China

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

Overcapacity at the Gate

March 26, 2024
Camille Boullenois ([email protected]), Agatha Kratz ([email protected]), Daniel H. Rosen
([email protected])

China’s National People’s Congress (NPC) concluded in March 2024 with an

explicit focus on industrial policy favoring high-technology industries, and very
little fiscal support for household consumption. This policy mix will compound the
growing imbalance between domestic supply and demand. Systemic bias toward
supporting producers rather than households or consumers allows Chinese firms
to ramp up production despite low margins, without the fear of bankruptcy that
constrains firms in market economies.

So far, policymakers in Brussels and other advanced economies have mostly

fretted over excess capacity in clean technology sectors, including electric
vehicles, solar modules, and wind turbines, which have already seen supply-
demand imbalances in China for years. However, indications of rapid production
expansion across many more sectors have emerged since 2021, as Beijing sought
to boost growth with supply-side policies during and after the pandemic. The
situation underscores a systemic problem, not confined to specific sectors, which
will set China on course for a trade confrontation with the rest of the world.

Saturation point
The simplest and most widely accepted definition of overcapacity is when factories’
production capacity is under-utilized. While temporary overcapacity can be harmless and
a normal part of market cycles, it becomes a problem when it is sustained through
government intervention. Structural overcapacity happens when companies maintain or
grow their unused capacity without worrying about making a profit (or a loss), often due
to a lack of economic pressure to operate efficiently, like a hard budget constraint.

China has a long history of structural overcapacity. Its last severe episode happened in
2014-2016, a few years after the government launched a massive stimulus package in
response to the 2008-09 global financial crisis. The program, centered on infrastructure
and property construction, triggered significant capacity build-up in a range of associated
industries. In 2014, as demand for property and infrastructure construction weakened,
overcapacity became evident in heavy industry products such as steel and aluminum.

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 1

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

After years of retreat, anecdotal evidence is mounting that overcapacity is back in China.
This is clear in emerging sectors such as clean technology. Capacity utilization rates for
silicon wafers have dropped from 78 percent in 2019 to 57 percent in 2022. China’s
production of lithium-ion batteries reached 1.9 times the volume of domestically installed
batteries in 2022. But beyond these higher-profile cases, overcapacity now affects the
industrial sector as a whole. In early 2023, aggregate capacity utilization dropped below
75% for the first time since the worst point of China’s last overcapacity cycle in 2016
(Figure 1), with a slight rebound since.

FIGURE 1
China’s industrial capacity utilization rate, Q1 2013-Q4 2023
Percent
81

79

77

75

73
2016 low point of 72.9 percent
71

69

67

65

Jul-21
Mar-13

Mar-14

Mar-15

Mar-16

Mar-17

Mar-18

Mar-19

Mar-20

Mar-21

Mar-22

Mar-23
Nov-15
Jul-13
Nov-13

Jul-14
Nov-14

Jul-15

Jul-16
Nov-16

Jul-17
Nov-17

Jul-18
Nov-18

Jul-19
Nov-19

Jul-20
Nov-20

Nov-21

Jul-22
Nov-22

Jul-23
Nov-23
Source: China’s National Bureau of Statistics

In addition to low overall capacity utilization, Chinese firms seem to have been suffering
from over-production. Inventories reached their highest absolute levels since the
beginning of the data series 13 years ago. After years of decline relative to GDP, they grew
again from 43% in 2019 right before the pandemic, to 48% in 2022 (Figure 2). The trend is
improving slightly, but the pattern of the past few years means that for many firms in China,
even when operating below capacity, their production does not find consumers.

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 2

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

FIGURE 2
China’s inventories, value and share of GDP, January 2010-December 2023
RMB trillion (left), percent (right)
Inventories Share of GDP
18 70%
16
60%
14
50%
12
10 40%

8 30%
6
20%
4
10%
2
0 0%
Dec-10

Dec-11

Dec-12

Dec-13

Dec-14

Dec-15

Dec-16

Dec-17

Dec-18

Dec-19

Dec-20

Dec-21

Dec-22

Dec-23
Source: National Bureau of Statistics

The problem is widespread—capacity utilization rates in China have declined over the
past couple of years in every surveyed manufacturing sector except non-ferrous metals
(Figure 3). Products linked to the property sector, such as plastics and non-metal minerals,
are experiencing severe overcapacity because of weak demand in their downstream
markets. But many other sectors are seeing declining capacity utilization, too, from
machinery to food, textiles, chemicals, and pharmaceuticals.

