Will the Dragon Fall Behind?
- Francesco Contestabile
- 2 days ago
- 27 min read
Updated: 1 day ago
How a plateau in growth complicates China's great-power ambitions
Since 1978, the Chinese economy has maintained an impressive near-double-digit growth rate, averaging 9.5% annually until 2019. After surpassing the United States in PPP terms in 2014, many analysts expected the same to occur in nominal terms by 2030. However, this prospect now seems increasingly unlikely. At current market exchange rates, China's economy has decreased from 75% of U.S. GDP in 2021 to roughly 64% today, a change attributed to a stronger dollar, a rapid post-pandemic recovery in the U.S., and a slowdown in China. Regardless of the exchange rate measure, one fact is becoming increasingly evident: China’s chances of returning to sustained double-digit growth are nearly nonexistent. Excluding the impact of the COVID-19 pandemic, growth has only increased year-on-year on one occasion since 2010. Since 2020, growth has averaged below 5%, nearly half of the average recorded from 1978 to 2019. This is the new trend that the Chinese Communist Party (CCP) and the world must confront.
This transition has significant implications for the global economy. Multinational corporations heavily invested in China are dealing with increased local competition and a more cautious consumer base. In 2024, Apple lost its position as the leading smartphone brand to domestic competitors, while Volkswagen experienced a decline of approximately 10% in its China sales due to a price war in the electric vehicle market, which also affected Tesla. Following two decades of a "China Supercycle," commodity exporters are now facing lower prices compared to the peaks seen after the pandemic. Moreover, trade bargaining power is shifting towards neighboring countries like Vietnam and India as companies diversify their supply chains through strategies such as "friend-shoring" and "China+1."
Crucially, the security ramifications of this situation include a decline in the popularity of the CCP. Most Chinese citizens do not support the government based on ideological beliefs but rather on economic grounds. Should economic growth stagnate, there exists a tangible risk of a resurgence in domestic unrest, not unlike the 1989 student protest movement. Conversely, Xi Jinping has demonstrated his desire to be remembered as one of China's great leaders, with one of his aspirations being the completion of Mao's vision of unifying China with Taiwan. Given the deteriorating economic outlook and the United States redirecting its attention towards the Pacific, it is plausible that Xi perceives a closing window of opportunity.
The Chinese Miracle and Its Consequences
China's economic transformation commenced with the Third Plenary Session of 1978, following the death of Mao Zedong, when Deng Xiaoping criticized the "two whatevers" (两个凡是) mentality and adopted the principle of "seeking truth from facts" (实事求是). Under Deng's leadership, the CCP redirected emphasis from Marxist-Leninist ideology to economic reforms. The first reforms were implemented in rural regions through the establishment of the Household Responsibility System, which provided farmers with increased autonomy, along with the rise of Township and Village Enterprises (TVEs), which sparked the development of small local businesses. Subsequently, Beijing introduced Special Economic Zones (SEZs) along the southeast coast to experiment with market dynamics, attract foreign direct investment (FDI), and promote export-driven manufacturing, following the strategy of "crossing the river by feeling the stones" (摸着石头过河) on a national scale. Throughout the 1980s and 1990s, the dual-track pricing system was liberalized, capital markets were reopened through the establishment of the Shanghai and Shenzhen stock exchanges in 1990, the 1994 tax-sharing reform was enacted to recentralize tax revenues, and in the late 1990s, State-Owned Enterprises (SOEs) were restructured, corporatized and then publicly listed.
