Authors: Zhong Zhengsheng, Zhang Lu, Chang Yixin (Zhong Zhengsheng is a director of the China Chief Economist Forum and the chief economist of Ping An Securities)
Key takeaways
This paper reviews the capacity cycle and overcapacity in China's history, examines the structural characteristics of the current overcapacity, and proposes a solution to the current round of overcapacity.
Historical capacity cycles and overcapacity. The capacity cycle often lags behind the economic cycle, and the introduction of new capacity may coincide with a decline in demand, resulting in overcapacity in the economy. Looking back on history, China has gone through three rounds of the Jugra cycle in the 1980s, 1990s, and 2000-2015, with the latest round of the Jugra cycle starting in 2016 and entering a downward phase from 2022.
At present, China's manufacturing industry is facing structural overcapacity. The fixed asset turnover rate of sub-industries and listed enterprises announced by the Comprehensive Bureau of Statistics: In the second half of 2023, the overall capacity utilization of China's manufacturing industry was lower than the historical pivot level. Among them, the equipment manufacturing industry such as computer communication electronics, electrical machinery, and automobile manufacturing has the weakest performance, and the overlap with the high-tech manufacturing industry is relatively high. The capacity utilization of the raw material industry is also insufficient, concentrated in non-metallic mineral products and chemical-related industries. In the consumer manufacturing industry, whether it is necessities such as medicine, food manufacturing, agricultural and sideline product processing, or optional consumer goods such as textiles and garments, furniture manufacturing, leather shoes, and textiles, there are varying degrees of underutilization of production capacity.
Structural characteristics of the current round of overcapacity. First, real estate and population are facing an inflection point, and the demand for building materials and commodities is facing changes. On the one hand, commodity consumption may change from an incremental market to a stock market, especially household appliances, furniture, wood and other real estate-related durable consumer goods, while food manufacturing, agricultural and sideline products processing, textiles and garments and other industries are also difficult to reproduce the growth logic of the "consumption upgrading" period. On the other hand, the real estate sector has a greater impact on the terminal demand for construction raw materials such as steel, cement, and flat glass, and the pressure of overcapacity in related industries is gradually accumulating. Second, the increase in production capacity and the weakening of external demand have led to prominent pressure on the chemical and pharmaceutical industries. Since 2021, external demand has promoted large-scale expansion of industries such as the chemical and pharmaceutical industries. However, since 2023, global demand has tended to decline, and the ability to digest the previous production capacity is insufficient, and the risk of overcapacity has gradually emerged. Third, driven by the wave of greening, the energy transition industry has invested rapidly. The long-term demand prospect of "carbon neutrality" is good, and the production capacity from the long-term perspective is expected to be digested. However, the technical route is in the process of evolution, and there is a contradiction between "advanced capacity" and "backward capacity". Fourth, the overseas industrial chain is accelerating the reconstruction, the semiconductor competition is fierce, and the industry is facing triple pressure. First, production capacity growth, China and overseas economies have increased capital expenditure in the semiconductor field, and new production capacity will be launched one after another. Second, the relocation of manufacturing has led to a decline in the production of foreign enterprises in China, which tends to be "onshore", "near-shore" and "friendly". Third, the decline in demand has intensified the operating pressure of related industries.
The solution to overcapacity. First, supply-side reforms are still necessary. This round of overcapacity industries involves more private enterprises, and it is necessary to avoid the recurrence of "one size fits all", and certain financial incentives can be given to backward production lines that take the initiative to withdraw, and market-oriented forms such as subsidizing the terminal consumption of low-energy consumption products and levying "carbon tax" can give private enterprises stable expectations and full confidence. Second, encourage innovation and improve quality standards. The introduction and promotion of high-quality products can create demand and help enterprises with structural overcapacity to open up the market and digest production capacity. Third, smooth the "external circulation". Create a good international environment, encourage enterprises to improve product competitiveness, and gain more international market share.
In December 2023, the Central Economic Work Conference proposed "overcapacity in some industries". At present, the divergence between "volume" and "price" has become an important problem facing China's economy, and its root cause is the price decline caused by overcapacity, and the increase in income of enterprises without increasing profits. This paper focuses on the historical trajectory of China's capacity cycle, focuses on the structural characteristics of the current overcapacity in China's manufacturing industry, and discusses the relevant strategies to resolve the current round of overcapacity based on the similarities and differences between history and reality.
One
Historical capacity cycles and overcapacity
How to characterize the capacity cycle?
The inventory cycle is a short cycle in the economic cycle, which is often characterized by the cumulative year-on-year growth rate of finished product inventory of industrial enterprises, and its historical operation is basically stable and follows the law of 3-4 years, and is a monthly data, which is an important cycle observed in macro research.
The mid-cycle in the economy – the capacity cycle (also known as the Jugra cycle) is associated with equipment investment activity, which includes multiple inventory cycles. The principle of the formation of overcapacity lies in the fact that investment decisions lag slightly behind the economic cycle, and the formation of production capacity also requires a process (it takes a certain amount of time for fixed capital formation such as equipment and plants), so that new production capacity is often concentrated in the economic downturn, resulting in overcapacity.
Combined with the capital formation rate in GDP and the completion of fixed asset investment, it can be roughly considered that the mainland has gone through three rounds of Jugra cycles in the 1980s, 1990s, and 2000-2015, with the latest round of the Jugra cycle starting in 2016 and entering a downward phase from 2022.
The most important indicator of overcapacity is capacity utilization. Capacity utilization is generally defined as the ratio of actual output to potential capacity. When the overall capacity utilization rate of an industry is at a low level, it means that there is a large amount of idle capacity, and the industry is in a state of overall overcapacity. Therefore, the measurement of capacity utilization rate has become the premise and basis for defining and analyzing overcapacity.
