Yao Yang on China’s Leverage in the US Trade War (Part 3)

"My guess is that in the end it will come down to a licensing system. You want to import [rare earths]? Fine, we’ll give you a licence—but we’ll be watching you." — Yao Yang

This final instalment in Yao Yang’s analysis of China’s new era of “correction” turns from the strengths and weaknesses of the PRC’s economy to their geopolitical ramifications — above all, the evolving landscape of Sino–US trade. With the APEC summit on 31 October approaching, Yao assesses the prospects for a Sino–US deal and offers a series of original predictions on the roles played by rare earths, digital services and foreign investment within this potential agreement. Regarding the tariffs themselves, he expects them to remain at current levels. Yet in the longer run, he argues, global tariffs may ultimately favour Chinese firms — which operate at lower costs than many tariff-hit competitors and are increasingly establishing manufacturing bases throughout South-East Asia.

— James Farquharson

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Yao Yang on China's Era of "Correction" (Part 1)

Yao Yang on Avoiding a Japan-style "Two Lost Decades" (Part 2)

Key Points

1. The Chinese government did not, as many expected, ride out the tariff storm by asking its people to endure more pain than Americans; instead, it played its rare earths “trump card” with precision.

2. Given that both sides have signalled goodwill, it is likely that a US-China deal will be announced at the APEC summit in South Korea on 31 October, as the culmination of a pre-agreed framework.

3. The main reason for optimism lies in the strong appetite of Chinese firms to invest in the US; the current obstacle to this is the ambiguity of American regulations and the lack of clarity over which sectors are genuinely off-limits.

4. For US investment into China, the same principle applies: Washington needs to provide greater clarity and remove barriers that prevent its own firms from entering China’s non-sensitive sectors.

5. China may ease export restrictions on rare earths through a licensing system that excludes military applications—with US producers potentially subject to on-site inspections. As a counterpart, the US could suitably relax its restrictions on chip exports to China.

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6. The significance of TikTok in the trade talks lies in the broader issue of digital services: in return for allowing continued market access, the US could seek reciprocal access to the Chinese market for its own digital platforms.

7. Tariffs will probably settle at 30%, locking in a relatively low rate for China; by hampering less efficient competitors in Europe and parts of the developing world, global tariffs are in fact working to the advantage of China’s more efficient firms.

8. The tariffs have also accelerated the trend of Chinese firms “going global” (出海), with South-East Asia’s manufacturing base becoming increasingly integrated across the region as a result.

9. Chinese overseas expansion is taking the form of a “China plus one” model, with firms keeping their domestic factories while also setting up abroad; as a result, it will become increasingly difficult to single out Chinese companies through tariff measures.

10. Sino–US relations are likely to return to being “politically cool but economically warm” within the year. The reason is that the broader economic structure remains unchanged: the United States continues to be centred on finance, while China remains focused on manufacturing.

The Scholar

Name: Yao Yang (姚洋)
Age: 60 (Nov. 1964)
Position: Dean and Professor, Dishui Lake Advanced Finance Institute, Shanghai University of Finance and Economics
Formerly: Dean of the National School of Development, Peking University (Nov. 2012 – Jan. 2024)
Research focus: China’s political economy, political philosophy and economic development
Education: BA Peking University (1986); MA Peking University (1989); PhD University of Wisconsin-Madison (1996)

YAO YANG: CHINA’S POLITICAL AND ECONOMIC SITUATION IN THE CONTEXT OF OUR ERA’S NARRATIVE | JIABIN FRONTLINE CLASSROOM
Yao Yang (姚洋）
Published by Jiabin Business School on 11 September
Translated by Jan Brughmans
(Illustration by OpenAI’s DALL·E 3)

1. Trump’s Mindset

Let me quickly touch on China–US relations.

