How to Tackle China’s Overcapacity Problem
A global economic slowdown, together with rising geopolitical tensions, has led to overcapacity in crucial Chinese industries like alternative energy and electric vehicles. The only feasible solution is for Chinese companies to expand their overseas investments, particularly in the United States.
Can China Reach Its 2024 Growth Target?
In 2024, a combination of falling consumption growth and declining real-estate investment is likely to impede Chinese GDP growth. If China is to meet its 5% growth target for this year, the government will have to offset these factors with more expansionary fiscal and monetary policy.
BEIJING – On March 5, at the opening of the annual meeting of China’s legislature, the National People’s Congress (NPC), Chinese Premier Li Qiang announced that the government’s target for GDP growth this year is around 5%. It is an encouraging target, but if China is to reach it, the government may need to adjust its policy approach.
Though China’s annual GDP growth reached 5.2% last year, it has been steadily declining, almost on a quarterly basis, since 2010. It does not help that China has been grappling with very low inflation and even deflation. The consumer price index grew by just 0.2% in 2023, while the producer price index shrank by 3%. This is in line with longer-term trends: Chinese CPI has been rising by less than 2%, on average, since 2012, and PPI has been in negative territory for the better part of the last decade.
The sooner China reverses these trends, the better. Otherwise, the cumulative impact of long-term structural factors like population aging, persistent “hysteresis effects” of past economic disruptions, and falling confidence will make it increasingly difficult – even impossible – to revive satisfactory growth. Fortunately, the window to robust recovery has not yet closed: with a more expansionary fiscal and monetary policy, China’s government can stabilize GDP growth at a higher level – around 6%.
Chinese policymakers seem to recognize the need for some fiscal expansion. According to its 2024 budget, which the NPC approved last month, the central government will increase its expenditure by about 4% this year, to CN¥28.5 trillion ($3.9 trillion). On top of CN¥4.06 trillion in government bonds, the government will issue CN¥1 trillion in ultra-long special treasury bonds, and CN¥3.9 trillion in local-government special-purpose bonds.
China’s government still anticipates that the budget deficit will be 3% of GDP – the same as last year. But its “augmented” deficit-to-GDP ratio, as defined by the International Monetary Fund, is set to reach 8.2% in 2024. This is a step in the right direction, but if China is to achieve, let alone surpass, its 5% growth target, it may need to go further.
Not everyone agrees. Some scholars oppose expansionary fiscal policy in China, arguing that the country should be shifting its growth model away from dependence on capital investment, and instead fostering private consumption. They might point out, for example, that final consumption amounted to just 53% of GDP in China in 2022, compared to 82.9% in the United States.
But this gap is attributable largely to differences in services consumption, which constitutes two-thirds of final consumption in the US, but just 43% in China, not least because the prices of services are much higher in the US than in China. Meanwhile, the share of total consumption expenditure that went toward goods (including catering) in China was 87.4% of the US share in 2022, even though China’s GDP is less than 70% that of the US.
In other words, the share of goods consumption in GDP is much higher in China than in the US. Moreover, in 2023, final consumption contributed a whopping 82.5% of China’s GDP growth, with total retail sales of consumer goods growing by 7.2% over the previous year. Add to this the persistent decline of fixed-asset investment’s share of GDP over the last decade, and it is clear that one should be wary of characterizing China’s current growth pattern as “investment-driven.”
Yes, China’s government should continue to promote consumption, not least to make the income distribution more equitable. But, whatever it does, consumption growth will almost certainly be lower in 2024 than it was last year, owing to the powerful post-pandemic base effect in 2023. Darkening China’s prospects further, real-estate investment – long a main driver of growth – continues to decline, having already fallen by 10% in 2022 and 9.6% in 2023.
More infrastructure investment is vital to offset the adverse effects of falling consumption growth and real-estate investment. And since infrastructure is a public good, and might not offer the kinds of large, relatively short-term returns private investors often seek, the bulk of financing for such investment must come from the government.
