Opinion | Fears of an economic slowdown must not stop China tackling overcapacity

Overcapacity, along with high local government debt and the property bubble, have been named as the three biggest risks in the Chinese economy today. With the government struggling to maintain stable growth in the face of severe downward pressures, tackling the problem of overcapacity won't be easy. But it must be done.

Industries afflicted with excess capacity are inefficient. They lead to distortions in resource allocation, diverting investments from where they would be most useful.

Chinese leaders have made it a goal to cut overcapacity in the past two years, and have ordered local governments to do so, but have their orders been strictly followed? By and large, provincial and city governments that said they have completed the task have complied in name only.

Many of them are hedging, waiting for their competitors in the other regions to cut production first. By being the last to act, they are hoping they would be the first to benefit when the economy rebounds. With less competition, the few left standing would be free to win a bigger market share.

Thus, instead of winding up the inefficient companies, local governments are helping them to tide over the bad times. Through the use of project approvals, loan levels, subsidies and tax rebates, openly or on the sly, local officials have been doing their best to prop up the "zombie" companies, particularly if they happen to be government-owned.

Overcapacity is hurting the economy, as can be seen in the lacklustre annual data provincial governments released just before the Lunar New Year. The 2014 results were especially poor for Hebei and Shanxi, for example, where the steel and coal sectors suffer severe overcapacity. If little is done, we expect worse for 2015.

There is no time to lose: we must recognise the dangers of overcapacity and act to avert further losses.