The unwinding of the boom in China’s resource-dependent provinces is leading to some introspection as to what went wrong. In a way, the explanation is not that complicated. The troubled provinces tend to be big producers of energy (mainly coal) and metals (mainly steel); prices for these goods are collapsing and demand is falling as China’s housing boom peters out. Therefore the slowdown is much, much worse in the northern and northeastern provinces that specialize in these industries.

The China Economic Times, one of the wonkier Chinese newspapers, has lately been running a nice series of in-depth reports on these economically troubled provinces. I particularly enjoyed this piece by reporter Zhang Yiming, which focuses less on the immediate troubles of the coal and steel sectors and more on the longer-term question of why the Northeast in particular is so vulnerable to these troubles. I like that the author seems to have rediscovered the concept of the “resource curse,” much debated in the economic literature, by just talking to a lot of people in the former Manchuria. The piece is short enough to translate and share:

The Northeast is a vast territory rich in resources, whether we are talking about grain, forests or various kinds of minerals, but these resources have not been effectively developed.

The Northeast produces much grain, but large quantities of its grain are shipped to the south where they are processed into finer products, such as Cantonese moon cakes, that are then sold back to the Northeast. Another example is the Northeast’s timber, much of which is shipped to the south and made into high-end furniture, which then returns to the Northeast to be sold. The Northeast also produces a lot of animal fur, and Northeastern people have a tradition of wearing mink coats. But most of the mink coats Northeasterners buy are made in the south, such as Guangdong, Zhejiang and other coastal areas.

There are many similar cases. Although the resources are located in the Northeast, they are not effectively converted [into finished goods], but are sold at a low price to the resource-poor south. After extensive processing by southern factories and transformation into high value-added products, they are bought back by Northeast people at a high price. In this way the Northeast is stuck at the low end of the industrial chain, while the most profitable and most efficient parts of the chain stay in the south. Local people say that “those shrewd southerners have taken all the money.” From the perspective of a southern businessperson who lacks resources, all of the Northeast’s resources are very valuable in the south, as they can yield all kinds of products and form a complete industrial chain.

The China Economic Times‘ research group in its local surveys found that there are many reasons for this situation in the Northeast. One issue is the lack of appropriate local conditions, while another issue is the lack of local spending power, and these issues are closely related. For example, processing mink pelts into mink coats requires sophisticated technology and skills, and there is a lack of local personnel with the right skills. Some local mineral resources and chemical raw materials, due to the lack of a local downstream industry, can only be sold to companies in the south.

Local people know that if they can process these resources it will bring profits and create much more value, but there are few people doing this kind of work and most people lack the drive to change the status quo. Locals generally agreed that that they can earn considerable amounts of money by selling resources, so there is no need to spend a lot of time and energy in an effort to change the status quo. This issue is clearly shown in the development of the local private sector.

State-owned enterprises make up a large share of the Northeast’s old industrial base. In recent years, the private sector has vigorously developed, and the share of state-owned enterprises has gradually declined. But the growth of the private sector is not as fast as locals imagine. We observed that most private-sector companies are closely related to the exploitation of natural resources. Few are in the higher-value-added parts of the industrial chain, even in high-tech industries.

Given that currently the Northeast lacks the capacity for doing high-end processing, studying and introducing skills from the south is a viable option. But the China Economic Times research group found that southerners who come to the Northeast often do not fit in. The majority who do stay work closely with the leading local state-owned enterprises, and those tend to be in the upstream part of their sectors.

It is an obvious fact is that the reasons why businesspeople from the south do not stay in the Northeast is closely related to the business environment, as it is difficult for outsiders to get accustomed to the bureaucratic environment in a short time. Also, Northeast people are relatively lacking in market knowledge, especially in comparison with people from the south. Because the Northeast has so many resources, people are easily contented with what they have, and are unwilling  to spend lots of time on improving and extending the industrial value chain.

To change this status quo of low-efficiency resource development requires a lot of time and effort to change people’s thinking, and these kind of changes obviously cannot happen overnight.

A failure to invest in manufacturing and other industries during resource booms is indeed one of the mechanisms by which the resource curse is thought to operate, and there is certainly anecdotal evidence that this is part of what has been going in the China’s Northeast. The consensus in the economics literature seems to be that resource curse effects exist, but are highly dependent on institutions: Norway and the United States have lots of natural resources but have turned out pretty well. On the other hand, there is some evidence that resource-curse effects operate at the regional level even within economies that, as a whole, have escaped its worst effects (for instance, here is a paper on the Appalachian region of the US).

