China’s economy hits a fork in the road

The rise of China as a tech superpower over the past decade or so is truly remarkable. As is its transformation since 1978 from a dirt-poor country to the world’s second largest economy.

But today, the Chinese economy has reached a fork in the road. The previous economic model has run its course. Productivity growth has slowed significantly. Reforms have stalled. And economic growth has ground to a virtual halt. The IMF has called for a new growth model.

What to make of this imbroglio?

Rise of high-tech China

China is now challenging the US and other Western countries in the production of electric vehicles, solar panels, drones, batteries, and is even trying to challenge the US in the production of semiconductors and artificial intelligence (AI).

China’s high-tech ambitions were most famously promulgated in 2015 in “Made in China 2025”, a national strategic plan and industrial policy. China aims to upgrade its industries, from a labor-intensive workshop into a more technology-intensive powerhouse with more value added and help achieve independence from foreign suppliers.

China’s 15th Five-Year Plan (2026–2030) reiterated the call for cutting-edge tech innovation, including AI, advanced manufacturing, robotics, quantum computing, and biomanufacturing. With the aim of technological self-reliance, it focuses on semiconductors, industrial machine tools, and core software.

China has been very successful in pursuing its tech ambitions according to Rebecca Fannin. China’s leading tech companies are no longer the copycats of yesteryear. According to the Critical Technology Tracker of the Australian Strategic Policy Institute, China has a clear lead in its global share of high-impact research output. China now leads in 66 of the 74 technologies tracked, with the US leading in the remaining eight. China would be the world’s 10th most innovative country, according to the Global Innovation Index 2026.

Geopolitics of high-tech China

Great power rivalry with the US, and the modernisation of China’s military, has motivated China’s investment in high tech. Another national security goal is eliminating technological dependence on the US, particularly for semiconductors, AI, and advanced manufacturing – along with insulating the domestic economy from foreign sanctions.

China's technology is key for the country’s surveillance state by which it controls its population. Technology can also help offset the adverse effects of China’s rapidly ageing population on the economy.

In sum, China’s tech ambitions are evidence that Chinese policy is motivated by national security priorities, more than economic efficiency and prosperity.

China’s rise as a tech power benefited from close collaboration with Silicon Valley. But this partnership came to grief as US–China competition intensified. The US has been trying to contain China’s rise as a tech powerhouse and curb its influence by cracking down on Silicon Valley’s investments in China and imposing manifold barriers to imports like semiconductors and other high-tech components. The Americans are also pushing back against state-backed subsidies, cybertheft of intellectual property, and forced technology transfers.

High-tech, weak productivity China

Technology has traditionally played a key role in economic growth, especially in the US, the world’s technology leader over the past 150 years. To what extent has China’s high-tech tilt over the past decade lifted China’s economy?

China's economic statistics are notoriously unreliable, as confirmed by former Chinese Premier, Li Keqiang. Thus official assertions that the Chinese economy would have been growing in the 4.5-5.0 percent range in recent years should be taken with a grain of salt.

A more reliable indicator comes from the Rhodium Group, an independent research provider, which estimates that the actual Chinese economic growth rate in 2024 and 2025 would be about half the official estimate of around 4-5 percent. If the Chinese economy was really growing at 5 percent, there would in fact be no need for a book like the IMF volume, and its discussion of China’s challenges.

Even more concerning are the Rhodium Group estimates that China's economic growth right now is somewhere between minus 1% and plus 1% annualised on GDP growth (that is around zero). And that's not temporary. It's basically the new trend potential growth rate unless they deal with its structural problems.

What’s the problem?

After the kickoff of reforms in 1978, China experienced rapid growth in productivity, helping fuel its historic economic expansion. But then China’s productivity growth peaked before the global financial crisis, and has been trending downwards since 2007 – as reforms have slowed and the government relied on increasingly inefficient investment to stoke the economy. This weighs on China’s growth potential and compounds the impact of the shrinking labor force due its ageing population.

Industry policy undermines productivity

A core part of China’s economic strategy has been industry policy – meaning subsidies and regulations – to promote strategically important economic sectors, mainly for manufacturing, with semiconductors, high-tech manufacturing, and automobiles benefiting the most.

However the IMF estimates that industrial policy imposed a fiscal cost of about 4 percent of GDP annually over 2013–23. Industry policy hit total factor productivity by about 1.2 percent, including by resource misallocation as less efficient industries are favoured. If China is serious about increasing productivity, it should scale back industrial policy.

China now spends more on research and development (R&D) than any country besides the US and files more patents than any other country. Shouldn’t that provide a fillip to China’s productivity? According to the IMF, China’s patents appear to have been of lower average quality and economic value, compared with those of advanced economies.

The IMF also argues that innovation has not translated into higher productivity growth in China due to declining business dynamism and the
key role played by generally less productive state-owned enterprises. Older and state-owned firms often benefit from preferential access to credit and face limited competitive pressures.

China’s deep challenges

Beyond China’s sometimes ill-conceived obsession with high technology, China faces some deep and perhaps intractable challenges.

China’s extraordinary economic rise over the past four decades was driven by market-oriented reforms and integration into global value chains. But according to the IMF, China has reached a fork in the road.

Many of the factors that drove China’s remarkable ascent are reaching their limit. The country now faces manifold challenges – a still unresolved real estate crisis; diminishing returns on investment and mounting public debt; weak domestic demand; ageing population; poor productivity; excessive reliance on exports which is stoking protectionist pressures; and geopolitical tensions.

According to the IMF, China must embark on a new growth model, one driven by consumption, services, and productivity gains – underpinned by deep and ambitious structural reforms. The Chinese authorities recognise the challenges, as reflected in China's 15th Five-Year Plan (2026–2030).

But the IMF seems to doubt the Chinese government’s resolve when it says these challenges require not a minor adjustment, but a “comprehensive rethink” of China's growth model. Further, the government has made promoting consumption a priority, consistent with the IMF’s policy advice, but there are very few concrete measures or metrics behind it.

Most worryingly this IMF report is very similar to many previous reports that were not acted upon by the Chinese government. The IMF makes a very strong case that China’s economic predicament is more serious than ever. But it is difficult to believe that China will take it seriously.

What China needs

In sum, China needs a reincarnation of Zhu Rongji, China's premier from 1998 to 2003. He led major reforms that transformed China into a global economic and trading powerhouse, and achieved membership of the World Trade Organisation. But there is little hope of that in Xi Jinping’s China. As the IMF reports, under Xi’s watch economic reforms were suspended and reversed in most cases between 2013 and 2018.

Part of the problem is that Xi’s regime sees “regime security” as being a more important policy priority than economic efficiency and prosperity. In reality, however, economic stagnation can be a greater threat to regime security than any disturbance caused by structural reform. Indeed, the failure to get serious about reform is stopping China from realising the enormous catchup potential of a country whose GDP per capita is only 16 percent of that of the US.