“Vorsprung durch Technik”, or to gain an edge through advanced technology, has been the motto of the German car industry for decades. Europe as a whole could be proud that, although it was far behind the United States in military and digital technologies, and much of its industrial capacity had moved to Asia, at least it still had a globally dominant European car industry. Despite the constant warnings and ominous omens, it was only this year that the wall of forced optimism was breached and panic set in: the European car industry is in big trouble. European cars are being squeezed out of their most important market, China, at a rapid pace. Car sales in Europe are also falling and the electric car transition is stalled. Companies’ profitability has fallen to a fraction of what it was; factory closures and a wave of supplier bankruptcies are imminent. What is really happening in the car industry, and where is the European car industry heading?
The stakes are high. Europe’s high value-added automotive ecosystem, with 13 million employees, accounts for around 10% of industrial jobs and 7% of the EU’s total economic output. The sector generates €400 billion a year in tax revenue for governments already facing severe budgetary difficulties. And the €100 billion pre-war surplus in automotive exports is one of the pillars of Europe’s social safety net that is the envy of the world.
Perhaps the strangest thing about the European automotive crisis is that it was foreseeable in every respect, and we are not talking about the fact that many analysts had warned of the danger. Robert Habeck himself, the economics minister and iconic politician of the radical German green shift, said in 2019 that German car manufacturers would “fail” if they could not “switch to offering electric cars under €20,000”. Carlos Tavares, the recently sacked head of Stellantis and a leading figure in the European car industry, warned in 2022 that China had a 10-year head start in developing electric cars, its production costs were much lower and that the “naive and dogmatic” European green transition regulation therefore put the future of car production in China’s hands. Tavares was thus already then proposing protective tariffs to protect the European automotive transition (although he later opposed them). It was also a warning sign that China had become so confident by 2022 that it lifted ownership share restrictions on Western-Chinese automotive joint ventures, and the US started to attract global automotive investment with tax breaks and generous investment subsidies under the IRA (Inflation Reduction Act). Finally, it should have had a sobering effect that even in the countries that have been converting to green cars the most dynamically in Europe, such as Norway, non-European brands like Tesla and Toyota are leading by far.
The chart can be referenced here: https://public.flourish.studio/visualisation/21249259/
So the writing was on the wall, but the EU’s economic policy had entered a kind of schizophrenic state. The EU was both aware of the unprecedented economic consequences of the Russia-Ukraine war and the energy crisis, and was stubbornly reluctant to make the green transition programme, which resembles planned economies and is marked by top-down control with ever tighter regulation, more flexible. This schizophrenic, out-of-touch state of mind has been exacerbated by the politicisation of electric cars. Unproductive debates – for example between conventional and electric car advocates – have distracted attention from the actually dangerous problems.
These problems include:
European car manufacturers will lose €15 billion as a result of the EU’s carbon emission penalties, which apply from 2025, according to estimates by ACEA, the European Automobile Manufacturers’ Association. This comes at a time when collapsing sales in China and sinking sales in Europe have already seen German carmakers’ profits plummet by 60-90 per cent in the third quarter, and profitability at other European carmakers is also falling fast. It is worth noting that the new US administration is preparing to introduce protective tariffs against Europe and to dismantle domestic environmental regulations. Apart from anything else, this in itself makes the imposition of penalties irrational.
The EU’s carbon emissions rules for car manufacturers have been deliberately designed to prevent conventional internal combustion cars from meeting them, gradually phasing ‘polluting’ cars out of the road. Beyond the fact that both consumers’ choices and manufacturers’ management decisions have been completely removed from this mechanism – which has by now, of course, backfired –, it is unclear whether conventional cars will actually be banned from 2035. This unknown, critical factor is in itself extremely damaging, creating uncertainty for car manufacturers, who now have to make development and capacity decisions that will affect them for decades in an inherently weak economic and financial situation.
In addition, methodical compliance with emissions regulations and the poor profitability of electric cars produced in Europe have forced European car manufacturers to move towards large, premium electric models. But this is not exactly the segment in which the European middle class will buy cars en masse after the inflation shock and amid weak growth. It is no coincidence that as soon as a country stops subsidising the purchase of electric cars with taxpayers’ money, sales immediately collapse. This is misleadingly characterised by many as a ‘lack of demand in Europe’, or perhaps explained by the lack of value of electric cars, when it is neither: sales of all new cars in the EU are falling, with electric cars only more spectacularly so because of the removal of subsidies. The average life of used cars has already risen to over 12 years in the EU, from 8 years a decade and a half ago. This in itself says a lot about the evolution of purchasing power in Europe and the pointlessness of regulations that are expanding like a black hole.
The chart can be referenced here: https://public.flourish.studio/visualisation/21249319/
This brings us to the problem of the cost of car production. The cost explosion in Europe – be it energy, raw materials, wages, regulatory compliance, not to mention the extraordinary cost of introducing electric car production – has of course been passed on by car manufacturers to their customers, across the entire vertical. This is why even conventional cars are much more expensive in Europe (in many cases twice as expensive) than they were before 2022. This expensive supply is now meeting a weakened European consumer. As Opel’s CEO put it, “we simply cannot produce a car for less than €25-30,000 in Germany”. Moreover, the car industry has been hit by ‘shrinkflation’, just like other product manufacturers: quality and reliability are also on the decline. Think of the exponential increase in the cost of servicing and spare parts for car owners.
