Chartbook 460 Greedflation meets China shock: Can Europe's car industry be saved without making the cost of living crisis worse?

The European car industry riding high, leading the world in sophisticated manufacturing, earning record profits, paying out huge dividends.

No, I am not dreaming.

I have not had a European summer stroke induced by a lack of air conditioning.

This was the state of play in 2019, when according to no lesser authority than McKinsey, the European car industry was the dominant player in the world.

Seven years later, the situation is transformed.

Today, it is China’s exports that are hogging the headlines. Europe’s industry is described as being in the grips of an existential crisis. One third of European car-making capacity is declared surplus to requirement. Policy elites are debating elaborate instruments to support and protect the industry.

China shock 2.0 is more than the European car industry. But without the crisis in the European car industry, China shock 2.0 would hardly be making the headlines that it is. The European car industry is not just “another case”. It is a flagship industry for Europe. Not for nothing it was highlighted by the Draghi report as the heart of Europe’s industrial R&D complex. Directly and indirectly it employs 13 million people.

To sharpen the China shock discussion to the European car industry is not to diminish its significance but to underline it.

What has happened?

One obvious framing is China-centric: China’s industrial policy; the undervaluation of China’s currency; China’s inadequate domestic demand'; China’s contribution to global imbalances.

But looking back to 2019 forces us to ask questions about the other side. What happened to the European producers? How did this once dominant industry, so suddenly become a victim?

Not only do we need to tell both sides of this story so as to better understand what is going on. But, more urgently, understanding the European failure is also crucial to thinking through the best way to respond to the China shock.

Crucially, we need to abandon the framing that one-sidedly pathologizes China whilst normalizing the rest of the world; the kind of framing that treats the European car industry as a fundamentally healthy sector that just needs a bit of protection to continue its, otherwise, normal development. The China shock is diagnostic. The fact that Europe’s car industry can be overrun in the way that it is being overrun, should be telling. It reveals things that are deeply wrong at the heart of the European economy. And this in turn means that if we really want to find a way out of the impasse, advocacy for protection and support should be tied to demands for systematic reform.

To see the full force of this argument we need to go beyond the narrow focus on production and industrial employment that is framed by the “China shock” narrative. After all, over the long-run the broader issue for Europe, has been the mercantilism of German economic strategy and the suppression of the standard of living that follows. Most recently this was compounded by the “cost of living crisis”, which was diagnosed by many in progressive circles as the result of profiteering and price gouging. To this aggravation of Europe’s social bargain by the aggression of European capital, an influx of affordable, high-quality Chinese imports might actually appear as a cure.

To put it in a nutshell, the challenge is not just how to respond to the China shock, but how to do so without exacerbating the damaging trends in Europe’s political economy that have produced the cost of living crisis. In the aftermath of the COVID price shock these were discussed controversially under the headline of “greedflation”. It would be hard to think of an industry for which this question is more pressing than the European car industry.

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There are various explanations for the crisis of European car industry, and the German industry in particular. Amongst the range of issues popular theories include:

1. The cost question: Compared to Toyota, for instance, VW appears heavily “overmanned”.

2. Another is the story of the failure of the European industry to grasp the challenge of EVs and “smart cars”, which are problems of electrotech and complex software systems.

3. The most overarching explanation concerns Europe’s car producers as businesses, whose job is to set prices for their output to maximize profit and then distribute that profit between financial reserves, dividends and new investment.

There are, no doubt, many more issues to pick over. They are all, no doubt, interconnected. Of my short list, 1. and 2. are long-term and structural problems that have accumulated over time. I will return to them in later posts. But, the angle of corporate finances, #3, is particularly interesting, because it so clearly illustrates the fast-moving switchback of success and failure.

I refer here to a particularly interesting report by the Dutch-based think tank SOMO, - Manufactured Crisis - which has not received the attention it deserves. As the SOMO compilation makes clear, whatever problems Europe’s car industry may have, poverty is not one of them.

As recently as 2023, the European automotive industry stood out, relative to its peers, for the huge profits it was earning.

In 2023 European firms earned 40.6 percent of all profits earned in the global automobile industry, up from a share of 27.9 percent in 2006. In 2023 the major producers collectively earned €98.1 billion in profits, versus a mere €10.9 billion in 2006. The Europeans reduced their US competitors - who a century before bestrode the world as the leaders of a new era of “Fordism” - to an also-ran in third place, behind Japan and South Korea.

Not just in total volume, but as a percentage of sales, the profitability of the European industry was second to none.

