COVID-19 and new geopolitical conflicts

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 theMiddle East, the U.S.-China trade war, Brexit, etc. Today, naturally, the focusis on the pandemic, yet the geopolitical gears continue to grind. In fact, thecrisis has unfolded in such a way that these two realms have becomeincreasingly intertwined to the point that new wrinkles have been added to someof the most pressing issues facing major nations in 2020.

These developments could have the effect of intensifyingexisting problems for some, while simultaneously creating more room formaneuver in pursuit of both short and long-term goals for others. One countryalready confronted with a revised reality is China, and therefore it is worthexamining how one of its preexisting challenges could be impacted by COVID-19.

China was contending with a plethora of issues beforeCOVID-19 including environmental degradation, the trade war with the U.S., anda projected demographics crisis. It is however the economy that most concernsthe Chinese Communist Party.

For decades, a social contract has existed between theChinese people and the government. Taken in its simplest form — the governmentprovides jobs, economic growth, and improved living standards in exchange foradherence to party dictates and the loss of some personal freedoms. For overthree decades the party achieved breakneck, double digit economic growth, andthe agreement continued unchallenged. Growth was largely dependent on low costmanufacturing 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 thatindicators suggest this model is approaching its expiration date. 

Higher living standards mean higher wages, safer workingconditions, and improved environmental regulations. Over the years Chinese workershave become more vocal in their demands, and herein lies the CCP’s dilemma. AsChina’s population became richer, some of the advantages held over competitorsbegan to erode. Higher wages increased production costs to the point that somecompanies have been relocating their operations to cheaper alternatives.Vietnam and Mexico among others had begun to benefit from this realignmentbefore the outbreak of COVID-19. Now, given the harsh realities brought to bearby the pandemic, this process is likely to accelerate.

The coronavirus led to the temporary shutdown of factoriesin China which soon created import shortages in other parts of the world inFebruary and March. Industries requiring component parts manufactured in Chinahad, due to the trade war, already begun to grasp the vulnerabilities of supplychains that rely too heavily on a solitary source, whether it be Chinese orelsewhere. 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 arethink. Japan, for example, has allotted over $2 billion to help businessesrelocate some manufacturing operations out of China, and back to Japan or otherhubs in southeast Asia. American businesses that, due to the trade war, werealready exploring the feasibility of re-configuring supply chains to decreasetheir China dependency now have an additional incentive to do so. China’sexports to the U.S. fell by around 17% in 2019, and an even greater decline islikely in 2020. In short, the virus is threatening to intensify the demise of asystem that was already on the ropes.

All this comes at a most inopportune time for Beijing as itattempts to jump-start its economy following the lifting of lockdownconditions. Millions of Chinese workers have lost their jobs and face anuncertain future. Those who have gone back to work are confronted with the verydifferent problem of dwindling demand. Hopes of a robust economic recovery willhave been extinguished by the relative collapse of international trade and adiminished appetite for Chinese goods both at home and abroad. Demand shouldbegin to tick upwards as the crisis wanes, but when and by how much is open todebate.

Given this precarious situation, the last thing China needsis an exodus of manufacturing jobs and industries driven by a rerouting ofsupply chains. It’s true that such a process would be slow and tedious, givingChina time to respond. Equally true is that despite rising competition fromsoutheast Asia, Latin America, and Africa China still boasts an enviable mix ofresources that ensure it remains a tempting destination for manufacturingoperations in the near future. However, these realities do not change the factthat China’s days as the low cost, low added value world’s factory arenumbered.

The big question is how China responds to these potentiallydestabilizing forces. The CCP has for years provided jobs and drasticallyimproved living standards for its people. The irony is that these incrediblegains have begun to undermine the economic model that made it possible in thefirst 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.

Rob Burger