China’s New Year public holiday, which starts this week, is a joyous time for businesses, but it doesn’t really tell us much about either the structural drags in much of the economy, or China’s impressive industrial sector. The government will have much to say on these things next month when the 15th Five Year Plan will be revealed.
The drags and the dynamism are closely linked. Massive resource mobilisation and industrial policy on steroids also strain government budgets, distort labour and product markets, repress consumption and sustain domestic imbalances that lie behind China’s huge and contentious trade surplus.
China’s economy is in effect a $20 trillion paradox. Five years into a damaging real estate crisis, which is by no means over, it features over-production, deflation, weak consumption, stagnant productivity and a fiscal crunch for local and provincial governments.
Last year’s officially measured 5 per cent GDP growth is about 1-2 percentage points over the upper limit of sustainable growth, and the economy requires persistent debt stimulus to sustain high target growth rates. New initiatives are expected in 2026.
Regardless, the economy boasts, to global acclaim, futuristic industry and manufacturing; leadership if not dominance in key sectors, including electric vehicles, batteries, AI, solar and wind, and pharmaceuticals; successful global brands; and, for the moment at least, chokeholds in key areas, notably rare earths processing.
Even within the modern sector there are complex paradoxes, for example unprecedented industrial policy support, costing 5-8 per cent of GDP annually, alongside vicious competition, inefficiency, loss-making and waste. The government has termed this “involution competition” for its damaging, rather than generative outcomes, but fixing it is tough when it is also an agent and consumer of that overproduction.
Domestic demand weakness and a gaping savings-investment imbalance mean China has had to rely on exports to limit already elevated unemployment. The trade surplus last year was a record $1.2 trillion or 6 per cent of GDP. Net exports generated at least a third of GDP growth last year. This is exceptional but not in a good way. A 40 per cent rise in export volume since 2019 accompanied by barely changed imports have revealed mercantilist behaviour that has stirred a new “China shock” focused on the global consequences of state-directed policies aimed at industrial dominance.
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Dozens of nations, including especially the developed countries of the OECD but also middle-income countries, fearful for their own industrialisation and jobs, have started to push back against China, erecting trade defences such as tariffs, anti-dumping measures and other import restraints.
China’s economic, industrial and other policies are a usual focus of attention at the annual National People’s Congress in March, and this time the government will announce details of its latest five-year plan, covering 2026-2030. The main thrust of the plan, discussed last October by the Chinese Communist Party’s central committee, endorses the goals of industrial strength, increased national security and self-reliance against a troubled geopolitical backdrop. The government is expected to refer prominently to increasing consumption, as well as to an array of other social and economic domestic initiatives, but changes are likely to be slow and restrained.
What the plan won’t do is address China’s imbalances, the need to change its development model, the paradox of its economic drags and industrial dynamism, or rising discontent among its trade partners. China’s modern manufacturing won’t be held back by real estate and other structural problems, but equally, China’s islands of technological excellence, accounting for 8-10 per cent of GDP, won’t resolve the problems in the other 90 per cent, and will exacerbate them with the rest of the world.
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Breaking this impasse would require political reforms that are simply not on the agenda, especially more robust fiscal and financial systems that allocate capital well, end soft budget constraints, incentivise entrepreneurship, and allow losses to be distributed under the impartial application of the law.
George Magnus is a research associate at Oxford university’s China Centre and at SOAS, and a former chief economist at UBS