July/August 2025 Issue
By Andy Xie
In 2025, the trade war that the US began with China in 2018 has adopted many of US President Trump’s trademark transactional tactics of large opening bids followed by negotiation. China, which has faced technology restrictions as well as tariff threats, has adopted its own form of hardball negotiations. But it is also playing a long game, developing its own technologies in response. Here Andy Xie unpacks some of the implications of China’s strategy for its domestic economy, the Global South and the Global North.
Since US President Donald Trump began the trade war with China in 2018 and the tech war against China in 2019, China’s economy has deflated financial and property bubbles and shifted its resources to tech. China’s advantage in scale is accelerating its pace of innovation across a broad spectrum. It appears that China is leaping over the catching-up phase of economic development and pushing the tech frontier.
As its cost advantage from economies of scale applies to all technology goods, low- and middle-income economies can afford high tech imports from China at an unprecedented scale and modernize rapidly in the coming decades. China is rapidly levelling the ground between developed and developing economies.
When Trump was first elected president in 2016, China was deeply embroiled in dangerous bubbles. The shadow banking system had expanded rapidly to 100% of Gross Domestic Product (GDP) in asset size. New residential property sales regularly reached 20% of GDP. The stock value of residential properties surpassed six times GDP, like Japan’s asset bubble three decades ago.
Even though President Xi Jinping said in 2013 that property was for living, not speculation, the bubble kept expanding. Indeed, most property debts happened after that. The bubble became too big to burst. The market consensus was that the government had to keep it going. Of course, if the trend had continued, China was headed to a crisis bigger than what Japan or Indonesia experienced in the 1990s.
Trump’s trade war shook up the country. People felt the world had become different but didn’t know what to do. The tech war in the following year convinced everyone that China was encountering an existential crisis. The consensus was to minimize internal risks and shift resources to tech.
The China Banking and Insurance Regulatory Commission limited risky shadow banking products and set up three red lines on property sector leverage. The shadow banking system shrank quickly to 30% of GDP in asset size. The property market had its final hurrah in 2021 and has shrunk by half since then in sales volume.
Property prices have come down by half in many tier two and three cities or the outlying areas of tier one cities. Even in central areas of tier one cities, the prices are down by one quarter to one third. The economy has slowed but is still growing, which reflects China’s resilience as the factory of the world. There are more pains in the financial system to come. But China has managed to self-correct without going over a cliff. Without Trump’s pressure this may not have been possible.
The money that went into the bubble economy is being repurposed for technology development. Household bank deposits are rising over 10%, twice as fast as the nominal GDP. During the bubble, household deposits were rising slower than nominal GDP, as people were speculating in the property bubble. Deposit growth over nominal GDP now is more than $1 trillion, which is likely being repurposed for technology development. Unlike the property boom, tech investment doesn’t have a high multiplier effect on the economy. Hence, the economy feels slow now. When new technology becomes mature and productive, the economy will benefit from higher growth or currency appreciation.
The initial signals from increased investment are positive. In areas where the United States is restricting China’s access to its technology, such as semiconductors, hi-tech materials and jet engines, China is breaking through at a rapid pace. China is already mass producing 7nm (nanometer) chips. In the current calendar year, we will see 5nm chips. The Artificial Intelligence (AI) chip from Huawei Technologies is quite close to the performance of the AI chips of industry leader NVIDIA Corporation (NVDA.NY).
China is succeeding in producing lithography machines for 14nm chips. Tremendous progress is being made in making the cutting edge extreme ultraviolet lithography (EUV) machine. China also appears to be leading in photonic chip technology, which will continue the trajectory of Moore’s law, that the number of transistors on integrated circuits doubles about every two years, beyond silicon1. It is possible that China could take the lead in chip technology between 2030 and 2035. Of course, the established players would laugh at such prognostication. We shall see.
The US has been betting the farm on AI to outcompete China. The West in general doesn’t believe that China can do real innovation, because it thinks that China’s success has come from low wage and copying. The global success of Hangzhou-based AI startup DeepSeek in January shocked the China skeptics and the Chinese government. It wasn’t among the top Chinese AI shops that were trying to chase OpenAI. Its employees didn’t go to Ivy League colleges or work for famous tech companies.
And yet, they truly innovated and created a path that required 10 times less computing than OpenAI and other rivals. It shows the depth of China’s talent pool. Its success has motivated Chinese government to spread Research and Development (R&D) funds around, betting on many universities, research labs, and startups. The results are extraordinarily successful. Breakthroughs are coming on a daily basis from hitherto obscure institutions.
China’s advances in new materials have been striking. It was dependent on countries like Japan and Germany for hi-tech materials. It is now coming up regularly with breakthroughs in materials for 3D printing, jet engine coating, batteries and solar panels. Its materials for advanced radar are leading the world. Hi-tech materials are the foundation for a twenty-first century economy. China is betting big to overcome embargos and take the lead in the new-new things. It seems to be working.
China is making remarkable progress in making machines. During the three years of Covid-19 many factories took advantage of the downtime to rebuild their factories to the standard of Industry 4.0. The US is targeting China’s development in this area by restricting its access to industrial software. Domestic substitutes are rising rapidly. Previously, China didn’t make key machines or software, because domestic users preferred imported ones. There were low incentives to develop domestic alternatives.
The US restrictions on access or the threat of such is incentivizing domestic users to prefer domestic substitutes. While it takes time for local companies to develop to the same levels as their US counterparts, time is on their side. The industrial base is in China. The demand for industrial software is there too. The US has an edge in industrial software because it was the dominant industrial economy. China is now that. It is in an advantageous position to develop all industrial services.
Necessity is the mother of invention. For two decades, China was content with being the factory of the world, making products for global companies with imported equipment and materials. The tech war is forcing it to make its own materials and equipment. As the US is increasingly restricting China’s market access, the country is forced to climb the value chain by developing its own branded products. The tech and trade war are effectively forcing China into becoming a self-contained industrial and technology hyperpower.
The rise of Chinese tech is redefining the world. First, China’s success in decarbonization, electrification, and digitalization offers a template for leapfrogging development. Solar power is becoming cheaper than hydrocarbon. Solar power makes grid or village-level electrification cheap and easy. Electrified mobility becomes possible for everyone and everywhere. An African family can invest US$1,500 to have enough electricity to power its home appliances and a three-wheeler that can go 150 km and carry 500 kilos. That is the cost for them to live and work in the twenty-first century.
The Trump administration talks about incentivizing third countries to limit trade with China. This is unlikely to work for 6 billion people in the Global South. China is offering them a chance to develop and modernize at a low price that the West has never offered and never will. How could they turn it down?
China’s impact on the Global North won’t be as positive. There was a complementary relationship between them in the past. The trade and tech war are forcing China to do what the Global North is doing. And, when China can do it all, its currency will remain low to sell to developing countries. That will force the Global North to hide inside a high-cost bubble by erecting high tariffs. It will lead to economic stagnation and recurrent cost-of-living crises.
If the US doesn’t want to make a deal with China on how the world is run with China as an equal partner, the US faces a difficult future. China just needs to build a new world.
Andy Xie is an independent economist based in Shanghai, and a former chief economist for Morgan Stanley Asia Pacific (Holdings) Ltd. Famous for his provocative and contrarian views, Xie left Morgan Stanley in 2006 after the leaking of an internal memo in which he described Singapore as a money laundering center for Indonesia. He has an MS in civil engineering and a PhD in economics from the Massachusetts Institute of Technology and joined Morgan Stanley in 1997 after working as an economist with the World Bank.
- Moore’s law is named after Intel co-founder Gordon Moore, who described the trend in a 1965 paper. ↩︎