Western accusations that China is flooding international markets with artificially low-priced goods have served as a rationale for imposing ever-increasing tariffs on Chinese goods. While China rejects the accusations, it has also pledged to rein in excess industrial capacity. Yet its share of global manufacturing exports continues to rise.

According to Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, concerns about Chinese overcapacity are both “excessive and resolvable.” Overcapacity surged in many industries after 2011, because fiscal and monetary tightening reduced aggregate demand at precisely the moment when new production capacity – a result of the previous expansion – was taking shape. If “overcapacity” is equivalent to “lack of effective demand,” implementing a more expansionary fiscal and monetary policy would help to reduce it.

But Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics, points out that Chinese exports have so far “defied the corrective effects of conventional policy levers,” including not only “ambitious government spending,” but also “large and sustained currency appreciation” and “aggressive protectionist measures.” There are a few possible reasons for this: China might be subsidizing its exports in an “unconventional or concealed manner,” or its firms might be very efficient. Rather than pursue “knee-jerk” protectionism, the West should be trying to understand the “stubborn, even mystifying, resilience of the Chinese export juggernaut” and “tailoring responses to the underlying diagnosis.”

For Zhang Jun, Dean of the School of Economics at Fudan University, the diagnosis is obvious: household consumption expenditure remains too low to support China’s efforts to rebalance its economy and reduce its dependence on exports. While China probably is not lagging as far behind other major economies in this respect as official data suggest, “more must be done to boost disposable household income,” such as “channeling more income and transfers toward households” and “increasing subsidized or free in-kind transfers to them.”

Yi Fuxian of the University of Wisconsin-Madison, however, is not particularly worried about Chinese excess capacity. In his view, “reduced access to the US market, combined with trends like population aging and a shift toward services,” has made the decline of Chinese manufacturing imminent, inevitable, and irreversible. But this, he warns, will not necessarily bring about the hoped-for revival of domestic manufacturing in the United States.

BEIJING – In recent months, Chinese overcapacity has been a major topic of discussion – and a source of controversy – among economists and policymakers around the world. While these concerns are not entirely off base, they are excessive and resolvable.

Over the past four decades, as China has shifted from a planned economy characterized by shortages to a market economy oscillating between insufficient aggregate demand and overheating, its government has often sought to eliminate overcapacity whenever it arose. In 2003, for example, a crackdown on overcapacity in the steel industry led to the shutdown of many steel mills.

Following the 2008 global financial crisis, China’s exports plummeted, leading to a significant economic slowdown. In the first quarter of 2009, Chinese GDP grew by just 6.1%, the lowest rate in more than a decade. To counteract this shock, China’s government introduced a CN¥4 trillion ($560 billion) stimulus plan. Fueled by massive investments – fixed-asset investment grew by 30.1% in 2009 and 23.8% in 2010 (year on year) – China’s economy rebounded sharply, achieving 10.6% growth in 2010.

Although aggregate demand also rose quickly, aggregate supply failed to keep pace, as it takes time for new investment to translate into increased production capacity. (The duration of the lag depends on the type of investment.) This mismatch contributed to an uptick in inflation, with the consumer price index rising by 3% in 2010.

By the time CPI growth peaked at 5.4% in March 2011, the Chinese government had announced that its top policy priority for the year would be to clamp down on inflation. And clamp down it did: from 2009 to 2011, China’s budget-deficit-to-GDP ratio fell from 2.8% to 1.1%, and new credit declined from CN¥9.6 trillion to CN¥7.5 trillion.

But the production capacity associated with past investments was already forming, if not becoming operational. Consequently, as fiscal and monetary tightening reduced aggregate demand, a new mismatch emerged, and overcapacity surged in many industries, including steel, automobiles, cement, electrolytic aluminum, pesticides, photovoltaics, and glass.

By this point, CPI growth had fallen below 3%, and the producer price index was in negative territory. Under these circumstances, the typical response to surging overcapacity would have been to return to fiscal and monetary expansion in order to stimulate the economy. Instead, China’s government decided to continue tightening. As a result, GDP growth fell to 7.7% in 2012 and has declined continuously ever since.

With hindsight, it seems entirely possible that inflationary pressures would have subsided later even if the government had not pursued fiscal and monetary tightening in 2011, owing to the gradual formation of new production capacities. If policymakers had pursued moderate fiscal and monetary expansion while encouraging the market to play a decisive role in eliminating sectoral overcapacity in 2012, China may well have achieved higher GDP growth rates in the ensuing years.

