China's steel production has expanded rapidly in the last decade. But its capacity for production has increased at an even higher rate than production, leading to growing excess steel capacity. The amount of Chinese excess steel capacity, defined conventionally as the capacity that could be used for production but is not, is commonly estimated at 325 million to 350 million tons. However, that range overestimates the actual size of excess capacity. As the section below explains, a more reasonable methodology of calculating "excess capacity" suggests 130 million tons, or only 40 percent of the number widely cited.
Even so, this more reasonable estimate of China's excess steel capacity is still large, roughly 65 percent higher than total US crude steel production last year. Chinese premier Li Keqiang stated in his Report on the Work of the Government (2016) that the government recognized "overcapacity is a serious problem in certain industries," and that in the coming year the government "will focus on addressing the overcapacity in the steel, coal, and other industries facing difficulties" to "strengthen supply-side structural reform to drive sustained growth."
Capacity cuts in 2016 progressed as planned by the Chinese government: A total of 65 million tons of iron and steel production capacity were closed, going beyond the annual target of 45 million tons. However, two shortcomings of the current practice, discussed later in more detail, could lead to erroneous assessments of China's steel overcapacity and ineffective capacity reduction policies.
As a follow-up on a previous post that presents China's production and exports statistics in 2016, this post starts by estimating excess steel capacity in China, then discusses key developments in the nation's capacity cuts last year.
Estimating Excess Capacity: A New Methodology
The widely cited figure for China's steel overcapacity, 325 million to 350 million tons, is calculated by taking the difference between crude steel production, as reported by the World Steel Association, and capacity figures, as estimated by the Organization for Economic Cooperation and Development (OECD) and other sources. Based on this conventional definition, excess capacity in the Chinese steel industry amounted to 328.1 million tons by the end of 2015.1 But this simple methodology overstates the actual size of excess capacity.
Why? Seasonal factors as well as the periodic need to close down operations to refurbish steel plants and add new facilities make it necessary for the industry to maintain some reasonable amount of "spare capacity." Therefore, it is not realistic for the steel industry to run at full capacity.2 In other words, not all of the 328.1 million tons of the previously calculated excess capacity is really "excess." Part of it is "spare capacity" deliberately maintained by the industry for times of extra need.
Part of China's excess steel capacity is "spare capacity" deliberately maintained by the industry for times of extra need.
Suppose that under normal economic conditions a capacity utilization rate of 80 percent is reasonable.3 Hence, at the 2015 production level of 798.8 million tons, spare capacity of 199.7 million tons would be within the reasonable range.4 Using this calculation, at the end of 2015, actual excess capacity in the Chinese steel industry was 128.4 million tons, much smaller than the number frequently reported and widely debated.5 Policies should aim to cut a net of this amount of crude steel capacity, around 130 million tons, instead of the roughly 350 million tons frequently cited.
Capacity and Capacity Cuts: Developments in 2016
By the end of 2015, China's crude steel capacity was 1,126.9 million tons.6 China produced 798.8 million tons of crude steel in 2015, indicating a capacity utilization rate of 70.9 percent, much lower than the level prior to the financial crisis, around 85 percent. As discussed in the previous section, assuming a desired capacity utilization rate of 80 percent, China had an overcapacity of 128.4 million tons in 2015. This suggests that to tackle the excess capacity problem, China would have to eliminate a net of 128.4 million tons of crude steel capacity, or roughly 11 percent of its 2015 capacity level.
Over the past year, key developments in cutting excess steel capacity include:
- February 1, 2016: The State Council issued the Guidance for the Iron and Steel Industry to Reduce Excess Capacity and Resolve Difficulties for Future Development. The Guidance set the target of cutting 100 million to 150 million tons of crude steel capacity over 2016–20, or an average of 20 million to 30 million tons per year over the next five years. It also strictly prohibits local governments and agencies from approving new projects that add capacities and demands that financial institutions not lend to firms that violate regulations. Eliminated capacities that had received subsidies and/or other forms of policy support cannot be used for replacement.7
- June 2016: Xu Shaoshi, director of the National Development and Reform Commission (NDRC), announced that the government set a target of cutting 45 million tons of iron and steel capacity during 2016.
