How China’s State-Owned Enterprises Became a Secret Weapon in the US-China Trade War

China’s vast state-owned enterprises, or SOEs, have long been dismissed by investors and analysts as outdated “dinosaurs” — clunky, inefficient entities that drain government resources while delivering lackluster economic returns. But a recent study reveals an unexpected dimension to these giants of China’s command economy: they serve as potent retaliatory tools in response to U.S. tariffs.

In a new NBER working paper, Felipe Saffie, an assistant professor at the University of Virginia’s Darden School of Business, and Felipe Benguria of the University of Kentucky, examine the role of SOEs during the U.S.-China trade war from the first Trump administration. It is the first academic paper to provide evidence of the use of SOEs as tools of trade policy.

What they found is that strong ties between SOEs and the country’s political leadership allowed them to be used strategically to disrupt trade and hurt the U.S. economy. Unlike private companies in a free-market system, China’s SOEs answer solely to the Communist Party and function as instruments of state policy. The largest SOEs include the likes of Sinopec, PetroChina, ICBC and China Mobile.

“Much of the discussion around the trade war focuses on tariffs, but it's important to remember that China is not a fully market-based economy —  its economic system is only partially market-driven, which means the government has tools at its disposal that other countries do not,” says Saffie, who is also a faculty research fellow at the National Bureau of Economic Research (NBER).

One such tool is the ability to issue direct mandates to state-owned enterprises. “These mandates can be quite powerful, potentially having an impact equivalent to 50% of the impact of tariffs,” he adds.

The Measurable Impact of SOEs

Using detailed Chinese customs data, the authors show that SOEs intentionally reduced purchases of U.S. goods — especially agricultural goods and industrial supplies.

While Chinese retaliatory tariffs account for an 8% drop in U.S. exports to China, the SOE effect explains a 4% drop and was concentrated toward the end of 2018 and beginning of 2019, at a point when a vast majority of products had already been targeted by tariffs.

“This tells us that there are other ways of hurting the U.S. during a trade war,” Saffie says. “We have to look beyond tariffs.”

Interestingly, the pullback in Chinese imports by SOEs disproportionately hit Republican-leaning U.S. regions, hinting at a politically strategic use of trade levers.

A New Dimension of Protectionism

The authors write that their findings highlight the use of SOEs “as an additional and so far, overlooked tool of trade policy” and that understanding how SOEs have been used to restrict trade is important to measure the full extent of protectionism, which goes beyond tariffs.

“While all countries can raise tariffs, SOEs are only available to countries with a large involvement of the state in the economy, such as China and other major developing countries,” they say. “This introduces asymmetry across countries in the tools that can be wielded in a trade war.”

Why It Matters Today

While the paper focused on the 2018-2019 U.S.-China trade war, the findings are especially relevant today as the two superpowers are once again engaged in a spat over tariffs.

The U.S. has imposed tariffs on a range of industries and trading partners since Trump came into office in January, raising the tariff rate to levels not seen in a century. While the president has temporarily suspended some of the tariffs to allow for trade negotiations, many are set to take effect in early July unless deals are struck.

On May 12 in Geneva, the U.S. and China agreed to de-escalate their trade dispute and suspend most tariffs on each other’s goods for 90 days. But within weeks of Washington’s trade truce with Beijing, the trans-Pacific tit-for-tat restarted with Washington accusing Beijing of not exporting critical rare-earth minerals, leading to shortages that are threatening to shut down parts of U.S. industry. These minerals are necessary components of high-tech equipment such as vehicles, robots and military equipment.

The Chinese government, meanwhile, has objected to America restricting its sale of advanced chips and its access to student visas for college and graduate students.

Last week, however, Trump and Xi Jinping  agreed to launch a new round of high-level trade talks and try to ease tensions that have been rattling the global economy. It was their first known conversation since his return to the White House in January.

The second round of talks began in London on Monday as top officials from the Trump administration met with their Chinese counterparts to try to resolve their differences over tariffs and supply chains and patch up the fragile truce between the world’s two biggest economies.

Tariffs and Inflation: A Costly Combo

In another worrying sign for trade discussions, the White House recently doubled U.S. tariffs on steel and aluminum imports — from 25 percent to 50 percent — in a bid to boost domestic metal production. President Trump argues the move will help revitalize American steel mills and aluminum smelters.

But this latest round of tariffs is likely to stoke inflation, says Saffie, especially for consumers and businesses that rely on these metals. Higher import costs will raise prices for products containing steel and aluminum, including canned goods, appliances and vehicles, potentially squeezing both industry and households. 

“It’s a very particular inflation, because it doesn’t come from aggregate demand,” explains Saffie. “Rather, it stems from rising production costs, which put upward pressure on prices at the same time that there is downward pressure on production.”

The Fed’s Dilemma

This tug-of-war puts the Federal Reserve “in an impossible pickle” with its dual mandate of stable prices and full employment, Saffie says.

“On the one hand, their mandate is to fight inflation, on the other hand, they must keep the economy operating near full potential. This type of supply shock — when tariffs are placed on raw materials and intermediate goods — forces the Fed to choose between the two,” he adds.

If the Fed chooses to fight inflation, the Federal Open Market Committee would need to sell securities to raise interest rates in order to slow down aggregate demand. Higher rates can tame inflation by making borrowing more expensive for firms and consumers, thereby reducing consumption and investment. However, this also increases the cost of servicing government debt, because the Treasury must pay higher interest on obligations. 

A Fiscal Tightrope

The challenge is compounded by the scale of U.S. debt. The debt-to-GDP ratio now stands at around 120% and the White House’s “One Big Beautiful Bill” is poised to increase it further. According to an analysis from the non-partisan Congressional Budget Office, the legislation would add $2.4 trillion to the national debt over the next decade, a projection the Trump administration hotly contests.

“Given that the labor market is quite robust, the Fed is likely to prioritize inflation control — and that will strain our fiscal budget,” says Saffie. “Not only will interest rates be higher, but the volume of debt that must be serviced will also grow.”

The point, he adds, is that the effects of tariffs don’t just show up on the trade balance or current account — they ripple through the monetary system, the political system and ultimately hit consumers’ pocketbooks.

Uncertainty Rules the Day

The uncertainty over tariffs is having a chilling effect on businesses and consumer confidence, who are choosing to “wait and see” rather than spend. Saffie worries that this will also deter entrepreneurs from starting new businesses which, in turn, will impede innovation.

“Part of the hangover of a prolonged period of uncertainty is a slowdown in productivity growth, which could have a ripple effect on innovation,” he says. “We have been losing dynamism in the U.S. economy for a very long time. This doesn’t help.”

Felipe Saffie is co-author with Felipe Benguria of the NBER working papers, “Beyond Tariffs: How Did China’s State-Owned Enterprises Shape the US-China Trade War? (2025) and “The Impact of the 2018-2019 Trade War on U.S. Local Labor Markets” (2020) and “Escaping the Trade War: Finance and Relational Supply Chains in the Adjustment to Trade Policy Shocks,” published in the Journal of International Economics (2024).