Weekend reading links

1. Jemima Kelly calls out the delusion among the successful Silicon Valley venture capitalists about the limits to their knowledge.

“If you go back, like, 400 years ago it never would have occurred to anybody to be introspective,” said a great sage of Silicon Valley last week, during the modern-day equivalent of a Socratic dialogue (a podcast). “Great men of history didn’t sit around doing this stuff.” The sage was none other than Marc Andreessen — venture capitalist, crypto enthusiast, devoted Democrat turned Donald Trump adviser, and author of the 2023 late-capitalist cry for help, the “Techno-Optimist Manifesto” (“love doesn’t scale . . . let’s stick with money”). The man who bet big on Web3 (remember that?) and NFTs (remember them?), and who once described criticisms of the metaverse as “reality privilege”. (Meta, on whose board Andreessen sits, announced this week it was all but pulling the plug on the metaverse.) The a16z founder was proudly explaining to Founders podcast host David Senra that he had “zero” levels of introspection. “Move forward. Go,” was his own anti-introspective mantra. “I’ve found that people who dwell on the past get stuck in the past. It’s a problem at work and it’s a problem at home.” He went on to claim that the very concept of the individual was only invented a few hundred years ago and that it wasn’t until the start of the 20th century that we started to believe in guilt and self-criticism.

She says something which more people should be talking about.

Andreessen seems to conflate the idea of overthinking, and even of guilt, with introspection, a word deriving from Latin that simply means “looking within”... He also fails to realise that the current era is the only one in which we would even have the option of not being introspective; the only one in which the a16z-backed merchants of the attention economy have made non-optional boredom extinct. In a recent X post, Andreessen described his “information consumption” thus: “1/4 X, 1/4 podcast interviews of the smartest practitioners, 1/4 talking to the leading AI models, and 1/4 reading old books. The opportunity cost of anything else is far too high, and rising daily.” (One wonders whether he reads the old books, or asks those leading AI models for their summaries.) My main issue with Andreessen is not so much that he’s wrong; it’s that he’s so confident about it. He sounded similarly confident when he told us that bitcoin represented a breakthrough akin to the internet, that Web3 was the future and that we shouldn’t fear AI because “the moral of every story is the good guys win”. We seem to believe, as a society, that wealth, influence and confidence can be equated with wisdom.

2. The market does not think that the war is about to end anytime soon.

In the last two weeks, there has been a big build-up of call options — which give a holder the right, but not the obligation, to buy an underlying futures contract — compared with put options, which give the holder the right to sell a futures contract. In the first week of the conflict, the opposite was true. That suggests the market believes we are in for further upside in oil prices rather than downside. The average strike for call options expiring in June expiration was $126 a barrel of oil whereas for put options it is $81. Worth noting, there is a small build in call options with a June strike price of $450 a barrel.

3. Off-grid energy is on the rise in the US to power data centres.

By the end of 2025, an estimated 39 percent of the gas power capacity being developed in the United States was designed to serve data centers on-site, according to the Global Energy Monitor, a nonprofit organization that tracks energy projects. That is up from 5 percent at the end of 2024...

Wait times vary by region, but it now takes an average of four years or more for data centers to connect to U.S. grids, according to JLL, a real estate services firm... Companies are gravitating to gas because it can theoretically generate electricity all day, unlike the wind or sun. And smaller gas generators and engines can be installed much faster than nuclear power plants... Industry analysts and executives also question whether power plants built alongside data centers will remain competitive if it becomes easier to connect to the grid.

3. Paul Graham has a brilliant essay on how the brand has become the product itself, illustrated with the example of Swiss watch makers. 

The most striking thing to me about the brand age is the sheer strangeness of it. The zombie watch brands that appear to be independent and even have their own retail stores, and yet are all owned by a few holding companies. The giant, awkwardly shaped watches that reverse 500 years of progress in making them smaller. The business model that requires a company to rebuy their own watches on the secondary market to catch rogue customers. The very concept of rogue customers. It's all so strange. And the reason it's strange is that there's no function for form to follow.

Up to the end of the golden age, mechanical watches were necessary. You needed them to know the time. And that constraint gave both the watches and the watchmaking industry a meaningful shape. There were certainly some strange-looking watches made during the golden age. They weren't all beautifully minimal. But when golden age watchmakers made a strange-looking watch, they knew they were doing it. In fact they give the impression of having done it as a deliberate exercise, to avoid getting into a rut.

That's not why brand age watches look strange. Brand age watches look strange because they have no practical function. Their function is to express brand, and while that is certainly a constraint, it's not the clean kind of constraint that generates good things. The constraints imposed by brand ultimately depend on some of the worst features of human psychology. So when you have a world defined only by brand, it's going to be a weird, bad world.

4. Interesting correlation between Truth Social posts of President Trump and oil market actions.

Traders made bets worth half a billion dollars in the oil market about 15 minutes before Donald Trump’s post touting “productive” talks with Iran sent the price of crude tumbling and ignited volatility in other assets. Roughly 6,200 Brent and West Texas Intermediate futures contracts changed hands between 6.49am and 6.50am New York time on Monday, just a quarter of an hour ahead of the US president’s post on Truth Social that there had in recent days been “productive conversations” with Tehran to end the war in Iran. The notional value of those trades was $580mn, according to FT calculations based on Bloomberg data... It was not known whether one entity or several entities were behind Monday’s trades. Trump’s announcement at 7.04am triggered a sharp sell-off across global energy markets and jumps in S&P 500 stock index futures and European equities as investors dialled back bets of a prolonged conflict.

The well-timed trades echoed the flurry of large highly profitable bets made on prediction market Polymarket on the timing of the US’s attacks in recent months on Iran and Venezuela... Several hedge funds noted that this was one of a number of examples in recent months of large trades being made ahead of official US government announcements. One trader at a major hedge fund said energy consultants had recently noticed several large block trades that they found to be unusually timed. Another portfolio manager said a series of large and well-timed trades had created a “level of frustration” among investors. “My gut from watching markets for the last 25 years is this is really abnormal,” he added. “It’s Monday morning, there’s no important data today, there aren’t any Fed speakers you’d want to front run. It’s an unusually large trade for a day with no event risk . . . Somebody just got a lot richer.”

