Chokepoints and Supply-Chain Vulnerabilities

- Trade policy has become entangled with concerns about economic and national security. We see that, for example, in policy discussions about choke points and cross-border supply chains. We also see it in the use of import tariffs and export restrictions in efforts to disadvantage geopolitical adversaries. To help us sort through the complexities in this area, we are fortunate to have two outstanding guests. Sumaya Kanes is an economics columnist for the Financial Times and host of the Economics Show with Sumaya Kanes. Chad Bone is a senior fellow at the Peterson Institute for International Economics and host of trade talks. Together, they have authored a book on how to win a trade war, an Optimistic Guide to an Anxious Economy. Their book will be published on May 26th, but I am fortunate to have an advanced copy, which I have read, and which I will set here on top of two books by Jag Dish bti, whose wisdom we would benefit from, I think in, in the current moment. Welcome to Economic Supply. I'm Steven Davis, senior fellow and director of research at the Hoover Institution and host of this show, Samaya Chad, thanks so much for joining the podcast and talking about your book. Thanks.

- Thanks so much for having us.

- You know, Samaya, I just can't resist asking, are you related to the John Maynard Keynes that everyone knows?

- Yeah, I am. You are. Okay. So he is, he's my great great uncle. Wow. Although, you know, for the record, he died in 1946, so, so we weren't close. You weren't close. I would say overlap. Yeah. I think, you know, he's a cool guy and minimize, you know, lower your expectations is what I'm saying.

- No, I'll, I'll, I'll, I'll try to maintain deference as appropriate. Chad, do you have anything equally illustrious in your lineage? Mayflower ancestors, anything like that?

- I know Samaya Kanes, and that's enough for me.

- Okay. That's enough for you. Okay, good. Very good. Alright, so we, we can't possibly cover everything in your book, but what I wanted to focus on is it is a topic you treat at some length, a set of topics around choke points, what we mean by them, the broader s set of issues related to su supply chain vulnerabilities. So I would like to just ask, maybe I'll ask Chad, 'cause I think you had to deal with this while you were working in the Biden administration. How do, how do you think about the vulnerabilities related to choke points, our cross border supply chains, particularly the, in terms of their implications for economic and national security?

- So I think that's the, it was a huge question in the Biden administration, and you're right, it was something that I worked on nearly every day, but I think it's, it was al it's also a huge issue right now, and it was an absolutely pivotal issue in 2025, the first year of the Trump administration. And maybe let me give you two examples of, of why and how. So, you know, the year started off with President Trump imposing a lot of tariffs, first on China and then on the world, but focusing on China, you know, the tariffs escalated to above a hundred percent. And one might've thought, well, okay, China's gonna retaliate with, with tariffs, but they don't actually import all that much, you know, American stuff. And so they really don't have all that much leverage against the United States. Well, if you thought that you were wrong, because China had tremendous leverage against the United States, but not through import tariffs, through these choke points that you're talking about. One was something called rare earths and permanent magnets. So permanent magnets, I don't think any of us, any economists anyway, really know what they are. But you talk to people in the industry and essentially they're, they're an essential input. They are something that you need, if you're a car manufacturer, you need to have it to, to make the seats go backward and forward to make the windshield wipers go back and forth. The windows go up and down. The point being that if you don't have these permanent magnets, you can't make a car that a consumer is willing to buy. And China not only has supply supplies 90% of the world's rare earth, but it also supplies 90% of the world's permanent magnets. And so when they stopped selling these things to the United States in April, may of, of 2025, suddenly the automobile industry in the United States was on the verge of having to shut down. Right. So a massive, massive choke points, that was the first example. Second, later on in the year after the US administration decide to sort of expand export controls, again, making China unhappy, China suddenly cut off another essential input that automakers needed. This one was a type of semiconductor, not a super fancy semiconductor one that, you know, lots of semiconductor companies could make. But the challenge was that it seemed like all of the auto parts suppliers, and particularly the big German one named Bosch, were all sourcing from this same company called Nexia. And so when the Chinese government cut off nex pious chips to the world, suddenly automakers no longer could make cars again. So these are two examples, and this is really when you step back and look at what happened over the course of 2025, what ultimately got the Trump administration to back down after imposing all of those tariffs on China a and really bring them back to the negotiating table and get them to not do a lot of other things, it was really those Chinese choke points that they took advantage of.

- Okay. So it was a, it's been a very big deal. So mean, how does it look any different across the Atlantic? I actually don't know whether you reside in the US or the UK or where, but, but I, I just wanna get your perspective. I'll take you for the moment. As a representative of a third party country. That's

