China’s Industrial Overcapacity Has Already Started To Hit Europe

Updated April 9, 2024 at 1:10 p.m.*

BERLIN — In late March, the BYD Explorer No. 1, a 200 meter-long bright white vehicles carrier, made its maiden voyage to Bremerhaven, a port city on Germany’s North Sea coast, to deliver 3,000 China-made electric cars. Technically equal to most German models, these cars are often significantly cheaper. And they are the first of many waves that will strike at the heart of a key German industry.

In the next few years, the Chinese electric vehicle maker BYD alone is planning to launch seven more cargo ships to transport cars from Asia to Europe.

And the electric cars are only the tip of the iceberg when it comes to industrial products that are expected to pour into Germany from China over the next few years. Many of these will likely be less expensive than their German counterparts, forcing companies and politicians to look for new ways to respond to this challenge.

Warnings of Chinese overcapacity were a key focus of a just completed China visit by U.S. Treasury Secretary Janet Yellen, where she aimed to stabilize U.S.-China economic relations. U.S. concerns echoed those in Europe about China’s state subsidies to the booming EV industry, which Yellen said could threaten American jobs and businesses,

Countering Europe

The situation no longer concerns only products such as steel, batteries and solar panels, which China has dominated for many years thanks to its unrivaled low prices. The communist country is now expanding to mechanical engineering — and is putting increasing pressure on European manufacturers.

One important sign that the European offensive is kicking into gear came in early March, at the Communist Party‘s annual congress at the Great Hall of the People in Beijing. Wearing a red tie, Premier Li Qiang stood at the lectern with red flags billowing in the background and announced a target of 5% growth for the Chinese economy in 2024, equalling that of last year.

Compared to the double-digit growth rates from around the turn of the century, that target seems modest. Yet given the current economic situation it is “ambitious,” Li said. The economy is suffering from a sustained slump in property prices and the stock market, which is lowering Chinese consumers’ confidence and spending. It is clear that the Communist Party cannot rely on greater domestic demand.

How Chinese EV Giant BYD Is Taking On Tesla

BYD dethroned Tesla in the fourth quarter of 2023 as the world’s top EV maker, according to CNBC, selling more battery-powered vehicles than its U.S. rival, Elon Musk’s Tesla.

China’s price advantage

So the party is looking to boost industrial production — which goes hand in hand with higher exports. According to recent trade figures, in the first two months of 2024, the value of exports rose by 7% compared to last year, reaching 8 billion. Because the Chinese yuan is weak compared to Western currencies, the number of exported goods may have risen by significantly more.

Price is a central factor. “Production is cheaper in China. There was no inflation and the standards in the factories are lower,” said Klaus-Jürgen Gern of the Kiel Institute for the World Economy. Gern said it is difficult to gauge how far state subsidies are also suppressing prices, but that “Chinese companies will reduce overcapacity at the expense of their margins, and in many industries that could lead to losses.”

With no prospect of reducing overcapacity in the near future, the importance of exports will only increase.

Electric cars are a good example of just how far supply is outstripping domestic demand. Chinese manufacturers are capable of producing around 50 million cars a year, but domestic demand is only around 23 million.

Cheaper imports from China could also have a positive effect in Europe. “Seen from the point of view of the economy as a whole, they reduce inflation and thereby raise demand, so in principle it is good news,” Gern said.

In the best case scenario, greater competition could force German companies to innovate more, improving their productivity. If Chinese products gain a larger market share, however, that would make the German economy is less independent and more exposed to geopolitical risks.

Research and development moved to China

That is not what the politicians want. As for companies, after seeing their supply chains temporarily break down during the COVID-19 pandemic, many are seeking to diversify their suppliers.

“They are therefore building or expanding sites in other countries,” said Maximilian Butek, a board member of the German Chamber of Commerce in China. At the same time, companies are increasingly moving research and development to China to better serve the market there. That is vital due to the Chinese market’s sheer size.

“Before, investment was mainly about sharing in China’s growth. Now they have to ensure they are competitive,” Butek said. The widespread price drops, in response to the risk of losses in various sectors of the domestic market, doesn’t make that any easier. But with no prospect of reducing overcapacity in the near future, the importance of exports will only increase.

German manufacturers are not afraid of competition — they still sell 50% more to China than they import.

Oliver Wack, a foreign trade expert at Germany’s Mechanical Engineering Industry Association, agreed. He said that the trend of European companies seeking growth by turning to Chinese manufacturers can be clearly seen in areas such as construction equipment. “In other industry sectors, for example, in machine tools, robotics or automatization solutions, the trend is less marked,” Wack said.

He said that German manufacturers are not afraid of competition — as it stands, they still sell 50% more to China than they import. “Yet the rules should be the same for everyone involved,” Wack said, adding that there will probably be more scrutiny about that in the coming years. “Due to current developments, we should expect that there will be more anti-dumping investigations in Europe,” he said.

European investigations into China

There are already signs of that. Last fall, the European Commission launched an investigation into Chinese electric car manufacturers, which could lead to higher import tariffs. And there are also investigations being launched into significantly less popular products.

Since November, officials in Brussels have been investigating a complaint from two French manufacturers about imported self-driving aerial work platforms. Yet the industry does not unanimously approve of these investigations. Some fear that China will respond by making it more difficult to import European products.

Beijing has been aware of the overcapacity problem for 15 years

In any case, these investigations will not bring about a fundamental change in China. “Overcapacity is a consequence of a planned economy,” said Jörg Wuttke, former president of the EU Chamber of Commerce in China. He said Beijing has been aware of the problem for 15 years but has not been able to do much to resolve it. Mainly state-owned companies are responsible, and they cannot be allowed to go bankrupt, as the jobs they provide must be protected.

These companies often benefit from regional support programs, which means that, alongside successful companies such as BYD, there are a large number of small car manufacturers, which are seen — at least in their region — as possible champions of tomorrow. In environmental tech, he says overcapacity has recently become a big problem.

China is not subject to Western guidelines

In the long term, that will have a negative effect on the economy. Because if more products are sold on the global market at less than their manufacturing cost, trade tensions will only increase. “And if the Chinese companies don’t make any money, they will invest less in research and pay less in taxes,” Wuttke said. That could be a significantly larger problem than whether or not the government achieves its 5% growth target.

Products from China also make their way to Europe via routes that, until recently, have not been very transparent. Florian Sieber, CEO of toy manufacturer Simba Dickie, been aware of this for some time. A big fan of China’s efficient manufacturing and integrated infrastructure — which covers the entire supply chain from subcontractors to packaging — Sieber said the country’s role is “irreplaceable.”

But as a market for selling products, he said China is not relevant because it is dominated by manufacturers who are not subject to strict Western guidelines, and whose products are therefore cheaper. The distinction is shifting, however. “That is mainly due to the growing popularity of digital marketplaces,” Sieber said.

While Western firms, such as Amazon, monitor their suppliers closely, Chinese platforms such as Temu rarely take action against products that do not meet Western standards. Sieber said there is a constant stream of licensed products sold without licenses, such as Disney soft toys like Mickey Mouse.

He says there is no solution in sight, as customs officers are not able to dedicate the extra time and effort required to inspect shipments more closely at the border. “If you take action against one supplier, another rises up in its place,” Sieber said. “It’s like battling a Hydra.”

*Originally published April 3, 2024, this article was updated April 9, 2024 with a report on Janet Yellen’s trip to China, as well as enriched media.