Changing Course in a Storm: China’s Economy in the Trade War
- Gerard DiPippo
- 1 hour ago
- 32 min read
China is weathering deflation, a property-sector collapse, and renewed trade tensions with the United States through calculated restraint rather than panic. Exports remain resilient via market diversification and price cuts. Chinese leaders are deploying targeted fiscal interventions, pursuing supply-side reforms, and combating “involution”–destructive race-to-the-bottom competition eroding profits across industries. This strategic patience reveals Beijing’s fundamental gamble: accept short-term economic pain to build long-term technological dominance and self-sufficiency. The leadership believes that the emerging high-tech sectors will ultimately replace both lost export markets and the crumbling property engine. This is a high-stakes bet on China’s ability to transform its economic model under pressure.
As Donald Trump returned to the White House in January 2025, some expected Beijing to buckle under pressure from potential new tariffs. The world’s second-largest economy was grappling with a historic property-sector collapse, persistent deflation, and slowing growth. Yet rather than launching a massive stimulus or responding cautiously as it did during the first U.S.–China trade war, Beijing fought back, deploying export controls on rare earths and showing it can inflict economic pain on the United States and its allies. Chinese leaders see U.S. actions as vindicating their self-reliance efforts, and they are willing to endure pain to pursue their vision of a more technology-driven economy, less dependent on property investment and foreign technology.
This article first sets the macroeconomic scene: slowing growth, deflation, and collapse of the property sector. It then assesses China’s vulnerabilities and performance during the second U.S.–China trade war. The final sections analyze Beijing’s cautious policy response, the “anti-involution” campaign, China’s techno-industrial priorities, and the risks these strategies face.
The Macro Picture: Slower Growth, Falling Prices
China reported real GDP growth of 5.2 percent year on year in the second quarter of 2025, in line with Beijing’s annual target of 5 percent. But prices are falling nationally. In nominal terms, China’s economy grew only 3.9 percent (Figure 1). Its nominal GDP growth is more volatile than its real (fixed price) GDP growth, and it better reflects conditions as experienced by workers, firms, and governments with wages, revenues, and budgets in nominal terms. China’s nominal GDP growth is less than half of what it was during the comparatively rapid pre-pandemic years of 2017–19. Growth dropped and then recovered in the early quarters of the pandemic period, but it has now stabilized at a lower rate. From the perspective of businesses and consumers, China’s slowdown is substantial.
The most significant change in China’s growth structure is the decline of the property sector. That engine stalled after 2020 when Beijing’s “three-red-lines” debt curbs choked off developer financing and home-buyer appetite, turning the once-dominant property sector into a drag on growth. Between 2017 and 2019, real estate and construction contributed an average of 16 percent to nominal GDP growth. After 2021, those two industries contributed almost nothing. Services (excluding real estate) are now the dominant driver of growth, having increased from a roughly 50 percent contribution before the pandemic to approximately 80 percent since 2023. Manufacturing’s contribution has barely changed on average.
Source: NBS via CEIC.
Deflationary periods often signal a weakening economy because people are not buying enough, or there is too much supply. China’s producer goods and manufactured goods have fallen in value steadily since mid-2022. Consumer price inflation has averaged only 0.2 percent year on year since 2023 (Figure 2), compared to a global average of more than 4 percent. Unlike other economies, China’s producer prices have continued to fall since mid-2022.[1]
Source: NBS via CEIC.
Exports are a support beam for China’s growth, while slower investment is weighing down growth (Figure 3). Net exports of goods and services contributed on average 38 percent of real GDP growth in the past four quarters, compared to barely any contribution between 2017 and 2019.[2] Growth in fixed asset investment is below 3 percent year on year nominally, less than half of its pre-pandemic pace. Real estate explains the slowdown in investment, with investment in manufacturing and, to a lesser extent, infrastructure holding up, at least until recent months. Household consumption, after recovering somewhat in 2023, is decelerating again this year.
Source: General Administration of Customs and NBS via CEIC.
