The majority of industries in China face severe overcapacity, which seriously threatens the smooth functioning of China’s economy.
Despite China’s high hopes, “the road map for launching an Asian Investment Bank” remained only a plan at the APEC summit this year. In addition, the Mexican government decided to cancel a $3.7 billion Chinese bid for a hi-speed railway project. China’s “Marshall Plan”—to export its overcapacity—is thus off to a bad start, and Beijing will still need to find ways to deal with this “nuclear threat” to China’s economy.
Why China Wants to Implement a “Marshall Plan”
Most comments made in China regarding the country’s “Marshall Plan” focus on overseas investments. And while some mention the term “export capacity,” they deliberately omit the key modifier for the word capacity: over.
China seeks to establish an Asian Infrastructure Investment Bank (AIIB) and, with that bank as the core, to materialize its plan for a “one belt and one road,” i.e., a “Silk Road Economic Belt” and a “Maritime Silk Road of the 21st Century.” Through this “one belt and one road,” China would be able to export its unwanted excess capacity. Commentators have dubbed this “China’s Marshall Plan.”
What I want to discuss here is the reason why China needs to implement its “Marshall Plan.” The majority of industries in China face severe overcapacity that seriously threatens the smooth functioning of the Chinese economy.
Why Is Overcapacity Deemed a “Nuclear Threat” to China’s Economy?
Overcapacity means the sum of productivity is greater than the sum of consumption. Unlike the U.S. Marshall Plan that exported predominantly manufacturing equipment (to help rebuild European economies after World War II), China’s version seeks to export its infrastructure (such as railways and roads) and the up- and downstream industries, where overcapacity is most noticeable.
China’s overcapacity came almost hand-in-hand with the country’s economic growth, and its roots can be summarized as follows: investment was handled in the socialist manner and demand followed the capitalist way.
By “investment was handled in the socialist manner,” I mean borrowers—the heads of state-owned-enterprise (exempt from shouldering responsibility, according to unwritten rules) and private company owners (who flee if they become bankrupt) alike—do not have to shoulder real risks as investment funds come mainly from the government or commercial banks, and the investment risks are transferred to banks as bad debt.
By “demand followed the capitalist way,” I mean that there has to be market demand for capacity. If demand is insufficient, excess, or in the case of the Chinese economy, overcapacity, will result.
Based on the aforementioned summary, we can see that China’s overcapacity has the following two characteristics:
First, overcapacity is the inevitable product of government interference in the economy.
Chinese economic growth is often linked to government stimulus policies. Whenever the central government launches stimulus policies, local authorities will without a doubt initiate, as they please, projects that are very similar in nature and result in severe excess capacity. Although the central government seeks to arrest excessive growth in some industries through macroeconomic regulations and control, their efforts have often been futile, with new overcapacity emerging while the existing ones have not yet been cleared.
In 2009, the NPC Financial and Economic Committee revealed in a survey and research report that starting from 2005, varying levels of overcapacity could be seen in 19 industries. At that time, the State Council Standing Committee set about a special plan to tackle the issue. However, with the local authorities seeing GDP growth as their achievement, overcapacity could not be controlled. By 2013, overcapacity became, as the respective industries acknowledged, a widely seen phenomenon that appeared in aluminum production, steel manufacturing, photovoltaic equipment, wind power, ship building, and the like.
Second, the macroeconomic regulation and control policy of the central government results, more often than not, in overcapacity becoming even more serious. Take for example the steel industry in China. Despite going through several attempts to suppress its excess capacity in the last decade or so, the industry somehow managed to circumvent those measures in one place or another.
For instance, government policy stipulated that furnaces smaller than 200 cubic meters would be phased out. The intention of the policy was to eliminate smaller mills. However, many of those mills replaced their furnaces with ones sized 300 and 500 cubic meters, or even bigger. The phased out standard was raised to 300 cubic meters later on, and the mills again made changes accordingly. This resulted in the actual capacity of China’s steel manufacture growing larger and larger.
Right now, the steel manufacturing industry has been in a state of overcapacity for several years, and yet enterprises are still very eager to increase their capacity. In 2013, the excess capacity of China’s steel industry was 300 million tons, roughly two times the EU’s capacity. And in 2014, according to China United Steel Net (CUSteel), 24 new furnaces were put into operation with a combined annual capacity of 35 million tons. Although this was half of the 70 million tons increase seen in 2013, it still added to the overcapacity issue when the demand was not strong.
According to a document from the National Development and Reform Commission, overcapacity could also be seen in a wide range of other industries and analysts were quoted as saying that there are but a handful of industries that do not have an excess capacity issue. Thus, overcapacity has become the “nuclear threat” of China’s economy.
Why is it so difficult to bring overcapacity under control? The reasons, apart from the systemic issues of investment mentioned above, are that local authorities have two things to consider. One is that phasing out overcapacity would result in huge layoffs, which would destabilize society and contradict the government objective of stability maintenance.
The second thing is debt risk. At present, the debt ratio of member companies of CUSteel is as high as 70 percent, with the total amount of loans reaching US$1.3 trillion. If the debt of non-CUSteel-member companies is also included, the sum of debt of the entire steel industry may exceed US$2 trillion. Phasing out companies to reduce excess capacity would leave behind a massive credit black hole.
Obstacles Abroad: Opposition to an Asian Infrastructure Investment Bank
Judging from China’s own situation, export of excess capacity might be a solution. So, during a 2013 visit to Indonesia, Xi Jinping offered to finance infrastructure projects in developing countries in Asia, including ASEAN member countries, and proposed to set up an Asian Infrastructure Investment Bank (AIIB).