See also this by Paul Krugman.

After the War broke out, the statements of Trump and his team have sharply lowered prices. Researchers somewhere are surely working on these to scrutinise market actions emerging alongside these decisions. 

5. Ed Luce brilliantly points to a striking home truths about the war in the Middle East.

One moment, Trump is threatening “an amount of strength and power that Iran has never seen or witnessed before”. Then, roughly 36 hours later, he declares that the US and Iran have been having “very good and productive conversations”. Few took the latter on trust. It is a strange situation where the world must await a statement from Iran to check whether there was any truth to what a US president said. Iran replied that no talks had taken place. Who were we to believe? 

... Trump will dial the invective up or down depending on Iran’s apparent negotiating position. The one offer Iran will never make is to give up its ability to disrupt the global energy markets. Yet that is the one thing Trump must have. Indirect talks are thus geared to swing from wild threat to outsized promise in line with Trump’s mood. Each time he is exposed as having made an empty threat that failed to push Iran into the desired concession, he will need to step up his threat level. This used to be known as the credibility gap. It does not take a seer to guess that at some point he will hint at using nuclear weapons.

6. A less discussed risk associated with the Gulf war is that on the semiconductor industry. Tej Parikh writes that the chip industry will face supply chain squeezes as the war drags on. 

7. Mohammed El Erian writes about how the Gulf war could impact global financial markets. 

The GCC countries have generated a current account surplus of more than $800bn in the past four years... Over the years, the GCC countries have expanded the scale and scope of their strategies to invest their patient capital, embracing the full spectrum of public and private markets, direct investments and more. Along the way, the countries have built deep financial relationships around the world and, most recently, the GCC has been at the vanguard of investments in AI, life sciences and robotics.

He points to reduced revenues and increased war reconstruction expenditures as likely to lower surplus flows into the global markets. This would come at a time when the global financial markets are feeling the pressure of sharply increased government deficit financing, refinancing of maturing debt, and a massive surge in AI investment-related borrowings. He says that the net impact on bond yields, even if in the short- to medium-term, can be significant. 

8. It can have adverse long-term impacts on the energy markets.

Critical Gulf energy infrastructure that was presumed to be safe is now seen as vulnerable, he said. A precedent has been set. “Buyers will price that risk for longer than the initial outage itself,” Jan-Eric Fahnrich, a senior analyst at Rystad Energy, wrote in an analysis. Countries in Asia and Europe, which depend on L.N.G., are likely to face more expensive gas prices long after the Strait of Hormuz reopens.

And this

“This is by far the largest disruption of crude oil and refined products that we’ve ever seen in history,” said Jason Miller, a professor in supply chain management at Michigan State University. “Petroleum goes into everything,” he said, so the inflationary impact could be enormous… Higher energy prices tend to slow economic growth, increase unemployment and speed inflation. It is also important to note that the price of diesel and jet fuel — which are processed differently — generally rise faster than the gasoline that drivers buy at the pump. And that has a disproportionate effect on moving goods around the globe, whether by plane, ship or truck. Those elevated energy prices could eventually increase the priceof practically every avocado, automobile, pair of sneakers, cellphone and drug that is bought and sold around the world.  

9. Nice article that points to how much of Trump's current actions are a replay of what he said and did nearly four decades back. 

He sketched out the first outlines in 1987, spending $94,801 to place a full-page ad in three US newspapers. The world was “laughing” at America’s leaders over the Gulf crisis triggered by the Iran-Iraq war, Trump declared. As the US escorted tankers through the Strait of Hormuz, he said Washington was trying to “protect ships we don’t own, carrying oil we don’t need, destined for allies who won’t help”. It is a line that his tirades echo today. But back then, as he tested the waters for a possible presidential run, Trump had concluded the problem was a lack of “backbone”. Appearing a few weeks later at a New Hampshire rotary club event in 1987, Trump sneered at how the Iranian navy — “little runabouts with machine guns” — had held America to ransom. “Why couldn’t we go in there and take some of their oilfields near the coast?” he asked. The then 41-year-old businessman put it even more starkly in a 1988 interview with the Guardian: “One bullet shot at one of our men or ships, and I’d do a number on Kharg Island. I’d go in and take it.”

This is similar to his belief that tariffs should be used to correct trade deficits, which he advocated in the case of Japan in the 1980s. 

10. Saudi Arabia may be a bigger proponent of regime change than Israel. A NYT report suggests.

Prince Mohammed, the people familiar with the discussions said, has argued that Iran poses a long-term threat to the Gulf that can only be eliminated by getting rid of the government. Prime Minister Benjamin Netanyahu of Israel also views Iran as a long-term threat, but analysts say Israeli officials would probably view a failed Iranian state that is too caught up in internal turmoil to menace Israel as a win, while Saudi Arabia views a failed state in Iran as a grave and direct security threat... 

Prince Mohammed has argued that the United States should consider putting troops in Iran to seize energy infrastructure and force the government out of power, according to the people briefed by U.S. officials... while Prince Mohammed probably preferred to avoid a war, he is concerned that if Mr. Trump pulls back now, Saudi Arabia and the rest of the Middle East will be left to confront an emboldened and furious Iran on their own. In this view, they say, a half-finished offensive would expose Saudi Arabia to frequent Iranian attacks. Such a scenario could also leave Iran with the power to periodically close the Strait of Hormuz.

11. German railways fact of the week.

Last year, Deutsche Bahn’s punctuality fell to the lowest level recorded in the 190 years since the first railway line was opened between Nuremberg and Fürth in Franconia. A mere 60 per cent of all long-distance trains arrived with less than six minutes delay, compared with 90 per cent two decades earlier. But this data excludes all of the trains that were cancelled. Deutsche Bahn now underperforms even the worst British train operator.

