Breaking the Involution Cycle: China's Risky Economic Gamble | Digging into China

Hi, I'm Dong Shong. Welcome to Digging into China, where we explore China in depth to reveal unique perspectives. On July 1st, the Chinese Communist Party convened a pivotal meeting of the Central Economic Committee. The significance of this gathering lies not in its title, but in the unprecedented shift it signaled. For the first time, the CCP prioritized addressing involution in its economic agenda. This represents a substantial change in China's economic strategy. In my view, this pivot is more consequential for China's economy than all the economic resolutions issued by the CCP over the past two years, even overshadowing the outcomes of the US China trade war negotiations. The concept of anti-involution has recently captured the attention of major investment banks such as JP Morgan, Goldman Sachs, and Morgan Stanley. Approximately half of their research reports on the Chinese markets focused on this topic. Yet, this issue has not received a significant coverage in the media or sparked widespread online discussion. Comparatively to the earlier focus on tariff disputes, the anti-involution policy has garnered far less public interest. This is why I believe it's essential to highlight and discuss this matter separately as it directly impacts the future of every Chinese citizen. If mishandled, efforts to combat involution could lead to widespread unemployment. Let's first clarify a key term. What is involution? And what exactly is the CCP aiming to address with its anti-involution policy? In the minds of many Chinese people, involution refers to unproductive competition in the workplace to impress their superiors or outmaneuver colleagues. Many employees engage in excessive overtime. This futile work, relentless striving, and the notorious 996 schedule, working from 9:00 a.m. to 9:00 p.m. 6 days a week, define what we commonly understand as involution. However, if you think the CCP is suddenly stepping in to alleviate this burden and end the 996 culture, you are mistaken. The CCP is not concerned with the involution affecting ordinary workers. To them, the populace is a resource to be maximized. The harder they work, the better, even if that effort yields little. The evolution the CCP targets is different. It's the competition between industries. Consider the electric vehicle sector, for instance. In China, relentless price wars have driven high sales but consistent losses for companies. This is the type of evolution the CCP seeks to address. Similarly, in the photovotayic industry, all Chinese solar companies are incurring losses due to cutthroat competition. Another form of evolution the CCP aims to tackle. The food delivery industry familiar to many is also caught in price wars creating hardship for those involved. This form of evolution is synonymous with over capacity and it's this issue the CCP is determined to confront. But why has the CCP suddenly prioritized the combating evolution? Two key factors are driving this shift. The first is the economy's troubling performance particularly in metrics related to inflation and deflation. Initially the CCP viewed in evolution as beneficial. Yes, it was challenging. But if it means Chinese electric vehicles and solar panels could dominate the global markets, wasn't that worthwhile? In early 2024, Xiinping dismissed concerns about deflation, involution, or over capacity, guided by Marxist economic principles. He famously remarked, "What's wrong with deflation? Don't people prefer lower prices?" When US Treasury Secretary Janet Yelen raised this issue during her visit to China, the CCP rebuffed her, accusing her of harboring intentions to undermine China. Despite this defiance, recent economic trends had forced the CCP to reconsider. By September of last year, they began addressing the issue on a smaller scale. Their initial response was to introduce subsidies, consumption subsidies, car purchase subsidies, and appliance subsidies, collectively known as national subsidies. These measures have been palpable for those living in China. At this stage, Xi Jinping acknowledged China's deflation issue, but was reluctant to scale back his championed industries such as electric vehicles and solar p solar power. His approach was to boost consumption rather than reduce production to tackle deflation, involution, and overcapacity. Early on, these national subsidies showed promising results. In the second half of 2024, China's deflation metrics improved with the consumer price index CPI gradually turning positive. However, by the first half of this year, particularly from February onward, the CPI slipped back into negative territory. The growth spurred by consumption subsidies began to wne and industries not covered by these subsidies showed no notable consumption growth underscoring the policy's limitations. After a year of implementation, the CCP recognized that the largecale consumption subsidies had a limited impact. They failed to reverse China's deflationary trend of insufficient consumption. It's akin to prescribing painkillers to a patient. It eases symptoms but doesn't address the root cause. This realization necessitated a bolder policies to rescue China's economy from its deflationary crisis, marking the first catalyst for the anti-evolution policy. The second catalyst is the US China trade war. Despite ongoing tensions, current data suggests the trade war has paradoxically boosted China's exports to the US in the first half of this year. China's trade surplus with the US grew by 34.8% compared to last year, reaching a historical high. Some analysts are questioning the accuracy of this data, but the impact of tariff is undeniable sooner or later. The export surge in the first half of the year likely reflects preemptive shipments before tariffs fully take effect, particularly through increase to trans shshipment the trade to bypass other countries trade agreements. This has effectively exhausted export capacity for the second half of the year. In the long term, China's exports will face pressure, a reality the CCP fully understands. Looking ahead to the second half of the year, domestic demand is projected to remain weak and export expectations are equally subdued. This suggests a further softening of demand and a worsening deflation problem. These factors have strengthened the CCP's resolve to pursue robust reforms, requiring stronger measures to reverse the current trajectory. That measure is the anti-involution policy. Why are Chinese companies trapped in involution? Some fervent nationalists argue that China has no over capacity