As its service sector rises and industrial growth slows, China may be in danger of developing into a two-speed economy.
While 2015 has been a year of weak global growth, the problems have been particularly troubling for China after escaping the Great Recession in 2009 by floating its economy on easy credit and state bank loans.
This year, the costs of that stimulus policy have come home to roost, dragging down the economy with industrial overcapacity, disinflation, bad debts and smog.
While economists continue to debate the accuracy of official figures, the People's Bank of China (PBOC) voiced confidence last week that the country would end 2015 with the 6.9-percent growth of gross domestic product (GDP) that it posted in the first three quarters of the year.
Although that would be the slowest rate since 1990, it roughly fulfills the government's forecast of "about 7 percent" growth.
Any rate above 5 percent would be the envy of most countries.
But not for China, which recorded growth of 7.3 percent last year, 7.7 percent in both 2013 and 2012, and average annual growth of 8.2 percent in the 60 years since 1953, according to the National Bureau of Statistics (NBS).
President Xi Jinping and Premier Li Keqiang have repeatedly stressed that the declining trend is a path to more sustainable development that relies on the service sector, innovation and consumption-led growth rather than the old engines of investment, trade and energy-intensive industries.
That may well be the case, but even so, China may be in danger of missing the goals it has set for itself.
In unveiling the draft of China's 13th Five-Year Plan through 2020 in October, Xi and Li all but abandoned the traditional central planning practice of setting GDP targets.
Instead they pegged a 6.5-percent average annual growth rate as the minimum needed to fulfill the ruling Chinese Communist Party's pledge of doubling 2010 GDP by 2020, without saying whether they would revert to stimulus policies if growth falls short of the mark.
Industrial and service sectors
One worry is that maintaining that average rate now depends on increasingly divergent industrial and service sector growth.
In the first nine months, the industrial sector grew at a 6-percent rate slipping to 5.8 percent in the third quarter, while the service sector gained 8.4 percent, rising to 8.6 percent in the quarterly period, according to NBS reports.
Government analysts have taken heart from official data showing that the faster-growing service sector now accounts for 51.4 percent of GDP.
But the service sector expansion is still short of the double-digit growth that will probably be needed to offset industrial declines.
In heavy industries like steel, there are signs the decline will be steep.
In the first 10 months of the year, large and medium-sized steel mills lost 72 billion yuan (U.S. $11.3 billion), the China Iron and Steel Association (CISA) reported this month.
Domestic demand for steel this year will fall 4.8 percent, according to the China Metallurgical Industry Planning and Research Institute (MPI).
The downturn for steel and other construction-related industries like cement, aluminum and glass is likely to persist throughout the coming Five-Year Plan due to the real estate slump that took hold in 2014.
This year, the growth of real estate investment has all but stopped, rising only 1.3 percent in the first 11 months, the NBS reported.
Property has been the weak spot in fixed-asset investment, which rose 10.2 percent over the 11-month period, slipping from 13.9 percent at the start of the year.
While property prices and sales have stabilized, the backlog of unsold homes is expected to weigh heavily on the market and supporting industries.
A report this month by the Chinese Academy of Social Sciences (CASS) National Academy of Economic Strategy found that the surplus of unfinished and unfinished homes could take six-and-a-half-years to sell.
"Destocking will be a prolonged process in small and medium-sized cities as demand growth from first-time homebuyers is offset by a population outflow to the more developed big cities," Fitch Ratings Inc. said in a report cited by the official Xinhua news agency.
Two-speed economy
The slow housing recovery points to a widening gap between manufacturing and service sector growth, setting the stage for a two-speed economy.
"It will probably be two-speed," said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington. "Absent a pretty dramatic change in policy, that's exactly what will happen."
Chinese officials have insisted that the average 6.5-percent GDP growth rate will be maintained through 2020, thanks to a combination of service sector growth and the country's "silk road" foreign investment initiatives that promote infrastructure building and development abroad.
