A World China is Creating

Ichiro Suzuki

China’s export machine is operating in near peak intensity. Its current account surpluses are nearing a trillion dollars mark in 2026, which is in excess of 4% of the size of the country’s economy. Quality of China’s manufactured products has vastly improved in recent years, way up from shoddiness that they used to characterize Chinese goods. Project “Made in China 2025” that Xi Jinping launched a decade ago has delivered results, even exceeding original expectations, probably. Today, China is providing the world with well manufactured products of a variety of kinds and they are still inexpensive compared to the ones sold by others. A trillion dollars surpluses are rewards for China’s relentless and persistent efforts for improved manufacturing. Right?

This world of ours isn’t so simple.  Massive external surpluses are as much attributed to insufficient efforts to boost domestic demand as to determination on sending better manufactured products to overseas markets. In theory, current account surpluses are explained by the size of domestic savings. High savings drive exports while low savings suck imports in. China is the land of high savings, along with the rest of East Asia. People there work diligently and save a lot as opposed to those in the West, especially in the United States. This is a correct statement up to a point. At the same time, surpluses are attributed to the social system that keeps people from spending more. Chinese people refrain from spending because of their concerns about life amid inadequate welfare and social security programs. Domestic demand insufficiency has been a long talked about problem in China, and the household sector’s consumption at 40% of GDP is vastly lower than the global average of 60% despite occasional lip service to lift the number. People in China have not been able to draw a brighter future, constrained by damaged household balance sheet as a result of persisting real estate market slump. On top of it, high youth unemployment could get  even worse amid proliferation of AI. 

In the absence of efforts to lift domestic demand, the Chinese government keeps pumping money into a variety of industries. Massive subsidies, including below market rate loans, are one of the factors behind Corporate China’s competitiveness in the export markets. By keeping some companies afloat, which otherwise would have been forced out of business, subsidies create overcapacity that then exerts downward pressure on prices and hence profitability. Low or sometimes absence of profitability has been rampant in a variety of industries. Steel prices have been depressed for some time. Few companies are reportedly making money in solar panels, which China has cemented its position as an undisputed leader. Then, there is the EV industry. Only a handful of EV makers are reportedly profitable among well over a hundred companies. There simply is too much competition in China. This is driving Corporate China look to overseas markets to dump their products. 

For the importers, made-in-China products contributes to lower inflation at a time when rising prices are afflicting consumers around the world. There is a downside to it, of course. Low-priced Chinese manufactured products are threatening factories in the importing countries, and their low prices are not entirely the result of Chinese ingenuity. In effect, over-subsidies are now beginning to steal jobs elsewhere, especially in Europe. Chinese EV makers are finding inroads into the European markets. The EU is responding to such moves by raising hurdles for imports. Some Chinese car makers are opting to make cars in Europe, but the key parts such as battery cells and electric motors still need to be imported from China. There are even fears that China sends workers to be deployed on assembly lines. This may be a crazy thought but this is what happened on Belt & Road infrastructure projects in Africa and other developing countries. In contrast, Japanese and South Korean car makers brought in a number of suppliers to surround new factories in North America and Europe, contributing to the local job markets and other segments of local economies. Chinese car makers would almost certainly try to build EVs in Canada and Mexico to be sent to the U.S. market. Doing this aggressively would be highly likely to lead to major changes in the trade pact among three countries, even under the 48th president or beyond, unless key and high value-added components are made inside the USMCA.  

Germany in particular has its own problem of their inability to fit themselves to the shifting environment in the 21st century. The state of Lower Saxony owns 20% of Volkswagen and the workers council has lots of voice in corporate decisions in Germany. This makes it really difficult to make timely restructuring moves to make the company fit. However, it is still one thing that Germany is slow and it is completely another thing that China is entitled to flood the European market with heavily subsidized EVs. In the age of hyper globalization in the early years of the century, low cost imports from developing countries suppressed inflation in the developed world but with the side effect of relocation of jobs to elsewhere outside the country, be they in China or in India. Job losses to developing countries led to the unfolding of toxic political culture that led to the rise of right wing parties. In the case of intermediate materials and commodities, they can be used as a choke point if dependence on China goes too far, and this is already happening on rare earths. China could tighten rare earths supply to Europe if the EU deploys import restrictions on Chinese EVs or receives a message they don’t like. In fact, Beijing is already doing this to Japan. International trade has rarely been free and fair, but it is becoming less so in the second quarter of the 21st century.

Benefits of low cost imports don’t seem to outweigh all the problems they create on the importing countries’ social fabric. For the importers in the developed world, it is obviously better if China spends its financial resources to support its household sector rather than subsidizing industries, but that’s not what interests Xi Jinping. China’s autocratic ruler never has shared feelings with politicians in the developed world since there is no election in his country. That said,  he shouldn’t be too relaxed about the privilege of not having to face elections. If left untouched, disillusionment about the country among the young people could erupt, ending up with upheavals that try to topple the system. China has witnessed such upheavals a number of times in the country’s long history. If this imbalance is to be solved by market forces, most likely it would take place in the foreign exchange market. However, only unimaginably huge forces could cause such changes on the Communist Party that refuses to let the renminbi trade freely in the market. 

About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.