- Right. Right. Yeah. So I get, I guess, you know, I think a lot of the discussion about resilience and choke points and vulnerability really reached a crescendo around the pandemic, right? There was this huge shock to supply chains and everyone freaked out. And, and so you had these exercises around the world. You had governments suddenly say, oh no, we lost access to this thing. How much else are we potentially vulnerable to? Right? Right. And so what these governments did is they went off and, and, and did these kind of surveys of where, where they were reliant on one partner who could maybe, you know, not, not prove to be so reliable. So that was, that was kind of this big shock and triggered all these exercises. And so you had the Australians, you had the Brits, did this thing called Project Defend, which is quite secretive. They never kind of, were very public about what they found. The European Commission did something, the OE DS did something. And so they were all kind of hunting for, for these things. And it, and it was happening in the US as well. And some of those exercises, I think Chad was, you know, observing or part of or, or what have you. And, and there was this really interesting process because, because I think one thing that can happen when thinking about vulnerabilities or choke points is, you know, a shock hits. And everyone who wanted to shut down the ship kind of loses their mind. And it's like, see, see, this is why we need to, you know, shut, shut off the borders. Right. You know, make everything at home kind of really hunker down. Right. And the risk is that you go way overboard. And so the, the really interesting thing that happened with some of these exercises, including in the US is you had the politicians kind of freak out commission these exercises, and the economists were like, oh, we, we need to make sure that we do this properly. Right? And so you have this kind of economist takeover of these exercises to make sure that, you know, it's rigorous and numbers based and, you know, you're not just, you know, you're not reading too much into the data. Right. And I think, you know, the way I think about this, I think, you know, at the start, a lot of the, you know, one approach might be to say, okay, well where are we importing lots of something from one country, right? That looks like a vulnerability, right? And actually, the right way to think about it is, where can we not recover quickly? Were we to lose access to this one thing? And, and if you've only one country as a supply, that's a hint that you might not be able to recover quickly. But it's not the only, the only sign, basically. And so, so the way I think about vulnerability mapping, the way I think lots of other governments kind of, you know, went on this learning process. It was a much broader and more complicated question about, you know, where can we find substitutes? Where do we produce stuff at home? How quickly can we get up and running? How quickly can we scale up production? You know, all of those questions, which are, which is just a much bigger messier issue. It is, it is, right? Where do we get one thing?

- It is bigger and messy. And in addition to what you said about the complexity, the, the supply side substitution possibly is, there's also the issue of can you substitute on the demand side away from less essential uses for some particular critical input to where it really is essential for national security or to make the economy run and so on. So, so that's another layer of complexity in, so just,

- Yeah. Can I just build on that? Yeah, please do, please do. Really, you know, you know this argument in the 20th century about essential goods, right? So, so there's a question of, okay, well, you know, how do we start thinking about our vulnerabilities? And maybe step one is to think about the, the things that we really need, right? And that can, that can kind of lead you astray, right? Yes. So if you think about the first world war, right? Britain was importing a lot of its food and was using lots of energy, right? Whereas Germany was producing much more of its food domestically and, and used much less energy, right? Driving cars around or whatever. And so it looked like the UK was much more vulnerable if there was going to be a shock. But actually the fact that Britain was, you know, it was using lots of energy for kind of leisure purposes, right? It was driving around you, you know, all countryside. It didn't need to use that energy, right? And so in an extreme situation, the Britain had much more sort of spare that it could not use, whereas the Germans were using what they really needed, so they were actually much more vulnerable to losing access to this extra energy. So, so you, you know, that capacity for, for an economy to switch demand is, is massive and massively understated Exactly as, as you say,

- Right? So I wanna go back to the first part of your previous response and get the sense from both you and Chad. So you, you, you, you talked about the exercises that were triggered in the United States, in, in Europe, in with the OECD and other organizations to identify and assess supply chain vulnerabilities after the pandemic experience, because we did have some serious supply chain problems at that time. And I wanna ask you, how successful was that exercise in anticipating what has turned out to be a different set of supply chain vulnerabilities in the 2025 episode that Chad described in particular? Were, were we, did we at least become aware of where we could be whacked over the head, or did we, or was it really a surprise? So I wanted to get that from maybe tar take that first to may your assessment of how successful that enterprise was. But then I, I want to go to Chad, and maybe Chad will have to say that they missed some things while he was on the, on the watch. I don't know. We'll see. Okay. So may Go ahead.

- Yeah. So, okay. So talking about the specific issues that Chad mentioned. So rare earths I think we kind of knew, right? I think we knew that there was a dependency on China for rare earths. I think we've known that for a long time. You know, the Chinese weaponized their dominance in rare earths back in, in 2010, right? With

- The, with Japan

- And with the Japanese, right? And, but you know, they were, they were tiny exports to the whole world, right? So we all, we all kind of knew, you know, the semiconductors issue. It's not particularly surprising that there would've been those issues. I think that I'm not confident that those mapping exercises would've raised those particular problems, and that's partly because of the, the complexity involved. I will say though, I mean, there's kind of one challenge because one thing that you noticed was that, of course, all these governments did these exercises and, and the headline was, okay, actually we are really vulnerable in fewer products than people think, right? So stop freaking out everyone. It's really not that many things where we are producing everything from one country, say, but they weren't that forthcoming about sharing what exactly the products were. So in some cases it was umbrellas, right? And it's like, okay, sure. You know, if there's an umbrella shortage, I think we'll cope. But when it comes to the kind of specific, you know, very fine grained codes, de describing the things, they, they, sometimes they were a bit vague, okay. Kind of for, for understandable reasons, right? You don't wanna tell anyone else that you've worked out exactly where you could be coerced, right? Right. And so they weren't that detailed. And so it's kind of hard to map, you know, all that specific product with these particular exercises. But yeah, I mean, maybe I should hand it over to Chad. He can tell you, I,

- I wanna get Chad's take on this 'cause you've been on the front lines, I think.

