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The Issue
Industrial transformation and competition with China in the automotive sector are key challenges for the European Union, but could also offer some opportunities. Policymakers in Brussels and European capitals will need to pursue smart policies to raise competitiveness and address growing competition with an eye to economic security. Although trade defense tools will continue to play a role in policy, the European Union is considering leveraging Chinese foreign direct investment. More active coordination will be needed at the EU level to develop local value chains and to ensure that strong electric vehicle demand rebounds, providing continued support for the growth of the industry.
It is no secret that the European Union and its member states face a critical moment in economic, security, and foreign policy. Documents and speeches by high-level European policymakers over the past few years have pointed to the mounting need for strategic reforms to support industrial transformation and technological innovation, manage dependencies on and competition with China, balance the rapidly evolving relationship with the United States, and achieve progress on climate goals. These complex and overlapping priorities are evident in the European automotive industry, once seen as an example of Europe’s dynamism and now a source of growing concern. The metaphor is not lost in Brussels, as rapid growth in automotive exports from China to Europe contrasts with the disappointing performance of European automakers in China in recent years, and the bloc’s slow progress on electric mobility and digitalization.
The debate over the automotive sector and electric vehicles (EVs) in Europe is shaped by two central issues that reflect the dual nature of the challenge: Policymakers need to increase European competitiveness, which has been declining in relative terms over the past several years, while addressing increasing competition from China. There is an open debate as to how much low production costs in China are attached to distortive subsidies and overcapacity as opposed to innovative and competitive dynamics. Exploring this distinction is still important, because manufacturing practices and innovation can be replicated, reproduced, and transferred, which means that embracing competition with China and foreign direct investment (FDI) in some areas may have potential benefits. In reality, it is difficult to distinguish where subsidies end and innovation begins, and even outside of China, the state is beginning to play a far more active role in supporting strategic industries. These dynamics complicate the use of trade measures, which for the most part under World Trade Organization (WTO) rules are meant to allow domestic players to catch up rather than to survive indefinitely in a protected market.
There is also a broader political and geopolitical dynamic at play: Governments are being forced to rethink their relationship with automotive companies that were, until recently, a source of pride, as their global value chains become potential geopolitical and economic liabilities. Part of the reason for the industry’s current woes is that many European manufacturers were slow to recognize the potential of EVs and make significant advances in digital integration in the face of increasing Chinese competition. Traditional Western automotive companies will need to catch up on digital platforms and autonomous driving capabilities as well, which tend to have strong performances on EVs.
Highly politically influential companies in the automotive industry, especially in Germany, are also heavily exposed to the Chinese market and have continued to invest in China even as they consider shrinking their European footprint, further highlighting policymakers’ dilemma. Yet slow demand for EVs in Europe, which might seem like a relief for European carmakers, could further exacerbate competition with China—especially at a time when internal combustion engine (ICE) vehicle and plug-in hybrid (PHEV) exports from China could still increase.
Totally dismissing automotive companies’ rationale for their supply chain organization would be a mistake. If policymakers want to achieve change in the supply chains, they must address the underlying incentive structure and recognize limits and trade-offs. Extensive industrial policy spending in China benefitting the automotive industry is well documented, but the industry also benefits from integrated value chains and cost advantages associated with production in China. For example, U.S.-based Tesla, the second-largest EV maker in the world, has leveraged its Shanghai factory in China to export hundreds of thousands of cars to Europe, rather than expand its U.S. or European production. Even if the Chinese industry were to consolidate and reduce manufacturing overcapacity, Europe will still have a competitiveness gap to breach in order to ensure it remains an attractive place to develop and make cars.
In this context, Chinese companies may increase investment in Europe to access the EU market—if demand for EVs holds. Much of Europe’s ability to shape standards, value chains, and company decisions on the location of production will hinge on continued and strong European demand for EVs. Increasing coordination across member states on FDI from China in the automotive sector and introducing stronger localization requirements could help develop a stronger domestic value chain—especially if other conditions are in place to ensure a certain level of diversification and long-term European innovation.
U.S.-China relations will also continue to affect global value chains. For example, if current U.S. rules on connected vehicles remain in place as expected, cars containing certain components and software made in China or by Chinese companies may no longer be sold in the United States in the coming years, posing a challenge for several European auto companies. Indeed, Europe itself will also have to contend with the security implications attached to connected vehicles, although it appears increasingly less likely that this will happen in coordination with the United States. European auto exports will also face higher tariffs to enter the U.S. market if no agreement is reached between Washington and Brussels, which would further complicate the outlook for European companies that rely on complex global value chains.