FIGURE 3
Change in China’s capacity utilization rate, 2021-2023
Percentage Point

Non metal minerals

ICT equipment
Electric machinery
Food
Textiles
Chemicals
Special equipment
Pharmaceuticals
General equipment
Ferrous metals
Chemical fibers
Automobiles
Non ferrous metals

-6 -5 -4 -3 -2 -1 0

Source: National Bureau of Statistics, official capacity utilization rate

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 3

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

Growing imbalances
The under-utilization of production capacity in China is concerning in its own right for
foreign policymakers and businesses. It incentivizes firms to lower their prices in search
of a market for their excess capacity. In the past, this has led to global over-supply, price
declines, weak profitability, bankruptcies, and job losses.

But the drop in capacity utilization rates observed in the past few years is only one aspect
of a more profound phenomenon that should draw equal concern for policymakers in
Brussels and other economies—China’s growing domestic production surplus. Chinese
companies, across a wide range of sectors, now produce far more than domestic
consumption can absorb. This domestic surplus can produce low factory utilization rates.
But it can also find its way into foreign markets, creating a growing trade surplus and, at
times, global redundancies that threaten industrial ecosystems in other countries.

Those imbalances are not new, but they have reached unprecedented levels since the
pandemic. In 2020, as COVID hit the global economy, China launched a stimulus program
to boost industrial companies, with little support for household consumption. Beijing
rolled out substantial tax credits, production subsidies, and interest rate cuts to keep
struggling companies afloat and workers employed. When economic growth continued to
disappoint in 2023, Beijing’s policy support kept the emphasis on producers, as their bias
against “welfarism” kept policymakers from stimulating consumption.

China’s growing support for its companies resulted in rapidly growing production capacity
across many industrial sectors. From 2016 to 2020, investment and production capacity
growth was concentrated in strategic sectors linked to the Made in China 2025 strategy,
such as advanced electronics, particularly chips, and clean technology sectors. In other
areas of the economy, the focus was instead on reducing capacity in the supply-side
structural reform campaign from 2015 to 2019. However, this changed in 2020, with
renewed growth across all manufacturing sectors, including non-strategic ones like steel
products, household refrigerators, fertilizers, microcomputers, and machine tools (Figure
4).

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 4

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

FIGURE 4
Production capacity, 2015-2023
Index (2015=100)

Chemical fertilizers Steel products

130 Household refrigerators Microcomputers
120 Metal cutting machine tools

110
100
90
80
70
60
50
2015 2016 2017 2018 2019 2020 2021 2022
Source: National Bureau of Statistics

This capacity build-up was supply-driven, and most often not matched by equivalent
domestic demand. With little support from the government, household consumption
labored under strict zero-COVID restrictions and failed to pick up enough in 2023 to
deliver a consumption-led recovery. The property market downturn played a role,
dampening demand for a wide range of goods, from machinery to plastics and furniture.
As a result, consumption did not grow nearly as fast as industrial production and
investment (Figure 5).

FIGURE 5
Value-added of industry, assets, and retail sales
Index (December 2019=100)
140
VAI Assets Retail sales
130

120

110

100

90

80
Dec-19 Dec-20 Dec-21 Dec-22 Dec-23
Source: National Bureau of Statistics

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 5

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

Déjà vu with a twist

Current growing overcapacity and domestic surplus is similar to previous occurrences,
but it differs in three important ways. The first is timing. The previous wave of overcapacity
and domestic surplus hit China six whole years after the 2008 investment boom because
domestic demand was strong enough to absorb the capacity expansion until 2014. This
time around, China’s investment boom immediately hit a wall because of the weakness of
domestic demand.

The second difference is the list of affected sectors. China’s 2008 stimulus focused on
construction, infrastructure, heavy industry, and mining. In recent years, however, support
for infrastructure and construction was derailed by China’s acute property crisis starting
in the second half of 2021. Distress in the property sector diverted credit to other
industrial sectors (Figure 6)—with the effect of concentrating China’s recent investment
boom in manufacturing (Figure 7).

FIGURE 6 FIGURE 7
Monthly change in bank loans Monthly change in assets by sector
Trillion RMB, 12m rolling sum Billion RMB, 12m rolling average
Industrial sector Real estate Mining and heavy industry Manufacturing
7 1000
6
800
5
4 600
3 400
2 200
1
0
0
-1 -200
Jul-09
Mar-07
May-08

Mar-14
May-15

Mar-21
May-22
Sep-03
Nov-04

Sep-10
Nov-11

Jul-16
Sep-17
Nov-18
Jan-06

Jan-13

Jan-20
Feb-23
Oct-13

Oct-15

Oct-17

Oct-19

Oct-21

Oct-23
Feb-13

Feb-15

Feb-17

Feb-19

Feb-21
Jun-12

Jun-14

Jun-16

Jun-18

Jun-20

Jun-22

Source: People’s Bank of China Source: National Bureau of Statistics

One last difference is how much support central and local governments have given failing
enterprises with little consideration of profit and efficiency. In addition to generous credit
and tax support measures, struggling companies were granted credit forbearances during
COVID to help them face liquidity crunches and operational disruptions. Government
support and prevention of market exit boosted the number of loss-making companies
(Figure 8). In a crowded environment, with loose budget constraints, firms lowered prices
and accepted razor-thin margins to retain market share. Perversely, it also pushed them
to build additional capacity in hopes of offsetting lower margins with higher volumes, and
because they knew from prior episodes that if authorities ultimately forced a market
consolidation, survival would be determined based on scale, not financial health.