1. The National Bureau of Statistics surveyed the capacity utilization rate
The National Bureau of Statistics uses the direct statistical survey method to measure the utilization rate of industrial capacity, conducts sample surveys of industrial enterprises, and extrapolates the population. In the sampling, all large and medium-sized enterprises above designated size are sampled, and small and micro enterprises above designated size are selected in stratified sampling (the sampling rate is 10%). The total output value of all sample enterprises in the survey accounts for more than 60% of the total output value of industrial enterprises above designated size.
The problems with the capacity utilization rate of the National Bureau of Statistics are: First, the release time is relatively short. At the end of 2017, the National Bureau of Statistics (NBS) published for the first time China's industrial capacity utilization rate for each quarter since the first quarter of 2013 and for each year since 2006. However, Chen Yingting and Xu Xianchun (2023) Figure 8 of "Statistical Methods and Improvement Directions of Industrial Capacity Utilization Rate in China's Survey Method" covers the quarterly capacity utilization rate data from 2006 to 2021, and indicates that the data comes from the National Bureau of Statistics, which can form an organic supplement. Second, the data has not been seasonally adjusted, showing a trend of falling quarter-on-quarter in the first quarter and rising quarter-on-quarter in the second, third and fourth quarters. Third, the breakdown data only announced 15 industries, did not cover 41 industrial industries, and began to be released as early as the fourth quarter of 2016, with a short comparable range.
In 2023, the industrial capacity utilization rate announced by the National Bureau of Statistics will be 75.1%, which is lower than the desirable range of 76%-80% (Chen Yingting (2021) "Analysis of the Dynamic Equilibrium of Supply and Demand in the Reasonable Range of Industrial Capacity Utilization in the Mainland").
2. The utilization level of equipment capacity of 5,000 enterprises of the central bank
Among the publicly available macro data in China, the closest thing to the definition of capacity utilization is the "Equipment Capacity Utilization Index" in the survey data of 5,000 industrial enterprises released by the People's Bank of China every quarter. The index was first released in the second quarter of 1992 and has a long time series. In the third quarter of 2023, the equipment capacity utilization level of the central bank's 5,000 enterprises was 38.8, which was in the 27th percentile since 2000.
However, the central bank's 5,000-enterprise survey is only applicable to the capacity utilization rate of the industry as a whole, and there is no industry-specific data. In order to study the characteristics and trends of capacity utilization at the industry level and at the firm level, it is necessary to use the micro data at the firm level as the basis for estimation.
3. Fixed asset turnover rate
From a micro perspective, the economic implications of fixed asset turnover and capacity utilization are consistent. Fixed asset turnover ratio = sales revenue / average net fixed assets, which represents the number of fixed asset turnover times in a fiscal year, or represents the sales revenue supported by fixed assets per 1 yuan. As of the end of the third quarter of 2023, the fixed asset turnover ratio of listed companies has only fallen to the middle of the year, similar to the position in 2013-2014.
Capacity cycle from 2000 to 2015
From 2001 to 2007, with China's accession to the WTO and the rise of the domestic real estate market, the growth of domestic and foreign demand led to the rapid expansion of industrial production capacity, especially in the fields of basic industry and heavy chemical industry. The outbreak of the global financial crisis in 2008, the sharp decline in external demand, and the implementation of large-scale economic stimulus programs by the government, further exacerbated the overcapacity of some industries.
Based on the growth rate of fixed asset investment by industry from 2004 to 2011, the industries with rapid expansion in this round of capacity cycle are concentrated in the upstream resources and midstream manufacturing sectors. Among them, the compound growth rate of investment in ferrous metal mining and dressing, non-ferrous metal mining and dressing and non-metallic mining and dressing industries reached 49.8%, 49.1% and 43.2% respectively, and the compound growth rate of investment in electrical machinery, general equipment, special equipment and metal products industry reached 47.6%, 44.9%, 42.3% and 41.9% respectively, and the seven major industries were stronger than the overall growth rate of 31.8% in the manufacturing industry.
In 2012, the problem of overcapacity in mainland China gradually emerged. On the one hand, the economy is overheated, the upward pressure on prices is greater, the overall macroeconomic control policy is tightened, and the new production capacity brought by the "four trillion" stimulus in the early stage has been released one after another. On the other hand, the outbreak of the European sovereign debt crisis, the slowdown of global economic growth, and the headwind environment for China's exports, which are also not conducive to the digestion of industrial capacity. From 2012 to 2014, the Central Economic Work Conference continued to pay attention to overcapacity, and solving the problem of overcapacity has become an important task of macroeconomic regulation and control. In October 2013, the State Council issued the "Guiding Opinions on Resolving the Contradiction of Serious Overcapacity" (Guo Fa [2013] No. 41), which showed that "at the end of 2012, the capacity utilization rate of steel, cement, electrolytic aluminum, flat glass and ships in mainland China was only 72%, 73.7%, 71.9%, 73.1% and 75% respectively, which was significantly lower than the international normal level". Many of these industries belong to industries with strong production continuity, and reasonable capacity utilization should be high, and capacity utilization below 75% indicates serious surplus.
Despite the attention and countermeasures on the policy side, the overcapacity situation in the mainland continued to increase from 2012 to 2015. In the 2013 "Guiding Opinions on Resolving the Contradiction of Serious Overcapacity" issued by the State Council, the relevant measures of "digesting a batch, transferring a batch, integrating a batch, and eliminating a batch" of excess capacity were proposed, but their results were limited. In 2015, the capacity utilization rate of mainland China and the equipment utilization capacity index of 5,000 enterprises were 6.1 and 5.0 percentage points lower than that in 2011, respectively, and the fixed asset turnover rate of listed manufacturing enterprises decreased by 15.3% compared with the end of 2011.
