Overcapacity: the economic buzzword fuelling Europe's clash with China

The Star

4 hours ago

In a soulless conference room in Brussels in November, officials and experts from around Europe and the United States were locked in a technical debate over a cryptic bit of economic jargon: global non-market overcapacity.
Beneath the geography-free legalese so common in Brussels, China was undoubtedly the subject. The conference, organised by the European Commission, was designed to thrash out solutions to the problem of overcapacity in China's economy and the second-order effects Europe fears.
Decades of overinvestment and state subsidies in China, weak domestic consumption, an addiction to manufacturing, crashing corporate profits, zombie companies that the state does not let die and a superpower trade war have, the EU believes, created a perfect storm.
China's industrial overflows must go somewhere, Brussels thinks, probably at a discount, and the only logical destination is Europe.
Governments fear companies that make everything from industrial machinery and chemicals to hydrogen electrolysers and wind turbines will be eaten alive, industries decimated and jobs lost forever. They worry about a wave that could sweep populist parties to power in Europe's hollowed-out manufacturing heartlands.
They insist that Beijing should worry too, or face a European anti-China backlash similar to the one that has coursed through the United States over the last decade.
'We are seeing a new 'China shock' – as China's economy slows down, Beijing floods global markets with subsidised overcapacity that its own market cannot absorb,' European Commission President Ursula von der Leyen said at the G7 meeting in Canada this week.
Back at the Brussels forum on global non-market overcapacity last year, the discussion was becoming bogged down in terminology – 'decreasing profit margins', 'returns on capital', 'underutilised assets' – when an arm shot up in the middle of the room.
'I have to make some remarks, because China is the elephant in the room, and everything is about China on the agenda,' a Chinese diplomat said.
Stirring the dozing room to life, the diplomat angrily disputed speakers' remarks that there was deflation in China – despite official government data showing a 31st successive monthly fall in producer prices in May – and flatly denied that China's industrial success was because of subsidies.
The diplomat rejected the argument that overcapacity in China's giant industrial economy could be a problem for anyone, particularly in cleantech industries at a time of climate emergency.
'There is no country which produces as they consume ... otherwise, there will be no need for global trade ... the challenge we're facing in new energy sectors is not overcapacity, but undercapacity,' he said. Xi Jinping doesn't like overcapacity, hence it doesn't exist
The word 'overcapacity' has become a battleground in China's rivalry with the West, and the episode in Brussels shows that the two sides have started airing their dirty laundry in public.
After years of complaints, Europe has grown frustrated by Beijing's lack of response. Chinese officials brush off EU grievances, pointing out that Germany exports more cars than Germans can drive, while Belgians could not possibly eat all the chocolate made there. A running joke in Brussels is that the official Chinese term for the trend is 'so-called overcapacity'.
'Western politicians and press have repeatedly hyped up the so-called Chinese 'overcapacity',' wrote Peng Gang, minister for economic and trade affairs at China's mission to the EU, in an article for Euractiv, a Brussels media outlet.
'Some Western countries, in order to protect their vested market shares and dominant positions ... hype up the 'Chinese economic threat' or Chinese 'overcapacity' by all means.'
In a highly polarised world, a seemingly innocuous economic term has become, in itself, a geopolitical tinderbox. Any mention of 'overcapacity' is enough to get eyes rolling in some quarters, and not just in Beijing. Prominent Western critics insist it is an ideological stick with which to beat China.
'We're seeing the emergence, from the standpoint of the West, at least, of a country that is from outside the West, from the South, an economic threat. I definitely think there's an ideological element behind these accusations of overcapacity,' said Jostein Hauge, an expert in development economics at Cambridge University, on a recent episode of the Sinica Podcast.
Adam Tooze, a noted economic historian, told the South China Morning Post late last year it was 'significant that the debate has come up at this moment, because it provides a kind of justification for industrial policy in the West'.
He asked: 'Why would you not simply take advantage of the subsidy that Chinese taxpayers effectively have provided to give us all really cheap vehicles?'
Part of the problem could lie with the imprecise nature of the term 'overcapacity'. In Western discourse, the phrase has become a Frankenstein's monster, a catch-all criticism for many of the structural issues critics do not like in China.
Trey McArver, co-founder of the Trivium China consultancy, said it 'has become a byword for either angst or anger regarding the Chinese economy'.
'It's applied in a lot of different instances, and it's not applicable in every context in which it's used. It is such a broad and abused term that it doesn't help further productive discussions from a policy perspective about what the EU wants to achieve,' he said.
Those gripes include opaque subsidies, zombie companies kept alive by local governments, an unwillingness to turbo-boost consumption, a proliferation of industrial policies throughout the country and, latterly, a group of highly competitive companies, many of which struggle to turn a profit in China.
'The way China does industrial policy leads to overcapacity,' said Bert Hofman, adjunct professor at the East Asian Institute at the National University of Singapore.
'More importantly, it leads to inefficiencies – just look at profitability. Even BYD, the greatest success in electric vehicles, can barely make ends meet amid strong price competition. In the automotive industry, one-third of companies is making a loss,' said Hofman, who was previously World Bank country director in China.
Even some overcapacity believers admit that the word does not quite capture the extent of the grievances they have with China's economic model.