To address the challenges outlined above, this policy brief provides context for how trade with and investment from China pose challenges and potential opportunities for Europe, offers suggestions for how to best navigate the current trends and discusses implications for the United States. The brief will first address the geopolitical and changing international economic environment, including Europe’s relations with China and the United States. Second, it will analyze how the traditional automotive industry has been disrupted by the rise of EVs and Chinese manufacturing. Finally, it will address current debates over Chinese investment in Europe, offer recommendations for European policymakers, and discuss implications for the United States.
Changing Geopolitical Relationships
The industrial transformation required for the European automotive industry to regain competitiveness is complicated by the changing and increasingly adversarial global geopolitical environment. Europe’s relationship with China has shifted rapidly in recent years to an uncomfortable competition centered around economic security. As late as 2020, Beijing and Brussels were still negotiating the Comprehensive Agreement on Investment (CAI), which would have linked the two economies even more closely. The agreement was put on hold by the EU parliament in 2021 after some of its members and European scholars were sanctioned by the Chinese government for their position on Xinjiang. The rapid shift in attitudes toward the investment deal with China mirrors a broader change in the relationship, which is far more tense today than it was a decade ago.
The Russian invasion of Ukraine in 2022 played a central role in reshaping European perspectives on economic security and bringing dependencies on China under closer scrutiny. Since then, relations between the European Union and China have deteriorated, as the European Commission has taken a more defensive stance and has launched multiple investigations targeting Chinese firms through several new tools aimed at protecting Europe’s economic security, including the Foreign Subsidy Regulation. Even more explicitly, the Anti-Coercion Instrument was developed to counter economic coercion after a diplomatic dispute with Lithuania led China to carry out a series of punitive economic measures. More broadly, 44 out of the 60 ongoing EU trade defense cases target China.
The anti-subsidy investigation on EVs made in China, which led to the imposition of tariffs in late 2024, is by far the most high-profile of these investigations and central to high-level discussions between Brussels and Beijing. Europe’s export surplus with China in the automotive sector has been rapidly declining over the past five years, highlighting how quickly markets are shifting in ways that confront Brussels and other European capitals with difficult choices on trade and economic policy.
Brussels is now bracing itself for a more confrontational relationship with Washington under the Trump presidency on issues surrounding trade, defense, and the war in Ukraine. This shift comes with several challenges, including potential damages to the European economy due to tariffs, the need to reallocate more spending toward defense, and potentially more pressure to align with the United States on technology restrictions concerning China, should Washington decide to ramp up pressure on Beijing.
Despite significant wariness of increasing dependencies on China, changes in the transatlantic relationship may also entice the European Commission to strike a more conciliatory note on Chinese investment and trade to avoid fighting trade wars on two fronts at a time when the European economy is struggling to find its footing. Yet, growing exports from China will make that balance challenging, especially since they may be directly competing with European manufacturing. Despite commitments to increase domestic consumption in China in the latest government documents, the trend is unlikely to change in the short term, and if the United States continues to impose higher tariffs on goods from China, Europe may find itself having to absorb or deflect a growing number of exports.
Trade and Innovation in the Automotive Sector
It is hard to overstate the importance of the automotive sector to the European economy: 4 of the top 10 automakers globally are headquartered in Europe, and the automotive sector represents about 8 percent of manufacturing value added and over 6 percent of total employment for the European Union. The sector’s importance also varies significantly across regions (ranging from 16 percent of total manufacturing for Slovakia to less than 1 percent for Greece), complicating the political economy of the sector as some countries have much less to lose than others.
The challenges in the automotive market come at a crucial time for Europe as it seeks to revive a stagnating economy, address long-term structural challenges to its competitiveness that could undermine its single market, and will likely have to rapidly increase defense spending. Within this context, the European Commission and member states have had to confront a rapid uptick in exports of EVs from China since 2020 that help fulfill demand given still-limited production in Europe of EVs, but that could upend current and future European production (see Figure 1). EV exports from China still comprise many Tesla and Western-branded vehicles made through joint ventures with Chinese firms, although the relative share of Chinese brands has been increasing rapidly. It is worth noting that exports of EVs from China to Europe may have peaked in the fall of 2024, after tariffs were introduced, although it is likely too early to tell whether this is a long-term trend.
