Deeper capacity cuts needed to avert protracted slowdown

We estimate that sectors responsible for two-thirds of China’s industrial output now suffer from overcapacity. Despite this, policymakers continue to drag their feet on reform due to fears that deep capacity cuts would cause a rise in lay-offs and an immediate economic downturn. But unless officials act soon, the economy’s sustainable growth rate could more than halve in the years ahead. In any economy, a cyclical fall in demand can create spare capacity temporarily. But a major concern in China’s case is that a misallocation of resources is causing production capacity to be persistently higher than demand.  The sectors that we identify as suffering from surplus capacity account for 70% of the country’s industrial output and almost a quarter of China’s GDP. Firms in these sectors also employ 80 million workers, which is 10% of China’s workforce.