Goldman Sachs rightly stress capacity constraints and not overcapacity are dominant in China

Relatively widespread coverage in economic media has been given to an important new analysis published by Goldman Sachs pointing to the inflationary consequences of major capacity constraints emerging in the Chinese economy. As Geoff Dyer noted in the Financial Times on 22 January: 'According to Yu Song and Helen Qiao... the most extreme example is in the auto sector, where extra shifts mean factories are running at above capacity. They also see emerging bottlenecks in electricity, coal and even in aluminium and steel which only a few months back seemed to be suffering from chronic overcapacity.

'"The capacity overhang has been quickly whittled down in major industrial sectors," they wrote... The apparent rebound in Chinese exports, which grew 17 per cent in December compared to the year before, has reinforced the impression that the output gap is shrinking.

'Inflationary pressures could also come from the labour market. Before the crisis, which led to millions of migrant workers losing jobs, wages were rising quickly as the labour supply started to slow. Surveys of job centres suggest employment is returning to pre-crisis levels.'

This analysis, which is confirmed not simply by the individual sectoral studies carried out by Yu Song and Helen Qiao but by macro-economic analysis, is intrinsically important for analysing China's current economic situation. But it also refutes the bad, and inaccurate, piece of economics produced last year by the European Chamber of Commerce in China which suggested overcapacity was the key issue in this regard in China - unfortunately this report was picked up in an editorial the Financial Times. To show the report's errors were evident not only after the event I cite my letter in the Financial Times in reply:

'The basis of the report is an alleged clash between a "rising savings rate in the United States", supposed to account for a decline in the US trade deficit, and China's economic policy. Factually no "rising savings rate" in the US savings rate has occurred. Since the second quarter of 2008 US savings have declined from 12.7 per cent of GDP to 10.4 per cent of GDP.

'In any country, including China, it is evidently possible to point to individual industries suffering from overcapacity, as well as those with insufficient capacity – a statistical measure necessarily means cases below and above average.

'Simply citing particular cases, as the report does, therefore establishes no general case of "overcapacity" as regards China's economy. This same mistake applies within individual industries. For example, in the Chinese chemical sector the report notes 50 per cent of the industry is in a balanced state of supply and demand, 30 per cent of products are in short supply, and 20 per cent have overcapacity problems – a normal market situation.'

Hopefully this new analysis by Goldman Sachs will put an end to erroneous claims overcapacity is the key issue in China. On the contrary it confirms clearly that capacity constraints, that is undercapacity and not overcapacity, is the dominant issue facing the Chinese economy in this field.

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This article originally appeared on the blog Key Trends in Globalisation.