This is the latest in the series of periodic updates on China. It covers the issues of structural imbalances, the use of industrial and foreign policy to promote its exporters and secure its interests, and more examples of its rising dominance in some sectors.
1. Without understanding the fundamental structural imbalance in the Chinese economy, both Chinese government officials and Western leaders like Donald Trump feel that China’s trade surplus can be lowered by making the country import more products and services. But as Michael Pettis writes, this rests on shaky ground.
China will not reduce its trade surplus by "importing more competitive and high-quality products and services". Incremental changes in specific imports and exports have almost no impact on the overall imbalance. That's because if the total value of everything China produces exceeds the total value of China's domestic investment and its domestic consumption, the difference is equal to China's trade surplus. Some analysts argue that if Beijing could buy more sanctioned high-tech goods, this would reduce China's trade surplus, but of course it wouldn't. The incremental purchases would simply be matched by fewer other imports or more other exports.
He presents the choices for China
There are literally only three ways China can reduce its trade surplus. One way, obviously, is to produce less, but of course that would be extremely painful economically and would force up unemployment. Beijing would do all it could to avoid this "solution". A second way would be to invest more domestically, but with years of excess investment in property, infrastructure and, increasingly, manufacturing capacity, China can only do this to the extent that it is willing to allow a much faster rise in its debt burden. The third way – the "good" way – would be to force up the consumption share of Chinese GDP, but Beijing has been talking about doing this for over a decade and is finding it too difficult to pull off. It would require a transformation of the domestic distribution of income.
But without changing this fundamental domestic imbalance between investment and savings, China will not alter its trade surplus, no matter how much it spends incrementally on imports of high-tech goods, soybeans, or anything else. To suggest otherwise is muddled thinking. By the way if global trade conflict forces a contraction in China's trade surplus, these are the same options Beijing faces. That is why China, like most persistent surplus countries, is so worried about a worsening global trade environment.
2. The most important imbalance in the Chinese economy is the low household consumption share of GDP. Adding to it is the country’s low public spending on individuals.
China’s state spends only about 6 per cent of GDP on what is known as individual consumption — services ranging from healthcare to social security that directly benefit citizens — while households spend another 38 per cent, according to data by the World Bank. Analysis of the data showed government spending on individual consumption in China, which is classified as an upper-middle income country by the World Bank, lags behind most members of the Brics group of emerging nations, including Brazil and Russia. It is also lower than that of many other emerging and developed economies.
This low public spending is reflected, for example, in the high out-of-pocket spending on catastrophic medical episodes by Chinese households.
Despite China’s growing wealth, the proportion of families suffering catastrophic health expenditure has risen. The Lancet study found that 21.7 per cent of households suffered catastrophic medical expenditure in 2018 as measured by out-of-pocket health spending greater than 10 per cent of total household consumption, up from 20.4 per cent in 2007. For rural households, the increase was sharper — to 27 per cent from about 18 per cent over the same period… By contrast, the global average incidence of catastrophic health expenditure of 10 per cent or more of total household spending was 13.2 per cent in 2017, the Lancet study found. In Russia and Malaysia, two countries with similar per-capita GDP to China, the ratio was 7.7 per cent and 1.5 per cent, respectively.
3. These imbalances arise from several distortions in the economy. Just before it demitted office, the Biden administration initiated an investigation under Section 301 of the Trade Act on how China uses non-market practices to dominate the global maritime, logistics, and ship-building industry. Rana Faroohar writes about China’s trade-distorting policies in the sector, especially the one arising from the hukou system.
There are the usual problems, like massive state loans and access to non-market excess capacity in raw materials. Then there are the distortions in the Chinese labour market that make it nearly impossible for market economies to compete in the maritime sector, where China now has a market share of more than 50 per cent.
