China’s trade surplus conundrum

Professor Shirley Yu discusses China’s record trade surplus in 2025: its causes, implications, risks and what it would take to rebalance

China recorded a trade surplus in 2025 of $1.189 trillion, led by a boom in exports to non-US markets as producers looked to diversify to other markets such as the Global South. This comes on the back of weak consumer demand at home and rising geopolitical pressures from its trading partners.

In this Q&A, Professor Shirley Yu discusses China’s trade surplus, its roots, implications and risks, and what it would take to rebalance the world’s second-largest economy.

Q: China’s trade surplus has reached historically high levels. Why do you think this is the case?

China’s $1.2 trillion trade surplus is the logical convergence of decades of policy choices that prioritized manufacturing capacity over household welfare systems.

Beijing’s industrial strategy has channeled massive resources into building competitive advantages across mid-to-high-end global manufacturing sectors. State-directed lending, subsidies, investment funds and coordinated industrial policies have created production capabilities that far exceed what market forces alone would generate.

With domestic demand painfully weak, exports become not just an incremental opportunity but a necessity for maintaining employment and growth.

The very success of China’s industrial strategy has created the overcapacity that must be exported, further generating international frictions that threaten the model’s sustainability. Until Beijing fundamentally reorients its policy toward household income growth and a consumption-led growth model, trade surpluses will most likely persist, along with the geopolitical costs they generate.

Q: How much of China’s current trade surplus is policy-driven vs being the result of market forces?

In an effort to create large manufacturing capacity and a strong trade surplus, the distinction between policy support and market forces is increasingly artificial. State policy intervention in strategic industrial development establishes the infrastructure necessary for the innovative ecosystem to take root.

Nationally or regionally, after the massive infrastructure investments are put in place, each strategic industry—quickly crowded with savvy entrepreneurship—becomes very competitive. Reflecting a very successful decade of Made in China 2025, it is precisely the convergence and symbiosis of infrastructure and market dynamism that have co-created globally competitive industries in the state-designated strategic sectors.

Q: Can you talk on the relationship between weak consumer demand within China, and the heavy focus on exporting?

The relationship between China’s consumption and export dependence forms a self-perpetuating feedback loop that policy has failed to break.

Chinese households consume approximately 40% of GDP, a remarkably small share compared to Western economies. Social insurance remains inadequate, forcing families to save for healthcare, education and retirement. The property market, which stores 70% of Chinese household wealth, has declined significantly without yet bottoming out. Income inequality continues to concentrate resources among high-income households, stifling broad-based consumption growth.

Faced with weak domestic demand, Chinese firms rationally orient toward exports. This further creates path dependence. National infrastructure investments lean towards manufacturing and logistics over consumption.

When the economic structure is deeply entrenched in developing a robust industrial economy, any abrupt and aggressive restructuring could trigger heavy unemployment and social instability. Yet delaying reform makes the eventual adjustment even more challenging, compounded by the accumulating geopolitical costs.

Breaking this cycle requires comprehensive policy rethinking. Policies must balance between long-term economic security through industrial scaling and long-term economic sustainability through consumption, an extremely difficult balancing act to accomplish. The current 15th Five-Year Plan suggests China is still prioritizing the former, while delaying comprehensive solutions for the latter.

Q: Why has rebalancing been so difficult for China?

The technical challenges are substantial. Rebalancing requires simultaneous reforms across fiscal policy, financial systems, social security, labor markets and land policies, to name just a few.

The international environment has also shifted adversely. Global trade tensions and technology restrictions create pressure to maintain manufacturing strength rather than transitioning away from it. Geopolitical competition makes economic vulnerability unacceptable, yet rebalancing inherently involves sacrificing cultivating China’s domestic manufacturing strength at the top end of the global supply chain.

Most fundamentally, Chinese policymakers have proven unwilling to tolerate significant slowdowns, repeatedly resorting to investment stimulus when growth cripples. Rebalancing requires accepting slower growth prospects, at least temporarily.

Q: What kind of policies would be effective in rebalancing?

A serious rebalancing agenda for China would require a comprehensive policy package that addresses multiple dimensions simultaneously. Piecemeal reforms won’t overcome the structural forces perpetuating such an imbalance.

Social security expansion must be central. This requires fiscal commitment to shift government spending from investments toward transfers and social insurance. The policy challenge is that such spending doesn’t generate the visible growth that infrastructure investment has produced, making it politically less attractive despite long-term welfare outcomes.