Since completing its CN¥4 trillion stimulus package in 2008-09 – a response to the 2008 global financial crisis – the central government’s contribution to infrastructure investment has been negligible, amounting to less than 1% percent of the total. Local governments contributed more – around 10%. But this is not only insufficient; it is also exacerbating debt risks for both local governments and real-estate developers, because when local governments invest in infrastructure, they must raise funds by borrowing at high interest rates and by selling land-use rights.
A back-of-the-envelope calculation indicates that the government’s planned expenditure for 2024 may fall significantly short of China’s infrastructure-financing needs. So, over the course of this year, policymakers may well have to adjust their approach – say, by issuing more government bonds than anticipated. Monetary expansion might also be needed, with the People’s Bank of China lowering its benchmark interest rate. One cannot rule out the possibility that the Chinese government will have to implement a sort of quantitative easing.
Achieving the government’s 5% growth target this year will not be easy. The target is achievable. But the government may need to pursue a more expansionary fiscal and monetary policy than it has planned.
China Confronts the Middle-Income Trap
While China obviously needs to boost private-sector confidence and revive growth with a more sustainable economic model, it is not clear that Chinese leaders fully appreciate the challenges they face. The shift back to state capitalism over the last decade is plainly incompatible with President Xi Jinping’s development goals.
NEW YORK – At this year’s China Development Forum (the highest-level annual meeting between senior Chinese policymakers and top CEOs, current and former policymakers, and academics like me), the discussion focused squarely on the risk of China falling into the dreaded “middle-income trap.” After all, few emerging economies have successfully joined the ranks of high-income countries.
Will China be an exception to this pattern? Following 30-plus years in which China achieved annual growth rates close to 10%, its economy has slowed sharply this decade. Even last year, with the strong rebound from the “zero-COVID” era, officially measured growth was only 5.2%. Worse, the International Monetary Fund estimates that China’s growth will fall to 3.4% per year by 2028, and, given its current policies, many analysts expect its potential growth rate to be only 3% by the end of this decade. If that happens, China will indeed find itself in the middle-income trap.
Moreover, China’s problems are structural, rather than cyclical. Among other factors, its slowdown is due to rapid aging, a busted real-estate bubble, a massive overhang of private and public debt (now close to 300% of GDP), and a shift from market-oriented reforms back toward state capitalism. Credit-fueled investment has grown excessive as state-owned banks lend to state-owned enterprises (SOEs) and local governments. At the same time, the government has been bashing the tech sector and other private enterprises, eroding business confidence and private investment.
In this new period of deglobalization and protectionism, China appears to have hit the limits to export-led growth. The West’s geopolitically motivated technology sanctions are constraining the growth of its high-tech sectors and reducing inflows of foreign direct investment (FDI); and the combination of a high domestic household savings rate and low consumption rates (owing to weak social insurance and the low share of household income) is further hampering growth.
The old Chinese growth model is broken. Initially, China’s low (and thus internationally competitive) wages meant it could rely on light manufacturing and exports, before pursuing massive investments in infrastructure and real estate. Now, Chinese authorities are advocating high-quality growth based on technologically advanced manufacturing and exports (electric vehicles, solar panels, and other green- and high-tech products) led by financial incentives to already-bloated SOEs. But without a matching increase in domestic demand – especially private consumption – over-investment in these sectors will lead to over-capacity and dumping in global markets.
China’s excess supply (relative to domestic demand) is already producing deflationary pressures, heightening the risk of secular stagnation. When China was smaller and poorer, a sharp increase in its exports was manageable in global markets. But now that it is the world’s second-largest economy, any dumping of its excess capacity will be met by even more draconian tariffs and protectionism targeting Chinese goods.
China therefore needs a new growth model concentrated on domestic services – rather than goods – and private consumption. Services as a share of GDP are too low by global standards, and though Chinese policymakers continue to talk about boosting domestic demand, they seem unwilling to adopt the fiscal and other policies required to boost private consumption and reduce precautionary household savings. The situation demands larger pension benefits, greater health-care provision, unemployment insurance, permanent urban residency for rural migrant workers who currently lack access to public services, higher real (inflation-adjusted) wages, and measures to redistribute SOE profits to households so that they can spend more.
