The Strange Political Economics of the Chinese Auto Industry

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This is a case study of one country’s relationship with private companies in a major industry.

 

The central government has made the production of EVs a national priority with massive subsidies. The provincial, county, and local governments compete to attract an EV assembly plant. All levels of government entice new companies with a wide range of incentives and subsidies. The result is that in a short period of time about 100 new plants have been built; a few new ones are planned. The industry may have a total capacity of around 25-30 million cars. 

 

Current production was 12.4 million cars in 2024; 2025 will probably be higher. Growth rates in the future will probably be lowered than in the past.

 

This is a common pattern for a new technology. In the United States, about 500 companies intended to produce cars. The difference with the current Chinese program is that most didn’t start production or produced very few cars. Only a few companies built a plant. Only two large companies survived (Chrysler came later). The rest disappeared, merged, or were marginal producers for a few decades. GM went bankrupt twice, stockholders and creditors took a financial bath. The company was only saved because the Du Pont family bought a controlling interest and created the modern industrial company.

 

Most commentary on the Chinese EV industry emphasizes the overcapacity and predicts that many companies will go bankrupt or at least merge. Competition is based on the assumption that a company will survive if it produces a minimum number of cars – at least 80% of rated capacity. In the past world of gas-powered cars, a minimum-sized plant of around 300,000 cars/year was necessary to achieve economies of scale and minimum unit cost. So this is a fight for market share. 

 

The result is a drastic fall in retail prices. The government has stepped in and told the companies to stop lowering prices! The companies seem to be ignoring the government and finding ways around it (more options or better lease or financing terms, encouraging their dealers to sell new cars as cheaper “used” cars). In the meantime, most companies are losing money; even the dominant firm (BYD) is experiencing falling profits.

 

A few companies have partnered with China’s largest high technology companies. Two of China’s biggest tech firms – Xiaomi (SP), Huawei – have started their own EV companies. 

 

But is there permanent overcapacity? In 2017, before EVs took off, the Chinese auto industry produced a record 28 million gas-powered cars. The domestic fall in gas-powered car sales has been about 10-12 million cars, about the same as the increase in EV sales. In other words, the total market is not expanding but EV sales are replacing gas-powered car sales. The change was accelerated by a government subsidy to consumers who traded in gas-powered cars for EVs. This subsidy has been terminated. The government is also reducing a tax credit. 

 

With lower government tax exemption and subsidies to consumers, some EV companies are planning on reducing wholesale prices to dealers in 2026. Sales growth will probably be lower than in the past few years and total financial losses will probably be greater.

 

At the end point, when there are no longer gas-powered cars being produced, EV domestic sales could increase about 14-16 million more. In other words, the current total EV production capacity is about equal to maximum future sales. 

 

When this “equilibrium” is reached is the critical question. How long can most producers lose money? When will the industry as a whole become profitable? Who will be the winners? Probably a combination of the lowest unit cost (biggest) producers, companies dominating large niches, and companies with deep-pockets partners or parents.

 

The other consideration is exports. Surprisingly (to me), most Chinese auto exports are gas-powered cars. Most EV exports now seem to be foreign companies. The long-run question is how large will the EV export market become? This partly depends on future geopolitics. Will the U.S. continue to ban Chinese EVs with very high tariffs and possibly quotas? Will the European Union continue to set high tariffs and de facto quotas on imported Chinese EVs? This is complicated because some European car companies, including VW, Europe’s largest car company, have shifted most of their EV production (and development) to China. Discrimination only on Chinese EV companies? Would China retaliate?

 

Beside ultimate domestic production of around 26-30 million, Chinese EV companies will have to develop more exports to grow further. Even with current restrictions. Their prime markets are probably middle-income countries like Brazil, Mexico, and southeast and southern Asian countries. But it is likely they will be forced to assemble their cars locally, possibly with local partners.

 

This is a Red Queen industry. The companies have to run faster to stay in the race.

 

But there is an interesting endgame. It is currently being played out in the gas-powered autos part of the industry. Collectively, the companies are probably producing at about 40% of capacity and the percent is falling. All companies are losing money; Ford has said it has lost money in China five years in a row; GM has taken a $5 billion write-off and will probably totally exit. Hyundai has closed one of its four plants. But no Chinese company intends to close. Why?

 

Four of the older gas-powered car companies are state-owned. All companies have been state-subsidized in the past. They owe state-owned banks and local governments. No level of government wants to close plants because of the resulting unemployment. The national government fears that unemployment could weaken social stability and possibly government control. So “zombie” plants are kept alive through further loans and local support. The uncertainty is:  how much longer?

 

Something similar is already happening in the EV sector of the industry. EV companies are not paying their suppliers. But suppliers can’t carry them indefinitely. Some companies are receiving new loans from state-owned banks. There may be some local relief through lower or deferred tax payments and loan payments. No local government wants to lose its EV plant.

 

So this is where Chinese political economy differs from a purely capitalist model. Even in capitalist countries, state and local governments compete with subsidies and tax abatements to attract new manufacturing plants. But these plants are allowed to go bankrupt. Creditors – suppliers and banks – often force them into some form of bankruptcy. Creditors take a loss and the local economy suffers.

 

The Chinese government picks technologies and industries it wants to develop and subsize. This industrial policy is a major component of China’s geopolitical competition with the United States. Local government officials are politically sensitive and encouraged to compete to subsidize and attract new companies and plants. The result is often overcapacity. Demand may or may not increase to equal total capacity. Some older industries seem to have massive overcapacity and companies lose money. Again, the question is when the government decides to close the companies. 

 

Overcapacity compared to demand leads to financial loses covered by state-bank loans but not bankruptcy. Closing plants is delayed and often based on political considerations. The strange economics of China.

 

 

For some of the reasons why demand for cars may not grow very much, if at all, see

 

 China's Economy, Politics, and Demography

 

 

Quick summary. Extremely low birth rate (far below replacement), shrinking numbers of labor force age group, high youth unemployment, large number of “gig” workers, low family formation, loss of wealth because of housing market collapse.

 

 

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