge financial crisis like 2008 happened, the only thing that occurred to them was, what should we do according to the textbook? And the textbook response is actually to stimulate the economy. And unlike the US, which they used extraordinary monetary policy, trying to prop up the economy at that time, our main method to expand the economy was through fiscal policy with some monetary expansion.

So I feel like they're just following the textbook. And that's the right thing to do according to the textbook. And that's why we should do it. And that's why there's very little reason to believe that they will think otherwise. And as a result of that, if we expand too much, it's actually not beneficial to me, right? I don't think anyone at that time would think from this angle.

And I think the third and actually the most important reason is that I don't think the Chinese leadership has prepared themselves to be on the center stage or on the leadership role for the global economy. As a result of that, we believe that propping up the U. S. economy is very important to save the global economy from the difficulty. I think most importantly a lot of the leadership back then, felt very strongly that if the U.S. failed to resurrect itself during the financial crisis, it would be a disaster for China.

So that kind of thinking was very deep in their mind. And so I don't think they were prepared, to say, oh, now it's my turn to call the shot. And so the best policy response, if we want to be a follower of a US-centric global economy, is to prop up our own economy through fiscal and monetary expansion, and while in the meantime US will have a period of time that they could avoid a huge deflation, restore inflation and everything can be back on track.

Robert: What do you think is the events and time period that this type of mindset was permanently changed? Clearly a lot has changed since 08. And I'm not talking about the mindset change of a specific person. I'm thinking about a generation of leaders. When do you think this mindset shifted?

Johnny: I think this mindset really kind of became the mainstream mainly after the 20th Party Congress. It's very recent actually.

Robert: The 20th? The 20th? So that was like, okay, two years ago? That’s really recent.

Johnny: The reason for that is that people always say that the current leadership, they centralized a lot of things for the past decade, but that's not necessarily true. If you look at The pre-COVID years of the Chinese capital markets or policy, economic policymaking, that is actually not the case.

There's a lot of liberalist thinking back then. And I believe the first biggest traumatic event towards this liberalist thinking is in 2015 when the Chinese A-shares collapsed. And during that time, I'm not sure if you've heard of the news that they actually involved the police to investigate what's going on there.

And this is the first time I believe the Chinese leadership actually came to a reckoning that, maybe copying the textbook from the West actually has its shortcomings, or at least doesn't apply here in China. It actually took them a while to really reshuffle and to think about it from a different perspective.

I believe it was the 20th party Congress when basically the state council's leaders changed. For the economic policymakers, actually they just reshuffled all the people last year, and even for the CSRC head, the change happened only this year.

[Baiguan note: in a sense, the core meaning of the newly coined phrase “新质生产力 New productive forces” is to increase China’s total factor productivity]

On the median income of Chinese people

Robert: In one of my favorite articles from you, you reminded your reader of a simple fact of a very low median income of Chinese people. And I actually didn't know about that until I read your article. And you were not inventing data. You were quoting directly from the statistics bureau. I remember it was about 4,600 something USD per year. And it’s just the median income, and so basically half of the Chinese people earn less than that. That’s a shocking number to me. What do you think will be the implication of this? How can this kind of observation help people better understand what is going on in China?

Johnny: I think most of the Western media or reporters, journalists, or observers when they look at at least anecdotal evidence towards the views on China, Chinese economy, and all that, they only look at first-tier cities because that's the place where they live or they visit. It's the easiest place, for them to visit. But actually, that's only a snippet of the Chinese economy.

Last year, I did a summary of my travel destinations in mainland China, and I figured out that actually I've traveled more to second and third-tier cities compared to the first-tier, which is a kind of anomaly compared to anything pre-COVID when I would just, pretty much predominantly go to first-tier cities for business travel.

I think the impression of these visits is also very telling. The first-tier cities in 2023 are actually, I feel a bit of a decline especially in cities like Shanghai in terms of traffic, in terms of economic activity, in terms of all that. But if you go to a second-tier city, Like Chengdu, Chongqing, Changsha, or even in the lower-tier cities. The vibrance there is so much different that there's a lot of vitality in these places.

The younger generation is willing to work there go there, or travel. And the overall vibe is just so different from the first-tier cities that I visited. So I felt this is a very important point of observation.

Another question we should ask is, where will this “median-income” person be? I felt he would not even be living in the third-tier cities, judging because judging from his income, he's not going to be living comfortably in the second to third-tier cities, so it's likely he's in like a fourth to fifth-tier city.

