New Delhi: China’s heavy dependence on manufacturing is increasingly seen as a key vulnerability that could trap its economy at the middle-income level, and this risk is now being compounded by a deepening deflationary crisis.
For decades, manufacturing powered China’s rapid growth, lifting millions out of poverty and turning the country into the world’s factory. But as labor costs rise and global demand shifts, China’s competitive edge is eroding. Many multinational companies are moving production to lower-cost countries like Vietnam and India. This overreliance on manufacturing has left China exposed to global shocks, trade wars, and supply chain disruptions, while its domestic economy remains underdeveloped in higher-value services and innovation.
This structural imbalance is central to the so-called “middle income trap.” As countries get richer, they need to shift from low-cost manufacturing to more advanced industries and services. China, however, has struggled to make this leap. Its focus on state-led manufacturing, especially in heavy industry and technology hardware, has come at the expense of supporting private enterprise, boosting domestic consumption, and nurturing a vibrant service sector. The result is sluggish productivity growth and a lack of new engines for sustainable, high-income expansion.
Deflation is now making these problems worse. In 2025, China has recorded several consecutive months of falling consumer prices, with the Consumer Price Index (CPI) dropping 0.1 percent year-on-year in April, and the Producer Price Index (PPI) falling 2.7 percent—marking the 30th straight month of factory-gate price declines. This deflationary spiral is a sign of weak demand: as consumers and businesses expect prices to keep falling, they delay purchases, which further reduces demand and forces companies to cut prices even more. Lower prices squeeze company profits, discourage investment, and can lead to layoffs, all of which feed back into weaker consumption and slower growth.
The manufacturing sector is hit especially hard. With global trade tensions and tariffs reducing export orders, Chinese factories are left with excess capacity. To clear unsold goods, they must slash prices, deepening deflation and putting even more pressure on margins. Many small and medium-sized manufacturers are facing bankruptcy, and unemployment is rising in export-dependent regions.
Deflation also makes China’s transition out of the middle income trap even harder. Falling prices reduce business revenues and government tax collections, leaving less room for investment in education, healthcare, and innovation—precisely the areas China needs to develop to move up the value chain. At the same time, deflation increases the real burden of debt, making it riskier for companies and households to borrow and spend.
Despite calls for stronger stimulus, the government has been cautious, worried about adding to already high debt levels. As a result, policy support has been piecemeal, and confidence remains weak. Until China can rebalance its economy away from manufacturing and successfully tackle deflation, it risks being stuck in a cycle of slow growth and missed opportunities—hallmarks of the middle income trap.
