Should the U.S. ban imports of Chinese-made electric vehicles?

The Biden administration recently ordered an investigation into the national security threat posed by Chinese connected-vehicle technology. 

The outcome, if taken to an extreme, could result in a ban on the import of Chinese vehicles into the United States. 

But there is much more driving the decision than national security concerns. For an administration that has embraced a revival of industrial policy, the investigation is the latest sign that it is intent on nurturing critical infant technologies such as microchips, artificial intelligence, quantum computing and, now, electric vehicles (EVs).

Bloomberg estimates the EV market will grow to $8.8 trillion by 2030, with the United States accounting for 21%, or $1.8 trillion.

And the investigation comes just as China is seeking to reinvigorate its sagging economy using an approach it has relied on for decades—make cheap goods and sell them to willing trading partners around the world. Only this time, those trading partners may not be so willing.

In response, developed economies like the United States are embracing industrial policies that are seeking to foster their own growth and blunt the influx of cheap goods like those made in China.

But there are risks to industrial policies:  They can result in the creation of national champions, which, in turn, leads to an inefficient allocation of scarce capital. Ultimately, industrial policy can make domestic businesses less competitive.

As such, should a pause or outright barrier on entry of Chinese EVs into the U.S. market happen, companies should not become complacent.

Rather, companies must continue prioritizing innovation, efficiency, consumer focus and agility to keep pace with the evolution of the automotive sector. They must continue to integrate sophisticated technology into the production of goods, even if that means reaching beyond national borders.

The move by many advanced economies to adopt industrial policy to confront the Chinese economic challenge—think of the Biden administration’s call for sharply higher tariffs on Chinese-made steel and aluminum products—will increasingly be a source of rising tensions.

Part of China’s solution to its slowing growth—to export excess manufacturing capacity and deflation—is not going to be accommodated like it might have been in past decades.

Competition and conflict generated by these choices, illustrated here by the attempt to protect an infant industry within the context of national security and economic security, indicate a new era of international security, economics and politics that will reshape the global order.  

China’s economic growth model reaches an end

China is ensnared in an era of debt and deleveraging that represents the functional end of the growth model that has fueled its economy for decades.

While this deleveraging has not yet evolved into a full-blown crisis, Chinese households, firms, and local and state governments must draw down the prodigious quantities of debt on their respective balance sheets. That process will reshape the domestic economy and hurt China’s relations with the major global economies. 

Essentially the debt overhang in commercial and residential real estate is acting as a drag on overall growth that once came from the modernization of infrastructure, housing and manufacturing.

Because two-thirds of that triad are now defined by diminishing returns, China finds itself in a difficult situation: It is reluctant to further rebalance its economy toward households, which would involve difficult and substantial redistributions of wealth that are not favored by the government.

In addition, given the size of China’s current account surplus and its national savings, which are greater than 40% of its gross domestic product (GDP), there is no way that the debt-fueled investment boom can continue. Any new debt, in effect, has nowhere to go. Now, as the 10% growth rate of previous decades slows substantially, secular stagnation has set in, which requires a different policy response.

Rather than reflate domestic consumption, which would maintain growth as the deleveraging continues, the government has decided to redirect risk capital back toward the manufacturing sector.  

Boosting industrial production is designed to protect employment in the manufacturing sector while exporting the burden of adjustment to its trading partners.

But China’s trading partners, unlike in previous decades, when they welcomed cheap goods, have little interest in playing along this time. And for China, the policy could ultimately backfire and increase domestic debt.  

To put that in perspective, consider that China’s share of global manufacturing stands near 31%, which is almost twice its 18% share of global GDP. Compare that with the United States, whose share of global manufacturing is roughly 15% in comparison with its 23% share of global GDP.

Given that China’s share of global consumption is approximately 13%, in contrast with the 27% share of the United States and the 17% of the European Union, Beijing obviously does not retain the domestic capacity to absorb that excess production, nor does it intend to.

In short, China intends to export its way out of its debt and deleveraging era through the U.S., EU and major regional trading partners, which would absorb that excess production and accept a reduced share of global manufacturing while accepting the deflation that comes with it.

With the U.S. and other major economies turning to industrial policy to capture a greater share of overall global manufacturing capacity, something will have to give.

The result is an escalation in global economic and geopolitical tensions.

This almost certainly means that the U.S., the EU and the other major economies will place barriers to entry to their domestic markets, using national security and the protection of infant industries as the reasons for doing so.

That’s where EVs come in, as the United States considers limiting the entry of cheap Chinese EVs into the North American market, whether they are made in China or assembled in Mexico.

If that were to happen, one would strongly expect the EU, the UK and the other major industrial powers to follow suit.

The U.S. electric vehicle market

The U.S. automotive sector currently sells an average of 15 million to 16 million new vehicles a year, with battery EVs making up about 8% of total sales.  

According to BloombergNEF data, the number of battery and plug-in hybrid EVs on the road in the U.S. neared 5 million last year—less than 2% of the total fleet. But that is expected to grow to close to 17% by 2030 and 40% by 2035.  

Battery and plug-in hybrid EV sales, which reached 1.4 million last year, are projected to climb to 8 million by 2030, constituting over 50% of total vehicle sales.

Even though the projected pace of EV sales growth may be debatable, it is undeniable that the U.S. EV market, the second-largest after China, has substantial growth opportunities and is highly attractive to global automakers. 

EV transition is not easy, for EV startups seeking investments for technology development and scaling production, and for established automakers striving to balance investments in EV production at the right pace while maintaining profitable internal combustion engine (ICE) models.

