As the coronavirus outbreak spreads, so does the menace to the global supply chain, which is heavily dependent on China for everything from auto parts and semiconductors to active ingredients for medicines.
Panos Kouvelis, who teaches and helped to popularize the Waffle House Index regarding natural disaster responses, says the outbreak’s impact on global supply chains promises to be multiple times worse than when the SARS virus emerged in 2002 in China.
Kouvelis, the director of The Boeing Center for Supply Chain Innovation and Emerson Distinguished Professor of Operations and Manufacturing Management at the Olin Business School at Washington University in St. Louis, predicted a $300 billion to $400 billion global impact caused by the outbreak and a window of 16 months to two years “until you stop seeing these shocks to the global supply chain.”
Kouvelis discussed why the outbreak will have such a deep, lasting worldwide impact:
Why is it so significant?
The coronavirus is an uncharted-territory event. It’s a “black swan,” which is a low-probability event with big consequences. The benchmarks we had in the past aren’t fully applicable because of the increased significance of China in the global economy, combined with our heavy dependence on China both as a market and as a manufacturing hub for goods that are more complex and more sophisticated than they were in 2002. So whatever we know from SARS is not a good predictor of the coronavirus’ likely impact.
In terms of the global supply chain, how do the U.S. trade tariffs on China intersect with the epidemic?
The trade situation and the coronavirus, are they friends or foes? The trade tariff is a friend to the coronavirus event in the following sense: It already drove many companies to rethink their sourcing strategy and the production strategy to diversify away from China. Some companies are better prepared as a result of that. Because of the uncertainty of the trade tariffs, many companies bought inventory ahead of time. So supply chains right now might have more inventory than they usually have, which is very good.
On the other hand, the coronavirus event will definitely harm China’s ability to keep its promises about the amount of American goods it is going to buy under the trade deal.
What long-term effects could come out of this crisis?
I look at the shocks where they happen. Then I look at how they’re going to propagate over time. As you go back in the supply chain, you’re going to see an increased effect as a result of the original shock. Let’s say, if reduced airline traffic leads to fewer planes, let’s say 10% fewer planes, then GE as the engine manufacturer and the other further back aerospace suppliers will see a larger effect, often at 20% and 30%. This is the second- or the third-order effect hidden behind the early shocks.
Sometimes people don’t think about it, but those are the effects that persist longer. And you’ve got to account for them. Then you’ve got to account for them during the recovery phase: If the supply chain is not ready and you try to recover, it’s not happening. Thin inventories and downsized capacities during the reduced demand phase will be slowly adjusted to the recovery phase. The shocks delay how long it takes before returning to a normal state.
Are we in any danger of heading into a recession?
I want to be optimistic, but China means a lot for a lot of companies. So if China really gets hurt, it will slow down the global economy in terms of its growth. We’re doing about 2% growth. Two percent can easily go away. If the epidemic lasts six, eight months, the global economy could face a recession state.
But I want to stay optimistic. I think many companies already might have diversified their supply chains. We’ve had good manufacturing news this quarter. Our companies are very healthy, so they can take some hit, and they might have become better at managing this kind of event.