Note: Indices calculated based on nominal values in yuan. Fixed asset investment values based on reported growth rates.
China’s household consumption and disposable income have held up better than investment, but both have decelerated from above 8 percent year on year nominally before the pandemic to 5 percent growth this year (Figure 4). Household savings rates in aggregate remain very high, at roughly 32 percent of disposable income, although they are slightly lower than they were in 2020–22 when the pandemic constrained consumers’ ability to travel and spend on services.
Source: NBS via CEIC.
Note: Values are nominal. Based on quarterly data.
The Big Story: China’s Property-Sector Collapse
The biggest shock to China’s economy so far this decade has been the collapse of the property sector. The COVID pandemic and the associated lockdowns had a disruptive and traumatic effect on people, with lingering effects. But the acute shock lasted about three years. China’s property-sector collapse and rebalancing process began in mid-2021, initially triggered by Beijing’s “three red lines” policy to curb property developer debt and speculation. The sector may not recover for several more years.[3]
Before 2021, the property sector – including real estate sales, construction, and related goods and services – accounted for about 30 percent of China’s economy.[4] Property sales – nearly 90 percent of which are residential properties – have fallen from 18 percent of GDP in mid-2021 to 7 percent as of 2025. New construction of residential properties fell 70 percent in terms of floor space during the same period, while sales declined more than 52 percent (Figure 5). China’s construction boom over the past two decades has been the largest in absolute terms of any economy in history. That boom is now a bust, albeit one partly engineered by Beijing. The collapse has strained local government finances (previously partly dependent on land sales), weakened smaller banks, and eroded household confidence.[5]
Source: NBS via CEIC.
The effects on consumer confidence and investment are clear (Figure 6). China’s official consumer confidence index collapsed in early 2022, coinciding almost exactly with year-on-year home price declines and the Shanghai COVID lockdown. As property sales fell, households reallocated their new savings flows from real estate to bank deposits. As of June 2025, Chinese households held nearly 120 trillion yuan in savings deposits, up from 60 trillion yuan at the end of 2020.[6] In terms of scale, such an increase is equivalent to more than 40 percent of China’s GDP.
Source: NBS via CEIC.
The property-sector correction is a necessary rebalancing of China’s economy away from speculative real estate and toward more sustainable and affordable prices.[7] But Beijing started the process without specific end goals (at least publicly), alternative funding sources for local governments (to replace land sales), or a clear timeline. Instead, officials have repeatedly adjusted, balancing leaders’ desires to avoid large-scale bailouts (either of developers, banks, or local governments), maintain economic and financial stability, and prevent a reinflation of real estate prices.
The most painful part of the transition has already occurred (at least in the real economy, if not the financial sector). Property construction starts and sales are still declining, but at a smaller rate and scale than from 2021 to 2024. With property prices still falling but salaries and wages growing in the low single digits, at least according to the official household survey,[8] buying a home is becoming more affordable, especially for younger Chinese.
But China’s property sector is not yet out of the woods, and continued price declines are affecting lower-tier (and lower-income) cities, increasing inequality, and eroding household wealth. According to official data, on average, prices for new homes have been stable or have been increasing in the largest cities since late 2024, while prices are still falling in smaller cities.[9] Of the seventy cities in the official survey, the number of Chinese cities experiencing month-on-month price declines jumped from 42 in January to 60 in July.[10]
China’s Vulnerability to a Trade War with the United States
China’s challenges, including those from the property sector, the post-pandemic recovery, and deflation, predate the second U.S.–China trade war. Nonetheless, as the second Trump administration began, Beijing faced the prospect that the intensified trade tensions would worsen China’s economy. China’s Central Economic Work Conference in December 2024 hinted at Beijing’s expectations. Given the “challenging environment of increasing external pressure,” Beijing’s plan was to stimulate domestic demand as its top economic priority for 2025.[11] But like other governments, Beijing was unsure about the timing and nature of the new U.S. trade measures.
