Chartbook 309 Can Western carmakers derisk in China? The unreality of geoeconomic realism.

German investment in China soars despite Berlin’s diversification drive. Politicians warn of rising geopolitical tensions but country’s carmakers stick with Chinese manufacturing

Thus blared the headline in the FT on Tuesday. The article reported new data which shows that:

German direct investment into China has risen sharply this year (2024), in a sign that companies in Europe’s largest economy are ignoring pleas from their government to diversify into other, less geopolitically risky markets. … German direct investments in China stood at €2.48bn in the first three months of 2024, rising to €4.8bn in the second quarter. That brings the total for the first half of 2024 to €7.3bn, compared with €6.5bn for the whole of 2023. The investment, much of it driven by big German carmakers, comes despite warnings from Olaf Scholz’s government about the growing geopolitical risks associated with the Chinese market. Ursula von der Leyen, European Commission president, has called on businesses across the EU to “de-risk” from Asia’s largest economy. Many in Europe worry that Germany’s business leaders have not learnt the lessons of the Ukraine war, which exposed its dangerous entanglement with Russia and its over-reliance on Russian gas.  The fear is that an escalation of geopolitical tensions in the Taiwan Strait could prove disastrous for the many German companies with extensive — and deepening — ties to China. It could also cut Germany off from many of the critical inputs and raw materials needed in the production of everything from chemicals to solar cells and batteries for electric cars. … Experts say much of the investment dollars are reinvested profits earned in China. Research by the Cologne Institute for Economic Research (IW Köln) has shown that more than half of the €19bn in profits made by German companies in China last year was reinvested there. They said the uptick in German direct investment reflected a new “In China, for China” strategy pursued by companies like Volkswagen aimed at shifting more production to one of their biggest markets. … The latest figures come just over a year after Scholz’s government adopted Germany’s first ever China strategy, a plan that was predicated on the need for Europe’s largest economy to “de-risk” its relations with China.  While insisting he opposed the idea of “decoupling” Germany from China, and completely severing ties, Scholz warned companies “not to put all their eggs in one basket”. … an analyst at US-based research group Rhodium Group, said the “strong momentum’ of German investment in China would continue through the rest of the year. She cited a number of big-ticket announcements in recent months, such as Volkswagen’s plan to invest €2.5bn in expanding its production and innovation hub in the city of Hefei, in Anhui province, and BMW’s planned €2.5bn in its Shenyang Production Base. “Over the past five years, German investments have consistently accounted for more than 50 per cent of EU27 investments in China, predominantly due to contributions from German carmakers,” … “Some of them are just too reliant on the profits they make in China,” said one. “They are stuck in a kind of golden cage.”

To me, this is a classic example of commentary that spouts and reiterates superficial geopolitical talking points without considering the economic and industrial forces that are actually in play.

This is, in no way, to deny the significance of geopolitics. The point is that blockade-fear and chatter about critical minerals distract from what are tectonic shifts in some of the world’s largest industries with huge implications for the energy transition, technological leadership and thus … geopolitics. You cannot treat geopolitics as merely a parameter of business choices. In the case of major industries like car-making, the choices themselves, the industry dynamics themselves are the geopolitical vector that matters. And in the case of a sector like car-making production, technological development and market size and dynamics are all closely coupled together. By comparison with these gigantic forces, concerns about niche critical minerals or tail-risk exposure are second-order.

It isn’t coincidental or incidental or surprising that car-makers are the main drivers of German FDI in China. The industry is one of the historic drivers of globalization and matters hugely to the German economy. Car industry investments in China far exceed those by the other usual suspects i.e. electrical engineering (Siemens) and heavy chemicals (BASF).

And why do Germany’s car-makers continue to stubbornly invest in China despite Olaf and Ursula’s fashionable worries about Taiwan? Because, already back in 2008 China became the largest car market and has since consolidated that position, far ahead of the United States, the EU and Japan. It was a profitable market for sure. But, it is by no means a cage. You can certainly leave. You fight to stay because you fear losing touch with the direction of the global industry. Exiting or deprioritizing China would be a defeat with strategic consequences.

Source: Statista

If you are in the business of making cars and selling cars at the global level, which is the aspiration of a VW and the German high-end marques, but also the likes of Toyota and, perhaps, GM, then being in China is not a basket you do or don’t put your eggs into. China is not a market that you can derisk from, or balance with other markets. It is the market, it is the country where both in terms of trends of consumption and production, the future of the global industry is likely to be decided.

Traveling in China recently with a senior manager from a German car-maker, he observed quite simply: “If we are in the business of making cars we have to be in China. If we aren’t here, we aren’t in the business.”

To put the same point another way, rebalancing from China may reduce your risks in the event of a war over Taiwan. But car firms are car firms. They don’t organize their strategy around the war-games of military think tanks. Exiting China, if you are a car-maker, doesn’t derisk your business. It substantially increases the risk that you do not stay on pace with the trends in the world’s leading market. It increases the risk that you get blindsided by competition you did not see coming.

If you want to talk seriously about industrial policy and geopolitics, you need to start not from drawing board analyses of supply chains, but from business dynamics i.e. from political economy and the hybrid, oligopolistic, state-sponsored capitalist assemblage that we are in. If you start there you immediately understand the real pressure that major non-Chinese corporate players are under in China.

In the summer of 2023, for the first time, non-Chinese joint venture manufacturers (JV) that for decades have earned fat profits in China, were overtaken by domestic, Chinese-owned and Chinese-led car makers.

