The Price of Plenty: Industrial Overcapacities, China and European Defence

CSDS POLICY BRIEF • 27/2025

By Daniel Fiott

30.9.2025

Key issues

• Despite the European Union’s (EU) steps in recent months to boost defence investment, the sector faces structural challenges, not least due to global industrial overcapacities;
• Large financial investments are being made in the European defence sector, but the EU must now address the structural issues that inhibit the growth of the European defence industrial base;
• Chinese industrial overcapacities persist as a major issue in the European defence sector, but more policy attention is required to address this concern.

Introduction

The global trading system has steadily deteriorated over the past decade or so due to the rise of tariffs, technology competition and industrial policy. In particular, competition between the United States (US) and China has led to retaliatory trade tariffs from both sides targeting the steel, electronics, machinery, agricultural and automobile sectors. Both sides have also redoubled efforts to support their major industries through subsidies, legislation and tax reform. For example, the US has introduced over the last few years legislation such as the Inflation Reduction Act (IRA) and the “One Big Beautiful Bill Act” to halt the US’ industrial decline. China, for its part, has introduced new legislation to shield its firms from foreign sanctions, and it has imposed export controls on various strategic technologies and resources. What is more, China is regarded as a major global source of industrial overcapacity.

Industrial overcapacity can be defined as a situation where the productive capacity of industries exceeds the demand for their products or services. This can lead to considerable economic challenges and inefficiencies, including oversupply, price erosion, wage depression, misallocation of capital, environmental concerns, resource depletion, trade dumping and more. The global economy has for several decades suffered from industrial overcapacity in sectors such as steel, textiles, electronics and even energy. The causes of overcapacity are manifold. First, there can be a mismatch between investment in production and market demand. Second, the use of new technologies and manufacturing processes can increase production efficiencies. Third, shifting consumer preferences can affect supply and demand. Fourth, the outsourcing of production to low-cost states or regions can lead to a surge in output. Finally, government policies may encourage overcapacity in support of employment and growth, despite weak demand.

There are considerable political challenges associated with industrial overcapacity. Indeed, it can lead to trade and resource disputes, political instability and disruptions to global supply chains. While overcapacity has been a mainstay of the global economy for many years, especially in the agricultural sector, today the main challenge is how overcapacity and subsidies are being applied to strategic industrial sectors and technologies that have a major bearing on global competition. Today, industrial overcapacity is not primarily an issue of economic inefficiencies per se because the reasons behind overcapacity are increasingly intertwined with international politics and statecraft. And they can also negatively impact strategic sectors such as defence.

Overcapacity impacts geopolitical dynamics between the EU, China, the US and other global players. The EU’s response to China’s overcapacity sometimes intersects with its relationship with the US. For example, both the EU and the US have similar concerns about China’s industrial subsidies, leading to potential transatlantic cooperation on trade policy. However, differences over how to address these issues can strain EU-US relations, too. This CSDS Policy Brief takes stock of overcapacity, especially as it specifically relates to the European defence sector. We first look at the overcapacity challenge posed by China. We then move on to consider some of the political and economic pathways that the EU can explore to better manage the challenge of overcapacity in its defence sector.

The problem of overcapacity: the China challenge

Active government policies to stimulate industrial production, which can lead to overcapacity, are a reality in many major economies. China, for example, plays a significant role in global industrial overcapacity. Given China’s unique market structure, the central government is engaged in an active economy-wide subsidisation strategy. China experiences a high degree of state intervention, and it supports State-Owned Enterprises (SOEs) in key sectors such as aluminium, cement, steel, electric vehicles, batteries and energy through cheap or favourable loans, tax breaks and state support for international commercialisation opportunities. SOEs have come to characterise China’s approach to production, with such strategies actively contributing to China’s economic strength. For the People’s Republic of China (PRC), such approaches help to maintain employment, social stability, global power and legitimise the PRC’s domestic political control. All of these effects are crucial during global economic downturns or shocks, as China wants to maintain growth and to avoid mass unemployment.

Yet, it is not only the role of SOEs that is relevant to China’s industrial overcapacities. In fact, China’s rapid development and urbanisation have also contributed. Meeting the initial demand of China’s urbanisation led to overcapacity in the real estate and construction sectors (cement, steel, etc.), but China’s building boom has cooled, leading Beijing to dump its excess production on global markets. Additionally, China’s state-controlled banks have been willing to lend large sums of money to industries that are already overproducing, contributing to debt-driven growth, bad loans and non-performing assets in some sectors. Finally, China is engaged in rapid technological advancement and automation, meaning that China’s ability to overproduce is not necessarily linked to its enormous labour pool.

