China’s increasingly large manufacturing production to hit the wall in Western economy

Since President Xi Jinping announced the rise of the “New Production Forces” as China‘s annual plenary sessions of the National People’s Congress and of the Chinese People‘s Political Consultative Conference (so-called “Two Sessions”), industrial production has been growing much faster than consumption and exports have been increasing. This is particularly the case of green tech exports which are sectors increasingly dominated by China in the global arena, The United States has been taking a rather harsh approach to China’s production forces, well before the term “new productive forces” was coined by Xi last September during a trip to a rustbelt city in northeast China, where he highlighted the need for a new model for economic development based on innovation in advanced sectors.The first step was taken by Trump when he imposed high tariffs on a wide number of Chinese goods. Besides import tariffs, Biden‘s grand industrial policy strategy, the Inflation Reduction Act (IRA) is geared towards subsidizing domestic production of green tech but also that of key allies, such as South Korea but also Europe, which equates to making it much harder for Chinese green tech to enter the US. Only a few days ago, the Biden administration announced a fresh round of additional import tariffs on Chinese goods, focusing on electric vehicles (EVs) and renewables. Such move comes as the worries about China’s overcapacity and state-led innovation have increased in the US but also in the European Union (EU). The EU, which is China‘s largest export market, has embarked in a number of anti-subsidy investigations to protect is market from what the EU commission considers to be China’s unfair competition due to the subsidization of production in China.While provisional duties on made-in-China electric vehicles are expected from July 4, the reality is that positions in the EU are not fully united on this issue, which is offering China room to manoeuvre. Furthermore, the fact that China is a key market for many European companies, from cars to agriculture products, does not make things any easier as China has threatened to retaliate by imposing tariffs on key EU products imported by China.When comparing the US response to China‘s dominance in key sectors as opposed to that of the EU, two issues stand out. Firstly, the US is much more aggressive and does not pay attention to being compliant with the World Trade Organization (WTO), but rather uses the national security clause to break away from what is considered a straight jacket when it comes to responding to (for some simply containing) China. The second key difference is that China has more space to retaliate against the EU because it has developed more strategic dependences than the US has ever had. This is demonstrated by the type of anti-dumping probes China has started, such as polyoxymethylene copolymer imports, widely used in electronics and cars, but also finished cars (mostly from the EU) as well as agriculture products.Beyond the West, it is important to note that the Global South is not immune to China‘s overcapacity. From India to Latin America, there are more pressure to impose tariffs on China’s exports with a wide product range, such as green tech and steel. However, it seems doubtful that the containment, in terms of trade actions will be as strong as that of the US.One key question, of course, is to analyze whether China is indeed in overcapacity and whether subsidization of production is the main reason for this. There is unfortunately no definitive answer as the data quality to analyze this issue is rather poor. Still, we can look at indicators such as China‘s utilization rate which has indeed fallen to 75.1% in 2023, the lowest level since 2021. At present, non-metal minerals, automobiles, food and electronics have the lowest utilization rates compared with the 2017-19 average. It confirms the pressure from weak real estate investment, cautious consumer sentiment and the tech cyclical downturn.Beyond the traditional industries, the focus is now more on new industries of green tech. EV makers may face pressure from a lower asset turnover ratio and excessively rapid capex growth pushed by the government support to these sectors under the mantra of the new production forces.Given the rapid pile up of production in China and the increasingly harsh response of the rest of the world, especially the US followed by the EU, it does seem as China may indeed be hitting the wall with a supply-focused growth model which increasingly depends on foreign demand to create growth.The pressure behind this unsustainable growth model is felt in the deflationary pressures in the Chinese economy, all the more so for producer and export prices. The inflationary environment in the US and Europe during the past few years was increasing the appeal of such imports from China but the situation is turning as disinflation forces become more entrenched. In other words, President Xi‘s call while in official visit to Paris last month, that the West should be happy to import cheaper goods from China which can keep inflation at bay, may be less and less appreciated as inflation slows down. On the contrary, the fear of de-industrialization, which is clearly apparent in Biden’s industrial policy but also in some EU member states, such as France, will become even more important. The wave of populism in the EU, as exemplified by the EU Parliament elections, can only make things worse.All in all, it seems clear that we are embarking an epic trade war between the West and China, which could also be followed by other countries. This trade war may also be followed by a currency war if China cannot manage to export its way out by cutting export prices. Against such backdrop, South Korea may also need to contemplate some similar actions as the pressure from a US market increasingly closed to China reverberates beyond the EU. *This is a reprint. This article was published by Herald Insight Collection./insight/view.php?ud=20240617050298