Will China Take Over the Global Auto Industry?

Massive, and Growing, Capacity

China has, according to the New York Times, the capacity to produce over 40 million internal combustion engine (ICE) cars a year.

Goldman Sachs thinks China will also have the capacity to produce around 20 million electric vehicles by the end of 2024. It should have the capacity to produce something close 25 million EVs by late 2025, as production is currently increasing by close to 4 million cars a year and Chinese firms continue to invest heavily.

As the New York Times story makes clear, China now has an incredible—and I would argue unprecedented—capacity to supply over half the global market for cars, which is typically around 90 million cars a year.

China’s internal market is around 25 million cars, and not really growing—so rising domestic EV sales progressively frees up internal combustion engine capacity for export. Domestic demand for traditional cars is likely to be well under 10 million cars next year given the enormous shift toward EVs now underway inside China.

Put differently, China currently has the capacity to produce over two times its own domestic demand and is adding to that capacity quickly thanks to the rapid expansion of its electric vehicle sector. It thus has almost unlimited potential capacity to export.*

That sets the scale for a potential revolution in global manufacturing.

China has gone from exporting a million (low end) cars a year in 2020 to exporting 6 million cars a year in 2024.

Right now nothing—except politics and the risk of further trade action—precludes exporting another 6 million or even another 12 million cars. China has the capacity to produce that many additional cars, and its shipyards are building the capacity to export them globally.

Historically, the autos market has been largely regional (setting aside trade in luxury cars, where volumes are smaller). Most cars sold in China were made in China, most cars sold in Europe are produced in Europe, most cars sold in the North America are produced in North America, and so on. The U.S. did import a few million cars, on net, from Asia, and China imported a million or so luxury cars from Europe, but those were the exceptions rather than the rule.

That could change, absent hefty restrictions on Chinese auto imports (like the 100 percent tariff the U.S. now levies on EVs imported from China).

The global market—with massive overcapacity in China’s internal combustion engine (ICE) sector, massive capacity expansion in China’s EV sector, effectively unlimited credit for Chinese manufacturing firms from China’s state banks, and a Chinese yuan that is weaker against the dollar than it was back in 2008—is pushing for global auto manufacturing to become more like global electronics manufacturing, with a concentration of global production in a single region and, for that matter, a single country.

So much for forecasts that the pandemic would lead to less concentrated and more resilient supply chains. Right now, the pressure from China’s automotive export success—and its enormously dynamic battery and EV sectors—are pushing toward the concentration of global automotive supply chains in a way that, if allowed, would be unprecedented.

The New York Times documented this in an excellent article.

I explored these themes in my Aspen Economic Strategy Group paper as well.

But I wanted to highlight a few key points that should matter for ongoing debates about the renegotiation of USMCA, European industrial policy, Germany’s future and the struggles of many emerging economies with modest automotive industries of their own.

A New Wave of A Familiar Strategy

Overcapacity in China’s automotive sector is not, in fact, all that new.

China’s traditional automotive sector was dominated by the joint ventures (“JVs”) formed by the large foreign firms and their (typically state-owned) Chinese partners. Chinese auto demand took off after the global financial crisis, and global firms responded by massively expanding their Chinese production capacity—as only the German luxury markets were interested in paying the 25 percent tariff and supplying the Chinese market from abroad.

But demand growth eventually slowed, and by 2018, the Wall Street Journal was reporting that the Chinese market was oversupplied:

“China now has enough factories to build 43 million cars but will produce fewer than 29 million this year, according to consulting firm PwC. While foreign and domestic auto makers alike find themselves under pressure, the slowdown has hit those that misread the market hardest of all … Now these auto makers face a painful dilemma: Abandon those big investments, or invest even more to turn around dying plants at an uncertain time in a crucial market.”

By 2019, the New York Times was reporting that one of Ford’s Chinese factories was running at only one fifth capacity:

“In the inland metropolis of Chongqing, where Ford builds cars like the compact Focus, three big assembly plants have been running at less than one-fifth of capacity.”

That overexpansion in the traditional auto sector—driven heavily by the joint ventures with foreign firms who overestimated future demand growth—came as China’s state was in the midst of a concerted effort to build out its “indigenous” EV and battery industry.

