Price wars, overcapacity and collapsing margins threaten to entrench deflation despite Beijing’s stimulus push
The world’s second-largest economy, China, is battling a silent crisis of prolonged deflation that few are openly discussing. China recorded zero consumer price inflation in 2025—its lowest in 16 years—even though December inflation ticked up to 0.8 per cent, driven largely by higher food costs rather than a broad-based recovery in demand.
The prolonged deflationary phase is emerging as a new headache for Xi Jinping led $19 trillion Chinese economy, despite aggressive policy push, the deflations seems to be a bigger problem
Economists and analysts believe that this underlying disinflationary phase is far entrenched than expected for China. Even the producer prices dipped 1.9 per cent in December, elongating the deflationary streak to 39 consecutive months. The deflationary phase is driven by persistent overcapacity across manufacturing, weak pricing power because of over competition, and a prolonged slump in property investment.
The ‘involution’ trap
China’s deflation problem has become a pain point for Xi Jinping. And at the heart of China’s deflation problem is a phenomenon which Bejing calls as involution- which is described as the race-to-the-bottom cycle in which companies tend to invest more , aggressively cut prices and work harder, yet earn less and are not that profitable.
The bottom of the problem lies in stimulus-driven factory expansion that made the industrial sector saddled with overcapacity. With overcapacity, Chinese producers are grappling with a situation in which too many producers chasing too few buyers, that leads to brutal price wars to stay afloat. This leads to a vicious cycle in which price wars leads to steeply falling margins of the companies that in turn aggrataves disinflationary pressure.
Simply put, when corporate profits fall, they have cascading effect on the economy. Falling profits leads to job cuts, wage pressure, which leads to depressed consumption, which eventually leads to more price cuts. This situation is labelled by the economists as deflation loop.
Acknowledging the threat of involution, the Chinese government launched an competition called as “anti-involution” campaign, to control the self-destructive competetion, to curb the price wars and accelerate the industry consolidation. In fact, Chinese regulators have asked electric-vehicle makers to halt aggressive discounting and are tightening capacity controls across manufacturing.
For Xi Jinping’s leadership, the challenge is stark: China’s deflation problem is no longer just about weak demand—it is now about breaking a deeply embedded economic model that rewards volume over value. And until that changes, the world’s second-largest economy may continue to struggle to escape its involution trap.
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