China today produces over 30% of the world’s manufactured goods — more than the United States, Germany, and South Korea combined. Some Chinese scholars argue that China should aim for 45% of global capacity, framing sheer scale as a shield against US pressure and a source of ‘narrative power’ in the global economy.

Arguments reveal how scale itself is a strategic asset. Yet size can be hazardous. Overwhelming productive capacity not only alters market dynamics but also destabilizes trade relations, creating systemic risks both for China and for the global economy.

At the heart of China’s industrial policy strategy is the Catalog of Industrial Guidance, first introduced in 1993 and institutionalized under the Five-Year Plans. Each catalog classifies industries as encouraged, restricted, or prohibited. Over time, it has evolved into the backbone of Chinese industrial policy.

In its latest form, the catalog has become more sophisticated, presenting clear linkages across industries. It is issued by the National Development and Reform Commission, with the 2024 version setting the direction of the 15th Five Year Plan. The 2024 catalog lists 51 industries to be encouraged, five as restricted and another five as prohibited.

For semiconductors — one of the most important industries — the catalog covers 16 sub-industries across information communication technology, materials, and related fields. These include ultra-thin substrate glass for touch panels and its production equipment, compound integrated circuits, advanced packaging and testing, electronic-grade polysilicon, silicon single crystals, and silicon carbide single crystals.

For iron and steel, it lists high-efficiency ore beneficiation and pelletizing, low-carbon ironmaking, ultra-high-strength steel, high-purity iron, and scrap steel recycling as encouraged. Open-hearth furnaces, inefficient blast furnaces, small-scale rolling mills are listed as restricted. Small-scale blast furnaces, excessive new construction, low-efficiency rolling equipment are prohibited.

The comprehensive catalog is more than an aspirational planning document — it sends a strong signal to Chinese state and society, guiding resource flows across a range of domains. In terms of resource allocation, local governments extend subsidies, land rights, and public facilities towards listed sectors. Financial institutions, including state banks and investment funds of both private and public entities, provide preferential loans or investments to catalog-aligned projects. And for human capital, universities and ministries establish new programs to train students for targeted industries.

This integration generates powerful external economies of scale that substantially reduce costs through deep inter-sectoral linkages that reinforce China’s industrial ecosystem. In this sense, subsidies or state-owned enterprises are secondary — the decisive factor is the catalog’s ability to coordinate firm entry and industrial linkages across sectors.

But the same catalog mechanism has also driven overcapacity through unintended local industrial expansion. The catalog enables local firms, often with the support of ambitious but technologically inexperienced local governments, to enter frontier industries and their subsystems.

The consequences of dynamics are now visible at the macroeconomic level.

In most cases, overproduction manifests as an industry-specific phenomenon rather than a macroeconomic condition. This distinction has been the subject of lively debate among Chinese scholars and China watchers alike. But China’s industrial deflators, officially published by the National Bureau of Statistics, suggest a far more pervasive reality. Since 2024, deflation has spread across virtually all sectors of the economy. In other words, excess capacity has become systemic rather than industry-specific.

But within China’s policy debate, the term ‘overproduction’ remains politically charged and is often rejected outright. Instead, discussions have coalesced around the notion of ‘involution’ — a term that implicitly acknowledges competitive stagnation but that avoids the structural and policy implications of overproduction. This asymmetry in the policy narrative stands in sharp contrast to the empirical evidence: the official data leaves little doubt that widespread overproduction is now a defining feature of China’s industrial landscape.

What is unfolding now is not a temporary deflationary phase but a structural outcome of China’s growth model.

Overproduction generates a negative externality by depressing the aggregate purchasing power of the nation and, by driving down export prices, it erodes China’s terms of trade. It is a situation which economist Jagdish Bhagwati termed as ‘immiserizing growth’. In the mid-2010s, China experienced overproduction in steel and other manufacturing sectors, cushioned only by a booming property market. In 2025, real estate no longer provides that buffer. Instead, industrial policy is entangled with geopolitical rivalry, locking Beijing into a ‘game of chicken’ of capacity expansion even when it undermines national welfare.

The international repercussions are profound. Steel, solar panels, and electric vehicles are flooding markets not only in advanced economies such as the United States, Japan, and the European Union, but also in emerging markets from Vietnam and Indonesia to Mexico and Türkiye.

The World Trade Organization’s current framework is insufficient to discipline this new reality of scale power. Three avenues for reform deserve consideration.

First, stronger scale-differentiated disciplines are needed to curb the abuse of scale power arising from excessive economic concentration in key sectors.

Trade remedies, anti-dumping, and countervailing measures, should also be recalibrated to reflect the outsized market power of certain countries in certain industries to offset the effects of economic coercion.

Most critically, greater international coordination on fair competition policy is essential. Establishing common principles for cross-border mergers and acquisitions, and ensuring fairness and transparency in their international approval would help contain distortive, state-led industrial interventions and promote a more balanced competitive environment.

Among them, the third reform is the most urgent under current circumstances, as it is essential to mitigate the negative spillover effect of US-China economic friction on third countries.

China’s catalog-based industrial policy has been a remarkable driver of growth, but it has also produced structural distortions at home and mounting frictions abroad. Scale has become both China’s greatest strength and its most dangerous liability.

The central challenge is not whether industrial policy exists, but how international rules can adapt to discipline the abuse of scale while preserving open markets. The ‘shadow of scale’ is thus not a uniquely Chinese challenge, but a global governance imperative.