WASHINGTON—China’s trade surplus, the largest in history at $1.2 trillion in 2025, is routinely cited as evidence of unfair competition or currency manipulation. It is much more than that. It is the visible byproduct of a deliberate strategy aimed at self-sufficiency that discourages private consumption, subsidizes industrial investment, and exports whatever the domestic market cannot absorb.
China’s strategy is mercantilist in a way many analysts recognize—but what is less widely appreciated is how that familiar label now operates through advanced manufacturing, global value chains, and geopolitical positioning. Western countries cannot correct China’s mercantilism merely through trade or exchange-rate diplomacy, and treating it simply as part of a broader global imbalances story misses the central problem. Whether China’s trade surplus is fair or manipulated is therefore an interesting but not essential question. The more important one is whether China’s geopolitical strategy can be contained by the democracies whose living standards and political stability it increasingly threatens.
The next China shock
China’s strategy rests on three mutually reinforcing pillars. The first is industrial: rapid technological diffusion, fierce state-sponsored competition encouraged by public subsidies in selected industries, and tight integration across the production chain. All are playing out inside a domestic market large enough to give Chinese firms a scale advantage that few rivals can match. The result is a manufacturing base that has kept expanding even as domestic demand has stagnated, forcing firms into destructive price competition at home and aggressive export pricing abroad. This has displaced Western producers in what has been dubbed the China Shock 2.0.
The second pillar is financial. A large share of China’s external surplus is recycled directly into loans, foreign direct investment, and infrastructure financing abroad, rather than left to accumulate as reserves that would put upward pressure on its currency. Because this recycling happens through state banks and policy vehicles rather than the central bank’s own balance sheet, it requires relatively little overt intervention, and it converts what would otherwise be a currency adjustment into an instrument of financial statecraft.
The third pillar is geopolitical. Beijing has pursued vertical integration and supply-chain consolidation not merely for industrial efficiency but as a deliberate instrument of leverage. Dominance in the mining and processing of rare earths and other critical minerals, for example, gives China control over chokepoints for inputs that Western defense, automotive, and electronics industries cannot currently replace. The same logic extends to investment in technology, ports, and other critical infrastructure across low-income and emerging-market economies, where Chinese finance builds dependencies that pay geopolitical as well as commercial dividends.
Contradictions inside the model
China’s external success masks considerable internal strains, of course. China’s working-age population has passed its peak. Major studies project a loss of roughly a quarter of the workforce by mid-century, an adjustment without precedent for large countries. Household wealth is trapped in a property sector that remains under water, and elevated youth unemployment is testing the social contract that underpinned three decades of rapid growth. These are genuine constraints on China’s model: an economy that depends on suppressing consumption and subsidizing production cannot indefinitely ignore a shrinking labor force and a household sector unwilling to spend.
Yet a repressive political system that exerts intensive surveillance over public discourse can manage these strains for far longer than an open economy could, all while the state builds out its geopolitical footprint. This is the paradox democracies need to internalize: The very tools that make China’s system resistant to a change in power also make its long-term trajectory harder to read, and potentially more dangerous. As internal contradictions become harder to manage through growth alone, a leadership under pressure may find external assertion—whether over Taiwan or in the South China Sea—a more useful instrument for controlling domestic dissent than economic reform.
History suggests that revisionist powers tend to become more willing to take risks if they believe their power is beginning to erode compared to that of their rivals. A low-probability lunge for advantage can appear preferable to leaders facing a humiliating and irreversible decline in relative power. Whether China currently exhibits that pattern is a live debate, but it is one that Western planners should not treat as a remote scenario.
The German precedent
China’s trajectory has a genuine, if imperfect, precedent in the newly unified German Empire of the late nineteenth and early twentieth centuries. Germany combined a tightly integrated corporate-industrial structure, headed by an autocratic regime oriented toward Prussian military ideals, with a large domestic market and rapid technological catch-up. It produced economic and military capabilities that rivals operating under older economic models found difficult to match. The friction this generated with the established powers of the day eventually erupted into conflict, and it took two world wars and the near-total exhaustion of the European state system before a more liberal order was reestablished.
Recent work on the Anglo-German rivalry shows that this contest was embedded in early global supply chains for dual-use industries, such as chemicals, electrical equipment, and machinery. At the time, Britain dominated high-value finance and shipping, while Germany was rapidly catching up in manufacturing under an autocratic, corporatist model. Their rivalry played out in naval rearmament and colonial competition. But it also played out through economic statecraft, as Britain sought to weaponize its control over shipping lanes and raw-material supply chains, while Germany responded by upgrading toward a more self-sufficient continental industrial base.
