The world has changed; but China has not. China has responded to the world financial crisis with what seems to be great success. But this is an illusion. China's solution – a surge in spending on investment – will create greater excess capacity. China's high-savings, high-investment economy is costly for its people and destabilising for the world. The time for a radical reform is long past.

In a disturbing new report, the European Chamber of Commerce in China lays out the challenge in six sectors: aluminium, where the capacity utilisation rate is forecast to be 67 per cent in 2009; windpower, on 70 per cent; steel, on 72 per cent; cement, on 78 per cent; chemicals, on 80 per cent; and refining, on 85 per cent. Yet vast additional capacity is on the way.

The scale of the excess capacity is breathtaking. At the end of 2008, China's steel capacity was 660m tons against demand of 470m tons. This difference is much the same as the European Union's total output. Yet, notes the report, “there are currently 58m tonnes of new capacity under construction in China”. To the extent that gross domestic product is driven by such absurd spending is a measure of waste, not of economic welfare.

Foreign producers fear the impact of China's growing surplus capacity on their markets. But this is not just a problem for specific industries. It is a broader problem. China has become hooked on an unbalanced pattern of economic development, in which investment cures this year's excess capacity by increasing next year's.

In China's current development model, household income is taxed, to support corporate profits. Corporations now generate more than half of China's huge savings. Since consumption tends to grow more slowly than GDP, excess capacity can only be used up via yet more investment or exports. This year, economic crisis has made the latter impossible. But China desperately needs to expand its exports once again. The result may well be a crisis in the trading system.

China's trading partners have to engage with the rising giant. They must explain that they cannot – and will not – absorb the surplus capacity its heavily distorted model of development is creating. But they can point out that this pattern also damages the standards of living of ordinary Chinese. China has to shift income from its corporations to its households and spending from investment to consumption. What is needed for that is a massive structural reform. This must start now. Indeed, it may already be too late.