- November 11, 2016: Li Pumin, secretary general of NDRC, said in a news conference that China had already hit its iron and steel capacity reduction target of 45 million tons by the end of October 2016.
- November 14, 2016: The Ministry of Industry and Information Technology (MIIT) issued the Iron and Steel Industry Adjustment and Upgrade Plan (2016 – 2020). The MIIT plan reviews achievements in cutting iron and steel capacity during the 12th five-year plan (2011–15) and sets targets for the 13th five-year plan (2016–20). Specifically, the plan sets the target of cutting crude steel capacity by a net of 100 million to 150 million tons over the next five years and raising the capacity utilization rate to 80 percent by 2020.
- March 5, 2017: Chinese premier Li Keqiang delivered the Report on the Work of the Governmentat the Fifth Session of the 12th National People's Congress. In his report, Li stated: "particular priority was given to cutting overcapacity in the iron, steel, and coal sectors. Over the year, iron and steel production capacity was cut by more than 65 million tons…, going beyond annual targets." Moreover, Li continued to rank "taking solid and effective steps to cut overcapacity" as one of the five priorities of work for 2017, and announced to "further reduce iron and steel production capacity by around 50 million tons" in 2017.
Since the State Council issued the Guidance in early February last year, relevant ministries issued eight documents covering areas such as taxation, funding, worker settlement, the environment, and others to facilitate capacity cuts.8 Major developments in resettling laid-off employees—that is, assisting them in finding new jobs—include:
- February 25, 2016: The vice minister of the MIIT said the central government decided to establish a fund of 100 billion renminbi over two years to compensate workers laid off because of capacity cuts in iron, steel, and coal sectors. The Ministry of Finance released specific guidelines on using the fund on May 10, 2016.
- February 29, 2016: Responding to questions at a news conference, the minister of Human Resources and Social Security announced an estimated total of 500,000 employees in the iron and steel industry, and 1,300,000 employees in the coal sector, would have to be resettled because of capacity cuts.
- March 1, 2017: The minister of Human Resources and Social Security said in a news conference that during 2016, a total of 726,000 employees in the coal, iron, and steel sectors were resettled. In addition, the minister stated that the estimated number of employees in the three sectors that will be laid off in 2017 is around 500,000.
- May 2017: Officials from the Ministry of Finance said that 41.869 billion renminbi were used to support capacity cuts in the iron, steel, and coal sectors in 2016.
Two points worth noting on China's capacity cuts last year: First, both the Guidance by the State Council and the MIIT plan set targets for cutting crude steel capacity. However, the annual target of cutting 45 million tons and the achieved level of 65 million tons were both on iron and steel production capacity. Neither of these two numbers specify capacity cuts in the steel sector by itself. Therefore, they are not directly comparable to the target of cutting 100 million to 150 million tons of crude steel capacity over five years set by the State Council and MIIT. In order to clearly track the progress of capacity reductions and implement effective policies to tackle the issue more efficiently, the Chinese government should separate the two sectors, set clear goals for each of them, and supervise each industry independently.
Second, the distinction between net and gross figures is not clear. Among the official announcements on capacity cuts mentioned above, only the MIIT plan emphasizes net figures, while all other official documents only discuss gross numbers. Obviously, when some capacity is eliminated, total capacity will decrease. On the other hand, if new capacity is added at the same time, total capacity might increase.9 Therefore, instead of emphasizing the gross amount of capacity that is eliminated, China should focus on the difference between reduced capacity and newly added capacity, or net capacity changes. Unfortunately, no official data on newly added capacity is available at this time, which makes it difficult to properly assess China's achievements in cutting steel capacity last year.10
In future years, policymakers should design distinct capacity reduction plans for the iron and steel sectors, and statistics should also be reported separately. Meanwhile, emphasis should be given to net capacity changes instead of just focusing on reduced capacity but not newly added capacity. Failure to address these shortcomings could lead to imprecise assessments of the steel overcapacity issue in China, as illustrated in the following section, and may ultimately result in ineffective policies.