- Yeah, no, I, I mean, I think that's right. I think the, the only other thing that I would add is, is where it becomes difficult is where you have an indirect vulnerability, right? So when you go back to this, you know, rare earths and, and permanent magnets issues, what's really interesting is, yeah, China has, you know, 90% of the world's supply of both the United States. You know, we may import a lot of these permanent magnets from Japan. And so we may think that, you know, we're not that vulnerable to, you know, China cutting us off from rare earths because we don't import it from Japan. We, you know, we, or permanent magnets 'cause we import our permanent magnets from Japan. But if China cuts off Japan from rare earths, we are vulnerable to China indirectly. And so what you realize is you need to have really good data, not just on your own imports, but your key trading partners vulnerabilities as well. And that's more difficult to see in the kind of standard trade statistics that we have access to. And it's not just rare earth t magnets. You can make the same argument for, you know, the auto parts suppliers in the next period chips, right? Even if the United States doesn't import it, if Germany does and they all go to Bosch, but we import the auto parts from Bosch and Germany, then we're vulnerable too, right? So it is really difficult sometimes to pick out all the vulnerabilities. Okay.

- So I'm, I'm hearing a couple of things and I, I wanna follow up. One is that it's, it, it can be done. We, we, we learned a lot or we, and we can, and we have learned a lot from these mapping exercises to borrow c may's term about our vulnerabilities. That knowledge is imperfect because it's harder than it looks on the surface to do this. Well, there's also the issue of how do you communi what do you want to communicate about what you learned? Okay? So all these are the, the, they're, they're challenging issues to deal with. But then there's another issue, which, which I want to get your reaction to, which is, okay, we did understand the vulnerabilities in the rare earth's domain, partly because China had used it as a weapon in a multiple, a weapon of economic statecraft, if you want to think about it that way, on multiple instances before 2025. And that raises the question, okay, why didn't we do anything about it? Why did we leave ourselves, and I'm speaking here as an American citizen, why did we leave ourselves so vulnerable to this kind of response that Chad described quite clearly earlier in response to the Trump tariffs on China? What, what happened there, Chad?

- It's just really, really hard to give up low prices. And so, yeah, China did this back in 2010, and Japan, to their credit, you know, they were the main target at the time. Japan worked really hard to try to create alternative sources of supply. What it did is it actually went out and subsidized an Australian firm called Linus that does mining of these rare earths in Australia, but then does processing of them in Malaysia. So like, just imagine how complicated this must be from a policy perspective. You're, you're, you're subsidizing another country's companies in a third, you know, it's crazy. But Japan did that and they reduced their dependencies, you know, on China from something like getting 90% back before this all started to now they're down to like 60%. But China sees that, and it's got a lot of stand on enterprises, especially, it's got two now that dominate this space. And when it starts to see entrances that are being successful in entering into this market, it says, ah, we have a way of thwarting that discouraging it. And that is to throw a lot of supply out into the market to really dis discourage that entry to make it unprofitable for, you know, companies to be able to do that kind of thing.

- Okay. But I, I wanna pick up on this point 'cause you go ahead, go ahead Sume. We're both eager to jump in here. Go ahead. You know, I'm gonna jump in after Yeah. For you,

- The thing I wanted to add was, you know, you know, back in, back in 2010, the, the Chinese, the Chinese restricted rare earth exports to everyone. They had this licensing regime among countries reacted very differently, right? So Japan was really at the front of this, right? It brought it, it got special treatment from the Chinese. And so they reacted in the most extreme way in the way that, that Chad said the US and and Europe were also affected by it, right? And, and the US like it, it did take action. It sued China at the World Trade Organization, right? It was, you know, it, it believed that if we just show that the Chinese are breaking the rules, then they won't do this again. And, and we, you know, you both kind of laughed, right? But like, but that's how the rules based system is supposed to work. Yes. No, I, it

- Was supposed to work. Yes.

- And, and so

- I was in government at the time, so you can lay that responsibility on on No,

- But, but it was a different time, right? When we had a system, when there was rule breaking and we, we had faith in that system and I think, you know, we were in a world where it was plausible that that system was gonna work, right? And so I kind of, I, you know, it, it's, i I guess, okay, so you're,

- You're explaining why we didn't respond in other ways. Okay.

- Yeah.

- But the, so I I I take that point. It is worth remembering that the tenor around trade policy and its intersection with national security has just shifted tremendously really in the last 10 years, but especially even more so in the last two years. But there's another aspect of this Japan's response to China's effort to exploit the rare earth choke point that I wanted to bring to, to this discussion. You talk about it in your book, I've read about it elsewhere, but what struck me, which really made my eyeballs almost fall out, is the cost of this program to Japan. If I have the numbers right for $250 million in subsidy, which is really just chump change. They, they took their, their supply chain dependence on rare earth to China from something like 90% to something like 60% that is really peanuts given the damage that can be done by this kind of choke point. Because these rare earths, as Chad alluded to earlier, are used in very small quantities. So they're critical inputs to many production processes, but often in very small quantities. So you don't really need that much of it, some volume sense. So I go back, if that's what it took the Japanese to go from 90% to 60%, why weren't we and other countries taking more proactive steps, especially after the WTO effort didn't work out to re and why aren't we doing it now? Maybe we are doing it now under the Trump administration. They are, they are trying to undertake several efforts to reduce the supply chain vulnerabilities. But Chad, why weren't you doing it?

- Well, we were trying during the Biden

- Administration.

- Yeah. We, we were trying, we, the problem I think of the Biden administration is we didn't even have $250 million. Right? So your, your points are Oh, no, no, that, no, take it.

- No, no, I can't the thing there were hundreds of billions that were

- No, no,

- No, but rolled out for other things. But that, that can't, that doesn't cut it.

