Diagnosing China’s Low-Demand, Low-Price Equilibrium: A Mathematical and Sectoral Breakdown, and Why Beijing’s External Posture is Shifting Toward India under Rising U.S. Pressure

 Analytical Conversations: From Trendlines to Thought Line

Diagnosing China’s Low-Demand, Low-Price Equilibrium: A Mathematical and Sectoral Breakdown, and Why Beijing’s External Posture is Shifting Toward India under Rising U.S. Pressure

 

Executive Summary (TL;DR)

China’s economy in 2024–25 faces a stubborn combination of weak consumption, contracting investment, and sectoral imbalances. Consumer price deflation (~−0.4% in August 2025) signals insufficient demand. Growth forecasts by multilateral agencies (IMF, World Bank) hover at 4.5–4.8%, underscoring a persistent slowdown compared with earlier double-digit booms. Property sector deleveraging, precautionary household savings, credit frictions, and aging demographics feed into this weak equilibrium.

A mathematical decomposition of GDP growth shows that small declines in consumption and investment can offset modest gains from fiscal spending and net exports, leaving aggregate growth subdued. The Phillips curve framework explains the persistence of deflationary pressures.

Sectoral breakdowns reveal:

• Property: the biggest drag on investment and household wealth.
• Manufacturing: squeezed between global demand uncertainty and domestic restructuring.
• Retail & Services: dampened by high savings and low consumer confidence.

Beijing has adopted targeted fiscal and credit interventions rather than massive stimulus, fearing leverage risks and external capital flight. Geopolitically, China is recalibrating: pursuing transactional commercial ties with India, recalculating its economic commitments to Pakistan’s CPEC, and navigating U.S. trade and technology pressure.

The policy challenge lies in lifting domestic demand sustainably while balancing geopolitical risks.

 

1. Key Macro Facts (Empirical Anchors)

• Consumer prices: Headline CPI turned negative in mid-2025. In August 2025, CPI was −0.4% year-on-year (TradingEconomics), consistent with deflationary pressures.
• Growth forecasts: IMF’s World Economic Outlook (2025) projects ~4.6–4.8% growth; World Bank’s June 2025 update echoes this trajectory, citing weak consumption and high uncertainty.
• Industrial/retail performance: Reuters (Sept 2025) reported a 0.9% rise in industrial profits (Jan–Aug 2025) with a rebound in August, yet retail sales and factory output remain below historic norms.

These three facts frame the entire analysis: deflation, muted growth, and uneven sectoral performance.

 

2. A Mathematical Diagnosis: GDP Decomposition and Demand Gap

2.1 Expenditure identity

 

Real GDP:

Y=C+I+G+(X−M)

Approximate growth decomposition:

ΔY≈sCΔC+sIΔI+sGΔG+sXΔX

where s⋅s_{\cdot}s⋅​ denote expenditure shares.

2.2 China’s expenditure structure

• sC≈0.40s_C \approx (consumption)
• sI≈0.35s_I \approx (investment)
• sG≈0.15s_G \approx (government)
• sNX≈0.10s_{NX} \ (net exports)

2.3 Numerical illustration

Suppose 2025 changes are:

• ΔC = 0% (flat consumption)
• ΔI = −1% (investment contraction)
• ΔG = +1% (modest fiscal expansion)
• Δ(X−M) = +0.5% (weak imports improve net exports)

Plugging in:

ΔY≈0.40(0)+0.35(−1)+0.15(1)+0.10(0.5)

This small negative aligns with real-world moderation from ~5% growth to mid-4%.

2.4 Demand gap and Phillips curve

Define output gap:

gt=Yt−Y∗g_t = Y_t - Y^*gt​=Yt​−Y∗

Inflation dynamics:

πt=πt−1+αgt+ϵt\pi_t = \pi_{t-1} + \alpha g_t + \epsilon_tπt​=πt−1​+αgt​+ϵt​

With gt<0g_t < 0gt​<0, inflation falls. China’s observed deflation (−0.4%) suggests a persistent negative gap, driven mainly by weak consumption and investment.

China’s economic structure can be explained through the lens of national income accounting. In simple terms, the total production of the economy—its gross domestic product—is made up of four major forces: household consumption, business and real estate investment, government expenditure, and the difference between exports and imports. Economists measure the change in GDP by observing how much each of these four parts expands or contracts, while also considering how large their share is in the overall economy.

Currently, household consumption in China accounts for less than half of total economic activity, roughly about two-fifths. Investment, particularly in infrastructure and real estate, forms about one-third. Government spending contributes close to one-sixth, while net exports provide the remaining share of around one-tenth. With such a structure, even a small decline in household spending or private investment can pull overall growth down significantly.

