China at a Crossroads

China at a Crossroads
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This fall, China has finally slightly relaxed its approach to COVID zero, with reduced testing and avoidance of lockdowns. The result? Climbing case counts. Now China is at a critical crossroads, with massive implications for global supply chains and possible recession.

For so long, China has kept COVID-19 at bay via massive testing and quick lockdowns that stopped virus transmission. Speed and severity were key. Massive testing enabled quick identification of outbreaks and the immediate, thorough lockdowns ended the outbreaks with as little pain as possible. But the severe approach has it's own costs. The testing is literally expensive, and the severe lockdowns have major economic consequences. China is now reassessing the tradeoffs of their former approach. Small changes have started, allowing case counts to approach records. Depending on their policy decisions in the near future, major change is possible.

In the short-term, here are two potential scenarios:

  1. Case counts nearing record levels spur a renewal of severe lockdowns, with major economic consequences including increased recession probability and significant supply chain disruption
  2. China lets this be the start of the end of COVID-zero, causing case counts to rise to massive records and allowing numerous deaths. China does not have the acquired immunity of essentially other country in the world, and vaccination rates are relatively low among the elderly, who are the most vulnerable. Such a wave could disrupt consumer behavior in China, with economic consequences including increased recession probability, though that could be offset by investment attracted do to the easing restrictions. Significant supply chain reduction would be less likely since factories and ports, though affected by worker absences, would not totally shut down.

In the long-term, the COVID-zero exit has major consequences for supply chains. Companies have moved away from China for a variety of reasons, with supply chain robustness the most publicly cited cause (i.e. onshoring, nearshoring, friendshoring). But there's a quiet and far more practical reason for the moves: Access. Normally, companies outside China visit their China-based factories at least annually to assess production, test products, and increase efficiency. This is true even if the manufacturer is a fully separate company. But China's travel restrictions have severely limited this critical exchange, motivating companies to shift production to countries where collaboration is easier.

If and when the COVID-zero exit happens, this will ease supply chain issues. Companies will find new efficiencies as collaboration resumes and costs will decrease as less manufacturing relocation is necessary. This will also have positive economic consequences purely from things running more efficiently. 

Much rides on Xi Jinping's decisions in the coming months. Companies will want to stay tuned not to the catchiest stories but to the nitty-gritty details about to what extent restrictions are or are not easing. There is both downside and upside risk, both for supply chains and the global economy. Stay tuned, and be ready to shift plans in response to China's policies.

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