Trading networks have a remarkable ability to heal themselves and continue along their previous paths
Here's a vision of how coronavirus might change the world.
Governments devastated by pandemic and the costs of supporting locked-down and unemployed workers will reverse decades of retreat to take a more muscular role in their economies. Businesses that for years have outsourced production to China and profits to tax havens will bring those activities home. In an echo of the years after World War II, a new era of egalitarianism will replace an age of private excess and public deprivation.
It's an alluring picture. Don't count on it coming to life.
"Assume that at some point we get a vaccine or herd immunity and we go back to normal a year from now," said Yossi Sheffi, a professor at the Massachusetts Institute of Technology who specializes in logistics. "The question is, will we go back to globalization as it was before, or will we start bringing stuff back home?"
Top-down attempts to reform the global trading system in the aftermath of shocks to the world's supply chains have rarely succeeded. The post-coronavirus world is likely to be little different. The growth in international commerce may indeed slow as growth stagnates — but the share of trade going to China and tax havens is more likely to grow than shrink.
Modern supply chains are often likened to biological systems in their complexity and interdependence. As with the coronavirus itself, a weakness in one part can metastasize into a sickness that causes the entire organism to collapse. As the pandemic has spread, limits on exports of medical supplies grew from a few locations to near-global prevalence. Problems with food trade, such as the restrictions on rice exports that Vietnam imposed in March and the closure of some of America's vast meatpacking plants after virus outbreaks among workers, threaten a seizure in the food supply chains on which billions of people depend.
Worldwide automotive sales will fall 22% this year, according to IHS Markit, a deeper drop than the industry suffered during the 2008-2009 financial crisis. Already in March, demand for air freight fell 15.2% from a year earlier, according to the International Air Transport Association — and the capacity available to carry it fell 22.7%, threatening a cargo crunch where insufficient planes are available to carry even the current reduced level of goods trade.
After a severe systemic shock, many of the efficiencies that make "just-in-time" lean manufacturing processes so productive can look like vulnerabilities. Shrinking inventory levels helps a company deploy its capital more effectively, but also leaves it without a safety net if a supplier shuts down. Purchasing materials in huge volumes from a small number of partners can drive down costs, but reduces the diversity of suppliers that companies need to recover from disruptions. Global supply chains allow companies to benefit from lower labor costs in emerging economies, but leave them exposed if trade tensions or pandemics tighten border controls.
"Supply chains are running on fumes and inertia now," said Nada Sanders, a professor at Boston's Northeastern University. That means the full impact of what's happening is mostly yet to be felt: "The medium term is going to be the most dangerous. Once winter comes in, I'm not optimistic."
The next shoe to drop is likely to be cash. A fall in merchandise trade by as much as a third this year, as projected by the World Trade Organization, will put severe pressure on the revenue of every company operating across borders. Businesses will be looking for bailouts from governments and clemency from lenders — but supply chains will bear a large share of the strain, as companies look to conserve cash by taking longer to pay their bills.
Such payment delays are one of the oldest forms of finance, and they have the virtue of being interest-free. They're substantial, too: Of 130 industrial companies worldwide with at least $10 billion in revenue for which Bloomberg has data, the median level of accounts payable was $2.59 billion. Financial debts coming due over the next 12 months, by contrast, came to a median $2.32 billion.
The pandemic's economic impact will leave large companies with strong balance sheets and the ability to access financial and government funds in a relatively stronger position. Smaller suppliers with critical niche positions as providers of essential components may be able to rely on the support of the multinationals at the peak of their supply chains. Those making more commodified products may find the going tougher. As trading networks have spanned the globe and generated an increasingly bespoke range of products, complexity and its associated costs have inexorably risen. A financial crisis will afford the biggest companies the opportunity — and necessity — to prune back those networks.
In spite of President Donald Trump's trade wars and increasing global suspicion of Beijing's more nationalistic turn, China is in a good position to benefit from that trend. In the mid-2000s, the country was mainly a location for the final assembly of products such as smartphones, whose sophisticated components and intellectual property were produced elsewhere.
Yet even before Trump's election, that era was dead. The share of domestic value-add in Chinese exports increased from 75% in 2005 to 85% a decade later, according to data from the Organization for Economic Cooperation and Development, bringing an extra $1.25 trillion into the economy annually. Even as it climbed the value chain, China has relinquished surprisingly little of its low-margin industry to other countries.
Incentives, such as favorable deals on tax rates and land-use, continue to lure foreign businesses. China has 2,543 of the world's 5,383 special economic zones, whose main attractions center on such benefits, according to the United Nations Conference on Trade and Development. That's turned it into a one-stop shop for manufacturing businesses. They end up more exposed to one country, but less at risk of generalized disruptions from multi-country supply chains.
