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China’s Auto Export Wave Echoes Japan’s in the ’70s

Bloomberg Screengrab
Thought Leader: Niall Ferguson
June 4, 2023
Source: Bloomberg
Written by: Niall Ferguson

Revolutions in transportation are rare and can define epochs. This has been true since men figured out how to ride horses (6,000 years ago) and to construct vehicles with wheels (just over 5,000 years ago).

How did the steam engine change the world? A lot. How did the internal combustion engine change the world? A lot. So how will battery-powered electric vehicles change the world? Probably a lot — but, if history is our guide, not necessarily in the ways we now anticipate.

Take the Steam Century. Coal-burning steam engines were a huge improvement on horses, carts and sails. After steam engines and steamships were developed in Britain and exported in the 19th century, they swiftly transformed the world economy. Both humans and goods got to travel a lot further, a lot faster and a lot cheaper. The gains were significant just about everywhere, but especially in North America, where railroads knit together a continental economy, while transatlantic ships full of migrants supplied the labor.

The social consequences of the Steam Century were to create a mass society but also a class society. Everyone traveled en masse together to a finite number of destinations on a finite number of routes. On the other hand, there were generally three classes of passenger. Watch the movie Titanic to see approximately how that worked.

Trains and steamships were the transport infrastructure of the great Marxist historian Eric Hobsbawm’s “Age of Industry” and “Age of Empire.” Of course, the British Empire predated the Steam Century. But it was no mere coincidence that the Empire reached its apogee when the rail and steamer networks also reached their maximum extent.

Coal was very conveniently located in the heartlands of Western civilization: central Scotland, northern England, south Wales, Belgium, the Ruhr and Pennsylvania. There is a good argument that the Industrial Revolution itself happened in such places precisely because coal was abundant and therefore cheap, while labor was by global standards rather expensive.

The geopolitical problem arose when the steam empires went to war. War by timetable and war by blockade: That was 1914-1918, the great industrial-imperial war. Without the mighty engines that transported the men, the guns and the munitions to the killing fields, that war would surely have run out of steam by 1916.

The infrastructure of the Steam Century was highly centralized around a few hubs. You need only look at maps of rail networks to see that. That centralization had important implications. Not only did it enable small numbers of Europeans to govern enormous empires — think of the British ruling India. It also, paradoxically, made it relatively easy for revolutionaries to gain control of an empire — as the Russian Bolsheviks seized control of the vast tsarist realm.

The major negative externality of the Steam Century was of course filthy air quality and chronic lung disease, not helped by the widespread compulsion to add tobacco smoke to the coal dust in the air, and therefore in the chest.

What about my second case, the age of the Internal Combustion Engine — ICE Age for short?

The economic consequences of the ICE Age were immense because of all the forward and backward linkages of automobile production. Beyond the Ford factories themselves arose a host of ancillary industries and occupations. Mass-producing cars was a fast track to economic development for many countries, as post-1914 Western Europe proved. The advent of a global market created opportunities for the most efficient producers (e.g., Germany and later Japan). In many ways, China today is merely following the Japanese playbook.

The social consequences of ICE vehicles were to create a new suburban lifestyle, pioneered in the US, partly imitated elsewhere. This was very democratizing. A Fiat Uno and a Rolls Royce Silver Shadow have to share the same roads.

So cars, trucks and motorbikes were the transport of the democratic, individualist age — though trains and ships still mattered when it came to fighting another world war. And the advent and spread of commercial air transport after World War II limited the democratization of travel. Not only was flying for many decades an elite activity; as it became more accessible, it retained the old class system. To this day, many airlines offer three classes of seat in their airborne Titanics.

The first obvious geopolitical downside of the ICE Age was dependence on the cheap oil produced in not-so-nice places. US imports of petroleum rose fivefold between 1960 and 1977. By 1973 this gave the Arab members of the Organization of Petroleum Exporting Countries the power to strangle the global economy in retaliation for American support for Israel. The result was stagflation, rationing, lines at gas stations — and a shift to more fuel-efficient vehicles. A less obvious consequence was to distort the political development of the oil-producing countries. Woe betide the countries that struck oil before they struck representative government. For illustrations of the “resource curse,” see Venezuela or Angola today.

The environmental consequences of the ICE Age were in a narrow sense good — gasoline-burning cars are cleaner than coal-burning trains — but in a broader sense bad, as the global economy’s total consumption of hydrocarbons only increased.

Now let’s think about the likely consequences of the Electric Vehicle Era. First, this is clearly a chance for China to leapfrog the European manufacturers who perfected the internal-combustion engine. Building ICE vehicles is quite hard, and China has not excelled at it the way the Germans do. So the European decision to prohibit the sale of ICE cars from 2035 onward creates an opportunity for China.

