History illustrates that neither individuals nor nations can thrive in isolation, as their survival and prosperity depend on interconnectedness. This principle forms the basis of international relations and trade. Economic thought has long explored the reasons behind the global exchange of goods, resulting in the development of key philosophies and intellectual contributions known as "theories of international trade." Among the most significant theories are Adam Smith's "Absolute Advantage" and David Ricardo's "Comparative Advantage."
These basic axioms also form the foundation of the current global economic system, known as the "Bretton Woods System." Its organizational structure consists of three institutions: the International Bank for Reconstruction and Development, the lending arm of the World Bank Group, the International Monetary Fund (IMF), and the World Trade Organization (WTO), which is responsible for liberalizing and regulating trade between nations today. The WTO also imposes sanctions on member states that violate its agreements. The latter was ratified by countries through arduous negotiations lasting nearly half a century within the framework of the "General Agreement on Tariffs and Trade" (GATT).
Although the world has maintained and defended the Bretton Woods system for the past eight decades, recent years have witnessed multiple significant trade conflicts. A potent example is the trade war between the US and China, which have competed in imposing tariff and non-tariff restrictions on each other's goods and products. This has led to the disruption of many of the foundations of the international trade system, threatening its stability and causing divisions which are likely to widen in the long term. This US-China trade conflict cannot be separated from its broader context: the rapidly escalating geopolitical struggle between the two powers. Similarly, we cannot ignore the link between this conflict and Washington and some Western countries' concern over China's excess productive capacity, which may be another episode in the broader trade and geopolitical struggle between the two sides.
China's Excess Productive Capacity
The Chinese economy achieved exceptional advancements during the three decades from 1980 to 2010, with growth exceeding 10 percent in most years of that period, even reaching levels of 15 percent in some years. Despite the global financial crisis that erupted in 2008 and weighed heavily on the global economy throughout the following years, the Chinese economy maintained annual growth exceeding 6 percent that decade. Moreover, the contraction of the global economy amid the COVID-19 pandemic in 2020 did not prevent the Chinese economy from growing and expanding. Beijing achieved growth of over 2 percent that year and surpassed 8 percent in 2021 before the expansion pace slowed in the subsequent two years (2022 and 2023), dropping to 5.2 percent and then 4.5 percent, respectively.
This expansion in Chinese economic activity means producing more goods and products, which required sufficient population growth. Despite China having the largest population in the world for many years, surpassed only by India in mid-2023, its population growth remained far below its economic growth. Consequently, the economy's production capacity exceeded the population's consumption capacity. From 1980 to the end of 2023, China's annual population growth averaged about 0.85 percent, which is less than a tenth of its annual economic growth rate. In this sense, for every ten additional units of production in China over those years, consumer demand increased by only one unit, leaving a nine-unit-surplus to its market needs.
Although the Chinese economy relied heavily on exports for decades to offload its excess production and alleviate some pressures, its ability to do so has declined in recent years. The primary reason for this decline is the global economic slowdown and reduced demand, especially during the COVID-19 crisis. This situation caused a significant dilemma for Chinese policymakers. Although this challenge coincided with China adopting a new economic approach relying on domestic demand, the dilemma worsened as the local market's ability to absorb increasing production dwindled, particularly since the country's population began to decline in 2022. This was reflected in China's industrial inventory levels, which saw accelerating and successive increases beginning in 2021.
Oxford Economics attributes the gap between China's industrial production and inventory levels to Beijing's renewed focus on a high-output growth strategy to ensure its economic recovery. The institution noted that China's return to this policy has negatively impacted meetings between its officials and their counterparts in the United States and some European Union countries. Western countries criticized this policy for pushing Chinese producers to export heavily to their markets at artificially low prices. In other words, China will follow a policy of dumping against their markets.
Excess Production: A Flaw or an Advantage?
Excess production is only problematic under specific conditions and within theoretical assumptions used solely for the purpose of simplification. In economic theory, this is discussed in two scenarios: first, when referring to the production of a specific economic unit (a company or factory), the production volume of the unit must match market needs, or else its production will accumulate, leading to losses. The second scenario involves the supply volume of a specific commodity in the market, regardless of the number of producers. Economic theory necessitates a balance between supply and demand for this commodity at a certain point. In the case of excess supply, producers will reduce their production to achieve balance, or some will incur losses and exit the market.