Foreign observers were initially not impressed by these efforts.

But China preserved, and eventually its EV industry reached critical mass—and it now produces the bulk of the world EVs (and almost half of all Teslas).

China’s EV industry—like EV industries in the U.S. and Europe—initially received substantial state backing. Chinese EV manufactures benefitted from downstream subsidies that built out China’s battery and battery chemical industry, as well as access to the world’s cheapest steel.

EV firms benefitted from cheap state financing—both equity injections from a myriad of state-backed funds and loans from state banks who (still) have to meeting lending quotas.

Moreover, China was quite explicitly protectionist in the application of its “consumer” EV subsidies.

Only EVs that were on state lists of qualifying vehicles were eligible for the subsidy, and the subsidy was only provided to cars that were made in China. Keith Bradsher of the New York Times highlighted this back in 2019:

“At the same time, [auto] executives said that some of their biggest trade concerns have not been addressed. These include China’s insistence that electric cars have batteries that are made in China, not imported. Local subsidies for electric vehicles, which total as much as $9,000 per car, are available only for cars with batteries that were manufactured in China. The subsidies have helped make China the world’s largest market by far for electric cars, so carmakers have rushed to shift their supplier networks to China.”

And initially, only cars that were made in China with a battery made in China by a Chinese firm qualified for the lists. The Wall Street Journal reported in 2018:

“In 2015, the government told auto makers they would only qualify for subsidies if they used batteries from a list of approved suppliers, which included dozens of Chinese firms but excluded foreign ones. Executives at global car companies say they were warned by Chinese officials to use local batteries or face reprisals in a country where foreign companies face a constant struggle to stay on good terms with the authorities. China’s Ministry of Industry and Information Technology did not respond to requests for comment.”

At the time, many global auto makers already had longstanding agreements with foreign battery producers. GM had invested in a Shanghai battery-pack facility with LG Chem, according to a former GM executive, while Ford had a global supply deal with Panasonic. The WSJ again:

“It was incredibly frustrating for us,” said a former executive at one foreign battery maker ... Unable to sell in China, the Korean and Japanese makers began using their existing factories to produce batteries for export” (emphasis added).

That gave CATL and BYD a leg up in the Chinese market—and kept cars assembled in China by GM and Hyundai from initially benefitting from the subsidies.

The only exception to the basic rule that qualifying for the list required using a battery made in China by a Chinese firm only confirmed the broad pattern of discrimination: Chinese-owned Volvo was allowed to use a Korean battery in one of its early EVs.

Sustained State Support

State support has not disappeared in any way as China’s EV industry took off. Looking at direct cash subsidies from the central government to the manufacturers misses the myriad of ways China, Inc helps out firms producing in China.

Tesla received a very generous package of incentives—including an exceptionally favorable lease, financing from the state banks at the SOE rate (so below the benchmark loan rate), and a special 15 percent tax rate—to set up shop in Shanghai.

Zhido, a smaller EV producer that went bust, was resurrected and started to invest to expand production after an equity injection from the government of Zhengzhou, a big state enterprise (Three Gorges), and one its rivals (Geely):

“After its restructuring in October, which involved a unit of state-owned company China Three Gorges and Chinese automaker Geely; green up pointing triangle, Zhido is now aiming to double sales annually through 2026 and release 16 new models by 2028. It plans to expand production capacity at its plant in Gansu to 300,000 vehicles a year and ‘actively cultivate overseas business.’”

Nio received a significant ($1.9 billion) equity investment from the City of Hefei and the Province of Anhui, helping to offset ongoing losses. That equity injection was on top of state support for a factory in Hefei, which The New York Times reports was effectively a gift from the local government.

“‘The local government provided the land and the building’, said Ji Huaqiang, Nio’s vice president for manufacturing. ‘Nio does not own the factory or the land — it is renting, but the factory was custom built for Nio’”

That kind of support explains how Nio managed to build out its EV capacity even when its existing factories weren’t really being used that much:

“Nio’s two factories give it the capacity to assemble 600,000 cars a year, even though its annual rate of sales this autumn [2023] is only about 200,000 cars. Nio is nonetheless already building a third plant.”

