Long and winding road ahead for China’s EV sector 

Chinese electric vehicles now face weak domestic demand and heightened geopolitical risk

As the world races to decarbonize its economies and transition to sustainable energy sources, the electric vehicle or EV industry has emerged as a key player in this global effort. 

China has carved out a significant role within this landscape, becoming the world’s largest market for electric cars and is home to some of the most prominent EV manufacturers. 

In fact, China produces 54% of total EVs globally and with an even higher share for electric batteries. Yet, the story of the industry is not just one of rapid growth and success. It also involves intricate geopolitical dynamics which could put that success at risk.

China’s rapid advancement in the EV sector is a combination of a massive industrial policy effort, such as large subsidies for indigenous innovation, an open-door policy for foreign leaders in the industry, and subsidies for consumers. 

Those incentives spurred domestic manufacturers to invest heavily in EV technology, competing with foreign companies. 

The fact that this is a new industry with no long-standing global incumbent clearly helped China leapfrog in this market, as opposed to the much slower progress for combustion-engine cars. 

Local manufacturers

The role of foreign players in China’s success in the EV space cannot be underestimated. Seen as a formidable competitor, Tesla’s presence inspired local manufacturers to step up their game and invest in upgrading their technology. 

While China’s homegrown EV makers have yet to catch up with Tesla’s technological prowess, their determination to do so has been instrumental in driving innovation and progress within the industry. 

It is unclear, however, how much technological transfer really took place from Tesla to its Chinese competitors, and how much of it was in exchange for local subsidies, available to Chinese producers and other foreign EV makers fully localized in the country. 

The combination of strong industrial policy protecting China’s domestic ecosystem and the sheer market size attracting top-notch EV manufacturers from overseas is an ideal combination.

Tesla has become a big auto player in China. Image: File

Despite the impressive growth, China’s electric vehicle industry faces challenges. 

The recent reduction of subsidies for EV purchases has led to a price war, which is feeding China’s deflationary trends. The reality is that the Chinese economy has not really lived up to the expectations after exiting zero-Covid policies at the end of 2022. 

Consumption remains stagnant with retail sales growing by barely 3.5% in July. Sales of automobiles and other consumer durables are doing even worse. 

Despite large subsidies up until recently, domestic and external demand for EVs has decelerated. This is partially because of the decelerating global economy, but also because of the pressures from the United States, and increasingly the European Union. 

With the introduction of the Inflation Reduction Act or IRA, the US aims to reduce its dependence on China for the energy transition, which involves a drastic reduction in imports of electric batteries and EVs. 

In the EU, the pressure to take action is mounting, as shown by President Macron’s call to impose anti-dumping duties on Chinese EVs. 

Building plants

This situation highlights the need for Chinese electric vehicle makers to redefine their strategies. Several are expanding overseas, building plants in other countries to bypass the US containment, in particular IRA. 

The region that has been receiving the bulk of the investment is Southeast Asia, but the EU is attracting increasing attention from Chinese automakers, especially for the fabrication of EV batteries. 

China’s leading position is even stronger in that sector, because of its state-of-the-art technology and its preferential access to the necessary critical raw materials. 

European leaders are by now painfully aware of the strategic dependencies that the EU has developed in the EV space, in particular when it comes to batteries and its key components. 

The policymakers’ response is that of de-risking or, in other words, reducing such dependencies through industrial policy and trade agreements aimed at sourcing critical raw materials.

Against such a backdrop, the international expansion goals that Chinese EV manufacturers have set their sights on are at risk, at least in the West.

Relations between the EU and China are flagging. Photo: Flickr

Geopolitical tensions and protectionist measures will further complicate this process. 

Given that Chinese EV production remains highly competitive, the key question is whether the growing chorus for de-risking from China, especially in the area of green technologies, may undermine global decarbonization efforts. 

At the same time, relying on a single country such as China when it comes to EVs is risky for all global players, including the EU. 

This is not only due to China’s potential use of the leverage through retaliation and other means but also because it may need to use an increasing share of its own production for domestic use if it wants to achieve decarbonization goals.

Industrial policy

All in all, China’s rapid rise in the EV space is a very good example of its ability to leapfrog in new sectors so long as it can count on the country’s massive industrial policy, with the help of foreign manufacturers leading the way. 

So far, positive prospects for the EV sector are becoming much more difficult for two reasons. 

First, the waning domestic demand is pushing down EV makers’ margins. Second, the pressures from the US and the EU to reduce their dependencies on China for their decarbonization plans. 

In other words, Western de-risking efforts are one of the key threats to China’s EV industry.

Alicia Garcia-Herrero is a Senior Fellow at Bruegel. She is the Chief Economist for Asia Pacific at French investment bank Natixis, based in Hong Kong.

This article is republished from Bruegel, a European think tank that specializes in economics. Read the original article here.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy of China Factor.