Industrial Overcapacity and Duplicate Construction in China

Reasons and Solutions

Ping Li, Feitao Jiang;Jianhai Cao

• Publisher: WSPC
• Year: 2019
• ISBN:
  9789813277298
• Topic: Politics & International Relations
• Subtopic: Asian Politics
• Index: Politics & International Relations

Since 2012, industrial overcapacity has become an increasingly serious problem in China, against the backdrop of domestic economic slowdown and continued downturn in international markets. Overcapacity is widespread in the traditional manufacturing sector, particularly in iron and steel, cement, electrolytic aluminium, flat glass, and ship-building industries. It is also grave in emerging industries such as polysilicon, solar cells, and wind power equipment.

This book provides an overview on the overcapacity problem facing China and examines the main characteristics of overcapacity in some important industries. The book identifies two types of overcapacity: one is excess capacity that results from natural supply-demand dynamics or cyclical economic fluctuations under a relatively sound market system; the other is overcapacity caused by the overinvestment of enterprises under a flawed economic system. It probes into how overcapacity is caused and finds two contributors — change of growth model and institutional flaws. It explores to establish a long-term mechanism for solving the problem. The book concludes that China should establish a long-term mechanism to prevent and resolve overcapacity, and to establish healthy relationship between the market and the government.

Contents:

• Preface
• About the Authors
• General Report
• Introduction
• Previous Studies on Overcapacity
• Understanding How Overcapacity Occurs in a Transition Economy
• An Empirical Study of the Impact of Subsidies on Corporate Investment
• Government Subsidy, Overcapacity and China's Economic Fluctuations — Empirical Tests Based on an RBC Model Involving Capacity Utilization
• Investment Subsidy, Overcapacity and Growing Inefficiency
• Overcapacity in the Iron and Steel Industry
• Overcapacity in the Solar PV Industry
• Improving Policy Responses: Fresh Ideas and New Approaches
• Bibliography
• Index

Readership: Academics, professionals, policy-makers and students interested in Chinese economy and industrial overcapacity.Industrial Overcapacity;Supply-Demand Dynamics;RBC Model;Duplicate Construction;Cyclical Economic Fluctuations;Corporate Investment00

Chapter One

Introduction

I.Research Question

1.Serious overcapacity after the financial crisis

Overcapacity has become more serious since the outbreak of the global financial crisis. On September 26, 2009, the State Council issued the Opinions on Reducing Overcapacity and Duplicate Construction in Some Industries and Leading Them Towards Healthy Growth jointly adopted by the National Development and Reform Commission (NDRC), Ministry of Industry and Information Technology (MIIT) and other authorities. According to the document, there was serious overcapacity and many duplicate constructions in iron and steel, cement, flat glass, coal chemicals and other traditional industries and enterprises were still expanding blindly; signs of duplicate construction had appeared in emerging industries such as polysilicon and wind power equipment. In 2008, China’s polysilicon industry had a production capacity of 20,000 tons and an output of around 4,000 tons, and facilities under construction had a capacity of about 80,000 tons. Apparently, the industry had excess capacity. In 2010, wind power equipment manufactured in China could be used to produce more than 20,000 megawatts of power but the installed wind power capacity was 10,000 megawatts annually. The document noted that overcapacity was also an acute problem in electrolytic aluminum, shipbuilding and soybean crushing industries. It prescribed nine policies to reduce overcapacity and duplicate construction including controlling market access strictly, imposing tougher environmental regulation, supplying land according to the law, adopting financial policies with clear focuses on what to secure and what to control, introducing stricter project approval procedures, promoting mergers and acquisitions, establishing an information release system, practicing an accountability system and deepening institutional reform. These policies effected big improvements in environmental protection, information services provided by the government sector, etc. and helped to give play to the basic role of the market. In policy implementation, however, the measures taken to control overcapacity and duplicate construction remained mostly administrative means.

From the fourth quarter of 2008 to 2010, China adopted an easy monetary policy and a proactive fiscal policy and the large-scale infrastructure building activities helped to alleviate industrial overcapacity to some extent. With the gradual withdrawal of the stimulus policy, however, the overcapacity problem in China’s industrial sector became more serious. According to the IMF Country Report released on July 6, 2012, China’s capacity utilization rate is only around 60% now, but was slightly lower than 80% before the global financial crisis. The U.S. Capacity Utilization: total Industry is now at 78.9%, compared to 66.8% at the peak of the crisis. It means that China’s current capacity utilization is not even reaching the U.S. level when the 2008 financial crisis was at its peak. Overcapacity can be seen in a wide range of industries, which has never happened before in this country. Specifically, overcapacity is very severe in traditional industries such as iron and steel, cement, flat glass, coal chemicals, shipbuilding and machine tools, prominent in the non-ferrous metals industry such as copper, aluminum, lead and zinc smelting and noticeable in emerging industries such as polysilicon and wind power equipment. There are also signs of overcapacity in the production of chemicals such as nitrogen fertilizer, calcium carbide, chlor-alkali, methanol and plastics.

