China's damaging overcapacity

A report released Monday by the European Union Chamber of Commerce in China warns that overcapacity - the ready ability of industry to produce far more than its market demands - is halting China's economic reform and hurting its trade relations.

A number of heavy industries cited by the report, from cement to paper production, are plagued by such inefficient expansion. "In just two years - 2011 and 2012 - China produced as much cement as the US did during the entire 20th century," it notes.

China's steel production is a particular sore point, said to now be "completely untethered from real market demand." The report comes a week after steel workers took to the streets of Brussels to demand swift action against Chinese "dumping," alongside a European Commission meeting with industry leaders discussing possible tariff measures.

The EU Chamber of Commerce in China is recognized as the "official voice of European business in China."

The report also adds to the dour chorus singing China's economic woes. Reduced growth forecasts have become so habitual that the government has stopped releasing them until the end of the year. The Communist government has also enacted austerity measures, most recently telling its party members to scale down on weddings and funerals.

But this report serves as a call for the Chinese government to live up to promises of much further-reaching economic reforms, as it prepares to release its 13th Five-Year Plan. It begins by citing Chinese Premier Li Keqiang, who last year described his government's task ahead as akin to "taking a knife to one's own flesh."

'Blind expansion'

The problem has long been acknowledged. The chamber issued its first warning of the phenomenon in 2009, the same year that the Chinese State Council released a statement noting that many of its industries were "blindly expanding."

But since then, the new report finds, the matter has only worsened. And it is "wreaking far-reaching damage on the global economy in general, and China's economic growth in particular." Overcapacity can close factories, cost jobs and sour loans.

China's response to the financial crisis is seen as particularly problematic. While foreign demand for its products sank, the government launched a stimulus program and encouraged a lending splurge that together greatly expanded the capacity of resource-intensive sectors.

A number of factors are cited to be behind the culture of massive overproduction, including local protectionism of industry, weak regulatory oversight, cheap input and technology, and policies that promote excessive investment.

Trading tension

China is producing twice as much steel as the next four largest producers - Japan, India, the US and Russia - combined. As a result, it has flooded foreign markets as other countries scramble to build dams.

EU member states have called on the bloc last year to defend Europe's steel industry, which is embroiled, according to Karl Koehler, chief executive of Tata Steel Europe, in "a fight for its future." The company has recently slashed thousands of jobs in the UK.

The European Union has been considering placing tariffs on Chinese steel imports, with a number of anti-dumping investigations underway. It imposed one anti-dumping measure last March.

The US has also been ratcheting up its tariffs on Chinese steel imports. The duty for Chinese corrosion-resistant steel has reached 255.8 percent.

"Since trade frictions hamper supply chains," the report warns, "this poses a major threat to the positive effects of globalization."

China is currently seeking to gain "market economy status" with the World Trade Organization, but European steelmakers hope to block this attempt until the dumping issue is resolved.

The report says China's neighbors - including India and ASEAN member countries - are also bristling at the ubiquity of cheap Chinese steel.

Large-scale reform

The Chinese government has enacted a number of measures since it first acknowledged its problem with overcapacity. It has made water and electricity more expensive for their biggest users and it has assumed more oversight of large projects.

But the EU Chamber of Commerce in China sees a number of ways (30 to be exact) in which the government can go further to boost demand and restrain supply.

These recommendations include measures directly aimed at combating overcapacity. They encourage, for example, further research into higher-tech products and stricter enforcement of environmental regulations.

Other recommendations are indirectly aimed at overcapacity, seeking to make China's economic system more sustainable. Such measures include redirecting funds from producers to consumers to stimulate demand, fostering the development of smaller enterprises and venture capital to diversify sources of revenue, and injecting more competition into the market.

The report posits that China's torrid growth after 2009 had made it complacent in combating the problem. This would mean that, given China's current economic slowdown, the push for major reforms may now be given more force.