You see "Excess Capacity" and "Bleeding." In the ChinArb framework, System B sees "Evolutionary Pressure."
1. The "Spartan" Selection Process Beijing knows it doesn't need 100 car companies. It needs 3 global killers. The 25 million units of excess capacity is the Furnace. The fact that SOEs and JVs (VW/GM) are the ones bleeding suggests the policy is working as intended. The state is letting the "Zombies" starve to feed the "Apex Predators" (BYD, Huawei). This is not a market failure; it is a controlled burn of the legacy forest to let the new species grow.
2. The EU "Minimum Price" Trap (Toyota Bank 2.0) Your analogy to the 1981 Japan VER is brilliant. If Brussels sets a Minimum Price, they are effectively banning Chinese firms from discounting.
Result: You force BYD to raise prices (guaranteeing them fat margins) and force them to move upmarket (adding tech/luxury to justify the price).
Historical Rhyme: The US trade restrictions turned Toyota into Lexus. The EU trade restrictions will turn BYD into a premium tech brand. System A is about to force System B to become more profitable.
3. The "New Species" Invasion The most terrifying chart is the rise of the "Telecom Car Companies" (Huawei/Xiaomi). This is Asymmetric Warfare. While Detroit tries to figure out batteries, Huawei is integrating the car into the Operating System of Life. They aren't selling transportation; they are selling a Mobile Node. The "Restructuring" you describe isn't just about factories closing; it's about the definition of the automobile being rewritten.
Except re your point 1, the SOEs are the clear (political) national champions. It's fine for private firms to fail, but not the SOEs, particularly the SOEs owned by the national government (FAW, Dongfeng, Changan). Until they are shut down, the "winners" can't make money.
Re your point 2, I'm awaiting details re European policy – I should learn more tomorrow at the GERPISA conference (go to https://gerpisa.org/en/node/8449 tomorrow morning ca 7:45am EST for the zoom link). The Dacia Spring is an import, and Dacia is about to start selling a second model. Ditto three Smart models. What terms will German and French firms face? Or Tesla with the Model 3, which is a Chinese car? Cf the US VERs, where GM vetoed the initial agreement which threatened to strand GM's investment in Isuzu and their strategy to import small cars from Japan.
Mike, you are looking for "Policy Intent." I am looking at "System Constants."
You are absolutely right: The SOEs distort the market and prevent clearance. But in the ChinArb model, we don't view this as a policy "mistake" that can be corrected by a new leader or a WTO ruling. We view it as a Physical Constant of System B.
1. The Feature, Not the Bug It doesn't matter if Beijing intends to crush global competitors or not. The internal social contract of System B dictates that SOEs (Employment/Stability) cannot simply exit. This makes "Uncleared Capacity" a permanent feature of the environment. It creates a "Pressure Cooker" that is always on. This is not a strategy; it is the Atmosphere.
2. The Order of Extinction You argue that under these conditions, "even the winners can't make money." Correct. But that misses the evolutionary point. The endgame isn't about who gets rich; it's about who survives.
System A Species (GM/VW): High metabolic rate. They require oxygen (Healthy Margins) to feed unions and shareholders. In a vacuum, they die first.
System B Species (BYD/Private sector): Low metabolic rate. They have evolved in this "Zero-Profit" environment. They are anaerobic.
The result is deterministic: The High-Cost structure will be liquidated by the Low-Cost structure. Whether the survivor eventually enjoys "pricing power" or just continues to grind in low margins is irrelevant to the fate of Detroit. Detroit dies either way.
I know the argument – I read Janoš Kornai back in the day, he'd been at Yale a decade before so the economics people knew him and his work.
For the auto industry in China, the problem wasn't the "soft budget constraint" – your "free money." It was that, thanks to the JVs, they were too profitable, not perennial loss-makers. As happens in cyclical industries in flush times, they grew fat. GM and VW are prime examples, Ford as well – if you talk to insiders, the senior people at Ford had all experienced at least one bust-boom-bust cycle, that institutional memory made Ford proactive in 2007 and hence avoid Chapter 11 during the Great Recession.
Oh, and BYD and Geely were quite profitable, that's how they got into autos. Geely may even be going against the grain and improving, they ran into trouble early on with Polestar. As far as I can tell, both firms have avoided government entanglement (the organizer of the Shanghai GERPISA conference co-authored a book on Geely and Li Shufu, which I've read).
