VZCZCXRO0999
RR RUEHCN RUEHGH
DE RUEHBJ #2549/01 1670553
ZNR UUUUU ZZH
R 160553Z JUN 06
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC 9168
INFO RUEHCN/AMCONSUL CHENGDU 6549
RUEHGZ/AMCONSUL GUANGZHOU 0818
RUEHGH/AMCONSUL SHANGHAI 4958
RUEHSH/AMCONSUL SHENYANG 6362
RUEHHK/AMCONSUL HONG KONG 7649
RUEHIN/AIT TAIPEI 5719
RHEHNSC/NSC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUEHGV/USMISSION GENEVA 1176
RUCPDOC/USDOC WASHDC

UNCLAS SECTION 01 OF 05 BEIJING 012549 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM, EB/TPP/BTA, AND EB/IFD/OIA 
STATE PASS USTR FOR STRATFORD/CELICO/KEMP 
TREASURY FOR OASIA/ISA 
USDOC FOR 5101/ITA/IA 
USDOC FOR 4220/ITA/MAC 
USDOC FOR 1003/ITA/OUS 
USDOC FOR 6310/ITA/TD/OIEM 
 
E.O. 12958: N/A 
TAGS: ECON EIND ENRG ELAB SENV WTRO CH
SUBJECT: CHINA: IS INDUSTRIAL OVERCAPACITY OVERWHELMING, OR 
OVERHYPED? 
 
 
¶1. (SBU) SUMMARY. THE CHINESE GOVERNMENT HAS IDENTIFIED 
SEVERAL INDUSTRIAL SECTORS AS SUFFERING FROM OVERCAPACITY. 
THE CENTRAL GOVERNMENT RECENTLY ISSUED REGULATIONS INTENDED 
TO ADDRESS THIS SITUATION OUT OF FEAR THAT THE OVERCAPACITY 
PROBLEM COULD IMPACT MACROECONOMIC STABILITY.  THE 
REGULATIONS ARE INTENDED TO CONTROL OVERCAPACITY BY 
PROMOTING THE ELIMINATION OF OUT-OF-DATE PRODUCTION 
TECHNOLOGY, INCREASING INDUSTRY ENTRY STANDARDS, AND 
ENCOURAGING GREATER ENVIRONMENTAL PROTECTION. SOME ANALYSTS 
BELIEVE OBSTRUCTIONISM BY LOCAL GOVERNMENT OFFICIALS INTENT 
ON PRESERVING THEIR LOCAL INDUSTRIAL BASE COULD DERAIL THE 
CENTRAL GOVERNMENT'S EFFORTS.  ADDITIONALLY, SOME EXPERTS 
ARE QUESTIONING WHETHER OVERCAPACITY REALLY EXISTS IN SOME 
SECTORS SUCH AS THE STEEL SECTOR.  IN THE END, EXPERTS 
BELIEVE THAT IF THE CENTRAL GOVERNMENT EXPECTS RESULTS FROM 
ITS EFFORTS TO COMBAT THE PERCEIVED OVERCAPACITY PROBLEM, A 
SENIOR LEVEL WORKING GROUP MUST BE ESTABLISHED IN THE 
CENTRAL GOVERNMENT TO LEAD THE CHARGE.  END SUMMARY. 
 
SEVERAL INDUSTRIAL SECTORS ASSESSED AS THREAT TO 
MACROECONOMIC STABILITY 
--------------------------------------------- -------------- 
 
¶2. (SBU) DR. SHI YAODONG, VICE-DIRECTOR OF THE STATE COUNCIL 
DEVELOPMENT RESEARCH CENTER'S (DRC) INDUSTRIAL ECONOMICS 
RESEARCH DEPARTMENT, SAID THAT THE NATIONAL DEVELOPMENT AND 
REFORM COMMISSION (NDRC) HAS IDENTIFIED SEVERAL INDUSTRIAL 
SECTORS AS POSSESSING EXCESS CAPACITY AND IS TAKING STEPS TO 
ELIMINATE THE OVERCAPACITY TO AVOID OVERHEATING THE ECONOMY. 
THE NDRC HAS DECIDED TO REIGN IN GROWING OVERCAPACITY IN THE 
STEEL, CEMENT, ALUMINUM, COKE, AND THE FERROUS ALLOY 
SECTORS.  TO ILLUSTRATE THE OVERCAPACITY PROBLEM, DR. SHI 
SAID THAT RESEARCHERS ASSESS THAT THERE IS SOME 470 MILLION 
METRIC TONS OF STEEL PRODUCTION CAPACITY, BUT THERE IS ONLY 
AROUND 350 MILLION METRIC TONS OF DOMESTIC DEMAND. 
MEANWHILE, IN THE CEMENT SECTOR THERE IS SOME 300 MILLION 
METRIC TONS OF EXCESS CAPACITY.  DR. SHI NOTED THAT MUCH OF 
THIS EXCESS CAPACITY IS GENERATED BY OUTDATED TECHNOLOGY 
THAT CONSUMES TOO MUCH ENERGY AND GENERATES EXCESSIVE 
POLLUTION. 
 