While China obviously needs to boost private-sector confidence and revive growth with a more sustainable economic model, it is not clear that Chinese leaders fully appreciate the challenges they face. While President Xi Jinping has overseen the move back to state capitalism over the last decade, Premier Li Qiang, a known market-oriented reformer, appears to have been sidelined. Li neither held the customary press conference following the recent National People’s Congress nor met with the full foreign delegation at the latest China Development Forum. Instead, Xi himself hosted a smaller delegation of foreign business leaders.
The most charitable interpretation of these signals is that Xi now realizes he needs to engage the private sector and international multinational corporations to restore their confidence and boost FDI, private sector-led growth, and private consumption. Since Li is still around, perhaps he is pushing quietly for “opening-up and reforms,” while keeping a low profile to show deference to Xi.
But many observers have a more pessimistic interpretation. They note that after sidelining market-oriented technocrats such as Li, former Premier Li Keqiang, former People’s Bank of China Governor Yi Gang, advisers like Liu He and Wang Qishan, and a variety of financial regulators, Xi has created new party committees on economic and financial affairs that supersede government bodies. He has surrounded himself with advisers like He Lifeng, the vice premier for the economy, and Zheng Shanjie, the new head of the National Development and Reform Commission, who are sympathetic to the obsolete dogma of state capitalism.
Lofty statements and mantras about reforms and attracting foreign investment mean little. What matters are the actual policies that China pursues over the next year, which will show whether it can circumvent the middle-income trap and return to the path of more robust growth.
China’s Economic Engine Is Running Out of Fuel
Western observers tend to focus on criticizing the rhetoric and decisions of China’s leaders. But pointing out the errors in the forecasts on which China bases its policies – which typically fail to account for unfavorable demographic trends – may be more constructive.
MADISON, WISCONSIN – Earlier this month, the ratings agency Moody’s cut its outlook on China’s sovereign credit rating to negative, citing risks from a deepening property crisis and a prolonged growth slowdown. In fact, Moody’s now predicts that annual economic growth will fall to 4% in 2024 and 2025, before slowing further, to 3.8%, on average, for the rest of the decade. Potential growth will decline to 3.5% by 2030. A major driver of this slowdown will be “weaker demographics.”
Not surprisingly, China’s leaders said they were “disappointed” with the downgrade, claiming that the economy still has “huge development resilience and potential” and will remain a powerful engine of global growth. But China’s assessment of its potential growth is based on deeply flawed forecasts.
On August 24, 2020, Chinese President Xi Jinping convened nine economists – including former World Bank Chief Economist Justin Yifu Lin – for a symposium that would guide the 14th Five-Year Plan for economic and social development. Based on that discussion, Xi declared that it was “completely possible” for China to double its GDP per capita over the next 16 years.
Lin explained the logic behind this optimistic forecast. In 2019, China’s GDP per capita was only 22.6% of the level in the United States (calculated by purchasing power parity). Germany was at the same level in 1946, Japan in 1956, and South Korea in 1985, and their economies grew at an average rate of 9.4%, 9.6%, and 9%, respectively, over the subsequent 16 years.
Even hampered by low population growth and a trade and technology war with the US, Lin concluded, China’s potential annual growth – 8% in 2019-35, and 6% in 2036-50 – could easily translate into real annual growth of 6% and 4%, respectively. Per this forecast, China’s GDP would surpass that of the US in 2030, and be twice as large by 2049, at which point there would be four times as many Chinese as Americans.
Lin had previously made even more optimistic predictions. In 2005, he forecast that China’s economy would be 1.5-2 times larger than America’s by 2030, and that there would be five times as many Chinese. In 2008, he was even more sanguine, predicting that China’s economy would be 2.5 times the size of America’s by 2030. In 2011, he was back to forecasting that China’s economy would be twice as large as that of the US in 2030, and in 2014, he returned to his 2005 forecast that China’s economy would be 1.5-2 times larger.