These profits were earned despite static or even falling demand. Indeed, the two thing went hand in hand. As Tommaso Pardi of the GERPISA think tank remarks:

“The profitability growth of EU carmakers reflects two distinct phases … Before 2020, German premium brands profited from strong exports to China and the US, while many other European manufacturers like Fiat, Renault, PSA, and Opel were struggling. Following the pandemic, supply shortages enabled carmakers to restrict volumes, raise prices, and push more aggressively into the premium segment. This strategy delivered record profits but also fuelled today’s affordability crisis in the EV transition, with very few smaller A- and B-segment electric models available.”2

As Pardi shows, the European industry was deliberately opting for a high-price strategy that narrowed its own market. From early 2021, prices surged by more than 20 index points. The entry level price for basic European cars

As Pardi tells the story:

Between January 2021 and February 2022, the average monthly inflation in prices of new cars (EU27) was already four times higher than the average of the previous five years (2016-2020). Following the collapse of sales due to the Covid crisis, demand rebounded in 2021, but due to the chip shortage crisis started at the end of 2020, supply could not follow. Carmakers took advantage of this situation of higher demand than supply to increase their margins and shift their sales upmarket. The concept of “pricing power” was then widely but mistakenly used to justify these much higher than usual margins, which were in fact due to this exceptional and temporary configuration. In 2022 and 2023, the chip supply crisis continued and was compounded by the energy price crisis triggered by the Russian invasion of Ukraine in February 2022. Energy price inflation was particularly severe in Europe due to its high dependence on Russian gas and oil. Between February 2022 and April 2024, the average monthly inflation in prices of new cars jumped to five times higher than during the period 2016-2020. A study by the IMT12 based on the French market shows that only one fourth of the average € 6800 price increase (+24%) in retail prices of new cars between 2020 and 2024 was due to the impact of energy, commodity prices and labour costs inflation, while three quarters were due to the combined effect of upmarket shift (both in ICE and electrified vehicles) and “pricing power”.

To put this same story another way, the European car industry in the early 2020s was a prime example of greedflation i.e. companies taking advantage of the COVID shock and other disruptions and to hike profits at the expense of consumers.

Unfortunately for them, the European car producers embarked on this strategy precisely as the Chinese industry was entering a phase of dramatic capacity expansion and price-cutting. Were the European car producers to “give back” the wedge of € 5000 in upgrades and “pricing power” they have inserted into the average car price since 2020, if they focused their attention on offering attractive models in the € 10-20,000 price band - the kind of affordable mobility European households need - perhaps their competitive position would be better.

Could this have been forestalled? To have done so would have required a complex refashioning of car production and corporate restructuring. This would have required lots of new investment. And here too the balance sheet data suggest serious failings.

The European industry certainly invested. But in relation to the profits it was earning and in relation to its existing plant, the European industry did so at a relatively low rate. Again we can draw on the SOMO data:

Backhandedly the same result is confirmed by an otherwise optimistic ECB report, which shows European car industry capex and R&D spending level-pegging with China and Japan i.e. far below its relative share of global profits.

So what where the European car firms doing with their outsized profits?

One thing they were doing was paying out generous dividends. I highlighted this in an earlier post. In the early 2020s, at what ought to have been a critical juncture for the competition with China, VW made huge payouts to its shareholders.

But, if we look systematically into the balance sheets, as SOMO has done, it is clear that the story goes beyond dividends. For players like VW the more remarkable thing is not the dividend distribution, but their build-up of financial reserves.

At the critical moment in the 2020s when the Chinese competitors burst onto the scene, the European car industry was in a singularly introverted - one might even say involuted - mode. It was was not expanding demand through competitive pricing. Europe’s producers were milking the market with high-priced vehicles, generating large profits that were returned to investors or stashed in reserves rather than being poured into strategic investment.

To be clear, the financial numbers tell only part of a complex story. Why this was happening at a firm like VW with significant trade union representation on the board, and why the investments that were made did not pay off in more successful vehicles, are questions for another place and another time.

If we remain at the level of broad aggregates, the story for the car industry highlighted by the SOMO data does not seem to have been unusual in European business more generally. As Mazzucato and colleagues have shown in a study of the top 200 European corporations commissioned by the European Trade Union Confederation, there has been a general pattern of “financialization” across European business. Leading firms have built up large financial holdings whilst running down their physical plant and at the same time paying out larger and larger sums in the form of dividends and buybacks.

