For China, is this as good as it gets?

The ‘middle-income trap’ that ended the rise of so many former tiger economies now ensnares China. The prognosis isn’t good.

We all know the story so far. After decades of chaos under Mao, China’s switch to state capitalism has transformed it into a global leader, the workshop of the world and – by one measure – having the world’s biggest economy. It now has formidable military force and has brought many millions out of extreme poverty.

That, so far as it goes, is true enough. But it says little about the nature of the society that’s being created or about whether the meteoric rise can go on – or come soon to a spluttering halt, as other emerging economies have done.

China’s performance is impressive in the aggregate for one reason: it has so many people, 1.46 billion of them, second in the world and just behind India. But looking only at the aggregate conceals what’s happening to each of those 1.46 billion individuals. How are they doing?

The measure of a nation’s status as middle or high income depends not on aggregates but on specifics. The usual broad measure is GDP per capita, or total economic output divided by the number of people. Only when that improves dramatically can China break out of the middle-income pack and join the developed nations: western Europe, North America, Australia and New Zealand.

On that basis, China’s rise has moved in a few decades from the bottom of the middle-income pack to the top. Compared to the rest, China’s trajectory looks impressive. Surely, if that keeps up, Chinese people will join the richest fairly soon.

Or will they?

Another comparison tells a very different story. Against the per-capita economic growth of the rich world, China’s trajectory looks less impressive, increasing at about the same rate but from a much lower base. Unless this changes, it will never catch up.

A people’s republic?

The state of a society is best measured not only by overall prosperity but by how fairly prosperity is shared. China, nominally, remains a socialist country, following the precepts laid down by Marx, Engels and Lenin.

Marx believed capitalism was incapable of delivering a fair distribution of resources because a small group controlled the three factors of production – land, labour and capital. Only when these became collectively owned could wealth be distributed more evenly.

The attempts to make this work have resulted instead in massive slaughter, starvation, and the even greater concentration of power and wealth in the hands of a highly authoritarian and often ruthless elite. China endured this under Mao: the collectivisation of agriculture, resulting in famine; the Great Leap Forward between 1958 and 1962 which attempted to force peasant farmers to industrialise but which caused the worst famine in human history; and the decade-long Cultural Revolution, in which as many as two million people died. (Xi Jinping grew up in harsh rural conditions after his high-ranking father was disgraced and sentenced to internal exile for not killing enough rich peasants and counter-revolutionaries. The son learnt early the lessons of power, concealment and survival.)

“Socialism with Chinese characteristics” is in fact state capitalism by another name. But is the nod to socialism more than just a convenient gesture?

So far this century, the increase in national income has disproportionately gone to the top 10%, to the relative detriment of the other 90%. Although everyone’s income increased in actual terms, the country as a whole became less equal.

To be fair, increasing inequality is usual in almost any country moving quickly up the income ladder. The entrepreneur class benefits first. As economies mature, rising wages and new tax and transfer systems can make the system fairer.

But how does China compare with other countries, both emerging economies and those which are already developed? On that basis, China is not doing badly. Despite the pressures of development working against equality, they are already reasonably close to the mature economies of the west and a great deal fairer than other big developing countries such as India, Russia and South Africa, where the very rich own so much. It’s also significantly better than the United States.

Despite the traditional Marxist disdain for the bourgeoisie, a vibrant and well-educated middle class is essential for consumption, growth and innovation. Oxford Economics has estimated that two-thirds of the world’s population will join the “global middle class” – people who consume substantially more than their basic needs – by 2030.

China’s middle class is doing relatively well by international standards. Its 34% share of total wealth compares favourably with the United States (30%), Australia and Canada (both 26%). This performance is a key to further growth and, eventually, to breaking out of the middle-income trap.

The share of wealth for the lower half of the population is problematic everywhere, but no more so in China than in most countries. The surprise here is not China but Sweden, where half the population has, on average, negative wealth of 11%: that’s people who owe more than they own. Most of this is likely to be the large migrant population, largely from Syria, Afghanistan and Iraq.

Wealth inequality in China, compared with other nations, is relatively benign. The challenge will be to ensure that situation persists as it advances further towards rich-nation status – if, of course, it can overcome entrenched internal barriers to growth which bedevil the world’s second-largest nation.

