What's Happening?
China's industrial policy, characterized by significant overcapacity, is creating instability both domestically and internationally. The country has developed a robust capability to mass-produce electric vehicles (EVs), but this success is overshadowed by the broader issue of overcapacity across various sectors. Domestically, this has led to price cuts, financial losses, and deflation, with the GDP deflator falling for nine consecutive quarters as of June 2025. Internationally, the surge in low-cost exports, referred to as the 'second China shock,' has prompted trade defense measures from countries like Brazil and India, as well as developed economies. This overcapacity is not limited to EVs but extends to high-speed rail, housing, and infrastructure, with many projects operating at a loss and contributing to China's growing debt.
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Why It's Important?
The implications of China's overcapacity are significant for global trade and economic stability. The influx of low-cost Chinese products threatens local industries, leading to job losses and deindustrialization in affected countries. This situation exacerbates trade tensions and could lead to more protectionist measures worldwide. Domestically, China's economic model, which emphasizes production and supply over consumer demand, may hinder its economic flexibility and growth. The persistent deflation and financial losses could impact China's long-term economic health, affecting global markets due to China's role as a major economic player.
What's Next?
China faces the challenge of addressing its systemic overcapacity issues. President Xi Jinping has acknowledged the problem, urging local governments to avoid overinvestment in sectors like AI and EVs. However, transitioning to a more consumer- and services-based economic model would require significant policy shifts, which may conflict with China's current industrial policy approach. The global community will likely continue to monitor China's economic strategies, as further trade tensions could arise if overcapacity issues remain unresolved.
Beyond the Headlines
The ethical and legal dimensions of China's industrial policy are noteworthy. The emphasis on production has led to practices such as bribery and graft, as well as irrational and illegal ventures. These issues highlight the need for stronger regulatory frameworks and transparency in China's economic activities. Additionally, the cultural impact of China's economic model, which prioritizes industrial growth over consumer welfare, may influence societal values and expectations within the country.
