Understanding the Impact of China’s Economic Policies on Global Trade

In early December, French President Emmanuel Macron returned from China without any significant achievements, after pleading with President Xi Jinping to assist in curtailing the ongoing war in Ukraine. Given China’s steadfast alignment with Russia, it was unlikely that Macron’s appeal would gain any meaningful traction.

Macron also raised concerns regarding China’s soaring trade surplus, a direct consequence of its economic and industrial strategies, but his requests fell on deaf ears. Xi had more pressing matters to attend to, including the upcoming politburo meeting and the Central Economic Work Conference (CEWC), which centered on the impending 15th five-year plan expected to be unveiled at the National People’s Congress in March. This plan will outline essential strategies for China’s economic developments through 2026.

The Second China Shock

It is crucial to observe the “second China shock” that is commencing. The first shock, identified after China joined the WTO in 2001, involved its integration into the global trade framework, producing significant effects on global labor and resource markets, causing many communities to endure job losses. The current wave revolves around China’s ambition to dominate advanced technologies—such as electric vehicles, semiconductors, and artificial intelligence—through a state-directed industrial strategy like never before.

The Chinese government continues to exude optimism about its economy during the CEWC, which they believe is following “the correct path.” However, this optimistic outlook starkly contrasts with proposed policy measures that include looser monetary policies, increased fiscal deficits, stabilizing the housing market, and ramping up social spending. They acknowledge the complexities of a challenging external environment characterized by overproduction, insufficient domestic demand, and risks to financial stability, particularly within the struggling real estate sector.

Domestic Demand and Industrial Policy

Beijing has prioritized the enhancement of domestic demand as central to its 2026 goals, a directive that reflects a narrative established over the past three to four years. While there are intentions to improve household consumption and income, actual advancements have been limited. The government misinterprets weak consumer demand as an issue of supply, viewing it as a shortage of available goods rather than a lack of purchasing power.

The overall policy framework continues to emphasize industrial policy, which constitutes a significant portion of GDP—outstripping most nations, barring military-spending countries like Ukraine and Russia. The aspiration is to excel in what Xi identifies as the fourth Industrial Revolution by mid-century, with a goal to reshape the global order and establish a governance framework more reflective of China’s political ideals.

This dual drive of enhancing consumption while bolstering industrial output may not always align. Resources, fiscal strategies, currency management, and regulatory frameworks may support one aim over the other, with the focus likely remaining on industrial policy. This could exacerbate existing issues surrounding overproduction and deflationary pressures, as evidenced by the declining GDP deflator in China, indicating a continuous reduction in prices.

The Trade Imbalance Challenge

Weak demand coupled with a surplus in supply has resulted in a thriving export sector, with China achieving a significant trade surplus of $1 trillion this year—of which one-third is with Europe and the UK. Since 2022, there has been a 50% increase in export volumes from China while imports have hardly budged. Despite previous tariffs imposed during Donald Trump’s tenure, they have not effectively addressed global trade imbalances but have altered traditional trade patterns, particularly reducing direct imports to the U.S.

Exports to Europe pose a genuine threat to European industry, particularly in sectors such as automotive, machinery, and high-tech equipment, adding to pre-existing challenges in textiles and steel. Meanwhile, stagnant imports into China, partly driven by weak domestic demand and an emphasis on self-reliance, limit opportunities for producers from Europe and beyond.

The growth in Chinese exports is also fueled by a strategically undervalued currency, which has depreciated approximately 20% in real effective terms over the past three years, reverting to levels not seen since 2012. The International Monetary Fund has suggested that China re-evaluate its currency policies, but the government insists on maintaining “basic stability” in the yuan.

During his visit to China, Macron labeled the trade imbalance as “unbearable,” stating it was a “question of life or death” for European industries. In response, the EU has implemented tariffs on specific Chinese electric vehicle imports and initiated an import monitoring mechanism to address unfair competition. The EU is likely to take a more assertive stance in future negotiations.

Currently, the UK’s response has been more muted. The government is working closely with the EU on trade policies, particularly relating to steel, and the business secretary is equipped with the authority to direct investigations into unfair trade practices.

As the UK’s political landscape evolves, Keir Starmer’s anticipated trip to China could shed light on these issues, especially if it occurs soon. However, like Macron, he may find engaging with Xi on critical trade matters a challenging task. Instead, Starmer should focus on understanding the implications of the second China shock for the UK’s economy.