- There’s a pattern in China: companies rush into an industry, then resort to discounts to stay afloat.
- “On the surface you’re dominating, but deep inside you’re paying a high price to dominate,” an economist said.
- The escalation of tariffs has made Chinese manufacturers more determined to build factories overseas, “potentially generating redundant supply in the coming years,” Goldman Sachs said.
Beijing In China, there is a common trend in industries like coffee, automobiles, and real estate: businesses enter the market quickly and then use discounts to stay afloat. Economists are concerned about that.
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Alicia Garcia Herrero, the chief economist for Asia-Pacific at Natixis, stated during a webinar on Friday that the company’s analysis of 2,500 listed Chinese companies supports the idea that while volume is increasing, deflationary pressure is hurting value. “You can see it sector by sector, company by company.”
“On the surface you’re dominating, but deep inside you’re paying a high price to dominate,” she stated. “You don’t get the revenue needed to continue.”
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The magnitude of the impact is demonstrated by the fact that, according to official data, factory-gate producer prices declined by 2.8% in the first half of this year, while consumer prices fell only 0.1% from the same period last year. About half of the 37 consumer price components increased over that period, but only seven of the 48 producer price subcategories did.
In China, this intense and frequently fruitless struggle is referred to as “involution”. In recent policy documents, the government has adopted the term and called for action to address the tendency.
The trend has lowered the cost of technology and products for the general public, but it has also raised concerns about a vicious cycle that could lead to further job losses for businesses.
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“With involution, the Chinese economy feels much colder than the headline growth suggests,” Macquarie chief China economist Larry Hu stated in a research released Thursday. “A share” businesses listed in mainland China grew their workforces by just 1% in 2024, the smallest expansion on record, he noted.
“From a more fundamental perspective, involution is both a feature and a bug of the ‘China model,'” he stated. “Price wars and low shareholder returns are the results of massive investment. Intense competition, however, may aid policymakers in achieving self-reliance and industrial development.
The most obvious example is China’s push into electric vehicles, where smartphone manufacturer Xiaomi is pricing its newest SUV lower than Tesla’s Model Y and industry behemoth BYD is providing certain discounts of almost 30% or more this year.
While a number of competitors, including Luckin Coffee and shops, sell lattes for as little as 9.9 yuan, the American coffee giant Starbucks has battled in China with declining sales, maintaining prices of about 30 yuan per cup ($4.20).
Rayman Zhang, the managing director for North China at property manager JLL, told reporters Thursday that property owners who attempted to boost rates in Beijing, even in the commercial real estate market, were met with more vacancies. He pointed out that there is still not enough demand and that a recovery is unlikely anytime soon.
According to a Reuters poll, China is anticipated to post second-quarter GDP growth of 5.2% from a year ago on Tuesday. That would be in line with the national goal of about 5% growth for the year, albeit slower than the 5.4% increase in the first quarter.
However, Jianwei Xu, senior economist for Greater China at Natixis, cautioned that the second half of the year will probably show a far more troubling picture. He spoke at the webinar on Friday as well.
“We are seeing the profits especially for manufacturing companies, are still decreasing,” he stated. “There could be more households under stress in [the second half of the year] because it will be more difficult to find a job.”
Analysts noted that China has already dealt with overcapacity, citing overcapacity in the state-run commodities sector roughly ten years prior. However, because there are fewer state-owned businesses engaged, it is more challenging for lawmakers to take action.
“The dominance of private firms in industries with overcapacity tends to complicate the coordination of mergers, even with government guidance,” a team led by Morgan Stanley senior China economist Robin Xing wrote in a research released Thursday.
“The economy is also starting from a weaker point, which necessitates more demand-side stimulus to counter the impact of supply reduction,” the paper stated. “However, the government’s debt level is already high (~100% of GDP), which may constrain its willingness and ability to undertake aggressive fiscal expansion.”
At a high-level Politburo meeting later this month, China’s senior leaders are anticipated to uphold the present fiscal stimulus. In March, Beijing increased the nation’s annual fiscal deficit from 3% to 4%.
Notably, a high-level finance and economic commission meeting convened by Chinese President Xi Jinping on July 1 demanded greater control over “low price, disorderly competition,” according to a Chinese state media translation provided by CNBC.
To combat involution-style competition, the official Qiushi journal of the ruling Chinese Communist Party on July 1 even listed a number of policies that encourage uniform government conduct while threatening severe economic harm. High-level government meetings during the past few months were referenced in the story.
“To achieve the growth target, Beijing will have no choice but to launch a major demand stimulus,” Hu stated. “Thereafter, the increased domestic demand would lessen the price competition between internet behemoths and material producers. However, absorbing the current capacity would be a drawn-out and painful process for manufacturers.
In a research released on July 1, Goldman Sachs analysts noted that the trade conflict with the United States is making it more difficult to resolve China’s domestic overcapacity.
Last year, the European Union and the United States grew increasingly critical of China’s ongoing overcapacity problems. In an effort to safeguard domestic automakers, both have increased taxes, specifically on Chinese electric vehicles. In April, the United States also imposed increased levies on China in general.
Chinese manufacturers are now more inclined to establish facilities abroad as a result of the tariffs’ increase, “potentially generating redundant supply in the coming years,” according to the Goldman analysis. Compared to the 0.4% to 10% expansion predicted a year ago, the analysts predicted a 0.5% to 14% increase in capacity by the end of 2028.
Additionally, according to Goldman analysts, five of the seven industries—air conditioners, solar modules, lithium batteries, electric vehicles, power semiconductors, steel, and construction machinery—have more capacity than the total amount of demand worldwide. The only vehicles with some market potential are air conditioners and electric vehicles.
This report was provided to by Victoria Yeo of CNBC.
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