This report has been lightly edited for clarity and length. Coauthors include:
CHEN Dongxiao, President of Shanghai Institutes for International Studies
YE Yu, Ph.D., Senior Fellow, Institute for World Economy Studies,
SIIS WANG Yuzhu, Ph.D., Senior Fellow, Institute for World Economy Studies, SIIS
XUE Lei, Ph.D., Research Fellow, Institute for World Economy Studies, SIIS
The novel coronavirus outbreak in the lead-up to the 2020 Chinese Spring Festival has inflicted great pain on tens of thousands of patients and their families, involving countless courageous Chinese citizens, who otherwise would have spent the holiday with their families and friends, in an unprecedented anti-virus war.
Although normal economic activity and social order have been disrupted, the good news is that the growth of new confirmed cases has been on a steady decline since Feb. 3 across the country (including the epicenter province of Hubei).
On current trends, health experts predict, the peak is expected to arrive in one to two weeks. Seeing optimistic signs, people now have begun to contemplate how to restore production to normal levels in the aftermath of the epidemic. This report reflects on the economic impact of this public health emergency on China and the world and puts forward some policy recommendations on how to contain the fallout.
Economic impacts local and transitory
The epidemic first dealt a severe blow to tourism and consumption. Less fatal but more contagious than the SARS virus in 2003, the novel coronavirus is more widespread, triggering a lockdown of Hubei province on Jan. 23, followed by activation of the highest alert levels across China.
As a result, the world’s largest seasonal population movement came to a sudden halt, new year film releases were suspended and reunion dinners were canceled. Disney mascot Mickey Mouse was left alone in deserted theme parks to greet the Year of the Mouse. According to China’s Civil Aviation Administration, air passenger traffic between Jan. 27 and Feb. 12 plummeted by 70 percent compared with last year’s Spring Festival travel rush. Thirty-two of the 41 trains running between Beijing and Shanghai were also suspended.
The impacts have spilled over into supply chains since early February. Businesses and factories had been scheduled to reopen on Feb. 10 after an extended Lunar New Year holiday, but with many workers and employees unwilling or unable to return to quarantined regions, the resumption of routine operations in many workplaces has been delayed. In a few cases, where business and production have been restored, raw material shortages, logistical difficulties and cash crunches are straining normal operations. The magnitude of the economic impact ultimately depends on how long the epidemic lasts.
At present, economists are most concerned about two challenges.
First is how to get small and medium-sized enterprises back to work. Compared with deep-pocketed multinationals enjoying preferential policies, such as Tesla, which are better positioned to resume production, smaller companies that account for 90 percent of Chinese enterprises have less financial flexibility to withstand long-lasting disruptions. SMEs contribute more than 80 percent of the country’s jobs, 70 percent of indigenous innovation, 60 percent of GDP and more than half of tax income. The impact of SME shutdowns or bankruptcies resulting from logistical interruptions or shortages of workers and cash may well go beyond China’s GDP numbers.
Second is the indefinite production shutdown in epidemic areas where supply chain disruptions may have far-reaching effects. With the growing prospect of the virus being fully under control outside Hubei by the end of the first quarter, the economic impact on both the supply and demand sides is likely to be limited. White collars in Beijing and Shanghai who have returned to work since Feb. 17 are now pleased to share photos of traffic jams during rush hours.
Some sectors have found business opportunities amid the unfolding coronavirus crisis. For example, the healthcare industry and providers of online services such as telecommunications, education and entertainment have expanded. According to the Shanghai Municipal Education Commission, primary and secondary school students in Shanghai will attend online classes starting from March 2 so that their learning progress will not be significantly affected. Schools will remain closed indefinitely,
Compared with the SARS outbreak, the COVID-19 epidemic will have a far greater economic impact on China, not only because this new virus is more contagious but also because China’s economic integration stands at a much higher level today and is thus more vulnerable to complex internal and external risks. Given the robust regulatory measures expected to be taken by the government, if the economic fallout can be confined in Hubei and substantially contained by the first quarter, the epidemic’s overall impact will be manageable.
President Xi Jinping’s declaration on Jan. 20 expressing China’s strong resolve to contain the virus prompted the central government and local authorities into instant response. A whole range of emergency measures have been taken, including stringent travel restrictions, regular information disclosures and sustained material supplies.
The strengths of China’s system have been fully demonstrated in this “people’s war.” Sixteen pairs of relationships have been set up involving 19 provinces coming to the aid of 16 localities other than Hubei’s Wuhan. Countless brave local government officials and volunteers have rushed to the battlefront, working nonstop to deliver supplies to affected regions. Thanks to mobile payments, tens of millions of Chinese citizens under quarantine or travel restrictions are able to buy fresh food and daily necessities.
Since early February, with things looking up outside Hubei, the struggle to revive the economy has begun. Government actions to help enterprises get through this difficult time include four targeted policies.
The first is increasing liquidity and financial resources through monetary and fiscal policy.
