Competition is a natural feature of human societies, and indeed of nature. It is a driving force for the stimulation of higher standards in many activities. But intense competition can have negative consequences. Think of students working until midnight every day to prepare for exams to gain entry to a university whose limited places are many times over-subscribed. Over-competition has been a feature of the chemical industry in China, where periodically the expansion in capacity for a given chemical has out-run demand during unexpected economic slowdowns.
There has been much lamentation in China of a recurring feature of over-building of production plants in the chemical and other industries, leading to over-competition and erosion of profits to zero or negative. There has been agonized discussion over the years, but no real action to correct, still less to anticipate, the problem, until recently. But from last year, there have been policy changes to correct what is now called nei juan, a term for self-negating over-effort, or, for industry, destructive over-competition. Those words are something of a mouthful in English, and commentators have co-opted a rather obscure word, namely involution, that has been a dictionary curiosity until now, as a one-word label. The Chinese term, nei juan, is a rough translation of involution. If evolution means survival of the fittest, involution means the survival of everybody, despite widespread suffering.
An extreme example of nei juan has been the electric vehicle (EV) industry in China. For many years, China’s automobile industry was dominated by a few state-owned firms. Until ten years ago, the top five companies accounted for 70% of automobile production. In 2018, the government removed entry barriers for the automobile industry. By 2022, there were more than 80 manufacturers, and today there are 169 automakers. This led to price cutting starting in 2023, which soon degenerated into an all-out price war. This led to a collapse in profitability, but only a few firms were actually forced out of business. Market exit is hindered by many factors, chief among which are the interests of local governments. The automobile industry is relied upon by local governments to maintain high employment, support community prosperity, and generate tax income. Success in these factors governs the prestige of local officials, who inevitably try to ensure the survival of local industry. What’s more, the local government may have made investments in the company and offered it tax breaks and financial incentives. These factors all combine to keep zombie companies in existence.
The petrochemical industry is once again marching towards overcapacity. Refiners have been expanding into petrochemical products in China’s overbuilt refining sector despite a squeeze on profits, prompting Fu Xiangsheng, vice chairman of the China Petroleum and Chemical Industry Federation, to complain that this sector, too, is facing involution. Production costs of basic petrochemical raw materials, such as paraxylene, are highly dependent on the cost of the petroleum feedstocks, which is encouraging integration of huge paraxylene plants into new refineries. Existing stand-alone paraxylene plants are becoming uncompetitive, but are not being shut down.
It became hard for officials to ignore that involution was leading to a drag on the economy and preventing optimum employment of capital. There were many other negative consequences, including a contribution to the deflation experienced by the economy over the last few years. There has been increasing debate of late on what measures to take, called fan nei juan or anti-involution, to avoid the negative effects of too many companies entering a business area. The various measures instituted can be listed as follows.
These measures have proved to be of limited success so far, in part due to the in-built resistance of interested parties, including local governments. More drastic action to encourage mergers and plant closures may be needed. A respite may be provided by increased prices in 2026, generated by increased energy and feedstock costs occasioned by the war in the Middle East, which are also allowing product prices to be raised.
A major obstacle to the measures listed above is the entrenched position of local government. It is common for local governments to offer incentives to attract companies to make investments in land within their jurisdiction. Incentives include assignment of cheap land, interest-free loans, equity participation, and provision of infrastructure. The central government is considering introducing measures to limit the extent of such local protectionism.
Anti-involution, if successful, would lead to reduced capacity, higher prices, and higher profits for the surviving companies. There would be less pressure on companies to offload surpluses at low prices, especially on export markets, which has been a source of friction with international trade partners. This would be an added benefit, especially in recent times of mounting challenges to world trade.
However, it should be mentioned that there are ambivalent attitudes to anti-involution, even by the central government. Firstly, the economic system is still geared toward supporting production capacity to meet GDP growth targets. Economists point out that it is consumption that needs to be stimulated in present deflationary times, not the supply side, but such a move would lead to lower GDP growth rates. Secondly, fierce competition in the domestic market forces efficiency in companies to the point that successful companies can become world leaders. Cut-throat price wars at home drive companies to capture overseas markets. China now makes 55 percent of the world's steel, 76 percent of lithium-ion batteries, more than 60 percent of EVs, 95% of the world’s polysilicon supply, and 80 percent of solar panels, despite chronic underinvestment present in these sectors. The beneficial side effects of involution -- stimulating innovation and the export drive -- mean Beijing has little incentive to change its system of economic governance beyond periodically pruning the excess of state-directed investment.
There is some evidence, but rather limited, about anti-involution measures that have worked.
From these examples, it is seen that the Chinese government takes a relatively light hand in correcting over-capacity, preferring to allow voluntary measures by an industry rather than imposing plant closures. However, there are indications that a more forceful policy is likely to be introduced in the future, possibly incorporated in the next Five-Year Plan.