Overcapacity in some industries is particularly serious. China’s iron and steel industry has shifted from a structural surplus to a full-blown surplus, and losses are incurred across the industry. In 2012, China’s steelmaking capacity was more than 1 billion tons and crude steel production was about 720 million tons so the capacity utilization rate was only about 72%. Overcapacity is serious for most steel varieties. Member enterprises of China Iron and Steel Association (CISA) brought in RMB 1.58 billion in profits, indicating a profit margin of 0.04%. At present, smelting overcapacity can be found in most parts of China’s non-ferrous metals industry, aluminum in particular. In 2012, China’s aluminum production capacity was 27.65 million tons but capacity utilization rate was only 72%; aluminum smelting profits amounted to RMB 930 million, down 92.7% year on year. At the end of 2012, China’s production capacity for cement and flat glass was still 3 billion tons and 1.04 billion weight-boxes, respectively. The capacity utilization rate fell to new lows — 72.7% and 68.3%, and total profits registered a year-on-year decline of 32.8% and 66.6%, respectively. The shipbuilding industry has seen a sharp decline in production, facing a serious overcapacity problem and a worsened business climate. In 2012, the ships completed had a capacity of 60.21 million DWT, down 21.4% year on year. Capacity utilization was seriously insufficient in most small and medium-sized shipyards. In the first 10 months of the year, the total profits of Chinese shipbuilding enterprises monitored by China Association of the National Shipbuilding Industry (CANSI) fell 55.6% year on year. Overcapacity is also prominent in some parts of the petrochemical industry. At the end of 2012, China had an excess capacity of about 18 million tons for urea; its capacity for phosphate fertilizer exceeded domestic demand by more than 10 million tons; the annual capacity utilization rate of the chlor-alkali industry was about 70% and about 60% of the PVC plants were put to use; about 50% of the methanol plants were brought into operation; the calcium carbide industry saw an increase of about 4 million tons in production capacity, far exceeding the total capacity of phased-out facilities in the year — 1.27 million tons, and the capacity utilization rate in the industry was about 76%. Some emerging industries such as solar PV, wind power equipment, carbon fiber and lithium batteries have also seen grave overcapacity problems. At present, China’s PV module capacity is nearly 40 GW but the actual output is 21 GW, so there is too much excess capacity. Most enterprises in the solar PV industry are basically out of operation. Suntech, LDK Solar and other leading enterprises are in a bankruptcy crisis. The whole industry is on the verge of breakdown. More than 40% of the facilities in the wind power equipment industry are left idle.

It was made clear at the Central Economic Work Conference held on December 15, 2012 that the resolution of overcapacity should be considered a priority of economic work under the impacts of the global financial crisis. The overriding principle was to respect the laws of economics, adopt industry-specific policies and a multipronged approach, and address both the symptoms and root causes. Intensified efforts should be made to forecast the development trends in industries suffering overcapacity, and work out targeted plans for making adjustments and resolving the problem.

2.Ineffective policies for addressing overcapacity

Since the 1980s, the problem of overcapacity and duplicate construction has been undermining the health of the Chinese economy like a chronic disease. The Chinese government has launched a large number of policies since 2003 to address the problem, such as Opinions on Curbing Blind Investments in the Iron and Steel Industry, Opinions on Curbing Illegal Projects and Blind Investments in the Electrolytic Aluminum Industry, Opinions on Curbing Blind Investments and Accelerating Structural Adjustment in the Cement Industry, Circular of the General Office of the State Council on Cleaning up Fixed Asset Investment Projects, Circular of National Development and Reform Commission on Issuing the NDRC Catalogue of Fixed Asset Investment Projects to Be Approved by the State Council, Circular of the State Council on Accelerating Structural Adjustment in Industries with Overcapacity, Circular on Opinions about Tightening Controls on Fixed Asset Investment and Newly-commenced Projects and Opinions on Reducing Overcapacity and Duplicate Construction in Some Industries and Leading Them Towards Healthy Growth.

The Opinions on Reducing Overcapacity and Duplicate Construction in Some Industries and Leading Them Towards Healthy Growth issued in 2009 prescribed nine policies to reduce overcapacity and duplicate construction, including controlling market access strictly, imposing tougher environmental regulation, supplying land according to the law, adopting financial policies with clear focuses on what to secure and what to control, introducing stricter project approval procedures, promoting mergers and acquisitions, establishing an information release system, practicing an accountability system and deepening institutional reform. These policies were largely the same as previous ones but more measures were introduced to boost land and loan supply control, and accountability was introduced to ensure policy implementation. According to the Opinions document, investment approval and market access policies were at the core and provided the basis for land supply and loan approval measures. However, no concrete measures were introduced to deepen institutional reform. In recent years, mandatory liquidation has also become an important means to address overcapacity, along with greater emphasis on accountability and stronger organizational leadership. Related policy documents show that direct intervention in economic activities remains a primary way of addressing overcapacity.

