Wen Jiabao is feeling hard done by. On Monday the premier rejected international calls for Beijing to let the yuan strengthen as 'unfair'. Although Wen's protest made the news headlines, in one way the premier was behind the times with his complaint. In recent days Beijing's critics have zeroed in on a new target. Instead of carping about the yuan, now they are grumbling about overcapacity in Chinese industries, which they say holds back domestic economic development and destabilises the international economy. Visiting Nanjing this week for a China-European Union summit meeting, European Commission president Jose Manuel Barroso said Beijing urgently needed to tackle overcapacity if governments were to engineer a smooth exit from the economic slowdown. Meanwhile prominent American economist Tyler Cowen warned in The New York Times that the economic relationship between China and the United States 'may unravel in a dangerous way, and if it does, the most likely culprit will be Chinese economic overcapacity'. According to a study published last week by the European Union Chamber of Commerce in China, China's economic model, although successful at producing rapid growth, is hard-wired to generate excess capacity. It argues that artificially low interest rates coupled with an overly wide spread between deposit and lending rates results in a transfer of wealth from households - the depositors - to corporations - the borrowers. The result is to suppress consumption while encouraging investment in new production facilities, leading to industrial overcapacity. The tendency is exacerbated by widespread state ownership. Because state-owned enterprises typically pay only limited dividends, the government has little interest in maximising their profitability. As a result, officials tend to prize rapid production growth over improved profits, again leading to excess capacity. Local turf wars make the problem worse. Officials anxious to protect local government value-added tax revenues resist industry consolidation, keeping inefficient companies in business by failing to enforce labour and environmental standards while erecting protectionist barriers that discriminate against companies from other areas. The result is extensive duplication and idle production capacity. This year's stimulus efforts have thrown the issue into sharp relief, as heavy investment by state companies has boosted production capacity faster than sales growth, leading to massive excess capacity across a range of industries (see the charts below). The European chamber's report argues that such extensive overcapacity is damaging China's economic prospects. Under-utilisation of production capacity equates to a waste of resources, which eats into corporate profit margins. It warns that thinner margins encourage companies to cut corners on labour and environmental standards, suppress research and development, making it more difficult for businesses to advance up the value chain, and increase the chances of future loan defaults. They also hold down wages, slowing the growth of domestic consumption. In addition, overcapacity is also likely to fuel a rise in international trade tensions, especially if excess production gets dumped on global markets. To tackle the problem, the European chamber suggests a whole suite of policy measures. Its report recommends liberalising interest rates to halt the transfer of wealth from households to the corporate sector. It also advocates raising the dividends paid by state-owned enterprises and speeding up privatisation to improve corporate governance. It says subsidies and price controls should be scrapped to force companies to pay market rates, while the power of environmental protection agencies should be bolstered to penalise inefficient and polluting corporations. Meanwhile local governments should be given more avenues to raise revenues, to reduce their dependence on local production. Oh yes, and the report also calls on Beijing to allow the yuan to appreciate, arguing an under-valued currency effectively subsidises domestic producers. So even though in one way Wen's protest about unfairness was behind the times, in another it was bang up to date.