Over the years, China’s leaders have embraced Lin’s forecasts as a kind of vindication of their political system and governance model. “The world is undergoing profound changes unseen in a century,” Xi declared in 2021, “but time and situation are in our favor.” Similarly, Ma Zhaoxu, the vice minister for foreign affairs, pledged last year that, in the face of efforts to impede China’s rise, Chinese diplomats would uphold the “spirit of struggle” to ensure the country’s continued development. During the COVID-19 pandemic, leaders eagerly presented China’s response as a reflection of its “institutional advantage.”
But, however appealing to China’s leaders Lin’s economic forecasts may be, they have proved wildly wrong, not least because they fail to account for China’s bleak demographic outlook. Both a higher median age and a higher proportion of people over 64 are negatively correlated with growth, and on both points, China is doing far worse than the three countries to which Lin compares it.
When Germany’s GDP per capita was equivalent to 22.6% that of the US, its median age was 34. In Japan and South Korea, the median age was just 24. After those 16 subsequent years of strong growth, the median age in the three countries stood at 35, 30, and 32, respectively. Contrast that with China, where the median age was 41 in 2019, and will reach 49 in 2035.
Likewise, at the beginning of the 16-year period to which Lin refers, the proportion of people over 64 in Germany, Japan, and South Korea was 8%, 5%, and 4%, respectively; at the end, it stood at 12%, 7%, and 7%. In China, that proportion was 13% in 2019 and will be 25% in 2035. In the 16 years after the proportion of people over 64 reached 13% in Germany (in 1966) and Japan (in 1991), these economies’ average annual growth was only 2.9% and 1.1%, respectively.
Moreover, in Germany, Japan, and South Korea, the labor force (aged 15-59) began to decline in the 12th, 38th, and 31st years after their per capita GDP equaled 22.6% that of the US. China’s began to decline in 2012.
If one imagines China’s economy as an airplane, the 1978 launch of the policy of reform and opening up would have been what ignited the fuel – the young workers – that enabled the economy to take off and fly at high speeds for three decades. But, in 2012, the fuel began to run low, causing the plane to decelerate.
Instead of adjusting to their new reality, the Chinese authorities – heeding the advice of economists like Lin – continued to lean on the throttle by investing heavily in real estate, thereby creating a massive property bubble. It is obviously dangerous to continue flying at a high speed without enough fuel, which is one reason why some economies are attempting to “de-risk” their trade by shifting supply chains away from China, which is currently more than 140 economies’ main trading partner.
Western observers tend to focus on criticizing Chinese leaders’ rhetoric and decisions. But pointing out the errors in the forecasts that form the basis of Chinese policy may be more constructive. For the country’s sake, the decisions made at the upcoming Third Plenum of the Communist Party of China must reflect reality, not more pie-in-the-sky predictions.
China Stifles Its Own Debate
For more than two decades, the China Development Forum was a meeting where foreign business, political, and academic leaders could debate the state of the Chinese economy with the country’s highest leaders. But this year’s gathering eschewed open and honest dialogue, in favor of telling only “good stories” about China.
NEW HAVEN – After my recent trip to Beijing to attend the 25th annual China Development Forum (CDF), the country’s most important public conference, one question keeps turning over in my head: What’s the point?
I raise this question as a CDF insider – as the longest-attending foreign delegate, having participated in all but the first CDF in 2000. I have witnessed this event at its best and its worst. I can say with certainty that this year’s gathering marked a new low – hence my question.
Former Premier Zhu Rongji conceived of the CDF as a forum for debate and exchange between senior Chinese leaders and foreign academics, think-tank experts, and business leaders. The timing of the conference – immediately following the National People’s Congress (NPC) – was deliberate: Zhu held the provocative view that the ministers of the State Council should engage with outside experts immediately after their internal deliberations at the NPC. It was, in effect, a stress test for senior Chinese officials.
