China should balance its…

At the height of the 2008 financial crisis, as the world peered into an abyss, China earned global gratitude by pumping a record amount of stimulus into its economy. Ironically, continued stimulus has left the Chinese economy with mounting debt and a production glut threatening world trade.

Managing the asymmetry between leading markets and China as the world’s largest manufacturer is among the biggest economic challenges of our time.

First and foremost the challenge is to Chinese leadership. Writing for China Leadership Monitor, seasoned observer Barry Naughton asked whether the leadership had lost its compass. An underlying theme was that President Xi Jinping’s focus on party-state building and concentration of power had a damaging effect on management capacity and institutions. The handling of the stock market and currency reform has revealed serious leadership and policy shortcomings, but the management of the real economy over the last several years seems to be proof of nothing less than a system-generated overcapacity crisis.

While fortunate for the global economy, China’s response to the global financial crisis became an addiction leading to serious indebtedness and credit-driven development of overcapacity of monumental proportions in a number of key sectors. Urgent reforms were put on hold, and total debt more than doubled, today exceeding 250 per cent of GDP and still growing. Corporate debt has risen more rapidly than in any other G20 country and in June the International Monetary Fund urged the Chinese government to address this issue or “risk dangerous detours during the country’s transition to a consumption-oriented economy.”

In a February report entitled “Overcapacity in China: An Impediment to the Party’s Reform Agenda,” the European Chamber of Commerce in China focused on eight sectors – steel, aluminum, cement, chemicals, refineries, shipbuilding, flat glass paper and paper board – and concluded that the stimulus packages supported industrial capacity that was “disconnected from real market demand.”

The rapid expansion created an industrial sector that faces profound structural challenges. Rarely has so much capital been wasted in building capacity far beyond any reasonable future demand.

China’s government has long expressed concern about the buildup of overcapacity, but local officials have kept expanding, driven by growth targets and greed. Even today, additional capacity in cement, for example, is being added, despite close to a billion tons in overcapacity. While a serious issue, cement is not a globally traded commodity of great significance.

Steel is an entirely different matter, and China’s overcapacity poses grave consequences for the global steel industry. Today, China accounts for half of global output. How to handle excess labour is the most sensitive domestic challenge of the painful transformation laying ahead. Labour unrest is increasingly common, as workers protest layoffs, and labor activists and protesting workers are detained.

An obvious solution, of course, is to export the oversupply and that has happened with Chinese steel. In the 1990s, China imported steel. Last year it exported 110 million tons, making China by far the world’s largest steel exporter.

Overcapacity adds to domestic challenges, and governments are responding. European steelworkers have protested in Brussels, and Tata Steel in the United Kingdom, in particular, has struggled to attract bids or tie up with Thyssen-Krupp.

In this sensitive situation, the question of market economic status, or MES, for China must be resolved. Beijing expects the status to be automatically granted as 15 years have passed since the country joined the World Trade Organisation. But that is hardly in the cards.

The United States has warned China that it has not done enough to qualify for market economic status, especially in steel and aluminum, and the political climate in the US is hardly conducive to soft compromises. Already last May, the European Parliament, which has the last European word, took a preemptive negative decion. The commission does, however, want to avoid a direct confrontation with China, and according remarks by Vice Chairman Jyrki Katainen, the solution might be to grant China MES while setting up an entirely new line of defense in the form of a general anti-dumping rules that could be applied to any country, including China.

The G20 meeting in Hangzhou in early September offers an opportunity to deepen global cooperation on structural issues at a time of grave potential polarisation. The imbalances between China and its markets in Europe and the United States are unsustainable, and steel is at the very epicenter of the biggest economic challenge of our time.

Börje Ljunggren is former Swedish ambassador to China and Vietnam © 2016 YaleGlobal and the MacMillan Center

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