12. Sanctioned oil, where it used to go and where it goes now.

13. Fascinating account of China's genius-class students.

An estimated 100,000 talented Chinese teenagers are selected every year to enter a network of science-focused talent streams run across the country’s top high schools. The genius classes, also called “experiment” or “competition” classes, coach gifted students to compete in international competitions in maths, physics, chemistry, biology and computer science... For decades, genius classes have been turning out the leading lights of China’s science and technology sectors... Genius-class graduates include the founder of TikTok’s parent company, ByteDance, and the core developers behind its powerful content recommendation algorithm. Both leaders of China’s two biggest ecommerce platforms, Taobao and PDD, came from the genius stream, as did the billionaire who started the food delivery “super-app” Meituan. The two brothers behind the chipmaker Cambricon, now one of the leading Chinese rivals to Nvidia, were in genius classes. So were the core engineers behind leading large language models at DeepSeek and Alibaba’s Qwen, not to mention Tencent’s celebrated new chief scientist, poached from OpenAI late last year...

China’s genius classes differ in important ways from talent streams in the west. First, the system dwarfs its international competitors in scale. Second, it is state-driven. China graduates around five million majors in science, technology, engineering and maths every year, according to the state media Xinhua, compared with about half a million in the US. Tens of thousands of these graduates are genius-class students, taken out of regular classes for an intense period of study between the ages of 16-18. While others swot for China’s feared college admissions exams, the gaokao, those on the genius path have the chance to bypass that fate altogether, bagging places at top universities before they are out of high school, depending on their results in starry international competitions. The best students continue to more advanced talent schemes at the top Chinese universities, such as the elite computer science programmes at Tsinghua and Shanghai Jiao Tong universities... Starting in the 2000s, university admissions were reformed, giving more flexibility to colleges to allocate places without relying solely on the results of the gaokao. National competitions were set up for students at the end of their sophomore year of high school. Those who won top prizes in the national exam could receive direct admission to one of the 985 Project universities, China’s 39-member Ivy League equivalent...

The chance to skip the gaokao was a strong incentive for students to participate in the genius stream. The traditional pathway for high-school students in China is three years of study in the gaokao’s mandatory subjects of Chinese, English and Maths, as well as three more chosen subjects from physics, chemistry, biology, history, geography and politics. Exams in all six subjects are taken at the end of the third year. Genius-class students, on the other hand, focus on their “competition subjects”. A student competing in the International Physics Olympiad, for example, needs to not only finish three years of high-school physics but also at least half of the college-level syllabus, in order to be competitive enough to take the national exam.

Should it be any surprise then that Chinese teams sweep most of the gold medals at Olympiads, with 22 out of the 23 contestants sent in 2025 winning gold medals.  

14. Energy consumption responds to prices.

After the Russian energy price shock, German households and industry used 17 and 26 per cent less gas respectively. A study of Britain’s response by economists at the Institute for Fiscal Studies found that a 45 per cent rise in residential energy prices triggered a 14 per cent drop in households’ consumption.

15. Some staggering statistics about the age of omniscalers and extreme business concentration. A new MGI report identifies nine "super-wizard" companies, omniscalers - Alphabet, Amazon, Apple, Microsoft, Meta, Tesla/SpaceX, Alibaba, Huawei, and Samsung - that are set to dominate many of the 18 fastest growing markets of the future. 

Collectively they generated $2.7tn of revenue in 2025, a sum larger than the GDP of Italy. They also invested more than $800bn in research and development and capital expenditure, a share of revenue three times greater than at companies in traditional industries... In 2024, the six US omniscalers generated $550bn of operating cash flow. That was 2.5 times the money raised on US equity markets that year and not far shy of the $600bn of total bank lending to the non-financial sector... Over the past 20 years, these nine companies have been active acquirers of smaller businesses, with Alphabet and Microsoft snapping up more than 200 companies apiece. Even when a US judge found Google to have been operating an “illegal monopoly”, he refrained from breaking up the company.

Graphical summary of the China risk in the global energy transition

This post will provide a graphical summary of China's overwhelming importance in achieving the global energy transition. It covers renewables manufacturing, renewables generation, critical minerals refining, batteries, and electric vehicles. This, this, and this are three reports in recent times by US think tanks examining the Chinese dominance of critical minerals for the energy transition and how to address it. 

Let's start with renewables manufacturing. Graham Allison writes on China's dominance of the solar generation industry

China manufactures 80 per cent of all the solar panels produced globally. And, as the IEA notes, China’s dominance is even more pronounced when one examines the entire supply chain. It produces 85 per cent of the global supply of solar cells, 88 per cent of solar-grade polysilicon, and 97 per cent of the silicon ingots and wafers that form the core of solar cells. China’s rise to dominance in solar has been rapid. In 2005, Europeans led this race, with Germany accounting for a fifth of global solar manufacturing. By 2010, while Europe installed eight out of every 10 solar panels in the world, it produced only one. This year, China will make eight of every 10 solar panels produced worldwide and add five of those to its grid. In 2023 alone, China will install more new solar capacity than the US has deployed since Americans bought their first panels in the early 1970s.

It dominates poly silicon production

Its dominance of the clean energy manufacturing investment has only increased over time

So has the market share of clean energy technology exports

This is a staggering level of dependence,

China for example last year exported 86.6GW of solar panels to Europe, a 112 per cent increase on 2021’s figure, according to InfoLink Consulting. “If we are going to hit our 2030 [climate] targets we need China,” says Jacob Kirkegaard of the Peterson Institute.

The SCMP has a four part series on China's dominance of the electric vehicle supply chain. 

China dominates the EV supply chain as 76 per cent of the world’s production capacity for batteries – they make up 40 per cent of a typical EV’s sticker price – is in the country, with Contemporary Amperex Technology Limited (CATL) and BYD among the world’s top three producers. Fujian-based CATL alone controls a third of the entire global battery market... The country also controls more than two-thirds of the components needed to make them... China is also home to 70 per cent of the global production capacity for cathodes and 85 per cent for anodes, both key battery components, according to the International Energy Agency (IEA). Over half of the world’s lithium, cobalt and graphite processing and refining capacity is located in China... Two-thirds of the 10 million EVs sold worldwide last year were in China, helped by a slew of government policies dating back to 2009 that include subsidies, tax breaks and procurement contracts.

