The Illusion Model: China's Artificial Productivity and the Dead End of State-Controlled Overproduction
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Published on: November 12, 2025 / Updated on: November 12, 2025 – Author: Konrad Wolfenstein
The Illusion Model: China's Artificial Productivity and the Dead End of State-Controlled Overproduction
The subsidy tsunami: China's flood of goods has a hidden price – and it's gigantic.
The $900 Billion Deception: How Beijing Artificially Inflates Its Industry and Deceives the World
The world is watching China and seeing an apparent economic miracle: record exports of electric cars, a dominance in solar panels, and steel production that puts the rest of the world in the shade. The sheer production figures suggest an unstoppable efficiency machine that has long since overtaken the West. But behind the gleaming facades of the super-factories lies a profound contradiction, the "illusion model": On average, a Chinese worker generates only about a quarter of the value of a European worker. How can a system that produces so much be so inefficient at the same time?
While some economists, like Weijian Shan, argue that the West simply underestimates China's true productivity due to price distortions, a more detailed analysis, primarily by the International Monetary Fund (IMF), paints a completely different picture. It is not a measurement error, but a system: a gigantic, state-funded overproduction that only feigns efficiency. With nearly $900 billion annually—around five percent of the national GDP—Beijing is artificially inflating its key industries.
This model of artificial productivity is sustained by an opaque network of direct subsidies, cheap loans, tax breaks, and hidden debt to local governments. It has led to massive global overcapacities in key industries such as electric vehicles, steel production, and solar technology, distorting world markets and obscuring the true capabilities of companies. The following text reveals how China's state-controlled economy mistakes volume for value, substitutes subsidies for efficiency, and has created a system trapped in a dangerous dead end of misallocation.
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When volume replaces efficiency: The great deception behind the numbers
The Chinese economy presents itself to the world as a marvel of modern productivity growth. Gigantic factories churn out millions of goods daily: electric vehicles, solar panels, steel, semiconductors, and batteries. The statistics seem convincing. China produces more than any other nation on earth, its industries are comprehensively modernized, and its workforce appears to function like a precision-controlled machine. But this glittering image is a mirage, an optical illusion that dissolves as soon as one looks behind the scenes.
The central contradiction is this: A Chinese worker generates only about 27 percent of the value added of a European worker per year. At the same time, ten times more people work in industry in China than in the USA, but produce only 1.5 times as much material output. This is not a statistical misunderstanding or a measurement error. It is the direct consequence of an economic policy that confuses production with productivity and has thereby created a system that sustains itself through state subsidies.
The subsidy paradox: A sugarcoated calculation
The economist Weijian Shan has attempted to explain this paradox. In his analysis, he argues that Western statistics systematically underestimate Chinese productivity. The low value-added figures do not stem from a genuine efficiency deficit, but rather from artificially low prices for Chinese goods, caused by exchange rates and political pricing. If these factors are taken into account, Chinese factories could actually achieve 80 percent of US productivity. Shan's logic seems compelling until one realizes the true basis of his argument.
The five industries Shan relies on—steel, cement, automotive, shipbuilding, and electronics—are not chosen at random. They are the most heavily subsidized sectors in China. State funds flow into these industries on a scale that defies Western imagination. The true productivity of these industries is not hidden; it is massively obscured. Shan makes a significant methodological error. He omits the crucial source of this apparent efficiency from his calculations—namely, the trillions in state transfer payments that keep the entire system afloat.
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The IMF diagnosis: How subsidies stifle productivity
The International Monetary Fund (IMF) addressed the issue and arrived at a precise, sobering diagnosis. The IMF used the same datasets as Shan – production statistics from the Chinese Bureau of Statistics, supplemented by World Bank comparative data. The difference lay not in the raw data, but in the analytical methodology. The IMF factored in all government transfers: direct grants, tax breaks, subsidized loans, subsidized energy prices, and free building land. The result paints a completely different picture.
According to IMF calculations, Beijing spends roughly five percent of its total gross domestic product annually on industrial and technological subsidies. This equates to approximately US$900 billion per year. To put this into perspective, it is roughly twice the military budget of the entire European Union. The largest sums flow into steel production, battery cell manufacturing, and automotive manufacturing. Some of this is paid out as direct purchase premiums, while the rest is hidden in the back channels of an economy organized from the top down: tax breaks, loans at interest rates below the benchmark, artificially lowered energy prices, and infrastructure investments whose profitability was never considered a primary objective.
According to the IMF model, overall factor productivity in subsidized industries falls by up to twelve percent. This is not an academic subtlety, but the very essence of economic dysfunction. It means that the state uses cheap capital to channel resources into activities that would not be viable without this support. Companies that should have gone bankrupt long ago are kept artificially alive. Overcapacities build up. Market prices collapse. And yet production continues because local authorities have to meet their quotas and the central bank provides cheap money.
The hidden debt machine: Intransparency as a system
Another report, the so-called Red Ink Report by the Center for Strategic & International Studies, confirms these findings and elaborates on them further. China experts DiPippo, Mazzocco, and Kennedy analyzed hundreds of provincial and local budgets and discovered a system of breathtaking complexity. Approximately 30 percent of all industrial investment in China is financed directly or indirectly by state funds. In key sectors such as solar technology, chemicals, and battery cell production, this share is considerably higher; some sources cite figures as high as 50 to 70 percent. The funds flow through a dense network of municipal finance platforms, industrial parks, and investment funds. This system is deliberately designed to be opaque because otherwise, its statistical significance would become apparent—the debts of local governments, the hidden liabilities, the write-offs that would have to be made.
