China’s efforts to curb overcapacity in the new energy sector can act as a window of opportunity for economies seeking to diversify from Chinese suppliers or leverage it to seek concessions in export controls imposed on technologies in the sector.
While China came to dominate the supply chain in batteries, solar energy equipment and electric vehicles, it has also resulted in massive overcapacity, or as the Chinese like to call it, ‘involution’. Involutionary competition, although a recurring phenomenon in the Chinese economy, has impacted it severely this time due to a combination of several factors.
Chinese regulators have introduced anti-involution policies to address the deteriorating situation. These measures are often compared to supply side reforms in the previous decade but they represent a distinct approach, and are implemented in a different context. For this time, the policies are focused on setting quality and safety standards for products, testing requirements, maximising R&D spending, and implementing stricter Intellectual Property rights as well as labour laws.
Potential efficacy of anti-involution measures
Current measures to limit outputs in the new energy sector are likely to take longer than previous supply-side reforms to consolidate the market. This is mainly due to the dominant share of privately-owned enterprises in these sectors, specifically EVs, batteries and solar. As opposed to regulating state-owned enterprises that followed the directive to slash outputs in the previous reforms, POEs will be more sensitive to market pressure and will require incentives to follow the set caps, and might revert to competitive pricing to survive longer. Another implication that is highly likely to follow this consolidation is massive job losses as second and third tier firms are pushed out of the market. The private sector is responsible for a large number of additional employment generated annually.
Furthermore, local governments that are used to incentives based on increasing manufacturing output, are highly indebted, and dependent on private sector enterprises for revenues are also likely to resist or delay directly reducing outputs or industrial consolidation. Local governments affected the most by a decline in land revenues have invested heavily in building these manufacturing clusters as means to generate revenues in the form of tax and social contributions.
Firms dealing with overcapacity
While China’s central leadership strives to push industry consolidation, companies have been trying to survive as well as come up with innovative products to distinguish themselves amid fierce competition. The most impacted by such price wars, especially in the battery manufacturing segment, are the second and third tier producers. Firms with a dominant share in the market or Tier-1 firms can absorb losses for a longer period, surviving until the market consolidates, and yet innovate with new technologies. The producers with smaller shares however, which mainly rely on price competitiveness rather than product differentiation will find it difficult to absorb losses.
In the case of lithium-ion batteries, China today supplies over 75% of batteries sold globally and has witnessed a 30% drop in battery prices in the year 2024 alone. This price drop is a result of two factors, decreasing cost of lithium and high price competition amid tier-2 suppliers. The country has installed over 2 TWh of production capacity in 2024, which is already 60% higher than the demand. With this gap, the Li-ion battery industry in China is bound to face the impact of ‘involution’.
The case of Li-ion batteries is similar to those of EVs- too many players, and too much capacity resulting in shrinking margins for second and third tier suppliers. Major suppliers like CATL have managed to remain profitable due to their larger share in the market. Tier 1 suppliers produce nearly 50% of the total battery cells in China. Reportedly, CATL’s gross profit margins increased between 2023-24 despite the fall in battery prices during this period. Similarly, EVE energy has also remained relatively stable. Leading firms therefore, are likely to emerge stronger from the domestic consolidation efforts due to their continued focus on R&D, cost efficiency along with technologically advanced products.
As competitive pressures increase, smaller players will be squeezed out. Meanwhile, safety standards in batteries are increasingly being compromised to achieve cost efficiency by smaller players. This is one of the reasons for setting higher quality standards and testing requirements by the regulators to eliminate lower quality and low-cost products.
The current scenario represents closing avenues for Chinese enterprises wherein domestic demand remains stagnant, and domestic markets flooded while major export markets are increasingly imposing duties on Chinese products in the new energy sectors. Additionally, the Chinese government has introduced controls that affect investments to manufacture outside of countries and restrict technology transfer. Such restrictions even hamper the growth of the enterprises that survive from the involutionary competition.
Window of opportunity
Between 2020 and 2025, prices of Li-ion batteries have dropped 80%, stripping companies of their profits. As Chinese enterprises undergo ‘involutionary’ pressures, and restrictions at both home and abroad, it presents an opportunity for producers outside China to reclaim their share in global markets by forging partnerships. While leading suppliers from China are likely to emerge stronger after the implementation of anti-involution policies, they will be eager to invest in foreign markets to retain their position.
It might take a longer time for the anti-involution policies to yield results as they pertain to setting product standards
and strengthening patent regulations, it could replace the unexpected price cuts from Chinese firms for global markets with price stability in sectors, especially EV and Li-ion batteries. The deflationary pressures in the Chinese economy can also be used to navigate and negotiate for concessions in the export controls on concerned sectors such as advanced lithium-ion batteries, and technologies used to produce lithium-ion cells.
Prior to the imposition of export controls, Chinese firms have been partnering with Southeast Asian firms extensively. Gotion High-tech has partnered with Vietnam’s VinES to jointly build a lithium iron phosphate battery plant, and CATL is also collaborating with the state-owned Indonesia Battery Corporation to build a battery production facility. For Chinese firms to successfully capture export markets, joint ventures and partnerships are becoming a necessary tool as countries demand them to invest in their economies and some form of technology transfer rather than simply furthering import dependence on China.
Progress on partnerships between Indian and Chinese companies in EV and battery manufacturing has been limited due to regulatory uncertainties in both countries. Exide batteries, for instance, entered an agreement with SVOLT energy to use and commercialise its lithium-ion cell manufacturing technology in 2022. Recently, Exide has also secured a deal to supply LFP batteries for Hyundai EVs in the Indian market. Viewing such partnerships involving transfer of technology as a threat to China’s dominance in the market, the Chinese government had reportedly advised EV companies against transferring advanced EV technology and investing in countries like India and Turkey that can later become competitors. Pressure from firms facing thinning profit margins at home could compel China to reconsider this position.
(Bhumika Sevkani is a Research Analyst at the Indo-Pacific Studies Program at the Takshashila Institution.)
Views are personal and do not represent the stand of this publication.
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