This illustrates the dominance of electric vehicle components and batteries.

And this points to the dominance in the processing of the critical minerals used in EVs

This is a good illustration of China's importance to the EV supply chain

And more on processing capacity

The Times primer captures the entire value chain, right up to final EV production, where China makes 54% of global EVs. 

This is a good summary of the geographical distribution of the entire EV supply chain.

This is a good summary of the different kinds of support the Chinese EV industry has gotten over the years. It has included a ten-year consumer subsidy program that ended in 2022 which reimbursed consumers as much as 60,000 yuan (~$8000), waiver of a 10% levy on smaller EVs till 2025, other tax breaks, manufacturing subsidies, government-funded charging infrastructure (6.36 million chargers, the largest in the world, and 649,000 chargers added in 2022, which is more than 70% of global additions). Several hurdles have been put to disincentivize ICE vehicles - license plate prices in auctions in Shanghai averaged 92,780 yuan last year whereas green license plates can be easily obtained; a tradeable dual-credit system for automobile manufacturers since 2017 that awards points for making clean cars and penalties for those with high fuel consumption, and producers with negative scores may be taken off the market. These were complemented by large purchases by governments at all levels and public transport networks. 

The result is that EVs made a quarter of all car sales last year, compared to one in seven in the US and one in eight in Europe. Including plug-in hybrids, clean-car sales hit 5.67 million in 2022, more than half of all global deliveries and 60% of the world’s 14.1 million new passenger EV sales this year. 

Rana Faroohar points to a German Marshall Fund paper that points to China's dominance of the rare earths market

As the GMF report notes, China controls 61 per cent of global lithium refining, and 70 per cent of the global supply of cobalt for lithium ion batteries comes from mines in the Democratic Republic of Congo, many of which are owned by the Chinese. China controls 100 per cent of the processing of natural graphite used for battery anodes, and 80 per cent of the total rare earth production and processing.

China's dominance of the supply chain for critical minerals is captured in the graphic below

This is a good summary of the drivers of the country's dominance in these markets, 

The factors driving China’s success in this arena are the same ones that have made it the uncontested manufacturing workshop of the world. These include low-cost capital, rapid regulatory approvals, protection from foreign competition, lower labour costs, an unparalleled network of suppliers, and fast-growing domestic demand.

In addition, China also dominates the supply chain for critical minerals used for defence purposes, or "war minerals". They include minerals like gallium, germanium, and indium that are critical for military equipment like lasers, radars, and spy satellites. These minerals have little commercial value and are mined and refined only in very small quantities. Sample this from The Economist

Antimony, known in biblical times as a medicine and cosmetic, is a flame retardant used in cable sheathing and ammunition. Vanadium, recognised for its resistance to fatigue since the 1900s, is blended with aluminium in airframes. Indium, a soft, malleable metal, has been used to coat bearings in aircraft engines since the second world war... Long before cobalt emerged as a battery material, nuclear tests in the 1950s showed that it was resistant to high temperatures. The blue metal was soon added to the alloys that make armour-penetrating munitions. Titanium—as strong as steel but 45% lighter—also emerged as an ideal weapons material. So did tungsten, which has the highest melting point of any metal and is vital for warheads. Tiny amounts of beryllium, blended with copper, produce a brilliant conductor of electricity and heat that resists deformation over time... Gallium goes into the chipsets of communication systems, fibre-optic networks and avionic sensors. Germanium, which is transparent to infrared radiation, is used in night-vision goggles. Rare earths go into high-performance magnets. Very small additions of niobium—as little as 200 grams a tonne—make steel much tougher. The metal is a frequent flyer in modern jet engines.

Beyond their varied properties, this group of mighty minerals share certain family traits. The first is that they are rarely, if ever, found in pure form naturally. Rather, they are often a by-product of the refining of other metals. Gallium and germanium compounds, for example, are found in trace amounts in zinc ores. Vanadium occurs in more than 60 different minerals. Producing them is therefore costly, technical, energy-intensive and polluting. And because the global market is small, countries that invested in production early can keep costs low, giving them an impregnable advantage. This explains why the production of war minerals is extremely concentrated. For each of our 13 war minerals, the top three exporters account for more than 60% of global supply. China is the biggest producer, by far, for eight of these minerals; Congo, a troubled mining country, tops the ranking for another two; Brazil, a more reliable trading partner, produces nine-tenths of the world’s niobium, though most of it is sent to China. Many minerals are impossible to replace in the near term, especially for cutting-edge military uses.

The combination of concentrated production, complex refining and critical uses means trading happens under the radar. The volumes are too small, and transacting parties too few, for them to be sold on an exchange. Because there are no spot transactions, prices are not reported. Would-be buyers have to rely on estimates. These vary widely. Vanadium is relatively cheap: around $25 per kilogram. Hafnium might cost you $1,200 for the same amount. All this makes building new supply chains much more difficult.  

On July 4, China announced restrictions on exports of gallium and germanium, that are important in semiconductors, solar panels, and missile systems. This has strategic significance since it highlights the vulnerability of US and other western militaries to such sanctions. In the aftermath of the Cold War, the US has run down its large stocks of strategic minerals and confined its strategic stockpiles to only commodities like oil and gas. 

Such global market-wide dominance by any one country, leave alone by one that's so belligerent and willing to exercise its power as China, should be a matter of serious concern to anyone outside China. 

Update 1 (11.08.2023)

This FT article describes how China came to control the renewables supply chain, focusing on promoting "the whole of supply chain" through a combination of purchases of mines, and the marriage of private sector enterprise and industrial policy in manufacturing and usage.