This is in contrast to the fully integrated Chinese manufacturing process, from mining to battery production to assembly, helped by the low cost of Chinese labour, cheap fossil energy and, of course, numerous direct and indirect state subsidies. (A good example in the latter case is that while the euro has weakened a lot since 2022, the Chinese yuan has still depreciated by 6 per cent against it. This is, of course, no coincidence.) So it is not surprising that the Draghi report says that it is 30 per cent more expensive to produce an electric car in Europe than in China, but the Rhodium Group estimates that the difference is actually twice as much for BYD! Obviously, this difference cannot be offset by tariffs of 30-40 per cent. It is about a meeting of two economic systems: one focused on environmental protection and the mandatory inclusion of safety features that are not of great value to consumers; the other on maximally competitive production with maximum economies of scale. The bankruptcy this year of Northvolt, touted as the European battery manufacturing champion, is also telling. Northvolt really received all the support that a European company could receive (cheap financing, generous capital investors, direct state subsidies, cheap Swedish energy), and yet it could not compete with its Chinese rivals.
The chart can be referenced here: https://public.flourish.studio/visualisation/21249372/
Another typical symptom of this failed economic policy is the way in which artificial, top-down pressures are also eroding traditional car and engine manufacturing capacity (based on internal combustion engines) in Europe, and the supply chains that serve it are withering away. (And Chinese companies are attracting the best European engineers.) This will mean that if demand for conventional cars increases anywhere in the world, Europe will not benefit. After all, rebuilding production capacity is not a matter of months or even a year or two, as every car buyer has learned since Covid. The lack of replacement and the lure of specialists will also mean a lack of the engineering brainpower needed to build competitive diesel cars.
But the most fundamental problems are in the capacity to innovate. Indeed, modern cars, and electric cars in particular, are not really vehicles but platforms for digital services, from Tesla’s self-driving function to BYD’s car carrying a drone. But the EU is lagging badly behind in digital innovation, and the proposed distribution of tens of billions of euros between dozens of companies will not help. After all, the Brussels regulatory factory is shifting the focus of automotive development to compliance and driving innovative tech firms away. It’s an acute and tangible gap in approach: much of the engineering energy of European companies is tied up in compliance. In the case of car manufacturers, for example, the need to ensure that engines have the right emissions profile at start-up and the installation of mandatory driver assistance systems, which proliferate year after year, while their US and Chinese competitors focus on the customer experience. Another consequence of the digital platform era is the dramatic increase in capital requirements. Think of the capital investment required to develop artificial intelligence; the €5-10 billion development budgets of European car manufacturers do not even come close. It is therefore particularly painful that the EU, unlike its competitors, does not have its own digital ecosystem and tech companies.
It’s also worth briefly touching on cultural trends: a whole generation of Europeans has been brought up with the idea that car ownership is selfish and impractical. On the other hand, the use of public transport and cycling are virtuous. A good example of this is France, where car advertisements must include “smoking is bad for your health” style warnings. When it comes to cars, European economists think of and deal with negative externalities, from noise and air pollution to accidents. This is how policy has been shaping transport infrastructure in the EU for decades: think of car-free zones, for example, or parking charges rising faster than inflation. This, of course, also goes against the growth of the car market, as does a shrinking young middle class (the ageing of Europe). In China, on the other hand, it is fashionable and patriotic to buy a Chinese electric car, and the infrastructure is being developed accordingly.
In the light of all this, while the public is preoccupied with the dilemmas of electric cars, the real risk is that the European car industry will be unable to make products that are attractive to the average person and are affordable compared to external competitors. Either because it cannot do so on the cost side, or because it cannot keep up with the pace of innovation, or, equally importantly, because it will have lost the capital strength to compete and become a ‘zombie’ company.
The chart can be referenced here: https://public.flourish.studio/visualisation/21249443/
Considering the above, it is clear that there are no “convenient” solutions to the crisis in the European automotive industry. Imposing high protective tariffs may slow down the advance of Chinese competitors in the EU, but export markets from South America to East Asia will still be lost. European politics may try – as it is doing now, for example in Germany – to force car manufacturers to cut costs, but that in itself is a hopeless struggle, a rearguard action against Chinese and US companies with much cheaper resources and less regulatory burden. Supplementing investment in the car industry with large-scale state and EU subsidies sounds good, but it does nothing to change the above. At best, it buys time, as does pushing back the green transition deadlines. In any case, the EU is not in a financial position at the moment to invest in the automotive industry on a truly large scale, given the extraordinary and barely bearable costs of re-armament and green transition.
In the interest of the future of the European car industry – and the industry in general –, we should get to the root of the problems instead of politically easy symptomatic treatments and hope:
- Restoring market mechanisms. All automotive industry-related deadlines, quotas and restrictions should be abolished, including the 2035 deadline. Reduce automotive industry regulations to a fraction – at least to the average level of Western competitors – so that automotive players can focus on competitiveness in predictable and stable conditions.
- Declare technological neutrality, regardless of the origin and type of technology and the energy source used, and guide this pragmatically through the jungle of EU regulations. Of course, this also implies the withdrawal of bureaucratic ESG obligations, the carbon certificate scheme and carbon tariffs, not forgetting the barriers to digital development.
- Redirect public and EU subsidies away from market distortions and towards building infrastructure and cheap financing, be it charging points or the large-scale construction of nuclear power plants essential for sustainable electrification.
- Overall, therefore, green transition should be based on competitiveness, low costs and attractive infrastructure for consumers, rather than on a system of planning-prescribing-punishing. All these steps could unleash a surprising amount of currently dormant growth potential in European economies.
Of course, the above programme now seems practically unfeasible: after the EU has invested most of its political capital in the top-down green transition over the last decade, it is very difficult to change direction. But there is little choice: hope will not be a successful strategy.
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