Beijing had learned lessons from the trade war with the first Trump administration. First, do not rely on the United States for key imports or technologies. Since roughly 2020, China’s techno-industrial policies have focused on self-reliance and economic security.[12] At the Third Plenum in July 2024, Xi emphasized the importance of balancing development with national security.[13]
Second, diversify export markets and rely less on U.S. demand. China has achieved this to a modest degree in recent years. Exports to the United States as a share of China’s total exports fell from 19 percent in 2019 to 15 percent in 2024.[14] China’s trade surplus with the world has increased relative to its GDP since 2020, but its surplus with the United States – at least directly – declined slightly, from 2.2 percent of GDP in 2022 to 1.9 percent in 2024.[15]
Third, develop tools to fight back and plan for their use, including by identifying other countries’ vulnerabilities. China has been the world’s top manufacturer since 2010, and Chinese firms have had increasingly dominant market shares in many goods for at least a decade (Figure 7).[16] Since the first trade war, Beijing has developed formal legal, regulatory, and administrative tools to more effectively leverage its market power to impose costs on foreign countries or companies with export controls and sanctions.[17]
Source: International Trade Centre.
Note: HS code categories: 3D printers (847759); circuit boards (8534); commercial aircraft (880240); electric vehicles (870380); industrial robots (847950); integrated circuits (8542); lithium-ion batteries (850760); medical imaging equipment (901812); rare earth magnets (850511); smartphones (851713); solar panels (854143); UAVs (8806); and wind turbines (850231).
How reliant is China’s economy on trade with the United States? As of 2020 (the latest OECD data available), U.S. final demand accounted for about 3 percent of China’s economy on a value-added basis. U.S. demand exposure was concentrated in manufacturing, at 6.8 percent of final demand for China’s manufacturing value added.[18] Value added originating in the United States, either directly or indirectly, was 1.3 percent of China’s final demand.[19] Chinese manufacturers sell mostly within China’s domestic market. In 2024, exports to the United States were only 2 percent of Chinese manufacturing firms’ revenues. Exports in total were 13 percent of gross revenue (Figure 8). The electronic and consumer goods industries are the most reliant on exports to the United States.
Source: NBS via CEIC and International Trade Centre.
Note: Ranked by U.S. export revenues. Export revenues by sector are based on NBS industrial survey data. U.S. shares are estimated from China Customs trade data and applied proportionally. China Customs values are often higher because they include freight on board prices and re-exports, whereas NBS data reflect enterprise-level revenue, excluding many trading firms and potentially underreporting contract manufacturing.
Lost access to the U.S. market would mean lost jobs in China. If bilateral trade were to end, it could result in up to 16 million fewer jobs in China, according to private-sector analysts.[20] China’s manufacturing industries – especially consumer electronics and electrical equipment – and its wholesale and retail industry would suffer the most because of their exposure to U.S. final demand (Figure 9). However, direct job losses under an extreme scenario would equal only about 2 percent of China’s 734 million jobs.[21]
Source: National Economic Census (2024) and OECD Trade in Value Added (TiVA).
Note: Employment figures are from 2023 and include only formally registered workers. The U.S. share of final demand is based on trade in value added data from 2020, the latest available.
China Goes to (Trade) War
The second U.S.–China trade war began only a few weeks after Trump took office. Washington imposed 10 percent tariffs on China in early February, another 10 percent in early March, and then another 24 percent on April 2 (“Liberation Day”). Beijing retaliated cautiously at first, partly because Washington was imposing tariffs on other countries as well. It retaliated with 10 percent tariffs on U.S. natural gas, coal, machinery, and agricultural products in February and March.[22]
After April 2, Beijing took off its gloves and imposed 34 percent tariffs on all U.S. goods. This triggered an escalatory spiral between Washington and Beijing that by mid-April resulted in U.S. tariffs on Chinese goods cumulatively rising to 145 percent and Chinese tariffs on U.S. goods rising to 125 percent. Tariffs that high, if sustained, would have effectively embargoed bilateral trade.
