Is The ‘Global Supply Chain’ Patient Sick?

Bottom line:

Chinese factories and the global supply chain have been in the headlines since the beginning of the COVID-19 epidemics. We believe that the virus outbreak will not have a lasting impact on the production capacity of the country.

China has emerged as a key player in the global supply chain and will maintain this position in the coming years.

The Impact Of The Coronavirus Is Unlikely To Last

When the Chinese factories sneeze, the global economy catches a cold

Chinese factories struggled to restart their activities after the Lunar New Year as the coronavirus (“COVID-19”) forced workers to stay at home. Given China’s role in the global supply chain, a worldwide domino effect was feared.

  • According to the World Bank, China accounts for 28% of the global net output of the manufacturing sector.
  • It has been the largest trading nation in the world since 2013.
  • China today represents 19% of worldwide GDP (approx. 3.5% in 1999).

A leading position in the global supply chain that is no coincidence

It took China over 40 years to become the factory of the world, thanks to economic reforms, a quasi-unlimited and cheap supply of labor, the creation of highly-incentivized industrial zones, and investments into its transportation network.

  • Seven of the top-10 world container ports are based in China.
  • The railway network is already the second-largest worldwide and will hit 175’000km of tracks by 2025 (from 131’000km in 2018).

A virus won’t harm China’s leadership in the global supply chain

COVID-19 will not significantly alter China’s role in the supply chain. China remains the only country capable of manufacturing goods in large volumes, at fair prices, and providing an efficient logistics network with a global reach.

  • At most, multinationals could review their business continuity plans and negotiate new clauses with Chinese producers to secure supply of goods.
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Economics Of A Quarantine

The financial impact of past epidemics

Pandemics are not necessary the first black swan event that comes to the mind of market strategists. It will take time to assess the total economic impact of COVID-19, even more since the virus spreads around the world. Comparison to recent epidemics is not easy, as they had lesser economic consequences.

  • SARS outbreak is often used as a benchmark, and it did cost about 0.5-1.0 percentage point of GDP growth to China in 2003.
  • MERS and Ebola occurred in less economically-important regions.

The importance of the inventory levels

A V-shaped economic recovery requires store shelves to remain full. Indeed, inventories were built ahead of the Lunar New Year festivities, creating a buffer for multinationals to look for alternative suppliers or temporarily relocate production.

  • According to Wells Fargo, U.S. retailers' inventories are enough to meet demand until at least mid-April.
  • Products manufactured with a just-in-time process and a complex supply chain, e.g., automobiles, are the most at risk.

COVID-19 impact is not limited to the production of goods

As organizations activated their business continuity plans, the outbreak turned into one of the most significant work-from-home programs in the world. The e-commerce share of retail sales is set to benefit from people forced to stay at home.

  • China is already a leader for e-commerce (approx. 35% of retail sales).
  • Chinese consumers spend nearly 5 hours per day on their mobile devices.

China Will Remain The Factory Of The World – For Now

Part of a long-term plan, Made in China 2025

The time when China was mainly producing goods with little value added is over. The country is implementing a multi-year strategy to become a technology-intensive powerhouse. Following COVID-19, China could double down its efforts to implement this plan and promote domestic innovation in IT, green energy, healthcare, etc.

  • The production of lower added value products shifted to Southeast Asia, a region where China is extending its economic and political influence.

An army of robots

As wages are on the rise and the population is aging, Chinese factories are investing massively in robots. Moreover, China is encouraging the development of its robot industry through subsidies attracting foreign investments. The Coronavirus situation could accelerate this trend as Chinese factories must be able to provide a minimal supply, in all types of situations.

  • China is the largest importer of industrial robots.
  • ABB will open in 2021, a new robotic manufacturing and research facility in Shanghai.

Potential risk from 3D printing

China will maintain its dominant position in the global supply chain as long as 3D printing remains in the developmental stage. The current outbreak could increase R&D spending and investments in this field, threatening China’s dominant position.

  • By producing components and goods locally, 3D printing could reduce global trades – and the world dependency on China.
  • According to ING, 50% of manufactured goods could be 3D-printed by 2060.
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Catalysts

  • New Silk road. To facilitate global trade and develop infrastructure, China is lending up to $8tn over >30 years to 68 countries, mainly in Central Asia, the Middle East, and Europe.
  • Made in China 2025. China is implementing a strategic plan to move higher the technology ladder. The country aims to compete directly with developed countries in the manufacturing process.
  • High human capital. Over the past few years, China has moved above developed countries in education. This young and educated population is entering the workforce and will increase innovation while preserving the competitive advantage on the supply chain.

Risks

  • Protectionism. Protectionism is globally on the rise. A significant increase in tariffs could have an impact on global trade – until the participants adapt to the new situation.
  • Seasonality of a virus. There are ongoing studies about the seasonality of COVID-19. If China was going to suffer a global shutdown every year due to a pandemic, major importers will have to look for alternative upstream suppliers located in other countries.
  • Third industrial revolution. In the long-run, increased automation and 3D printing have the potential to relocate the global supply chain closer to the final consumers.

Sources:
Data from World Bank and OECD as of February 2020, World Shipping Council, Ministry of Transport of the People’s Republic of China Wells Fargo, CNBC, International Federation of Robotics – World Robotics 2019, ING

Companies mentioned in this article:
ABB (ABB SW)

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