China Across CSIS: China Weathers the Storm of U.S. Tariffs
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Hello, loyal listeners of the Pekingology podcast, and if you are new, welcome. Pekingology is hosted by the Center for Strategic and International Studies in Washington, D.C.,

which is home to many great podcasts. In this special episode, we are excited to feature the Truth of the Matter podcast by host Andrew Schwartz. His guest is Scott Kennedy, the CSIS Senior Advisor and Trustee Chair in Chinese Business and Economics, and they discuss the Chinese economy, how it might weather U.S. tariffs, and China's overall economic strategy. Thank you for listening. ♪

I'm Andrew Schwartz, and you're listening to The Truth of the Matter, a podcast by CSIS where we break down the top policy issues of the day and talk with the people that can help us best understand what's really going on. To get to The Truth of the Matter about the latest in the U.S.-China trade war, we have with us CSIS's Scott Kennedy, a senior advisor here at CSIS and our trustee chair.

in China, business and economics. Scott, welcome to the podcast. Happy to be with you, Andrew. Scott, so we want to talk about the trade war. But first, I want to ask you, what is the economic picture in China right now? Well, I'm happy to discuss all of this with you. And, you know, for the past few years, China's economy has been growing extremely slowly. As most people know, the pandemic was not good to China, at least the last year of it in 2022, where

Following the Shanghai lockdown, lockdowns in other cities, the country's economy really froze up. There were global supply chain challenges. Folks probably remember auto chips and all these other things that were affecting the world, including China. In 2023, people thought there'd be a bounce back. There was not, nor was there in 2024. The Chinese government has thrown a ton of money

at industry, advanced manufacturing, their production has exploded, but demand in China, a lot of that has been exported abroad. Hence, China had a $1 trillion trade surplus last year. So last year, China clocked in officially at 5% is probably south of that, but slower than it's been in a long time. This year, I was just in China for a couple of weeks, and it feels like the economy has

roughly stabilized. They have rolled out the beginnings of a stimulus. You've seen some shoots of growth, more consumption, a little bit more growth in private investment. The Liberation Day was certainly a huge shock to the Chinese system, political, economic. So far, we haven't seen real signs that this has been shock and awe that's really pushed China's economy to the edge. I think actually things seem relatively stable.

stable there. Remember, China has a relatively small financial market, closed capital accounts, so there can't be capital rushing out if there's problems. They control their exchange rate. So at the moment, China's economy looks like it's

relatively steady and some signs of positive growth, but the headwinds from the trade war will probably get bigger. And with the current tariffs as they stand, what kind of pain does this inflict upon the Chinese people and thus on the Chinese government?

I think China's dependence on products from the U.S. and to export to the U.S. has gone down. About five years ago, at its peak, the U.S. was about 20% of Chinese exports. Now it's down to about 14%. Same shift on the other side. They depend even less on American imports. And so they're

There are a slate of Chinese companies that are reeling right now that if this goes on very long, they won't have customers.

Some Chinese have invested in Vietnam and India as a way to get around direct American tariffs and move supply chains with other multinationals. Vietnam and India aren't as good locales to produce. They don't have the logistics and infrastructure that China has. And so that's not been great for them. And as you see, the U.S. has tariffs on those countries as well, not as high as on China. So that strategy is a challenge.

We did see the Trump administration back away a little bit over the last few days, lowering tariffs on electronics, products, phones down to about 25% instead of the 145% level. That's still a lot. So this is not good for China's economy, especially for public confidence. But they do have staying power. And this is something that I don't see them backing down.

You know, I want to ask you about their Southeast Asia strategy in a minute. But sticking with this, how much pain can the Chinese actually tolerate?

I actually think they are in a much better position now than they were during the first Trump administration. Yes, cyclically, the economy has slowed down. Some of these structural problems that they have with demography and debt look more imposing. But China's got a whole variety of ways that they can weather this major storm.

Technologically, they are way more capable than they were six to seven years ago. I visited several companies on my last trip and I do when I go for each of my trips. And they are genuinely impressive world beaters, some of these firms. Even visited a company that is facing export controls from the United States. And when I went there over a year ago, they were really in bad shape. They did not know how to adjust with not having access to this technology.

When I just talked to them recently, they've overcome those problems and the quality and efficiency of their production has increased. And this is not just them saying it, others have noticed that as well. So the Chinese tech wise still dependent on the US and West, but not as much as they used to be. China has a huge pile of savings and both households in the bank, as well as the government, they still have a lot of fiscal bullets they can shoot to stimulate growth.

