Weighing Why China Is Juicing Exports

In fact, China
exports far
fewer
cars
as a percent of total production than countries like Japan or Germany. But because China is just so huge, what look like small swings to China are huge, disruptive swings for other countries around the world.

In the short term, it's very hard to tell whether overcapacity is being driven by subsidies or by companies simply not being able to adjust quickly to drops in domestic demand. The Rhodium Group calls these “structural” versus“temporary” overcapacity.

But both versions manifest as a seemingly huge flood of cheap Chinese goods glutting world markets and threatening other countries' manufacturing industries.

China's leaders, of course, strongly contest the idea that their country is suffering from overcapacity. In a speech on April 30 , Chinese Foreign Ministry spokesman Lin Jian argued that China's exports simply represent the country taking its natural place as the world's manufacturer:

Lin is slightly misapplying the theory of comparative advantage here. Comparative advantage explains balanced trade - I give you soybeans because I'm good at growing soybeans, you give me cars in exchange for soybeans because you're good at making cars, and so on. It can't explain unbalanced trade - you give me cars in exchange for IOUs. Trade surpluses and deficits require ideas that go beyond comparative advantage.

But Lin's core belief here is that manufacturing is simply what China does best and that fundamental economic factors dictate that China should do more of it, and other countries should do correspondingly less. Perhaps in the end, trade will balance out, and other countries will deindustrialize and become farms, financial service providers, and so on, while China makes all their goods.

This isn't
such
a far-fetched notion. In the 20th century, Europe, the US, and a few countries in East Asia made most of the world's manufactured goods, so it's possible for manufacturing to be very geographically concentrated. And China has an enormous fundamental strength that no other country has (except perhaps a future India) - its vast internal market.

China has a vast number of consumers, who will tend to prefer Chinese products (out of cultural proximity, even without taking nationalism into account). That huge domestic market allows Chinese manufacturers to reach enormous scale, driving their costs down relative to companies in other countries, even before they export anything.

It also allows China to have a vast network of suppliers for every type of manufacturing, without having to order many parts and materials abroad. And it tends to create clustering effects, where all the EV makers or chipmakers want to go to China because that's where the greatest numbers of their competitors are located; companies like to poach employees and appropriate ideas from their competitors.

So it's possible that China's massive flood of exports is
simply a transitory stage
in a long-term shift of global manufacturing to its natural location. Chinese economic planners
may believe
that accelerating this inevitable shift is the best way to boost their country's growth:

“China wants to be the Amazon of countries - Amazon is the everything store, China wants to be the 'make everything' country,” said Damien Ma of US think tank Macropolo, who met senior policymakers in Beijing last year.“The vision is to bring a complete supply chain to China.”

There are some issues with this theory, of course. Why would an inevitable transition need such massive subsidies? Why would comparative advantage manifest as many decades of unbalanced trade? But basically, I think something like this theory is what many Chinese policymakers either believe - or will profess to believe, in order to defend China from accusations of“overcapacity.”

There is another, darker version of the“comparative advantage” theory. This is the notion that China is intentionally trying to wreck the manufacturing industries of its geopolitical rivals, in order to gain a military advantage over them.

In any major protracted war, industrial capacity becomes extremely important. Civilian manufacturing gets repurposed for military use. The most famous example is when the US
out-manufactured its opponents
in World War 2. The US still has a law called the Defense Production Act that's supposed to allow a repeat of the civilian-to-military factory conversion.

The larger the percentage of global manufacturing China has, and the lower the percentage its rivals have, the better its chances would be of overwhelming those rivals in a war.

Gaining a commanding share of global manufacturing might even allow China to displace the US and its allies as the world's dominant power - something the country's leaders have
repeatedly said they want to do
- without a fight. Currently, the blocs are about evenly matched:

The Second China Shock might tip that balance decisively in China's favor.

Comparative advantage, on its own, probably won't be enough to make that happen. Usually, when new countries added themselves to the roster of high-output, high-tech manufacturers, they didn't cause wholesale deindustrialization in other countries. The First China Shock coincided with a big decrease in US
manufacturing employment , but actual manufacturing output remained
about the same .

That's where subsidies could come in. If Chinese government subsidies make it essentially impossible for any non-Chinese company to compete, it could artificially tip the balance of comparative advantage, to the point where the US, Europe, Japan, and Korea could be inefficiently bereft of manufacturing industries - at least as long as China keeps up the subsidies.

That window of time might be enough for China to accomplish its military objectives (e.g. conquering Taiwan), and establishing itself as the global hegemon.

An outcome like this is something the US and others would naturally want to prevent, and my bet is that the threat of forced deindustrialization was very much on the minds of the people who crafted the new tariffs.

One possibility that we can never dismiss is that China does things simply because it has an absolute ruler who decides to do those things. Tanner Greer, director of the Center for Strategic Translation, believes that Xi Jinping and his hand-picked subordinates are obsessed with propelling China to greatness by monopolizing a few high-tech industries of the future:

This might sound like a bunch of Marxist mumbo-jumbo, but it's actually not very different from how other countries think about technology, industry, and the national interest.

For example, if you read
the White House's report
on“critical and emerging technologies”, the language is a little less millenarian, but the basic idea is recognizably the same - if you want your country to be powerful, it's good to monopolize strategic cutting-edge high-tech industries as much as you can.

As to what those key technologies are, neither the Chinese government nor the US government appears to be quite sure - instead they're placing diversified bets across a number of industries, in case any of those turn out to be the key to the future. Greer writes:

That's an incredibly general list. But maybe Xi and the Politburo think China needs to massively subsidize all of these things in order to maximize its chances of being a superpower in the world of tomorrow. The export boom could be downstream of that decision.

There is one last theory that is the darkest of all, which I only hear muttered in hawkish national security circles. This is the idea that China's subsidy-driven manufacturing boom represents the beginning of war production.

There are basically two parts to this theory. First, as I mentioned, countries at war convert civilian production lines to military production. So building up civilian industries like steel and computer chips that are easily converted to military use could be a way of preparing for this conversion. Nathaniel Sher, writing in The National Interest, hypothesizes something along these lines :

Second, any country at war is vulnerable to having its supply lines cut, so building up domestic manufacturing of critical components like chips is a way to insulate a country against sanctions and blockades. Under Xi Jinping, a big focus of Chinese industrial policy has been to onshore entire supply chains, and the current big manufacturing push is continuing that trend :

This strategic shift is not just related to trade wars, perceived supply chain vulnerabilities, or de-risking dynamics. Xi seems to have studied the sanctions playbook the West used against Russia over Ukraine and subsequently initiated long-lead protective measures to batten down the hatches of China's economy to resist similar pressure.

This is the most ominous theory of all. It suggests that the export boom might be incidental - an accidental side effect of China's creation of the greatest military production machine the world has ever known.

It's important to reiterate that none of these theories are mutually exclusive. It's possible that the objectives of war production, industrial policy, forced deindustrialization of rivals, and recession-fighting simply align in the minds of China's leaders.

And it's possible that natural forces like China's recession and a long-term shift of manufacturing to China are lending a helping hand to the government's effort.
All of these theories could be true at once.
Or perhaps only some subset of them.

But I think breaking the possibilities down in this way is a helpful prelude to thinking carefully about what tariffs and other protectionist measures might realistically hope to accomplish.

This article was first published on Noah Smith's Noahpinion Substack and is republished with kind permission. Read the original and become a Noahopinion subscriber here.

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