Alf: Hello and welcome to Seeking Truth from Facts. I am once again privileged to be joined by the brilliant Steve Hsu. Thank you so much for coming on once again, Steve. How are you doing?
Steve Hsu: I'm great, Alf. The pleasure is all mine.
Alf: Great to hear. So I thought we would kick off by discussing the subject which has been all over the news geopolitically, which is It's the recent confrontation between Iran and Israel and Iran's use of ballistic missiles in its operation against Israel, Operation True Promise 2, I believe it was called.
I know you've been discussing those events quite frequently on Twitter or X. And yeah. What do you, what are your thoughts on it? What do you make of it?
Steve Hsu: Well, I, I really thank you for giving me the opportunity to discourse at length on this particular topic, because I wrote a Substack post on it.
And anybody who follows me on X or Twitter knows that I've tweeted probably a dozen times on this topic. And the reason being that to really understand the strategic situation between Iran and Israel, you really need to understand a little bit about ballistic missile technology and anti missile defense systems.
And for me personally, this goes all the way back to when I was a kid because When I was a kid, Ronald Reagan was running for the White House, and he was a big proponent of something called Star Wars. So there was a huge debate, both in the general public, but also in the physics community, which I was part of, about the feasibility of missile defense.
Like, just how hard is it to hit, literally hit a bullet with a bullet because these missiles are going many times faster than a bullet fired from an AR 15. Okay. So just imagine trying to hit one of them with another one of them, right? That's literally what you're trying to do when you do missile defense. And the general public really doesn't understand this.
And now that sort of even the strategic leadership of the country isn't as they were back in the eighties, totally immersed in the cold war, the cold war technologies, the advanced technologies that would be used by advanced countries in fighting a war. Almost nobody remembers any of this stuff.
So that's why I got so exercised about talking about it. So roughly speaking, let me first mention a missile, a weapon system that was deployed literally in the 1980s and it was taken out, it was removed from service. Uh in 88 starting in 88 because there's something called the INF Uh treaty which eliminated these medium range ballistic missiles from both the US and the Soviet inventories. And they were considered quite dangerous because if you have a thing, which is as fast as a ballistic missile, but it's an intermediate range missile.
So you're not firing it from one continent to another continent. You're firing it within a particular continent. Like say maybe just from a thousand miles away, like say from. Ukraine to Moscow. or West Germany to Moscow. It's very dangerous because the reaction time that your enemy has to deal with this thing is so short.
So there was this thing called the Persian 2 missile that the US deployed. 1980s technology. No advanced radar, no advanced microchips. This thing had a rough accuracy of about 30 meters. So it would, it would land typically about a hundred feet within a hundred feet of where you aimed it.It was a ballistic missile, so it would go up really fast.
It would leave the Earth's atmosphere. And it had the, after the warhead separated from the boosters, it had the ability to maneuver. So maneuver a little bit. It wasn't just a simple parabolic trajectory that, you know, if you have a parabolic trajectory, once the rate your radar locates this thing and gets its velocity, you can kind of project where it's going to be because it just follows the same trajectory, right?
Like you throw a baseball and are going to follow a particular path, right? But if the rocket has what's called a marv, a maneuverable reentry vehicle, that means it can jitter a little bit. It can deviate at any point during its path. It can deviate from the purely ballistic trajectory. And then it becomes extremely hard to hit because even if you're measuring exactly where it is, you don't know how it's going to jitter half a second later, right?
So, it's pretty easy to build missiles that are very hard to intercept. Okay, so that's the lesson that goes all the way back to the 80s, but people just kind of forgot it right.
Now, I think it's pretty clear that all the major powers have these kinds of missiles. The U.S. hasn't really reconstituted its intermediate range program, but the Russians have this kind of missile and more advanced missiles. The Chinese have this kind of missile and even more advanced missiles. North Korea and Iran both have this kind of missile. So what happened on October 1st was a launch of about 200 ballistic missiles from Iran from many different launch sites in Iran attacking Israel. And If you look on YouTube, because of social media, anybody with a phone who was in, you know Iraq or Israel or Iran could film, you know, the launch of this thing, the mid course of this thing, or even the final impact of this, of one of these missiles on, say, Nevatim Air Base in Israel, which there are 32 hits, okay?
So, there's a lot of documentation about what happened. The official story, for various reasons, which I'll explain, is that, oh, nothing happens. The official Western story is these missiles were mostly shot down, or even if they are mostly shot, the ones who weren't shot down, they didn't really do it. Okay, so that's kind of the official story.
Now, what really happened? Now, there are many, many videos out there where you can see, in the video, something like dozens of missiles at a time going through the air and even hitting the ground. Okay, very precisely hitting the ground. And, so in none of those videos, of which there are dozens, can you see anything like a high intercept rate?
You might see one missile getting intercepted or failing or something, but there's no video in which say over 50 percent of the missiles are intercepted or even like 20 percent of the missiles. So there's no prima facie evidence that the Israeli anti missile systems were effective against this attack.
Now, the Israelis have the most advanced anti missile system. So they have, you know, they had U.S. help building their system. They have their own ingenuity in designing some specific aspects of their system. And furthermore, there were two Arleigh Burke destroyers. Those are the American ships that defend aircraft carriers at sea, and they're supposed to have, for the United States, among the leading capability for missile defense.
Okay? So it was a perfect situation for the defenders. They had the ground based radar, they had the radars on the Berks, they had tons of systems in place, and I think it's fair to say they did not shoot down the majority of the missiles. Okay.
Now, after a few days of, of, you know, people speculating online about what happened and the official story from the US being that well, nothing happened.
And the Israelis, of course, don't allow people to even release information about these kinds of attacks. Like I remember on the night of the attack, I was reading online and some Israeli guy had tweeted out a video and his, his, his description of it was in Hebrew, which I had to read in translation.