One of Deng’s most controversial policies was the one-child policy, introduced in 1980 to limit most families to a single child and formally ended in 2016. It used administrative quotas and penalties to suppress births, and over time it produced profound demographic effects, with official estimates indicating ~336 million abortions were performed from 1971–2013, contributing to a sharply narrowed base in China’s population pyramid. This policy reduced the dependency ratio by an estimated 10.6%, allowing families to invest more resources into their only child (customarily a son) and boosting the size and quality of the labor force, which contributed to the subsequent economic boom. This policy has a tragic legacy however, as the country’s working-age population peaked around 2011 at 925 million people and has been declining, down to 876 million (ages 16–59) by end-2022, eroding the labor supply that powered earlier growth. Now that the policy has been abolished, Chinese families are accustomed to having only one child, meaning that the fertility rate has not recovered. China’s population declined in 2022 and 2023, and looking ahead, the 65+ share is projected to exceed 30% by 2050, implying a heavier old-age burden, a smaller pool of workers, and sustained pressure on growth unless offset by faster productivity gains.
Following China's accession to the WTO in 2001, exports experienced a significant increase, transforming the nation into the world's manufacturing hub. This led to higher wages along the coast and attracted workers from the interior provinces, culminating in over 286 million rural migrants by 2020. For instance, Shenzhen, once a relatively small fishing village in 1980, saw its population soar to over 17 million by the 2020 census (though unofficial estimates put it at above 20 million). The housing reform of 1998 abolished employer-assigned housing and established a commercial real estate market. The combination of rising incomes, extensive migration, and a robust culture of home ownership sparked a property boom, with real estate and related sectors reaching a peak of around 29% of GDP in 2021. Local governments capitalized on land use through substantial land-lease sales and, later, Local Government Financing Vehicles (LGFVs), making real estate a cornerstone of public finance. When the Global Financial Crisis in 2009 posed a threat to China's growth, a stimulus package of 4 trillion yuan ($585 billion) for infrastructure projects sustained economic expansion but also intensified the economy’s dependency on fixed-asset investment. Concurrently, the central government prioritized technological advancement, as demonstrated by the Made in China 2025 initiative which aimed to progress toward technological independence and develop Chinese companies at the bleeding edge of innovation. Through a blend of joint venture regulations, significant investments in scientific research, and technological espionage, China has managed to close the gap with the West in various technological domains and, in some instances, take the lead, particularly in battery technology, solar panel manufacturing, nuclear energy, and mobile connectivity. With negative export forecasts and pressures on the property sector, this investment-driven model is beginning to reveal its limitations.
China's ascent represents one of the most significant economic transformations in modern history. When reforms started in 1978, China's economic output was approximately $150 billion, with a per-capita GDP of $156, which was lower than that of most African countries. Currently, the economy stands at around $18.7 trillion, with a per-capita GDP of $13,300, contributing to one-fifth of global economic output. Its portion of world merchandise exports surged from 1% in 1973 to 14.8% in 2022, and it possesses the largest foreign-exchange reserves globally, exceeding $3 trillion. Since 1980, more than 800 million Chinese have escaped extreme poverty, even though many still lack decent living conditions. Military expenditure ranks as the second-highest worldwide, making it East Asia’s pre-eminent military power. China leads the world in manufacturing output and goods exports, electric-vehicle production and battery capacity, solar panel manufacturing, shipbuilding, steel and cement output, high-speed-rail network length, container port throughput, rare-earths processing, 5G deployment, commercial drone production, mobile payments and e-commerce adoption and much more. Due to its vast scale, financial resources, and pivotal role in supply chains, China can exert immense influence through economic interdependence and position itself as an alternative to the US-led order. The ongoing tariff disputes with Washington highlight that U.S. economic supremacy is no longer one-sided and China's ability to leverage trade, supply chains and technological independence marks an end to the Plaza Accord era of world politics.
