China's hardened rhetoric against price wars among producers is raising expectations Beijing may be about to kick off industrial capacity cuts in a long-awaited but challenging campaign against deflation that carries risks to economic growth.
Communist Party leaders pledged this month to step up regulation of aggressive price-cutting, with state media running its harshest warnings yet against what it describes as a form of industrial competition that damages the economy.
The signals echo Beijing's supply-side reforms a decade ago to reduce the production of steel, cement, glass and coal, which were crucial to ending 54 consecutive months of falling factory gate prices.
This time, however, the fight against deflation will be more complicated and poses risks to employment and growth, economists said. The trade war with the US is intensifying price wars and squeezing factory profits.
Challenges Beijing didn't face last decade include high private ownership, misaligned incentives at local and national level and limited stimulus options in other economic sectors to absorb the job losses resulting from capacity cuts.
Beijing sees employment as key to social stability. Exporters and the state sector are shedding jobs and cutting wages, while youth unemployment runs at 14.5%.
“The round of supply-side reform is far more difficult than the one in 2015,” said He-Ling Shi, economics professor at Monash University in Melbourne.
“The likelihood of failure is very high and if it does fail, it would mean China’s overall economic growth rate will decline.”
Economists expect efforts by Beijing to reduce capacity will be undertaken in small and cautious steps, with officials keen to achieve annual economic growth of about 5% keeping a close eye on spillover effects.
An expected meeting of the Politburo, a decision-making body of the party, at the end of the month might issue more industry guidelines, though the conclave rarely delivers a detailed implementation road map.
Analysts expect Beijing to first target high-end industries it once billed as the “new three” growth drivers, but which state media singled out for fighting price wars in autos, batteries and solar panels.
Their expansion accelerated in the 2020s as China redirected resources from the crisis-hit property sector to advanced manufacturing to move the world's No 2 economy up the value chain.
However, China's industrial complex, a third of global manufacturing, looks bloated across the board.
Most sectors have capacity utilisation rates below the 80% “healthy” level, Societe Generale analysts said, blaming weak domestic demand and an investment-driven growth model that favours producers over consumers.
US and EU officials have repeatedly complained the model is flooding global markets with cheap goods made in China and endangers their domestic industries.
A foreign chemicals company manager surnamed Jiang, who asked for partial anonymity to discuss the industry, said overcapacity in her sector was evident as early as 2023 but firms continue to expand.
“If money is cheap and abundant, any company thinks it won't go bankrupt and can crush competitors to death,” Jiang said.
For all the state support manufacturers receive, most are privately owned, unlike the raw material producers Beijing trimmed last decade, largely through blunt administrative orders.
Reducing capacity requires a less predictable process of curbing subsidies, cheap land supply, preferential loans or tax rebates and then letting markets pick winners and losers.
However, the local officials who would have to implement this have the opposite incentive: developing industry champions that draw supply chain investments and employment to their region.
“Local governments, in their efforts to transform the local economy, encouraged firms to invest in new sectors” such as solar and batteries, a policy adviser said on condition of anonymity due to the topic's sensitivity.
“There’s nothing inherently wrong with transformation and upgrading, but the problem is everyone is targeting the same few sectors,” said the adviser, adding the US trade war has exposed such industries as being “too big”.
Yan Se, deputy director of the Institute of Economic Policy at Peking University, said local government resistance would turn “important and necessary” capacity cuts into a long-term, gradual process that won't end deflationary pressure on its own.
Stimulating demand would work better, Yan told a conference last week.
Producer prices dropped for the 33rd month in June.
China faces a painful trade-off between a deeper and shorter stretch of price falls as output cuts trigger job losses and a longer run of overcapacity and deflation that delays the blow to employment, economists said.
Macquarie estimated last decade's reforms chopped tens of millions of jobs. However, an ambitious project to redevelop shantytowns across China, estimated by Morgan Stanley at 10-trillion yuan (R24.5-trillion), offered displaced workers new jobs.
Manufacturing is much less labour intensive. However, jobs will be lost and “there's no way” other economic sectors, also facing weak consumer demand, can absorb the shock, said Shi.
In another echo from last decade, high level talk of urban redevelopment re-emerged last week. However, any new investment in that area would likely be too small to compensate for lost industrial activity and jobs.
“I don't think we can expect real estate to continue to digest job losses from supply-side reforms,” said John Lam, head of Greater China property research at UBS.
“It was used for that in the past and it created overcapacity in our sector. Authorities don't seem to be going in that direction, which I think is correct.”
Reuters
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