Cadillac Expands in China — at the Wrong Time?

SMITH BRAIN TRUST — Cadillac has just opened a state-of-the-art $1.3 billion plant outside Shanghai, and it plans to open another $1 billion factory in Wuhan next year. The company sold 80,000 cars in China in 2015, compared with 175,000 in the U.S., and the goal for 2017 is to surpass 100,000.

While it only has 4 percent of the luxury car segment in the growing Chinese market, Cadillac is hoping to boost that to 10 percent. Market share aside, the GM division sees a chance to remake its image: The average Chinese buyer of a Cadillac is a sprightly 34, compared to a graying 60 in the United States.

But is this precisely the worst time to be opening new car factories in China? Despite a fairly robust 8 percent increase in car and SUV sales from 2014 to 2015, many factors are contributing to a slowdown in the car market in China, points out Anil K. Gupta, the Michael D. Dingman Chair in Strategy and Entrepreneurship at the Robert H. Smith School of Business.

First, China's economy last year hit a rocky patch unlike anything it has seen in decades. Additionally, in an effort to fight gridlock and pollution, some cities are limiting the number of cars that can be registered. Finally, despite its massive population, China is unlikely to see the per-person car ownership ever reach U.S. levels because of urbanization and population density.

"My own analysis is that if you look at 2015 to 2025, the growth rate of the Chinese auto market is unlikely to be more than 5 percent a year, averaged out," Gupta says. "Yet in the auto industry, just as in steel and cement and some other sectors, both foreign and domestic companies have been adding capacity." As a result, he concludes, "production capacity for cars may be as high as 20 to 25 percent over demand."

A key question for automakers is whether the overcapacity is evenly distributed throughout price points for vehicles. "Evidence seems to suggest that overcapacity is much more of a problem in the low end than the high end," Gupta says. That would be good news for Cadillac, not so good for Chinese carmakers, who dominate the market's low end. Chinese demand for SUVs in particular seems to be insatiable, as consumers trade up from entry-level cars.

Tax incentives are one reason for the new factories. By building in China, GM escapes a 25 percent tax on imported cars. (China also requires U.S. automotive factories in China to be jointly owned by domestic firms.) That has led to some criticism that GM, and U.S. companies in general, are all too willing to play by trade rules that are rigged in China's favor. The new factory will even export the plug-in version of the CT6 hybrid sedan to the U.S. (GM's Buick division also has plans to export its Envision model from China to the U.S.)

Gupta says there is some merit to the complaints about unfair trade. As a condition of being admitted to the World Trade Organization, in 2001, China committed to eliminating its tariffs on foreign automobiles in due course, but it has not followed through, Gupta says. In recent years, it has justified tariffs on cars by arguing that the U.S. is "dumping" vehicles, or selling them below cost — a charge that  most objective observers dispute.

"China has been allowed to get away with asymmetrical openness," Gupta says. "And other governments have not had the backbone to take on China."

Given the importance of the U.S. market to Chinese companies, Gupta thinks that it should be possible to pressure China to meet its obligations regarding tariffs on cars — without launching a destructive trade war, and without denigrating the overall value of foreign trade (as some presidential candidates have done).