We cannot change the past, but we can heed its lessons to achieve a better future. In China’s case, this means implementing a more expansionary fiscal and monetary policy today. This would help reduce “overcapacity” at the macroeconomic level, which is equivalent to “lack of effective demand,” while creating more space to eliminate overcapacity at the sectoral level – a process in which China’s government should be allowing the market to play a decisive role.

All this would go a long way toward improving China’s trade balance. Though there is no justification for countries to introduce protectionist trade policies in the name of “national security” – as the United States, for example, has been doing – China must ensure that it adheres to all World Trade Organization rules.

On this front, the Third Plenary Session of the 20th Central Committee of the Communist Party of China, held earlier this month, was encouraging. As the meeting’s communiqué noted, China plans to “enhance [its] capacity for opening up” its own economy to the outside world; foster “new drivers of foreign trade”; and develop, through expanded cooperation with other countries, “new institutions” to support an open global economy. As long as all parties are committed to mutually beneficial – and mutually respectful – engagement, no trade dispute is unresolvable.

WASHINGTON, DC – China’s trading partners are once again fretting about the country’s supposedly unfair economic practices. This time, the focus is on China’s alleged attempt to export its excess capacity, especially in emerging sectors such as electric vehicles (EVs), and to undermine domestic industries in the United States and Europe.

But before the world embarks on the next round of retaliatory action against China, it is critical to understand the stubborn, even mystifying, resilience of the Chinese export juggernaut. As my co-authors and I document in a recent paper, China’s share of global exports has continued to soar, despite other countries’ more restrictive trade responses and domestic actions that should have corrected the imbalance. This paradox has serious policy implications.

The figure below shows the role of trade in China’s exceptional economic performance over recent decades. From the mid-1980s until the global financial crisis (GFC) of 2008, the ratio of China’s imports to GDP more than doubled, from roughly 14% to around 33%. But China’s current-account balance (the excess of exports over imports) swung from a deficit of 4% of GDP to a surplus of nearly 10%.

These two outcomes reflected China’s opening to the outside world. A rising import-to-GDP ratio typically results from trade liberalization, including the reduction of tariff and non-tariff barriers. China famously shed its inward orientation after Deng Xiaoping’s reforms, culminating in the country’s accession to the World Trade Organization in 2001.

At the same time, rising current-account surpluses can be traced to China’s aggressive export-promotion strategy, which entailed the government keeping the economy closed to foreign capital inflows and the central bank buying surplus foreign currency to maintain a competitive exchange rate. As a result, foreign-exchange reserves ballooned, peaking at $4 trillion.

Trade openness and aggressive mercantilism then contributed to a third outcome: China’s steadily increasing share of global exports. In particular, its share of global manufacturing exports rose from less than 1% in 1985 to 12% by 2007, reaching astronomical levels of up to 50% in sectors such as apparel and footwear. In other words, trade and other policies produced faster manufacturing-sector productivity growth in China compared to the rest of the world.

China’s rising exports and current-account surpluses provoked anxiety in America and elsewhere, triggering a series of policy responses. First, facing pressure from the US, China began allowing the renminbi to appreciate against the dollar right before the GFC. The currency strengthened by around 50% over a decade, and the country’s current-account surplus fell from a peak of 10% of GDP in 2006 to virtually zero in 2018.

Second, China embarked on a massive stimulus in the years after the GFC, financing a real estate and infrastructure boom. This shift in public spending tilted the composition of output toward non-tradables. Third, under President Xi Jinping, China started turning inward, emphasizing “localization” and “internal circulation” which aimed to restrict foreign competition in the Chinese economy. Lastly, the US under former President Donald Trump hiked tariffs against China, a strategy that President Joe Biden has pursued even more aggressively.

These measures – a large and sustained currency appreciation, ambitious government spending, and aggressive protectionist measures – should have undermined China’s competitiveness. It makes intuitive sense that a stronger renminbi and America’s protectionist turn should have reduced China’s exports. And in more subtle, but no less important, ways, Chinese protectionism and stimulus should have had the same effect.

The collapse of imports after the GFC should have impeded export competitiveness, according to the economist Abba Lerner’s view that “an import tax is an export tax.” And the relative boom in non-tradables caused by the stimulus should have undermined the competitiveness of the tradable sector because of rising wages and price inflation domestically (also known as the Balassa-Samuelson effect). But none of this happened. The march of the Chinese export juggernaut has been relentless, with China’s share of global manufacturing exports jumping from 12% around the GFC to 22% by 2022.

Now, China’s current-account surplus is soaring again (despite being obscured by flawed data, as Brad Setser of the Council on Foreign Relations has shown), and its currency is weakening. Pressure is mounting on the US and Europe to take retaliatory action.

