Overcapacity troubles China economy, reform needed

Local governments are deeply involved in managing production, which can affect market operation.

"Government power causes similar choices to be made in different places," Feng said. "Vastly profitable sectors like land and mineral resources have led local governments to steer corporate investment."

Local governments are also in charge of approving projects, leading investors to prefer government-targeted sectors so as to ensure approval, Feng said.

Despite central government urges to curb excess capacity, local governments have not taken all the factors involved in industrial layout into consideration. Boosting the local GDP and employment are still prioritized, leading to repeated input for the same projects.

Regional protectionism and lagging systematic reform have sheltered many incompetent companies, hampering the market's function, analysts said.

Structural reform

The overcapacity problem may be solved through structural reform that boosts innovation and quality-oriented economic growth.

Li said the way local government performance is evaluated should be changed to fit the market and facilitate fair competition, as well as reduce administrative meddling.

Local governments should be banned from using direct stimulative measures to encourage investment, he said.

He also called for more transparent and stricter approval for land projects, leaving decision and risk for enterprisess to cope with.

Financial and taxation reform needs further implementation, in order to act as an efficient tool to restrain local investment while reducing pressure on the expenditures of local governments.

Necessary taxes for resources are expected to cover more products and sectors with high energy consumption, Li said.

Governments at all levels should create a healthy environment that allows the market to maintain itself and weed out unsustainable capacity, he said.

Li said less-controlled market operation and stricter approval for key projects can contribute to realizing greater market competition.

"More open market access, a stricter bankruptcy system and a smoother market pricing mechanism can help give full play to market competition," Feng added.

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