Language : English 简体 繁體

How to Tackle China’s Overcapacity Problem

Apr 30, 2024
  • Yao Yang

    Professor, China Center for Economic Research

During her recent visit to Beijing, US Treasury Secretary Janet Yellen criticized her Chinese counterparts, arguing that China’s government subsidies have led to overcapacity in crucial sectors like alternative energy and electric vehicles (EVs). This, she contended, provides Chinese companies with unfair cost advantages that enable them to outcompete American firms. But while Yellen was right to point out China’s overcapacity problem, her assertion that government subsidies are the root cause was misplaced. 

For Chinese people of my generation, the leap from scarcity to abundance over the past four decades has been a dream come true. Until the early 1990s, everything in China was rationed; nowadays, it is hard to find anything that is not readily available. 

China’s experience is not unique. Japan underwent a similar transformation after World War II, as decades of export-led growth enabled the country to rebuild and develop its industry. But the collapse of the Bretton Woods system in 1971, followed by that decade’s oil shocks, forced Japanese companies to focus on domestic, consumer-led growth. This shift quickly resulted in overcapacity and triggered numerous trade disputes between the United States and Japan throughout the 1980s. 

The extent of China’s overcapacity problem has become increasingly evident in recent years. While the Chinese economy accounts for 17% of global GDP, it produces 35% of the world’s manufacturing output. Exports have historically offset this imbalance, but in the face of declining global demand and heightened geopolitical tensions, Chinese exporters are being increasingly forced to compete on price. 

At the root of China’s vast industrial capacity is its savings-centric society. Despite establishing a strong state 2,000 years ago, Chinese maintain a strong sense of self-reliance, especially during difficult times. Instead of relying on the government to establish an adequate safety net, they save on their own as a safeguard against future adversity. 

Chinese policymakers share this outlook, as evidenced by their response to the ongoing economic slowdown. It is widely acknowledged that the economy’s sluggish recovery from the COVID-19 downturn stems from insufficient domestic demand. But the authorities’ strategy has been to limit local-government borrowing and mandate stricter budget controls. 

Driven by explosive export growth, China’s national savings rate increased from roughly 35% at the end of the 1990s to 52% in 2010. Although it has decreased since then, it still stands at 45%, which implies annual savings of about CN¥57 trillion ($7.9 trillion). Aside from a minor portion allocated to foreign assets, these savings fuel domestic investment, laying the groundwork for the economy’s current overcapacity. 

The problem is exacerbated by the absence of a vibrant capital market capable of directing savings toward innovation-driven businesses. Bank finance dominates 70% of China’s total social financing, and banks are reluctant to back innovative enterprises. Owing to insufficient capital-market support, investment tends to be concentrated in a few high-tech industries with promising market potential, such as alternative energy, EVs, and artificial intelligence, leading to overcapacity in these sectors. 

How can China resolve its overcapacity problem? The seemingly obvious solution is to increase domestic demand; however, this requires changing the population’s saving behavior, which would take time. Moreover, given its aversion to taking on debt, it is doubtful that the government will boost its spending. 

The only feasible solution is for Chinese firms to invest overseas. This strategy could both mitigate China’s overcapacity problem and support industrial development in recipient countries. China’s foreign investments cover a wide range of technologies, from labor-intensive goods to advanced technologies like solar panels, batteries, and EVs, making them suitable for countries at various stages of development. 

In particular, the US should welcome Chinese investment. For starters, this could ease economic tensions between the two countries. In the 1980s, Japan avoided a potential clash with the US by investing heavily in the American auto industry. 

Similarly, Chinese investment could support America’s reindustrialization efforts. This is particularly important, given US President Joe Biden’s flawed strategy, which subsidizes sectors in which US firms are at a clear disadvantage compared to their Chinese competitors, such as alternative energy, batteries, and EVs. Alas, the current political climate prevents US policymakers from thinking rationally about this issue. Sooner or later, however, it will become evident that even with significant government subsidies, US firms cannot outcompete their Chinese rivals in these industries. 

In the post-globalization era, governments around the world have set aside traditional criticisms of industrial policy. But what constitutes effective industrial policy remains open to debate. In terms of global welfare, the best approach is for countries to subsidize sectors where they already have or are likely to develop a comparative advantage and then trade with countries that specialize in complementary technologies. 

Regrettably, increased geopolitical tensions have knocked many countries, including the US and China, off the optimal path. Given the potential global repercussions of Sino-American decoupling, it is incumbent on both countries to take the lead and work together to put the world economy back on track.


Copyright: Project Syndicate, 2024.

You might also like
Back to Top