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RR RUEHCN RUEHGH RUEHVC
DE RUEHBJ #3349/01 3490920
ZNR UUUUU ZZH
R 150920Z DEC 09
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC 7238
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 03 BEIJING 003349 
 
SIPDIS 
 
SENSITIVE 
 
TREASURY FOR OIA CWINSHIP AND TTYANG 
NSC FOR LOI 
 
E.O. 12958: N/A 
TAGS: ECON EIND EFIN EU CH
SUBJECT: CHINA/OVERCAPACITY: OVERWEIGHT OR HEALTHY BABY FAT? 
 
Refs: A. Beijing 2952; B. Hong Kong 2124; C. Shanghai 0273. 
 
¶1. (SBU) SUMMARY: China's industrial structure is extremely 
overcapacity and the recent massive government stimulus packages and 
credit expansion exacerbated the problems, according to a November 
26, 2009 EU Chamber of Commerce report.  The report stirred 
controversy in China's blogosphere and media with its claim that 
excess capacity fueled trade protectionism, and was soon followed by 
a Chinese government press conference outlining the government's 
measures to combat overcapacity.  Economists, academics, and 
policymakers agreed industrial overcapacity was a serious and 
pervasive problem in China, although difficult to evaluate on an 
industry-level basis.  While the recent fiscal and monetary stimulus 
plans increased investment, there was little consensus on whether 
the majority of funding went to fuel infrastructure projects or 
further industrial overcapacity.  Chinese observers hoped 
overcapacity would not lead to trade disputes, but the EU Chamber of 
Commerce's president noted a series of trade remedy cases currently 
making their way through the European system.  END SUMMARY. 
 
 
EU Chamber Report: Overcapacity a "blight" 
------------------------ 
 
¶2. (SBU) The Beijing-based European Union Chamber of Commerce on 
November 26, 2009 released a report, "Overcapacity in China," 
charging that Chinese industrial overcapacity was a "blight on 
China's industrial landscape... wrecking far-reaching damage on the 
global economy in general and economic growth in particular."  The 
report stated that Chinese industrial overcapacity would lead to 
trade disputes as other economies sought to protect their markets. 
It investigated six industries that the Chinese government had 
identified as suffering from over-capacity: steel, aluminum, cement, 
chemicals, refining, and wind power equipment. 
 
¶3. (SBU) The authors attributed overcapacity to several "key 
recurring factors," namely: 
-- high retained earnings (i.e. excess profits) by State-Owned 
Enterprises (SOEs) 
-- collapse of export-market demand 
-- low domestic consumption due to low incomes 
-- weak enforcement of regulations and health/safety standards 
-- artificially low input prices 
-- artificially low capital costs 
-- artificially low technology costs 
-- incentives to local governments to attract investment 
-- local protectionism and regionalism 
-- an over-emphasis on market share over profitability. 
 
Report Provokes a Harsh Reaction 
-------------------------- 
 
¶4. (SBU) EU Chamber President Joerg Wuttke admitted to Econoff that 
the report was timed for release just before the EU-China Summit, 
and had provoked an unexpectedly strong reaction from both the 
foreign and domestic media.  Chinese state media and netizens lashed 
out at the concept that such excess production could result in trade 
protectionism.  The Global Times warned flatly: "Do not blame trade 
protectionism on China's excessive productivity."  Blogs such as 
EEO, Huachen, Wang Yi, and Jin Rong Jie acknowledged that 
overcapacity has been a problem for years, especially in the six 
industries Chen Bin, Director of the Department of Industry at 
China's National Development & Reform Commission (NDRC) committed to 
curbing in October: steel, cement, plate glass, coal-chemicals, 
polycrystalline silicon, and windpower equipment.  Bloggers, 
however, called the EU Chamber's assertion that overcapacity would 
lead to global trade disputes "inaccurate" and "absurd."  And the 
Chinese government reacted quickly: the NDRC and Ministry of 
Industry and Information Technology (MIIT) held a press conference 
in Beijing on December 3, 2009, announcing new, stricter guidelines 
to control overcapacity in steel, cement and flat glass. 
 
But Is Overcapacity Really a Problem? 
--------------------------- 
 
¶5. (SBU) Within a specific industry, and even with excellent data 
sets, measuring overcapacity was challenging, analysts told EconOff. 
 Steven Watson, Chairman of Capital Research and Management's China 
Business Group, explained to Econoff that his staff had been looking 
at the Chinese steel sector in great detail, but had been unable to 
determine whether China's current excess capacity is a long-term 
systemic problem, or a cyclical downturn resulting in a dip in 
demand, implying that China will grow into its current capacity. 
Similarly, Dragonomics Research Managing Director Arthur Kroeber 
noted that it was possible many companies were "just a little bit 
 
BEIJING 00003349  002 OF 003 
 
 
ahead of growing demand."  Kroeber cited the auto industry as a case 
where many analysts thought the major players were producing at too 
high volumes, but later revised their opinion when new cars were 
still rolling off the lots.  China Academy of Social Sciences (CASS) 
Researcher Liu Feng opined that traditional industries, such as 
iron, steel and cement suffered from overcapacity, but commented 
that new industries, such as wind and solar power, may not be over 
capacity.  Moreover, Chinese industrial overcapacity was temporary, 
he said, and just an issue during this period of rapid development: 
"People should see the problem from a developing country 
perspective." 
 