But if you think about it, if he's living in a city like this, then actually his living standards is not low because the cost of living is, is so much lower there. Probably a person like this got some housing from the government, and so he doesn't have a real housing issue. A lot of his living expenses are low, so you would want to probe more into profiles like this, what kind of entertainment does he or she have? What is his biggest, his or her biggest concern? Is it really cumbersome for a person like that to raise a family and all that? So if you think about all these questions, actually you jump out of a certain narrative that only looks at first-year cities within China, and they will really open up your mind.

And if you look at the overall growth potential for these people to increase their income, as well as to stimulate these local economies, there's a lot to be done. So I think overall it actually reminds you there's still a lot of growth potential within China.

On why we should be confident about China’s future

Robert: Over the last few years, there have been a lot of doom and doomsayers about China.

For a lot of foreign investors they are either completely leaving China or they are super cautious about either increasing their stakes. Basically, a lot of people are on the sidelines. Even though in the last few months, Hong Kong has returned the best performance of the whole world, reversing the trend of the last few years. However, I still think the overall sentiment about China is bad, especially long-term sentiment. So it's still very hard to persuade foreign investors to put long-term capital into China for an extended period of time.

So there are a lot of naysayers about China's future. What do you want to say to them? And you seem to be someone who is confident. about China's future. What makes you confident?

Johnny: Robert, I think one of the reasons why I'm really admiring your work is that you have been working on this area of trying to disseminate different views on the Chinese economy or China, in general, using English.

We used to talk about it. I actually started a website back in 2016 it's called China Spoon. Back then I had the same aspiration and even today you can find its Twitter account, but, but the website is already off. And I think it's during this experience that I actually got to know a lot more about how Western media operate and kind of shape the views of.

People's perspective and at that time I felt that the real point when I feel lonely is that you're just a person fighting against a giant machine and this machine's productivity and the ways that they operate is so much more influential than what a person could achieve. And a lot of people's views are shaped by these mainstream media even till today.

And so, I do feel lonely at that time, and I sometimes would even get attacked on Twitter, which is very common nowadays. But at that point, I felt that there was just no reason for me to continue this line of work. And if I think today when I really view the naysayers of China, I really don't have a lot to say to them because I think they're, as you said, really married to their own information bubble that they wanted to be in.

I just feel a little bit sad that in the, because we, you know, Western-educated, we did have a point where we believed that at least the Western thinking or the Western sort of liberalist society is a model for China to catch up on. But if you look at where things are unfolding today, it's the complete opposite, right? So I just feel a little bit sad for these people. I'm not necessarily saying that you should be a China Bull or be bullish on everything related to China. I, myself, actually criticize a lot of things at least on the economic policy side of China

Yeah. But I do feel that people need, need to open their eyes a little bit and look at a different perspective. So when it comes down to my view on China, I'm very optimistic in the short to medium term in the sense that we have an economy that is, is kind of wandering for a bit because of the first question about the productivity side that we just talked about, but it is catching up.

But I think just look at big numbers in general. The manufacturing sector of China is twice that of the U.S. The electricity production of China is almost three times that of the U.S. We manufacture about 60 to 70 percent of the world's shipping containers. And if it comes down to new energy, solar panels, and new energy cars, then we don't need to mention more. The recent tariffs actually are very telling about all things. So I think we have a lot of upside when it comes down to production.

Obviously people are worried that this will have an “overcapacity issue”. But the world is not just Western Europe and the U.S. And I think there's just so many so much population out there that never owns a car and they don't have very good energy supply. And they don't have very good infrastructure. Who's going to supply to them? And I think the only answer to that is quite obvious.

But I think that the core reason why I'm very optimistic is I believe our generation, which is the post-85s and the post-90s kind of population in China is the most competitive in the entire world. The reason for that is also very simple because we had a baby boom at that time, and so it was very competitive and we tried our best trying to out-compete others, to do whatever we could until now. And so in different areas, people are super competitive, but at the same time, we're also global-minded in the sense that a lot of our education or higher education, at least partially in the Western world.

So we have a lot of globalist thinking and at least trying to make things even across the globe. So I think we do have a comprehensive view of different things, and we do tend to be very competitive. So there's no reason why the economy shouldn't be prosperous in the next decade.

Longer-term worries

Robert: You talk about why you are confident. You say that you're confident “in the short- to medium-term”. Seems like you have some reservations about long-term prospects. So what do you think are the biggest concerns about China's future?

