Industrial capacity in China and the US
A tale of two cities
Industrialization has the potential to transform not only China’s appearance but the face of the entire world. It has the power to determine not only the fate of China, but the fate of the planet. Industrialization cannot be restricted to China, after all. We must go out to meet the world. Not only do we want our products to “go global,” we also want our industrialization to go global, and our high-quality talent to go global. We can spread industrialization to every corner of the world. Many of our scientists and technicians will travel around the world to work, bringing with them civilization, a dignified existence, and relief from poverty. This is one thing that Westerners have been unwilling or powerless to accomplish.
Turns out it really is possible to have too much of a good thing, and that’s what China has right now.
After decades of explosive growth (~70x GDP since 1979) centered around industrial policy to build all kinds of physical infrastructure and products, China is now facing economic crisis, as shown through recent real estate crashes, slow GDP growth, high youth unemployment, etc.
The reasons for this crisis are overdetermined. You can point to the country’s demographics (China’s aging population), its politics (Xi Jinping’s grip over society), its foreign relations (countries pulling out foreign direct investment), etc., and it really is probably a combination of all these things and more! But the story I like is one of industrial policy. China is simply directing its economy to build too much stuff.
The US is facing problems, too, but to dig ourselves out of them, we need to build more, not less. We have a massive housing shortage, can’t build infrastructure quickly or cheaply, and are facing structural blockers to our industrial policy.
So China and the US are each facing their respective problems, but these problems stem from two opposite sides of the same coin of industrial capacity. It’s clear from examining a few specific industries that China overbuilds while the US underbuilds. The reasons for their divergence are different—in China, it’s a problem of political economy while in the US, it’s more a problem of building constraints. And the problems that result are economic in nature although we’ll see that in the US, it’s also geopolitical. In any case, for all of the differences and animosity between China and the US, they’d be wise to inch nearer to each other in how much they build.
China simply builds way too many things. When I say “things,” I specifically mean physical assets that require significant up-front capital to produce—things like infrastructure (e.g., housing, transportation), manufactured products (e.g., solar panels), and manufactured commodities (e.g., steel, cement). And when I say “way too many,” I mean that the level of demand for these things is drastically lower than the level of supply to make the economics work. You can see China’s overproduction problem in a few of these industries below (although you can see it in many others too, like steel, coal, heat pumps, aluminum, glass, and low-end robotics):
Housing. China has infamous “ghost cities,” where massive real estate buildup combined with weak demand has created some housing developments that are ~1% occupied. According to Goldman Sachs, the total value of unsold homes, unfinished projects and unused land in China is about $4.1 trillion.
Transportation. China’s high-speed rail network is the longest in the world—approximately ~28,000 miles, enough to encircle the entire Earth. While some routes like Beijing-Shanghai are packed with people, other routes are heavily underutilized since they connect cities with low population densities.
China also builds too many airports. In 2017, WSJ reported that 75% of Chinese airports lost money because they serviced too few flights. A new airport built in Cangyuan (a remote part of China), for instance, only serviced 3 flights a week. Of course, that was pre-COVID, and it’s taken some time for Chinese air travel to rebound, but China still plans to build a few hundred additional commercial airports over the next 10 years.Climate technologies. Countries around the world have accused China of “dumping” its climate wares on the global market. Indeed, China’s yearly production capacity of solar cells and batteries is 2x and 1x global demand, respectively. As a result of this oversupply, Chinese factories are going idle. For example, the utilization rate in China’s solar power industry plummeted to just 23% this year.
The way overproduction happens is a story of political economy. That is, China’s politics affect the way individual actors—specifically, local governments—decide whether and how much to build.
