Over capacity issues in China

Investors may lose temporarily but not China

| by N.S.Venkataraman

( September 15, 2012, Chennai, Sri Lanka Guardian) In recent times, there have been number of research articles and investigative reports in the media published in Europe and USA about what they call as “possibility of collapse of industries and economy in China”, due to over capacity creation and low industry capacity utilization in China at present.

However, this is unlikely to happen. Having created a strong base for the manufacturing sector in China which was practically nothing a few decades back, certainly industries in China would not look back. It can only go forward from the strength that it has built within itself due to huge investments from multi national companies and introduction of modern technology practices.

Even as some observers are predicting the likely collapse of industries in China and the global media is full of such news (views ?), it is appropriate to remember that no economy has collapsed due to over capacity creation in the manufacturing sector based on future projections of demand , even if it would be beyond the immediate requirement of capacity.

Industries and economy have collapsed due to over borrowing beyond the capacity to pay and not using the borrowed funds in optimum and productive manner. Industries have collapsed due to bad debts (bad receivables) and poor technology practices leading to uncompetitive cost of production. But, building up manufacturing capacity, which is similar to building of muscle strength , can never be disastrous. If there would be any immediate financial strain due to over creation of capacity or building up of huge infra structure, the problems are likely to be temporary, as the demand is bound to catch up. This is the price that any economy has to pay for aiming at rapid growth.

It appears to be the view of the critics that the over capacity creation and low capacity utilization at present will retard the growth of industries and economy in China. Such critics do not seem to understand the strategic planning of industries in China, who seek to overwhelm the world market by their sheer size and dominating power and are willing to wait for the results.

What is happening in China now is that the industries are operating at average capacity utilisation level of 65 to 75% . It has to be noted that they are operating however low the capacity may be and not collapsing. Further , it has to be noted that in developing counties like India, capacity utilisation of around 65% is not considered abnormal and industries thrive in such state for several years.

When the industries operate at 65 to 70% capacity level, obviously the profit margins will be low and investors will not be benefited immediately. Investors getting less return is perhaps what the media is calling as impending collapse.

When one region creates large capacity and other regions do not create such capacity, the region creating the capacity is bound to have competitive advantage when the demand would steadily go up in the course of time.

It has to be seen that China is building up capacity in manufacturing and infra structure projects that have high level of relevance to the industrial and economic growth pattern of the world and they are not obsolete products or activities and are not likely to become obsolete in the foreseeable future.

The critics should also understand that substantial investment in industries in China have been made by Europe and America based multi national companies and in the unlikely event of collapse of industries and economy in China, the multi national companies and the economy in Europe and USA would suffer as much as that of China.

The clever strategy of the Chinese industry is that they have integrated the interests of Chinese industry with that of the multi national companies to a significant extent and therefore any collapse will not be an isolated affair. Under the circumstances, it is in the interest of everyone that the industries in China should survive and prosper and the multi national companies would contribute to ensure this by their appropriate policies.