Thus, in either of the aforementioned scenarios, it is necessary to balance the supply of the product and the market demand to meet production economics requirements. However, if the excess supply pertains to a country's or an economy's production, the situation is different, and economic theory does not present this as problematic. Instead, it views excess production as the real reason for trade between countries, where countries with surplus export to those with deficits. This aligns with the absolute advantage and comparative advantage theories, which are foundational theories of international trade and economics.
This also aligns with the principles and agreements on which international economic organizations were founded within the Bretton Woods system. The extensive effort that countries exerted to conclude the General Agreement on Tariffs and Trade, which led to the establishment of the World Trade Organization, aimed to liberalize and regulate trade between nations. There can be no trade between countries without excess production.
Other Beneficiaries
Even though China has significantly benefited from extensive exporting, whether before or after joining the World Trade Organization, this does not mean it is the only beneficiary. All markets that received cheap Chinese exports also gained from the exchange, as they could secure their needs for certain goods at a lower cost than if they had imported from other countries with higher production costs.
For example, the production cost of jeans in the United States is nine times higher than in China. This means that if an American consumer has to pay USD 90 for jeans produced by an American company domestically, they will only pay USD 10 for the same jeans from the company's factory in China.
The positive effects of low Chinese production costs are not limited to consumers' living standards worldwide. They also benefit large companies, which achieve returns and profits from their operations in China that they could not have achieved otherwise. This is why companies have been eager to establish factories in China to benefit from low production costs. For instance, according to a report by Wood Mackenzie, a global provider of data and analytics for the energy transition, the production cost of equipment required for achieving the global goal of transitioning to clean energy is about 20.7 percent lower if produced in China than outside it. The institution estimated the production cost of this equipment in China to be about USD 29 trillion, compared to USD 35 trillion outside of China. This means companies can increase their profits by about USD 6 trillion by setting up factories in China to produce this equipment.
According to the same report, intensive Chinese investments have reduced the cost of global clean energy industries and technologies. The cost of wind energy equipment production has decreased by about 43 percent, solar energy equipment by about 85 percent, and energy storage equipment (including batteries) by about 87 percent. These figures indicate significant positive implications for the spread of clean energy technologies. This is necessary to achieve global climate goals and enhance energy security, which is a facet of comprehensive and sustainable development worldwide.
New Economic War
The reasons for the current emphasis on China's excess productive capacity cannot be understood without considering the historical and geopolitical context. Over the past decades, the rise of China's export capabilities has concerned governments in developed countries, such as the United States and most European economies, notably Germany, France, and Italy. The increase in Chinese exports has come at their expense, cutting into their export markets and making Chinese products strong competitors in their domestic markets.
In the case of the United States, the trade balance has shifted to a chronic and significant deficit with China. Beijing has also become a major destination for American investments, raising concerns among US policymakers about the future of their economy and its dominance. According to data from the US Department of Commerce, the US trade deficit with China was about USD 367.4 billion in 2022 and is expected to grow. While US imports from China increased by about 6.3 percent that year, US exports to China grew by only 1.7 percent. Concurrently, China has long been a preferred destination for American investments due to its low production costs. The same data shows that cumulative US investments in China reached about USD 126.1 billion in 2022, while Chinese investments in the US amounted to USD 28.7 billion in the same year, highlighting the significant gap in the attractiveness of each side to the other's investments.
The situation becomes more apparent when considering that the growth rate of US investments in Chinese markets is higher than that of Chinese investments in the US While the former increased by about 9 percent, or USD 10.4 billion, in 2022, Chinese investments in the US grew by only about 7.2 percent, or USD 1.9 billion, in the same year. In other words, for every dollar the US receives from Chinese investments, it sends about five to China.
This occurs despite US policymakers having long implemented restrictive measures to curb the flow of Chinese products into their country and prevent US investments from flowing to China. This was evident in former President Donald Trump's "America First" policy to prevent what he called "the export of American jobs to China." US economic policies towards China have continued even after Trump left office, coinciding with similar European policies. The situation intensified as Washington and Europe adopted initiatives to compete with China's "Belt and Road" initiative, such as the Build Back Better World initiative undertaken by the G7, the EU's Global Gateway strategy, and the Economic Corridor initiative linking Europe to India, which has US support.
Under these circumstances, the issue of "China's excess productive capacity" arises, and we and some European countries use it as a new economic pressure tool against Beijing. This suggests we are facing a new chapter in the economic war between the US and China, deepening the global economy's division. Conversely, any excess capacity in any country represents an opportunity to produce as many goods as possible before exporting them to countries in need at the lowest possible prices. This is the essence of international trade, which aims to improve living standards and global development rates.
