US accuses China of economic ‘overcapacity’

It’s interesting to consider what Yellen actually means when she asks China to address its “industrial overcapacity,” especially in the areas of solar panels and electric vehicles. To start, what exactly is ‘industrial overcapacity’?

The official definition for this is: “when an industry’s production capabilities exceed the demand for its products, leading to imperfections and reduced profits.” What are the key metrics to determine if a country has ‘industrial overcapacity’. There are three:

• Capacity consumption figures: these show the percentage of a country’s industrial capacity that is actually being used. If you don’t use much of it, you have too much capacity.
• Inventory levels: High levels of unsold goods can be an indication that production is exceeding demand, indicating overcapacity.
• Profit margins: declining profit margins in the manufacturing industry may indicate overcapacity; because companies lower prices to boost sales.

So let’s look at all three as far as China is concerned. Let’s start with the capacity consumption figures. Look at the graphs: it is crystal clear that these have remained fairly constant in China over the last 10 years; they currently stand at a rough estimate of 76%. That is about the same as that of the United States with its 78%. So here: no problem.

Let us now look at the inventory levels. At the start of 2024, China’s finished goods buyers index stood at around 49 versus the United States’ 48 for manufacturing. An index higher than 50 is an indication of growing stocks; this is not the case here for either country. Finally, let us look at the profit margins. China’s industrial profits rose 10.2% in the first two months of the year, marking a continuously rising profit margin since August last year. So no problem here either.

Now what does that mean?

Whichever way you look at it, there is no sign of industrial overcapacity in China. Could the United States, by accusing China of “industrial overcapacity” mean that China is violating WTO rules by engaging in “dumping”; meaning the practice where firms export products at prices lower than those charged in their home country or below the cost of production?

No, that is not what China is being accused of here: despite the very low prices for its electric vehicles or solar panels, the companies involved are still making profits (even more; as we just saw, industrial profits are rising with a growth rate of double digits) and they do charge higher prices abroad than in their home country.

No, the real problem here is actually not one of industrial capacity but one of competitiveness. It is clear as day that the competitiveness of Chinese companies is overwhelming: there is today; in the scores of industries such as solar panels or electric vehicles, there is no way for American or European companies to compete with the Chinese companies.

Here’s the real problem: Yellen and Western leaders are afraid that if things continue the way they are, China will tower over everyone. Contrary to popular belief; is this competitiveness not the result of Chinese “cheap labor”.

Someone who explained this extremely well is Tim Cook from Apple:

“There is confusion about China. The popular belief is that companies go to China because of the low labor costs. I don’t know which part of China they go to, but China stopped being a low-labor cost country many years ago. And it is also no reason to come to China because of the supply of raw materials. The reason is the presence of the skills, and the amount of skills in one location and what type of skills it is.”

He praises the Chinese education system for this: “I give the Chinese education system a lot of credit for continuing to emphasize this where others placed less emphasis on dedication…China has understood that well from the beginning.”

Having a high level of expertise is one thing, but there is also control over the entire supply chain, as China is the only country in the world that produces all categories of goods classified by the World Customs Organization (WCO).

This gives it a key advantage when it comes to final prices: if you want to make something in China, you can literally find the entire supply chain in the country itself.

Energy prices are another matter: for example, the International Energy Agency points out that “low-cost electricity is key to the competitiveness of the main pillars of the solar panel supply chain” and that around 80% of the electricity used for producing polysilicon is consumed today in Chinese provinces at an average electricity price of approximately USD 75 per megawatt hour (MWh).”

For comparison, in 2023, energy prices for industrial customers in Germany were approximately USD 251.21 per megawatt hour (MWh), an incredible 234.94% more expensive!

Finally, China has developed into a powerful innovator. In 2023, it roughly applied for as many patents as the rest of the world combined and is now estimated to hold the leadership position for 37 of a total of 44 critical technologies for the future.

All this also influences the final prices of its products. To take the example of solar panels again, the IEA notes that “continued innovation led by China has halved the intensity of emissions from solar panel making since 2011” meaning that not only does China have raw electricity prices that are immensely cheaper than those in the West, but that it has innovated in such a way that it uses much less electricity in the production of solar panels.

So, the ‘threat of China’s industrial overcapacity’ is one buzzword that actually means that China is too competitive, and by asking to address this, what Yellen is actually asking of China is akin to a fellow sprinter asking Usain Bolt to slow down because he can’t keep up.

I’m not arguing that there is no value in this question. Ultimately, it is very understandable that when you see a competitor constantly increasing in strength, you become afraid for your own future and that of your people.

But it must be framed in the right way: presenting it as if China is doing something nefarious with deliberate ‘overcapacity’ is only an unfair character drawing. China played the game correctly: as Tim Cook explained, it invested first and by far the most in its own people, in their education.

They also invested heavily in innovation and did not shoot themselves in the foot on energy prices, as Europe did, as with so many other decisions. This demonization is simply not correct and it is certainly not the correct way to ask China to do what is essentially doing someone a great favor: slowing down so that the West can follow…

And especially if the West’s slow pace is due to its catastrophic leadership of the past decades: first and foremost wasting trillions of dollars killing people abroad instead of investing in its own progress…

I fear that this ‘overcapacity framework’ is just another illustration of weak leadership: choosing to blame others for your own failures rather than face reality.

This text appeared on https://twitter.com/RnaudBertrand/status/1776486765463048674?t=kas5n3DU_rdplhr-_v2Riw&s=03. Translation: Bart Dewil.