China's economic setback and broken supply chains will make businesses look elsewhere
High frequency indicators, like coal demand show that the Chinese economy slowed sharply in Q1. Since China accounts for 17% of world trade and 9% of world tourism over 40% of some commodities the effect could be massive. A sharp decline in world tourism is logical and likely, the question is more about its duration and damage. A more difficult question is about the weak commodity demand, customer confidence and the disruption in supply chains with its effect on China's geopolitical position.
China was in a severe trade war with the US since 2018 which already slowed down growth. Many travels and events were cancelled, at least 10 cities were locked down and multiple venues were closed to contain the new virus. Businesses in China were already cutting down on operations because of the Lunar New Year (which started on January 25th), but the closures were extended because of the virus. Many factories and businesses were told to stay for at least until 10 February closed, and according to CNBC International these hubs account more than 80% of China's GDP and 90% of its exports. China's tourism industry is in a huge descent, domestic rail trips plummeted 75%. China's box office revenues descended below 4 million dollars, whereas in 2019 it was over the same period 1.5 billion dollars.
The return to normal manufacturing operation has been slow due to travel disruptions and quarantine efforts disrupting the return of workers to factories following the Chinese New Year holidays. As workers in China are being kept home amid fears of spreading the coronavirus, it's causing delays in the manufacturing supply chain.
The fashion industry and other sectors are also facing huge challenges from the other end of the production chain: consumer demand. Pauline Brown, ex-chairman of North America at LVMH, the world's largest luxury company and owner of Louis Vuitton says the luxury market is already experiencing the effect of the virus, especially as Chinese shoppers don't travel to make big-ticket purchases in cities like New York and Paris. Brown says that, as the consumer landscape becomes focused on health, there is less demand for luxury goods. According to Brown "The Chinese people have been the biggest driver in luxury and fashion for the last 10 years,". "They comprise about one-third of all purchases of luxury, but they are more than 70% of the annual growth in luxury consumption. So there has been a disproportionate reliance for quite a few years in that consumer."
But not only has the consumer landscape changed. China's isolation resulted in the disruption of global trade and supply chains in the process. In the weeks following 20 January the shipping activity at China's major ports fell 20% as CNBC explains. Since oil prices have fallen as demand weakens, automakers from Nissan to Honda will be impacted, and American giants for example Apple and Nike will also be affected since they have crucial operations in China. China's intertwinement to the world economy is the greatest in history; therefore the whole world will be affected by China's epidemic in economic terms as well.
Such reports have caused stock markets to plummet. The last week of February was one of the worst since the 2008 financial crisis for both the Dow Jones Industrial Average and the London Stock Exchange. Fluctuations in the stock market may continue as the fear of the coronavirus remains in the next few months. Stabilization can be expected only if the spread of the virus comes to a halt or if a feasible solution is proposed. The global spread of the virus creates volatility, and the fluctuation could increase if fear-generating events happen like other outbreaks apart from Italy, South Korea, Iran etc. or the mutation of the virus.
Companies in a wide range of industries are extremely dependent on China both as a consumer market of more than a billion dollars and as a manufacturing giant. But as life in some regions of the country slows down drastically as a result of the outbreak, that reliance is more and more a weakness. As Gary A Wassner, the chairman of InterLuxe and CEO of Hilldun Corporation, both leading factoring and financing companies, said "The majority of certain products are only done in China and we became very dependent, and we allowed it to happen because it was cost-efficient, but that's not the only thing to consider."
Supply chains can get really complex, since the suppliers have suppliers of their own, who may, in turn, even have a third layer of suppliers. Therefore this whole intertwinement can cost a lot for companies with obscure or long supply chains. Even risk-averse Microsoft announced that its quarterly sales would be lower than expected as a result of the virus's impact on its supply chains.
Like Apple, companies around the world start to realize that their China-linked supply chains bring not only financial advantages but huge risks, too. And the Coronavirus won't be the last risk. China's inequality, recent protests in Hong Kong and authoritarian governing pose a threat that the stability of the supply chains will be broken in the future if the unexpected happens.
Instead, businesses should start to focus in the direction of diversification. Although, having additional suppliers in other countries would cost more, but it would also guarantee some stability in case of crises.
Long international supply chains pose an enormous vulnerability, not just to the companies relying on them but to the countries where those companies are based and where their products are delivered. Therefore it may also come to question, that countries will be motivated by what happens regarding the virus to create regulations on supply chains in crucial sectors like healthcare and defense sector. This way countries can make sure that if crises happen their population will be safe.
This all suggest that China is likely to lose its place as the manufacturing behemoth for first world countries. The degree of China's relegation from the focus will mostly depend on the severity of the outcome of the outbreak, how businesses will react and what options they will have, but it is already clear, that he is now the underdog of the crisis.
(Sources: OECD, ECOSCOPE, FP, Trowerprice, TIME, World Economic Forum, CNBC, MSNBC, New York Times)