Every country and company with exposure to China, whether on the supply or demand side, is feeling the slowdown. Countries in closer proximity and with tighter production links to China are feeling the worst effects of the slowdown (see following article), but no country is immune.
Producers who depend on goods from China are already feeling the pinch. A zealous pursuit of lower inventories has been rewarded by shareholders, but smaller inventories will be depleted faster. Apple was the first company to warn of missing sales targets due to unavailability of its products, but it will not be the last. It felt a shock of both supply and demand: Chinese factories could not ship its products at their usual volume, while Chinese consumers deferred their electronics purchases.
We expect the global economy to weather the COVID-19 outbreak, but its aftermath will bring scrutiny to fragile supply chains. The future could bring other epidemics, natural disasters and higher costs of shipping if carbon pricing takes hold. Business continuity assessments will surely take these risks more seriously. And the U.S-China trade conflict illustrated the political vulnerability of international commerce. Concerns about terms of trade and national security can derail productive relationships.
As tariff fears took hold, producers found shifting production out of China to be a difficult and expensive proposition. JIT has made supply chains difficult to move. A determined manager could close a factory in China and reopen in another country, but rebuilding a tightly integrated supply chain takes years of coordination. These efficiencies have made China a sticky destination, and it has been holding on to production even as its own labor costs have risen. China is no longer the cheapest place in the world to run a factory, but it remains the most efficient.
Trade tensions and a pandemic are shifting the conventional wisdom around manufacturing. In a world of good health and free trade, production will naturally flow to locations that offer the lowest costs and greatest efficiencies. But as uncertainty grows around the world, manufacturers may reconsider the benefits of dispersion and redundancy in their production processes. In this sense, COVID-19 could have a more lasting effect on global commerce.
Not Immune
While China’s was the locus of COVID-19, the virus has gained a foothold in Asia’s major economies. Japan and South Korea, the world’s third and 12th largest economies respectively, now claim the highest numbers of confirmed cases of the virus outside of China.
Japan and South Korea are highly vulnerable to supply chain disruptions. China is both the biggest export market in the world and a key source of goods imports for both countries. In addition, the outbreak threatens to slow domestic demand as residents spend more time in isolation.
The Japanese economy was already struggling before the outbreak, contracting in the fourth quarter of 2019. COVID-19 may cause Japan to fall further in the first quarter of 2020. Equity markets have fallen while the yen has depreciated, as Japan faces increased risks of recession owing to its dependencies with China.