The Chinese Model
China's growth model after the 1990s increasingly relied on the real estate sector. The liberalization of markets contributed to a rapidly growing and highly leveraged construction industry, while local governments became dependent on revenues from land sales and households accumulated a significant portion of their wealth in real estate. Developers leveraged by using pre-sales requiring 20% down payments and selling most units before construction even started. The cycle reached its peak in 2021 when Beijing recognized the issue too late and implemented the "three red lines", significantly restricting funding for firms with high leverage. This led to a downturn where new-build sales plummeted to about half of their peak, and new-home prices experienced consecutive annual declines. Land-sale revenue, which previously accounted for around 38% of local fiscal income, decreased from ¥8-9 trillion (≈$1.2 trillion) to ¥4.87 trillion (≈$690 billion), constricting local budgets. This shock led to tighter credit conditions, diminished construction activity, reduced upstream demand, and a negative wealth effect (with an estimated $18 trillion of household wealth lost). Major corporations such as Evergrande Group and Country Garden failed to meet their financial obligations, with total offshore developer defaults approaching $150 billion, with minimal recoveries. In response, Beijing has implemented measures such as mortgage easing, project "white-list" lending, and a multi-trillion-yuan local-debt refinancing initiative. However, a long-term adjustment will require several years.
Another challenge is the quality of construction and its durability. "Tofu-dreg projects" (poorly constructed works) are widespread, and both officials and academics have repeatedly raised concerns regarding the short lifespan of assets. Former vice-minister of the Ministry of Housing and Urban-Rural Development, Qiu Baoxing, indicated that the average lifespan of buildings is between 25 to 30 years (with peer-reviewed studies generally agreeing), which is significantly below the established design standards. These shorter life spans lead to increased life-cycle costs, require earlier replacements, and divert capital from more productive uses. The recent partial failure of the newly constructed 758-meter Hongqi Bridge in Sichuan serves as a reminder that in the hunt for rapid growth, the quality of construction and environmental considerations have been relegated to a secondary priority. Given that the construction boom started a couple of decades ago, it is anticipated that the repercussions on buildings will become evident in the near future.
Beyond housing, China's growth model, characterized by substantial investment, significant export surpluses, and state-driven infrastructure, is appearing increasingly inefficient. In 2023, gross capital formation (investment in fixed assets like housing, factories, machinery, and infrastructure) accounted for about 41% of GDP, highlighting China’s reliance on construction and state-led investment. Korea and Japan, which also developed through an investment-driven growth model, similarly invested heavily during their peak periods (Japan reached 39% in 1973, Korea 40% in 1991), but since then, both countries have shifted towards consumption and services. Furthermore, returns on investment are declining. The Incremental Capital Output Ratio (ICOR), the extra investment needed to produce one extra unit of output, rose from 3.5 in 2007 to 5.9 in 2015, meaning each point of growth required far more capital. IMF estimates likewise show a falling marginal product of capital through the 2010s, pointing to diminishing returns and misallocation. At the same time, exports are unable to compensate for a shortfall in domestic consumption, as record goods-trade surpluses (approximately $1 trillion in 2024) are exacerbating trade tensions with numerous trading partners. Foreign investment is also facing challenges. For thirty years, FDI has significantly contributed to China's economic expansion by providing much-needed external financing. Currently, China's balance-of-payments statistics show a net direct investment of -$168.4 billion in 2024, marking the highest outflow ever recorded, following the first negative dip in Q3 2023. The Chinese government is attempting to mitigate this outflow by introducing a 10% tax credit for profit reinvestment; however, this is likely insufficient. With direct investment liabilities in 2024 totaling about $18.6 billion, the lowest in three decades, FDI is unlikely to be a potential growth catalyst.
Following a period of turbulence due to the pandemic, China's growth reached 5% in 2024. This figure, while exceptional by contemporary Western standards, is insufficient to designate the 21st century as the "Chinese century." In contrast, neighboring countries such as India, with 7% growth in 2024 and Vietnam, which reported 7.1%, are emerging as potential economic competitors. The United States, with a growth rate of 2.8%, may not be experiencing rapid expansion, but this rate is sufficient to maintain a nominal economic gap for over a decade. Notably, as the developed world is attempting to manage inflation and achieve a soft landing, China's Consumer Price Index (CPI) has shown a year-on-year decline of 0.3% in September 2025, with the Producer Price Index (PPI) reflecting an even steeper decrease, while core inflation is at its highest point in over a year. This suggests that while the service sector is healthy, industrial overcapacity is weighing on energy and food prices. Despite a significant consolidated fiscal deficit estimated at 8.8% of GDP and a surge in exports from the "new-three" sectors (electric vehicles, batteries, and solar energy), domestic demand continues to be weak, especially for manufactured goods, as consumers remain cautious after the property crisis.