To illustrate this, imagine a scenario where household consumption remains flat, showing no increase from the previous year. At the same time, private investment falls slightly, say by around one percent. Meanwhile, the government increases its expenditure by about one percent, and net exports improve modestly by half a percent, largely because imports have weakened. When all these effects are combined, the decline in investment outweighs the positive contributions from government and exports, leaving the economy with negligible growth. This matches recent forecasts by international institutions that expect China’s growth to slip from around five percent to closer to four and a half percent.

Another important perspective is the idea of an “output gap.” This measures the distance between how much an economy is currently producing and how much it could produce if all its resources—workers, machines, and land—were fully employed. When actual production falls short of potential, the economy experiences slack. In such situations, businesses are unable to raise prices easily because demand is weak, while households cut back on spending. Economists call this the Phillips-curve effect: low demand puts downward pressure on prices, and if this continues, the economy may experience deflation. China is showing signs of exactly this trend—consumer prices in August 2025 were about half a percent lower than a year earlier, reflecting how demand weakness has spilled into falling prices.

 

3. Sectoral Anatomy

Property & Investment

• Once contributing ~25–30% of GDP (direct + indirect), property now drags growth.
• Developer defaults and presale collapses reduce both III and household wealth effects, dampening CCC.
• Local governments reliant on land sales face shrinking revenue, curbing fiscal capacity.

Manufacturing & Exports

• Industrial profits rebounded 0.9% (Reuters, 2025), but masks stress in consumer durables and export sectors.
• Trade restrictions on semiconductors and advanced manufacturing weigh on expectations.
• Export gains are uneven: EVs and green tech strong, traditional consumer goods weak.

Services & Retail

• Retail sales growth remains below 2% (2025, NBS data).
• Services sectors (hospitality, leisure) fail to recover strongly, suggesting households prefer saving.

 

4. Transmission Channels

4.1 Household precautionary savings

C=(1−s)YC = (1 - s)YC=(1−s)Y

If saving rate sss rises from 35% to 37%, consumption share falls ~2 percentage points of GDP. This alone can drag growth by ~0.8 percentage points.

4.2 Banking system

• Risk aversion toward property developers and LGFVs curtails lending.
• Credit growth flows mainly to “strategic” industries, not households or SMEs.

4.3 Demographics

• Working-age population peaked in 2015; dependency ratios rising.
• Potential output Y∗Y^*Y∗ slowing, meaning even small demand shocks can push CPI negative.

 

5. Policy Toolkit

Tools deployed

• Targeted fiscal spending (urban renovation, green projects).
• Tax relief for SMEs.
• Vouchers in select provinces to stimulate service demand.
• Regulatory easing for some property projects.

Constraints

• Broad stimulus risks re-leveraging property.
• External trade friction reduces fiscal multiplier.
• Currency stability constrains monetary easing.

Result: surgical, micro-targeted interventions.

 

6. Geopolitical–Economic Angle

6.1 China and India

• Bilateral trade ~US$120bn (2024), with China exporting electronics, machinery; India exporting iron ore, cotton.
• China sees India as:
• Large consumer market.
• Supply-chain diversification node (hedging against U.S. tariffs).
• Engagement remains transactional — business-driven, not strategic alignment.

6.2 China and Pakistan

• CPEC: >US$60bn pledged; yet security risks, political instability, and debt service concerns slow implementation.
• Shift from mega-infrastructure toward green/renewable projects with clearer revenue models.
• Interpretation: not abandonment, but recalibration for financial sustainability.

6.3 U.S. pressure

• Tariffs and export controls on semiconductors, AI, telecom equipment.
• Raises uncertainty premium for Chinese firms, dampens investment III.
• Pushes Beijing to double down on self-reliance while diversifying trade ties (India, ASEAN, Africa).

 

7. Scenarios and Benchmarks

Scenario A: Gentle Recovery (Base Case)

• ΔC = +2%, ΔI = +1%, ΔG = +1%.
• Growth: 4.8–5.0%. Inflation returns to ~+0.5%.

Scenario B: Stagnation

• ΔC = 0%, ΔI = −2%, exports flat.
• Growth <4%. CPI negative for 6+ quarters.

Scenario C: Big Stimulus

• Fiscal expansion 3–4% of GDP.
• Growth near 6%, but debt/GDP rises and RMB depreciation risk.

Benchmarks for policymakers:

• Household consumption growth >3% yoy.
• CPI must revert >0% within 4 quarters.
• Property completion rate >90% for presold units (to restore confidence).

