China’s leadership has correctly diagnosed its most pressing economic ailments. Within the halls of power, the Chinese Communist Party has openly acknowledged that the nation’s growth model relies far too heavily on investment and exports, while persistently weak household consumption represents the single greatest threat to long-term prosperity. Beijing is equally aware that this imbalanced growth model is generating intense trade friction with both advanced industrialized nations and emerging economies alike—a tension that shows no sign of abating.
A growing chorus of economists, including many quiet voices inside China itself, continues to raise the alarm. They warn that if Beijing fails to enact major structural changes soon, the country will face a prolonged period of slowing growth, cascading trade disputes, and potentially stagnating household incomes.
Yet, what continues to puzzle international observers is that the country’s top leaders are simply not taking decisive action. Instead of sweeping overhauls, Beijing has announced only modest plans to boost household consumption and domestic demand. Its overarching economic strategy remains largely unchanged, laser-focused on expanding capital investment in manufacturing, particularly within advanced technologies and new strategic industries.
Numerous theories abound as to why Beijing has chosen to seemingly ignore these stark warnings. Many analysts speculate that Chinese leader Xi Jinping is not receiving accurate information from his subordinates, or that he and his closest allies have deliberately subordinated economic development to national security goals and a desire to command the heights of global industry. Other observers argue that Beijing knows precisely what remedial steps it should take, but that rigid political or institutional constraints prevent officials from executing decisive policy shifts.
In truth, while these varied factors undoubtedly play some part in shaping policy, the real explanation is far simpler. The party is sticking stubbornly to its current path because the leadership genuinely believes that its strategy is working. Officials look at the same troubling economic data—including rising external surpluses, weak consumer demand, slower household income growth, stagnant credit demand, rising unemployment and underemployment, and persistent deflation—but they have reached wildly different conclusions about what these developments signify and how Beijing should respond.
Chinese economic policy is deeply nested within a methodical, long-term planning process designed to ensure that short-term cyclical pressures do not distract from overarching strategic priorities. The fundamental problem, however, is that this long-term strategy is predicated on the unwavering belief that absolute state control over advanced technologies and physical capital will trigger a brand-new cycle of high-speed growth.
This economic strategy can best be understood as a Marxism-infused misapplication of neoclassical economic development theory. Beijing is utterly obsessed with controlling technology and physical capital, operating under the conviction that ultrahigh levels of investment will automatically accelerate productivity gains and wage growth. But a disproportionate, singular focus on manufacturing and technology cannot sustainably increase productivity or wages if those massive investments are fundamentally decoupled from the actual needs of the market and broader trends in aggregate final demand. This reality is especially pronounced in a country as vast as China—already the world’s largest exporter—which can no longer rely on endless export expansion to fuel its economic engine.
Sticking to Their Guns
China’s prevailing worldview treats development as directly equivalent to capital accumulation, viewing productivity as a metric determined by the centralized control and deployment of technology. The party’s doctrine posits that the natural growth of the service sector, higher wages, and higher domestic consumption are merely secondary consequences of that physical underlying foundation. In this view, these desirable outcomes follow naturally in later stages of the development process once heavy productive industries have fully flourished.
Within this conceptual framework of economic development, the correct strategy is always more investment, more industry, and more technology. The primary role of the state is to ensure that household savings and industrial profits are efficiently recycled through the state-owned banking system or government-guided capital pools into priority investments rather than diverted into what Beijing views as frivolous activities, such as services or consumer spending. The resulting structural imbalances—which weaken household income growth, stunt the service sector, and starve public services—were thus never an accident. In China’s economic development theory, this deliberate sacrifice is seen as a form of national self-discipline that will eventually pay off with more rapid, self-reliant long-term development.
A key corollary to this view is that government macroeconomic management must actively guide resource allocation through hands-on intervention, rather than passively managing the economy through traditional levers like interest rates and exchange rates. The state actively harnesses the dynamism and ambition of domestic markets to promote efficiency and innovation within tightly defined boundaries. However, it remains the government’s explicit job to identify the correct focal points for capital investment, ensuring that priority sectors grow at maximum speed while intervening directly to ameliorate structural imbalances when they inevitably arise.