- But, but you're right. I mean, it doesn't take that much money, but it does take like a concerted government effort. The point is like the private sector doesn't have an incentive to do this, and it has even less of an incentive when China begins to see that you're doing it. And their, their firms are sort of directed to, no, I produce more output in lower

- Prices. I take that point. I take that point. The private sector firms acting on their own will be vulnerable to manipulation Yeah. From China. So that, that I take, yeah, but there is a national security interest here for the United States, for other countries. So there's a, there's kind of a standard public goods argument to provide for the national security. So I'm, I'm okay, and I'm not sure all economists are, but I'm okay with government efforts to subsidize this kind of activity on national security grounds. When you can establish the, you know, the sumaya went through this earlier in her remarks when, when you can't do it, when you can't, when you don't have enough supply side substitution possibilities in the near term or demand side, substitution possibilities or stockpiling, which could also be an effective response in this case perhaps, but not in all cases. So it seems to me there, there's been a fail, there's been a policy failure, and I'm trying to understand the dimensions of it. One, it sounds like just getting the government to, you know, to do something other than shovel money out the door in transfer programs, which is what western governments seem to be the only one, the one thing they do well. So

- Can I, can I,

- Yeah, go ahead, Sam. I'm ranting

- Up

- A little bit.

- Yes, okay. No, no, no, this is great. My fear. So that, that's 90% to 60% dependence of Japan, right? Is, is a stat that, you know, we, I think we use in the book as well. Like we're, we're, we're aware of that, and that is impressive. What I don't think that includes is all of the rare earth that are embedded in other products that are then exported, right? I'm pretty sure that refers to the more direct sales, you know, because Japan does do some, does import some of them directly, right? And so what's going on right now is that China has massively broadened its export controls scheme, right? And so the real thing that freaked everyone out was, it wasn't just the kind of raw ingredients, it was anything that contains a, a Chinese rare earth, right? They were, they were, they were reaching way, way broader in terms of the supply supply chains that they were trying to restrict. And so actually, if you think about, you know, Japan's dependence on every, anything containing a rare earth made in China, I'm pretty sure that dependence would've moved by much less with that particular government intervention. And so right now the challenge you have is that, so you are right, defense industry defendants in the defense industry is, you know, a an important consumer of rare earth's, but for some of them actually the private sector, the autos industry, right? They're, they're, the thing demand from them is the thing that gives you the scale that you need to sustainably make a profit, right? And so if the only thing you have is the defense industry jumping up and down and saying, we need Chinese rare earths, in some cases, that's actually not enough to get a sustainable, sustainable production of X China rare earth or an alternative supply

- Chain. An

- Alternative supply chain.

- Yeah. I - Point I also need a private sector on board. I that point, it's like

- I, I want the government to pay for tanks and if there's no good alternative, I want them to pay for the supply chain for rare earths for for,

- Right. But, but, but the, but the non, but basically you, you can't ignore the private sector, right? Because they're the ones that are making, they're, they're essential for the economic case for these mines and these processings

- Well, they, they

- Matter for the scale

- Economies and, and,

- Right?

- Yes, for

- Sure. And so, so you need, it's, it's not just a question of throwing cash at the supply chain, supplying the defense sector. You also need to think about incentives to make sure that the private sector changes as well. And that's much bigger. You're

- Quite right in this, this part of our discussion. We, we talked earlier about it's there, there's a fair bit of complexity in assessing these supply chain vulnerabilities, collecting the data that's necessary to have all the visibility backwards into supply chains that Chad mentioned. So there's complexity on this measurement assessment side. And now you're drawing out, there's also quite a bit of complexity on the policy design side when you decide you have a problem. So I think part of, part of my answer to Chad's, the question I was pressing Chad on would be, it's the common, it's, it's the combination of the complexities on the measurement side, then the communication to the decision makers. 'cause it's not enough to convince some product design engineer, you've got a problem here. It has to be explained to the political decision makers. And, and they presumably then have to explain to the, the electorate or the electorate representatives why we need to do something. And then we get to the complexities of the design so that we just don't waste a lot of money trying to do something that could be done much more effectively and cheaply. That's what I take to be your, your point. So you put all this together and you start to get some inkling into why, just from a policy perspective, it's not the easiest thing to deal with.

- And also just, just drawing out the, you know, the, the contrast between, you know, the, the car makers and weapons manufacturers, right? One of those two is much more comfortable sharing information with the government, right? Because the government is just a much bigger purchaser of their product, right? Whereas, so there's, there's that, it's very obvious why we don't want the North Koreans supplying parts that go into an F 35. That would be really dumb. But that kind of mindset or culture or, you know, system isn't there for the private car makers, for example,

- Right? So, okay. And I wanna put one other aspect of the policy in puzzle or a puzzle's not quite the right, the policy impediments here, which is to some extent, and I'll get your, I want to hear both of you on this point, but to some extent, and I'm not sure how much, but to some extent, the vulnerabilities we face are conseque, they're self-inflicted wounds from other policy cases. So an obvious one where we're, we're we're gas price controls in the United States in the 1970s that made the economic impact of the OPEC oil price cut. So supply cut back much worse. The fact that, but the one that's more relevant today is the fact, the, the what. We have no rare earth's refinement in the United States currently. Am I correct about that? And I think we have what one working rare earth's mine now in the United States. And it's not because we don't have these minerals in the ground, it's because we have, by regulation made it cost prohibitive to mine these and to refine these products in the United States. So to some extent, these vulnerabilities are consequences of policies that were implemented for other reasons. And I'd like to get, again, Chad, let me start with you 'cause you were on the ground. How, how I important is that aspect of the vulnerabilities we face. How much of it, and not just with respect to rare earths, but more broadly and can I just put one more example on the table? The Europeans have made a number of decisions over the years that have increased their vulnerability to Russia from natural gas supplies. And why don't they have a fracking industry? My understanding is this, because the regulation and property rights system there isn't very conducive to fracking, even though they have some of the right geology. So that's ano that's a self-inflicted wound there. So I wanna get both of you on the, on the record about this. 'cause I think it's another important aspect of the overall picture. Who wants to take that one first?

