Wednesday, August 26, 2009 0 comments ++[ CLICK TO COMMENT ]++

China studying overcapacity issues

I ran across a Bloomberg story that suggested that China is studying potential overcapacity in several industries:

China said it’s studying curbs on overcapacity in industries including steel and cement, adding to concern policy makers may seek to rein in growth fueled by record credit expansion this year.

The government will increase “guidance” of industries including steel, cement, coal chemical, plate glass and wind power equipment, the State Council, China’s cabinet, said in a statement on its Web site today. The government will strengthen controls on approval of stock and bond sales by companies in these industries, according to the statement.

I have been following (but not very closely) stories pertaining to China for many years now, and this is one of the few times I can remember where the government is actually targetting the overcapacity problem. China has attempted to improve the efficiency of its steel mills for more than a decade now. There are way too many small operations that are inefficient. But because they are inefficient, they create a lot of jobs—at least in the medium-term. Little progress seems to have been made in the steel industry over the decade. What's new here, at least for me, is how they are targetting areas with potential overcapacity such as wind power equipment, cement, and so on.

People like me have been concerned about massive overcapacity in China for years. To get an idea why I believe there is overcapacity, consider China's output capability, as mentioned by the Bloomberg story:

China produced 500.5 million metric tons of steel last year as the world’s largest producer. That’s more than the combined output of Japan, the U.S., Russia and India, the next four biggest makers, according to the World Steel Association. In the first seven months of 2009, China accounted for almost half of global steel output.

The nation is also the world’s biggest coal producer and consumer, accounting for 43 percent of global demand last year, according to BP Plc. Imports averaged 8 million tons a month this year, more than twice last year’s average of 3.4 million tons.

China produced an estimated 1.45 billion tons of cement last year, accounting for half of world output and making it more than eight times bigger than its nearest rival India, according to the U.S. Geological Survey.

These numbers are truly mind-boggling. Think about it: China produces as much steel as the next 4 biggest countries combined; china produces 8x more cement than the 2nd place country (India); and so on.

Yes, China is growing and will require more than other countries. It is also a big country so it would suck up a sizeable amount of resources. Yet, this seems very extreme to me.

The risk with all this overcapacity is not what happens now—although some argue that resources are being misallocated towards fixed-assets—but, rather, what happens when China doesn't consume at the same rate. Can you see why people like me think China can potentially unleash massive deflationary forces? If China can produce far more, say, solar panels than is needed, it will drive down the price of solar panels everywhere. Secondly, it may also dump the excess goods on the world market, potentially causing trade disputes.

From China's point of view, imagine what happens to all these workers in, say, a cement factory, who are not needed anymore. Repeat this with countless other industries. The only industries that may not need to shrink are those related to energy (since energy consumption is likely to continuously increase.) So, I don't think there is overcapacity problems in coal, even though the story says the government is looking into it. But what happens to all those employed in the steel industry—not just in the mills but, say, those working in the iron ore import business. How about the copper industry? On and on.

Another problem with these Chinese industries with overcapacity is that they are also the ones that are thought to be inefficient. In other words, for China to increase its wealth—GDP per capita or income per person—it needs to increase productivity. Doing so will require streamling the industry, getting rid of the smaller ones producing poor-quality products, using new technology, and so on. Such actions will create unemployment! Use of new technology will automatically reduce the number of workers needed to do the same job. The only way around this issue without a political revolution is if China develops its service industry. Generally service industries are consumption-oriented and utilize more labour. But that takes a long time and it remains to be seen what actually comes of all these overcapacity problems...


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