The Chinese market is so big, but why does overcapacity still occur?

Fu said there are short-term and long-term reasons for China's surplus capacity. In the long term, since reform and opening up, China has been adopting an extensive model of development, where enterprises prefer simple expansion of scale but ignore improvement of technology and quality of development, leading to low-end rapid growth of production capacity. Moreover, local governments excessively concentrate on GDP growth, attracting investment through low land prices, environmental protection costs and labor costs, intensifying excessive production capacity. During the process of accelerated industrialization and urbanization, because market demand increases fast, some enterprises have unrealistic market expectations and blindly expand investment. China has long been at the low end of international industrial chains and its process of industrial upgrading is slow, therefore the excessively rapid expansion of low-end production capacity worsens the problem of overcapacity.

In the short term, China has been relying on investment and exports to drive up economic growth, but the global financial and European debt crisis seriously curbed external demand. As it takes time to nurture domestic demand, and the total market demand shrank, it exacerbated the overcapacity problem.

The Western world is now accelerating the process of re-industrialization, and emerging economies are boosting industrialization and adjusting industrial structures, therefore the trend of global expansion of production capacity will not change in the short term. According to Fu, it will be unrealistic for China to rely on fast recovery of the external market in order to solve overcapacity.

Of all the contributing factors, Fu thinks local governments are the most responsible. In many cases, overcapacity is not caused by misjudgment by enterprises, but blind investment pushed forward by local governments. Most industries that local governments support, including the newly emerging photovoltaic industry, have seen overcapacity, while in highly market-oriented industries such as textiles and home appliances, the overcapacity problem is not serious.

Fu said under a market economy, appropriate oversupply is precondition for market competition mechanisms to work, and helps balance supply and demand and boost technology advancement and management innovation. But when production capacity far exceeds effective demand, there will be a serious waste of social resources.

Withdrawal mechanism

Overcapacity is one of the problems the new cabinet hopes to solve since taking office in March. But restricting investment or shutting down surplus capacity only through administrative measures will not achieve the goal and may cause other problems.

A withdrawal mechanism of production capacity will be an important measure to tackle overcapacity under market rules.

The Enterprise Research Institute of the Development Research Center of the State Council has established a research group to determine "how to establish and improve corporate withdrawal policy system against the background of overcapacity."

A report written by the research group suggests withdrawal of surplus capacity should be made through methods that include repurchase, M&As and outbound transfer of production capacity.

Repurchase means government, non-governmental organizations or some enterprises purchase surplus equipment and infrastructure or even whole enterprises, in the industries with excessive capacity, and then cease production. Promoting M&As will reduce demand and improve product quality via industrial reorganization. Outbound transfer means to export or move products or production capacity in industries with overcapacity overseas.

In fact, the fast growth of China's manufacturing industries mainly benefited from the transfer of surplus capacity by developed countries.

According to the report, China's withdrawal mechanism of surplus capacity should be based on the establishment of sound market mechanisms, reducing withdrawal costs and simplifying withdrawal procedures. Direct government intervention in some specific industries should also rely on market mechanisms as much as possible.

The report suggests China learn from international experience in how to tackle overcapacity. In developed economies of the United States, Japan and Europe, there are mainly two ways: market-oriented withdrawal mechanism through deregistration and bankruptcy of enterprises; direct government intervention through fiscal, taxation, financial and industrial policies in the forms of repurchase, promoting M&As, stimulating consumption, limiting production and promoting outbound transfer of production capacity.

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