Chinese EVs leave other carmakers with only bad options

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The expressway from Shenzhen to Dongguan and Guangzhou, through one of China’s industrial heartlands, boasts almost every vehicle the global market has to offer. Toyota sedans weave aggressively between industrial tankers; sleek Maybachs and Mercedes ferry executives; Teslas silently demand attention; and global staples like the Volkswagen Golf chug along, minding their own business. But they are only half the fleet. Every second car seems to have an unfamiliar nameplate, funky headlights and a whining electric motor. These are the new Chinese automobiles. They are taking over their domestic market. Soon they will take over the world.

The rise of Chinese cars in China is already claiming victims abroad: Volkswagen plans to close factories in Germany for the first time and lay off tens of thousands of workers as it loses share in the world’s biggest auto market. But this is just the beginning. Established carmakers are vowing to cut costs, begging for subsidies, demanding tariffs — which the EU has just enacted — and trying to cling to the internal combustion engine. If the intention is to preserve industrial employment then these efforts are doomed to fail. That is because the shock is not just China or just electric vehicles. It is both at once.

It is important to understand why the automotive powertrain has been the symbol of industrial might for a century. Each one is a marvel of engineering, with thousands of moving parts, machined to a high tolerance and assembled into a compact package, which must function safely for years, despite vibration, mishandling and changing weather. They are difficult to make. An electric vehicle, by contrast, is a battery on wheels — little more than a scaled-up version of a child’s toy. Its supply chain is simpler. Much of the value is in the battery, which is chemical and not mechanical. Even without China, EVs would transform the auto industry.

Manufacturing commodity chemical and electrical products, however, is something China does extremely well. They require massive scale, cheap capital, low operating margins and an ample supply of affordable technical labour. Foreign rivals are rightly upset at the subsidies Chinese carmakers receive, but they would be formidable competitors without them.

What, then, are established carmakers to do? There is a range of bad options to explore.

One is tariffs. In addition to all the usual economic reasons to dislike tariffs, they can only protect a domestic market, which might help net importers such as the US and the UK, but is no use to countries such as Germany, Japan and South Korea, which rely on their lucrative export trade, including the real jewels: markets such as Australia and Saudi Arabia that have considerable purchasing power but no domestic car industry at all. Such countries have zero reason to impose tariffs on cars and even less reason to adopt a discriminatory tariff against China.

The US has gone about it from the other direction, with subsidies for EVs and new battery plants. It is one thing to get an industry off the ground, however, and quite another to sustain it if a rival has lower costs. Right now, as new factories come online across the US, Joe Biden’s Inflation Reduction Act looks like a triumph of industrial policy. In five years, it may not look as clever.

The case of solar panels is instructive. Europe subsidised solar installations, and imposed tariffs on Chinese solar panels from 2013 to 2018: a period during which most of its solar industry went bust. You must be somewhat competitive to stay in the game. Neither subsidies nor tariffs change industrial reality.

Another bad option is to try to force the market towards a different technology. Japan and Toyota have doggedly pursued hydrogen fuel cells, in part because greater manufacturing complexity means greater barriers to entry. From film cameras to Concorde, however, the market is a ruthless winnower of technologies. Similar logic applies to carrying on with internal combustion. If you believe the transition must happen at some point, then delaying simply puts you further behind.

There are some better options, even if they are still not good. If EVs wipe out the value added in the powertrain, the question is where value will then accrue. It may make sense to import batteries from China, keep final assembly at home and concentrate on engineering for comfort, performance, experience and safety. An EV still needs sophisticated elements such as brakes, airbags and tyres. Japan no longer makes televisions and Sony is still in the TV business, although that is cold comfort to its former manufacturing workforce.

There is also the race to control what may be the greatest source of future value-added in the auto industry: the software for autonomous driving, ride hailing and in-car entertainment. The iPhone is manufactured in China but most of the value accrues to the semiconductor from Taiwan and the operating system from California. The physical car, in business terms, may become the least important part.

It is hard to back huge manufacturers such as Toyota and Volkswagen against software competitors in that contest. Even if they prevail, it would not necessarily help their factories. China will be a fierce competitor in software, too. There is going to be pain for Volkswagen and its peers. The worst thing would be to pretend it can be avoided.

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