I would love to know how the Xiaomi factory in Beijing that so impresses foreign visitors was financed. Xiaomi’s various investment funds typically get backing from the Beijing and Tianjin governments. Certainly, Xiaomi and others with exceptionally automated facilities have benefitted from the large subsidies China provided to build out its capacity to build industrial robots.

These efforts have worked so well VW now apparently only uses one German robot in its latest Chinese factory. The rest were all made in China.

“A bright orange robot, 10 feet tall, looms over Volkswagen’s new electric car assembly line in central China. It was imported from Germany. The factory’s other 1,074 robots were made in Shanghai.”

That new factory is the first VW factory in China that is 75 percent owned by VW. It clearly was meant to replicate Tesla’s Chinese success. It also produces EVs for export as well as the domestic market — and was caught up in the EU’s counter-vailing subsidy probe when VW, somewhat bizarrely, didn’t respond to the Commission’s inquiry.

A true market economy—or a savings-constrained economy—wouldn’t be able to support China’s 100 different EV firms. But with different levels of government providing generous financial support to one and all, producers all across China have been able to try to scale up.

History of State Support Matters as China Goes Global

The result of all the competing industrial policies of China’s various provinces was an exceptionally competitive domestic auto market.

Now, the most successful of China’s domestic EV producers—led by BYD—are going global, no doubt with substantial direct and indirect state support. It isn’t a coincidence that Hungary recently got a large loan from the PBOC, the Export-Import Bank of China, and the China Development Bank.

The history of China’s support for its EV sector matters as other countries consider how to protect their own sectors from Chinese competition. There should be no doubt that China’s EV industry developed behind large protective walls (including a long-standing 25 percent tariff that was only reduced to 15 percent when it was clear that China’s own market was over supplied) and with large direct and indirect subsidies.

VW’s China chair Ralf Brandstätter told Keith Bradsher back in 2023: “To build up a Chinese automotive industry was a clear target always of the industrial policy of the government.”

What’s even more striking is that the investments that built out China’s EV capacity came in a market that was already saturated with modern auto production capacity. That kind of investment wouldn’t have taken place without state guidance and support, support that was intended both to develop an indigenous Chinese industry (See China 2025) and to support a green transition that would reduce Chinese dependence on import fossil energy. It was the result of policy driven by the central government and backed financially by all levels of government. It also worked, China is now the world leader in EVs and batteries.

If other countries decide to keep their markets open to Chinese EVs, they are in a sense choosing a different path than the path that led to China’s current success.

China’s export success in EVs was also the product of building out a Chinese supply chain rather than relying on imported parts.

BYD’s local supply chain gives it a global cost edge.

Tesla gets 90 percent of the parts for its Shanghai factory from inside China (and it exports about a quarter of its output, if not more).

VW is substituting Chinese parts for imported German parts whenever possible, and likely looking to substitute Chinese parts into its German and global production as well.

If the world’s global firms can only compete with Chinese firms by using Chinese batteries and Chinese parts, that will hollow out much of the automotive industries of Europe and North America—a European brand on a Chinese-made car with a Chinese battery and drive train won’t sustain the current European auto supply chain or current European employment in the auto industry.

The risks to other global centers of automotive engineering, design, and production thus should be clear.

Germany in particular needs to take note.

But it is nonetheless hard not to be impressed by the pace and scale of China’s transformation into an auto exporter—it was a net importer in 2020 (the year of the pandemic). It is on track to export over 6 million vehicles in 2024, and to export well over 5 million on net.

That’s a massive swing, and it shows up in trade data all around the world.

In Chinese exports of autos to Brazil.

To Turkey.

To Thailand (a hub for the Japanese ICE manufacturers).

To Korea (a hub for Hyundai, obviously, and a big auto exporter globally).

To Mexico, where Michael Dunne reports imports from China now meet a third of local demand... and where BYD is trying to scale up further.

Even Europe—though Europe still has significant two-way trade (for now) thanks to legacy luxury sedan and sports car exports from Germany.

The risk of second China shock, in other words, isn’t just an issue because of Donald J. Trump.

The pressure for protection from this shock won’t just come from the United States.

* The JV structure has historically impeded exports, as foreign firms haven’t wanted to split the profit on their foreign sales. That is starting to change though, given the scale of underutilized capacity in China—and could change rapidly if the foreign automotive marks sell out to a local player.