Opec’s coronavirus discussions are proof of the global nature of this crisis

This will give another push to the trend of businesses attempting to simplify their manufacturing processes, writes Hamish McRae

Tuesday 04 February 2020 22:43 GMT
Volunteers in protective suits disinfect a railway station in Hunan province on Tuesday
Volunteers in protective suits disinfect a railway station in Hunan province on Tuesday (cnsphoto via Reuters)

The tentacles of the coronavirus have embraced the oil market, and Opec seems set to decide on an emergency cut in oil production to offset a collapse in demand from China.

The oil market gives a snapshot of what is happening to the world economy, and in particular to world trade. Airlines cutting their flights to China have an immediate impact on aircraft fuel, but that is just an early sign of wider pressure. If factories in China shut down production, they will use less power. Many products use petroleum as a feedstock. If fewer goods are being produced, fewer ships will be needed to carry those goods around the world. So demand for bunker fuel declines.

The travel and tourism industry is affected far from China, partly because fewer Chinese people are travelling, and partly because advice to non-Chinese not to travel to China is cutting travel to southeast Asia as well. The latest warning from the UK Foreign Office that UK residents should leave China will have a particularly chilling effect.

So the snapshot from the oil market confirms a wider global slowdown. What more can it tell us?

There are clear messages, one obvious, the other less so. The obvious message is that we are still in the early stages of what will become a big blow to the world economy. Calculations to date suggest that this will knock up to 1 per cent off China’s growth this year, and assuming the virus is contained by the spring, about 0.3 per cent off global growth this quarter.

There would then be a bounce back. But these relatively benign calculations assume that a turning point in the outbreak will be reached fairly soon. Until that point is reached and the numbers of new infections start to decline it is hard to be confident that the global impact will be so easily accommodated.

There is a twist here. The expansion phase of the world economy is likely to turn down in the coming months, given that this is the longest growth period in the US (and much of the rest of the world) since the Second World War. This could become the trigger for that downturn.

The other message is that the coronavirus will have a structural impact as well as a cyclical one. In other words, it will not only have an impact on the economic cycle; it will also change the longer-term shape of the global economy.

We have developed an economy that is extraordinarily complex, with goods and components of goods being shipped (and flown) around the world in the manufacturing process, before being sent to the final purchasers. This has happened because it is cheaper to do so. At every stage of manufacturing the handful of cheapest suppliers in the world get the work. But complexity brings fragility.

For example, Apple announced on Saturday that it would temporarily close all its offices and stores in China. But the greater risk is to its iPhone supply chain, for much of its manufacturing is done there. Not being able to sell is phones in China is a one-off blow. Not being able to manufacture its phones because it cannot get the parts is something else.

Now Apple will find ways to get round any production problems. But disruption is expensive, and it and other manufacturers need to ask whether the marginal savings in costs adequately offset the risks to interruptions in supply. Most of the cost in an iPhone is in design, marketing and distribution. The actual manufacturing is relatively cheap. So better to create a global network of suppliers and assembly points, so that if any one supplier, region or country gets into trouble there are options.

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This questioning of whether companies should simplify their manufacturing processes had begun about five years ago. Remember how “offshoring” was being replaced by “reshoring” – bringing production back home? The present trade tensions have given a boost to this movement. Now the coronavirus will give another push to a trend that was already established.

A final point. Simpler supply chains mean fewer components will be moved around the world. That means a reduction in demand for ships and aircraft to carry them. That in turn means a decline in demand for fuel. Put together these cyclical and structural forces at work, add in longer-term concerns about climate change and the impact of burning fossil fuels, and what do you get? A decline in demand for oil, gas and petroleum products – as the Opec meeting is now having to face.

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