First, why did Trump launch a tariff war? This question often reflects the projection of a Chinese mindset onto American politics, where people assume a grand conspiracy lurks behind every move. The trade war is interpreted as an effort to contain China, to hold it down. His outreach to Russia and Putin is cast as a bid to enlist Moscow against Beijing. Even initiatives on stablecoins are read as attempts to defend dollar dominance and suppress the renminbi [Note: We covered many of these debates earlier this month]. Taken together, these actions are often depicted as part of a vast, coherent strategy.

Let me tell you—there isn’t one. Trump is straightforward and does exactly what he says. Why fight a trade war with China, or even with the world at large? He gave the reasons himself. First, the trade deficit: he sees it as a loss and wants to claw it back through tariffs. Second, he believes that higher trade barriers will bring manufacturing back home. Third, with the government short of money, he views tariffs as a way to plug the fiscal deficit.

Now look at how he calculated tariffs. Leaving aside the “divide by two” [arithmetic] for the moment: his idea was that the increase in tariff rates should equal the trade deficit divided by imports. Rearranged, the equation becomes imports multiplied by the tariff increase equalling the trade deficit—in other words, using tariffs to claw back the deficit.

And why divide by two? Probably because he realised that otherwise the required tariff rate would be absurdly high. For China, it would have meant more than 60%—which would have killed trade altogether and left no tariffs to collect. So he simply halved it. This was nothing more than a formula he contrived—with no basis in economic theory. The only logic behind it was his determination to claw back the deficit through tariffs.

2. China Hawks, Decouplers and the Status Quo Faction

There are several camps in the US regarding China. One is the genuine China hawks [对华鹰派]—people like Navarro, Waltz, and Rubio. If they held power, China would be facing a far harsher environment than today’s.

Another camp is the decouplers [脱钩派], now the US mainstream. Why do they want to decouple from China?

First, they say that China has been taking advantage of the United States—and this can no longer continue. Second, [they think]: you have taken advantage of me and now become my competitor, so I must punish you. There are many people who think this way, including some who once could have been called China-friendly but have since turned towards decoupling.

Take Kurt Campbell, for example. He spent many years working on China at the State Department and was in some respects once regarded as China-friendly. In recent years, though, he has become what you might call a decoupler. Because of the two-track economic dialogue, we saw him almost every year—and we met him again last year, when he was already the number two at the State Department. After our conversation he asked to take a photo; perhaps he knew it would be his last time in public office. After the photo he said to us, “Remember—in the past 50 years no country has helped China as much as the United States has.” I could hear the mixed emotions in his voice.

You see the logic? Actually, relations between countries are just like relations between people. If you help someone—at least from your point of view you feel you’ve helped them—and then they suddenly stand in front of you as a challenger, you’ll come up with a thousand reasons to finish them off [整死]. Right? That’s basically the attitude of the US decouplers—they want to finish China off.

Then there is the status-quo faction [维持派]—mostly business figures, including people like Treasury Secretary Bessent, who came out of Wall Street. They already know that a full decoupling from China is impossible and that they still need to make their money in China.

And then there are the pro-China voices [对华友好人士]—fewer now, but not gone in their entirety. Talking with them is genuinely moving: even in today’s tough domestic climate in the United States, they still choose to speak up for China.

Trump himself has no party loyalty or affiliation, and thinks purely in terms of deals. His foreign policy is very straightforward: give up global responsibility [放弃全球责任]. In the past, the United States carried that burden and, in his eyes, got burned and wants out [吃亏了，不干了]. From his perspective, he isn’t wrong. Since the Second World War, America has fought many wars—50,000 dead in Korea, another 50,000 in Vietnam, plus countless other conflicts. Altogether, over the past seventy or eighty years, perhaps three to four hundred thousand Americans have died overseas. And from the American point of view, they haven’t reaped commensurate benefits.

So Trump says: fine, I’ll get you something this time. That’s why he wants to slap a 10% tariff on every country—to bring the money back.