¶3. (SBU) NOTE:  DR. SHI DEFINED OVERCAPACITY AS THE ABILITY 
OF A SECTOR TO OVERPRODUCE A GIVEN PRODUCT, BUT CAUTIONED 
THAT WHAT IS CONSIDERED OVERPRODUCTION CAPACITY CAN VARY BY 
SECTOR.  FOR EXAMPLE, IN SOME SECTORS, SUCH AS 
TRANSPORTATION, USAGE RATES BELOW 85-90 PERCENT -- THAT IS, 
10-15 PERCENT OF AVAILABLE CAPACITY IS NOT BEING UTILIZED -- 
SUGGESTS THAT THERE MAY BE AN OVERCAPACITY PROBLEM.  IN 
OTHER SECTORS, UTILIZATION OR PRODUCTION RATES CAN BE AS LOW 
AS 70 PERCENT BEFORE RESEARCHERS ASSESS THERE IS A PROBLEM. 
DR. SHI ALSO NOTED THAT THERE IS NOT ALWAYS AGREEMENT ON 
WHAT USAGE RATE SIGNALS OVERCAPACITY PROBLEMS, CITING THE 
COAL SECTOR AS AN EXAMPLE WHERE THERE IS SOME DEBATE ON ITS 
STATUS.  BY CONTRAST, CHINA'S FERROUS ALLOY SECTOR 
PRODUCTION RATE OF 50 PERCENT IS AN EXAMPLE WHERE THERE IS 
CLEAR AGREEMENT ON THE SECTOR'S INCLUSION IN THE 
OVERCAPACITY CAMP. END NOTE. 
 
¶4. (SBU) DR. SHI STATED THAT THE CENTRAL GOVERNMENT MUST 
ADDRESS THE OVERCAPACITY PROBLEM BECAUSE IT IS POSING A 
TWOFOLD THREAT TO MACROECONOMIC STABILITY.  FIRST, THERE IS 
A VERY CLEAR TENDENCY TOWARDS EXCESS INVESTMENT IN THESE 
SECTORS.  AS AN EXAMPLE OF THIS PROBLEM, DR. SHI NOTED THAT 
DURING THE FIRST QUARTER OF 2006, IN SEVERAL OF THE 
OVERCAPACITY SECTORS, INVESTMENT IS SOME 30 PERCENT HIGHER 
THAN LAST YEAR DESPITE THE ALREADY CLEAR MISMATCH BETWEEN 
DEMAND AND SUPPLY.  SECOND, THE PRICE LEVEL OF NATURAL 
RESOURCE INPUTS INTO THESE SECTORS, MAINLY ENERGY RESOURCES 
SUCH AS OIL, IS RAPIDLY INCREASING, WHICH IS PLACING 
INFLATIONARY PRESSURE ON THE ECONOMY, ACCORDING TO DR. SHI. 
 
CENTRAL GOVERNMENT TRYING TO ADDRESS OVERCAPACITY... 
--------------------------------------------- ------- 
 
BEIJING 00012549  002 OF 005 
 
 
 
