Production overcapacity is not a new phenomenon in China, but this time it concerns a greater number of products. This variety makes oversupply more difficult to control, and the shortfall in the domestic market will have to be made up by other means. Discover which ones in our study.
Overcapacity, is not new to China
China has long relied on an investment-driven growth model, fuelling its impressive economic rise over the past three decades. However, this approach also makes the economy vulnerable to supply-demand imbalances, leading to recurring periods of industrial overcapacity. This issue dates back to the 1990s, when market reforms led to an oversupply of labor-intensive goods. A more recent example occurred between 2014 and 2016, when a large investment stimulus after the global financial crisis created an oversupply of construction materials.
Though this pattern isn't new, imbalances have resurfaced since the COVID-19 pandemic, largely due to a production-driven stimulus aimed at reducing social interaction. As the economy recovered, household consumption hasn't increased enough to absorb the excess production. Additionally, as global attention turns to green energy, China's surplus of clean technology products has become a key concern, as its excess capacity could potentially double exports in this sector.
Current overcapacity is more widespread
At first glance, the extent of overcapacity appears to be milder than the last severe episode, gauged by industrial capacity utilisation rates. But this problem could worsen if growth in fixed investment continues to outstrip that of production, accentuating the excess capacity, especially if domestic demand does not keep pace. Meanwhile, excess capacity risks are not confined to specific sectors but are evident across consumption goods, construction materials as well as machinery and transportation equipment.
Revitalise domestic market to absorb excess capacity takes time
Government measures have been taken to regulate capacity expansion through industrial upgrading while boosting demand to absorb it. For example, higher quality requirements have been imposed on the production of lithium-ion batteries, solar energy, and cement clinker. However, these measures are unlikely to be replicated across a broad range of sectors since doing so also hurts near-term economic growth.
A more sustainable solution is to stimulate demand, with recent fiscal support shifting more towards subsidising goods and facility consumption rather than construction. But with consumer confidence near historic lows, the economy cannot just rely on domestic demand and endure chronic overcapacity. Because this will amplify deflationary pressures, affect corporate profits, and hinder business expansion.
The era of easily accessing export markets seems fading
Exports have historically made up for the shortfall in domestic demand. But the golden days of free trade - which had allowed China to prosper – look to have passed as trade barriers are growing, likely at an even faster pace under a second Trump presidency. Despite China's efforts to strengthen ties with the global South, many emerging nations have also erected trade barriers to protect domestic jobs and manufacturers. Indonesia, for example, is considering imposing tariffs of up to 200% on a range of basic industrial goods imported from China.
More outbound investment to seek a win-win outcome
The increased trade friction may in turn prompt Chinese companies to invest directly in recipient countries to bypass such hurdles. This measure may be welcomed by some trading partners as direct investment could create jobs and bring technologies while boosting exports of Chinese intermediate goods.
ASEAN1 remains the main destination for Chinese investment in 2022-2023, while Hungary is the main beneficiary in Europe, receiving 4.5% of Chinese FDI. Nevertheless, Chinese investment is coming under increasing scrutiny from governments in developed countries, not least for reasons of national security. In Europe, although scrutiny has intensified, some countries such as Hungary, Poland and Italy continue to welcome such investment, particularly in the electric vehicle sector.
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1The Association of Southeast Asian Nations (ASEAN) comprises 10 member states. Created by Indonesia, Malaysia, Singapore, Thailand and the Philippines in 1967, it was joined by Brunei (1984), Vietnam (1995), Laos and Burma (1997) and finally Cambodia (1999).
