Economy, Talking Point

The great reconfiguration

Is the global supply chain set to be reshaped after Shanghai’s lockdown?


Apple is said to be looking to India and Vietnam to boost supply chain resilience and diversify from China

Is Shanghai’s two months of Covid lockdown finally coming to an end? Not quite yet, it seems, with most of the city’s 25 million residents still waiting for the green light to leave their homes for the first time in weeks.

Shanghai’s deputy mayor has already announced that the city will be reopened in phases, aiming for a return to normal life by the middle of June, and there has been a partial easing of restrictions in some districts over the last few days.

But former freedoms are returning slowly for most residents, with limitations on how far and how often they can venture out. Temporary passes have been issued allowing just one person per household to go shopping within narrowly set time periods, for instance, and neighbourhood committees are watching closely to make sure that no one breaks the rules.

The cautious approach signals how Shanghai’s exit from isolation could take a little longer than many expect. That’s not just going to be frustrating for its residents. Companies around the world are desperate for the lockdown to be lifted as well, as a first step towards getting their businesses back to pre-pandemic levels.

The long reach of Shanghai’s supply chain sclerosis

Lockdowns or pandemic-related restrictions have been reported in at least 40 cities in China since the beginning of the year, although Shanghai has taken centre-stage in the country’s battle to contain the virus.

Partly that’s because the lockdown there has been so extensive in scale and duration. But it’s also because Shanghai is symbolic as China’s commercial capital. Policymakers are proud of its claims to be the leading hub or gateway to the rest of the country, making its closure all the more confounding.

The city serves as a key conduit for trade and investment between the Chinese economy and the wider world, handling about a fifth of national goods through its port.

The seizing up of traffic at the city’s container terminal in recent weeks has created massive congestion in the global supply chain, with hundreds of vessels not only waiting at anchor off Shanghai but also at other ports on the eastern and southern seaboard.

According to maritime consultancy Drewry around 260,000 TEU cargo boxes have not been shipped during the Shanghai lockdown (equivalent to 10 fully loaded container ships) and HSBC says the time it now takes for a cargo vessel to voyage from China to the US is now 104 days versus pre-pandemic levels of under 50 days.

Other delays in shipments – with manufacturers closed down by Covid-related restrictions – have added to the logistical logjam, wreaking havoc much further afield than China.

In one major news story from the US this month, hospitals warned that they were running low on supplies of a contrast dye used in the scans of millions of patients. General Electric, the dye’s manufacturer, explained that it had been forced to close its Shanghai manufacturing facility for several weeks, although it has been scrambling to boost production at other plants to make up on the shortfall.

More than 180 listed companies around the world have mentioned terms including “China” and “lockdowns” in their first-quarter earnings calls or financial statements, Bloomberg reported.

With an extensive list of outsourcing partners in a number of Chinese cities, Apple is one of the worst affected, warning that sclerosis in the supply chain could cost it between $4 billion and $8 billion in sales this quarter.

Similar pressures led to an alarming slump last Friday in the share price of John Deere, an American manufacturer of agricultural machinery, after it blamed disappointing sales on difficulties getting components from China and warned that supply chain challenges were expected to persist until the end of the year.

The ripple effect has even threatened to derail some of China’s own Belt and Road projects. The Daily Star newspaper in Bangladesh reported last week that Chinese contractors may fail to meet the deadlines to finish three mega infrastructure projects including two railways and a tunnel in Bangladesh thanks to delay in the shipment of construction materials from China.

The same frustrations were voiced by one of the world’s largest consumer goods makers at the World Economic Forum in Davos this week, when Procter & Gamble added that it was thinking about shaking up its supply chain so that most of the goods that it sells in Europe are actually made there.

“The price to pay, the time to wait to get some of our products from China to Europe is not compatible anymore with our industry that’s called FMCG [fast-moving consumer goods],” complained P&G Europe President Loic Tassel.