One of the most interesting sections of the report dives deep into the hukou system. In this, Chinese citizens are classified as rural or urban residents, and can’t receive state benefits such as education, housing, or healthcare outside the jurisdiction in which they were born. Since many rural residents migrate to coastal areas to work, the result is that half of the population resides in urban areas, but only a third have an urban classification. That has a hugely distorting effect on Chinese and global labour markets. As one scholar quoted in the report notes, the hukou system creates a “huge class of super-exploitable, yet highly mobile or flexible industrial workers for China’s new economy, now closely integrated into global trade networks”. It is essentially a massive state transfer from labour to the owners of capital, which is one of the reasons why Chinese economists concerned about bolstering domestic consumption would like to get rid of it (hukou reform is happening, though not as fast as many would like). It’s also one of many ways in which China’s system is incompatible with the Bretton Woods trading system as it exists today. “There’s no question that China’s very different economic model makes it difficult to have a system of globalisation based on WTO rules,” notes economist and Nobel laureate Michael Spence. Indeed, that’s the reason that Biden’s trade representative, Katherine Tai, pushed (albeit unsuccessfully) for a new model of trade based on setting a floor, rather than a ceiling, on environmental and labour standards.
The USTR Section 301 investigation report on China’s targeting of maritime, logistics, and ship-building sectors for dominance points to the contribution of the country’s hukou system. This is a good description of the hukou system.
Under the hukou system administered by the Chinese government, every Chinese citizen is classified at birth as either an “agricultural” (rural) or “non-agricultural” (urban) resident and registered with a local jurisdiction (a city, town, or village) that is considered that person’s official and only place of “permanent residence.” This local hukou typically passes from mother to child and entitles the holder to services including education, housing, healthcare, and social welfare provided by the local jurisdiction. Transferring the place of registration of one’s hukou is a difficult bureaucratic process.
The hukou has persisted despite the rapid urban expansion that has resulted in large migration from rural to urban areas, and from the hinterland to coastal regions. The result is that while half the population live in urban areas whereas only a third of the urban population has an urban hukou.
As one scholar has noted, the hukou system has created a “huge class of super-exploitable, yet highly mobile or flexible industrial workers for China’s new economy, now closely integrated into global trade networks.” Several hukou-related factors continue to limit labor mobility. First, rural hukou holders have shown reluctance to transfer their hukou to an urban location because it requires them to relinquish their increasingly valuable rural land-use rights, which in many cases represents the only retirement security that rural residents and their families have. Second, rural residents that migrate outside the geographical area of their hukou registration may not have access to public services, healthcare benefits, housing, the educational system and formal employment under a written labor contract… (it) provide indirect non-market advantages that increase costs for migrant workers by depriving them of local social benefits, and benefit producers, as businesses indirectly benefit from reduced labor costs as a result of reduced social welfare costs.
4. China has always used industrial policy and foreign policy as instruments to further its interests. As an example, Chinese manufacturers have been establishing manufacturing facilities in places like Mexico, Hungary, and Vietnam.
In fact, Vietnam is rapidly becoming an off-shore site for Chinese manufacturers who now form a third of all new investments in the country. This also creates vulnerabilities given its trade surplus with US surging to $123.5 bn in 2024, the third biggest after Mexico and China. Companies such as Apple and Intel have moved production facilities to Vietnam to diversify away from the mainland.
Vietnam is also increasingly getting investment from Chinese companies, accounting for 28 per cent of new projects last year, up from 22 per cent in 2023… Most Chinese manufacturing investments in Vietnam were being made to avoid US tariffs and secure a different “certificate of origin” for goods produced by Chinese companies… In the first month of 2025, Chinese companies accounted for 30 per cent of projects…Chinese investments also came via Hong Kong and Singapore, the latter of which was the top investor in dollar terms in Vietnam last year… The US accounts for nearly 30 per cent of Vietnam’s exports… Most Chinese investment in Vietnam is in assembly and low-to-mid-end manufacturing, from cars to solar panels. China’s strict curbs during the Covid-19 pandemic also pushed some companies to diversify outside the country. A small percentage of Chinese goods were also relabelled “Made in Vietnam” without any value-added and rerouted to the US, experts said, a practice that is illegal… 38% of Vietnam's imports came from China, while 30% of exports went to US.
