Driving Diplomacy

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.

▲ Figure 1: Volume and Value of Chinese Passenger EV Exports to the European Union. Source: China General Administration of Customs.

Tariffs can have unexpected undesirable effects: For example, some Chinese manufacturers have indicated that they may pivot to exporting more plug-in hybrids (PHEVs) from China to Europe, since they are not subject to tariffs. PHEVs would still present a competitive challenge for European manufacturers, but their contribution to emission reduction is far less significant than that of battery electric vehicles, which are currently subject to tariffs.

Although less significant in terms of value and volume, a significant uptick in exports of ICE vehicles from China to Europe, which are not subject to the additional tariffs levied on EVs since 2024, is now an established trend (see Figure 2). Although Europe still exports more ICE vehicles to China than it imports, the growth over the past two years merits attention, especially given how quickly the market has changed.

▲ Figure 2: Volume and Value of Chinese Passenger ICE Vehicle Exports to the European Union. Source: China General Administration of Customs.

Global ICE automotive exports from China have surged over the past few years, outpacing EVs (see Figure 3). Unlike in the case of EVs, the main destination for these exports has not been Europe, but rather Russia and emerging markets including Mexico. However, this may change as the quality of Chinese-branded ICE vehicles increases and more western brands are exported from China.

▲ Figure 3: China Passenger Vehicle Exports by Type. Source: China General Administration of Customs.

As Chinese consumers shift towards EVs, which including PHEVs accounted for almost half of new vehicle sales in China in the second half of 2024 (see Figure 4), growing overcapacity in ICE vehicle production is incentivizing producers to export more. Although some ICE vehicle factories in China are being repurposed or shut down, the shift in consumer preference has been so rapid that it may take years for production capacity to follow suit—especially if foreign markets remain available and companies producing domestically continue to receive some level of institutional support in the form of industrial policy.

▲ Figure 4: EV Share of Total Passenger Vehicle Sales in China. Source: China Passenger Car Association.

Here too, in some cases, Western automakers may be tempted to use their Chinese joint ventures to export to Europe or elsewhere rather than close them as demand for ICE vehicles declines in China. Regardless, the trend could have disastrous implications for emissions globally by increasing the global supply of ICE vehicles at a time when some markets could be accelerating their transition to low-carbon transport. It also highlights how European manufacturing faces increased competition with China on all technologies domestically and in third markets. Focusing solely on competition in the EV sector or solely on Chinese brands would risk losing sight of the bigger picture.

The challenges of competing in electric mobility have led some to believe that by slowing down the deployment of EVs, traditional ICE vehicle manufacturers can improve their competitiveness. The argument in Europe is presented as a plea for either technological neutrality or for loosening requirements on car manufacturers. Few would buy the argument for delaying or avoiding technological evolution in other sectors. For example, hardly anyone would argue that to win the AI race, a country should slow down its digitalization and AI usage relative to that of a rival country. Ultimately, growing exports of ICE vehicles from China prove that hitting pause on the energy transition will not spare Europe the challenges of dealing with increasing competition with China. In fact, the European Commission may also want to consider how increasing imports of ICE and PHEV vehicles from China will affect its competitiveness strategy in the automotive sector and its decarbonization plans. Battery electric vehicles may have been the canary in the coal mine, but they are not the only or even the main challenge facing Europe when it comes to global trade imbalances or competitiveness.

Open to Investment?

In Brussels and other European capitals, the debate is no longer whether to welcome Chinese investment, but rather how to best coordinate approaches and how Europe can leverage access to its market to secure more investment and technology from advanced Chinese companies in the automotive and battery sectors. Whether it was intended or not, the EU tariffs introduced in 2024 on EVs from China provided an incentive to move production to Europe to access the European market. Take the Volvo EX30: The vehicle was initially exported to Europe from China, but its strong performance on the European market led the company to announce it will start production in its Belgium plant this year. It’s worth noting that the announcement was made shortly after the European Union launched its investigation on subsidized EVs from China in October 2023. Europe is heading down a very different path from the United States, where trade and national security regulations have, so far, effectively pushed automakers to make plans to restructure their value chains with an eye toward de-risking from China.

