China’s overcapacity is already backfiring

China’s first-quarter growth beat most estimates, rising 5.3% on the year. Photographer: Qilai Shen/Bloomberg (Bloomberg)
China’s first-quarter growth beat most estimates, rising 5.3% on the year. Photographer: Qilai Shen/Bloomberg (Bloomberg)

Summary

Excess investment in industry isn’t made up by China’s trading partners, and it has domestic consequences.

In the “China Shock 2.0" narrative, not only is China a security threat and a low-end factory competitor, but it is also angling to swamp the West with cut-rate high-tech goods. There has been less focus on the downsides of such a strategy for China itself.

China’s first-quarter growth beat most estimates, rising 5.3% on the year—thanks mostly to strong industrial output and exports. But the economic data released Tuesday also showed that excess capacity is very real, and could be damaging to China itself.

While China’s industrial engine revved up in January and February, it downshifted again in March: output rose just 4.5% on the year, down sharply from January and February’s 7%. More tellingly, manufacturing capacity utilization plummeted to 73.8% in the first quarter—its weakest, excluding the pandemic-affected first quarter of 2020, since at least 2015. In volume terms, China’s exports hit a nearly 10-year high in March. But in value terms they were barely above where they sat in October.

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In other words, firms’ pricing power both at home and abroad is weakening and margin pressure is probably mounting: The March industrial financial data, which will be released later this month, will be worth watching.

So will private investment in manufacturing. If external demand, in value terms, doesn’t find a stronger footing soon and China’s domestic economy remains weak, then eventually such investment will need to slow. Otherwise the government, or state-owned banks, will have to start absorbing the cost of too many loans to industry more directly, as they already have with real estate and infrastructure.

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Particularly interesting is the breakdown of that capacity utilization data itself. Falling run rates were especially obvious in Beijing’s favorite sectors like automobiles and electrical equipment—the so-called “new productive forces," including electric vehicles, chips and solar panels, which policymakers have highlighted in recent speeches and have been stalking Western politicians’ nightmares. Automobile manufacturing utilization rates fell below 65% in the third quarter: well below their previous low (excluding the first quarter of 2020) of 69.1% in mid-2016.

China’s traditional export sectors, on the other hand, have actually held up relatively well. Textiles utilization rose in the first quarter, while run rates for computer and communication gear fell, but much less sharply.

Meanwhile, economywide borrowing—excluding government bond issuance—weakened further in March, despite bond yields and interest rates near multiyear lows. If margin pressure starts to force some “new productive forces" to start slowing investment, fiscal policy would need to step in to prop up growth.

Alternatively, China can keep funneling its excess savings into new manufacturing overcapacity—but Chinese banks and Beijing, not just China’s trade partners, will eventually end up footing the bill.

Write to Nathaniel Taplin at nathaniel.taplin@wsj.com

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