Zhu practiced what he preached. At my first CDF in 2001 – a much smaller and more intimate gathering – I delivered a keynote luncheon address on the state of the global economy, arguing that a post-dot-com slowdown was at hand. Fred Bergsten, the founding director of the Petersen Institute for International Economics, challenged me in the discussion that followed. At the concluding session of CDF 2001, Zhu interrupted John Bond, then chairman of HSBC, during his summary of the three-day gathering, and instead called on me and Bergsten to recap our views. Zhu was more interested in the debate than in Bond’s commentary.
After the meeting, Zhu pulled me aside and said, in perfect English, “Roach, I hope you are wrong, but we will plan as if you are right.” At the following year’s CDF, he warmly greeted me with a simple, “Thank you.”
It is in that spirit and in the spirit of many subsequent years of active participation in CDF sessions that I bemoan the loss of what had been a vigorous culture of debate in China. The CDF has effectively been neutered as an open and honest platform of engagement. Word has been sent down from on high that there is room for only “good stories of China.” Anyone who raises questions about problems, or even challenges, faces exclusion from the public sessions.
That was certainly true for me. On the eve of this year’s CDF, the powers that be informed me that my recent comments on the Chinese economy “have generated intense scrutiny and even controversy” among the Chinese and international press, which suggested to them that anything I say publicly at the conference “will be misinterpreted and even sensationalized” by the media. I was told in no uncertain terms that this would not be in my – or China’s – best interest.
No surprise, then, that I was not given a speaking role for the first time in 24 years. Moreover, my background paper on Chinese rebalancing, which I had been invited to prepare as part of the CDF Engagement Initiative, was neither published nor distributed, as has always been the case for invited submissions in the past.
Nor was I the only one singled out: an economist friend whom I have known and respected for years was instructed before going on stage not to say anything negative about the economic outlook.
Political correctness can be bad enough. But censorship and attempted thought control, with the aim of stifling debate, are something else entirely. That led me to the seemingly pointless feeling of resignation. Why even bother?
My answer is both idealistic and admittedly naive. I went to Beijing in late March with the hope that the CDF would retain a sliver of its original spirit. As I wrote in my book Accidental Conflict, I am fully aware of the changes in Chinese discourse in recent years. Even taking into account recent efforts by Chinese authorities to tighten their control of the narrative, I clung to the hope that there may still be room for empirical research and analysis. After all, I was China’s “good friend.” My error was to presume that this seemingly special status allowed me to raise tough questions about China’s medium- to longer-term growth outlook.
CDF 2024 closed the door on that possibility. This year’s event was tightly scripted, with no debate, no meaningful exchange of views – not even at the smaller roundtables, which are designed for engagement. Yes, plenty of Western business leaders were in attendance, but mainly for shameless commercialized pitches of their commitment to China. Moreover, the truncated conference had a streamlined agenda. The normally high-profile Monday lunch slot was left empty, while the premier’s closing session was replaced by an opening speech that regurgitated the work report he delivered to the NPC on March 5.
It saddens me to watch the CDF become a remnant of its former self. But my admiration for the Chinese people and the extraordinary transformation of China’s economy over the past 45 years persists. I still disagree with the consensus view in the West that the Chinese miracle was always doomed to fail. Moreover, I remain highly critical of America’s virulent Sinophobia, while maintaining the view that China faces serious structural growth challenges. And I continue to believe that US-China codependency offers a recipe for mutually beneficial conflict resolution. My agenda remains analytically driven, not politically motivated.
In the end, I intend to keep showing up. In the spirit of Deng Xiaoping’s credo, “seeking truth from facts,” I will keep pushing for free and open debate in China. I am not giving up. Ultimately, that is the point of it all.
Humanizing the US-China Relationship
The US and China must work through many differences, which will not happen overnight. In the meantime, the escalating tensions between their governments make it more important than ever to preserve in-person interactions between ordinary Chinese and Americans.
HONG KONG – On a recent trip to China with my Northwestern Kellogg students, we were all struck by how few Americans had returned to the country since the end of its zero-COVID policy in December 2022.
