China’s risk involved in indicating retaliation in opposition to high EV tariffs imposed by EU

1. Both the United States and the EU criticize China’s overproduction

Criticism of overproduction by Chinese businesses is growing.

When U.S. Treasury Secretary Janet Yellen visited China in April, she raised concerns about overproduction.

When Chinese President Xi Jinping visited Paris in May, French President Emmanuel Macron, accompanied by European Commission President Ursula von der Leyen, held a three-way meeting in which the issue of overproduction of electric vehicles (EVs) and solar panels was taken up as a key issue.

They criticized Chinese government subsidies as the cause.

Chinese President Xi responded that China was helping to improve the global environment and control inflation and that China’s overcapacity problem did not exist.

In Europe, the meeting was perceived as a discrepancy in opinion, and as a result, the European Commission announced on June 12 that it would increase additional tariffs on Chinese EVs by up to 38.1%.

German Chancellor Olaf Scholz negotiated to avoid higher tariffs, but his efforts were not rewarded.

Even for President Xi, this result must have been harsher than expected.

He was told about German businesses’ willingness to invest in China when Scholz met with representatives of major automakers in Beijing in mid-April, just before his visit to Europe.

When he came to Europe with that in mind, President Xi found that this severe result awaited him.

Major German automakers have expressed opposition to the sanctions because of concerns that they could negatively impact Chinese business, given their high market share in China.

Automaking is Germany’s key industry with a broad base of related industries and has a strong influence on the policy administration of the German government.

In order to reverse the policy already announced by the European Commission, however, it is necessary to reject it by a qualified majority vote in a Council of Heads of State or Government, which takes into account the population of the member states for weighted voting.

For this reason, even if some countries, such as Germany, oppose the policy, it is expected to be difficult to obtain a majority, and the sanctions are likely to take effect by the end of this year.

2. China’s response to EU tariff hikes

China strongly opposed the move and indicated that it would retaliate.

A Brussels expert familiar with EU trade issues explained about this as described below.

If China insists that the problem of overproduction caused by subsidies does not exist, a reasonable response would be to present objective data showing this. It remains possible that the sanctions will not be applied if such data are found to be legitimate grounds for supporting China’s claims.

China’s EV industry group has briefed EU on subsidies, but the explanation was not accepted. As a result, China reportedly pointed out problems with the way EU investigated subsidies.

In fact, some European experts say that it is difficult to distinguish subsidies granted by the Chinese government from industrial policies implemented by Japan, the U.S., and European countries to promote their industries by providing subsidies to semiconductor-related businesses.

If it is assumed that subsidized semiconductor-related businesses increase production in Japan, the U.S., and European countries and that some products are exported as supply exceeds demand, there is not much difference in nature from China’s current EV exports.

However, some point out that the amount of subsidies provided by the Chinese government is estimated to be much larger than that of those granted by the U.S. and Japan and that that is a problem.

It is reported that China has indicated to counter the EU’s tariff hikes on Chinese EVs, saying, “China will take decisive steps to protect its rights and interests” if things don’t change.

This response is not based on the spirit of the rule of law.

China has repeatedly stressed its emphasis on the rule of law in government documents. If China respects the rule of law, it should specifically point out what EU does not accept about China’s explanation and refute it by clearly listing the reasons why Europe’s judgment is considered inappropriate.

It is difficult for other countries to recognize China as a country that values the rule of law as long as it continues to take retaliatory measures and respond with force as soon as its argument is not accepted.

If China believes that its claims are correct, it must logically refute them on the basis of facts, which is a major premise for gaining greater international confidence.

3. Western response to the overproduction problem

Until only a few years ago, China had long suffered from overcapacity problems.

The so-called “four trillion yuan stimulus package” was implemented in November 2008 to cope with the global economic crisis caused by the bankruptcy of Lehman Brothers.

That policy not only helped China to recover double-digit growth in a year but also prevented the world economy from falling into a major depression.

However, its side effects led to two difficult problems: massive overcapacity and enormous non-performing loans, both of which became China’s biggest economic policy issues over the years until it was largely resolved around 2018.

Considering that such a long and painful experience continued until a few years ago, it is unlikely that the government will adopt a policy that will repeat the challenges that were finally solved.

Therefore, it is reasonable to assume that the Chinese government did not lead the way in creating overcapacity.

In the market, however, major developed countries point out that Chinese businesses have overproduced, which has led to lower prices for steel, petrochemicals, cars, and solar panels in the form of a surge in cheap product exports.

Since export prices have fallen significantly during this period, it is highly likely that exports have been increased by selling at low prices in order to release excess domestic inventories.

