Why China is Flooding Europe with Cars.

How is China able to sell European drivers so many cheap cars? Customs data shows that Chinese EV shipments to the European Union have increased by 361% since 2021.

All over the world, Chinese automakers are taking market share which is threatening European automakers. 

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Transcript

Why China is Flooding Europe with Cars.

In a remarkably short period of time, China transformed from being a net importer of cars to the largest exporter of finished cars by volume, outpacing automotive giants like Germany and Japan. This rapid increase has startled trade partners who worry that cheap foreign imports that are highly state subsidized could harm their economies, costing workers their jobs and companies their market share.

The Chinese economy has been struggling in recent years. Chinese exports, based on the most recent data were 5.5% below the prior year’s numbers. But while overall exports are declining, quite the opposite is happening with automobiles.  In 2022 China overtook Germany as the world’s second largest vehicle exporter. Last May we learned that China had exported one million new vehicles in the first quarter of the year and had overtaken Japan (in terms of units – not dollars) as the world’s biggest auto exporting nation.  

In that quarter Chinas auto exports were up 58% when compared to the same quarter the prior year. Japanese vehicle exports only grew 6% over the same period.  There are a number of reasons for this huge growth, which include increased demand for electric cars (which China builds a lot of), sales of vehicles to Russia who are under sanctions from other countries and Tesla’s Shanghai plant which exports about half of the cars that they build in China to Japan and Europe. The biggest part of this growth, however, has been homegrown brands like SAIC, BYD, Geely and Cherry. Chinese automakers were able to capitalize on the shortage of chips over the last few years and other core components needed by large auto manufacturers that they struggled to buy due to their far-flung supply chains.

According to government statistics, Chinas trade balance in finished vehicles went from importing 40 billion dollars’ worth of vehicles in 2021 to an export surplus of over 30 billion dollars’ worth of cars annualized for 2023. You don’t normally see a transformation occurring this quickly, a country going from exporting almost nothing to being the world’s largest exporter of a complex manufactured product in just two years. 

Here is a clip from Top Gear from more than ten years ago when the presenters went to China to see what the local car industry looked like. [Clip] 

China has been an exporter of car components for quite some time, and has had an automobile industry for years, but didn’t really export many finished cars until quite recently.  Americans will not have noticed a lot of these new brands (other than possibly seeing a few BYD busses around) as in 2018, Donald Trump put import tariffs in place, including a twenty-seven and a half percent tariff on cars made in China. That policy has continued under the Biden administration and does not look like it will end any time soon. 

In Europe, the tariff on Chinese cars is 9% — which is low enough to make Chinese Cars competitive. European customs data shows that Chinese EV shipments to the European Union have increased by over 350% since 2021. The MG4 built by Chinese – State owned - MG was one of the top-selling EVs in Europe last year.

Other brands, like NIO, BYD and Geely have been growing their market shares too, causing concern in Brussels. The EU launched an investigation into China's trade practices in September, as Commission President Ursula von der Leyen explained. [Clip]

The EU investigation covers battery-powered cars manufactured in China, meaning that it includes Western brands that are built in China, like Tesla, BMW and Renault. The investigation is quite unusual within the EU as it is instigated by the European Commission itself, rather than coming in response to an industry complaint.

Despite all of the worries around Chinese car exports, production of new vehicles in China is not actually higher today, than it was at the prior peak in Chinese car manufacturing in 2018. Back then around 28 million new cars were manufactured which is roughly the same number as are being built right now. 

The surge in Chinese car exports is not a function of higher overall production, but, of something else.  

While Americans are big buyers of foreign cars, with around 45% of the cars on the road in the United States being imported, the US market is notoriously difficult for foreign auto makers to crack. Meeting US safety regulations can be both expensive and difficult, building out a dealer network can be costly.  For this reason, even without the 27.5% import tariff, many of the biggest European and Japanese manufacturers don’t sell any cars in the United States. Despite the challenges and the high tariffs, many Chinese manufacturers still have their eyes on the US car market.

According to the Financial Times, MG, BYD and Chery, have all been speaking to officials in Mexico to find factory sites to build cars. Biden’s Inflation Reduction Act allows certain EV’s built in North America to qualify for the full $7,500 federal tax credit, which enables cars like the Ford Mustang Mach-E to be built in Mexico and sold in the United States. Building Chinese electric vehicles in Mexico would also make them eligible for the full tax credit – which was put in place to speed up the deployment of electric vehicles in the United States. The act requires that the cars be built in North America and source materials and components from countries with US free trade agreements. No parts can come from China or other “foreign entities of concern”.

