Earlier this week, during her Beijing meetings, U.S. Treasury Secretary Janet Yellen said she had reached an agreement with China to “launch intensive exchanges on balanced growth in the domestic and global economies.” If history is any guide, this is an empty agreement that will only delay the inevitable.
The headline reason for Ms. Yellen’s trip to Beijing was to discuss Chinese overcapacity in key industries, from solar panels to automobiles. The other side of this equation is that the low Chinese consumption rate and a high investment rate drive rapid growth in areas such as manufacturing capacity and infrastructure.
Chinese and international economists have begun raising the Chinese savings rate, which suppresses consumption and increases investment in poorly directed infrastructure and capacity. Despite their simplistic cut-and-paste solutions borrowed from economic textbooks, China has avoided addressing problems of overcapacity for the entire century.
Dating back to the George W. Bush administration, industrial overcapacity driven by Chinese subsidies to companies and state-controlled finance has dominated policy writing.
In 2007, a UBS economist wrote for the International Monetary Fund, “Because of excess domestic capacity creation, heavy industrial companies have effectively expropriated savings from the rest of the world through abnormally high market share gains both at home and abroad.”
Throughout the Bush, Obama, and Trump administrations, Beijing was more than happy to create working groups, conferences, and pledges to discuss the issue with Washington as long as nothing happened. Despite all the pledges and working groups, the problem of Chinese overcapacity has only worsened, with no end in sight.
So does the agreement with China to “launch intensive exchanges” mean anything?
Chinese consumer demand is sluggish at best. Automobile demand in China has been basically stagnant since about 2015, even as it continued to build more capacity. The Chinese auto export flood stems as much from a lack of demand as it does from too much capacity. All this capacity that Chinese and foreign firms are building in China is not being consumed in China.
The primary hurdle is that China has no interest in limiting its capacity. Front and center in Chinese leadership thinking is the need to create 10 million jobs per year, decouple from the United States, and control the industries of the future. This only happens with high levels of investment coming from the Chinese saver. Put another way, Beijing has no interest in reducing its problem of overcapacity and taking deflationary market share on global markets.
The Chinese model of state-directed finance drives the problem. As Beijing declares favored sectors and local governments compete with state-owned banks to locate favored sectors in their provinces, this prompts a flood of subsidies and state-controlled investment into output capacity. This pattern appears clearly in the low profit margins, sluggish profit growth, and bad loan growth. Despite running large trade surpluses and high savings rates, China has used capital extremely poorly, which has been reflected in a stock market flat for the century and banks teetering on insolvency.
Despite Ms. Yellen’s cheery statement, U.S. negotiators have been trying to work with China to reduce its overcapacity problems, which drive down global prices and unfairly affect global markets for years. This entire century has been a never-ending parade of officials meeting with counterparts in Beijing to return with no change.
This leaves the United States and other areas such as Europe and Japan in an uncomfortable position: If China is unwilling to change, what measures should they take unilaterally to address the problem of Chinese subsidies that affect global markets in a range of products through overcapacity?
A range of options exist, from anti-dumping to World Trade Organization legal filings to tariffs, but the reality is that the United States should not count on China to solve the issue; it is promoting rather than restraining.