But the first step should be understanding this paradox of China’s globalization, namely, why exports have defied the corrective effects of conventional policy levers. For example, China may be massively subsidizing its exports, but in an unconventional or concealed manner. Or it could be that Chinese firms have been very efficient, especially in mastering new technologies in sectors such as EVs. The US and Europe should be discussing these issues with China, tailoring responses to the underlying diagnosis, rather than taking knee-jerk protectionist measures that serve only to stoke tensions.

SHANGHAI – In May, US President Joe Biden’s administration accused China of “flooding global markets” with “artificially low-priced exports.” Such accusations are not new, nor are they likely to stop any time soon. But many of those complaining about Chinese overcapacity overlook a critical fact: China’s net exports have been falling relative to GDP since 2008, and its trade surplus in goods has shrunk to less than 2% of GDP.

For years, China has been committed to rebalancing its economy and reducing its dependence on exports by boosting domestic demand, not through increased investment, which it has been discouraging, but rather through higher household consumption. And yet, despite rising labor income, which constitutes the bulk of household disposable income and accounts for about 56% today compared to 48% in 2007, household consumption expenditure has remained stubbornly low. According to official figures, total household consumption accounts for just 38% of GDP, compared to 60-70% in most developed countries.

But, as anyone who has studied China’s economy can attest, when using official figures, international comparisons can be misleading. For example, in a 2015 study, Tian Zhu and I found that official figures underestimate Chinese households’ consumption expenditure on housing (as a share of GDP) by at least six percentage points.

Moreover, as Asian Development Bank (ADB) senior economist Juzhong Zhuang recently showed, China’s total household consumption expenditure appears much smaller than that of high-income economies (as a share of GDP) largely because of differences in services consumption. Using input-output data compiled by the OECD and the ADB, he found that services consumption amounted to only 67% of total household final consumption expenditure in China in 2018-19, equivalent to about 26% of GDP. Compare that with the share of services consumption in the United States (more than 80%, or about 55% of GDP); the European Union (72%, or 38% of GDP); and 75%, on average, in East Asia’s three high-income economies, Taiwan, Japan, and South Korea (about 38-39% of GDP). Even in Asia’s five major developing economies – India, Indonesia, Malaysia, Thailand, and the Philippines – services consumption accounted for more than 54% of total household final consumption expenditure, on average, equivalent to 33% of GDP.

China’s under-estimation of services consumption is further compounded by large price distortions in services. According to the World Bank’s International Comparison Program, services prices in China at purchasing power parity are lower, on average, than overall prices. In other words, when Chinese households are purchasing services, their expenditure on them appears lower, complicating cross-country comparisons.

Further disparities might also arise from the fact that the Chinese government provides many services that households elsewhere might have to purchase themselves. A significant share of the recent growth in Chinese public expenditure represents in-kind transfers to households, including spending more on education, health care, and pensions, as well as social services like cultural facilities. Given this, in making cross-country comparisons of household consumption expenditure, it might well be worth including government consumption expenditure, which in China amounts to about 16% of GDP, in accounting that of households.

If we exclude government transfers to households, the disposable income of Chinese households amounts to about 60% of national income. This is 10-15 percentage points lower than in most high-income countries, where in-kind social transfers are included in household disposable incomes. But if one removes such transfers, the levels of disposable income in Japan, South Korea, Germany, and the eurozone as a whole fall to Chinese levels. In 2020, household disposable income in Denmark was even lower than that in China.

Therefore, when it comes to the real level of the household consumption-to-GDP ratio, China is probably not lagging as far behind other major economies as it seems. Nonetheless, as the relative importance of capital accumulation declines, and returns on investment continue to fall, more must be done through policy changes to support consumer spending. For policymakers, this means not only channeling more income and transfers toward households, but also increasing subsidized or free in-kind transfers to them.

A strong social safety net is particularly important in China, where decades of family-planning policies have encouraged households to save at exceptionally high rates, partly in anticipation of supporting parents and, ultimately, themselves in old age. If households can be certain that they will have strong family-based support and welfare programs from governments, so that they don’t need to save so much today, they are likely to consume more and might even have more children, thereby helping to stem China’s demographic decline. (The current fertility rate – about 1.1 births per woman – is well below the replacement level).

Ultimately, China must shift to a growth model that supports the growth of household disposable incomes, rather than continuing on the path of excessive capital accumulation. To that end, the government must encourage higher-wage economic activities, such as in the service sector, and strengthen the business environment, not least by expanding the decisive role of market forces in resource allocation.

MADISON, WISCONSIN – Chinese overcapacity is raising concerns worldwide. It is easy to see why: China accounts for nearly one-third of the world’s manufacturing value-added, and one-fifth of global manufacturing exports. But there is good reason to believe that the decline of China’s manufacturing sector is imminent.