'There's no formal definition for overcapacity and so that's what makes it such a fraught, complicated term to use,' said Agatha Kratz, a China specialist at Rhodium Group, a research house whose work on the topic has been cited widely by Western officials pushing for China to change, and for Europe to act.
Kratz pushed back strongly against the idea that an endless supply of Chinese cleantech products would be good for the world, even during a climate emergency, since it would kill European industries.
'This is going to sound simplistic, but I really, truly believe this. You cannot buy a solar panel if you don't have a salary. You can't invest in the green transition if you don't have a taxable base,' she said.
Jens Eskelund, chair of the EU Chamber of Commerce in China, has for years advocated moving away from the term since it strikes such a nerve in Beijing. Instead, he points to nearly three years of producer price deflation in China as an official metric that the government cannot really shoot down.
'[Premier] Li Qiang calls it 'involution' [ neijuan ]. I'm fine with calling it involution,' said Eskelund. He was referring to a term most often associated with a Chinese societal trend described by the journal Economics & Human Biology as 'a state of intense, internal competition and overwork without significant progress or improvement'.
'But when you have China producing four times more electrolysers than the world can absorb, then it's overcapacity. When you have battery factories that only produce at 65 per cent capacity, then it's overcapacity. But you can call it something else if you want,' Eskelund said.
Chinese leaders have used the term 'overcapacity' before, but in a different context understood by most to refer to real estate-related sectors. During the Central Economic Work Conference in December 2023, President Xi Jinping said that 'some difficulties and challenges must be tackled to achieve further economic recovery. Those include a lack of effective demand, overcapacity in some industries, weak social expectations and many hidden risks'.
The same meeting in 2024 pledged to 'comprehensively address 'involution-style' competition and regulate the behaviour of local governments and corporations'.
The chairman of auto giant Geely, Li Shufu, said last week that 'the global automotive industry is mired in severe overcapacity woes, [so] we have decided to stop building new car plants'.
Yao Yang, dean of the National School of Development at Peking University, in a recent interview with the Post said: 'From a domestic perspective, overcapacity in China is a reality. We have to acknowledge that. It's a factual, scientific issue, which is precisely why we're talking about countering involution – it happens because of overcapacity,'
But he added that it was a result of an excess of capital instead of government policies and, in the case of EVs, the private sector played the dominant role.
So why the strong pushback from Chinese officials?
Eskelund at the EU chamber believes it is because 'China doesn't like finger-pointing', but he senses some level of acceptance in Beijing.
'China is beginning to realise it's out of balance and comes at a cost to China. Like changing any habit, it starts with recognising there's an issue,' he said.
Some EU officials complain about 'semantics'. They believe Beijing is trying to distract from what they consider to be serious problems by poking holes in the terminology.
'Even if we used another term, the response would be the same,' said one official.
Joerg Wuttke, a partner at DGA-Albright Stonebridge Group and formerly Europe's top lobbyist in China, described the debate as an 'echo chamber' that took its lead from the top.
'It reflects the messaging in the system. Xi Jinping doesn't like overcapacity, hence it doesn't exist,' said Wuttke, who said senior Chinese government figures had told him a decade ago there would be across-the-board overcapacity in hi-tech industries.
'There are similarities in DC and Beijing about delusional language. When you meet someone in DC now, they say 'we had the best 100 days ever'. The same in China: we have an echo chamber there that actually comes out with Xi's messages and people who should know better will parrot this, despite the fact it's not the truth.'
In the West, some official documents have started referring to 'non-market policies and practices', with overcapacity a subcomponent of that, perhaps recognising the fraught nature of the term, but also the challenge in defining unprecedented developments in China's economy.
Others are looking for more innovative language. The economist Arthur Kroeber uses the term a 'venture capital state' to describe Beijing's hydra of policies designed to boost labour productivity, upgrade its technology base and boost self-sufficiency.
Like a venture capital fund, the state identifies high-return sectors and pumps them full of money, producing a few winners and many failures. The difference is that in China, the failures are not allowed to die, according to Kroeber.
In a contribution to a book published last month, Not Just Another Cold War: The Global Implications of the US-China Rivalry , Kroeber said 1.8 per cent of China's GDP was pumped into funds supporting these sectors – which were all geared towards manufacturing hi-tech goods, 'a feature, not a bug of Chinese policy under Xi' – from 2017 to 2019, 'three to four times higher than comparable spending in other countries'.
The funds, 'superficially modelled on venture capital funds, are basically dressed-up subsidy channels', Kroeber wrote, adding that the 'market exit and reallocation of resources is essentially zero'.
On June 17, the Anji Soundness car-carrying ship set sail on its maiden voyage from Taicang Port in Suzhou, bound for Europe. With capacity for 9,500 vehicles that could fill 20 football fields, the world's largest methanol-ready cargo ship is the stuff of EU policymakers' nightmares – a floating emblem of overcapacity and of Beijing's unwillingness to change gear.
For others, it is a more benign symbol.
'The Chinese model involves ferocious competition – and that doesn't sit well with the classic Brussels mindset, that this is all down to market-distorting subsidies,' said Simon Evenett, the founder of Global Trade Alert, a policy tracker.
'What the Chinese have done is take subsidies and combine [them] with ferocious competition. And in Europe, I'm not sure we're ready for such levels of ferocious competition.' -- SOUTH CHINA MORNING POST