China's 'anti-involution'

Earlier this year, Chinese consumers had some tasty deals on offer for takeout. The country’s three biggest food delivery services started a price war, with each firm offering customers big discounts in hopes of taking market share. A craze of frivolous purchasing set in, attracting government notice. Prices for many goods came down to practically nothing and, in the case of a coupon for free milk tea, went all the way there.

In recent years the Chinese word neijuan (“involution”) has come to refer to a state of fruitless or destructive competition, with this year’s delivery price war serving as a leading example. This May, the People’s Daily, the communist party’s official newspaper, ran an article on “involution style” business practices that the government wishes to suppress. President Xi Jinping soon took up the cause, and the country’s “anti-involution” era was underway.

The problem of “involution” affects more than just the profit margins on a family’s weeknight dinner. The country suffers widely from overcapacity, which has led to deflation and endless competition between market participants. Producer prices have been negative for roughly the past three years.

China launched a similar drive against overcapacity in 2015 in industries like steel and cement, an effort that was largely considered successful. That mostly affected state-controlled enterprises. This time around, we see a broader array of mostly privately owned businesses, which creates certain difficulties. In addition to heavy industrials businesses like steel and cement, overcapacity is a problem at the aforementioned delivery firms, along with such industries as polysilicon, solar panels, lithium batteries, coal mining and even pig farming! While the government would not want to impose its will directly, it can expect to exert influence though the mediation of industry associations and regulators.

Goldman Sachs says that more than 80% of China’s steel mills responding to a recent survey report that they have started to cut 2025 production as of July, by 1%-16% so far. Cement producers also saw production pause for several days in July. Lithium supply levels were at 22% surplus in May, but that figure is down from higher figures earlier this year. And CATL, the largest battery maker in the world, had to suspend operation on its lithium mine on August 9, when regulators stepped in and did not renew its mining license. This mine is about 7% of global supply, and there are other smaller mines in the region that could face similar treatment in the near future too.

What are investors to do? There are certainly risks. Individual companies may suffer if they are told their new factory or mine must close. (Admittedly, some of these firms are in unattractive, loss-making industries anyway.) But on the macro level, reducing overcapacity is unambiguously good for China, and I expect the government to get its way. Investors with sufficient risk tolerance might want to consider increasing allocations.

China’s economy has otherwise just been muddling along, with President Trump’s tariffs an additional source of difficulty. However, its equity market, despite a heavy dose of intermittent volatility, continues to rise with a quiet yet steady momentum. Is the market telling us something?