China and the US should sort out their own policies to tackle the imbalance that’s straining their ties

The imbalance, in other words, is not narrowing. It is being rerouted.

But this raises a harder question: is China simply moving up the value chain through comparative advantage, or are industrial policies and subsidies distorting the system?

The answer is likely both. China has built formidable industrial capabilities, supported by scale, infrastructure and supply-chain integration. Recent analysis by the International Monetary Fund (IMF) reinforces the ambiguity. It finds little empirical evidence that industrial policies have driven China’s aggregate external surplus.

The more important issue lies at the macroeconomic level: when domestic demand remains weak, productivity gains—however achieved—translate disproportionately into exports.

China’s continued reliance on exports is not simply a matter of policy choice. It reflects deeper constraints. A prolonged property downturn, heavily indebted local governments and rising financial pressures have narrowed the space for fiscal support to households. Borrowing is being used to stabilize the financial system rather than boost demand. In this context, industrial production and exports become the default growth engine.

China is also caught in a feedback loop. Weak consumption suppresses growth; slower growth worsens debt dynamics; and rising debt concerns reinforce policy caution. The longer restructuring is delayed, the more entrenched the external imbalance becomes.

This makes rebalancing far more difficult than standard policy prescriptions suggest. The challenge is not just economic—it is political and financial.

Focusing exclusively on China, however, misses the equally important American side of the equation.

The US external deficit is often framed politically as evidence of foreign unfairness. In reality, it reflects long-standing domestic macroeconomic choices.

The first driver is fiscal policy. The US continues to run large budget deficits even in relatively normal economic conditions. This is not merely cyclical stimulus; it is structural public dissaving.

Second, private savings remain comparatively weak. Americans consume heavily relative to income, while domestic investment demand remains strong. When a country invests more than it saves, the difference appears as a current account deficit.

But there is a third, increasingly important factor: capital flows.

The US deficit persists not simply because Americans buy imports, but because the rest of the world wants to buy American assets. Treasuries remain the world’s dominant reserve asset, while US equity markets continue to attract global capital. Institutional depth, legal protections and geopolitical uncertainty all reinforce demand for dollar assets.

This inflow keeps the dollar structurally strong, making imports cheaper and exports less competitive. Paradoxically, American economic strength helps sustain the very deficit that politicians condemn.

There is also another, important shift underway. For decades, the US benefited from earning more on its overseas investments than it paid on foreign-held liabilities. That advantage is weakening as foreign investors hold more US equities and higher-yielding assets, increasing dividend and interest outflows. Even without additional trade deterioration, this puts further pressure on the external balance.

Thus, tariff politics are disconnected from economic reality.

Tariffs may reduce imports from one country, but they rarely reduce aggregate deficits if the savings-investment imbalance remains unchanged. Trade simply reroutes through third countries, as supply-chain adjustments have already demonstrated.

The real adjustment requires politically harder reforms.

For China, that means shifting toward consumption-led growth: strengthening household incomes, expanding social protection and reducing reliance on export-led manufacturing.

For the US, it means restoring fiscal discipline and addressing the structural savings shortfall that underpins persistent deficits.

Neither side appears willing to do this. Washington prefers tariffs and industrial subsidies. Beijing continues to rely on manufacturing strength and external demand. Both sides attack symptoms while preserving causes.

The imbalance increasingly reflects structural constraints on both sides. China cannot easily rebalance without confronting debt and restructuring losses, while the US shows little willingness to address its fiscal and savings imbalance.

Unless both countries confront the macroeconomic foundations of the imbalance, they are fighting the wrong economic war.

The author is a distinguished fellow at the Centre for Social and Economic Progress (CSEP) and a former member of the 15th Finance Commission