China’s economic model will continue to alarm its trading partners

Beijing’s prioritization of manufacturing over domestic consumption has sustained its large trade surpluses and threatens to entrench deflation. To cement its position as a global leader, it should change course.

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Published 29 October 2025 — 4 minute READ

Image — Workers at an automobile gear manufacturing enterprise in Qingzhou, Shandong Province of China, on 15 October 2025. Photo by VCG/VCG via Getty Images.

David Lubin

Michael Klein Senior Research Fellow, Global Economy and Finance Programme

China’s economic performance has been looking grim in recent months. The growth rates of retail sales and investment spending have been falling; property prices continue to decline; and credit demand is subdued. Against a background of very weak household confidence, China’s inflation rate has been below zero in each of the past eight months, something the economy hasn’t seen since the immediate aftermath of the 2008 global financial crisis. 

Last week’s Fourth Plenum of the Communist Party’s 20th Central Committee could have been an opportunity to arrest this decline, as it set the framework for the authorities’ 15th Five-Year Plan to be laid out next March. 

Yet the plenum communiqué suggests a business-as-usual attitude to the economy, promising two objectives overall, neither of them new. The first is the pursuit of manufacturing self-reliance and industrial independence, achieved through technological innovation. The second is a long-standing promise to boost domestic consumption. 

Of these two objectives, the one that is by far the more cherished of the authorities is to enhance China’s status as a manufacturing superpower. Beijing’s commitment to ‘rebalance’ the economy towards the consumer is a theme that has been a feature of Chinese policymaking for two decades now. But in reality, it has had little impact: in 2024, consumption still accounted for the same 56 per cent of GDP (low by global standards) that it did in 2004.  

Pessimistic outlook

As we head towards formal adoption of the next Five-Year Plan early next year, it is difficult to be optimistic about near-term prospects for the economy, thanks to a few factors.

First, fiscal support was front-loaded during the early part of 2025, leaving the economy more vulnerable now as government stimulus fades. One highly visible element of the authorities’ fiscal support in the past year has been the ‘trade-in programmes’ that subsidise households’ purchases of new appliances, electronic goods and the like. Since these subsidies – which in any case merely borrow consumption from the future – are running low, China’s retail sales growth rate is now weaker than in the US. 

In any case, the efficiency of government support for the economy – the impact that government spending has on GDP, known as the ‘fiscal multiplier’ – seems to be falling fast. Although this year’s budget deficit is set to reach 9 per cent of GDP – 3 percentage points higher than it was in 2024 – GDP growth will almost certainly end up lower than last year’s 5 per cent.

The imbalance of too much supply and too little demand seems most likely to remain.

Economic activity is being subdued by other forces too. One is a form of self-induced stagflation known as the ‘anti-involution’ campaign, aimed at restricting the output of goods, like EVs, solar panels and cement, that are in obvious over-supply. Another is the latest iteration of President Xi Jinping’s anti-corruption campaigns, which has generated a reluctance to spend throughout the public sector by creating a climate of fear around expenditure. Meanwhile, Chinese export growth is showing signs of decline, and that will also put downward pressure on GDP growth in the final part of 2025. 

It’s not that nothing is being done to support the economy. The People’s Bank of China, for example, recently announced a facility that will channel RMB 500 billion (around  $70.4 billion, or 0.3 per cent of China’s GDP) of new lending to government-approved projects. Meanwhile, the authorities have announced other new spending schemes: for example, offering child benefits to families with children under the age of three. Another government initiative provides new subsidies for interest payments on loans taken out by companies and by individuals. 

Yet these initiatives, however well-intentioned, seem unlikely to confront the basic challenge in the Chinese economy, which can be summarised as too little demand and too much supply. That combination not only drives declining prices in China, but is also what sustains its very large trade surpluses. 

And if the authorities do indeed end up prioritizing manufacturing over the consumer in the Five-Year Plan, the imbalance between supply and demand will remain entrenched.

Structural imbalances

One basic reason why it is so difficult to be optimistic about the Chinese economy is that this imbalance is sewn into the entire structure of the relationship between central and local governments. 

The problem on the demand side arises from the fact that most government services – education, healthcare, pensions – are provided by provincial governments that have few revenue sources. Provincial governments’ ‘fiscal gap’ – the difference between their spending and locally generated revenues – is close to 12 per cent of provincial GDP, rising more or less continuously over the past two decades. This locks them into dependence on the central government for transfers, but the central government is also revenue-constrained and remains unwilling to boost provincial hand-outs meaningfully.

China would be well-advised to become more a source of demand in the world economy, and less a source of supply.

The problem on the supply side is that each local governor wants to support their own tech sectors, their own factories and their own investments. This inter-provincial competition needlessly boosts output, to the point that Xi Jinping offered a blunt complaint during the summer: ‘When it comes to launching new projects, it’s always the same few things: artificial intelligence, computing power, new-energy vehicles…Should every province in the country be developing industries in these areas?’

Frustrations like this underpin Beijing’s efforts to establish a ‘unified national market’. Yet progress is likely to be slow at best, since a full re-ordering of the relationship between central and local governments implies a scale of reform that would be fraught with risk, both logistical and political. Don’t hold your breath.

Impact on the world economy

So, the imbalance of too much supply and too little demand seems most likely to remain. China’s capture of global market share will therefore remain a prominent feature of the world economy. That’s the inescapable result of a situation where Chinese exports are still growing by around 10 per cent in volume terms, while world import growth is closer to 5 per cent. 

This overabundance of Chinese manufactured goods has not just alarmed the US and the EU; developing countries are also irritated by the way in which Chinese industrial policy supports an oversupply of cheap goods that threatens to render their own manufacturing sectors uncompetitive.

The danger for China is that its pursuit of economic security by dominating global manufacturing will end up creating so much displeasure among its trading partners that Beijing will lose friends as fast as it gains market share. In order really to shore up its leadership position in global affairs, China would be well-advised to become more a source of demand in the world economy, and less a source of supply.