The surge in exports, however, was driven by a short-term demand for more output to boost growth rate in the fourth quarter of 2023, not by the expansion of overcapacity caused by the subsidy policy, which the U.S. and Europe have criticized.

Overproduction has been pointed out mainly in EVs and solar panels, but the problem of EVs is particularly large. This is due to the large impact on key industries in Europe.

Labor-intensive products such as toys, furniture, shoes, and clothing, which are not major industries in developed countries, are not criticized when Chinese businesses overproduce them.

Moreover, if Chinese businesses build EV factories in the EU area and increase production, resulting in oversupply and increased exports outside the EU, they will not be criticized by the EU for overproduction.

In other words, overproduction is seen as a problem when it affects the performance and employment of key industries in major countries.

In this case, consideration must be given to the location of factories. Chinese businesses have already announced plans to build EV factories in Hungary and Spain, but those countries accepted the plans because automaking was not a key industry for them.

In Germany and France, however, automaking is one of the key industries and the influence of automakers is large, so there will be friction if Chinese businesses try to enter.

Such considerations must be taken into account when entering the European market.

On the other hand, the situation in the U.S. is very different.

The U.S. will strictly regard not only the construction of factories by Chinese businesses but also technology alliances with American businesses as problematic even if they do not affect its own key industries and employment.

In the U.S., there are many politicians, government officials, and academics, mainly members of Congress, who want to prevent the development of China, and they are basically trying to promote decoupling.

The EU opposes decoupling and favors de-risking.

For this reason, the construction of factories by Chinese businesses that contribute to the creation of jobs in the EU area is not regarded as a problem as long as the EU is not overly dependent on China.

It is pointed out that behind the additional 38.1% tariff on Chinese EVs, there is an analysis that if the tariff rate reaches 40-50%, Chinese businesses will have to build factories in the EU area and produce EVs locally to make a profit.

If 38.1% is added to the existing tariff rate of 10%, the tariff rate will be 48.1%, and the decision to shift to local production will be made.

Probably in anticipation of this European stance, Chinese businesses have been promoting local production of EVs and in-vehicle batteries in recent years.

This is similar to the situation in which Japan, after experiencing trade friction, promoted local production in the U.S. and Europe.

This measure cannot be used in the U.S., but it is effective in Europe.

4. The essence of the overproduction problem is excessive competition among businesses

There is another problem that is not widely known.

Chinese businesses tend to give top priority to market share growth in competition among their peers in the domestic market and not to worry about a decline in profitability due to excessive competition.

This phenomenon is typical of the construction machinery industry, but it exists in a wide range of sectors, including solar panels, gasoline vehicles, e-commerce, and various consumer electronics.

This EV issue is much the same. This is not due to government policy, but due to the way Chinese businesses choose to compete freely in the domestic market.

As a result, the industry as a whole is overstocked, price-cutting competition intensifies, and profitability deteriorates, leading many businesses to bankruptcy.

Nevertheless, many of them continue excessive competition, and this is one of characteristics of Chinese businesses.

In the past, owing to the low level of technology among Chinese businesses, price-cutting competition resulting from such excessive competition did not have much impact on the market of developed countries, which was dominated by high-value-added products.

However, recent improvements in the technological level of Chinese businesses have gradually affected high-value-added product sectors such as construction machinery, solar panels, and gasoline vehicles, which compete with those from companies in developed countries.

This EV issue is another example of this.

To be sure, the Chinese government did not promote overproduction as part of its policies, so it is thought to be insisting that there is no difference from other countries’ industrial policies.

But if China’s overproduction actually has major effects on the key industries and employment of other countries, it is unavoidable that it is seen as an international problem.

China, in particular, is a major economic power, and its production capacity is outstanding in the world economy, and therefore its influence on Western developed countries cannot be compared with other countries’ influence. That is why China’s overproduction is considered as a problem.

In the future, the Chinese government needs to better understand the nature of this problem and coordinate Chinese businesses so that they promote orderly production, investment, export, local production, etc. both at home and abroad while giving consideration to cooperation with trading partners.

This is also a sign that China is becoming a developed country.

In the 1980s and thereafter, Japan faced enormously severe pressure from the U.S. and Europe in terms of trade and investment and was made to realize the need for such consideration.

In fact, there is no real free competition in the global market. This is what China needs to learn now.

It is consideration for trading partners required of economic powers whose technological capabilities have reached almost the same level as those of developed countries.

Hopefully, the EV subsidy issue will be an important learning opportunity for China in many ways.