During this period, the overcapacity was not resolved well, because the development model of investment-led economic growth has not fundamentally changed. In 1990, the investment rate fell by 5 percentage points from the 1985 high, the investment rate in 2000 fell by 9.7 percentage points from the 1993 high, and the investment rate in 2014 fell by only 1.4 percentage points from the 2011 high. The essence of overcapacity is that the supply of new capacity released by investment far exceeds the growth rate of demand, and the resolution of overcapacity will inevitably be accompanied by a significant decline in the growth rate of new investment relative to the growth rate of exports and domestic consumption.
Some state-owned "zombie enterprises" have not been cleared in time, which is an important obstacle to the management of overcapacity before 2015. These enterprises generally face operational difficulties, such as frequent shutdowns, continuous losses, insolvency and other problems, which occupy a large amount of resources for a long time and distort the allocation of resources. From the financial indicators of industrial enterprises, it can be seen that the production capacity of state-owned enterprises has been slow to clear during this period: First, the asset-liability ratio of state-owned enterprises has further risen from a high level, which is different from the overall "deleveraging" of industrial enterprises. Second, the operating efficiency of state-owned enterprises is low, the profit growth rate continues to be lower than that of joint-stock and private enterprises, and the loss area (the proportion of loss-making units in the whole sample) has climbed to nearly 3%.
After the start of supply-side reform at the end of 2015, the effectiveness of overcapacity control has appeared quickly. On November 10, 2015, the 11th meeting of the Central Leading Group for Financial and Economic Affairs was held, and General Secretary Xi Jinping delivered an important speech emphasizing that while moderately expanding aggregate demand, efforts should be made to strengthen supply-side structural reforms, focus on improving the quality and efficiency of the supply system, and first mention "supply-side structural reform". In December 2015, the Central Economic Work Conference proposed to do a good job in the five major tasks of "de-capacity, de-inventory, de-leveraging, cost reduction, and making up for shortcomings". Among them, "de-capacity" is the first of the five major tasks, and the focus is to continue to promote the management of excess capacity in steel, coal and other industries. At the same time, in 2016, the State-owned Assets Supervision and Administration Commission (SASAC) launched the work of "dealing with stalemate and curing difficulties", making a thorough survey of the subsidiaries of central enterprises, identifying 2,041 "zombie enterprises" and "extremely poor enterprises", and planning to complete the "stalemate and predicament" of these enterprises in three years. At the same time, the macro policy takes the "shed reform" as the starting point to promote the "destocking" of real estate and other upstream industries, and "reduces costs" for enterprises through tax and fee reductions, RRR and interest rate cuts, helps demand stabilize and rebound, and provides a good environment for getting out of overcapacity.
From 2015 to 2016, the mainland's investment rate (fixed asset formation as a share of GDP) fell by 3.8 percentage points, far exceeding the 1.4 percentage points in 2012-2014.
- From the perspective of the production capacity of major industrial products, from 2015 to 2018, the production capacity of raw materials such as steel, coke, and cement has been reduced, and the capacity utilization rate has risen. According to CCTV, from 2016 to mid-2019, the mainland has reduced crude steel production capacity by more than 150 million tons, withdrawn 810 million tons of backward coal production capacity, and eliminated and shut down more than 20 million kilowatts of backward coal-fired power units, all of which have completed the "13th Five-Year Plan" capacity reduction target two years ahead of schedule.
- From the perspective of capacity utilization related indicators, the capacity utilization rate and equipment utilization capacity index of 5,000 enterprises announced by the Bureau of Statistics have rebounded since the second quarter of 2016, the fixed asset turnover rate of listed manufacturing enterprises has rebounded since the fourth quarter of 2016, and China's economy has been revitalized since the second half of 2016.
Capacity cycle in the 1990s
At the beginning of 1992, Deng Xiaoping, the chief architect of reform and opening up, delivered a speech on the south, which greatly stimulated the enthusiasm of the broad masses of cadres and masses for economic development.
From 1996 to 1999, overcapacity was concentrated in consumer goods and light industry, represented by textiles, household appliances, plastic products, etc. According to the results of the third industrial census in 1995, among the more than 900 major industrial products, half of the country's products have a production capacity utilization rate of less than 60 percent; for example, the capacity utilization rate of photographic film is only 13.3 percent, that of motion picture film is 25.5 percent, that of single telephones is 51.4 percent, that of color televisions is 46.1 percent, that of household washing machines is 43.4 percent, and that of bicycles is 54.5 percent. At the end of 1996, 40 percent of the country's production capacity of 28 major industrial products was idle. In the second half of 1997, one-third of the consumer goods were in oversupply; in 1998, among the more than 900 major industrial products, the utilization rate of the production capacity of most industrial products was below 60 percent, and the lowest was only 10 percent.
The contradiction of overcapacity has directly led to the deterioration of corporate efficiency and the decline in investment growth, which has been exacerbated by the outbreak of the Asian financial crisis. At the beginning of 1998, the impact of the Asian financial crisis on the mainland became apparent, with a sharp decline in export growth, a marked suppression of external demand, and a sharp drop in direct investment by overseas countries and regions in the mainland. The main contradiction facing the mainland is no longer inflation, but deflation brought about by economic recession.
At this stage, the following measures were mainly taken to address the problem of overcapacity:
- First, we need to promote supply-side reform through administrative means. Terminate duplicate construction, clean up excess capacity, and at the same time take the textile industry as a pilot to promote the merger and reorganization of state-owned enterprises, and divert and resettle laid-off workers. Specifically, in September 1997, the 15 th CPC National Congress proposed that "the majority of large and medium-sized loss-making state-owned enterprises should be extricated from their predicament in about three years"; in June 1998, the CPC Central Committee and the State Council issued the "Circular on Conscientiously Doing a Good Job in Ensuring the Basic Livelihood and Reemployment of Laid-off Workers of State-Owned Enterprises"; and in September 1999, the Fourth Plenary Session of the 15 th CPC Central Committee adopted the "Decision on Several Major Issues Concerning the Reform and Development of State-Owned Enterprises."
