China – the industrial price war

Image: Zhang Kaiyv


In China, the main problem is no longer rising prices, but falling prices

While European families continue to face the serious social consequences of inflation, another threat is already looming on the other side of the world: deflation. In China, the main problem is no longer rising prices, but falling prices. In January, consumer prices fell 0,8%. It is the fourth consecutive month of price drops, the last one being the most pronounced since 2009.

Even more worrying is the fact that annual Chinese industrial production prices have been falling for eleven months. In January, they fell 3,4%. This situation is the logical consequence of the worsening of the economic situation in the country and, in particular, of the real estate crisis that began at the end of 2021. Note the difficulties of the developer Evergrande, which was placed in liquidation on January 28th by a court of Hong Kong.

The crisis spread across the country and affected most large developers, depriving them of the opportunity to complete their projects. At the same time, confidence in the housing market has plummeted and excess capacity from the bubble years between 2015 and 2021 led to a drop in sales prices that deterred many buyers from entering the market, leading to a further drop in prices.

At the end of November 2023, new house prices recorded the biggest drop since 2014. In Beijing, existing house prices fell by 1,4% year-on-year. At its peak, the housing bubble could have been responsible for nearly 30% of China's GDP, considering its broader effects. The crisis therefore had a negative effect on activity, depriving many companies of markets, reducing cash inflows for local authorities and negatively impacting family incomes, which often used property as a form of retirement savings.

The strategy of industrial overproduction

The Chinese government was reluctant to openly support the real estate sector, whose adjustment was inevitable. The strategy adopted at the time was based on an idea that Xi Jinping had been championing since the late 2010s. The Chinese president is obsessed with the “middle-income trap” – China’s inability to join the club of high-income countries . To get out of this, he argues that the economy needs to rise by developing the high-technology sector.

Production prices in China. Infographic from China National Bureau of Statistics (SNB).

With the onset of the real estate crisis, Beijing redoubled its efforts in this regard, directing credits and subsidies to three large sectors already in development: electric cars, renewable energy, particularly solar, and lithium batteries. In the last quarter of 2023, production in these three sectors increased by 28,5%, 54% and 30,3% year-on-year, according to data from the National Statistics Office. In 2023, China became the world's leading automobile producer.

At the same time, investment in the technology sector increased by 10,3%, offsetting the 9,6% drop in the real estate sector. For a while, this strategy kept up appearances, that is, the official growth figures. But it opened a new front, reminiscent of the situation after the 2008-2009 crisis: what to do with all the goods produced?

The Chinese market is unable to absorb this production for several reasons. Firstly, as has already been said, because the real estate crisis had a negative effect on confidence and, consequently, on the consumption of durable goods. Rising youth unemployment has heightened concerns. In June 2023, this rate peaked at 21,3% of the working population aged 16 to 24, before the government stopped publishing the number and, through a change in statistical method, reduced it to 14,3. XNUMX% in December.

Second, despite rising Chinese wages, China's supply-driven development model continues to be based on low wage costs. In its attempt to gain market share in the technology sector, China has no choice but to reduce wages given its relatively low labor productivity. Remember that, in 2022, the share of household consumption in Chinese GDP was 37%, almost 16 points below the global average and 7 points below the average for upper-middle income countries (see data from the World Bank).

All of this means that the Chinese market cannot absorb all the technological products designed in the country. This, in fact, is the core of the strategy of “developing new productive forces” defended by Xi Jinping at the Politburo meeting on January 31st.

As in the 1990s, the change in China's economic model will have to be based on exports and the establishment of a dominant position in international markets. It is this leadership that will, in turn, raise the standard of living in China. Xi Jinping has always been highly critical of any demand-side or welfare state policies. His central idea is that it is the development of productive forces that leads to the development of consumption, and not the other way around.

But this evolution presupposes, first and foremost, being able to play a leading role in the world market. And it's no coincidence that China has focused on electric cars that use lithium batteries. These are the sectors that benefit from strong demand from advanced countries that have embarked on “carbon neutrality” and “green growth” strategies. The situation is therefore very simple: these countries have needs and China has the means to satisfy them at low cost.