¶5. (SBU) DR. SHI SAID THAT IN MARCH AND APRIL 2006 THE NDRC 
AND OTHER RELEVANT CENTRAL GOVERNMENT DEPARTMENTS 
PROMULGATED SEVERAL REGULATIONS AS A FIRST STEP TO 
ADDRESSING THE CURRENT OVERCAPACITY PROBLEM.  THE 
REGULATIONS ARE INTENDED TO CONTROL OVERCAPACITY BY 
PROMOTING THE ELIMINATION OF OUT-OF-DATE PRODUCTION 
TECHNOLOGY, INCREASING INDUSTRY ENTRY STANDARDS, AND 
ENCOURAGING GREATER ENVIRONMENTAL PROTECTION.  DR. SHI 
STATED THAT THE REGULATIONS ARE NOT A CENTRAL GOVERNMENT 
ATTEMPT TO EXERT DIRECT CONTROL ON ENTERPRISES.  RATHER, THE 
REGULATIONS ARE A PART OF A BASKET OF MEASURES THAT WILL 
RELY ON COOPERATION BETWEEN THE CENTRAL GOVERNMENT AND LOCAL 
OFFICIALS AS WELL AS BETWEEN DIFFERENT CENTRAL GOVERNMENT 
DEPARTMENTS. 
 
¶6. (SBU) DR. SHI STATED THAT THE NEW CENTRAL GOVERNMENT 
REGULATIONS INTENDED TO FIGHT OVERCAPACITY PRIMARILY ADDRESS 
LAND MANAGEMENT, BANK LOANS, AND INDUSTRIAL SECTOR 
CONCENTRATION ISSUES.  OFFICIALS FROM THE MINISTRY OF LAND 
MANAGEMENT STATED THAT THEIR OFFICE RECENTLY ISSUED A 
REGULATION, ENTITLED DOCUMENT NUMBER EIGHTY-EIGHT, THAT WILL 
ADDRESS LAND MISUSE BY THE COAL SECTOR THROUGH THE LINKAGE 
OF TAXATION RATES TO ENERGY UTILIZATION.  THE MINISTRY 
INTENDS FOR THE REGULATION, WHICH IS CURRENTLY IN A TRIAL 
PHASE, TO PROMOTE BETTER UTILIZATION OF EXISTING MINES AND 
DISSUADE ABUSIVE LAND PRACTICES BY MINING COMPANIES. 
 
¶7. (SBU) DR. SHI NOTED THAT ON THE BANK LOAN FRONT, THE 
CENTRAL GOVERNMENT INTENDS TO PLACE RESTRICTIONS ON LOAN 
AMOUNTS TO INDUSTRIAL CUSTOMERS.  THE CENTRAL GOVERNMENT 
ALSO WILL ADJUST THE INTEREST RATE OF THE LOAN BASED UPON 
CERTAIN CRITERIA, MOST NOTABLY THE SIZE OF THE PROPOSED 
INDUSTRIAL PROJECT THE LOAN IS FUNDING.  AS AN EXAMPLE OF 
THE CENTRAL GOVERNMENT'S GOALS ON THE INDUSTRIAL 
CONCENTRATION FRONT, DR. SHI STATED THAT THE NDRC AIMS TO 
HAVE THE TEN LARGEST CEMENT PRODUCERS ACCOUNTING FOR 30 
PERCENT OF CHINA'S CEMENT PRODUCTION BY 2011.   AT PRESENT, 
THERE ARE SOME 5,000 CEMENT ENTERPRSES IN CHINA WITH THE 
TEN LARGEST PRODUCERS ONLY ACCOUNTING FOR ABOUT 15 PERCENT 
OF TOTAL PRODUCTION. 
 
...BUT TODAY'S REGULATIONS JUST THE LATEST IN A SERIES 
--------------------------------------------- --------- 
 
¶8. (SBU) DR. SHI STATED THAT THE JURY IS OUT ON HOW 
EFFECTIVE THE NEW REGULATIONS WILL BE AT CONTROLLING 
OVERCAPACITY.  THE RECENT REGULATIONS ARE JUST THE LATEST IN 
A SERIES OF MOVES THAT HAVE ALTERNATIVELY SOUGHT TO PROMOTE 
GROWTH IN THE NOW OVERCAPACITY SECTORS AND THEN, 
SUBSEQUENTLY, REIN IN GROWTH.  FOR EXAMPLE, DR. SHI SAID 
THAT IN 1998 THE CENTRAL GOVERNMENT ISSUED REGULATIONS TO 
PROMOTE THE GROWTH OF CERTAIN ENERGY-INTENSIVE SECTORS, SUCH 
AS ALUMINUM.  AS A RESULT, THE ALUMINUM SECTOR RECEIVED 
PREFERENTIAL POWER AND WATER PRICING THAT ENABLED THAT 
SECTOR TO GROW.  DR. SHI STATED THAT THE ALUMINUM SECTOR DID 
GROW, BUT NOT IN THE CONCENTRATED FORM THE CENTRAL 
GOVERNMENT SOUGHT.  THE CENTRAL GOVERNMENT THEN ISSUED NEW 
REGULATIONS IN 2004 THAT SOUGHT TO ENCOURAGE MORE LARGE- 
SCALE PRODUCTION IN THE ALUMINUM AND OTHER ENERGY INTENSIVE 
INDUSTRIAL SECTORS.  DR. SHI STATED THAT MANY OF THESE SMALL- 
TO-MEDIUM SCALE ALUMINUM ENTERPRISES ARE NOW CONSIDERED 
"BACKBONE ENTERPRISES" IN CERTAIN AREAS AND LOCAL 
GOVERNMENTS ARE RESISTING REGULATIONS THAT COULD DISLOCATE 
OR CLOSE THESE ENTERPRISES. 
 
