IMF Working Papers

European countries have set ambitious goals to reduce their carbon emissions. These goals include a transition to electric vehicles (EVs)—a sector that China increasingly dominates globally—which could reduce the demand for Europe’s large and interconnected auto sector. This paper aims to size up the tradeoffs between Europe’s shift towards EVs and key macroeconomic outcomes, and analyze which policies may sharpen or ease them. Using state-of-the-art macroeconomic and trade models we analyze a scenario in which the share of Chinese cars in EU purchases rises by 15 percent over 5 years as a result of both a positive productivity shock for car production in China and a demand shock that shifts consumer preferences towards Chinese cars (given China’s dominance in the EV sector). We find that for the EU as a whole, the GDP cost of this shift is small in the short term, in the range of 0.2-0.3 percent of GDP, and close to zero over the long term. Adverse short-run effects are more significant for smaller economies heavily reliant on the car sector, mainly in Central Europe. Protectionist policies, such as tariffs on Chinese EVs, would raise the GDP cost of the EV transition. A further increase in Chinese FDI inflows that results in a significant share of Chinese EVs being produced in Central European economies, on the other hand, would offset losses in these economies by supporting their shift from supplying the internal combustion engine (ICE) production chain to that of EVs.