In this unique conception of macroeconomics, the entire national economy is envisioned as a massive input-output table, where every single cell in the matrix represents a sector that consumes the outputs of other cells while providing vital inputs to other producers. If an imbalance emerges in the supply or demand for certain products—which becomes readily evident in fluctuating high or low prices—policymakers view it as a symptom of overinvestment in the producing sector or underinvestment in downstream consuming sectors.
Government policy continuously seeks to increase output and steadily lower prices by facilitating investment and production throughout the matrix, adjusting the pace and allocation of resources as needed if one sector’s output outstrips the demands of the others. The goal is ostensibly not to foster permanent overcapacity or low profitability in these targeted sectors, but policymakers accept that the optimal path for rapid development will inevitably push certain sectors in that direction.
Beijing has followed this playbook with remarkable consistency. When China’s real estate sector collapsed in 2022 and the structural imbalances in the broader economy became too glaring to ignore, Beijing responded by intensifying its efforts to micromanage credit flows. It reversed previous experiments with interest rate liberalization and financial market reforms while tightening regulatory oversight over capital markets and industrial policy funding.
Today, central bank relending facilities routinely channel low-cost bank loans to prioritize industrial upgrading and equipment purchases for heavily targeted sectors. Thousands of government-run equity funds provide subsidized capital to firms supporting an intricate web of industrial and technology strategies. State-owned enterprises frequently intervene to prop up valuations in the domestic stock market, while financial regulators prioritize firms in strategic state-backed sectors for new public listings.
When a specific sector suffers from severe overinvestment, policy campaigns such as "anti-involution"—a neologism describing a basket of discordant administrative policies aimed at resolving overcapacity—are hastily deployed. These campaigns slow future investment, buttress corporate profitability by fixing artificial price floors, or establish stringent standards to restrict market entry. The overarching bid is to slow output in one area while other cells in the national input-output tables gradually catch up and restore macroeconomic balance over time.
While difficult to comprehend within the framework of a traditional market economy, certain aspects of this approach possess an understandable internal logic at the micro level, particularly in the wake of major shocks. The collapse of the property sector, which accounted for roughly a quarter of China’s GDP at its peak, sent massive shock waves through very specific supply and demand pathways across the economy. It made logical sense for Beijing to calibrate targeted policy responses for the affected sectors, utilizing the mental model of input-output tables to design its interventions. Furthermore, the persistent frequency of dangerous bubbles in China’s equity, commodity, and property markets over the past 15 years has left policymakers deeply wary of deploying broad, accommodative monetary policy for the entire economy, helping to explain their ongoing experimentation with highly targeted tools aimed at specific industrial niches.
Likewise, a certain level of institutional triumphalism in Beijing is entirely understandable given that Chinese companies are successfully breaking into pole positions in major conventional industries, such as automobiles and telecommunications, while others are poised to dominate cutting-edge sectors like robotics and biotechnology. For a generation of economic policymakers who cut their teeth trying to revitalize a moribund, centrally planned economy back in the 1990s and the 2000s, the explosive emergence of world-leading firms stands as definitive empirical evidence that Beijing has discovered a winning economic recipe. From this perspective, Beijing easily dismisses foreign complaints about unfair market interventions or trade imbalances as mere sour grapes from wealthy Western countries that have grown unaccustomed to competition and rent-seeking technology monopolies.
China’s leaders also view persistent deflationary pressures not as a crisis, but as the tangible fruits of hard-won efficiency gains. They point to the systematic elimination of economic bottlenecks, massive economies of scale within manufacturing clusters, the construction of world-class infrastructure, improved logistics, and the removal of market barriers that have successfully lowered costs up and down manufacturing supply chains. In their view, these one-off cost reductions must be fully digested by the domestic economy rather than artificially offset by broad macroeconomic stimulus. And while foreign commentators and international dignitaries continue to warn of growing global trade pushback, Beijing notes that the hard data tells a surprisingly resilient story: China’s export growth barely slowed even as the Trump administration imposed sweeping tariff duties and the European Union began erecting defensive trade barriers against targeted sectors like electric vehicles.
