In a wide-ranging interview with the South China Morning Post, U.S. Economist Nicholas Lardy, Non-resident Senior Fellow at the Peterson Institute for International Economics, discussed China's economy and U.S.-China relations. Professor Lardy has studied the Chinese economy extensively and has written several books on its growth and development since the late 1970s. Lardy does not believe that the U.S.' “Made in America” program will be able to restore manufacturing jobs and win back market share from China. Manufacturing jobs in the U.S. as a share of total employment have been shrinking for about 70 or 80 years. The manufacturing share of output has not gone down as much, because productivity per worker has gone up. “But the idea that we’re going to restore manufacturing jobs to any significant degree, I think, is very unlikely.” Manufacturing jobs in 2025 are shrinking, partly because of tariffs. President Trump had this idea that if you put on big tariffs manufacturing would return to the United States. Maybe some companies will start producing in the U.S. to avoid tariffs, but there are a lot of manufacturing companies in the United States that use imported inputs like steel and other things, and as the cost of those goes up, these firms become less productive. They lose market share, and eventually they start laying off workers. Tariffs are not going to be a mechanism for bringing back a significant number of manufacturing jobs.
Is China going to fall into a “middle-income trap”, or continue to grow fast and overtake the U.S. to become the world’s No 1 economy? Two or three years ago, some people were talking about “peak China”, the idea that China was no longer catching up with the United States. I think that was a mistaken view. To make these comparisons, you have to start out with nominal gross domestic product and then convert it into dollars. China was going through a period of slow inflation, sometimes deflation, for a number of years, which still continues. And the United States had high inflation. So in nominal terms, U.S. GDP was growing rapidly, and Chinese GDP was growing slowly. It looked like they were separating, that China was never going to catch up. But if you took into account the fact that price trends in the two countries diverged, the idea of China reaching its peak relative to the U.S. didn’t make any sense because of the inflation. Remember in 2021 and 2022 we had high inflation. Nobody thought that high inflation was going to persist. The Federal Reserve was raising interest rates to slow down inflation, and inflation has come down quite a bit. I think China will continue to grow more rapidly than the U.S. The potential growth of the US is something in the neighborhood of 1.5% to 2% – the precise number doesn’t really matter. China’s potential growth is probably something in the range of 4.5% to 5%. Five years from now, it would be a little bit less. China is still growing, for the next three to five years, at least twice as fast as the United States. So I am of the view that convergence – that is, China approaching the U.S.’ level of total output – is continuing.
China will not be subject to the middle-income trap. According to the World Bank’s categories, China is already an upper-middle-income country. If its growth continues for a few more years, it will be reclassified as an upper-income country, and it will then be one of the handful of countries that have moved from very poor to upper income. There are only a handful of countries that have made this transition, and I think China has a good chance of joining that select group.
What are the biggest challenges for the Chinese economy? The first is productivity. Productivity growth, as measured by total factor productivity, has weakened over the last 10 years, and it’s the obvious corollary of the slowing growth combined with a fairly rapid growth of assets. For China to continue to grow at a reasonable rate, it needs to do better on total factor productivity, particularly given the aging of the population, which has now been under way for a few years and will accelerate over the next decade. So if the working-age population is shrinking, as it has been, the only way to get stronger growth is to make more productive use of the physical assets and labor. That’s the biggest underlying challenge. And I think implicitly that’s been recognized by China’s leadership. They don’t talk about total factor productivity like an economist would, but it’s in the language, and it’s in the thinking that they need to have a more productive manufacturing sector.
The second challenge is to deal with the rapid aging of the population. China has frequently been accused of having a very weak social safety net, but I’ve been looking at social insurance expenditures for pensions, healthcare, workers’ compensation and so forth. Their share of GDP over the last 15 years has more than doubled, from about 3.6% of GDP to about 7.7%. That will have to continue, because there are going to be more people retiring. As the share of the older population increases, it’s going to be challenging to have an adequate pension system.
China used to depend on exports a lot, what if tensions escalate? It’s easy to exaggerate the extent to which China depends on exports. In the past, China was growing quite rapidly. Its exports were growing, but its imports were also growing; net exports did not grow enough to add to economic growth. That situation changed dramatically in 2024, when the contribution of net exports became huge, and is continuing in 2025 when China has an all-time trade surplus. They were important then, but they were not a driver. In the last two years, they have become a driver. In that respect, China’s growth has become unbalanced. It’s too dependent on the expansion of exports, and the rest of the world is beginning to take some steps. What China has to do is get back to the situation that prevailed in earlier years, where China was growing fairly rapidly, but it was not dependent on exports. One way of doing that is to increase consumption demand, have more domestic sources of demand, rather than relying on exports. The Chinese call this current situation “involution”. China has more than 100 companies that are making EVs. Most of them are losing money. The more efficient firms should take a leading role, like BYD and a few others. There needs to be a consolidation.
Where is China's economy headed? I’m optimistic about the future of the Chinese economy if they continue on the path of reform. A big part of that is more reform in the financial sector, which I don’t think is getting the attention it deserves. All this talk about involution, nobody mentions the role of the financial sector in creating excess capacity. The problem is what I indicated earlier, too much supply coming from companies that do not cover their costs. As long as that situation continues, then you will have a structural problem, including deflation. That’s the cause of deflation in China, companies selling goods where they can’t cover their costs trying to get market share. Everyone wants to get more market share. As they become more dominant producers, they’ll be able to raise their prices and make money. But if everybody’s doing that, it doesn’t work out. I think that’s a big challenge, to have a more efficient allocation of capital.
