As the world continues its fight against the Coronavirus, geopolitics has been largely relegated to the backburner of media coverage. Months ago, the news was full of stories detailing internal conflicts in the Middle East, the U.S.-China trade war, Brexit, etc. Today, naturally, the focus is on the pandemic, yet the geopolitical gears continue to grind. In fact, the crisis has unfolded in such a way that these two realms have become increasingly intertwined to the point that new wrinkles have been added to some of the most pressing issues facing major nations in 2020.
These developments could have the effect of intensifying existing problems for some, while simultaneously creating more room for maneuver in pursuit of both short and long-term goals for others. One country already confronted with a revised reality is China, and therefore it is worth examining how one of its preexisting challenges could be impacted by COVID-19.
China was contending with a plethora of issues before COVID-19 including environmental degradation, the trade war with the U.S., and a projected demographics crisis. It is however the economy that most concerns the Chinese Communist Party.
For decades, a social contract has existed between the Chinese people and the government. Taken in its simplest form — the government provides jobs, economic growth, and improved living standards in exchange for adherence to party dictates and the loss of some personal freedoms. For over three decades the party achieved breakneck, double digit economic growth, and the agreement continued unchallenged. Growth was largely dependent on low cost manufacturing operations eager to tap into China’s huge, low paid labour pool. The problem that China has begun to face in the last few years is that indicators suggest this model is approaching its expiration date.
Higher living standards mean higher wages, safer working conditions, and improved environmental regulations. Over the years Chinese workers have become more vocal in their demands, and herein lies the CCP’s dilemma. As China’s population became richer, some of the advantages held over competitors began to erode. Higher wages increased production costs to the point that some companies have been relocating their operations to cheaper alternatives. Vietnam and Mexico among others had begun to benefit from this realignment before the outbreak of COVID-19. Now, given the harsh realities brought to bear by the pandemic, this process is likely to accelerate.
The coronavirus led to the temporary shutdown of factories in China which soon created import shortages in other parts of the world in February and March. Industries requiring component parts manufactured in China had, due to the trade war, already begun to grasp the vulnerabilities of supply chains that rely too heavily on a solitary source, whether it be Chinese or elsewhere. This unease is now magnified by pandemic induced disruptions, creating further doubts about the system’s ability to respond to shocks.
This realization has hit hard for some nations and forced a rethink. Japan, for example, has allotted over $2 billion to help businesses relocate some manufacturing operations out of China, and back to Japan or other hubs in southeast Asia. American businesses that, due to the trade war, were already exploring the feasibility of re-configuring supply chains to decrease their China dependency now have an additional incentive to do so. China’s exports to the U.S. fell by around 17% in 2019, and an even greater decline is likely in 2020. In short, the virus is threatening to intensify the demise of a system that was already on the ropes.
All this comes at a most inopportune time for Beijing as it attempts to jump-start its economy following the lifting of lockdown conditions. Millions of Chinese workers have lost their jobs and face an uncertain future. Those who have gone back to work are confronted with the very different problem of dwindling demand. Hopes of a robust economic recovery will have been extinguished by the relative collapse of international trade and a diminished appetite for Chinese goods both at home and abroad. Demand should begin to tick upwards as the crisis wanes, but when and by how much is open to debate.
Given this precarious situation, the last thing China needs is an exodus of manufacturing jobs and industries driven by a rerouting of supply chains. It’s true that such a process would be slow and tedious, giving China time to respond. Equally true is that despite rising competition from southeast Asia, Latin America, and Africa China still boasts an enviable mix of resources that ensure it remains a tempting destination for manufacturing operations in the near future. However, these realities do not change the fact that China’s days as the low cost, low added value world’s factory are numbered.
The big question is how China responds to these potentially destabilizing forces. The CCP has for years provided jobs and drastically improved living standards for its people. The irony is that these incredible gains have begun to undermine the economic model that made it possible in the first place.
China long ago recognized the perils of the middle-income trap, and initiatives such as its ‘Made in China 2025’ are designed to ensure it doesn’t get old before it gets rich. Moving up the manufacturing value added chain however is easier said than done and will require a massive expense of energy and investment. China is capable of meeting these demands and has shown commitment to ensuring goals are achieved. However, the systemic shock created by the Coronavirus will have served as a timely reminder to Beijing that the old economic engine is running out of steam. A new path is needed, and the window of opportunity for changing course is closing just a little bit quicker than before.