China Pushes Production Abroad With 'Capacity Cooperation' Initiative

In the annals of Chinese sloganeering, few formulas have been so well-crafted or rapidly promoted as the government's new pitch to sell "industrial capacity cooperation" abroad.

On his four-nation tour through South America last month, Premier Li Keqiang hailed the international benefits of industrial capacity cooperation at each stop, although there had apparently been no reference to the newly-minted concept in China's official press before May 7.

"Chinese Firms Sail on International Capacity Cooperation Boat," read a headline by the state's Xinhua news agency on May 25 during Premier Li's visits to Brazil, Colombia, Peru and Chile.

Some of Li's hosts might have been forgiven for not knowing exactly what industrial capacity cooperation was.

Simply put, China has hit upon a new way to cut its crippling domestic manufacturing overcapacity in industries like steel and building materials, where prices and profits have plunged.

Instead of just closing plants at home, it would open up new ones in cooperating countries that don't have enough.

Officials say the initiative is broader than China's previous trade and investment promotions.

"Capacity cooperation means more than export of finished products, but also the transfer of the whole industrial chain to help other countries beef up their manufacturing capability," said Gu Dawei, a foreign investment official at the National Development and Reform Commission (NDRC) planning agency, according to Xinhua.

The new mantra ties together many of China's pressing economic problems and the prescriptions to fix them.

The concept links the search for new sources of growth to industrial restructuring, the war against pollution, weakening trade prospects, financing by the new Asian Infrastructure Investment Bank (AIIB) and the government's Silk Road trade initiatives.

"Industrial capacity cooperation is something they came up with as a natural extension of what they were doing anyway, and it's a nice slogan to take with you on these trips," said Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington.

As labor costs rise and manufacturing losses mount, China's planners see the export of excess production capacity as a way out of its industry-heavy trap and a path to economic transformation.

"Previously known as the low-cost factory of the world, China is no longer satisfied with low-value manufacturing," Xinhua said in its report on another new initiative called "Made in China 2025," introduced last month.

The country is trying to redefine itself as a source of technology and services for other countries as it shifts the balance away from manufacturing in its own economy.

"China has long been labeled as the factory of the world, while Latin America has always been seen as a global supplier of raw materials," Xinhua said in a commentary. "However, to realize faster and better economic development, both sides should upgrade their development models."

Exporting problems

But while the goals sound lofty, the list of 12 priority industries that the government wants to export reads like a roster of China's problems.

Many—like steel, non-ferrous metals, construction materials, electric power and chemicals—have been officially targeted as energy-wasters and pollution sources for the past decade.

Most are suffering from chronic overcapacity, despite government orders to close older plants and production lines.

In the case of steel, the industry has been weighed down for years with over 300 million metric tons of excess capacity, even as China produces more steel than the rest of the world combined.

The margin of surplus has remained substantially unchanged despite government orders to phase out inefficient producers since 2013.

As a slogan, industrial capacity cooperation may be satisfying, but it seems unlikely to solve China's problems.

If China dismantles entire plants and ships their production machinery overseas, it may reduce overcapacity on its territory and realize some savings in local pollution and subsidies, but worldwide capacity and price pressures will stay much the same.

"They're still going to have the global excess supply problems and they're still going to have the mismatch of what their capacity is to their partners," Scissors said.

China has been defending itself against criticism that it is seeking to move its outmoded manufacturing to other countries, essentially exporting pollution.

"The core of the international industrial cooperation is to encourage our advanced capacity to go global," said the NDRC's Gu Dawei in another Xinhua report that highlighted manufacturing in rail, aviation and aerospace industries, as well as steel and construction materials.

But Scissors argued that Chinese industries would only find investment opportunities attractive if there are reduced costs and regulations overseas.

"They're not looking just to export older capacity, but they are looking for looser social opposition to pollution, cheaper land and cheaper labor," said Scissors.

"They're not going to leave China in order to accept equal pressure elsewhere," he said.

Takers likely

Despite the drawbacks, industrial capacity cooperation is likely to find takers in receptive countries, in part because it may offer more local employment than earlier Chinese foreign investment projects, which have often favored Chinese labor.

Chinese financing will also provide a push. Speaking at the start of his tour in Brazil, Li promised to back industrial capacity cooperation in Latin America with a new U.S. $30-billion (186-billion yuan) fund, the official English-language China Daily said.

Planners can take credit for creativity in repackaging China's economic challenges and goals into a new foreign investment initiative that tries to address overcapacity at the same time.

But it seems unlikely that China can cure its capacity headache by shipping it overseas.

"It's not a bad strategy, but it's not going to work to any significant extent for China," Scissors said. "At the scale that the Chinese are looking at, it's a slogan," he said.

Scissors also doubts that industrial capacity cooperation will provide a boost for Chinese exports, as Xinhua claimed, citing unnamed analysts.

Instead, China is expected to realize a one-time increase in exports by sending production machinery abroad. But after that, the exports that new factories produce would also be shifted overseas.

The capacity initiative coincides with increasingly poor trade results and signs of a slowing economy.

On Monday, the General Administration of Customs reported that exports in May fell 2.8 percent from a year before while imports plunged 18.1 percent.

In the first five months of the year, exports declined 0.8 and imports were down 17.2 percent. Total trade volume has dropped 7.8 percent from the year-earlier period, Xinhua said.