Overcapacity is Not Harmonious

China and the European Union are meeting these two days, and it is hoped that with the newly-elected president of the EU, Van Rompuy, the EU will finally have one voice and figure out its China policy.

Nevertheless, the meeting of the 12th China-EU Summit in Nanjing has had a bit of a rocky start with the EU Chamber of Commerce in Beijing releasing a report late last week claiming that China's industrial overcapacity is sparking trade tensions and raising the risk of bad loans.

According to the study by the chamber and Roland Berger Strategy Consultants, China's 4 trillion yuan ($586 billion) stimulus package is worsening capacity, especially in steel, aluminum, cement, chemical, refining and wind-power equipment industries.

Basically, in order for China to maintain its economic momentum this past year, it has propped up the above-mentioned industries with subsidies, keeping business as usual even though orders overseas are way down. And because domestic demand for these goods are not high enough, many of these things are dumped in other countries at extremely low prices. Which is why we are seeing so many tariffs being slapped on Chinese-made goods.

"The Chinese stimulus package has poured credit into increasingly questionable projects," the report said, without specifying them. "The global impact can already be felt in the form of growing trade tensions."

It also says that China is the main "victim" of its own overcapacity. The chamber said lower profits means companies lack money to invest in research and development, to create value-added goods. Businesses are also forced to cut costs, leading to slower wage growth and thus less consumption.

"This is a major obstacle on the government's path to become both an innovative and sustainable economy," the report said.

It recommends the Chinese government cut overcapacity by lowering subsidies, raising interest rates to curb easy credit, and investing more in the social security net so people feel more free to spend. It also says costs for utilities like electricity and water should be raised so there will be less wastage and impact on the environment.

However, China will not take any of these recommendations, at least not right away. Currently it is painting itself as a victim of all these tariffs and its people cannot understand why China has good relations with say the United States when they are slapping tariffs on all kinds of Chinese-made goods.

What China should have done a year ago was seriously restructure its economy, especially state-run enterprises, cutting the excess fat, as they are not even as close as productive as privately-run companies, consolidate companies -- do you really need some 40 car manufacturers? And it needs to seriously invest in innovation. We're not talking about making the tiniest computer or developing more games on cell phones, but things that are not yet on the market.

Instead the country is dragging its feet, preferring to just continue on the same path it has always been on and hope that the rest of the economies around the world pick up again so it can continue being the world's factory.

Speaking of which, the Ministry of Commerce has produced a 30-second commercial I saw once today on CNN where the government is trying to promote that China manufactures all kinds of goods, from gadgets to clothing to airplanes. As if we didn't know that already.

It is the perfect illustration of how behind the government is in realizing what is going on outside the country and trying to get a step ahead instead of just trying to keep up.