EU Tells China to Cut Investment Frenzy

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Never short of good advice for other people, the European Union’s Chamber of Commerce has written up a report they are pressing the Chinese to implement. At the heart of the EU’s concerns is a massive and ongoing over investment in production capacity which rather than be tackled head on as a result of the economic crisis has actually gotten worse as a result of the stimulus package and state directed bank lending.

The study, reported in Reuters, by the EU’s Chamber of Commerce in China listed a series of recommendations they were urging the Chinese to adopt, namely:

  • To redistribute national income from firms to households; state-owned enterprises should disgorge dividends for the government to spend on social security, health and education instead of ploughing profits back into fresh investment
  • Companies must slash capital expenditure in coming years
  • Remove subsidies for energy and other inputs, provided indirectly by households, to which manufacturing has become addicted; increase resource and environmental charges
  • Currently low interest rates subsidise bank borrowing by manufacturers and must rise to reflect the real cost of capital; let the yuan’s exchange rate gradually appreciate
  • Reform the fiscal system to give more funding opportunities to local governments, which now compete to attract industrial investment for the tax revenues and jobs it generates.

No doubt these helpful suggestions will be warmly received by the Chinese and rapidly implemented, then again may be they won’t. The State Council in China had already commented on what even they would acknowledge has been a long running problem. Back in August they singled out iron and steel, cement, primary aluminum, glass, coal, chemicals, poly silicon and wind power equipment as the worst offenders for over investment and announced steps to rein in their expansion. But in many cases, capacity is already way over the country’s needs. Take aluminum, production is probably running at about 13m tons at the moment but with capacity estimated to be more like 18m tons. Even at China’s growth rate that’s going to take some time to utilize. Meanwhile, anti-dumping and unfair competition cases proliferate and often result in tit for tat retaliation.

Say what you will about the capitalist system but it is generally more efficient at allocating resources than state directed macro lever pulling of the economy. The Chinese stock market is booming on the basis of current and anticipated company profits. Can you imagine what impact the EU Chamber’s suggestions would have on company profits going forward and therefore on the share price? Suffice to say they will probably not be immediately implemented, however much behind closed doors those in power may concede for once the Europeans may have a point.

–Stuart Burns

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