China has been called the world’s factory floor and for good reason. When China’s factories shut down, the effects are felt globally. Bloomberg reports note, “The economic consequences from China’s COVID-19 lockdowns are starting to be felt by companies and consumers across the globe, and expectations are that the reverberations will only get stronger.”[1] Chinese lockdowns are particularly being felt in one of China’s largest cities and busiest ports — Shanghai. Financial Times journalists report, “As [Chinese] authorities raced to contain an outbreak of the highly infectious coronavirus variant Omicron, the repercussions have rippled across the globe, with multinationals from Apple, Tesla and General Electric, to Amazon, Adidas and Estée Lauder warning of disruption to their supply chains due to the lockdown of a city that handles 20 per cent of China’s international trade.”[2]
Of course, Shanghai isn’t the only Chinese city affected by COVID-19 outbreaks. The Financial Times reporters observe, “[Supply chain woes] are likely to intensify if China digs its heels in and continues to pursue a zero-Covid policy that has left millions of workers across the country confined to their homes. President Xi Jinping, architect of the controversial policy, has vowed to crack down on criticism of it despite signs that the zero-Covid approach is damaging the economy. … Authorities have now imposed restrictions on Beijing, while the central Chinese city of Zhengzhou, a gateway for air freight, also limited the movement of people in May.” If the Chinese lockdown policy continues, the long-term repercussions will be enormous. The global medical community is already starting to battle variants beyond Omicron (e.g., BA.2, BA.4, and BA.5.) Since China is home to seven of the world’s 10 biggest container ports, lockdowns could disrupt supply chains well into the foreseeable future. Supply chain concerns, however, don’t focus solely on the movement of consumer goods.
Bloomberg reporters note, “While ‘supply chain disruption’ is emerging once more as the most repeated phrase of corporate earnings season, the impact goes beyond multinationals’ profits. Hospitals from the U.S. to Australia are wrestling with a shortage of chemicals used in X-rays, while real-estate projects are held up by delayed materials. … Beijing’s zero-tolerance approach to Covid has idled factories and warehouses, slowed truck deliveries and worsened container logjams. As the country accounts for about 12% of global trade, it was only a matter of time before the upheaval began to trickle across economies, threatening to further stoke rising inflation.”
Consequences of Chinese Lockdowns
Journalist Eamon Barrett (@Eamonbarrett88) reports, “According to shipping analytics firm Windward, 20% of the world’s roughly 9,000 active container ships are currently sitting in traffic jams outside congested ports. Close to 30% of that backlog alone is in China.”[3] As a result of these logjams, McKinsey’s Tom Bartman (@tom_bartman) reports, “Global supply chains have been buckling under the strain of unprecedented demand and constricted effective logistics capacity. On average, global container shipping rates have more than quadrupled since 2019, and schedule delays have risen. In some key trading routes, such as Asia–Europe and Asia–North America, the rate spikes are even higher and the delays more frequent.”[4]
If and when the Chinese logjam breaks, its effects will be felt elsewhere. According to John Bree, chief risk officer at Supply Wisdom, “The downstream impact is coming, and it’ll be heavy. The latest China lockdowns combined with the Russia-Ukraine war is too heavy a burden. The global chaos is going to further exacerbate disruption and take inflation to a new level.”[5] Roger W. Ferguson Jr. and Upamanyu Lahiri, international economic analysts at the Council on Foreign Relations, note, “Even if the current crisis is resolved over the next year or so, there are systemic issues that should be addressed so that global supply chains will be more resilient to future shocks. Some of these problems are unique to the United States, while others are present around the world.”[6]
Addressing Current Supply Chain Challenges
Because snarls and disruptions are dominating supply chain discussions, resilience has risen to the top of most companies’ priority list. According to supply chain expert Richard Howells (@howellsrichard), “To increase resiliency across global supply chains companies will need to rebalance on-shore, near-shore and off-shore strategies for manufacturing locations.”[7] Analysts from the International Monetary Fund (IMF) are worried that many companies may decide to curtail, rather than rebalance, global supply chains — which they believe would be a big mistake. Journalist David Lawder (@davelawder) reports, “International Monetary Fund research shows that more diversification of source countries and inputs can significantly reduce the economic drag from supply disruptions.”[8] He also reported that IMF researchers concluded, “Dismantling global value chains is not the answer. More diversification, not less, improves resilience.” And, reports Lawder, “The IMF researchers said that the benefits of increased geographical diversification raise questions about national policies aimed at ‘reshoring’ production to domestic sources, such as the Made In-China 2025 program, the Make in India initiative and the U.S. Innovation and Competition Act of 2021.”
