Something in the Chinese economy is not working as it should. People and organizations are expending more effort yet failing to create new value. Competition is intensifying, but productivity gains are disappearing.
Officials have dubbed the phenomenon “involution”. And they are convinced they can turn it around.
Those of us who lived through the collapse of communism in the late 1980s recognise the condition well. For us, it is an all-too-predictable manifestation of quota-driven bureaucratic or corporate systems: when non-performing entities are measured against centrally-determined targets or quotas, leading actors to optimize for meeting metrics (reports, targets, approvals) rather than improving underlying efficiency or innovation.
The former communist bloc countries did not handle the crisis well. As demand for shoddily produced products collapsed, factories closed, and the planned economy that had guided everyday life for millions of people began to close in on itself. As it did so, the safety net that had for decades kept society together began to unravel. State-enterprise employees were left suddenly destitute, with incomes incapable of buying core essentials. Many were thrust from civil comfort into instant poverty seemingly overnight.
Chinese officials are desperate to avoid a similar scenario occurring in China. They know something must be done about the inefficient and unsustainable enterprises that haunt their system. But they also can’t afford to just shut them down, as that would invite a humanitarian crisis of Russia 2.0 levels, if not greater.
Their solution? A government program aimed at discreetly unwinding unproductive companies with as little social fallout as possible. It’s something officials coyly announced at the accompanying press conference for the fourth session of the 14th National People’s Congress on March 6. Strangely, not much of this has been picked up in the Western press.
So what’s going on exactly?
According to the press material, the ‘National Mergers and Acquisitions (M&A) Guidance Fund’ will be a new financial initiative that will be launched “this year” by the government “to further smoothen exit channels for venture capital investment and improve capital turnover efficiency”.
The primary purpose of the fund will be to provide a structured, financially supported pathway for failing or struggling businesses to bow out gracefully.
Officials have noted that by helping “companies exit the market in case of need”, the government can “unlock over 1 trillion yuan of additional funds in relevant sectors,” thereby freeing up and redirecting capital towards more productive uses.
That means, rather than relying primarily on bankruptcy courts or ad-hoc closures, the policy will oversee state-guided mergers and acquisitions as the principal mechanism for market exit focused on removing or restructuring non-performing companies that are otherwise exhausting resources in a stagnant “race to the bottom.”
Stronger firms, private equity vehicles, or state-backed industrial investors will use capital from the guidance fund to acquire struggling competitors, particularly in sectors suffering from fragmentation or overcapacity.
Once acquired, these firms will not necessarily be preserved as independent businesses. In many cases, the acquiring company will integrate valuable assets — technology, patents, production lines, or skilled staff — while shutting down redundant capacity, divesting unprofitable divisions, or selling salvageable units to other buyers. In effect, the fund will finance the process of selective absorption and dismantling.
A nice way to think of it as a giant government-mandated vulture fund.
Indeed, the best parallel comes from the 1980s when corporate raiders and distressed-asset investors descended on underperforming conglomerates to strip out valuable divisions, and close or sell the rest at a profit. The key difference is that in China, the process will be state-managed, rather than private-sector-led.
Utilizing this M&A fund to help companies exit the market is “a very important step for us to address the problem of evolutionary [involutionary] competition,” an official said during the press conference.
No more quotas
But it doesn’t end there. People’s Bank of China Governor Pan Gongsheng, also present at the briefing, noted that the central bank will further guide financial institutions to scientifically assess risks, improve credit structures, and provide targeted credit controls to strictly “prevent involutionary competition and support economic structural adjustments, transition and upgrading.”
This comes as the PBOC aims to improve market-based interest rate formation, adjustment, as well as its pass-through mechanism (i.e. allow price discovery in Chinese rate markets). To do this, the central bank will gradually deemphasize quantity-based intermediate targets, in favour of market-set benchmark rates
In practical terms, this means the state is attempting to squeeze the problem from both sides: capital from the guidance fund encourages consolidation and acquisitions, while tighter credit standards make it harder for weak firms to survive independently by rolling over debt. Firms that cannot compete will face increasing pressure either to be acquired and restructured or to exit the market entirely.
