Two weeks after the 2011 Tohoku earthquake in Japan, carmakers began to halt production lines on every continent as they ran short of a specialised paint pigment that allowed their cars to glisten. It was manufactured in just one factory near the stricken Fukushima nuclear plant.
Companies in complex manufacturing industries vowed never to be so geographically exposed again. But a week after the World Health Organization declared the coronavirus outbreak a public health emergency, the robustness of global supply chains is once more being tested.
Fiat Chrysler warned this week that one of its European plants could be forced to halt production within a fortnight and Chinese copper traders have delayed imports of the commodity from Chile to Nigeria, highlighting how the economic consequences of the outbreak are extending worldwide.
“Given that China is now at the heart of many global supply chains, this will have knock-on effects around the world,” said Neil Shearing, chief economist of Capital Economics.
Christine Lagarde, president of the European Central Bank, said this week the coronavirus was adding a “new layer of uncertainty” that would weigh on the eurozone economy.
The nightmare job for economists is to turn general statements about global interconnectedness into precise forecasts, given the uncertainty over the progression of the disease in coming weeks.
“If the epidemiologists are unsure how events will play out, then you should be sceptical of any economist that claims to know better,” said Mr Shearing.Nonetheless, economists are finding ways to gauge the consequences.
One tool is to look at historical precedents. The 2003 Sars outbreak knocked 2 percentage points off Chinese growth in the second quarter of that year, with a rebound coming in the third quarter. The epidemic was “estimated to have damped [China’s] gross domestic product growth by about 1 percentage point in 2003”, according to the Ifo Institute in Germany.
Then, as now, the hit then came mostly from travel, tourism and leisure industries but it was temporary and mild, leading to practically no wider consequences outside China.
But this benign historical precedent provides false comfort, according to Erik Nielsen, chief economist of UniCredit. At prevailing exchange rates, China’s economy accounted for only 4.3 per cent of global output in 2003, far below the 16.9 per cent the IMF thinks it will represent in 2020. And noting that China was then growing at an annual rate of 10 per cent and only 6 per cent now, “we risk being too complacent by using [Sars] as benchmark”, said Mr Nielsen.
A second useful approach is to compare the sensitivity of one country’s economic performance to shocks elsewhere. Ifo, for example, calculates that each percentage point knocked off China’s growth rate in 2020 would reduce German growth by 0.06 percentage points and, because the rest of the eurozone was much less integrated, it would be hit by only 0.01 percentage points.
The figures appear reassuring. It is largely on the basis of similar calculations, the Chinese reduction in tariffs on US goods and a loosening of monetary policy that calm has been restored to equity markets.
But the problems with such analyses is that the direct trade linkages calculated generally do not include the knock-on consequences to corporate planning and business investment.
A Bank of England study from 2016 found that the direct effects from trade linkages of a 1 percentage point Chinese slowdown would be dwarfed by indirect confidence and financial effects. That would mean instead of lowering UK growth by about 0.03 percentage points, it would have an effect three times as large.
But even this could be an underestimate of the damage, according to Robert Carnell, Asia chief economist at ING. He worried that calibrations of the scale of the effect often also fail to take into account the behaviour of people in response to health scares.
Temporary declines in supply would be dwarfed by reductions in demand if people decide or are forced to stay home, stop spending and sit it out until the risks decrease. Retail, leisure services and tourism have already dived in China. Restrictions on travel have also seen a plunge in the number of Chinese tourists going abroad, a crucial source of income for the sector and luxury brands.
As the outbreak spreads beyond China, “fear of catching the virus results in a change in household behaviour that is arguably disproportionate to the chances of either catching the disease, or of dying from it”, Mr Carnell said. This would result “a very substantial decline in consumption of consumer services” worldwide.
With consumer spending driving growth across the US and Europe and interest rates already at rock bottom, there would be little scope for the normal policy response of looser monetary and fiscal policy to work.
With the global economy growing at a rate of only 3 per cent in 2019, were fear to take hold of public attitudes, growth could easily sink below 2.5 per cent this year — the level the IMF considers qualifies as a global recession.
Copyright The Financial Times Limited 2020