A McKinsey survey indicates that IMF concerns about massive “reshoring” may be unfounded. A 2021 survey found, “When it came to regionalizing supply chains, 25% [of survey participants] had taken action, as opposed to 38% planning to do this a year earlier. Steps for reshoring and increasing the supplier base were taken by 15%, although 40% had indicated they wanted to do so in 2020. Moves to nearshore production were performed by 11% of respondents, down from 15% having such plans in 2020. Nevertheless, regionalization remains a priority for many firms. … 90% [of participants] stated that they expected to pursue this to some extent during the next three years.”[9] Regionalization is more in line with Howells’ call for rebalancing manufacturing strategies than it is with national reshoring policies.
A key to making supply chains more resilient, is improving visibility. McKinsey analysts report, “Only 2 percent of companies have visibility into their supply base beyond the second tier.”[10] Ferguson and Lahiri also insist that systemic challenges, like truck driver and other labor shortages, must be addressed. Howells believes technology will relieve some of these shortages. He explains, “Technology will help alleviate worker shortages and improve retention by improving the productivity and decision making of existing employees, and attracting new talent with state-of-the-art tools. And as the degree of automation increases, it frees up the workforce from repetitive tasks, and allows them to focus on more complexity problems and decisions that required human interactions.”
Ferguson and Lahiri also believe supply chain strategies, especially just-in-time (JIT) manufacturing, need to be reconsidered. They explain, “[JIT] has proven to be a risky strategy, as there are always factors outside the supplier’s control. What is gained in terms of supply chain efficiency and speed is lost in resiliency. The pandemic is only the latest example. Supply chain disruptions due to natural disasters, such as earthquakes, floods, and hurricanes, cost billions of dollars in lost output and revenue. Such events are likely to increase in frequency in the years to come due to climate change.” Ferguson and Lahiri also agree with IMF researchers that diversification needs to be explored. They write, “The pandemic placed renewed focus on the hot-button issue of diversifying U.S. supply chains and reducing reliance on China, which has been the ‘factory of the world’ for decades.”
Concluding Thoughts
Financial Times‘ correspondents conclude, “Volatility and uncertainty have become a way of life for many reliant on China for goods.” And there few signs that this volatility will end any time soon. As a result, McKinsey analysts conclude, “Coming months could turn out to be critical for supply-chain leaders. Some companies will build upon the momentum they gained during the pandemic, with decisive action to adapt their supply-chain footprint, modernize their technologies, and build their capabilities. Others may slip back, reverting to old ways of working that leave them struggling to compete with their more agile competitors on cost or service, and still vulnerable to shocks and disruptions.” Diversification of manufacturing appears to be the best way to ensure that the world doesn’t catch a cold when China sneezes. In the meantime, China remains the world’s factory floor and too much of that factory floor remains quiet.
Footnotes
[1] Bloomberg, “From Sneakers to Teslas, China Lockdowns Upend Global Supply Chains,” SupplyChainBrain, 16 May 2022.
[2] Peggy Hollinger, Andrew Edgecliffe-Johnson, Primrose Riordan, and Gloria Li, “Shanghai lockdown exposes global supply chain strains,” Financial Times, 15 May 2022.
[3] Eamon Barrett, “China’s COVID-19 lockdown is inflaming the world’s supply chain backlog, with 1 in 5 container ships stuck outside congested ports,” Fortune, 21 April 2022.
[4] Tom Bartman, “Overcoming global supply chain challenges,” McKinsey & Company, 28 April 2022.
[5] Will Daniel, “‘Companies are beginning to panic’: Experts say China’s lockdowns will make inflation and the supply chain nightmare even worse,” Fortune, 23 April 2022.
[6] Roger W. Ferguson, Jr. and Upamanyu Lahiri, “How to Fix Global Supply Chains for Good,” Council on Foreign Relations, 23 November 2021.
[7] Richard Howells, “2022 Global Supply Chains: Four Trends That Will Shape The Future,” Forbes, 19 January 2022.
[8] David Lawder, “Diversify global supply chains, don’t dismantle them, IMF says,” Reuters, 12 April 2022.
[9] Ian Putzger, “McKinsey study explores progress in supply chain transformation,” The Loadstar, 16 December 2021.
[10] Knut Alicke, Ed Barriball, and Vera Trautwein, “How COVID-19 is reshaping supply chains,” McKinsey & Company, 23 November 2021.