But don’t think the United States is in decline. Trump will subdue other countries with naked power [赤裸裸的强权]. How did he subdue Iran? Simple: he sends B-2s from home, refuels them en route, flies ten thousand kilometres, drops a few bombs and then flies back—just to show how easily America could wipe you out. And when EU leaders turn up with Zelensky to meet him, what happens? They’re made to sit on little stools in the Oval Office and put up with his humiliation.

3. China Has the Cards

In China–US trade, we’ve already had three rounds of talks—Geneva, London, and Stockholm. Why is China treated as a special case? As Bessent put it: when it comes to China, the decision lies with the President himself; Trump alone decides. And why does Trump show such respect to China? Because China has real clout [有实力].

When tariffs first went up on 2 April, many people called it a battle of national destiny [国运之战]. They said: if we can hold our breath longer than the Americans, we’ll win. Why? Because, supposedly, we have institutional advantages and obedient citizens. That made me furious. We are a country led by the Communist Party, and the Party’s founding purpose is to serve the people—not to use them as gambling stakes. I did the sums: with tariffs that high, if we did nothing, it would throw around ten million people out of work. Counting their families, that’s thirty to forty million lives affected. To wager the livelihoods of tens of millions of ordinary people in a trade war—that is not what the Communist Party is meant to do.

In fact, the central government didn’t go down that route. What did it do? It showed steel [亮剑]—using hard power, in this case rare earths. That alone was enough to floor [打趴下] the United States. And with rare earths it’s simple: just clamp down on smuggling. Cut off the rare-earth supply and America gets nervous.

China still holds plenty of other trump cards [杀手锏]. As Bessent put it, “If you keep asking the US to hand over advanced chips, why don’t you give them hypersonic missile technology as well?” [Note: Reportedly said during the London round of trade talks]. We have many such cards, and we must rely on real clout so that Americans understand: the US may try to contain China, but China can hit back too.

At the Geneva talks, my initial expectation was that tariffs would be cut back to 34%—where they had been on 2 April. In the end, the outcome was even better: not only were they reduced to 34%, but 24 percent[age points] of that were deferred for 90 days. Then, at the Stockholm talks, they extended it for another 90 days.

So if you add it all up, that means Trump’s first-stage tariff of 20%, plus the current 10%, plus the extra so-called fentanyl tariff of 20%. That was the Americans playing us. I suspect they had agreed during negotiations to drop the fentanyl tariff, but in the end they didn’t. That’s when we got serious and really tightened up on rare earths. The Americans quickly realised that wouldn’t work, so they came back to the table. China, for its part, also made concessions—we didn’t impose an additional 20% in retaliation. So in practice, China is at 20% plus 10%, which comes to 30%.

4. The Final Deal

Looking ahead, I think the chances of reaching a deal are very high, because both sides have shown goodwill. True, Stockholm didn’t produce an agreement, but Bessent’s remarks afterwards were very positive. And our country—well, we went a step further. Bessent had already said the 90-day extension would have to be taken back to the President for a final decision. Yet China went ahead and unilaterally announced the 90-day extension as if it were already settled. It was quite interesting—essentially putting pressure on the Americans, a way of saying: we’re not done talking yet.

Right now, the market widely expects the two heads of state to meet at the APEC summit in South Korea on 31 October. If that meeting takes place, it will almost certainly mean the contract has already been signed—or at least drafted—in advance, with the two leaders simply there to witness it. He Lifeng and Bessent will be the ones actually putting pen to paper. In my view, the probability of this happening is extremely high.

So what are the demands on each side? On the American side, the first ask is for China to increase purchases of US farm products and oil and gas. That’s not a problem—China can do that. The second demand is reciprocal opening in services, transport, energy and minerals. But in truth, transport, energy and minerals are just add-ons; the real issue is services, and that’s where TikTok comes in.

