How will western economies respond to mitigate the risks inherent on relying on a single manufacturing source?
How the coronavirus crisis will play out is unclear, due largely to the opacity — or as some observers describe it, “managed transparency” — of China’s central and provincial governments. Perhaps, as some observers caution, the virus plaguing manufacturing centers like Wuhan affects the global supply chain in the same way an earthquake in Taiwan shuts down chip fabs.
Eventually, we hope, production comes back.
That’s looking less likely with each passing week. Among the first concrete signs of virus-induced strains in the technology pipeline emerged on Feb. 4 when automaker Hyundai ran out of key components, shutting down production lines in South Korea.
What worries China watchers is a full-blown pandemic that would have long-term consequences, exposing the vulnerability of a global distribution network reliant on a single national source of everything from toys and surgical gowns to auto components and flat screens. That worst-case scenario in which factories are indefinitely shut down and even the movement of goods becomes too risky means western economies would lack entire sets of finished products.
“We are very far away from it yet, [but] if the risk of that happening goes up I would want to have a hedge” to shift production, “which we don’t have at the moment,” said Dan Breznitz, a long-time observer of China’s technological transformation.
Indeed, shifting production out of China would take years, not months, since key competencies like production engineers and alternative suppliers have largely disappeared in the U.S., added Breznitz, Munk Chair of Innovation Studies at the University of Toronto and co-author of an influential book on China’s transformation, Run of the Red Queen.
Recent U.S-China trade tensions prompted a shift of some electronics manufacturing to Vietnam. Vietnam starts out with a lack of scale that limits its potential as an alternate source, however, a pandemic would eliminate it (along with most of China’s other neighbors as well) entirely from consideration as an immediate option.
Hence, the key questions are whether the Wuhan virus or other factors eventually change western perceptions of China as the world’s manufacturer, and whether western investors will take steps to mitigate future risks.
“The question is at what point those kinds of risks are deemed so high that not just the companies and their managers but their very active investors — hedge funds — understand that you have to invest billions of dollars over multiple years in order to recreate those sets of skills and capabilities somewhere else,” said Breznitz, who also directs the University of Toronto’s Innovation Policy Lab.
Only a confluence of trade frictions and unforeseeable events like a global pandemic would be sufficient to reconstitute the global supply chain, he added. It’s a Catch-22 situation for technology managers: The threat of a pandemic highlights the risks of doing nothing, but individual companies or investors are for now unwilling to seize the first-mover advantage, fearing a miscalculation would be a career-killer.
The supply chain disruptions caused by the coronavirus have only served to advance the thesis put forth by Breznitz and others that the U.S. industrial base is in rapid decline and will be extremely difficult to rebuild.
“I’m surprised at how quickly American industry lost critical capabilities in order to produce stuff,” Breznitz warned. “How many years will it take American companies to actually figure out how to produce basic stuff?”
His formula for reviving manufacturing in the west is straightforward: “You need to provide carrots, not just sticks.” Put another way, pressing China on trade isn’t enough; the U.S., European Union and Japan must invest for the long term in order to attract the private equity needed to reconstitute their manufacturing infrastructure.
“This is an opportunity,” said Breznitz, “because the private business leaders will listen to you if you talk now,” at the height of a crisis. “They might not listen to you if you talk about it two years from now.”