One of the good things about China that you wouldn't have thought is positive is that they have relatively undeveloped financial markets, which account for only about 60% of China's GDP. American financial markets are about 140% of US GDP. So when our markets go down, we all suffer big time. When Chinese markets go down, it's not as big a problem for them. They also have a closed capital account, as I said. Finally,

China is much more protectionist than the United States. So we can go around the world offering goodies to folks in Southeast Asia, Europe, elsewhere, to get them to not side with the U.S. in this fight. That's harder for the U.S. The U.S. can basically say, we won't impose those tariffs on you.

So I think the Chinese have, I guess the last thing I should say, Andrew, which I think may be most important, is that for the Chinese leadership, this was originally a trade spat. It's now an existential conflict. For them, they must come out doing well because this is about the leadership of the party and overall direction of China. So I think they would be willing to take this, as they say, to the end.

if absolutely necessary. And so they are a very difficult, challenging opponent for the Trump administration. So Scott, if I understand this right, what you're saying is it's an existential crisis to their leadership because if they're the ones that blink, they're the ones that back down, they become weak to their people, but they also become weaker on the international stage. Do I understand that correctly?

I think that's exactly right, Andrew, that this is a monster challenge for them. Xi Jinping cannot come out of this a loser. It'll be bad for China. It will be hugely bad for him as well. This is the issue now on which his leader governance is going to be judged.

Scott, I want to ask you, what is their overarching strategy economically during this period of instability? You know, China's strategy to deal with the current circumstances isn't a radical departure from what they've been trying to do under Xi Jinping's leadership and even before, which is move up the global value-added chain in advanced technologies, be less dependent on

on others for those technologies, translate those technologies to have positive spillovers in other parts of their economy. You know, for them, AI is not just AI. It's applied to the medical sector, to automobiles, to manufacturing processes. It's not just chat GPT or deep seek or something like that.

That's been with them for a long time. They've also been trying to reduce the significance of real estate infrastructure in their economy as well so that they can get to a higher level of development. So I don't think that those things change. I do think what is different for them now is they've got to get through this without a mega economic crisis. And two, they have to accelerate their growth.

decline independence on foreign markets and increase their reliance on domestic demand and consumer demand, which is something they've not wanted to do because to do that means a shift in the political economy of who has power in China from state-owned enterprises and producers to households. So you have to raise their wages, provide them a much broader safety net, address their concerns about housing and all of those things.

And that's something that China has been very hesitant to do. But the pressure from the United States and that they're going to be facing from others who don't want to be the targets of unloaded Chinese products, who are already anxious about that, it might accelerate that. So in some odd way, what the Trump administration is doing might actually push the Chinese to do things which they should have been doing for the last decade. Okay, so where does this all go next between China and the U.S.?

Well, I think right now, odd enough to say, we are in, I don't like to use this word these days, but in a stable moment. Really? Because what we're seeing now is, you know, the big pieces have already been put in place in terms of tariffs, in terms of Chinese restrictions on rare earths, other things. We're going to see little pieces moved. You know, the Chinese just shut off imports of some American movies. There's a report that

that they're going to stop taking deliveries of new Boeing aircraft. The U.S. may respond and put export controls on technologies that go into China's own commercial aircraft, the C919. So we may see individual pieces like that. But I'm not sure we're going to see a mega escalation of this crisis right now. If we do, it's going to be in the financial sector. It's going to be the U.S. going after Chinese banks, Chinese companies listed in New York.

perhaps swift sanctions against Chinese institutions if they wanted to go nuclear. The Chinese could do a parallel kind of things. Pushing those big buttons have major blowback. And so the consequences we saw last week on the American stock market and bond market would be even bigger if either side pushes those buttons. So I think they may hold off on those things.

I think right now, both Beijing and Washington are focused on negotiating with everybody else to fight for the middle, to see if they can outflank the other. And then I think they're beginning to think about what would a negotiation with the other side look like? Who would it be? What would the topics be on the table? That's still down the road. But I think that as they are thinking about potential escalation and negotiating with others, they also have in mind how they are positioned vis-a-vis the other side.

And Scott, we talk a lot about decoupling. First, I want to ask you, what does decoupling actually mean? Second, I want to ask you, are we decoupling with China?

So, from a physical perspective, if the US and Chinese economies decouple, we become far less interdependent across a range of measures. That means we would have much less direct trade with each other, direct investment with our companies producing in each other's markets, finance, so portfolio investment, corporate bonds,

etc., we'd have much less travel of tourists and students. We would basically come apart. It doesn't necessarily mean that we would be isolated globally because we might be still connected to many other economies or them, but our direct connections would basically be eliminated in a decoupled context. We're not there yet by any stretch of the imagination. Last year, $650 billion in trade

in goods and services, if not more. We have 286 Chinese companies listed in New York with a market cap of 1.1 trillion. The Chinese directly hold 760 billion in U.S. treasuries and 600 more through other parties. We have thousands of American companies on the ground producing in China. Last year, sold about 500 billion worth of goods.