In private conversations, interlocutors from China and Europe often refer to the Japanese automotive sector’s development in the 1970s and 1980s, which led to increasing trade tensions with Washington and was eventually ameliorated through direct investment in the United States. The story is somewhat more complicated insofar as Tokyo and Japanese manufacturers agreed to self-imposed export quotas, but perhaps even more importantly because U.S. automotive companies were able to regain their competitiveness by focusing on different segments of the market. Moreover, the challenges faced by U.S. companies seeking access to the Japanese market were never fully resolved. However, one of the most enduring legacies of that era was that competition with Japanese auto companies led to a wave of innovation in manufacturing practices; the question remains open as to whether the same types of lessons can be drawn from Chinese manufacturers or not.

In the absence of geopolitical tension, the path forward for automakers and governments would likely include a healthy combination of learning, cross-investment, and technology acquisition. Indeed, at least two major European automakers, Stellantis and Volkswagen (VW), have made investments in Chinese startups with promising technology, and several others have deals relevant for their production in Europe (see Table 1). For example, Stellantis became a strategic investor in Leapmotor in 2023 and reportedly began assembly of Leapmotor vehicles at the Stellantis factory in Tychy, Poland.

▲ Table 1: Select Partnerships Between Chinese and EU Auto and Battery Makers in the European Union. Source: Compiled by the CSIS Trustee Chair in Chinese Business and Economics.

Europe’s greatest gap in the EV value chain remains batteries. The industry has largely been concentrated in East Asia until now, and Chinese companies excel in the production of low-cost lithium iron phosphate batteries. Chinese companies, whether in China or elsewhere, are also the leading refiners of the critical minerals required to produce batteries. In this segment of the value chain, some reliance on China and Chinese firms is inevitable, and given the increasing use of export controls by the Chinese government, the European Union would do well to adopt a strategy that balances long-term economic security concerns and immediate economic and climate objectives.

Some reporting has suggested that the Chinese government may already be influencing corporate decisions in Europe and trying to leverage its economic power to shape European foreign policy decisions. The risk of political coercion and geopolitical risk highlights the core difference between Japan in the 1980s and China in the 2020s. Governments will need to ensure that foreign investments do not undermine the European Union’s unity, which is what gives European countries their leverage. To that end, the European Union will need better coordination mechanisms on investment screening and conditions tied to state aid funding. Ultimately, governments are less likely to risk losing investment opportunities by requiring more localization if neighboring countries in the European Union are not going to undercut them and offer more favorable terms. European officials have privately expressed concerns that internal competition to receive Chinese investment could lead to a “race to the bottom” with negative implications for everyone, but that without an EU-wide approach, they find themselves in a prisoner’s dilemma. The European Commission has been taking steps toward improved coordination, but the path forward will likely remain challenging.

Despite risks of economic coercion, the presence of partnerships between Chinese and European companies in the automotive value chain can offer some opportunities for companies to access advanced technologies. European experts have been far more concerned about greenfield investment, which member states have incentivized without requiring anything in return. One recent report analyzed investments by South Korean and Chinese companies in Hungary and Poland backed by significant state aid, including from the European post-Covid recovery fund, and found that the governments did not secure commitments for local employment or technology partnerships.

Coaxing Companies Toward Innovation

Partnerships could be a pathway to learning, technology sharing, and inherently reducing the share of foreign ownership. However, the question of technology transfers is complicated, as it is not clear that state-negotiated or imposed transfers of technology are always successful in ensuring that the beneficiary companies are then competitive. The case of ICE vehicle companies in China should be a cautionary tale. Decades of mandated joint ventures between state-owned Chinese automakers and foreign companies did only so much to transform China into an automotive technological leader. It was the shift toward electric mobility and the advancement of digital technologies that made China into the automotive powerhouse it is today. Certainly, foreign technology played an important role even in the EV sector. For example, lithium-ion batteries were not invented in China, but it was the acquisition and development of these technologies at a relatively early stage that gave Chinese firms a head start.

