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The trade conflict between the U.S. and China is escalating. After repeatedly accusing the Chinese government of “economic aggression,” the U.S. government is considering imposing tariffs on as much as $450 billion of goods imported from China. China cannot respond symmetrically—it imports too little from the U.S.—but it could easily devalue its exchange rate or use discriminatory regulations to harm the profitability of American multinationals.

American anger is justified: Chinese policies have systematically distorted the world economy at the expense of U.S. workers. But tariffs are the wrong response. They will penalize regular Americans while doing little to address China’s harmful practices. Those practices have caused at least as much harm to ordinary Chinese as they have to the rest of the world.

China’s economic policies are a product of the Communist Party’s intolerance of alternative centers of power. After the pro-democracy movement met its violent end in 1989, Deng Xiaoping’s program of “reform and opening up” was modified so that party elites could capture as much of China’s new wealth for themselves as possible.

The result is that China is now one of the most unequal societies in the world. Between 1980 and 2010, the share of income officially earned by the top 1% of Chinese households rose by about nine percentage points.

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This likely understates the gains of the elite because it does not count their control of the corporate sector, which benefits from the authoritarian government’s hostility to collective bargaining. In most countries, nonfinancial corporations pay their employees about two-thirds of the value of what they produce. In China, however, workers get only 40%.

Unlike most other countries, taxes and government benefits in China do not transfer spending power from the rich to poor. Disposable household income is only about 45% of China’s gross domestic product. The personal income-tax system collects only about 1% of GDP, while taxes on consumption and forced social security “contributions” take in about 14% of GDP.

The perverse result is that low earners pay effective tax rates around 35%, while higher earners pay rates as little as 10%. Meanwhile, the Chinese government limits health care, pensions, education, and unemployment insurance through the so-called hukou system of household registration. Hundreds of millions of migrants who moved from the countryside for jobs in cities are ineligible to receive government benefits even when they have paid for them, because they are not officially residents of the city where they live.

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The Chinese financial system is also rigged against ordinary households for the benefit of politically connected elites. Most Chinese have few investment alternatives to bank deposits and real estate, while the four big party-controlled banks pay interest rates on deposits far below the cost of capital and pass along the savings to favored corporations in the form of cheap loans. Private businesses have to fight for financing and savers get stuck with inadequate returns, but the “vested interests”—Chinese Premier Li Keqiang’s term—can borrow at preposterously low rates.

Since Chinese households cannot depend on the government to cover health expenses or retirement, the rational response to low interest rates is to save even more than they otherwise would to compensate for the lack of compounding.

This deliberate concentration of wealth has crushed household consumption. The share of China’s national income spent by households on goods and services collapsed from about 52% in the early 1980s to less than 36% by 2010. The flip side of this was the meteoric rise in China’s national savings rate from about 32% to more than 50%. While things have marginally improved in the past few years, household consumption in China is still less than 40% of GDP. The world average is about 60%.

While much of the wealth transferred from Chinese workers is spent on construction projects and other forms of fixed investment, a large chunk is used to buy financial assets abroad, often from the U.S. The Chinese government alone has spent about $4 trillion acquiring foreign assets since 2000. Rich Chinese households and private businesses have spent another $3 trillion on top of that, according to official data, although the true number could be even higher after accounting for surreptitious capital outflows.

China’s repressed consumption and state-sponsored capital outflows have their counterpart in massive trade surpluses. China exports almost $1 trillion more in manufactured goods than it imports, for example, a surplus worth more than 1% of the world’s GDP. China may be the workshop of the world, but the Chinese people cannot afford to buy what they produce. Instead, foreigners buy Chinese goods with money stolen from Chinese households by the Chinese government. Foreign workers are also victims of this arrangement, because their cheap goods come at the price of lost jobs and rising debt.

The trade conflict between the U.S. and China is therefore a consequence of China’s internal class conflict. Tariffs will not fix anything as long as China’s elites remain committed to extracting as much as they can from Chinese workers. The better approach would be to hit those elites where it hurts: Western governments should coordinate to ban Chinese investment in their countries, starting with housing. The U.S. and its allies should also become the champions of Chinese workers, especially rural migrants deprived of basic government benefits.

While Chinese rebalancing is ultimately a choice for the Chinese people, the rest of the world can help by refusing to tolerate the negative spillovers of China’s harmful domestic policies.

Write to Matthew C. Klein at matthew.klein@barrons.com

Follow @M_C_Klein