China’s Economy is Trapped in a Doom Loop It Can’t Escape

Key Points and Summary – China’s leadership, including Xi Jinping, is now openly admitting to a crisis of industrial “overcapacity,” a problem they have termed “involution.”

-This counterproductive and “disorderly competition” is causing destructive price wars, particularly in the massive auto industry.

Xi Jinping President of the People’s Republic of China speak’s at a United Nations Office at Geneva. 18 january 2017. UN Photo / Jean-Marc Ferré

-While Beijing is attempting to use dictatorial measures like price controls to fix the issue, experts argue this will fail.

-With weak domestic consumption and export markets closing due to tariff wars, China’s only path to achieving its growth targets is more investment in manufacturing, a move that only worsens the overcapacity problem in a dangerous doom loop.

China’s Economy Can’t Escape the Doom Loop

In recent weeks, both the Politburo of the Chinese Communist Party and the State Council of China’s central government have signaled deep concern about the country’s industrial sector.

Washington and others say China has an “overcapacity” problem. China’s leaders and technocrats, not wanting to concede that others have a point about their predatory manufacturing-sector policies, have adopted a more oblique term to describe their worsening situation: “Involution.”

In July, Qiushi, the Party’s official theoretical journal, complained that “disorderly competition has destroyed entire industry ecology.” This was, in the words of Diana Choyleva of Enodo Economics, “an admission that destructive competition had reached crisis proportions.”

Party theoreticians are not the only ones alarmed. Xi Jinping, on July 1, at a meeting of the Party’s Central Financial and Economic Affairs Commission, said the country needed to “lawfully regulate enterprises’ disorderly low-price competition, guide companies to improve product quality, and promote the orderly exit of outdated production capacity.”

Later in the month, Xi promised to “break involution.” Involution, neijuan or rolling inwards, “involves frenetic activity” that is counterproductive. As a Chinese ministry explained, “Uncontrolled price wars among businesses are a classic example of ‘involutionary’ competition.”

The car industry is, these days, the example uppermost in the minds of China’s planners, especially those at the National Development and Reform Commission and the Ministry of Industry and Information Technology. Pricing, they demanded recently at a new energy vehicle symposium, must be “monitored and standardized.”

Cars are the prime example of China excess industrial capacity. There are now about 150 passenger car manufacturers in China, 97 Chinese domestic ones and 43 joint ventures according to one count. Many, due to cutthroat price cutting, are losing money.

China, at the moment, can supply over half of the world’s requirements for passenger vehicles. As a result, Brad Setser of the Council on Foreign Relations asks this: “Will China Take Over the Global Auto Industry?”

Before China takes over the world market, however, it has to take control of its domestic one. To do that, Beijing must deal with what the State Council termed “irrational competition” in new energy vehicles.

The dictatorial regime’s solution is dictatorial: Mandate an end to competition, something evident from the amendments to the country’s Price Law, proposed last month. Similarly, technocrats think they can overpower the market. “China’s approach appears to favor gradual consolidation and regulatory discipline over dramatic market interventions,” writes Choyleva.

The belief that Beijing is stronger than market forces, however, is wrong. Prices will continue to drop as long as there is too much productive capacity.

There will be too much capacity as long as provinces and localities promote local industrial development and protect inefficient and smallish producers. These lower-tier governments, Andrew Collier, a senior fellow at the Harvard Kennedy School, told me, “are already struggling with declining tax revenue” and cannot afford to see factories close.

As Collier, also author of Shadow Banking and the Rise of Capitalism in China, pointed out, the country has had an overcapacity problem since the middle of last decade, the result of excessive central government stimulus spending following the global 2008 downturn. Factory utilization in China fell, Collier noted, from 76.4% in the last quarter of last year to 74.1% in the first quarter of this one.

“The Party is aware that overcapacity is a problem,” Anne Stevenson-Yang of J Capital Research USA, wrote to me. “But Chinese officials and leaders feel that growth is a bigger problem, and growth in a weak-consumption environment means investment, so they will continue to invest in capacity.”

Why is investment Beijing’s only real option? There are only two alternatives: consumption or exports.

As economists, analysts, and observers say, the country needs to move to a consumption-based economy. Consumption’s contribution to GDP, already among the lowest in the world in China, appears to be declining. Yet the Party refuses to empower Chinese consumers as this would weaken its grip over society.

China could solve its overcapacity problem if it exported more, but countries are closing off their markets to China, as the U.S. and EU, China’s largest markets, are now doing. The ongoing “tariff war” suggests China will have to solve problems without the help of foreign sales.

That leaves investment. As Stevenson-Yang, also author of Wild Ride: A Short History of the Opening and Closing of the Chinese Economy, pointed out, there are “three principal areas to invest in: property, infrastructure, and manufacturing capacity.” Property is overbuilt, and the country is building as much infrastructure as it can. That leaves the factory sector.

“Even as productivity declines, China’s technocrats have to invest in manufacturing capacity to achieve their growth target,” she noted. “So they will, and more capacity means falling prices.”

The Chinese leadership, which failed to restructure the economy last decade when it would have been easier, is unlikely to restructure now, when the first effects of restructuring would be a severe and prolonged downturn.

China, as a practical matter, cannot solve today’s overcapacity, involution, or whatever Chinese leaders care to call it.

About the Author: Gordon G. Chang

Gordon G. Chang is the author of Plan Red: China’s Project to Destroy America and The Coming Collapse of China. Follow him on X @GordonGChang. Chang is a Contributing Editor for National Security Journal. 

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