Global tensions over China’s overcapacity will rise under Trump

 

While president-elect Donald Trump’s tariff threats are likely to dominate headlines in the near term, China’s industrial overcapacity remains a larger, core challenge for the global economy and trading system in the coming years.

With recently implemented tariffs by advanced and emerging economies, and Chinese responses and macro stimulus, how this issue may evolve over the next few years is becoming clearer – with significant geopolitical implications.

On Oct 29, a month after US tariffs targeting China’s overcapacity went into effect, the European Commission imposed its own tariffs on Chinese electric vehicles (EVs). While these actions attracted significant media attention, China’s recent World Trade Organization complaint against Turkey’s EV tariffs – a case underscoring China’s failure to discourage major emerging markets from following the lead of developed economies – passed largely under the radar.

At the same time, the surge in Chinese overseas manufacturing is reshaping the global economy and China’s role within it. China’s latest stimulus plan demonstrates that despite the government’s acknowledgment of weak domestic demand, macroeconomic rebalancing remains off the table. The policies driving China’s overcapacity – and the resulting trade tensions – are probably here to stay.

While the US-China trade war may return to the fore with Trump’s promise of 60% tariffs on imports from China, China’s overcapacity is ultimately likely to be felt more acutely in other major economies.

Structural trends suggest that the European Union could bear the brunt of a new China shock and ensuing trade tensions. As Europe’s trade conflict with China escalates, the EU’s EV tariffs – which faced resistance from some member states – may prove to be just the opening salvo.

In response to these pressures, Chinese exporters have turned their attention to developing economies, which accounted for more than 50% of China’s exports in 2023. This trend is expected to persist, further widening China’s trade deficits with major emerging markets.

But while these countries benefit from cheap Chinese goods and direct investment, they are also increasingly frustrated by limited access to China’s markets, which jeopardises their own industrial aspirations.

New US tariffs on China under Trump, who has also promised a 10-20% across-the-board tariff on all imports from other countries, will accelerate the shift of Chinese exports to emerging markets and the EU. This, in turn, would exacerbate these economies’ concerns about Chinese “non-market overcapacity” and trade imbalances.

Non-market overcapacity, though an imperfect term, captures three interconnected economic forces. For starters, China’s industrial policies promote strategic sectors and push for import substitution, systematically reducing foreign imports across multiple industries.

At the same time, persistent macroeconomic imbalances weaken domestic demand and drive China’s massive trade surplus. Lastly, the global economy is highly dependent on Chinese supply chains, which heightens the risk of disruption and economic coercion.

China’s tightened export controls, particularly on critical raw materials whose supply it effectively controls, highlight the risks posed by this dependence. Some may argue that, given the urgency of addressing climate change, overcapacity in key green industries is not necessarily a bad thing.

Yet this argument would be far more compelling if China allowed fair competition in other sectors and did not threaten foreign access to vital clean-energy inputs like graphite.

Through public messaging, multilateral engagement, and targeted tariffs, the US and EU have prompted a necessary reckoning with China’s industrial overcapacity, starting to address the problem before it wreaks havoc on industries and communities.

Encouragingly, there are signs that Chinese firms have scaled back their expansion plans, owing to weak domestic demand and the growing difficulty of exporting excess capacity to international markets. While Chinese authorities have, as expected, largely denied the issue publicly, the external pressure has forced policymakers to take notice.

That said, addressing the complex global challenges posed by China’s overcapacity will require additional trade restrictions and innovative policy tools. The speed with which G7 countries were able to reach a consensus on this issue signals more coordinated action ahead.

As the EU, the US, Japan, and India tighten restrictions on Chinese goods routed through third countries, imports from China are likely to face increased scrutiny on national security, environmental, and labour grounds.

Meanwhile, supply-chain diversification – though still in its early stages – could create significant opportunities for developing economies elsewhere.

China’s primary response to these challenges has been increased foreign direct investment, largely welcomed by its trading partners. Some emerging-market governments have even lowered duties on Chinese EV companies that establish manufacturing facilities within their borders.

But there are growing doubts about the scalability and effectiveness of this approach. Chinese authorities are reportedly pressing for planned EV and battery investments in Europe to be curtailed. In Thailand, Chinese EV companies have faced criticism for not sourcing from local suppliers.

More broadly, expecting Chinese firms to build large-scale manufacturing facilities in every major trading partner is unrealistic. And China’s weak labour market might make the authorities more reluctant to allow manufacturing jobs to move overseas. In fact, Bloomberg reported in September that China had advised automakers to keep certain EV technologies and production capabilities at home.

China’s recent policy shift towards stabilisation measures to support the domestic economy and markets reflects a belated response to weak domestic demand and confidence.

So far, however, government efforts to stimulate consumption – essential for sustainable long-term growth – have been limited to increased funding for an appliance trade-in programme and a reduction in mortgage interest rates. Stabilising the property sector could boost household confidence, but the government has shown little willingness to allocate the necessary resources.

Tackling China’s overcapacity problem will require rebalancing the economy and overhauling industrial policies. Despite government-affiliated economists’ growing discussion of innovative approaches, Chinese leaders remain opposed to essential reforms. As tariffs pile up and geopolitical tensions escalate, exacerbating China’s economic slowdown, they may eventually be forced to confront these structural issues. - FMT

Brendan Kelly, a former director for China economics issues on the US National Security Council staff, is a non-resident fellow on Chinese Economy and Technology at the Asia Society Policy Institute’s Center for China Analysis.

The views expressed are those of the writer and do not necessarily reflect those of MMKtT.