U.S.-China Commission Highlights Industrial Overcapacity, Stagnant Reforms in 2014

In 2013, there were high hopes that change was on the horizon for many of the issues that have caused tension in the U.S.-China economic relationship.  China’s new president, Xi Jinping, hailed by many as an aggressive and unapologetic reformer, unveiled an agenda at the Chinese Communist Party’s Third Plenum to fundamentally reorient the nature of the Chinese economy.  Just before the release of the Third Plenum reform plan, China’s State Council also released a plan promising to address rampant overcapacity in industrial sectors such as steel and aluminum.  According to the U.S.-China Economic and Security Review Commission’s (USCC) 2014 Annual Report, however, China fell short this year both in addressing overcapacity and in implementing its broader reform agenda.  The Report’s conclusions indicate that, despite recent pronouncements regarding trade deals with the United States and other countries, China has a long way to go before it can be considered to operate as a true market economy.

While some observers characterized the 2013 overcapacity plan as a meaningful new step, USCC reminds readers that “Chinese policymakers have been trying to pare down industrial overcapacity since 2005; yet after nearly a decade of efforts, economists believe that the problem has actually worsened.”  Specifically, USCC’s Report notes that China has added approximately three million tons of new aluminum smelter capacity since 2013.

According to the World Aluminum Association, China now produces more primary aluminum than the rest of the world combined.  USCC’s Report also notes that China’s steel sector continues to suffer from overcapacity, as “local government [rely] on steel mill expansion as an easy way to increase local output and employment.”  The Report highlights this year’s antidumping and countervailing duty investigations into steel wire rod from China as an example of the global effects of China’s failure to adequately resolve its domestic overcapacity problems.

Lingering industrial overcapacity and continued reliance on exports are only some of the symptoms of sluggish progress in the Chinese leadership’s broader economic reform agenda. USCC’s Report specifically notes:

  • Shanghai Free Trade Zone: “[T]he Free Trade Zone (FTZ) has achieved minimal progress in 2014 as businesses and legal advisers struggle to find any notable benefit from operating in the trade zone rather than elsewhere in China.”  The Shanghai FTZ’s shift to a “negative list” approach to regulating foreign investment remains overly broad, with restrictions on 139 sectors.
  • State-Owned Enterprise Reform: “Reform of China’s State-Owned Enterprises (SOE) largely stalled in 2014, though some limited SOE reform did take place.”  These limited reforms, including introducing hybrid ownership structures into certain SOEs that remain wholly owned by the government, are similar to earlier rounds of SOE reform inasmuch as they aim to increase operational efficiency but do little to fundamentally alter the nature of state control over certain industries.
  • Financial Reforms: While Chinese financial regulators have recognized the need for broad reform to China’s financial system, USCC’s Report notes that they “lack the political clout to implement” certain reforms and that, even these regulators have said that “timing would depend on ‘good conditions’ in the Chinese and global economies.”  China’s policymakers have been both cautious and suspicious of financial liberalization ever since the Asian Financial Crisis crippled many of its neighbors’ economies in the late 1990s.
  • Foreign Investment Reform: According to USCC, “China’s government has made minimal progress in liberalizing restrictions on foreign investment. . . . Many sectors remain fully or partially closed to foreign investment in China, but the government has reformed foreign ownership restrictions in some niche sectors.”  Notably, in 2014, Chinese foreign direct investment into the United States exceeded U.S. investment into China for the first time since economic ties were re-established.

While the “deadline” for accomplishing the goals set out in the Third Plenum reform plan is not until 2020, slow progress thus far may serve as an indication of what can be expected in the coming years.