Friday, December 25, 2009

China and the "capacity glut"

Ben Bernanke famously attributed the global macroeconomic imbalances of the last fifteen years to a global "savings glut" whose fountainhead was China. The most damaging consequence of this "savings glut" was the sub-prime bubble in Wall Street. A less discussed, hitherto benign, result has been a massive "capacity glut" in the Chinese manufacturing machine. This "capacity glut" has been facilitated by two factors - export and build forex reserves and keep domestic consumption depressed.

Chastened by the events that precipitated the East Asian economic crisis of the late nineties, the Chinese government adopted a single-minded strategy of building up massive foreign exchange reserves by turning the country into the factory of the world and exporting the major share of production. Policies were designed to facilitate manufacturing production - tax and other fiscal concessions, cheap (often free) electricity and water, cheap and unlimited credit, limited licensing and other regulatory restrictions and so on. And all of this was driven by local party bosses, intent on generating GDP growth in their jurisdictions, regardless of how it is achieved.

And enabling this was complementary set of policies that contributed towards incentivizing savings and discouraging domestic consumption. The renminbi was tagged to dollar and aggressive exchange rate interventions to keep currency under-valued meant that imports stayed expensive. The absence of adequate health care, pensionary, and social safety nets, especially for the armies of people laid off from the old state owned units and who subsequently found work in the town and village enterprises, have meant that people have little choice but to save for the rainy day. The result was the lowest private consumption rate (35%) and one of the highest savings rate among all major economies.

The global economic recession has left the export market weak and the Chinese domestic market unwilling or unable to step in, amplifying the "capacity glut". And Mark DeWeaver has this to write about the results of the dramatic capacity explosion

"Mao’s dream of catching up with the rest of the world has been realized, albeit a bit behind schedule, not only in steel making, where annual capacity has reached 660 million tons, but in many other sectors as well. In 2008, China ranked first in steel (about half of world production), cement (also about half), aluminum (about 40%), and glass (31%)... The country topped the US in auto production in 2009, and remains second only to South Korea in shipbuilding, with 36% of global capacity...

Based on the National Development and Reform Commission (NDRC) figures, 2008 capacity utilization rates were just 76% for steel, 75% for cement, 73% for aluminum, 88% for flat glass, 40% for methanol, and 20% for poly-crystalline silicon (a key raw material for solar cells). The current project pipeline also implies less than 50% utilization for wind-power equipment manufacturers in 2010...

If simply leading the world in output is the goal, the Chairman’s vision has been resoundingly vindicated. But if product quality, environmental protection, and economic efficiency are important as well, this state of affairs is little short of nightmarish."

And to compound the problem, the conventional solution of addressing this excess capacity by shutting down production has become a political hot potato given the strong support these firms and investments have from the local party bosses and the large numbers of people they employ. The result is that even these aforementioned capacity utilization rates understates the true magnitude of the problem.


Vinay said...

How does keeping domestic consumption depressed help a country advance? can you please explain?

gulzar said...

a country can statistically increase its GDP by producing more, which in turn requires investments - both from internal and external sources. household savings being the major source of internal resources, governments try to promote them. but there is a straight trade-off between savings and consumtion - u save more at the expense of consumption.

in China's case, while the government promotes savings, it has (or had till the recession struck) a large enough export market to more than off-set any adverse impact of the depressed consumption. but now that the external market is weak, the lack of adequate demand-side traction in the domestic market is starting to pinch.

Harish YN said...

In that sense, India has helped the world economy to come out of the recession more than china. Is it true?

gulzar said...

the logic breaks down when u just look at the stats. india's domestic demand (57% of GDP) may be much higher than China's at 37%. but for a start, the Chinese economy is four times bigger than India's.

its imports (which benefit the world economy) are five times India's. india's $300 bn imports exert a miniscule effect on global aggregate demand. its stimulus spending, at $581 bn, dwarfs India's tiny $16 bn fiscal stimulus. and unlike tax cuts and loan waivers, most of China's stimulus has been on direct spending.

this stimulus may have done more to keep prices low across the world and increased the relative purchasing power (income effect) for beleaguered consumers (individuals and businesses) across the world.

one example of the Chinese stimulus impacting India is the lower prices on Chinese power equipment, which in turn enables lower tariffs in competitive bids, which in turn keeps subsidies on power supplied to consumers low. there are numerous other examples across manufacturing, across the spectrum.

Harish YN said...

On Nov, 2009 The Economist in the article "Land of Eastern promise" noted “AN EASY but instructive way to bait an Indian economist is to credit the Chinese economy with coming to Asia’s rescue and arguably the world’s..For all the credit that it gets for its recovery, China’s near double-digit show this year is mainly a command-economy extravaganza involving massive state-directed spending. When that show is over, the skew in China’s economy—an undervalued currency, a mercantilist bias in favour of manufactured exports and an obsession with accumulating foreign reserves—remains less the solution to global imbalances than one of the fundamental causes.
By contrast, though India’s annualised growth rate of around 6% this year is below China’s heady levels, it is impressive against a backdrop of global turmoil. What is more, government stimulus plays only a small part in the growth. Levels of capital and infrastructure investment compare favourably with China’s. And, much more than in China, the hot story in India is domestic demand. India is no mercantilist adding to global imbalances. It imports more than it exports, creating much needed global demand. India’s long-run growth will overtake even China’s”

It is difficult to get convinced by the sheer domestic demand of India.

Vinay said...

Sir Thank you very much, that was useful

Conservative Lounge said...

Hello Mr. Gulzar, when really do you think the Chinese are going to spend for a change? They (read: the Chinese government) really seem to be dollar-fetish. Whatever, the Americans are enjoying the Chinese diet, by printing dollars for Chinese goods.