Critically, the external dimension of China’s overcapacity is relevant for international politics and global competition. China’s dumping of notable products such as steel and textiles has led to political and trade tensions. This is why, in 2018, President Trump imposed a 25% tariff on imported steel under Section 232 of the Trade Expansion Act, citing national security concerns, in part due to the overcapacity problem. In 2025, President Trump imposed a 50% tariff on China on a range of goods such as steel and aluminium. China’s massive production capacity in consumer electronics, such as smartphones, computers and batteries, has led to global price pressures and political rivalry. China’s dominance in high-tech goods (e.g. 5G, electric batteries and semiconductors) has led to major security concerns. Beijing has also used the Belt and Road Initiative (BRI) to export its cheap industrial goods, which not only allows China to build cheaper infrastructure abroad, but also grows its strategic relevance by generating financial and political dependencies through debt, territorial access/ownership and political concessions.

The effect on European defence

Industrial overcapacity is a major concern for the EU, especially in sectors such as steel, textiles, solar panels and electronics. Overcapacity in China not only distorts global markets but also poses specific trade, economic and political challenges for the EU. China’s dumping of steel, for example, undercuts EU steel manufacturers, who cannot compete with prices that are artificially lowered by subsidies or overproduction. In response, the EU has imposed anti-dumping tariffs on Chinese steel, aiming to protect its own industries within World Trade Organisation (WTO) rules. Such measures can lead to legal action within the WTO, but the organisation is currently weakened, and any EU case can lead to lengthy and costly legal battles, straining the EU’s relationship with China and creating uncertainty in the global trading environment. Perhaps more importantly, China’s overcapacity puts considerable economic pressure on European manufacturers, particularly small and medium-sized enterprises. This can lead to job losses in Europe in critical sectors and a crowding out of investment, as well as lower innovation.

However, one particularly important sector that can be negatively affected by overcapacity is the European defence market. European defence producers are reliant on a range of dual-use and civilian products and technologies. While China is not a direct player in Europe’s defence market, its industrial overcapacities hit defence-relevant product groups such as steel, rare earths, solar panels and shipbuilding. China’s overcapacity in steel, aluminium and rare earth production is leading to global price suppression, which, in one regard, might be viewed as positive, but European defence manufacturers are dependent on these supplies for aircraft and shipbuilding, electronics and missile systems. The low prices might be valued in the short run, but over the longer term, they erode European defence suppliers’ security of supply, as Europeans are increasingly open to Chinese regulatory and supply manipulation. Overly subsidised goods by China, such as semiconductors, electronic components and ship parts, are flooding the European market, and unfair competition in dual-use industries could lead to structural defects in the defence market.

Look, for example, at the shipbuilding sector, where China dominates over 50% of global output through state-subsidised efforts. The naval industry is a strategic asset for Europe, not least as it creates positive economic and social spillover for research and transport sectors. The shipbuilding sector in Europe comprises some 300 shipyards and 22,000 equipment suppliers, and it is responsible for over 1 million direct and indirect jobs, as well as a value of some €125 billion. This is a critical sector given Europe’s essential maritime location and its trading prowess. Yet, Europe’s shipping sector is subject to growing competition from Asia (China, Japan and South Korea), and one estimate states that unfair trade practices in Asia have led to a price difference of 30-40% between European and Asian ships. In 2024, China was reported to have swallowed up 70% of total global new orders for large ocean-going ships. As European shipowners seek to manage costs by acquiring cheaper shipping goods from outside of Europe, this is having a detrimental effect on Europe’s own industry, and China’s direct footprint in the European maritime market raises security questions.

Crucially, Europe’s naval sector shares important supply chains with the commercial shipping industry. While Europe’s naval sector is set for an expansion due to the deteriorating geopolitical context, China’s dominance poses structural risks to Europe in terms of supply chain dependency, missed innovation opportunities and labour/skill shortages. We have seen in the US how there are growing fears that China’s shipbuilding mastery poses a strategic threat to America’s defence, as the erosion of the US shipbuilding base is seen as limiting Washington’s naval production potential. Similar concerns should fuel Europe’s own focus on its shipbuilding and naval industries. To be sure, the European Commission is aware of the issue, and it has in the past imposed duties on Chinese and Turkish shipbuilding producers for dumping in the European market. However, more is needed, including European support for ‘a strong high-tech European maritime manufacturing industry’ that prioritises the development of high-end technologies (e.g. Artificial Intelligence and cloud computing) and ensures that unfair competition does not lead to a further downsizing of the shipbuilding industry, which would have devastating effects on the European naval sector as it seeks to ramp up production.

