China's economy stood at a critical juncture of transformation. Exports, investment and consumption —its three key drivers of economic growth —faced dual pressures. Externally, escalating trade frictions and decoupling risks have intensified uncertainty in foreign trade. Internally, the return on traditional investments diminished, while technology-driven investments remained underdeveloped. Persistently low consumer price index (CPI) figures reflected weakening consumer confidence, shaped by uncertainties and unclear income prospects. In 2024, China's consumption rate stood at merely 56.6%, nearly 20 percentage points below the 70% to 80% average seen in developed economies.

Sheng Songcheng, professor of economics and finance at China Europe International Business School (CEIBS) said, "At this stage, expanding domestic demand represents an effective countermeasure against external shocks. Stimulating consumption will more effectively achieve demand stability and economic growth."

Linking consumption to long-term growth

Sheng saw substantial growth potential in China's consumption market. Firstly, consumption remains intrinsically linked to economic growth. International patterns show that as per capita gross domestic product (GDP) and disposable income rise, consumption rates also increase. With China's current per capita GDP at approximately $13,000 – well below major developed economies – significant catch-up potential exists.

Second, consumption is closely linked to income distribution. World Bank data showed that China's per capita GDP in 2023 was roughly equivalent to that of developed countries in the 1980s. "Our calculations show that, at comparable income levels, developed economies recorded an average consumption rate of 73% – far exceeding China's 56%. This suggests certain factors constrain China's consumption potential, notably imperfections in the income distribution system," Sheng said.

This year's Report on the Work of the Government（2025）called for "vigorously stimulating consumption, enhancing investment efficiency and comprehensively expanding domestic demand," while the April 2025 Politburo meeting emphasised "consumption's role in driving economic growth."

Sheng said consumption will play an amplified role this year, noting that it reinforces—not opposes—investment by driving production, employment and investment. While early growth relied on high savings and investment, diminishing returns now pose a challenge. “Stimulating consumption is no longer just a short-term tool for managing aggregate demand and spurring growth. In this era,  consumption plays a more vital mission—continuously generating emerging, diverse, high-tier consumption demands that guide high-quality, efficient investment. We must recognise that while ineffective investment exists, ineffective consumption does not."

Boosting household spending through redistribution

China's consumption stimulus policies supported modest recovery. From January to May 2025, total retail sales grew 5.0% year-on-year (YoY), with May alone up 6.4%. Sheng attributed this to measures such as consumer goods trade-in programmes and consumption vouchers." However, he cautioned: "The endogenous momentum for sustained consumption recovery remained weak, conspicuously reflected in persistently low price levels. In May, terminal consumption prices fell 0.1% YoY and 0.2% month-on-month, while January to May CPI down 0.1%. Enhancing household consumption propensity is crucial, and improving redistribution may be pivotal in resolving these contradictions."

Sheng said that strengthening household purchasing power required better redistribution. While often associated with equity, redistribution at China's current development stage could also influence consumption and consequently, economic growth. He pointed out that households received a disproportionately low share of disposable income, partly due to flawed redistribution– where household expenditure exceeds income during transfer payments. There is substantial scope to increase social welfare expenditure. Hence, targeted policies must optimise redistribution to boost consumption and economic growth.

Sheng said, "China's high household savings rate presented an opportunity. Transferring portions of deposits into personal pension accounts could expand pension contributions without affecting immediate household cash flow, thereby, elevating overall pension replacement rates and boosting current consumption. He suggested amplifying tax incentives for personal pension accounts to encourage uptake while refining fund manager incentives to enhance product stability and returns. Linking pension accounts to services—such as care and healthcare with matching contribution scales – could also motivate enterprises to expand service supply innovatively, according to market principles."

Tripartite reform approach to stimulate consumption

Sheng prescribed a tripartite reform approach focused on tax, services and local fiscal incentives.
For income distribution, he proposed "reducing individual income tax rates by five percentage points for annual incomes between RMB 100,000 to RMB 350,000. ($13,956 to $48,846). " This RMB 100 billion ($13.9 billion) annual tax cut would directly increase low- and middle-income households' cash flow. In parallel, transferring state-owned capital (RMB 132.6 trillion) [$18.5 billion] to urban-rural resident pension schemes could raise average monthly pensions from RMB 200 to RMB 500 ($27.91 to $69.78) –unleashing an estimated RMB 800 billion ($111.6 billion) in consumption potential. Sheng also recommended introducing a "consumption-based compensation" mechanism for value-added tax (VAT) to address local governments' bias toward production over consumption.
Sheng said China should replicate its post–World Trade Organization (WTO) manufacturing liberalisation in the services sector. Two decades ago, China’s manufacturing was predominantly low-to-mid range, lacking technology and experience, while plagued by monopolistic practices. Productivity lagged developed economies, core technologies were deficient, and industrial competitiveness was weak. Openness to foreign investment deepened market reforms, improved resource allocation through competition, and enhanced productivity and innovation through knowledge spillovers and the adoption of advanced foreign technologies and management practices.

The services sector now faces similar challenges. Rather than sending citizens abroad, China should incentivise foreign institutions to establish universities and hospitals locally. This would stimulate competition, breaking monopolistic pricing, facilitate the adoption of mature business models, cultivate high-end service talent and expand domestic employment. In the long-term, it would increase the supply of high-quality domestic services and unlock greater consumption potential. Sheng said, "Success hinges on enhancing foreign enterprises' long-term investment commitment and guiding domestic firms into market competition."

Local governments also play a vital role in energising consumption. Since the second quarter (Q2) of 2025, multiple regions have intensified demand-expansion and consumption-promotion measures, including proposals to incorporate consumption indicators into local government performance assessments. As consumption increasingly drives growth, optimising value- added tax (VAT) distribution has become imperative. The 2016 nationwide transition from business tax to VAT established a 50:50 central-local revenue sharing arrangement, alleviating local fiscal pressure. However, the 1994 tax reform's "place-of-production" principle persists, allocating VAT to the location of business registration rather than where consumption occurs. For instance, when a Beijing resident buys a car made in Shanghai, VAT accrues to Shanghai. While this supports domestic production, it inadvertently diminishes focus on local consumption activities.

Sheng proposed "establishing a more scientific, equitable consumption-based compensation mechanism." This would incentivise local governments to actively formulate and implement consumption-boosting policies, directly stimulating local consumption. New tax revenue could replenish local coffers, funding redistribution to enhance income equality and invigorate local consumption.

"Given China's extreme regional development disparities, implementing consumption-based principles may impose significant tax losses on certain areas. Therefore, corresponding compensation mechanisms warrant further exploration. For instance, appropriately increasing local governments' VAT share could sustain policy support for key industries while mitigating reform impacts," Sheng added.

Resolving consumption constraints demands systematic institutional innovation. Short-term individual tax reforms can activate low- and middle-income purchasing power. In the medium-term, replicating manufacturing liberalisation can elevate services sector productivity, converting precautionary savings into tangible consumption. "Consumption not only regulates aggregate demand but iterates higher-tier demands that guide effective investment," Sheng concluded.

The rebound in retail sales in early 2025 validates policy efficacy. Yet only through deepened income distribution reforms and services sector upgrading can the consumption power of 1.4 billion citizens' become the economy's "steadfast anchor."
The gradual dissipation of hospital queues, adequate elderly care facilities, and middle-income families no longer seeking medical treatment abroad – these will signal China's transformative economic breakthrough.