Recent discussions about global economies often overlook the complexities of individual nations’ situations, particularly when it comes to ideological biases. While both the United States and Europe are grappling with significant economic challenges—such as reports indicating that 28% of Americans are skipping meals due to food inflation—this does not automatically position China as a model economy. A new article from the Wall Street Journal highlights China’s electric vehicle (EV) overproduction, a reality that many ardent supporters of China refuse to acknowledge. In fact, China’s top officials admit to ongoing issues of overcapacity in their automotive sector, reflecting a disparity between manufacturing output and consumer demand.
My perspective on this matter takes shape from experiences during Japan’s economic peak in the 1980s. While working closely with a distinguished group from Sumitomo Bank as a McKinsey consultant, I witnessed firsthand the high caliber of Japanese management—even when communication occurred in imperfect English. I was convinced of Japan’s economic dominance, a belief so strong that I invested in Japanese stocks during the post-bubble era, a misstep I now recognize.
Despite robust manufacturing capabilities, there is substantial resistance from anti-imperialists to acknowledge that China’s investment and export-driven economic model is reaching its limits. Shifting towards a more balanced growth model, focused on internal consumption, has proven to be a challenging endeavor. This overproduction, referred to as “involution” by Chinese leaders, brings into question whether changing terminologies can alter the essential issues at hand.
For more than a year, the overcapacity challenge has been on the official radar. Some commentators have vehemently denied the existence of overinvestment in China, but the evidence tells a different story. Officials in various industries have increasingly urged companies to refrain from cutting prices in a bid to maintain market share. The crux of this concern is that unchecked deflation can be far more damaging—and more difficult to resolve—than inflation.
Supporters of China are often quick to dismiss any concerns regarding the economy. However, criticism is escalating even from the highest echelons of power, including President Xi Jinping. A recent article from the Economist noted that China’s proficiency in producing affordable electric vehicles has not only raised alarms within countries housing major automakers but has also spurred unease within China’s own government. The incessant price competition in this sector symbolizes the greater difficulties facing China’s economy.
The latest news about BYD, China’s largest electric vehicle manufacturer, shocked the market when it drastically reduced prices on multiple models. This move, occurring just two years after the launch of the original electric hatchback, signifies a dramatic shift in strategy. If internal pressures prompt such aggressive pricing, it raises questions about the future stability of the industry.
Further, reports from the Financial Times discuss how Chinese authorities have been vocal in criticizing local companies for exacerbating overproduction and driving down prices. The manufacturing industry has encountered a persistent decline in producer prices since September 2022, complicating the growth prospects traditionally reliant on exports and manufacturing.
Even state-run media have acknowledged overcapacity as an issue. President Xi has emphasized the need to regulate unpredictable price competition among enterprises, further demonstrating the gravity of the situation. Critically, the Chinese Communist Party admits to recognizing the peril of excessive competition, with the term “involution” coming to the forefront of policy discussions.
According to additional analyses, factory-gate prices have plummeted across various sectors, not just in the automotive industry. Such widespread deflation can have dire consequences for economic stability, making it imperative that policymakers address these challenges head-on.
Despite facets of China’s economy demonstrating resilience, the specter of deflation looms large. If entrenched, deflation could lead to widespread business failures, job losses, and slow spending, ultimately intensifying economic contractions. With declining birth rates and concerns surrounding consumer confidence, the road ahead for China’s economy warrants careful consideration.
A recent recap of a Wall Street Journal article indicated that a shift away from an export-led growth model toward more domestic consumption is fraught with ideological challenges. President Xi appears reluctant to embrace measures that would boost household demand, mistakenly viewing such growth as wasteful. Such resistance hampers the necessary adjustments to balance consumption and investment.
I suspected that parts of China’s top leadership objected to a household focused stimulus. Turns out the epicenter of opposition is Xi himself: “Xi sees such growth as wasteful and at odds with his goal of making China a world-leading industrial and technological powerhouse”
— Brad Setser (@Brad_Setser) August 27, 2023
Beijing’s mind seems made up — but Chinese policy makers have this backwards.
Using the central government’s clean balance sheet to support household demand would actually make it easier for households, property developers and local governments to delever.
— Brad Setser (@Brad_Setser) August 27, 2023
A hypothesis: there can be no durably stable Chinese and global economy so long China’s national savings rate stays around 45% of GDP …
(note that, contrary to the IMF’s forecasts, savings has been rising since 2020 …)
— Brad Setser (@Brad_Setser) August 28, 2023
The prevailing narrative often depicts China’s growth model as resilient. However, as economist Herbert Stein famously noted: “That which can’t continue, won’t.” It appears that this time, that limit has been reached.
Turning to the Wall Street Journal article provides valuable insights into the automotive sector. An in-depth exploration of the challenges facing companies like Skyworth illustrates how local government investments have fueled aspirations that may now be unrealistic. In a country struggling with a declining population and a shift towards alternative transportation options, the prospects for sustained growth in car sales appear grim.
This year, China has plants capable of producing around 63 million light vehicles annually—more than triple the number of cars that consumers are projected to purchase.
Faced with excessive production capacity, Chinese car manufacturers find themselves squeezed. With internal demand declining, they must choose between reducing prices or focusing on exports to bolster their businesses. The situation is precarious, with prices having dropped significantly this year and a decline in profit margins.
In conclusion, China’s automotive landscape showcases the complexities of a shifting economy under pressure from internal and external challenges. Despite the increasing production capabilities and innovative strides in technology, the reality remains that businesses must adapt to a market that is increasingly saturated and demanding. As policymakers and industry leaders grapple with these issues, the lessons from Japan’s past serve as powerful reminders of the consequences of ignoring economic limits. Keeping a close watch on these developments is crucial as the situation unfolds.
