China's "overcapacity" reveals two different visions of the world

One vision is about competing to make things better and cheaper, which seems like a good thing for everyone. The other is about jobs and a growing sense of unfairness.

Chinese EVs waiting to be exported. Source: CGTN

China’s industrial “overcapacity” is one of the most dominant issues in the world at the moment. This week, US Treasury Secretary Janet Yellen is warning China against flooding the market with low-cost exports during a trip there. European Commission President Ursula von der Leyen sounded the alarm in a recent speech that China’s “overcapacities in protected industries are flooding global markets and can undermine our industrial base.”

But the debate over “overcapacity” reveals something much deeper. Let me describe two different visions of how the global economy should work, and tell me which resonates more with you.

Vision 1: Finite demand and unfair competition

Global demand for manufactured goods, such as cars and solar panels, may be growing over time, but it’s limited. Each country that’s able to produce these goods at a decent level of quality and at a decent price should get a fair shot at getting a piece of the global production pie. This is important because there are jobs tied to this production. China’s production of more than its fair share of certain goods—relying on unfair state support to drive down prices—is contributing to “overcapacity” and preventing other countries from getting their fair share of the jobs associated with this production.

Vision 2: Helping the world through global competition

All the talk about “overcapacity” is overblown. When firms compete with each other globally to make products better and cheaper, everybody benefits. Consumers are the most obvious winners. But so are businesses that rely on these products as inputs. If these goods are related to clean energy and can help reduce carbon emissions, that’s a big win for the planet on climate change. State support for domestic companies is not unfair; it’s just another set of tools for raising competitiveness. Countries that are upset about Chinese companies dominating their markets with better, cheaper products should focus on making their own companies more competitive.

Geely plant making Polestar EVs

What’s missing in the debate about “overcapacity”?

Lately, there’s been a lot of good writing on Chinese “overcapacity.” Lan Xiaohuan at Fudan University and Yanmei Xie at Gavekal have argued separately that overcapacity is a deliberate part of China’s industrial strategy, geared towards ramping up investment and stimulating competition. Mary Gallagher at the University of Michigan shows how overcapacity is part of a broader style of Chinese governance that tends toward “excess capacity” and overshooting targets, from the Great Leap Forward to China’s real estate boom.

Other analysis has focused on overcapacity as a problem of supply and demand. A recent Rhodium Group report makes a distinction between the temporary oversupply swings that are “a normal part of market cycles” versus a state-driven “systemic bias toward supporting producers rather than households or consumers” that causes an “imbalance between domestic supply and demand.” This imbalance, combined with China’s current economic malaise, has led to questions about whether China is trying to export its way out of its problems. Zongyuan Zoe Liu at the Council on Foreign Relations and Michael Pettis at the Carnegie Endowment for International Peace have argued that China should focus more on boosting domestic consumption rather than fueling overcapacity through more investment.

But several important issues are being overlooked.

1. China itself pays a price for overcapacity.

China makes a gamble when it throws state support behind an industry. Chinese companies that receive state investments might not succeed and even go bankrupt. Fiscal resources might be wasted on supporting products that no one wants. State bank loans and other forms of financing might see little-to-no return on investment and be written off. China’s state resources are finite, and there are significant risks and costs for China when it makes these kinds of bets. In retrospect, we see EVs and solar panels as obvious successes for China. But there are plenty of areas of uncertainty where China’s big, expensive bets might not pan out, such as semiconductors and commercial jets.

Boeing factory

2. Many countries besides China use state policies to support their own industries.

Every country with a major automotive industry—the US, Germany, Japan, India—has strong state measures to protect their own domestic industries and their own auto-related manufacturing jobs. Boeing and Airbus have long received significant state support. The US Inflation Reduction Act’s preferential treatment of American clean energy companies, particularly in EV manufacturing, has provoked outcry from the EU, South Korea, and Japan. The EU has already struck back with its own self-preferencing Green Deal Industrial Plan. The difference between China and other countries is a matter of scale: China’s industrial policy is far broader, deeper, and arguably more effective at generating domestic production capacity.

3. Why do countries have to produce as much as they consume?

A lot of the arguments about China’s overcapacity seem to assume that countries should be producing at or below their level of consumption. But why should this be the case at all? Saudi Arabia and Norway produce far more oil than they consume. Likewise with American natural gas. Taiwan singlehandedly produces more than half of the world’s semiconductor chips. The idea of exporting goods to other countries—goods that they want to buy voluntarily—is suddenly being talked about like it’s borderline criminal behavior. Part of this is just a longer-standing gripe about China not consuming enough the way that the US does, for example. The great irony is that as Western countries urge China to become more like them, they’re becoming more like China.

