Editors' Pick: Originally published Jan. 26.
TAIPEI, Taiwan (TheStreet) -- Imagine making stuff no one wants, earning money anyway and then wondering why the economy went awry.
China is doing just that. Continued overproduction at state-owned companies despite poor demand is holding back China's efforts to reverse its slowing economic growth.
Analysts call this overcapacity a top concern that architects of the world's second-biggest economy have known about for more than 20 years.
But the communist state, whose government-run companies now include U.S.-listed firms such as Aluminum Corporation of China ACH and China Petroleum & Chemical Corp. (SNP - Get Report) , just can't turn off its machinery.
That's because Beijing wants to avoid a hard landing as China transitions from an industrial, state-financed economy to one driven by consumer spending and private investment.
Yet, the reluctance could hamper any recovery in China's battered stock market. Global share prices also have taken a hit over the past year because of worries about slowing economic growth.
Even so, China will wean itself only gradually from slow state-funded production.
"If you don't add as you subtract, that will cause an impact on GDP," said Zhao Xijun, deputy dean of the school of finance at Renmin University in Beijing. "You need to pull back and move forward in sync."
Sudden stoppage of state enterprise work would at least force people out of jobs and strike at China's tax base. State investment rose 10.9% in the final quarter of last year, coming to about 35% of the GDP.
Still, overcapacity adds to corporate debt already at $28.2 trillion in 2014 and irritates countries that make the same products and compete with floods of cheaper goods from China.
Steel exports, for example, rose 20% to a record high last year overall slowing economic growth. China shipped some of that to the United States at "rock-bottom prices," the Association of American Manufacturing said on its website this month.
Other industries chugging along over the past decade at overcapacity include cement, wind power and ethylene chemicals. Demand is weak in China's major export market Europe, while local manufacturers that might need some of those goods are slowing production due to rising costs, a cause for the growth slowdown.
"The most important thing China needs to do is to really introduce a market economy for its larger corporations," said Alicia Garcia Herrero, chief Asia-Pacific economist with French investment bank Natixis. "Without this, there is no way China can solve its overcapacity in a sustainable way."
Authorities acknowledged last month that supply gluts present "a major challenge to growth," as worded by the official Xinhua News Agency. They will formulate policies to cover bankruptcy cases, idle assets and laid-off workers, Xinhua said.
They might also wait for consumption to expand. Rising wages that have hurt the bottom lines of once all important export manufacturers may eventually spawn a massive bloc of eager consumers, said Liang Kuo-yuan, chairman of Yuanta-Polaris Research Institute, an economic think tank in Taipei. Consumer spending reached an unusually high 60% of GDP in the first half of 2015.
Officials are also pushing clean-burning private investment to offset state spending and ease pollution. The country must push harder on opening finance, education and healthcare to private firms, said Scott Kennedy, a China economic expert with the Center for Strategic & International Studies think tank.
"Greater private investment and reduced regulatory barriers would result in much better services that would improve the economy's efficiency and address a great deal of pent-up demand," he said.