China’s overcapacity and the rise of tariffs

The world economy has been shaken by Trump’s policy of increasing tariffs. It has become the primary economic tool to get companies to set up factories in the United States. At the same time, it has now become a political tool. Trump increases tariffs for countries he perceives as enemies. He uses tariffs also to reward nations whose leaders treat Trump like an emperor or a king. It has become known in international circles that the best way to treat Trump in any diplomatic meetings is to shower him with praises.

There is, however, another underlying reason why tariffs have become popular in the rest of the world. Tariffs have become a tool to protect national economies from being swamped with Chinese imports.

China’s role has entered a new phase while continuing to produce and export goods across the world. Instead of its attempt to produce manufactured goods of higher value, it has now continued to export due to the fact that China’s economy produces much more than what the domestic market can consume.

During the Biden administration, it imposed tariff hikes up to 100 percent on a variety of Chinese goods. This action was justified as a defensive responsive to Beijing “flooding global markets with artificially low-priced exports.” The European Commission also imposed additional duties on Chinese goods like electric vehicles, complaining that China’s unfair government subsidies were causing a threat to the European Union economy and manufacturers.

Through all these trade tensions, the message is very clear that the rest of the world believes that China makes more than what the world can consume. There have been numerous complaints from other countries, including the United States and the European Union, that China produced too much steel, coal, cement and other goods which outcompeted other competitors and drove global prices to an unprofitable lower volume. The common conclusion is that in China, government subsidies and investments in manufacturing and infrastructure are unusually high compared with those in other advanced economies. As Lizzi Lee, a well-known analyst on the Chinese economy said: “Simply put, China lacks enough domestic demand to soak up what the country’s factories produce, which then causes a glut of exports.”

According to Lee and other China experts, the real challenge for the Chinese economy lies not in weak domestic demand or excessive state handouts but in an extraordinary and seemingly uncontrollable surge in supply. The problem is that if Beijing were to step in and force consolidation or close factories, it would risk increasing domestic unemployment and result in lower economic growth. Exports have become one of the few bright remaining spots in the Chinese economy, whose GDP has begun to slow down. If Beijing decides to reduce production and exports, it would cause significant damage to Chinese overall economy. This in turn could lead to domestic dissatisfaction with the Chinese Communist Party and lead to internal conflicts.

On top of the changes in the Chinese economy since 2020, the real estate market has seen a dramatic drop in domestic demand. Already, price wars in China have affected the labor market, with firms freezing wages or cutting jobs. In an earlier era, China dominated the global manufacturing of clothes, toys and batteries. Today, it dominates in other fields like electric vehicles, solar panels and batteries. China is an economy today where companies might be world-class but with very thin profitability.

When demand softens, or the market becomes crowded, companies have a tendency to further reduce prices and expand exports to keep production running. This leads to further erosion of their profit margins China’s economic statistics report that the average profit margin of the country’s automakers declined from five percent in 2023 to 4.4 percent in 2024, as these companies tried to increase market share through heavy discounting. In a free market system, companies that are unprofitable would already begin to close. However, in spite of the over-capacity problem, Beijing has allowed the present economic system to continue because it wants to avoid serious unemployment which could cause political uncertainty.

According to Lee: “To create a more sustainable model – one that encourages innovation but does not spiral into overcapacity, China will have to undergo an institutional reckoning. The logic of speed over quality, of scale over innovation and of investment volume over returns is deeply embedded in the system. Reversing that logic means making long deferred tradeoffs and moving past structures that once powered China’s incredible rise.”

If Beijing cannot overcome its overcapacity problem, it will continue to try and solve this problem by exporting to the world and competing with domestic industries in other countries. These other countries, including the Philippines, must try and protect its domestic industries and rising unemployment by imposing higher tariffs.

This only means that higher tariffs will become an integral part of international trade.