U.S. tar­iff threats give China all the more rea­son to re­form its auto sec­tor

Bei­jing will take steps to con­sol­i­date the sec­tor to strengthen do­mes­tic au­tomak­ers and re­duce over­ca­pac­ity.

Financial Nigeria Magazine - - Contents -

China's for­mi­da­ble but frag­mented auto in­dus­try is ripe for a re­struc­tur­ing. As the world's largest auto pro­ducer, China now makes more cars than its mar­ket can han­dle. Yet China ex­ports only a tiny frac­tion of the ve­hi­cles it pro­duces, mostly to de­vel­op­ing mar­kets such as those in Iran and Viet­nam be­cause its cars pri­mar­ily are lower-end ve­hi­cles and, with the ex­cep­tion of elec­tric ve­hi­cles, Chi­nese brands still can't hold their own against the com­pe­ti­tion over­seas. On top of these prob­lems, China is un­der grow­ing pres­sure from other coun­tries, in­clud­ing the United States, to open its auto mar­ket to for­eign brands and in­vestors.

Pres­i­dent Xi Jin­ping an­nounced mea­sures in part to ad­dress the U.S. de­mand, in­clud­ing low­er­ing im­port tar­iffs and eas­ing Bei­jing's 20-year-old re­stric­tions on for­eign own­er­ship in the auto in­dus­try, in a speech at the Boao Fo­rum in April. A few months later, the Chi­nese Na­tional De­vel­op­ment and Re­form Com­mis­sion pro­posed a plan to cor­rect over­ca­pac­ity and pro­mote in­dus­trial con­sol­i­da­tion in the sec­tor. The ini­tia­tive aims to con­sol­i­date the Chi­nese au­to­mo­tive sec­tor to make it more com­pet­i­tive as the United States pushes for greater ac­cess to the do­mes­tic mar­ket – and drives au­tomak­ers else­where to look for new ex­port des­ti­na­tions un­der the threat of in­creased U.S. tar­iffs. But the road to re­form will be long and dif­fi­cult.

The Big Pic­ture

China is work­ing to grad­u­ally open its auto mar­ket – just in time for the United States to pres­sure Bei­jing for greater mar­ket ac­cess and threaten higher tar­iffs on auto im­ports from its Asian, Eu­ro­pean and North Amer­i­can al­lies. The prospect of a more com­pet­i­tive en­vi­ron­ment un­der height­ened U.S. pres­sure is push­ing Bei­jing to pick up the pace in its at­tempts to con­sol­i­date the Chi­nese auto in­dus­try in a bid to shore up do­mes­tic brands and man­age over­ca­pac­ity.

Too Big to Thrive

Sim­ply put, China's au­to­mo­tive in­dus­try is too big for its own good. Do­mes­tic con­sump­tion is show­ing signs of slow­ing af­ter two decades of steady growth; since May, pas­sen­ger ve­hi­cle sales have been down com­pared with last year. Pro­duc­tion, on the other hand, is set to keep ris­ing. The ca­pac­ity un­der con­struc­tion in 2017 could bring China's to­tal an­nual pro­duc­tion to 63.6 mil­lion con­ven­tional ve­hi­cles, more than dou­ble the cur­rent de­mand. Sim­i­larly, plans to ex­pand elec­tric ve­hi­cle man­u­fac­tur­ing would put pro­duc­tion at 6 mil­lion cars per year by 2020 – more than pro­jected yearly sales for elec­tric ve­hi­cles world­wide. The over­ca­pac­ity in China's au­to­mo­tive sec­tor, like that in its steel or so­lar panel man­u­fac­tur­ing in­dus­try, is a long-stand­ing and mul­ti­fac­eted prob­lem. More than in these other sec­tors, though, pro­tec­tion­ist gov­ern­ment poli­cies and com­pet­ing lo­cal and cor­po­rate in­ter­ests have con­trib­uted to ex­cess pro­duc­tion ca­pac­ity in auto man­u­fac­tur­ing. Bei­jing made the au­to­mo­tive in­dus­try a pil­lar of its plans to in­dus­tri­al­ize China and to cre­ate in­ter­na­tion­ally rec­og­nized Chi­nese brands. To that end, it has long nur­tured and shel­tered the sec­tor with high tar­iffs (110 per­cent in 1994) and caps on im­ported ve­hi­cles. And when for­eign au­tomak­ers flooded in look­ing for in­vest­ment op­por­tu­ni­ties in China, Bei­jing ac­ceded, with a con­di­tion: For­eign com­pa­nies would have to set up equal part­ner­ships with Chi­nese au­tomak­ers, mostly state-owned ones. The joint ven­ture strat­egy, the cen­tral gov­ern­ment hoped, would make the most of China's po­ten­tially lu­cra­tive mar­ket while help­ing lo­cal man­u­fac­tur­ers to hone their skills and tech­nol­ogy.