China is responsible for the production of about 90 per cent of the world’s rare earth elements, at least 80 per cent of all the stages of making solar panels and 60 per cent of wind turbines and electric-car batteries. In some of the materials used in batteries and more niche products, China’s market share is close to 100 per cent... China’s grip on raw materials is “more than it appears”. This is thanks to equity investments in overseas mining operations by Chinese companies such as metals group Huayou Cobalt, carmaker BYD and battery giant CATL. In lithium, for instance, China only has a small share in mining, yet by next year Chinese interests will control more of the resource than the country needs for domestic purposes... 

The country’s overseas metals and mining investments are on track to hit a record this year, according to data published last week by Fudan University in Shanghai. Spending in the first six months of 2023 hit $10bn, more than the total in 2022, and investments this year are likely to surpass the previous annual record of $17bn in 2018... China is the leading producer of at least one stage of the supply chain for 35 of the 54 mineral commodities that are considered critical to the US... China produces a “staggering” 98 per cent of the world’s supply of raw gallium, according to CSIS, despite the product’s US military applications, including in next-generation missile defence and radar systems. In electric-car batteries, for example, China’s share of the raw materials they require is lower than 20 per cent but it holds a 90 per cent share of the market for processed versions of the same materials... The production of graphite, used in the anodes in the heart of a lithium-ion battery, is instructive. While China’s market share of graphite reserves is just over 20 per cent, its market share for graphite processing is nearly 70 per cent... 

More than half of all new wind turbines installed this year will be in China, according to the Global Wind Energy Council, an industry lobby group. In the production of nacelles, which house the turbine’s power generation equipment, China has a market share of 60 per cent. It is currently building more than 60 new nacelle assembly facilities, adding to the 100 already in operation. Further down the turbine supply chain, the GWEC data shows China has more than 70 per cent market share of many crucial components including castings, forgings, slewing bearings, towers and flanges.

This about industrial policy,

Beijing’s cumulative state spending on the EV sector is more than $125bn between 2009 to 2021. Domestic industry was prioritised with heavy-handed local requirements, and from 2016 South Korea’s leading battery makers, LG, SK and Samsung, were cut off from accessing generous subsidies, setting up a boom in CATL and BYD’s battery production. 

This about the inherent advantages that completely distort the playing field for foreign competitors,

The advantages that China now boasts when it comes to manufacturing clean tech products are underpinned by massive economies of scale benefits. Goldman data suggests that China can build an EV factory in about a third of the time it takes in other countries while a battery factory in the US will cost nearly 80 per cent more than in China. Bernstein says the cost of some manufacturing in the US can be three times more than in China. This highlights how China’s rivals must grapple with not only limited access to resources and upfront technology costs, but also labour shortages, wage inflation and higher environmental standards...

Buoyed by massive domestic demand, Chinese manufacturing of polysilicon and its processing results in costs that are two-thirds the price of a European-made product, the IEA says. Chinese wind turbines are half the price of western rivals, according to S&P data. Across these industries, Mazzocco says it is important to credit the role of intense private sector competition. “It is something we miss from the outside: we think it’s just about the subsidies. But in reality, it’s also because [companies] have been able to overcome their competitors within China in an extremely cut-throat environment,” she says. “They are the best of the best at squeezing every cent out of their operations.”

And as if extraction and processing was not enough, China is now seeking to control the trading of clean energy metals. 

China is making a push to dominate the trading of lithium carbonate futures, as it seeks to wrest the financial plumbing linked to metals vital to the clean energy revolution away from the western dollar-based financial system. Last month the Guangzhou Futures Exchange became the fourth global commodities exchange to launch contracts tracking the price of lithium carbonate, a mineral used in the manufacture of electric-vehicle batteries. 

Within three weeks open interest — a key measure of the size of the market — had risen to more than 20,000 lots and far outstripped activity at rivals London Metal Exchange, Singapore Exchange and the US’s CME Group, which had launched its own version just days earlier. The proliferation of futures contracts on crucial elements of electric-vehicle products such as nickel, copper and lithium carbonate in part reflects the growing importance of the industry, as companies up and down the supply chains seek to hedge against price swings. But the early lead established by Guangzhou has underscored how China is seeking to seize greater control over trading in what it sees as a group of metals critical for the 21st century. By establishing its own trading hubs and benchmarks priced in renminbi, the drive is part of Beijing’s efforts to lessen the commodities market’s reliance on the US dollar...

Even so, China’s drive to convert its dominance over the flow of commodities into global pricing power faces substantial hurdles, including using a currency that cannot be freely traded, and the absence of a global warehousing network for any of China’s five domestic futures exchanges. The LME, which is owned by Hong Kong Exchanges and Clearing, does have a network of warehouses outside of China. It also argues its nickel futures contract — which represents the worst quality piece of metal in the worst part of the world — is more representative of the global market. Its pricing system is based on the value traded on its exchange, supplemented with “regional premiums” to reflect local problems such as distribution.

The economic growth-regulation trade-off

How much regulation is too much? 

Works in Progress has a very good article that highlights the trade-off between regulation and economic growth in the context of developed economies in infrastructure construction. The case in point is environmental and other safeguards-related permissions required for infrastructure projects in developed countries. 

Consider this on the prohibitive costs of environmental and other safeguards documentation required to obtain permissions for large infrastructure projects in the US,

1,961. That’s the number of documents contained within a single planning application for a wind farm off the northeast coast of England – capable of powering around 1.5 million homes. The environmental impact assessment and environmental scoping documents alone totalled 13,275 pages. To put that into context, that’s 144 pages longer than the complete works of Tolstoy combined with Proust’s seven volume opus In Search of Lost Time... EDF Energy had to produce 44,260 pages of environmental documentation for Sizewell C, a new nuclear power station to be built on the same site as two existing nuclear power stations in Suffolk, England.... a Freedom of Information request from New Civil Engineer magazine recently revealed that the UK’s National Highways agency spent £267 million preparing a planning application to build a 23-kilometer road. The planning application, which featured 30,000-plus pages of environmental documentation, was the longest ever prepared... 

