China: An economy in a state of exhaustion

Seoul. If even the undisputed number one is groaning, the situation must be extremely serious. Last month, Stella Li, the second-most important executive at electric car manufacturer BYD, complained about the extremely brutal price war in the Chinese market. "It's very extreme, fierce competition. The current level is unsustainable," the businesswoman admitted in an interview with Bloomberg.

Your statements are particularly astonishing because in just a few years, BYD, once a completely unknown state-owned company, has now secured pole position in the field of e-mobility.

But the fact remains: The success of China's industrial policy is increasingly revealing its dark side. "We have a situation in which hardly any company is making a profit," says Jörg Wuttke. Since last year, the Heidelberg native has been working at the consulting firm DGA Albright Stonebridge Group in Washington. Previously, he headed the European Chamber of Commerce in Beijing, where he had lived since the 1980s, on several occasions. His opinion still counts: Wuttke is considered arguably the most profound German-speaking expert on the Chinese economy.

On Wednesday, the Beijing Bureau of Statistics, of all places, provided empirical evidence to support its findings. Producer prices, which have been in a sustained downward spiral since September 2022, fell particularly sharply in June, by 3.6 percent. What might initially sound positive, especially for consumers—lower product prices—is an extremely worrying development, especially in the long term, as it points to a weakening, even deflationary economy.

At a time when many Western countries are still feeling the effects of persistent inflation, there may be little awareness that deflation is a far more dangerous economic development. In such a phase, not only do investments decline, but the real value of debt also continues to rise. And, above all, deflation means that companies de facto earn less.

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The problem, however, is homegrown. China's industrial policy is based on Xi Jinping's economic planners specifying in five-year plans which strategic industries should be developed in the national interest. All companies then blindly follow the central government's call, knowing that money awaits them in the form of subsidies.

And since every Chinese local government wants to cultivate its own “champions” in the relevant industries, even unprofitable companies are kept artificially alive with excessive amounts of state money.

The negative consequences of this state-controlled economic model are also being increasingly openly criticized in the West: massive overcapacities, which are ultimately dumped on global markets at dumping prices. In retrospect, they also triggered the US-China trade war that Donald Trump unleashed during his first presidency.

Ahead of the EU-China summit, scheduled for the second half of July, EU Commissioner Ursula von der Leyen also addressed the problem in a keynote speech. In it, she accused the People's Republic of "flooding global markets with subsidized overcapacity – not only to boost its own industry, but also to stifle international competition."

The most impressive and instructive shock for the European Union was probably the solar industry, where German companies were once market leaders. But in the face of Chinese competition, which was able to offer its panels at radically lower prices, the former market leaders from Germany sank into irrelevance in just a few years.

However, the Chinese company's success was a double-edged sword: While they were able to quickly decimate their foreign competitors and achieve a kind of monopoly, they achieved virtually no profit margins along the way. A similar pattern is also evident with the success of Chinese electric cars: Only a few of the brands are currently making profits.

"The starting signal for a cleansing process that will certainly be painful has just begun," says China expert Wuttke. He was the first foreign expert to prominently warn about the growing problem of Chinese overcapacity. What Wuttke had already outlined in his policy paper with the European Chamber of Commerce in 2016 has now come to pass: namely, that China's companies in the solar and wind energy, battery, and electric car sectors will generate massive overcapacity.

The Chinese central government has long simply denied the problem. When French President Emmanuel Macron tried to discuss China's overcapacity with Xi Jinping last year, he consistently replied that "there is no such thing."

Of course, this was just a bluff. Nevertheless, it is remarkable that Beijing is now openly acknowledging the Achilles heel of its own economy. The current issue of Qiushi magazine, the leading political organ of the Communist Party, warned: "The imbalance between supply and demand (...) is primarily reflected in weak domestic demand and overcapacity in some industries, forcing existing companies to compete in a limited market to survive."

The Chinese have long been familiar with this feeling of being stuck in a hamster wheel. "Neijuan," which best translates as "involution," has become a viral buzzword: It describes the feeling of stagnating despite hard work because social advancement remains blocked for most. But companies also feel the "neijuan" concept—when they produce and export like world champions but ultimately fail to make a profit.

The economic planners in Beijing actually know what to do: They need to not only strengthen consumers to stimulate demand, but also consolidate the market. In plain language, this means that numerous unprofitable companies would go bankrupt. And this is rightly a nightmare for the party leadership because it poses a threat to social stability. Because, at least in the short term, unemployment in the country would rise significantly.