China's under-reported drive against overcapacity, massive M&As, home appliances subsidies - Week in Review #26

Hi folks, this week I will dedicate to a review of developments in China that are very relevant to the so-called “over-capacity” issue. (And don’t worry, you will have Part 2 of my Georgia travelogue very soon.)

Ever since Janet Yellen brought this issue up in her April visit, the term “over-capacity” has carried with itself very politicized connotations, to the point that I often feel uncomfortable using this term directly, lest unknown troublemakers from the shadow use it to claim that I align myself too closely with China-unfriendly narratives.

But setting aside the moral question of whether it’s better to produce too many or too few, and if you just ask whether there is an over-competition issue in many Chinese industries, leading to low margins and worn-out businesses across the board, to “involution”: Yes, we definitely have that. As we repeatedly mention at Baiguan, this is the situation that China ourselves want to break out of as well.

In the past few weeks, I have observed that some tangible measures have been underway to finally solve this issue, which is minimally talked about in the outside world. In this week’s review of events in China that matter beyond news cycles, I will give this one a review. I will also comment on the moderate consumer home appliance subsidy programs that have been rolled out in many cities.

#1 The (under-reported) national sweep of local subsidy programs

In the 3rd Plenum Decision, there is a very crucial line that has sent shivers to local governments around China:

规范招商引资法规制度，严禁违法违规给予政策优惠行为。

We will bring local regulations and institutions for attracting investment under regulation and strictly prohibit policy incentives in breach of laws and regulations

This line points to the heart of the so-called “over-capacity”, or “over-competition” issue in China.

If you think about it, when people say “China has over-capacity”, why has that happened? It’s definitely not a situation where Beijing just orders we should have a serious over-capacity of industrial goods. It’s not in Beijing’s interests for manufacturers and workers in China to earn just a penny while subsidizing the whole world’s consumption.

But long-time observers of China understand you often find answers to China’s different problems not in Beijing, but at China’s local government level: the 300-something prefectures and 3,000-something counties that are constantly competing among themselves.

One big job of local government in the past few decades, apart from selling land, is to do 招商引资, or “attracting businesses and investment”. Each local “招商办 business attraction office” usually has among the biggest local budgets in any local government, especially for poorer regions. Even in first-tier cities like Shanghai or Beijing, local district governments also fiercely compete for business.

In their arsenal of tools to attract business, the main weapon has always been various kinds of subsidy programs. And a lot of the subsidies are tied to taxation. It’s common to see various schemes to “return” to relocated businesses almost all of the local taxes and even land sale revenue, essentially giving all sorts of freebies to attract businesses from richer regions. Our production-centered economy can find roots in this unique setup. (And that’s why I keep pounding at the idea that fiscal reform and reform to the relationship between central and local governments are at the heart of the 3rd Plenum reform and almost any consequential reforms you see in China.)

The hope of local government is that as businesses move in, local GDP and employment will go up, and it will be easier for them to sell more land. Any loss of taxation as a result of subsidy programs will be more than made up for by more land sales. Land, after all, was the real source of income for local government.

This is a smart move by local governments when real estate is booming. But real estate is not booming now. And suddenly local governments are caught by a double storm of declining land sales and over-subsidised business taxes.

Another negative side effect of this over-competition between regional governments is “over-capacity”, or in the Party’s preferred language: 重复建设 duplicate construction. From the eyes of the central government, local government is essentially giving away valuable fiscal resources in order to build capacity that we do not need anymore, which, eventually, will turn to waste.

As soon as the 3rd Plenum is over, this becomes one of the areas the central government is going against really hard.

This comes in the form of 2 important documents. One is titled “关于规范招商引资行为促进招商引资高质量发展若干措施的通知 Notice on Several Measures Regulating and Promoting High-quality Development of Business and Investment Promotion Activities.” (“Document No.28”). Another is “公平竞争审查条例Regulation on Review of Fair Competition” (“Fair Competition Regulation”)

The exact contents of Document No.28 have not been made public, while the Fair Competition Regulation has been announced and has been implemented since August 1, immediately after the conclusion of the 3rd Plenum.

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