In Shanghai, our tour guide had hosted only one other US school group, and she expected to have only one more this year – a marked decline from the 30-plus she booked each year prior to the pandemic. In Guilin, where the iconic mountains, a UNESCO World Heritage site, had previously been among the most visited places on Earth, we were allegedly the first American group to visit since the beginning of 2020. Only two more are expected this year. One hopes these are low estimates and that more have and will come. But there is no denying that the number of Americans traveling to China, which plummeted during the pandemic, has been slow to recover.
This sharp decline comes at a time when US-China relations have reached their lowest point since President Richard Nixon visited Chairman Mao Zedong in 1972. The public discourse in both countries has become almost exclusively about zero-sum competition, if not outright hostility. While US politicians and commentators from across the political spectrum portray China as the economic and geopolitical threat, Chinese media insist that American democracy is false and that the US is unfairly containing China’s growth and development.
With most of the news coverage in both countries focused on macroeconomic and geopolitical issues, little attention is paid to the lives and perspectives of ordinary people. Opportunities to generate empathy are scarce, and the results are increasingly apparent. In US opinion polls, only 15% of respondents viewed China favorably in 2023, down from 53% in 2018, and from 72% in 1989.
Some concerns are well-founded. In 2018, Americans and Canadians were shaken by China’s three-year-long detention of two Canadian NGO workers in retaliation for the relatively mild house arrest of Meng Wanzhou, a Huawei executive who had been charged with helping her company evade sanctions on Iran. Then came China’s pandemic lockdowns, which prompted most Americans to leave the country.
While completely understandable, the mass exodus of Americans and other expatriates has further curtailed the flow of information and in-person exchanges between the two countries’ business and NGO sectors. Add the fact that Western journalists’ activities are extremely restricted in China, and it is easy to see why the country feels so foreign and opaque to many outsiders. The exciting economic opportunities and fun travel stories of just a few years ago have given way to angst and uncertainty.
But has China changed fundamentally since 2019? Do Chinese people no longer believe in the potential of markets? Do they hate Americans?
My class saw as much of the country as possible in the space of just two weeks. We visited three cities and saw many Chinese and American companies – some thriving, others fighting for survival. Students also dashed around cities and suburbs on their own to conduct independent projects.
On our last day, when I asked them what stood out the most, perspectives varied. Some were impressed by China’s transportation infrastructure and cleanliness, and by the sophistication of its economy. Others remarked on the apparent poverty amid the glamor and glitz of Shanghai and Hong Kong, and many noted the constant presence of government surveillance. But all had been pleasantly surprised by their in-person encounters and meetings with Chinese people from all walks of life – from people on the street to heirs of billion-dollar family businesses. They found the Chinese people to be warm and even humble.
Students who had been wary or suspicious were heartened by the experience. One had previously helped draft anti-China legislation when she worked in government, and another had experienced an intense US-China standoff in the South China Sea. A US Department of State travel advisory had left many students worried, but they wanted to know more about the country beyond what they had read in the headlines.
The joy and sense of relief were mutual. Chinese children and their parents giggled when one of my students picked up a toddler and tossed him in the air. Women selling bowls of noodles for six renminbi (less than a dollar) made sure that students who could not read Chinese received the same discounts offered to Chinese customers. Everywhere we went, people told me that my students were a breath of fresh air – just as fun and open as they remembered Americans to be. They laughed with them, took pictures, and delighted in showcasing their work to them. They had missed these Americans. After years of isolation and negative press, they had grown worried that Americans had changed.
Of course, not all Chinese and Americans would get along, and the trip did not suddenly transform my students into China super-fans. But it did help them appreciate the complexity of the world’s second-most-populous country. They saw first-hand that the Chinese people – almost entirely absent from US news coverage – are not the same as the Chinese government or what US news headlines might suggest.
The US and China must work through many differences, which will not happen overnight. In the meantime, it is crucial that we preserve in-person interactions. Chinese and Americans must not lose sight of their common humanity. The greater the tension between their governments, the more important this becomes.
BEIJING – During her recent visit to Beijing, US Treasury Secretary Janet Yellen criticized her Chinese counterparts, arguing that China’s government subsidies have led to overcapacity in crucial sectors like alternative energy and electric vehicles (EVs). This, she contended, provides Chinese companies with unfair cost advantages that enable them to outcompete American firms. But while Yellen was right to point out China’s overcapacity problem, her assertion that government subsidies are the root cause was misplaced.