However, China’s most consequential retaliatory measure, at least in the medium term, was the export control regime on rare earths it unveiled on April 4.[23] China cut off U.S. firms from these critical inputs, giving it leverage with Washington. If such export restrictions were sustained, some U.S. industries reliant on these materials – such as defense, electronics, and renewable energy – would be severely disrupted.
The United States and China negotiated a truce and a de-escalation of the trade war. Both sides’ representatives have so far formally met in Geneva (May), London (June), and Stockholm (July). The effective embargo on bilateral trade via extremely high tariffs thus lasted only about a month. During that time, both countries issued tariff exemptions for some critical goods, mostly electronics on the U.S. side and mostly semiconductors and aviation parts on the Chinese side.[24]
U.S. tariffs on Chinese goods are still effectively around 50 percent once all prior tariffs (including those from the first trade war) are included.[25] By the standards of less than a decade ago, that is staggeringly high. It is enough to cause a drop in direct U.S. imports from China and a substantial redirection of China’s exports to other economies.
China’s overall exports are holding up well so far. From April to July 2025, China’s reported exports to the United States fell 23 percent year on year, or a $41 billion decline. Meanwhile, China’s exports to other markets increased 11 percent, or a $117 billion increase. Overall, China’s exports were up 6 percent year on year during that period. The gains in other regions were broad-based (Figure 10).
Source: General Administration of Customs via CEIC.
Note: Values are nominal.
Chinese exporters may have found new markets to replace what they have lost in the U.S. market. By comparing the decline in China’s exports of specific goods to the United States with the increase in its exports of those same goods to other markets, we can approximate how much of China’s exports are being diverted. By this method, about 82 percent of China’s lost exports to the United States found alternative markets in the second quarter (Figure 11). The top destinations for those diverted exports are Southeast Asia and Europe. Comparing those trade diversion estimates with the increased U.S. imports of those same goods from those regions, we can estimate a maximum for potential transshipment into the U.S. market. By that metric, Southeast Asia is the top potential source of transshipped goods. Overall, potentially transshipped goods during the second quarter equal 23 percent of China’s diverted trade, suggesting that Chinese exporters have, at least so far, mostly found alternative markets.
Source: China Customs and U.S. Census Bureau via Trade Data Monitor.
Note: This table estimates the maximum potential trade diversion from the United States to other regions by comparing year-on-year changes in China’s exports at the HS6 level. For each product, the smaller absolute value between the decline in exports to the United States and the total increase in exports to other regions is used to define the upper bound on the trade diversion. When total increases across regions exceed the decline to the United States, the diverted value is allocated proportionally based on each region’s share of the total increase. To estimate the maximum potential transshipment, the region-level diversion estimates are compared to U.S. import data. At the HS6 level, the minimum between China’s diverted exports to each region and the increase in U.S. imports from that region is calculated. The result represents an upper bound on rerouted trade flows, but it does not confirm that transshipment occurred.
With only a few months of data, it is difficult to say whether China’s export growth elsewhere will be durable. Some of China’s increased exports to other markets could be offshore stockpiling, given uncertainty about U.S. tariffs globally. Some of China’s diverted or new exports will ultimately end up in the United States, either as inputs to other countries’ exports or through tariff-evasion schemes. The Trump administration is concerned about tariff evasion, especially through Southeast Asia. On July 31, President Trump announced additional tariffs of 40 percent on “transshipped” goods; this applies to all countries, but it is mostly aimed at Chinese exporters shipping through third countries with lower tariffs. How this will work in practice, such as with “rules of origin” for all content, is not yet clear.[26]
Make Up in Volume What You Lose in Margin
China’s sustained export growth in the face of U.S. tariffs has likely benefited from policy support, a weaker exchange rate, and lower export prices, which have increased volumes. As the trade war heated up, Beijing pledged to support affected export industries, with rebates, trade credits, and upgraded free trade zones.[27] These actions may have helped at the margins.