After representatives from 21 countries, including China, India, Kazakhstan, and Vietnam signed on the AIIB memorandum on Oct. 24, the financial institution is expected to complete its charter signing procedures and start operations before the end of 2015.
The obstacles AIIB faces include a lack of interest from major economies in the Asia-Pacific region. Representative from four key economies in the region—Japan, Korea, Indonesia, and Australia—did not attend the AIIB memorandum signing ceremony. In addition, both the United States and Japan oppose it. There were reports that the United States asked its allies to consider the issue carefully before deciding to join the AIIB. Nakao Takehiro, president of the Asian Development Bank (ADB), stated simply that he does not welcome the creation of another regional bank spearheaded by China with objectives similar to the ADB.
Without the China-led AIIB to handle the lending business, it would not be easy for China to implement its plan to export the country’s overcapacity.
Obstacles Abroad: Investment Risks Outweigh Opportunities
The idea of a “belt and road” fascinates China, with plenty of articles expounding its bright prospects. These articles, I have to say, were written by starry-eyed people who took into account only where to invest, i.e., where they could export the excess capacity. They did not think about ways to get their investment returns guaranteed.
China’s so-called “market economy,” manipulated by the state administration, focuses only on how to get approval from superiors, how banks will lend the money, and how to spend it. Never once was return of investment taken into consideration, and unfinished projects and debts were simply deemed “the cost of making mistakes.”
Taking a look at the countries and regions covered by this “belt and road” plan, we can see that ASEAN, Southern Asia, West Asia, North Africa, and Europe are all included.
Sure enough, countries like Korea, the Netherlands, France, Germany, Belgium, and Russia are not in the initial stages of industrialization, and they have in place well-developed infrastructure; so they don’t need to take in massive excess capacity from China.
As for India, it is a populous country that doesn’t lag very far behind China in terms of manufacturing and IT industries. It also has plenty of workers if it really needs to build infrastructure.
Hence, countries that might actually need China’s help would only be Indonesia, Malaysia, and Central Asian countries, such as Tajikistan and Turkmenistan.
Obstacles Abroad: Troubles and Losses
The difference between investments in the “belt and road” area and overseas investments China made in the past is that in the past, China’s overseas investments were strategic investments made to resolve its energy and mineral needs. This time, it is to release China’s massive overcapacity, and so it came up with the premise that other countries need infrastructure and yet they lack the funds to finance them.
But all investment, whatever the purposes may be, needs to bring returns. The gains and losses incurred in overseas investment made in the past can provide meaningful insight into how China has been doing.
The Heritage Foundation set up a database called China’s Global Reach to keep trace of overseas investment projects by Chinese enterprises worth $100 million or more. The data shows that China invested in industries like energy, mining, transportation, and banking.
Between 2005 and 2012, Chinese enterprises made investments in 492 projects worth at least $100 million and committed a total of $505.15 billion, with around 90 percent of this money coming from state-owned enterprises. According to the list of “troublesome projects” in the database, 88 projects of the same period were either rejected by supervision agencies in later stages or partly, or completely, failed, with a total of US$198.81 billion involved.
But things are much, much worse according to China’s own calculations. Wang Wenli, vice-president of the China Economic and Trade Promotion Association, said in August this year that of the over 20,000 Chinese companies who have investments overseas, more than 90 percent have suffered losses because of (faulty) asset valuation, labor disputes, anti-monopoly and national security issues, tax issues, public relations problems, and so on. What Wang did not include was embezzlement committed by the overseas investment management of state-owned enterprises.
These factors contributing to losses would not go away just because the investment objective of the “one belt and one road” changed to exporting overcapacity.
Beneficiaries of China’s Overseas Investment
The massive investments China made in the last decade or so is a phenomenon unlike anything the international community has ever seen. Such a phenomenon could not possibly emerge in capitalist countries, where all investment is private money.
No multinationals would keep making investments with a loss rate as high as 70-90 percent over a long period. This didn’t emerge in any other socialist countries either. Before the 1990s, socialist countries only traded among themselves. Today, of the remaining socialist countries, China is the only one to have amassed a wealth so massive that it can make large-scale and ineffective overseas investments using its state power.
As a result, China, as a socialist authoritarian country, became economically intertwined with democratic countries around the world, and adversaries were turned into partners.
But for all the political gains, China’s overseas investment has so far incurred only economic losses. And despite this, China is still making investments abroad. According to China’s Ministry of Commerce, the country committed 81.9 billion dollars for direct investment overseas. It’s hard to consider this as normal investment behavior.
A Sept. 2 news report in a Guangzhou newspaper perhaps holds the key to the question why China is so persistent in making investments overseas despite the staggering losses: many mid-level officials of PetroChina and Sinopec have sought opportunities to emigrate to Canada, the United States, the United Arab Emirates, and elsewhere to escape from being struck down by the regime’s anti-corruption drive. An estimated $20-40 billion would thus be moved out of China.
This is an abridged translation of a two-part series published in Chinese on Voice of America on Nov. 15 and 18, 2014, respectively.
He Qinglian is a prominent Chinese writer and economist living in the United States. She is the author of “China’s Pitfalls,” which concerns corruption in China’s economic reform of the 1990s, and “The Fog of Censorship: Media Control in China,” which addresses the manipulation and restriction of the press. She regularly writes on contemporary Chinese social and economic issues.