China leads the world in EV adoption because China also leads the world in EV battery manufacture. Six of the top 10 EV battery companies are Chinese. The top two Chinese producers, CATL (Contemporary Amperex Technology Co.) and BYD (Build Your Dreams) account for half the global market.

In recent years, Chinese consumers have been strongly incentivized to switch to EVs. It has worked. Now a quarter of Chinese passenger vehicle sales are pure EVs or plug-in hybrids.   Including the latter category, BYD now leads even Tesla in total global sales, despite Tesla’s rapid expansion in China.

Now, with the domestic market saturated and the subsidies for EVs wound up, a wave of Chinese EVs is sweeping the world. In the first quarter of this year, China exported 1.07 million vehicles, up 58% on the same period last year and overtaking Japan (950,000 units) as the world’s No. 1 car exporter.

Pedal to the Metal

True, a part of the Chinese jump is explained by Western sanctions on Russia, which boosted Chinese exports to that market, and most of those sales are ICE vehicles. But around 31% of Chinese auto exports are of EVs or hybrids. And more than a third — 35% — of all the world’s EV exports are Chinese.

Not for the first time in history, the new entrants are competing aggressively on price. Earlier this year, according to the Wall Street Journal, BYD introduced a hatchback called the Seagull with a starting price of just $11,000. That is one reason why Elon Musk is being forced to cut Tesla prices. The importance of China as both a manufacturing base and a market explains Musk’s recent visit to Beijing and Shanghai.

In a room usually used for senior government visitors and with a metaphor carefully crafted for the occasion, the Chinese Foreign Minister Qin Gang told Musk that an improvement in US-China relations required “holding on to the steering wheel,” avoiding “dangerous driving” by “stepping on the brakes” when necessary, and “putting the pedal to the metal” when appropriate to “promote mutually beneficial cooperation.” Musk responded that the US and China were “conjoined twins” — music to his host’s ears, given the Chinese campaign against Western attempts at “decoupling.”

We have seen a version of this movie before. Between 1975 and 1980s, Japanese auto exports quintupled. The Japanese share of the US car market doubled from 6% in 1972 to 12% in 1978, and to 21% in 1980. Domestic new-car sales slumped by 29% between 1978 and 1980.

An Earlier Wave From Asia

Despite the Reagan administration’s rhetorical commitment to free trade and market forces, it could not ignore the domestic political pressure for some kind of action. However, rather than go down the routes available under the General Agreement on Tariffs and Trade, the administration found it easier to let Congress threaten Japan with quotas or domestic-content rules.

This forced Japan in 1981 to agree to voluntary export restrictions (VERs) that limited car exports to the US to 1.68 million units (down from 1.91 million units in 1980), a ceiling that could subsequently be raised by no more than 16.5% of the growth experienced in US new-car sales during the previous year.

This was better politics than it was economics. According to Michael Bryan and Owen Humpage, VERs “added over $1,114 to the options-adjusted price of a new Japanese car, transferred roughly $2.0 billion from consumers of new Japanese cars to producers and dealers, and generated $166.4 million in efficiency costs,” while they “‘protected’ at most 1,500 new jobs for domestic autoworkers.”

The other way the US responded was to insist on a substantial appreciation of the Japanese currency — a move that tends to be equated with the Plaza Accord of Sept. 22, 1985, but really began with James Baker’s appointment as Treasury secretary earlier that year. The dollar exchange rate came down from ¥240 to ¥150, ushering in the “high yen” (endaka) challenge for Japanese automakers. They responded by setting up factories inside the US — Honda in Ohio, Nissan in Tennessee — while at the same time driving up productivity, with the result that they continued to increase their share of the US market.

At first, the Europeans lagged behind the Americans in responding to the Japanese challenge, but then they brought in their own “voluntary restraint agreement,” plus a patchwork of national quotas. “The Elements of Consensus” of July 1991 restricted Japanese car exports to the European Community until 1999, while at the same time creating an integrated European market — changes that were beneficial for the more competitive automakers, notably those in Germany, but did nothing to arrest the decline of British car production.

In response to the Chinese auto-export wave, we can therefore expect the US once again to rely on tariffs and other nontariff barriers to limit the threat to its own manufacturers. In an insightful analysis, Nadia Schadlow points out that “some of the federal government’s newest rules related to EVs require that batteries contain critical minerals sourced or processed in the United States or in allied countries with which we have a free trade agreement.” (Note that this requirement relates to eligibility for a specific tax credit rather than to market access.) According to the Treasury Department, 40% of a battery must already meet those criteria today. By 2027, it will be 70%.

I would expect the Europeans to be a little slower to react, as they were in the 1980s. But the process is underway. “Chinese Cars Overrun Europe” was a recent front-page headline on the website of Germany’s tabloid newspaper Bild-Zeitung. “That’s how dangerous the People’s Republic is for our industry.”

