Could “involution” be solved by companies’ investment decisions? More needs to be done

Since the start of 2025, the anti-involution campaign by Chinese government has revived some investors’ confidence for a few sectors with deep overcapacity, such as autos, renewables and coal. However, it remains unconfirmed whether these efforts will pay off with the challenge of weak demand. In this note, we try to depict how this may play out with the example of renewable energy.The renewable energy sector had emerged as a “darling” to investors since 2020 who bet on China’s huge clean energy demand but also the world’s commitments to reducing emissions. Europe’s quest for alternative energy sources after deciding to move away from Russia as a response to Ukraine’s invasion also contributed to the surge in demand for green tech. The optimism about future demand thus stoked up renewable firms’ capex in 2021 and 2022.However, the slower-than-expected adoption in overseas markets since 2023 led to an unexpected demand cliff for Chinese manufacturers, forcing them to slash prices to keep orders coming in. The fact that many companies had been lured into this sector through subsidies only made things worse as it increased vicious competition further. From 2023, renewable companies have been suffering from negative operating income growth and even contraction of capex since 2024 (Chart 1). The deteriorating cash flows also weakened firms’ repayment ability, with a surging share of zombie firms, namely having insufficient revenue (EBITDA) to cover interest payments, reaching 30% in 2024 (Chart 2). In short, the miscalculated capex boost and the unexpected demand cliff had catalyzed Chinese renewable makers’ fallout. Against such backdrop, the key solution will be quick consolidation of production capacity to restore supply-demand equilibrium, which is the aim of the anti-involution campaign.However, as China’s domestic market saturates with installation bound to slow under new pricing scheme for renewable power (Chart 3), and overseas demand facing headwinds from inventory glut and rising hostility against China’s cheap green products, the demand for renewables seems to be rather elastic, meaning the downstream suppliers’ pricing power may be capped even with overcapacity abated, which won’t lift their profitability much. Furthermore, the fact that most Chinese renewable firms are privately owned could mean slow progress of mergers and acquisitions and delayed exit of inefficient capacities. Finally, the time gap of price hike across the supply chain (first upstream then downstream) could squeeze downstream producers’ profits even more and eventually backfire (Chart 4).Therefore, solving China’s involution problem requires not only policy intervention to stop price wars but also coordinated efforts to reduce the number of players and phase out excessive capacities in a quick manner. Moreover, a smooth transition also requires a demand boost to shore up the survivors’ profitability and financial health. Without this, it may take longer for renewable companies to see a material improvement.