Transcription
[Music] China is heading straight into a dangerous economic trap caused by producing too much. Yes, producing a lot is usually good news, but this time it's quite the opposite. Overproduction, the concept that is shaking Beijing, alarming Washington, and unsettling Brussels.
China is manufacturing electric cars, solar panels, and batteries at such a brutal pace that even they cannot consume what they produce. Normally, having highly advanced and, above all, very, very cheap products should be cause for celebration. But neither Washington nor Brussels see it that way. What's more, many Chinese politicians fear that this model could burst.
Take a look at what Li Qiang, premier of the State Council, has to say. "The foundation for China's sustained economic recovery and growth is not solid enough, as evidenced by a lack of effective demand, overcapacity in some industries, low public expectations, and many lingering risks and hidden dangers." - Li Qiang, premier of the State Council, 2024.
The result: products sold at rock-bottom prices flooding the global market. This is a problem for Europe and the United States because they cannot compete. But it's also a problem for China itself because its profit margins are plummeting, even reaching losses. The G7 is already talking about a trade war and is organizing to stop it.
"Yellen pushes for joint G7 response to China's industrial overcapacity."
And this isn't just a matter for superpowers. It's an economic bomb that could go off anywhere. Producing without selling is like inflating a balloon non-stop. It seems unstoppable until it bursts. A full-blown economic bubble. The question is, how did we get here? Why did China fall into this overproduction trap? And what will it mean for the rest of the planet?
Today on Visual Economic, we're going to tell you all about it. But first, let me ask you a quick question. How many AI tools are you juggling right now? One for writing, another for images, maybe a separate one for video, and before you know it, your wallet's empty and you're still switching tabs. That's why I want to introduce you to chatlm.abacus.ai, a single platform that brings all the top AI models together in one place. We're talking ChatGPT 5, ChatGPT 3 Pro, GPT 4.1, Gemini 2.5 Pro, Claude Sonic 4, Grok 4, DeepSeek, the best of the best. And here's the smart part: their built-in root LLM figures out which model is right for your prompt, so you don't waste time guessing.
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And now back to our topic.
[Music] To understand what is happening in China today, we first need to look back. And there's no better starting point than the moment when this country went from pure communism to capitalism with Chinese characteristics. We are, of course, talking about the transition that began after the death of Mao Zedong. Because although these days China evokes futuristic mega-cities and impossible skyscrapers like those in Shanghai, the truth is that the economic revolution began in the countryside. Yeah. In the villages.
During the 1980s, rural incomes grew twice as fast as urban incomes. Poverty plummeted and inequality declined. It was a rural version of an economic miracle. But this fairy tale did not last long. After the Tiananmen protests in 1989, the Communist Party said, "We've come as far as we can." The model of the previous decade was too decentralized, too chaotic, and too democratic for their liking. The solution: reorient the model without returning to communism. Bet on big cities like Shanghai. Open up to foreign investment. And so, China entered a new era, that of economic growth at any price. GDP became a religion.
[Music] You can see the results on the screen. Shanghai's share of the country's GDP was falling in the 1980s because the rural areas were becoming increasingly wealthy. But after Tiananmen, the situation took a 180° turn. Shanghai went from being four to five times richer than the national average. But pay attention, because it was only richer in terms of GDP per capita. If we look at the income of the actual Shanghai residents, the trend did not change. And even though the GDP per capita was five times higher than the average, the money that ended up in workers' pockets was not even twice as high.
Visual Economic community, let me present to you overproduction. Shanghai produced a lot. The GDP was large, yes, but that production did not generate wealth for ordinary Chinese people. So, yes, overproduction is a very real disease. But one thing must be made very clear here: the main losers under this economic model were Chinese workers, not Americans or Europeans. Of course, this does not mean that China did not become rich during this period. What I'm saying is that the living conditions of the Chinese improved much less than their GDP suggested.
And yes, I know what many of you are thinking. But come on, Josh. How did the rest of the world not lose out with the flood of cheap products? What about all the jobs that were lost because of Chinese industry? Well, take a look. "The first time China upended the US economy between 1999 and 2007, it helped erase nearly a quarter of all US manufacturing jobs."
You heard it before. A quarter of all manufacturing jobs in the US wiped off the map by Chinese competition. Perfect proof that the disease of overproduction doesn't just affect patient zero. Or does it? Because as is almost always the case, the reality is a little more complicated. You see, these studies that are so often cited compare regions of the United States that are more or less exposed to Chinese competition. And yes, in the most exposed areas, employment has plummeted. But beware, that tells us nothing about the total impact on the entire economy. Nothing.