It’s really about jobs and “fairness”

So the “overcapacity” debate is not really about factory utilization rates or supply-demand imbalances. It’s about jobs and a sense of what’s fair. That’s Vision 1 of the world.

You can tell it’s really about jobs because the overcapacity issue only comes up for certain types of goods tied to certain types of jobs. Nobody in the US or Europe is accusing China of overcapacity in clothing or toy or smartphone manufacturing because, frankly, Americans and Europeans don’t want those kinds of low-skill, low-wage “sweatshop” jobs—and they like their cheap clothing.

The “China shock” was a big deal not because manufacturing moved to China per se but because many “good jobs” tied to manufacturing left the US. Remember: the headlines about the original “China shock” paper were all about the estimated loss of more than 2 million American manufacturing jobs due to imports from China. Biden and Trump both talk all the time about stemming the loss of jobs to China on the campaign trail. Now fears of a “second China shock” are looming for the same reasons—except this time it’s the loss of advanced manufacturing jobs and jobs tied to new, emerging industries that are at stake. Plus, the Chinese economy is just much bigger now, meaning that the impact will be that much larger.

China Shock. Source: WSJ.

So while China’s vision of the world is focused on the global competition over goods, the rest of the world is focused on the global competition over good jobs.

The question then becomes: who’s getting the good jobs, and is it fair? Indeed, the issue of fairness comes up all the time. Biden used the phrase “unfair economic practices” when talking about China in his latest State of the Union address. Janet Yellen used the same phrase several times in a recent speech on China. Ursula von der Leyen, during a summit with Xi Jinping, said: “Politically, EU leaders will not be able to tolerate that our industrial base is undermined by unfair competition.” (Of course, China is also trying to use the same language, saying that a recent EU investigation into state support for Chinese EV makers is “unfair.”)

China’s mistake is political

China views its industrial success as being the result of a superior system that can integrate state coordination with the competitive forces of the market. (In the world of Chinese SOEs, I call this approach “managed competition.”) China doesn’t think it’s being unfair—it’s just better.

Of course, the rest of the world doesn’t see it that way. China is not only explicitly trying to dominate critical industries, such as clean energy; it’s also bragging about it. This is part of a longer pattern of tin-ear geopolitics where China doesn’t seem to fully appreciate how much its cheerleading and boasting aimed at domestic audiences—like talking up “China’s manufacturing prowess”—is angering foreign audiences and fueling a powerful geopolitical backlash. The classic example of this is “Made in China 2025,” China’s now infamous industrial policy plan targeting a set of strategic industries, which has been widely cited by other countries as a reason to push back against China economically.

European Commission President Ursula von der Leyen giving a speech on China

There is some recognition of this problem within China. Two Peking University economists, Huang Yiping and Lu Feng, have argued: “We need to take this [criticism] seriously. If a protectionist wave against Chinese products gained momentum around the globe, then it would be detrimental to our development in the next phase, especially in innovation.” A recent high-level Chinese government work report stated: “We will strengthen coordination, planning, and investment guidance for key sectors to prevent overcapacity and poor-quality, redundant development.” But China needs to take real action.

What should China do?

Rather than simply pushing back more forcefully and asserting that its vision of the world is the right one, China needs to better appreciate the concerns of other countries and incorporate this into its policies. One way that China can do better is to work with other countries to make sure they get a larger share of the jobs associated with advanced manufacturing. China could do more to encourage its companies to set up plants abroad that provide jobs to workers in those countries. Chinese firms are already starting to do this, like BYD’s factories in Hungary and Brazil. Chinese companies can also try to partner more with local firms in other countries, like SAIC is doing in India.

Ultimately, China might not believe that “the customer is always right.” But in an age of greater economic nationalism and concern about China’s actions, listening to your customers and trying to really understand their point of view would be a wise first step.

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More reading:

• Financial Times: Will Xi’s manufacturing plan be enough to rescue China’s economy?

• Bloomberg: Xi’s Solution for China’s Economy Risks Triggering New Trade War

  • These are two of the best overviews of the overcapacity issue and its geopolitical backlash

• Lan Xiaohuan on China's Local Government Competition and Overcapacity

  • An excerpt from Fudan University economist Lan Xiaohuan’s book How China Works: An Introduction to China’s State-led Economic Development

• The Economist: How Xi Jinping plans to overtake America

  • A good overview of China’s current industrial policy strategy