Municipal financing vehicles, also known as local investment platforms, are a unique feature of the Chinese system. They are established to raise funds outside of regular budget constraints and finance projects. Over the years, this practice has spiraled completely out of control. The hidden debts of these local governments amounted to approximately 14.3 trillion yuan (around 1.8 trillion euros) in 2023. In early 2024, the Beijing government was forced to announce a crisis program aimed at reducing these hidden debts to a third over five years. This means, conversely, that a large portion of these debts stemmed from investments that failed economically. They now exist only as paper and concrete.
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Beijing's subsidy trap: Billions for overcapacity
Focus on the following industries: Electromobility, steel and solar technology
This system is particularly evident in the case of electric vehicles. China has exported over a million electric cars annually. Manufacturers don't simply receive subsidized energy and preferential loans. The government pays for new factory buildings, invests in ports and rail connections, even partially covers labor costs, and provides a direct purchase premium for every vehicle produced. The result is a production output per worker that appears in Shan's statistics as proof of high productivity. In reality, it's a mathematical illusion. Without these transfer payments, production would be many times lower, the number of employees significantly smaller, and prices considerably higher.
The same pattern is evident in the steel sector. China produces more than a billion tons of steel per year, while the US produces only about 90 million tons. Measured against the size of the workforce, this is an impressive achievement. However, the OECD has calculated that China subsidizes its steel sector ten times more than all 38 OECD countries combined. Subsidized energy keeps plants afloat that would not survive in international competition. Cheap credit makes it possible to operate plants that are economically unprofitable. The result is a global overcapacity that drives down the price of steel worldwide. Output remains high, margins remain narrow, and productivity appears better than it actually is.
The fate of the Chinese solar industry is particularly illustrative. Between 2010 and 2023, over US$200 billion flowed into this sector in the form of direct purchase incentives, tax breaks, infrastructure funding, and research subsidies. Buyers of solar panels received discounts of up to 30 percent, and ten years of VAT exemption further depressed prices. Provincial and local governments invested billions in establishing production facilities, often without regard for actual demand or profitability. The result was a production volume that far exceeded global demand. The sector grew to gigantic proportions before Beijing realized that this was unsustainable. By 2025, the effects were becoming apparent: China was significantly reducing solar production capacity, phasing out export tax refunds, and prices, after years of dumping, were beginning to rise again.
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Beyond the numbers: The neglected value and fragile data
Shan's second blind spot lies in neglecting the value of manufactured goods. A Chinese auto worker may produce the same number of vehicles in a year as an American counterpart. However, the economic value of these vehicles differs fundamentally. Tesla generates tens of thousands of dollars in added value per car through brand strength, battery technology, and software integration. Ford relies on established quality and a broad spare parts network. A BYD or NIO achieves only a fraction of this value per vehicle. In many cases, these manufacturers operate on margins that are only possible with government support. Therefore, the number of units produced says absolutely nothing about true productivity when quality, technology, brand value, and sustainable profitability are not taken into account.
The data itself is fragile. Shan relies largely on figures from the Chinese National Bureau of Statistics. These figures are highly politically sensitive and often embellished. Independent checks using satellite data show that official production volumes in some industries are up to 20 percent higher than realistic values. Mining companies that track raw material flows often arrive at different results than the official statistical authorities. This undermines Shan's entire line of reasoning.
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A system on the verge of misallocation
After critical analysis, little remains of Shan's optimistic picture. He is right that Western statistics contain structural distortions and that China is indeed more productive in some areas than its value-added figures suggest. However, his correction simply replaces one misinterpretation with another. The new IMF study, on the other hand, suggests that while China's economy produces high volumes, it is simultaneously consuming ever-increasing amounts of capital and energy. The apparent efficiency stems from mass production and state subsidies, not from genuine performance improvement. The state is buying time, not innovation. It is buying excess capacity, not sustainable growth.
This has profound implications for investors and trading partners. The apparent strength of Chinese industries rests on shaky ground. As long as Beijing continues subsidies, output remains stable and exports flow. However, once funding decreases—either because debt reaches its limits or because political priorities shift—the true extent of competitiveness will become apparent. Past experience is clear: industries entirely dependent on subsidies collapse rapidly when the money stops flowing. They are not genuine industries, but rather administrative rents that consume themselves.
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The dead end of state capitalism: Bought time instead of real growth
According to the IMF analysis, China's economic model is trapped in a classic dead end. The state has had to make massive overinvestments to secure economic growth. This has led to overcapacity in almost all priority sectors. This overcapacity puts downward pressure on prices and reduces profitability. Without further subsidies, these industries would not be viable. With further subsidies, the debt burden increases while overall factor productivity falls. It is a system that constantly requires more government spending to maintain the illusion of efficiency.
This makes Weijian Shan a contradictory authority. He is right that China's productivity is higher than Western statistics suggest. However, this is not proof of a successful model, but rather of a system of resource misallocation artificially sustained from the outside. The price for this artificial vitality is paid by the economy as a whole. The state diverts capital into profitable industries—resulting in declining overall efficiency. Workers who go into these subsidized sectors could be employed more productively. Resources wasted on overcapacity could finance education, genuine innovation, or infrastructure. Instead, a system of permanent economic distortion is created.
This transforms the debate about China's productivity into a debate about the limits of state intervention. There is a point beyond which more government intervention no longer leads to more growth, but rather to less. China has long since crossed this threshold. The result is an economy that produces enormous quantities but must consume ever-increasing amounts of capital to do so. The decline in returns is undeniable. China's total factor productivity is growing more slowly than before, even though investments are increasing. The system is losing its internal consistency.
Weijian Shan wanted to solve the productivity paradox. The IMF shows that it hasn't been solved, but rather exists in reality. China's workers produce a high quantity of goods, but they operate within a system that confuses performance with money and equates output with economic profitability. The numbers improve, but the bills worsen. That's the real story behind Chinese productivity.
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