The “flexible and moderate” monetary policy adopted at the Central Conference on Economic Work in December indicates a more permissive financial environment in 2020. In support of the nationwide anti-virus combat, starting from February, China’s central bank has improved market liquidity through several rounds of open market operations to drive down interest rates and stabilize the capital market.
The second is moderate deregulation to increase the accessibility of financial resources. Increased market liquidity cannot directly help enterprises overcome their difficulties. On Feb. 1, the central bank announced that it would issue loans totaling 300 billion yuan ($43 billion) at a preferential rate to policy and commercial banks via its re-lending program as part of measures to finance the control of the COVID-19 outbreak.
China will also raise its tolerance for non-performing loans to small and micro companies and set up a long-term mechanism to encourage more lending to those companies.
According to Zhou Liang, vice chairman of the Banking and Insurance Regulatory Commission, non-performing assets worth 2.3 trillion yuan were resolved last year; and with the provision coverage ratio in the banking system reaching over 180 percent, China has sufficient resources to cope with possible increases in non-performing loans. The central bank has also called on financial institutions to make interest rate concessions to brick-and- mortar businesses, limit loan interest and reduce financing costs for SMEs.
Moreover, the government, law enforcement agencies and trade associations are expected to provide force majeure remedies and credit repair for epidemic-affected enterprises that have failed to fulfill contractual obligations.
The third policy is cutting taxes and fees to reduce burdens on enterprises. Suzhou, Jiangsu province, announced 10 specific measures on Feb. 2 to help SMEs weather the epidemic. It was followed by other localities around the country that have adopted their own relief and remedy measures. Despite near-zero growth of government revenue in 2019, Shanghai has taken as many as 28 measures to help local companies, such as exempting corporate tenants from two months’ rent. The State Council announced on Feb. 18 that it had instructed local authorities to reduce or exempt companies’ contributions to the pension, unemployment, and work-related injury insurance funds.
The fourth policy involves differential measures to maximize policy effectiveness. Many of the above measures are aimed at small, medium and micro enterprises and give special support to worst-hit epidemic areas. Enterprises that are important in supply chains are prioritized in government policies. At present, travel restrictions and traffic controls remain the biggest obstacle to the resumption of business and production.
Apart from tax relief, three macro-regulatory measures in the future are advisable.
• First, using foreign exchange reserves as a quasi-fiscal tool for the purchase of emergency supplies to reduce government spending.
Using forex reserves as a quasi-fiscal tool will add to China’s financial flexibility at this critical juncture while allaying the long-standing concern over China’s holding of U.S. Treasury securities.
Moreover, purchasing emergency supplies with forex reserves may also help reduce government medical insurance expenditures by listing some items under the price quota system, and promote external economies and sustained growth by achieving more balanced trade.
• Second, widening capital market access to mitigate the epidemic’s impact.
The capital market has long been under strict control as China worries that greater openness may come at the expense of stability. But from a mid- to long-term perspective, taking in foreign investment by opening the capital market will drive China’s sustained growth.
• Third, building a new labor-capital consensus through social mobilization.
Sustained economic development is generating a social self-salvage sense. More and more employees have come to realize that their personal development is bound up with their employers’ growth. In a people’s war against the epidemic, everyone needs to pitch in, and social relief and assistance needs to play a more important part. Rent reductions and exemptions have helped bring down corporate operating costs. For manufacturers, operating costs in the future may be further reduced by encouraging employees to work makeup days or work overtime unpaid for an agreed period of time.
Long-term effects of COVID-19
• First, it has helped foster a national consensus on high-quality development.
The notion of high-quality development had long been advocated in China before it was formally proposed at the 19th National Congress of the Communist Party of China in 2017. However, the structural problems in China’s economy have remained difficult to solve, mainly because of the parochial thinking of local governments and the inherent expansionist tendency of the market.
In the fight against the coronavirus epidemic, the Chinese government’s strenuous efforts to balance public security with economic growth once again manifest the resolve of the central leadership to promote the building of a modern economic system, optimize the industrial structure and achieve sustainable development. The negative economic effects of the epidemic also serve as an important catalyst for the formation of a national consensus on high-quality development, which paves the way for deeper social and economic reforms in China.
• Second, it has helped enhance China’s national governance capacity and comprehensive capabilities in countering social and economic risks.
To a country with a superlarge population, a strong capacity for social organization and mobilization not only provides an institutional safeguard against various social emergencies but is a key element of the national system’s competitiveness. Few countries can unite a whole nation in a concerted policy implementation in such a short time — as China did.
When the “pause” button was pressed on China’s economy, the public responded spontaneously, trying to stay home all the time and maintaining good social order regardless of personal wants, which demonstrates strong public trust in the government and recognition of its leadership in fighting the epidemic.
The Chinese government, in turn, has proved itself trustworthy by effectively mobilizing national resources for the worst-hit areas, optimizing the work of such aid agencies as the Red Cross, building numerous makeshift hospitals within weeks, and promptly dismissing incompetent government officials, among other actions.
