The Lux List / Business of Luxury

Coronavirus COVID-19 Has Put the Global Economy in Jeopardy because of Over-dependence on China

Deeply exposed to China, Burberry’s share price was hit as investor confidence fell to new lows but the brand is not alone in this crisis. The world’s market has been over-dependent on China.

Feb 19, 2020 | By Jonathan Ho

Last week, Burberry Group shares fell after announcement that the coronavirus (COVID-19) was hitting sales in its biggest market, China. And it’s not alone, prior to the outbreak, Kering Group, the owner of rival brand Gucci posted strong performance for January driven by Chinese customers but following spread of COVID-19 which has infected over 70,000 and caused the deaths of more than 1700 so far, Gucci has been negatively impacted on sales, said the CEO during its fourth quarter earnings call.

“We have a strong drop in traffic and in sales over the last 10 days,” – Gucci CEO Francois-Henri Pinault discussing its fourth-quarter earnings.

To date, Burberry has closed 24 out of its 64 stores in the mainland, while Gucci closed half of its stores, many brands have opted to reduce operating hours over boutiques which remain amidst significant footfall declines.

Without doubt, the coronavirus is wreaking havoc on global economies from a demand-side position considering that China with with a GDP of $25.27 trillion, hitting $36.99 trillion by 2023, is after-all the world’s largest economy,  But when the country’s nickname just happens to be “the world’s factory” as well, what sort of chaos would it cause on the supply-side of the global economy should the Middle Kingdom find itself quarantined from the world at large?

“China has evolved into a principal element of the global economy, making the epidemic a substantially more potent threat to fortunes,” – Peter Goodman for NYT

Coronavirus Has Put the Global Economy in Jeopardy because of Over-dependence on China

Designed in Cupertino, made in China, brands like Apple are emblematic of a new global economy where corporations turn to China for parts and/or assembly. It’s a faustian bargain that has meant that demagogues like President Trump get to decry the loss of domestic jobs and blame it on foreign suppliers like Foxconn (where Apple makes its iPhones) and a system that inordinately affects the wider economy beyond Asia simply because everyone has grown over-dependent on China in the new world economy – they are both makers and consumers of the world’s products. Beyond tech, even the luxury industry finds itself in a bind.

Business Korea reported that the 2018 IT shoe, the Balenciaga Triple S sneaker, which was initially produced in Italy – was being made in China. In addition, Prada makes 20% of its bags, clothes and shoes in China and others like Burberry, and Armani, make products to differing degrees in the territory, often for logistics purposes but usually for cost-economies.

Even Swiss watchmaking, a once geographically secure activity, has seen the manufacture of components like dials, sapphire glass, screws, gears and cases flourishing in China; because even with external components, the majority of the market value still takes place in the hands of Swiss-based artisans, many of these end watches are still designated “Swiss-made”. A Reuters report also showed that Swiss component suppliers might outsource production to China without the knowledge of their client-brands. What we provide is neither criticism nor judgement but evidence that China’s economic reach has grown so intertwined with the global market that decoupling might not just be painful but catastrophic.

“Sectors and countries with varying degrees of exposure to China’s economy could be more or less vulnerable to a changing relationship between China and the world. The increasing exposure of the rest of the world to China reflects China’s increasing importance as a market, supplier, and provider of capital.” – McKinsey Report

The China during 2003’s SARs and the country during today’s COVID-19 outbreak is not the same China. If not already evident from the preamble, China’s importance in the global economy has grown exponentially on both supply and demand sides of the economics equation. For one, China was on the cusp of joining the World Trade Organisation in the early 2000s, and at the time, had a GDP of only $1.7 trillion, a far cry from over $20 trillion to date. Oxford Economics data also showed that China’s share of global trade more than doubled, accounting for 12.8% up from 5.3% almost 20 years ago. Individual income had also grown by almost 10x, from $1,500 per annum to $10,000 – multiple that across a nation of 1.4 billion people with growing consumer demand for cars, electronics, fashion and watches and we are talking about the most populous consumer market in the world. In fact, the country has been a main growth driver worldwide, with the International Monetary Fund estimating that China alone accounted for 39% of global economic expansion in 2019.

Worldwide Disruptions

According to the World Tourism Organization, in 2012 China overtook Japan as Asia’s biggest spender in international tourism, also outperforming the United Kingdom and Germany to rank second in the world. By 2014, China had outspent the United States to become the world’s most generous source of international tourism revenue.

In 2017, Chinese tourists spent $257.7 billion on international travel, 18.15 times the $14.2 billion spent in 2000. The average annual increase over that period was 18.6%, considerably higher than the nominal GDP growth of 13.2%; A global comparison shows that the increase in China’s international tourism far exceeds the world’s average of 6%.