- Second, debt restructuring should be implemented to replenish bank capital and enhance the soundness of the banking system. In August 1998, with the approval of the Standing Committee of the National People's Congress, the Ministry of Finance issued a long-term special treasury bond of 270 billion yuan to supplement the capital of the four major banks and enhance their solvency. In 1999, the Big Four Asset Management Companies were established to acquire non-performing assets from the Big Four banks.
- Finally, reform should be used to unleash the vitality of domestic demand, and a positive fiscal policy should be used to support demand. In 1998, the housing reform was launched, creating a new demand growth point for the manufacturing industry, and from 1998 to 2000, it issued additional long-term construction bonds to strengthen the construction of agriculture, forestry and water conservancy, transportation, infrastructure, power grids, and other infrastructure. According to Zhang Zhanbin (2016), the total amount of non-performing assets stripped from 1999 to 2005 was as high as 2.58 trillion yuan, from 1996 to 1998, the number of state-owned enterprises dropped from 113,800 to 65,000, a decrease of 42 percent, and from 1998 to 1999, the number of employees in state-owned enterprises fell by about 22 million.
From the perspective of macroeconomic indicators, the compound average growth rate of China's fixed asset investment reached 34.7 percent between 1991 and 1995, and the growth rate dropped to 10.5 percent between 1996 and 2000. The equipment utilization capacity index of the central bank's 5,000 enterprises, which represents the utilization of production capacity, gradually fell from the average level of 38.2 in 1992 to an extremely low level of 31.4 in early 1998, and then began to bottom out with the promotion of capacity reduction.
Capacity cycle in the 1980s
In the 1980s, in the process of transitioning from a planned economy to a market economy, demand increased and administrative power was decentralized, which stimulated the rapid growth of investment. With the development of the economy and the improvement of people's living standards, consumer demand is becoming increasingly diversified, the commodity market is becoming prosperous, and the expansion of demand has pushed up the production capacity construction of the supply side. At the same time, the enthusiasm of local governments for economic construction is relatively high, but it is inevitable that there will be problems with the goal of maximizing the interests of administrative boundaries, and there will be duplicate investment and blind construction. At that time, the popular consumer goods were mainly primary non-agricultural products such as bicycles and sewing machines, and they were also areas where production capacity construction was relatively concentrated. According to Xu Jing'an (1983), about 50% of the country's watch and television factories, 75% of the bicycle factories, and 80% of the washing machine factories and refrigerator factories in the country did not reach the minimum production batch.
With the gradual increase of overcapacity pressure, the cash flow of enterprises is unsustainable, accounts are in arrears with each other, the "triangular debt" is intensifying, and inflationary pressure is also coming after the rapid growth of investment. Around 1989, the Central Committee of the Communist Party of China passed the "Decision on Further Rectification and Deepening Reform", and the country began a three-year rectification work. At the beginning of 1990, the State Council decided to carry out the work of clearing up the "triangular debt" nationwide.
From the perspective of macroeconomic indicators, the compound average growth rate of fixed asset investment in China was as high as 22.9 percent between 1981 and 1988, but the growth rate fell by 7.2 percent in 1989 and increased slightly by 2.4 percent in 1990, before recovering in 1991.
Two
Structural characteristics of a new round of overcapacity
Which industries are facing overcapacity in this cycle?
From 2016 to 2019, at the beginning of the current round of production capacity cycle, China's industrial and manufacturing investment grew steadily, and the investment in fixed assets in the secondary industry increased by 3.5%, 3.2%, 6.5% and 3.2% respectively, and only in 2018 the investment was strong, thanks to the support of the demand for equipment renewal in computer communication electronics, instrumentation and other industries. Compared with 2016, 9 sub-sectors had a negative investment growth rate in 2019, and 22 sub-sectors had an average annual growth rate of less than 5%. The outbreak of the new crown epidemic in 2020 has hit both industrial demand and investment.
From 2021 to 2023, investment in the industrial sector will grow rapidly, and production capacity will tend to expand. Compared with the end of 2019, the average annual compound growth rate of fixed asset investment in the secondary industry in 2023 will reach 7.4%, and the growth rate of manufacturing investment will reach 6.6%, both higher than the growth rate of industry added value. In terms of industries, industries with a growth rate of about 10% or more in fixed asset investment from 2020 to 2023 can be divided into three categories. First, the equipment manufacturing industry, which is highly dependent on exports, including electrical machinery, computer communication electronics, instrumentation, special equipment, etc., grew by 21.1%, 15.6%, 13.2% and 10.7% respectively. Second, the growth rate of resources, energy and raw material industries, including power production and supply, non-metallic mineral mining and dressing, coal mining and washing, non-ferrous metal mining and dressing, chemical raw material products, ferrous metal processing, etc., is between 10% and 18%. Third, consumption-related industries, including pharmaceutical manufacturing, wine, beverage and tea, agricultural and sideline food processing, etc., grew by 11.2%, 10.2% and 10.1% respectively.
Since the second half of 2022, China's industrial capacity utilization level has tended to decline. In 2022, China's economy will be affected by the impact of the epidemic and triple pressure, and in 2023, it will be greatly dragged down by external demand and real estate, and the launch of new capacity will coincide with sluggish demand.
