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China’s Lockdowns
ANDERS CORR is a principal at Corr Analytics Inc., publisher of the Journal of Political Risk. He is an expert in political science and government. Anders Corr
China Lockdown Cuts Supplies
Subsidies to domestic industry could fix global supply chains
China’s COVID lockdowns are grinding the country’s manufacturing to a halt and alarming global business leaders who depend on the country for parts and manufacturing.
The CEO of Mercedes Benz, Ola Kallenius, told Bloomberg on April 29 that “new lockdowns in China, in Shanghai but also in other places in China, affects the business and also the supply chains in China but also globally.”
A senior executive from an international supplier that manufactures in China, India, and Vietnam warned in an April 29 South China Morning Post article that lockdowns in Beijing are making China less competitive for companies that have a choice and are constantly comparing business locations on metrics of stability, labor cost, and logistics.
“It is crucial that the current draconian COVID policies in China cannot be normalized,” she said. “The current strict epidemic prevention policy will make [Beijing] lose points in the future.”
According to a Nikkei Asia analysis reported on April 28, approximately half of the 200 top suppliers to Apple manufacture in the environs of Shanghai, where coronavirus lockdowns are some of the strictest in the world, including traffic restrictions and mass lockdowns when a single case is discovered. This, despite the relatively low fatality rates of, and difficulty controlling, the highly contagious Omicron variant.
The affected Apple suppliers range from iPhone and iPad assemblers “to makers of components such as displays, printed circuit boards, thermal parts, batteries, and acoustic components,” according to the Financial Times.
The problems in China sourcing this month and last will continue affecting global supply chains throughout the summer, according to multiple reports. This will decrease the supply of finished goods and increase price inflation.
The remedy, according to some, will be higher interest rates offered by the U.S. and European governments to pull money out of the private economy. That will decrease demand for goods, bringing prices down but increasing the risk of business loss, unemployment, and recession.
Raising interest rates to target inflation makes more sense when the inflation is due to government overspending and overprinting of money. It makes less sense when it’s because of supply issues. In the latter case, the remedy should be support of domestic industry, including, most importantly, where there are supply chain bottlenecks.
Suppose money is pulled out of the economy through higher interest rates offered for government debt in the context of broken supply chains. In that case, the government should put money back into the economy through targeted subsidies of domestic manufacturing that provide the missing inputs.
In addition to COVID lockdowns in China, Kallenius mentioned two other effects on Mercedes’s operations. First, the lack of microchips used in everything from toasters to cars; second, the Ukraine war, which threatens a supply shock if Russia turns off the gas.
Kallenius said, “We work very closely with the German government” on energy independence as a “top priority.”
European and North American governments could also work closely with businesses to fix the mistake of too much offshoring and foreign sourcing. They should strategically subsidize supply chains to domesticize microchip manufacturing and decouple from China’s supply lines, in addition to sourcing energy from friends rather than adversaries.
Some have called for “reshoring,” while others add the need to establish supply line sourcing to allied nations. Europe, for example, can’t source its own hydrocarbons. The answer, to use a term minted by U.S. Treasury Secretary Janet Yellen, is “friend-shoring.”
That the Treasury Department mints more than currency during an inflationary period is a good sign for business.
But left to themselves, businesses will almost always ignore the negative externalities of their sourcing to maximize profits. Improving their sourcing from a public good perspective requires moving the goalposts through the award of subsidies to companies that provide positive externalities and the imposition of tariffs on those that cause negative externalities. An example of a negative externality is the empowering of dictators caused by sourcing from Russia and China.
Subsidies and tariffs, known jointly as “industrial policy,” used to be dirty words among economists. After China’s lockdowns, the semiconductor shortage, and the energy crisis from Russian President Vladimir Putin’s war, it should be cleaned up and made ready to rumble.