or involution. But this stance is outdated as the CCP itself now acknowledges the issue. Others attribute all of China's problems to US hedgemony or claim that China's large population is the root cause, suggesting things would improve if the population were halfed. These claims are varied and far-fetched and economists largely dismiss them. The prevailing view among economists is that China's current deflation and a corporate involution result from resource misallocation. What does this mean? For example, excessive capital has flowed into the solar industry, enabling companies to build factories far beyond the market demand. a taxport case of resource misallocation. China's solar production capacity has long outstripped global demand. Yet, this hasn't deterred some solar firms from expanding. In 2022, many doubled their production lines, pushing China's solar capacity to unprecedented levels. This disregard for market dynamics led to the entire Chinese solar industry operating at a loss by 2024. Even so, in March of this year, solar production capacity hit a new peak. This clearly illustrates resource misallocation and the rational allocation. These firms wouldn't have had the funds to build production lines exceeding market needs. The electric vehicle industry presents an even clearer case. While some mock traditional automakers like a BMW, Mercedes, and Audi for not heavily in investing in EVs, those companies see Chinese firms overinvesting in EVs, engaging in involution within a limited market. Various theories explain China's resource misallocation. One perspective from CCP aligned economist Ling E Fu attributes it to a surge phenomenon in corporate development. He argues that when an industry or sector presents significant growth opportunities, it attracts excessive capital and labor leading to rapid or even overexpansion. This reasoning somewhat blames capital greed for China's evolution and over capacity. But this doesn't hold up. The US has greater capital freedom yet it doesn't experience this surge phenomenon. Why does it emerge in China? The reason I am focusing on anti-involution today is that the CCP has identified the core issue. China's industrial evolution and over capacity aren't driven by unchecked capital expansion but by government guidance. The surge in certain industries results not from capital's choice but from government intervention. China's passed over capacity stemmed from Shiinping's ambition to surpass the US fueling massive growth in electric vehicles and solar power. After committing to combat involution, the CCP's mouthpiece Chos magazine published an article on anti-involution, explicitly stating that excessive local government intervention in markets is a major cause. This is essentially a veiled admission of past policy errors. Though it shifts blame to local government, suggesting corrupt officials misled the central leadership rather than she's intentions being flawed. While this is a scapegoating, it's better than denial and signals the CCP's willingness to reform. Perhaps because this reform carries an element of self-criticism, this significant policy shift has generated little domestic attention. So, how will the CCP execute this U-turn? And why do I warn it could risk widespread unemployment? Currently, the CCP's approach to regulate anti-imolution mirrors its previous efforts to tackle over capacity. In 2015, China faced a significant overcapacity addressed through supply side reforms. You may have heard the term supply side reform frequently. Though it may seem unfamiliar, it refers to a 2015 initiative by Xiinping to reduce over capacity. Back then, China had a clear over capacity issues, particularly in outdated sectors like a steel, cement, and coal. China's steel output alone was more than double the combined production of Japan, India, the US and Russia and evident case of overcapacity. These industries were not only overproducing but also low efficiency and highly polluting. Xiinping led efforts to phase them out. To address this, the CCP established the industry associations to limit aggressive expansion and production. This time the CCP is adopting a similar strategy. Anti-involution is essentially supply side reform 2.0. Since May, Chinese steel meals have received inspection orders from relevant authorities with a strict enforcement beginning in July. The measures are rigorous. After receiving production cut targets, steel mills have you have held industry meetings to allocate capacity for each factory. submitting plans to the central government. The central government is reportedly demanding at least a 40% reduction in steel production capacity, but the effort extends beyond steel. According to a July 18 statement from the Ministry of Industry and Information Technology, 10 key traditional industries in compassing at least 7% of China's traditional industrial sector are under scrutiny. This approach echoes supply side reform 1.0, but with a key difference. In 2015, over capacity was primarily in state-owned enterprises, which could be managed through coordination. Private firms, however, are less compliant. The CCP's final regulatory measures for private companies remain unclear, but initial strategies involve issuing directives through industry associations combined with media and government criticism. For instance, in the food delivery industry, the catering chamber of commerce has called for an end to unfair subsidies and competition. Recently, people's daily began criticizing the delivery sector and the state administration for market regulation summoned the Muan Elder and JD's delivery service for discussions. These are likely initial anti-involution measures for the industry. If these companies don't comply, the CCP could impose harsher measures with no upper limit. After all, when Jack Mah challenged the CCP, he vanished. Something similar could happen or could occur in the delivery sector. In the automotive industry, Great War Motor CEO Wei Jen Jin's criticism of BYD appears to be part of the CCB's anti-evolution campaign, likely a preliminary signal. Overall, using administrative orders to aggressively reduce capacity and combat involution may likely be the CCP's primary strategy moving forward. While combating involution is a positive step, I believe the CCP's approach could lead to concerning outcomes. First, involution was caused by excessive government intervention. A return to a planned economy where the party dictates production. Now, to address this, they are doubling down on the same party directed approach. It's like creating a problem through misguided direction and then intervening