5. Kyle Chan has a good summary of China’s Faustian Bargain for foreign firms.
Foreign firms agree to a Faustian bargain where they profit from selling to China’s market in the near term but build up their future Chinese competitors in the long run… Foreign companies agree to build manufacturing plants in China, form joint ventures with Chinese companies, set up R&D centers, share technology and production techniques, and even sell off parts of their business… Over time, China pushes these foreign firms to share more technology and use more Chinese suppliers. Foreign companies end up training a whole cohort of Chinese engineers and managers who can later help Chinese companies or even launch new startups. Time and again, foreign firms start with a useful partnership but end up helping to grow their most formidable competitors.
Foreign firms find three attractive aspects - market access, low-cost manufacturing, and an arrogance and overconfidence that they can dominate the Chinese market (this Elon Musk interview on BYD is epic). Apart from this, China was a major market for these companies - Apple made $227 bn in operating profit in China over the past 10 years (a quarter of its total operating profit in the period), Volkswagen made over €54 billion in operating profit in China over the past 15 years, and GM made over $17 bn in profit in China over 2012-23. Chinese, in turn, demand localisation and technology-sharing through JVs for market access. Soon the Chinese JV partners mastered the technology, innovated, and out-competed and muscled out their foreign partners.
6. In another blog, Kyle Chan describes how China is using industrial diplomacy and technology controls to reshape a China-centric supply chain. He points to how Chinese companies are racing to build factories around the world and forge new global supply chains, especially in “connector countries” like Mexico and Vietnam, driven by a desire to circumvent tariffs and secure access to markets. It’s encouraging Chinese companies to build plants in “friendly” countries while discouraging them from investing in others in a kind of “industrial diplomacy.” Hungary and Brazil are two examples of “friendly” countries where capacity expansion has been happening at frenetic pace, whereas India and Philippines stand at the unfriendly end.
India, a likely competitor, is a major economy where Chinese companies have seen restrictions.
Electronics. Recently, Beijing appears to be limiting Apple’s manufacturing partner Foxconn from bringing Chinese equipment and Chinese workers to India. Some of Foxconn’s Chinese workers in India were even told to return to China. This informal Chinese ban extends to other electronics firms working in India but notably does not seem to affect countries in the Middle East or Southeast Asia.
Automotive. Beijing has told Chinese automakers specifically not to invest in India. India has been increasing scrutiny of Chinese automotive investment, blocking a 2023 plan by BYD to set up a plant in Hyderabad on national security grounds and putting pressure on SAIC’s MG brand.
Solar equipment. China has been reportedly blocking the export of Chinese solar equipment to India. India’s solar industry relies heavily on China for inputs, including for 80% of India’s solar cells and modules, as well as manufacturing equipment.
Tunnel boring machines. TBMs made in China by Germany’s Herrenknecht for export to India have been reportedly held up by Chinese customs.
Noah Smith too has an essay on the same topic here.
7. Kyle Chan draws attention to an important aspect of Chinese industrial policy by pointing to its unique “overlapping tech-industrial ecosystems” which create a mutually reinforcing feedback loop.
China has developed multiple tech-industrial ecosystems that overlap in terms of the firms and technologies involved. China doesn’t just have a smartphone industry or a battery industry or an electric vehicle industry. It has all of these industries and more. China’s strength across multiple overlapping industries creates a compounding effect for its industrial policy efforts… China has created a system of interlocking industries. As China becomes stronger in some industries, this tightens its grip on others…
In a number of cases, you have what I call “industrial coevolution” where two or more related industries develop together in an iterative, two-way process. This is happening now with China’s EV and battery industries, which makes sense given how deeply dependent these two industries are on one another. China’s EV industry leveraged the existing scale that China’s battery manufacturing industry enjoyed, which in turn gave China’s battery industry even more production volume and manufacturing experience. This is also happening with China’s battery industry and its solar industry where solar plants are increasingly being deployed with integrated battery energy storage systems (BESS). Industrial coevolution can also happen across multiple industries simultaneously: for example, China’s lidar, EV, drone, and autonomous vehicle industries. And the co-development of this nexus of industries can have spillover effects into other industries, such as the proliferation of new kinds of autonomous equipment in agriculture, mining, construction, and energy...
