The term “involution” was coined in 1937 to describe Maori art appearing to reach a point where it could no longer evolve. It was popularized in the 1960s by the anthropologist Clifford Geertz to describe the devastation of Dutch colonialism on Indonesia’s rice farming ecology. For the third time in a century, “involution” has re-emerged, this time in a country that’s the world’s largest economy by purchasing power parity.

Involution is applied in many contexts in and by the Chinese to their current socioeconomic condition. For policy, businesses, and China’s massive workforce, it has come to refer to an intractable combination of overproduction and underachievement. China’s producer prices have fallen in half the years during the two decades since 2005.

Corporate profits have been weak since 2021 and remain near levels last seen in the mid-2010s. GDP growth is slowing. Employment, particularly of graduates, is weak. Anecdotes of massive goods surpluses cycle from electric scooters to solar, steel, and now perhaps the most advanced electric vehicles (EVs).

China has summed up these factors as “involution” or neijuan in Chinese. Beijing has launched a campaign against the involution, urging greater discipline in the industry to avert destructive price wars, imposing minimum price floors, and vowing to defeat “local protectionism.” In his 2026 National People’s Congress work report, Premier Li Qiang addressed neijuan, saying:

“We will address monopolies and unfair competition with greater intensity, enhance the binding force of fair competition review, and thoroughly address rat race competition with a full range of approaches, including production regulation, standard-based guidance, pricing compliance and enforcement, and quality supervision, so as to cultivate a sound market environment.”

At the same time as confronting the angst from competitive excess, China has been supremely effective in delivering products that go global and which local markets want at prices that are compelling. Technological, design, and engineering skills have made it the world’s largest goods trading nation.

But the factors that Chinese policymakers target in their view of involution are mere symptoms. The symptoms can be stayed but will keep resurfacing if the underlying and worsening structural weaknesses in China’s economy remain unaddressed.

The thread that ties together these apparently contradictory narratives is a change in the orientation of policy in China — the sort of change that has historically caused similar structural socioeconomic maladies in other countries as well. The late Canadian economist Robert Mundell, who advised Chinese state leaders on economic policy from 1995 through the 2000s, argued that the right policy mix for China to set a sustainable transition for its economic growth was a fixed nominal anchor for the renminbi (RMB) exchange rate, domestic monetary stability, restrictions on capital flows, but also a goal of currency convertibility and systematic domestic reform based on fiscal and structural discipline of privatization, an end to systematic subsidization of industrial inputs, and clearer property rights.

It’s not for nothing that Mundell, who died in 2021, received a Nobel Memorial Prize in Economic Sciences in 1999. Some of his recommendations were imbibed by policymakers in China. Yet on some critical issues, China changed its mind.

From 2005, China started to introduce currency flexibility but, more importantly, after 2008, the other parts of the Mundell policy mix lost priority. Emergency measures and what Chinese policymakers apparently viewed as pragmatic tinkering chipped away at the logic of Mundell’s reform blueprint.

Key among them is for China to have a credible international currency exchange system. Mundell had argued that a rise in the RMB without the right policy reforms would result in:

a reduction in investments from overseas,
a slowdown of the Chinese economy,
an increase in nonperforming loans held by banks,
a decrease in the profitability of Chinese enterprises,
a delay in the realization of the yuan's convertibility, and
a rise in deflationary pressure in rural agricultural areas.

This summary, written in 2006, drawing on earlier insights, was prescient. It is not a bad description of what we now see in China, although the causes are found in the structural policy gaps that have emerged as currency tinkering has replaced a fixed anchor.

It is an apocryphal tale that Henry Ford increased wages of workers to ensure demand for the Model T. The basic idea has insight for a wider economy. The sectors in China’s economy that have attracted recent attention for allegations of Chinese overproduction are particularly in autos, where domestic demand has been volatile. In 2025, new energy vehicle (NEV) production in China was 16.49 million, with 84% sold domestically. In the first seven months of 2026, only 68% of the nine million NEVs produced were sold to local consumers, with sales falling 12% year-on-year, leaving a surplus potentially destined for export markets that can sometimes be physically seen in factory yards and docks.