Foreign investment data suggests that the trade war drumbeats from Washington have done little to diminish China's attractions. While investment inflows in recent years have declined with a global slowdown, the country's share of the global total in the most recent four quarters was about 11% — roughly in line with its level through the late 2000s. Last December, China posted a greater sum of exports than in any month in history. Japan's stimulus package is providing $2.2 billion in support to companies that move their production out of China, but the country's industrial giants seem reluctant to take the offer.
Even in America the trade war doesn't appear to have changed behavior much, with foreign direct investments from the US to China actually increasing in 2019 to $14 billion thanks to large new projects such as Tesla Inc.'s Shanghai factory, according to a report this month by Rhodium Group, a research consultancy. That's roughly in line with levels that have been little changed since 2005.
The immediate aftermath of the coronavirus suggests China's allure as a manufacturing center will endure. With its cities starting to go back to work, supply right now is more than ample for the subdued demand coming from overseas trading partners. The Caixin Manufacturing PMI, a closely watched indicator of economic activity, expanded in March, when the rest of the world was in deep contraction. Inditex SA, owner of fast-fashion pioneer Zara, is ramping up exports to Asia as shoppers return to stores.
While China will continue to swallow up more of the world's physical supply chain, it's worth paying attention to what's happening to flows of intangible assets such as royalties, licensing fees and intra-company loan payments, too. After all, the biggest beneficiaries of the past decade of reworking global supply chains have been the low-tax offshore jurisdictions that receive an outsized share of such funds — a group of countries that had been singled out as the losers of the supply shock after the 2008 financial crisis.
In the years prior to the crash, multinational corporations increasingly used them to suck profits away from larger, higher-tax countries. The elimination of such activities, dubbed "base erosion and profit-shifting," was a major item on the post-financial crisis agenda of the Group of 20's 2012 meeting in Los Cabos, Mexico. All the evidence, though, is that the trend has accelerated.
Flows of intangibles are now growing faster than foreign investment itself. About a third of the increase in inward investments globally between 2008 and 2018 occurred in just seven financial centers: the British Virgin Islands, the Cayman Islands, Hong Kong, Ireland, the Netherlands, Singapore and Switzerland. That's an acceleration over the previous decade, when the same countries sucked up about one quarter of the increase in investments. The attractions of such tax avoidance are unlikely to diminish as corporate budgets tighten and debt-ridden governments seek a larger share of the profit pie.
In the times when supply shocks have led to major reforms of supply chains, companies have generally done the pushing. Closer surveillance of cargo in the wake of the Sept. 11 attacks — prompted, to be sure, by governments, but enthusiastically adopted by logistics businesses — contributed to the detailed tracking of shipment data that's become a routine part of supply-chain management ever since.
Ever since a devastating Japanese earthquake and Thai floods in 2011 brought renewed attention to the vulnerability of trading networks, inventories held by carmakers have been edging up. The median auto business last year held 69 days of stock compared with 59 days in 2010, according to data compiled by Bloomberg, giving it a form of self-insurance against supply shocks. Toyota Motor Co., whose legendary efficiency is synonymous with just-in-time manufacturing, was holding 36 days of inventory at the end of December — almost a week more than at the end of 2010, and its highest level in decades outside of a spike during the 2008-2009 financial crisis.
As the world recovers from coronavirus, the resilience of supply chains is certain to take even greater precedence over just-in-time leanness. That process has been underway already, as managers have woken up to the damage that upsets can cause: Some 56% of companies in a recent survey by the Business Continuity Institute had suffered a supply chain disruption in the past 12 months, with 15% experiencing at least five significant upsets and 14% reporting losses of at least 1 million euros.
It's possible that the vast liabilities that governments have assumed this year will spur them to seek more dramatic changes in the relationship between citizens, businesses and the state. A reversal of just-in-time production and global sourcing may be beneficial from a sustainability point of view, too, given how much transport fuel is wasted moving around half-empty shipping containers and pallets to meet the needs of supply-chain managers.
Still, the lesson of the decade or so encompassing the 2008 financial crisis and the trade drama of the Trump administration is that, in spite of the efforts of governments and managers, supply chains in both physical goods and intangible assets have a remarkable ability to heal themselves and continue along their previous paths. The world is struggling to come to grips with one willful biological entity right now. We shouldn't expect intricate trading networks to be any more tractable in our efforts to bring them under control.
David Fickling is a Bloomberg Opinion columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.
Disclaimer: This article first appeared on Bloomberg.com, and is published by special syndication arrangement.