Mike, dropping a reference to János Kornai? Now we are cooking. Respect. It’s rare to find someone who remembers the "Soft Budget Constraint" theory in a Substack comment section.
1. The Irony of the "Fat" You are absolutely right. For 20 years, the JVs (GM/VW) were cash cows that made the SOEs incredibly rich and lazy. But here is the dark twist in 2026: That "Fat" is now the Fuel.
The SOEs are not relying on bank loans (Kornai's model); they are burning the massive retained earnings accumulated from their Western partners to fund the current price war.
System A (GM/VW) effectively funded the war chest of System B. The profits from the "Golden Era" are now paying for the "Liquidation Era."
2. Implicit vs. Explicit Entanglement On Geely and BYD: You are correct that they avoided direct state ownership (Explicit Entanglement). But in System B, no one avoids Ecological Entanglement.
Li Shufu and Wang Chuanfu act as "Privateers." They don't take orders, but they sail on the State's Wind.
They benefit from the "System B Subsidy Stack": $0.08/kWh industrial power, heavily subsidized lithium processing, and aggressive municipal procurement.
They might not be "owned" by the government, but they are the apex predators of the environment the government built.
In the end, the distinction matters little to Detroit. Whether killed by a State Army or a State-Sponsored Privateer, the result is the same.
Anhui also has JAC, which has mostly exited passenger vehicles, selling the operation that made Sehol brand vehicles to VW (so VW has full control, it's not a joint venture). VW was going to use it as a pure EV production facility. I don't know the current status. Anhui's historically a poor province, and today autos loom large.
GERPISA conference Zoom link
Time: Jan 15, 2026 02:00 PM Paris-Brussels
Tommaso Pardi: From Eldorado to existential threat: the changing role of China
and the return of protectionism
Mike Smitka: Restructuring China's Auto Industry. Growth stimulated much
too much entry
Martin Schroeder: The expansion of Chinese OEMs to Southeast Asian
markets
John Paul MacDuffie: Strengths and weaknesses of Chinese OEMs amid the price war and
overcapacity crisis
https://cnrs.zoom.us/j/97102954238?pwd=nz4rbqX2o4ne1efbQ0WJKvvxI8eRH2.1
Meeting ID: 971 0295 4238
Passcode: i9JuJ9
Mike, this is the "Gladiator School" syllabus.
You see "Excess Capacity" and "Bleeding." In the ChinArb framework, System B sees "Evolutionary Pressure."
1. The "Spartan" Selection Process Beijing knows it doesn't need 100 car companies. It needs 3 global killers. The 25 million units of excess capacity is the Furnace. The fact that SOEs and JVs (VW/GM) are the ones bleeding suggests the policy is working as intended. The state is letting the "Zombies" starve to feed the "Apex Predators" (BYD, Huawei). This is not a market failure; it is a controlled burn of the legacy forest to let the new species grow.
2. The EU "Minimum Price" Trap (Toyota Bank 2.0) Your analogy to the 1981 Japan VER is brilliant. If Brussels sets a Minimum Price, they are effectively banning Chinese firms from discounting.
Result: You force BYD to raise prices (guaranteeing them fat margins) and force them to move upmarket (adding tech/luxury to justify the price).
Historical Rhyme: The US trade restrictions turned Toyota into Lexus. The EU trade restrictions will turn BYD into a premium tech brand. System A is about to force System B to become more profitable.
3. The "New Species" Invasion The most terrifying chart is the rise of the "Telecom Car Companies" (Huawei/Xiaomi). This is Asymmetric Warfare. While Detroit tries to figure out batteries, Huawei is integrating the car into the Operating System of Life. They aren't selling transportation; they are selling a Mobile Node. The "Restructuring" you describe isn't just about factories closing; it's about the definition of the automobile being rewritten.
Except re your point 1, the SOEs are the clear (political) national champions. It's fine for private firms to fail, but not the SOEs, particularly the SOEs owned by the national government (FAW, Dongfeng, Changan). Until they are shut down, the "winners" can't make money.
Re your point 2, I'm awaiting details re European policy – I should learn more tomorrow at the GERPISA conference (go to https://gerpisa.org/en/node/8449 tomorrow morning ca 7:45am EST for the zoom link). The Dacia Spring is an import, and Dacia is about to start selling a second model. Ditto three Smart models. What terms will German and French firms face? Or Tesla with the Model 3, which is a Chinese car? Cf the US VERs, where GM vetoed the initial agreement which threatened to strand GM's investment in Isuzu and their strategy to import small cars from Japan.
