By Tanner Brown

China faces a number of conundrums, but none is greater than this: President Xi Jinping wants domestic consumption to drive the economy. And he wants the economy to grow 5% this year.

Those two goals look incompatible. Mountains of exports made the Chinese economic miracle of the last four decades, which brought millions out of poverty and served as a catalyst for global economic expansion. China shipped cars and phones and textiles around the world, mostly to the U.S. and Europe. Nearly everyone involved benefited. Times were good.

Those halcyon days are over. China's export engine is bloated at home and countries are refusing to import its goods for a range of reasons. The export part of the miracle is dead.

At the same time, leaders are grasping toward a GDP expansion rate of 5% for 2025. But this modest goal is being poked at from every direction.

China is cruising toward a U.S. trade war. Its youth are unemployed and disillusioned. The country is aging so quickly it will soon host a vast number of residents at its growing nursing homes -- if citizens can afford it, which they can't -- the Chinese Academy of Social Science says the pension system will be dry by 2035.

The mismanaged property sector -- which accounts for 70% of China's economy -- has been fizzling for years and draining with it trillions in middle-class savings.

China's vast population of consumers -- a billion customers -- could buy goods and services and light a white-hot spark that would thrust the economy into soaring overdrive. But they aren't spending. They are nervous about the political and economic environments. Everyone knows someone who's been ruined by the property meltdown.

"I don't think I've bought any new clothes in five years," said 29-year-old legal assistant Wu Lingyi.

Adam Wolfe, Emerging Markets Economist at Absolute Strategy Research, said "the level of real household income and consumption are both about 8% below their prepandemic trend lines."

Wolfe argues that -- rather than simply falling property prices or jittery savers -- the decline in returns on financial assets has been a key factor dragging down consumption.

This is apparent in the recent fall in bond yields, he said. "We estimate that the yield on the average household's financial assets slipped to 2% as of November 2024, down about 30 bps from a year prior and roughly half of the prepandemic level. This is likely to remain a constraint on income growth, especially for wealthier households, which account for a disproportionate share of consumption."

Beijing has reform options available to boost consumption, but they vary in financial and political viability. Structural reforms are needed to address the rural-urban divide, the precarious position of migrant workers, and the misallocation of capital by SOEs and banks.

"Many of these issues were recognized in China's 2013 reform agenda but have remained largely unaddressed due to political and financial constraints," analysts at the Rhodium Group said.

Substantial fiscal resources will be required as well. Tens of trillions of Chinese yuan -- likely around 30% of China's GDP -- would be needed to fund both one-time investments, such as social infrastructure and financial stabilization measures, and ongoing expenditures to support social transfers and public services, the group concluded.

Many argue that a major fiscal overhaul is unavoidable, including tax reform, reallocation of government spending, and more central government borrowing. In this case, local government incentives would need to be realigned to ensure that new fiscal resources are directed toward social spending rather than investment-driven growth.

While costly, these reforms are plausible. Beijing still has the space to raise fiscal deficits and tax revenue without destabilizing the economy.

"However, implementing these changes would be politically painful for entrenched interests and would shift costs to China's urban middle class, " Rhodium analysts said.

One bright spot: Xi's comments at a symposium with business executives, including Alibaba Group Holding co-founder Jack Ma, was viewed by analysts as a sign that Beijing wants to revive its economy and boost private sector confidence.

Meanwhile, Chinese businesses with exposure to the U.S. are bracing for layers of tariffs, fearing that they will have to raise prices at home and abroad. Liu Wendong's company has exported generators to the U.S. for more than 10 years. "They are calling this Trump 2.0. For us, it is just another American law pushing us against the wall," said the 49-year-old Shanghai resident.

"I think we should just be able to buy and sell, without all the politics," he told Barron's.

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February 19, 2025 02:00 ET (07:00 GMT)

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