Immediately, there were several comments under his tweet, which said, Hey, you're going to be in trouble for tweeting this. You know, this is a, this is a criminal offense to, to tweet out this video. Right. And the guy's like, what, you know, whatever, what are they going to do to me? So it's very, there was a period of a few days where the matter was very unsettled and people, you know, people took maximalist positions where some people claimed very quite a lot of damage was done, but the Israelis were hiding it. And other people were saying, no, this attack was totally useless and only killed one Palestinian guy by accident or something, right? And so, you know, sometimes in war, this is just what happens because both sides are incentivized to lie.
And obviously the information could be classified or highly secret. And so you just don't know what happened, but in this case, a few days later, actually, a bunch of photos were actually released of the hits on at least two of them. Israeli air bases. And in both cases, actually, I think Nevada is the clearest one.
There are 32 hits. So this was analyzed by some actual missile experts. So they're about 32 hits on Nevada, but they're spread out over one or two kilometers. On the other hand, there are some very close hits, which are one through one that went through the roof of the reinforced hangar where they keep an F 30 F 35.
Five. So that's a very critical target.there are other hits that just land right in the entrance way where you would have to wheel out your plane from the protected hangar if you wanted to bring it to the runway. So those are super precise like definitely like sort of 10 meter ish accuracy, but then there are these sort of random hits around the base that don't seem to have any rhyme or reason.
And I think the most parsimonious interpretation of this data is that, you know, if you're Iranian and you've been making ballistic missiles of ever increasing quality since the nineties or so, you have an old inventory and then you have recent missiles, which are as advanced as the Persian two that I described earlier.
What would you do if you were attacking Israel? You would probably fire a mix because the defender doesn't know which of your missiles is highly accurate and which ones are the old useless kind that, you know, are, are totally obsolete, right? So probably what hit Nevatom were dozens of missiles, some of which were high precision and accurate, and some of which were just junk.
And that's what the impact is. pattern looks like, okay. So I think that's the best interpretation of what happened. Iran does have the ability to overwhelm the missile defense system. They used, in this case, a mix of accurate modern missiles and some old obsolete missiles. Now, if things further escalate, I think it's pretty plausible that they have a huge inventory of both the old and the new missiles, and they could scale this attack up dramatically.
I don't think they wanted to escalate. I think both of the April, both the April attack by Iran and the October attack were not meant to escalate the situation. They just want to demonstrate to the Israelis that they have this capability and that they basically shouldn't, these are really shouldn't, excuse my language, fuck with them.
Right. But they didn't really want to escalate further, but probably the next one would be much more serious. And I have every reason to think that, you know, for example, the five power plants that Israel has, reportedly they have five power plants, that the precise missiles could probably take those power plants offline.
And the components of these power plants like gigantic transformers or, you know, giant pumps and mechanical things, those have a very long lead time for replacement as, for example, we're finding out in the southeastern United States after this hurricane, right? So, I actually think the situation is that Iran could do a lot of damage to Israel, if this were to further escalate.
And I suspect what's actually happening is the Biden administration is telling the Israelis not to escalate the situation, you know, Netanyahu is, is you know you know, wants to retain his strategic autonomy and saying, oh, in the worst case, we might even try to bomb Iran on our own without us support.
So, but interestingly, you know, the counterattack, the response by the Israelis has not happened yet, and it's been some time. So definitely, you know, they. I think there are definitely some negotiations or deliberations going on. Let me stop there and let you react.
Alf: That's a very, very interesting and thorough breakdown of the situation.
Thank you for that. Another potential avenue for escalation that some people have discussed is potentially a third oil crisis in a similar fashion to 1973 and 1979, but probably more like 1973 in terms of intensity from some of the predictions that I've seen. And some people are saying that the spark for that could be if Israel attacks Iran's oil facilities, or if Iran blocks the Straits of Hormuz.
What do you think of the prospects for an oil crisis like we saw in the 70s? And what do you think the impact of such a crisis would be if it were to happen?
Steve Hsu: Well, I think nobody wants it. Nobody wants that oil crisis. I mean, you know, maybe the Russians would like it because it would increase the value of their oil they're selling.
But the Chinese don't want it. The Americans don't want it. The Europeans don't want it. The Iranians, I think, don't want it, and definitely the other oil producing countries in the Gulf don't want it either. So, you know, one hopes that diplomacy will prevent that. Now, the way it would arise is that Iran's oil producing infrastructure is very vulnerable.
So, you know, when they build all these oil pipelines and refineries, generally it's not at all secured against a military attack, right? And so the balance of terror here is that Iran has actually threatened that if their stuff goes, they might go after some of the other oil producing countries' infrastructure.
For example, when Saudi Arabia and Iran were, you know, at each other's throats before this rapprochement that the Chinese engineered recently, you know, they were threatening each other's oil infrastructure, right? So it could, it could go, get out of hand that way. I think the other way it could go is not that the Israelis would target the oil infrastructure, but they might because the Americans would tell them definitely not to do that.
maybe they would attack the nuclear capabilities of Iran. And that's another important topic to discuss. And I think just to make it really brief, most of Iran's nuclear capabilities are buried deep underground. So it's a very challenging mission for the Israelis to go after it. It's probably a challenging thing for Americans to go after, Iran, you know, I think within their government, there's been a sort of tension between some more aggressive hawks that want them to take that nuclear step.
And, you know, people either because they're moderates and they want to reestablish economic relationships with the West, they don't want Iran to take the nuclear step. And also there's a religious reason. So there's actually a fatwa from one of the Ayatollahs.against the idea of having nuclear weapons because it's, you know, I think the, the, the, the opinion stated is that it's immoral to have weapons that are mainly used to kill massive numbers of civilians, right?
So, but there are actually indications that, for example, this religious prohibition against taking that final nuclear step, you know, is being lifted in Iran because Iran is now under a lot of pressure. They're afraid of being directly attacked by the U.S. and Israel. And so that might incentivize them to take the step.