IMBY: PLANNERS STRUGGLE WITH "IN MY BACK YARD" SYNDROME 
--------------------------------------------- ---------- 
 
¶9. (SBU) DR. LU TIE, PROFESSOR AT THE INSTITUTE OF 
INDUSTRIAL ECONOMICS AT THE CHINESE ACADEMY OF SOCIAL 
SCIENCES (CASS) EMPHASIZED THAT THE KEY TO REINING IN 
OVERCAPACITY IS TO REPAIR THE RELATIONSHIP BETWEEN THE 
 
BEIJING 00012549  003 OF 005 
 
 
CENTRAL GOVERNMENT AND LOCAL GOVERNMENTS.  THE CENTRAL 
GOVERNMENT HAS EMERGING ECONOMIC, LEGAL, AND ADMINISTRATIVE 
MEASURES TO COMBAT OVERCAPACITY, BUT LOCAL OFFICIALS HAVE 
MUCH GREATER INFLUENCE ON ECONOMIC DEVELOPMENT IN THEIR 
AREAS.  LU STATED THAT LOCAL LEADERS ARE COMPETING TO 
PROMOTE INDUSTRIALIZATION TO GENERATE JOBS, TAX REVENUE, AND 
GDP GROWTH AND, AS A RESULT, ARE CREATING OVERCAPACITY AND 
ENVIRONMENTAL PROBLEMS.  CENTRAL GOVERNMENT REGULATIONS ARE 
BEING MET BY RESPONSES FROM MOST PROVINCIAL AND LOCAL 
GOVERNMENTS THAT SUCH CONTROLS ARE APPLICABLE FOR OTHER 
AREAS, NOT THEIRS. 
 
¶10. (SBU) DR. LU COMPARED LOCAL GOVERNMENT LEADERS TO 
MANAGERS OF A LARGE BUSINESS IN THAT THEY SQUARELY FOCUS ON 
PROFITS AND THE BOTTOM LINE.  LOCAL GOVERNMENTS OFTEN DO NOT 
HAVE THE RESOURCES TO PROMOTE LARGE-SCALE PROJECTS SO THEY 
SEEK TO ENCOURAGE THE DEVELOPMENT OF MULTIPLE SMALL-TO- 
MEDIUM SCALE INDUSTRIAL ENTERPRISES TO FILL THE GAP.  DR. LU 
STATED THE CENTRAL GOVERNMENT'S LONG-STANDING ECONOMIC 
THEORY IS THAT LARGE-SCALE INDUSTRIAL ENTERPRISES HAVE LOWER 
COSTS BECAUSE OF ECONOMIES OF SCALE.  THE REALITY IN MANY 
PARTS OF CHINA IS QUITE DIFFERENT.  MANY SMALL-TO-MEDIUM 
SIZED ENTERPRISES ARE MUCH MORE PROFITABLE BECAUSE OF 
PROTECTION FROM LOCAL GOVERNMENT LEADERS.  THE RESULT IS 
THAT THESE INDUSTRIAL ENTERPRISES ARE ABLE TO SAVE MONEY BY 
FORGOING COSTLY OUTLAYS ON CENTRAL GOVERNMENT MANDATED 
ENERGY CONSERVATION OR ENVIRONMENTAL PROTECTION EFFORTS, 
ACCORDING TO DR. LU. 
 