China usually tends to feature in this literature as one of the resource-poor Asian economies that was forced to become competitive in manufacturing because it could not rely on natural resources. This view obviously needs to be nuanced, and a regional perspective is helpful. China is in fact a huge producer of energy and other natural resources; it just happens to consume virtually all of its production domestically, and import a lot more besides. The main reason that a major resource endowment did not end up dominating the domestic economy is probably that China is just too darn big, and those resources are so unevenly spread across the country. China’s southern coast is indeed largely a resource-poor region forced to rely on its own manufacturing skills, but some other parts of the country do look like they are suffering from a variety of the resource curse.

One of the more interesting developments in official Chinese discussions about the economy has been the appearance of the term “zombie companies”; Premier Li Keqiang himself has repeatedly used the term. It’s a loose shorthand for a problem that everyone knows about but is difficult to precisely define: money-losing companies that seem to stay alive far longer than economic fundamentals warrant. This problem is particularly acute in the commodity sectors: a global supply glut has driven down prices of iron ore and coal to multi-year lows, levels where China’s relatively low-quality and high-cost mines have difficulty being competitive. And yet they continue operating despite losing money, because it is easier to keep producing than to completely shut down. An excellent story this week in the China Economic Times on the woes of the coal heartland of Shanxi quoted one executive saying, “If we produce a ton of coal, we lose a hundred yuan. If we don’t produce, we lose even more.”

The incentive problem is very clear. If many companies shut down, output would fall and prices would rise, and the remaining companies would be more profitable. However every company wants to be one of the companies that is left standing rather than one of the companies that shuts down, and so they do everything they can to continue operating. They can also usually count on help from banks and local governments, who want to avoid the financial and social impact of a large employer closing. This is why there are increasing calls for the central government to break the logjam and organize the closure of excess capacity that market mechanisms should be producing. Indeed, I translated on this blog a very interesting proposal from the State Council’s Development Research Center on how to do exactly that.

The fact that top leaders are now talking openly about zombie companies could indicate some progress on this issue. So here’s another relevant translation: a recent interview with Feng Fei, a senior industrial official. Feng is also one of China’s top scholars of industrial policy, and in fact spent many years at the DRC. In October he was elevated to one of the vice-minister jobs at the Ministry of Industry and Information Technology, which has bureaucratic responsibility for most of the sectors with lots of zombie companies. His interview with Caijing magazine is short but to the point. He diagnoses the problem and its consequences very clearly, but hedges a bit when asked what the government is going to do. However he seems to indicate that the current preference is to deal with zombie companies by encouraging stronger companies to take them over–which I think is not as good a solution as the one the DRC has already proposed.

Reporter: Why is the exit of “zombie companies” being discussed now? What is the background to this question?

Feng Fei: There is not yet a consensus view about “zombie companies.” My understanding is that “zombie companies” refer to companies that have been losing money for a long time, and which have no hope of turning around or smoothly exiting the market. Currently the problem of “zombie companies” is very prominent, and this is related to three major issues in the economy.

First, China’s economic growth has entered a “new normal.” Downward pressure on the economy has increased, and the external environment for business is getting tougher. There are some companies whose technology, management and so forth are relatively poor, and who are finding it difficult to adapt to the new situation and to market changes, and as a result have fallen into serious trouble.

Second, there is serious excess capacity in some industries, resulting in a continuous decline in product prices and a fall in corporate profits. There are some sectors in which all companies are losing money, and operations are very difficult. For instance, in the third quarter of this year, the steel industry’s profit margin on sales was only 0.05%, and the sector’s total profits declined 97.5%; nearly half of the companies in the sector are loss-making.

Third, the market system is not robust: there are still some institutional obstacles that result in “zombie companies” finding it difficult to exit according to market rules.

Reporter: In more specific terms, what harm do “zombie companies” bring to China’s economy?

Feng Fei: The existence of a large number of “zombie companies” hinders China’s economic transformation and the upgrading of its industrial structure, and also increases macroeconomic risks.

First, these companies are holding on to a lot of resources, hindering the effective resolution of excess capacity. “Zombie companies” have low profitability, but take up a lot of land, capital, energy, labor and other resources, and prevent these resources from flowing to more profitable sectors, resulting in a serious waste of resources. You could even say that if “zombie companies” do not exit the market, the problem of excess capacity cannot be fundamentally solved, and it will be very difficult to achieve structural adjustment and industrial upgrading. Only if enough companies exit will there be enough companies entering.

