China’s overcapacity so ‘deeply rooted’ at local levels that analysts say its ebbs and

Xi now contends there is no such thing as “China’s overcapacity problem”. And Beijing argues that, from a global perspective, there is actually a shortage of capacity in the new-energy sector.

Still, Beijing’s concerns and evaluations of unchecked manufacturing have been well documented over the past three decades, with acknowledgements that institutional and mechanism factors – including local governments’ excessive involvement – have long led to instances of overcapacity weighing on the economy.

“The system goes like this: China has a plan, and then puts a lot of money into this. And then China tries to keep the foreigners out to give the Chinese companies a chance to grow in size. Then every province wants to have the same thing – the same steel, aluminium, chemicals, cars and batteries,” he explained. “And you have, all of a sudden, this incredible growth in capacities.”

China has seen ebbs and flows of overcapacity since it began shifting from a purely planned economy to a market-oriented economy – a roughly 20-year transition that started in 1978.

The first wave, involving consumer products such as televisions, occurred in the 1990s amid a strong growth spurt in the manufacturing sector as it catered to pent-up consumer demand.

“After China acceded to the WTO, its massive industrial capacity was indeed designed to cater to the whole world, especially the US and Europe,” said Tao Ran, a professor with the School of Humanities and Social Science at the Chinese University of Hong Kong (Shenzhen), who specialises in China’s economic transition and has closely followed land reform and urban development.

“Of course, China’s overall production capacity has become bigger, thus putting more pressure on the West,” Tao added, noting that the fierce competition among domestic firms, coupled with government subsidies and loosened environmental regulations, indeed increased their production capacity, leaving foreign firms little room to compete.

For local governments around the world, the appeal of attracting manufacturing investment typically involves increasing employment and tax revenue, while China’s local authorities tend to have deeper motivations to shore up their respective economies in order to gain political promotions, many Chinese scholars have argued.

And a tax-regime reform in the country, which took place from 2012-16 and shifted away the business tax burden on companies to value-added tax on consumers, also added to local governments’ incentives to attract more manufacturing investment, as more tax revenue generated from these firms could be retained at local levels after the reform, according to Tao.

Meanwhile, the policy toolboxes of Chinese local governments have always been bigger than those of their foreign peers.

Previously, local authorities could lower land prices – by reducing the acquisition compensation for farmers – curtail labour costs and relax environmental constraints. In the past decade, many shifted to so-called government guidance funds – investment vehicles for China’s private equity market that are used to direct capital to some strategic emerging industries such as semiconductors. And the source of such funding largely relied on borrowing from banks, Tao said.

“If the industry in the end fails to develop, the banks will be the ones that eventually lose money,” he added.

“As there has been serious overcapacity, and no more money to set up the [guidance] funds, projects in some places may inevitably be left unfinished, which means the money has been poured down the drain,” Tao said.