¶11. (SBU) DR. LU INDICATED THAT THE EVALUATION SYSTEM ON 
WHICH LOCAL GOVERNMENT OFFICIALS RELY FOR THEIR PROMOTION 
AND ADVANCEMENT IS THE CAUSE OF THIS PROBLEM.  MOST LOCAL 
GOVERNMENT LEADERS UNDERSTAND THAT A CENTRAL GOVERNMENT 
PRIORITY DURING THE ELEVENTH FIVE YEAR PLAN IS TO PROMOTE 
POLICIES LEADING TO GREATER CONSUMER CONSUMPTION AND 
ENVIRONMENTAL PROTECTION. LOCAL GOVERNMENTS OFFICIALS ALSO 
ARE AWARE THAT DEVELOPING MORE ENVIRONMENTALLY FRIENDLY AND 
CONSUMPTION PRODUCING SECTORS, SUCH AS THE TOURISM AND 
SERVICE SECTORS, DOES LITTLE TO GENERATE TAX REVENUE.  LU 
STATED THAT AS A RESULT, MANY LOCAL GOVERNMENT OFFICIALS 
REMAIN COMMITTED TO USING INDUSTRIALIZATION TO DRIVE LOCAL 
ECONOMIC DEVELOPMENT AND GDP GROWTH.  ECONOMIC PLANNERS 
RECOGNIZE THIS DILEMMA AND ARE TAKING STEPS TO ADDRESS IT, 
BUT IN DR. LU'S OPINION, THEY ARE OVERLY OPTIMISTIC THAT 
THESE STEPS CAN SOLVE THE PROBLEMS IN A SHORT PERIOD. 
 
EMERGING POWER SURPLUS ALSO A PROBLEM FOR PLANNERS 
--------------------------------------------- ----- 
 
¶12. (SBU) DR. LU SAID THAT POWER GENERATION SURPLUSES THAT 
SHOULD EMERGE IN 2007 WILL EXACERBATE LOCAL GOVERNMENT'S 
PREDILECTION FOR ENCOURAGING INDUSTRIALIZATION. LOCAL 
GOVERNMENTS AND POWER PLANTS WILL OFFER SIGNIFICANT REBATES 
ON POWER PURCHASES BY INDUSTRIAL CUSTOMERS DURING THE NEXT 
SEVERAL YEARS BECAUSE THE NEWLY CONSTRUCTED POWER PLANTS 
WILL HAVE LOANS THAT THEY NEED TO PAYOFF.  DR. LU SAID THAT 
THIS MAY NOT BE A MAJOR PROBLEM IN EASTERN CHINA WHERE THE 
WELL ESTABLISHED POWER GRID CAN BE EFFECTIVELY REGULATED BY 
THE NDRC, ALTHOUGH SOME POWER PLANTS THERE MAY GIVE 
PREFERENTIAL PRICES TO INDUSTRIAL ENTERPRISES BECAUSE THEY 
ARE SUCH GOOD CUSTOMERS.  DR. LU SAID THE PREFERENTIAL POWER 
PRICING PRACTICE WILL BE MORE MANIFEST IN THE MIDDLE AND 
WESTERN PARTS OF CHINA.  THIS AREA HAS NEW POWER PLANTS, 
MANY OF THEM OFF THE ESTABLISHED REGIONAL GRIDS, THAT WILL 
BE COMPETING FOR THE BUSINESS OF SMALL-TO-MEDIUM SIZED 
INDUSTRIAL CUSTOMERS, PARTICULARLY THAT OF THE LARGE NUMBER 
OF FERROUS METAL SMELTING PLANTS LOCATED THERE. 
 
¶13. (SBU) NOTE: DR. LU DURING THE DISCUSSION ON CHINA'S 
POWER SITUATION SOUGHT TO REFUTE A STUDY THAT CALLED INTO 
QUESTION CHINA'S GDP GROWTH RATE FROM 1997-2000 PUBLISHED IN 
2001 BY AMERICAN RESEARCHER THOMAS RAWSKI.  THE STUDY 
ASSERTED THAT CHINA'S GDP WAS MOST LIKELY OVERSTATED BECAUSE 
 