How tigers grow

Emergent economies tend to follow a familiar pattern: spectacular rise followed by stasis. The reason is that they all tend to follow the same model for growth, which works well until it doesn’t.

The first essential element is a strong authoritarian government, because this model relies on suppressing the income and consumption of the great mass of the people so resources can go instead into investment – roads, railways, factories, ships and new cities. The tools are high taxation, wage suppression and low bank deposit interest rates.

The government then redirects the wealth it has denied to its people into rapid development of industry, usually with a heavy emphasis on low production costs and competitively-priced exports. To achieve this, workers’ wages are kept low and company debt is subsidised. The exchange rate is kept low to make exports cheaper and imports more expensive, and tariffs can further shelter import-competing industries.

Usually, writes economist (and now federal Labor MP) Andrew Charlton, the three sectors of an economy – consumption, investment and net exports – grow at roughly the same rate. Under the investment-led growth model, that no longer happens.

“Over time, the investment and export sectors become more and more dominant, which creates underlying and ultimately unsustainable imbalances. [All such countries] were successful in using this strategy for a period, but almost all experienced significant and, in some cases, devastating challenges as a result.”

China is now at that point. As Charlton pointed out in his 2014 Quarterly Essay, such a large economy is unlikely to suffer a sudden, comprehensive crisis. Instead, as it is now turning out, many crises can happen in succession.

The first of these was the collapse of the real estate bubble in 2021. Chinese savers, unable to access a diverse range of domestic and foreign assets, put huge amounts of money into that single sector. According to Australia’s Reserve Bank, by 2016 residential property investment accounted for around 20% of China’s GDP, compared to less than 5% in the United States, South Korea and Japan.

As the bubble continued to inflate, boosted by borrowed money and risky, over-leveraged development, real estate companies made massive profits. Eventually central planners in Beijing started to worry and introduced modest restrictions that had little effect. Finally, in 2020, Xi Jinping pierced the bubble with highly restrictive new rules on debt.

Evergrande, which had become the world’s most-indebted property developer, collapsed in 2021 starting a cascade of similar collapses across the sector. Millions of small investors lost life savings. At the time of writing, February 2026, property prices were still falling and losses still being accrued.

If this was confined to a single sector, it would not be so important. The problem is greater because it is built into the system. It’s how China does things.

Priority sectors are picked out by planners in Beijing for special treatment: subsidy, easier finance, promises of promotion to party cadres who facilitate the rise of favoured enterprises. Investment floods in, new firms multiply, cadres are promoted and production soars. We have seen this now with electric vehicles, solar panels, high-speed rail and advanced computing.

Fairly soon, all that investment and soaring output results in unsupportable overcapacity. Firms produce more than they can sell, prices collapse and profits disappear. The world cannot soak up that vast overproduction and tariff walls are erected to counteract dumping. Soon, most of those new companies are losing money.

China now has 129 electric vehicle brands. Most are losing money and according to a recent analysis, only 15 are expected to be financially viable by 2030.

In the first half of 2025, China’s four biggest solar panel manufacturers sustained losses of $US1.54 billion, two and a half times as much as the previous corresponding period.

High-speed rail is another financial black hole. A report published on a Shanghai-based news website said China’s high-speed railway network was 45,000 kilometres at the end of 2023, but only 2,300 kilometres, or 6% of the total, could make a profit. 

“In fact,” the story went on, “the profitability of high-speed rail is not as glamorous as it seems on the surface. The Beijing-Shanghai high-speed railway is known as the ‘most profitable high-speed railway’, but in 2023 its total operating costs reached 25.369 billion yuan, and its net profit attributable to the parent company was 11.546 billion yuan.

“However, the initial investment was 220.9 billion yuan, equivalent to 95 million yuan per kilometre. If calculated based on the net profit attributable to the parent company in 2023, it would take a full 20 years to recoup the investment.”

Information technology firms are still in the expansionary stage. Most still make money. But of the world’s top 25 tech companies, four are in China and in 2025 had a combined profit of $US60 billion. The US has 11 in the top list, with combined profits of $US592 billion – 940% greater than China’s four. And IT startups in China are already finding it hard to turn a decent profit.