Second, it undermines the market principle of survival of the fittest. Because of social stability considerations and other issues, there are efforts to preserve “zombie companies” and give them blood transfusions. This results in unfair competition, and could even cause a Gresham’s Law phenomenon [in which the bad drives out the good].

Third, it may lead to financial risks. “Zombie companies” have a lot of debt, which if not dealt with in a timely manner will result in an increase in banks’ non-performing loans. When you add in the complex chain of inter-enterprise debt, the problem becomes serious, and could lead to systemic risk. Therefore the State Council is paying great attention to this issue, and has required [us] to handle the “zombie companies” issue.

Reporter: If it is so urgent for “zombie companies” to exit the market, why has this been a difficult issue for so long? Why is it hard to establish a mechanism for market exit?

Feng Fei: “Zombie companies” can be dealt with in two ways, through market-oriented mergers and restructuring, or bankruptcy according to law. The handling of “zombie companies” will be more through restructuring, and less through bankruptcy, and will also ensure social stability. In terms of these methods, China has considered the design of the system, but has faced some difficulties and problems in terms of actual operation, and a complete system for market exit has not yet been formed.

First, in the restructuring and bankruptcy processes, there are difficulties with the placement of workers, the debt burden, and historical issues, which increase the cost of restructurings and bankruptcies. This is an obstacle to “zombie companies” exiting the market.

Second, some local governments interfere in the normal process of bankruptcy and market exit because of considerations related to preserving jobs, maintaining social stability, or the worries of banks and other creditors about bad debts.

Third, China’s “Bankruptcy Law” needs to be further clarified and refined. Although it has already been revised several times to adapt to the market economy, there are still some regulations that are more like general principles.

Fourth, in the context of increasing downward pressure on the economy, many sectors do not have a clear outlook, and firms face financing difficulties, which means they have little interest in pursuing mergers and corporate restructuring.

Finally, the current economic situation increases the risk and the consequences of corporate bankruptcies, which means that many parts of society are very wary toward bankruptcies and restructuring.

…

Reporter: According to the State Council, the Ministry of Industry and Information Technology is in charge of researching and promulgating policies on “zombie companies.” What is your plan for this work?

Feng Fei: MIIT will step up its research and survey work, find out the true situation, and figure out the major difficulties and problems in “zombie companies” exiting the market. In conjunction with relevant departments, we will research policy measures to handle “zombie companies,” improve the market, legal and policy environment, and improve the exit mechanisms for “zombie companies.”

The exit of “zombie companies” requires a proper relationship between the government and the market. The role of government is mainly to provide the necessary support for displaced workers, not to rescue companies, and to make the exit as smooth and quick as possible. At the same time, we will adhere to the policy of “more mergers, fewer bankrutpcies,” so that more exits of “zombie companies” happen through mergers and restructuring. This will result in appropriate placement of workers, reduce the impact on society, reduce the economic risk, and raise the quality and efficiency of economic development.

Most liberal-leaning thinkers in China seem to be disappointed with the long-awaited plan on state-owned enterprise reform that was published in September, a reaction I share. But if you would like to read a thoroughgoing rant on why the SOE reform plan is not just disappointing but completely missing the point, I recommend reading the interview below.

The speaker is Sheng Hong of the Unirule Institute, an independent and very liberal think tank. They are also unapologetically out of the mainstream of the Chinese discussion on SOEs, so you won’t see these kind of opinions represented in most reporting. I probably wouldn’t frame the issues the same way they do, but I still appreciate their views, which are a bracing corrective to most of what is written about SOEs in China.

The interview was also quite fun to translate, since it is so plain-spoken and polemical; hat tip to the folks at China Policy for the pointer. (Note: I have translated most but not all of the interview, leaving out some repetitions and some of the harder-to-follow bits; the original is here).

Interviewer: Why do you not support the new round of SOE reform?

Sheng Hong: Reform is about solving problems, and this reform basically does not address the problems I am talking about. For instance, the issue of state enterprise monopolies, the issue of state enterprises using national resources for free or for a low price, the issue of not sharing their profits, the issue of unlimited allocation [of resources] within state enterprises–these are the real problems.

What I think is the most serious problem is that state enterprises even exist. State enterprises make it impossible for the government to treat both non-state and state enterprises fairly, damaging the impartiality of government. Officials move back and forth between state enterprise jobs and civil service positions, which means that government officials and SOE executives are the same group of people. The existence of state enterprises makes it very difficult for us to expect the government will treat state and non-state firms equally, which damages the basic reason for government to exist: that it is impartial. We give state enterprises so many favorable policies and monopoly rights, how can private companies compete with them? They are not equal competitors in the market, which damages the basic principles of the market economy.

