What overcapacity?

The last day of US Secretary Janet Yellen’s trip to China coincided with the strongest retort yet from Beijing officials over her claims that China is flooding global markets with cheap goods, particularly in the new green industries.

As Yellen laid out plans to formalise dialogue with China over excess industrial capacity in electric vehicles (EVs), solar panels and batteries, saying Washington would not accept U.S. industry being “decimated”, the Chinese finance ministry issued a statement saying it had already “fully responded” to her concerns.

Commerce Minister Wang Wentao, at a roundtable meeting with Chinese EV makers in Paris on Monday, said U.S. and European assertions of excess capacity were groundless, adding China’s rise in these industries was driven by innovation and complete supply chain systems, among other factors.

China’s latest response, analysts say, centres on the idea that its production system is simply more competitive, a sharp change in tone from only a month ago when officials including Premier Li Qiang sounded their own warnings on overcapacity.

The strong pushback from Beijing contrasts with the generally warm interactions between Yellen and Chinese officials during her trip, leaving the two largest economies further apart on the hottest dispute in global trade, which could add to tensions.

“They cannot win the race, so they try to slow it down,” said Li Yong, chief researcher at D&C Think, a Chinese think tank, referring to the West’s rhetoric on overcapacity.

“We just do our things, they can do whatever they want – the knife is in their hands.”

Both sides believe they have solid, data-supported arguments not to back down.

The core criticism coming primarily from Washington and Brussels is that state-led support for manufacturers, coupled with depressed domestic demand, is pushing excessive Chinese supply onto global markets.

This drives down prices.

Prices have fallen sharply in two of the green energy industries dominated by China. In lower-end industries prices have been more stable.

The data showing the year-on-year growth in volume and value of Chinese exports of the following items between 2021 and 2024: electric vehicles, solar panels, lithium-ion batteries, tractors, decorative wooden products and shoes.

Consequently, it threatens U.S. and EU firms which survive on profits rather than what Western officials argue is a drip-feed of state resources in China. And, it can complicate longer-term investment decisions.

China’s industrial complex is expanding, but many firms cannot cope with the heightened competition.

While China denies subsidies and points to U.S. and EU government programmes to support their own industries, its critics take a wider view of state support that incorporates cheap loans, land use, huge infrastructure investment and other benefits that span across a fully-integrated supply chain.

EU trade officials have singled out the huge resources redirected by China’s state-dominated financial system from the ailing property sector to its sprawling manufacturing complex, as Beijing looks for other economic growth drivers.

PBOC channels more credit into the manufacturing sector at the expense of the property sector.

For its part, China says industrial overcapacity is not unique to the world’s second-largest economy.

“The so-called ‘overcapacity’ is a manifestation of the market mechanism at work, where supply-demand imbalance is often the norm,” vice finance minister Liao Min told local media.

“This can occur in any market economy system, including in the United States and other Western countries, where it has happened multiple times in history”.

Industrial capacity utilisation in China is lower than in the United States or Europe, but not by much.

As U.S., EU industries find it harder to compete with their Chinese rivals, Western officials say China’s state-led, investment-heavy manufacturing model is unfair.

Also, China asserts supply and demand should be viewed from a global perspective, particularly given Western criticism focuses on industries key to climate goals for the entire planet.

That argument resonates.

“I’m very sceptical about this idea of overcapacity,” Nicholas Lardy, senior fellow at Peterson Institute told a financial forum in Hong Kong.

“If you think about it, it means every country should only produce what it consumed itself. That means no trade. Where would we be if there was no trade?”

It’s not a new debate. More than a decade ago, Washington complained that the U.S. rust belt was crippled by Chinese overproduction of steel, which had forced China to dump it at very low prices.

But China can argue its output is more in tune with global demand than it was back then. China’s inventory levels have ticked up during the COVID-hit years, but remain well below levels seen in the 2010s.

Inventory levels in China are picking up but still remain much lower than the historical norm.

China views the “new three” industries of electric vehicles, batteries and solar power as key for its development.

In 2023, exports of the “new three” totalled 1.06 trillion yuan ($146.6 billion), up 29.9% year-on-year, official data showed. But they accounted for only 4.5% of China’s total yuan-denominated exports last year, so those on Beijing’s side of the debate see the West’s focus on them as hypocritical.

“U.S. and Europe have a bit of a gangster logic,” said Wang Jun, chief economist at Huatai Asset Management.

In the automotive sector, China argues overcapacity is concentrated in combustion-engine cars rather than EVs and says market mechanisms will eventually weed out weak players.

Moreover, some models by Chinese EV maker BYD sell in Germany for more than double their price in China - an argument that critics use against Europe’s concerns over unfair pricing.

China also says many of its firms are more innovative, hence more competitive. It can point to surpassing the United States as world leader in patent applications.