BEIJING 00012549  004 OF 005 
 
 
THE RATE OF GDP GROWTH AND ENERGY CONSUMPTION WERE 
UNCORRELATED.  DR. LU STATED THAT RAWSKI UNDERESTIMATED 
ENERGY CONSUMPTION BECAUSE OF HIS OVERRELIANCE ON DATA FROM 
LARGE POWER PLANTS.  THE STUDY FAILED TO PROPERLY ACCOUNT 
FOR THE MANY SMALL-TO-MEDIUM SIZE POWER PLANTS IN CHINA THAT 
CONTRIBUTE TO CHINA'S OVERALL POWER GENERATION AND RESULTING 
ENERGY CONSUMPTION.  DR. LU ALSO CLAIMED THAT THE STUDY 
FAILED TO FACTOR IN THE PHENOMENON OF ENERGY AND POWER 
PRODUCERS UNDERREPORTING THEIR PRODUCTION TO AVOID PAYING 
TAXES, A PROBLEM THAT HE SAYS REMAINS TODAY. END NOTE. 
 
FOR STEEL SECTOR AT LEAST, WORRIES MAYBE OVERWROUGHT 
--------------------------------------------- ------- 
 
¶14. (SBU) YANG ZUNQING, DEPUTY SECRETARY GENERAL OF THE 
CHINA IRON AND STEEL ASSOCIATION (CISA) SAID THAT THE 
CENTRAL GOVERNMENT'S CONCERNS ABOUT OVERCAPACITY IN THE 
STEEL SECTOR ARE MISPLACED. IN FACT, CHINA'S CURRENT STEEL 
CAPACITY WILL BE INADEQUATE TO MEET RISING DOMESTIC DEMAND, 
DESPITE PUBLIC STATEMENTS BY CENTRAL GOVERNMENT OFFICIALS TO 
THE CONTRARY.  CISA ESTIMATES THAT ACTUAL STEEL PRODUCTION 
CAPACITY IS AROUND 415 MILLION METRIC TONS, VICE THE 470 
MILLION METRIC TONS TOUTED BY THE NDRC, AND NOT ALL OF THIS 
PRODUCTION CAPACITY IS AVAILABLE. YANG STATED THAT DURING 
THE NEXT TWO TO THREE YEARS, THE CURRENT STEEL PRODUCTION 
CAPACITY WILL MEET THE COUNTRY'S NEEDS THAT LAST YEAR WERE 
ESTIMATED AT AROUND 350 MILLION METRIC TONS.  BEYOND THAT 
TIMEFRAME, CURRENT PRODUCTION CAPACITY WILL FAIL TO MEET 
CHINA'S RISING DEMAND, ESTIMATED TO BE ANNUALLY INCREASING 
AT AROUND 15 PERCENT. 
 
¶15. (SBU) YANG SAID THAT TO MANAGE THE APPROACHING SUPPLY 
PROBLEM, THE CENTRAL GOVERNMENT MUST CONTROL THE GROWTH OF 
REAL ESTATE DEVELOPMENT AND NEW CONSTRUCTION, THE LARGEST 
DRIVERS OF STEEL DEMAND IN CHINA.  THE CENTRAL GOVERNMENT IS 
HAVING DIFFICULTY CONTROLLING THE ECONOMY AND IN PARTICULAR, 
REINING IN LOCAL AND PROVINCIAL GOVERNMENT SPENDING AND 
INVESTMENT.  YANG NOTED THAT CHINESE ECONOMIC POLICYMAKERS 
ARE LEARNING THE HARD WAY THAT ENACTING EFFECTIVE 
MACROECONOMIC POLICIES IN A MARKET ECONOMY IS VERY TOUGH. 
THE POLICYMAKERS ARE ALSO LEARNING THAT PREDICTING SUPPLY 
AND DEMAND IN CHINA'S RAPIDLY EXPANDING ECONOMY IS VERY 
DIFFICULT.  FIVE YEARS AGO ANALYSTS AND POLICYMAKERS ASSUMED 
150 MILLION METRIC TONS OF STEEL MAKING CAPACITY WAS 
SUFFICIENT TO MEET CHINA'S DEMAND, BUT THAT FIGURE IS NOT 
EVEN ONE HALF OF TODAY'S REAL DEMAND. 
 