Turning Towards The Future
Rebalancing the Chinese economy requires an increase in household consumption, which currently constitutes approximately 40% of GDP. The IMF and World Bank advocate for enhanced social transfers and health coverage to reduce precautionary savings, a reform of the hukou system to enable migrants to access urban services, and a reduction in industry-targeted subsidies to allocate resources towards services. Additionally, China's service sector currently represents just over half of the GDP, significantly lower than the 70% seen in developed economies, indicating potential for expansion. By deregulating protected sectors such as healthcare, education, finance, telecommunications, logistics, and professional services, productivity and wages in urban employment hubs could be enhanced, youth unemployment lowered, and the domestic market could be expanded. Specifically, this could involve substituting administrative approvals with simple licensing, reducing the 'negative list' for private providers (the list of industries where the private sector is barred from operating), limiting state-owned enterprise monopolies through competition policy, and allowing private service firms access to public procurement. Politically, implementing reforms promoting consumption poses significant challenges. Xi Jinping’s agenda emphasizes the development of "new productive forces" in advanced manufacturing and the enhancement of national security, while placing considerably less emphasis on welfare spending. A transition towards consumption would also undermine the power of Party-affiliated groups: export-driven state enterprises and their supply chains, local governments dependent on land sales and investments, as well as private "national champions" that have integrated Party committees. Additionally, redirecting fiscal resources towards households and services would conflict with Xi’s declared objectives of achieving technological self-sufficiency and establishing a world-class military.
Judging whether such a reallocation is proving effective requires reliable data. Yet China’s official statistics lack transparency and credibility, which is why analysts have frequently cross-verified GDP figures with the Li Keqiang Index for many years. This proxy for GDP gained popularity following a leaked cable from 2007 in which Li referred to numerous local statistics as "unreliable." Instances such as those in Liaoning from 2011 to 2014 and Tianjin in 2016 have demonstrated that local governments have manipulated economic data for political motives. Furthermore, independent research utilizing night-lights and other objective indicators shows that China's actual growth is more erratic than the consistently smooth official statistics. Since 2019, China's National Bureau of Statistics has transitioned to a consolidated national accounting system for regional GDP, implicitly acknowledging the necessity for top-down adjustments in provincial reporting.
Most projections (including those from the IMF, OECD, and World Bank) now anticipate that China will stabilize at approximately 4-5% growth in the short term. In the medium term, potential growth is expected to average around 3.8% from 2025 to 2030, gradually declining to 2.8% in the 2030s unless significant reforms are implemented. A scenario characterized by increased social transfers, a shift towards consumption, and improvements in efficiency could maintain potential growth close to 4.3%. Demographics play a crucial role in this context. According to official statistics, China's population began to decline in 2022, and the working-age population is decreasing, which exacerbates the negative trend. It is evident that China's growth rate is unlikely to sustainably return to pre-pandemic levels soon. For many years, the reallocation of labor and capital from low-productivity sectors into urban areas and manufacturing facilities at a low expense was the driving force behind economic expansion. The next phase of growth will present greater challenges: efficiency will need to be derived from more profound reforms and innovations, such as enhancing competition, improving services and human resources, providing clearer regulations, and incentivizing productive private investments. This growth will be more gradual, riskier, and financially demanding than simply constructing an additional highway or industrial zone.
