Geo-economic impacts of the coronavirus: Global Supply Chains (Part I)

Introduction 

The outbreak and swift spread of COVID-19, though comparable to previous incidents such as the SARS-CoV virus outbreak in 2003, has had a far more severe impact for a number of reasons which inter alia, include China’s enhanced role  in the world economy and global supply chains. Back in 2003, China produced a mere 5% of the Global GDP, which has since increased nearly four times to 16%, with similar rises  in Chinese imports, exports,  services sector and tourism. Emerging as a public health emergency and global pandemic over the past few months, there have been 7 million confirmed cases of COVID-19 and nearly 4,00,000 deaths worldwide.  The resultant economic impact has also been devastating for most affected countries. In most instances, it can be traced back to China’s integral role as the “world’s factory.”

As the situation worsened in January, the response from China was drastic, with complete lockdowns of cities and provinces giving free reign to the surveillance state to control the lives of its citizens. The province of Hubei with a population of 58 million people was completely isolated from the rest of the country and millions of businesses worldwide, as it was placed in strict lockdown for months.

The adverse impact of a viral outbreak in a city was compounded greatly by the rate at which it can spread due to the efficiency of modern transport systems. The Chinese aviation sector being one of the largest in the world led to the rapid spread of COVID-19 across a number of countries. Beyond the impact on human lives, it has also exposed the pitfalls of placing complete reliance on one manufacturing hub. 

Through this two part blog post, two broad impacts will be addressed– in part one, the impact of China’s shutdown on global supply chains and economy and in part two, the implications for the future of 5G technology. The latter would also include how China has strategically leveraged its near monopoly status in certain sectors, its earlier recovery, and the vulnerable economic position of states as effective tools to further its lead in the all-important 5G tech race.  

BLOG POST 1 : Global Supply Chains

Disruption of Global Supply Chains

Internationally, the manufacturing industry is structured within the intertwined nature of global supply chains. This implies that a break in the flow of production and distribution of one part of the chain would have a compound effect on the interconnected global economy. It would prevent the manufacture of finished products in several other countries which are dependent on a specific region for components. However, these highly interdependent supply chains have only developed over the last three decades, with China’s extensive expansion and a massive push towards globalisation from the 1990s. China emerged as an industrial hub for several reasons which inter alia include: a low-cost workforce, extremely efficient manufacturing capabilities, lower tax rates, and streamlined logistics – placing it miles ahead of competing developing economies. This would provide companies with two particular benefits – extremely low production cost and a significant increase in profit margins. For businesses in the West, it became nearly impossible to compete with another that was manufacturing in China because they had significantly larger margins to undercut them on cost. Thus, businesses globally gravitated towards China as a manufacturer and provider of essential components with no readily available alternatives. 

The resultant global supply chains tend to be rather opaque in their functioning, due to the prohibitively high investment of time and resources required in supply network mapping (the process of figuring out where each component of a product is sourced from).  As a direct consequence, most companies tend to not have sufficient clarity on when disruptions are likely and no conceivable back-up plans. This has been witnessed in previous disasters such as the 2011 tsunami and earthquake in Japan when several automobile companies were oblivious to the supply chain disruptions for several weeks and production was halted globally.  Yet, the troubles caused by placing reliance on a single supplier has not led to companies across sectors taking major steps to remedy the situation. 

The lack of prior estimation of such an incident and creation of response plans despite a similar, albeit much smaller coronavirus outbreak (SARS-CoV in 2003) recently, has halted production across sectors US, Germany, France and others. The global supply chains have broken down in sectors ranging from machinery, aviation,  pharmaceuticals, medical equipment, apparel, automobiles, and technology.  This is majorly due to the limited inventories and paucity of substitutable source for components. 

As per reports of a survey conducted by the Institute for Supply Management, nearly 75% of companies have faced supply chain disruptions due to China’s lockdown measures and transportation restrictions – showing the level of unpreparedness that most businesses are at within the current global crisis. A second study conducted by Dun & Bradstreet  found that nearly 51,000 companies had direct suppliers in Wuhan itself – and the province has facilities which are Tier-2 suppliers for nearly 5 million companies in the world. Both multinationals and small businesses depend on China for either finished products or essential components – this enhances the economic impact with production being disrupted across all levels. So when China’s factories are closed, half the world’s factories across diverse sectors cannot continue production beyond the inventory they possess. 

Excessive dependence?

The Sino-American Trade war had already stressed supply chains sufficiently over the past two years and China’s shutdown ended up being the last straw. Two key areas that have been impacted – critical medical equipment production (given the public health emergency) and the technology industry. The two have also been strategically linked by China to extract important geo-political benefits. 

The response to the pandemic exposed the world’s over-dependence on China for key medical equipment including PPE, ventilators, and N95 masks which became highly valued as infection numbers rose.  China produced nearly half of the world’s N95 respirators before the pandemic and with production in overdrive, it accounts for 85% . With China looking to use it as a bargaining chip, it had soured US-China relations further.

China’s integral role in the global electronics and technology industry produced a definitive impact on production for US companies and the rest of the world.  Even the smartphone market which has witnessed consistent growth over the past decade has seen a decline in the first quarter of 2020. Apple was one of the first tech companies to acknowledge the impact on revenues and smartphone sales world over. Thus, the shutdown of China’s factory floors had created a supply side problem which soon evolved into a demand crunch due to lockdowns being imposed in all major economies. 

