“Competition is only true as long as it is fair,” said Ursula von der Leyen, the president of the European Commission. “We have to be clear-eyed about the risks we face.”

This was von der Leyen’s unexpected announcement of a formal anti-subsidy investigation into China-made electric cars coming into the European market, which prompted applause from MEPs in the Strasbourg hemicycle on Wednesday.

“Global markets are now flooded with cheaper Chinese electric cars. And their price is kept artificially low by huge state subsidies. This is distorting our market,” she said. “And as we do not accept this distortion from the inside in our market, we do not accept this from the outside.”

But what exactly does this mean?

Pumping public cash

As the executive branch, the European Commission has the exclusive competence to set the EU’s common commercial policy and regularly launches probes into foreign imports that might harm the single market.

An anti-subsidy investigation is triggered when a foreign country is suspected of subsidising a company or group of companies to produce a certain product and this subsidy causes “injury” to the European industry.

Thanks to this generous state aid, the assembly costs are significantly offset and the company is therefore able to sell its product at a lower price.

The discount puts European companies that sell a similar product at a great disadvantage because they do not receive the same level of support from their national governments and are left with two choices: either sell their goods at a lower price but risk losing money or sell their goods at a higher price but risk losing clients.

This is what appears to be happening with Chinese electric cars.

Beijing has long been accused by Western countries of pumping an excessive amount of public money into its domestic industry. The aid is hard to track down and can take many forms, including preferential lending, friendly taxation and direct transfers of funds.

By injecting subsidies, China ensures its national companies comply with the objectives set in its five-year economic plans. The current plan (2021-2025) explicitly mentions “new energy vehicles” as one of the pillars of the industrial system.

According to the European Commission, the continued lavishing has resulted in an average 20% price difference between China-made electric cars and their EU-made equivalents, meaning consumers can immediately detect a much lower price on Chinese brands when they go shopping for a clean vehicle.

China has the additional leverage of holding a dominant position in the raw materials needed for manufacturing batteries, such as lithium, cobalt, nickel and manganese, creating an all-encompassing environment in which China controls virtually every aspect of the supply chain. The inevitable result has been a dramatic surge in the assembly of China-made electric cars and a wave of exports all around the world.

The EU market is considered particularly attractive because of its gradual ban on the combustion engine and its 10% duty on all imported cars. By comparison, the United States applies a 27.5% rate and India a 70% tariff– essentially a ban.

The Commission estimates that Chinese brands, such as BYD, Nio and Xpeng, have already captured 8% of the European market for electric cars, up from 4% in 2021, and could get up to 15% in 2025 if the trend goes on uninterrupted.

The projection might be conservative. Just last week, Chinese companies reportedly stole the spotlight with their low-cost models at a massive auto show in Munich, leaving their German rivals looking like icons from a bygone era.

“China has its gaze set on the European market, with the potential to fundamentally change the face of Europe’s industries as we know it,” said Sigrid de Vries, the director general of the European Automobile Manufacturers’ Association (ACEA), in a blog post published last month. “It appears China’s strategic decision to invest early and along the entire value chain is paying dividends.”

Subsidies vs tariffs

Faced with an even bigger avalanche of cheap Chinese cars that could decimate European firms, which are struggling to cope with the plethora of economic woes unleashed by Russia’s war on Ukraine, Brussels is taking pre-emptive action.

“Europe is open to competition, but not to a race to the bottom. We must defend ourselves against unfair practices,” von der Leyen said.

In a sign of how serious the threat is, the Commission has launched the inquiry on its own initiative (ex-officio) rather than waiting for a member state to submit a formal complaint, as it usually happens in this type of trade case.

Once the investigation is notified in the EU’s official journal, the clock begins ticking: the Commission will have a maximum of 13 months to decide whether to impose so-called “countervailing duties” (in other words, trade tariffs) on Chinese electric cars or close the investigation without taking further steps.

The tariffs, which would come on top of the existing 10% import duty, are meant to compensate for the unfair advantage given by the subsidies and their scope would depend on the evidence collected by the executive.

If eventually approved, the tariffs would apply to all battery electric vehicles (BEVs) manufactured in China. This means a European company that operates a China-based factory could be potentially slapped with duties if it benefits from Chinese state aid.

Member states would have the possibility to block the imposition of tariffs but only if they secure a qualified majority (15 countries representing at least 65% of the EU population).

Regardless of the final outcome, the launching of the investigation marks a significant escalation in EU-China relations, which had been strained since the COVID-19 pandemic and the outbreak of the Ukraine war. It also represents one of the first tangible consequences of “de-risking,” the strategy employed by von der Leyen to manage Beijing’s increasingly assertive behaviour without breaking off ties.

For Simone Tagliapietra, a senior fellow at Bruegel, an economics think tank, the Commission’s decision signals the willingness to use its arsenal of trade instruments “more proactively” to defend the homegrown industry and avoid past mistakes, a reference to how Europe’s solar industry was overtaken by Chinese competition.

“This is the start of a long journey,” Tagliapietra said in a statement. “It could ultimately work, but this must go in parallel with an active industrial policy to make EU industry quickly develop its competitiveness.”

VDA, the German Association of the Automotive Industry, offered a more careful assessment and called for a wider framework to stimulate investments and help companies cope with high energy costs, taxes, levies and excessive bureaucracy.

“Damages must be causally measured, and the common interest must be taken into account. Possible reactions from China must also be considered,” a spokesperson said. 

Meanwhile, the China Chamber of Commerce to the EU (CCCEU) expressed its strong condemnation, saying the “substantial industrial edge” of Chinese vehicles was not the result of subsidies but of “innovation” and “cooperative partnerships.”

“We strongly encourage the EU to approach the progress of China’s electric vehicle industry with objectivity rather than resorting to unilateral economic and trade measures,” the CCCEU said, warning the tariffs could run counter to the World Trade Organization.