“F stands for fast. If your container is stuck in Shanghai, it is not fast-moving anymore,” he added.

Supply chain strains could get worse before they get better?

Increased chatter that more normal conditions could return to Shanghai and its manufacturing hinterlands, freeing up flows of much-needed goods to international markets, seems to bode well for customers like P&G and Apple.

A sudden influx of new supply should bring down the prices of many goods, perhaps, countering some of the other inflationary pressures in many countries. But there are warnings that moving too quickly from famine to feast could have the opposite effect as Shanghai’s export economy starts to fire on all cylinders again.

That’s particularly the case because of congestion in container shipping, where experts are predicting another period of chaos as shipments start to move again in massive volumes.

Restrictions on operations at exporters in Shanghai and other eastern cities in China have given ports in the United States a chance to clear some of the logjams created last year when seaborne trade surged back after the initial period of the pandemic. But as manufacturing gets back to full speed and more goods start to be shipped out of China, destination ports are likely to be strained to breaking point once more.

In this kind of context Shanghai’s reopening is set to fuel another uptick in transportation costs, with shipping lines pushing freight rates back to record levels.

Indeed, few other industries have prospered quite as much from the impact of the pandemic as the container shipping lines, with Drewry now estimating that they will have earned half a trillion US dollars of operating profit from two years of supply-chain chaos.

After record returns of $190 billion last year, the 11 largest carriers (that publish results) reported “mind-bending” profits of $59.3 billion in the first quarter, adds John McCown from Blue Alpha Capital. That was more than double the combined quarterly profits for Facebook, Amazon, Netflix and Google in the same period and McCown is forecasting full-year profits of $220.5 billion for the container lines in 2022.

“These actual results are diametrically opposed to what anybody could have contemplated at the beginning of the pandemic just over two years ago,” he writes.

Is it unfair to blame Shanghai’s lockdown for supply chain chaos?

The Federal Reserve Bank of New York said last week it is now tracking stress in global supply chains with a new proprietary index. The Global Supply Chain Pressure Index, which combines an array of statistics including global transport costs and delivery times, found rising supply chain pressure in April, posting a reading of 3.29, compared with 2.80 in March (and a historical high of 4.45 in December last year with data going back to 1997).

It’s not just the pandemic that has been causing problems for the global supply chain or China’s outsized role in supporting it.

A quick look back at the stories of delays and disruptions of recent years soon makes the point that trade flows have been troubled by a range of other factors. There have bee one-off disasters, such as the blockage of the Suez Canal by a ship from a Taiwanese line in March last year (this held up more than $50 billion in trade).

More recently it’s the conflict in the Ukraine that has been creating havoc, especially in the energy sector, where Russian leader Vladimir Putin is shutting off gas supplies to governments that displease him.

A Russian blockade of Ukraine’s shipments of grains and oilseeds is also having dangerous repercussions for global food prices.

Tariffs and tech export bans have played a much larger role in destabilising hundreds of billions of dollars of trade, of course, not least when former American President Donald Trump made a totem of bringing manufacturing capacity back to the United States in slapping tariffs on Chinese goods four years ago.

Despite Trump’s rallying cry there hasn’t been any real change in the balance of trade between China and the US, however, nor much indication that American firms are heading home in the way that he demanded.

But is China’s position in the supply chain under threat over the longer term?

Commentators still question whether the last few weeks of shutdowns in Shanghai might have been a tipping point for companies that rely too heavily on factories in China for goods and components.

A period ahead in which delivery times for shipments will be escalating almost as much as freight rates could spark a further bout of reflection on the situation.

There’s also widespread frustration from multinational companies in China about how the response to Covid has been handled and that a lack of clarity from the government has made it impossible to make commercial plans with any certainty.

Surveys from foreign chambers of commerce report how their international staff are leaving China in record numbers, while their employers are hitting pause on investment until the landscape is clearer.