The fact that these monopolistic state enterprises exist, and occupy a large share of our national resources, creates an enormous loss of resources–many trillions of yuan a year. The slowdown in our country’s economy is to a large degree a result of the existence of monopolistic state enterprises and protected monopolies. This is a pressing issue, every day it is not fixed we lose billions. If it is not going to solve this problem, then what is reform for?

Interviewer: The reform document mentions that we should make state enterprises “stronger, better and bigger.”

Sheng Hong: To make state enterprises “stronger, better and bigger” is a mistake. Why do state enterprises need to be bigger and stronger? State enterprises are not normal companies, they should not be competing with private companies in profit-oriented sectors. If profit-making companies can do something, then state enterprises should not do it. Add to that the fact state enterprises can use their political capital to obtain monopoly rights, they can use their political strength to obtain free resources–this harms the Chinese people. …

What we say are problems, they [government officials] do not think are problems, what we think are not problems, they think are problems. What can this reform plan for state enterprises really mean? They have completely ignored different opinions and critical voices in society, and are hell-bent on making state enterprises bigger and stronger. Can this be called reform? Under the flag of reform they are doing anti-reform things, this is just deceiving the public.

Interviewer: Aside from the problem of monopolies, there are also internal governance problems with state enterprises. You have mentioned the fact that insiders control the award of bonuses, and this reform document also calls for separating state enterprise managers into two categories, [political] appointees and those recruited [from the market]. Can this have any effect on the vested interests of state-enterprise executives?

Sheng Hong: It cannot. Say you split the executives into two categories, one category is commercial, the other category is public interest. Let’s just talk about the commercial ones. I want to evaluate you according to your performance, but how to assess your performance? The performance is not real. Where does your profit come from? Because you have a monopoly, because you don’t pay rent for your land, because the interest rate on your loan is low, you only pay 30 yuan a ton for oil exploration rights while everyone else pays 400 yuan, it is completely unequal. So how am I supposed to judge your real performance?

Take finance as another example: banks make a lot of profit, but you have to know where their profit comes from. The central bank determines the gap between deposit and lending rates, and though it has been adjusted some in the last couple of years, for more than 10 years the margin was unchanged at 3%. This margin is equivalent to a monopoly price, and it is also a regulated price: the government determines your 3% margin. In most countries this is 1.5%-2%; in countries with a market economy the margin is decided by competition. But this 3% is decided by administrative departments, how can it be a true indicator? How are you supposed to judge whether these people are really working hard? If you give an idiot the right to a monopoly won’t he still make money? …

Interviewer: The reform document also covers the management of state assets, and drawing on the Temasek model, it proposes a change from the management of state assets to the management of state capital. … What do you make of the Temasek model?

Sheng Hong: Discussion of the Temasek model is superfluous. All you need to know is that some people in China want to keep state enterprises, so they are always bringing up Temasek. Why do we need to talk about the Temasek model? Temasek is called “state capital” rather than a state-owned enterprise, this means it is a company operated according to civil law but its capital is owned by the state. The problem is why do you want this state-owned capital, there is no need for it. The state capital can be given to the Singaporean people. The basic principle is that a state or a government gets its income from taxes, so why do you need to do this stuff? There is no value in having a deep discussion of this [Temasek model]. …

Interviwer: You have previously proposed dismembering state enterprises, for instance splitting PetroChina and Sinopec into many small companies. But instead we see that after the merger of the two railcar makers, there is now a wave of mergers among the central SOEs. What effects will this have?

Sheng Hong: After the mergers and acquisitions the power of the monopolies will only get bigger, which means nothing good for society, for consumers or for private companies. The logic is very simple: as monopoly power gets stronger there is less and less you can do to constrain it. After the merger of central SOEs, it will be even harder for the central government to manage them, because there will be more conflicts. Take PetroChina and Sinopec–the NDRC and NEA cannot control them, you cannot say no to these monsters. If you merge the three oil companies into one oil company, then it would be even worse. If Premier Li Keqiang goes up against China’s one and only oil company, then his negotiating position is not at all the same as if there were three companies or five companies.