¶16. (SBU) YANG ACKNOWLEDGED THAT THERE HAS BEEN PERIODIC 
OVERCAPACITY IN THE CHINESE STEEL SECTOR IN THE PAST. 
DESPITE THIS FACT, THE NEXT COUPLE OF YEARS OF EXCESS STEEL 
PRODUCTION CAPACITY SHOULD BE VIEWED AS AN OPPORTUNITY 
RATHER THAN A PROBLEM.  FOR EXAMPLE, STRUCTURAL REFORMS OF 
THE SECTOR THROUGH MERGER AND ACQUISITION ACTIVITIES AND 
TECHNOLOGY UPGRADES CAN ONLY BE DONE DURING SUCH PERIODS OF 
EXCESS CAPACITY. YANG STATED THAT THE CENTRAL GOVERNMENT 
SHOULD TAKE ADVANTAGE OF THIS OPPORTUNITY TO ENCOURAGE THE 
ADAPTATION OF TECHNOLOGIES THAT PROMOTE ENERGY EFFICIENCY 
AND ENVIRONMENTAL PROTECTION AND TO FACILITATE THE GROWTH OF 
INTERNATIONALLY COMPETITIVE STEEL ENTERPRISES.  THE CENTRAL 
GOVERNMENT WILL FACE AN UPHILL BATTLE IN DOING THIS BECAUSE 
APPROVAL AT MULTIPLE GOVERNMENT LEVELS IS REQUIRED FOR THESE 
EFFORTS, AND MANY LOCAL GOVERNMENTS HAVE SPHERES OF 
INFLUENCE THEY WANT TO PROTECT THAT SUCH INITIATIVES COULD 
CHALLENGE. 
 
OVERCAPACITY, OR NOT, PLANNERS HAVE TOUGH ROW TO HOE 
--------------------------------------------- ------ 
 
¶17. (SBU) CASS' DR. LU STATED THAT GIVEN THE OBSTACLES 
ARRAYED AGAINST THE OVERCAPACITY CONTROL EFFORTS, THE 
CENTRAL GOVERNMENT NEEDS TO FORM AN OVERCAPACITY LEADING 
GROUP SIMILAR TO THE ONE THAT MANAGES ENERGY POLICY.  THIS 
STEP SHOULD BE TAKEN SOON GIVEN THE CENTRAL GOVERNMENT'S 
 
BEIJING 00012549  005 OF 005 
 
 
GOAL OF 
OVERCAPACITY REDUCTION HELPING THE COUNTRY MEET ITS ENERGY 
CONSERVATION GOALS, AS OUTLINED BY THE ELEVENTH FIVE YEAR 
PLAN.  DR. LU STATED THAT THIS MEANS THAT IF REGULATIONS TO 
REDUCE OVERCAPACITY ARE GOING TO CONTRIBUTE TO THIS EFFORT, 
THEY MUST BE YIELDING RESULTS BY 2006 OR 2007. DESPITE THIS 
APPROACHING DEADLINE, THERE IS NOT YET A CLEAR, DEFINED 
SEQUENCING SCHEDULE FOR EFFORTS TO REDUCE OVERCAPACITY, 
ACCORDING TO DR. LU. 
 
¶18. (SBU) THE DRC'S DR. SHI NOTED THAT CENTRAL GOVERNMENT 
PLANNERS MUST ACCELERATE THEIR UNDERSTANDING OF HOW TO 
EMPLOY THE ECONOMIC, LEGAL, AND ADMINISTRATIVE TOOLS AT 
THEIR DISPOSAL TO ADDRESS OVERCAPACITY.  HISTORICALLY, 
CHINESE ECONOMIC PLANNERS RELIED SOLELY ON ADMINISTRATIVE 
MEASURES TO MAKE ADJUSTMENTS IN THE COMMAND ECONOMY.  SUCH A 
PRACTICE IS INADEQUATE IN CHINA' CURRENT ECONOMY. OVER THE 
LONG TERM, DR. SHI STATED THAT CHINA MUST DEVELOP ITS 
CORPORATE GOVERNANCE ARRANGEMENTS, INDUSTRIAL RELATIONS 
SYSTEMS, AND OTHER INSTITUTIONS IF IT WANTS TO DEAL WITH 
PERIODS OF INDUSTRIAL OVERCAPACITY IN A COHERENT FASHION. 
ABSENT SUCH MATURATION, CHINESE PLANNERS WILL PROBABLY FIGHT 
AN UPHILL BATTLE TO CREATE A BALANCED INDUSTRIAL STRUCTURE. 
 
RANDT