China’s economy grew just 4.3% in the second quarter, the slowest pace since the end of the pandemic and below Beijing’s target. But the headline figure masks a deeper imbalance: the country’s growth problem increasingly looks like a consumption problem. Retail sales rose just 1.0% in June, even as exports jumped 27% in dollar terms and industrial output increased 5.3%.

The world’s second-largest economy is operating at two different speeds. One is an export-driven manufacturing sector that is benefiting from global demand for electronics and semiconductors. The other is a weaker domestic economy weighed down by sluggish sales, a property-sector downturn, and “involution,” China’s term for fierce competition that squeezes margins.

“There’s remarkable resilience and bright spots in manufacturing and exports, and softness in consumption and fixed asset investment,” said Carol Liao, Greater China chair for Boston Consulting Group. “That’s been the pattern for a while now, since 2025.”

No ‘free handouts’

The pandemic created a clear break in Chinese consumer behavior. Before COVID-19, consumption growth consistently outpaced GDP growth. Since the pandemic, the reverse has been true, Liao said.

The most obvious factor is the property market. Falling home values have eroded household wealth in a country where most families hold the bulk of their assets in real estate, discouraging spending. “This is about the willingness to spend, not ability,” William Bratton, head of cash equity research, APAC at BNP Paribas, wrote in a July 22 note.

Chinese officials remain reluctant to provide direct cash transfers. President Xi Jinping has warned against both “welfarism” and “feeding lazy people.”

“China normally doesn’t give free handouts,” Liao said. Instead, Beijing prefers to “invest in people,” directing money toward human capital through measures such as early-education subsidies, elderly care, and social safety-net spending rather than household checks.

On July 13, China unveiled its first standalone five-year plan for consumption, as part of the broader 15th Five-Year Plan. The move underscores how central domestic demand has become to policy discussions as external demand remains firm but household spending stays uneven. “By 2030, the overall scale of the consumer market will continue to expand, the household consumption rate will rise markedly…and consumption’s role in driving economic growth will be further strengthened,” the State Council said.

The plan targets 60 trillion yuan, or almost $9 trillion, in annual retail sales by 2030. Even so, the government’s ambitions remain limited: reaching that target would require annual consumption growth of 3.7% over the next five years, below the 5.0% pace recorded in the first half of the decade.

“It’s small steps, but it’s moving in the right direction,” Liao said. “Policymakers are very good at the supply side of things; they’re not so good at the demand side.”

Cars are the biggest drag — but not the whole story

The two-speed pattern is visible within consumption itself. Goods spending remains weak, while services consumption is outperforming and growing above headline GDP, Liao said.

Cars have been one of the biggest drags on consumption. Chinese automakers sold 1.6 million cars last month, down 23.2% from a year earlier. The China Passenger Car Association now expects total car sales to fall 14% this year to 20.4 million. Exports, however, remain a bright spot: China exported 1.1 million cars last year, up 70% year over year.

Liao said two forces are deepening the slump. Consumption subsidies that had encouraged buyers to purchase electric vehicles and plug-in hybrids are “fading off a bit” after roughly two years. At the same time, “cut-throat competition” among domestic automakers has compressed industry margins and, in some cases, discouraged buyers from purchasing at all as they wait for prices to fall further.

The retreat is not universal. For basic necessities such as dairy, rice, and other staples where supply is abundant and quality is reliable, shoppers are increasingly focused on finding the best price.

“For things like dairy products and rice—basic daily necessities where supply is ample and the quality is pretty good—shoppers are looking for a bargain,” Liao said.

By contrast, discretionary lifestyle spending remains firmer. Pop Mart’s Labubu dolls, pet care, and outdoor recreation are among the categories where consumers are still willing to spend.

“This stuff adds color to people’s lives,” she said.

Data collected by Zhaopin, a jobs platform, in March found that “pet services” had the second-highest hiring growth after “robotics.” HSBC China economists Erin Xin and Taylor Wang wrote in a July 15 note that funding support should continue shifting toward services consumption, which still offers significant untapped potential in China.