Trump has already said: either TikTok sells to an American company, or it shuts down. Now TikTok has declared it won’t sell—it would rather shut down—and that’s clearly because the Chinese government is backing them behind the scenes. So things are stuck. At the same time, the US doesn’t actually want TikTok to disappear—after all, Trump himself has opened an account on it.

So how might this play out? The Americans could well turn around and say: look, our internet is open to Chinese companies, so China should open up to us. Should Google be allowed back in? Should Facebook be allowed back in? Should X be allowed back in? My guess is that this is what they mean by opening up the services sector.

The third demand is to stop importing oil from Russia and Iran. Obviously, that’s something China cannot do. The US raises it mainly as a bargaining chip. And you can see the double standards here. When India imports Russian oil, Trump wants to punish them. Bessent even said outright: India is importing Russian oil just to resell it and make money. At least China uses the oil for itself—so India gets punished, but China doesn’t.

The fourth demand is to lift restrictions on rare earth exports. My guess is that in the end it will come down to a licensing system. You want to import? Fine, we’ll give you a licence—but we’ll be watching you. We’re simply following the American playbook; in fact, we’ve copied plenty from the US. Remember how they carried out surprise inspections [飞行检查], even sending officials into ZTE for permanent oversight [常驻审查]? Well, we can do the same. Companies using [our] rare earths could be subject to our spot checks. But when it comes to military use—we’re sorry, that will absolutely not be allowed. That’s why the US is scrambling to develop its own supply, especially heavy rare earths. They think they can manage it within five years. My bet is that by the time they succeed, we’ll have lifted the restrictions, leaving them with nothing to profit from.

And then there’s the demand to exchange market access for technology. Personally, I take that as a compliment to China. In the past, it was us who had to trade market access for technology. Now it’s the Americans and the Europeans. Isn’t that a good thing? Finally, there’s further cooperation on fentanyl. That one is relatively easy to deliver.

So, what does China want? Scrap the phased tariffs, and lift—or at least ease—the restrictions on chip exports to China; these are the counterpart to China’s own rare earth restrictions. Next, remove the barriers for American firms investing in China’s non-sensitive sectors. Could we get a proper negative list [Note: 负面清单, the management model employed for inbound foreign investment in the PRC]? If it’s a sensitive area, fine—leave it off the table. But for non-sensitive areas, let US companies come in and invest.

Then, lift the restrictions on Chinese investment in the United States. The way CFIUS—the Committee on Foreign Investment in the US—operates is rather odd. If you’re investing in America, especially in a sensitive field, and you feel it’s sensitive, then you’re supposed to self-report. CFIUS is a passive regulator; it doesn’t compel you to undergo review, leaving that to you. Many Chinese companies don’t want to spend the time and money—tens of thousands of dollars in lawyers’ fees and paperwork—to go through that process. But if they don’t, they risk trouble later. So now China can legitimately ask the US to be more transparent: spell it out. Which sectors really require approval? Put them clearly on a list.

In sum, once you lay out both sides’ demands, you can see there’s room for negotiation. That’s why I believe the chances of reaching a compromise are very high. In the end, it will probably mean both sides keeping tariffs at 30%—the original 20% plus the new 10%. And what does China get out of it? China locks in the lowest tariff rate of this round.

In the foreseeable future, China–US relations will be what I call “politically cool but economically warm” [政冷经温]. Politically, there’s no going back—the US has completely shifted, and for them China is now a competitor, even an enemy. But business will carry on. Trade between the two countries will continue, and bilateral investment will pick up again.

In fact, over the past decade or so, no country has invested more in US manufacturing than China. [Note: In terms of new FDI, Chinese investment into the US peaked in 2016 at $27.6-45.6 billion (depending on sources), while Canada, the largest investor that year, invested $58.5 billion; since then, Chinese investments in the US have plummeted, so the claim is best taken rhetorically] I’m sure some of you know companies that have quietly put money into America; going forward, they’ll be doing it openly. And that’s why I’m more optimistic about China–US relations than most.