And I just want to talk about that nuclear step because we just lived through this in the last few years with North Korea. So North Korea for a long time was on the nuclear threshold and there were just incredible efforts internationally to prevent them from taking that step, but they finally took the step and North Korea, like Iran, both have pretty advanced missile missile programs.
So independent of the nuclear weapon itself, they have advanced missile systems. So once they get the missile, once they could take the nuclear step, they suddenly become capable of hitting, not just their local neighbors. But in the case of North Korea now, there's pretty good evidence they could actually hit the continent of the United States.
And so at that point, if you notice. There's like dead silence now about North Korea's nuclear program. So the lesson is that, you know, the powers that be are going to try to stop you as much as they can before you cross the nuclear threshold. But once you cross the nuclear threshold, what are they going to do to you, right?
No one thinks at all about ever invading North Korea now, right? And so the Iranians have to understand this, obviously, and so there's, there's definitely, if, if they, you know, if Netanyahu's rhetoric is too aggressive, or it looks like the U.S. might combine with Israel to attack Iran, they have every incentive to take that step, because what are they going to lose now? Right. you know, if, if the, if they're about to be attacked, what do you care about sanctions on your economy?
Now, the thing that I haven't seen discussed by anyone. Is that prior to the JCPOA and the earlier attempts to kind of diffuse the Iranian nuclear program, the Russians sided with the Americans.
Right. So if you're a Russian strategist and you're looking south, it's not that far to Iran and all things being equal, the Russians would just as soon not have a nuclear rundown. Right. And they've had their problems with Islamic, you know you know, terrorists and things like this. So, so, you know, for them, it's like, okay, yes, let's support the Americans. Let's try to talk to the Iranians out of going nuclear and let's only give them limited support for their own military modernization, etc Right. That was a situation before the U.S. pushed and NATO pushed a huge proxy war on the Russians, which has caused probably 100, 000 KIAs among the Russian soldiers.
Uh, the U.S. has stolen 300 billion from the Russians now, and fully sanctioned, as much as they can, the Russian economy. Now you have to ask, what do the Russians have to lose in providing some military aid to Iran? Uh, reportedly, they are setting up S 400, air defense systems in Iran, which would make it much harder for the Israelis and Americans to attack Iranian airspace. But even beyond that, I've not seen anybody discuss this, so the Russians seem to have switched their position now about whether, you know, about opposing Iran taking that nuclear step. And because the Russians and the Chinese have such advanced nuclear technology, they could bring Iran to a state where they're able to miniaturize pretty effective warheads. They could just give them designs and technical assistance literally from the 1960s or something, but that would accelerate Iran tremendously. And Iran could easily get to the point where North Korea is, where they have long range missiles that are pretty accurate and they have, who knows, maybe 10 warheads. And then at that point, Iran is kind of untouchable.
Now, what does it mean for Iran to be untouchable? It literally means Israel has no recourse against Iranian aggression. If Iran wants to go after Israel, no one's going to mess with Iran, right? Because there's a balance of terror now between the nuclear arsenal of Israel and Iran.
So, this is like a very bad outcome with Israel as collateral damage. And people are not admitting this is a consequence of the Ukraine war, right? So, if we launch a proxy war against Russia, You could say like, oh, the Russians are not going to get mad. They're just dumb sub humans. They don't care that we caused a hundred thousand of their soldiers to be killed.
They're not going to take it out on us in the Middle East. Well, maybe they will take it out on us in the Middle East. And turnabout is fair play. So what would turnabout be? Turnabout would be arming some other proxy that's capable of damaging U.S. interests in the Middle East. And Iran could be that proxy.
And, you know, like, sort of less inflammatory things would be giving some modern anti ship missiles to the Yemen, you know, the Houthis in Yemen, or to Hezbollah, et cetera, et cetera. The Russians have very, very good modern weapon systems. And so no one who is tallying up the pros and cons of this misadventure in Ukraine is talking about these second order consequences which, you know, might be second order for Americans, but they could be first order for Israelis.
Alf: Yeah, that's a good point. And again, linking to the proxy war in Ukraine. We've been seeing some interesting news surrounding that we saw Biden has pulled out of the Ramstein meeting in Germany. And do you think that that and other things I mean growing opposition. in the West to continue support for Ukraine to the extent that it has been given support.
Do you see fatigue setting in on the part of the West in supporting Ukraine in the war? And do you think that that could have the consequence of ending the war in the not too distant future?
Steve Hsu: Yeah, I think that, first of all, you've got Trump, who's a wild card, who is saying he's gonna end the war and is against U.S. participation. Vance has been much more eloquent about the reasons why, the U. S., it's really not in the U.S. interest to pursue this proxy war, and I actually agree with Vance on a lot of these things. So, you know, sort of 50 50, if he gets into office, then the war may be over on pretty unfavorable terms for the Ukrainians. But even a Harris administration I think does have, as you said, fatigue on this matter.
And let's face it, we've given huge amounts of weapons and support and money to the Ukrainians. They've taken heavy, heavy casualties. They're reportedly not very able to replenish their losses now. And if you look at that Eastern front, it's starting to crack. For people who didn't study the situation before Putin invaded in 2022. Those areas in the Donbass region were heavily, heavily fortified by Ukraine. So there was this Minsk, a good set of Minsk agreements, which, you know, Merkel even said this later gave Ukraine and NATO breathing room to basically build up defensive fortifications. And that's why the war has sort of been stuck, kind of like World War I trench warfare for a long time.
But now it appears the Russians are actually breaking through. And so some people even say that Putin kind of has some influence on the U.S. election, not via propaganda, but by, if he really decided to crank things up on the Eastern front, that would get back into the news. So if the Ukrainian lines are really collapsing and the Russians are all the way to the Dnieper in the next month, then, you know, obviously that would then raise it in the campaign as a big issue and Trump would make a big deal about this, about how stupid the Biden administration was to, you know, to pursue this current strategy.