Technology transfers were more successful in the wind turbine industry, where China also pursued aggressive localization policies. Requirements to localize production and components, combined with a very large and growing market, were also helpful to the development of an indigenous battery industry in China. Localization policies can be controversial; those pursued by the Chinese government have not always been WTO compliant, and the European Union has criticized the United States’ use of localization conditions in the Inflation Reduction Act (IRA), for example. However, the recently issued Industrial Action Plan for the European Automotive Sector makes clear that the European Commission now expects member states to take more proactive measures to ensure that FDI in the automotive industry brings added value to Europe and will produce a proposed set of conditions for inbound investment. Similarly, the Clean Industrial Deal published on February 26, 2025, addresses this question and provides a helpful recommendation that the European Council and European Parliament strengthen and harmonize the EU investment screening framework.

Two lessons from China’s experience will be valuable for European policymakers to consider as they develop a new strategy toward FDI:

1. Technology transfers and joint ventures on their own can fail to develop domestic innovation if they do not provide incentives for companies to go beyond their comfort zone. Localization requirements including hiring local staff, local training, and targets for sourcing domestically or from a third country can be more effective in enabling the development of an ecosystem in the medium to long term. However, these requirements will need to be part of a comprehensive plan to develop a local or diversified value chain for those segments that are deemed strategic and will require having a targeted strategic view of what levels of Chinese participation and technology are acceptable. One lesson of the IRA for Europe is that the stricter the approach to Chinese content, the higher the costs and the longer the time frames.

2. The EV and battery sectors will need to experience growing demand in Europe in order for companies to succeed in their localization efforts. That demand may risk accelerating the trade deficit with China in the short term, but will be necessary to ensure that companies have incentives to continue to invest in EV and battery manufacturing and research and development, that they can achieve scale, and that Europe has a say in shaping the technology itself through standard setting.

The European Commission’s power to enforce conditions on investment and investment screening will always be dependent on member states, who are unlikely to hand over authority, complicating the path forward for enhanced coordination. However, there is urgency to ensuring that Europe reaches a consensus on how to approach current and future investments from China for two reasons: First, as more investments are confirmed, the European side will have less leverage in negotiations. Second, the more rules are in place, the less member states will be incentivized to compete against one another and be responsive to potential political pressure from China. Finally, as Chinese automotive companies make investments around the world, including potentially in the United States (although the likelihood of this happening is low), their latitude to make more commitments in Europe will decline.

Coordination should not mean blocking FDI, as more investment in Europe can have some positive effects, especially if it can boost local value chain development and training of local talent. Indeed, Europe should look beyond China to diversify sources of FDI in vehicle and battery production, including attracting more and supporting existing Korean and Japanese companies in Europe. Investment in home-grown companies is a sensitive topic in Europe following battery maker Northvolt’s filing for bankruptcy protection, which, among other things, suggested a need for more due diligence and discipline for recipients of state aid. Northvolt’s collapse also revealed the extent to which the company was still reliant on Chinese value chains, including for its machinery, highlighting how challenging it is to fully separate value chains in the short term. However, the failure of a single firm does not mean that production of batteries in Europe is impossible.

Brussels would do well to learn from Washington’s own failure to view its industrial policy in perspective. The Department of Energy’s large loan to Solyndra, the solar panel producer that filed for bankruptcy in 2012, still receives equal coverage as the loan issued to Tesla, which has gone on to be a remarkably successful firm. The current U.S. administration’s dramatic reversal on electric vehicles and renewable energy could also have a devastating economic effect by undermining existing investments made because of the IRA’s incentives and expectations of growing demand and expanding charging infrastructure, among other things.

Predictability and long-term thinking will be an advantage for Europe as it provides clear signals and incentives for firms to make investments. Brussels and other capitals will also need to seriously consider security, especially when it comes to data and remote access of technologies, which are also key factors shaping company decisions. The Trump administration has not signaled any changes yet when it comes to restrictions on Chinese technology, including connected vehicles, but unpredictability in the White House may make it harder to achieve transatlantic coordination in this area.

Moving Forward: Openness, Industrial Strategy, and Global Governance

The good news is that the energy transition can positively reinforce many of Europe’s existing economic goals; the bad news is that it will require significant political capital and resolve at a time when the external environment is changing at breakneck speed. Indeed, European policymakers will need to move quickly if they wish to shape the future of the automotive value chain, something that is difficult to achieve when multiple democratic countries need to find agreement.

