BYD's Demand for Government Subsidies Can Face Mixed Consequences

Sep. 9.09 | About: BYD Co., (BYDDF)

BYD (OTCPK:BYDDF) Chairman Wang Chuanfu is actively seeking commitments from the Chinese government to subsidize purchases of all-electric automobiles such as the e6 sedan as well as plug-in hybrids such as the F3DM model. While BYD has made some progress selling its plug-in hybrid F3DM vehicle to fleet customers, the cost has proven to be prohibitively high for private consumers in China. The Wall Street Journal reported on these developments in an article published Tuesday.

“Make or Break Juncture”

At 150,000 yuan, or $22,000, BYD is having trouble selling its plug-in hybrid vehicle within China:

“We’re at a critical make-or-break juncture in our effort” to make electric vehicles mainstream, Mr. Wang told the conference. To help accelerate an adoption of heavily electrified vehicles “the government needs to play a key role and help us reduce their cost, especially for private buyers.”

If the proposed government role is to be temporary, then it follows that BYD and other automakers would be able to use economies of scale to reduce per-unit costs of plug-in hybrid and all-electric vehicles once production volumes ramp up. At that point, the cost of ownership would need to be comparable to conventional gasoline and diesel vehicles to gain consumer acceptance.

What is often ignored, however, is that the appropriate measure should be cost of ownership over the life of a vehicle rather than the purchase price alone. To the extent that the electricity needed to power these vehicles would be less costly than the gasoline required to power an equivalent conventional vehicle, a case could be made in favor of the electric vehicle even if the initial price tag of the car is higher.

Subsidizing “Wealthy Private Buyers”

Sentiment within the Chinese government does not appear to be universally in favor of BYD’s proposal for subsidies:

One senior Chinese industrial policy maker, speaking at the conference Sunday, pointed to reservations among some Chinese officials about providing consumer incentives to spur electric-car sales. “Why do we need to provide subsidies and rebates for wealthy private buyers who would be the first in line to buy electric cars? That’s a question some of us in the government are asking,” said Chen Jianguo, a senior official at the National Development and Reform Commission, China’s main economic planning agency.

Indeed, this is the same question that must be asked in the United States where subsidies for electric vehicles are most likely to be used by wealthy environmentalists living in suburban locations with access to recharge points in private garages. Without wide access to recharge points, the initial buyers of all-electric vehicles will not be individuals who lack garage parking.

Government’s “Helping Hand” vs. Central Planning

If it is true that per-unit production costs will drop substantially as mass production volumes are realized, a case can be made for temporary government subsidies which must be withdrawn as mass production becomes a reality. These subsidies could be in the form of a rebate on all-electric vehicles or through subsidized electric power to charge the vehicles at off-peak hours. The goal would be to make the overall cost of ownership of all-electric vehicles competitive with conventional vehicles until mass production naturally lowers per-unit costs.

The negative aspect of government intervention, whether in China, the United States, or elsewhere, is that centrally planned industrial policies favoring targeted companies inevitably become entangled in the political process. The entire premise for temporary government intervention would be undermined, for example, if mass production fails to bring down per-unit costs. This would mean that ongoing subsidies would be necessary over the long term to keep the industry viable. Government intervention would then end up favoring “national champions” or politically connected companies in a way that corrupts rational capital allocation and reduces the overall economic well being of society.

Disclosure: The author owns shares of Berkshire Hathaway (NYSE:BRK.A). Berkshire Hathaway owns shares of BYD.