Overcapacity comes under the spotlight

EU Chamber of Commerce says issue reduces investment, but China's latest development plan will prioritize solutions.

European companies would be more willing to invest in China if the country's overcapacity issues were fixed, says Joerg Wuttke, president of the European Union Chamber of Commerce in China.

"If China is willing to go through with strong political will in order to eliminate the overcapacity, I think Europeans will be more interested in investing in upscale, top-end technologies in those respective sectors," he said before the chamber released a report in Beijing about overcapacity on Feb 22.

The report, Overcapacity in China: An Impediment to the Party's Reform Agenda, provides a detailed examination of the causes and consequences of overcapacity in eight key industries and analyzes the developments that have taken place since the European Chamber published its original report on the topic in 2009.

Wuttke says China began talking about overcapacity a few years ago, but didn't pay enough attention to it. In the years since 2009, overcapacity has gotten worse in eight industries in China, including crude steel, electrolytic aluminum, cement, chemicals, refining, flat glass, shipbuilding, and paper and paperboard.

"After 2009, China still had double-digit growth. Maybe many decision-makers got complacent," he says.

Wuttke says while China's investment in Europe grew by 30 percent last year and reached more than $20 billion, the European Union's investment in China has dropped 20 to 25 percent to $10 billion. Overcapacity could be a reason because in the affected industries, there is not much room for European companies to invest.

He says China's overcapacity also makes it difficult for European companies in their home markets and also in third markets, and it can result in trade tensions and protectionism in Europe.

On one hand, Europe welcomes China's investment, but on the other hand, in Brussels recently, steelworkers demonstrated in the streets against Chinese products, he says.

In the past few years, China has made many efforts to curb overcapacity, including recent supply-side reform, and overcapacity reduction has also been written into the 13th Five Year Plan (2016-20).

Zhu Zhenxin, a researcher with Minsheng Securities in Beijing, says that both China's central government and local governments have realized it is urgent to reduce overcapacity. But consideration is given to actions possibly affecting employment and financial systems, so officials prefer to take action step by step rather than trying to resolve the problem in an abrupt way.

"Traditional industries face overcapacity, so it is natural that overseas investment in these areas will go down, but there's no need to be too pessimistic about it," Zhu says.

He says compared with the global market, the Chinese market still has its strengths and should be attractive to investors. The services sector is now opening up, and should present great potential, Zhu says.

The new report explains that China's central government has made great efforts to address excessive production capacity, but the implementation has not been as effective as intended, due to factors such as some regional protectionism inside China, weak regulatory enforcement, and an emphasis on market share.

Regional protectionism is the main barrier to resolving overcapacity in industries where there are state equity interests, Wuttke says.

"In the private sector, you hardly see overcapacity because they live in the marketplace. In the stated-owned sector, the problems might be the local government, too strong of an engagement by the local government in industries," he says.

There are many companies sponsored by local governments and under the sway of local governments, he says. Until the market is more open, and these companies in their current form are taken out of the equation by either being closed down or merged, they won't have the power and incentives to do more research and development, advance in environmental protection and similar market-based moves, Wuttke says. At that point, it would be more interesting for Europeans to enter the market.

The report also provides 30 recommendations for addressing this problem. The European chamber hopes that they will also contribute to a strengthening of the government's resolve to implement the core tenet of the Party's decision to establish the market as the decisive force in China's economy, he says.

But reducing overcapacity cannot be done in an incomplete fashion, he says.

"It is not done in six months or 10 months. It takes years to unfold. It takes a lot of policies, and small steps implemented particularly on the local ground," he says.