Explaining overcapacity in China's EV sector
How China's decentralized state structure enables involution-style competition.
In the West, China’s EV sector is often portrayed as an unstoppable force, poised to dominate global electric vehicle exports over the next decade. Chinese auto exports have indeed surged, driven almost exclusively by EVs—shipping over 5 million units in 2024, up from just a few hundred thousand in the early 2020s. Meanwhile, Chinese EV makers have also dominated their domestic market, which has for decades been firmly controlled by foreign brands.
However, this narrative of China's unchallenged ascent obscures the fierce and destabilizing price war gripping China's EV sector. In 2022, China's top EV maker, BYD, only had an average net profit per car of $1,550. Xpeng and Nio, two other top EV makers in China, had negative net profits per car of $11,735 and $19,141.1 By contrast, Tesla reported a net profit of $9,574 per car.
Yet as domestic competition in China has intensified over the past two years, even Tesla has been forced to slash prices to compete with Chinese auto markets, offering five-year zero-interest financing, free charging, and substantial insurance subsidies to attract buyers. Competition has intensified to such a degree that even the industry’s leading firms have all slashed prices and offered unprecedented discounts to maintain market share. Today, Chinese EV makers have fallen into a vicious cycle of price-cutting in a zero-sum battle for limited market share.
According to the China Association of Automobile Manufacturers (中国汽车工业协会), the average profit margin across the auto industry fell to just 6.5% in 2023, down 0.8 percentage points from the previous year. Profit margins continued to drop in 2024 to just over 4% marking a historic low for the sector (for comparison, profit margins in the auto sector are over double that in North America). And despite a 4% increase in revenues in 2024, profits fell 8% year-over-year.
Taken together, these figures reveal a sector deep in crisis. As margins collapse and competition grows ever more cutthroat, Chinese automakers are increasingly turning to foreign markets not merely for growth, but as a necessary outlet to absorb their mounting overcapacity.
EV price wars
The rise of China’s EV sector is frequently attributed to state-led industrial policy—and rightly so. Government subsidies and loans have played a pivotal role in scaling up the industry. And as early as 2009, policies have been put in place to bolster EV manufacturers and help them leapfrog over incumbent automakers. However, this state intervention is also at the root of many of the sector’s current challenges.
Western narratives often portray the Chinese state as deliberately subsidizing firms to flood global markets, undercut competitors, and achieve export dominance. But the reality is far more complex. While state support has undeniably been critical, the intense, cutthroat competition among domestic firms—marked by the aggressive price war and the erosion of profit margins—is not Beijing's desired outcome but something that they are actively trying to curb. At the July 2024 Politburo meeting, Chinese leaders even called for greater industry self-discipline to curb unproductive competition.
So how did we get here? To explain why Chinese EV makers are trapped in a price war, we must first understand China's political structure and how industrial policy is carried out across it.
In China, the central government sets the overarching developmental agenda—in our case, it is to promote EVs as a strategic technology. Once a signal from Beijing indicates that they are prioritizing a particular technology, local officials race to back firms doing activities related to said technology in their jurisdictions, hoping to claim credit for building a future industrial pillar.
Here, its worth highlighting that local and central governments aren't aligned on their incentives. Beijing’s goal is to cultivate a small number of globally competitive and financially sustainable national champions. This requires local governments to exercise discipline when allocating support and, crucially, to allow underperforming firms to exit the market. In practice, however, local governments find themselves locked in intense competition with one another, each vying for a stake in the country’s industrial future. And as a result, they frequently throw support behind trending technologies without sufficient scrutiny—backing under-qualified firms and allowing poor performers to linger.
From the firm’s perspective, there is little incentive to pursue commercial viability when local governments are willing to absorb losses and provide bailouts. Instead, firms focus on expanding market share, often by aggressively cutting prices—made possible by government-backed loans that effectively subsidize customers. In this context, scale becomes a form of insurance: by increasing their economic footprint and the potential social fallout of failure, they become too big to fail. Fearing the political and social consequences of mass layoffs, local governments will prevent ineffective firms from exit since they are also assessed on their ability to drive regional economic growth, create jobs, and preserve social stability within their jurisdiction.
This misalignment between central and local government creates highly problematic exit conditions for firms. Normally, unprofitable firms are forced to exit, allowing markets to consolidate. This was also a feature of earlier developmental states like South Korea and Japan, where state support was conditional on firm performance (what economist Alice Amsden called "discipline"2). Firms that failed to meet clearly established benchmarks were cut off from subsidies, making continued operations unsustainable thus leading to exit.
In contrast, China’s EV sector operates under a far softer set of budget constraints. Local governments, locked in political competition with other municipalities, are unwilling to allow high-profile firms in their jurisdictions to fail—especially major employers. A telling example is NIO’s near-bankruptcy in 2020, which was averted through a major bailout by the Anhui provincial government. In cases like this, firms remain afloat not because they are commercially viable or globally competitive, but because local officials continue subsidizing operational inefficiencies—unwilling to face the political fallout and economic disruption that would accompany failure. And as a result, actually efficient firms (BYD, for instance) pay the price of having to participate in the price war.