Di­verg­ing Goals

More than two decades later, the plan hasn't worked out quite as in­tended. The state-owned en­ter­prises are still not com­pet­i­tive in the world mar­ket, or even the do­mes­tic one – pri­vate Chi­nese au­tomak­ers such as Geely and Chery far out­sell them in China. Most of their prof­its to­day come from their joint ven­tures with for­eign com­pa­nies in­stead of from their own brands. Mean­while, Bei­jing's var­i­ous pro­tec­tions for the com­pa­nies – di­rect sub­si­dies, in­vest­ment into re­search and de­vel­op­ment, and tax in­cen­tives – have dis­cour­aged rather than fos­tered in­no­va­tion. Worse yet for the cen­tral gov­ern­ment, the joint ven­ture pro­gram has united sta­te­owned au­tomak­ers, their for­eign part­ners and their lo­cal gov­ern­ments against its de­sires to in­no­vate and stream­line the sup­ply chain, ini­tia­tives that would threaten their in­ter­ests.

The cen­tral gov­ern­ment al­ready has re­duced its tar­iffs on im­ported ve­hi­cles (ex­clud­ing those im­ported from the United States) and has also sug­gested that it will end its sub­si­dies for elec­tric ve­hi­cles by 2020.

As China's auto in­dus­try has de­vel­oped, the in­ter­ests of lo­cal gov­ern­ments of­ten have clashed with those of the cen­tral gov­ern­ment. The pri­or­ity for lo­cal lead­ers is to pro­mote eco­nomic growth and pro­tect jobs in their ju­ris­dic­tions, even if do­ing so en­tails pour­ing money into sub­si­dies and other pro­grams to sup­port au­tomak­ers in the area. Some lo­cal gov­ern­ments of­fered elec­tric ve­hi­cle man­u­fac­tur­ers sub­si­dies that cov­ered the en­tire cost of pro­duc­tion, a prac­tice that en­ticed hun­dreds of com­pa­nies to start pro­duc­ing elec­tric cars. The re­sult is a mar­ket in which sup­ply far out­paces de­mand and a whole class of com­pa­nies that de­pend on gov­ern­ment sup­port to sur­vive. Though China is home to more au­tomak­ers than any­where else in the world – it has an es­ti­mated 184 tra­di­tional ve­hi­cle brands – its top 10 auto com­pa­nies ac­count for a whop­ping 87 per­cent of sales. Six of those firms are joint ven­tures with for­eign com­pa­nies.

The Risks of Re­form

China's cen­tral gov­ern­ment has tried to pare down the un­wieldy auto in­dus­try be­fore, with mixed re­sults. Sev­eral prospec­tive merg­ers fell through be­cause of ob­jec­tions from pro­vin­cial gov­ern­ments or from the cor­po­ra­tions in­volved, while the num­ber of au­tomak­ers kept on grow­ing. To­day, how­ever, the in­ter­nal and ex­ter­nal fac­tors weigh­ing on the Chi­nese au­to­mo­tive sec­tor have added new ur­gency to the re­form ini­tia­tive. The cen­tral gov­ern­ment al­ready has re­duced its tar­iffs on im­ported ve­hi­cles (ex­clud­ing those im­ported from the United States) and has also sug­gested that it will end its sub­si­dies for elec­tric ve­hi­cles by 2020. But the real chal­lenge will be to cre­ate a more com­pet­i­tive do­mes­tic au­to­mo­tive in­dus­try by en­cour­ag­ing man­u­fac­tur­ers to move up the value chain and in­no­vate.

Of course, Bei­jing won't be able to re­al­ize its goals for the auto in­dus­try overnight. The cen­tral gov­ern­ment is mov­ing slowly to avoid in­flict­ing too much pain on its do­mes­tic au­tomak­ers at once, as the Na­tional De­vel­op­ment and Re­form Com­mis­sion's pro­posal sug­gests. And even so, the process won't be easy. As Bei­jing forcibly closes in­ef­fi­cient and un­prof­itable au­tomak­ers, work­ers will lose their jobs and lo­cal gov­ern­ments will ex­press their dis­sat­is­fac­tion. Ac­quir­ing state-owned au­tomak­ers, more­over, could un­der­mine in­no­va­tion at more prof­itable pri­vate com­pa­nies and hurt their ca­pac­ity. Fi­nally, the con­sol­i­da­tion could worry for­eign firms wary of grow­ing com­pe­ti­tion from China. But for Bei­jing, the risks of un­der­tak­ing re­form pale in com­par­i­son with the risks of fail­ing to do so.

“U.S. Tar­iff Threats Give China All the More Rea­son to Re­form Its Auto Sec­tor” is re­pub­lished un­der con­tent con­fed­er­a­tion be­tween Fi­nan­cial Nige­ria and Strat­for.

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