International | 10:30 AM
Chinese authorities want to address over-capacity in parts of the domestic economy, but authorities will act cautiously in the face of many uncertainties, T. Rowe Price's Clarence Li explains.
- Chinese authorities are battling internal “involution”, the result of excessive domestic competition
- Tackling excess capacity triggers rising deflation risks
- Amidst multiple risks and uncertainties, Beijing is likely to move cautiously
- Achieving healthier, more sustainable growth ultimately results in a more efficient, enterprise-oriented economy
By Clarence Li, Lead Portfolio Analyst, Equity & Fixed Income Investment Specialists at T. Rowe Price
China is often accused of export dumping, but the ultralow prices of Chinese goods in world markets are largely driven by internal “involution” —excessive domestic competition— rather than an attempt to boost export competitiveness.
For China, involution, or neijuan (literally, curling inwards), refers to the cycle of cut throat competition in which increased effort is rewarded with shrinking returns.
Companies find themselves trapped in a situation where excess capacity forces them to lower prices to increase output, prompting their competitors to do the same. This dynamic results in shrinking profits for all involved and an increase in the number of loss-making enterprises.
Excess capacity is evident today across a number of Chinese industries, including electric vehicles (EVs), solar panels, and steel.
Recognizing the negative impacts this can have not only on individual companies and industries, but also on the broader economy —particularly through rising deflation risks— China’s government has taken action.
In this article, we take a closer look at Beijing’s “anti-involution” campaign, which industries may benefit, and whether these reforms can be as successful as the supply-side reforms of 2015.
What is China’s anti-involution policy really about?
Elevated as a key policy focus by the Central Commission for Financial and Economic Affairs in July, the campaign targets a broad range of industries.
This includes both traditional industries like steel, building materials, autos, and petrochemicals as well as some “New Economy” sectors such as electric vehicles, lithium-ion batteries, polysilicon, and solar energy.
The common goal is to curb excessive competition and promote healthier, more sustainable growth.
Anti-involution policy guidelines can be found in the government’s recently published two-year plans for 10 key industries. For many of these industries, Beijing has set output growth targets for 2025–2026 that are lower than in 2024.
This reflects a cautious approach toward industry expansion in the face of existing overcapacity.
Policy requirements in the two-year plans tend to be quite broadly defined. Detailed implementation will follow at the provincial and regional levels, involving central and local government, state- and private-owned enterprises (POEs), and industry associations.
If the policies are to succeed, it is essential that there is buy-in from key provincial and city governments like Guangdong and Shanghai.
As examples of the new measures, several industries have been ordered to reduce excess capacity and strengthen compliance with output quotas. For example, steel mills in Tangshan in Hebei province were ordered to cut their output by approximately -30%, while coal mines must adhere to annual capacity quotas.
In solar energy, China’s top 10 solar glass firms have agreed to lower output, while polysilicon producers are coordinating to phase out obsolete capacity. Meanwhile, central government officials have pledged to carefully monitor EV pricing in order to prevent market distortions.
Lessons from the last supply-side reform in 2015
Supply-side reforms launched in 2015–2016 demonstrated that cutting overcapacity could help reshape industries and lift profitability.
In the years that followed, the measures helped to ease deflationary pressures by bringing supply and demand into better balance.
For example, strong deflation trends in the producer prices for coal and steel mining and manufacturing reversed in 2016 following production and capacity cuts.
These basic industries were able to improve their profitability, sustaining higher profit margins in 2017 and 2018.
Will China’s 2025 anti-involution campaign succeed?
Ideally, a mix of market-driven consolidation, structural reforms, and sufficient demand-side support would create durable reflation. Unlike the previous cycle, however, overcapacity today is concentrated in China’s New Economy sectors, which are dominated by POEs.
Supply-side policies in 2025 must therefore rely more on incentives and persuasion aimed at private sector companies rather than on government-mandated capacity cuts by a few large state-owned firms, which is what happened in 2015.
As a result, supply-side reforms today may take longer to produce results.
By their nature, supply-side reform involves capacity cuts, plant closures, and job losses. This makes them politically sensitive as they can weigh on near-term gross domestic product growth and employment.
It’s also important to note that administrative output cuts without sufficient offsetting demand stimulus may be self-defeating if it undermines business confidence and weakens labor market conditions. Enforced too harshly, anti-involution measures could even risk a more prolonged period of deflation.
Against this backdrop, policy implementation is therefore likely to be gradual. We do not anticipate the same broad-based positive macro-outcomes as in 2015.
China’s economic growth trend this year is relatively weak, which makes the broad-based implementation of supply-side reforms challenging to say the least.
Who might benefit from China’s anti-involution policy?
Selected industries and commodities could still benefit if China’s anti-involution efforts help to stabilize prices and profitability in those sectors.
Examples of sectors that we believe could benefit from improved supply/demand conditions in 2026 include cement, copper, cobalt (needed for rechargeable batteries), and fiberglass (used in electric vehicles, wind turbines, and printed circuit boards).
Within services, we think express delivery could be a policy focus for the anti-involution campaign after China’s Post bureau established price floors in some regions.
Conclusion
China’s anti-involution campaign reflects Beijing’s recognition of the need for further supply-side reforms, or capacity reductions, in sectors where intense competition in recent years has eroded profits and led to a rise in the number of loss-making companies.
The focus in 2025 is on more market-oriented solutions to achieve production discipline, capacity rationalization, and industry consolidation.
In the short term, we think the new policy is likely to be applied cautiously given China’s subdued macro-outlook and ongoing property sector overhang.
Over the longer term, if it is successful, the orderly exit of excess capacity could help reduce deflation pressures in the affected industries and improve their return on investment.
For investors, it could signal the start of a shift in China’s economy away from state and local government direction toward a more efficient, enterprise-oriented system.
Re-published with permission. Views expressed are not by association FNArena’s.
Find out why FNArena subscribers like the service so much: “Your Feedback (Thank You)” – Warning this story contains unashamedly positive feedback on the service provided.
FNArena is proud about its track record and past achievements: Ten Years On