Fiscal reform should include progressive taxation and transfers that raise household disposable income. Currently, the tax system burdens labor more than capital, and transfer systems remain underdeveloped. Property taxes could replace land sales as local government revenue while discouraging speculative holding. Corporate dividend policies should favor distribution over retention, moving resources from the corporates to households.

Financial system reform is equally critical. Interest rate liberalization would ensure savers receive fair returns. Expanding the scope and depth of the financial markets and ensuring market transparency would offer households more financial options than overwhelmingly resorting to property investments. Developing a versatile consumer credit market (with clear oversight) would smooth consumption over lifetimes.

Reforming the hukou system would boost consumption directly. Service sector liberalization would expand consumption opportunities while creating jobs.

Without a comprehensive reform, marginal adjustments will continue producing marginal results while fundamental imbalances persist.

Q: Why are China’s trading partners reacting so strongly to the surplus? Is it economic or political?

Economically, large trade deficits impose real costs on the importing countries. Manufacturing job losses create de-industrialization in specific communities. Some losses of industrial capabilities are also deemed critical to national security. Across the West, these economic stresses create electoral constituencies that demand protectionism and populism.

Geopolitical concerns compound the above economic and political anxieties. Advanced economies worry about losing industrial capabilities in sectors deemed critical to their national security—rare earth minerals, components for defense, telecommunications, semiconductors, or pharmaceuticals. Dependence on China for these inputs creates vulnerabilities that extend beyond economics into national security.

For China, expecting trading partners to indefinitely accept large and growing trade deficits is politically untenable, whatever the economic logic merits.

The growing Chinese trade surplus induces additional tariffs, investment restrictions, technology controls, and strategic supply chain decoupling. Western protectionism is a predictable political response that must be factored into China’s own policy calculus.

Q: What are the biggest risks if China maintains such a trade surplus? Both for China and for its trading partners.

Tariffs, sanctions and subsidy countermeasures are proliferating across developed and developing economies alike. Export controls and investment restrictions increasingly target vital Chinese industries. Economic decoupling in strategic sectors threatens to cut China off from critical inputs and markets in crucial domestic industrial sectors.

Persistent surpluses also require accumulating foreign assets, typically low-yielding securities, such as the US Treasuries. As the economy grows, export-dependent growth also becomes mathematically unsustainable. There simply aren’t enough foreign markets to absorb indefinite production increases from an economy of China’s scale.

As more countries pursue their own industrial policies and protectionism in response to China’s surplus, fragmentation accelerates and the multilateral system collapses.

Q: Are we moving towards a world of fragmentation rather than open global markets? If so, what implications would that have on China?

Current global trading dynamics point clearly toward trade fragmentation. Friend-shoring and near-shoring become de facto Western corporate strategies. Technology export controls proliferate across frontier technological domains. Investment screening mechanisms intensify. Industrial policies have returned across advanced economies, defying liberal market principles. Regional trade arrangements advance while the multilateral trading framework retreats.

China’s share of market access in the US will likely decline, especially in strategic sectors. Critical technology and capital goods may become harder to obtain. China has reoriented its global trade gravity towards the Global South, though these markets have limited absorption capacity for Chinese high-value exports. Regional integration through frameworks like RCEP becomes more critical, yet faces limits given members’ own concerns about massive Chinese industrial capacity transfer inundating local markets.

However, a full supply chain decoupling from China remains implausible. After many decades of globalization, global supply chains have become too complicated, and many goods lack alternative sourcing. But selective decoupling in strategic sectors appears inevitable, creating a bifurcated ecosystem where some goods trade relatively freely while others trade restrictively.

As Chinese export markets become less reliable, cultivating strong domestic demand becomes not just economically sensible but strategically necessary. As protectionism fuels global backlash on Chinese exports, further opening up the Chinese domestic consumer market to global exports also becomes crucial.

Q: Looking ahead, how do you see the issue playing out over the next year or two?

The near-term outlook suggests that structurally, large Chinese trade surpluses will likely persist. Cultivating robust domestic demand faces multiple headwinds. Property market retrenchments face a multi-year correction; local government debt constrains infrastructure investments that previously supported growth; and household savings expand amid economic uncertainty. Meanwhile, China’s manufacturing competitiveness in key high-end manufacturing industries remains globally formidable.

As a result, global trade frictions will also intensify. The US will likely maintain or increase trade protective measures during the Trump era. The EU is implementing anti-subsidy measures and considering broader protection measures for its strategic industries. Emerging economies increasingly adopt their own defensive measures to balance the economic interests between China and the US. This creates a ratchet effect. Protectionism rarely reverses itself, even if underlying conditions improve.