The politics of discipline
So why can't the Chinese state enact the kind of discipline needed to avoid unproductive competition?
Sociologist Peter Evans famously argued that effective industrial policy requires embedded autonomy.3 To discipline firms and steer industrial development, state agencies must be deeply embedded within the business community—capable of monitoring firm behavior and negotiating production targets. This embeddedness ensures that the state also remains attuned to industry dynamics and can detect when firms are exploiting policy support. However, this close relationship with the private sector also carries the risk of capture, in which state actors become beholden to firms and lose the willingness—or capacity—to enforce discipline. To mitigate this, Evans argues, the state must also maintain autonomy.
This is where China's political structure is a problem. The extent to which the Chinese state is embedded and autonomous is complicated by the loose coupling between central and local governments.
On the one hand, the central government has a high degree of autonomy allowing it to set the national priorities without the influence of private interests. However, it lacks direct engagement with firms and the local proximity to force poor performers to exit. On the other hand, local governments are highly embedded, maintaining close and frequent interactions with local businesses. Yet their autonomy—and thus their capacity to enforce discipline—is constrained by political competition across municipalities often leading them to shield underperforming firms from market exit. Combined, I call this China’s dis-embedded autonomy problem.
In this decentralized structure, local governments end up indiscriminately supplying their regional firms with policy favors to outcompete other municipalities. And so, firm longevity arises not from developing efficient and sustainable production capacities but from the generosity of a local government's policy favors. As a result, regional governments rich in policy resources can outlast those with genuinely competitive firms, so the apparent winners may not end up being the most economically competitive firms.
Concluding thoughts
The dynamics unfolding in China’s EV sector are not unique. Similar patterns of overcapacity, misaligned incentives, and unsustainable competition can be observed across other strategic industries, from solar PV manufacturing to batteries to semiconductors. (I've written about a similar dynamic in the solar pv sector here.)
This pattern of industrial policy has produced remarkable scale and production capacity, but also serious distortions. Scandals like the collapse of Hongxin Semiconductor—a firm that secured billions in investment from the Wuhan government with promises of cutting-edge chipmaking, only to be exposed as a fraudulent venture—underscore how local governments can be blinded by their industrial ambition.
Yet, it would be a mistake to conclude that China should cease doing industrial policy. Despite being in the troughs of a price war, China has, in just over a decade, built a world-class EV manufacturing ecosystem with global reach—and in doing so has pushed the world one step closer to a green transition. These newly developed productive capabilities have also generated important complementarities, reinforcing China’s strengths in other industrial and high-tech sectors—a dynamic highlighted by Kyle Chan.
Looking ahead, the question then is how to foster healthier forms of competition within China’s decentralized political structure. The key will be making sure that local governments allow underperforming firms to exit. This requires new forms of inter-regional coordination—such as setting price floors as well as industry-wide standards that ensure quality and value-added features like intelligence and safety enhancements over pure cost-cutting. The goal is to shift the basis of competition from price to quality/innovation.
See: https://www.reuters.com/business/autos-transportation/tesla-uses-its-profits-weapon-an-ev-price-war-2023-01-19/
See: Amsden, Alice H. 1992. Asia’s next Giant: South Korea and Late Industrialization. Paperback ed. New York: Oxford Univ. Pr.
Evans, Peter B. 1995. Embedded Autonomy: States and Industrial Transformation. Princeton, N.J: Princeton University Press.
My experience in China indicates that ferocious price wars are common. Years back a guest piece in HBR explained price wars as a strategy and used the example of the microwave oven appliance industry. State directed capital has proven to be directionally effective, but the allocation of capital, as you clearly explain, is not efficient. There is no incentive for local governments to constrain their support for a local business that has a multiplier effect for the local economy. Perhaps this is where private investors, risking their own funds, could provide market discipline that the local government cannot. Private, market focused, VC-PE-Angel investors, would stop funding the weaker competitors earlier than a local government.
Interesting—two observations:
1. The idea of setting price floors was already tested by the China Association of Automobile Manufacturers, in the now-famous joint letter “汽车行业维护公平竞争市场秩序承诺书” co-signed by all major players.
Notably, the clause related to pricing floors was later removed—under pressure. But where did that pressure come from? My take: either the government had its hands tied, or it made a conscious choice to stay out.
2. Local government competition isn’t unique to China. Look at the U.S. or Canada—every time a foreign investor like Northvolt shows interest, provinces or states pull out all the stops to win the deal. And they tolerate failure—often more than they should.
But this margin of tolerance doesn’t necessarily improve the odds of picking a winner.
Conclusion: The real engine behind China’s industrial transformation lies elsewhere. Keep digging.