Another example is that when there was just one telecom company, China Telecom, the cost for the central government to negotiate with it was very high. Later when China Unicom entered the market, the change was very rapid. So if the central government really wants to reform, it should not do mergers, but the exact opposite: breakups. …

It’s just like Jia Yi said during the Han dynasty: the more dukes there are, the less power they have. In the early Han, there were many dukes who were too powerful, and the central government could not control them, so it used its power to grant titles to increase their number. For instance if one duke had three sons, after the duke died all three sons were given a title, so each one got a third of the land. In this way after a few generations each duke became very small, and this was beneficial to the central government. For monopolistic state enterprises it’s the same: if you think that merging them together will make them easier to manage, that is a very foolish idea. …

Interviewer: There’s one thing I really don’t understand. After the late 1990s, when China Telecom, China Unicom, PetroChina, Sinopec and all these central SOEs were set up, why has market reform of state enterprises slowly ground to a halt?

Sheng Hong: Because the interest groups figured things out. In the beginning, no one really understood the market economy, but later the state enterprises and government departments figured it out: if you get rid of competitors you can make more profit. There is also some historical background. In the late 1990s, state enterprises were all in deep trouble, so there was discussion of how to bail out state enterprises, Zhu Rongji was also trying to solve the triangular debt problem, and so on. Around 2000, resource prices were fairly low, including the price of oil, coal and land, so the resource-based state enterprises had very serious difficulties. At that time the state enterprise executives understood the benefits of monopoly, and Zhu Rongji thought this was a good way to bail them out. Especially at the beginning no one really noticed. The monopoly of the three national oil companies was established in 1999 with a series of mergers. At that time the oil price was pretty low, so they wanted a monopoly. The justification at the time was to save the SOEs, so there was not much political opposition. That’s the historical background. No one paid much attention, and didn’t think much of the three national oil companies; it was only later that they started thinking the three oil companies were so great. As the oil price gradually rose, it made them aware of their own interests, so they reinforced their monopoly rights. That was the process.

What is to be done about the excess capacity in China’s heavy industry? As the decade-long housing boom has topped out in recent years, companies that had bet on ever-rising demand for construction and building materials are finding themselves with idle factory capacity. The excess is probably most serious in steel, but is also evident in related sectors like coal mining (the fuel for the power plants that drive steel smelters). This idle capacity weighs on the economy by depressing prices and margins in the affected industries, and holding back corporate investment and hiring plans. The debate over how to respond to this issue pits those who advocate letting the troubled companies collapse and markets right themselves, against those who fear too much dislocation and argue for extending more subsidies and bank credit to help troubled companies through a rough patch.

Neither of these options is particularly attractive, and the choice to some extent is a false one. Yet discussion of the excess capacity problem seems to mostly swing between an extreme Andrew Mellon-style “liquidationist” position, and the “extend and pretend” school of hoping the problem will go away eventually if troubled enterprises get enough support. The government of late has seemed to lean toward the latter position: the central bank’s lowering of interest rates makes it easier for indebted companies to stay current on their interest payments. A May decision to lower industrial electricity rates and give iron ore mines a tax break was also clearly aimed at reducing operating costs for excess-capacity sectors. Recently Liu Shijin, an economist and senior official at the Development Research Center, a government think tank, stepped in with a proposal cleverly designed to appeal to both sides.

Because I think his proposal is both interesting and realistic in the Chinese context, I have translated here the relevant section of interview in which it appears. The key point is that he proposes using government debt to fund a restructuring plan to shut down excess capacity–which, because it will have real money behind it, will be more effective than previous such plans. I think he is right that direct government funding will be more effective than indirect measures like subsidies, and that there is a public interest in getting the market to clear sooner rather than later. But his plan does require the government to accept a higher level of official debt–something it has historically been reluctant to do, though recent plans for restructuring local-government debt have shown some acceptance of the principle. On the other hand, the sum of 300 billion renminbi that he quotes is hardly a prohibitive figure, given the size of China’s economy and government revenues. Overall this proposal seems like an advance on the current confused strategy, but I do not know how to handicap its chances of actually becoming policy.

China Economic Times: In recent years, China has been restructuring industries with serious excess capacity, but the speed of adjustment is not satisfactory. What are the underlying causes, and how can the situation be improved?

Liu Shijin: I think that the slow pace of restructuring in industries with serious excess capacity in recent years is due to two reasons. First is the effect of the “acceleration principle” that is inherent to the heavy and chemical industries. Due to the increasing specialization of the modern market economy, the production chain for final goods including infrastructure and real estate has lengthened. When demand for these final goods enters into a long-term phase of rapid growth, intermediate inputs will experience a self-reinforcing “acceleration effect.” So the extent of excess capacity in these industries, and the scale of the required reduction, could be greater than originally expected.

