China’s trade surplus has widened significantly while the US trade deficit has grown at an accelerated pace. These developments have revived concerns about global trade imbalances, fueling debates around their causes and consequences. Central to this discussion is the idea that China’s external surpluses may result from industrial policies designed to stimulate exports and support economic growth amid weak domestic demand. Critics worry that China’s export-driven model, compounded by these policies, could lead to a “China Shock 2.0,” a scenario in which a surge in Chinese exports displaces workers and disrupts industrial activity in other nations.
While this trade and industrial policy view offers a partial explanation, it fails to account for the broader macroeconomic factors at play. Global external balances are shaped by deeper economic forces, including the interplay of savings and investment across different economies. By examining the macroeconomic fundamentals that drive savings and investment decisions—not just in China, but globally—we gain a clearer understanding of the imbalances. This is especially true for the two largest contributors to global imbalances: the United States and China, which together account for about one-third of the world’s current account balances.
China’s trade surplus surged during the early months of the pandemic, driven in part by the global demand for medical supplies and other essential goods. Consumers around the world, confined to their homes by social distancing measures, shifted their spending from services to goods, fueling Chinese exports. However, starting in late 2021, China’s domestic demand weakened due to a large-scale property market correction and a series of strict lockdowns in 2022 that further damaged consumer confidence.
As household saving rates in China rose and investment contracted, the resulting drag on the real economy was severe. At the same time, global demand—particularly in the United States—remained robust, driven by a fiscal expansion that saw the US budget deficit swell and household saving rates decline significantly.
The combination of weak domestic demand in China and strong global demand, particularly from the US, has kept China’s trade balance at 2-4% of gross domestic product (GDP). Although China’s trade surplus as a percentage of GDP is smaller than during the “China Shock” of the 2000s (when it peaked at around 10%), China’s share of the global economy has grown significantly. As a result, the global spillover effects of China’s trade balance remain substantial, even if the share relative to China’s own economy has shrunk.
Macroeconomic Drivers of Trade Imbalances
To understand these trends, it’s essential to look at the macroeconomic fundamentals. Analysis using the IMF’s Group of Twenty (G20) model highlights the role of domestic demand shocks in China and dissaving shocks in the United States in driving current account imbalances. In China, the property market downturn and low household confidence have suppressed domestic demand, boosting China’s current account surplus by about 1.5 percentage points—closely matching the data.
As China’s saving rates increased, its real effective exchange rate depreciated, further supporting export growth while suppressing import demand. Meanwhile, in the US, a strong domestic demand surge, driven by both government and household spending, has led to a deterioration in the current account balance by about 1 percentage point, again reflecting real-world data.
Unlike the 2000s, when a global savings glut—largely originating in Asian emerging economies—contributed to global imbalances, today’s environment is different. Global real interest rates have risen, reflecting a lack of excess saving outside of China. The contribution of China’s savings shock to the US trade deficit is minimal, and the same is true for the impact of US dissaving on China’s trade balance.
Ultimately, external surpluses and deficits in both countries are “homegrown” and require domestic solutions. In China’s case, this means addressing long-standing internal economic imbalances, such as the drag from the property sector and the challenges posed by an aging population. With its economy now too large to rely on export-driven growth, China’s future lies in structural and macroeconomic reforms aimed at stimulating domestic demand. The US, on the other hand, must tackle its own trade deficit by addressing fiscal imbalances. Reducing the fiscal deficit through tax reforms and entitlement restructuring is key to restoring external balance.
Industrial and Trade Policies: Limited Impact on Overall Trade Balance
A significant part of the debate over global imbalances focuses on China’s industrial and trade policies, with concerns that state support for certain sectors has created overcapacity and distorted global markets. China has indeed implemented extensive subsidy programs—approximately 5,400 measures from 2009 to 2022, accounting for two-thirds of all subsidies among G20 economies.
These subsidies are concentrated in key sectors, such as software, automobiles, transportation, semiconductors, and green technology. For example, China’s electric vehicle (EV) subsidies have drawn attention as the country produced 8.9 million EVs in 2023, accounting for two-thirds of global production. However, these exports still only represent a small fraction—about 1%—of China’s total goods exports.
While subsidies have boosted activity in targeted sectors, their overall impact on China’s external trade balance has been modest. Analysis shows that exports of subsidized products are just 1% higher than non-subsidized products, suggesting that the role of industrial policy in driving China’s overall trade surplus is limited. Moreover, a lack of transparency around legacy subsidies and their financial magnitude makes it difficult to fully assess their aggregate impact.
Transparency and Multilateral Cooperation
The World Trade Organization (WTO) has raised concerns about China’s lack of transparency regarding its subsidy policies, emphasizing that clearer data is needed to assess the global impact. This is not just a China-specific issue; industrial policies, including subsidies, are increasingly prevalent worldwide. The United States, for example, has ramped up its use of industrial policies, particularly in emerging sectors such as clean energy.
Even though industrial policies may not be the primary driver of global imbalances, they can still have significant spillover effects on trading partners, undercutting competitiveness and exacerbating trade tensions. To mitigate these risks, countries must ensure that their industrial policies are narrowly focused on addressing specific market failures or externalities, and that they comply with international trade obligations.
When industrial policies distort global markets, affected countries have the right to seek redress through WTO-consistent tools such as multilateral dispute settlements or countervailing duties. However, unilateral measures, such as tariffs and non-tariff barriers, are counterproductive and risk further destabilizing global trade relations. Such actions increase the likelihood of retaliation and undermine the multilateral trading system.
The rise of global value chains, the central role of state-driven economies, and the urgent need to address climate change have exposed gaps in the current international trade framework. The WTO, established in a very different global environment, must adapt to these new realities. Governments must work together to strengthen multilateral trade rules and ensure that industrial policies and other trade-related measures do not lead to unfair competition or market distortions.
Multilateralism remains the best approach to addressing global trade imbalances. Efforts to resolve disputes and improve transparency must be conducted within the framework of international institutions like the WTO, rather than through unilateral actions that risk fragmenting the global economy.
The widening trade surplus in China and the growing US trade deficit reflect deeper macroeconomic forces rather than solely the effects of industrial and trade policies. Understanding the global imbalances requires a macroeconomic lens that examines the drivers of savings and investment decisions across economies. As China and the United States account for a significant portion of global imbalances, their domestic policies will play a crucial role in addressing these issues.
For China, the path forward involves rebalancing the economy through structural reforms that stimulate domestic demand and reduce dependence on exports. The United States must address its fiscal imbalances to restore its external balance. Both countries, along with their global trading partners, must ensure that industrial policies are transparent, narrowly focused, and consistent with international obligations. Only through multilateral cooperation can the risks of trade imbalances and global economic instability be effectively managed.
