China Fights Fraud In Auto Sector – Analysis

By Michael Lelyveld

Thanks to government policies, China leads the world in production of new energy vehicles (NEVs), but a crackdown on fraud suggests that subsidies may be adding to industrial overcapacity instead of putting cleaner cars on the road.

Last year, sales of some 507,000 electric cars, plug-in hybrids and other NEVs soared 53 percent, the China Association of Automobile Manufacturers (CAAM) reported.

About 80 percent of the NEVs were fully electric cars with sales posting a 65-percent gain, the official Xinhua news agency said.

Growth rates in the sector have been stunning, sparked by consumer demand for new vehicles despite thickening traffic and smog.

China’s overall auto sales rose 13.7 percent to a record 28 million vehicles last year, while the small but fast-growing NEV segment accounted for less than two percent of total sales.

NEV sales are up nearly sevenfold since 2014 while fully electric models have climbed more than 470 percent, based on CAAM figures.

But success in the sector has been marred by complaints about too many manufacturers and defects including lower battery life, particularly in colder northern cities where NEVs are needed most.

With more than 200 manufacturers crowding the market, many have been suspected of making false claims to cash in on government subsidies.

Questions about subsidy abuse were first raised by former Finance Minister Lou Jiwei in January 2016 following a report on fraudulent practices by The Economic Observer, an independent weekly based in Beijing.

The paper found that some automakers were installing batteries in existing models and claiming subsidies of up to 100,000 yuan (U.S. $14,538) per vehicle for cars purchased by phantom companies but never really sold for use.

Since then, the government has investigated 90 makers of 401,000 NEVs for claiming subsidies on unsold or inoperable vehicles, according to Bloomberg News.

In September, the Ministry of Finance slapped penalties on five car and bus companies for false subsidy claims of more than 1 billion yuan (U.S. $145 million) on 3,547 vehicles, state media reported.

This month, the Ministry of Industry and Information Technology (MIIT) accused seven more NEV manufacturers in its probe of subsidy fraud and substandard batteries, the official English-language China Daily said.

NEV sales plunge

It is unclear whether the alleged fraud cases and those under investigation have been reflected in CAAM sales totals.

In January, reported NEV sales plunged 74.4 percent from a year earlier following the crackdown on subsidy scams.

The subsidy issue raises questions about the role that government support has played in the problem of industrial overcapacity, which the government is now trying to solve.

For the past year, the government has been pushing the coal and steel industries to cut surplus capacity, which has been blamed for overproduction, low prices, pollution and antidumping measures abroad.

The problems of excess capacity and low utilization rates have been widespread throughout China’s industries after decades of investment-led growth and implicit subsidies from easy state bank loans.

But the government has been cautious about tackling the problem due to concerns for employment and social stability.

So far, it has focused its capacity-cutting initiative on the coal and steel sectors, where it has predicted that 1.8 million jobs will be lost.

That approach may be changing.

Earlier this month, the government said it was sending inspection teams to check on whether the cement and glass industries were eliminating outdated production capacity, Xinhua reported.

A report by Economic Information Daily also cited officials of the National Development and Reform Commission (NDRC) and MIIT as saying that capacity cutting will spread in 2017 to bring sectors including autos, nonferrous metals and new energy under “strict control.”

Concerns about overcapacity and low-quality production have dogged the auto sector for years, despite spectacular growth.

Although last year’s 13.7-percent sales increase was substantial, it was a shadow of the peak growth of 45 percent in 2009. The Ministry of Commerce expects sales growth will slip further to between 2 and 6 percent this year, Xinhua said.

License restrictions, congestion and antipollution efforts have driven consumers into the NEV market, which benefits from both subsidies and special breaks.

“Virtually all (NEV) sales are spurred by government subsidies or perks, such as exemptions from the lotteries for license plates in big cities,” said an Automotive News report last year. “Without incentives, it’s unclear how (NEVs) would win traction at all.”

Rooting out fraud

The government hopes to root out fraudulent and shoddy production in the NEV sector with its investigations and a previously planned decrease in subsidies that took effect at the start of this year.

From 2009 to 2015, the central government paid out 33 billion yuan (U.S. $4.8 billion) in subsidies, Xinhua reported this month. Regional governments offered additional subsidies of 20 billion yuan (U.S. $2.9 billion) from 2013 to 2015, China Daily said last July.

The incentives may have opened the door to a bonanza of fraud. But the government ordered its subsidies to be cut by just 20 percent for sales this year and urged local authorities not to add subsidies exceeding half the central government amount, China Daily said.

The subsidy syndrome may be seen in other sectors where the government has put its economic muscle behind a new technology initiative with the intent of showing global leadership.

With wind power, for example, China has taken the world lead in ramping up non-fossil generation by offering huge subsidies to producers.

Last year, China expanded wind power capacity by nearly 15 percent to 149 kilowatts, the National Energy Administration (NEA) reported. But many wind farms were in remote areas that lacked connections to the national grid.

Wind power generation reached 241 billion kilowatt-hours (kWh), accounting for four percent of China’s electricity output. But nearly 50 billion kWh, or more than 20 percent, was wasted due to distribution problems.

In northwestern Gansu province, the proportion of wasted wind power generation was as high as 43 percent, the Communist Party-affiliated Global Times reported. But producers continue to benefit from subsidies paid by the National Renewable Energy Fund.

In such cases, subsidies guarantee profits for investments that would otherwise incur losses in the real market.

Left unchecked for years, subsidies may be the source of useless or excess production capacity, some of which is supported by local pressure to provide employment, or in other cases, corruption.

“Mostly useless spending can’t continue for more than a few years unless subsidized,” said Derek Scissors, a resident scholar at the American Enterprise Institute in Washington.

How much of China’s gross domestic product can be traced to subsidized, useless or surplus production is unclear, but the NEV and wind power cases suggest that otherwise bad investment is big business, making it hard to curtail.

One test for market viability would be to withdraw subsidies and see whether low-quality or surplus production can continue without support.

So far, the steps toward reforming the NEV sector are gradual. The central government plans to phase out its subsidies entirely by 2020, Xinhua said.

“The biggest subsidy is the impossibility of failure,” Scissors said in an email message.

“If the national government won’t let the major car companies fail and local governments won’t let NEV car companies fail, all the uncompetitive companies will continue to produce when they should be killed off by better companies,” said Scissors.

“This production is entirely subsidized and largely wasted,” he said.


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