Excess Savings Are Driving the New China Shock

The first “China shock” followed China’s entry to the world trading system, when the mobilization of its massive pool of low-cost labor, combined with heavy investment from abroad, caused global manufacturing capacity to shift decisively toward the country. The new China shock is different: it is rooted in domestic technological upgrading and amplified by weak domestic demand.

During China Shock 1.0, which began in the mid-1990s, China’s immense manufacturing capacity led to the formation of a huge surplus. After the 2008 global financial crisis, however, this surplus shrank. Infrastructure and housing booms absorbed domestic resources; imports of machinery and raw materials rose; and outbound tourism helped offset the goods surplus. By the late 2000s, the first China shock had come to an end.

But the tide soon turned again. The COVID-19 pandemic brought tourism to a standstill, and the 2022 collapse of a massive housing bubble undermined domestic demand. As Chinese firms chased markets abroad, exports rose and imports fell. China’s trade surplus again soared, surpassing $1 trillion last year–equivalent to just under 1% of global GDP (about $120 trillion).

While China’s exports are lower today than in 2008 as a share of its GDP, that is only because Chinese GDP has grown substantially over this period. Similarly, though China’s share of the global economy (evaluated at current prices) has fallen slightly over the last five years, that is because the renminbi has weakened considerably, and domestic prices have remained flat, while they rose almost everywhere else.

As China’s low domestic demand fueled a trade surplus, exports naturally increased in its most internationally competitive industries. But whereas the effects of the first China shock were concentrated in low-tech, labor-intensive sectors, such as textiles, toys, and furniture, Chinese exports now dominate several high-tech green sectors, such as batteries, solar panels, electric vehicles, and machinery.

Industrial policy and subsidies help channel China’s surging exports toward favored sectors. But they are not the underlying driver of that surge. Rather, China needs an external outlet for its excess savings.

China today is often compared to Japan in the 1980s. At the time, Japan was a high-saving Asian economy that had secured dominance in frontier manufacturing sectors, especially cars, consumer electronics, and semiconductors. It accounted for about 30% of global car production, similar to China’s 33% share today. Japan’s share of global GDP peaked at around 18% in 1994–again comparable to China’s current share.

Also, like China, Japan saw its surplus peak, triggering a strong political backlash abroad, then fall for a few years, owing to a housing boom. Once that bubble burst, the surplus again swelled, reaching a new peak in the mid-1990s. Eventually, however, slowing growth and declining savings weakened Japan’s economy. This is not happening in China.

China Shock 2.0 combines continued supply upgrading with an absorption problem: the decline in property and related investment has reduced domestic demand, but national saving remains very high. The result is a larger savings-investment surplus that spills into net exports. Unlike a permanent increase in productivity growth, this macro component is mainly a level effect: once the economy reaches a new lower investment equilibrium, exports and the current account are higher by a finite amount, unless savings rise further or domestic investment continues to fall.

The time path of savings is the underlying reason why China’s trajectory has diverged from that of Japan. Between 1991 and 2024, Japan’s savings rate fell from over 38% of GDP to under 27% of GDP. In 2024, China’s savings rate exceeded 43% of GDP.

Unless the economy is growing at close to double-digit rates, creating enough profitable investment opportunities to absorb such a large pool of savings is virtually impossible. With China’s GDP having grown at around 5% annually over the last five years, one can expect the country to continue running large surpluses for the foreseeable future.

It has often been argued that China needs to shift to a new growth model driven by domestic demand, and that a reduction in savings would go a long way toward supporting that goal. The same argument was made during the first China shock and about Japan in the 1980s. But it turned out to be difficult to get people to spend more. If Japan’s experience is any guide, it will take decades before China’s excess savings begin to fall.

This has an uncomfortable implication for Europe and the United States. Protectionist policies might slow the influx of Chinese products in some sectors, but they cannot eliminate the macroeconomic driver of the new China shock. So long as China saves more than it can profitably invest at home, the surplus will appear in foreign markets.

The first China shock faded as China’s economy absorbed more of what it produced. The second will wane only when China’s saving rate falls or domestic demand recovers. Neither is likely to happen quickly.

Copyright: Project Syndicate, 2026. www.project-syndicate.org