The ongoing medical crisis has led neighbouring countries (including Singapore), even its largest trader partner – Russia, to restrict travel to and from China, or close off their borders to the middle kingdom entirely. Countries around the world, including the US, Australia, the Philippines, Japan (which still has a cruise ship quarantined offshore) and Israel, have imposed stringent restrictions on travellers who have been in China recently, and have also issued travel advisories against travel to the affect region. Suffice it to say, tourism around the world has plunged and given the penchant for Chinese tourists to spend – $39 billion in Singapore last year for example – the vacuum is deeply felt in many destinations.

The ripple effects from the coronavirus are not just affecting commerce and consumer markets but also commodities, imported machinery and raw materials associated with manufacturing –  computer chips from Taiwan and South Korea, copper from Chile and Canada, factory equipment from Germany and Italy, crude oil from producers like OPEC, all used in Chinese production are plummeting. Prices for oil in New York and London commodity markets are both down about 15% since the outbreak began which means oil-producing countries like the Russia, the Middle East and US (which became a net exporter of oil thanks to shale fracking) would be in for a slippery ride down. Saudi Arabia, the biggest OPEC producer is already planning to reduce output to maintain some semblance of a price floor before further declines.

“This decision has not been an easy one but we believe that the best option for Bvlgari is to go directly to the markets as of March. It does not mean that Bvlgari is definitely leaving Baselworld and [the] decision for 2021 and beyond will be made by the end of June. As said in the past, the main criteria to continue participating to watch fairs will be the timing as well as the costs which today are not consistent with commercial requirements and returns of investments,” – Bvlgari CEO jean-Christophe Babin

Trade Shows Cancelled or drastically curtailed

The Singapore Air Show opened last week with 70 fewer exhibiting companies including prominent American defence supplier, Lockheed Martin. The Singapore Yacht Show was postponed. Art Basel Hong Kong finally gave in to exhibitor demands and called it quits and The Mobile World Congress, a giant telecoms conference due to take place in Barcelona this month, was cancelled after mega-brands like Facebook and Amazon pulled out.

Earlier this month, Swatch Group announced cancellation of its Time To Move watch fair in Zurich. Later that week, President Shuji Takahashi of Seiko Watch Corporation cited a Japanese government advisory to cancel its watch summit in Tokyo slated for March 4-6. Bvlgari, following the success of its own LVMH Watch Week in Dubai, played it safe by opting to leave Baselworld 2020, parting ways with its sister brands Zenith, TAG Heuer and Hublot, leaving journalists wondering if it was still worthwhile to have the watch fair considering that this latest edition was a far cry from what was once the most sought-after watch exhibition in Switzerland with all the prominent brands fitting into just Hall 1.

Mostly empty streets at the capital city’s popular shopping mall in Beijing, Monday, Feb. 10, 2020. China reported a rise in new virus cases on Monday, possibly denting optimism that its disease control measures like isolating major cities might be working, while Japan reported dozens of new cases aboard a quarantined cruise ship. (AP Photo/Andy Wong)

Forget the US-China trade war, that looks like tears in the rainstorm. A torrential hurricane of hurt is headed for businesses relying on Chinese suppliers and Chinese consumers, upending current business models and corporate strategies. A prolonged embargo on logistics out of the mainland is accelerating an unplanned decoupling which many international multinationals are unprepared for. The only question remains – just how disastrous will the fallout be?

Domestic Catastrophe if Virus Outbreak is prolonged in China

Many small manufacturers fear foreign customers will shift orders to other countries due to disruptions in production and delivery. In a survey of 995 SMEs by academics from Tsinghua and Peking universities, 85 per cent said they would be unable to survive for more than three months under the current conditions. If the disruption goes on long enough, it could trigger a wave of bankruptcy among SMEs, which contribute more than 60 per cent of China’s GDP, 70 per cent of its patents and account for 80 per cent of jobs nationwide. – Cary Huang, China affairs columnist for SCMP

Last week, after a self-imposed 10 day extension of Lunar New Year celebrations to “contain the spread” did little to allay fears. The re-opening of the commercial markets after the extended break saw China’s heavily-controlled domestic stock exchange plunge into a free-fall, triggering an auto-stop mechanism on trades after multiple stocks hit the daily 10% drop threshold.

Nevertheless, there is a silver lining – the dangers of over-dependence which LUXUO’s 2019 state of the luxury report warned about would have passed by the time the outbreak is successfully contained. Needless to say, it would be a bitter pill to swallow, yet one necessary for the health of the global economy. A situation like this is exactly the reason why your business professor cautioned against too many eggs in one market, especially if your chicken happens to be in the same basket.


 
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