TSLA 0.96%

will build a factory in Shanghai, the city government announced Tuesday, a move expected to boost sales in the world’s largest auto market but comes amid a broader trade dispute between the U.S. and China.

The electric-car maker will set up and wholly own the plant that is expected to produce 500,000 vehicles a year sometime next decade, the Shanghai authorities said in a statement. Tesla Chief Executive

Elon Musk

was in Shanghai to sign a memorandum of cooperation with Mayor

Ying Yong,

the authorities said.

Tesla is doing something that no foreign auto maker has done before: build a factory and a network of suppliers in China without the support of a local joint venture partner. The larger trade dispute also poses a risk to Tesla if the issues should create consumer backlash against American products.

Even so, China offers opportunities for growth—especially with electric vehicles—and building its own plant allows Tesla to keep all the revenue it generates, instead of having to share it with a Chinese partner, said

James Chao,

Asia-Pacific automotive director at

IHS Markit

“They’ll be able to control the process far more tightly than a [joint] operation.,” Mr. Chao said. “It frees them to build this the way they want to.”

Mr. Musk has been under intense pressure for the past year to ramp up production of the Model 3, the company’s bet that it can broaden its appeal to more mainstream buyers with a compact sedan that is supposed to start at $35,000.

He reached an often missed goal of producing 5,000 Model 3 sedans in a single week during the final seven days of the second quarter, a threshold that if continued throughout the third quarter should make the auto maker cash flow positive and profitable. Analysts have said Tesla will need to raised additional money in the future, especially to pay for Mr. Musk’s ambitious growth in China.

China is already Tesla’s second-biggest market after the U.S., selling about 17,000 cars there last year, compared with roughly 50,000 in the U.S. and 103,000 globally.

But those volumes are relatively small, and building locally, rather than importing, would enable Tesla to grow in China, where sales of electric vehicles are rising quickly, boosted by government policy. Chinese customers are projected to buy 3.5 million electric passenger cars in 2022, IHS Markit forecasts, up from 580,000 last year.

The Wall Street Journal reported last October that Tesla had reached an agreement with the Shanghai authorities to build a wholly owned plant in the city, but formal confirmation of the deal was slow to come amid regulatory uncertainty.

Beijing finally confirmed plans in April to phase out rules that have forced all traditional foreign makers, including Ford Motor Co. and General Motors Co., to manufacture cars with Chinese partners to avoid paying steep import tariffs.

Electronic vehicle makers are the first to benefit from the new government policy, paving the way for Tesla to move ahead this year. Foreign-investment restrictions on commercial vehicle makers will be lifted by 2020, and on all remaining auto makers by 2022. It remains to be seen whether auto makers with longstanding partnerships in China will attempt to emulate Tesla, given the complexity of dissolving joint ventures that have existed in some cases for more than two decades.

A Tesla spokesman said it would take about two years until the factory begins producing vehicles, and another two to three years before the facility is hitting its annual capacity of 500,000 vehicles. “Today’s announcement will not impact our U.S. manufacturing operations, which continue to grow,” the spokesman said in a statement.

That is an aggressive timeline that sets up 2020 to be a major year for Tesla. Mr. Musk has already said he plans that year to begin production of the Model Y, a new compact sport-utility vehicle, as well as the new Roadster sports car and Semi, a tractor-trailer truck.

Tesla does have at least one local ally, with internet giant

Tencent Holdings

having spent $1.7 billion on a 5% stake in the electronic-vehicle maker last year, and raising local capital to help build the Shanghai plant shouldn’t be a problem.

“If there were an opportunity for Chinese investors to go into Tesla, they’d do it in a heartbeat,” Mr. Chao said.

Imported Teslas just got more expensive in China after Beijing slapped a 40% tariff on cars imported from the U.S. last week in retaliation for new tariffs imposed by Washington.

Over the weekend, Tesla’s Chinese website increased by nearly 20% the price listings. A basic Model S sedan now costs about $128,400 from $107,300. Tesla employs about 1,500 people in China.

Total world-wide, the auto maker has about 40,000 employees with one assembly plant outside of San Francisco in Fremont, Calif., that aims to make 100,000 Model S sedan and Model X sport-utility vehicles this year plus as many Model 3s as it can. Tesla makes batteries at a factory outside of Reno, Nev.


Donald Trump

has put pressure on American manufacturers to invest in domestic production rather than build plants in places like China or Mexico. Last month, Mr. Trump publicly berated motorcycle company


over plans to shift some production from Kansas to Thailand. Tesla, though, has no plans to move any production out of the U.S.

Mr. Musk appealed directly to Mr. Trump via


back in March for help persuading China to reduce its then-25% tariff on auto imports, which he described as a handicap akin to “competing in an Olympic race wearing lead shoes.” China then granted Mr. Musk’s wish, lowering its tariff on autos to 15%, until Mr. Trump’s decision to place tariffs on Chinese goods, inducing Beijing to increase its own tariff on U.S. cars on July 6.

Write to Trefor Moss at and Tim Higgins at



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