again with another round of direction. Could this new intervention create larger problems? It's certainly possible. One potential issue is product shortages. Starting in 2016, China experienced the power restrictions in various regions continuing through 2021. When a nationwide power shortage occurred, many might wonder why. If the China progressed, its power supply became increasingly inadequate. The root cause lies in the 2015 supply side reform, which curtail the coal production leading to critically low output and years of power shortages. The most pressing concern with anti-evolution in my view is unemployment. China's economy is deeply mired in involution and correcting it is a complex challenge. Reducing capacity and combating involution requires complimentary measures for industries like electric vehicles and solar power. Cutting production can restore prices and profits to sustainable levels, which is why the Shanghai stock index rose noticeably after the anti-imolution policy was announced. However, reducing capacity inevitably leads to significant unemployment. The logic is simple. Less production means fewer products, which requires fewer workers. This was evident during the 2015 supply side reform. According to the CCP's own reports, the 2015 reforms targeting steel, coal, and cement led to massive layoffs. approximately half a million steel workers and 1.3 million co-workers in 2016 alone including other sectors over 5 million jobs were affected. A similar scenario is likely during this anti-evolution period. The food delivery industries is another case though its dynamics are more complex. The sector's ecosystem is widely recognized as distorted. Contrary to common belief, these companies profits are not high compared to platforms like a Door Dash and Uber Eats. May Twan's profit margins are lower and Earl Me operates at a loss. If the CCP impose a blanket ban on involution, preventing delivery companies from offering subsidies or exploiting riders and merchants, delivery prices will rise. If a meal delivery cost 25 yen instead of 15, people will order less frequently. Riders delivering 50 orders a day may drop to 30 and the merchants with 100 orders a day may see only 50. This could lead to widespread layoffs among writers and the closure of many restaurants, potentially worsening conditions compared to the involution era. We don't yet know which industries will be targeted in anti-involution campaign or which new quality productive forces with over capacity will be addressed. But the 10 industries highlighted by the Ministry of Industry and Information Technology are likely at risk. Sectors Xi Jinping has cautioned against developing recklessly or uniformly nationwide are also vulnerable. This isn't to say evolution shouldn't be addressed. However, anti-involution efforts must be paired with measures to stimulate the demand. Resource misallocation often accompanies a job misallocation. Unemployment isn't inherently negative, provided new jobs are created to replace those lost. This was the case during the 2015 supply side reform. Why didn't the massive layoffs then lead to widespread unemployment? Because the CCP paired supply side reform with a shanty town redevelopment policy, transforming outdated urban housing into new commercial properties known as the shanty town reform. This reform offset the job losses from supply side reforms. Between 2015 and 2018, China invested 6 and a4 trillion yen in Shanti Town redevelopment. In 2015 alone, 5.8 million housing units were started, followed by 6 million in 2016, resulting in about 26 million new homes. This created substantial employment opportunities. It also drove up real estate prices, increasing household wealth and boosting consumption. Essentially, the CCP used an inflated real estate bubble to mitigate the adverse effects of supply side reform with Shanty Town redevelopment creating jobs to offset those loss. We won't debate whether that shanty town reform was a short-term fix with long-term costs, but it prevented widespread unemployment. Thus, this anti-evolution efforts or supply side reform 2.0 0 must be accompanied by a shanty town reform 2.0. Anti-involution is about reallocating resources. It's reasonable to reduce overallocation to industries like electric vehicles, solar power, and food delivery. But there must be a new destination for those resources. While eliminating excess jobs from over capacity, new industries must emerge to absorb that employment. If workers from electric vehicle factories lose their jobs, new factories should provide opportunities. Society's purchasing power must also improve. Food delivery can move away from evolution, but people must be able to afford 25 meals instead of 15 UN ones. Delivery writers leaving their roles must find the new employment. Supply side reform uh reform 1.0 0 removed excess funds and capacity from certain industries while shanty town reform 1.0 redirected those resources to a new sector. The two were interdependent. Without the shanty town reform to redirect resources, supply side reform alone would have left millions unemployed. Anti-evolution is a positive step, but it must be supported by policies to stimulate employment. What will China's shanty town reform 2.0 0 entail. We don't know yet, but it will be more challenging than last time as many previous strategies are no longer viable. Some speculate that China might attempt another literal shanty town reform, boosting real estate by re relocating rural populations to urban commercial housing to stimulate the jobs. However, this seems impractical. China's real estate bubble and population size can't support another shanty town reform. Real estate is just one example. China's debt levels and household leverage ratios are far higher than in 2015, leaving the CCP with fewer options this time. Beyond the limited options, another concern is that shanty town reform 2.0 will need to create even more jobs than before. In 2015, over capacity was confined to traditional industries like a steel, coal and cement. Now those industries remain overproductive, but new sectors like electric vehicles and solar power have added to the problem requiring a broader solution and affecting more jobs. As for what from China's shanty town reform 2.0 or or complimentary stimulus policies will take will likely need to wait until the second half of the year for clarity. I'll provide a further analysis then. Thank you so much for watching. If you find this video helpful, please like it, drop a comment below, and hit the subscribe button right here. 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