"China’s rapid economic transformation to become the world’s second-largest economy is inextricably linked to its investment-led growth model. This investment has been financed by high levels of domestic savings resulting from a number of government policies.[1] These savings have been channelled into a financial system that has provided highly-subsidised lending for infrastructure, manufacturing and real estate investment. As a result, China has achieved high rates of economic growth by ramping up its level of investment faster than most other countries at a similar level of development (Chart 1, panel a).[2]Nevertheless, this investment-led growth model is coming under increasing pressure. First, diminishing rates of return imply that it is becoming more difficult to generate growth from one additional unit of investment, and some observers believe that China has long passed the point at which it can productively absorb these high rates of investment. Second, a policy-driven severe downturn in China’s property sector, which accounted for about 30% of GDP before the real estate downturn in 2021, is set to sustainably diminish this major pillar of domestic demand. Third, external demand is also shrinking, as trade tensions are increasing and a rising number of trading partners are unwilling to further accommodate higher trade deficits with China. More generally, structural challenges, including an ageing population and low productivity growth, are adding to the headwinds faced by China’s economy. In response to these challenges, China’s government is redoubling its efforts to spur growth through investment-centric policies.
This additional push to boost investment appears to be driven almost exclusively by the state-owned sector, whereas fixed asset investment by the private sector has stalled since the onset of the housing crisis in 2021 (Chart 1, panel b). Government policies to expand output in the face of slowing demand have potential implications for China’s trading partners. A supply-driven expansion of production could materially affect trade prices and hence inflation in their economies. The shift towards manufacturing previously-imported advanced goods is designed to enhance China’s self-reliance, thereby reducing the import intensity of its growth while shifting competitiveness and trade balances in relation to its trading partners."
