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Yes, it is a liability, because in exchange for your reserve currency status you are indebting your country. Gradually, as you outsource more and produce less,

Yes, it is a liability, because in exchange for your reserve currency status you are indebting your country. Gradually, as you outsource more and produce less, your country derives more and more of its returns from soft economic assets (financial markets, legal structures, software, pharma, IP, etc.), than hard economic assets (commodities, energy, manufacturing, transportation, logistics, etc.). In the long run, this hollows out your industrial base, drives income inequality (because labor is devalued when products/soft assets have zero marginal cost of replication), and defangs your country. Said differently — vertical integration is the key to “innovation” in the abstract. You can see this with BYD. With the above in mind, let’s say your goal as a country is to develop your industries so you can achieve vertical integration. Soft economic assets are easier to bootstrap once you have hard economic assets. If you lose your hard economic assets and only have soft ones, you are at a strategic disadvantage because your opponent (in this case China), can bootstrap their soft assets relatively quickly. By comparison, it will take you much longer to get your hard assets back (through the mythical process of “reshoring/reindustrialization”). All that being said, this is not a commentary on the effectiveness of the tariff policy of the Trump administration.

Centigonal 2y ago
Thanks for the explanation! Most of what you wrote makes sense to me. In particular, I think the concept that going hard -> soft economic assets is easier than the reverse is really interesting. I'll have to think on that more. Things that still give me pause: 1. I don't understand why hard economic assets like manufacturing are more heavily impacted by this phenomenon. Wouldn't exporting a $50,000 car and a $50,000 software license have the same impact on the country's current account? I think it might have something to do with the marginal cost of replication point you made, but, for example, the marginal cost of manufacturing semiconductors is very small, and we trail in that too. 2. I disagree with your assertion that 'vertical integration is the key to “innovation” in the abstract.' I think this is often true, because vertical integration enables more control/flexibility and faster iteration, which allows innovation to occur. However, there are many cases (e.g. fabless semiconductors, meat poultry farming, software companies build on the cloud) where the innovation was actually to split the value chain into separate concerns with separate concerns.
- sebmellen 2y ago
  1. The further you are up the chain of abstraction, the less “valuable” the export is as a form of power. Think of this as a spectrum between hard and soft assets — if you decline to sell advanced computing software to your rival, you may harm their ability to optimize crop yields, or whatever. But if you decline to sell them steel, or oil, you may decimate their energy supply and bring their economy to a halt. So, generally speaking, harder assets have more “declination risk” for the purchaser than softer ones, because the softer ones are either a) at the tip of the value chain, or b) easier to clone and replace. China has done a great job of outright refusing US SaaS exports like social media companies, while “stealing” millions of Windows licenses from Microsoft. Said differently, IP is fragile! If your opponent does not respect your laws, you can’t enforce them. Hard assets are the opposite, because you can more easily cut them off. And again, they are usually at the bottom of the value chain, so everything else is dependent on them being available. No oil, no cloud computing. Not the other way around. 2. Great counterexamples. I think it depends on what you define as innovation, and perhaps more specifically what about innovation as a concept is important to you. - There are “open” kinds of innovation that push humanity forward, grow global wealth and prosperity, and make everyone better off. - There are also “closed” kinds of innovation that benefit only a particular group. Generally speaking, open innovation is “fangless.” What I mean by this is that it does not greatly increase your geopolitical power. The Dutch, for example, own ASML, but this doesn’t really give them any power, because their tools are relatively “open”. Swiss companies own massive numbers of pharmaceutical patents, but that’s just a domicile on paper. If Switzerland were invaded tomorrow, their patent regime wouldn’t offer much protection. By contrast, a more “closed” form of innovation (weapons manufacturing being the most extreme example) will dramatically increase your geopolitical power. Think back to the atomic bomb. Now look to the future. If the US develops killer drone swarm technology, or genome-targeted bioweapons, or whatever else, that means we have the cards. Once you have world (or space) domination technology, you can disproportionately benefit from it, and you can selectively enrich your allies by giving them access to it, like the US currently does with our weapons systems. If you don’t vertically integrate, you can’t do closed innovation. And closed innovation is the only “hard money” — and perhaps the dominant power struggle in geopolitics.
  - 2y ago

Centigonal 2y ago

Thanks for the explanation! Most of what you wrote makes sense to me. In particular, I think the concept that going hard -> soft economic assets is easier than the reverse is really interesting. I'll have to think on that more. Things that still give me pause: 1. I don't understand why hard economic assets like manufacturing are more heavily impacted by this phenomenon. Wouldn't exporting a $50,000 car and a $50,000 software license have the same impact on the country's current account? I think it might have something to do with the marginal cost of replication point you made, but, for example, the marginal cost of manufacturing semiconductors is very small, and we trail in that too. 2. I disagree with your assertion that 'vertical integration is the key to “innovation” in the abstract.' I think this is often true, because vertical integration enables more control/flexibility and faster iteration, which allows innovation to occur. However, there are many cases (e.g. fabless semiconductors, meat poultry farming, software companies build on the cloud) where the innovation was actually to split the value chain into separate concerns with separate concerns.

sebmellen 2y ago
1. The further you are up the chain of abstraction, the less “valuable” the export is as a form of power. Think of this as a spectrum between hard and soft assets — if you decline to sell advanced computing software to your rival, you may harm their ability to optimize crop yields, or whatever. But if you decline to sell them steel, or oil, you may decimate their energy supply and bring their economy to a halt. So, generally speaking, harder assets have more “declination risk” for the purchaser than softer ones, because the softer ones are either a) at the tip of the value chain, or b) easier to clone and replace. China has done a great job of outright refusing US SaaS exports like social media companies, while “stealing” millions of Windows licenses from Microsoft. Said differently, IP is fragile! If your opponent does not respect your laws, you can’t enforce them. Hard assets are the opposite, because you can more easily cut them off. And again, they are usually at the bottom of the value chain, so everything else is dependent on them being available. No oil, no cloud computing. Not the other way around. 2. Great counterexamples. I think it depends on what you define as innovation, and perhaps more specifically what about innovation as a concept is important to you. - There are “open” kinds of innovation that push humanity forward, grow global wealth and prosperity, and make everyone better off. - There are also “closed” kinds of innovation that benefit only a particular group. Generally speaking, open innovation is “fangless.” What I mean by this is that it does not greatly increase your geopolitical power. The Dutch, for example, own ASML, but this doesn’t really give them any power, because their tools are relatively “open”. Swiss companies own massive numbers of pharmaceutical patents, but that’s just a domicile on paper. If Switzerland were invaded tomorrow, their patent regime wouldn’t offer much protection. By contrast, a more “closed” form of innovation (weapons manufacturing being the most extreme example) will dramatically increase your geopolitical power. Think back to the atomic bomb. Now look to the future. If the US develops killer drone swarm technology, or genome-targeted bioweapons, or whatever else, that means we have the cards. Once you have world (or space) domination technology, you can disproportionately benefit from it, and you can selectively enrich your allies by giving them access to it, like the US currently does with our weapons systems. If you don’t vertically integrate, you can’t do closed innovation. And closed innovation is the only “hard money” — and perhaps the dominant power struggle in geopolitics.
- 2y ago