The Ripple Effects on Markets
The slowdown in Chinese growth is already evident in Western earnings, particularly in sectors where local competitors are gaining ground and pricing power is diminishing. Luckin has surpassed Starbucks in China in terms of both store count and annual sales, while Anta is now positioned at the top of the sportswear rankings, ahead of Nike and Adidas. The automotive sector is embroiled in a price war for electric vehicles. Tesla has consistently reduced prices in China since 2024 to remain competitive with BYD and others, while Volkswagen and BMW are rapidly losing market share, down approximately 10 percentage points since 2020. Multinational pharmaceutical companies (including AstraZeneca and Novartis) are facing challenges due to volume-based state procurement, which necessitates significant price reductions. Suppliers of chips and fabrication equipment (including Qualcomm and ASML) are encountering risks related to export controls and a government-supported initiative for domestic substitution. Despite these market shifts, most companies are not abandoning China; rather, they are diversifying their operations. The prevailing strategies include "in-China-for-China" localization to supply the domestic market, establishing "China+1" footprints (notably in Vietnam and India), and near-shoring for end markets. Firms still want a direct presence in China, but following the disruptions caused by the pandemic, many are also opting to produce closer to their customers, such as in Mexico for the U.S. market and Eastern Europe for the EU, and are distributing production across various countries. For instance, Apple’s assembler Foxconn has increased their operations in India and Vietnam; HP and Dell are relocating parts of their laptop production to Vietnam, Thailand, and Mexico; and GoPro has shifted much of its U.S.-bound camera production to Mexico.
China's vast market size implies that sluggish growth will have repercussions for most countries in the world. As the second largest importer on a global scale, China purchased approximately US$2.6 trillion worth of goods in 2024, increasing by $600 billion in only the past 10 years. This significant level of demand has positioned China as a crucial contributor to global economic growth and the IMF indicates that China was responsible for about one-third of world growth in 2023 and remains a vital engine of growth. Numerous economies are heavily dependent on Chinese demand for their export revenues, which in turn influences their growth trajectories. However, the degree of exposure varies among countries. In 2024, Australia exported approximately 30% of its goods to China, primarily consisting of iron ore and various other commodities; Brazil exported about 28% to China, with soybeans, iron ore, and oil being the main products; and South Korea sent nearly 19% of its exports to China, mainly focusing on semiconductors and other intermediate products. This exposure has resulted in higher growth rates. Research from the IMF indicates that a 1 percentage point change in China’s GDP generally affects the output of advanced economies by approximately 0.2-0.4% and other emerging markets by around 0.3-0.8%, with trade and global value chain connections being the primary transmission mechanism. A 1% slowdown in China’s GDP is estimated to reduce Brazil’s and Australia’s growth by about 0.3% and South Korea’s by around 0.6%. The effects on trade depend on the type of good exported. Commodities are globally interchangeable but are highly sensitive to price fluctuations based on China’s substantial demand. Conversely, industrial intermediates, including chips and machinery, may be redirected towards markets in the U.S., the EU, or ASEAN. However, this relocation can only be partial since China remains the ultimate source of demand for these products. Overall, while China's growth has played a significant role in the development of many countries, its stagnation would yield the opposite effect. Given China's substantial presence in the global marketplace, countries that export to it cannot find alternatives that can match the same price and volume, indicating that trade dependencies have reached unprecedented levels.