At the bottom of all this,” wrote Tej Parikh, economics leader writer for the Financial Times,  is one basic fact: China’s vast population does not provide a vast market for its own products. Until  that is successfully addressed, the prospect for long-term growth remains dim.

“Aside from the sheer cost of subsidies – which the researchers calculate to be about 4.4 per cent of China’s GDP in 2023 – Beijing’s largesse has supported inefficiency, driven overcapacity and created huge financial losses. Subsidies have tended to flow to better-connected firms –  not necessarily the most efficient ones – and have created barriers to entry for others, notes Adam Wolfe, emerging markets economist at Absolute Strategy Research.

“’Local officials tend to subsidise the same industries and then protect firms in their jurisdiction from competition,’ says Wolfe. ‘The reallocation of credit to high-tech manufacturing should, in theory, boost total factor productivity. But it has been more than offset, in practice, by the misallocation of labour and capital due to duplicative local subsidies and suppressed market exits.’”

Joseph Schumpeter described “creative destruction” as an essential element of an efficient capitalist system. Unless failing enterprises are allowed to die, resources – land, capital and labour – cannot be reallocated to more viable and productive areas.

At first glance, the growth in Chinese economic efficiency over the past 70 years is impressive. Labour productivity – GDP per hour worked – has risen by 3,200% over the period in constant (inflation-adjusted) terms.

But, when compared with other countries – and particularly those in the rich-nation club that it aspires to join – China remains remarkably inefficient.

There is a very long way to go from here. Standing in the way are the most fundamental aspects of how the nation is structured and how its people are governed. The task is formidable, particularly in a political environment that values stability above everything else.

They don’t spend. They save.

Chinese leaders have long recognised the urgent the need to expand the domestic market for the output of its huge economy. It first became a priority in 2007, when President Wen Jibao raised the issue at the National People’s Congress.

“We need to adjust the balance between investment and consumption. We must adhere to the principle of boosting domestic demand, focusing on expanding consumer demand,”he said.

When Xi Jinping became president in 2012, it was one of the first things he talked about.

But, as this chart shows, there has been little progress, if any, since then. Many of the developed nations which China wishes to join also have problems with domestic consumption but China’s performance, with household consumption at around a third of GDP, has been heading in the wrong direction for far too long.

Over the past 30 years, a large and rising proportion of economic output has been locked up in personal savings, reaching 51% in 2010 during the Global Financial Crisis. It has now stabilised at around 43%, one of the highest in the world.

Only eight countries in the world have higher rates of domestic saving. People save when, in the absence of a social safety net, they worry about the future: whether they can afford to educate their children, get the healthcare they need, and live when they can no longer work.

China has a relatively poor social safety net. Unemployment benefits cover only 19% of the median wage.  Patients have to pay for 32% of healthcare costs, compared with 15% for the European Union. Age pensions are largely paid for by employers, and topping-up payments are the responsibility of local provincial governments. Hundreds of millions of people – those without secure employment, and almost all foreign guest workers, are left out.

The save-don’t spend mindset is deeply embedded in Chinese culture, and improving the safety net – and there are already moves to do so – may not quickly change behaviour. It will take time.

Local difficulties

Despite the appearance of being a highly centralised economy, China is more accurately regarded as a federation. There are 33 provincial administrative units – 22 provinces, five autonomous regions and four municipalities under the direct control of the central government. These local governments are responsible for managing their own economies, land development, healthcare, education, environmental protection, and public security.

The central government makes some contributions to these, but its overriding area of spending is defence. In 2025, the military accounted for $US246 billion, by far the biggest category in the central government’s budget.

But those figures are somewhat misleading. When we look at total spending – all levels of government, not only the central government – a different picture emerges.

Although the Chinese armed forces have been growing quickly, the United States continues to outstrip them in in almost every category. The US spends more than twice as much on its armed forces as a proportion of government expenditure and as a percentage of GDP. The People’s Liberation Army has many more personnel but less than half the number of aircraft and less than a third as many aircraft carriers.

In the fiscal tussle between guns and butter, too many guns is not the main reason for not enough butter. The real problem is much deeper and much more intractable. It goes to the heart of how China structures its administration.