China’s overcapacity in a range of dual-use industries is a major challenge to the defence sector in Europe. Indeed, the Commission is already engaged in several anti-dumping investigations into China’s practices. As of September 2025, the Commission has 67 ongoing investigations and 50 of these investigations pertain to China and sensitive products (steel cylinders, phosphorus acid and ferrosilicon) with applications in the defence sector. The Commission’s own trade defence statistics reveal that China represents the most investigations for anti-subsidy and anti-dumping investigations compared to any other trade partner – from 2020 to 2024, 44 new investigations were launched against China (India was in second place with 7 new investigations over the same period). Some 430 subsidy investigations are currently underway in total, with more than 400 focusing on China. Furthermore, the Commission’s recent analysis of trade diversion shows that China is present in the global top 10% of potentially harmful imports into the EU market in critical sectors for defence, such as basic metals, machinery, electronic equipment and chemicals.

In its recent analysis of China’s trade-distorting measures, the Commission states that it is not just Chinese overcapacity that is of concern, but how key industrial sectors are viewed by the PRC as part of their overall national strategy. For example, the Chinese government provides wide trade-distorting support to the steel industry, which is contributing to a depression in steel prices globally. Although these lower prices damage European steel production interests by artificially depressing prices and crowding out competition, they also have the political aim of putting out of business China’s steel production competitors, which further grants the PRC market dominance. Even aluminium production, which both NATO and the EU recognise as a critical material for defence production in Europe, is subject to control by the PRC. Not only does Beijing heavily subsidise energy for aluminium production – it is an energy-intensive manufacturing sector –, but members of the Chinese Communist Party are also present on the working committees of Chinese aluminium firms, giving them political influence over business decisions.

Responding to overcapacity in defence

We know that the EU has designed a range of trade defence tools to help shield critical European industrial sectors, such as defence and aerospace. The European Commission is increasingly responding to such harmful measures, such as subsidies and dumping, which affect the security and performance of the European defence sector. For example, in terms of its anti-subsidy measures, the EU can impose duties to counteract subsidies that negatively affect European industry. We should also not overlook the importance of the EU’s Foreign Direct Investment mechanism in lowering the risk of private and public ownership of strategic assets (critical infrastructure, technologies, financial institutions, critical inputs) by potentially harmful third-state owners. Finally, the Union’s relatively recent Anti-Coercion Instrument is designed to stop third states from coercing the EU on its trade and economic policy by allowing for retaliatory EU measures such as trade restrictions and/or limiting market access.

Yet, there is a sense in which the EU’s trade and defence industrial policies remain disjointed. For example, the recent EU White Paper on Defence speaks of the growing military risks posed by China, but it only pays passing reference to the effect of its trade-distorting measures on the European defence sector – “China” is mentioned 10 times in the White Paper, “trade” only once. The good news is that the White Paper does acknowledge the importance of critical raw materials for the defence sector, and that the Union must diversify its trade relations and nurture home-grown technologies, components and processes. This logic follows the positive tone set by the 2024 European Defence Industrial Strategy, which recognised the critical importance of access to raw materials, but without ever mentioning the specific risk posed by China. Yet, the EU needs to collectively do more to protect the European defence market and not take knee-jerk decisions in trade or defence policy under pressure from the US or China.

As we saw with the recent EU-US trade agreement, for example, there is a sense in which the defence sector can be used as a bargaining chip during trade negotiations. The EU pledged, for instance, to ‘substantially increase procurement of military and defence equipment from the United States’, even though weeks before the meeting in Turnberry, Scotland, the Commission was working on initiatives under the Readiness 2030 plan designed to enhance the Union’s autonomy in the defence sector. This is a contradiction that can only damage the credibility of the EU in the defence sector. Although the Union used ambiguous language in the agreement on the defence sector (i.e. not spelling out a total amount of procurement from the US, or a time horizon), the fact remains that a supposedly critical sector for Europe was quite readily thrown into a less-than-favourable trade agreement (and this was even the assessment of those that negotiated it) with Washington to sweeten the Union’s offer to President Trump. As stated in the EU’s own White Paper on Defence, and to further emphasise the contradictions of current EU policy, one of the core ways of supporting the European defence sector is investing in Europe’s own capability technologies, components and processes rather than increasing dependencies on third states.

