Overcapacity caused by China -- a false narrative


by Zhou Mi

Recently, overcapacity seems to be attracting more attention in Western countries. And unsurprisingly, the main reason behind this so-called overcapacity is China. Unlike the last round of debate which involved iron and steel products, low-carbon or green products are now in the spotlight. Is that a reasonable worry and should we do something about it?

In the real world, the relationship between supply and demand decides the price. As compared to demand, the status of more supply or less can be described as overcapacity and undercapacity. If the market is small enough, when and whether production is suitable may not be difficult to decide. But when the interaction involves more stakeholders, e.g. in a global scenario, it becomes more complicated and dynamic. A lot of factors are affecting the process of approaching balance. As a result, the ideal balance of demand and supply will be much more difficult to reach.

Undercapacity is painful for both individual consumers and the whole society. Human society is indeed developing quickly. As purchasing ability increases, more products of higher quality are desired. Many countries have experienced insufficient supply. After the Industrial Revolution, steam engines improved productivity and vast areas where there was no water power like rivers needed more power support. But there were only several countries that had the technology to build steam engines and they were quite cautious about sharing that knowledge and ability with others.

When productivity is far from meeting demand, consumers do not have many choices, but accept the limited products at a much higher price. Some people may choose to buy more than they need to stock up, when possible, which will make undercapacity more serious. Thus, suppliers may not have the motivation to engage in research and development while getting high enough profits. The cycle of the product then stops to evolve. If a society has neither technology transfer nor product supply, the demand potential will be suppressed.

As time goes by, we enter a new era. Globalization has provided the world with so many opportunities. Countries are encouraged to enter the multilateral trade system of the World Trade Organization (WTO), to abide by the common understanding and rules to reduce barriers to international trade. Cooperation has reduced the limitation of development for so many countries and they can reach development goals by exchanging what they want with what they have. The nature of the increase in the volume of international trade is the market mechanism.

Demand can be met by supply from many possible suppliers. China is gaining its position in the international trade system as a leading country based on facts: Chinese companies can provide their partners with products of high quality and competitive prices. The importing countries can benefit from this either as consumers or by receiving intermediate products for further value-added processing.

Recently, three new products have attracted a lot of attention; electric vehicles, lithium batteries and solar panels are all related to the low carbon economy. These products are like the steam engines in the 18th century. But the differences are also obvious. China is open-minded and it shares with the world its knowledge and products to meet the demand.

Two weeks ago, I had an opportunity to talk with an expert from Malaysia in an online radio interview program. When asked about her opinion of the most serious challenge this year, she cited climate change; we are witnessing so many unusual weather phenomena. The United Arab Emirates received a whole year's worth of rainfall in one day. Extreme weather affects agriculture and logistics and changes the living conditions in both urban and rural areas. Fortunately, most members made promises in the Paris Agreement and are willing to put energy transfer actions on their social and economic agendas.

But the ability to fulfil commitments is different. To reduce fossil fuels and use renewable energy, people's awareness, technology, infrastructure, enterprises' ability and policy environment are all necessary. It is easy to claim to be environment-friendly. But if the cost of using renewable energy is too expensive, if the equipment and tools of renewable energy easily misfunction, and if the use of renewable energy can cause inconveniences due to incompatibilities, people may feel uncomfortable and finally return to fossil fuels.

China provides solutions. After more than a decade of exploration, Chinese companies established a complete supply chain that provides not only the final green products, but also personalized solutions. When you are looking at the main players among the solar panel suppliers, there are almost no companies that were also in the market 10 years ago. Survival of the fittest is the gold principle of the market. Innovation is normally risky and requires more returns. Opportunities are only left for the bravest.

The Chinese government has reminded enterprises of the opportunities in the low-carbon era and created a comfortable development environment for these emerging sectors. Chinese companies for their part are attracted to going "green" thanks to potential profits. Without the participation of these companies, the low carbon transfer will be too expensive. Then it is easy to understand the reason for the boom in China's exports of electric vehicles, lithium batteries and solar panels. Every country wants to solve the problem of slowing down climate change at an affordable cost and as quickly as possible. Without enough market demand, strong manufacturing bases and quick innovation ability, even the United States needs to depend on foreign supply to meet its domestic demand. The Biden administration postponed its additional tariffs on the import of solar panels from Southeast Asian countries in May 2023.

Indeed, the word "overcapacity" sounds familiar. About 10 years ago, there was already a debate on the overcapacity of iron and steel products. Quite a few Western countries believed that the main cause was China. They criticized China for producing too many steel products, which made the world suffer. When I met with a delegate from the U.S. Congress, we were asked to explain how China dealt with the overcapacity problem. Well, it is true that the Chinese government has carried out many practices to optimize the steel sectors. I tried to discuss that issue from a rational perspective. When there is more capacity than demand, there is overcapacity.

But we need to figure out the reason. The global financial crisis from 2007 to 2008 had a serious impact on the demand side and many economies including Europe suffered a lot. Meanwhile, China's steel and iron production has been stable. Most of the capacity is absorbed in China's domestic market, namely in real estate and infrastructure during the urbanization process. It's not difficult to find that the overcapacity comes from the demand side and the United States should be responsible due to its subprime mortgage crisis. The delegate seemed to agree with my analysis.

As a responsible country, China did a lot to reduce overcapacity. While assuming the presidency of the G20 Hangzhou Summit, China and the G20 members agreed to set up the Global Steel Summit, which allows the stakeholders in the global supply chain for steel to discuss solutions and coordinate actions from different parts of the world.

Generally speaking, there are mainly three parts in a supply chain, the supply side, demand side and logistics. Ideally, a change in demand can be known by the suppliers for their production plan consideration. The suppliers will not produce much more than the market can really absorb.

But there may be several issues to address. First, demand is changing. Demand is decided by purchasing ability and also by the psychology of the consumers. Second, there are time lags between demand and supply. Production needs time for preparing raw materials and other inputs, and production arrangement. Third, logistics delays need to be considered, especially in international trade. Fourth, competition is always reshaping the supply-demand relationship. Competitors will join more profitable sectors. They are trying to increase the efficiency and provide consumers with different choices. Competition increases the dynamics of the market and also makes the supply-demand relationship more complicated. Last but not least, the government plays an important role in providing an open and fair market environment, including anti-competition administration.

Based on these discussions, it may be reasonable to say that the so-called "overcapacity" in China's low-carbon products stems from either guesses that are not based on facts or just excuses supporting future actions. But none of these actions should be used to waste the already tight space on reacting to climate change, and hurt innovation and a developing economy's effort to develop capacity-building.

Editor's note: Zhou Mi is a senior research fellow at the Chinese Academy of International Trade and Economic Cooperation.

The views expressed in this article are those of the author and do not necessarily reflect those of Xinhua News Agency.

(Source: Xinhua)