China Battles Overcapacity Due to Internal Economic Pressures

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China’s Economic Balancing Act: Navigating Overcapacity and Domestic Demand

At teh recent Summer Davos forum, Chinese Premier Li Qiang dismissed concerns about China flooding the world with excess supply, quipping that China is not “stupid enough” to subsidize exports. Tho,within China,policymakers are grappling with a different problem: a domestic battle against overcapacity. The issue isn’t driven by external pressure, but by internal fragmentation and a lack of cohesive economic planning.

The Problem of ‘Neijuan’ and Local Competition

China’s economic system, while centrally governed, relies heavily on delegation to provincial governments for economic planning and regulation. This has led to a situation where local officials, incentivized by GDP targets, compete with each other, resulting in overlapping industrial initiatives and protectionist trade barriers. This dynamic has given rise to the concept of neijuan (“involution”), originally a sociological term describing stagnant productivity despite increased effort, but now used to describe a self-defeating cycle of price wars, redundant capacity, and diminishing returns across various industries.

Fragmented Markets and Inefficient Allocation

this fragmentation has significant economic consequences. Inconsistent rules favor firms with local connections, hindering cross-regional expansion and reducing overall efficiency.Studies show that local firms are substantially more likely to win government contracts than their non-local competitors, even when offering less value.

Addressing the Imbalance: A Focus on Domestic Market Integration

China’s leadership recognizes this issue and has reaffirmed its commitment to unifying the national market and improving market discipline.This aims to rein in “disorderly competition” and create a more level playing field. The focus is shifting from export-led growth to bolstering domestic demand and a more enduring economic model. However, implementing this shift requires tackling deeply ingrained local incentives and the fragmented system that fuels them.

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What internal economic factors have contributed to China’s overcapacity issues beyond initial investment in manufacturing?

The Roots of China’s Overcapacity Problem

China’s current struggle with overcapacity isn’t a sudden development; it’s a culmination of decades of economic policy. Initially, a key driver of China’s economic growth was massive investment in manufacturing, fueled by readily available credit and a focus on becoming the “world’s factory.” This led to notable expansion in sectors like steel, aluminum, cement, and, more recently, electric vehicles (EVs) and renewable energy technologies. However, several internal economic pressures are now exacerbating this issue.

Declining Domestic Demand: A slowdown in China’s property market, coupled with cautious consumer spending, has reduced domestic demand for many goods. The real estate sector, historically a major engine of growth, is facing a debt crisis and declining sales.

Local Government Investment: Local governments, incentivized by GDP growth targets, often overinvested in industrial projects, sometimes with little regard for market demand. This resulted in duplicated efforts and excess capacity.

Demographic Shifts: China’s aging population and declining birth rate are impacting the labor force and possibly long-term economic growth, further dampening demand.

COVID-19 Disruptions: The pandemic and subsequent lockdowns disrupted supply chains and further weakened economic activity, contributing to the overcapacity situation.

Key Sectors Facing Overcapacity

Several industries are particularly affected by China’s overcapacity issues. Understanding these sectors is crucial for assessing the broader economic implications.

Steel Industry

The steel industry has been grappling with overcapacity for years. Despite government efforts to consolidate and eliminate outdated capacity, significant excess remains. This has led to:

Price Wars: Intense competition and falling steel prices, impacting profitability for domestic producers.

Export Dumping: Concerns about China exporting excess steel at artificially low prices,harming steel industries in other countries (leading to trade disputes).

Environmental Concerns: Many older steel plants rely on polluting technologies, contributing to environmental problems.

Electric vehicle (EV) Sector

While globally seen as a growth area, China’s EV sector is now facing potential overcapacity. The government heavily subsidized EV production, leading to a proliferation of manufacturers.

Intense Competition: Hundreds of EV companies are vying for market share,leading to price cuts and margin pressure.

Consolidation Expected: Analysts predict significant consolidation within the EV industry as weaker players struggle to survive.

Export Focus: Chinese EV manufacturers are increasingly looking to export markets to absorb excess production.

Renewable Energy (Solar & Wind)

similar to EVs, China’s renewable energy sector benefited from substantial government support.This resulted in rapid expansion of manufacturing capacity for solar panels and wind turbines.

Global Market Dominance: China dominates the global supply chain for solar panels, but overcapacity is driving down prices.

Supply Chain Vulnerabilities: Reliance on a single country for critical components raises concerns about supply chain security for other nations.

Technological Advancement: The need to innovate and maintain a competitive edge is pushing companies to invest in research and development.

Government Responses and Policy Adjustments

The Chinese government is actively attempting to address the overcapacity problem through a variety of measures.

1. Supply-Side Structural Reform: this involves eliminating outdated and inefficient capacity, promoting innovation, and upgrading industrial structures.
2. Consolidation and Mergers: Encouraging mergers and acquisitions to reduce the number of players in oversupplied sectors.
3. Stricter Environmental Regulations: Closing down polluting plants and enforcing stricter environmental standards.
4. Controlling Local Government Debt: Curbing excessive investment by local governments and tightening credit controls.
5. Promoting Domestic consumption: Implementing policies to stimulate domestic demand and reduce reliance on exports.
6. “Dual Circulation” Strategy: Focusing on both domestic and international markets, aiming to reduce dependence on external demand.

Impact on Global Trade and Geopolitics

China’s overcapacity issue has significant implications for global trade and geopolitics.

Trade Tensions: Export dumping of goods like steel and EVs can lead to trade disputes with other countries, as seen with recent investigations into Chinese EV subsidies by the EU and the US.

Supply Chain Resilience: Countries are increasingly seeking to diversify their supply chains to reduce reliance on China for critical goods.

Geopolitical Competition: China’s dominance in key industries like renewable energy gives it significant leverage in international negotiations.

Global Inflation: Excess supply can contribute to deflationary pressures in certain sectors, impacting global inflation dynamics.

case Study: The Steel Industry and the US Trade War

The steel industry provides a clear example of the consequences of China’s overcapacity. In 2015-2016,a surge in Chinese steel exports flooded the global market,driving down prices and harming steel producers in the United States and Europe. This contributed to the imposition of tariffs on Chinese steel by the US under the Trump administration, escalating trade tensions. While the tariffs provided some relief to US steelmakers, thay also increased costs for downstream industries that rely on steel.

Benefits of Addressing Overcapacity

Successfully tackling overcapacity could yield several benefits for China and the global economy.

Increased Efficiency: A more streamlined and efficient industrial sector.

Higher Profitability: Improved profitability for domestic companies.

Sustainable Growth: A more sustainable and balanced economic growth model.

* Reduced trade Tensions: Easing of trade