So, yes, I think the war is kind of coming to an end. I think there, you know, there was so much propaganda from NATO types and British types and some Americans, you know, in the last couple of years that people are behind, they're not really tracking the real situation. They still think, oh, Ukraine has a chance to win.
Look, they even invaded Kursk, right? So, so, yeah, so people, people's understanding of the actual situation on the ground, I think, is all over the map, but I think it's very likely now that the Russians have the upper hand and there's actually not much the U.S. can do, actually, to reverse that, even if it wanted to, without actually putting U.S. and NATO troops on the ground there.
And, of course, we would never do that, and this is one of the crazy things that the pro proxy war people never address, which is that, well, even if we did get the upper hand, we, the West, got the upper hand in the conventional war, then Putin would probably resort to tactical nuclear weapons.
And then what would we do? Right? So this is what Obama said as he was leaving office. He said, I didn't get involved in this Ukraine thing because smart people know that the Russians have what's called escalation dominance in that region. They care more about it than we do. And even if we win by using conventional weapons, they can always escalate to using practical nukes.
And then what would we do? We're not gonna, you know, have a full blown nuclear exchange with the Russians over Ukraine. So they have what Obama called escalation dominance, and he was totally right.
Alf: Yeah, and I mean, linking what's going on in Ukraine and its impact on Europe, I wanted to discuss the trend, which I think is one of the most important trends in terms of global economics and geopolitics of the past 15 years, which is the relative decline of Europe. And that's been seen in the data since 2008, really, since the financial crisis, but it's really accelerated, particularly in Germany's case, since 2022.
And I just wanted to get your idea from your analysis from your work in Europe and everything. What do you think were the causes of that decline? And what do you think are its consequences? Both the decline since 2008 and particularly Germany's decline accelerated since 2022.
Steve Hsu: Well, it's a very complicated story. It's tough to do it justice, but Europe definitely didn't recover from 2008 as well as the U.S. did. And so you start to see that in the numbers. So if you look at like the, the, the, I don't know if they use this terminology in the UK, but in, on the continent. When you ask somebody, oh, how much do you make? People will usually respond, oh, gross or net. And so gross means the, the total amount you get, and net is what you actually take home after taxes, right? So, if you actually look at even the richest countries in Europe, and you ask, what's a good net salary for a professional, like even a lawyer. Like I was just in the Netherlands and a good net salary for a lawyer in the Netherlands turns out to be about 4, 000 euros a month.
Okay. And that's, there's nothing wrong with 4, 000 euros a month. And because these are wonderful countries with modern infrastructure, you can have a perfectly good life on that salary. But compared to what Americans make, it's, it's pretty, it's pretty low. Okay. So even the, like, I think it's been said that if Germany were a state in the United States, it would be like Mississippi, it would be poorer than the poorest state in the United States. In terms of just dollars or euros that people take home and they can spend. Okay.
So Europe is falling behind. Most of the strong European companies are companies that were founded really a long time ago. And all of the new companies in the world, which are leading companies in usually high tech industries, they're all either American or Chinese.
So Europe isn't really producing the kind of innovation that you need to keep up with countries like the United States and China. So I guess ASML is probably the best counterexample, which is a Dutch company, but it's a Dutch company that really depended on about 20 years of U.S. government sponsored research in lithography, extreme and deep ultraviolet lithography that was sold off to Philips.
And then ASML was spun out of Philips. But even the origins of that company are really heavily American.So anyway, I think Europe is not in good shape. Now, Germany was kind of keeping pace as a manufacturing export powerhouse. I think that was the conventional wisdom. And also is very strong in certain chemical industries, like that goes all the way back to Bayer and Zyklon B and BASF, like this.
But all of those industries are pretty energy intensive. And so a lot of analysts immediately, when the U.S. blew up the Nord Stream pipeline and prevented Germany and the Western European countries from benefiting from cheap Russian energy, a lot of analysts immediately said, and the companies themselves realized, this is the end for that class of industries in Germany because they're simply not competitive, because of their input costs now.
And in slow motion in the last two years, you've seen more and more capability leaving Germany. Uh, I think like a year or so ago, BASF, you know, announced that they had some billion dollar investments in chemical production in China. And they were just going to shift, they were going to idle some of their plants in Germany and shift the activity to China.
So I think that was all predictable. and it's just, it's just slowly dawning on the, you know, EU bureaucrats or whatever that this is actually happening and they're, they're in big trouble.
Alf: And that's what leads me on to my next point. And I meant to ask, to what extent do you think that Europe's relative decline can be attributed to the austerity measures implemented in the aftermath of 2008 in Europe, particularly cuts to things like infrastructure investment? And how can this approach taken by Europe be contrasted to the approach taken by America on the one hand, and also the approach taken by China?
Steve Hsu: These are really hard macro economic questions which, you know, I think the experts would argue quite a bit about.
I would say the following that, first of all, Europe, Europe and the U.S. both have big national debt problems, and I think a lot of the European banks are really secretly underwater. They're only sort of solvent because the European Central Bank keeps them alive. And when you're in that situation, it's pretty tough to, you know, deal with something like a big financial crisis.
I would say that the one thing that I'm really confident of vis a vis Europe is that if you don't incentivize innovation, new business formation, that sort of thing, you're just going to have trouble competing against the U.S. and China. The U.S. and China are very aggressive in building new companies, exploiting new technologies, and attracting Top talents to their countries, Europe.
What's great about Europe is, you know, the quality of life is super high. The educational systems are still pretty good. There are so many talented people there, but I think that, so that they're able to produce talented people, good human capital, but they're not really able to deploy it to, it's best use.
And I would say it's because of regulatory, you know, overly tight regulatory issues and lack of dynamism for new company formation. I would, and even like a lack of optimism. So Americans are in a way, cousins of the Europeans who were selected for being more optimistic because they left the continent and went somewhere completely new to start to try their luck.
