Is China turning out the lights on the sunset industries?

In the cement industry, companies have been ordered to shut down facilities with annual production capacity of more than 92 million tonnes, while steel producers have been ordered to eliminate 7 million tonnes of capacity. 

This clamp down on overproduction is the beginning of a painful makeover of the economy as the government attempts to shift manufacturing from sunset to sunrise industries. China wants to maintain a strong mass-manufacturing base, but rising wages and cooling markets means it has to move up the value chain by switching to high-margin, high-end manufacturing in areas such as biotech, IT, aerospace and telecommunications. 

Reorganising the manufacturing sector is a tough challenge for any country. For China, this is especially so, as it strikes at the very heart of its economic and political system. Industrial investment is centrally planned and heavily driven by subsidies, estimated to contribute up to 30 per cent of industrial output. This has led to overcapacity, distorted prices, and wastage of scarce resources such as electricity and water supplies. 

The subsidies are mainly distributed through local governments and take the form of cash, cheap land, cheap credit, discounted utilities and tax breaks. They, therefore, provide useful levers for local officials to gain political influence so previous efforts by the central government to reform the manufacturing sector have had limited success.

It may seem surprising that the current campaign against overcapacity comes at a time when the economy is slowing down but there is a strong rationale for doing it now. The economy needs to be reinvigorated and one way to do this is to redirect resources to more efficient use. Most of the factories being shut down are heavy users of electricity and outdated technology. It is estimated that in these target industries, capacity utilisation is running at 75 per cent or less – whereas in a normal competitive economy it should be over 85 per cent.

Another good reason to carry out the reforms now is that the government has embarked on a programme to rejuvenate 120 cities saddled with polluting heavy industries, which were set up in the early days of China’s industrialisation drive. The cost of relocating these industries is huge, running into trillions of yuan, and since most are sunset industries, which are bankrupt or nearly bankrupt, there is a strong case for closing them down altogether.

Abrupt closures would cause social problems, however, as they are major employers in the provincial centres so local governments have been asked to develop detailed plans for transition. This involves not just the phasing-out or relocation of outdated plants, but encouraging other types of industry, such as high-speed rail, aircraft, renewable power and biochemical industries.

Despite many challenges and obstacles China faces, Zhang Gaoli, the executive vice premier in charge of the economy, says the government is determined to succeed: “We intend to accelerate the transformation of the economic development model and vigorously adjust and optimise the economic structure.”

In addition to providing incentives for sunrise industries, the government will take a tough stand on compliance – such as banning approvals for new projects in industries with overcapacity and halting constructions in industries that violate regulations. One thing is clear – this is an important era of transition for China. As the economy matures China may not be able to return to double-digit growth, but with a new energetic leadership it has an opportunity to launch a very positive wave of development, which is clean, efficient and modern.

 

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