Coronavirus: As crisis drags on, cracks show in global supply chains

After decades of offshoring manufacturing to China, the disruption to supply chains caused by the Covid-19 outbreak may prompt some sectors to consider diversifying production
The car and smartphone industries have proved quite vulnerable

Neal Kimberley

Published: 1:00am, 19 Feb 2020

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China’s Foreign Minister Wang Yi believes that the adverse effects of the coronavirus on the Chinese economy will be temporary. There’s no reason why that shouldn’t be the case. But that doesn’t mean there won’t be consequences, both at a domestic and an international level.

“I believe, once the epidemic is over, the depressed consumption demand will be unleashed quickly, and the economic momentum will have a resilient rebound,” Wang said in Germany last Thursday.

Of course, once the epidemic is over, there must also be an investigation into why and how the outbreak began and spread in the first place.

Public disquiet about the way local officials reacted to the outbreak in Wuhan won’t be assuaged simply by the removal of senior officials from office in Hubei province. The central government needs to reinforce its political legitimacy, and it is in its own best interests to follow up on the botched local response and usher in systemic reform at the national level.

Political legitimacy matters, even under China’s system of government. But it can be built on a number of different foundations.

Back in 1970, German political scientist Fritz Scharpf defined two major types of political legitimacy: legitimacy through participation and legitimacy through performance. Applying Scharpf’s definitions, and given the absence of democratic accountability in China, the political legitimacy of the Chinese government rests on performance.

Beijing is painfully aware that the way the outbreak was initially handled in Wuhan has done nothing to enhance the performance legitimacy of the local and central governments.

How China’s ‘controlocracy’ lost control of the coronavirus

At a practical level, if, as has been asserted, the coronavirus – which causes the disease now officially known as Covid-19 – emerged from inadequate sanitary and phytosanitary conditions in a live animal and seafood market in Wuhan, then a national clampdown on such wet markets is necessary and inevitable.

Of course, that begs the question of why the Chinese authorities had tolerated insanitary conditions in wet markets up to now, though that issue is likely to be glossed over.

But even as Beijing concentrates on domestic measures that will have economic and social implications domestically, global business needs to consider what lessons it can learn from the coronavirus outbreak in China.

As the second-largest national economy in the world, China both lies at the heart of global supply chains and is a key consumer market relied on by manufacturers.

The outbreak has opened up vulnerabilities in global supply chains. Indeed, after decades of offshoring manufacturing to China, the disruption to global supply chains caused by the Covid-19 outbreak may prompt some businesses to consider diversifying or reshoring some parts of production.

Coronavirus chaos lays bare the price of being a linked global economy

The car industry is a case in point. Reliant on just-in-time delivery of components to assembly plants, firms such as South Korea’s Hyundai Motor have had to halt production outside China due to a lack of car parts from Chinese factories – factories that have been temporarily, understandably shuttered as part of a drive to contain the spread of the disease.

It remains to be seen whether such reliance, or should it be over-reliance, on China for car components is fully compatible with the just-in-time production process. Some automobile manufacturers might decide that changes need to be made.

In the global smartphone industry, senior executives may also be having a similar thought process. Taiwan-based Foxconn Technology Group, which assembles the vast majority of the world’s Apple iPhones at its Zhengzhou facility in central China, may have resumed some operations there last week but it remains to be seen when the factory can get back into full production.

It also remains to be seen whether senior executives at Apple’s headquarters in Cupertino, California will regard the coronavirus-related dent in iPhone production as just a hiccup or a supply chain vulnerability that needs to be addressed.

Separately, the effect of the Covid-19 outbreak on energy prices might point to vulnerabilities in parts of the oil extraction industry.

Low borrowing costs and a reasonably strong oil price is a combination that has helped fuel the expansion of shale oil production in the United States, even though the break-even prices are relatively high compared to places like Saudi Arabia.

But when the oil price falls and stays low, such projects become uneconomic. Lenders to the shale sector start to get twitchy. Many US shale oil executives must be hoping China’s economy will rebound smartly and the oil price will bounce back.

Covid-19 is a major threat to public health but it will have consequences that extend beyond the realm of epidemiology.

Neal Kimberley is a commentator on macroeconomics and financial markets

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