So, one way of combating overcapacity in the global market for critical products and resources is to invest far more directly and coherently in the European defence sector. To offset some of the costs that go into defence production in Europe, EU-backed grant and loan instruments can play an important role in creating scale and innovation, as well as incentivising the development of cross-border common defence projects. The EU is seeking to unlock more than €900 billion in defence spending over the next decade, including through the new SAFE Instrument worth some €150 billion in loans; flexibility in the Stability and Growth Pact, which could lead to an additional €650 billion in national defence spending; a call for €131 billion for defence and space under the next Multi-Annual Financial Framework; and not to mention European Investment Bank loans or the unlocked investments that will appear through a reform of the EU’s regional and cohesion funds.

However, these initiatives – while more than welcome – will not be enough to address the issue of overcapacity or harmful trade practices by third states that can negatively affect the European defence sector. One of the growing strategies to decrease the Union’s dependency on China’s critical products and materials is trade diversification. To date, the EU has signed 14 raw material partnerships and memoranda with Argentina, Australia, Canada, Chile, the Democratic Republic of Congo, Greenland, Kazakhstan, Namibia, Norway, Rwanda, Serbia, Ukraine, Uzbekistan and Zambia. It will be important to ensure that these partnerships deliver over time, and this requires a constant stream of financial support to enable raw material innovation and supply chain security. We should also bear in mind that these 14 partnerships are not enough to fully diversify away from China’s dominance in certain critical raw materials. For example, in August 2025, China produced 3,764 thousand metric tonnes of aluminium, and the rest of the world combined produced 2,513 metric tonnes (Africa produced 140 metric tonnes, Asia (minus China) 412 metric tonnes). To confirm what one recent piece of analysis has already stated, Europe will remain vulnerable to Beijing’s critical raw material and trade practices for some time.

The US, under President Trump, has sought to address the issue of China’s overcapacity in a somewhat radical manner via wide-ranging high tariffs, although these tariffs also apply to close US partners such as the EU, Japan, the United Kingdom and more. China’s recent steps to forego asking for developing country benefits at the WTO, which could dampen China’s use of duties and subsidies, might be seen as Beijing’s move to ramp up its influence in the WTO in the face of US tariff pressure. The EU has also utilised tariffs for certain goods in the past, and there is an indication that the Commission is willing to impose between 25% and 50% tariffs on Chinese steel and related products in the near future. Tariffs may not be the most comfortable policy choice for the EU, but the Union is becoming seemingly more willing to use these trade measures. President Trump has directly requested the EU to impose up to 100% tariffs on China and India to both constrain Russia’s war efforts and economically constrain China. The trouble with US tariffs on China, however, is that Beijing is diverting more trade towards Europe to make up for its trade losses in America, which only exacerbates Europe’s position.

Still, in the current geopolitical climate, some further EU tariffs may be necessary, especially as critical sectors such as defence need safeguarding as they continue to ramp up production. From an economic perspective, tariffs are less than ideal and can significantly harm economic performance (and some argue that US tariffs may actually harm the US defence sector). However, in history, tariffs have been utilised not only to protect domestic industries but also to generate income that can then be used to pay down war debts and construct militaries. In the late 18^th and 19^th centuries, the US federal government imposed tariffs on imports and used the revenue to pay down the debt incurred during the Civil War and to effectively kick-start the US’ path towards becoming a global military power, even if US global trade was relatively low during these periods. We should also recall that the US’ growth as a global military superpower after the Second World War occurred during a period of historically low tariffs, pointing to the benefits of low tariffs.

The EU is unlikely to use a more aggressive tariff policy in order to finance the development of strategic sectors such as defence. That said, we should recognise that customs duties do presently comprise one-third of the total sources of revenue for the EU budget, with some 13.7% of the EU budget accruing through tariffs in 2024. In 2023 alone, customs duties worth €28.2 billion were collected by EU member states. If we are entering a period of history where the EU will face little option but to impose further tariffs to safeguard critical industries, then we may well experience an increase in customs duties contributions to the EU budget. The issue here is that customs duties can only ever represent a small share of the EU’s own resources to reinvest in critical sectors. This is why the Commission has called for an expansion of its own resource base to include new sources of revenue from the emissions trading system, the Carbon Border Adjustment Mechanism, tobacco taxes, e-waste and corporate levies. Such new sources have been called for, partly due to the interest and principal payments that need to be made by the Union on the NextGenerationEU bonds.

