What China's EV City Says About the State of the Economy

State-of-the-art factories produce electric cars and solar panels in Hefei, an industrial center in the heart of central China. Wide avenues connect office towers and landscaped parks. Metro lines are opening at a rapid pace.

But in Hefei's building materials market, which covers 10 city blocks, local traders are gloomy. Wu Junlin, a door salesman, has closed two of his three stores and laid off all but one of his 12 employees.

“I've been doing this for 20 years – after all these years, this year is the worst,” he said as he sat in his last store, with no customers in sight.

Nowhere are the opportunities and vulnerabilities of the Chinese economy better demonstrated than in Hefei.

Government-led growth in sectors such as electric vehicles and solar panels has made China the world's export powerhouse, making Hefei a model for other Chinese cities. But a nationwide real estate market downturn has devastated the finances of millions of families and small businesses, including in Hefei.

Hefei and nearby cities have become a hub for electric vehicle production, with total car production nearly tripling since 2019 and now exceeding that of Michigan. Hefei's industrial policy has been so successful in encouraging technology manufacturers that the country's central government has embraced the principles of what is known as the Hefei model.

Now so many cities are subsidizing electric vehicle factories that the industry is facing serious overcapacity and heavy losses.

“Some places and companies are still blindly launching and duplicating new energy vehicle projects – these require our close attention, and effective measures must be taken to solve them,” said Xin Guobin, Vice Minister at the Chinese Ministry of Industry and Information Technology. said at a news briefing last week.

The Hefei model involves using government money to buy newly issued shares from manufacturers and startups that need cash. Officials also arrange loans with attractive interest rates from state-owned banks to finance new factories.

Over the past two decades, Hefei has been transformed by the municipal government's bets on companies like BOE Technology Group, a flat panel display manufacturer, and Nio, an electric car maker. When Nio was running low on cash in 2020, the Hefei government injected $1 billion for a 24 percent stake and state-controlled lenders pumped in another $1.6 billion.

Hefei, a provincial capital in a previously impoverished agricultural area, has risen in the income rankings of Chinese cities. Local government executives, urban economists and institutional investors visit Hefei to study its methods.

Hefei has one $86 billion municipal holding company who has poured money into struggling, but technologically advanced companies. The holding company, the fourth largest of its kind in China, is buying company shares cheaply when few other investors want them.

These companies sometimes recover, as BOE Technology and Nio did after Hefei's investments. The city then encourages these companies' suppliers and customers to also move to Hefei, said Li Bo, assistant professor at Beijing University's Guanghua School of Management.

“Hefei has a clear understanding of local industries – the government-led investment fund is tailored to the needs of businesses,” she said.

Hefei sits at the top of several industrial supply chains. A fifth of the world's liquid crystal displays for consumer electronics are made in Hefei. This also applies to many Lenovo laptops and notebooks. Hefei produces a tenth of China's household appliances. The city government has provided $2 billion of the $2.5 billion needed to build China's first factories for an advanced type of computer memory chips.

Hefei's production of electric cars quadrupled last year, and that will rise further this year as Volkswagen ramps up production at a massive new factory. An electric car battery manufacturer partly owned by VW, the Gotion High-tech Company, has also built a factory in Hefei.

Other Chinese car manufacturers are following suit. BYD, which is vying with Tesla to become the world's largest electric car maker, has nearly completed a $5.6 billion factory complex with a planned capacity of 1.3 million cars a year.

Hefei owes much of its success to a top tech university, just as Carnegie Mellon University helped fuel Pittsburgh's tech renaissance. Most of China's top universities are located in Beijing or Shanghai. But leaders of the University of Science and Technology of China moved the institute from Beijing during the chaos of Mao's Cultural Revolution and ended up in relatively quiet Hefei in 1970.

In 2005, a new municipal leader in Hefei, Sun Jinlong, pioneered the city's focus on engineering manufacturing. At the time, BOE Technology was mainly based in Beijing, but was struggling financially. The city persuaded the company to build factories in Hefei and offered more than $1 billion in investments and loans.

BOE Technology's subsequent corporate statements show that it collected an additional $250 million in direct grants from the city between 2011 and 2016. BOE Technology is now one of the world's largest manufacturers of flat panel displays.

Hefei had a powerful ally in furthering its success. Li Keqiang, China's second-highest official and premier until his retirement almost a year ago, grew up in Hefei.

During a trip to the city in 2015, Mr Li promoted his “Made in China 2025” plan. That plan called for replacing many imported advanced manufactured goods with Chinese production by 2025, using an industrial policy that mirrored Hefei's. Mr Li died in October.

Hefei still faces challenges. Automakers have struggled to convince executives and engineers to leave the glitz of Shanghai or Beijing for a quieter life in Hefei, despite the low cost of living. BOE Technology has retained its headquarters in Beijing.

But Hefei's biggest problem lies in housing.

Until China's housing crisis hit Hefei two years ago, construction and real estate development slightly outpaced manufacturing in the city. Apartment buildings, office towers and hotels loom over small farms left over from the city's recent agricultural past.

That dependence on the construction sector is now hurting Hefei.

According to the China Index Academy, a real estate market data provider, the number of new apartments sold each month in Hefei has fallen sharply. In November, turnover was 45 percent lower than a year earlier.

The plunge in sales is crippling the ability of debt-laden real estate developers to finance new projects. The total floor area of ​​new projects decreased by 57 percent last year compared to 2022.

As developers run out of money, they buy fewer land leases from the government. The sale of these leases, the cornerstone of local government budgets in China, typically covers half of Hefei's municipal expenditure. Last year, lease sales in Hefei fell 38 percent, putting government programs at risk.

Small businesses say the local government, previously a major customer, has stopped placing orders.

“The government has run out of money,” said Tao Yingcheng, the owner of a flooring company in Hefei.

Some local workers also complain that they do not have the skills to compete for jobs. Companies like Nio and Volkswagen are increasingly relying on robots and other automation tools and hiring graduates from top universities elsewhere.

“The current employment environment is not very good,” said Xu Mingyi, a Hefei resident who studied computer programming and still has not been able to find work in his field. Instead he works as a hail driver. “These companies in Hefei need such talents that ordinary people can hardly meet the requirements.”

Li you research contributed.