How China is fighting ‘involution’, with Yanmei Xie

Episode Summary

Executive Summary: The episode examines China’s growth model: weak domestic demand, persistent deflation, and intense price competition are driving a wave of supply expansion and exports. Yan Mei Xia argues Beijing prioritizes managing internal supply-demand imbalances and industrial upgrading over reducing external surpluses, using supply-side tools, consolidation, and tighter control of local investment rather than broad consumption stimulus.

Main Topics: China’s internal imbalance and weak demand (Priority: 5/5): The conversation opens with China’s economy as unbalanced: weak household demand coexisting with aggressive production and export growth. Yan Mei Xia says Beijing cares more about internal supply-demand gaps than external trade imbalances. Consumption vs domestic demand in China (Priority: 5/5): Yan clarifies that Chinese officials often mean expanding 'domestic demand,' which includes investment, not a Western-style shift to household consumption. Stimulus is still oriented toward production and manufacturing. Deflation, falling profits, and price wars (Priority: 5/5): The discussion highlights entrenched deflation, declining corporate margins, and destructive price competition, especially in autos. These pressures have prompted official concern and interventions to prevent further downward pricing spirals. Anti-involution campaign and overcapacity (Priority: 5/5): 'Involution' is used to describe self-consuming competition where firms slash prices, overinvest, and survive on subsidies or credit. Beijing’s anti-involution measures aim to slow entry, encourage consolidation, and centralize investment control. Local government incentives and politicized investment (Priority: 4/5): Local officials are motivated to preserve jobs, tax revenue, GDP growth, and career prospects, so they keep weak firms alive and continue subsidizing favored industries. This makes market exit and reallocation difficult. Global spillovers and the 'reverse Deng' idea (Priority: 4/5): China’s surplus production is pushing exports abroad, raising fears of industrial damage in Europe and the US. Some Western policymakers want to emulate China’s technology-transfer playbook, but Yan is skeptical it can work under Western cost structures. China’s emerging policy shift (Priority: 3/5): Yan sees a limited but real shift in party language: the next phase may give more balanced attention to both supply and consumption, though the state still prefers supply-led solutions and industrial steering.

Key Arguments: Chinese leadership ranks reducing external trade imbalances very low; the real priority is managing internal supply-demand mismatch while still using surplus production to support growth and industrial upgrading. The party does not want a pure consumption-led economy. It treats investment, manufacturing, infrastructure, and capital spending as part of 'domestic demand.' Consumer vouchers and appliance trade-ins are not pure cash stimulus; they are also a way to support factory production and steer spending toward politically preferred sectors. Beijing believes consumption should be stimulated mainly through better supply—higher-quality products, logistics, and infrastructure—rather than large unrestricted cash transfers. Deflation and low profits are economy-wide problems, not limited to one or two sectors. Price wars, especially in cars, show that firms lack pricing power because aggregate demand is weak. Local governments subsidize and protect firms because shutdowns mean job losses, tax losses, GDP damage, and worse promotion prospects for officials. 'Involution' captures a self-destructive race to the bottom: firms overbuild capacity, duplicate industries, and cut prices below cost to survive or gain share. Current anti-involution policies focus on supply-side controls: slowing new entry, encouraging mergers and consolidation, and constraining local subsidy autonomy. The state is more comfortable managing production outcomes than fixing the underlying incentives that create overcapacity in the first place. Western 'reverse Deng' strategies misunderstand China’s model because China paired foreign investment with selective protection and because Western producers face structurally higher costs. Chinese exports keep rising, but reduced access to the US forces firms into lower-price alternative markets, which may intensify China’s domestic deflation. There are signs of a mild policy shift: officials may be putting slightly more emphasis on consumption alongside supply, but the change remains limited.

Data Points: Priority of reducing external trade imbalances: 1/10 - Yan Mei Xia says this is low on China’s policy agenda compared with internal supply-demand issues. Growth target for local officials: around 5% - Used to explain why local governments keep investing even when sectors are weak. Corporate profit margins: 4th year of decline - Evidence of persistent weakness in China’s industrial economy. Car sector price war duration: 3–4 years - Industry-wide competition has driven prices and margins down for several years. Below-cost selling: a large number of car manufacturers - Survey cited to show severity of price wars in autos. AI plan rollout: August last year - Central government issued the AI Plus Action Plan, which triggered local duplication and subsidies. RD tax rebate: as high as 100% - State support for research and development in strategic sectors. Steel overcapacity episode: 2015–2016 - Historical comparison showing earlier overcapacity was easier to solve because it was concentrated in SOEs and demand later recovered. Direct exports from China to the US: plunged - Yan argues export rerouting to other markets is lowering pricing power and deepening deflation.

Pivotal Quotes: "Perhaps it's more concerned about solving this internal supply-demand gap." — Yan Mei Xia: On why external trade imbalance is not a top priority for Chinese policymakers. "The party wants to control the structure of the economy, right? So it's repeatedly stressed that the economy has to be led by the real economy, meaning manufacturing." — Yan Mei Xia: Explaining why stimulus and consumption policy are still tied to industrial production. "This idea of companies just cutting prices, sometimes below cost, in order to stay in the market." — Yan Mei Xia: Defining 'involution' as destructive competition across Chinese industries.

Implications: China is likely to keep using supply-side controls and industrial policy to manage deflation and overcapacity, while exports absorb excess production. That may preserve growth, but it risks prolonging weak pricing power, global trade tensions, and repeated overinvestment in favored sectors.