And both China and the United States are super optimistic in general about new technologies and new company formation. So it's much more likely to find some guy who's willing to take a big risk, risk failure, work for 10 years to build some company and cash out for a billion dollars. just doesn't happen as much in Europe.
There probably isn't the social support, cultural support for that kind of activity or ambition in a young person in Europe. I think all these things are changing over time, but they still have a long way to go to catch up.
Just on a purely personal level. Yeah, as I said, I just spent a few weeks in Europe and most of the time I was in the Netherlands, and I really love the Netherlands. It's for people who haven't been there. It's totally flat.
Everything works, the public transit system works, they've reengineered all the streets in their cities to be super bicycle friendly. So a typical street in even an urban setting is kind of a narrow road for the cars, which have to move really slowly, and then two bike lanes, one on either side going in opposite directions, and then pedestrian sidewalks.
So it's very human friendly and you spend most of your time just kind of peddling slowly on your chill kind of relaxed way on your crappy bike, going over to the cafe or the grocery store and it's just the lifestyle cannot be beat other than the fact that it rains a little bit too much, you know, in that environment.
And, you know, my wife remarked at this as well. you know, in that environment, who's gonna. They're going to really kill themselves to start a company or build a business or, you know, if you're doing okay, and the government's going to take 60 percent of what you make if you're really ambitious, you know, I think the incentive just isn't there for the kind of drive that it takes to build a Silicon Valley type company.
And I don't see an easy way to fix that kind of thing. Now, some people might say, like, you shouldn't fix it, because, look, the quality of life in the Netherlands is so high. Why, why should people behave like Americans, right? What's so great about living in a McMansion, you know, and having to drive everywhere, and having poor homeless people living only a few miles from your house, right?
So maybe you don't want that. But for whatever reason, I don't see Europe as a technology or business innovation leader anytime in the near future.
Alf: Returning to the different approaches taken in response to 2008, obviously China took the approach of massive public works, loads of new infrastructure, and obviously infrastructure investment has been a key theme of China's rise for the last 40 years.
But some observers who are very critical of China have alleged that investment was wet, was very much excessive.that the infrastructure is of poor quality. I hear the phrase tofu dry construction come up and that other people have said that the investment in infrastructure has been the cause of local government debt issues and bankruptcies in recent years. I mean, to what extent is any of that true?
Steve Hsu: Well, I think some of it is true for sure. So, you know, if you have a massive country like that with pretty decentralized execution, I think you and I may have mentioned that in the last conversation, that actually local governments and provincial governments have a lot of freedom in deciding what they do.
So in that, under those circumstances, it's going to be a lot of wasted investment, a lot of corruption, but that's true everywhere. So, you know, a typical venture capitalist who's incentivized, or say private equity manager, who's incentivized very directly to be successful in his or her investments, they're going to have a significant number of losers in every portfolio, right?
And so it would be the same thing if, if, if you green light some real estate development or you decide, oh, this, this bridge really has, there's a good rationale for building this fancy bridge or something or, or extending the train line in this direction. Maybe most of the time, let's say 80 percent of the time, you're right, and the thing that you spend the money on pays off in terms of economic benefits or social benefits.
But 20 percent of the time, you're totally wrong. But then the critics would be able to find lots and lots of shitty projects that didn't pan out, right? If 20, literally 20 percent of all the big infrastructure projects China attempted in a 10 year period were bad in absolute terms, that would be a great outcome, 80 percent success rate, but it would mean that critics could easily find examples of stuff that didn't work out.
Right. So I think the way to really test this is to go to China and travel around and you realize the train system actually really works. It really is good. And Glenn Luke has done a very, very detailed financial analysis.Some people would say, oh, the train system is good. It's great for people to ride around in. I love to travel on it. But the government's spending way too much money on this. And it's eventually going to collapse because it's not economically, you know, it's not an economically feasible thing to continue supporting. Glenn's numbers suggest the opposite. That actually is pretty successful. The government does have to subsidize it, but what the government gets backed by subsidizing it in terms of development, is actually positive.
So, it's pretty complicated and it's the kind of thing that's going to play out over decades. So I couldn't give you an absolutely high conviction answer that they're not in trouble. I do think local governments probably spent too much money recently and now they have a big debt overhang. And so like, you're going to see a big retrenchment at the local level in terms of what kind of projects they can support.
But you know, by and large, if you go there and you go into some really beautiful train station or a beautiful public library or, you know, some real estate development, it it's all needed, you know, it's all needed for a country that is so large and you have people, it still hasn't fully urbanized. So the urbanization rate is only about 65 percent there. It's still got another plus 15 or 20 percent to go.I don't think much of that infrastructure is really wasted, but you could point to a particular development in a particular city and say, oh, look, all the units in that development in that building that high rise are unsold right now because the property market is kind of collapsed and what will happen to those units.
And I would say, yeah, that's probably part of the 20 percent of the projects that inevitably, you know, should not have been done, or the timing was bad, or it'll take them a lot longer to fill those units than the original property developers who are now bankrupt thought. So, so it's, it's one of these things where I always have to say this to people who are talking about China, you know, both things can be true, both things.
One thing is that by and large, they did efficiently allocate capital and they developed their economy in a very dramatic way over this 10, 20 year period. But it can also simultaneously be true that you can easily find projects that were a waste that shouldn't have been done and, you know, et cetera, et cetera.
So it's, it's a, it's a pretty complicated question to answer.
Alf: And yeah, I suppose as well, just to add a point onto what you were saying, are you talking about the railways and how it has to be partially subsidized by the government? And I guess, but the reason for that being the same as the reason with infrastructure generally.
That it has very high capital costs up front. And it's also naturally monopolistic, therefore it makes sense that the government would need to step in to invest in it. Otherwise Uh, it would be under invested if it was just left to the market.
Steve Hsu: Yeah, you know, like, the reason the Netherlands are so nice, I was just there, is that, you know, I can get from Leiden to Amsterdam to Utrecht on a public train, which is running very, very precisely at certain times.