Flawed Foundation
The core, inescapable problem with China’s economic strategy, however, is that aggregate domestic demand consistently falls far short of domestic supply. Chinese planners’ intricate input-output tables simply will not balance over the long term unless domestic workers possess the purchasing power to buy the vast quantities of goods that China’s factories produce. If domestic consumers cannot absorb this output, virtually everything else must be exported to global markets, frequently at heavily discounted prices. While the national leadership understands this mathematical reality in principle, they maintain the deep-seated belief that the state-directed control of advanced industries and technology will, ipso facto, cause overall productivity to rise, sustain long-term economic growth, and eventually generate higher wages and higher consumption.
This is the fundamental flaw in Beijing’s approach—the dangerous economic legacy of vestigial Marxism combined with a misapplied version of neoclassical growth theory. In reality, heavy-handed state intervention in markets can severely depress overall productivity, and workers frequently experience flat or declining wages even when the state successfully promotes advanced industries.
It is entirely true that capital and technology create substantial productivity gains in well-functioning market economies. However, that traditional causality usually breaks down entirely if resources are allocated through administrative policy interventions that are completely divorced from genuine returns on investment. The mere state-directed control or ownership of advanced industries does not inherently cause broader economic growth, because those elite sectors typically account for far too small a share of the total economy.
Instead, new products and technologies generate genuine productivity gains only when they are widely distributed and utilized throughout the broader economy in ways that improve overall efficiency or increase output. It is not the mere financial success of a high-tech robotics firm that leads to macroeconomic efficiency gains, for example; rather, it is the practical deployment of those robots in ordinary factories to lower production costs—primarily by displacing human labor—and boost manufacturing output. If those resulting efficiency benefits do not exceed the true economic cost of deploying the new industrial robots, even after factoring in layers of government subsidies, then the net macroeconomic effect is negative, no matter how impressive the automated factories look or how successful the individual robotics firm appears on paper.
The widespread use of new production technologies also requires a degree of creative destruction that Beijing’s own industrial policy interventions have actively inhibited. When governments, rather than price-conscious firms, make foundational technology and investment decisions, policymakers are not merely gambling that they possess superior knowledge to the free market regarding how to boost long-run performance. They are also betting that they know precisely how to utilize those technologies to create innovative new business models. Yet in China, pervasive state influence over resource allocation has ossified domestic markets, particularly by artificially reducing corporate bankruptcies in ways that severely limit the natural fruits of innovation and efficiency gains across the wider economy. Additionally, much of China’s industrial policy is explicitly aimed at achieving national self-reliance—a goal that, by definition, focuses heavily on duplicative investments designed to buttress domestic industrial prowess without necessarily adding economic efficiency.
Moreover, even though China’s many layers of industrial policy have successfully launched world-class companies and built an impressive fleet of ultramodern factories, the strategy has also generated tremendous inefficiencies and financial waste that rarely make front-page headlines. Total national productivity must be calculated comprehensively, evaluating net output gains against the staggering weight of industrial subsidies, bad corporate debts, foregone profits, and indirect financial support provided by the state.
The empirical reality is that China’s aggregate success rate is far lower than its shining corporate stars might suggest. The remarkable global reach of electric vehicle and battery makers such as BYD, CATL, and Li Auto effectively masks dozens of failed domestic companies that generated massive nonperforming loans and consumed unprofitable capital subsidies throughout the broader supply chain. It remains far from obvious that the net return on investment from industrial policy spending—estimated by the International Monetary Fund to be as high as four percent of GDP—is positive. In fact, when measured comprehensively, it could be deeply negative, despite isolated pockets of glittering commercial success.
Finally, Beijing is betting heavily that superefficient manufacturing and success in strategic industries will eventually trickle down to higher household wages, which will then cause domestic consumption to surge. While it is true that productivity growth causes real incomes to rise in a competitive market economy, the equation changes drastically when investments in labor-saving technologies are driven primarily by state policy mandates rather than traditional returns on investment. Under those conditions, wages can easily fall even as individual firms become technically more efficient.