China’s central bank, with the help of the state-owned commercial banks, has effectively targeted a stable exchange rate against the U.S. dollar since 2023.[28] In the first half of 2025, the U.S. dollar fell about 11 percent globally against all key currencies.[29] With a quasi-peg to the weakening U.S. dollar, the Chinese yuan fell relative to other currencies. Its real effective exchange rate (inflation-adjusted trade-weighted currency value) declined about 4 percent in the second quarter (Figure 12), while other key currencies such as the euro appreciated. That likely has helped China’s exports.
Source: Bank for International Settlements and the People’s Bank of China via CEIC.
Finally, Chinese exporters are offering lower prices in exchange for increased volumes. The total value of China’s exports has continued to grow as larger quantities have offset lower prices. In the past year, the divergence between China’s export volume growth and export unit value (price) growth has been the largest in over a decade (Figure 13). Only four broad categories of manufactured goods have registered price increases for exports year on year, with all others declining (Figure 14).
Source: General Administration of Customs via CEIC.
Source: General Administration of Customs via CEIC.
Note: Unit values calculated based on U.S. dollar prices.
Who Is Feeling the Pain?
The trade war has likely worsened sentiments, while export-oriented job losses may be masked by wage freezes, reduced hours, or furloughs. However, China has avoided the worst-case scenario of a sudden stop in its trade with the United States, and China’s total exports to the world continue to grow, with only limited evidence of transshipment to the United States. Overall, only a small share of the pain Chinese workers and households are feeling is likely coming from the trade war.
The employment situation in China is clearly worse than it was before the pandemic. According to official statistics, roughly 12.5 million new urban jobs were created in the twelve months leading up to June 2025. That figure, while above Beijing’s annual target of 12 million, is trending downward and about 1.6 million lower than the pre-pandemic trend would have suggested (Figure 15).[30] Data from online recruitment platforms in China (compiled by Baiguan) suggest that new job postings continue to decline, while part-time and gig work are increasingly common, even though wages in those industries are nearly flat.[31]
Source: Ministry of Human Resources and Social Security via CEIC.
Youth unemployment, especially for recent graduates, is a problem. Applications for stable jobs in the civil service or at state-owned enterprises have surged.[32] Young Chinese express frustration with their prospects.[33] Average starting salaries for “new economy” industries have declined since 2022.[34] However, part of the problem for Chinese graduates is that their numbers have increased since 2022, while overall job creation has slowed. About 12.2 million Chinese will graduate from higher-education programs in 2025.[35] If graduation levels had stayed on their pre-2022 trend, that number would have been only 10 million.[36]
Chinese workers are feeling the pain. The central bank’s quarterly survey of depositors suggests that sentiment about income is trending downward, and sentiment about employment is the worst since at least the 2008–9 global financial crisis (Figure 16).
Source: People’s Bank of China via CEIC, author’s calculations.
Note: Each line shows how household perceptions of income and employment conditions compare to their historical averages, using a z-score. A value of 0 means sentiment is at its historical norm; positive values indicate more optimistic sentiment, and negative values reflect weaker-than-normal sentiment. Based on quarterly diffusion indexes from the PBOC’s urban depositor survey, which gauges confidence among residents of fifty major Chinese cities.
However, the trade war likely explains only a small share of this distress. So far, Chinese export-oriented industries appear to have avoided large-scale layoffs. Based on employment sub-indexes within China’s official purchasing manager index surveys, this year’s job losses in the manufacturing sector (the export sector) have been small. Job losses in services are notably worse, reflecting weaknesses in the domestic economy. Meanwhile, job losses in construction are very high due to the collapse of the property sector (Figure 17). In terms of scale, manufacturing, services, and construction accounted for 20 percent, 68 percent, and 10 percent of total registered employment, respectively, as of the 2023 national economic census.[37] In terms of aggregate job losses, the weakness of the service sector is the most concerning.
Source: NBS via CEIC, author’s calculations.
Note: Each line shows how employment in that sector compares to its historical average, using a z-score. A value of 0 means employment is at normal levels; positive values mean better-than-normal, and negative values mean worse-than-normal. Based on employment sub-indexes from China’s official purchasing managers’ index (PMI) surveys, which track monthly changes in business conditions.
