Historical patterns, status quo and countermeasures to overcapacity

Editor's note: Gao Shanwen, a member of the Academic Committee of China Finance 40 Forum and Chief Economist at SDIC Securities. The article was first published on the China Finance 40 Forum's official WeChat account and has been translated from Chinese and edited for brevity and clarity. It reflects the author's opinions and not necessarily the views of CGTN.

Recently, both the United States and the European Union have expressed concerns over the so-called "overcapacity" issue, with the U.S. even announcing new tariffs on Chinese products like electric vehicles. 

Speaking from historical experiences, the development trajectories of many U.S. industries, such as railroissueads, automotive manufacturing, telecommunications and computer manufacturing, have demonstrated that encountering periodic overcapacity is an unavoidable step in the transition from emerging to mature industries.

Some external criticisms argue that the Chinese government's subsidies are the culprit for overcapacity, but this view is quite one-sided. This is because:

First, both the large-scale "spindle reduction" in China's textile industry in the 1990s and the massive capacity reduction in industries like steel and coal driven by the "Three Cuts, One Lower, and One Strengthen" policy (cutting excess capacity, reducing excess inventory, deleveraging, lowering costs, and strengthening areas of weakness) in 2016 show that the Chinese government does not favor overcapacity. 

Instead, the primary reason for overcapacity in these industries is that emerging industries must go through a phase of industry-wide overcapacity in their development process to establish a stable competitive landscape and truly become mature.

Second, Chinese industries such as home appliances and liquor also experienced significant industry-wide overcapacity in history and gradually moved toward market clearing, which cannot be explained by government subsidies.

Lastly, if the government indeed subsidized certain industries and enhanced their competitiveness, then this would lead to an appreciation of the renminbi in an open economy with a floating exchange rate, thus offsetting the impact of government subsidies and maintaining an international balance of payments. This does not align with the macro narrative of overcapacity.

It is essential to recognize that behind the U.S. criticism of China's overcapacity is its fear of China's rapidly enhancing competitiveness in fields like electric vehicles and photovoltaics. It reflects its concerns about U.S. industries struggling to cope with the competitive pressure from Chinese companies, thus leading to extensive industry adjustments and widespread unemployment. 

There are also worries about the so-called "second China shock" (the first being China's ascension into the WTO, and the second being the rise of industries like Chinese electric vehicles) impacting U.S. income distribution, disrupting social stability, and altering the American political trends.

In addition, we should also note that China's manufacturing sector is enormous, accounting for one-third of the global total, and comparable to the combined total of G7 countries. Fluctuations in Chinese demand create a supply-demand gap that could tremendously affect other countries through trade, price, and other channels. China's competitive advantages and periodic overcapacity in some emerging industries could similarly exert a substantial influence on other countries. If the U.S. macroeconomic policy produces notable spillover effects through the dollar exchange rate, then China's macroeconomic policy mainly generates evident spillover effects through trade.

For these countries, it is increasingly challenging to absorb the spillover effects of Chinese manufacturing through short-term cyclical policies, social safety nets, governments' transfer payment systems, and spontaneous market adjustments, thus triggering a political backlash.

Therefore, in order to cope with the situation, China should, firstly, strategically shift towards expanding domestic demand, particularly domestic consumption demand, to drive economic growth. 

Secondly, it is essential to maintain a stable overall demand, smooth out economic fluctuations as much as possible, keep the flexibility of the exchange rate, and enhance international coordination as well as internal and external communication of macroeconomic policies. 

Thirdly, as emerging industries gain competitive edges, China should promptly clear related supportive industrial policies, guide the international layout of industry supply chains, production, and sales systems, enhance resilience against trade frictions, and facilitate timely elimination of inefficient capacity based on marketisation. 

Finally, it is imperative to uphold a rules-based international free trade system, practice self-restraint and remain rational, and address trade disputes through agreed-upon dispute resolution procedures.