- I'll, I'll start. So agree, a hundred percent rare earth's, to be fair, are like the dirtiest, most polluting thing out there. You know, toxic chemicals sometimes, you know, nuclear level. And so if you have a trusted trading partner who's willing and able to do it, that's great. 'cause then I don't have to deal with the environmental problems. And I think for a long time, you know, that was very much the United States' approach. In fact, we used to be the dominant supplier of rare earths before the 1990s, and we decided just how dirty this was and China was offering to do it. And so we in a, in a sense, you know, help transfer the technology to allow them to do it, right? So don't disagree, but sometimes these, this market concentration that happens is for also purely economic efficiency reasons, right? We as economists espouse the benefits of agglomeration economies and the positive externalities associated with getting lots of spillovers of smart people all locating in one place and huge fixed costs of capital that you can spread across lots of output. So think of semiconductor manufacturing, right? TSMC and Taiwan. That's the global concentration of leading edge semiconductors. It's not really a policy decision. It wasn't because, you know, we regulated that out of business in the United States. It's because it's super efficient and we had basically free trade and it just made sense for it to all end up in one place there. And that's in a, in a world where we all trust each other and we don't have maybe earthquakes and climate change shocks and things of that nature, it would make economic efficiency sense to have that, that agglomeration in one place. But in this new world, right? Going back to the point that Samaya made earlier, these are now vulnerabilities, right? Where you get that concentration of production and now you have geopolitical tensions and somebody willing and able to cut you off from it. We have to take these things into account that we'd never really had to consider before. And so it's, yes, sometimes it's bad policy choices, but sometimes it seemed like really economically efficient policy choices as well that just ended up putting us in this outcome.

- Yeah. Okay. Samaya, what's your take on this?

- I mean, I actually, I don't think I have very much to add to that. That's basically okay. But, okay, so Chad was, Chad was sympathetic right to the policy makers saying they didn't make, they didn't make mistakes. So maybe I'll try and be critical to, you know, I, I love, I love to disagree with Chad, right? So, but no, I can't Is

- It hard to disagree with Chad, I mean,

- Or

- No? She does Oh, no, no. All the time. This is the only point that maybe we do agree on

- Is the only point. Yeah. I mean, you know, maybe the criticism is that, you know, policy makers woke up to the fact that they were in that different world too late. Yeah. You know, I, I think the old, the old system of, you know, the old system involved, you know, we, we, we were vulnerable to other countries cutting us off, but they were vulnerable to us, right? And the US was actually in a pretty strong position, right? The idea that, you know, someone might start pushing the US around, right? The US has the dollars, right? The dollar network that it can cut you off of. It's got, you know, incredible tech. You know, so, so I think that kind of system is easier to build up when you are so confident in your own strength that it doesn't occur to you that someone else is gonna start hitting you. Right? And so, so actually I guess I'm being sympathetic to policy makers again, right? But that's, but that's another reason I think that, that, you know, we, we got here, right? Which is that, you know, when, when you are the global heman, it's okay, you can make yourself vulnerable in a few places because obviously no one's gonna try to attack you 'cause you'll just, you know, swat 'em like a fly. You know, the surprise, the unexpected thing is that we are now in this kind of unexpectedly equal situation where actually you've got this kind of, you know, the wrestling match, you know, it's unclear. It, it, it's kind of locked in the middle, right? It's not clear who's gonna win.

- You know, one thing that I think both Simon and I found really remarkable as we were researching the book is kind of the speed at which various countries and governments are recognizing this, right? I think if you look at what Europe is going through right now with respect to China, they, they were affected equally to the United States last year by the rare earths and permanent magnet saga and this nex period saga, right? The United States has kind of just been more aware of the China national security threat for a while. Europe has kind of taken the, obviously Europe's been much more focused on Russia, but you know, the speed at which countries are being now confronted with having to deal with this national security thing is not all at the same time either. And I think that's part of what's going on here too.

- Yeah, I I don't think there's any doubt that we live in a world that's, that's from the one that prevailed during most of the 80 or so years after World War ii, in which there was, at least outside the Soviet Communist and communist sphere, a hegemon that largely set the rules, or I'm, I'm overstating the case now, but there was an enlightened, a more or less enlightened leading actor in the system. And that's not the case anymore. It's not clear whether there will, will a leading actor will emerge or will just be in this world where nobody's really fully in charge going forward. That could, that could last for a long, long time. But it does mean that we can't just think about scale economies and locational efficiencies that these national security vulnerabilities are. Well, these vulnerabilities in supply chains, which were always relevant for, as Chad indicated earlier, in the event of a hurricane or a natural disaster or a manmade disaster, they were always somewhat relevant. The difference is now they can be used as conscious tools of leverage in, in, in geopolitical rivalries and, and countries are using them United States and China in particular in a big way. And I, I don't think that's going to, that's gonna dissolve anytime soon. I completely

- Agree.

