A lasting lesson on the fragility of global supply chains
They say when America sneezes, the world catches a cold. It would seem the same holds true for China. The coronavirus has erupted into an economic contagion as much as a biological one.
Supply chains in various industries and across multiple regions have been disrupted. Chief industries impacted include pharmaceuticals, automotive, logistics, and tourism. The automotive industry has been grappling with production deadlock on the account of Wuhan being home to multiple car plants.
Nissan, for example, has large factories in Wuhan which have been under shutdown, halting production. Even its European counterparts have not been immune -- Volkswagen, which depends on its Chinese plants for 40% of its production, postponed production.
Technology giants such as Dell Technologies, HP, Huawei, and Samsung are also expected to experience supply-chain shocks. From a regional standpoint, Asia will likely bear the brunt of economic shocks, particularly Thailand which has seen shrinking tourism revenue. The global commodities market has been affected with a sharp fall in oil prices.
Despite the widespread impact and the accompanying media storm, coronavirus is ultimately a temporary problem. From a policy perspective, China and other Asian countries have deployed monetary easing measures and fiscal stimuli. The disease itself is likely to be contained sooner or later.
What coronavirus, however, will leave us with is a lasting lesson on the fragility of global supply chains. Global supply chains of today exist as an interdependent, complex web of operations. Unprecedented mobility has made it possible and cost-efficient to outsource production to other countries.
Take the auto industry as an example. Long gone are the days of Henry Ford when cars were manufactured 100% in-house. Instead, today some 75% of automotive parts are not designed by car manufacturers themselves, but by various suppliers, often located elsewhere in the world.
Moreover, supply chains are more “on-demand” in nature. The Just in Time (JIT) inventory system, pioneered by Toyota in the 1970s, is an example of this. Here, low inventory levels are maintained, and raw material orders are placed closely in line with production schedules. The goal is to reduce wastage and maximize efficiency.
Despite the efficiency gains, the fragmented and spontaneous character of today’s supply chains make them more exposed to “Black Swan” events like the coronavirus. An outbreak or natural disaster in one country can set off a chain reaction somewhere else and before long, everywhere else. It is easy to imagine the disastrous implications of this if an integral sector like the food sector is affected.
Additionally, where manufacturers operate low inventory levels, putting trust in their supply chains, production gridlock is likely. In 1997, a fire hit one of Toyota’s parts-suppliers and Toyota was obligated to halt its production. This caused a domino effect where Toyota’s other parts-suppliers halted their production too, as Toyota had little use for them -- 99% of a car is as good as no car at all.
Today, this domino effect is amplified, as these interdependencies are global in nature. As such, production is shaping up to be a precarious zero-sum game.
Coronavirus also reveals the need to revisit our collective reliance on China as the world’s factory. One can compare coronavirus to the SARS outbreak in 2003 to see how significantly our dependency on China has risen. For one, China’s general economic importance has grown leaps and bounds. In 2003, China comprised 4% of the world’s GDP -- this has quadrupled to 16% in 2018.
China’s integration with the world’s supply chains is also higher than ever -- the nation accounts for 13% of the world’s exports, making it the world’s biggest trading nation. Intermediate goods made by China, which make inputs for other countries’ exports, rose to 32% of China’s total exports in 2018, compared to 24% in 2003.
Of course, this does not nullify the promise of globalization. But it is important for businesses to factor in these global risks when designing supply chains. This might entail diversifying sources of inputs across production facilities and across countries.
This is more important when Bangladesh apparel, textiles, consumer electronics, pharma and health care, plastic, leather, and essential commodities sectors are already apprehending big time supply challenges. So is India and many other developing countries, who shifted to low-priced sourcing to command global supply chains.
Mamun Rashid is a leading economic analyst.