BEIJING — A troubling trend is emerging in China across various sectors, from coffee and automobiles to real estate, as companies increasingly turn to discounts to maintain market presence. This phenomenon is raising concerns among economists.
According to a recent study by Natixis, which evaluated 2,500 publicly listed Chinese companies, the observed growth in volume is accompanied by deflationary pressures that are damaging overall value. Alicia Garcia Herrero, Natixis’ chief economist for Asia-Pacific, highlighted these issues during a Friday webinar, stating, “You can see it sector by sector, company by company.”
“While dominance in the market appears strong, the underlying costs of such dominance are high,” she noted. “Sales revenues aren’t sufficient to sustain operations.”
Official data reflects the widespread impact of these market dynamics, showing a 0.1% decline in consumer prices during the first half of the year, compared to the previous year, and a staggering 2.8% drop in factory-gate producer prices. Only seven out of 48 producer price sub-categories exhibited any increase, while nearly 50% of the 37 consumer price components showed some improvement.
This phenomenon of aggressive yet often unproductive competition has been termed “involution” in China, a concept that has gained traction in government discussions and policy papers aimed at addressing the issue.
Despite making technology and products more accessible to consumers, this trend raises alarms about a potential downward spiral that could lead to increased job losses across industries.
“The cold reality of the Chinese economy is often obscured by the headlines of growth,” remarked Larry Hu, chief China economist at Macquarie, in a report released Thursday. He pointed out that “A share” companies in China have seen workforce growth of merely 1% in 2024, marking the slowest expansion on record.
“Involution is a dual-edged sword within the ‘China model,'” Hu explained. “Significant investments can trigger price wars, resulting in poor returns for investors. Nevertheless, such competitive conditions could play a role in promoting industrial advancement and self-sufficiency.”
China’s advances in the electric vehicle sector provide a clear illustration, with major players like BYD offering discounts of nearly 30%, while Xiaomi has introduced its newest SUV at a price lower than Tesla’s Model Y.
Meanwhile, Starbucks has faced challenges in the Chinese market, experiencing declines in sales despite maintaining cup prices around 30 yuan (approximately $4.20), as various competitors, including Luckin Coffee, offer similar beverages for as low as 9.9 yuan.
In the realm of commercial real estate, attempts by property owners in Beijing to increase prices have resulted in increased vacancies, according to Rayman Zhang, managing director for North China at JLL. He expressed concerns over inadequate demand and the bleak prospects for a rebound.
China is expected to announce a gross domestic product growth rate of 5.2% for the second quarter compared to the same period last year, according to a Reuters poll. Though this figure falls short of the 5.4% growth recorded in the first quarter, it aligns with the national target for overall annual growth set at around 5%.
However, the latter half of the year may present a much grimmer picture, warned Jianwei Xu, a senior economist for Greater China at Natixis, who also participated in Friday’s webinar.
“We are observing that profits—particularly among manufacturing firms—continue to decline,” he stated. “The pressure on households is likely to intensify in the second half of the year, making employment opportunities scarcer.”
A different challenge
Analysts have noted that this is not the first encounter China has had with overcapacity, recalling issues with excess capacity in the state-controlled commodities sector a decade ago. However, the current landscape is complicated by the significant involvement of private enterprises, making policymaking more challenging.
“The prevalence of private companies in segments afflicted by overcapacity complicates the coordination of mergers, even with governmental encouragement,” stated Robin Xing, chief China economist at Morgan Stanley, alongside his research team in a Thursday report.
“Moreover, the economy is beginning at a weakened juncture, which necessitates demand-side stimulus to mitigate the effects of supply reduction,” the report observed. “Unfortunately, the government’s high debt levels—approximately 100% of GDP—may limit its ability and willingness to engage in aggressive fiscal expansion.”
Top leaders in China are anticipated to uphold significant fiscal stimulus measures during an influential Politburo meeting scheduled for later this month. Earlier this year, Beijing announced an increase in the fiscal deficit target for 2023 to 4%, up from 3% in the prior year.
During a high-level financial and economic commission meeting led by Chinese President Xi Jinping on July 1, officials stressed the necessity for improved governance concerning “low price, disorderly competition,” according to a translation by Finance Newso of Chinese state media reports.
The ruling Communist Party’s Qiushi journal outlined various measures aimed at establishing standardized behaviors within the government to mitigate the effects of involution-style competition, warning of significant economic repercussions. The article referenced multiple high-level discussions that had taken place in recent months.
“To achieve the growth target, it is essential for Beijing to initiate major demand stimulus efforts,” emphasized Hu. “Subsequently, enhancing domestic demand could alleviate price competition among material producers and internet companies. However, manufacturers may face a prolonged and arduous journey to manage their existing capacity.”
Global spillover
The ongoing trade war with the U.S. has further complicated efforts to address China’s domestic overcapacity, as highlighted by Goldman Sachs analysts in a report dated July 1.
Last year, both the U.S. and the European Union intensified their scrutiny of China’s persistent overcapacity challenges, raising tariffs specifically on Chinese electric vehicles to protect domestic manufacturers. Additionally, the U.S. applied higher duties on a broader range of goods in April.
The escalation of tariffs has pushed Chinese manufacturers to establish overseas factories, which could lead to redundant supply in the years ahead, the Goldman report indicates. Analysts project a capacity increase ranging from 0.5% to 14% by the end of 2028, up from previous estimates of 0.4% to 10%.
Among seven specific sectors—air conditioners, solar modules, lithium batteries, electric vehicles, power semiconductors, steel, and construction machinery—five currently possess more capacity than the global market can absorb, according to Goldman Sachs analysts. Only air conditioners and electric vehicles show minimal market potential.
— Finance Newso’s Victoria Yeo contributed to this report.