The policy implicitly acknowledges that consolidation will involve plant closures and workforce reductions in some cases, since eliminating redundant capacity is part of the restructuring logic. However, by channeling exits through acquisitions rather than abrupt bankruptcies, policymakers hope to manage layoffs gradually and redistribute assets and labor through stronger firms instead of allowing disorderly collapses.
A private credit mirror?
When you step back and look at the system from a much wider perspective, you realise — as per the ongoing Michael Pettis narrative — that what is happening in China is essentially a mirror image of what is happening in the United States and much of the West. The flip side of the industrial policy China effectively forced on the world is a financialised, tech-led policy response in the West.
Zoom out further still, and the private credit bubble everyone is currently worrying about in the West starts to resemble the exact mirror of China’s industrial involution.
It’s just that our “involution” resides in the endless zombie companies that have been supported by state-backed liquidity through private credit, especially in tech and finance.
For more on the West’s involution dynamic, see the excellent guest post we ran on The Peg, “Too Big to Flow,” which explores how rising financialisation — measured by the growth of financial assets relative to GDP and payment volumes — can actually increase systemic fragility. As the piece argues, when financial intermediation becomes too large relative to the underlying economy, the system becomes less able to absorb shocks rather than more resilient.
Viewed through that lens, the current stress in private credit is merely the other side of the global rebalancing ledger.
For years, Western financial systems kept certain sectors afloat — not unlike China’s industrial zombies — because they helped offset the deflationary pressures generated by China’s massive industrial expansion. Cheap capital sustained waves of tech investment, private equity expansion, and credit-fuelled growth that absorbed liquidity and demand.
Now, a semi-deliberate unwinding of that arrangement is underway, driven by central banks’ conscious withdrawal of liquidity. As conditions tighten, the system is effectively defunding the zombies — all those companies and strategies that were viable only under conditions of extremely abundant capital.
If that’s true, private credit stress is less a sudden accident and much more the inevitable counterpart of monetary tightening and a broader structural transition. The critical factor will be whether the associated unemployment trend can be managed gracefully and whether intellectual workers can be repositioned into the real economy at a comparable quality of life.
Constructive dezombification?
But there is another important distinction between the Chinese and Western cases: who was actually employed by the systems that are now unwinding. China’s industrial policy channelled capital into labour-intensive sectors like manufacturing, construction and export supply chains, which absorbed vast numbers of workers across large factory ecosystems. The Western version of the same dynamic, by contrast, channelled capital primarily into finance, technology and private-equity-owned service firms — sectors that employ far fewer workers relative to the capital invested.
In short, China produced labour-heavy industrial overcapacity, while the West produced capital-heavy financial and digital overcapacity. The gains in the West accrued largely to a relatively small financial and technological elite, while much of the broader workforce remained in lower-productivity services or welfare-supported employment.
That difference matters enormously for how painful the adjustment may be. In the West, pulling the plug on capital flows that sustained tech valuations, private-equity strategies, and private-credit borrowers primarily hits investors and highly skilled workers. Those workers are typically mobile and able to redeploy into other sectors.
China faces the harder problem: how to absorb millions of workers tied to industrial capacity into a social system far less prepared to handle large-scale displacement.
Either way, as excess capital leaves finance and tech in the West, resources can return to the real economy just as China’s restructuring will release demand cross-border rather than trapping it inside industrial overcapacity.
Crucially, private credit itself may limit systemic fallout. Unlike the securitised structures behind the Global Financial Crisis, most private credit is funded by long-duration institutional capital rather than fragile short-term funding, meaning losses may trigger restructurings rather than contagious financial collapse.
As they say, a watched pot never boils. Few pots, however, have been watched as closely as the private credit market.