In other words, in Xi Jinping's development model, overproduction is not accidental, it is structural. Ensure dominance in the sectors that will drive the Chinese economy towards the upmarket. Thus, Chinese products are immediately available and cheap on the world market.

For advanced countries, the choice is a priori the most logical: instead of investing resources in building an expensive and time-consuming industrial tool, they could use Chinese products to advance their “climate goals”. Beijing's strategy is therefore to build market dominance that renders any competition useless.

China's price offensive

This is where the issue of deflation resurfaces. If China's strategy works, imports will put downward pressure on prices. All the more so as they will force a reduction in wages throughout the economy. This is what happened when China went through its first overproduction crisis, between 2009 and 2014. The United States and then Europe then faced a deflationary risk that was not unrelated to the eurozone debt crisis. When prices weaken, the debt burden becomes heavier for debtors.

But this time, the stakes are even higher, because Chinese production of electric vehicles threatens an important part of European and American industrial activity: the automotive industry. Western groups are lagging behind in this field.

Between 1990 and 2015, Western companies abandoned less profitable industries in favor of China to focus on the high-end market. Chinese overproduction was not a threat to European industry. On the contrary, it could have boosted German production of machine tools, for example, and exports of high-end cars to China. But the situation has changed completely: Beijing now has to seek confrontation with what remains of Western industry.

Imports of Chinese products to the United States. FRED Infographic (St. Louis Federal Reserve).

 This is why Western countries are trying to react. The United States, which entered a phase of almost direct confrontation with Beijing, is further along this path. With Donald Trump's protectionist measures, followed by Joe Biden's Inflation Reduction Act, it began to diversify its offer. In 2023, for the first time in twenty years, China ceded its position as the country's main supplier to Mexico. US imports from the People's Republic fell 20%.

But these numbers are misleading, because China gets around the obstacles by exporting to Mexico, which in turn ships to the United States. Therefore, supply chains have not changed radically.

On February 18, Jay Shambaugh, Assistant Secretary of State for International Affairs, upon returning from a trip to China, said he was “concerned about China’s industrial support and supply policies.” He then warned that “the rest of the world will respond” to this policy of exporting Chinese overproduction.

Last year, the European Union launched an investigation into Chinese subsidies for electric vehicles. This investigation is likely to lead to an increase in customs duties in this area, but probably at a rather late stage. Meanwhile, the market is flooded with cheap Chinese products.

Furthermore, Western officials remain very ambiguous about their policy toward China. In fact, exporting Chinese deflation is also a way to reduce inflation in the short term by allowing interest rates to fall. Several observers, such as Bloomberg editorialist Daniel Moss, already believe that “falling Chinese prices will provide a quiet but powerful help to many central banks.”

Production of electric vehicles in China. AIE infographic / Motor Intelligence.

But there are also more concrete reasons. First, the West is lagging behind in the field of “green” technologies as China has the advantage in the availability of essential inputs. Western governments' approach to the environment is largely defensive, limited to meeting quantified targets for reducing carbon emissions. Chinese products make it possible to advance quickly towards these objectives and it is unlikely, for this reason, that there will be obstacles to their development in Western markets.

Finally, the global situation is complex. China is so advanced that European automakers have already signed major agreements with Chinese players to advance in the electrical sector, sometimes even with their own competitors. In 2023, Volkswagen signed an agreement with Xpeng and Stellantis with Leapmotors.

Furthermore, the issue not only affects the assembly of electric vehicles, but also on-board equipment and electronics. BMW, for example, announced that it will use products from the Shenzhen-based Appotronics group to equip its electric vehicles. In mid-February, automotive equipment group Forvia (formerly Faurecia) announced that it was investing heavily in its Chinese production through partnerships with local companies. In fact, China is already the undisputed center for electric vehicle production. Even Tesla is increasingly relying on its Shanghai factory.

In the other two sectors, the situation is not very different. China accounts for 80% of the solar cell market and 50% of the lithium battery market. And the price war should further reinforce this position. In the face of such power, the moderate protectionism of the United States and the European Union appears ineffective – and contrary to their own objectives.

The possible effects of deflation

Therefore, Chinese overproduction is expected to impact prices in advanced countries. Especially because this overproduction is not limited to just these three sectors. January producer price figures show a general drop in prices, affecting the automotive industry (-1%), textiles (-1,3%), metal products (-1,8%), computer products (-3 %) and paper industry (-5,8%).