- I, so, so yeah. So we're in this new world, we, we just have to wrestle with it, which is part of the reason we're having this conversation. I I wanted to put a somewhat different question on the table and get the sense from both of you. So I, I think we're all on the page, but you can tell me if you disagree, that there's an essential public good role for the government to play in assessing these vulnerabilities for the national economy, for national security, and also to some extent for building the data pipelines that make it feasible to assess these vulnerabilities. So I, I'm gonna take it for granted that we all kind of share that view. The question I want to get to is how much, how far could we get in mitigating not eliminating, but mitigating these supply chain vulnerabilities simple by, by doing a, an an a better, maybe even an excellent job of quantifying and assessing these vulnerabilities and then publicizing them either in a, you know, in a literally a public way or through private conversations with company X. You know, we've, we've analyzed the supply chain issues. We recognize your product is critical to the functioning of national security or defense or the economy, and we've identified this vulnerability in your supply chain and we think you ought to take steps to rectify it. What I'm trying to get at is, is is there a, is there a useful role and if so, how big is for really just amplifying the government's usual? We are, you know, we think about the BLS, the Census Bureau and so on as informing us about the economy. Private sector actors then make use of that information that you get from the census BLS and other statistical agencies in the United States and around the world. And then they make good use of that information. So how far could we get with just that approach, Chad, what do you think? And, and is that something we should be doing more of? And

- So I I fear we can't get as far with that approach as we might like. Right? I definitely think that's part of it. And I think there's a role for government to do more, you know, as Sume indicated earlier of going out and surveying firms. And the, the challenge is firms don't wanna provide that information a lot of times. And oftentimes they, they don't know. When we went out and talked to companies, we went out and talked to, you know, the big multinationals and ask them, you know, how far do you, and they said, well, we, we can't get our, you know, tier two suppliers to tell us who their suppliers are because if they did, they think we would cut them out of the supply chain, right? Or negotiate a better contract, right? So there's certain information the firms aren't able to get themselves, right? Right. So one of the things that we noticed in our research is there's actually now an emerging private sector that's trying to fill this data gap. And you'd be surprised to learn what they're using to help fill that gap. Ai, right? So, no, I mean, part of it is lid, you know, is actual data. So they are piecing together data sets oftentimes because government agencies can't talk to one another for various regulatory reasons, and they can figure out ways to combine data sets and make connections between companies. They're able to get private companies to participate by offering them access to some of their data and, and make some of these supply chain connections themselves. So the private sector is doing some of this, and then where they aren't able to kind of create data or where they aren't able to get the data, they're using artificial intelligence to, to kind of forecast or, you know, simulate what they think the connections would look like. Now, as a policymaker, that makes me a little bit uncomfortable because as we've all now experienced, you know, with chat GBT or Claude or whatever, they're very good at providing an answer. When you prompt them with a question, they're not so great at telling you their confidence in their own answer, right? And sometimes they just get it completely wrong and you can imagine it going in either direction, right? Them telling you about a vulnerability that doesn't exist, and you then as a policymaker acting on it, or them missing a vulnerability that does exist, and you feeling confident that there's nothing there when there actually is something to be done. So I think this is an approach that can be useful to kind of compliment what governments are doing on their own. But I don't think even when this happens, right, that this is going to fully solve the problem, either, I think we're still gonna have some holes in our knowledge and some, and some missed, you know, visibilities there that, that are gonna remain concerning,

- Right? So I guess the way I interpreted your question was, if we solve the information problem, would the private sector move to reduce the vulnerabilities on its own? Right? So the reason to be, the reason to think that it might is that because you do hear companies complain, right? You do hear, well we, we can't find out where the vulnerabilities are because we only hear of these things when our seventh tier suppliers tell us that there's a problem, right? So, so they seem to want more information. But you know, the counter argument, which is I guess where I fall down, is that there are cases where they have huge amounts of information, right? They know, they know that they're very dependent on Taiwan for, for high end chips, or they know that, you know, China is a hugely important supplier of the regions that help to make APIs, right? So there, there are just these cases where, where they know they're very dependent and the problem isn't information. It's where theres a huge, you know, that it's hugely efficient and cheap to get the stuff from where it's all being made already, right? There's huge upfront cost to switching and no one wants to be the one to bear that cost.

- Well, it is clearly not a full solution of the problem, the better information. But the reason I, the reason I think it has some appeal is that the other approaches all invite rent seeking responses big time in the sense that once you start like subsidizing the mining of rare earth, for example, while, well, it's gonna be very, once the government is in that business, it will be very hard to get out of that business for all the usual political economy reasons. You create a constituency for a continuation of subsidies. So even something that might be a good idea to subsidize at a point in time, if somebody invents a substitute for some critical rare earth down the road, it'll be hard to get rid of the, it'll be hard to get rid of the subsidy. We have many examples of that. The core ethanol subsidy keeps coming back over and over again, even though it was once touted, I guess for some combination of national security and environmental benefits. I don't remember. It goes back to the OPEC oil price shock days. So I'm just groping for some, some less vulnerable to rent seeking activities approach. And what I hear you saying is, yeah, better information would help, but it's not gonna fully solve the problem. And I think that's, I think that's right.