So, if so many cars are being sold by Chinese manufacturers internationally why are there not more cars being built in China today than were being built in 2018 – when China was not a major auto exporter?

The answer is that more cars are being exported from China because of the economic slowdown being experienced over there. There is much lower domestic demand for new cars in China today than there was in 2018 when auto manufacturing first hit 28 million units.  When Chinese auto manufacturers were unable to sell the cars at home, they turned to international markets where they were able to sell them.

Interestingly, the downturn in demand for new cars in China occurred before the global pandemic, and while the pandemic may have worsened the situation, it was not the cause.  Since the turn of the century there was huge demand for new cars in China, and this was driven not just by the increasing wealth within the country. Twenty years ago, there was extremely low automobile ownership in China. When you start from a level like that, every car you build can be sold, as there is much more demand than supply.  This initial demand was huge, but not really sustainable as once everyone who needed a car had a car, sales growth within the country was eventually going to fall to a level reflecting the need to replace old cars as they wear out. 

On top of this there were very large subsidies being given to both auto manufacturers and to buyers of cars by the central government in Beijing and by local governments around the country. A lot of Chinese people bought cars because of these subsidies – as the cars were being sold for less than their cost of manufacture.  Now that these subsidies are drying up – especially the ones from local governments – who now can no longer afford them, there is considerably lower demand for new cars.  It is unlikely that these subsidies will come back any time soon, as local governments in China are mostly funded by leasing land to developers for construction, and construction activity has almost entirely dried up in China.

Overall, consumption in China has fallen significantly in recent years.  The real estate collapse – which we have discussed extensively on this channel (in terms of both sales volume and declining property prices) has made most Chinese people poorer, as one way or another most Chinese people invested their savings in property, or in high interest savings accounts that were issued by property developers. 

During Covid – wage growth in China slowed significantly, meaning that people were less confident about their future wealth and less willing to make big purchases – like a new car. Recently we have seen rising unemployment in China – particularly amongst young people – and situations where employers have not laid off employees - but have been withholding pay.  In this environment, it is no surprise that car purchases within China have declined.

The real reason that the rest of the world has been flooded with Chinese cars is not that China specifically had a goal to export vehicles, it is that they are building a huge number of cars that there is not the local demand for, and they are forced to sell them internationally because they can’t sell them at home.

There would probably be more Chinese cars in Europe today, except that a shortage of car-moving ships has pushed up shipping prices to record levels limiting the flow of electric vehicle exports from China to Europe.

This situation has been particularly difficult for European auto manufacturers.  According to research from BCG, the European auto industry historically benefited from five advantages: technological leadership, cost efficiency, brand value, stable geopolitics, and the Chinese sales market. All of these are currently under threat.

Their defining features of European cars were high performance, fuel efficiency, durability, vehicle handling, and design—as buyers are moving to to electric and software-defined vehicles these features are shrinking in importance. The threats to the European auto industry are not just coming from China. As software becomes the distinguishing feature of new cars, companies like Tesla, Lucid, and Rivian are now serious new competitors. A shrinking auto industry in Europe would be a big problem. The auto industry directly employs 4 million people in Europe and Makes up 3% of European GDP.

The Chinese auto industry is very competitive – The Wall Street Journal says that there are more than 160 electric car brands in China and that only twenty-five or thirty of them are likely to survive in the long run. Wikipedia lists 19 Chinese government owned auto manufacturers, and over a hundred other brands.

The Chinese government provides subsidies both for manufacturing and for buying cars, particularly electric vehicles.  A lot of the subsidies for buying the cars have been withdrawn in recent years, but auto manufacturing is still heavily subsidized in China.

The "Big Three" American automakers abandoned the compact and subcompact car business about five years ago. Data from Kelley Blue Book shows the average cost of a new car in the United States in 2023 was 48 thousand dollars. The last new car with an average sales price of less than $20,000 on sale in The United States was the Mitsubishi Mirage, which was discontinued last summer after poor sales.  

If western automakers are no longer building affordable cars, they can’t really act too upset if foreign manufacturers start selling them. Chinese manufacturers are by far the biggest sellers globally of cars that cost twelve thousand dollars or less. Most of these cheap cars that are being exported are being sold in developing countries.

While China has a good network of EV charging stations, this is far from the case in the rest of the developing world. Seventy five percent of the Chinese cars being exported today have conventional petrol or diesel engines. These inexpensive cars have seen huge sales in Mexico, accounting for nearly a fifth of new car sales, they have become the top sellers in Ecuador, they have an 11 percent market share in Australia, 8 percent in South Africa, and 7 percent in Spain.  These are not the cars that people appear to be getting upset over, it’s the export of cheap Chinese electric cars that is making politicians and carmakers nervous around the world and causing governments to consider various trade restrictions. 