In part this shift in the market is no doubt a matter of patriotism. When everyone in China who might afford an American car, hears everyday that the US is threatening to impose prohibitive sanctions on Chinese exports and is trying to sabotage China’s tech development, you would expect a reaction.

As data from Dunne Insights shows, German marques are holding up relatively well, but they are not exempt. Korean manufacturers can tell a tale of how geopolitical tension can reverberate in boycotts in Chinese markets.

And in the current moment, the force of the patriotic sentiment is compounded by a revolutionary technological shift. Only a few months after China’s own brands eclipsed the market share of non-Chinese join ventures (JV), the news came through that the sale of New Energy Vehicles (NEV hybrid and battery-electric) in China has overtaken that of internal combustion engined vehicles.

Here are data from the essential twitter feed of Adam Wolfe showing the shifting balance over the long-run. The scene is very fast moving.

Crucially, the dramatic surge in NEV sales in China began in 2021 when the rest of the world was distracted by COVID-drama.

The fall in the foreign JV share and the rise of new energy vehicles in China are directly related. With the exception of Tesla, which has its own PR issues, the New Energy Vehicles tend to wear “new” Chinese badges. By contrast the overwhelming majority of cars produced by non-Chinese JVs are old-tech internal combustion engine vehicles. As a share of their sales, Chinese manufacturers are seven-times more focused on NEV than their JV competitors.

Source: Just Auto

Consumer preferences, politics, technological and competitive failure on the part of non-Chinese JV all compound each other.

As far as Chinese consumers are concerned, If the West was anti-Chinese, but high-tech that would be one thing. There would be a choice to make. Right now, the technological backwardness of non-Chinese manufacturers confirms Beijing’s narrative of China rising in the face of resentful opposition from the incumbent American superpower and its European and Asian helpers. For the non-Chinese car firms, it is a painfully bad look.

And this sudden shift in the balance of the market is compounded by deliberate strategizing by Chinese corporate and government players. Key parts of the Chinese supply-chain for NEV are recipients of major national and local subsidy, as Nikkei reports:

SAIC’s prominent position on this list is striking because

… after decades of relying on two separate, lucrative joint venture arrangements with Volkswagen and General Motors -- largely focused on gasoline-engine cars -- SAIC has been promoting its own EV brands lately. The company is "now under the process of transformation," President Wang Xiaoqiu told investors after SAIC's annual earnings report. SAIC has been China's biggest auto exporter as well, powered by MG, a century-old British brand it acquired in 2007. The company sold 1.208 million units abroad in 2023, up 18.8% on the year, with MG cars accounting for 840,000 of the total exports -- mainly to Europe.

Another big subsidy recipient is BYD, a private EV maker backed by Warren Buffett's Berkshire Hathaway. It received 2.18 billion yuan in 2023, or 28% more than the year before. The Guangdong-based BYD is the country's leading EV maker and a key export engine, selling in over 50 overseas markets. Its peer, Great Wall Motor, also received over 2 billion yuan in subsidies last year.

Shinichi Seki, a senior economist at the Japan Research Institute who specializes in the Chinese economy, told Nikkei Asia that CATL's rise to the top of the government aid list indicates that Beijing is "flexibly adjusting which sectors should receive state funding."

Whilst the Chinese state assists its national champions to shift out of internal combustion, the non-Chinese JV are relegated to the declining IC market. Many of them in turn are responsible for driving the surge in vehicle exports from China.

Given this historic challenge, it would surely be surprising if serious-minded businesses in Germany or elsewhere were paying much attention to soundbites about “derisking”, or scolding from security experts about dangerous scenarios in Taiwan.

That kind of talk has the air of seriousness about it, but is actually profoundly superficial. Dramatic scenarios in Taiwan make for hair-raising war-games, but what probability should one attach to such extreme cases? Clearly the answer is non-zero, but if you are a giant global business, you can’t afford to indulge tail-risk doom-mongers. What you have to address first and foremost are the very real and existential risks to your own business, in your own sector, not in the future, but right here and right now.

For a firm like VW, what is at stake in China, the way it is nowhere else - not in Taiwan or Thailand, in North America or even Europe - is nothing less than the future of the industry. What is being decided in that market, in the current moment, is the future of auto-mobility for the next decade and beyond.

Back in 2017 America’s last truly global auto player, GM, sold 4.1 million units in China. And as Kyle Chan has calculated, it made handsome profits doing so.

In 2024 GM’s sales have collapsed to 1.8 million units and it has announced a strategic rebalancing away from China.

To be clear, GM’s pullback from China is not a far-sighted Taiwan-related derisking. This is a competitive defeat, plain and simple. As David Fickling put it, in an angry but compelling column back in May:

What we’re witnessing is an astonishing loss of nerve in a country whose capitalist hunger once created the modern auto industry. … Faced with the greatest challenge of the 21st century, America is giving up.

When Germany’s leading automakers stop plowing back the billions into China, we will know that the game for non-Chinese producers in the world’s biggest market, is truly up.

That is not the end of the world. As Chan argues in a level-headed post on his excellent substack High-Capacity, fear of a global Chinese EV invasion is overblown. But the gearshift in the industry is dramatic and, right now, non-Western firms are at risk of losing touch with the technological frontier being defined by China’s EV ecosystem. That is a far more serious scenario for German and other Western decision-makers to worry about, than wartime interruptions to the supply of scandium and yttrium. The shift in the balance of the global automotive market isn’t a hypothetical tail-risk scenario. It is happening before our eyes on a huge scale. We really don’t need to add drama to the global economic scenery. Reality is dramatic enough.

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