China's economic deceleration is also diminishing the supportive influence of the "China supercycle" that has sustained commodity markets for the past twenty years. Since 2000, the World Bank’s Metals & Minerals index in 2010 dollars has doubled, just as China became the largest source of demand for these commodities. Minerals like copper, iron, coal, nickel and even steel have all increased steadily in price, making extraction and refining more lucrative than ever. As the property sector and heavy industry have been experiencing a slowdown since 2021, the growth in demand for bulk materials has become tamer (Steel and iron ore prices are roughly half compared to 2021 peaks). Consequently, miners are postponing greenfield projects (new builds) and are instead prioritizing brownfield modifications (expansions of existing mines) and cash returns over significant investments. The nickel industry exemplifies this: following a surge of Indonesian supply through Chinese investments, BHP opted to suspend Nickel West and West Musgrave in Western Australia. In the lithium sector, as prices retreated towards pre-2021 levels, Albemarle reduced capital expenditures and postponed certain expansions. In terms of iron ore and copper, major companies continue to invest but now prefer brownfield modular, phased developments rather than large, simultaneous greenfield projects. Increases in capital expenditure guidance are focused on near-term, high-return opportunities, such as Rio’s copper/lithium pipeline and multi-staged iron-ore initiatives. The net effect is a reduction in the number of mega-projects and a transition away from a mindset of "grow at any cost." This is the key impact of China’s deceleration: all firms serving China, whether domestic or foreign, used to expand at breakneck speeds as demand was expected to always keep up, but that is no longer the case. This evolution requires a transformative change in the mentality of business leaders and permanently affects the level of business confidence in the country.
A Change in Power Dynamics
China’s slowdown is also reshaping its international finance. Since its 2013 launch, the Belt and Road Initiative (BRI) has moved from debt-financed projects to investments and construction contracts. Sovereign lending was only $6.1B in 2024, a fraction of the 2015-17 peak, but overall engagement is increasing via investments and construction contracts, totaling $125 billion in the first half of 2025. This reflects a shift in priorities as Beijing calculates that lower growth projections will make the cost of forgiving loans very expensive for the state budget and not worth the diplomatic payoff. The approach is safer for China’s balance sheet but relies more on direct investment and long-term ownership arrangements, which can trigger political backlash in host countries if projects are perceived as extractive rather than developmental. Concurrently, while China's total foreign exchange reserves remain above $3 trillion, their composition is changing: Beijing has been increasing its gold reserves, whereas its holdings of U.S. Treasuries have decreased to the lowest levels since 2009, despite a rise in overall foreign ownership of Treasuries, with the U.K. now surpassing China in this regard. Slower growth and weaker inflows mean less capacity, and less need, to recycle trade surpluses into reserves and treasuries, extending a multi-year decline that makes Beijing an ever less significant U.S. creditor and erodes what little financial leverage it once had (at most nudging U.S. borrowing costs slightly higher at the margin). With China’s sovereign lending stuck near post-2020 lows and a growing share of balance-sheet capacity absorbed by bailouts and restructurings ($240 billion between 2000-2021), Beijing’s ability to underwrite large international loans has narrowed. The need to restructure local-government debt coincides with an expansion of the U.S./MDB (Multilateral Development Bank) lending order, just as World Bank reforms lift capacity and lower borrowing costs (potentially >$150 billion in additional lending over the next decade). As China’s lending terms are less transparent and funding is drying up, an increasing number of low- and middle-income countries are turning toward the U.S./MDB for funds (e.g., Zambia, Sri Lanka, Ghana). This suggests China is unlikely to upend the U.S.-led lending order with rapid, non-politically contingent loans as commentators expected. It is instead taking a larger position through equity and EPC-style contracts (engineering, procurement, and construction), partly because weaker growth and tighter fiscal space limit debt finance.
