China’s cull of EV overcapacity will bring little relief to Europe

The writer is the geopolitics analyst at Gavekal Research

A senior official in charge of China’s industrial policy recently vowed to get serious about slashing excess capacity in the country’s electric-vehicle industry, seemingly taking to heart a key trade complaint from the EU. 

The bloc last October initiated an anti-subsidy investigation on imported EVs from China. European Commission president Ursula von der Leyen pledged to defend Europe’s auto industry against cheap Chinese exports driven by subsidy-fed overcapacity. But now Beijing is setting about making things right, trade tensions with Brussels will dissipate, surely? Not a chance. 

Overcapacity is a chronic affliction of Chinese industrial policy. Like an adaptable virus, it is difficult to eliminate and requires continuous suppression, which often takes the form of government-orchestrated industry consolidation. The treatment culls the weak. The companies that survive are fitter and meaner and become even more fierce in export markets. 

The Chinese government designated EVs a “strategic emerging industry” in 2009, and began flooding the sector with subsidies, sheltering the infant industry behind a protectionist wall. At the peak, one EV attracted up to $19,000 of consumer purchase subsidies, in addition to tax breaks, cheap land, energy and bank credits for manufacturers. Foreign carmakers and battery producers were mostly excluded by eligibility requirements. 

Government largesse and protectionism created fertile ground for abuse. Myriad companies emerged, churning out low-cost, low-tech vehicles with little appeal to consumers. Many sold their EVs to oversized municipal bus and taxi fleets, which often sat idle.

A bloated industry was the result. In 2014 alone, more than 80,000 companies registered in China to enter the EV sector, more than doubling the previous year’s number of new registrants. The strategic emerging industry appeared to be a textbook cautionary tale of waste, corruption, overcapacity, vicious price wars and low profitability. 

As a veteran practitioner of industrial policy, however, the Chinese government is familiar with this malaise and skilled at treating it. It began raising the bar for issuing production licences and withdrawing subsidies in phases. Vehicles with low driving ranges lost support first. The low-tech producers were either barred from entering the market or forced to exit it. Those who withstood both the price-war attrition and the government-engineered culling became ruthlessly efficient. 

When the government felt confident that its domestic industry was strong enough, it lowered the protectionist wall. In 2018, Beijing allowed Tesla to open a gigafactory in Shanghai making the Model 3 with Panasonic batteries and eligible for the full suite of government support. Even BYD, China’s EV leader, was on its knees: it sold 21 per cent fewer vehicles in 2019 and its earnings dropped by almost half. The company’s founder Wang Chuanfu said then that survival was the only objective. 

But instead, BYD thrived. It doubled down on research and development and produced a new battery called the Blade, which is more compact than earlier versions, charges faster and powers cars over greater distances. The company’s sales more than quadrupled from 2020 to 2022. Tesla adopted the Blade battery last year for its Model Y, produced in Germany. BYD sold more cars than Tesla in the fourth quarter of 2023 — although Tesla still outsold it over the year — and it is now the latter’s turn to brace for “notably lower” sales growth. 

China’s well-rehearsed industrial policy can be staggeringly wasteful but still produce stunning results. This same pattern of fattening up companies with subsidies and protection and then cutting support and introducing market discipline to weed out the weak has already produced domestic and export juggernauts in steel, shipbuilding and solar panels.

China’s EV champions are focusing on the EU market, which is the biggest international prize since the US has effectively kept out Chinese EVs with its own protectionist measures of tariffs and origin requirements for subsidies. 

When it launched its anti-subsidy probe, the European Commission said that China’s share of EVs sold in the EU had risen to 8 per cent, from less than 1 per cent in 2019, and could reach 15 per cent in 2025. BYD is selling five models in eight European countries, including Germany, France, Italy, Spain and the UK, and gunning “to be in the top five” in Europe. Rubbing salt into the wound, Europe’s football federation Uefa has replaced Volkswagen with BYD as its official automotive partner for the Euro 2024 tournament. 

Overcapacity still dogs China’s EV industry. In the first four months of 2023, capacity utilisation of the top 10 sellers hovered below 70 per cent. Price wars have persisted, suppressing profits. Beijing’s pledge to squeeze excess capacity out of the industry was sincere. As with its culling exercises in other sectors, the Chinese government aims to mop up low-end producers to boost the profitability of the industry champions, so they can invest more in R&D and in conquering export markets.

The next round of consolidation in China’s EV industry will not deliver European carmakers a reprieve. It will produce even more formidable rivals.