But officials have been just as adamant that the government has sworn off stimulus policies for good, said Hufbauer.
The red line may limit policy options and leave service sector growth to carry the economy on its own.
Hufbauer argues that without some stimulus or industrial revival, the outlook for the service sector is too optimistic.
"The top speed for services might be 8 percent, or 7 percent or 6 percent. The overall growth really can't be much more than 5 percent. So, there's a real contradiction there in terms of rhetoric versus performance," he said.
On Monday, the government issued a statement following its annual Central Economic Work Conference, pledging to meet the growth challenge through a combination of monetary and budgetary moves next year.
The government "will make fiscal policy more forceful and monetary policy more flexible to keep growth in a proper range," Xinhua said.
There are signs that the two-speed prospect has raised policy concerns within China.
In an Oct. 29 commentary for the official English-language China Daily, a Ministry of Commerce researcher made the case that manufacturing continues to be "the country's economic backbone."
"It should be noted that a big country's sustainable economic development can only be built on industrialization, because the modern service sector, which provides the majority of people with decent incomes and employment opportunities, is also built on the foundation of modern manufacturing," wrote Wang Xiaoying of the ministry's International Trade and Economic Cooperation Institute.
The argument was echoed in a Xinhua commentary on Dec. 8.
"It would be unwise, especially during an economic slowdown, for China to solely rely on the service sector, as it belittles the significance, and potential, of its industry," Xinhua said.
State-owned enterprises
But the decline of major industries means the government will have its work cut out for it, particularly with regard to reforming major state-owned enterprises (SOEs).
In the first nine months, profits fell at 21 percent of China's listed SOEs, Beijing Youth Daily reported. The 10 worst performers suffered losses of 13.5 billion yuan (U.S. $2.1 billion), the paper said.
Many SOEs are under pressure to cut deeply into production capacity, suggesting slim or negative contributions to economic growth next year.
In a report, the MPI estimated that China's domestic steel demand would drop to 668 million metric tons in 2015, falling by another 3 percent next year to 648 million tons.
Annual world steel demand is expected to decline this year and next to around 1.5 billion tons, dimming prospects for exports and profits.
Production overcapacity in China's steel sector is estimated at a whopping 400 million tons, China Daily said in a separate report.
As the economy struggles, the surplus capacity in major industries suggests that wrenching cuts, closures and layoffs are coming.
On Dec. 9, the State Council, or cabinet, issued a statement calling for elimination of SOEs "that survive only on government bailouts."
"Such 'zombie companies' in oversupplied industries should be closed or restructured" by the end of 2017, the State Council said, indicating that those with three years of losses may be broken up or forced into bankruptcy.
This month, the state-owned China Business News also reported that the government is likely to introduce measures for destocking the housing market, cutting into the backlog of unsold homes.
The moves are not expected to rescue the real estate market but may add liquidity to the property sector, said Xinhua.
In its statement on Monday, the government urged property developers to lower home prices and pursue consolidation, a recommendation that may point to the prospect of bigger losses next year.
The government is also relying on liberalization of China's hukou, or household registration system, which has denied urban social benefits to migrant workers for generations.
At a meeting last week, the Political Bureau of the Party's Central Committee made clear that it sees hukou reform as a way to ease the real estate problem.
"The country should expand the effective demand on the housing market by turning more migrant rural workers into urban residents in order to reduce high housing inventory," the Politburo said in a statement reported by state media.
But much of the unsold housing may be priced beyond the reach of migrant workers even with discounts, while the government's plan to draw rural dwellers into smaller and mid-sized cities may not match up with available jobs.
It is unclear what other steps the government will take, but in its housing report this month, CASS recommended a range of remedies including subsidies for first-time buyers, tax cuts and mortgage interest deductions.
Even if such proposals are implemented, a turn round for the construction-related industries appears unlikely in the near term without more stimulus, Hufbauer said.