To understand the whole picture, we need to look at what economists call general equilibrium. And yes, it is more complex, more technical, but also more realistic. The verdict: the famous China shock didn't destroy net jobs in the United States. On the contrary, it created them. It's true that 16% of manufacturing jobs disappeared. But at the same time, new ones emerged that offset that blow. And here comes the interesting part: for 3/4 of the US population, the Chinese shock was a blessing. More money in their pockets. And the poorest 25%, true, they lost out, but the rest gained so much that with a good tax system, they could be compensated without any problem. And that's not all. China also made life cheaper. For every extra 1% of Chinese products on the market, prices fell by almost 2%. Cheap, cheap, cheap. In short, more jobs, better wages, and a shopping basket at bargain prices. Yes, there were losers. But pay attention to this fact: of the 10 metropolitan areas most exposed to the Chinese shock, eight have more jobs today than they did 20 years ago. And in all of them, wages have risen, especially among the poorest 10%.
But take note, the shock of 20 years ago is not the same as today. Back then, China was basically selling trinkets, toys, textiles, spare parts for European factories. Little added value. Not today. Today, it sells cars, its own, good, attractive, and cheap. So, be careful. Shock 2.0 doesn't necessarily mean the same cards will land on the table.
But here's the final surprise. Do you know how many of those Chinese electric cars are exported? 80%? Half, like in Germany? Well, no. Barely 15% leave the country. The rest stay at home. So, if there's a problem of overproduction, the first to find out won't be the Europeans or the Americans. It will be the Chinese themselves. Exactly the same as what happened 30 years ago.
And when we say "just like 30 years ago," we're not just talking. During his first term in office, Hu Jintao, president from 2003 to 2013, tried to correct all these imbalances. It was a slow process, and the 2008 crisis didn't help. But by the time he left power, the GDP-at-any-price model had already begun to cool. However, there was still a major problem in the Chinese economy, an elephant in the room that no politician wanted to look in the eye. We're talking, of course, about the real estate bubble.
[Music] 40% of the economy revolved around bricks and mortar. You know the story: housing always goes up. And incidentally, so does the GDP of the provinces, which is very convenient for local politicians in meeting the GDP targets set by the party. The problem: what ended up rising was not just housing prices, but also debt, defaults, and bankruptcies. Until one day, with the collapse of Evergrande, everything exploded. That's when Xi Jinping pressed the red button. He ordered the real estate system to be allowed to collapse in order to burst the bubble. No more bailouts. And all that credit that used to go into bricks and mortar now had to go into industry.
The decision came just as the country was reeling after the aftermath of COVID. Youth unemployment was skyrocketing and the new cold war with the United States was heating up. The result: on the one hand, industrial production skyrocketed with industrial credit growing at an annual rate of 35%. But let's be clear, the credit boom is not the only important factor. As we've told you many times on this channel, Chinese companies have been preparing for takeoff for more than a decade, taking advantage of economies of scale and the learning curve. But this was the trigger.
On the other hand, consumption collapsed. Remember that most Chinese people could not invest in the S&P 500 or anything like that. So, real estate was the number one savings vehicle. So, after the bubble burst and with all the economic uncertainty at the time, households stopped spending and started putting their savings under the mattress. In short, high production, which is not exported, and very low domestic consumption. The perfect recipe for falling back into the trap of overproduction.
Remember, this industrial boom did not come out of nowhere. It was the direct consequence of the collapse of the construction industry. The problem: many analysts believe that these factories are not responding to real demand but simply absorbing the credit that previously fueled the real estate sector. In other words, they're building for the sake of building.
But at this point, we need to pause because the crucial question is: why are the Chinese consuming so little? One theory is the most intuitive: people are saving out of fear, job insecurity, lack of confidence, an uncertain future. It all adds up. But others, such as Michael Pettis, have a much more structural explanation: Chinese workers are paid very little. Not because they're unproductive, but because the system is designed to pay them just enough. In other words, artificially low wages.
Does that make sense? Well, yes, because according to official figures, Chinese households earn and consume much less than other countries with similar GDP levels. Take Mexico, for example. There, domestic consumption accounts for 70% of GDP, very much in line with any developed economy. But in China, the figure is only 40%. The other 60% is divided between companies and the state.
Now, there's one big question that springs to mind: do Chinese households really consume half as much as Mexican households? Does this data make sense? Well, no. For instance, in China, twice as many cars are purchased as in Mexico if we adjust for population. And consumption of clothing, furniture, and appliances is at the same level. In other words, when we look at the macroeconomic figures, there's a very large gap. But then that gap doesn't appear in the statistics on actual consumption of goods. How can this be explained? Well, there are two reasons.
