Is Europe facing Thucydides’ Trap?

Key points in this equity note

• The EU is engaging in a “war” against Chinese electric vehicles on the ground of heavy Chinese subsidies extending the geopolitical fragmentation game from semiconductors to electric vehicles.
  
  
• If electric vehicles develop into a trade war then it will be even more difficult to predict which carmakers will win the future of electric vehicles. As a result we suggest that investors go look for opportunities in the growing ecosystem around electric vehicles.

The fragmentation games evolves from semiconductors to the green transformation

The Commission president Ursula von der Leyen announced yesterday in her annual address to EU lawmakers that the EU would launch an investigation into Chinese subsidies of electric vehicles production, which have flooded the market with cheap Chinese EVs. In the past, Chinese cars were no threat to Europe’s carmakers because of poor build quality, but the Chinese carmakers have climbed the learning curve, and the transition to EVs from ICEs have undoubtedly flatten and shorten the learning curve creating an opening for Chinese carmakers.

Chinese carmakers are already facing 27.5% tariffs on their EVs exported to the US market, so it would be reasonably to assume that Europe could contemplate a similar tariff rate. The initial reaction was negative for Chinese EV-makers and positive for European carmakers, but the price action did not extend today suggesting the market is in a wait-and-see mode. Today China responded saying the EU’s action is a “naked protectionist act” and could negative impact the trading relationship between the EU and China. No thing that is blatantly indicating that China is heavily subsidizing its car industry is the car factory utilization rate which according to China Passenger Car Association (CPCA) is only 54.5% down from 66.6% in 2017. This is a sign of overinvestment and potentially gross malinvestment in non-productive assets.

Just like the US is facing the Thucydides Trap with China in semiconductors so is Europe now in the green transformation spanning production of solar panels, wind turbines, batteries, and electric vehicles. Europe’s “war” against China was inevitable because Europe has a much more open economy (see chart) and thus stands to lose the most from state subsidies in foreign countries but also the fragmentation game, which is a geopolitical dynamic in which the US, Europe, and China are all reshoring key technologies to reduce strategic fragilities.