Fostering new demand, patterns and services is vital to sustained growth over the next decade

The coming decade is pivotal for the Chinese economy. Structural adjustment will be essential to sustain high-quality development. This transformation will need to be grounded in a deep understanding of demand, supported by technological advancement and driven by improvements in labor productivity.

From a macroeconomic perspective, China's economy is facing a set of new constraints.

While the short-term economic cycle appears to be nearing the bottom, the outlook remains uncertain. Movements in price levels suggest that domestic demand is still weak, indicating that growth targets should not be overly ambitious. The growth target of 4.5 to 5 percent for this year is therefore one of the lowest in decades.

Demographic trends represent one of the most significant constraints. With the population declining by around 0.2 percent in 2025 and the working-age population peaking about 15 years ago, the first baby-boom cohort will gradually exit the labor force over the next 10 years, continuing to reduce the size of the workforce.

In addition, persistent debt pressures and the uncertainty caused by global geoeconomic fragmentation will continue to weigh on growth.

Beyond tightening constraints, it is crucial to understand the evolving structure of China's growth drivers. Over the past two years, domestic consumption has become the primary engine of economic growth. In 2025, consumption contributed 52 percent to growth, up from 44.5 percent in 2024. By contrast, investment growth has fallen to a historic low, with its contribution declining from 25.2 percent in 2024 to 15.3 percent in 2025.

Although part of this shift is cyclical, it is unlikely that investment will regain its dominant role over the next decade. The end of China's rapid urbanization means investment demand is settling into a new equilibrium. Moreover, the latest wave of technological progress does not require as much investment as the earlier industrial modernization did. The service sector, which now accounts for 57.7 percent of GDP and is still growing, requires relatively less intensive fixed-asset investment.

Changes in net exports also deserve attention. In 2025, net exports contributed 32.7 percent to growth, up from 30.3 percent in 2024. Such an externally driven pattern is unusual for a large economy and helps explain why solid macroeconomic performance is not always strongly felt at the household level. A key risk is that external demand is highly uncertain. For instance, sharp shifts in the global environment in 2023 caused net exports to subtract 11.4 percent from growth. Such volatility is likely to persist in the years ahead.

Given the tightening constraints and shifting growth drivers, labor productivity is clearly becoming the central engine of future growth. Labor productivity, referring to the value added generated by each worker per unit of time, is closely linked to economic growth: Overall GDP growth rate is approximated as the sum of the labor productivity growth rate and labor force growth rate.

Last year, the labor force shrank by 0.77 percent, and it is expected to further decline, making labor productivity gains a critical source of economic expansion. Based on current GDP growth targets, productivity will need to increase by around 6 to 6.5 percent in the coming years, a challenging task by both international standards and historical experience.

Therefore, to ensure high-quality growth under new constraints, economic policies in 2026 should focus on improving labor productivity by expanding demand, reforming the labor market and advancing technological innovation.

One important source of labor productivity growth is the market-driven reallocation of labor across sectors, regions and tasks. Over the past few decades, the large-scale movement of labor from agriculture to manufacturing and services has been a key driver of productivity gains, as many rural migrant workers moved from low-productivity activities to higher ones.

Cross-sector reallocation will remain important in the future, but it is likely to become more complex. For example, some workers with agricultural expertise may return to modern farming. What's more important is cross-region and cross-task reallocation, as new industries and artificial intelligence are creating new forms of work that could become major sources of productivity growth. Supporting this shift will require a more flexible labor market system.

Another key driver of productivity growth is capital deepening, particularly when supported by technological progress. For instance, in the years ahead, AI is more likely to collaborate with humans, reshaping the boundaries between humans and machines, rather than simply replacing labor.

Sustained productivity growth also requires support from exploratory consumption, which refers to the process of how consumers select, combine and recreate products and services, often investing time and effort to generate additional value. In this sense, consumption goes beyond merely "buying things". Its exploratory nature represents a form of value creation that can guide businesses in developing new products and services.

The role of consumption in economic growth has long been understated. Some view it as less productive and therefore of secondary importance in policy. Others believe its contribution lasts only in the short term. Yet in China, it is now widely acknowledged that the relatively low share of consumption in GDP has become a long-term structural issue.

At this new stage of China's economy, greater attention should be given to exploratory consumption as a key driver of labor productivity. Proposals to reduce overtime and shorten working hours have already been put forward. Such measures can yield long-term benefits by freeing up time, creativity and energy needed for consumption-related activities, which in turn can contribute to market innovation and sustained productivity gains. Unlocking new avenues for consumption requires institutional support. Measures such as reducing working hours, increasing public holidays and expanding public cultural consumption spaces signal important policy directions.

In summary, improving labor productivity is a core response to the current constraints on growth and the structural shifts in the Chinese economy. This will require more efficient resource allocation, supported by capital and technology. At the same time, productivity gains should not come at the expense of extended working hours. Rather, the more sustainable source of growth lies in the creation of new demand, consumption patterns and services.

In particular, the trajectory of AI development can be largely shaped by the policy environment. China should introduce policies to foster better complementarity between technology and human labor, with greater emphasis on consumption and quality of life. This remains a relatively underdeveloped policy space, but also one with significant potential returns, and is likely to become a key driver of high-quality growth in the decade ahead.

The author is a professor at the Department of Applied Economics at Guanghua School of Management at Peking University and the director of the Institute for Economic Policy Research at Peking University.

The author contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn.