Why ‘overcapacity’ is a vague and misleading term
EAI senior research fellow Lance Gore notes that US concerns over what is perceived as China’s overcapacity might be unfounded and even indicative of US protectionism, and the fear that China might dominate manufacturing.
Before her China trip, US Treasury Secretary Janet Yellen revealed that one of its objectives was to address the global economic imbalance caused by China’s overcapacity.
At this time, China is vigorously discussing the “new quality productive forces” (新质生产力) and using it as a guiding principle for the next stage of economic development. People across the nation are deliberating on this topic, formulating various plans around it, which has also sparked international concerns about a new round of overcapacity.
Shift in the US’s China policy
Wrapping up her China trip at a media conference, Yellen said that the two sides will discuss China’s overcapacity “in a detailed and targeted manner” through dedicated mechanisms.
Yellen’s comments mark an important shift in the US’s China policy, from focusing on China’s external actions to its internal structure and from its foreign trade to its entire economy, thus opening up a new front line in the intensifying US-China competition.
She specifically mentioned the “new three” (新三样) of China’s exports: new energy vehicles (NEVs, including electric and hybrid vehicles), lithium batteries and photovoltaic products. Globally, China’s photovoltaic output has ranked first for 16 straight years, and its production and sales of NEVs have been top for nine consecutive years, while China’s enterprises account for more than 60% of global installed capacity of power batteries. These are the bright spots amidst China’s economic slowdown.
Viewed in the context of history, this rivalry has only just begun, with its ramifications likely to be extensive and its duration prolonged.
Trend towards de-globalisation
The backdrop of the capacity war is the abrupt trend towards de-globalisation. Developed nations are veering away from the post-Cold War global division of labour, where they monopolised high-end manufacturing and services industries while outsourcing low-end manufacturing to developing nations. This arrangement favoured the affluent elite at the top but marginalised the majority of blue- and white-collar workers.
The consequent political recoil has led these developed nations to change course, from embracing liberal globalisation to adopting economic nationalism. In order to boost domestic employment, they have to re-establish manufacturing industries domestically and develop their own industries and supply chains, which means they have to protect their domestic markets.
However, the US does not welcome Chinese products now because it believes that creating jobs is of greater interest to its middle class.
Due to this strategic reset, Yellen has publicly declared that the US no longer welcomes cheap imports. As its working-class income has stagnated since the 1970s, the US has maintained standards of living with Chinese products that have consistently become cheaper and better quality.
However, the US does not welcome Chinese products now because it believes that creating jobs is of greater interest to its middle class. To enable its domestic enterprises to be competitive, the US government has not only raised tariffs but also wants to tackle the issue at its source, which is China’s overcapacity.
East Asia’s success goes against free market rules
This transformation by developed nations is actually taken from the pages of the textbook on East Asia’s development model. After World War II, every nation has worked on economic development, but only East Asia’s export-oriented model has succeeded. The exports of East Asian nations are competitive and constantly improving, with their governments’ industrial policies playing a significant role.
For example, Taiwan Semiconductor Manufacturing Company Limited is funded by the Taiwanese government, and South Korea’s Samsung, Hyundai and other conglomerates continue to lead, favoured by its government. It is much the same with Japanese conglomerates — which is where South Korea learned from.
During their infancy, East Asian industries had governments protecting domestic markets, which gave them room to survive, grow and develop. Being at the frontline of the Cold War, the East Asian economies also benefited from US military procurement, open market and generous technology transfer. These favourable conditions have enabled them to raise the initial capital and compete and overcome their competitors, claiming market share with cheap and high-quality products as well as achieving optimal production scale. In short, East Asia’s success goes against free market rules.
Overcapacity rapidly becomes the norm when local governments and state-owned enterprises repeatedly invest in popular industries.
Likewise, China’s export-oriented economy has benefited from post-Cold War industrial redeployment during globalisation and access to the markets of developed nations, as well as integration with the capitalist global economy.
Excessive competition and overcapacity within China
However, as a super-large economy, China’s development differs from the East Asian model. China’s four levels of local governments — numbered in the thousands at county level and above — are all committed to developing the local economies.
Compared to private enterprises, the various levels of government can quickly mobilise resources, raise capital and compete to attract external investments. Hence, China’s economic model is characterised by investment-led growth. Overcapacity rapidly becomes the norm when local governments and state-owned enterprises repeatedly invest in popular industries. What happens first is not external sales but local trade barriers and trade wars, and the central government is still trying to establish a unified national market to tackle this.
Eliminating excessive and low-quality production capacity has been a long-term problem for China’s central government. When Shanghai completely abandoned its textile industry for other strategically more important industries in the 1990s, the central authorities sent its people to the scene to supervise the destruction of the spindles and the textile machines to prevent their re-assembly and re-use elsewhere.
In February 2016, China vowed to close 500 million tonnes of coal production in the next three to five years and reduce steel production capacity by more than 50 million tonnes. As of 2018, a total of 150 gigawatts of new coal capacity were canceled or postponed until at least 2020, while older plants producing up to 20 gW were expected to be closed. The utilisation rate of China’s silicon wafer capacity dropped from 78% in 2019 to 57% in 2022, while in 2022, China’s lithium-ion battery production reached 1.9 times the domestic installation volumes.
In early 2023, China’s total capacity utilisation fell below 75% for the first time since 2016. During this year’s Two Sessions, the Government continued to emphasise the need to “strengthen coordination, planning, and investment guidance for key sectors to prevent overcapacity and poor-quality, redundant development”.
Excessive competition within China has resulted in meagre profits or even losses for many enterprises, so they must recoup from the export markets.