The results of policy implementation show that policies featuring administrative control will not only fail to solve the overcapacity problem but also bring about adverse effects such as the market mechanism’s failure to function and even more violent market fluctuations. The current policies for addressing overcapacity are characterized by the preference for large facilities in the investment approval process and for large enterprises in market access control, but they have exacerbated the problem to some degree.

3.Causes of overcapacity and policies for addressing it to be studied in depth

There are two different traditions in the research into how overcapacity and duplicate construction are caused: one is to blame market failure for construction do-over while the other is to conclude that the distorted behavior of market participants can be accounted for by institutional flaws in a transition economy. Over the years, the government has been using market failure as one of the most important justifications for its broad intervention in microeconomic activities. Blaming institutional flaws for overcapacity would mean the need to improve the market system to manage overcapacity. Therefore, policymakers are more inclined to think that overcapacity and duplicate construction are the result of market failure.

The “market failure” approach to explaining overcapacity can be traced back to the understanding of economic cycle in the political economy of socialism. Early studies suggested that the decentralized investment decision-making and anarchy in the socialized production of market economy lead to duplicate construction. In later studies, most scholars used the theory of industrial organization to explain how duplicate construction and excessive competition are caused and put the blame on market failure. There are four most representative views. The first is that the low concentration of market structure leads to duplicate construction. Scholars who hold such views have misinterpreted the theories of Bain (1959) and about excessive competition, as well as the theory of effective competition proposed by Clark (1973), and their argumentation lacks strict theoretical logic. The second is that the low entry barriers and high exit barriers in industries lead to duplicate construction (Yang, 2000, 2004; Niu, 2001). The theoretical and logical paradox of this view is that exit barriers are actually entry barriers (Caves & Porter, 1977; Gilbert, 1989; Caves, 1998); high exit barriers will lead to high entry barriers, and low entry barriers and high exit barriers cannot coexist (Li, 2006). The third explanation for excessive competition or construction do-over is that the number of enterprises with free access may be greater than the number of enterprises when social welfare is maximized (i.e. excess entry theorem) (Zhang, 1998; Cao, 2001; Luo, 2004). The establishment of the theorem relies strictly on the two strong hypotheses of cost subadditivity and commercial theft effect. Since these two conditions are not satisfied in most competitive industries, it is inappropriate to apply the excessive entry theorem to the excessive competition and duplicate construction in such industries (Jiang & Cao, 2009). The fourth explanation for duplicate construction or excessive competition is that maintaining excess capacity facilitates price collusion among enterprises (Luo, 2004). A fundamental flaw of the theory is that excessive capacity investment can lead to an increase in cost. In addition, because of the asymmetric and delayed information about real prices, and the high observability of capacity investment, maintaining a balanced amount of capacity when there is tacit collusion instead of increasing additional capacity is more conducive to the collusion between enterprises than to price coordination.

In recent years, Justin Yifu Lin, Ho-mou Wu and Xing Yiqing have put forward a “tide theory”, attributing overcapacity to “market failure” which is unique to developing countries. According to the theory, in developing countries, there is an accurate and good social consensus about the development prospects of new industries that will lead to an “investment tide” and thus overcapacity. The theory has exerted far-reaching influence since it was put forward, but the important defects of the hypothesis are neglected, which will be discussed in detail later in this book. Firstly, the basic hypothesis of the “tide theory” does not hold water since there is no so-called consensus (based on correct prediction) on the market demand in promising industries. Secondly, the potential overcapacity in the model is a deviation from the state of equilibrium under the condition of incomplete information, which is the normal of the real market. Judging from the results of policy implementation in China, the policies for addressing overcapacity, characterized by market failure as justification for direct intervention in microeconomic activities, cannot fundamentally resolve overcapacity and brings about a series of adverse effects (Jiang et al., 2007).