According to the data of the National Bureau of Statistics, the average capacity utilization rate of the industrial, water, electricity and gas and mining industries in 2023 is higher than the central level since the fourth quarter of 2016. However, the capacity utilization rate of the manufacturing industry, which is the main body of the industry, is only 75.3%, 0.9 percentage points lower than the central level. Taking 2023 as a benchmark, if the capacity utilization rate of the industry is lower than the pivot since the statistics were established in the fourth quarter of 16, it can be considered that the industry is underutilized. Based on this filter, the capacity utilization rate of raw material industries such as chemical raw materials and non-metallic mineral products is 0.3 and 4.1 percentage points lower than that of the center, respectively, the equipment manufacturing industries such as computer communication electronics, automobile manufacturing, and electrical machinery are 3.2, 2.3 and 1.5 percentage points lower than those of the center, and the capacity utilization rates of consumer manufacturing industries such as food manufacturing, pharmaceutical manufacturing, and textiles are 2.6, 1.7, and 1.3 percentage points lower than the central level, respectively.
In terms of the fixed asset turnover rate of listed manufacturing enterprises, in the third quarter of 2023, the fixed asset turnover rate of listed manufacturing enterprises is at the 43% quantile since 2016, and the capacity utilization degree is at a neutral low level. Among the three sectors of the manufacturing industry, the capacity utilization level of the equipment manufacturing industry is obviously low, and the fixed asset turnover rate is at the lowest point since 2016, while the fixed asset turnover rate of the raw material manufacturing and consumer manufacturing industries has fallen from the high point in the first quarter of 2022, at the 70% and 50% quantile levels since 2016, respectively. If the indicator is at a relatively low historical level (below the 1/3 quantile), it can be considered that the industry is at risk of underutilizing capacity. As of the third quarter of 2023, the fixed asset turnover rate of six industries, including computer communication electronics, pharmaceutical manufacturing, automobile manufacturing, electrical machinery and equipment manufacturing, rubber and plastic products, and textiles, garments and apparel, is below the 10% quantile since 2016, and the capacity utilization level is insufficient; The turnover rate of fixed assets in the textile industry and other consumer manufacturing industries is at the historical 13%-33% quantile level, and there is also a certain risk of overcapacity.
The capacity utilization rate of sub-sectors and the fixed asset turnover rate of listed enterprises announced by the Comprehensive Bureau of Statistics: In the second half of 2023, the overall capacity utilization rate of China's manufacturing industry was lower than the historical pivot level. Among them, the equipment manufacturing industry such as computer communication electronics, electrical machinery, and automobile manufacturing has the weakest performance, and the overlap with the high-tech manufacturing industry is relatively high. The capacity utilization of the raw material industry is also insufficient, concentrated in non-metallic mineral products and chemical-related industries. In the consumer manufacturing industry, whether it is necessities such as medicine, food manufacturing, agricultural and sideline product processing, or optional consumer goods such as textiles and garments, furniture manufacturing, leather shoes, and textiles, there are varying degrees of underutilization of production capacity. Next, we will explore and summarize the structural characteristics of this round of overcapacity, in order to seek the deep-seated causes of overcapacity and the way to solve it.
1. The inflection point of real estate and population, and the demand for building raw materials and commodities is changing
In 2022 and 2023, the Chinese population will grow negatively for two consecutive years, and a major turning point in the real estate cycle will appear, which means that residential consumption and residential investment will change in trend, which will have a far-reaching impact on the demand for building raw materials. In the context of an aging population, a slow decline in potential economic growth, and a peak in real estate demand, the center of consumption growth will also fall, and structurally it may reduce housing-related consumption and increase service-oriented consumption such as health care, catering and accommodation, cultural tourism, and transportation. This means that commodity consumption may change from an incremental market to a stock market, especially household appliances, furniture, wood and other real estate-related durable consumer goods, while food manufacturing, agricultural and sideline products processing, textiles and garments and other industries are also difficult to reproduce the growth logic of the "consumption upgrading" period.
In this cycle, the overcapacity pressure of the raw material industry has accumulated since the second half of 2022, and as of 2023, the degree of overcapacity is not as high as that of the previous round. Starting from the input-output table, the real estate sector has a greater impact on the terminal demand for construction raw materials such as steel, cement, and flat glass.
On the one hand, the contradiction of overcapacity in the non-metallic mineral products industry represented by cement is the most prominent, because its demand is highly dependent on the real estate sector, and the expansion of infrastructure demand is still difficult to hedge. Based on the latest input-output table and industrial value-added data, the real estate sector will account for 44.6% of the final demand of the non-metallic mineral products industry in 2023, while the infrastructure sector will account for only 28%, which is 16.6 percentage points lower than the impact of the real estate sector. According to the data of the Bureau of Statistics, the average capacity utilization rate of the non-metallic mineral products industry in 2023 will only be 64.7%, 5.4 percentage points lower than that at the end of 2016. Moving the high-frequency data for an average of 12 months to remove seasonality, we observed that the cement mill operating rate at the end of the first quarter of 2024 was only 41%, 15.8 percentage points lower than the peak level at the end of 2019 and 4 percentage points lower than the lowest point of the previous production cycle (February 2016).
On the other hand, the problem of overcapacity in the construction raw materials industry such as ferrous metal processing is not prominent, and the hedging of infrastructure investment, the rapid development of new energy and the automobile industry have brought about an increase in demand, which has won time for the digestion and adjustment of production capacity. For raw material industries such as ferrous metal processing and petroleum and coal processing, although the real estate sector accounted for 28.7% and 19.7% of its final demand respectively, it was less than the 30.8% and 34.7% of the infrastructure sector. For the non-ferrous metal processing industry, the real estate sector accounted for 17.5% of its terminal demand, while the automobile and new energy related industries and infrastructure sectors accounted for 29.3% and 12.2% respectively, which can form an effective hedge. For example, the capacity utilization rate of steel represented by ferrous metal processing is generally at a high level, but the structural differentiation is obvious. The capacity utilization rate of rebar and wire rod, which is closely related to real estate, has dropped to 4 to 6 percent, while the capacity utilization rate of medium and heavy plate is more than 9 percent, and the capacity utilization rate of hot rolling and cold rolling is also more than 8 percent, which is related to the support of manufacturing, infrastructure and export demand.
