On the bigness of China

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Most pundits get China wrong. There are lots of mistakes being made, but many of them center on three fallacies:

1. Pundits (subconsciously) underestimate China’s size.
2. Pundits accept the long-discredited mercantilist theory that exports are good and imports are bad.
3. Pundits underestimate the importance of Say’s Law.

I’ll address the first two fallacies in this post, and the Say’s Law issue in the next post.

For the world as a whole, the current account balance should be exactly zero. As a result, there is a sense in which any country that runs a current account surplus “forces” the rest of the world to run a current account deficit. But this is a strange use of the term “force”, as it is equally true that any individual who chooses to become a net lender “forces” all other humans on planet Earth, in aggregate, to become net borrowers. But let’s not quibble about semantics. What is actually at stake here?

Martin Wolf in the FT expresses a view that I’ve seen repeated over and over again:

As a result, China’s policies look unavoidably threatening to much of the world. If a major trading partner runs huge and persistent trade and current account surpluses, everyone else has to run offsetting deficits. This leads to the shrinkage of sectors specialising in producing tradeable goods and services, as well as huge domestic financial deficits. These, in turn, create protectionist pressures of the kind we have been seeing in the US and increasingly the EU. Yet high-income countries are not the only victims of China’s push for dominance in manufacturing. Among them, argue Shoumitro Chatterjee and Arvind Subramanian, are also the poor countries whose development it blocks.

Notice how Wolf moves from an accounting identity to some highly questionable assertions. Before examining his statement in detail, I’d like to remind readers that the world’s current account surpluses are almost entirely concentrated in two regions, East Asia and the continental part of northern Europe. Here are the approximate figures (from AI Overview) for the first quarter of 2026, the most recent figures available. All figures are surpluses for Q1 only. I have decided to separate East Asia into two components:

China (pop. 1400 million) $184.3 billion surplus or $131.6 per capita

East Asia ex-China (pop. 200 million) $246.1 billion surplus or $1230 per capita

Northern Europe (pop. 140 million) $180.2 billion surplus or $1287 per capita

Here are the individual East Asian countries that I looked at:

Japan $77.75 billion surplus

South Korea $73.78 billion surplus

Taiwan $62.53 billion surplus

Singapore $32.0 billion surplus

Here are the individual northern European countries that I looked at:

Germany $70.9 billion surplus

Netherlands $30.0 billion surplus

Norway $27.2 billion surplus

Switzerland $18.9 billion surplus

Denmark $15.5 billion surplus

Sweden $9.4 billion surplus

Austria $8.35 billion surplus

I was surprised at how small the current account surpluses were outside of these two regions. Even Saudi Arabia had a surplus of only $4.1 billion. I didn’t know whether to put Hong Kong in with China or in ex-China, but its surplus was only $4.7 billion. Again, East Asia and Northern Europe represent the world’s only major current account surpluses.

There is a sense in which these surpluses ”force” the rest of the world to run deficits, but it is equally true that America’s decision to run a $226.8 billion current account deficit in the first quarter of 2026 forced the rest of the world to run a big surplus. In other words, we are forcing workers in China, Japan and Germany to slave away producing goods like air conditioners for our comfort, while much of Europe suffers from sweltering heat.

But that’s not the framing used by Martin Wolf, who seems to view deficit countries as the victims of trade imbalances. Even more oddly, he includes the EU as one of the victims, even though the EU as a whole ran a current account surplus of $129.3 billion in the first quarter of 2026. That’s right, anti-Chinese bias has reached such a fever pitch that highly respected columnists seem to be hallucinating current account deficits where they do not exist.

OK, I’m being a unfair to Wolf, who does not explicitly suggest the EU is running a trade deficit. But the average reader is likely to infer that from the fact that he mentions that China is running a big surplus, and the fact that China’s surplus forces a deficit on the rest of the world, and the fact that protectionist pressures are rising in the EU as their firms are being hurt by Chinese competition. All three claims are true, but do you see how Wolf’s framing tends to obscure the fact that northern Europe has a current account surplus nearly as large as China’s, and much larger in per capita terms? What are we doing here?

You might argue that I’ve cheated by lumping together a bunch of different countries in Europe and East Asia and them comparing them to one single country like China. China’s surplus is more than twice the size of the next largest surplus. But someone could just as well argue the opposite, that it is unfair to China to compare it to countries with much smaller populations. The fact that both northern Europe and East Asia ex-China have CA surpluses in per capita terms that are nearly 10 times larger than China’s surplus suggests that they are the true villains, at least if you regard CA surpluses as a sin. (I don’t.)

Notice how the dotted lines on the map that we call international borders tend to distort our view of the world. Suppose China decided to emulate Europe and become “the China Union” and treated each province as a separate economic entity. You might regard the idea as far-fetched, but Hong Kong has been treated that way for decades, and the rest of the world has accepted the fact that Hong Kong’s economic data should be viewed separately. I challenge you to find a single news article anywhere that presents Chinese economic data that includes Hong Kong, even though it is technically part of China.

If China were to form an EU-style federation, where each province was treated as an individual country, then the “problem” of China’s massive current account surplus would immediately vanish, even as nothing of substance would change. Without national borders, no one cares about current account balances. Back when I was in college, we were taught that places like New York ran big CA surpluses and California ran deficits. But no one cared or even bothered to collect the data. (BTW, that’s probably no longer true, as California is no longer a fast-growing state.)

The 1.3 billion Han people who live in Mainland China are in some ways an unfortunate ethnic group. They have a comparative advantage in producing the sort of good that is sold in highly competitive markets, and they are not so good at producing goods sold in protected markets with high profit margins. The Han are also the largest ethnic group on Earth—no other group even comes close. That means that industries such as EVs quickly become highly competitive after Chinese firms enter, and the terms of trade tend to move against China. Some of China’s apparent dominance in manufacturing comes from the fact that they need to sell a large volume of inexpensive manufactured goods in highly competitive markets in order to purchase a small volume of very expensive luxury goods from places like Switzerland. The ships leave China bloated with goods and return mostly empty.

Even worse, China is not earning the surplus in investment income that you would expect from a country that had accumulated vast wealth through trade surpluses. Here’s Wolf:

China shows an unexplained negative net income of around $125bn on its net foreign investments. But it should, on reasonable assumptions about the income it earns on its $4tn in net foreign assets, have a surplus of some $100bn.

I’m not sure exactly why this is occurring, but in an accounting sense it appears that foreigners investing in China have earned much greater returns than the Chinese who have invested outside their country. This may partly reflect the fact that multinationals in China earn relatively high profit margins whereas China’s government earns low returns on Treasury bonds bought during the 2010s and early 2020s. Or perhaps there is some measurement error. Even so, it is a striking data point.

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