Editor's note: Warwick Powell, a special commentator for CGTN, is an adjunct professor at Queensland University of Technology. The article reflects the author's opinions and not necessarily the views of CGTN.

As China reported 5% GDP growth in Q1 2026, industrial profits of major enterprises surged 15.5% year on year, reaching 1.696 trillion yuan ($248 billion). High-tech manufacturing profits soared 47.4%, equipment manufacturing performed strongly, and producer prices turned positive after years of deflationary pressure. Yet the familiar chorus of "overcapacity" is echoing once again in Western commentary. This static diagnosis — focusing on snapshots of factory utilization, inventory levels, and export volumes — fundamentally misunderstands the dynamic processes underway in the world's largest industrial economy.

What is portrayed as overcapacity is in reality the transitional overlap of industrial vintages: Older, lower-productivity fixed capital from previous investment waves continues operating, generating intense price competition (known in China as neijuan or involution), while newer green, digital, and high-tech capacities scale up. This interregnum is messy and, for some, painful in the short term, but it reflects a purposeful process of demand-led structural transformation that is raising the economy's long-run productive potential.

The central role of Kaldor-Verdoorn Dynamics

At the heart of this transition lies the Kaldor-Verdoorn (K-V) law, one of the most important empirical regularities in heterodox economics. First observed by Dutch economist Petrus Johannes Verdoorn in 1949 and later developed by Nicholas Kaldor, the law establishes a strong positive relationship between output growth and labor productivity growth. Unlike the conventional neoclassical view — in which technical progress is largely exogenous and supply-driven — the K-V perspective sees productivity and innovation as largely endogenous to demand expansion.

In their 2025 paper published in the Review of Political Economy, Suranjana Nabar-Bhaduri and Matías Vernengo provide robust empirical confirmation of these dynamics in China (and India) over the period 1991–2019. Using two sophisticated approaches — partitioned regression analysis and structural vector autoregression — the authors demonstrate that output growth powerfully "pulls" productivity growth. For China, they estimated Verdoorn coefficients between approximately 0.89 and 1.05. In practical terms, this means that for every percentage point increase in GDP growth, labor productivity growth rises by nearly the same amount. GDP/output shocks accounted for over 80–90% of the forecast error variance in productivity, while short-term cyclical effects linked to unemployment (Okun's law) were small and statistically insignificant.

For non-specialist readers, the mechanism works as follows. Autonomous demand — in China's case, heavily driven by public and strategic investment in infrastructure, industrialization, and now green and high-tech sectors — acts as the initial catalyst. This demand induces private investment through the accelerator principle and expectations of sustained market growth. Firms first respond by raising capacity utilization rates on existing plant and equipment. When high utilization is sustained over time, several productivity-enhancing processes are activated:

●   Increasing returns to scale: Larger production volumes allow more efficient use of resources and specialization.

●   Learning-by-doing: Workers and engineers gain experience, discovering incremental improvements in processes.

●   Embodied technical change: New investment incorporates superior machinery, software, and methods.

●   Division of labor and structural transformation: Resources shift from lower- to higher-productivity activities.

International implications and policy choices

The international reaction to China's transition reveals two distinct paths. Advanced economies with mature but increasingly obsolescent industrial sectors, such as those in the EU, have leaned toward heavy protectionism — tariffs, subsidies, and investment screening on Chinese EVs, solar panels, batteries, and related goods. This approach is misguided. Many of these economies are simultaneously pursuing remilitarization while practicing relative fiscal austerity elsewhere. The combination dampens domestic demand-pull, weakening the very conditions needed for local Kaldor-Verdoorn effects. Low industrial capacity utilisation data is evidence of the effects of these policies. Rather than blocking Chinese advancements, a more productive strategy would be managed openness to Chinese firm investment and technology collaboration. This would accelerate technical propagation, speed the green transition / technical upgrade, and allow these economies to capitalize on cost and efficiency gains generated by China's scale. Social policy would then be needed to manage temporary dislocations and enable upskilling.

Developing economies with limited industrial bases face a different opportunity. Chinese productive capabilities — delivering affordable renewables, machinery, transport equipment, and infrastructure goods — provide powerful tools for their own structural transformation. Recent trade patterns confirm this: Chinese exports have increasingly oriented toward the Global South and Belt and Road partners, now accounting for over half of China's total trade. While advanced economies remain preoccupied with current account balances and "dumping" concerns, developing nations are harnessing these flows to build industrial foundations.

Short-term headwinds from geopolitics

The ongoing war in Iran introduces additional near-term pressures. Disruptions to energy supplies are creating pressures on input costs, which may temporarily dampen some investment plans and slow global demand. For China, higher downstream prices could paradoxically encourage a drawdown of household savings to maintain material consumption volumes. Tapered real wage and household income growth — the mirror image of rising profit shares during this capital-deepening phase — reinforces this adjustment. Stronger industrial profits, particularly in upgrading sectors, provide resources for continued reinvestment in new technologies. Well-calibrated policies to support domestic consumption and equipment modernization can help bridge the transition.

Moving beyond static tropes

The "overcapacity" debate ultimately reflects a deeper methodological divide. Neoclassical frameworks favor equilibrium analysis and exogenous supply factors. Alternative approaches, grounded in the Kaldor-Verdoorn tradition, emphasize cumulative causation, demand-led growth, and evolutionary technical change. China's experience since the 1990s — and the strong econometric results in the Nabar-Bhaduri and Vernengo study — provide compelling evidence for the latter.

As older industrial modes gradually yield to newer ones, the current period of involution will ease. Q1 2026 indicators — accelerating profits in advanced manufacturing, recovering producer prices, and resilient high-tech momentum despite external shocks — suggest the transition is advancing. Understanding this process as demand-induced, competition-driven obsolescence rather than simple excess capacity offers a far more accurate guide for policymakers.

For China, the priority remains sustaining autonomous demand while managing orderly upgrading. For the world, the wiser course is complementary industrial policies that harness rather than resist the global productivity wave. Development is not a zero-sum optimization problem but an evolutionary process of structural transformation. Static snapshots obscure more than they reveal. Dynamic analysis points toward higher systemic efficiency and shared potential gains — if the politics can catch up with the economics.