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Coronavirus overreaction risks disrupting business far beyond China

World now more dependent on Chinese high-end manufacturing

| China

Hopes that China will return to work this week appear dashed as factory gates remain locked and authorities struggle to halt the coronavirus. This will dent China's growth -- but it also suggests the virus's international economic implications could be more far-reaching than many realize.

Pandemics have cut output in multiple ways. Tourism is one, as visitors busily cancel Asian trips. Consumption is another, with shops and restaurants closed. Globally, however, the most significant hit will come from shocks to international supply chains.

This is true in Hubei province, where Wuhan, the epidemic's heart, is an automotive hub, forcing companies like Honda Motor to extend shutdowns in local factories. But facilities are likely to remain shuttered in provinces accounting for almost three quarters of Chinese output, according to Bloomberg, including important coastal exporting zones.

SARS cut global growth in 2003 in part because of similar disruption, and today China represents a larger chunk of the world economy, so the effect this time will be bigger.

But the less understood risk stems from the fact that China is now a much more important producer of intermediate goods, meaning the components that go into products finished elsewhere.

This effect is less intuitive than it might seem. Compared to 10 years ago, fewer parts and components are whizzing around between production sites in Asia and elsewhere. What trade wonks call global value chains -- the production networks that make everything from iPhones to passenger jets -- have lately become less complex and more regional.

But this is not predominantly a trade war trend: it is because China has moved upmarket. At the time of SARS, Chinese companies exported basic goods and imported plenty of parts from more advanced economies. Now factories in cities like Wuhan make those complex components domestically and export them to factories abroad.

As a result the world is also more reliant on exported Chinese products than ever, suggests Alicia Garcia Herrero, chief Asia-Pacific economist for French investment bank Natixis, which has studied China's role in global supply chains. "Because of this, the virus's impact may be quite a bit more costly than many analysts anticipate," she says.

Production in factory Asia is especially vulnerable. Manufacturers in countries like Malaysia and Thailand increasingly rely on made in China parts. Hyundai also stopped auto production in South Korea recently for this reason.

Other advanced manufacturing nations are likely to take a hit too, including in Japan and Germany. Fiat Chrysler warned on February 6 that it might halt production at one plant in Europe. Others are likely to follow. China's new strength in high-end components makes it harder to find alternative suppliers too.

Understanding these supply chain shocks is now a crucial step to containing the pandemic's economic effect. Avoiding institutional overreaction is the other.

Estimates by Morgan Stanley suggest an "extended disruption" scenario -- where the virus does not peak until April and factories remain closed -- could knock as much as 0.5% off global growth in the first half of this year.

Given this, the question is whether it is wise to keep industrial and commercial facilities closed just as a precaution, as when China's authorities recently blocked plans by Foxconn, a major Apple suppler, to resume factory production, even in facilities with no reported virus cases.

This echoes a point made by Singapore's Prime Minister Lee Hsien Loong in a level-headed speech on February 8. Lee noted evidence suggesting that the virus is more contagious than SARS, but much less lethal. It may very well thus keep spreading, but at minimal loss of life.

If that happens, Lee suggested, governments like his own are likely to "reconsider" their strategies -- in effect moving from trying to contain its spread and more toward managing its effects.

In medical terms this would mean less use of isolation and quarantine. But it also means avoiding the kind of far-reaching shutdowns that have seen businesses and schools closed in cities like Hong Kong, spooking the public at large.

Economically much the same logic is true. It would be unwise to keep industrial facilities shuttered for lengthy periods simply as a precaution, given the economic cost -- both in China and internationally -- is likely to far exceed the benefits in terms of stopping the virus's spread. Governments and companies in affected countries need to realize that widespread precautionary shutdowns are often not sensible in the long run.

This is of course a tricky balance. Measures to contain and manage pandemics are vital to ensure public confidence and minimize social and economic disruption. China's authorities have rightly been pilloried for their failure to take the virus seriously in the early stages of its spread. But as the pandemic continues, and the initial shock wears off, an extended period of institutional overreaction could be just as damaging.

James Crabtree is an associate professor in practice at the Lee Kuan Yew School of Public Policy at the National University of Singapore. He is author of "The Billionaire Raj."

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