This chart gives us a clue: there is a clear fiscal imbalance between the central and local government levels. For both, expenses outstrip revenue, but the disparity for local authorities is dramatically worse.

“In China,” wrote France’s Institut Montaigne think-tank, “government finance is a study in contrast. On the one hand, the debt of the central government is very conservatively managed, and kept at a relatively low level compared to other major economies and to most developing countries. On the other hand local governments are structurally in deficit, and have to use all kinds of tricks and loopholes to make ends meet.”

The greatest impediments to China’s future growth come from two major sources: the central government’s narrow focus on a few favoured industries, rather than on growing the broader economy; and the seriously inadequate revenue streams for the 33 provinces and administrative regions.

The basic structure of China’s political administration leads inevitably to massive over-production, plunging prices and vanishing profits. But policy-makers in Beijing find they cannot shut down loss-making enterprises (mostly, these days, private rather than state-owned) for fear of increasing unemployment, social unrest and the knock-on effects on other companies. In the past five years, the real estate implosion and a heavy-handed clampdown on business borrowing and investment, the situation has become much worse.

So the vicious cycle of government favouritism, over-production, falling prices and zombie companies produces a massive misallocation of resources. No country, particularly one wishing to make its people more prosperous, can afford such costly ineptitude.

But the problems arising in Beijing are magnified in the regions. As we can see in the previous chart, local administration – taken as a whole – is significantly bigger than the central government. But its income stream is so inadequate that these authorities have to make economically disastrous decisions just to stay afloat.

In 2005, the administration of Hu Jintao abolished a 2,000-year-old agricultural tax. It helped farmers, which was its intention, but its revenue had gone to local authorities – and that revenue stream was not replaced. It typifies the shortcomings of top-down decision-making that is keeping the world’s second-biggest country out of the rich-country club. Decrees issued centrally, such as the one which produced the collapse of the real estate market, are frequent and, sometimes, devastating.

After the demise of the agriculture tax – and with the active encouragement of the central government – local authorities piled into real estate, which became a cash-cow. After Xi Jinping punctured that bubble, property sales collapsed from 18% of GDP in 2021 to 7% four years later – and tax revenue went the same way.

The proceeds of China’s biggest tax, the value-added tax, is evenly split between central and local governments. But, unusually, the local share goes to where a product is made, not where it is consumed. Because this encourages ever-bigger industrial precincts, local authorities cultivate as much activity they can: their tax base depends upon it. When they all do this at once, targeting the same limited priority areas decreed by Beijing, overproduction quickly follows.

“When the predictable shakeout happens, those failing companies are kept on life support,” an Asia Society China analyst, Lizzie Lee, wrote in Foreign Affairs. “They still employ people. They still make social welfare contributions and still buy inputs to their businesses, generating VAT. Their employees pay taxes.

“Unprofitable firms remain fiscally valuable not because they generate profits but because they generate taxes.”.

Is reform even possible?

The structural failures bedevilling the Chinese economy are so profound that minor tweaks to the system will have little effect; but major change could be devastating to the nation’s social and political cohesion. According to the popular concept, the Chinese Communist Party retains its dominance because of an implicit deal with the people: stay out of politics, let us rule, and we’ll ensure you prosper. But if prosperity stalls or goes backwards, what happens to that implicit deal?

Generally, it is in the world’s interests for Chinese society to avoid too much disorder. Vague fantasies among some in the west about China becoming a nice liberal democracy if only the Communist Party can be swept away are naïve and potentially dangerous.

And it is certainly in the interests of China’s trade partners – particularly Australia – for its economic growth to continue. Other countries can, and are, dealing with chronic Chinese over-production and artificially low export prices by legitimately and conservatively raising their own trade barriers – though not with Trump’s chaotic tariffs as the model.

Xi Jinping, in common with his predecessors, has been unable and unwilling to tackle seriously the structural inhibitors of continued growth. But unless that happens, and happens without producing chaos, China is likely to remain where it is now, a middle-income nation with mediocre performance and a people condemned to watch from afar as the bounty of state capitalism is enjoyed by a privileged, powerful elite – but never by them.