In 2022, China will be responsible for 20,8% of imports of goods from the European Union and 14% of imports from the USA. These are positions capable of influencing prices in most of the markets in question. All the more so as the first to be affected by the export of Chinese deflation will be emerging countries, close partners of the People's Republic.

For companies in these countries, this means having to match Chinese prices to maintain their positions in their own markets, but also on an international scale. The effect of the falling price of Chinese industrial goods is therefore broader than the share of Chinese trade in imports alone would suggest.

In fact, the phenomenon has probably already begun. The prices of manufactured imports in the euro zone have already fallen 3,05% in one year. In France, the drop was 1,7% in December 2023. Although they are still well above pre-pandemic levels, this drop portends strong pressure on industrial prices. In France, producer prices fell 1,2% year-on-year in December. And wages in the eurozone began to fall in nominal terms in the last quarter of 2023.

Industrial import prices in France. © Infographic Insee.

As we have seen, some may rejoice: this drop in import prices will accelerate disinflation and allow central banks to lower interest rates. But that would be misleading considering the real situation of Western economies and, in particular, European ones. Contrary to popular belief, deflation is no more enviable than inflation. The most violent and long-lasting crises of capitalism – those of 1873, 1929 and 2008 – were deflationary in nature.

Since then, the pace of growth in these countries has slowed down significantly. Everywhere, real living standards have been weakened by inflation and neoliberal policies. All industries have experienced, at best, a further weakening of productivity gains and a stagnation of production. Finally, 2024 heralds the return of austerity and budgetary restrictions in the eurozone.

Strong downward pressure on prices in this context would have formidable consequences. Since living standards have been severely affected by inflation, it will probably be impossible to resist price-based competition. Faced with this situation, Western industries would have no choice but to pass on this downward pressure on prices to employees and suppliers, in an attempt to safeguard their margins, weakening family demand and the productive fabric in general.

Undoubtedly, some industries will struggle to survive and thus “green” reindustrialization plans will become a pipe dream. Under these conditions, employees would have to accept wage moderation and reduced employment. In a context where living standards have not yet recovered from the effects of inflation, the impact on demand would be tremendous.

Especially because what remains of European industry would be in the spotlight. The only way to compensate in terms of employment would be in low-productivity, low-paying services.

It should also be remembered that deflation increases the real level of public and private debt, leading to spending restrictions that make the situation even worse. Central banks would certainly return to more accommodative policies, but experience from 2009-2019 shows that their effectiveness in this area is limited.

General instability

Obviously, the situation has not reached that point yet. Inflation remains high, but a deflationary crisis cannot be ruled out at a time when producer prices have fallen into the red in many Western countries. And China's strategy is far from winning. By playing with fire, Beijing risks becoming the first victim of deflation and entering a phase of delicate Japanese-style stagnation. Above all, the American example shows that the development of a high-standard industrial sector does not guarantee income growth for the majority.

On Tuesday, February 20, a significant five-year home loan rate for the Chinese market fell 0,25 points, its biggest cut since 2019. And more aggressive measures could be taken in early March when new policy targets are defined. But as we have seen, overproduction is a structural fact of China's strategy and the idea is probably more to avoid any recessionary spiral than to end deflation. Therefore, no turning point is expected.

On the other hand, Western economies appear quite helpless. They do not really have the means to return to severe protectionism, due to the lack of adequate means of production and the increasing complexity of value chains. Certainly, the United States is determined to maintain its technological edge, particularly by controlling the production of next-generation semiconductors. But this defensive posture hides a weakness in advanced markets, where China is already building its hegemony.

The fact that world capitalism is repeatedly thrown between deflationary and inflationary crises reveals, above all, its inconsistencies and internal contradictions. Any attempt to resolve a crisis in one part of the world opens up a new problem in another, more global part, which already appears to be embedded in the ecological crisis. Therefore, economic stabilization does not appear to be an option.

*Romaric Godin is a journalist. Author, among other books, of La monnaie pourra-t-elle changer le monde. Vers une écologique et solidaire (10 x 18).

Translation: Eleutério FS Prado.

Originally published on the portal Mediapart.

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