The risk of China spiralling into an unprecedentedly prolonged recession is increasing.
Its economy is experiencing deflation, with the price level falling for a second consecutive year in 2024, according to recent data from the National Bureau of Statistics of China. It’s on track for the longest period of economy-wide price declines since the 1960s.
Coupled with the collapse of the property sector, a looming trade war with the United States and demographic and debt overhang challenges, much of the Chinese public has lost confidence in the economy and its leadership.
The country has the ingredients for a recession, and not a short one. It has spent too much on investment and needs to turn to consumption as a source of demand, but people are unwilling to spend. They have long had high savings rates, and now deflation is further discouraging spending. So do falling property values, ageing of the population and excessive corporate and government debt.
Getting out of such a recession will be hard, because of the challenge of restoring confidence and getting households and businesses to spend more. Since local government debt is high, expanding public expenditure to stoke demand would worsen economic imbalances.
Current deflation is a result of the Chinese government’s long-standing adherence to the China model, which consists of extensive state control and ownership of resources, limited free-market activity, and authoritarian CCP leadership. The model fueled both the country’s economic miracle and its most intractable problem: a structural imbalance between investment and domestic consumption.
To sustain fast growth and cushion economic downturns, China has long relied mainly on investment in infrastructure, property and manufacturing. Household consumption is seriously constrained through unfair policies and a discriminatory social security system. These include strictly limited rights to move for work, weak human rights protections and relatively low benefits for migrant workers.
In the 30 years to 2012, investment gradually rose from 32 percent to 46 percent of GDP, while the share of final consumption declined from 66.6 percent to 51.1 percent. The high rate of investment financed necessary infrastructure upgrades and modernised China’s production technology, helping the country become a global manufacturing powerhouse. However, over time, high rates of investment led to severe overcapacity in key industrial sectors, particularly after the 2008 financial crisis.
Under Xi Jinping’s leadership since 2012, the government has persisted with an export-oriented policy. In 2023, investment accounted for 41.1 percent of nominal GDP (versus a global average of 24 percent), with consumption representing 56 percent (versus a global average of 76 percent). China’s trade surplus in 2024 reached a record US$992 billion. This may displease Donald Trump who may choose to implement trade barriers that could further destabilise the Chinese economy.
Xi has failed to progressively institute a welfare state to create the confidence needed for boosting household consumption. He believes welfarism encourages laziness. So, amid ongoing economic and political uncertainty, families have long prioritised cutting expenses and increasing savings, which has further depressed domestic consumption.
In the second quarter of 2024, the central bank’s income confidence index registered 45.6 percent, down 4.4 percentage points from the first quarter of 2022, when the government imposed strict controls against Covid-19. China’s household savings rate surged to 55 percent in 2024, up 11.2 percentage points from 2023 and the highest level since 1952.
Xi has made it clear that he intends to stay the course, and is doubling down on state economic control. China has shifted away from market liberalisation, reverting to state-led development and industrial policy. The private sector has lost out. The share of private enterprises among China’s largest listed companies declined sharply over three years, from 55 percent in mid-2021 to 33 percent in mid-2024. China’s foreign direct investment dropped 27.1 percent in 2024, following an 8.0 percent decline in 2023.
The rapid ageing of China’s population will make it difficult to boost domestic consumption and rein in ballooning debt over the next decade. The pension system is at risk of running dry by 2035, further exacerbating structural imbalances that policymakers have vowed to address.
With never-ending anti-corruption and ‘strictly governing the Party’ campaigns, Xi has taken China back to a personal dictatorship after decades of institutionalised collective leadership. Under the centralised one-man rule, any efforts by local governments and officials to break the rigid political system risk severe punishment.
More and more laws and regulations have been enacted to surveil the population, driving up social costs. Reformers and advocates of greater freedom of thought and expression have been silenced under Xi’s crackdown on human rights. The political reforms in the Deng Xiaoping, Jiang Zemin and Hu Jintao eras, which unleashed economic dynamism and spurred innovation, have come to a halt or even regressed.
The government’s stimulus measures have failed to boost economic recovery. Since July 2024, the youth unemployment rate has remained above 17 percent.
The economy might not yet be in recession—meaning contraction in GDP—but it is now growing very slowly by its standards of the past four decades. The government estimates GDP was 5.0 percent higher last year than in 2023, but researchers at Rhodium Group estimate growth was in fact only 2.4 to 2.8 percent.
