Over the past few years, China has emerged as an electric vehicle (EV) manufacturing powerhouse, threatening to upend traditional automakers and their supply chains. Indeed, the country became the world’s largest producer and exporter of cars in 2023. BYD overtook Tesla in Q1 2024 and is now the world’s largest EV maker. China’s EV production has risen by a factor of 10 and now accounts for a third of all autos produced (Chart 1).

China’s industrial policy has helped drive this shift, creating a fiercely competitive domestic market that will likely undergo significant consolidation in the coming years. Cheap loans, tax breaks, and consumption subsidies have driven competition and technical progress.

However, China’s automakers are increasingly struggling with excess capacity, partly because domestic EV sales have eased. Global markets and exports have helped to take up the slack. Overall, auto export volumes have risen by a factor of 5, while values are up 2.5 times (Chart 2).

This doesn’t just apply to EVs. Internal combustion engine (ICE) exports to Russia have surged – reflecting the retreat of Western-aligned firms following the Ukraine invasion – while emerging markets (EM) have also been importing a mix of EV and ICE cars to varying degrees.

More striking is the near trebling of exports to the European Union (EU) (Chart 3), reflecting a more open trade environment for foreign manufacturers, in which government EV consumption subsidies do not discriminate on origin.

Europe appears to be the destination for around 40% of China’s EV exports, while China’s share of the EU’s auto imports has risen from 8% to 18%. In addition, Western automakers have substantial operations in China, accounting for almost half of “Chinese” EV exports to the EU. Tesla alone makes up around 40% of the EVs shipped from China to the EU, while joint ventures between European firms, such as BMW and Chinese firms, account for another 10%. Overall, 25% of EVs sold in Europe in 2024 are expected to be produced in China, but Chinese brands are forecast to take just 8% of the market share.

Since the three largest German manufacturers sell about as many cars in China as they do in Europe – and are heavily reliant on Chinese suppliers for battery technology – it is no wonder they are not pressing the European Commission for a strong response to China’s support for its auto industry. Indeed, China still represents the largest growth market, with an average of 185 vehicles per 1000 people, compared to a rate of 800 in the US and 580 in Germany.

Corporate and national interests may not always align across the EU. French auto manufacturers sell few cars in China, while China’s inroads into Europe’s auto market may have a far wider impact. Autos make up around 10% of the added value of EU manufacturing, while the figure can be twice as high in Emerging European economies, such as Czechia and Slovakia.

Worse before getting better?

While we believe excess capacity will eventually drive consolidation within the Chinese market, the China shock could get worse before it gets better: BYD has the capacity to produce 4 million cars a year already – in 2023, it made 3 million – and is in the process of building plants in Brazil, Hungary, Thailand, and Uzbekistan, while considering expansion in Indonesia and Mexico.

Given infrastructure challenges, EMs, excluding China, are unlikely to match Europe as a source of demand for EVs in the near term. But rising demand in markets such as Thailand highlights that there is some potential. Indeed, we expect Emerging Asia as well as the Middle East and North Africa (MENA) to be fast-growing consumer markets.

China’s rapid rise and the spillover of excess supply onto international markets is generating geopolitical backlash. However, policymakers are taking different approaches to the challenge: the US is firmly protectionist, while parts of Southeast Asia and Europe are more open.

Keeping the door shut on Chinese EVs

The market share of Chinese EVs in the US is minimal, and US policymakers want to keep it that way.

Chinese autos currently face a 27.5% tariff, and additional measures will almost certainly be introduced. The US has launched an investigation into data and cybersecurity risks posed by Chinese EVs – a sign of the national security current that now runs through US policy.

A Trump presidency would cement this approach. He has been highly critical of EVs, arguing that the entire industry supports the Chinese economy and that Chinese manufacturers will use factories in Mexico to attempt to circumnavigate tariffs. Trump proposes to increase the tariff on Chinese EVs to 100%, while rules of origin may be tightened more aggressively to stop Chinese firms from manufacturing in Mexico and shipping north of the border.

Europe is set to take action …

… but conflicting aims are likely to blunt the effect, exposing automakers.

In October 2023, the EU investigated China’s EV sector. This is not due to conclude until November 2024, but provisional documents show the EU believes it has sufficient evidence showing Chinese vehicles are receiving significant subsidies. Provisional tariffs could be introduced from July.