- Yeah. And, and just on that, that point though, on the, on the subsidies point, I think, you know, both of us, neither of us love a subsidy, right? I think, you know, the reason you need a book to understand how to win a trade war is that none of the tools in this trade war are good, right? They're all, they're all really hard to use, they're really blunt, horrible, unintended consequences. We are really annoyed that we're having to use these tools, but I think, you know, the, the, I think for a long time our approach was, and obviously, you know, there are many government subsidies that are in practice. So, but, but the kind of the, the philosophy from economists was these things are terrible, they invite rent sinking, we're really bad at using them, therefore we shouldn't use them. And, and I think that, you know, where I think we need to change is basically saying like, we're gonna need to use these things. So how, how do we use them? Well, right? Because not using them at all just isn't really an option. And so we need to, we need to look to where they're being done and, and how, you know, how do we phase them out or not give them to winners, right? But, but I think the question needs to change, right? To how do we gather evidence? Well, let's doing them. Well, let's,

- That's a good question. Let's take up exactly that question. So then let's, let's make it concrete. Let's say we decide that we need to subsidize the supply of certain rare earths, and it could, could be through our, it could be with our allies, you know, on secure trading lines. There's many ways to do it. That government can take an equity stake in a company that then control and then, you know, then it, it's the government's in control. It could, it could set price floors for certain uses if it's supplied domestically or through a sup, a secure PLI supply chain. It could impose tariffs on alternative sources, which is indirectly an effort to encourage the activity. It could give special breaks on certain environmental regulations or permits. There's a whole host of do it. So how would, what are your thoughts about how to do it? Well, maybe I'll I'll turn to Chad to, to get started here or,

- Well, I think it's, they do it less badly. Well, that, that's, that's it, right? It's like, it's how do we do it less badly and, and what's the, what experiences can we draw on and what evidence that we have that's, that's out there. We could, we could go through rare earth, but I think there's an even more fascinating one that we came across for the book and it's also relevant, which is the CHIPS Act, right? And so, you know, the, the Biden administration Congress passed the whole, it was bipartisan, right? A whole lot of money to kind of move back some, especially high-end semiconductor production in the United States. Very worried about the concentration of production in Taiwan, as we talked about earlier. And, you know, there were different types of subsidies that were implemented. Some were grants which involved an application procedure and screening government officials and a lot of paperwork and a lot of time. And one of the company executives that we spoke, spoke to said something like, it's the most expensive free money, you know, that we've ever received kind of thing. And then there's tax credits, which is essentially, you know, just a reduction off of your tax bill if you do this stuff that qualifies, which doesn't require nearly as much paperwork is probably economic activity that you would have liked to do anyway, right? So those are different, different, different trade-offs. But I think what came out of all of that process was the United States was incredibly effective at encouraging additional supply of, or production capacity anyway, of high-end semiconductors. TSMC is now, you know, making chips in the United States, Intel and Samsung, right? The other major companies out there with the capacity to produce the leading Edge chips are all doing this. The challenge though is that the design companies, the NVIDIAs and the AMDs of the world, they look at those options and they say, yeah, you've got that diversification of capacity there, but we still really like TSMC, so we're gonna have them continue to make the chips that we want. And so what you realize is sometimes these supply side policies aren't enough. You do have to think about demand side policies too, right? And then it be gets it, it gets complicated. And lemme say one more thing and then I'll, I'll, and I know I've been going on, we talked to this guy, Dan Kim, who's now at Tech Insights, but he was the, the chief economist in the for the CHIPS Act implementation team. And one of the ideas that he had as sort of a demand side policy was recognizing that a company like Nvidia or a MD or one of these artificial intelligence chip design companies, in order for them to port their designs from A-T-S-M-C to an Intel or a Samsung, it's still a couple hundred million dollars, right? To take those designs from one of the other. So what if the government offered a subsidy for that and said, Hey, you know, we'll defray some of that cost, try out Samsung or Intel, one of their new, we'd like for some more diversification away from TSMC. But the point is, you know, sometimes the supply side policies aren't enough. If you're really trying to make a difference here, you have to think about the demand side too.

- There's another attractive feature of that particular form of intervention that I like, which is itself ending if it, if it's really about switching costs. If you're trying, if you're trying to subsidize switching costs, then once the switch is made, the rationale for the policy goes away. I mean, one of the things I liked about Operation warp speed during the pandemic is it had a nat, it, it was self-liquidating. You kind of, you got, you got the va the vaccines demonstrated that they worked with some reasonable degree of success and that was it. You didn't need to keep subsidized. Whereas a lot of these more conventional subsidy programs have no natural end points that tend no natural termination date that, that tend to intensify the, the entrenchment and rent seeking problems. So I I like that one. Sumo, what are your thoughts here?

- Yeah, I guess, okay, so really big picture. So in the book we talked about the, the subsidies chapter was all had food analogies, right? It was all, it was all around cooking. And the reason for that was that both Chad and I are really, really terrible chefs. And so, you know, it's important in the area of subsidies to have humility, right? To know what we don't know. And, you know, as I was, you know, doing the research for the chapter and kind of, you know, saying, okay, well what, what economic evidence do we have on the relative efficacy of these instruments? So one problem is that there just, it just really wasn't a very fashionable topic of study for a very long time. So we just don't know in some cases, you know, which instruments are better than others. There, there is a recent, you know, there has been a recent wave of, of studies trying to look at that. And then the other sort of issue was that often what they were looking at was the outcomes that they were looking at weren't quite the ones that we are interested in this world, right? Because often the question is, well, do these subsidies get you a profitable self-sustaining business at the end of it? Right? But as we were saying earlier that that's not necessarily the thing that we're trying to optimize for, right? Right. If what you're interested in is profit maximization, you're probably just gonna get people to stick with the original supply, right? So you, we've kind of got these, this, this different objective, which is harder to quantify success or maybe you just, all you care about is volume of production. And so our evidence base on that is, is a bit weaker or even just

- Production capacity,

- Right? Production capacity, capacity

- You can draw upon in an emergency. It's not even production volume.