One industry where global demand does not keep up with Chinese production, though, is solar.

Xuyang Dong, China energy policy analyst at Climate Energy Finance in Sydney, estimates China’s wafer, cell and module capacity coming online in 2024 is sufficient to meet annual global demand now through to 2032.

At the end of 2023, China’s annual production capacity for finished solar modules was 861 gigawatts (GW) equivalent, more than double global module installations of 390 GW.

“If you think of it from this perspective, the Chinese government is subsidising the whole world’s green transition,” said Yue Su, principal China economist at the Economist Intelligence Unit.

“Whether this is fair to EU manufacturers or workers is a different question.”

“Having said that, even if the West increases tariffs, I still foresee that China is going to dominate in many of these industries.”

Tariff decisions

Yellen hammered home a stern warning to China’s economic leaders that their overinvestment in factory capacity for clean energy goods is unacceptable throughout her four-day visit to Guangzhou and Beijing.

She did it while appearing to charm her Chinese hosts this past week, but now comes the hard part: deciding whether to advise President Joe Biden to move toward raising U.S. tariffs on Chinese electric vehicles, solar panels and other clean energy goods to protect U.S. producers and workers.

Her other option is to press for time to allow a new U.S.-China dialogue on the issue to generate other solutions.

Yellen and her main counterpart, vice premier He Lifeng, launched the talks on “balanced growth,” including industrial capacity and weak Chinese and global demand, on Saturday in the southern factory hub of Guangzhou.

Previous U.S.-China dialogues, including one launched in 2006 by former Treasury secretary Hank Paulson and a successor forum during Barack Obama’s administration, largely failed to persuade China to shift away from its state-driven, investment-led economic model to a more market-driven path despite years of regular meetings.

On what may be her last trip to China as Treasury chief, Yellen saw pushback on her core complaint that a massive export wave of cheap EVs and solar panels, fuelled by state-supported production capacity that far exceeds domestic demand, was threatening competitors all over the world.

China trade experts say that the new dialogue may need to take place alongside a new Biden administration trade action, such as a new “Section 301” tariff investigation or World Trade Organization complaint.

Former president Donald Trump used Section 301 of the Trade Act of 1974, which covers unfair trade practices, to impose tariffs on hundreds of billions of dollars worth of Chinese imports in 2018. The Biden administration is now nearing completion of a lengthy review of whether to renew those duties.

“This dialogue isn’t meant to be a negotiation, so I don’t expect the U.S. to sit on its hands,” said Scott Kennedy, a China economics expert at the Center for Strategic and International Studies in Washington. “Washington will continue to amass evidence to be prepared to take action.”

While in China, Yellen won plaudits from Chinese officials, academics and social media users. She publicly savoured Chinese cuisine and culture, sipping a beer made with American hops at a Beijing microbrewery and showing off her chopstick skills at a Cantonese restaurant in Guangzhou, the southern export hub.

Chinese Premier Li Qiang took note of the social media attention, telling Yellen: “The Chinese ‘netizens’ have been following your trip since the moment you landed in Guangzhou, and that shows the high expectations they have for the outcome of your visit.”

They spoke for nearly three times the 30 minutes scheduled for their bilateral meeting on Sunday.

Unlike her first trip to China in July 2023, Yellen took time out to socialize with her hosts and visit cultural sites, including Beijing’s Forbidden City on a private, after-hours tour.

Yellen and He exchanged gifts on a Pearl River boat cruise, in the southern export hub of Guangzhou. She received a ceramic platter with an image of her official photo, and presented him with a signed painting print of cherry blossoms at Washington’s Tidal Basin, an attendee said.

“She has a particularly high level of credibility within the Chinese government,” American Chamber of Commerce in China Chair Sean Stein said of Yellen. “She maintains a focus on economics and talks about things in a dispassionate way.”

While the goodwill opened doors, pushback from state media and Chinese officials show disagreement with Yellen’s core assertion that China’s green energy manufacturing capacity far outstrips local demand and is flooding global markets with cheap exports from money-losing firms.

Chinese Commerce Minister Wang Wentao on Monday called such claims baseless and said Chinese EV makers’ success is due to innovation, not subsidies.

A Chinese government adviser told Reuters that industrial overcapacity is a topic for discussion with U.S. officials, “but not something that can be resolved.”

“There will be no global trade if there is no overcapacity” and assertions of excess output in new energy sectors are “outrageous,” the adviser said on condition of anonymity.

Still, Yellen’s trip and the growing relationship with Chinese officials give her an “elevated voice” in the Biden tariff debate, said Wendy Cutler, a former U.S. trade negotiator who heads the Asia Society Policy Institute.

But Cutler said it would be hard for Yellen to argue in favour of more time for dialogue during a hotly contested U.S. presidential election year amid rising anti-China sentiment in the United States.