Tesla Plant in China May Be a First

BEIJING — Tesla is moving closer to becoming the first foreign car company to have a wholly owned manufacturing operation in China — but how much that will help the company is not yet clear.

For Tesla and other car manufacturers, many of the options in China are guided by the government. One option is to set up a joint venture and share much of its technology — and half the profits — with a Chinese partner. The other is to manufacture in a so-called foreign trade zone in China but still be subject to steep Chinese import tariffs on any cars sold in the country.

Carmakers usually end up in a joint venture and have to share their technology. Tesla, however, is taking a different path that reflects the importance the Chinese government is putting on electric cars.

The company has a preliminary deal with the Shanghai municipal government that would give Tesla ownership of its facility, two people familiar with the negotiations said on Sunday.

The operation would be located inside a free-trade zone, said the two people, who insisted on anonymity because they were not authorized to discuss the talks. Being inside a foreign trade zone means that unless Tesla can negotiate a special exemption, the cars could still be subject to China’s steep tariffs — treated as though they were still being shipped from outside China even though they were being produced in the country.
The preliminary deal still offers Tesla control over its trade secrets, however, and may give the company leverage to negotiate better terms with the Chinese government in the future.

Tesla hopes to complete the deal by the end of the year, the two people said.

Any comprehensive arrangement would still require the approval of the central government in Beijing. The Beijing authorities have sometimes used their power to delay deals or demand further concessions from foreign investors.

Persuading Tesla to build cars in Shanghai while still paying tariffs on them would be a coup for the Chinese government, which has tried to turn China into the world’s dominant producer of electric cars. If Tesla were making cars in the Shanghai area, it would have a powerful incentive to buy many, if not most, of the parts in China, strengthening China’s base of suppliers for the fast-growing electric car industry.

China already has the world’s largest market for electric cars, mainly because of extensive subsidies as part of a comprehensive government plan to shift the country away from gasoline-powered cars. The shift would not only curb pollution but also reduce the country’s dependence on imported oil. LMC Automotive, a global consulting firm, estimates that 295,000 battery-electric cars will be sold this year in China, compared with 287,000 in the rest of the world combined.

That gap may widen. LMC predicts that China’s total will nearly triple in the next two years, while the rest of the world’s will merely double. That is because, in part, Chinese government regulations will require automakers starting in 2019 to sell ever-increasing numbers of electric cars and plug-in hybrids if they want to be allowed to keep selling gasoline cars. China has also begun research on imposing a rule to ban the sale of internal combustion cars someday.

Bill Russo, the founder and chief executive of Automobility, a Shanghai consulting firm, said that Tesla had little commercial choice in starting to build cars in China.

“China is and will be the largest consumer and producer of electric vehicles in the world,” he said. “If Tesla hopes to compete as a global electric vehicle maker, it must tap the manufacturing and supply footprint of China in order to compete globally.”

China has the steepest barriers to automotive trade of any large market in the world, making it difficult to compete in the Chinese market without producing in the country. Beijing has been able to retain steep tariffs and other obstacles to imports because it insisted that it was a developing country when it entered the World Trade Organization in 2001.

The W.T.O. has allowed developing countries to retain much higher trade barriers than industrialized countries, on the theory that they have infant industries that may not have grown big enough to withstand global competition. Today, however, China has the world’s largest auto industry.

China charges a tariff of 25 percent on imported cars, compared with 2.5 percent in the United States and 9.8 percent in the European Union. China also has a 17 percent value-added tax — a kind of sales tax — that is charged not only on the price of the car but also on the tariff, so that the taxes are effectively compounded.

Unlike these taxes, the costs of shipping a car across the Pacific are tiny. They can be as little as 1 percent of the cost of a high-priced model like Tesla’s offerings. “Shipping costs are usually not a big deal — it is the 25 percent tariff” that keeps out imports, said Yale Zhang, the managing director of Automotive Foresight, a Shanghai consulting firm.

Robert Lighthizer, the United States trade representative, has expressed concern about China’s trade practices. President Trump is set to visit Beijing from Nov. 8 to 10, but China has shown little sign of willingness to negotiate on sectors that it regards as strategic imperatives, and electric cars are one such industry.

If the deal does come to pass, Tesla would have achieved a breakthrough of sorts in being preliminarily allowed to have a wholly owned operation in a foreign trade zone. Honda also received permission to set up a majority owned operation in a foreign trade zone more than a decade ago, but unlike Tesla, it has been forced to export the output from that factory, mainly to Europe.

Tesla said in June that it was negotiating to produce cars in Shanghai. But the company has been struggling to decide whether to produce inside or outside a free-trade zone in Shanghai and on what terms.

The Wall Street Journal reported on Sunday that Tesla had a deal to produce cars in Shanghai. The Shanghai government declined to comment on the status of the talks with Tesla.