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 6

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

FIGURE 8
Number and ratio of loss-making industrial companies
Thousand companies (left), percent (right)

120 25%
Number of loss-making enterprises Ratio of loss-making enterprises
100
20%

80
15%
60
10%
40

5%
20

0 0%
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Source: National Bureau of Statistics

Trade spillovers: Bracing for impact

Because China’s previous cycles of policy-driven capacity expansion severely affected
global markets—especially in steel and aluminum, but also in promising sunrise industries
like solar panels—advanced economies are watching with intense concern and evaluating
response options. In 2023, the number of EVs exported from China was already 7 times
greater than in 2019 and 1.7 times greater year-on-year. China’s exports of solar cells in
2023 were five times larger than in 2018, and 40% above 2022 levels. These surges are
potentially devastating to market-constrained producers in advanced economies.

The growing mismatch between fast-paced capacity expansion and slow-growing

domestic demand in China will have trade impacts beyond green technology sectors too.
China’s share of global trade expanded by 1.5 percentage points in 2020, arguably in the
context of global supply chain disruptions that put China at a global advantage. But,
importantly, that share did not come down as COVID-19 restrictions retreated
everywhere. In select sectors, Chinese firms have been gaining significant global export
shares in the past four years. In the electronic machinery sector, for example, China’s
share of global exports grew more than 5 percentage points between 2019 and 2022 in
18 of 46 HS-4 product categories. In 2016-2019, that was the case for only 7 out of 46
categories. In lower-technology sectors such as textiles and furniture, China has also been
re-gaining market shares it had lost in previous years due to diversification of production
and relocation to lower-cost destinations (Figure 9).

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 7

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

FIGURE 9
Chinese share of global exports, selected products, 2019-2023
Percent

41% Knitted apparel Other apparel Footwear Leather

39%

37%

35%

33%

31%

29%

27%

25%
2016 2017 2018 2019 2020 2021 2022
Source: International Trade Center

Export gains are not the only spillover channel for China’s rapidly growing production
capacity. In sectors where China used to be a net importer, such as the petrochemical
sector, the combination of domestic production capacity increase and weak demand in
China resulted in sometimes drastic declines in Chinese imports, affecting firms in Europe
and the United States (Figure 10).

FIGURE 10
Decrease in Chinese imports of selected chemicals, 2019-2023
Percent

PE

Ethylene

Propylene

PP

Paraxylene

PVC

Styrene polymer

ABS

Styrene

0% 10% 20% 30% 40% 50% 60% 70% 80%

Source: International Trade Center

Low prices are not the only factor behind Chinese firms’ ability to export their growing
capacity abroad. Competitiveness is another one. By lowering firms’ costs, allowing them

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 8

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

to scale up, and increasing their ability to improve products as they “learned by doing,”
state support made some Chinese companies fiercely competitive in global markets. The
electric vehicle sector is a case in point. The top Chinese exporters of EVs, BYD and SAIC,
are not the most affected by overcapacity—they are close to working at full capacity. Still,
these carmakers were able to leverage the supportive environment of the past four years
to become more efficient and more technologically competitive than their rivals. Facing
low profit margins in China today, and intense competition, they are uniquely equipped
and motivated to capture growth and profits outside of China.

The effects of this new wave of policy-driven capacity expansion in China are not yet all
visible. In certain industries, the timeline from investment to production can stretch over
years, meaning that funds allocated in 2021-2022 might only begin to materialize into
market-ready products or services several years later, with a delayed impact on Chinese
and global markets.

What’s more, although overcapacity created strong deflationary pressure within China, it
has not yet impacted global prices to the same extent (Figure 11). In fact, China’s export
prices were up in most sectors in 2023 compared to 2021, and the prices of imports from
China rose more quickly than the prices of imports from other extra-EU countries in 2021-
2022, before decelerating in 2023.

FIGURE 11
Export unit values and PPI, December 2017 to December 2023
Change from 2017 (2017 basis=100)
140
Export unit value index PPI
130

120

110

100

90

80

70
Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 Dec-22 Dec-23

Source: National Bureau of Statistics, Rhodium calculations

This is because many Chinese firms are still using overseas markets to make up for lower
prices, margins, or even losses on the China market. But this China-world price
discrepancy also means that Chinese firms could lower their export prices further in the
future to gain market access, weed out competitors, or make up for new tariff barriers in
the EU or the US.

