cross-posted from: https://lemmy.sdf.org/post/44587032

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China makes more than the world can take.

This tension, of course, is not new. China’s “overcapacity”—the shorthand term for producing more than demand calls for—has long led other governments to complain. In the past, China produced too much steel, coal, cement, and other goods, which crowded out competitors elsewhere and drove global prices to unprofitable lows.

China’s tendency toward overcapacity has traditionally been blamed on a fundamental mismatch in its economy; government subsidies and investment in manufacturing and infrastructure are unusually high compared with those in other advanced economies, and the country’s household consumption as a share of GDP is unusually low. Simply put, China lacks enough domestic demand to soak up what the country’s factories produce, which then causes a glut of exports.

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The real challenge, then, lies […] in an extraordinary and seemingly uncontrollable surge in supply—one that Beijing is struggling to get its arms around. Since mid‑2024, central government authorities have warned repeatedly about “blind expansion” in solar power, batteries, and EVs. This summer, after a brutal price war in the solar industry saw prices fall around 40 percent year-over-year, Chinese leaders directed officials to tackle overcapacity and “irrational” pricing in key industries, including solar. Shortly thereafter, high-level officials met with industry leaders to collectively urge companies to curb price wars and strengthen industry regulations.

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Unlike earlier bouts of [Chinese] overcapacity, today’s top offenders are private companies, not state-owned enterprises. If Beijing were to step in and force consolidations or shutter factories, it would risk sparking unemployment and potentially stall local growth engines that depend on these industries. Moreover, exports have become one of the few remaining bright spots in otherwise slowing GDP performance. If Beijing were to meaningfully curb production and exports, it could cause significant damage to China’s overall economy.

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By rewarding speed and scale over productivity and differentiation, the internal plumbing of China’s political economy incentivizes businesses to produce too much stuff. Although that has always been the predictable outcome of China’s political and financial system, the dysfunction was kept in check during much of China’s spectacular rise. Changes in the Chinese economy since 2020, however, including the cratering real estate market and a crackdown on private businesses and investments, have compounded the structural incentives that lead to overcapacity.

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China’s tendency to overproduce starts in an unlikely place: the Chinese Communist Party’s performance and promotion system. In the CCP bureaucracy, local officials are evaluated primarily on their ability to deliver growth, employment, and tax revenues. But China’s largest single tax, the value-added tax (VAT), is split evenly between the central government and the local government of the place where a good or service is produced, not the place where it is consumed. Since the system allocates tax revenue to regions based on production, it rewards the decision to build larger industrial bases. Local Chinese officials try to retain as much upstream and downstream activity as they can to expand their tax base.

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This system effectively encourages provincial and municipal leaders [China] to act like industrial investors or venture capitalists. And in many cases, it has produced profound efficiencies. Over the past decade, for instance, Hefei, the capital of Anhui Province, has poured about $25 billion of state capital into various struggling companies, including the EV maker Nio and the flat-panel display manufacturer BOE, to great effect. By acting as an early investor and bearing the initial risk, Hefei stimulated about $96 billion in follow-on investment and generated around $9 billion in tax revenues. The Hefei model has since been widely imitated, with other provinces racing to assemble their own industrial clusters.

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Firms rarely close down operations altogether [if they become unprofitable], however, because the state-backed banks prefer to roll over existing loans so that the firms appear solvent on paper. That way, even if those companies are only servicing their interest payments and not generating strong returns, the banks avoid having to book immediate losses—and avoid potentially contributing to the collapse of a large local employer. Credit keeps flowing into these “zombie” sectors and companies with declining productivity even as they are dragging down the broader economy in the long run.

Private firms not chasing government-backed industries, meanwhile, have long struggled to access affordable bank credit, which means they tend to seek capital from costly nonbank channels, such as venture capital, private equity, and initial public offerings. These channels helped fuel much of China’s record growth in the first two decades of the twenty-first century: by October 2020, 217 Chinese companies were listed on major U.S. exchanges with a combined $2.2 trillion market cap, illustrating how deeply private firms tapped global equity markets. Leading venture capital platforms scaled as well. Sequoia’s China arm (now HongShan), for instance, backed hundreds of private firms, including some of China’s most prominent success stories, such as the social media company ByteDance and the transportation platform Didi.

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The price wars are a mere symptom of the overcapacity problem. Beijing can’t hope to make meaningful progress without reengineering the underlying incentive structure that is causing overcapacity. Consider, for example, how the CCP evaluates local officials. At present, cadres are promoted largely based on how much growth they deliver; that means judging them based on how much new factory space they build and how many roads or industrial parks they pave. Such measures favor scale over quality.

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To create a more sustainable model—one that encourages innovation but doesn’t spiral into overcapacity—China will have to undergo an institutional reckoning. The logic of speed over quality, of scale over innovation, and of investment volume over returns is deeply embedded in the system. Reversing that logic means making long-deferred tradeoffs and moving past the structures that once powered China’s incredible rise.

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