This is a parallel that should concern today’s policymakers: A mercantilist economic model, paired with an autocratic political system capable of directing capital and industry with little internal resistance, can generate sustained economic and perhaps military advantages for many years. Another uncomfortable reality is that the contest between today’s newcomer and a group of democratic incumbents will unfold without an outside power to tip the scales in the way the United States rescued Europe twice in the twentieth century.
Time is still on Beijing’s side
It is possible for today’s democratic allies, who still dominate China in economic and financial terms, to stand their ground. But this will require a sustained, coordinated effort. None of China’s internal contradictions suggest an imminent reckoning for its Communist Party. The scale of its demographic decline is real, but its pace is slow enough that Beijing will likely have many more years to exploit its current strengths before the labor force shrinks enough to meaningfully constrain output.
Combined with continued gains in automation and robotics, China will likely remain a potent competitive force well beyond the point at which its internal strains become impossible to ignore. A counterstrategy that relies on China’s demographic decline or assumes its internal contradictions will resolve the competitive challenge on their own is not a strategy, but a wager on time.
As for the United States and Europe, which are also aging, their higher living standards relative to those in China continue to imply higher labor costs, and social welfare commitments are larger as well. Both will constrain the speed and scale of their industrial response. Moreover, just as economic hardship bred protectionist backlash in the past, today’s rising inequality and fear of economic decline narrow the political space available for the sustained, patient industrial and technological response the moment requires.
Designing a durable counterstrategy
Hard as it may be, the task ahead for the United States and its democratic allies is to design a counterstrategy that is durable enough to outlast a prolonged contest and calibrated enough to avoid tipping it into military confrontation. In the meantime, Western economies need to rebuild the industrial and technological depth that will allow them to negotiate from a position of strength rather than anxiety.
The first element is mitigating the China Shock 2.0 directly. Keeping subsidized Chinese products out of specific domestic markets, at least until Western industries rebuild competitive capacity, is a defensible response. But trade defenses have diminishing returns, and tariff walls buy time without automatically restoring competitiveness. They should therefore be treated as a bridge to a more durable strategy, not a substitute for one.
The second is playing to areas of durable Western advantage that are currently underused. In finance, the West’s advantage lies in trusted, open, and liquid markets that have underpinned the centrality of the dollar for eight decades. The priority should be to modernize how money and securities move through those systems so they remain fast, secure, and reliable. In technology, the United States and its allies maintain important advantages at critical points in the supply chains for frontier artificial intelligence, advanced semiconductors, and high-end machine tools. Export controls can help preserve or even expand that lead, but temporary barriers should not be mistaken for a durable solution.
The third is accelerating the contest for the Global South, where the signs of a shift are already visible but need to move faster. Beijing’s Belt and Road Initiative missteps, mounting debt distress, and its shift from capital provider to debt collector have already cost China reputational capital. Yet Western governments have simultaneously cut official development assistance at precisely the moment this opening has appeared. Moreover, financing by multilateral development banks has not been sufficient on its own. Many developing-country governments have asked for market access and technology transfer rather than concessional loans. Africa should be prioritized both for its position among the fastest-growing consumer markets of the coming decades and as the region where the West has the clearest opportunity to offer a more credible alternative.
The fourth and most urgent is closing the trust gap between the United States and its allies, since none of the above is achievable without functioning coordination among democracies themselves. The current US administration’s approach to allies has weakened trust even as its tactics have produced useful shifts in behavior, most visibly faster European defense spending. NATO and other treaty partners around the world remain an important force multiplier for the US, whereas China’s own relationships with US allies remain narrow, limited largely to economic ties already under strain and lacking the deeper cultural, institutional, and historical connections that characterize the transatlantic partnership.
A settlement built from strength
To sum up, the strategic task ahead is not to relitigate whether China’s currency is undervalued or whether its subsidies violate trade norms. It is to leverage the durable strengths democracies still hold—in education, fundamental research, financial and entrepreneurial capacity, and the institutional flexibility that a more open, if messier, political system still provides.
China’s rise to dominance is not preordained. Its diplomacy has often proven self-limiting. Its aversion to formal alliances constrains its ability to build the kind of trust-based coalitions that magnify hard power into durable influence. The low productivity of its domestic economy, its demographic trajectory, and its incomplete progress toward technological self-sufficiency all impose real ceilings on how far its current advantages can carry it. But neither should one assume that China will stall on its own anytime soon. Nor should confidence in the country’s structural constraints translate into complacency about the possibility that a leadership watching its window of advantage narrow might choose confrontation over managed decline.