China’s ascent as a manufacturing powerhouse has put the country in the driver’s seat of global supply chains, allowing it to corner the market on goods that are more sought-after than ever before. Competing nations are alarmed by China’s tactics in achieving this. Most recently, the issue of industrial overcapacity in manufacturing has taken the spotlight in political discussions at the highest levels.
During a press conference in Stresa, Italy, prior to a meeting of the Group of Seven (G7) finance ministers and central bank governors, the United States Treasury Secretary Janet Yellen stated, “Overcapacity threatens the viability of firms around the world, including in emerging markets.” The issue also poses a challenge to China’s own economic growth, she noted.
Similarly, European Commission President Ursula Von Der Leyen, commenting on electric vehicles (EV) last year before the European Union-China Summit, said, “There is a clear overcapacity in China, and this overcapacity will be exported for sure.”
Overcapacity is a situation where the industry’s capacity to produce exceeds the demand for its products, resulting in underutilised production capacity. Overcapacity can be a normal part of the market cycle — a temporary mismatch between production capacity and product demand.
The problem lies in “structural overcapacity,” which is independent of market forces and signifies a long-term, persistent mismatch between product demand and production capacity.
Structural overcapacity may result from government policies and subsidies that encourage overinvestment in specific industries, reducing the pressure on them to perform efficiently. Technological advancements can also help by resulting in more efficient production processes, allowing businesses to produce more goods at a lower cost. If these factors coincide with declining demand, it could result in overcapacity.
China’s industrial overcapacity problem is not new and has been highlighted previously. Sectors from iron and steel, cement, aluminum and even housing have all reported excess capacity or oversupply in the recent past. Presently, the discussion centres on alleged overcapacity in automobile industry and clean technology manufacturing, including solar panels and EV batteries.
So, what is wrong with overcapacity? Among other things, in the search for markets, industries with an excess of supply tend to lower product prices, which reduces profitability for the entire sector and leads to job losses.
This scenario occurred in the steel sector a few years ago. In a global market, this phenomenon causes production capacities to be uprooted in other regions due to the influx of cheap goods from overcapacity regions.
The New York-based research provider Rhodium Group, in a recent report, flagged the falling capacity utilisation rates in solar photovoltaic (PV) manufacturing — capacity utilisation rates for silicon wafers dropped from 78 per cent in 2019 to 57 per cent in 2022, the report stated.
Average capacity utilisation of battery plants in China fell from 51 per cent in 2022 to 43 per cent in 2023, according to Business and market news website Bloomberg.
While the overcapacity issue in solar PV manufacturing and batteries is mostly agreed upon, the narrative for the automobile sector has been claimed to be ’exaggerated and oversimplified’ by analysts and contested by China.
Bloomberg analysed data on Chinese overcapacity across various sectors. According to their findings, China’s planned solar equipment production capacity for 2024-2027 will exceed global demand by more than double, even under optimistic demand forecasts. Major Chinese EV exporters, on the other hand, have capacity utilisation rates of more than 80 per cent implying little overcapacity.
Lower capacity utilisation rates have been observed more frequently in internal combustion engine vehicle manufacturing, possibly due to outdated production processes. The notion of cheap Chinese EVs flooding global markets also defies current pricing trends. China’s top automaker, BYD, has been selling EVs in foreign markets at significantly higher prices, often two to three times higher than domestic prices.
Yet the drumbeat grows louder over China’s industrial surplus, and dominant powers are rushing to respond, wary of being edged out. Western countries continue to highlight the risks associated with China’s overcapacity.
A vocal concern from the West has been around job losses stemming from Chinese excess capacity. With the energy transition already set to disrupt traditional fossil-based industries and lead to significant shifts in employment, the additional pressure from Chinese oversupply creates fears of further job losses in other countries.
In the US, job losses due to Chinese trade practices are a political issue and have been a feature of both leading presidential candidates’ speeches.
Previously, the Donald Trump administration in the US imposed tariffs on steel and aluminium imports in 2018 to counter the ‘overcapacity’ created by China in these sectors, which were then found to violate World Trade Organization trade rules. In response, the US Trade Representative stated, “the WTO has proven ineffective at stopping severe and persistent non-market excess capacity from the PRC and others that pose an existential threat to market-oriented steel and aluminium sectors and a threat to US national security.”
Recently, the US announced that it would further raise tariffs on imports from China, from 0-7.5 per cent to 25 per cent in 2024 on certain steel and aluminum products, from 25 per cent to 50 per cent by 2025 for semiconductors, and from 25 per cent to 100 per cent in 2024 for EVs.
Similarly, the European Union has also raised tariffs on imported EVs from China, which now range between 17.4 per cent and 37.6 per cent, in addition to the existing 10 per cent duty on all EV imports from China. In addition, the Indian government has announced a 40 per cent basic customs duty (BCD) on imported solar modules, of which 63 per cent are from China, and a 25 per cent BCD on imported solar cells, of which 53 per cent are from China, beginning April 2022.
