As the trade war with the U.S. intensifies, China’s leaders are no longer under any illusion about the impact of tariffs. The stakes are higher than they were during Donald Trump’s first term. While the U.S. previously focused on trade imbalances, its current goal appears to be the slow strangling of China’s economic rise. But could this pressure ultimately make China’s economy more resilient and efficient?
The Long-Term Strategy
In recent years, China has become increasingly dependent on U.S. exports, particularly in the semiconductor sector. In 2022, the U.S. exported $12.1 billion worth of chips to China, making it the largest buyer of American semiconductors. But instead of fostering this relationship, the U.S. has imposed stricter export controls. By 2023, these restrictions led to a decline in semiconductor exports to China, falling to $10.2 billion.
With the tariff war expected to persist, China is bracing for a long-term economic struggle. While fiscal stimulus may offer short-term relief, the real key to China’s future lies in addressing its internal market weaknesses.
China’s Internal Market Challenges
To understand China’s economic vulnerability, we need to look back at its past. In 2009, the global financial crisis forced China to focus on strengthening its domestic market. However, the country’s highly centralized governance has long been undermined by local protectionism.
For instance, in Gongan county, Hubei province, public employees were forced to buy and smoke locally produced cigarettes or face penalties. This kind of local protectionism, while extreme, was not an isolated incident. In 2006, another county, Hanchuan, mandated that bureaucrats drink locally produced liquor, even to the point of requiring them to drink several bottles a day.
These examples highlight a systemic issue: China’s internal market is fragmented by provincial barriers, even though the government has a centralized approach to governance. Local officials, incentivized to prioritize local GDP growth, often impose invisible trade barriers by raising surcharges, blocking outside competitors, and distorting the market. These actions are a form of domestic tariffs that significantly increase the costs of doing business.
The Cost of Fragmentation
The impact of this fragmentation is staggering. According to the China Federation of Logistics and Purchasing, domestic logistics costs in China account for 14% of its GDP—nearly twice the global average. The World Bank reports that agricultural shipments crossing provincial borders face delays and spoilage rates much higher than in the U.S.
These internal barriers cost China between 3% and 5% of its GDP each year, according to estimates from the State Council’s Development Research Centre. By contrast, the tariffs imposed by Trump’s administration are expected to reduce China’s GDP by only about 2.4%, according to Goldman Sachs.
The National Unified Market Initiative
Recognizing these vulnerabilities, China launched the “National Unified Market Initiative” in 2022. This initiative aims to break down local economic fiefdoms, streamline regulations, and merge the country’s 31 provinces into a cohesive economic bloc. While progress has been slow and met with resistance from entrenched local interests, the trade war with the U.S. may provide the necessary push to overcome these hurdles.
If China can fully implement its unified market, the benefits could be immense. By reducing logistics costs and eliminating inefficiencies in the domestic market, China could significantly increase productivity, more than offsetting the negative impact of foreign tariffs. This could give Chinese businesses a competitive edge on a global scale, enabling them to grow faster and more efficiently.
A Path Toward Economic Reform
History has shown that China often reforms most quickly when it is under external pressure. The trade war with the U.S. may accelerate the elimination of inefficiencies that have long held back China’s economy. As Friedrich Nietzsche famously said: “What does not kill me makes me stronger.” For China, the ultimate victory may not come from outlasting Washington in a tariff battle, but from using the external pressure to strengthen its economy.
The Future Outlook
The road ahead will not be easy for China. Internal reform, especially in a country with such a large and diverse economy, is never simple. But if the National Unified Market Initiative succeeds and local protectionism is dismantled, the country’s economy could emerge much stronger. Trump’s tariffs, while painful, may inadvertently lead to the unification of China’s market—an outcome that could ultimately turn the pressure from Washington into an economic advantage.
