European automotive industry: Defense companies and The fight for "Made in EU"

In 2026, the European car industry is undergoing one of the most significant structural changes in decades, and the phenomena such as creating new production capacity's trough defense sector, or an influx of foreign capital and the sharing of production facilities are closely related such as sides of the same coin.

The surplus capacity is both acute and long-term.

The analysis examined data from 108 automotive plants in Europe and revealed that 69 of them were producing at less than 80% of their capacity, which is regarded as the lowest threshold for achieving profitable operations. In older EU member states, capacity utilization often hovers around 50-60%, particularly affecting manufacturers from these older member countries. A combination of weak demand for electric vehicles, strict emissions limits, and increasing Chinese competition is creating pressure that has forced companies to physically close or redirect factories – Volkswagen has closed a production plant (Audi Brussels) for the first time since 1988 and is also shutting down in Dresden. Nissan has already closed its factory in Barcelona.

Unquestionably accepted trend?

The arms industry has become a natural outlet for these excess capacities – and it's politically easier to justify than subsidizing loss-making civilian production. Volkswagen has confirmed that its factory in Osnabrück will stop producing civilian cars starting next year, and the group plans to lay off 100,000 of its 660,000 employees by 2030. Instead, the factory will focus on producing components for the Israeli missile defense system Iron Dome in collaboration with Rafael – specifically trucks, launch systems, and e-generators, with production expected to start in 12 to 18 months.

Mercedes is also in talks with the French-German defense group KNDS about leasing part of the Ludwigsfelde plant near Berlin. The group's CEO, Ola Källenius, emphasized that car manufacturers can produce exactly what defense companies need – precise manufacturing in large volumes. Suppliers like Schaeffler and Deutz are also following a similar path by establishing their own defense divisions. Schaeffler launched a defense division last year that produces engines for drones, systems for armored vehicles, and components for military aviation, aiming to contribute 10% to its revenue. Traditional engine manufacturer Deutz shifted its focus to the military sector after 2022, and Rheinmetall has decided to convert two of its factories, originally focused on automotive components, to defense production.

Chinese manufacturers could be a "smart solution"

At the same time, the available capacities are attracting Chinese car manufacturers. VW's CEO, Oliver Blume, openly stated that sharing unused European production capacity with Chinese manufacturers could be a "smart solution" since the company is reducing its global production from 12 million to 9 million vehicles per year. The former VW factory in Dresden is of interest to BYD, Xpeng, and MG, and according to sources from CarNewsChina, they are not the only ones interested in VW's vacant spaces. BYD is already building a European production base in Szeged-Hungary, which is expected to have an annual capacity of 300,000 vehicles. Recently, the Chinese company MG announced the construction of its first European manufacturing facility in Galicia's Vigo, which will create 2,000 jobs.

"Made in EU"

Under what conditions will a Chinese brand car truly be considered "Made in EU"? There are actually three layers of rules that can easily get confusing. The first is the standard EU customs origin rule (known as non-preferential origin), which states that simply assembling imported Chinese parts (CKD/SKD kits) is not enough to qualify for European origin – there must be "sufficient processing". Otherwise, even with European assembly, the car is still viewed as a Chinese product subject to anti-subsidy tariffs. Although manufacturing in the EU avoids the 17% anti-subsidy duty, the standard 10% import tariff on components remains, and the origin rules can be tricky when assembling from Chinese kits. This is exactly why BYD is shifting its focus to the Hungarian plant, which has a higher level of European added value, instead of relying on contract manufacturing in Turkey.

Accelerator Act (IAA) combustion cars vs. e-vehicles

The IAA focuses solely on electric vehicles, not on combustion cars – and this is not a coincidence, but a logical outcome of the statistics that the Commission itself uses to justify the proposal: for cars with combustion engines, the share of European content typically exceeds 80%, while for battery electric vehicles, it is below 50%, mainly due to imported batteries.

Therefore, combustion cars essentially do not need regulation, as they already naturally meet the 'Made in EU' standard thanks to established European supply chains (engines, transmissions, exhaust systems, etc. are mostly produced in the EU).

The issue that the IAA addresses is specifically related to electric mobility, where Europe has lost control over the battery supply chain in favor of China and South Korea.

According to the proposed regulation (Annex III), the 'Union origin' pertains to electric vehicles (pure battery electric vehicles, plug-in hybrids charged from the grid, and hydrogen fuel cell cars) and must meet the following criteria:

• The final assembly of the vehicle must take place in the EU,

• At least 70% of the value of components (excluding the battery, calculated from 'ex-works' prices) must have Union origin,

• The traction battery must contain at least three main components (including cells) of Union origin – after three years from the regulation's entry into force, the requirement will tighten to five components (including cathode material and battery control electronics), and additionally, at least 50% of the value of the e-drive unit and 50% of the value of the main electronic systems must also have Union origin.

These rules, however, do not apply to the regular sale of cars to anyone – they only serve as a condition for accessing public contracts, public financial support, "emission supercredits" for small electric vehicles (the new M1E category), and for targets related to clean corporate fleets.

A combustion engine vehicle does not need to meet this condition at all, as it either does not fall under these schemes or its European origin is addressed differently (and effectively without issues).

A separate topic is the framework for reviewing foreign investments (ownership cap of 49%, requirement for a share of employees from the EU) – this is linked, according to the proposal, to investments in so-called "emerging strategic sectors": electric vehicle production, battery technologies, and critical raw materials for batteries (lithium, nickel, cobalt, manganese).

The focus is specifically on electromobility and batteries, not on the production of combustion engines as such – although a Chinese investment in a combustion car assembly plant in the EU would likely be subject to different, more general rules for reviewing foreign investments (which already existed before), rather than this specific point of the IAA.

For Chinese car manufacturers, this practically means: for combustion and traditional hybrid models, the current customs and origin rules are relatively easy to meet, provided they ensure sufficient processing in the EU. The real pressure for localization (batteries, e-drives, electronics) fully shifts to them only with the rise of electric vehicles – and that’s why BYD, MG, and Xpeng are so intensely working on building European gigafactories and assembly plants specifically for their electric models, while they are not establishing similar operations for combustion cars, which are on the edge of profitability.

These are not random coincidences, but rather a manifestation of a single logic – the European civil automotive industry is losing its price and technological competitiveness faster than it can restructure, and the available space (both capacity and political) is automatically filled by two players who have a clear interest and ready cash: The defense sector driven by an unprecedented increase in European defense budgets and Chinese manufacturers with excess production capacity at home. The question of whether this will lead to a healthy diversification (with cars and defense, European and Chinese production coexisting) or merely a slow deindustrialization of the traditional automotive industry disguised with new labels remains open – and critics argue that the IAA in its current form lacks the sharpness to decisively favor Europe.