The Chinese Communist Party is obsessed with industrialization. From the time Deng Xiaoping took power in 1979 and opened China to the world, the country has made industrial policy one of the sharpest tools in its policy toolkit. But industrial policy is a means, not an end, and initially that end was rapid GDP growth. Over the past decade, however, industrialization has become an ideology all to itself, inextricable from nationalism, self-sufficiency, and legitimacy. Wang Xiaodong, the author quoted in my intro, penned the seminal essay that gave birth to China’s so-called “Industrial Party” subculture. This Industrial Party stands in stark contrast to the West’s “Sentimental Party,” which emphasizes consumerism. While this dichotomy is grossly reductionist, it’s true for many countries that, after industrialization has produced rapid GDP growth, their economies have shifted towards consumption (US at 70%, UK at 61%, Japan at 51%, China only at 39%). China simply scorns consumerism, preferring, as Wang says, to “Let the Americans sing and dance for us while we smelt our iron.”
Too many local governments and companies are building. The Chinese state is centralized in theory but decentralized in practice. While the CCP articulates top-down targets and incentives to build more infrastructure, it’s actually local and provincial governments that make the day-to-day decisions to build. These local party politicians, looking to capture those incentives and perhaps earn faster promotion within the party, take on massive debt from state-owned banks to build infrastructure. Local companies also earn local government and bank support.
The economics of overproduction just don’t work. Because building these things requires significant capital up-front, and because many of these things are undifferentiated, making the economics work is a game of low margins and high volume. This is why companies and cities across China are over-producing solar cells, batteries, steel, airports, roads, etc. But the Chinese economy can’t absorb all these things being churned out, which is why you see the ghost cities, ghost airports, and underutilized factories! Unable to generate enough revenue to service their debts and manage their costs, these companies are forced to lower prices, cut wages, and resort to “dumping” their wares onto foreign markets.
The problems with industrial overproduction are primarily economic in nature. I won’t comment on the tradeoff between the economics of China’s industrial policy vs. the political ideology of pursuing industrial policy, but here are the economic problems:
Consumers are hurting. As described, local governments and businesses overproduce these products, reduce those products’ prices, and reduce wages. Inflation in China has hovered near 0% (no, this is not a good thing), and China is at risk of sliding into a deflationary spiral. The CCP has lowered taxes to help consumers, but this has come at the expense of local government revenue, which is also problematic, since social services spending is on the rise due to the rapidly aging population. This debt distress has forced many Chinese cities to slash spending on other programs, including basic services like heating.
It’s not good to keep zombies alive. Companies and state-owned enterprises are teetering on the edge of solvency. The income statements for these companies suggest they should be dead, but the Chinese government keeps them on life support—hence, zombies. The government has reduced the taxes and fees levied on firms as a way to spur their growth.
Keeping these zombies alive is bad for economic recovery. If market signals can’t inform these companies that they’re over-building things that people won’t buy, then the incremental dollar spent on building these things is highly wasteful. Indeed, China’s incremental capital-output ratio — the dollars of capital needed in order to generate an additional dollar of GDP — has risen relentlessly from 2007. Furthermore, total factor productivity in China has been down significantly since the post-Great Financial Crisis, largely because unproductive firms aren’t exiting over time.Depreciation costs will be painful. China will need to maintain all its manufacturing plants, buildings, infrastructure, etc. In other words, China is spending lots of money today to build, but it will also need to spend lots of money tomorrow to maintain it all.
While China builds too much, the US builds too little. Let’s look at the exact same industries we looked at for China.
Housing. We have a massive housing shortage (experts estimate between 4-7 million) that’s causing a run-up in home prices. If the average home price in the US is ~$500,000, this is up to a $3.5 trillion housing shortage (compared to China’s $4.1 trillion housing surplus).
Transportation. Our roads and trains cost way more per mile than those of other rich countries. A retrofit of the San Francisco Bay Bridge, which was originally supposed to cost $250 million, ended up costing $6.5 billion. New York’s Second Avenue subway, which we began planning for over 20 years ago and was originally slated to cost ~$3 billion, is still under construction (on Phase 2 of 4) and has already cost ~$9 billion.