In a recent article, JW Mason, an associate professor of economics at John Jay College, City University of New York, pointed out that China is adopting the same policies that countries like the US used in their earlier stages of development, such as “protection for infant industries, public investment in infrastructure, adoption of foreign technology, cheap but strategically directed credit”.
Many of these interventions can be clubbed under the broad category of industrial policy, that is, government policy intervention in strategic or infant industrial sectors. This could be done by injecting funds to create new production capacities, offering subsidies, production-linked incentives or setting industrial targets. The US has now forged a return to industrial policy through its bottomless tax credits offered through the Inflation Reduction Act (IRA) in an effort to scale up green manufacturing.
The duplicity is evident here: “There is something odd and unseemly about describing the same policies as devious manipulation when China uses them,” writes Mason.
In May 2024, US Treasury Secretary Janet Yellen commented that “over time, investments will help lower the costs of clean energy technologies globally,” speaking about the IRA.
The question to ask here is, hasn’t China already done this for the world?
Consider solar photovoltaic (PV) technology. The International Energy Agency’s analysis said that Chinese industrial policy contributed to an 80 per cent decline in module prices between 2011 and 2021. According to the agency, this significant cost reduction made solar PV the most affordable energy generation technology in many parts of the world.
The aggressive Chinese expansion also partly encouraged competitive domestic policies in other countries such as the Inflation Reduction Act in the US and the Production Linked Incentive scheme in India.
Take another example of EV batteries. Carmakers often draw attention to the need for the cost of batteries to come down for EVs to become affordable. Chinese overcapacity in battery production could, in this sense, benefit carmakers elsewhere by providing cheaper batteries.
EV battery prices in China dropped by 50 per cent in 2023 due to lower demand and increased capacity. China’s CATL, the world’s largest EV battery manufacturer, plans to further reduce prices by 50 per cent in 2024.
Lauri Myllyvirta, a co-founder and lead analyst of the Centre for Research on Energy and Clean Air, points out that the decline in prices for solar equipment or EV batteries is also due to genuine technological advances and more efficient production, rather than just the increase in production capacities.
This is acknowledged even in the US, where, despite new tariffs imposed by the government, firms have acquired Chinese technology and collaborated with Chinese manufacturing giants such as CATL to produce batteries.
Impact on green transition
The above conditions thus offer a clear benefit for the green transition, given the need to move away from fossil fuels both in electricity generation and transportation as quickly as we can. In this sense, concerns about overcapacity should be weighed against the urgent need to increase global supplies of cheaper environmental goods.
“A glut in renewables and green products is precisely what the climate doctor ordered”, wrote Harvard economist Dani Rodrik.
It is clear that China’s industrial prowess has reduced costs and promoted the adoption of green technologies. Where its excess supply presents a challenge is in terms of broader impacts on global supply chains, fairness in trade and opportunities and risks to employment.
Particularly for developing countries, it poses a dilemma: Do we depend solely on one country for an abundant supply of cheap, green goods, or focus on indigenisation of production of the same to capture the economic benefits and promote self-sufficiency in the long run?
A focus on the latter can most likely be achieved through some combination of protectionist measures. Here, wealthy nations have the advantage — they can use tariffs or subsidies to counteract Chinese industry and trade practices.
Developing countries, however, cannot always afford to do so, as they lack the fiscal space to offer bottomless subsidies, and their domestic industries lack readiness to scale up clean technology manufacturing competitively to meet the growing needs of the energy transition.
There is also the issue of supply chain overconcentration and the resultant national security concerns if China were to weaponize its status as the world’s supplier of green goods. China’s share of the world’s solar equipment manufacturing capacity for example, is well over 75 per cent. The IEA predicts a significant excess global solar PV supply by 2027 due to Chinese overcapacity.
Solar PV manufacturing capacity by country and region (2021)
Moreover, China is also accused of overcapacity in sectors such as steel and aluminium, where the production process happens to be highly carbon-intensive.
Excess manufacturing in China also drives significant demand for natural resources, which are sourced globally to sustain production levels. For Africa, this entails exporting large quantities of crude oil, refined copper, iron, and aluminium ores to China, while importing manufactured goods. This dynamiccontinues to widen the trade deficit between the two regions, now at $64 billion, which is 59 per cent of Africa’s exports to China by value.
Africa’s exports and imports to China by sector
The geopolitical implications of China’s aggressive manufacturing dominance must be carefully addressed. The response from other countries — both current and anticipated — to safeguard security interests and reinstate ‘fairness’ in trade, could provoke tariff wars and protectionist policies, which could in turn slow down the global green transition.
The world cannot afford this due to the urgency of the heightening climate crisis and the imperative for global decarbonisation.
Yet the dominance of one country as the sole supplier of the goods needed for decarbonisation is creating a new relationship of dependence that no one wants. This is the dilemma the world must contend with today.