We have a thousand plus Chinese companies in the US selling about 80 billion worth of product and services in the United States. So we are still deeply connected, but we can see decoupling from here. It used to be way off on the horizon, but now you can imagine it because with 125 to 150% tariffs, that's going to make just about every good uncompetitive, throw on the export controls and then potential financial restrictions that both sides might be contemplating.

And then, of course, for travelers, the number of Americans traveling to China now is definitely going to fall, not because of expensive plane tickets, but because of nerves of what it means to go there. And the same for Chinese potentially thinking about coming to the United States. So certain elements of the relationship are definitely going to be restricted in the direction of decoupling. Both sides would have to do a lot more to really actually pull the relationship entirely apart.

And Scott, for us in the United States, we're pursuing strategies so we can go it alone without China. The Trump administration is starting to articulate a lot of those. But what about China? What are they doing? Xi Jinping's currently on a trip to Southeast Asia. Is that part of what he's trying to do? So I think the Chinese have been de-risking

to use a Biden administration term, for quite some time. In fact, the word decoupling originally was something that they thought of in the 1990s when they began to become more economically connected with us. They're worried about dependence on the dollar, American technology, and they thought, well, do we need to decouple from these elements of the West because of our security differences?

So they started the de-risking long before we even thought of that idea. And so they're, again, continuing this long-term plan of technology self-reliance in information technologies, robotics, in automobiles, medical, pharmaceuticals, de-Americanizing. They still are going to rely on lots of things from the rest of the world, but they're trying to radically reduce their dependence on the United States in particular.

And at the same time, they are going out to the rest of the world selling, being close to China, doing business with China. Chinese leader Xi Jinping was in Vietnam yesterday, met with Vietnamese leadership. They signed 45 deals in a day. Forty-five. Forty-five. Now, today in Malaysia, he's going to Cambodia. Other Chinese officials are going to be talking to the Japanese, South Koreans, Australians, the Europeans, Latin Americans. They are in deal-making mode with everybody. Now,

Now, some of these are very small individual deals. Some of them aren't about business. They're about other issues. But China wants to build the pile. You remember when academics, you know, when you got your job, the job is to make that publishing pile as high as possible to impress the hell out of everybody. That's what the Chinese are doing right now. They are trying to make it look like they are cleaning up around the globe, even as the relationship with the U.S. is foundering. So they have

accelerated their diplomacy to avoid being isolated because the biggest thing that they fear is not that the U.S. and Japan will figure out how to reduce tariffs and restrictions on each other, but that part of the deal will be Japan limit its trade with China, limit its investment in China.

And the same with everybody else around the world, that the U.S. builds some common wall. Now, given how much the U.S. has offended everybody, I think the Chinese might think this is going to be hard for the U.S. to do. But if the Trump administration is really smart and they play their cards right as best they can, then the Chinese have something to worry about. Scott, you know, with all the talk about decoupling, de-risking,

Us walking away from each other, the United States walking away from China, China walking away from us. What does it do to major national security issues between the two countries?

Well, I think the conventional wisdom that has solidified in the last five to eight years is that our economic interdependence with China creates real huge risks and that we have to limit that connectivity because of the economic security challenges that arise, technology leakage, supply chain dependence, vulnerabilities for critical infrastructure, Chinese economic coercion. We've got to pull all that back.

and we've got to align more with others. We have to build at home, you know, the Biden administration's, you know, invest, align, compete. And we see that we're continuing to move in many of those same directions, even with the reductions in the CHIPS Act spending and things like that. I do think that there's a significant risk, though, on the national security side by really pulling these two economies apart. It really would eliminate many of the areas where we do have

common commercial interests. It would make it much harder to find common ground to tackle climate change, to tackle general AI and what it means for our economies and societies and national security to deal with potential future pandemics, and makes it more likely that hot spots, which have been sort of bubbling, become much, much more dangerous. And the most important of those is in the Taiwan Strait.

So if we are not interacting with each other, if we're not communicating with each other, and it's simply one side against the other, as tough as they possibly can be, a la the Cold War, that may feel like we're protected in one way. But in the other way, our risks go up dramatically. Dr. Scott Kennedy, as always, thank you very much. Really appreciate your insight and your expertise. Great talking to you, Andrew. Thanks so much.

If you enjoyed this podcast, check out our larger suite of CSIS podcasts from Into Africa, The Asia Chessboard, China Power, AIDS 2020, The Trade Guys, Smart Women, Smart Power, and more. You can listen to them all on major streaming platforms like iTunes and Spotify. Visit csis.org slash podcasts to see our full catalog.