Climate technologies. In spite of Biden’s Inflation Reduction Act, which allocates $400 billion to building green energy projects like solar, wind, EV chargers, etc., we’re still woefully behind in bringing green energy online. Even after these projects get completed, they need to get hooked up to the power grid in a process known as “interconnection.” Today, nearly 11,600 projects are actively seeking interconnection, up from 5,100 in 2020. Projects being built today are taking nearly 5 years from the initial interconnection request to begin commercial operations, compared to 3 years in 2015 and < 2 years in 2008.
Unlike China, the way this happens in the US is less about political economy and more about building constraints. We have the budget, dollars, and often even the willpower to build, but the US government requires builders to jump through a number of regulatory hoops. To make matters worse, it’s too easy for everyday people to also slow down the building process.
The government makes it hard to build. Ezra Klein’s piece on “everything bagel liberalism” captures it all here. Builders must fulfill a host of expensive requirements before they even put shovels to the ground—requirements like small business requirements, local hiring requirements, sex/race/ethnicity requirements, etc. You also have regulations like the National Environmental Policy Act (NEPA) review process, which gives everyday people the right to sue project developers and force them to complete a cumbersome environmental review. This sets projects back by years, costs lots of money, and discourages developers from pursuing projects in the first place.
People make it hard to build. The “Not In My Back Yard” (NIMBY) movement is basically a bunch of people (conservatives and progressives alike) whose goal is to prevent others from building physical things. This is a classic example of vetocracy, where an outspoken minority can effectively veto and dominate the will of the majority. They wield procedural laws like NEPA to delay project developers, whether or not those developers are violating any substantive regulations in the first place.
We need competent administrators to build. Noah Smith emphasizes that we lack the state capacity to administer projects efficiently. Instead, conservatives afraid of bloated government have chosen to gut the number of federal administrators, and progressives looking to protect minorities have chosen to farm power out to individuals (described above) and nonprofit consultants, who are corrupt and care little about cost.
These conservatives and progressives are both wrong. A well-staffed, competent bureaucracy (yes, like the ones you might find in China) would study all infrastructure projects, make sure they check the substantive regulatory boxes, and proceed with building, without lawsuits or expensive multi-year studies.
Unfortunately, signs point to further gutting of an already-weak bureaucracy. This year, SCOTUS issued a ruling (Chevron) that now prevents specialized regulators from interpreting specialized regulatory laws. Republicans are also talking about an executive order (Schedule F) that would convert some thousands of career officials into political appointees that can be fired at will by POTUS. These bureaucrats could soon be in the difficult position of needing to prioritize placating POTUS ahead of using their specialized knowledge to actually do their jobs.
Finally, we face problems from our inability to build things. Beyond the obvious ones like the fact that people wanna buy cheaper homes, we also have the following:
Aggregate supply might need to be our key lever of economic growth. Again, Noah Smith argues that we can’t afford to depend on increasing aggregate demand for GDP growth, since that would exacerbate existing problems like inflation and our national debt. Our yearly inflation, which was ~1% in the 2010s, hit 9.1% after COVID due to things like increased government spending, the release of pent-up consumer demand, and supply chain snarls. Our federal debt load is $35 trillion—our yearly interest payments to service that debt (~$900 billion) now exceed our defense budget (~$850 billion). Instead of spending, we need to focus on easing constraints to increase aggregate supply.
Geopolitics and national security. But beyond economics, there’s another reason why we need to make it easier to build, and that’s geopolitics. From 1980-2016, we believed that globalism would be an unfettered good. Since Trump, we’ve woken up to the idea that globalism can undermine American security and economic interests. Today, the US needs to focus on re-shoring and “friend-shoring” the manufacturing of critical technologies like semiconductors and climate technologies, which will require us to make it easier to build.
Anyway, China and the US are a tale of two cities when it comes to industrial capacity. While it’s too reductionist to boil their problems entirely down to over- and under-capacity, I think it’s an interesting lens to view where these countries are today.