This will likely result in tariff increases of 10–15 percentage points, taking overall EV tariffs to 20–25% – deliberately below current US levels. The EU’s desire to remain WTO-compliant and meet its target of ending sales of internal combustion engine cars by 2035 implies the Commission will attempt to strike a balance across several fronts, which will water down the strength and effectiveness of any action.

The Commission will be acutely aware that action could spark retaliation from China. This could range from announcing export controls on the critical minerals needed for European electric vehicle production to measures hitting production and sales within China.

Critical minerals and battery supply chain present challenges

Although the most high-profile action taken by developed economies against China is currently focused on finished electric vehicles, critical minerals, and battery manufacturing may be an even bigger concern from a geopolitical perspective. However, avoiding dependency on China is going to be extremely difficult. To be truly independent of reliance on China, Western countries must develop their own domestic EV battery manufacturing capabilities and reduce dependencies on Chinese refined raw materials.

The US uses the Inflation Reduction Act (IRA) to catalyze its own industry, while the European Parliament passed the Critical Raw Materials Act with similar aims. Australia, a major source of critical minerals, has announced plans to double investment in the sector. Given China’s dominance in key minerals and batteries – which are ~40% of the cost of EVs – the ability to disconnect from China seems very unlikely in the near term.

Decoupling dilemma

Sustained investment may reduce dependencies on China, but it would be contingent on high levels of political will and consistent policymaking, which are never guaranteed. Moreover, the push for alternative sources of critical raw materials and to compete with China in battery production risk leading to an oversupply that will add to the costs of decoupling.

BloombergNEF is tracking 7.9 terawatt-hour (TWh) of annual battery manufacturing capacity announced for the end of 2025, with China alone making up nearly 6.0 TWh. This is much higher than demand, which projections forecast at 1.6 TWh, assuming steady EV demand growth and a rapid increase in batteries for storage unrelated to autos.

Since China already dominates the low end of the cost curve through CATL and BYD, Western battery capacity expansion will likely be uneconomical, requiring governments to absorb large losses.

What electrification means for EM ex-China

For EMs, the rise of EVs presents opportunities, mostly adding to the potential gains from reshoring.

Electrification has already helped several commodity exporters. Chile, Indonesia, and the Philippines have all benefitted from increased demand for nickel, lithium, and cobalt, as have frontier markets such as the Democratic Republic of Congo and Zimbabwe.

However, mining less economically viable mineral reserves to make production independent from China has its risks. The 80% drop in lithium prices has pushed many miners into loss-making territory, and the prices of other EV-related commodities have also fallen sharply as demand projections have been pared back (Chart 4).

Source: Bloomberg, Haver, abrdn, May 2024.

Moreover, what counts as being sourced from a “foreign entity of concern” (a key definition within the US IRA) could be crucial. Indonesia is potentially well-placed to benefit from electrification, partly as battery makers seek to reduce reliance on Russian nickel. However, most of its nickel refiners are Chinese-owned, which implies that rules of origin will be key to assessing geopolitical risk.

Winners and losers

Disruption to the auto industry will also create winners and losers. On the one hand, Eastern Europe is already highly integrated into existing ICE supply chains. But on the other hand, it could benefit if Chinese manufacturers move EV production closer to the end consumer. Similarly, Thailand may suffer in the transition to EVs. Still, the government has leaned in corporate tax waivers that have generated $2.2 billion worth of investment from Chinese firms, and more are expected.

Consumers should at least benefit from falling prices and rising air quality as EVs gain a foothold. Countries open to Chinese imports and production – such as Southeast Asia and MENA – could attract Chinese investment into charging stations and power infrastructure.

It is not just developed markets pushing back when their domestic brands are threatened. Brazil and Turkey have instituted moves to restrict EV imports that may be replicated in other EMs.

Final thoughts

Whether the West protects its legacy automakers or uses cheap Chinese EVs to aid the green transition is set to become a defining feature of industrial and environmental policy and geopolitics.

The US appears set to erect high barriers. At the same time, the EU’s reaction will be tempered by putting a higher weight on environmental considerations and automakers’ desire to remain embedded in China.

Therefore, the electrification of transport is another key force driving Globalization 3.0.

Important information

Discussion of individual securities above is for informational purposes only and not meant as a buy and sell recommendation nor as an indication of any holdings in our products.

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed, and actual events or results may differ materially.

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

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