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| China's capitalist dilemma |
| Wei Gu / Feb 10, 2010, 00:21 IST |
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China capacity: In the days of the command economy, China's politicians could tell factory owners when to invest, and when not to. Times have changed. Beijing's orders to stop building new factories in sectors plagued by overcapacity are going unheeded. The answer may be to give overzealous managers a stronger taste of market forces.
Last year, investment contributed twice as much as consumption to China’s GDP growth. Some of the expansion looks excessive, even if a stimulus-driven consumption boost is currently keeping car and cement factories humming. Credit Suisse estimates surplus capacity in autos will double from current levels in two years — after factoring in 11 per cent projected annual sales growth.
In China, overcapacity does not always cut into profits. Cement, steel, and nonferrous metal in China all enjoy higher returns on equity than the industrial world average. For example, China Resources Cement and Baoshan Steel reported 2008 ROEs of 17 per cent and 7 per cent, respectively, far higher than foreign peers.
Much of the Chinese advantage comes from artificially low costs. Energy and bank credit are all available at well below world prices. The cheap yuan plays a role, but government-set prices are more significant. China’s gasoline, water, and industrial electricity tariffs are about one-third to one-half of world averages. This pattern is common in developing countries, but China’s prices are especially low, according to UBS research.
The simplest way to curtail excessive investment is to make it less profitable by letting input costs rise. Some steps have already been taken. National import tariffs for fuel oil were tripled for this year. But there is more to be done. Electricity prices, for example, remain too low.
Suppliers might try to pass increased costs on to customers, adding to inflationary pressures. But it’s a worthy trade-off. Without the right price signals, redundant factories could be a blot on the landscape for years to come.
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