I just go to the station, I have to wait 10 minutes, I jump on the train, and then 20 minutes later, I'm in Amsterdam. It all works. But of course, it's all being subsidized by the government. The government has decided this is a social good to have good public transportation that people can use. If I'm going to a business meeting in Amsterdam from Leiden, I can do it and it doesn't take me the whole day.
I can go there and come back, you know, for dinner. So the governments are always subsidizing that the, the, the counterpart in the US, if you look at most states budgets, like the state of Michigan's budget, a huge amount of their budget is just building and maintaining roads. So we like cars here, and we spend a lot of our tax money on making sure the environment is, the infrastructure is set up so you can drive your car around, right?
And trains are just another choice but similar. And so, I think Glenn's analysis is the best I've seen, maybe you could link to that in the show notes. it's in his Substack. Will do. But he's done a very, very, very lengthy financial analysis of the train, high speed rail system in China.
Alf: Has he done any analysis of any other Chinese infrastructure like the energy grid or anything like that?
Steve Hsu: Yeah, I'd like to. I'm glad you mentioned that. So the one that I'm most interested in right now, which is, I think, nearing a tipping point, has to do with solar and connecting to the grid. So, if you look at just per unit generation costs, like when the sun is shining, what is the cheapest way to generate some electrical power?
It turns out solar is now beating everything else. Okay. So, if you just look at that naive number, it's like, wow, every country should just build lots of solar capacity and, Oh, it's all being sourced from China because they dominate the market. For solar cells and such, but then the critics say, aha, not so fast.
If you build that capacity, what are you gonna do when the sun goes down? Or if it's cloudy? Like are you people just gonna not have power at night or they're not gonna power when it's cloudy? And then they do some calculations, say, aha, you're going to have to build a bunch of gas or coal plants to go along with the solar because the solar is so intermittent, right?
At best, you're going to get that power for, I don't know, 12, 14 hours a day or something, right? And, so you have to build all this other stuff. And when you add it all together, it doesn't make sense, right? So that, that, that's been a claim, even for example, in countries like Germany that were very aggressive.
In moving to wind and solar that criticism was levied. I think properly levied against their policies 10 years ago But now something is starting to happen in china where okay the the cost of photovoltaic the solar panels has gone down significantly recently, the cost of batteries has gone down really significantly to the point where it even looks like you could have battery storage, you could have huge battery farms that store the, you know, the solar wind energy so it can be used when later at some point where it's not sunny. And even Tesla is in this business now building giant Tesla battery farms that store energy.
And the third thing that China uniquely has that almost nobody else has is they continue to develop an ultra high voltage grid capability. So, for those of you who remember your college physics, when you try to transmit power over long distances, the loss that you have to suffer is much smaller if the voltage is high.
And so there's old timey technology. This is like old timey electrical engineering, which doesn't even involve circuits. It has, it involves literally like, you know, transmitting electrons on a wire. China has continued to push that technology and they've deployed an ultra high voltage grid that can transport energy all the way across the country.
So now what's happening, and Glenn has written about this, and it's something I'm super interested in is they are now rolling out big projects in, for example, Inner Mongolia. So Inner Mongolia, there's not much in Inner Mongolia, right? But it's very sunny there and there's lots of wind. And, they, they, they, generate the power there through wind and solar. They transmit it through this UHV grid, back to the cities on the East Coast, which need it. And they also then build some coal or gas or nuclear, they're often called peaker plants. They're plants that, you know, when the solar energy turns off, they can jump in and provide some backup power. And they're also building battery farms.
So, this mix of things that they're building, it is claimed now, this mix of things all in, including the intermittency, is more economically viable than simply just building an additional coal plant to service some additional demand in one of these East Coast cities. So, that's the claim. Now, I don't know if it's true, but serious people are looking at this.
I think I tweeted out one of the analyst reports. There was a big consulting firm in Hong Kong that did an analysis of this and claimed that it's, quote, in the money now. And if indeed it's in the money, that means something very interesting. It means China could eventually be a power exporter.
They could export electricity to neighboring countries by just extending their grid and just building out more and more of this solar and wind energy capability. And it's interesting because there are deals with, believe it or not, Saudi Arabia. So some Gulf countries know that they're eventually going to run out of oil, but luckily for them, they have a lot of sunlight.
And they can, you know, partner with Chinese companies to build infrastructure. They are looking at the possibility of, you know, you can imagine Saudi, the kingdom of Saudi Arabia becoming a huge solar energy exporter eventually with these technologies. Now, again, like, I don't know whether we're really at or past this tipping point, but even if we're not, all the costs for these things are going down.
So the solar cell costs, the battery costs, and the, you know, capability to build these UHV ultra high voltage transmission grids, smart grids, is increasing. So we will pass this tipping point probably in the next, you know, five years, if we haven't passed it already, and that will change things dramatically.
It'll change the whole world.
Alf: That's a very interesting point. And I think on the point of infrastructure investment in particular, and its role in China's success, I think that point might feed in well to what my next question is, which is I've seen a lot of people, particularly those who are more critical of China and who really subscribe to the notion that liberal democracy is essential for long term development.A lot of them have been saying that they think that India will eventually either catch up to China or some are saying overtake China Economically. And to what extent do you think that is a possibility? One thing that they bring up often are the people who are very excited about India. They often bring up the fact that India has a demographic advantage over China. so, to what extent do you think that's possible, and if that's not possible, why do you think India would lag behind, continue to lag behind China?
Steve Hsu: Yeah, so let me, before I turn to India, let me confront the more fundamental question, which is the assertion that specifically liberal democracy is necessary for successful long term development, because I don't, I don't think, you know, with these kind of difficult multifactorial questions that involve humans and human society and stuff, it's, it's, you know, being a physicist, I would say like, well, I'm happy to discuss these things, but it's difficult to reach a high level of conviction.
