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.