It takes, on average, ten years for an electricity transmission project to be completed. But before you get to that point, it can take as long as 13 years just to get approval for the project. For example, Harvard’s Belfer Center cites the case of the 732-mile Transwest Express high-voltage transmission line. It applied for its permit in 2007, but did not receive full approval for construction to begin until 2020. It’ll come online in 2026, 19 years after that first permit application was filed... Using the average environmental page count from a sample of 18 projects (11,756) gives us an average per-project cost of £98 million. And that’s before the projects have put a single spade in the ground and before any spending on environmental mitigations has taken place. Think what could be achieved with even half of that nearly £100 million cost per project.

In stark contrast, sample this from history

France responded to the oil shock of 1973 with the beautiful slogan: ‘In France, we do not have oil, but we have ideas’. Over the next 15 years, the French built 56 nuclear reactors. To this day, France gets more than two thirds of its electricity from nuclear power... consider the construction of Britain’s national electricity grid in the 1920s–1930s. In the space of three years, Britain devised a plan to connect over 100 of the UK’s most efficient power stations into seven local grids across the country, and passed legislation needed to enable the plan and begin work on it. It took five more years for the project to be completed, with 4,000 miles of cables running across 26,000 pylons around the country. A year after the seven local grids were built, a group of impatient and rebellious engineers decided it was easier to ask for forgiveness than permission, and switched on the connections between the seven grid areas themselves to form a single national system. That national system remains to this day. It is hard to imagine projects of similar scale taking place today at similar speeds.

This debate has important relevance in the context of developing countries. In many areas, developing countries tend to adopt state-of-art regulations from their developed counterparts - labour standards, environmental protection, corporate and financial markets regulation, etc. In fact, they are actively encouraged to do so by multilateral lending agencies. But this has consequences that adversely impact their growth. 

Regulation is an incremental cost that gets added to the cost of production. It manifests in the form of additional equipment or building or infrastructure, slack or redundancies, increased construction times, etc on the grounds of safety, pollution abatement, employee welfare and working conditions, community welfare, social inclusiveness etc. This is a simple model of how regulation increases costs, lowers demand, and reduces economic competitiveness. 

Therefore, historically, the scope of these regulations has expanded progressively with the country's development. In fact, the historical trajectories of economic growth of today's developed economies point to a Maslowian hierarchy of values. The values associated with a subsistence economy are very different from that of an aspirational middle-income economy or a rich post-modern economy. 

The early development pathway of all today's developed countries, including that of China recently, have been characterized by large-scale externalisation of costs by all economic agents. The industrial revolution happened in a very loosely regulated world. In fact, it could not have happened with the modern world regulations. 

While gains are privatised, environmental and social costs are externalised on the society. Looser regulations and their enforcement, corruption, crony capitalism, etc are inevitable accompaniments to rapid economic growth from a low baseline. Once countries reach a certain income level and command adequate tax revenues, they venture into the higher levels of the values hierarchy. This is a messy reality of development. Nothing has changed to warrant a revisit of this theory of change.

Many developing countries, or regions there, continue to remain in the pre-industrial stage of economic development. Forget the fourth, they are still to fully realise the benefits of the second industrial revolution. In this debate, the irony of developed countries that have enjoyed lighter regulations during their growth phases now turning around and forcing developing countries to adopt tighter regulations should not be missed. 

Further, the commentators and opinion makers in developing countries, who inhabit the post-modern world, too tend to foist the social and economic values they share with the developed countries on the collective choices of their nations. Politicians and policymakers in developing countries should keep this in mind while making policy decisions on regulations.

The problem with this is that once we accept lower regulation, there is a slippery slope of exploitation by all kinds of economic interests. The markets are not known for restraint and social responsibility. So the challenge is to get regulation right. This has to be borne in mind as policymakers in developing countries adopt progressive regulations. 

These aspects should also inform global policy formulation on such issues. The energy transition debate where developing countries are being asked to sharply cut their carbon footprints at a very early stage in their economic growth is a case in point. Steep cuts and rapid changes by developing countries will erode their global competitiveness, besides also raising questions of affordability and market demand (see this and this). It's also an existential issue for people in many developing countries - poverty will get you before climate change can. I'll write about this in the coming days.

Examining more myths on energy transitions

Happy New Year!

I'll kick off the new year with a post questioning some principles of one of the most powerful enduring narratives, on energy transition. In an earlier post, I had shown using an economic model how economic transitions impose costs, whose allocation is always a problem. 

Consider these claims. There are trillions of private dollars waiting for opportunities in developing countries, especially in infrastructure sectors. There are hundreds of billions available for investment in green energy projects. There are tens of billions waiting to invest in businesses that help the poor. 

There are powerful proponents and supporters of these narratives that it's almost impossible to make a contrarian voice heard. These supporters are very rarely the capital providers themselves, but consultants, think-tanks, boosters, commentators, do-gooders, lobbyists, retired investors, philanthropists, and so on. 

For practitioners who engage from the other side of attracting these trillions and billions (like governments,  and green energy and impact entrepreneurs) and who have experienced the repeated frustrations from such engagements, nothing could be farther from the truth. I feel the same would apply to fund managers and investors who taken in by the hype trawl the market only to find little of substance. These are all pure ideological tropes at best, self-serving market making advocacy at worst. 

I have blogged on multiple occasions and written a long paper here questioning these narratives. The essence is this. The amount of foreign private capital available for infrastructure, green energy, and development in general for developing countries is much much smaller than is claimed. The risk appetite and returns expectations of the trillions of investment capital sloshing around is very different from that available (or even possible) in/from developing countries like India. After all, even theoretically these are different asset categories. Besides there are fundamental mismatches - foreign capital investment and local currency revenues.

For sure the regulatory environment can be improved and government policies can be made more predictable. And the envelope of investible projects can be expanded with support from development finance institutions. But these are all tinkering at the margins compared to the requirements. A continental economy like India can make large strides on its energy transition predominantly only with domestic capital, which includes significant concessional capital from its government. And it also requires demand-side acceptance of some of the costs associated with these transitions - see this for a model for economic transitions. 