¶6. (SBU) Taking a more macroeconomic, economy-wide view, however, 
most economists agreed that excess investment had led to excess 
capacity.  World Bank Economist Louis Kuijs told Econoff that 
government policies led to increased capacity, such as direct 
stimulus money, subsidies to energy, lax environmental regulation, 
and over-accommodating local officials.  Stephen Green, an analyst 
with Standard Chartered, agreed that the stimulus package had 
encouraged new capacity, especially in the cement industry where new 
facilities are easily constructed.  Green echoed Kuijs' main reasons 
for overcapacity: "artificially low energy and land prices, local 
protectionism, and the lack of a proper framework for mergers and 
acquisitions do indeed facilitate the building of more and more 
heavy industrial capacity."  UBS Economist Wang Tao added another 
factor, noting that local officials were evaluated by their 
locality's GDP growth rates, and capital-intensive growth tended to 
be faster, creating an incentive for lowering the costs of such 
investment. 
 
Does the Stimulus Investment Exacerbate It? 
------------------------------- 
 
¶7. (SBU) CASS's Liu noted that much of the stimulus was aimed at 
earthquake reconstruction and infrastructure projects like light 
rail, subways and roadways.  Additionally, infrastructure 
investments in Western provinces such as Gansu and Qinghai may be 
underused at present, but it was widely believed they would be 
utilized in the future.  UBS's Wang Tao agreed that China could 
still utilize large amounts of infrastructure investment.  She 
asserted that, given China's size, population, and rapid growth, 
China did not have too much infrastructure.  She went on to compare 
China's transportation infrastructure with the United States at 
similar stages in development, arguing that China could still make 
productive use of large infrastructure investments.  Dragonomics' 
Kroeber agreed China had huge infrastructure needs and this spending 
had not been wasted.  As hundreds of millions of people moved to the 
cities, they would require much more infrastructure.  Some funded 
projects were anticipatory, but at worst China had "borrowed" some 
future growth by front-loading infrastructure spending. 
 
¶8. (SBU) The World Bank's Kuijs, on the other hand, argued that much 
of the Chinese stimulus program was not simply infrastructure 
investment but rather a more accommodative lending environment.  He 
saw the recent global economic crisis policy environment as 
exacerbating overcapacity because it led to very easy access to 
credit in China.  Extremely fluid capital led to "worrisome" 
increases in investment even in industries where domestic demand had 
not increased.  IMF's Vivek Arora also worried that credit was 
flowing to certain industries already burdened with overcapacity. 
While unconcerned about loans extended to households and 
infrastructure projects, he was unable to determine the destination 
for almost two-thirds of the stimulus-fueled credit expansion. 
(Note: in a recent meeting with U.S. visitors, a Chinese banker 
admitted that that new bank lending often flowed to industries with 
overcapacity, despite careful guidance from Beijing on the types of 
business allowed to receive loans.  End note.) 
 
 
Stimulus Indirectly "Fuels the Trade War Fire" 
------------------------ 
 
¶9. (SBU) Kroeber asserted that it may have been true in the late 
1990s that excess consumer goods and textiles were dumped on the 
international market.  However, not all current overcapacity led to 
trade disputes, he cautioned.  Instead, the problem was one of 
scale.  For example, even if only 10 percent of steel produced in 
China was for export, that approximately 60 million tons was still 
"an astonishing figure that influences global prices and markets." 
Kroeber added that Chinese policymakers were not used to thinking 
about their policy impacts on global markets.  They were, however, 
used to the reverse, playing victim to international influences. 
 
¶10. (SBU) CASS researchers Lu Tie and Li Xiaohua disagreed with the 
claim that excessive Chinese productivity directly led to global 
 
BEIJING 00003349  003 OF 003 
 
 
trade disputes:  "It is hard to say how much the stimulus packages 
fan the trade war fire.  This is another excuse for trade 
protectionism."  However, CASS researchers agreed that excessive 
productivity in certain industries pressured exports.  Economic 
recovery would alleviate the situation, even though official data 
showed Chinese industry has about a 60 percent reliance on exports. 
 
¶11. (SBU) EU Chamber President Wuttke disagreed strongly, suggesting 
that the world would see many anti-dumping cases against China 
coming from the European Union.  "Eleven are in the works," Wuttke 
claimed. 
 
 
HUNTSMAN