China's global influence has been driven by its scale: a large import market, a robust export sector, and a state-controlled financial system capable of mobilizing substantial loans and swap lines. Despite a slowdown in growth, Beijing continues to exert power at critical chokepoints and is unreserved in utilizing market access as leverage. When Australia demanded an investigation into the origins of Covid-19, Beijing informally restricted Australian coal imports (2020–22), redirecting billions of dollars of trade with the stroke of a pen. Following Lithuania’s decision to let the Taiwanese Representative Office open in Vilnius in 2021, Beijing induced a ~80% drop in Lithuanian exports to China in Jan–Oct 2022. In November 2025, after new Prime Minister Sanae Takaichi said a Chinese attack on Taiwan could warrant possible military action, Beijing issued an advisory discouraging travel and study in Japan, Chinese airlines offered fee-free refunds, and Japanese travel/retail stocks fell. Beijing's dominance over the global rare earth metal industry, from extraction to refinement, has become the most effective means of gaining international leverage recently, as seen by the export controls established after Trump’s Liberation Day tariffs, which forced the US back to the negotiating table. Rare earths (17 elements on the periodic table) are crucial for high-performance magnets that drive electric vehicle powertrains, wind turbine generators, precision motors, and various defense and electronics applications. China not only accounts for 61% of the ore production but also dominates global processing (92% market share), where capacity, expertise and environmental regulations make the industry hard to develop in the West. This dominance gives China policy instruments such as stricter licensing, quotas, and targeted export controls (as evidenced by graphite, gallium, and germanium) that can elevate prices, extend timelines, or compel negotiations. Nevertheless, to sustain this kind of market-oriented leverage, the economy needs to keep expanding. If China ever wants to expand overseas lending projects, increase its exports and expand its multinationals, or even dethrone the US Dollar as world reserve currency, it will need to keep growing until it becomes the largest economic force in the world. This is unlikely to happen anymore.
Security on The Line: From Taipei to Beijing
A decelerating economy will not impede China's military advancement, however it is likely to limit its global ambitions. In 2025, Beijing increased defense expenditures by an additional 7.2%, bringing the total to approximately ¥1.78 trillion (around $250 billion), keeping the People’s Liberation Army (PLA) the world’s No. 2 spender. Nevertheless, these resources need to be allocated according to priorities, and this appears to be in equipment and infrastructure in the 'near seas' - specifically, the Taiwan Strait and the South China Sea - where Anti Access/Area Denial (A2/AD) capabilities (including missiles, submarines, air power, and Intelligence, Surveillance, and Reconnaissance (ISR)), along with the coast guard, provide the most deterrence. U.S. intelligence says Xi has instructed the PLA to be ready by 2027 (the PLA’s centennial) for a Taiwan contingency, although this is simply a preparation milestone. Numerous analysts also point towards Xi wanting to leave behind a legacy akin to Mao. Like Mao, Xi’s name is explicitly mentioned in the party (2017) and state constitutions (2018), and he too has published books about his political philosophy ("Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era"). Nevertheless, the repercussions of any conflict would be significant: beyond military hazards, China's substantial dependence on advanced foreign technology, export markets, and the dollar-centric financial system implies that sanctions and supply-chain disruptions would inflict enduring harm. These consequences might be underestimated as Chinese leadership likely perceives the West to be divided, as seen by the significant opposition to Europe’s sanctions against Russia and their lax application. If Europe cannot get together against Russia, how can it plan against a country that is ten times larger by most metrics and is located a continent away?
Debt sustainability is also a critical issue for the country, as it appears manageable yet increasingly fragile. In recent years, central government deficits have expanded, while local governments - under pressure to meet growth objectives - have consistently depended on off-balance-sheet LGFVs to finance land, infrastructure, and non-essential projects with insufficient cash flow. This has resulted in an increase in consolidated public debt, even though the overall sovereign ratio still seems reasonable compared to developed countries (88% of GDP). Worryingly, though, as growth slows and the rest of the world is trying to lower its debt levels, China has increased its debt-to-GDP ratio significantly every year, doubling it over the last decade. The current debt level is still sustainable though, as a significant portion of the borrowing is domestic and denominated in RMB, supported by a captive savings base, state-owned banks, and capital controls, although off-balance sheet debt makes the system very opaque. However, the situation is more tense in the private sector. Developers and certain LGFVs have accumulated offshore USD debt, and refinancing has become more challenging due to declining property revenues. On the surface, one might be concerned China may go through a Japan-style balance sheet recession - characterized by slow growth, disinflation, and misallocated capital - but China has three important buffers: a large foreign exchange reserve, a large pool of state-owned assets and a firm grip on its banking sector. Nevertheless, China’s current debt trajectory is not sustainable for a country with a slowing growth rate, and it needs to reform. It needs to transition from land-collateralized local expenditures to more transparent central borrowing, enhance the onshore government bond market and increase SOE dividend transfers. Without this shift, debt will continue to escalate to unsustainable levels.