Mike, you are looking for "Policy Intent." I am looking at "System Constants."
You are absolutely right: The SOEs distort the market and prevent clearance. But in the ChinArb model, we don't view this as a policy "mistake" that can be corrected by a new leader or a WTO ruling. We view it as a Physical Constant of System B.
1. The Feature, Not the Bug It doesn't matter if Beijing intends to crush global competitors or not. The internal social contract of System B dictates that SOEs (Employment/Stability) cannot simply exit. This makes "Uncleared Capacity" a permanent feature of the environment. It creates a "Pressure Cooker" that is always on. This is not a strategy; it is the Atmosphere.
2. The Order of Extinction You argue that under these conditions, "even the winners can't make money." Correct. But that misses the evolutionary point. The endgame isn't about who gets rich; it's about who survives.
System A Species (GM/VW): High metabolic rate. They require oxygen (Healthy Margins) to feed unions and shareholders. In a vacuum, they die first.
System B Species (BYD/Private sector): Low metabolic rate. They have evolved in this "Zero-Profit" environment. They are anaerobic.
The result is deterministic: The High-Cost structure will be liquidated by the Low-Cost structure. Whether the survivor eventually enjoys "pricing power" or just continues to grind in low margins is irrelevant to the fate of Detroit. Detroit dies either way.
[“Neijuan”: Why Your Chinese Competitor Would Rather Die Than Lose Market Share]https://chinarbitrageur.substack.com/p/neijuan-why-your-chinese-competitor?r=71ctq6
[The Underlying Operating System of Chinese Manufacturing: The R.I.C.E. System (The China Trilogy Part I)]https://chinarbitrageur.substack.com/p/the-underlying-operating-system-of?r=71ctq6
I know the argument – I read Janoš Kornai back in the day, he'd been at Yale a decade before so the economics people knew him and his work.
For the auto industry in China, the problem wasn't the "soft budget constraint" – your "free money." It was that, thanks to the JVs, they were too profitable, not perennial loss-makers. As happens in cyclical industries in flush times, they grew fat. GM and VW are prime examples, Ford as well – if you talk to insiders, the senior people at Ford had all experienced at least one bust-boom-bust cycle, that institutional memory made Ford proactive in 2007 and hence avoid Chapter 11 during the Great Recession.
Oh, and BYD and Geely were quite profitable, that's how they got into autos. Geely may even be going against the grain and improving, they ran into trouble early on with Polestar. As far as I can tell, both firms have avoided government entanglement (the organizer of the Shanghai GERPISA conference co-authored a book on Geely and Li Shufu, which I've read).
Mike, dropping a reference to János Kornai? Now we are cooking. Respect. It’s rare to find someone who remembers the "Soft Budget Constraint" theory in a Substack comment section.
1. The Irony of the "Fat" You are absolutely right. For 20 years, the JVs (GM/VW) were cash cows that made the SOEs incredibly rich and lazy. But here is the dark twist in 2026: That "Fat" is now the Fuel.
The SOEs are not relying on bank loans (Kornai's model); they are burning the massive retained earnings accumulated from their Western partners to fund the current price war.
System A (GM/VW) effectively funded the war chest of System B. The profits from the "Golden Era" are now paying for the "Liquidation Era."
2. Implicit vs. Explicit Entanglement On Geely and BYD: You are correct that they avoided direct state ownership (Explicit Entanglement). But in System B, no one avoids Ecological Entanglement.
Li Shufu and Wang Chuanfu act as "Privateers." They don't take orders, but they sail on the State's Wind.
They benefit from the "System B Subsidy Stack": $0.08/kWh industrial power, heavily subsidized lithium processing, and aggressive municipal procurement.
They might not be "owned" by the government, but they are the apex predators of the environment the government built.
In the end, the distinction matters little to Detroit. Whether killed by a State Army or a State-Sponsored Privateer, the result is the same.
Helpful comment!
Anhui also has JAC, which has mostly exited passenger vehicles, selling the operation that made Sehol brand vehicles to VW (so VW has full control, it's not a joint venture). VW was going to use it as a pure EV production facility. I don't know the current status. Anhui's historically a poor province, and today autos loom large.