Globalization faces a bend-but-won’t-break crisis on coronavirus

Globalization is going through its biggest stress test since the 2008 global financial crisis and its aftermath. But if you want to understand why the forces of economic integration may be more resilient than many think, consider the centerpiece of a fancy new kitchen.

When executives from Middleby Corp., the kitchen equipment maker behind the commercial-grade Viking and Aga stoves, reported earnings last month, they joined the growing chorus of business people warning of supply chain disruptions in China that would hit its first-quarter profits.

Middleby also offered a curious upside twist. The supply stresses it had suffered over the past two years thanks to President Donald Trump’s tariff war on China had actually prepped the company for the new crisis in a way that meant it would be able to limit the damage.

“I’m telling you, within days of the virus being announced I knew exactly what components were going to be affected and had a tactical plan on addressing it,” David Brewer, the chief operations officer, told analysts.

On that same earnings call, executives from the Elgin, Illinois-based company celebrated the opening of a new factory in China late last year that would help it grow revenue from the Chinese market and elsewhere in Asia. For the first time, overseas revenues topped $1 billion in 2019, or more than a third of total net sales for the year, they added.

Globalization — the increasingly barrier-free flow of goods, services and people across national boundaries — has spent the past four years weathering a political assault that has left companies bruised and battered and the multilateral guardians of the global economy weakened. But it is the epidemiological attack now unfolding that appears set to be even more corrosive.

For all the pronounced angst over Trump’s tariffs over the past two years, the coronavirus outbreak has taken just weeks to emerge as a potentially bigger threat to 21st century globalization than trade wars. Economists at Allianz have calculated that the outbreak and efforts to contain it will cost the world $320 billion a quarter in lost exports of goods and services, or more each quarter than the annual cost of the U.S.-China trade war.

It’s not an overstatement to say the integration that has come to define commerce in the past 40 years is under the biggest assault since the financial meltdown more a decade ago or the Sept. 11 attacks before that. There will be an ugly quarter or two for the global trade in goods and services that is rightly prompting fears of new recessions in major economies and concerns about whether policy makers are up to the challenge of tackling it — or even have the appropriate tools.

But it’s also not wrong to say that some of the key traits of globalization look more battle-tested and robust than ever before. Or that focusing on the trade in physical goods as a manifestation of globalization also means missing other elements such as the dependence on overseas revenues of U.S.-listed companies, or the flows of data and ideas that are likely to endure even in a pandemic.

Which might explain why Apple’s Tim Cook said he expected only minor tweaks to supply and production when asked about longer-term disruptions on Fox Business Network last week. “We’re talking about adjusting some knobs, not some sort of wholesale, fundamental change,” he said.

There is no doubt critics of globalization and China are seizing on the outbreak and raising anew concerns about an over-dependence on China for everything from antibiotics and face masks to paint pigments.

“Globalization had gotten out of control,” Wilbur Ross, the U.S. Commerce secretary, offered in a Feb. 6 speech at the Oxford Union in which he defended the Trump administration’s assault on global trade in part by complaining that it now “takes 200 suppliers in 43 countries on six continents to make an iPhone.”

American tariffs have undoubtedly accelerated an existing trend of shifting production toward local or regional production. But it’s been well-documented that the beneficiaries have been places like Vietnam, Mexico or Eastern Europe rather than the U.S. And in many cases, even if the final assembly location of products shifts, Chinese components or a Chinese parent company remain part of the equation.

Reactions like Cook’s are driven in part by the reality that as a result of longer trends ranging from rising factory wages in China to consumer demands for customization and the relentless march of automation, there has been a slow adjustment underway in global supply chains for more than a decade now. If Apple’s iPhone is the often touted example of the complexity of international supply chains, it turns out its launch in 2007 may actually have marked their peak.

According to World Bank research published last year, trade associated with global supply chains has actually been falling as a share of global commerce since the 2008 financial crisis. Trade in components has stalled since the crisis, the bank’s economists found, and actually fell between 2011 and 2014, partly because of China’s increasing domestic production of many parts.

But Caroline Freund, who oversees the World Bank’s work on trade and investment, says it would be wrong to read that as a sign of de-globalization.

“While supply chains have stopped expanding there is no evidence that they have been shortening,” she says. And, she adds, it’s not clear that even the shock emerging from the coronavirus outbreak in China will change that.

“The shock would have to be big enough – and the likelihood of future shocks big enough – that you would want to change your production structure. And it’s not clear that it is at this point,” Freund says.

The bet companies have made on those supply chains is vast. At least 51,000 companies around the world have one or more tier 1 supplier in the affected regions of China, according to Dun & Bradstreet. A further five million global firms, the consultancy calculates, have at least one second-tier supplier in the affected area of China, including 938 of the Fortune 1,000.

Vasco Carvalho, a Cambridge University economist who studied the last major supply-chain shock to hit the global economy — the 2011 earthquake and tsunami in Japan that took key suppliers for the auto industry out of circulation for a time — says the impact of the coronavirus seems likely to be far more consequential.

It also, he argues, illustrates the difficult choices companies now face between potentially fragile global supply chains and the higher costs of producing closer to home in what is likely to be an era of many more disruptions.

“We are entering a more uncertain world and in order to adapt to that uncertainty, some scaling back seems likely,” he says. “I don’t have any apocalyptic view on this. I just think either you accept fragility or costs go up.”

The short-term cost in lost production appears likely to outstrip that of the tariffs introduced in the past two years, says Kyle Handley, a University of Michigan economist who with colleagues at the Census Bureau and Federal Reserve Board has enumerated the costs of those tariffs on American companies.

That is mainly because it will again illustrate how hard it is to shift supply chains out of China for many components, amplified this time by a shortage of supply due to shutdown of factories that the virus caused — rather than simply higher costs, Handley says. Moreover, this time companies around the world are joining American firms that sought to find alternative suppliers to get around the tariffs over the past two years.

Since the 2011 disaster in Japan, which was accompanied that year by floods in Thailand that also wreaked havoc with supply chains, many multinational companies have learned how to cope better with disasters and other threats to production by diversifying production sites, for example.

And there is an argument made by some that the coronavirus may end up making the case for more — not less — globalization whether it relates to production or revenues, or as a result of unintended consequences. Just as the trade wars of the past two years have caused some companies to rethink their reliance on China, some in the tech world have begun talking quietly about a de-Americanization of their production to reduce political risk.

Indeed, after the Japanese earthquake, one documented effect was a decision by domestic automakers and other companies to move some production offshore as a hedge against future disasters.

Any diversification of supply chains away from China is unlikely to lead to a consolidation of production in a single country. In some ways jolts like the tariffs and coronavirus have created an impetus to broaden global supply chains to many more countries to make them shock-proof rather than re-nationalize them.

“We don’t know where the next hurricane and tsunami and deadly disease will originate,” Handley says.

Globalization is a force that has had an up-and-down history going back more than 2,000 years. But the production lines that companies have built up around the world in recent decades are also less movable than many think.

“Supply chains are physical things like bridges, factories, ships, railway lines,” says Robin Brooks, chief economist at the Institute of International Finance. “Those things take a long time to disrupt and the virus and work stoppages we are currently seeing aren’t disrupting those.”