Whilst Britain’s Labour government continues its war on the price mechanism, Communist China wrestles with the ill effects of an extreme capitalist competition that it has unleashed across its own economy. State subsidies to various industries have encouraged such fierce price wars that margins have disappeared as quickly as protesters in Tiananmen Square, and left a glut of products unable to be absorbed by domestic consumers.
Bulldozing through all normal market mechanisms has led to huge problems in the Chinese economy
This is ‘Nei-juan’, the economic phenomenon that is wreaking havoc across China, but is almost unheard of outside the Middle Kingdom. This needs to change, because the Chinese Communist Party’s (CCP) attempts to deal with this crisis will have enormous repercussions on the global economy and on the great power rivalry between the US and China.
Literally ‘curling inwards’, nei-juan is instead often translated as ‘involution’. Originally a term used to describe agricultural economies that fail to translate more work into higher productivity, involution was picked as a term by the growing Chinese middle class to describe the horrors of the 21st century rat race. This first looked like intense 7-days-a-week work, exam preparation (‘gaokao’) for students that is so intense that images have been shared of pupils attached to IV drips so as not to break their studying, and the general demoralising effect of working ever harder for ever less.
From there, the term developed to encompass big macro-economic trends in China. Ever since the ‘opening up’ of the economy in the 1980s, there has been an embrace of market mechanisms that seem utterly heretical to the pure Communist ideology of earlier generations. Under Xi Jinping, however, the undoubted surpluses and growth only possible under a market economy have been ever more co-opted back to serving the political ends of the ruling Communist Party.
I asked senior party officials about this last month during a visit to the Communist Party School in Beijing. They told me that Adam Smith was a genius, and that The Wealth of Nations was prescribed reading to party cadres, because ‘only the market can create wealth sufficient for countries to develop’. But, in a surreal and contradictory attempt at wordplay, I was told that the Chinese economy was guided both by the invisible hand of the market and the ‘invisible hand of the state’.
This approach has been more of an invisible fist, clobbering free exchange with public money in subsidies and grants into targeted areas of the economy, at both the national and provincial levels. Private businesses have been compelled to wage crippling price wars, desperately eking out advantages and cutting margins in an attempt to win domestic market share across a swathe of these new industries (compelled less by the profit motive than the terror of failing before the eyes of Party bosses). It is a sort of perfect storm of the ruthless creative destruction caused by capitalism as described by Joseph Schumpeter, and the worst effects of centrally planned economies.
The result has been a mixed blessing. It is clearly achieving one goal of the CCP, to push the economy up the value chain from cheap goods to high-end manufacturing. Look at the leapfrogging that Chinese firms have achieved in electric vehicles, photovoltaics and many consumer gadgets over their Western competitors.
But on the flipside, bulldozing through all normal market mechanisms has led, unsurprisingly, to huge problems in the Chinese economy. Combined with the property market crash in 2021, there is not nearly enough domestic demand for all of the goods created through subsidies and distorted markets.
This has led to the longest period of deflation in decades, and combines with decreasing returns on investment that has led many to describe the Chinese economy as undergoing ‘Japanification’. The classical solution would be to unspool these bad investments and allow a ‘correction’. That would unfortunately likely lead to higher unemployment and debt defaulting as reality reasserts. This often means the end of elected governments in the West; but the CCP fears that the scale of such economic damage could present an existential risk to the Party itself.
So the show must go on. Sounding like my dad bemoaning that Britain ‘doesn’t make anything anymore’, Xi and the official Party journal has called for even greater investment in the ‘real’ economy. In the latest edition of the Party’s official ‘theoretical journal and news magazine’, Qiushi, published this week, an article curated quotes by Xi himself acknowledging the problems of involution.
But instead of unspooling the subsidies and allowing real market realities to reassert, its response is typical of a planned economy – it will meddle even more to fix things. The 15th 5-year plan (2026-2030) calls for more investment and development in a group of new growth sectors, including new-generation information technology, artificial intelligence, biotechnology, energy, material science, high-end equipment and green industry.
As recently as a meeting with the European Union (EU) in May 2024, Xi had refused to acknowledge involution was real. He argued that there was ‘no such thing as China’s overcapacity problem’. China’s ability to undercut rivals across a plethora of sectors was instead due, according to Xi, to its ‘comparative advantage’. No wonder the EU deployed the phrase ‘derisking’ to describe its future relationship with the People’s Republic around the same time.
The admission of the problem, coming just after the visit of Donald Trump and his gaggle of US business CEOs, is a fascinating development. The raising of tariffs and other barriers against China is, in no small part, to prevent this glut of products being dumped into the American market. So too, is the increasingly protectionist tone that the EU has made for like purpose.
It doesn’t look like the Party will be either willing or able to stop involution. For Britain and the rest of the world this means more dumping, of impressive, very cheap goods and all the knock-on hurt to domestic industries that will cause. I recently got into an argument with my wife in Currys when I insisted on buying a South Korean washing machine, even though the (wifi-enabled) Chinese models were just as good and literally half the price.
Just as water finds a way downstream, so too will these Chinese goods find their way around the world. Exports climbed last year, accounting for a third of official Chinese economic growth. These exports, blocked from America and increasingly Europe, are finding their way to the developing world, potentially swallowing up those markets and preventing Western firms from getting footholds in these new technologies. This could further ramp up tensions between the US, Europe and China.
I don’t doubt that there are those in the CCP’s military planning arena who would be delighted to see the domestic industries of the West splutter. After all, American military productive power in the Second World War came in no small part from industry that was originally civilian in intent (cereal company General Mills made torpedoes, and the Lionel Toy Train company provided equipment for warships). They might continue to convince the leadership that the domestic pain is worth it for the prize of debilitating productive capacity overseas. This would only store up further economic pain at home.
Regardless, British politics needs to pay much closer attention to what is happening inside the Middle Kingdom. Miscalculations about China’s behaviour, from its grand strategy to macroeconomics, and Britain bungling its response, could prove even more fatal than a new Labour leader to our economy.
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