Cars and buses awaiting shipment sit at an automobile storage yard in Yantai, Shandong Province, China, in July, ahead of export.

Involution does not seem to be the first cause of the visible glut in these markets. Nor does it seem necessarily to be a nefarious plan to dominate global markets. The challenge for companies is unstable domestic demand and dwindling growth. Since 2019, per capita disposable income growth rates in China have been volatile and declining.

Companies that struggle to forecast demand will build excess capacity and will need to keep more working capital to support that volatility, driving down returns. They will work hard to generate demand with extreme product differentiation. The industrial and competitive features of the market are symptoms of this problem.

It is not just an auto sector or consumer products problem. Non-consumer sectors like solar, batteries, steel, chemicals, and nonferrous metals are the most targeted sectors contributing to involution. This is usually attributed to rivalry between local and provincial governments to meet national development targets, industrial policy-driven subsidies, and policy support for easy credit. That all leads to similar company strategies replicating similar plants, marginal cost pricing, and margin collapse.

However, problems of producer price deflation, weak margins, and poor returns are pervasive. These factors also impact concentrated industries that are outside of policy focus and where there are no subsidies or where support has been cut. Symptoms of deflation like these point to an important monetary driver that is often missed in the debate. It is not that consumers or companies at intermediary stages of production do not want to buy the products, but after a series of shocks to businesses and households, money demand is high relative to supply and that demand is not being met.

Deflation is not the natural state of an economy, nor is systematic emergence of trade dominance. Commentators understandably talk about the “imbalances” that might be behind these uncommon occurrences, although “balance” is a strange ideal for a dynamic economy in a constant state of flux.

The Economist recently hosted an insightful debate about the role of the RMB and China’s large goods trade surplus in global trade imbalances. This debate pivoted around the issue of whether global economic balance needs a much stronger RMB. The International Monetary Fund’s 2026 assessment puts the gap between the ideal and current currency strength at 21.3%. The discussants were split on whether a stronger yuan is the trade surplus remedy, yet none realistically expect Beijing to deliver a large discrete revaluation.

What that debate misses, that Mundell would see, is that under the broad auspices of a managed currency, China has had stronger and weaker periods of economic outcomes. When China kept the currency stable or fixed but allowed other natural stabilizers and market signals to operate, this facilitated economic reform that supported growth. Companies thrived.

Under a fixed exchange rate, Chinese exporters need to convert much of the proceeds of their sales to RMB. When they do that through banks and the People’s Bank of China (PBOC), the RMB money supply expands. That supplies local currency to meet the demand to pay wages, other suppliers, and distribute profits. That demand for money is generated by the economic activity of those successful exporters. The expansion of the money supply simply meets that rising demand for money. All other things being equal, it should not be inflationary.

However, the PBOC has historically sterilized the impact of foreign trade as it has sought to exercise discretion in monetary policy and manage inflation risks. That sterilization has more recently moved from PBOC using required RMB reserve ratios and bond issuance to more opaque management of foreign exchange reserves through commercial banks, but to similar effect. Policy has gradually allowed more channels for offsetting capital and investment outflows. China has also made great strides reining in lending excesses to property, local government financing vehicles, and other state-favored industries. Bank lending is steadier and more contained by bank capital, risk management, and prudential standards. Informal banking has been sharply reduced. China can now contemplate unsterilized foreign exchange flows without having to worry about the risks of run-away credit expansion and inflation. Natural stabilizers can be restored to allow domestic demand that should follow from export success. Nominal exchange rate stability can remain if real exchange rates are allowed to adjust.

The resulting market-based enhancement of domestic demand will allow companies to better forecast what customers want and weaken the domestic case for industry policies, including export rebates, that are generating an increasing international backlash against China’s trade success. This would help China’s fiscal policy challenges, especially at the provincial and local government level.

China worries about an involution problem. Other countries worry about brutal export competition from China and international trade imbalances. We all see the visible fruits of excess capacity but pay too little attention to the less visible monetary drivers of domestic demand that could absorb that capacity. There is a practical opportunity to address the core of these concerns, with China following Mundell’s prescription for exchange rate stability, but accepting the disciplines for domestic monetary, fiscal, and industrial policies that must logically follow.