Foreign Affairs Article: China’s Real Economic Crisis - Why Beijing Won’t Give Up on a Failing Model
In 2022, China abruptly ended its stringent "zero COVID" policy, prompting predictions of a robust economic rebound. Many expected China's growth engine to restart quickly after years of pandemic-induced economic slowdown. However, China's economic recovery has been far from smooth, marred by sluggish GDP growth, weakening consumer confidence, Western tensions, and a catastrophic property market collapse. By mid-2024, China's GDP growth lagged behind its own 5% target, revealing an economy struggling to regain its momentum.
But what lies behind this economic stagnation? Western analysts have pointed to various causes, including an aging population, the real estate crisis, and President Xi Jinping's increasingly authoritarian grip on the economy. Yet, a deeper, structural problem is at play—a decades-old economic strategy that has privileged industrial production at the expense of balanced growth. This policy has led to chronic overcapacity, a glut of goods that neither China nor the global market can absorb sustainably, creating a ripple effect across the world economy.
Industrial Overcapacity: The Core Problem
For years, China has overinvested in key sectors like raw materials, steel, robotics, and electric vehicle batteries, generating excess production far beyond what its domestic or global markets can consume. This overcapacity forces manufacturers to flood foreign markets with cheap goods, driving global prices down and undermining international competitors. Domestically, it creates a cycle of falling prices, factory closures, insolvency, and job losses.
Moreover, China's factories are often not the most efficient but are kept afloat by government subsidies and cheap financing. This system discourages market-driven efficiency and innovation, allowing inefficient firms to outlast their competitors simply because they have better access to government resources.
Global Repercussions of China's Overproduction
China’s industrial overcapacity is not just a domestic issue; it destabilizes global trade. European Commission President Ursula von der Leyen and U.S. Treasury Secretary Janet Yellen have both raised alarms about China's excessive production of steel, electric vehicles, and other goods, warning of "unsustainable" trade imbalances. China's ability to produce and export vast quantities of goods at cutthroat prices poses a severe threat to industries in Europe and the United States, forcing Western manufacturers out of business and disrupting global supply chains.
Yet, even as these challenges mount, China shows no signs of reversing its strategy. Instead, it has doubled down, investing heavily in strategic sectors like artificial intelligence, robotics, and renewable energy, all while maintaining its overproduction model. This has resulted in inefficiencies and a focus on scale rather than innovation, creating a tech industry that struggles to produce high-end, autonomous systems or disruptive technologies.
Debt-Fueled Growth and the Risk of Economic Instability
Local governments, eager to meet Beijing's GDP growth targets, have engaged in risky financing to develop industrial infrastructure. This has created a dangerous debt bubble. As of mid-2024, local government debt across China was estimated to range from $7 trillion to $11 trillion, with hundreds of billions at risk of default.
This debt-driven growth model is unsustainable. Local governments are incentivized to invest in sectors like solar power and robotics, often duplicating efforts in other regions. The result is a glut of production, even in industries where China dominates the global market. For example, China's solar panel production is twice what the world can currently use, yet factories continue to operate to service debts and cover fixed costs.
The Dilemma for the West
For Western nations, China's overcapacity problem is a long-term challenge that cannot be solved through simple trade barriers. Although tariffs may slow the influx of cheap Chinese goods, they will not address the structural inefficiencies in China’s economy. Moreover, isolating China economically risks pushing the country further into a self-sufficient, state-led economic model, which could exacerbate overproduction and increase tensions with the West.
Instead, Western policymakers should focus on keeping China integrated within the global economic system. Using market incentives to guide Beijing toward more balanced growth could reduce the pressures of overproduction. Excluding China, on the other hand, might drive the country to double down on its current strategy, further destabilizing global trade.
Conclusion: A Critical Juncture for Global Economic Policy
China’s overcapacity problem presents a profound challenge for both China and the West. While the Chinese government has shown little willingness to abandon its production-heavy economic model, the West must navigate a delicate balance between protecting its industries and keeping China engaged in the global market.
As China continues to produce beyond its capacity, the risks of a deflationary trap and a global trade crisis loom large. Addressing this issue will require sustained dialogue, targeted policy interventions, and a renewed commitment to multilateral economic engagement. For the U.S. and Europe, the question is clear: How can they protect their industries while preventing China's economic policies from destabilizing the global economy?
What should the West's strategy be in addressing China's overcapacity crisis? Should the focus be on engagement through trade or more aggressive protective measures?
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