“Overcapacity” Talks Will Hurt America, Not China

Washington’s protectionist instinct is counterproductive when Chinese EV firms are simply more competitive

Janet Yellen’s trip to China this April laid bare Washington’s latest focus of China anxiety: the country’s alleged “excess industrial capacity” in electric vehicles (EVs), lithium-ion batteries, and solar panels. The U.S. Treasury Secretary complained to Beijing officials about China’s leveraging industrial policies to unleash a deluge of these “artificially cheap” goods into the global market. To paint an even more alarming picture, she drew a parallel between China’s ongoing “overcapacity” and its massive “below-cost” steel dumping. She said that it had “decimated” industries in America, and President Biden “will not accept that reality again.”

Ms. Yellen’s analogy is as false for her intended Chinese audience as the overcapacity story is misguiding for Washington policymakers. Unlike the Chinese steelmakers, whose rise over the past decades was mainly propelled by the state-sponsored infrastructure drive, China’s clean energy sector, especially the EV industry, is largely driven by a sustainable, ever-expanding consumer market. More importantly, the “three new industries” pinpointed by Ms. Yellen are a far cry from some low-tech, labor-intensive businesses relocated from developed nations. Chinese clean energy companies, most of which are privately owned, blaze their way into the global market thanks to key technological breakthroughs. It unveils an inconvenient fact that China’s comparative advantage is shifting from cheap labor towards technological advances, and it will make the world’s second-biggest economy all the more impervious to trade barriers in the future.

The “overcapacity” story distorts these facts. It helps indulge the belief that protectionist measures are still a panacea for rectifying trade imbalance, even in sectors where American technological superiority is slipping away. As for clean energy industries, an act to seclude itself from Chinese products along with the country’s technological innovation and supply chains will further stunt American companies’ competitiveness in this promising business. Propagating the myth of “excess capacity” is poisonous for America, not China.

Washington Pitches the Wrong Story

A closer look at the available data would suggest that Ms. Yellen’s rehash of China's excess manufacturing capacity in the renewable energy industry simply does not add up.

First, the domestic market has long been the mainstay of China’s EV production. China is the world’s biggest EV producer, and also the largest consumer. In 2023, China’s EV exports reached 1.77 million, accounting for only 18.6 percent of the country’s total EV sales. It is roughly the same export ratio for all types of vehicles produced in China last year. At the same time, for every 100 vehicles produced in Germany, 75 were shipped away for foreign consumers. And Japan, another auto powerhouse, had 58 percent of its car production absorbed by the overseas market. By this standard, China has long stayed at the receiving end of foreign carmaking powers’ “overcapacity,” not the other way around.

Interestingly, out of China’s 1.77 million EV exports last year, nearly 20 percent came from Tesla’s gigafactory in Shanghai. The other 600,000 Tesla EV models assembled there were directly delivered to the Chinese market. It should be noted that Tesla’s Shanghai plant is the first and only automaker wholly owned by a foreign company on Chinese soil. That is to say, this American-controlled factory is responsible for 1/5 of China’s EV “spillover” Ms. Yellen warned against.

Second, China’s major EV makers have fared particularly well in capacity utilization, a widely accepted metric that gauges the level of overcapacity. Companies like BYD, SAIC, Li Auto, have all achieved north of 80 percent in that regard, which indicates that overcapacity is practically a nonissue for the sector. By contrast, it was the producers of internal combustion engine (ICE) vehicles that had much lower capacity utilization, in some cases the figures are even below 50 percent. Also, the total production and sales of Chinese EVs in 2023 both stood at around 9.5 million, indicating a robust consumption vis-a-vis production.

Third, there is an unfulfilled, fast-growing demand in the global market. According to the Global EV Outlook 2024 published this April, EV sales will reach 45 million in 2030, and 65 million in 2035. This report projects a global EV fleet of 250 million in a matter of six years. The world market has not fully transformed from a blue ocean of expanding market space to a red ocean of brutal competition.

Furthermore, the so-called “artificially cheap” pricing is a gross over-generalization for Chinese EVs on sales overseas. The latest generation of Atto 3 produced by BYD, China’s and the world’s biggest EV maker, was once priced at 47,000 euros in Europe at its peak, surpassing Volkswagen’s ID.4 (43,900 euros) and Tesla’s Model Y (44,890 euros). Even after several bouts of market adjustments, the price for Atto 3 still hovers around 40,000 euros. Gone are the days when Made-in-China was only competitive in pricing. It is the quality and technology that counts now.

The three products Ms. Yellen used as evidence for “excess capacity” allegations only accounted for 4.5 percent of China’s total yuan-dominated exports last year. If anything, what should come to plague the White House officials’ minds is not China’s industrial overcapacity, but its expanding innovation capacity. Washington pitches the wrong story.

When Trade Barriers Don’t Work Anymore

As a matter of fact, the EV industry has undergone an upheaval over the past two decades that was once obscure even to those who have the sharpest business acumen, let alone career politicians in Washington. When asked about BYD’s EV models in a 2011 interview, Elon Musk burst into laughter with undisguised contempt: “Have you seen their car?... I don’t think it’s particularly attractive, the technology is not very strong.” However, during a recent Tesla earning call, the American billionaire hailed his Chinese counterparts as “the most competitive car companies in the world.”