2. The superposition of production capacity and external demand has weakened, and the pressure on the chemical and pharmaceutical industry is prominent
The chemical industry has experienced a massive expansion of production capacity. Since the second half of 2020, overseas has been affected by the spread of the epidemic and the energy crisis, and the production capacity of some chemical industries is difficult to operate normally. The first unit of the new Verbund site in Zhanjiang, Guangdong Province, will be put into operation in September 2022, with a total planned investment of 10 billion euros by 2030, making it the third largest BASF site in the world.
However, since 2023, global demand has tended to decline, the digestion capacity of the early production capacity is insufficient, and the risk of overcapacity of basic chemical raw materials has gradually emerged. The "Action Plan for Carbon Peaking Before 2030" previously issued by the State Council clearly requires that by 2025, the domestic crude oil primary processing capacity will be controlled within 1 billion tons, and the capacity utilization rate of major products will be increased to more than 80%.
1) On the demand side: the export delivery value of the chemical raw materials and products industry will fall by 14.3% in 2023, and the industry PPI will fall by 9% in the same period, and the export delivery value will fall by 9.4% in the first and second months of 2024, and the industry PPI will fall by 6.4% in the same period. Excluding the impact of price factors, the decline in export "volume" is still a drag.
2) Supply side: According to Longzhong data, the total crude oil processing capacity of China's 162 refineries at the end of November 2023 was about 984 million tons/year, approaching the red line level of 1 billion tons. Ethylene, which is the core of the petrochemical industry (ethylene derivatives account for more than 75% of petrochemical products), has a large amount of production capacity that brings the risk of overcapacity. According to the statistics of the Petrochemical Federation, the ethylene production capacity of the mainland will reach 46.75 million tons/year in 2022, and the domestic ethylene production capacity planned to be put into operation at the end of the "14th Five-Year Plan" is still 34.75 million tons/year. On February 1, 2024, Fu Xiangsheng, vice president of the Petrochemical Federation, said at a press conference that "the current problem of overcapacity in the chemical industry is not only a problem faced by fertilizers, acids, alkalis, coatings, pesticides, titanium dioxide, silicone monomers, PTA, PET and other basic chemicals and general materials, but also 1,4-butanediol, EVA, POE, adiponitrile, caprolactam, nylon 6, nylon 66 and lithium carbonate, lithium iron phosphate, and lithium carbonate and lithium iron phosphate related to new energy power batteries. Lithium hexafluorophosphate, etc., the production capacity under construction and proposed for many products is surprising. For some products, if the planned production capacity can be completed and put into operation as scheduled, it is not only a matter of meeting the domestic market demand, but also more than enough to meet the total consumption of the world market."
The pharmaceutical industry once benefited from the overseas epidemic, and the sharp decline in demand dragged down greatly. From 2020 to 2021, the foreign epidemic situation formed a strong support for the export of new crown vaccines, biological drugs, sanitary materials, medical equipment and equipment, etc., and the export delivery value of the pharmaceutical industry increased by 36.6% and 64.6% respectively, but the growth rate fell back to -25.1% and -22.8% from 2022 to 2023.
3. Driven by the wave of greening, the energy transition industry has invested rapidly
The energy sector is facing more structural overcapacity. The long-term demand prospect of "carbon neutrality" is good, and the production capacity from the long-term perspective is expected to be digested. However, the technical route is in the process of evolution, and there is a contradiction between "advanced capacity" and "backward capacity". Small and medium-sized enterprises and backward production capacity have not yet withdrawn, and large enterprises and listed companies have been built first with financial support, adding a large amount of production capacity.
There is a consensus to triple the global installed renewable energy capacity by 2030. In November and December 2023, the 28th Conference of the Parties to the United Nations Framework Convention on Climate Change (COP28) was held, and in order to combat climate change and promote sustainable development, countries reached an important agreement to triple the global installed renewable energy capacity by 2030 to at least 11,000GW, of which photovoltaic installed capacity will increase from 1,055GW in 2022 to 5,457GW in 2030. Against this backdrop, China and the United States issued the Sunnyland Statement on Strengthening Cooperation to Address the Climate Crisis, demonstrating that the two countries are willing to strengthen cooperation on climate action and jointly promote the development of global renewable energy.
New energy-related enterprises have a very strong willingness to expand production, and the growth rate of production capacity is faster than the increase in output and demand. The new energy field covers many industries such as photovoltaic, wind power, energy storage, power battery, and new energy vehicles. According to the National Energy Administration, in 2023, China's investment in the new energy sector increased by more than 34% year-on-year, and the investment in solar power and wind power increased significantly. At the same time, the installed capacity of new energy storage has grown rapidly, with about 22.6 million kilowatts of new installed capacity, surpassing the capacity of the Three Gorges Hydropower Station and increasing by more than 260% from the end of 2022. In the classification of national economic industries, the electrical machinery and equipment manufacturing industry and the automobile manufacturing industry are closely related to the new energy field, with the year-on-year growth rates of fixed asset investment in 2023 being 32.2% and 19.4% respectively, and the year-on-year growth rates of industrial added value being 12.9% and 13.0% respectively. As the growth rate of production capacity is much faster than the growth rate of production, the pressure of overcapacity has emerged, and the quarterly average capacity utilization rate of the electrical machinery industry in 2023 will be 76.95%, 1.5 percentage points lower than the average level since 2016. According to GGII data, the average utilization rate of power batteries will drop from more than 75% in 2022 to less than 65% in 2023, and the capacity utilization rate of energy storage batteries will also drop from more than 85% in 2022 to less than 55% in 2023.
