April 22, 2024
World Economy

Overcapacity in China is a Burden for the World Economy


Overcapacity in China has been an ongoing theme for more than fifteen years: From steel and cement it has now morphed to green technologies and automobiles. It would be in Beijing’s own interest to tackle the problem.

Deutsche Version

Overcapacity has been a blight on China’s industrial landscape for many years now, affecting dozens of industries. It has been wreaking far-reaching damage on the global economy in general, and China’s economic growth in particular. Yet when the European Chamber of Commerce in China released its first report on this topic in 2009, it was a seldom-examined phenomenon.

Unfortunately, after I had launched an updated report in late 2016, overcapacity in China has only continued to worsen. But unlike in 2009 and 2016, when China’s steel, aluminium and cement industries were struggling, this time the problem hits the world in more sophisticated products: Green technologies, such as solar panels and automobiles.

China in a deflationary grip

Due to the effect of overcapacity on industry profits, China is now stuck in a deflationary grip, witnessing its consumer and producer price indexes to continually decline. This trend seriously influences the profitability of China’s industrial producers and hurts the fabric of the Chinese economy.

The primary victim of China’s overcapacity is the Chinese economy itself. However, it is not the only victim that feels the pain. Since industries in other regions of the world are also affected by the overcapacity in China’s system, the global economy also suffers, as tensions between China and its trading partners increase.

The European Union is presently conducting investigations that may result in tariffs on Chinese vehicles. In the United States, countervailing duties and tariffs were enacted by the U.S. Department of Commerce against a range of Chinese products. Since trade frictions hamper supply chains, this poses a major threat to the world economy.

So why have the many attempts that have been made to address overcapacity in China produced weak outcomes? A number of factors are at play:

  1. Local protectionism and the fragmentation of industries that is driven by regionalism;
  2. Weak enforcement of regulations;
  3. Low input prices due to government policies and subsidies;
  4. A fiscal system that encourages local governments to attract excessive investment;
  5. Inexpensive and widespread availability of technology;
  6. Environmental, health and safety (EHS) standards and laws that are not fully implemented; and
  7. A philosophy of market share vs. profitability.

Levin Zhu, former head of China International Capital Corporation and son of former Premier Zhu Rongji, argued already in 2015 that due to the scale of the challenges China faces, fundamental restructuring must take place if the long-term potential of the economy is to be realised.

The State Council has taken some actions since, but unfortunately, these measures have resulted in few real breakthroughs that positively address China’s industrial overcapacity. This poses the question: Why has follow-through on many central government initiatives and statements been so limited?

One possible explanation is that the past high economic growth rates have caused the government to become complacent. Furthermore, anticipation among industry players of an explosion of demand led to irrational exuberance and further malinvestment.

The government’s current role in the Chinese economy is part of the fundamental problem. This renders it exceedingly difficult for the government to effectively implement long-term solutions, as doing so would require letting go and giving market forces a freer rein. For a system that is often deeply wedded to government-led solutions, such reforms go against established instincts as well as a development model that had worked well in the past.

Capacity needs to be reduced

So, how can overcapacity be reduced?

A number of simple measures would be in order:

  1. Cut capital expenditure («capex») in industries characterised by overcapacity.
  2. Reform the fiscal system to give local regions more funding possibilities in order to reduce their incentive to subsidise local companies with the goal of maintaining their tax base and employment levels.
  3. Reduce national subsidies to industry in general.
  4. Expand and increase dividend payments of state-owned enterprises (SOE) to reduce the ability of SOEs to invest in unneeded expansions.
  5. Redistribute SOE dividend payments to Chinese households indirectly through government spending on social security, healthcare and education in order to stimulate more private consumption and economic growth through the resulting growth in domestic demand for goods and services.

Ultimately, tackling overcapacity is not only a matter of reducing capacity growth. Capacity itself has to be reduced.

The longer the long-mooted restructuring of outdated and inefficient capacity in the industrial sector is postponed, including the closure of excess facilities, the more likely it will be a painful experience. For China certainly, but also for the global economy.

Joerg Wuttke

Joerg Wuttke is the former president of the EU Chamber of Commerce in China.

Joerg Wuttke is the former president of the EU Chamber of Commerce in China.



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