Just as he spoke, the Tesla Model Y midsize SUVs equipped with BYD’s state-of-the-art blade batteries were rolling off the production line at Tesla’s Berlin factory. It was made possible by BYD’s major technology leapfrogging in 2020 that dramatically raised the energy density of LFP (lithium-iron-phosphate) power cells, which were later refashioned into the company’s knock-out product: blade batteries. It sent shock waves across the EV battery market then dominated by the ternary lithium cells. Two years after this breakthrough, BYD dethroned Tesla as the world’s biggest EV manufacturer.

Clinging to the story of China’s “unfair trade practices,” Washington’s “overcapacity” talks have not had any bearings on reality, and tried to provoke an ill-considered arms race of protectionist measures. Ms. Yellen urged Beijing to change its industrial policy featured by alleged massive government subsidies in the clean energy sector, which she believes is the root cause for the non-existing “excess capacity.”

With or without Ms. Yellen’s demand, the state-directed support for China’s new energy industry has already been phased out. By 2022, China ended the six-year-long purchase incentives for EVs, and there was also a gradual decrease in subsidies in effect. The subsidies for solar panel production also stopped in 2021. According to a Bloomberg research, most Chinese renewable companies have very low borrowing relative to their cashflows, indicating that the sector is unlikely to be buttressed by government loans. They are more than capable of making profits in market competition.

Ironically, Washington is doing exactly what it accuses Beijing of doing. The Inflation Reduction Act has offered a US$7,500 tax credit for Americans who buy a new EV, and US$4,000 for those who purchase a second-hand EV. But this is hardly the remedy for American auto giants who struggle to pivot EV production. Last year, Ford lost over US$64,000 for every EV it sold. General Motors stumbled over its ambitious ultium battery platform, which is set to be the core of its future EV models. As warned by the IMF officials, industrial policy initiatives pursued by the U.S. to steer innovation is no magic cure for economic growth.

Rather than helping build up the competitiveness of homeland EV makers, the “overcapacity” narrative will often lead to the slippery slope towards tariff regimes and market seclusion. This approach proved ineffective in the sectors where America lags in technological innovation.

In 2011, Washington for the first time slapped anti-dumping tariffs on Chinese solar panel exports, which induced a 37.5 percent decline in the sector’s export value the following year. The second round of sanctions came in 2014, but the result was much less dire as the one-way trade fell only 21.7 percent. By the time the infamous Trump Tariffs against Chinese goods including photovoltaic products was in place in 2018, China’s outbound solar panel sales soared from US$13.5 billion to US$19.1 billion. Ever since China began to master the core photovoltaic technology, the marginal effect of trade barriers diminished.

The U.S. vigilance and hostility towards Chinese high-tech clean energy enterprises is unlikely to benefit itself. China took a radically different approach when it gave super-preferential treatment to Tesla’s Shanghai factory project in 2019. Less than a year after the plant had broken ground, Tesla delivered its first batch of vehicles made in China. As it turned out, the introduction of the world’s top EV maker helped incentivize China’s domestic innovation drive in this sector and the build-up of a wholesale supply chain. Had the Chinese government blocked Tesla on the grounds of its “overcapacity,” things would have turned out quite differently.

New Reality Calls for New Thinking

Ms. Yellen, and by extension President Biden, has got this false sense of déjà vu. What is happening is not a repetition of China’s massive build-up of cheap exports. This is the new reality that Washington needs to cope with: China’s comparative advantage is shifting in the global system.

As China’s vast population starts to age and the cost of all factors of production rises, the only way to keep up the economic growth is to boost its total factor productivity (TFP), mainly through technological innovation. And that is what Chinese leadership has been vehemently advocating through the latest drive of “new quality productive forces.” Gone are the days when China tried to squeeze into the global trading system with labor-intensive, low-tech, low-value-added goods. There is no other option for an upper-middle income economy that yearns for sustainable growth.

Therefore, it is quite ridiculous that Ms. Yellen asked Beijing to hold its horses in the new energy industry under the pretext that it would be good for “China’s long-term productivity and growth.” Either it shows Washington’s astounding ignorance of China’s resolve to achieve industrial upgrading, or they are simply too pigheaded to acknowledge that China has managed to make some progress in that regard.

Today, China’s comparative advantage has shifted from the cheap labor dividend to rich human capital, an integrated and large market, and a sophisticated infrastructure system. It largely explains the success of China’s EV industry. The hiring cost of Chinese research scientists is almost one time lower than their American counterparts. The Chinese market takes up 60 percent of the world’s EV sales. And the industry is also supported by an enormous network of charging facilities that the government started building a decade ago. More importantly, China still upholds the policy of opening up to the global market, which keeps its clean energy sector vibrant and competitive.

If America wants to keep up with the clean energy revolution that is rapidly unraveling around us, what it takes is more input into the research and development in the industry, and efforts to invest in related infrastructure building. Shutting the door to competitive Chinese technologies and products is not conducive to encouraging U.S. consumers to go green or nurturing a healthy environment for innovation.

While Ms. Yellen called for “the need for a shift in policy by China” when she fed into the false narrative of “overcapacity,” what requires a major overhaul is Washington’s thinking and policy-making in its future economic competition with China. At the end of the day, one should first and foremost do his own homework well.

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Subscribe to Sinical China for more original pieces to help you read Chinese news between the lines. Xu Zeyu, founder of Sinical China, is a senior correspondent with Xinhua News Agency, China’s official newswire. Follow him on X (Twitter) @XuZeyu_Philip

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