Second is the fact that local governments’ attitude toward industrial restructuring is not very proactive, or even passive. Although everyone has recognized that overcapacity is serious and that restructuring is inevitable, often they hope that others will restructure first so they do not have to. In addition to trying to avoid the conflicts caused by shuttering businesses and dealing with debts and re-employment, there is also a lot of selfish thinking by local governments: maintaining the existing businesses means you have a chunk of GDP, from which you can also get tax revenue. The result of these actions is that businesses are losing lots of money; bad companies want to exit the market but cannot, and good companies are also worn down. This is not sustainable.

To cope with this difficult situation, we must have determination to make progress, within a specific time period, in the exit and restructuring of this serious excess capacity. We can consider implementing an action plan for reducing capacity and raising efficiency in industries with serious excess capacity.

China Economic Times: Can you tell us about the specific ideas and measures you envision being part of this action plan?

Liu Shijin: I think this plan should include the following six parts:

First, select the industries to be included in the scope of the action plan, such as steel, coal, petroleum, petrochemicals, iron ore and other industries.

Second, draft a capacity reduction plan. As a preliminary calculation, the plan can be drafted to cover 10% of nationwide production in 2015, with the affected provinces’ plans made according to their share. State macro management departments can sign capacity reduction commitments or agreements with the affected provinces.

Third, establish a “capacity reduction and restructuring fund,” funded largely through the issuance of long-term (10 years or more) dedicated bonds. The amount of the bond issue will be determined by the scale of the capacity reduction in each province. The bonds will be issued and repaid by provincial governments, but the central government will subsidize the interest. The fund will be mainly used to subsidize corporate closures, restructuring and capacity reduction, as well as the placement and re-employment of affected workers. The size of the fund will be approved on the basis of these costs.

Fourth, the affected provinces will use this fund as a lever to promote implementation of the capacity reduction and restructuring plan. When designating production capacity for exit, we should not use the phrase “backward production capacity,” as this terminology is very characteristic of the planned economy. In practice it often means using the size or age of the equipment as a benchmark, rather than its efficiency or compliance with regulations. We recommend using the categories of “illegal capacity” and “inefficient capacity;” the former meaning that which does not national regulations on environmental, energy saving, safety, etc., and the latter meaning capacity with low efficiency that does not have a strong position in market competition. Local governments should follow open and transparent criteria to make a list of companies with “illegal capacity” and “inefficient capacity,” and guide these companies to take the initiative to participate in the capacity reduction and restructuring action plan. Companies that go through closure, restructuring and other capacity reduction measures can receive corresponding subsidies for capacity reduction, staff placement and re-employment. Regions with a large number of competitive enterprises can try using an auction technique, in which the company that bids the lowest [restructuring] cost will have preference in obtaining the subsidy. In short, the idea is to reduce the barriers and conflicts in the process by giving some compensation and some choice to companies that reduce their capacity.

Fifth, give local governments a relatively large amount of autonomy and scope for innovation in the use of the fund and the techniques for cutting capacity. [trimmed for space reasons] …

Sixth, there should be appropriate preventive and punitive measures to prevent a situation where companies think “other people are cutting capacity so I don’t have cut to cut capacity.” National statistics and auditing agencies can do checks in the affected regions, and we can also introduce mechanisms for public supervision. If they find that capacity reductions have been reduced or falsified, there can be a public report and criticism, and a corresponding reduction in the central government’s subsidy. There can also be a request for political discipline of those areas that have committed to reduce capacity. We can use administrative methods in combination with market mechanisms to ensure the desired effect.

China Economic Times: What do you think will happen if such an action plan is implemented?

Liu Shijin: If you implement this action plan for reducing capacity, restructuring industry and raising efficiency, it will send an important signal to society, which is that there will be important changes in the relationship of supply and demand in the affected industries. This signal may drive a rebound in prices. Coal and steel account for a large share of the industries with severe overcapacity. According to preliminary estimates, the funds required for these two sectors are 80-100 billion yuan and 200 billion yuan respectively. If the term of the bonds is over 10 years, and there is an interest subsidy from the central government, it will not create great pressure for local governments. In the short term, there may be some impact on the growth of local GDP and tax revenue from cutting capacity, but once prices rise, these losses will be more than made up for. This is a process of “trading quantity for price,” and is overall beneficial to the locality. Therefore this should be considered a supportive policy for areas with a high concentration of excess capacity, particularly the old industrial bases that have a high proportion of heavy and chemical industries.