My suspicion is that people who have a high level of conviction, either yes or no on this question, are secretly pretty ideological, right? So you can, it's easy to find a libertarian who will argue this, this point with super high conviction, but then when you break down their case, you realize it's built on a, just a bunch of assumptions about human nature or how things work, how complex systems work and, and I don't know that they're right, right?
So the point I want to make is that if someone said without some kind of market mechanisms, you can't have successful long term development, I would say, yeah, that's very plausible to me just because of the information problem, right, because if you want to allocate resources in an economy, the market solves that problem.
It lets individual bagel shops in New York figure out how many bagels to make every morning, because of the price. And without that you're in real trouble and you end up with these kinds of Soviet problems or old Chinese communist Chinese problems of how to run your economy. Right. Now, China doesn't have that problem.
They have market forces. Everybody who's active in the economy in China is trying to make money. They're, they're more focused on money than, you know, the average person in the Netherlands for sure. Right? So, so, they're trying to make money and it's a market system and the government is smart enough to make use of this market system to develop its economy.
Liberal democracy is a slightly different thing. What do you mean by liberal democracy? So, does that mean you could say like, well, if you don't have a free press that can criticize company X, that company will, I don't know, become a monopoly and it'll destroy your economy and your scrutiny, right? You have to make some case that it's actually the liberal democracy, something that China doesn't have, that is going to hamper economic development.
You could say, oh, communist bureaucrats, even if they're super smart and selected in a meritocratic system and actually patriotic, they're doomed to failure in regulating or overseeing this economy because they weren't elected by guys voting in on their seats. Right. So if that's your claim, then it might be true, but I'm not sure it's true.
And the thing that I want to mention is highly relevant is that in the Chinese system, the government monitors what people are saying online. And the government also actively surveys people all the time. So it is very easy for the government, like say you're one department of the government, the Ministry of Finance.
And you realize people are really, you're doing surveys, and you know, there's another, there's another ministry, Ministry of Education, and they're doing surveys, and there's another ministry called Ministry of Defense, or whatever. They're doing surveys, and they really, you could realize something like, oh my god, Ministry of Education is really fucking up because people are very unhappy about the way the schools are run, right?
You can't keep that secret in China. And the Ministry of Finance, or the Ministry of Defense, or some other industry, some other ministry, is not going to let the Ministry of Education get away with it. Right. So effectively you have input from quote, the people into the running of the country and you can't prevent it.
Everybody in China is on their phones, you know, messaging back and forth on WeChat or Weibo or whatever. And so the function that you thought you needed, like a farmer in Iowa goes into a voting booth to throw out that rascal who's a bad congressman. You sort of have it through a different set of mechanisms now.
And, of course, you could say, no, no, what will actually happen is, yes, Steve, I understand all these mechanisms there, but Xi Jinping will seize so much power, and then as he turns 80, he'll just go insane and he'll wreck the country. Okay? Maybe. That, you know, I'm not saying that can't happen, right? But if you average over hundreds of years, is the damage done by the occasional bad emperor who goes crazy?
Does that completely cancel out the efficiency gains from running a highly meritocratic more kind of like you know, a system with more state power? You know, maybe, maybe not. I, I think, I'm not saying I know the answer to this, but I'm, I'm saying I'm very skeptical of anybody who claims or they can, they can make some very, you know, mathematically precise or rigorous claim about it.
Now, getting back to India, so what are India's strengths and weaknesses? They do have a demographic dividend on their side, so they have a lot of young people who are going to enter the economy in the coming decades. They still have really terrible infrastructure problems. They are really terrible So this is something that's a surprise to most people because the standard narrative about India doesn't tell you this.
They still have terrible problems with malnutrition. So there's statistics, there are technical terms like wasting and stunting that people who study human development or public health use these terms. It's sort of like, oh, you're more than two standard deviations shorter than you're supposed to be at your age, or you're more than two standard deviations lighter in weight, skinnier than you should be at your age.
And this is normalized to the Indian population, not comparing Indians to Germans or something, right? So, according to those statistics, there's not been any decrease in the percentage of the populations that's wasted or stunted in India. So they haven't really overcome their poverty problems. There's probably a group of, you know, a hundred million, a few hundred million people in India that are doing much better than they were before.
But the bottom half doesn't seem to be doing that much better, at least according to these statistics. So they still have a lot of challenges that a kind of simple narrative doesn't really you know, doesn't really expose. You know, you just look at how people actually get to work in India, you know, they might spend two hours like queuing for a train and some really terrible dystopian scenario where you're crammed together with people and you're all sweaty.
And by the time you get to work, you're exhausted. It's easy, you can just go on YouTube and find the details of what people's commutes look like in India. I would just say that they have a long way to go on basic infrastructure, basic education, even nutrition. And things like that. I don't think there are very many examples of companies that went to India and said, hey, we're going to manufacture in India. It's too expensive. In China, we're going to move. Uh, we don't want to be sanctioned by the Americans. Let's move our factory to India. Apple tried it. Now they've given up. Apple did it with Foxconn. It actually makes their stuff. Foxconn is a Taiwanese company. They went to India. Now they've basically, you know, realized it's not really working very well. And they've moved a lot of the production away from India specifically, like I think iPhone production. I'm not aware of very many examples where successful relocation of manufacturing to India, you know, has been achieved. Most people in this business, and there's a guy, there's a guy that I had on my show who tweets about this, is Molson Hart, that's his name.
Yeah, so he's, he's quite an expert on this because he runs a business that imports toys and other things that are manufactured in Asia and sells them in the U.S. And so he's been doing this for a long time. Traveling in both Asia and Southeast Asia for a long time. And, you know, people like him, who are experts on this, if you question them, they'll say, you know, you say like, okay, either because labor is getting too expensive in China, or because you want to avoid sanctions, where, where is this work likely to go?
People like that will tell you that manufacturing is nothing like it's not easy. It's very complex. You're competing against other people. They're trying to do it efficiently. You need a lot of infrastructure. You need highly skilled people. You need engineers who help set up the factory and keep it running, not just the workers who do the manual work.