MILTON EZRATI is chief economist for Vested, a contributing editor at The National Interest, and author of “Thirty Tomorrows” and “Bite-Sized Investing.” Milton Ezrati
Scary Report on the US Economy
The first quarter’s GDP decline is overstated but offers a warning
frightening economic report has come out of the Commerce Department: U.S. real gross domestic product (GDP) fell at a 1.4 percent annual rate during the first quarter of the year. Suddenly the prospect of recession has become very real.
A slowdown in the recovery was already evident, and recession is indeed on the horizon, but the first quarter’s outright GDP decline overstates the economy’s present degree of weakness.
The first quarter’s decline constitutes quite a turn from the 6.9 percent annualized real GDP growth reported for 2021’s fourth quarter. Sudden turns of this sort often suggest that the data include distortions from particulars and less that is fundamental. In this case, three of these kinds of particulars stand out: in government spending, inventories, and foreign trade.
Government spending in the first quarter fell a sharp 5.9 percent in real terms at the federal level and 0.8 percent at the state and local levels. Alone, these declines took half a percentage point off aggregate GDP and accounted for fully one-third of the recorded overall drop.
The first quarter’s declines extend the slide in government spending for the seventh consecutive quarter since the pandemic stood at its worst in early 2020. Rather than signaling some basic shift in government practice, however, these declines reflect a natural adjustment to the tremendous surge in government spending required to fight the pandemic.
The slide is unlikely to typify coming quarters. Indeed, the fighting in Ukraine will boost defense spending and may have already given the Pentagon appropriations recently hurried into law. Otherwise, history shows that governments tend to increase, not decrease, spending over time. State and local governments certainly have huge infusions of federal cash at their disposal.
Inventories, too, seem to be making one-time adjustments to past pressures. For much of 2021, inventories fell as supply chain shortages forced retailers and others to meet sales with what they had on hand. But in the fourth quarter, those supply problems eased enough to allow businesses to rebuild their depleted inventory stocks. Inventory building surged beyond any historical norms. By comparison, the first quarter’s return to something closer to normal looked paltry.
In the Commerce Department’s accounting, that shift back to historical norms seemed to deny the economy some $34.5 billion. A recurrence of this kind of shift seems unlikely.
Foreign trade in the first quarter had complex but not likely lasting effects. Imports were strong, indicating robust buying by Americans. Exports, however, fell sharply, no doubt because of the lockdowns in China and the troubles that lingering pandemic effects and Ukraine war sanctions are having on Europe.
Because the GDP calculation subtracts imports from exports, the net effect trimmed some 3.2 percentage points off the overall GDP figures, accounting for more than twice the overall decline in real GDP. It’s indicative of the effect that overall real final sales in the first quarter showed a 0.6 percent annual rate of decline, but sales to domestic buyers rose at a 2.6 percent rate. Problems in China and Europe may well persist and delay a recovery in U.S. exports, but the sudden shift that affected the first quarter won’t recur.
Meanwhile, much else in the GDP accounting is encouraging. American households, for example, increased their real consumer spending at a 2.7 percent annual rate, an acceleration over the 2.5 percent rate of 2021’s fourth quarter and the 2.0 rate of the third quarter. Still more encouraging is how businesses have increased their capital spending on productive facilities, equipment, and technologies. These rose at a 9.2 percent annual rate in the first quarter, far faster than the 2.9 percent of 2021’s fourth quarter and certainly the 1.7 percent rate of the summer quarter. This kind of spending expands the economy’s overall productive abilities and paves the way for job growth.
If this shocker of a report still doesn’t say recession, the country’s undeniable inflation problem makes clear that one is nonetheless on the horizon. It will arrive either because the Federal Reserve’s anti-inflation policies precipitate recession as they frequently have in the past, or the inflation itself causes enough economic distortions to bring on recession regardless of what the Fed does.
This very real and fundamental recessionary threat would seem to lie some 18 to 24 months in the future. If this latest disturbing report is not the real recessionary thing, perhaps it will serve as a warning that more significant problems lie not too far in the future.