A recent slowdown in EV sales growth, driven by rising interest rates and vehicle prices making consumers more cost-conscious, highlights the uncertainty for EV demand. Even with the $7,500 EV tax credit, the upfront cost of EVs remains higher than that of their ICE cousins. 

New restrictions on sourcing battery components and critical minerals from foreign entities reduced the number of qualifying models to just 13 at the start of the year. The slowing pace of EV sales growth has already prompted several original equipment manufacturers to reduce prices and scale back on production and supply chain commitments.

In addition to demand uncertainties, the sector faces higher costs of production. Labor costs, for instance, are rising across the board, not just for the Detroit Three but also for the entire industry, as automakers and suppliers adjust to higher unionized wage standards established by recent contract renegotiations.

Transition requires significant investments in EV technology development and the retooling and launching of EV assembly lines. And it takes time to build out supply chains tailored to EV technology.

The Inflation Reduction Act prompted a surge in investments in EV manufacturing facilities and battery production. This investment growth will eventually increase production capacity and localize critical EV technology components. Until these investments become operational, however, the industry will depend on sourcing certain battery technologies and materials from China.

Competition and economic conflict of the type that may be about to begin will almost certainly result in the U.S. having to look elsewhere for such technologies.

Chinese market dynamics and U.S. tariffs

Chinese automakers embarked on developing their EV sector more than a decade ago and now have a significant lead across the value chain, from pioneering battery technology to securing reliable sources of materials.

This advantage stems from many factors: lower production costs, well-developed electronics research and development, a robust manufacturing ecosystem, access to domestically mined and processed critical minerals, a large domestic market, and, most important, hefty government subsidies.

According to Bloomberg, this governmental support has catalyzed the launch of more than 500 EV companies, enabling Chinese automakers to dominate their home market. Now, waning domestic growth and the slowdown of the Chinese economy are forcing companies to look for global expansion. Notably, in the fourth quarter of 2023, China’s BYD automotive brand surpassed Tesla in EV sales, and China eclipsed Japan as the world's leading car exporter, with 5 million exported units. Most of the sales went into Europe, causing the EU to launch an anti-subsidies probe into the Chinese-produced EVs.

In the U.S., heavy 27.5% tariffs on Chinese car imports have kept Chinese automakers out, but this barrier may not last much longer.

An increasing number of Chinese automakers and suppliers are setting up production facilities in Mexico. These factories could soon enable Chinese vehicles manufactured in Mexico to enter the U.S. market. Whether these vehicles will meet USMCA trade requirements or face new import restrictions remains to be seen.

Problems with protectionism

This is not the first time that U.S. trading partners have held a comparative advantage. In the 1960s and 1970s, more fuel-efficient foreign cars captured significant market share when the oil embargoes caught the West off guard, sending economies in the West into a series of deep economic crises.

It was not until the 1980s that Detroit could even think of competing with foreign automakers.

The decline of the once-complacent U.S. auto industry suggests that free trade is beneficial in terms of maintaining competitiveness, expanding the market for other U.S. products and maintaining the worldwide demand for the dollar.   

Deviation from that condition should be done with the utmost care.

Two centuries of economic and empirical evidence show the significant problems with protectionism. Economists have found that the U.S. retreat from international trade in recent decades has in fact hurt the middle class—the very people such barriers were supposed to protect.

Contrary to conventional wisdom that trade caused the displacement of manufacturing employment, it was rapid change in technology as well as changes in preference and taste that caused job losses in some areas of the economy. Still, free trade continues to be a scapegoat for technological and cultural change, which could lead to inefficient, suboptimal, politically driven economic outcomes.

Which again leads us back to the Chinese EVs. The question of blocking the import of cheaply made cars made in China into North America and Europe remains fraught with the ramifications of potential retaliation.

The advanced economies of Europe and North America specialize in high-value-added sectors, where wages and technological requirements are high and foreign competition should not pose a threat. In fact, competition is a source of innovation, and it led American automakers to regain their edge.

The return of that edge is evident in the superior technology currently integrated into American autos versus the vehicles of foreign competitors.  

If the use of national security concerns and the nurturing of infant industries result in an era of economic and industrial complacency, then industrial policy will fail.

While the administration understandably intends to follow through on addressing China’s mercantilist challenge, effective policy design and implementation involves nuance, requires great care, and should be subject to strenuous oversight and review.

The takeaway

Structural economic problems inside China and its ineffective and misguided policy response will result in greater economic and security tensions.  

Attempts to export its burden of adjustment to the U.S., EU, India and other major trading partners will be correctly interpreted as a “beggar-thy-neighbor” trade policy and fought vigorously.

That approach might have worked 30 years ago, at the outset of the era of hyperglobalization. But in this era of industrial policy, it will only stoke an increase in trade, investment and geopolitical tensions.

In the near term, the United States and its major trading partners will likely move to limit entry of Chinese EVs into their wealthy consumer markets.

The rationale and policy actions will almost certainly be replicated in other value-added areas of the economy in general and in artificial intelligence and quantum computing in particular.

For better or worse, the advent of industrial policy in the West and the end of the Chinese economic model are going to result in an increase in tensions in the near term.

The logic of industrial policy, however well-intentioned, will likely result in further demands for protection. Such protection can lead to complacency and a lack of innovation by firms.

There is no substitute for productivity-enhancing capital expenditures and an understanding that the only constant in modern commerce is change. Innovation is not an option—rather, it is a fundamental requirement to compete in the modern economy.