Achieving rising household income requires a vital intermediate economic step: robust employment. Unfortunately, employment is not a core characteristic of China’s capital-intensive, advanced manufacturing investment strategy. Indeed, heavy state funding has helped propel China—still fundamentally a middle-income developing economy—to become a global leader in high-tech "dark factories" that operate entirely without the need for human accommodations such as interior lighting. While this undoubtedly increases physical output in prized manufacturing cells within the national input-output tables, if aggregate demand for human labor is not growing alongside output, the entire socioeconomic equation begins to collapse.
A China Dream Deferred
Still, the most pernicious and immediate consequence of Beijing’s entrenched economic model is persistent, systemic deflation. The unrelenting focus on expanding industrial production, combined with chronically weak domestic consumer demand, has caused China’s producer price index to fall for longer stretches than it has risen over the past decade. This dynamic represents a far larger threat to China’s economic stability than a mere nuisance of sectoral imbalances.
Deflation actively suppresses private-sector credit demand, undercuts private incentives for new capital investments, and severely damages employment prospects and wage expectations. This, in turn, crushes consumer confidence, leading to even weaker domestic demand that reverberates not just through carefully demarcated input-output relationships, but across the entire economy.
Deflation also relentlessly saps government fiscal revenues and places acute financial pressure on banking institutions, severely limiting the state’s capacity to act decisively the longer the trend persists. These deflationary pressures do not stay contained within China’s borders; they routinely spill over into the global economy through artificially cheap exports and a weakening real exchange rate, driving mounting trade tensions between Beijing and its major international trading partners.
While falling behind the curve in the fight against deflation carries immense macroeconomic risks, Beijing is unlikely to change course as long as it remains convinced that its current strategy will ultimately boost productivity and jumpstart domestic demand over the long run. Some external analysts continue to speculate that Beijing could eventually be forced into a major reappraisal of its vision in response to mounting domestic unemployment pressures or the proliferation of foreign trade pushback. However, the leadership has already shown its policy cards.
The accumulation of rising unemployment, underemployment, and suppressed wages for Chinese households and workers has already reached significant levels, yet Beijing has responded with only modest new household subsidies and incremental investments in social services. Likewise, as external trade tensions have escalated globally, Beijing has chosen to manage these disputes primarily as diplomatic issues, utilizing a calculated mix of threats and bilateral negotiations to preserve the bulk of China’s lucrative export markets.
This deliberate decision to pursue short-term Band-Aid measures to address a weak domestic labor market and mounting foreign trade tensions can seem confusing at first glance. For a government that is laser-focused on national self-reliance and eliminating foreign dependencies, it is a curious and contradictory strategy to become increasingly dependent on foreign demand—over which Beijing ultimately has little control—as the primary external driver of its economic growth. Likewise, for an authoritarian regime that is pathologically obsessed with maintaining social stability, it would seem prudent to place far greater policy emphasis on wages and domestic labor demand.
Yet this strategy makes a degree of internal logic when viewed through the leadership’s unwavering perspective that China is currently navigating a difficult historical transition. The process may be socially unpleasant and economically painful, but Beijing views it as an unavoidable, necessary step on the path toward a fully realized, technology-led growth model.
The leadership’s current institutional confidence in this difficult transition process implies that it could be many years before these visible warning signs become internally persuasive. This dynamic all but guarantees that Beijing will continue to defer decisive structural action while deflationary pressures and external trade tensions steadily compound.
Already, deflation and weak corporate profitability are actively eroding China’s fiscal revenues, which have remained essentially flat in nominal terms since 2019. At the same time, falling prices and a growing structural debt burden are steadily corroding the financial system. Eventually, this will require massive debt write-offs and substantial recapitalization from the central government budget just to prevent overall credit growth from slowing further. A $54 billion bank recapitalization took place just two months ago, yet it produced little to no noticeable effect on underlying lending activity.
Beijing’s unyielding ideological commitment to its industry- and technology-focused development strategy is actively creating a dangerous cycle that will likely produce structurally weaker consumption, slower income growth, and even greater trade friction with the rest of the world. Moreover, in the face of these compounding challenges, China’s economic leadership continues to compensate by expanding state intervention in the economy in ways that further undermine market forces and the long-term independence of the private sector. At this rate, even if the leadership eventually recognizes the urgent need to change course, China may no longer possess the fiscal or financial space required to successfully rebalance its economy toward a more sustainable and diversified growth model.