- Yeah. But you know, at a basic level, we can see China, if you hurl enough money at, at your capacity, eventually you'll, you'll get it, it might take a lot of time, but you know, in a country as big as the US and as innovative as the US you, you can get there, right? It, it's just about, you know, what we don't know is, you know, is the kinda the full suite of trade-offs involved there. Yeah.

- I, yeah. So that's, those points are all well taken. I just wanna add one thing to the China thing, and I, this is not your, you guys are aware of this, but I, just to make sure our audience is aware of it, we have a much more successful economic model than China. GDP per capita in the United States is about six times what it is in China. So yes, they've built this huge industrial base, but that doesn't mean they've got an economy that we want to emulate in all respects. So part of the point of this whole discussion has been, we haven't said it in this way, but it's how can we cost effectively address these vulnerabilities that are of concern for reasons of economic and national security going down. The Chinese model path is in, in my view, a recipe towards, towards self impoverishment. So we, we, we don't wanna do that, at least I don't think so the whole challenge is to figure out how can we do something that's much more cost effective that preserves as much as possible, the, the virtues and the bounty that come from our, our more market oriented, decentralized economic system.

- Yeah. Just, just to add to that, I think, you know, when thinking about China, I think it's important to learn the right lessons, right? And so you could take away from it that, you know, massive state intervention is the way to go. But actually when you look at particular industries in particular sectors, really, I mean, and this is actually a problem. They've gone too far, but, but they have very intensive competition, right? They have ways of, of making sure that you don't end up with one subsidized fat industry that just is kind of sits there inefficiently. You have, you have this kind of, you know, tooth and nail fight and that has its own problems. Yes. But, you know, thinking about the kind of innovation, the successes that they've seen, I think competition has been a really important ingredient in that

- It has. But there, there's another point to put on the table here. So co competition is wonderful, but one of the ways that one of, a lot of the virtues come out of competition that come from competition are that failures in the profit and loss sense exit. Yeah. If you have sufficiently large subsidies, you can sustain a lot of competition. Doesn't mean all that. All of that continued operation of loss making enterprises is a good idea. So there's a lot of that in China right now. And you know, it goes into the word of involution,

- Which is exactly, that's, that's the waste in excess, right? That's the waste in excess. They've gone too far.

- There, there there's, there's another way to think about involution. It means almost all of the surplus is going to the consumers and, and you know, who are the consumers in this relationship. They're off of the rest of the world. So a lot of the, a lot of the subsidies that China has put into what, what is probably a, a, a vastly overbuilt manufacturing enterprise, the value of much of that is reaped by the consumers and the rest of the world. And it's important to not lose sight of that fact in the context of our discussion about the security vulnerabilities. We wanna keep both sides of that forefront in our minds. And I don't think we, we wanna address in the western world, in the United States, the security vulnerabilities that are presented by the Chinese model without it, at the same time redoing all of their mistakes. 'cause there are mistakes in their, in their approach as well. And without, I dunno about you guys, but I'm not really interested in subsidizing consumers in other parts of the world except for humanitarian, charitable reasons and so on. So I'll, I'll get you respond to that soapbox box pitch and then we'll wrap up.

- Yeah, I mean, I, I, I think that's right. I mean, I, I guess the other main takeaway from that is if you are the rest of the world, the United States, Europe going to respond to this. Somehow the implication is going to be what China has been doing in terms of subsidizing our consumers, you know, for the last 25 years is going to end. Right? We are gonna end up paying more for some of the stuff that we have been taken for granted. If it's important for national security or economic security or political reasons for us to have more of this manufacturing activity outside of China, it's just gonna be more costly and we need to be prepared for that. But if it's going to be more costly, let's try to make it as least costly as possible within that space. Exactly, exactly right and right. I think the concern right now is we're not thinking about it that way. It would be a lot less costly if we worked to try to get scale between the United States and Europe and Japan, all these countries that for by and large look at this very, very similarly. Right now, the challenge on, on their perspective is the United States. It doesn't seem like you're willing to work with us on this stuff. All you wanna do is impose tariffs on us too. So

- I I couldn't agree more with that. So may you get the last word.

- I think that's a really good way of, of wrapping up, I guess. Yeah. Can I just use my last word to thank you for these, these great questions and I was gonna thank you guys for reading the book.

- This has been a, a great conversation and I hope lots of people read the book and really thank

- There's a lot more. There's, there's,

- Oh, there's tons. We've only, I, I kind of, I, I told these guys in advance I was gonna focus on these three chapters, but there's, there's 12 or 15 chapters in the book, so, so we, there's a lot more to, if you, if you like this conversation, go buy the book. Buy it for your friends. Great. Alright. Thanks a lot. I really enjoyed it.

- Thanks Steve. Thank you so much.

- Take.