China, explained.
Vehicles waiting to be loaded for export at Nanjing Port on 6 July 2025 (Fang Dongxu/VCG via Getty Images)
Facing an addiction to manufacturing, Beijing’s rhetoric will need to be matched by deep structural and political reforms.
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Too much of a good thing: Will China finally commit to solving overcapacity?Too much of a good thing: Will China finally commit to solving overcapacity?
China’s attitude towards the problem of overcapacity has been, in a word, contradictory.
Speaking at a China–France–European Union trilateral in May last year, President Xi Jinping assured his hosts that “there is no such thing as China’s overcapacity problem”. China’s ability to undercut rivals across a plethora of sectors was due to its “comparative advantage”. If China was producing much more than it – or indeed the entire world – could consume in sectors such as solar panels and lithium-ion batteries, the problem was insufficient global demand.
The Middle Kingdom abhors being lectured to by foreigners. However, even if overcapacity was dismissed as being a figment of barbarians’ febrile imagination, Beijing’s leadership has acknowledged for some time the problem of neijuan or “involution”. Just a couple of months after Xi blithely dismissed European concerns, he warned the Politburo to guard against “neijuan-style vicious competition”.
It is instructive to view these latest efforts in their historical context – overcapacity is far from a new phenomenon in China.
Six of one, half a dozen of another. Although they naturally focus on different symptoms, the malignancy described by Western and Chinese commentary is very similar. Across China, there are too many subsidised and often loss-making companies competing in the same industries. The result is compressed or negative margins, chronic deflation, vicious price wars and diminishing productivity. Overseas, the most obvious manifestation is a glut of exports threatening industrial heartlands from central Java to the Rhine-Ruhr.
Last month, Xi made his most forceful comments on involution to date. Addressing the Central Urban Work Conference, Xi pointedly asked whether “all provinces in the country” have to target the development of “Artificial intelligence, computing power and new energy vehicles”? Cadres could be forgiven for feeling a little miffed. These are, after all, the exact industries that Beijing has ordered provincial governments to prioritise for years.
Xi’s comments came after the Central Financial and Economic Affairs Commission called for “low-price competition to be regulated” and obsolescent industrial capacity to be “phased out in an orderly manner”.
Acting on cue, regulators have already released draft amendments to pricing laws that would proscribe selling goods below cost. Industries ranging from the electric vehicle to polysilicon sector (which primarily serves the solar cell and semiconductor industry) have been put on notice, with the latter having developed its own initiative to consolidate the grossly oversupplied sector.
It is instructive to view these latest efforts in their historical context – overcapacity is far from a new phenomenon in China.
Is the problem overcapacity or insufficient global demand? (ダモ リ/Unsplash)
Efforts to address overcapacity in the late 1990s were an important impetus behind the sale or rationalisation of thousands of loss-making state-owned enterprises. But since this time, policy responses have generally been fitful and piecemeal. The last serious attempt to address overcapacity petered out around 2016 after Xi became exercised by China’s reliance on foreign technology and inputs.
Consolidating individual sectors such as steel – as past rounds of policy responses have tended to do – does little to address the underlying causes of overcapacity.
Local governments and individual officials are strongly incentivised to meet factitious, centrally determined growth targets, maintain jobs and social stability, and ply aspirant national champions with subsidies in strategic sectors identified by Beijing.
Local governments’ tax bases are also disproportionately reliant on taxes such as VAT, which are mostly paid by manufacturers. With bankruptcy requiring the consent of local governments and state-owned banks who often refuse to countenance losses, struggling firms lack an easy exit.
With Beijing and local governments unwilling to dispense with China’s growth addiction, manufacturing was tasked with filling the growth void left by property.
Heaven is high and the Emperor is far away. Hackneyed cliché, but one that still has resonance in Xi’s China. Even when they really want to, it can be hard for central government agencies to maintain effective oversight over industrial activity. All this makes overcapacity an especially prickly nettle that successive leaders have avoided grasping.
When Xi finally acted decisively in 2020 to deflate China’s gargantuan property bubble, he inadvertently made any future reckoning with overcapacity much more difficult. China’s property sector was a huge source of demand for industrial materials. It was also a wealth generating machine that filled local government coffers and helped boost Chinese consumption – and demands for goods such as cars and electrical appliances.
With Beijing and local governments unwilling to dispense with China’s growth addiction, manufacturing was tasked with filling the growth void left by property.
There are of course, alternative growth models that domestic and foreign economists have long admonished Beijing to consider. Peking University Professor Michael Pettis has been one of the more indefatigable advocates of China reorientating its growth model towards consumption. At around 39 per cent of GDP, China’s household consumption is derisory compared to peer economies.
Overcapacity is in many ways the obverse of low consumption. As Pettis argues, producers benefit from direct or indirect transfers that could otherwise resource social safety nets, pay cheques and bank accounts, fostering much greater consumption of manufactured goods.
Unfortunately, despite ample rhetoric, there is little sign that China is serious about undertaking the equally complex structural reforms required to boost consumption. Xi’s government appears to be fundamentally ideologically averse to Western-style consumer capitalism.
China’s latest reform efforts may well succeed in reducing overcapacity in discreet sectors. But without deeper changes to China’s underlying political economy, the cycle of overcapacity will be destined to repeat.
About the author
Henry Storey
Henry Storey is Manager - Projects, Research and Analysis at Dragoman with a focus primarily on Asia and the South Pacific.
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