Assessing China's Steel Overcapacity Properly
With the two previously discussed shortcomings of China's current practice in capacity cuts, this section illustrates how these deficiencies, if not corrected, could lead to improper assessments of China's steel overcapacity.
At the end of 2015, China's crude steel capacity stood at 1,126.9 million tons. China cut 65 million tons of iron and steel production capacity in 2016 and set the target of cutting another 50 million tons of iron and steel capacity in 2017. Assume that all capacity cuts are made in the steel sector, and that China successfully hits its target by the end of 2017. Furthermore, assume no new crude steel capacity is added in the steel industry.
Based on these assumptions, China will cut a net of 115 million tons of steel capacity during 2016–17. Therefore, by the end of 2017, China's crude steel capacity will be 1,011.9 million tons. If production remains roughly the same as in 2016, the capacity utilization rate will be 79.1 percent by the end of 2017, which is fairly close to the desired rate of 80 percent set by MIIT.11
Put another way, based on the above assumptions, by the end of 2017, Chinese crude steel production capacity will be 115 million tons lower than that at the end of 2015. As excess capacity was estimated at 128.4 million tons at the end of 2015, a cut of 115 million tons in two years means that China will have tackled almost 90 percent of its excess capacity problem in the steel industry by the end of 2017.
The arithmetic is simple, and comments made by NDRC officials in a news conference on March 6, 2017, seem to follow this calculation. However, this is an optimistic scenario. Policies that build on the basis of this line of arguments could substantially overlook the real extent of the problem. If part of the capacity cut takes place in the iron industry, or if new crude steel production capacity is added, the capacity utilization rate by the end of 2017 will be lower than the previously estimated 79.1 percent.
2. See Excess Capacity in the Global Steel Industry and the Implications of New Investment Projects, OECD Science, Technology and Industry Policy Papers, no. 18, Paris: Organization for Economic Cooperation and Development.
3. The assumption of 80 percent is made here because China's average capacity utilization rate over 2006–15 was 78.5 percent, or roughly 80 percent. If the rate is set at the average of 2005–08 rates of 85 percent, which is a more preferable level considering the Great Recession and the growing steel overcapacity in recent years, excess capacity defined under this new methodology would be larger (around 190 million tons). As the target level of the capacity utilization rate set by the Chinese government to be achieved by 2020 was the 2006–15 average of 80 percent, discussions in this section and the following sections on evaluating the progress on capacity cuts in 2016 are based on this number.
4. Calculated as (798.8 / 80%) – 798.8 = 199.7 million tons.
5. Calculated as 1126.9 – (798.8 / 80%) = 128.4 million tons.
7. On July 31, 2014, the Ministry of Industry and Information Technology (MIIT) issued Notice of the MIIT Regarding Capacity Replacement of Some Industries with Serious Excess Capacity （工业和信息化部关于做好部分产能严重过剩行业产能置换工作的通知）. The document, which is valid until December 31, 2017, sets principles for replacing obsolete or excess capacity in steel and other industries with excess capacity. Outdated capacity can be replaced by new capacity of an equal or smaller amount. For more details, see "MIIT announces new capacity-cutting plan."
8. By May 12, 2016, seven of the eight supporting policy documents were in force. The remaining document on funding was issued by the Ministry of Finance on May 10, 2016.
9. As mentioned earlier, the Chinese government allows certain steel firms to replace outdated capacity with new capacity of an equal or smaller amount. This type of new capacity may sometimes be referred to as "replaced capacity." This post does not distinguish between newly added capacity used to replace obsolete capacity and that used for new projects. Both concepts are referred to as "newly added capacity."
10. A report by Greenpeace and Custeel estimated that in 2016, China eliminated 23.37 million tons of operating crude steel capacity but added 59.96 million tons, leading to a net increase of 36.59 million tons.
11. Calculated as (800 / 1011.9) * 100% = 79.1%.