As a result, Chinese tech companies are increasingly becoming tech Swiss Army knives, starting in one industry but then quickly branching out into a range of adjacent tech domains: smartphones, EVs, autonomous vehicles, generative AI, drones, robotics. You have smartphone makers like Xiaomi jumping into EVs, drone makers like DJI jumping into lidar, EV makers like BYD jumping into semiconductors or Li Auto jumping into humanoid robots, and traditional internet companies like Baidu jumping into autonomous vehicles. These days, it’s almost strange if you’re a Chinese tech or electronics company and you don’t have your own cutting-edge large language model. Chinese tech companies used to model themselves after Google, Apple, or Facebook, but now they look more like Elon Musk’s Tesla/xAI. And of course, there is the ultimate Chinese tech generalist, at the center of so many of China’s tech-industrial ambitions: Huawei.
8. Some more links about emerging developments on China.
An area where Chinese companies have arguably built their greatest dominance is in critical minerals extraction and processing. FT points to new research by AidData at the College of William & Mary in the US, which shows that China’s control of critical minerals across the developing world was built up over the last two decades through lending by a network of 26 state-backed financial institutions. They gave loans worth nearly $57 bn from 2000 to 2021 to 19 low and middle-income countries for mining and processing copper, cobalt, nickel, lithium, and rare earth minerals central for solar panels and EV batteries.
The research also found that this state-backed lending was to entities with long-term control over extraction and processing of strategic mineral deposits where Chinese firms held ownership stakes.
The study contrasts the critical minerals financing from the lending under the BRI projects
Unlike most loans made for BRI projects, which are dominated by a handful of Chinese development banks, the network of lenders to the mineral sector was much broader. Beijing’s state-owned commercial banks, including the Industrial and Commercial Bank of China, Bank of China and Citic, play the largest role. However, a much larger network of 86 entities, including 26 Chinese official sector entities as well as scores of private Chinese companies and some non-Chinese financiers, also provided financing alongside Chinese state-backed participants in syndicated loans. This represents a much more diversified creditor base than traditional BRI lending…
The minerals lending also mostly involved serial lending, rather than one-off loans, in contrast to the BRI. State lenders initially provided an acquisition loan to help a Chinese company gain an ownership stake in a mine, before further credit facilities were extended for development and to provide working capital… AidData showed that about one-quarter of China’s mineral lending was backed by a Chinese guarantor, compared with an estimated 4 per cent in Beijing’s broader overseas lending portfolio, reflecting an increased emphasis on risk mitigation and safeguarding investment returns.
The lending was mostly targeted at upstream resource extraction, AidData said. This helped secure China’s access to raw materials, creating a vertically integrated Chinese-controlled supply chain, while avoiding competing with its own domestic mineral processing industry. The data showed that two-thirds of the financing went into JVs or SPVs where the host government held no significant level of ownership. Bypassing local governments reduced those countries’ financial liabilities but also potentially limited their access to future financial returns.
In the context of critical minerals and the Chinese restrictions, Javier Blas introduces a dose of realism.
Beijing has targeted five metals: tungsten, tellurium, bismuth, molybdenum and indium. China is the biggest producer of all of them...My calculations suggest the US spends about $300 million importing tungsten; roughly $30 million on bismuth; about $90 million on indium; and less than $1 million on tellurium. The total annual cost for all four comes to less than $500 million... it’s the same trend as the one observed in the much-hyped rare earth elements sector. Fears abound, but the cost of importing the 17 metals that form that category is tiny. The US Geological Survey calculated rare earth imports at less than $200 million in 2023...The import bill of minor metals could increase by five, 10, 20, even 50 times, and not amount to more than a rounding error for the US economy. Prices, however, are lower today than they were a decade ago. Did you notice when they were high? Nope; for a reason. Indium, for example, traded as high as $800 per kilogram in 2011; it’s now at $345. The cost of the most common compound of tungsten, one of the much-hyped critical minerals, is trading 25% below its 2011 peak. Even if prices rise because of Chinese restrictions, recycling will increase, American engineers will work to reduce their use and alternatives will be found. High prices cure high prices.