The big difference between today and the 80s and 90s is that so many Western car makers are heavily invested in China, in a way they were not invested in Japan. As my Greenmantle colleague Joseph de Weck points out, “roughly 60 percent of the Chinese EV exports to Europe are deliveries for Western brands. We have to think of Chinese EVs not primarily as BYD or Geely, but Tesla, BMW, or Renault.”

This time, in other words, the resistance to Asian imports won’t be driven by the car companies. It will have to be the workers and the voters — and the politicians who have to care what they think. Hence French President Emmanuel Macron’s announcement last month that France’s €7,000 purchase subsidy will be limited to cars with a low-carbon footprint in production — i.e., not ones made in China, which manufactures its EVs with power generated by burning coal.

Socially, the EV is not as big a game-changer as the ICE. A car is still a car, whether it’s gasoline-fueled or battery-powered. In that sense EVs are to the automobile what the triple-expansion steam turbine engine was to the steamship: an improvement more than a transformation. When EVs are finally self-driving it will make more of a difference, as then we’ll all be much easier to control. But we’re still individualists behind the wheel for now.

However, in the energy transition, there will increasingly be two classes of driver — dirty and clean — and government policy will discriminate. No prizes for guessing how this will play out in US politics. Soon I expect the internal combustion engine to join the gun and the Bible as a physical expression of American conservatism, with election-fueled outbreaks of road rage pitting Tesla drivers against the owners of big, red, gas-guzzling pick-ups.

If you don’t believe me, read Alexander Sammon’s entertaining report on the annual convention of the National Automobile Dealers Association, whose staunchly conservative members clearly fear and loathe EVs, not least because Tesla’s system of online ordering has cut them out as middlemen.

In short, the coming auto trade war won’t be like your father’s. Not only are the Western car companies conflicted by their massive investments in Chinese factories, there’s also the vexed question of the semiconductors, without which your brand-new EV won’t go. True, the US has been ingeniously limiting China’s access to the most sophisticated microchips and the tools needed to manufacture them. But the average EV contains about 5,000 chips, of which maybe five are of the highly sophisticated type, not forgetting the silicon carbide ones that regulate the power management system. All the rest are the sort overwhelmingly made in China.

There is another big difference if you follow the EV supply chain upstream. ICEs run on petroleum, and the swing producers with the power to set the oil price still reside in the Persian Gulf region. EV batteries, by contrast, require a combination of critical minerals, particularly lithium, nickel, cobalt and graphite. China accounts for more than half the global processing capacity for three of those. (In the case of nickel, it is only around a third.) Moreover, China is scrambling to increase its control of lithium, nickel, and cobalt mining. (It already dominates graphite mining.)

In the past two years, according to the Wall Street Journal, Chinese companies have spent $4.5 billion acquiring stakes in nearly 20 lithium mines, most of them in Latin America (for example, Bolivia) or Africa (Zimbabwe). If the International Energy Agency is right that global lithium demand will grow by 13% per year from 2020 to 2030 and 8% per year from 2030 to 2040, we are going to be reading a lot more about the “Lithium Triangle” — the arid, high-altitude patch of land that connects Argentina, Bolivia and Chile — which holds more than 60% of the world’s lithium.

If lithium is the new oil, in other words, there will be a familiar struggle between the governments that have ultimate control of the mineral rights and the companies that want to exploit them. Indeed, that struggle has already begun.

A similar scramble is unfolding for nickel, of which Indonesia has abundant reserves, and cobalt (bad news: there’s a lot in the war-torn Democratic Republic of Congo). In each of these markets, there seems little doubt that Chinese companies are ahead of the competition. If the West intends to challenge China’s dominance of the EV battery market, it apparently aspires to be the tortoise to China’s hare.

Will the transition to EVs solve the problems we lump together as “climate change”? According to Gregor Macdonald, a US journalist who has built up a real expertise in the field, “Electrifying the country’s vehicle fleet would … roughly … represent a halving of [energy] demand. Based on an average oil price of $75/barrel that would sum to about $1.5 billion a day in savings or nearly $550 billion a year.”

That kind of increase in efficiency will suffice to encourage EV adoption. But there will only be a major impact on the global climate if there is simultaneously a sustained shift away from burning hydrocarbons for electricity generation. That may be happening in some parts of the world — Texas, for example — where wind and solar are clearly displacing coal. But Asia remains hooked on coal, and it is far from clear how quickly many industrial processes — such as making steel and concrete — can swap metallurgical coal for hydrogen.

The law of unintended consequences is the only real law of history. I expect it to operate during this energy transition as in past ones. Motivated by a desire to save the planet, we are ending the ICE Age and embarking on the EV Era. By itself, I doubt this new transportation revolution will much affect the Earth’s climate. But it will certainly unleash new and surprising trade conflicts, unexpected social and political changes and novel geopolitical shifts.

Buckle up.

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