Overcapacity brings oversupply and the "price war" intensifies, making China's new energy-related industries face a severe situation in the short term. Compared with the end of 2022, the composite price index of the photovoltaic industry fell by 69.8% on March 25, 2024, of which the price of cells fell by 72.7%, and the prices of lithium iron phosphate and ternary cells of prismatic batteries fell by 54.3% and 49.5%, respectively. Since 2023, there have been a series of project adjustments in the new energy field, including termination and postponement of production.
4. The restructuring of overseas industrial chains has accelerated, and semiconductor competition has become fierce
In 2023, the capacity utilization rate of the semiconductor and electronics industry chain will be at a low level. Overseas, TechInsights estimates that the average capacity utilization rate of the semiconductor industry in 2023 will be about 73.3%, which is below a reasonable level of more than 80%, while the capacity utilization rate of computer and electronics manufacturing in the United States will be only 69.9%, 3.7 percentage points lower than the average since 2005. The average capacity utilization rate of China's computer, communication and other electronic equipment manufacturing industry in 2023 was 75.6%, which was at a historical low, according to the National Bureau of Statistics. In the fourth quarter of 2023, the capacity utilization rates of SMIC and Huahong, the two largest wafer giants in China, were 76.8% and 84.1%, respectively, lower than the historical center.
After the 2008 financial crisis, trade protectionism and anti-globalization in developed countries have risen. After the new crown epidemic, countries have paid more attention to supply chain security, and the United States and Europe have launched policies of "reindustrialization" and "de-risking".
First, production capacity growth, China and overseas economies have increased capital expenditure in the semiconductor field, and new production capacity will be launched one after another. Take wafers as the basic material of semiconductors as an example: according to the "World Fab Forecast Report" released by SEMI on January 2, 2024, after the global semiconductor monthly wafer (WPM) production capacity increased by 5.5% to 29.6 million pieces in 2023, it is expected that 42 projects will be put into operation in 2024, with a capacity increase of 6.4%, breaking the 30 million pieces per month mark for the first time. According to the report, 1) the production capacity of chip manufacturers in Chinese mainland will increase by 12% year-on-year in 2023, and 18 projects will be put into operation in 2024, and the production capacity is expected to increase by 13% year-on-year. 2) In 2024, the wafer production capacity of Taiwan, South Korea, and Japan will increase by 4.2%, 5.4%, and 2%, respectively. 3) In addition, 6 new fabs will be added in the Americas in 2024, with an expected year-on-year increase of 6%, 4 new fabs in Europe and the Middle East will be commissioned with an expected 3.6% year-on-year increase in production capacity, and 4 new fab projects will be launched in Southeast Asia, with a 4% increase in production capacity.
Second, the relocation of manufacturing has led to a decline in the production of foreign enterprises in China, which tends to be "onshore", "near-shore" and "friendly". Take the Apple industry chain as an example: 1) According to Caijing statistics, 151 Apple suppliers in fiscal 2022 set up factories in Chinese mainland, a decrease of 4 from fiscal 2020; at the same time, the number of suppliers in ASEAN countries (Vietnam, Malaysia, the Philippines, Thailand, Singapore) and India increased by 10 and 5 respectively compared with fiscal 2020. 2) According to Countpoint, China's share in the production of iPhones, headphones, PCs, and tablets will decline in 2023, with India's share of iPhones increasing from 4% to 7%, and Vietnam's share of other three categories of products also increasing.
Third, the decline in demand, in the context of the restructuring of the global industrial chain, the decline in demand has exacerbated the operating pressure of semiconductor-related industries. In 2023, global semiconductor demand will fall due to sluggish sales of computers, smartphones, etc., and reduced spending on data centers, and global semiconductor sales in 2023 will decline by 9.4% year-on-year.
Three
A realistic response to a new round of overcapacity
How is the new round of overcapacity different from the previous one?
On the one hand, the industries with overcapacity in this round are more concentrated in equipment manufacturing and downstream consumption industries, involving more private enterprises. The most prominent contradiction in the last round of overcapacity is in the steel, cement, non-ferrous metals and other raw material industries, and the proportion of state-owned enterprises is relatively high.
On the other hand, some of the industries with overcapacity in this round have benefited from the strong support of industrial policies. For example, the computer, communication, electronics, electrical machinery, and pharmaceutical manufacturing industries are all high-tech industries and strategic emerging industries, and in recent years, they have enjoyed more subsidies and support from local industrial policies.
In summary, the reasons for this round of overcapacity are more complex, and the "excessive subsidies" of industrial policies, the change of technical routes, strong expectations and weak realities on the demand side are related, and the resolution of this round of overcapacity should start from both ends of supply and demand at the same time, "two-pronged".
First, supply-side reforms are still necessary
There are lessons worth learning from the last round of overcapacity management. Environmental protection inspections have been carried out nationwide to help the withdrawal of backward production capacity in the energy-intensive raw material industry, as well as downstream industries such as printing, papermaking, and leather shoemaking. For example, according to the data of the Ministry of Industry and Information Technology, 1) in the context of in-depth air pollution control in the country, in 2016, 6.77 million tons of backward iron-making capacity, 10.96 million tons of steel-making capacity, 320,000 tons of electrolytic aluminum production capacity, 5.59 million tons of cement clinker production capacity, 33.4 million weight boxes of flat glass production capacity, and more than 1,500 backward small coal mines below 300,000 tons/year were closed, involving more than 100 million tons of coal production capacity. 2) In 2017, during the special action of "strip steel" backward production capacity elimination inspectors, a total of 31.7 million tons of steel production capacity were withdrawn across the country, which can not only eliminate quality problems and safety hazards, but also reduce environmental pollution.