9. BYD is surging ahead and entrenching its dominance of innovation in the EV market with two announcements. First, it unveiled a new charging system, Super e-Platform, that can add about 470 km in range to BYD’s batteries in just five minutes, just as fast as filling up cars with petrol or diesel. The platform has a charging power of 1000 kW and takes up to 1000 Amps, allowing it to charge batteries at the rate of 2 km per second. The platform has been tested for safety risks, shorter battery lifespans, and costs of installation. This advance appears to have been brought about by a more sophisticated battery cooling system that allows the battery to reach peak charging power faster and sustain it longer. In contrast, the Teslas take 15 minutes to charge 320 km and Mercedes Benz’s new super-charger takes 10 minutes to charge 325 km.
This follows an announcement that its “God’s Eye” advanced driver-assistance system will be made available for free on all its models, including its cheapest models. It includes advanced options like remote parking using smartphones and autonomous overtaking on roads. The announcement said that BYD wants to make advanced driver-assistance systems an essential tool like safety belts and airbags.
These announcements also demonstrate BYD’s leadership across the EV value chain - EV, battery, charging technology, and drive management software. It also ensures easier and tighter integration of all systems when compared to rivals.
While it’s doing great on technology, BYD’s biggest worry may be the questions being raised about its factories and investments in Mexico (local opposition to a new factory), Hungary (investigated by EU authorities), and Brazil (slavery-like conditions in its factory). This is a good profile of Wang Chuanfu, BYD’s metallurgist founder. It focused initially on lithium batteries for mobile phones like Nokia and Motorola, and then shifted to vehicles in the early 2000s and pioneered the “cell-to-body” technology that sandwiched a battery cell inside a vehicle’s structure.
10. The DeepSeek is only the latest example where Chinese companies have been exploring all pathways available in their pursuit of market dominance. In this endeavour, as Leo Lewis writes, Chinese businesses appear to have perfected the Japanese management technique of kaizen, continuous improvement.
As well as directly observing kaizen in action at Japanese manufacturing operations, Chinese companies, according to recruitment agents in Tokyo, have found they can lure away Japanese semiconductor, railway and robotics engineers as consultants. This is not new, say the agents, but it is now sharply accelerating. Japanese companies tend to retire highly qualified people early, have not, for some years during the deflationary period, paid them especially handsomely and have instilled less parting loyalty than they might have hoped. They can be paid well by a Chinese company and, without explicitly imparting industrial secrets, their worth is immense: kaizen is fundamentally a process of trial and error, and an experienced engineer can impart the invaluable, cost-saving nod on what was tried but didn’t work.
11. While the debate on Chinese trade surpluses and tariffs has been largely focused on the developed markets, I have long maintained that Chinese exports are perhaps an even greater threat to developing countries like India. The cheap Chinese exports create problems in two dimensions - they distort the playing field and erode domestic manufacturing base; and they displace exports from other developing countries.
While the former is well known, the latter is equally important. Sample this:
During the China Shock period, Chinese imports primarily replaced imports from other Asian countries, not US production: the overall portion of imports into the United States from Pacific Rim countries remained constant between 1990 and 2017 with only China’s share of those importsincreasing substantially, and Americans’ import consumption remained stable during the China Shock period.
Cheap Chinese manufatures are a threat not only to the domestic manufacturing base of developing countries, but also to their exporters in other markets.
12. Finally from a recent RAND report on China’s dominance of global exports of high-tech goods.
