China today presents a striking paradox. Its vast overseas investments and the enormous financing extended by its largest banks project an image of wealth, confidence, and financial resilience. Yet beneath this outward strength lies a far less reassuring reality. The real estate sector, once a pillar of growth, is faltering amid falling housing prices and developers’ diminishing capacity to complete projects. At the same time, local governments, burdened with debts exceeding $4 trillion, appear increasingly immobilized. Rather than signaling control and stability, these trends point to mounting fragility and disarray.
In many respects, China has become a dual economy. One face is prosperous and outward-looking; the other is deeply indebted and increasingly uncertain about the future. This tension is not accidental but the result of policy choices made in Beijing, particularly after the 2008 global financial crisis. As the export-driven growth model began to lose momentum, the central government pivoted toward domestic investment, especially in real estate and infrastructure. Responsibility for sustaining growth was effectively delegated to local governments and property developers, allowing Beijing to retain distance from the risks such a strategy entailed.
Local authorities complied. Yet the arrangement they entered into with developers, mutually advantageous in the short term, has proven corrosive over time. Since the 1994 fiscal reforms under Jiang Zemin, tax revenues have remained heavily centralized, leaving local governments with limited fiscal capacity. Tasked with delivering growth and public services, local officials turned to alternative, state-sanctioned mechanisms to raise funds. In doing so, they set in motion a gradual but persistent accumulation of risk.
Because formal budget deficits were tightly constrained, local governments created quasi-corporate financing vehicles through which they could borrow on capital markets. These funds were channeled into infrastructure projects that inflated GDP through sustained capital injections rather than underlying productivity gains. Meanwhile, although land in China cannot be sold outright, it can be leased. Local governments exploited this mechanism, granting land-use rights to developers who, in turn, fueled a construction boom, often producing underpopulated or “ghost” cities.
This system fostered a symbiotic but ultimately destructive relationship. Local officials benefited from rents and, at times, corruption tied to land allocation, while developers profited from high-margin projects built at relatively low cost. Each side reinforced the other’s expansion, but neither contributed to sustainable national wealth. As borrowing escalated to finance ever-larger projects, debt levels became untenable.
Today, that interdependence has turned from an engine of growth into a source of systemic risk. Local governments, weighed down by debt, can no longer support the very firms through which they once accessed financing. Local banks, themselves exposed, have struggled to extend further credit, forcing authorities into the position of rescuing both financial institutions and developers. As the public sector weakened, major real estate firms edged toward default, further eroding confidence.
The consequences are mutually reinforcing. Indebted developers are no longer able to pay for land leases, depriving local governments of a crucial revenue stream and widening fiscal gaps. Meanwhile, Beijing, having for years maintained a degree of distance from these dynamics, now confronts the deterioration of the very pillars that sustained China’s post-crisis growth model. Despite centralizing fiscal revenues, the government has invested relatively little in nationwide social protections, such as robust unemployment insurance or a comprehensive, high-quality health-care system. At the same time, it continues to back major state-owned banks and control the country’s most profitable enterprises, even as local governments, banks, and private developers struggle under mounting debt burdens.
The result is a political economy marked by deep internal imbalance. At the center, China appears wealthy and stable; at the periphery, it is strained and uneven. What emerges is not merely a contradiction but a structural duality, one that increasingly defines the country’s economic trajectory.
