China has a ‘vicious’ problem and even Xi Jinping will struggle to fix it

Many are worried that China is making way more than the world needs. From electric vehicles to solar panels, plunging prices at home and abroad are igniting a new round of trade wars. Even Beijing is concerned: In a top-level meeting late last month, policymakers pledged to curb “vicious competition” among businesses.

Industrial overcapacity has flared up in recent months. There isn’t enough global demand to absorb all the lithium batteries, solar modules or steel that Chinese factories can produce. But this is happening at the painful expense of corporate profits. More than half of industry supply in solar, EV, steel, and construction machinery isn’t making money, a sharp deterioration from a year earlier, according to Goldman Sachs.

Even those producing consumer staples are not spared. Fresh milk, for instance, is caught in its longest price slump in 14 years, exacerbating a deflationary gloom that’s enveloping the economy.

We’ve been here before. China went through an extended producers’ deflation between 2012 and 2016, caused by the same problem. As the economy slowed, the utilisation rate in the steel and coal industries contracted from 79 per cent and 90 per cent in 2010 to 70 per cent and 65 per cent in 2015, according to the International Monetary Fund. Back then, excess capacity was also an international issue. About half of the anti-dumping and anti-subsidy investigations against China in 2016 were related to steel.

President Xi Jinping’s solution then was a supply-side reform that aimed to rein in production. Starting in 2015, the government closed factories and deployed 100 billion yuan ($20.8 billion) for severance pay to steel and coal workers. It was a success. By 2017, deflation was gone, and some big state-owned enterprises, such as Aluminum Corporation of China, swung to profit.

So it’s only natural that some industry insiders are urging the government to tackle supply again. But there are at least three reasons to believe why that won’t work this time.

Firstly, the government has less sway in sectors where overcapacity is the most acute. If steel, coal and, to a lesser extent, aluminium were the big headaches a decade ago, the international focus this time is on lithium batteries, solar and EVs. Unfortunately, unlike steel, where roughly half of the producers are state-owned, these new economy sectors are largely dominated by private businesses. The government can’t really tell entrepreneurs what to do, unless Xi is prepared to return to the old days of a command economy.

Secondly, some industry leaders might see overcapacity as an advantage, in that it will force weaker ones to exit more quickly, leaving the survivors with a brighter future and fatter profits. Take lithium batteries, for instance. Contemporary Amperex TechnologY is the biggest manufacturer. Contrary to its peers, CATL’s profit margin has been on the rise despite falling battery prices. Scale and good cost control are helping.