China’s unstable domestic outlook: Geopolitical instability forces China to tackle barriers to creating a single market

Since the release of the Five-Year Plan, China’s government has increased its efforts to curb local protectionism and create a single national market in order to give a boost to domestic demand and its lagging economic growth. China’s export-dependent model leaves it exposed to weak global demand and foreign policy decisions – constituting a central risk for its leaders.

At the national level, China’s export dependency reflects a structural imbalance in which investment-driven industrial policy expands production capacity faster than domestic demand can absorb it, pushing excess output into export markets. But China’s fragmented political economy is an equally important driver. Provinces and cities protect their local firms through subsidies, tax breaks, weak regulation and informal barriers. This keeps inefficient firms alive, drives price wars and prevents capital, labor and demand from moving across the country. Local governments often support weaker producers to protect growth, jobs and tax revenue, rather than letting them exit or merge. The result is excess production in sectors such as metal, chemical and automotive, making many domestic firms unprofitable while creating unfair competition conditions abroad. In the auto sector, for example, capacity utilization at Chinese car plants fell to an average of 50 percent in 2024, its lowest level in a decade, illustrating how excess production capacity is squeezing profitability at home while pushing firms to seek demand abroad. 

Shifting from policy exhortation to enforcement and institutionalization, the government launched a May–December special campaign against market-fragmentation barriers on May 13. The next day, the State Council released its annual legislative plan, which includes formulating regulations on the construction of a unified national market.

If these measures cannot tackle the barriers to a single market, the dependence on export-driven growth may continue without enough external demand to meet the supply. This will negatively affect China’s manufacturing industries with a major knock-on effect for employment, tax revenue and fiscal spending on social services. This would compound current issues like unemployment, regional inequalities and current AI-driven workforce shifts, all risks to China’s social stability. 

Whereas, if the government manages to halt local protectionism in sectors like EVs and other sectors where Western firms compete, it could eradicate many zombie firms, ease pressures and gradually increase domestic demand. It is perfectly possible that Beijing may allow local governments to continue propping up firms overproducing in other sectors to maintain employment. Muddling through could be good enough and is the likely scenario. Doing so would portray Beijing as attempting to curb overcapacities and could help avoid the more punitive reactions from foreign governments. 

Domestically, the gradual and partial approach would buy time for some of these firms to become more competitive, and at the same time prevent simultaneous market exit of firms and related mass layoffs, maintaining relative societal stability. The risk for Europe is clear. It would continue to act as the outlet for overcapacities supported by local protectionism, as European industry is already finding out, and therefore is in its best interests to support Beijing’s efforts to eradicate local protectionism and build a single market.