As they move to operationalize the Clean Industrial Deal and other plans relating to the Automotive sector, European policymakers today should focus on four priority areas:

1. Enhance European coordination on both the industrial strategy and the economic security side. As stated by the Clean Industrial Deal, foreign companies should not be able to exploit inconsistencies in national policies when choosing their future location, especially if this undermines the bloc’s unity vis-à-vis other national actors, including China. This will be challenging given different interests and priorities at the member-state level, and the European Commission will need to continue to provide guidelines and coordinate actively between different interests. Coordination, however, can mitigate potential risks posed by FDI or increased dependencies.

   Openness to investment and trade will have to continue to be part of Europe’s strategy in order to ensure companies are exposed to competitive pressure and engage in international value chains. Moreover, the European Union will need to address the competitiveness issues for its industry that have been identified, including issues not discussed in this paper in the digital sphere and industrial automation. Within this context, the European Union’s continued pursuit of free trade agreements—most recently with Mercosur and India—and international institutions will help ensure European companies retain an international footprint. Although challenging, the European Union should also strive to ensure that the newly proposed Clean Trade and Investment Partnerships are operationalized in ways that are effective and attractive for partner countries.

2. Remain committed to engaging with the rest of the world on the basis of mutually agreed upon rules and fairness. Actual negotiations with Beijing on addressing overcapacity produced by China’s energy transition and the lack of industry consolidation in the automotive sector could be beneficial. But perhaps most importantly, the European Union can work with other constructive partners to broker a broader conversation on global coordination on industrial policy spending and new rules of engagement on global trade and sustainability that may put more pressure on China. The European Union’s Carbon Border Adjustment Mechanism and the EU Battery Passport show that climate-related conditions to accessing the EU market can actually have an impact on Chinese firm behavior, an important lesson for the future that should not be overlooked.

3. Ensure continued growth of the EV industry by supporting demand through strong regulation on ICE vehicles and, as the Industrial Action Plan for the European Automotive Industry suggests, increasing coordination at the member-state level on EV incentive schemes. Research shows that automotive companies respond to stricter fuel and emission standards with more innovation despite potential up-front costs, which the government can under certain conditions help reduce. Ultimately, if Europe wants to compete globally in what is becoming the next generation of the automotive sector, it will need to engage in the race and leverage its internal market. Subsidization and market protection always works best when combined with strong incentives for companies to innovate, compete, and focus on efficiency. One of the key lessons from China’s experience is that competition (even if artificially generated through subsidies) is useful in propelling technological development forward, providing consumers with attractive options, and generating strong companies that can compete internationally.

4. Address head-on the risks posed by growing digitalization in all aspects of the economy, including personal vehicles. To do so, the European Union could coordinate more closely with other democratic allies including Japan, Canada, Australia, and potentially some developing nations such as India to produce frameworks that can enhance trust in data security within a relatively open world with trade and investment. Cybersecurity and data protection will only become bigger concerns in the coming years, and the European Union would serve itself and the world well by providing continued regulatory leadership that enhances competition as well as trust in concert with other leading actors in this area.

For the United States, there are some implications from the automotive industry transformation in Europe. First, the results of Europe’s confrontation and negotiation with China on economic security issues will prove instructive on what can and cannot be done bilaterally with Beijing. Although Washington’s position is significantly different, there will likely be lessons to be drawn from Brussels’ experience. Second, despite shifting U.S. foreign policy priorities, Europe is a large economic and diplomatic actor and market globally, so its long-term stability and prosperity is in the best interest of the United States. Third, if Europe is able to make reforms that improve its competitiveness, there may be long-term implications for effective policymaking, including the role of international trade and global governance. Finally, and more generally, the future of the automotive sector in Europe will likely shape and be shaped by evolving relations between the European Union and China, and the European Union and global institutions including the WTO, with long-term implications for the United States.

Ilaria Mazzocco is deputy director and senior fellow with the Trustee Chair in Chinese Business and Economics at the Center for Strategic and International Studies in Washington, D.C.