Employees, wearing masks, work on a production line manufacturing display monitors at a TPV factory in Wuhan, Hubei province, the epicentre of the novel coronavirus disease (COVID-19) outbreak in China, April 7, 2020. China Daily via REUTERS ATTENTION EDITORS - THIS IMAGE WAS PROVIDED BY A THIRD PARTY. CHINA OUT.
Moving parts: Globalisation and world-encompassing supply chains are once again under threat, this time from the coronavirus pandemic © Reuters

The death of globalisation and world-encompassing supply chains has been foretold so often that it is hard to imagine it might actually be happening. The September 11 attacks in 2001; the Sars virus of 2002; the controversy in the early 2000s over offshoring services; the global financial crisis of 2008; the trade wars between Donald Trump’s US and Xi Jinping’s China.

All inflicted some damage on global trade. In particular, commerce in goods after the global financial crisis has grown more slowly relative to GDP than in the preceding decade. But while the expansion of supply chains may have decelerated, it has not stopped or gone into reverse.

Could Covid-19 be the blow that finally shatters them? Global goods trade is in freefall. The World Trade Organization forecasts this will contract between 13 per cent and 32 per cent this year. But what are the lessons for companies and governments?

On the supply side, there have been disruptions to production. China’s Hubei province, where the outbreak began, is a manufacturing hub producing components for cars, electronics and pharmaceuticals. Its factory closures were felt by downstream companies across the world. Closures of ports and airports, and rising air freight charges from cancelled flights, have also contributed to contracting trade. But the main problem is a lack of demand.

Employees work on a production line inside a Dongfeng Honda factory after lockdown measures in Wuhan, the capital of Hubei province and China's epicentre of the novel coronavirus disease (COVID-19) outbreak, were further eased, April 8, 2020. REUTERS/Aly Song
High tech hub: Dongfeng Honda’s factory in Hubei province, China’s epicentre of the coronavirus outbreak © Reuters

There have been some problems in food distribution, but this has held up well so far. According to Panjiva, a supply chain analysis unit of S&P Global, nearly two-thirds of participants at a recent event cited demand contraction rather than closure of suppliers or disruption to logistics as the main threat to company earnings in the short term.

Assuming the pandemic lifts and lockdowns end, the medium-term threat to long and complex supply chains comes from two sets of decisions. One is by companies concluding they have overexposed themselves to shocks. The other is governments trying to force businesses to diversify supply internationally or to bring their production home.

On the first, it is unclear whether shortening or diversifying supply chains would have helped companies avoid a global shock such as Covid-19. There is a strong view among some academics and management theorists that it would. Beata Javorcik, chief economist at the European Bank for Reconstruction and Development, wrote in the FT: “The quest to find the most cost-effective suppliers has left many companies without a plan B. Businesses will be forced to rethink their global value chains . . . the disadvantages of a system that requires all of its elements to work like clockwork have now been exposed.”

Some executives say it is not that simple. John Neill, chief executive of the British supply chain company Unipart, which sources components for the car industry, notes that UK manufacturers closed during Covid-19, so buying from closer to home would have made little difference.

Meanwhile, the costs of changing supplier — and sourcing from more than one provider to spread the risk — is prohibitively expensive for an industry as complex as carmaking. “You need to spend a great deal of management time and effort and expertise on actually making sure the supplier you have chosen has processes that are capable, reliable and repeatable,” Mr Neill says.

Companies in other countries are also sceptical. The Japanese government has created a $2bn fund for businesses to examine their supply chains and possibly reshore them to Japan or diversify outside the country. However, the initial reaction from corporate Japan was cool. Such reluctance can be explained by the basic logic of supply chains that has driven their expansion since the early 1990s.

The combination of labour cost arbitrage and clusters of specialisms push companies towards constructing a disaggregated international value chain. Executives look for the most cost-effective and efficient means of servicing a final market — but as Mr Neill says, that process in itself is neither cheap nor easy.

Two more supportive phenomena involving China have also emerged. First, China has become a massive consumer as well as a producer. Even if multinational companies from rich countries could source from cheaper alternatives, many want a footprint in China to sell as well as to buy. Those Japanese companies insisting they wanted to remain involved with China had this in mind.

Second, China has actively encouraged its companies to create supply chains with state help through the Belt and Road Initiative, which includes a strong motivation to service the European market. There will always be some life in global supply chains as long as the vast resources of the Chinese state are busy building infrastructure and establishing trading links across the world.

When the Covid-19 pandemic lifts and companies start making those decisions, they are unlikely to be uniform. Car companies with expensive and complex supply chains are less likely to change than garment manufacturers, which undertake simpler exercises in labour cost arbitrage and can switch more simply.

Executives will make those decisions in a newly politicised environment. Policymakers instinctively in favour of reshoring production, such as US trade representative Robert Lighthizer or EU internal market commissioner Thierry Breton, have seized the opportunity to argue that governments should actively encourage supply chains to be reshored.

Business representatives regard the wholesale interference of politicians in sourcing decisions as unwise. Anna Stellinger of the Confederation of Swedish Enterprise says: “The best way that governments can encourage efficient diversification and resilience is to restore business normality, removing export bans, facilitating airfreight and making sure that companies can send staff with key competencies to other countries.”

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