There are strong government incentives in many countries to buy electric vehicles. In places like Brazil, for example, the import tariff on combustion cars is 35 percent but there is no tariff on importing electric vehicles, meaning that cheap Chinese EV’s could be very competitive in Brazil despite the more sparce charging infrastructure.

The EU offers a wide array of benefits for EV manufacturers and buyers.

Countries are nervous that these subsidies which were put in place to encourage a transition to electric cars will benefit foreign manufacturers and destroy employment in a key industry.

The most important component in an electric vehicle is the battery and China today accounts for almost two-thirds of the world's lithium processing capacity, 75% of its cobalt capacity, 95% of its manganese capacity and almost all of its graphite capacity. 

For many of the mined raw materials that are not produced or processed in China, the country has locked in future supply in each metallic stream of the battery chain.

More than 70% of the world’s electric car batteries are made in China, including the ones that go in American and European electric vehicles. Lithium mining and battery production create a lot of pollution and are difficult to do under western environmental standards, but there is a goal in the west to onshore or friendshore these industries. 

BYD, Chinas biggest electric car maker started out as a battery manufacturer for mobile phones and computers.  They have a huge cost advantage in building EV’s due to their experience in producing car battery packs which are the most expensive part of any electric car.  An Electric Vehicle battery pack is significantly more expensive than the engine in a conventional car. 

Most western EV manufacturers buy their batteries from BYD, Panasonic, LG and so on.  The fact that BYD manufacture their own batteries, means that they have been able to undercut the prices of most western EV makers when selling in Europe.  The subsidies they receive from the Chinese government only make that advantage greater.

The US Inflation Reduction Act requires that, starting in 2024, any EV that contains battery components produced by a foreign entity of concern will be ineligible for the $7,500 credit. Beginning in 2025, the restrictions will widen to include any critical minerals in the battery that are extracted, processed or recycled by a foreign entity of concern.  That means countries like China, Iran, Russia and North Korea.

The problem western governments face is that they are trying to achieve two competing agendas — reducing the use of subsidized low-cost Chinese materials, while still incentivizing EV adoption to achieve their environmental targets.  These tensions can be clearly heard in Ursula von der Leyen’s speech announcing the EU investigation into Chinas Trade practices. [Clip]

Gavin Maguire at Reuters points out that, the European Union offers a wide array of benefits for EV producers and consumers, including tax breaks for manufacturers, thousands of euros of subsidies per car for buyers and tax credits for households and businesses that install EV chargers.

The United States offers tax credits to buyers and several more for manufacturers of EVs and EV components, and each government views the support they provide as merely doing "whatever it takes" to keep their own industries competitive.

The US and Europe have additionally been focusing their attention on the security risks of having Chinese made components in critical infrastructure like energy and telecom systems. These concerns are also being applied to Chinese vehicles along with batteries and other clean technologies.

The security risk worries work in both directions.  American EV’s which are filled with cameras and other sensors have been banned from Chinese military bases, from driving near key government buildings and from a resort town that hosts Communist Party summer retreats in recent years. The fear is that these vehicles could be used to spy on them.

European policymakers are worried that China is increasing its manufacturing output, at a time when Chinese domestic demand is weak and other countries like the United States, India and Turkey are reducing access to their markets. This leaves Europe the only large auto manufacturing region with a somewhat open market and no big trade protections in place against cheap Chinese exports.  

The stakes are high for Europe's automotive industry. According to Automotive News Europe four out of five cars sold in Europe are assembled locally and the car trade has made between 70 billion and 110 billion euros in trade surplus for the European economy per year over the last decade.

Europe's car manufacturers are in a tricky position. They have seen a huge drop in their sales of their vehicles in China, where local EV makers have been growing market share, and they are facing rising sales of imported Chinese EVs – cars built in China by either Chinese or Western automakers.

China risks a backlash from their trade partners if they push too many cars into a given region which would likely cause protectionist measures to be put in place.  China might also struggle to export more goods – just from a practical perspective - as its trade surplus in manufactured goods is already at around ten percent of the overall Chinese economy, it may be difficult to expand it much beyond that level.

Thanks for tuning into this week’s podcast.  If you found it interesting send a link to a friend as that helps the podcast grow.  All of these podcasts are also available on YouTube as videos, if you prefer watching rather than listening.  Have a great day and talk to you again soon.  Bye.