No Big Demand Stimulus
Chinese leaders do not seem overly concerned with near-term growth, and recent stimulus measures have mostly followed the path laid out before the trade tensions escalated in April. The July Politburo readout struck a more confident tone than that in April, emphasizing policy continuity and macroeconomic stability.[38] Notably, the July readout made no mention of the property sector, although Premier Li Qiang called for real estate stabilization measures at the State Council plenary in August.[39] The Central Urban Work Conference also offered no major new policies to address the ongoing real estate downturn.[40]
Monetary policy has been “moderately accommodative,” with a small policy rate cut and a reduction in banks’ required reserves in May.[41] Beijing is likely worried that a more aggressive monetary response would do little to spur weak demand, while it would require more intervention to maintain a stable exchange rate against the dollar, and it would squeeze commercial banks’ already-tightening profit margins.
Instead, Beijing is relying on fiscal stimulus measures. Fiscal expenditures have accelerated (funded by expanded borrowing) to support the economy (Figure 18), while cutting waste elsewhere in the budgets.[42] China’s stimulus spending is on track to increase the national on-budget fiscal deficit by 2 percentage points of GDP, as announced at the National People’s Congress in March. Counting the general and fund budgets, China’s fiscal deficit was a substantial 8.8 percent of GDP as of the second quarter, even larger than that during the pandemic.[43]
Source: Ministry of Finance via CEIC.
Note: The general budget covers the central and local governments’ core fiscal revenues and expenditures, such as taxes, transfers, and public services. The government fund budget is separate and records revenues and expenditures tied to specific purposes, most notably land sales, which are a major funding source for local governments.
Chinese leaders have provided high-level guidance with broad objectives, such as directives to stabilize employment in early July,[44] which can be difficult for officials – especially in cash-strapped localities – to reconcile. Measures with specific funding allocations or quotas are the most concrete. This year, those include the trade-in program for consumer goods (300 billion yuan in central funding),[45] local special-purpose bonds, mainly for infrastructure (500 billion yuan quota),[46] a central bank re-lending program to support services (500 billion yuan quota),[47] and a state-led recapitalization of the big banks to sustain lending (500 billion yuan in central funding).[48] Guiding opinions announced in late June suggest more credit support for consumption will be forthcoming.[49]
Beijing is also ramping up social spending. In the first half of 2025, social security and employment spending surpassed 2.4 trillion yuan (17 percent of the general budget).[50] Expenditures on unemployment benefits totaled 94 billion yuan, the largest since the 2020 COVID shock.[51] In July, Beijing announced a new consumption subsidy program for disabled elderly people and a national subsidy of 3,600 yuan for children younger than age 3.[52]
These measures do not provide a major sustained boost to demand. For example, the National Development and Reform Commission claims that the consumer trade-in program supported 1.4 trillion in sales through July (5.8 percent of retail sales).[53] But that could be at the cost of future purchases of those same durable goods. The subsidy for children is an attempt to stem China’s falling birth rates, a major long-term problem. The 3,600-yuan subsidy would disperse 34 billion yuan per year based on the 9.5 million births in 2024. Each child would bring a subsidy equal to 7 percent of the median urban disposable income per capita, which could make a difference for many families. But it would only equal about 0.04 percent of the national household disposable income.[54]
Supply-Side Structural Reform 2.0: Involution Edition
In recent years, there has been a key economic – and geopolitical – tension in Beijing’s support for manufacturing: Chinese factories accelerated investment and added capacity beyond what the increasingly service-oriented domestic consumer economy could sustain. That means (and has meant in recent years) that a larger share of China’s manufactured goods depend on external markets at the same time that China’s economy has become too big to rely on exports for a large share of its growth. This tension can be partly resolved by the surge in overseas demand for goods during the pandemic and by Chinese firms’ competitiveness in key growth technologies, like electric vehicles. But overall, this contradiction cannot be sustained.
