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China’s Overcapacity: A Waste But Not a Mortal Danger
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At the start of the decade, perhaps only one family in three in Oufang village was growing citrus trees. They earned a good living until five years ago nearly all their neighbors piled in and started planting.

The result has been predictable.

“There are too many oranges here. Nobody wants them and we can’t sell them,” said one of the growers, Peng Xiaomin.

Peng, 27, who has posted an advertisement on a fruit website to try to sell his oranges, said the villagers were now just scraping by.

“The farmers have planted too many citrus trees,” he said. “Development has just been too fast.”

Oufang, in southern Jiangxi province, is a microcosm of China’s economy: overcapacity blights an array of sectors, notably in heavy industries that are dominated by state-owned enterprises.

By diverting capital from areas in dire need like health and education, unproductive investment is a drag on Chinese living standards. If manufacturers dump their excess production abroad, trade strains flare up.

But is the problem serious enough to warrant all the government hand-wringing lately?

Yolanda Fernandez-Lommen, an economist with the Asian Development Bank in Beijing, said excess capacity represents an opportunity cost for China, which could put the resources to better use in, say, the stunted services sector.

“Overcapacity is a reminder that the economy is now mature enough for China to start looking into new sources of growth,” she said. “But when I think of the risks facing the economy, overcapacity is not high on the list.”


For a start, the problem is not new.

Excess capacity is almost hard-wired into China’s economic model of industrialization based on high levels of public investment. With a host of factors suppressing spending, surplus savings are channeled to state-owned firms that gorge on cheap capital and subsidized inputs.

For their part, private entrepreneurs have a gold-rush mentality, plunging headlong into the hot sectors of the day. Solar panels and electric bikes come to mind. Grabbing market share by swamping the competition, not by building brands, is the usual approach. Excess capacity is the usual outcome.

“We need to know that overcapacity is a necessary evil of market competition. Socialist central planning economies were marked with shortages, while capitalist economies are frequently haunted by overcapacities,” Ting Lu, an economist with Bank of America Merrill Lynch, said in a recent note.

At the macro level, profitability, sales growth and returns on investment do not suggest a serious overcapacity problem, according to some economists.

The six sectors targeted in the latest government drive to curb blind expansion — steel, cement, flat glass, chemically processed coal, polysilicon and wind turbines — account for just five percent of total fixed asset investment, Lu noted.

Doomsayers warn that it is only a matter of time before excess capacity leads to a wave of bankruptcies and sour loans.

But Mingchun Sun, Nomura’s chief China economist, sees things differently. Projects in the pipeline from the government’s 4 trillion yuan ($585 billion) fiscal stimulus as well as a revival of private capital spending could propel growth in fixed asset investment, now running at 33.4 percent, to 38 percent or higher in the first half of 2010.

“By then, investment demand for capital goods, raw materials and energy could be so strong that even upstream sectors with overcapacity now may experience very high capacity utilisation, or even shortages,” he said.


Optimists also cite the composition of the pump-priming package as evidence that Beijing is at last getting serious about tackling structural defects in the economy — including the innate tendency to create too much capacity.

The lion’s share of the stimulus has gone to areas where it is needed. In the first three quarters, investment in infrastructure rose by 52.6 percent from a year earlier; in railways, by 87.5 percent; in health, social security and social welfare, by 72.9 percent, according to government figures.

True, parallel programs of incentives and tax breaks have boosted sales of cars and household appliances, but economists say little of the stimulus money has gone into manufacturing.

“There was concern when the fiscal stimulus was launched that a lot would go into sectors with overcapacity and that we’d get oversupply and deflation. But it hasn’t,” said Fernandez-Lommen at the ADB.

This is not to say that all is for the best in the best of all possible worlds. Chinese manufacturing is crying out for consolidation — not for the 26.9 percent expansion in capacity recorded in the first three quarters.

China, for example, makes as much steel as the next eight producers combined. The runaway rate of expansion looks like an accident waiting to happen.

“International experience tells us that it is very important to avoid exporting overcapacity — steel, shipbuilding, chemicals, etc — to prevent trade frictions that harm the political atmosphere and interrupt supply chains,” said Joerg Wuttke, president of the European Union Chamber of Commerce in China.

A root cause of the problem is that local governments forced to attract tax-generating investment, even if there is surplus capacity nationwide, because they are starved of revenue from other sources. Unlike the United States and most of Europe, for example, China does not levy local property taxes.

So getting local party chiefs to toe the line on overcapacity will be a tall order for the central government, which has struggled down the ages to impose its will on distant provinces.

“Implementation depends on local authorities, and it will not be easy,” said Ken Peng, Citigroup’s economist in Beijing.
Source: Alan Wheatley / Reuters

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