It should be noted that there are more private enterprises involved in this round of overcapacity industries, and the means of realization cannot simply copy the previous experience. Private enterprises are usually more reliant on market mechanisms and profit-driven, and it is not easy to reduce production capacity by executive order. Through the guidance of energy consumption, quality and standards, enterprises can be more effectively encouraged to take the initiative to eliminate backward production capacity and realize the optimization and upgrading of industrial structure. In terms of ways and means, we can not ignore the lessons of the previous round to avoid the recurrence of "one size fits all", and can give certain financial incentives to backward production lines that voluntarily withdraw, subsidize the terminal consumption of low-energy consumption products, levy "carbon tax" and other market-oriented forms, and give private enterprises stable expectations and full confidence.
Second, encourage innovation and improve quality standards
On the one hand, advanced production capacity is not easy to overcapacity, and technological innovation plays a vital role in capacity digestion. 1) Take semiconductors as an example: in the downward stage of the industry's prosperity, the capacity utilization rate of mature processes tends to decline more sharply, while advanced processes have technological leadership and exclusivity, and the impact is relatively limited. It can be seen that in the downward cycle of semiconductors, the key to the success of counter-cyclical expansion depends on whether the expansion factory has advanced technology, whether it has innovation ability, and whether it adapts to market changes. 2) In the power battery industry, the current excess capacity is close to the standard battery products used in the previous generation of old models, and the upgraded battery products (800V, etc.) have the problem of insufficient capacity and supply.
On the other hand, innovation in channels, business models and applications is equally important, and the launch and promotion of high-quality products can create demand, which will help enterprises with structural overcapacity to open up the market and digest production capacity. For example, photovoltaic and building integration projects, photovoltaic + transportation, photovoltaic + communications, photovoltaic + fishery and other models will help to broaden the market space on the demand side. In addition, it is necessary to improve the power grid's ability to absorb distributed photovoltaic grids, and relax the red line of 95% of clean energy consumption in stages, so as to avoid administrative restrictions becoming a bottleneck for the development of the industry.
Third, smooth the "external circulation" to resolve excess pressure
Create a good international environment, encourage enterprises to improve product competitiveness, and gain more international market share. As an emerging power, China plays an increasingly important role in international relations, but also faces the challenge of rising trade protectionism, and needs to actively participate in multilateral economic and trade cooperation to create a good international environment for enterprises to go overseas. On the one hand, we will consolidate the achievements of the Regional Comprehensive Economic Partnership (RCEP), the Belt and Road Initiative, and the BRICS cooperation mechanism. On the other hand, China will expand or upgrade free trade negotiations, further expand the network of high-standard free trade zones facing the world, including but not limited to the ASEAN Free Trade Area 3.0 negotiations, continue to promote accession to the CPTPP and DEPA, and conduct free trade negotiations or upgrade negotiations with Honduras, Peru, the GCC, New Zealand, South Korea, and Switzerland.
In the last round of overcapacity, the shipbuilding industry was a typical example of seizing international market share by improving its own competitiveness. Looking back on the development of China's shipbuilding industry in recent years, it can provide a useful mirror for dealing with the problem of overcapacity:
1) The shipbuilding industry was "big but not strong" in the early stage, and the shipbuilding industry was in trouble after the downward cycle. As early as 2011, the mainland became the largest shipbuilding country, but it has problems such as weak innovation ability, low management level and efficiency. In 2015, the mainland's new ship orders fell sharply, Taizhou's largest private shipbuilding enterprise Dongfang Heavy Industry, Wenzhou's largest private shipbuilding enterprise Zhuangji Shipbuilding, Zhejiang's well-known private shipbuilding enterprise Zhenghe Shipbuilding, China's largest foreign-funded shipbuilding enterprise STX (Dalian) Shipbuilding, all entered bankruptcy reorganization. On the one hand, this is due to the sluggish shipping, insufficient demand, overcapacity, and fierce competition in the domestic and foreign markets; on the other hand, the mainland's high-tech content and high value-added shipbuilding capacity is low, and it is difficult to compete with the technological advantages of Japanese and Korean shipbuilders. In 2015, there were 1,452 shipbuilding enterprises above designated size in China, with a main business income of 789.38 billion yuan, a year-on-year increase of 1.3%, and a total profit of 17.9 billion yuan, a year-on-year decrease of 32.3%, with a profit margin of only 2.3%.
3) After the transformation of the shipbuilding industry, it rose with the wind. During the transition period, China's shipbuilding industry has moved from conventional ship types to high-tech and high value-added ship types, achieving technological breakthroughs in green ships and zero-carbon ships such as LNG, methanol power, ammonia fuel reservation, hydrogen fuel cell and so on, and obtaining overseas orders. In 2023, the number of completed shipbuilding projects, new orders, and hand-held orders in mainland China will account for 50.2%, 66.6%, and 55.0% of the world's total in terms of deadweight tonnage, respectively, and the three major market share indicators will all exceed 50% for the first time. According to data from the China Shipbuilding Industry Association, China's shipbuilding capacity utilization monitoring index (CCI) will reach 894 points in 2023, an increase of 17.0% compared with 2022, and the annual operation will continue to rise. In 2023, the main business income of shipbuilding enterprises above designated size will be 623.7 billion yuan, a year-on-year increase of 20%, and the total profit will be 25.9 billion yuan, a year-on-year increase of 131.7%.
Risk Warning:
1. China is in a critical period of structural transformation, and the law of historical data may not be enough to guide reality.
2. If the domestic fiscal policy and monetary policy are less than expected, or the local government debt burden is too heavy to affect the policy transmission, the effect of "stable growth" may not be as expected.
3. If the real estate market adjustment pressure exceeds expectations, it may affect consumer confidence through the "wealth effect", and put pressure on the cash flow of real estate companies, impacting real estate investment.
4. If the overseas economic downturn exceeds expectations, or the risk of global industrial chain adjustment exceeds expectations, global demand may weaken, or China's export share declines, dragging down the performance of external demand.