What China exports has changed

Liao expects China’s economy to see “stabilization or growth” in the second half of the year, driven primarily by exports.

But she says the export boom looks different from previous cycles. “It’s not the traditional, low-value-added stuff,” she said. “It’s advanced manufacturing, related to the AI investment boom.”

China does not produce the most advanced chips used in AI processors from companies such as Nvidia, but it dominates production of older-generation chips used in phones, PCs, game consoles, and other consumer electronics. Those chips are now in short supply as data-center construction absorbs capacity that would otherwise serve consumer-electronics makers.

China’s chip manufacturers reported a 2,579% increase in profit in the first half of the year, according to data from the National Bureau of Statistics released on July 27.

Apple is even lobbying the Trump administration for approval to buy memory chips from CXMT, a Chinese manufacturer that is currently the world’s fourth-largest producer of dynamic random-access memory. Apple reportedly wants assurances that Washington will not add CXMT to its Entity List, which would require licenses for dealing with the company.

CXMT shares began trading on Shanghai’s STAR market on July 27 after a $9.8 billion IPO. The stock surged 470% on its first day, making the chipmaker the most valuable company listed in mainland China.

China’s “fitness center” economy

Liao uses a metaphor now common among Chinese officials and consultants: China’s domestic market as a “fitness center,” a phrase popularized by Premier Li Qiang and echoed by figures such as McKinsey Greater China chair Joe Ngai.

“You really have the toughest exercise scheme in this market,” Liao said.

Part of the competition comes from industrial policy. “When policymakers say that some industries will be priorities, local governments then encourage local champions to go into the market,” Liao said. That dynamic has produced an oversupply of companies in favored sectors such as green technology, electric vehicles, and semiconductors, all chasing more customers than the domestic or global market can support. “Unfortunately, people just need to fight it out,” she said.

Foreign companies have been struggling in China’s “gym.” Nike, Starbucks, and General Motors have all seen sales decline in China as consumers turn to local competitors that are seen as high quality and affordable.

Liao cautioned against reading that as a sudden reversal. “Foreign brands have been losing share in China for about a decade,” she said. Not every foreign company is losing ground, however: Adidas and Lululemon have both grown sales in China.

“A lot of the big multinational brands are known, but they’re not necessarily loved,” Liao said. “In today’s market, you have to be 100% suitable for 5% of the population—not 60% for 80% of the population.”

The companies that succeed, she said, do so by targeting narrow niches with precision. She pointed to an unnamed instant-coffee brand that built much of its business on Douyin, ByteDance’s domestic version of TikTok, by focusing its marketing on two specific moments: first thing in the morning or right before a gym session.

“You take it either at the beginning of the morning or before you go to the gym, and all their Douyin communications are focused on that specific occasion and that specific benefit,” she said.

‘Ferraris’ versus ‘Mercedes at Toyota prices’

China’s AI push reflects the same “fitness center” dynamic, Liao said: a crowded, high-intensity environment where adaptability can matter more than size. Companies are not only racing to build the most powerful models, even as the title of China’s best model appears to change every few weeks, but also to show they can survive intense competition while turning those models into viable businesses.

Liao spoke with Fortune hours after Moonshot AI released the newest version of its Kimi large language model, which approaches the performance of offerings from OpenAI and Anthropic at a significantly lower price.

“China and the U.S. take quite different approaches to AI,” Liao said. “The U.S. really focuses on moonshots, no pun intended. China is all about ‘AI-plus,’ or applied AI.”

She described the contrast in market terms: “The U.S. is technically more advanced, so they’re selling Ferraris at the Ferrari price. But we sell Mercedes at the Toyota price. That’s China’s strength.”

As in the U.S., Chinese executives are concerned about falling behind. “They’re very much afraid they’ve not caught the wave,” Liao said. “They want to embrace it.”

Carol Liao will be speaking at the Fortune Leaders Forum in Macau on Sep. 8.

In Fortune’s “Asia Agenda” column, published twice a month, the publication speaks with Asia’s top business leaders about how they are building for the future and the lessons they have drawn from leading companies in one of the world’s fastest-growing and most dynamic regions.