How China got Tesla and what we can learn from it

Despite doubts about the net carbon impact of electric vehicles (EVs), given that they use energy which could be generated in either clean or unclean ways, they are widely seen as the vanguard of the technological change that is sweeping through the global auto industry. Their development is also likely to yield several positive externalities that can transform mobility as we know it. Therefore, cultivating a robust and well- developed EV industry is a laudable and necessary objective of our industrial policy.

However, this objective cannot be achieved via investments in import-dependent assembly plants with minimal local sourcing, as Tesla plans to do in India, according to many reports. Developing a viable domestic EV industry would require widespread diffusion of technical knowhow and the development of an ecosystem of local component suppliers that could be leveraged by other domestic carmakers to compete with Tesla in the EV market.

Tesla has invested in China, and Shanghai’s deal with Tesla offers a classic template of how a ‘carrot and stick’ investment policy can lead to the development of a powerful EV ecosystem. When China started negotiations with Tesla, its local market was plagued with low-quality EVs (mostly hybrids) of limited capability. Chinese policymakers were clear-headed about how they wanted to use Tesla. The US-based company would have to develop Shanghai as its export hub and source locally. They reasoned that this would kill three birds with a single stone. It would not only bolster exports, but also make local component suppliers more competitive and help them acquire sophisticated manufacturing knowhow. Lastly, Tesla would put pressure on other local manufacturers to upgrade their standards and act as the proverbial aggressive catfish that forces other fish in the pond to swim faster. To achieve this, Tesla was provided with lavish incentives, including cheap land, low cost loans, subsidies, tax breaks and 100% ownership of the factory ( a first in China where all foreign automakers need domestic partners). There was plenty of stick as well. Tesla would have to invest at least $2 billion over 5 years, for example, and start paying Chinese taxes of at least $323 million from 2023 onwards, failing which Tesla would lose its factory to the Chinese government.

China’s strategy has yielded phenomenal results. Shanghai is now Tesla’s largest and most important manufacturing facility. It sources 86% of its components domestically, compared to 73% for the California factory. Local component manufacturers have acquired extraordinary technical expertise, like the LK group which has developed the largest casting machine in the world for Tesla. And the catfish effect has led to a deluge of new and more sophisticated models from local automakers, making China the EV Mecca of the world.

This brings us to why Tesla is now keen to enter India with imports instead of local manufacturing. A large part of the output from the Shanghai factory is exported to EU. With Giga Berlin (Tesla’s German factory) and Giga Texas on the anvil, Giga Shanghai will no longer be needed to export products to the EU. Moreover, Tesla is facing stiff competition (and eroding market share) in China from established players like BYD as well as upstarts like Nio. With tax breaks expiring in 2023, Tesla will also be constrained in competitively pricing its output from the Shanghai plant. This is why it wants to use its Shanghai plant to export to other Asian countries, including India, and is lobbying for lower import duties instead of incentives to manufacture locally.

Indian policymakers and sundry politicians should be aware that domestic manufacturing is critical for the country to leverage our burgeoning demand for cars and develop new production capabilities. Even free-market economies like the US under radical free-trade adherents like President Ronald Reagan hammered Japanese automakers with quotas and tariffs to force them to manufacture vehicles in the US.

India too should use Tesla as a catalyst for setting off a chain reaction that transforms domestic EV manufacturing, instead of surrendering our vast market for myopic political gains. Indian politicians right now ought to be driving a hard bargain for a Giga Ludhiana, Giga Hyderabad, Giga Kolkata, Giga Bengaluru or a Giga Chennai, instead of serenading Elon Musk with ballads of unrequited incentives and open-ended promises.

The original Tesla (Nikola) is said to have remarked, “A new idea must not be judged by its immediate results." Neither should a new investment.

Diva Jain is a director at Arrjavv and a ‘probabilist’ who researches and writes on behavioural finance and economics. Her Twitter handle is @DivaJain2