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2009-03-23 | All chapters

Stimulus Dilemma for China
Spending on Public Works Risks Making Production Glut Worse
Andrew Batson, Wall Street Journal, 22nd March 2009

BEIJING -- The Chinese government's massive investment in the economy could end up increasing excess capacity in industries from steel to petrochemicals, some executives and economists say.

Given China's global manufacturing heft, more idle factories could heighten competitive pressure world-wide, sparking trade squabbles as Chinese factories ship surplus products abroad. U.S. and European steelmakers already are looking at import curbs.

"China is now already plagued by overcapacity in some industries. To add more investment now, just to get some companies going, might threaten the industrial base years from now," said Joerg Wuttke, president of the European Union Chamber of Commerce in China. "Authorities here seem to underestimate the severity of overcapacity," he said, in part because they are so focused on getting economic growth moving in the short term.

China is the world's largest steelmaker and third-largest vehicle maker. The supply of these and other industrial products exceeds demand both at home and abroad. According to China's industry ministry, as of this month about 30% of the nation's aluminum production capacity is idle, as is 20% of cement and plate-glass capacity and 70% of semiconductor production.

The Chinese government's four trillion yuan (about $585 billion) investment program attempts to tackle part of the problem. By boosting construction of public works, the government can increase demand for products such as steel, thereby reducing idle capacity. But with policy makers also opening the taps on bank lending and rushing to approve big projects like petrochemical plants, the stimulus could end up adding capacity.

"We think it's unavoidable that this stimulus plan will create some excess capacity," said Hu Yifan, chief global economist for Citic Securities in Hong Kong. That makes it more urgent for China to boost domestic demand, she said, since world markets will likely be unable to absorb the surplus.

A number of analysts caution against using current depressed conditions to judge whether there is too much capacity for the longer term, because some idle factories will start up again when demand recovers. "In an economic downturn, almost by definition, supply exceeds demand," said Wensheng Peng, economist for Barclays Capital. "I think almost every economy now has excess capacity."

The expansion of industry in China in recent years is almost unprecedented: It has been investing more as a share of the economy than Japan or South Korea did even at the peak of their industrialization. Much of that investment could perhaps be justified if China's recent run of 10%-plus growth continued indefinitely. But with U.S. consumers saving more and spending less, many economists say China needs to adjust to more subdued demand for its exports for years to come.

"With the global economy expected to remain weak for quite a while, some of the capacity in some manufacturing sectors may never be fully used, and may have to be written off," said Louis Kuijs, an economist in the World Bank's Beijing office.

So far there has been little effort in China to permanently shutter unneeded factories. Although a new corporate bankruptcy code took effect in 2007, lawyers say it has seen little use, with the government preferring negotiated solutions that keep workers at least nominally employed.

Along with the stimulus, the government is pushing a series of "restructuring and revitalization" plans for heavy industries. Among the goals of the plans are "curbing the expansion of industries with excess production capacity, and speeding up the phase-out of backward production capacity," according to a statement last month from China's economic planning agency.

While the plans' complete details haven't yet been made public, they don't seem to include major reductions in capacity. For instance, China's crude steel-making capacity reached 660 million tons at the end of 2008, but production was only about 500 million tons. The draft plan for the steel industry calls for eliminating 25 million tons of capacity by 2011, only a small fraction of the gap.

It's understandable that China's political leaders want to help major industries and not close them; witness the reluctance in the U.S. to let auto makers go bankrupt.

China also has auto-sector concerns. The country has the capacity to produce about 12 million automobiles a year, but only 9.37 million were sold in 2008. The government's plan encourages mergers among auto makers but doesn't call for reducing capacity and is intended to consolidate the positions of major firms, according to an industry executive briefed on its contents.

Source: http://online.wsj.com/article/SB123759537916001075.html