Coronavirus and supply-side disruption: Lessons not learnt from the past

The immediate outlook for the Chinese economy worsened with international agencies and global banks revising down the growth forecast for the country in view of disruptions arising from the coronavirus epidemic.

Investment bank Morgan Stanley predicts a 3.5% GDP growth for the country in the first quarter of 2020 (January-March quarter) and its adverse impact is being felt across the globe. Shipping rates have fallen to a record low, oil demand is expected to grow at its lowest rate in almost a decade, and many companies across the world are planning to cut production because of supply-side shortage.

It is easy to understand why. China contributes 19% to the global output. It is the second-largest economy in the world and imports a wide range of items such as commodities (like crude and manganese) and intermediate goods used to manufacture everything from hairdryers to automobiles. It is also one of the largest exporters of the world’s electrical machinery equipment (26.6%) and computers (17.2%). According to the U.S. Central Intelligence Agency (CIA), exports of medical equipment from China are worth $71.4 billion and that of iron and steel articles is worth $65.5 billion.

It is also home to major parts of the global supply chain networks that produce goods from textiles to mobile phones and cars. An extended shutdown of production lines in China will not only affect the supply of those products but also hurt other markets’ ability to produce goods.

For instance, Foxconn, the world’s largest contract manufacturer of electronics and a key player in Apple’s supply chain, said its revenue would take a hit from the spread of coronavirus, and that it would be “cautious” in resuming work at its factories in China. Plants outside of the country, in places like Vietnam and Mexico, were at full capacity, the company said.

Similarly, global car majors are fearing shutdowns because of supply shortages. Auto parts shortages have forced Hyundai to close plants in South Korea and Fiat Chrysler to make contingency plans to avoid the same result at one of its plants in Europe. According to S&P Global Ratings, the outbreak will force carmakers in China to slash production by about 15% in the first quarter. On February 16, British carmaker Jaguar Land Rover said that it would start to run out of parts in two weeks’ time and that it had flown in emergency supplies.

Luxury goods makers are terrified about the absence of rich Chinese tourists travelling abroad and buying their goods. According to news reports, British brand Burberry has closed 24 of its 64 stores in mainland China, and its chief executive warned on Friday that the virus is causing a “material negative effect on luxury demand”. Dozens of global airlines have curtailed flights to and from China.

Yet the critical question remains: Why has the world not learnt the lessons from earlier supply-side disruptions like the oil crisis of the 1970s, or in 2007, the SAARs crisis of 2003, and the impact of tsunami on Japan and continued to depend on one country for most of its intermediate and final products, instead of diversifying its product portfolio from different countries?

The decision to stop exporting oil to the U.S. on October 19, 1973, by the 12-member Organisation of Petroleum Exporting Countries, for instance, led to a steep hike in crude prices in the next six months. It rose from an average of $25.97 per barrel in 1973 to $ 46.35 per barrel in 1974, and the prices never came down.

The oil crisis ended three decades of unprecedented growth and led to what has come to be known as “stagflation”—high prices of goods accompanied by low economic growth. “When supply is constrained prices can accelerate even as the economy wobbles,’’ explains Sunil Sinha, principal economist with India Ratings and Research. It poses a huge challenge to the central bank, adds Sinha, because it has to decide whether to reduce inflation by hiking interest rates or to push growth by keeping policy rates intact, especially at a time when the economy is already facing serious headwinds.

The shock of the oil price hike not only forced many U.S. companies to seek new suppliers but oil traders and companies were forced to look for new supply lines and resources. The high transport and transaction costs in finding new players added to the already high price of the fuel. Many economists believe that it was one of the reasons that led to the recession in the U.S. in the 1970s. Similarly, high oil prices in 2007—crude touched a record $147 a barrel—the U.S. went into recession because of a collapse in household consumption.

Similarly, the Severe Acute Respiratory Syndrome (SARS) outbreak in China in 2003 saw the global economy lose $40 billion if SARS is seen as a single event, versus close to $54 million if it is seen as a recurring event, according to a paper by economists Jong-Wha Lee and Warwick J. Mokebben in their paper “Estimating the global economic cost of SARS”. The higher cost for the recurring event was because it also included the cost of the loss of investment and the impact on confidence and therefore spending on 2003.

However, to compare China of 2003 with that of 2020 would not be correct because China has grown by nearly four times in these years and its inter-linkages with the global economy are far more than before. Various studies have shown that China could have grown by 0.5% to 1% if it had not been disrupted by SARS.

The challenge today before the world is to build new and more resilient and diversified production supply chains, otherwise, there is always the threat of a new and more dangerous coronavirus, destabilising the global economy.