Why Coronavirus Triggered the First Global Supply-Chain Crisis

The only reason why there is no shortage of goods in American markets is that the epidemic outbreak was close to the Chinese New Year and that shipping by sea to either the US or Europe takes, on average, 30 days. Monetary and fiscal policy can do very little to prevent major economic consequences. 

 

 

In 2011, tsunami waves damaged the Japanese nuclear plant of Fukushima. The second worse accident in the history of nuclear power generation had many unpleasant consequences. From a business standpoint, one noteworthy consequence was that Apple customers had to wait more than six weeks to get the iPad 2s they had ordered.

 

The Fukushima accident was not comparable to the coronavirus shock, but it was more than enough to have a major impact on the Apple supply chain. The battery of the iPad 2 includes a resin called Polyvinylidene Fluoride (PVDF), and 70 percent of the PVDF market is controlled by the Kureha Corporation in Iwaki, Japan, which is 37 miles south of Fukushima Daiichi. After the accident, all of Kureha’s customers had to rely on its competitors, at least for a while. 

 

The recent coronavirus outbreak has impacted a much more crucial hub: the Hubei region and the whole of China, where 20 percent of global trade manufacturing originates. How big will the impact on the global supply chain be? What is the 2020 equivalent of the 2011 six-week delay in iPad 2 deliveries? The only honest answer is that we don’t know yet. There are multiple reasons for this, the most important of which is that we have never faced a global crisis comparable to the current coronavirus outbreak. 

 

A second relevant element is that usually, big multinational corporations do not have full control over their supply chain: Once they decide to outsource the production of goods and services, they tend to deal only with the first layer of suppliers. But those suppliers also buy intermediate goods and services from other suppliers, who buy from other suppliers, and so on. A single bottleneck can harm the whole supply chain. Shutting down gigantic plants in China creates a gigantic bottleneck. 

 

So why are Walmart shelves or Ikea stores still full of goods ready to buy? Even in a globalized world, distance still matters, and it takes time to ship goods from China. According to a recent Harvard Business Review article, “Shipping by sea to either the U.S. or Europe takes, on average, 30 days. This implies that if Chinese plants stopped manufacturing prior to the beginning of the Chinese holiday on January 25, the last of their shipments will be arriving the last week of February.”

 

Since the coronavirus outbreak overlapped with the Chinese Lunar New Year, many western counterparts of Chinese corporations already had more inventories than usual facing longer shipping times due to the holidays. The difference this year is that, after the holidays, a worrying number of production plants remained closed due to quarantine.

 

As David Wilcox of the Peterson Institute wrote, “Even manufacturers nowhere near the initial outbreak are being hobbled by their inability to source inputs from plants closer to the epicenter of the disease. Such effects seem to have been limited thus far but may become more severe as inventories are depleted. Everyone is getting a fast lesson that globally interconnected supply chains have their vulnerabilities as well as their virtues.”

 

We only have anecdotal evidence of a deteriorating situation whose impact is not evident yet. Honda, a major Japanese automotive manufacturer, announced that it will “reduce vehicle output at two of its domestic plants in Saitama Prefecture for a week or so in March due to concerns about parts supply from China where a new coronavirus outbreak continues to disrupt economic activities.” 

 

The Institute for Supply Management, a research company, monitored eight major industries and until February did not register any sign of collapse, despite the fact that many companies reported a negative impact of the coronavirus outbreak. A surveyed producer of computer and electronic products said to ISM: “There are always supply chain challenges with Lunar New Year shutdowns, and this year is no different. Coronavirus is wreaking havoc on the electronics industry. Companies are delayed in starting up production, which is resulting in longer lead times, constraints, and increased pricing. It’s a mad dash to dual-source stateside in case China isn’t back online soon.”

 

However, there are reasons to be less optimistic. The United Nations Conference on Trade and Development (UNCTAD) did a first assessment of the Chinese shutdown’s impact on global supply chains. The China Manufacturing Purchasing Manager’s Index (PMI) fell by about 22 points in February. This index is highly correlated with exports, and such a decline implies a reduction in exports of about 2 percent on an annualized basis. In other words, the drop observed in February, spread over the year, is equivalent to a 2 percent reduction of the supply of intermediate exports for the month of February. 

 

 

Industries and countries more integrated with the Chinese supply chain will be the most damaged, especially when they rely on a just-in-time supply chain with very little room for adjustment. According to UNCTAD estimates, a 2 percent reduction of China exports in intermediate inputs will transmit through the supply chain negative consequences of $5.8 billion in the United States, $5.2 billion in Japan, and the catastrophic amount of $15.6 billion in the European Union. It is worth repeating that these are the consequences only of the Chinese outbreak and containment measures; the estimate does not consider locally-originated crises, such as in Italy, nor does it include demand-side shocks. 

 

Supply chain disruption can generate a supply-side bottleneck: Companies struggle to assemble products and to deliver them to their customers who have money and willingness to pay the price demanded. However, a pandemic crisis impacts demand as well: Customers get ill, they have to stay at home, and they face high health care expenses in countries like the United States, where there is no public system. The fear of contagion and the apocalyptic atmosphere are good reasons to delay shopping decisions, to cancel already booked trips, or to stop going out for dinner.  

 

Traditional policy responses, such as the recent decision of the Federal Reserve to cut interest rates, are not very effective in the face of a supply chain crisis: Lower interest rates can boost investments or help households get a mortgage, but they cannot prevent a German automotive company from facing a shortage of Chinese components. And government public expenditure, such as the €3.6 billion emergency package recently approved by the Italian government, cannot put products on shops’ shelves. 

 

A slow-motion economic collapse started almost one month ago in Wuhan, China. We still have no idea of how great its impact will be or how we might be able to mitigate it. 

 

ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.