Policy signals this year suggest that Chinese leaders are starting to reckon with this contradiction. Beijing is focused on “domestic circulation.” This includes boosting consumption, unifying the national market (including by reducing local protectionism), integrating technology and industry (including by deploying artificial intelligence), strengthening supply chains, and balancing supply and demand.[55] As noted above, support for demand is modest and cautious.
Beijing’s revealed preference is to focus on the supply side.[56] The key line of effort on the supply side is Beijing’s campaign against “involution,” or excessive competition. Chinese planners had mentioned this earlier, but by mid-2025 it had become a priority.[57] It aims to curb destructive price wars that have contributed to falling profit margins (Figure 19). In aggregate, Chinese manufacturers’ reported total profits fell 30 percent from 2021 to June 2025, and their reported losses increased from 14 percent of total profits in 2019 to 27 percent in June 2025.[58]
Source: NBS via CEIC.
Note: Data as of Q2 2025. Includes manufacturing industries reported by the NBS. The wine and beverage industry is excluded as a positive outlier, with increased profit margins of 6.5 percentage points.
The anti-involution campaign is distinct from a traditional overcapacity policy, such as the 2015 Supply-Side Structural Reforms.[59] While overcapacity refers to supply exceeding demand, involution describes margin-eroding competition that can occur even without significant overcapacity, as in e-commerce. The two concepts overlap, however, as overcapacity often triggers involution by flooding markets and driving prices down. Some of China’s industries are indeed suffering from overcapacity (Figure 20) but not necessarily those industries that foreign governments complain about.
Source: NBS via CEIC.
Beijing is pursuing the anti-involution campaign with a mix of administrative guidance, legal reforms, price monitoring, production curbs, subsidy tightening, platform regulation, and narrative framing.[60] Somewhat ironically, the “new trio” technologies that were highlighted in 2024 as key to China’s “new quality productive forces”– EVs, batteries, and solar panels – are now all targets in the anti-involution campaign.[61] One key challenge – especially for EVs – will be to overcome provincial protectionism and support for local champions.[62]
While Beijing frames the anti-involution campaign in domestic terms (and seems to carefully avoid the term overcapacity), it aligns with external pressure over China’s excess supply and trade distortions.[63] For China, reducing involution is probably much more about domestic sustainability than about deflecting an international backlash. However, the campaign could give rhetorical fodder to the United States, European Union, and others as tacit acknowledgment of the overcapacity problems that they accuse China of not addressing.
Improving profitability and reversing (or at least stemming) deflation via the anti-involution campaign could take many months, assuming the supply-side approach offsets demand-side weakness. Industrial consolidation will require mergers, acquisitions, and bankruptcies. However, Chinese manufacturing firms and banks appear to have received Beijing’s message. In July 2025, fixed asset investment in manufacturing declined 0.2 percent year on year, the first contraction since the early months of the pandemic.[64] Bank loans for the industrial sector fell to 11 percent year on year in the second quarter, down from a peak growth rate of 32 percent in mid-2023.[65]
Nonetheless, Beijing continues to see manufacturing and science and technology as the foundations of China’s long-term development. Industrial upgrading and tech self-reliance are consistently framed as the cores of economic security, high-quality growth, and global competitiveness. Beijing wants to improve industrial policy to build national resilience.[66] The involution campaign is partly an attempt to clean up the side effects of aggressive state-backed industrial growth without abandoning the model itself.