Excessive competition within China has resulted in meagre profits or even losses for many enterprises, so they must recoup from the export markets. Therefore, exporting cheap and high-quality goods is a matter of survival, and not an aggressive national strategy as argued by some in the West.
Is it fair to target China’s ‘new three’?
The US presidential candidates of both parties have said that EVs from China would be prohibited in the US market, and Yellen has vowed that the US would never allow the repetition of “below-cost Chinese steel flooding the global market and decimating industries across the world and in the US”.
The “new three” she is targeting this time, however, differ from the export of labour-intensive products of mature industries and lagging technologies. China is leading the world in production capacity and the technologies of the “new three”, and the contributions of these technologies to environmental protection and climate change make them unique.
... as illustrated by the Apple iPhone and Tesla EVs that are produced in China by US enterprises; it is difficult to link such companies to overcapacity.
Ford Motor Company and Tesla’s Elon Musk have claimed that protectionism is the only thing stopping China’s NEVs from demolishing the competition. In 2023, the number of NEVs exported by China exceeded 1.1 million, a 61.6% year-on-year increase; lithium batteries saw an output value of over 1.4 trillion RMB (US$197 billion), up 70% year-on-year, and exports of photovoltaic products exceeded US$500 billion, up 50% year-on-year.
Compared to traditional industries such as steel, cement and textiles, which are exported in large quantities due to overcapacity, the “new three” are different in at least two ways.
First, the positive spillover benefits of the “new three” cannot be ignored. Their rapid development and export contribute to China’s economic growth and the world’s green development and low-carbon transformation. The International Energy Agency (IEA) has said that such high-quality production capacities cannot be considered overcapacity, as they are important in tackling climate change and propelling global development of NEVs.
If all the combustion engine vehicles on the roads in the world were to be replaced by NEVs, its production capacity would not be in excess but severely deficient. The US Foreign Policy magazine has published an analysis that Yellen has a “three-body problem” with China, and that her criticism of Beijing’s industrial overcapacity is unconvincing.
Second, the “new three” are industries of the fourth industrial revolution, mainly driven by new technologies such as artificial intelligence (AI), digitalisation and information technology, allowing them to achieve exponential growth, with much more rapid emergent enterprises spawned by the new technological revolution, production capacities are largely concentrated within a few enterprises or nations.
To fully take advantage of their production capacities and technologies, these enterprises must think global and aim at the global market, as illustrated by the Apple iPhone and Tesla EVs that are produced in China by US enterprises; it is difficult to link such companies to overcapacity.
For example, despite its short history, the number of spacecraft launches by SpaceX has very rapidly ranked among aerospace superpowers such as the US, China, Russia and Europe. Driven by rapid growth and constant innovations, SpaceX’s costs of spacecraft launches have dropped sharply, yet no one accuses it of overcapacity. Some Chinese enterprises, such as Huawei and BYD, are in a similar situation.
The leading technologies of the “new three” create products with unique advantages that are beneficial to enterprises and the environment. The positive spillover effects of their production capacity cannot be viewed similarly as previous low-tech exports, such as steel; otherwise, it would protect the laggards and obstruct progress, and become a political issue.
“Overcapacity” is a vague and misleading term, while the “capacity politics” it engenders has made Yellen, an expert economist, openly disregard the basic economic theory that international trade will cease if every nation only produces to meet its consumption needs.
The meaning of ‘overcapacity’
In a press conference at the end of her China visit, Yellen said China’s excess capacity has built up over a significant amount of time, and concerns will not be resolved in a week or a month. In other words, this issue presents an opportunity for the US to intervene in China’s industrial policy, and this confrontation will be protracted.
While accusing China of providing government subsidies to support its industries, the US and other developed nations are themselves providing similar support through their industrial policies. In this post-globalised era, such accusations would seem increasingly pathetic and weak.
“Overcapacity” is a vague and misleading term, while the “capacity politics” it engenders has made Yellen, an expert economist, openly disregard the basic economic theory that international trade will cease if every nation only produces to meet its consumption needs.
Now, it is the turn of China’s officials to reiterate the tenets of liberalism: overcapacity is a market outcome and supply-demand imbalance is the norm. It has often happened in the history of the US and Western nations and tackling overcapacity depends on market adjustments based on the law of value.
Based on the above characteristics of the industries of the fourth industrial revolution, we can visualise one country holding all the comparative advantages to produce and supply cheap and high-quality goods to the world — given rapid AI development, this is entirely possible.
Yellen is practically saying that the US cannot compete with China’s “new three” but the US workers’ livelihoods must be protected, so production capacity must be allocated and the benefits shared.
Asking China to share the benefits
From a purely economic perspective, with the skills, quality, diligence, discipline and hard work of China’s workers, as well as China’s “996” (9am to 9pm, six days a week) workplace culture, industrial agglomeration, supply chain ecosystem and first-class infrastructure, no other nation trumps China’s comparative advantages.
To take NEVs as an example, China’s automobile companies supply the best quality NEVs to consumers using the most advanced technologies, at the most optimal scale and at the lowest production costs, while consuming fewer resources to more quickly improve the environment. For humankind, this is perhaps the best option.
However, capitalism naturally dictates that livelihoods depend on employment. Without industry, there are no jobs. Yellen is practically saying that the US cannot compete with China’s “new three” but the US workers’ livelihoods must be protected, so production capacity must be allocated and the benefits shared.
In essence, the economic issue has become political, exposing the predicament of capitalist mode of production. Although her advocacy that China implements some demand-side reforms (such as boosting household consumption, instead of concentrating only on supply-side reforms) seems reasonable, it merely addresses the symptoms and not the causes. The ultimate solution will require a post-capitalist mode of production to develop, mature and eventually become mainstream.
This article was first published in Lianhe Zaobao as “产能政治的兴起”.