To understand what is happening now in China, it is worth recalling Japan’s recent history. After World War II, Japan’s manufacturing sector grew rapidly, thanks largely to access to the massive US market. But the 1985 Plaza Accord (which boosted the yen’s value and weakened Japanese exports), together with an aging population and a shrinking labor force, reversed this trend.

From 1985 to 2022, the share of Japanese goods in US imports dropped from 22% to 5%, and Japan’s share of global manufacturing exports declined from 16% to 4%. Moreover, Japan’s share of global manufacturing value-added fell sharply, from 22% in 1992 to 5% in 2022. And the number of Japanese companies on the Fortune Global 500 list dropped from 149 in 1995 to just 40 today.

As the chart shows, China has followed a similar upward trajectory in recent decades, but China’s manufacturing rise was even more dependent on the US market. Japan’s imports from the United States equaled 51% of its exports to the US in 1978-84, compared to a 23% share for China in 2001-18.

Chinese family-planning policies are largely to blame for this imbalance. Typically, household disposable income would account for 60-70% of a country’s GDP, in order to sustain household consumption of around 60% of GDP. In China, however, the one-child policy – which was in place from 1980 until 2015 – limited household earnings, encouraged high savings, and constrained domestic demand.

As a result, Chinese household disposable income dropped from 62% of GDP in 1983 to 44% of GDP today, with household consumption falling from 53% of GDP to 37% of GDP. In Japan, by contrast, household consumption equals 56% of GDP. One can look at it this way: if wages would normally amount to $60-70, Chinese workers receive only $44 and have just $37 of spending power, whereas Japanese workers have $56 of spending power.

China’s government, however, has plenty of financial resources, which it uses to support industrial subsidies and investment in manufacturing. Moreover, because China’s manufacturing sector offers high returns, international investors are willing to channel capital toward it. Add to that a surplus of about 100 million workers, and excess capacity is difficult to avoid.

Given insufficient demand at home, China’s only option for reducing its excess capacity and creating enough jobs for its population is to maintain a large current-account surplus. That is where the US comes in: the share of Chinese goods in US imports rose from 1% in 1985 to 22% in 2017. In 2001-18, the US accounted for three-quarters of China’s trade surplus.

China’s giant surplus is the mirror image of America’s deficit, and while the rise of Chinese manufacturing is hardly the only reason for the decline of US manufacturing, it is a big one. America’s share of world manufacturing exports remained stable, at 13%, between 1971 and 2000, but fell sharply after China joined the World Trade Organization in 2001, and stood at just 6% in 2022. America’s share of manufacturing value-added likewise plummeted, from 25% in 2000 to 16% in 2021.

As these trends decimated America’s Rust Belt, which stretches from Wisconsin to eastern Pennsylvania, popular frustration with globalization, and with the “political elites” who had encouraged it, grew steadily. In 2016, Donald Trump rode their frustration into the White House, vowing to revive US manufacturing and force China to change its trading practices. And Trump hopes to do the same this November.

In this sense, China’s one-child policy indirectly but profoundly reshaped the American political landscape. And now American politics are reshaping China’s economy. The US backlash against China, which began with Trump’s tariffs in 2018 and has intensified under President Joe Biden, has caused the share of Chinese goods in US imports to drop to just 12.7% in the first half of 2024.

Beyond losing the American market, China is losing some of its own manufacturing companies, which are shifting part of their production to countries such as Vietnam and Mexico, to avoid US tariffs. This partial transfer augurs a wider withdrawal, much like that faced by Japan’s manufacturing sector as it fell into decline.

China is looking increasingly like Japan for two other reasons. First, its workforce is rapidly shrinking and aging. According to the government, annual births have plummeted from 23.4 million, on average, in 1962-90 to just nine million last year, and even that figure is probably grossly exaggerated. Within a few years, China will probably record just six million births per year. Meanwhile, the median age of migrant workers, who make up 80% of China’s manufacturing workforce, has risen from 34 in 2008 to 43 last year, with the share of people over 50 rising from 11% to 31%. Some manufacturing plants are already closing for lack of workers.

Second, China’s services sector is set to squeeze manufacturing. As China’s government seeks to increase the GDP share of household disposable income, Chinese demand for US goods will rise, and some manufacturing workers will shift to services, which is also where China’s rapidly growing pool of college graduates will find employment.

The decline of manufacturing might not happen as fast as it did in Japan, because China has a larger domestic market and a more complete industrial ecosystem, and because it is investing heavily in artificial intelligence and robotics, which could deliver productivity gains. But decline is both inevitable and irreversible. Unfortunately for the US, however, this will not necessarily bring about a revival of domestic manufacturing.