In Shanghai last month I was puzzled by one of the VW Jettas by the hotel. It didn't look quite right. There was no VW badge and the window line looked slightly different from the version we have here. I wondered whether there was a custom-car craze in China and this one had been tarted up by its proud owner. Then I saw another, and another.

I discovered that these were not VWs at all. There are a lot of Jettas around Shanghai because they are assembled there under a joint venture. But these near-Jettas are actually clones, copies of the original produced in a rival factory and sold 20 per cent cheaper. The VW people were less than thrilled but there was not much they could do about it. There are several other clones of western cars in China. Indeed, there was one case this year where the clone was launched before the actual model, the new Chevrolet Spark. I imagine GM are none too pleased, either.

Of course, cars have been produced under licence for years, the licensed models often modified and improved, though not always. Some poor Chinese are driving around in local versions of the Austin Maestro. But this is different. China is potentially the world's largest car market and is already the fastest-growing. Its wage levels are one-fifth of those of Western Europe or America. But it can produce manufacturing quality akin to that of the developed world, maybe better, because many of its plants are new.

This leads to the tough question: what can the developed world do that China cannot do more cheaply? The challenge is different from that posed by Japan a generation ago. Japan made big inroads into the US and European markets but its own cost base rose rapidly and it was forced into local production for many of its models. All thanks to Nissan, Honda and Toyota, because Britain has been an important beneficiary of that trend.

But China's cost base will remain low. Unlike Japan, it has a huge surplus of labour moving in from the land which will hold down wage rates for a generation at least, and its domestic market is potentially much larger. While at present foreign producers have some influence through these joint ventures, by 2010 China plans to have half of its domestic car sales produced by local firms without foreign connection. It would be odd if it did not want to export some of those too. The potential to flood our market with cheap cars is huge.

Obviously, VW is not going to bring in its regular Jettas made by its Chinese partner if it does not want to. And WTO rules would keep out the clones. To some extent, the West is protected by a combination of branding and design skills; that is how BMW manages to charge a premium for its products. But in a few years who is to say China will not have either developed designers who can challenge European and American ones, or it will have hired them from us.

They couldn't do it? Well, remember what they said about Japan. In 1954, John Foster Dulles, then the US Secretary of State, dismissed Japan as a commercial threat to America. "The Japanese don't make anything the people in the US would want." And in 1979, when Japanese car imports were starting to build, Business Week scoffed: "With [more than] 50 foreign cars on sale here, the Japanese auto industry isn't likely to carve out a big slice of the US market."

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