For Chinese people of my generation, the leap from scarcity to abundance over the past four decades has been a dream come true. Until the early 1990s, everything in China was rationed; nowadays, it is hard to find anything that is not readily available.
China’s experience is not unique. Japan underwent a similar transformation after World War II, as decades of export-led growth enabled the country to rebuild and develop its industry. But the collapse of the Bretton Woods system in 1971, followed by that decade’s oil shocks, forced Japanese companies to focus on domestic, consumer-led growth. This shift quickly resulted in overcapacity and triggered numerous trade disputes between the United States and Japan throughout the 1980s.
The extent of China’s overcapacity problem has become increasingly evident in recent years. While the Chinese economy accounts for 17% of global GDP, it produces 35% of the world’s manufacturing output. Exports have historically offset this imbalance, but in the face of declining global demand and heightened geopolitical tensions, Chinese exporters are being increasingly forced to compete on price.
At the root of China’s vast industrial capacity is its savings-centric society. Despite establishing a strong state 2,000 years ago, Chinese maintain a strong sense of self-reliance, especially during difficult times. Instead of relying on the government to establish an adequate safety net, they save on their own as a safeguard against future adversity.
Chinese policymakers share this outlook, as evidenced by their response to the ongoing economic slowdown. It is widely acknowledged that the economy’s sluggish recovery from the COVID-19 downturn stems from insufficient domestic demand. But the authorities’ strategy has been to limit local-government borrowing and mandate stricter budget controls.
Driven by explosive export growth, China’s national savings rate increased from roughly 35% at the end of the 1990s to 52% in 2010. Although it has decreased since then, it still stands at 45%, which implies annual savings of about CN¥57 trillion ($7.9 trillion). Aside from a minor portion allocated to foreign assets, these savings fuel domestic investment, laying the groundwork for the economy’s current overcapacity.
The problem is exacerbated by the absence of a vibrant capital market capable of directing savings toward innovation-driven businesses. Bank finance dominates 70% of China’s total social financing, and banks are reluctant to back innovative enterprises. Owing to insufficient capital-market support, investment tends to be concentrated in a few high-tech industries with promising market potential, such as alternative energy, EVs, and artificial intelligence, leading to overcapacity in these sectors.
How can China resolve its overcapacity problem? The seemingly obvious solution is to increase domestic demand; however, this requires changing the population’s saving behavior, which would take time. Moreover, given its aversion to taking on debt, it is doubtful that the government will boost its spending.
The only feasible solution is for Chinese firms to invest overseas. This strategy could both mitigate China’s overcapacity problem and support industrial development in recipient countries. China’s foreign investments cover a wide range of technologies, from labor-intensive goods to advanced technologies like solar panels, batteries, and EVs, making them suitable for countries at various stages of development.
In particular, the US should welcome Chinese investment. For starters, this could ease economic tensions between the two countries. In the 1980s, Japan avoided a potential clash with the US by investing heavily in the American auto industry.
Similarly, Chinese investment could support America’s reindustrialization efforts. This is particularly important, given US President Joe Biden’s flawed strategy, which subsidizes sectors in which US firms are at a clear disadvantage compared to their Chinese competitors, such as alternative energy, batteries, and EVs. Alas, the current political climate prevents US policymakers from thinking rationally about this issue. Sooner or later, however, it will become evident that even with significant government subsidies, US firms cannot outcompete their Chinese rivals in these industries.
In the post-globalization era, governments around the world have set aside traditional criticisms of industrial policy. But what constitutes effective industrial policy remains open to debate. In terms of global welfare, the best approach is for countries to subsidize sectors where they already have or are likely to develop a comparative advantage and then trade with countries that specialize in complementary technologies.
Regrettably, increased geopolitical tensions have knocked many countries, including the US and China, off the optimal path. Given the potential global repercussions of Sino-American decoupling, it is incumbent on both countries to take the lead and work together to put the world economy back on track.