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 9

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

Outlook
In the last two quarters of 2023, China’s capacity utilization rates have picked up, reaching
75.9%—a level similar to 2018-2019. However, China’s capacity expansion in
manufacturing sectors will likely stay elevated in the long run, creating episodes of
overcapacity and further effects on global trade.

In previous overcapacity cycles, cheap Chinese exports contributed to rising trade

tensions and a series of anti-dumping investigations, such as the EU investigations on
Chinese steel in 2016. Overcapacity also hurt Chinese companies’ profits and came with
unsustainable debt growth. Reducing overcapacity thus became a priority for the Chinese
government in 2016.

This time around, the Chinese government is also expressing awareness of the issue. The
Government Work Report in February 2024, for example, mentioned strengthening
“investment guidance for key sectors to prevent overcapacity, poor quality, and
redundant development.” However, the solutions adopted will likely center on retiring
obsolete capacity and letting the most uncompetitive companies shut down while
continuing to support capacity expansion, innovation, and exports in others.

This policy mix is part of a broader economic strategy that emphasizes manufacturing and
exports as key growth drivers. Beijing has made clear in recent years that it wants to
prevent China from de-industrializing, including in low-tech industries that would
otherwise naturally migrate to lower labor-cost countries. Since the 14th Five-Year Plan
in 2021, Beijing has vowed to stabilize the share of the manufacturing sector in GDP—a
reversal of a decade-long trend. Several key local governments have since announced
quantified objectives for their share of manufacturing in the economy.

Beijing is also desperately looking to rebalance the economy away from the infrastructure
and property sectors and toward new growth drivers. Yet in the absence of a clear
strategy to prop up consumption, this means supporting the manufacturing industry—
particularly in emerging sectors such as renewable energy and electric vehicles—as a
core engine of growth. China’s March 2024 NPC meeting set an explicit focus on industrial
policy favoring high-technology industries, with very little fiscal policy support for
household consumption. This policy mix will only compound the trade impacts of China’s
growing state-supported industrial capacity and set China on a course of trade
confrontation with the rest of the world.

This sets China, the EU, and the US on a dangerous course of trade confrontation in 2024,
with a high probability of trade defense action cases. The systemic nature of China’s trade
surplus and market distortions, not confined to specific sectors, may also motivate larger
actions. Strong measures such as revoking the Permanent Normal Trade Relations status
or introducing a new tariff column for China are already on the radar of US politicians
during an election year. But China’s growing manufacturing surplus is not only a problem
for the US and the EU. In fact, China’s trade surplus with G7 countries grew by a third
between 2019 and 2023 while it more than tripled with developing economies, setting a
daunting barrier as they try to nurture their own industrial sectors. The spillovers of
China’s domestic imbalances are already compelling a response from a broader set of
countries, including Brazil, India, Mexico, and South Africa. If China’s imbalances continue,
this emerging market pushback will also likely intensify.

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 10

RHODIUM GROUP | CHINA OVERCAPACITY AT THE GATE

ABOUT RHODIUM GROUP

Rhodium Group is an independent research provider with deep expertise in policy and
economic analysis. We help decision-makers in both the public and private sectors
navigate global challenges through objective, original, and data-driven research and
insights. Our key areas of expertise are China’s economy and policy dynamics, and global
climate change and energy systems. More information is available at www.rhg.com.

DISCLOSURES
This material was produced by Rhodium Group LLC solely for the recipient. No part of the
content may be copied, photocopied or duplicated in any form by any means without the
prior written consent of Rhodium Group. Redistribution, forwarding, translation, or
republication of this material in any form by you to anyone else is prohibited. Rhodium
Group LLC is not an investment advisor. Any information contained herein is not intended
to be relied on as investment advice and this information is not purported to be tailored
advice to the individual needs, objectives or financial situation of a recipient of this
information. This report is intended for informational purposes only and does not
constitute a recommendation, or an offer, to buy or sell any securities or related financial
instruments. The information contained herein accurately reflects the opinion of Rhodium
Group at the time the report was released. The opinions of Rhodium Group are subject to
change at any time without notice and without obligation of notification. Rhodium Group
does not receive any compensation from companies that may be mentioned in this report.
No warranty is made as to the accuracy of the information contained herein.

© 2024 Rhodium Group LLC, 5 Columbus Circle, New York, NY 10019. All rights reserved.

New York | California | Washington, DC | Paris

Website: www.rhg.com

FOR MORE INFORMATION REGARDING OUR RESEARCH, PLEASE EMAIL [email protected] 11