 

8. Policy Recommendations

1. Targeted consumption vouchers: If each 0.5% of GDP program raises ΔC by 1%, GDP growth lifts ~0.4pp.
2. Property confidence via completion guarantees: escrow + delivery assurance restores household wealth effect.
3. SME loan guarantees: partial risk-sharing can lift investment without broad credit loosening.
4. Multilateral engagement: reduce tariff risks via regional trade pacts.
5. Geoeconomic diplomacy:
• Treat India as complementary partner in trade + supply chains.
• Reframe Pakistan projects toward bankable, green ventures.
• Balance U.S. pressure by accelerating tech self-reliance.

 

Conclusion

China’s economy in 2025 is not collapsing but stuck in a low-demand, low-price equilibrium. GDP arithmetic shows even modest declines in consumption and investment outweigh gains elsewhere. The Phillips curve framework explains why deflation persists.

Externally, Beijing’s recalibration reflects pragmatism: leaning toward Indian commerce, tightening project viability in Pakistan, and responding to U.S. restrictions with diversification. The path forward requires confidence restoration at home (property, consumption) and strategic engagement abroad (India for markets, Pakistan for stability, U.S. for containment).

The challenge is to engineer sustainable demand growth without repeating the debt-driven cycles of the past. Micro-targeted fiscal support, credible property measures, and SME investment support remain the best levers.

 

References

1. TradingEconomics. China Inflation Rate (CPI), August 2025.
2. IMF. World Economic Outlook, Country Data: China, 2025 projections.
3. World Bank. China Economic Update, June 2025.
4. Reuters. China’s industrial profits rise 0.9% in Jan–Aug 2025, September 2025.
5. China Briefing. China–India Trade Data and Trends, 2024–25.
6. Carnegie Endowment. India–China Economic Ties: Determinants and Possibilities, August 2025.
7. Wikipedia. China–Pakistan Economic Corridor (CPEC).
8. Council on Foreign Relations. U.S. Export Controls and Trade Restrictions on China, 2024–25.

Case-Cum-Story: The Numbers Behind China’s Slowdown

In 2025, Professor Li, an economics lecturer in Beijing, decided to explain China’s slowdown to his students through a real-life example. He began by drawing the basic GDP formula on the board:

Y=C+I+G+(X−M)

“Think of this like a family budget,” he said. “Household consumption is what families spend daily, investment is what businesses and real estate developers put into new projects, government spending is like community welfare, and net exports are what we sell to the world minus what we buy from it.”

The class nodded. To make it clearer, Li created a simplified snapshot of China’s economy:

• Household consumption (CCC) = 40% of GDP
• Investment (III) = 30%
• Government spending (GGG) = 20%
• Net exports (X−MX - MX−M) = 10%

He then asked: “What happens if households stop increasing their spending because they are worried about job security? Suppose consumption growth is zero. At the same time, investment in real estate shrinks by 1%. The government tries to help, increasing its spending by 1%. Meanwhile, net exports rise slightly, by half a percent, because imports are weak.”

Using the weighted growth contribution formula, he showed the calculation:

ΔY=(0.40×0%)+(0.30×−1%)+(0.20×1%)+(0.10×0.5%) -

“See,” Professor Li explained, “even with the government spending more and exports giving a small boost, the fall in investment drags the entire economy close to zero growth.”

Then he connected it to the output gap:

Output Gap=Y−Y∗Y∗\text{Output Gap} = \frac{Y - Y^*}{Y^*} ​

China’s actual GDP growth was 4.5%, while potential GDP was estimated at 6%. That meant the economy was running below capacity:

4.5−66=−0.25  or  −25%\frac{4.5 - 6}{6} = -0.25

“This negative gap,” Li said, “creates slack. Factories stand idle, and workers cannot find jobs.”

Finally, he drew the Phillips Curve:

πt=πt−1−α(ut−u∗)+εt\pi_t = \pi_{t-1} - \alpha (u_t - u^*) + \varepsilon_tπt​=πt−1​−α(ut​−u∗)+εt​

He explained that unemployment had risen slightly above the natural rate. “That’s why consumer prices in August 2025 were 0.5% lower than last year. Weak demand pushes inflation downward, sometimes even into deflation.”

The students suddenly realized the link: behind the abstract formulas were real stories of families cutting spending, construction projects stalling, and shops lowering prices to attract hesitant customers.

Professor Li closed the lecture: “Economics is not just numbers; it’s about people. When investment falls, jobs vanish. When households lose confidence, spending stops. The formulas simply show us the chain reaction.”