II.Research Purpose and Significance

This study has a very high theoretical value. Creating a rigorous economic model by using modern economic theories, on the basis of indepth research, to explain how overcapacity is caused is of great importance to the promotion of theoretical studies on how overcapacity and duplicate construction are caused, the better understanding of special phenomena in a transition economy and the enriching of theories about transition economics. Overcapacity and duplicate construction are special problems that have arisen in China’s economic transition, and the two terms have special meanings in China. For Western scholars, overcapacity and duplicate construction are normal phenomena in a market economy and do not deserve too much attention. Therefore, the research they have done in this regard is insufficient. Chinese scholars have conducted many studies on this issue but most of them are fundamentally flawed. The most common problem is that the analysis of theories and systems is very inconsistent with the descriptive analysis of phenomena, and there are fundamental flaws in the application of theories. To be specific, in the descriptive analysis of phenomena and the analysis of systems, overcapacity and duplicate construction are attributed to the institutional flaws of a transition economy. In theoretical analysis, however, they try to apply related theories of industrial economics and conveniently place the blame on market failure, and there are some fundamental defects such as misinterpretation of theories and wrongly extended scope of theory application. In recent years, some researchers have proceeded from institutional flaws such as unclear land-related property rights, soft constraints of the financial system and the local officials’ assessment and promotion system focusing on GDP growth in the effort to explain why overcapacity and duplicate construction have occurred. Of these studies, some focus on what local governments do and some focus on the impact of overcapacity and duplicate construction on the macroeconomic level but there is no thorough, systematic and rigorous theoretical analysis as to how the institutional flaws lead to overcapacity and duplicate construction. In that sense, this study has great theoretical significance.

This study also has immense practical significance because correctly understanding how overcapacity is caused and reflecting on the desirability of previous policies for addressing the problem helps to fundamentally resolve the problem of overcapacity and duplicate construction, avoid sharp fluctuations in the development of industries and the economy and maintain the healthy growth of industries and economic stability. Only with a comprehensive and correct understanding of how overcapacity and duplicate construction are used can China devise the right policies to fundamentally solve the problem. China’s current policies for addressing overcapacity and duplicate construction are still mainly administrative measures such as project approval, access control and mandatory liquidation, and it is very necessary to rethink the theoretical basis of such policies. So far, these policies have failed to fundamentally resolve overcapacity and produced some undesirable results. Therefore, it is really necessary to examine what local governments and enterprises have done in the process of policy implementation and the consequences of their actions through in-depth research and theoretical analysis, and to fully check what effects the policies for addressing overcapacity and duplicate construction have made. It will inform the formulation of future policies. In that sense, this study is practically important.

III.Research Methods and Analytical Framework

In this study, we try to reach our objectives by building rigorous mathematical models and carrying out solid empirical research, using modern economics and its frontier theories as well as statistical and econometric theories and tools.

Based on the theory of industrial organization, game theory and the related research results on the behavior of local governments in China in the transition economics and public economics, we study how overcapacity is caused in the transition period and construct a rigorous mathematical model. Based on the theory of industrial organization as well as the game theory and theoretical studies on industrial policy, we examine the impact of industrial policy on enterprises’ capacity investment and local governments’ behavior, discuss how excessive investment and overcapacity are caused due to the improper intervention of industrial policy and construct a rigorous mathematical model. Based on the theory of industrial organization, incentive theory, theory of competition, Austrian theory of the market process and theoretical studies about industrial policy, we discuss the influence of China’s policies for addressing overcapacity and duplicate construction, how enterprises and local governments respond to the policies and the desirability of the policies.

In this study, we empirically test how overcapacity is caused using the cointegration, impulse response and other methods, gather information about the investment strategies and actions of enterprises in industries with excess capacity by means of questionnaire survey, site visit and statistical analysis, verify policies and some theories produced in theoretical studies and empirically test the major hypotheses and main conclusions drawn in the study of policies.

Chapter Two

Previous Studies on Overcapacity

I.Defining and Measuring Overcapacity

1.Definition of overcapacity

Overcapacity is a rather broad economic concept. Zhang (2006) defines overcapacity at the macrolevel as the underutilization of resources before economic activities reach the potential level of output, and overcapacity at the microlevel as excess capacity that occurs when enterprises maintain the marginal efficiency of capital at the level of marginal cost. Zhou (2007a) defines overcapacity at the microlevel as the surplus of production capacity, i.e. actual output of economic activities being much lower than the level of optimal capacity, and overcapacity at the macrolevel as the situation that output is larger than needed, which is actually ...

Table of contents

• Cover
• Halftitle
• Series Editors
• Title
• Copyright
• Contents
• Preface
• About the Authors
• General Report
• Chapter One Introduction
• Chapter Two Previous Studies on Overcapacity
• Chapter Three Understanding How Overcapacity Occurs in a Transition Economy
• Chapter Four An Empirical Study of the Impact of Subsidies on Corporate Investment
• Chapter Five Government Subsidy, Overcapacity and China’s Economic Fluctuations — Empirical Tests Based on an RBC Model Involving Capacity Utilization
• Chapter Six Investment Subsidy, Overcapacity and Growing Inefficiency
• Chapter Seven Overcapacity in the Iron and Steel Industry
• Chapter Eight Overcapacity in the Solar PV Industry
• Chapter Nine Improving Policy Responses: Fresh Ideas and New Approaches
• Bibliography
• Index