The most crucial consequence of slowing growth is internal security. Economic stagnation impacts younger urban populations and the aspiring middle class, whose hopes were founded on increasing job opportunities and property wealth. In 1989, nationwide protests led by students were ignited by declining living standards, characterized by high inflation and shortages, frustration over corruption, and concerns regarding employment; the government reacted with deadly force, and since then, political stability has been meticulously controlled. A similar situation today - characterized by weak graduate employment, stagnant social mobility, and evident inequality - could once again incite unrest, particularly among digitally savvy and educated youth who were promised a pathway towards success through education, but instead find themselves unemployed or working low-paid menial jobs. Ongoing underemployment and a slowdown in growth heighten the likelihood of tension and localized protests concerning wages, rapidly escalating to a national scale as with the 2022 “white-paper” protests against zero-COVID. In that case, Beijing managed to alleviate that crisis by reversing its policy while subsequently intensifying law enforcement, but a larger youth movement grounded in economic demands will be harder to quell. As economic growth falters, the Party is expected to increasingly rely on narratives of nationalism and security to uphold its legitimacy, although this is a fragile balance that complicates the maintenance of the Chinese social contract.
Conclusion
Since the establishment of the People’s Republic in 1949, China has consistently set out to reclaim its status as a great power. Throughout much of history, it held the title of the world’s largest economy, a status derived from its extensive population and advanced commercial and governance systems. However, the Industrial Revolution disrupted this equilibrium: Western technology, capital, and market institutions transformed global power dynamics, and China’s defeats beginning with the First Opium War in 1839 marked the onset of the so-called “Century of Humiliation.” Following decades of civil conflict and foreign occupation, the country united once again under Mao Zedong in 1950, giving him significant prestige among the Chinese people who for millennia had always respected leaders who could unify the country, since the times of Qin Shihuang. Since then, Beijing began its reintegration into the international system, reaching a significant milestone in 1971 when the PRC assumed China’s seat at the United Nations and secured its permanent seat on the Security Council. However, the modern era has introduced new difficulties for the country. Nationalism has ignited ethnic conflict, making the Chinese “empire” more unstable and requiring more security spending in provinces like Xinjiang and Tibet. China's Confucian and Legalist heritage has also historically favored authority and order, which combined with the modern Marxist-Leninist party-bureaucracy, facilitates the concentration of power in one leader. During Mao Zedong's era, this personalist governance led to catastrophic events such as the Great Leap Forward famine and the chaos of the Cultural Revolution. Under Xi Jinping's leadership, power is once more being centralized. Global politics has also changed as globalization has shrunk the world and the historical Chinese policy of isolationism is no longer feasible. The most seismic shift in terms of global balance of power is the declining fertility rate around the world, which is now expected to decimate China’s population within the next few decades. After implementing a brutal one-child policy for decades, China’s population is set to shrink by over 10% by 2050, eroding its labor-force advantage even as India expands and the United States grows via immigration.
In this context, economic growth is crucial. A prolonged plateau would constrain Beijing’s great-power ambitions. China’s slowdown has arrived at a lower income level than Japan’s or Korea’s decelerations, reflecting structural inefficiencies and policy choices, from heavier regulation in certain sectors to a more intrusive role for the state and the Party in the economy. Without significant reforms that lift household incomes, strengthen market competition, and improve capital allocation, China risks underperforming the earlier Asian tigers just as its demographic window closes, putting its long-term strategic agenda at risk.
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