So, even if the EU does experience higher revenue from customs duties in the coming years, this will not be enough to support the defence (or defence-relevant) sector/s or to address the structural constraints facing the Union in defence. Of course, there are structural initiatives that can be taken to support the defence sector and economic domains that are vital to defence. One such initiative is truly developing a cross-border security of supply regime, which would ensure that member states can effectively manage supply shortages in the EU during peace and wartime. However, member states are still reluctant to create such a system under the future European Defence Industry Programme. And, as the “Letta Report” makes clear, the EU does not today enjoy anywhere close to a Single Market in defence, which limits access to defence supplies across borders and ensures that the EU cannot develop the critical economic scales needed in defence equipment and technology to strengthen autonomy. Maintaining largely fragmented national defence markets in Europe is not the best defence against Chinese overcapacity or supply shocks.

Clearly, what is required in Europe today is to ensure that additional defence investments go into developing and procuring the military equipment we need to defend Europe. Yet, more coordinated action at the EU level for the defence market as a whole may be required, even if such action will not remove the challenge posed by Chinese overcapacity. Indeed, in her annual State of the Union address in 2025, President von der Leyen resurrected the idea of a “European Defence Semester”. Borrowing from the economic semester, one presumes the logic is for the Commission to provide guidance to member states on defence against commonly agreed criteria. The economic semester already gives guidance to member states on defence investment levels, so it will be interesting to see what is meant by a defence semester. Here, we should recognise that past attempts at creating a defence semester were watered down by member states and they eventually found a home in the Coordinated Annual Review on Defence (which does not address wider defence economic needs). Whether member states are ready for the Commission to play a centralised role in defence planning remains to be seen.

Given the sheer scale of China’s economy, we should not believe that a fully integrated EU Single Market is the only answer to China’s overcapacity. The US enjoys an integrated, federal market, and it still experiences considerable pressure from China’s trade policies. However, it is an inescapable fact that the EU experiences undue trade pressures due to the continued fragmented nature of the defence market and the European market more generally. Creating a genuine defence market in Europe is a necessity regardless of the future of US and China trade policy. Predictions augur that global trade will continue to deteriorate as the US and China engage in retaliatory trade measures. Not only will this “trade war” hit global economic health hard, but it will place increasingly more pressure on Europe’s economy – at a time when many governments have limited fiscal or political space to take bold reforms or investments. And if the global economy worsens in this way, then Europe’s defence industrial revival may be short-lived, with monetary pledges of investment not being converted into manufacturing capacity or military capabilities.

Conclusion

In an ideal world, international cooperation could promote global coordination on overproduction. Cooperation could lead to manufacturing diversity, leading governments and firms to prioritise other industries with stronger demand – this would require R&D investments and labour reskilling. Overcapacity could be managed by a reduction in government subsidies, and international trade rules could address dumping and subsidisation. We do not, however, live in an ideal world. International trade cooperation and governance through the WTO has been significantly eroded. We live in a world where major powers such as China, the US and others are effectively engaged in industrial subsidisation, tariffs and protectionism. These measures, designed with the specific aim of enhancing industrial and technological autonomy, are today a feature of statecraft. All of this places considerable strain on Europe’s defence revival.

China’s state-driven industrial policy, marked by heavy subsidies and support for SOEs, has created significant global overcapacity in sectors like steel, aluminium, batteries and shipbuilding, distorting trade and pressuring global markets. This overcapacity poses serious challenges for the EU, especially in defence-relevant industries, by undercutting prices, increasing supply chain dependencies and threatening industrial competitiveness. While the EU has responded with anti-dumping measures, trade defence tools and investment in defence capabilities, its fragmented defence market and misalignment between trade and defence industrial policies weaken its response. New initiatives, including raw material partnerships and financial instruments, are helpful but insufficient. Without greater market integration and strategic coordination, the EU risks falling further behind amid rising geopolitical and economic pressures from China’s industrial dominance and the escalating US-China trade rivalry.

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