Johnny: Yeah, I think that's more longer term. In the short to medium term, we will have certain setbacks just like during COVID but it's not gonna shake us. But I think in the longer term and I think it's our generation's mission is to really reshape our cultural foundation.

China has at least 3,000 years of written history. We have been a very successful civilization since that time. And there's a lot of wisdom and philosophy that were but completely shattered because, a hundred years ago, we were lesser of a civilization compared to the West. And there's a point even that our characters would not exist because people feel like adopting Western alphabets will be more efficient. Well, luckily we didn't do that.

But I do feel like there is a need for us to restore and to rejuvenate our core culture. But unfortunately, because of the past 100 years of history, a lot of us have come down to, being accustomed to Western values, and we believe that this is the way to be. But fundamentally, we are not like Western civilization. And I believe the biggest problem in China is that a lot of us have a belief system right now that is quite mixed and weak.

We tend to believe that all traditional thinking, traditional values, and culture should be completely left behind, but it's actually not the best use of our history or our culture. And I feel like this is the thing that we should work on as an entire generation.

We are probably already the biggest economy in the world. It's a matter of time and our political influence globally is also on the rise. But how would that really sustain without a solid cultural foundation, without a solid belief system? It doesn't necessarily have to be related to religion. It's just the core values that we have. And I feel like the current foundation is quite weak and it's not of the priority of our leadership, at least for now. They've gradually come to the understanding that this is very important. And as a result of that, they have tried to promote a lot of things related to nationalist thinking and all that, but I don't think it's good enough in order to really rejuvenate our culture.

Is there nothing to be left behind, or there's actually a lot of wisdom to it? It's something that we really need to think about. And we really have a mission to take in terms of trying to make this relevant to our day-to-day life.

As long as this foundation is solid, we, as a nation, have a solid ground to withhold any sort of challenges and defeats. But if we are just so weak in this, then maybe we currently are in the heyday of our economic growth, but our successes could still be destroyed easily because there will always be cycles and there will always be new challenges.

Traditional Chinese medicine as an example of rejuvenating our cultural foundation

Robert: Could you maybe entertain us with one specific example of where “a more solid belief system” could help make things better?

Johnny: Yeah, I will probably raise a very specific example. I think there's a lot of audience or listeners for your program that they don't believe in traditional Chinese medicine. And as a result, the reason for that is that they believe that this is not based on proper experiment.

People think it's a very gray, even shady area. But is that really representative of the entire thinking behind it? Or, are there actually a lot of merits to at least some of the thinking underpinning the traditional system?

Because I'm an investor in biotech and most of the companies we look into are Western biotech companies, or even based in China, they use Western medicine. And I have a very interesting observation that a lot of the so-called “really good” drugs, for diseases like cancer, it can only raise your life expectancy by like 12 months.

So, is that really a good drug, is something that I really often ask myself. And from the traditional Chinese sort of thinking is that instead of trying to cure a disease when it happens, you should actually do some precautionary measures to avoid certain things from happening. For instance, right now people eat a lot, and they eat a lot of different foods, and they either get overweight or get the nutrition system not in good shape.

Is that the way for us to call it a living? And then we incur a lot of different illnesses. And then we use the medical system to try to make us healthy again. Is that the best approach? So if you look at the Western medical world, at least, the best drug is, “you take it and you take it forever”. That's the best drug. But from, you know, the traditional Chinese thinking, it's actually not to take drugs. It's the best approach, rather to prevent something from happening, because we know that you are prone to something or there's a certain risks of your incurring certain diseases.

And just as a statistical detail to that, the U. S. healthcare system is the most inefficient in the world because its expenditure in terms of GDP is so high. And, if you look at it, purely from a capitalist view, the best pharma companies are all in the U.S. mostly.

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At Baiguan, we regularly broadcast thoughts and ideas from professionals and subscribers like you to our 6000-strong and rapidly growing subscriber base including CEOs, CIOs, high-ranking government officials, media chiefs, diplomats, analysts, and academics all across the world who have real stake in China. We wish to become a platform for like-minded professionals with skin in the game to get to know each other’s stories and ideas. Apart from Johnny, our past guest speakers include Andrew Cainey, founding director of the U.K. National Committee on China, Han, ByteDance’s ex-head of Legal for SEA, Australia, and New Zealand, Shaojian Zhang, Partner of CITIC Capital.

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