Today the editors of the Wall Street Journal warn about the potential impact on the U. S. economy of the coronavirus outbreak in China:
Some of President Trump’s advisers may want to wall off the U.S. and China into separate spheres of influence, but the novel coronavirus is showing the futility of economic quarantines. Like it or not, the Chinese and world economies sniffle and cough together.
Commodities prices sank on Monday amid news that the coronavirus and resulting economic contagion are spreading. U.S. crude oil prices have fallen 20% over the last three weeks as Chinese oil demand is expected to fall by two million barrels a day and global economic growth forecasts have plunged. Copper is down 13%, and iron and steel prices have tumbled.
More than 20,000 coronavirus cases have been confirmed worldwide—an eight-fold increase over the last week—and experts say hundreds of thousands may not yet have been diagnosed. Two dozen or so countries have reported cases, and many have restricted travel from China to limit the contagion. Companies are evacuating employees from China.
Most businesses in Wuhan where the virus originated have shut down as China has quarantined 56 million or so people in the province of Hubei. Businesses across the mainland are extending the Lunar New Year holiday or directing employees to work from home. Apple, McDonald’s, Levi Strauss and Starbucks have temporarily closed stores.
U.S. manufacturers such as Ford, Apple and Tesla have temporarily halted production. One-sixth of Apple sales and nearly half of chip-maker Qualcomm’s revenues come from China. So do 80% of active ingredients used by drug-makers to produce finished medicines. Because China is the world’s largest manufacturer and an enormous consumer market, the economic freeze will disrupt supply chains and reduce corporate earnings.
I think they’re wrong or, at the very least, exaggerating but let’s dig into that a little bit more. First, these words
80% of active ingredients used by drug-makers to produce finished medicines
are made in China should fill you with dread. Just a few years ago food ingredients from China adulterated with melamine killed who knows how many dogs? To this day we don’t know whether it was an accident, malice, or fraud. There is materially no legal recourse for damage done by Chinese suppliers. We can stop doing business with them. That’s about it. Despite that experience not only most pharmaceutical active ingredients but nearly all food additives, i.e. anything that changes a food product’s taste, look, or nutritional content, is produced in China.
Who should bear the risks of supply chains that run through China? As I pointed out some time ago 98% of the economic surplus realized by that is captured by producers not by consumers. The answer is obvious: producers should bear the risk.
How much will a one week suspension of production cost Ford, Apple, or Tesla? A two week. I submit that it will cost them nothing or, at most, the costs will be temporary. I would also suggest that if those producers don’t have enough inventory to hold them through a brief hiatus they are being reckless.
Finally, I don’t recall the editors of the WSJ ever warning that there were risks associated with doing business with Chinese suppliers. Hoocoodanode? Being dependent on sole sources is a risk, too, and the reality is that all too frequently multiple Chinese suppliers are actually a single supplier with multiple nameplates. How would you ever know?
Capitalism and markets just fixate on the lowest price, not the safest practices. We saw this to a lesser extent with Puerto Rico. A lot of medical manufacturing was concentrated there and it was disruptive when the hurricanes hit. We also see it in medicine when competition results in one producer for older generic medicines. Then if that one producer has problems we no longer have access to that drug. There are weaknesses in a market based economy that need to be recognized.
China is its own special case and I suspect that once again China will be blamed for everything. To be sure they are not a totally innocent party, but they didnt forcefully drag US companies over there. US companies went there willingly to make money. If we want them to stay here we need to find a way to make that financially feasible.
Steve
That’s not entirely true. Risk assessment plays a role in purchasing decisions. When a manager assesses risk improperly, his company should suffer. It shouldn’t be underwritten to prevent it from failing but that happens all too frequently. That has nothing to do with capitalism.
In my view we shouldn’t be doing business with a country lacking a robust system of civil law but if we must U. S. companies doing business with suppliers in such countries should face strict liability.
You’ve got to read the fine print when talking about “free trade”. There are a lot of suppositions.
Let me say it another way. If supply chain stability has NO value, then the Wall Street Journal editors are wrong. Taking China offline would have no impact on the U. S. economy. If it does have value, that value should be included in the calculations.
“Capitalism and markets just fixate on the lowest price..â€
Well, Dave beat me to essential points. In addition, what is price? It includes durability, reliability, quality, features, availability, options and on and on.
Steve, you observation is high school level. You can do better.
OK, so I took a shortcut and didnt write War and Peace. There is risk assessment for individual purchases. For moving your company overseas. What we dont get is risk assessment of what happens if all of our companies of some sort move to China or elsewhere. Of what happens if we get down to a single source supplier for any important products. (Single source can mean just one company or just one geographic area. Really, I thought my examples should have made this clear.)
So capitalism tells us the price, including the risks of reliability etc. It includes the risks and costs of transporting overseas. What happens if access is temporarily lost. What it does not price is the risks and costs to our COUNTRY if all of the manufacturing/producing/mining etc of key stuff that we need for our health, safety, security etc are all concentrated into one place, be that a single company in Wisconsin, a single territory like Puerto Rico or a single foreign country. Furthermore the risks for each those may be different, varying from a Shkreli, to national disaster to political and others.
Steve
A big reason why so much of our Pharma has been outsourced overseas is our litigious tort system. The anti-vaxxers are one notable component of that. Lawsuits over environmental disposal is another. The Greens are apparently fine with extremely substandard manufacturing, labor, and waste disposal as long as its not in their backyard or America. That’s why the Niger Delta is one of the worst environmental disaster zones of all time, because we sue the living s**t out of domestic oil companies over a few oiled ducks. Any sane businessman would take their business away from such a toxic legal environment.
I’m not for lowering environmental, safety, or manufacturing standards, if the regulators at least make some effort to balance costs versus damage and cleanup. But there is a law of diminishing returns. Regulating, inspecting and fining manufacturers to the point of incentivizing offshoring does no good to the local economy or to the environment.
Do you have any data on torts agains the big pharma companies? I am well acquainted with the data on malpractice and its issues. It is one of those things that should be fixed, but it is not a big factor in costs. I would like to see data before assuming torts are driving stuff.
Also, forgot to add here also that people should know that Trump did away with the endemic response team. We now have a former pharmaceutical lobbyist leading our coronavirus effort. “Heck of a job Brownie”? Hope not. (My point here is that I think Dave and many others keep focusing on China and other countries. That is fine. China could be a lot better, but we have direct control over the things we do. We have the resources, the right people available (generally) and the funding if we choose to use it. We still keep screwing it up.)
Steve
I would be interested in a reasonable explanation of why there is an advantage to manufacturing pharmaceuticals or food additives in China over the U. S. It puzzles me. The labor involved is nominal so that can’t be the explanation.
I can only think of two: lax enforcement of environmental regulations and price manipulation.