“Covid lockdowns this year and the restrictions over the past two years are going to mean that three, four, five years from now, we will most likely see investment [in China] decline,” adds Michael Hart, president of the American Chamber of Commerce in China, in other words of warning.

Pressures like these have perplexed participants at this month’s World Economic Forum in Davos, who fret that the world is on the verge of reversing decades of economic gains from globalisation. Yet the evidence for that kind of reversal is still largely missing. Foreign direct investment has continued to flow into China over the duration of the tariff row with Washington, for example, as well as for much of the period when the pandemic has had its most disruptive impact.

That seems to suggest that overseas investors aren’t completely disenchanted with China as a commercial opportunity, even if there is a sense that geopolitical tensions have been putting a growing strain on trade and investment.

Perhaps there will be a broader political dimension to efforts to split more of the world’s supply chain into separate blocs as governments try to forge closer ties between likeminded nations.

Janet Yellen, the US Secretary of the Treasury, warned again last month that the world has “become too vulnerable to countries using their market positions in raw materials, technologies, or products to exercise geopolitical leverage or disrupt markets for their own gain”.

This explains the formation of the Indo-Pacific Economic Framework for Prosperity (IPEF), a 13- country trade deal launched by American President Joe Biden during his visit to Asia this week, has set “supply chain resilience” as one of the key goals.

Initiatives like these would add to other trends like ‘near shoring’, where companies bring their contracts closer to their home markets, reducing some of the risks of overextended supply lines.

Supply chain experts have also talked for years about the ‘China plus one’ strategy in which businesses look for more flexibility in their international sourcing by choosing additional production partners in markets other than China.

Last week the Wall Street Journal reported that Apple – which manufactures 90% of its products in China – had instructed some of its contract manufacturers that it wants them to boost production in countries such as Vietnam and India.

But as Frederic Neumann, HSBC’s Chief Asia Economist and Co-Head of Global Research, Asia Pacific, has pointed out, this sense of separation is sometimes misleading as producers in these alternative locations are often reliant on key parts and materials from Chinese suppliers themselves.

For instance 14% of Vietnam’s exports are exposed to delays in shipments of components from China, Neumann reported recently, with only a slightly lesser exposure for producers in Thailand and Malaysia.

And although trade tensions and shipping delays have been making the headlines, Chinese companies still have huge advantages in winning business from overseas customers, including a large and increasingly skilled workforce and unrivalled access to raw materials and components across specialised ‘clusters’ that often spread across neighbouring towns and cities.

Recreating these clusters is a massive undertaking, while years of heavy investment from the Chinese government in roads, ports and power stations has also made it much harder for rivals from other Asian countries to challenge Chinese firms in areas like speed, flexibility and reliability.

Businesses that depend on larger amounts of manual labour or that are difficult to automate are highly unlikely to come back to more developed markets in Europe and North America either, although the argument may be stronger for a ‘re-shoring’ of companies whose research and development capabilities make up a higher portion of profits.

Perhaps there will be more reshoring momentum for industries that have been identified as strategic priorities too, such as semiconductors, defence and aerospace, and some areas of the biotech world. There could also be re-shoring of sectors where governments have come to appreciate the benefits of higher levels of self-sufficiency, such as energy supply or the production of equipment and drugs that have countered threats like Covid.

At heart any major shift in thinking is going to have to come from the companies themselves, however, in reviewing the operational risks of being stretched too thinly over too many miles or too many time zones. Perhaps there will be a push for more regionalised arrangements, underpinned by new thinking that draws on newer technologies and Big Data. There might even be a little more readiness to talk about doing things differently because of the way that the current disruption is already causing so many problems.

But China is simply too embedded in the supply chains of most of the world’s largest companies to be cut out entirely. Companies also know that trying to do so risks disaster in forcing up prices for consumers. Ultimately sourcing from Chinese suppliers has supported years of falling prices – unless that changes radically China’s role in the supply chain seems pretty well protected.

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