Meanwhile, the epidemic makes clear that there is much more to do before a modernized national governance system is fully established with adequate governance capacity both at the central and local levels. Indeed, with joint social efforts to combat the epidemic, China’s national governance capacity and social governance system have been further strengthened. Profound reforms have been launched in epidemic monitoring and control, disaster relief, mobilization, management and distribution of aid, as well as other areas. Multiple policy innovations are also being made. For example, the e-government system and some policies for improving the business environment, which the Chinese government has been promoting in recent years, have been widely adopted during the epidemic, greatly facilitating the government approval process for enterprises and the public.
• Third, it helped strengthen the digital economy and generate new momentum for economic growth.
As a main driver of China’s economic growth, the digital economy accounted for 34.8 percent of the national economy in 2018, and it has been employed by nearly 60 percent of Chinese enterprises, including those in the real estate sector. To meet the many new demands created by the epidemic, China’s digital economy is expected to “fast-forward” in the near future.
For instance, large quantities of medical supplies and daily necessities were transported from JD.com’s Renhe branch to No. 9 Hospital in Wuhan by the company’s intelligent robots in “non-human contact” mode. Likewise, application of such technologies as intelligent video conferencing, long-distance medical treatment, e-learning, telecommuting and big-data testing have been surging. All are conducive to the intelligent automation of enterprises.
The epidemic has also helped optimize China’s economic structure and the public’s asset allocation. For one thing, the widely practiced “work from home” mode creates pressure on commercial real estate, leading social capital away from the overheated sector. For another, because of the epidemic, enterprises and the public have developed a better understanding about economic uncertainties and thus may start to pay more for insurance and invest in other sectors, by which China will lessen its decade long dependence on the real estate economy.
In addition, as the transportation and logistics networks around China have been heavily struck by the epidemic, Chinese enterprises have paid greater attention to the stability and smoothness of supply chains. With the rapid development of manufacturing in interior provinces, regional supply chains are likely to be further strengthened as more measures are taken to enhance their stability.
As the world’s second-largest economy, China’s GDP accounts for 16.3 percent of the total and contributing 38 percent of the world’s economic growth in 2019. The great economic impacts of the epidemic are naturally spilling over the globe. Judging from current trends, most provinces and municipalities are likely to call off the unconventional lockdown and control measures to help the national economy get back on track.
According to IHS Markit estimates, if all economic activity resumes by the end of February, the world economy will not suffer too much, with a potential drop in economic growth of 0.8 percent and 0.5 percent in the first and second quarters, respectively. The world GDP growth rate for 2020 might be 0.4 percent lower than previously estimated and could be 0.4 percent higher in 2021 than previous predictions.
In merchandise trading, since China’s economy was in a virtual pause for two to three weeks with minimal demand for raw materials, global bulk commodity prices — especially of crude oil — have plummeted. At the same time, because of tight traffic controls and travel restrictions, the processing of goods imports in major economic centers and ports has slowed down, hindering the inflow of imported goods. For example, agricultural exporters in the United States, New Zealand and Australia may need to dispose of their inventories originally prepared for China’s Spring Festival holiday.
Global supply chains will face the biggest and most profound challenge. As China holds a key position in global production networks (according to IHS Markit, in 2019, China took up 30.5 percent of the world’s total added value in manufacturing and 26.3 percent of that in high-tech manufacturing), the slowing pace and even total stop of industrial production around the country has greatly disrupted global supply chains.
For example, Apple recently lowered its revenue expectations because the epidemic has both limited iPhone production and curtailed the demand of Chinese mainland consumers. On Feb. 2, a Wall Street analyst estimated a 10 percent drop in iPhone shipments in the first quarter.
Possible impacts on China-U.S. relations
On the whole, the COVID-19 epidemic may have only limited impact on the U.S. economy, thanks to its huge size and market power. Wall Street witnessed a slowing trend of major stock-market indexes like the Dow Jones, Standard & Poor’s and Nasdaq during the first month of 2020, but they seem to be gathering speed again as the epidemic comes increasingly under control in the Chinese mainland.
Meanwhile, to hedge against risks caused by slowing world economic growth, international capital is flooding to the United States, leading to the appreciation of the U.S. dollar and falling U.S. Treasury yields in recent weeks. In this sense, the epidemic is beneficial to the U.S. economy.
However, the epidemic will to varying degrees harm American enterprises with close economic ties or large investments in China. At present, Starbucks, Apple, Disney and a number of other American companies have suspended operations in China. Delta, United and American airlines have halted many flights between China and the United States. General Motors, Ford and Fiat Chrysler have closed their factories in China. To those enterprises, the loss of revenues from China will significantly decrease their total revenues for the year.
For now, the biggest impact of the epidemic on China-U.S. economic relations may be the delay in the implementation of their phase one trade deal.
Therefore, it is necessary for both sides to strengthen consultation and negotiation during and after the epidemic to facilitate implementation.