5. The Emerging Model for Chinese Overseas Investment

A few words about Chinese companies going global [出海]. Everyone’s talking about it—and rightly so. It’s a big deal. On the one hand, international experience shows that every country eventually goes through this stage; on the other, it’s simply China’s turn now. And the model is clear: “China + 1”, meaning not shutting down factories at home but setting up another one abroad. The two can then work seamlessly together.

Take the current US tariffs: they’ve thrown the whole system into chaos. Our direct exports to the US have fallen by 9%. But at the same time, our exports to ASEAN are up 14%, and ASEAN’s exports to the US have jumped by half. That’s extraordinary. What explains it? In large part, Chinese companies. When direct exports to the US were cut off, their overseas factories simply ramped up production—and kept selling to America.

So in reality, America’s dependence on China hasn’t gone down at all. In fact, China’s exports to the US have actually increased. If you calculate by the rule of origin, America’s reliance on China hasn’t fallen—it’s risen. And that, right there, is China’s strength.

The US government has realised this too. Under Biden they toyed with a whack-a-mole approach—spot a Chinese firm popping up somewhere, then whack it with a hammer [拿锤子去敲]. Trump even proposed that whenever a product exported to the US contained any Chinese inputs, he’d slap a 40% tariff on it. But after all the shouting, he never actually put it into practice—because it’s simply impractical. How do you determine how much of a product’s content is Chinese? The moment you pin it down, manufacturers tweak the model, call it a new product, and you have to start the whole process again. The administrative cost would be enormous. I don’t think it can be done.

Why does it feel like China–US relations never really change? Because the fundamentals haven’t changed. America is still focused on finance. China is still focused on manufacturing—and we’re doubling down, pushing harder and harder. With those fundamentals unchanged, the basic economic and trade structure simply isn’t going to shift.

In fact, it’s quite possible the world will end up sidelining the United States altogether—a kind of “world minus one” [世界减一]. When we were in Japan for meetings, it was the Japanese themselves who raised the idea: maybe in the end there won’t be an America in the picture; we’ll just do it ourselves. For example, the EU has already been in talks with Japan about joining the CPTPP, and China has also applied to join. If you add the EU to the current 12 members, plus China, the bloc would account for about 70% of global GDP. And the US would be left out.

And here’s the thing—these US tariffs actually work in China’s favour. Why? When tariffs go up, which companies get knocked out? The ones with higher costs—in other words, many European firms, and those in developing countries that are less efficient.

Chinese companies, by contrast, are extremely efficient and run at much lower cost levels. So in effect, the tariffs clear the field for us. You see what I mean? For Chinese firms going global, this is a good thing. Everyone faces higher tariffs, but that only makes China’s cost advantage stand out all the more. So without even realising it, Trump has ended up doing China a favour.

So, to wrap up, the external environment isn’t nearly as bad as many once imagined. Right after the pandemic, whenever I spoke with entrepreneurs, they were constantly worrying that supply chains would collapse, that China would be forced out of the global value chain. But today, nobody talks about that anymore. The facts speak for themselves—China’s strength is plain for all to see.

On the other hand, I expect China–US relations to improve within the year. At the very least, I can say that during Trump’s four years in office, China–US relations won’t get too bad. And China has grown more and more skilful [娴熟] in international relations. We no longer go for head-on clashes every time. When it’s time to show steel [亮剑], we show steel; when it’s time to be soft [柔软], we’re soft. You hit me; I’ll hit you back—but on something like the fentanyl tariff, we can compromise and let you impose taxes first.

Domestically, we still need to strike the right balance. Structural adjustment is essential, but we cannot neglect short-term growth. As Keynes reminded us, “In the long run we are all dead.” Without growth in the short run, there is no long run. So what should be done? The focus must be on the two elephants in the room: halting the slide in real estate and ensuring that local governments can continue to function. If those two problems are addressed, the economy will be back on the right track.

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