As the report continues:

If the corporate sector were merely paying out more of what it earned, the story would end with the distributions. It does not. The European non-financial corporate sector has been distributing more while accumulating record reserves on its balance sheets, a reflection of an era in which companies saw skyrocketing profits and cheap access to capital. Across firms with available data for every year, median retained earnings rose from €0.75 billion in 2000 to €5.09 billion in 2024 – a 322 percent increase in real terms (Figure 7). …. the same firms paying record amounts to shareholders are also accumulating record liquid reserves. They are not a contradiction but complementary strategies for financial flexibility. The corporate sector under a financialised governance is not constrained by cash availability but by a return threshold that productive investment can no longer meet – a threshold set not by what the economy needs from new productive capacity, but by what shareholders earn from financial alternatives. As a result, profits are increasingly absorbed into the corporate balance sheet without being recycled into the productive economy or shared with workers or the public institutions that underwrite the underlying market positions on which those companies depend. Increases in retained earnings skew towards the biggest firms. The 34 highestearning companies in the panel accrued €621 billion in retained earnings between 2020 and 2024, accounting for 81 percent of the entire panel’s €769 billion.

This is precisely the story for the European car industry. The result is visible at the macroeconomic level.

At the national-accounts level this trend appears as the corporate saving glut. EU27 NFC gross saving moved from 0.82 of investment in 2000 to 1.05 by 2024 – the sector now saves more than it invests in absolute terms, €2.28 trillion against €2.18 trillion in 2024 (Figure 8). Cash is generated and retained but not deployed towards innovation or production.

The cumulative effect is one of the most striking findings: the European non-financial corporate sector, historically regarded as a net borrower that absorbs household saving to fund new investment, became a structural net lender to the rest of the economy after 2009, with net lending reaching +1.2 percent of EU GDP in 2024 (Figure 9).

At the aggregate level this helps to explain why Europe, for all the focus on the bilateral deficit with China, remains heavily in surplus with the rest of the world. The two seemingly contradictory trends connect, because the relatively low rate of productive investment leaves European industry vulnerable to its most vigorous competitors whose firms are contending with an even more deflationary macroeconomic situation at home in China.

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China Shock 2.0 in its most vital arena - the European car market - is defined by multiple converging influences. Many of these are on the Chinese side. But we should not ignore “pathologies” on the European side too, of which I have highlighted just two in this post: the shift towards financialization visible in European corporate balance sheets and the deliberate high-price strategy adopted by the leading European car producers since the late 2010s. These developments on the European side have made the European car industry particularly vulnerable to the surge of competition from China that has hit global markets since the early 2020s.

In meeting the current urgency, Europe should not, therefore, focus only on China’s pathologies, but needs to examine what is going on at home. After all, Europe is nominally committed to the energy transition. Europe boasts of itself as a competitive social market economy. It presumably favors an affordable cost of living for its population. It does not generally favor a world of over-priced, over-powered, polluting SUVs. Europe does not explicitly endorse profit-taking and financialization as desirable social and economic developments. But all of those were trends that were being deliberately promoted by its leading industrial firms, notably in the car industry.

Furthermore, it is an open secret that Europe’s car industry has not just pursued a dead end competitive strategy but has deliberately set out to sabotage the green energy transition, whilst, in the case of the German industry, lobbying against determined action to meet the Chinese challenge. They do so, not because they favor affordable mobility for European consumers, but because they want to go on selling increasingly outdated vehicles in China’s rapidly dwindling market for internal combustion engine vehicles.

The dilemmas posed by the China shock are real. Employment and national security are key issues. Command of key technologies gives one a claim on the future. But we must never lose sight of the fact that that the trade offs are as painful as they are in 2026, because of the strategic choices of Europe’s industry. Some form of interim protection for the European car industry makes sense. But it must be accompanied with a reckoning with this track record of strategic failure on the part of the industry itself. Merely providing protection risks entrenching a high-price island for European consumers, whilst leaving in place the managerial elites that are co-responsible for the crisis that Europe finds itself in. To avoid this, an answer to the China shock must be combined with an effort to reorganize and discipline the interests that have turned what was once a crown jewel of the European economy, into an embarrassing train wreck.

Who should do that reorganizing and disciplining? It must be some combination of politics, management, outside expertise, workers but also tax-payers and consumer groups. And to generate change and innovation, it must, as Sabel and Victor argue, threaten credible penalty defaults for inaction. The target must be clear, unambiguous and non-negotiable: The aim is not to restore or secure the status quo, but to move as quickly as possible to a competitive and affordable model of electric mobility at an average price per vehicle far below that which the European industry sought to establish in the 2020s and much closer to that promised by China’s extraordinary technical breakthroughs of the last ten years. Otherwise, the protective reaction to the China Shock risks becoming a vehicle through which European industrial interests secure political backing for the gains they extracted during the greedflation moment of the early 2020s.

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