And usually people point to countries like Vietnam or Malaysia as places that are going to benefit from the movement of manufacturing out of China and, you know, like those are not small countries. Those are countries with populations of 100 plus million people. So, you know, you could say, Oh, there are a billion Indians that are going to take these jobs.
But, well, there are hundreds of millions of people in Southeast Asia that are in line for these jobs ahead of the Indians. Actually, I think if you look carefully at it, I'm, you know, I'm optimistic about India, but I just don't think it's going to be quite as rosy as what some people project.
Alf: It's running to the point of is liberal democracy necessary for long term development to me that statement doesn't seem to gel with the historical record. If you look at South Korea and I mean I think we touched on this in our last episode if you look at South Korea when they had Park Chung hee and Chun Deokhwan.
Or Taiwan before 1988, or Vietnam today. A lot of the East Asian or Southeast Asian countries which have very rapidly developed have done so under non liberal or non liberal democratic systems.
Steve Hsu: I agree, I agree with you a hundred percent. So what I, the stylized fact, the way the economists or economic historians would, would describe it, the stylized fact is that if you're playing catch up, so you're a poor developing country and trying to play catch up and just get your economy going, you're going to be willing to take the lowest paying, ugliest kind of work. You're willing to do it. You have a lot of poor laborers who are coming in off the farms who, you know, can, in the Chinese phrase, eat bitterness. Like they're willing to put up with a lot because they've been, you know, they're subsistence farmers or something, right?
Still, the record, as you say, is usually a kind of quasi authoritarian government that's able to, like, Get the roads built, get the factory built, keep the labor unions from protesting and striking to grab the money away from the capitalists. You know, it keeps the cap, forces the capitalists to keep some of the money in the country and not just take it out.
You know, once they start succeeding, you know, there's a bunch of things that an authoritarian government, at least historically, was able to do in Korea and Taiwan and Japan and these other places in order to get going, to catch up. The other example that people often have in mind, but it's the wrong example, is what happened in Europe and the United States.
Now, in that case, you just happen to have, I would say, you happen to have, they could be linked in a subtle way, but, you know, not directly causally, you happen to have countries that pioneered the Industrial Revolution at the same time that they also started, you know, experimenting with democracy.
Actually, these things aren't really directly linked because like, you know, like American democracy sort of happened well before the Industrial Revolution, right? But roughly speaking, these things happen at the same time. And so you could make the mistake that, oh, the way to get ahead is you, you both establish democracy and you have a kind of industrial revolution at the same time. And that's how you become a rich country.
But that can't work for countries that are behind because the industrial revolution or the semiconductor revolution or AI revolution already happened somewhere else and you're playing catch up. And, and so in the catch up situation all the good examples I know are mainly authoritarian states who at least make that first zero to one jump, and then later liberalized.
Alf: And that leads me on to, I think the point on the question that we'll round up on today. on your recommendation and on the recommendation of others, I've been reading from Third World to First by Lee Kuan Yew, and I've been really enjoying, I really enjoy the structure of the book because it's not just a linear memoir as such, he breaks it down into sections on specific issues and specific policy issues in the first section and on specific countries in the second.
And, I suppose I wanted to ask, in your analysis, 'cause I know you've spent a lot of time in Singapore, you've worked a lot in Singapore, which policies that were pursued by Lee and his successes were the most impactful in ushering in Singapore's transformation. And to what extent was the transformation due to the government stepping back and allowing market forces to operate freely?
And to what extent was it the result of active government policy? And those two things interacting,
Steve Hsu: I have to admit, I'm not expert enough in the history of Singapore to actually make a comparison between those things like what was it more the laissez-faire aspects of the government work versus direct intervention by the government.
And also I think, in general, it's just hard to ascribe causality to things because almost everything is so multifactorial, like in the economy, or cultural development. I'll just say that. They did not shy away from government intervention, like so much of, you know, remember, it's a city. It's not like a huge sprawling country that you can't control.
It's like a small city. So, the government did so many things to like, you know, improve the education system, give scholarships to the top students to go abroad. Make sure those people came back and were could become well paid government service servants You know, they did a lot of things which were pretty unique to singapore and seemed to me to be very successful and contribute to singapore's success um You know lee kuan yew was very focused on eliminating crime and corruption so that businesses could trust the system and would therefore be willing to invest.
So, there are a bunch of different things that I think are unique that you could point to about Singapore. Yeah, the other aspect of it is, you know, increasingly now it's becoming just this financial sense. Like I don't think Singapore is actually that competitive in most major industries. You know, I would have a hard time pointing to any particular thing that they're like, Super competitive in, just to give you a specific example, when I was there, I was meeting with a lot of government officials about AI and some of them were trying to get us to open an office of my company, super focused, open an office and put some people there and you know, I'm was interested in that and they were willing to actually provide venture capital investment and stuff like that in order to encourage and make it happen.
But when you look at the cost factor of an engineer in Singapore, versus some of the other countries in the same time zone, it didn't seem like it was that good an idea and lots of other startups had come to that same conclusion. So, actually a lot of the prosperity right now in Singapore is basically kind of two things.
One, they have a highly educated, high trust society where everything works. So that, that's, that's pretty advantageous. And secondly, it's become kind of a financial hub where if you're a Chinese company and you're trying to evade sanctions, you incorporate your company in Singapore and you move your money to Singapore.
And to some extent, you know, kind of like with the case in the case of like London, a lot of the, the prosperity in that economy is due to not is due not to their ability to make things better than other people. It's more due to, you know, the way the laws work and some accidents of geopolitics and such that make you a desirable place to, you know, run money for other people.
And you know, that's definitely a big part of the Singapore story.
Alf: On that note we are going to end this episode of Seeking Truth from Facts. Thank you so much. For coming on once again, Steve, and I hope to have you back on the podcast in the not too distant future. Great. It's been a pleasure. Wonderful.
