With tariffs the focus of last year, and now the shutdown of factories in China over the coronavirus (now called COVID-19), people and businesses are learning how intertwined the global supply chain is. Businesses may think that they do not have exposure to a certain country for their supply chain only to learn that they actually do.
The COVID-19 virus situation is a perfect illustration of how supply chains can be impacted from non-economic events and how intertwined the supply chains have become. As the COVID-19 virus surfaced and began to spread, China responded with a fairly draconian solution of quarantining the major cities where the virus was occurring. This had the impact of shutting down the factories in the affected region. Other countries responded by cancelling flights and shipping to and from China.
This medical event is creating an economic event as the supply chain from the affected region is now shut down. This means that industries that rely on supply from that region are now unable to get their supply, and alternative supply chains may not be able to meet the increased demand. Hyundai had to close their car plants in South Korea because it ran out of parts that are supplied by China and major automakers throughout the world are indicating that they are weeks away from running out of parts supplied by China. We may well see other industries announcing similar issues if the closure, or reduced production, from Chinese factories continues. If a business cannot produce its product because their supply chain is disrupted, then the risk is that they cannot meet the demand for their product. If they run out of parts, they may have to reduce hours for their employees or lay off employees until the supply chain is re-established or a new one is found. This will clearly impact economic growth. The question is for how long?
Many companies moved some or all of their supply chains from China over the past several years and may have thought they were no longer exposed to the Chinese supply chain. Research done by an independent research firm (Capital Economics) shows that many of the Southeast Asian alternative supply chain countries actually source parts from China. As a result, businesses may think they eliminated their Chinese supply chain exposure when they moved to another country only to find that they still have exposure to China. The question is whether they can find the supply from someone else or whether the ability to manufacture the product is hindered. Here is a table that Capital Economics supplied to show the various Southeast Asian countries and their exposure to the Chinese supply chain.
|Industry||Vietnam||Malaysia||Cambodia||Thailand||South Korea||Taiwan||Hong Kong|
|Wood & cork||27%||27%||39%||27%||28%||26%||22%|
|Paper & Printing||28%||19%||39%||27%||28%||26%||22%|
|Rubber & Plastic||29%||19%||52%||23%||24%||19%||21%|
|Autos & parts||40%||25%||21%||24%||31%||23%||25%|
Source: Capital Economics
This is an illustration of the tangled web of the global supply chain. It is not unique to China even though China has been the focus of the past year. It highlights the need for businesses to understand the full linkage of their supply chain. With the growth of globalization, it may now be rare to have a direct supply chain with just one country (or business).
The question is: if you own a business, do you know all of the connected parts of your global supply chain and what countries you have exposure to for producing your product?
Steve Scranton is the Chief Investment Officer and Economist for Washington Trust Bank and is a CFA charter holder with over 30 years of investment experience with equities, tax-exempt and taxable fixed income securities. Steve actively participates on committees within the bank to help design strategies and policies related to client and bank owned investments. Steve also serves as the economist for the Bank and has been a featured speaker for both client and professional organization events throughout the Northwest.