Ten challenges facing China’s economy

Depending on how it is measured, China’s economy is now the world’s largest or second largest. It is also the world’s second-most intertwined in terms of trade relationships, after the European Union, and is a major investor and lender in the emerging world. Understanding where China is heading is important for the whole world. This requires an assessment of both China’s strengths – and also the challenges it faces, of which ten can be highlighted.According to Chinese policymakers, the economic outlook is positive, despite the trade war ignited by President Donald Trump, and China’s growth target has been kept at 5 percent. However, to reach that level in 2024, China needed a massive $1 trillion trade surplus. Chinese trade is now threatened by a more protectionist external environment.Laxer fiscal policies have seen the official deficit eased from 3 percent to 4 percent of GDP, the largest on record, and a less strict monetary policy. However, no stimulus has been announced – a rather conservative response to the external environment. Meanwhile, China’s inflation target has been cut from 3 percent to 2 percent1, but the reality is that China is already suffering from entrenched deflation, which the government does not seem ready to fight.This may be because of the need to remain competitive in export markets, even at the cost of a deflationary environment. Export prices fell in 2024 and have continued to fall in 2025. Even consumer prices in China have fallen since February 2025. While pushing prices down to compete is not without risk (Japan’s experience in the 1990s is a good example; García-Herrero and Xu, 2025), President Trump’s tariffs and the ongoing weakness of the dollar do not leave China much space.China has also confirmed it will continue to step up manufacturing as a growth engine – there is no intention of correcting overcapacity by reducing supply. Because the increase in the fiscal deficit seems directed at supporting the debt restructuring of local governments rather than boosting domestic consumption, and because China’s labour market remains weak and disposable income stagnant, Chinese consumption cannot be expected to jump substantially in 2025.  China will thus need to continue to force exports to reduce overcapacity.For Europe these trends are worrying because Chinese products may further flood the European market and because European companies in China will face even more competition from Chinese players, given the strong deflationary pressure.China also intends to step up self-reliance in critical technologies, including artificial intelligence (AI), quantum computing and semiconductors – areas in which China still lags the US (García-Herrero et al, 2025). Large-scale US investment programmes such as the Stargate AI project2 have pushed Beijing to channel more resources to AI and quantum3, with China looking much more credible after the launch of the DeepSeek AI platform in January 2025 (Martens, 2025).Will it work? China’s 10 economic challengesWhether China’s strategy will re-ignite its economy or mitigate its structural deceleration, will depend on the extent to which the responses tackle China’s ten biggest challenges. *This is a reprint of Bruegel article. /analysis/ten-challenges-facing-chinas-economy