The first is that the macroeconomic figures are wrong. This could be because estimating purchasing power parity between two economies is quite complicated. In other words, a dollar does not buy the same thing in the US, Mexico, or China. The other reason is that the quality of goods and, above all, services in Mexico is much higher than in China. But I don't know, is healthcare or education really twice as good? I don't think this hypothesis makes much sense.
Basically, if Chinese households aren't consuming much, it's not necessarily because their incomes are very low. The most important factor is uncertainty. With this in mind, we can now answer the crucial question in the video: Is Chinese industry really producing much more than demand? Well, the answer is yes, but no. Company inventories and debts are rising at the same time as profits are plummeting. In other words, companies are going into debt to produce products that they cannot then sell. However, this is not happening across all sectors. Sorry to say, but there's no single answer for the entire Chinese economy. There's no one-size-fits-all solution here.
So, let's take it step by step. Where do we start? Where it hurts most in the West: electric cars. The sector that worries the United States and Europe the most. Paradoxically, this is the healthiest sector of all, at least at first glance. The ratio between sales and cars remaining in inventory is low, or even significantly lower than that of other companies such as Ford or Tesla. In other words, China is producing a huge number of electric vehicles, but it's the Chinese who are buying them all.
Nevertheless, all that glitters is not gold. In recent months, we've seen the Chinese political elite, including Xi Jinping, complain about "内卷" (nèi juǎn), or regression. This is how they refer to the price war in the automotive industry that is setting off alarm bells. Now, didn't we say that Chinese manufacturers were selling all their cars? Yes, we did. But we only showed you a very small part of all the companies. The real problem lies with all the others.
In China, there are about six large companies that are very profitable, much more profitable than Tesla, such as BYD. But the rest, well, you can see for yourselves. Although it isn't shown in this graph, dozens of brands are using less than 2% of their production capacity because they know perfectly well that even if they produce more, they will not be able to sell them and make a profit. In general, we're talking about local companies that are simply staying alive thanks to public aid. This is the opposite of giants like Build Your Dreams. So yes, the automotive sector in China is suffering from an illness, but it's not the one that Ursula von der Leyen or Donald Trump are complaining about.
There's another sector that is clearly suffering from this disease, although for very different reasons: construction. In April 2024, cement plant capacity utilization was below 50% compared to 80% last year. But the problem here is not small zombie companies. It's the real estate bubble. And we have used cement as an example. But the same is true for glass and steel. What remains to be seen is whether all these companies will go bankrupt and free up resources for the rest of the economy, or whether they will continue to exist as the living dead. For now, Xi Jinping is allowing the real estate sector to collapse, however painful that may be. For example, total steel production capacity is lower today than in 2015. And the government is keeping a close eye on new large furnace projects to increase production.
Now, what is happening with solar panels, China's other top industry? Well, this is the most difficult case of all. Bloomberg compared China's planned manufacturing capacity for solar. It compared announced capacity with its optimistic demand scenario, finding China's planned production capacity over 2024-27 will be more than double demand. On the one hand, as you can already see, production is rampant and demand cannot keep pace. Tongwei, the largest producer of polysilicon, which is a crucial material for solar panels, suffered a 70% drop in the third quarter of 2024 compared to the previous year. And we can see the same pattern in other competing companies.
We're also seeing something very concerning with copper, another key component of high technology. Futures for smelters are in negative territory, indicating that these companies will pay to be able to smelt copper. The world turned upside down. Overproduction led to too many companies competing in a sector that now could not sustain so many people. The closest thing we've seen to this was when oil prices hit the red because storing it was much more expensive than selling it. And that could only happen because of an event as unique as the COVID-19 pandemic.
Even so, this sector may still have one last chance. Most likely, there is no demand for so many solar panels right now. We've already seen that Chinese demand is slumping due to economic circumstances. Since this is not a structural issue, the situation may reverse in the coming years. What's more, electricity has countless uses, most of which have not yet been discovered. So, who knows? Perhaps this artificially cheap energy will encourage research leading to the discovery of new ways to harness all this electricity and thus trigger a surge in demand.
Keep in mind this issue divides the Chinese government itself, between those who believe the overproduction of new technologies is positive given all the positive externalities they have and the new demand they can generate, and the more conservative faction that does not want to risk bankruptcies or an apocalypse of zombie companies.
But at this point, it's your turn. Do you think there are similarities between the overproduction of the 1990s and today? Or are they completely different cases? Will China let the less efficient tech companies go bankrupt, or will it continue to fuel the price war? Is this Shock 2.0 a threat to the rest of the world? Or will it be as positive as its predecessor? You can leave your answers in the comments. Don't forget that here on Visual Economic, we release new videos every week. So, subscribe if you haven't already done so to make sure that you don't miss any of our upcoming episodes. If you like this video, give it a like and I'll see you next time. All the best. See you soon.
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