Beijing has a bifurcated view on capital and this is something that has continuously perplexed Americans. There is “strategic” non-market-oriented capital and then there is normal market-oriented capital that we are very familiar with.

The entire SOE sector represents “strategic” non-market-oriented capital. And many privately-invested firms are also subject to “strategic” goals through regulation and the active hand.

The primary goal with strategic capital is not to make outsized returns on equity. The returns on equity could include non-monetized returns that accrue to society instead.

Public goods like rail are an example of this. Notably, I have discussed this topic at length with China Railway and the buildout of the high-speed rail network.

In sectors that do feature heavy presence of private capital, oftentimes SOEs play a disciplining role by ensuring enough level of competition to the keep the private players focused on society-benefiting development instead of rent-seeking.

We can see this with the auto sector, where heavy presence of SOEs like Chery, Chang’an and SAIC work alongside private players like BYD, Geely and Xiaomi.

Rare earths is now once again popping up into the news. Upstream materials sectors tend to be viewed by Beijing as enabling factors for downstream production. It is relatively agnostic to state or private capital; the key societal factor is avoiding production bottlenecks.

This means that private firms in the sector are permitted (through regulation or controlled competitiom) can make modest — but not outsized — returns on capital as long as they focus on preventing downstream production bottlenecks (via their control of supply).

Rentseekers that fiddle around with artificially limiting production need not apply and will be harshly and swiftly dealt with by Beijing’s economic planners. Beijing wants firms operating in these upstream sectors that can raise elasticity of supply .

In China, private capital thrives where it is intimately tied to entrepreneurial drive and employment. In particular, small businesses will always be the domain of truly market-oriented private capital. Tech and adv mfg businesses that push the productivity frontier, as well.

So this is what the West is up against. The problem with rare earths — we have known about this issue for more than a decade and so far diversification of supply chain has been just empty talk — is that it is an upstream sector where *by design* Beijing does not seek to optimize for return on capital.

This makes it very difficult to attract traditional private “market” capital that is attracted to high risk-adjusted returns and has many options to deploy elsewhere. This leaves strategic “state” capital but at least in the U.S. the state lacks direct institutional capacity to execute operating businesses. And approaches to apply financially subsidized “market-oriented” approaches have also largely failed. And sorry, tariffs on their own aren’t going to magically solve this either.

Other countries in the Western sphere have had more success here, notably Japan. They have done this because they have more state/institutional capacity to execute on this type of strategy. Absent the U.S. suddenly developing this type of state capacity, it will have to rely *heavily on allies like Japan.

This thread also discusses the differences between different forms of equity capital. The U.S. has a big gap in the top right quadrant compared to China.