A recent oped in Business Standard was effusive on the foreign capital supply-side of the climate financing problem, 

Climate financing for investment is a largely solved problem: The highway to near-infinite resourcing from foreign capital has been established in the form of ESG investment. This involves pensioners and insurance customers in DMs who get a sub-market rate of return for their investments in return for funding the Indian energy transition. Global ESG investment has reshaped the facts on the ground in investment finance in Mumbai.

The confidence - "largely solved problem", "near-infinite resourcing from foreign capital" etc - is mind-boggling. Such articulation does tremendous dis-service to the cause itself. It reinforces the already strong narrative of private and foreign capital being the solution to many complex development problems. It misleads the highest level decision-makers and forces policy makers into expending their efforts chasing chimeras. 

The oped then lays the blame for the lack of availability of demand side on the easiest target, governments.

The ESG world is quite able to support the Indian energy transition, subject to the limitations of present and future Indian financial regulation, capital controls, tax policy and rule of law. It is now hard to find financial closure for fossil fuel energy businesses in Mumbai. It is easy to find financial closure, at concessional rates, for economically sound clean energy businesses. 

The climate financing glass is thus half full for the Indian energy transition. On the one hand, infinite capital is available from the global financial system for sound projects. But on the other hand, there are limitations in the Indian electricity sector that limit what is possible. Our foundational problem is that we have an electricity sector that operates through state control instead of one which operates through the price system.

This is illustrative of a typical problem with armchair prescriptions. Such prescriptions are made on the assumption that there is a clean slate and governments have the agency to do whatever is technically right. 

Consider the problems with the above. India is what India is. Its financial market regulation, for sure, could and will improve. Its bond markets will deepen. Taxes will come down. But it's not at all clear that all this deregulation and lower taxation will lead to significant increases in capital inflows.   

On reforms to the electricity sector as a whole, it's easy enough to advocate cost-recovery pricing. In a country which is poorer than conventional wisdom appreciates, and where meaningful pricing reform on the farm power side is years away, the accounting reality is that aggregate cost recovery tariff schedule, even with cross-subsidisation, will require significant increases in tariff for the lowest category of consumers and large increases for middling consumers. Would our political economy, the shaping of which is a responsibility of the same commentators, allow any government to survive an electoral cycle after having raised tariffs as proposed? As Jean Claude Juncker famously said, we'll know what to do, but the problem is to win elections after having done that.

I have yet to see an oped by any esteemed commentator illustrating how less in purchasing power terms our higher category electricity consumers pay compared to similarly placed consumers in developed countries. Or a research work documenting the extent of farm power subsidy captured by undeserving large farmers, or a campaign exhorting governments to end free power subsidies to those large farmers. Most importantly, apart from articles blaming governments, I have not seen any oped or sustained efforts which seek to marshal hard facts to mobilise public awareness campaigns that creates the political space to undertake reforms.  

Take the example of privatisation of power sector assets, as a source to finance one-time expenditures. For a start, these are heavily regulated assets, whose upside potential is tightly capped. Further, almost all public sector generation and distribution companies have significant volumes of unregulated debt on their balance sheets. Besides, many also carry on their balance sheets debts raised on behalf of their state government to finance subsidies, debts which cannot be assumed by fiscally constrained governments. Finally, the political economy related uncertainties associated with the distribution sector also means that private investors will hedge and heavily discount any power sector asset purchased from the government. If all the liabilities are netted off and discounts applied, the likely returns from even the most competitive privatisation of power sector assets will be small, even negative. One should ask officials in any state where governments have seriously explored these options about the nature of these challenges. 

However, this is not to overlook the near certain improvements to efficiency and reduction in further bleeding from privatisations. But these are all in the future, and cannot make up for the legacy burdens. 

Commentators should acknowledge (as markets do) that developing countries like India, no matter what kinds of regulatory facilitators are put in place, are a different asset category from developed markets. It's fundamentally wrong to believe that even a significant proportion of the large volumes of private and public capital chasing infrastructure and green energy projects will flow into these markets. It's just as wrong to assume that the regulatory and political economy constraints that deter these investors can be addressed or alleviated significantly in quick enough time. 

The first requirement to create conditions for meaningful efforts at energy transition (or anything else) is to acknowledge the real extent of the problem/issue. Then, it's required to usher stability and predictability in policies, expand the envelope of investible projects, create enablers for effective intermediation of domestic risk capital into these projects, and of course create conditions to attract whatever foreign capital is available. All this has to be coupled with serious reforms on the power sector side in loss reduction, utilities performance improvements, and tariff increases. This will require a mix of regulatory oversight, state capability and governance improvements, and private participation where appropriate and possible. None of these are anywhere near close to being "solved problems". 

A model of economic transitions

I'll argue that any forced transitions to formality or higher labour or environmental standards is a supply shock induced demand compression, which invariably lowers the output. In general, any economic transition increases costs which if not supported by associated increases in demand, will necessarily lower output.  

I have blogged earlier in the context of formalisation of the economy that formality introduces layers of production costs which increases the market prices, which in turn reduces market demand. At the higher price, only a smaller number of customers can afford the good or service. The cost structure of the formal market can be met by only a small proportion of the total demand. The market settles down to a lower equilibrium output. 

In fact, it can create perverse incentives. In case of goods and services which are essential (or which have inelastic demand), the reduced affordable formal supply has to invariably result in substitution with lower cost informal supply. If formality is tightly enforced (as in case of certain goods and services), the informal market supply becomes an illegal (or harmful) market supply. 

Supporters will point out that increased formality will raise wages, productivity, profits, and quality which in turn will benefit workers, firms, and consumers in a virtuous loop. But this simplified belief assumes away the considerable adjustment requirements on all sides, which in the real world takes an inordinate time, and in many cases never materialises. It's for these reasons that such transitions have historically taken time, as with the developed countries of today. This ain't an area for leapfrogging. 