Tacking into the Wind
Chinese leaders appear confident that they can steer the economy toward their desired techno-industrial future of “new quality productive forces” while managing external tensions. Beijing’s demonstrated ability to both endure and impose pain on Washington – especially via export controls on rare earths – reflects China’s rising assertiveness. Previously, China tried to pick fights only with smaller economies, and it was more cautious during the first U.S.–China trade war.[67]
Beijing’s export control regime on rare earths is not going away, and export licenses are valid for only six months.[68] If tensions with the United States re-escalate, Beijing may again choke off rare earth exports. This would come at a diplomatic cost because other countries would be affected. In the second quarter of 2025, the export volumes of China’s rare earth magnets to the United States fell 67 percent year on year, while such exports to the rest of the world were down 50 percent; China squeezed all exports, probably in part to prevent transshipments or stockpiling, and they likely will need to do so again. But in the short term, there is little the United States or others can do about it.[69]
A key external risk for China’s economy is that other economies might join U.S. efforts to stem imports from China or to impose protective tariffs on their own. So far, Washington does not appear to be assembling a grand trade coalition against China, although the U.S.–E.U. agreement mentions cooperation on economic security.[70] Washington’s additional tariffs of 40 percent on “transshipped” goods could threaten China’s exports of intermediate goods to Southeast Asia and elsewhere if they are broadly interpreted to cover Chinese value added with low thresholds.[71]
That said, Beijing’s preference is stability. China would likely welcome a leader-to-leader summit with the United States, provided that preparatory talks clarify expectations and Washington does not first impose additional tariffs or export controls.[72] However, Chinese leaders’ overall development, techno-industrial, and national security strategy is unlikely to change irrespective of bilateral negotiations. The 15th Five-Year Plan, scheduled to be announced in 2026, will likely offer new insights about that strategy.[73]
China is biding its time for its manufacturing and high-tech industries to consolidate and advance, including through the diffusion of artificial intelligence.[74] It is trying to reassure private Chinese firms, such as by adopting the Private Economy Promotion Law.[75] It is also offering tax credits, streamlined approvals, and regulatory support to encourage foreign firms to reinvest profits into domestic strategic sectors. These measures aim to retain foreign capital, align it with industrial priorities, and reinforce a “high-level opening-up” (Figure 21).[76] Roughly 30 percent of FDI flows into the high-tech industries, according to official statistics.[77]
Source: State Administration of Foreign Exchange via CEIC.
China’s high-tech economy is indeed advancing. Value-added production of high-tech manufacturing continues to outpace overall manufacturing.[78] Last year, the “new economy” (high-tech industries) contributed 35 percent of China’s nominal GDP growth, the highest share so far (Figure 22). The “old economy”– especially but not only the property sector – is weighing down China’s growth.[79]
Source: NBS via CEIC.
Note: “New economy” as defined by the NBS’ “three new” activities value added from new industry, new business, and new business models.
Chinese leaders seem content to let the property-sector correction run its course without massive central interventions, confident that a more sustainable, high-tech economy will emerge. Even if it takes a few more years, they believe China will eventually recover: housing will stabilize and grow again (though from a lower base), headline indicators will brighten, and the country’s innovative industries will chalk up quieter gains behind the drag of weaker sectors. Domestic demand could accelerate.
Or at least that is the hope. Slowing investment in manufacturing and infrastructure as of July 2025 could presage a further weakening in total demand that domestic consumption will not offset, absent more policy support. An extended property slump, coupled with years of weak job and price growth, may leave permanent scars on local-government and bank balance sheets, household savings, and especially on younger, educated Chinese who are forced to settle for less. High-tech champions – consolidated under the anti-involution campaign – might prove profitable yet fail to create the broad employment needed for shared prosperity.
Beijing is placing big bets on financial resilience and technology to chart a course to sustained growth. Chinese leaders are trying to ride out the property storm, convinced that time is on their side. The next few years will test whether China’s economy is strong enough to withstand both domestic and external headwinds. Trade tensions may not decide the outcome, but they could magnify the costs of delayed policies and force harder choices sooner than Beijing expects.
About the Contributor
Gerard DiPippo is an Associate Director of the RAND China Research Center and a Senior Researcher in RAND’s D.C. office. Prior to joining RAND, DiPippo was Senior Geo-Economics Analyst at Bloomberg Economics. His research focuses on the Chinese economy, U.S.–China relations, industrial policy, and financial issues. He was previously a Senior Fellow in the Economics Program at the Center for Strategic and International Studies. He served 11 years in the U.S. intelligence community, including at the Central Intelligence Agency and as a Deputy National Intelligence Officer for Economic Issues at the National Intelligence Council. DiPippo has a B.A. in economics and philosophy from Dartmouth College.
Notes
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