The Rise and Coming Fall of Chinese Manufacturing

Chinese overcapacity is raising concerns worldwide. It is easy to see why: China accounts for nearly one-third of the world’s manufacturing value-added, and one-fifth of global manufacturing exports. But there is good reason to believe that the decline of China’s manufacturing sector is imminent.

To understand what is happening now in China, it is worth recalling Japan’s recent history. After World War II, Japan’s manufacturing sector grew rapidly, thanks largely to access to the massive US market.

But the 1985 Plaza Accord (which boosted the yen’s value and weakened Japanese exports), together with an ageing population and a shrinking labour force, reversed this trend.

From 1985 to 2022, the share of Japanese goods in US imports dropped from 22% to 5%, and Japan’s share of global manufacturing exports declined from 16% to 4%.

Moreover, Japan’s share of global manufacturing value-added fell sharply, from 22% in 1992 to 5% in 2022. And the number of Japanese companies on the Fortune Global 500 list dropped from 149 in 1995 to just 40 today.

China has followed a similar upward trajectory in recent decades, but its manufacturing rise was even more dependent on the US market. Japan’s imports from the US equalled 51% of its exports to the US in 1978-84, compared to a 23% share for China in 2001-18.

Chinese family-planning policies are largely to blame for this imbalance. Typically, household disposable income would account for 60-70% of a country’s gross domestic product, in order to sustain household consumption of around 60% of GDP.

In China, however, the one-child policy – which was in place from 1980 until 2015 – limited household earnings, encouraged high savings, and constrained domestic demand.

As a result, Chinese household disposable income dropped from 62% of GDP in 1983 to 44% of GDP today, with household consumption falling from 53% of GDP to 37% of GDP. In Japan, by contrast, household consumption equals 56% of GDP.

One can look at it this way: if wages normally amount to US$60-70, Chinese workers would receive only US$44 and would have just US$37 of spending power, whereas Japanese workers would have US$56 of spending power.

China’s government, however, has plenty of financial resources, which it uses to support industrial subsidies and investment in manufacturing. Moreover, because China’s manufacturing sector offers high returns, international investors are willing to channel capital towards it. Add to that a surplus of about 100 million workers, and excess capacity is difficult to avoid.

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