The smartphone market demand crunch is indicative of a larger pattern of a sharp fall in demand across industries in the West. South Korea, one of the top exporters, has witnessed a 46.3% fall in exports as per its May numbers. Even in early March, a UNCTAD report estimated that global value chains had already suffered a loss of $50 billion, due to COVID-19 related shutdowns, of which the major impact has been on the US, EU, Japan and South Korea. Just two months later, the estimated losses to the global economy stand at $5.8-8.8 trillion, as per a report by the Asian Development Bank. China’s production shutdown along with the continued spread of COVID-19 has caused a catastrophic domino effect for the global economy which cannot be overstated.

Path ahead for Global Supply Chains & China’s Role

China has been slowly trying to get production back up with increased safety measures in place and stood at around 80% of earlier levels in April. Nonetheless the devastating impact of the pandemic has caused several states to re-evaluate their strategies of complete reliance on China for essential components. The sole dependence on China for essential components must be cut down despite the lower margins it provides simply because of the possibly incalculable damage caused by such an event. 

An overarching trend among countries largely dependent on China has been their government’s push to decouple from China’s supply chains by setting-up of manufacturing facilities in South-East Asia. A number of businesses had been considering a transfer of part of their production centres to other Asian countries including India and other South-East Asian nations. These include the US tech giants – Apple, Microsoft and Google as well as Samsung, Intel, Nike and Adidas, that are considering a shift in partial production to Vietnam and Thailand. As a reactionary measure, governments in the United States and the EU have announced economic stimulus packages with figures in trillions. Within these stimulus packages some countries such as Japan have offered incentives in billions of dollars to firms for shifting production out of China.  

Even though the US had signed phase one of a “historic” trade deal with China in January 2020, signalling a short truce after the trade wars, Trump has pushed the pedal back on sanctions in May. These include sanctions targeting Huawei to cover up loopholes which allowed American companies with facilities abroad to continue supplying components to China - including the all important semiconductor chips used in most Huawei devices and 5G base-stations. China has stated that they will retaliate with  all necessary measures suggesting the trade wars are only likely to heighten once again. There have also been reports that China, taking a leaf out of the US’s ‘lawfare’ strategy, intends to launch innumerable investigations into US tech companies in retaliation. The sanctions could include investigations into companies such as Apple, Cisco, and Qualcomm that are heavily reliant on Chinese suppliers along with a prospective ban on Boeing aircrafts being purchased in China. 

In light of the fresh sanctions and pressure on Johnson from his own party, even the UK has announced its intentions of forming a 5G alliance of democratic nations - the D10 - independent of Chinese reliance. (US sanctions on Huawei and the 5G alliance will be addressed in further detail in Part Two). China’s economic sanctions against Australia as retaliation for official investigations demands on the origin of the virus has caused Australia to consider reducing complete reliance on China as the primary market for its goods but stopping short of decoupling due to their mutual dependence. 

Another strong indicator of a prominent economy looking to limit China’s impact in its economy and supply chains has been India’s move to block the automatic FDI route for neighbours given the “volatile business climate” in the COVID-19 hit economy. India’s clear intention is to prevent hostile takeover of businesses in India by Chinese firms and their rising commercial  influence in India’s markets. All of these moves certainly suggest that several major economies are looking to reduce their economic reliance on China and diversify their supply chains. 

With several countries looking to decouple their supply chains from China, geo-economic relations could be starkly different from the standards of normalcy. However, shifting production away from China and reducing their dependency presents several complex obstacles. China’s infrastructure and supply of highly-skilled workers in the technology and electronics industry are difficult to replicate elsewhere. Creation of adequate replacement for component manufacturing particularly is likely to take several years to develop capacity and infrastructure as well. Even if manufacturing processes are shifted outside China, companies may still have to rely on China for component sourcing, one of the major causes for the current breakdown of supply chains. Nintendo had partially transferred production of Switch consoles to Vietnam in 2019. In the wake of China’s shutdown, the console has been unavailable in stores since component supply dried up from China. 

Even if a large swathe of countries is miraculously successful in reducing their economic reliance on China – the pattern of continued dependence displayed by companies like Nintendo in the technology sector point towards China’s continued importance. Its domination in 5G network infrastructure is also likely to continue - as will be mentioned in the subsequent blog post- this further entrenches the world’s reliance on China in the manufacture and deployment of technology. China is already slated to lead the global economic recovery since it is well ahead of other states and one of the only major economies likely to grow this year. 

China has also displayed a willingness to take action to kickstart the process of global economic recovery by engaging and providing aid through several multilateral fora - including the ASEAN, the Central and Eastern European States under its controversial 17=1 Mechanism, the ten Pacific Island states, and the Arab League. The US, under Trump, has been adopting a policy of ‘America First’ which led to a lack of crucial international cooperation during the pandemic with other countries adopting export controls on essential products too. Furthermore, the US decision to cut funding from the WHO in the midst of a pandemic only brought further harms to their soft power and position as an international leader. The key advantages held and actions taken by China, in contrast to the US’s apathy could ensure their emergence as a winner in the emerging global economic order of the post-pandemic world.  The control of global supply chains entrenched in Chinese domination seems unlikely to witness a radical shift because of the very over-dependence on China. This factor coupled with its earlier economic recovery from the pandemic highlight the importance it will continue to play in global economic affairs.    

(Nikhil Dave is a student at the West Bengal University of National Juridical Sciences and a researcher at CIS. This post was edited and reviewed by Arindrajit Basu and Aman Nair)