Cheap Chinese high-tech goods have flooded the global economy this year, raising alarms in Washington and Brussels as Western businesses complain about what they see as a new round of unfair competition.
Chinese leader Xi Jinping has dismissed the charges, saying “there is no so-called problem of Chinese overcapacity.” Instead, Chinese officials say the country’s electric vehicles, solar panels and other products are simply better and more competitive than Western versions.
But a look at China’s industrial sector shows clear signs of overcapacity, especially in industries such as solar panels, automobiles and steel. In some sectors, the situation looks poised to get worse, as China keeps expanding capacity even as domestic demand stays weak.
Defining ‘overcapacity’ is hard—but one measure stands out
It isn’t easy to define ‘overcapacity’, because it is unclear what the ‘over’ is in comparison to. Should China’s industrial scale, and new investment, be benchmarked against its current growth? Against the world’s growth? Or against China’s future growth?
Western politicians eyeing a tidal wave of cheap goods prefer the first definition. Beijing prefers the second or third.
What is clear is that since 2021, Chinese companies have invested more in manufacturing than usual, even though domestic demand and exports have often been weak. The trend has been especially stark for certain sectors that are favored by Beijing and often benefit from subsidies, such as EVs.
Auto-sector investment growth hit nearly 25 per cent year-over-year in early 2023. The investment surge in solar panels, chips and batteries has been even more impressive.
Profit margins are falling -- another hint of overcapacity
As investment has surged, profit margins for Chinese producers have plummeted, especially for autos and steel.
Net profit margins for China’s manufacturing sector as a whole were under 4.0 per cent in early 2024, well below average levels of around 6.0 per cent in the late 2010s.
Export prices for some Chinese products have fallen
Enormous capacity paired with weak demand and lower margins at home has pushed more Chinese goods into global markets. That excess supply has driven prices for some Chinese goods lower and undercut competitors abroad.
But the impact has been different for different products.
While Western politicians have focused on the threat from Chinese autos, falling prices have so far been much worse in steel and solar panels. Prices for lithium-ion batteries have actually been sharply higher since 2020 -- although recently they have been falling rapidly.
China’s weak property market is partly to blame
China’s latest excess capacity problem emerged in earnest around the same time as the nation’s epic property crash. That is no coincidence.
The property crash curbed demand for steel and other building materials. As mortgage borrowing dried up, the bust also freed up excess savings for investment in things such as autos, chips and solar-cell factories -- something actively encouraged by Beijing, which prefers a manufacturing-driven, rather than property -- and consumption-driven, growth model.
As long as China’s property market remains in the doldrums, Chinese households keep saving, and Beijing remains determined to manufacture its way out of economic trouble, China’s overcapacity problem is unlikely to substantially improve.
Excess capacity looks worst in solar
China’s excess capacity looks worst in solar-cell manufacturing, which, along with other clean energy applications, is one of the so-called “new productive forces” that Beijing has highlighted as central to its future growth strategy.
China in 2023 produced over 450 gigawatts of solar cells, according to official data. It installed less than 220 gigawatts at home—a massive figure but still less than half of what it produces.
Capital Economics estimates that China will manufacture around 750 gigawatts this year. If installations stay at the same level, that would mean China producing around 500 gigawatts of “excess” solar cells in 2024.
That is nearly four times the total number of panels installed in 2023 in the rest of the world.
Things could get worse in steel and batteries
China is the world’s largest steel producer and consumer. Its exports tend to surge when the property market runs into trouble.
But the nation is still using a higher percentage of its steel production domestically than it did at the height of the last big real-estate downturn in 2015, and during the global financial crisis in 2009.
Profit margins for steel look much worse than in 2015, though, in part because of pricey iron ore. That means steelmakers have a strong incentive to find higher prices abroad.
For batteries, the global supply-and-demand balance looked better until recently. But there are now clear warning signs ahead.
Export prices of Chinese lithium-ion batteries have trended sharply down since late 2023 as global automakers tapped the brakes on the EV revolution. Meanwhile, Chinese manufacturers are preparing a historic surge of supply, despite recent guidelines from Beijing aiming to restrict investment in low-end battery capacity.
Goldman Sachs last year estimated that Chinese EV battery production capacity, adjusted for yield, will reach around 1,000 gigawatt-hours by 2025 -- roughly twice the bank’s forecast for Chinese demand. Goldman expects battery factory utilization rates outside China to fall from nearly 100 per cent in 2022 to around 80 per cent by 2026.
Glimmers of hope in autos
Political attention has focused on China’s rising auto exports and excess capacity -- for good reason, given how important the auto sector is to Western economies.
But while the situation for some Western carmakers is undeniably dire, the investment surge in China’s auto sector in 2022 and 2023 is now cooling. Investment, which was growing at nearly 20 per cent year on year in 2023, has fallen to 5.7 per cent, roughly in line with the historical average. Profit margins also appear to have stabilized, albeit at a lower level than in the past.
In other words, while overcapacity remains severe, it may no longer be rapidly worsening. An auto price war in China and slower EV adoption abroad seem to finally be curbing the investment mania at home.
Margins in electrical equipment, however, are trending down again—another warning sign for solar cells and other equipment like batteries.