The supply will be constrained at both the intensive and extensive margins. At the intensive margin, the informal workers will not be able to acquire the skills required and the informal businesses will not be able to put up the capital for the increased production costs. At the extensive margin, supply of both new sets of workers and businesses will not expand as required. And, in any case, demand cannot expand enough in quick time to create a market which can absorb the higher production costs. 

This dynamic is just as true of labour or environmental or any other set of standards, which can all be seen as dimensions or aspects of formality. Each of these standards adds a layer of production and supply cost to the industry. And these costs must be passed through in the form of higher costs. 

In fact, we can extend this logic to economic growth itself. Economic output can grow sustainably only if the demand side can grow at the same pace as the expansion in supply. While it's possible for the supply to expand rapidly (say, with foreign capital), it cannot do much in the short-run to increase demand. In other words, sustained high economic growth requires the growth to be broad-based enough as to support growth in demand. 

The exception, which China and East Asian economies benefited from, is if the increased demand can come from an external market. In this case, the local economy can benefit with more investments and jobs, and greater productivity and higher incomes, without the proportionate expansion in demand. This positive supply shock will, in course of time, create the foundations for sustained broad-based economic growth. But this opportunity appears to have shrunk considerably. 

In the circumstances, any action plans for economic transitions, like that involving informality or renewables, should acknowledge its limitations and financial costs.

Weekend reading links

1. Peter Thiel is Exhibit A on several things which are bad with our world. Foremost, he represents one of the totemic examples of elite capture of political power. He's also an exemplar for human cognitive failing in terms of expecting expertise and success in one field to be sufficient to make them successful in another field, especially on public issues. 

And he's backed by libertarian ideologues like Tyler Cowen at Marginal Revolution blog and George Mason University's Mercatus Centre, who has serious conflicts of interests involving Thiel, considers him one of the foremost public intellectuals alive. Sample this fawning introduction,

It’s been my view for years now that Peter Thiel is one of the greatest and most important public intellectuals of our entire time. Throughout the course of history, he will be recognized as such... Peter himself doesn’t need an introduction; he has a best-selling book. His role in PayPal, Facebook, Palantir, many other companies, is well known. Peter is a dynamo. There is no one like Peter.

2. India's Nifty stock index has comfortably outperformed its peers, including developed markets, in dollar returns over the last decade. 

In the 10 years to mid-October this year, Nifty returns stand at 124% against 54.5% for the Dax and 33.8% for China’s Shanghai Composite Index. The UK’s FTSE and Hang Seng generated negative returns of 8.4% and 12.8%, respectively... The Nifty outperformed its peers despite the Indian currency being the worst performer against the dollar in the 10-year period. The rupee depreciated 60% versus the dollar, against the euro’s 23% depreciation and the pound’s 27% decline. The yuan was pegged at 6-7 to a dollar while the Hong Kong dollar moved in a narrow 7.75 -7.87 during the period.

3. The recoveries from the IBC process have been declining

However, it's still superior to the other recovery mechanisms.

For the four years until 2020-21, the recovery from IBC averaged 43.5 per cent, compared to 26.4 per cent for ARCs, 4.5 per cent for debt recovery tribunals and 4.8 per cent for Lok Adalats... By March 2022, the IBC recovery rate had declined compared to previous years. The time taken for resolution had increased to 700 days, as against the envisaged time of 330 days.

4. As European countries grapple with high energy prices every country has some market intervention in place to cushion people. Martin Sandbu examines the most incentive compatible approach in this regard. He points to the need to retain the price signal incentive that can reduce gas consumption, and therefore prefers means-tested cash compensation. He writes about the likely German approach,

It seems an amount of gas — in general, 80 per cent of consumption — will be subsidised so as to cost no more than €120/MWh. A particularly nice feature of the German proposal is that you get to keep the whole rebate that secures the guaranteed price even if you manage to bring consumption down to less than 80 per cent (the full allocation). In theory, you could come out in profit if you reduced your energy use enough as explained here. The market incentive to economise never disappears... The German reference to past consumption is far from ideal, for example, because it favours those who could afford to be profligate with their energy use — a flat allowance based on household characteristics rather than past behaviour would be better.

See this explainer by Sebastian Dullien. 

5. Bank of Japan is the undisputed leader in pioneering new frontiers in monetary policy. The latest example is its unrelenting pursuit of monetary accommodation which was initiated in 2013 by Haruhiko Kuroda and Shinzo Abe. This is despite rising inflation, the Yen plunging to a 32-year low against the dollar, and reversals across the world. And the BoJ's policy has broad consensus within the country and unstinting support from the government of Fumio Kishida. 

There is an important nuance to BoJ's policy,

Japan wants good inflation — the kind created by lively consumer demand. But it has gotten bad inflation — the kind created by a strong dollar and supply shortfalls related to the pandemic and the war in Ukraine — and that is why the bank should stay the course... In Japan, however, there is broad agreement that — at least for now — a rate rise would do more harm than good. The Japanese economy, the world’s third largest, has barely returned to its prepandemic levels, and wages have stagnated despite a labor market so tight that unemployment remained below 3 percent during the pandemic’s worst months... While inflation pressures in the United States have been broadly distributed, in Japan they have primarily hit essentials like food and energy, for which demand is satisfied largely through imports. Inflation in Japan (excluding volatile fresh food prices) has reached 3 percent, the government reported on Friday, the highest since 1991, excluding a brief spike related to a 2014 tax increase. But stripped of food and energy, Japanese prices in September were just 1.8 percent higher over the last year. In the United States, that number was 6.6 percent...

Perhaps the largest contributor, however, is a public grown used to stable prices. Producer prices — a measure of inflation for companies’ goods and services — have climbed nearly 10 percent over the last year. But Japanese companies, unlike their American counterparts, have been reluctant to pass on those additional costs to consumers. That means much of the current inflation pressure is coming from the strong dollar and supply issues affecting imports — factors outside Japan and therefore outside the Bank of Japan’s control. Under those circumstances, bank officials “know full well that driving up interest rates is not going to attenuate those price pressures — it’s just going to push up business costs,” said Bill Mitchell, a professor of economics at the University of Newcastle in Australia.