With lockdowns in China spreading in impact and significance, there are extensive challenges being created in supply chains that have the potential for a global impact.
Inside China, the three biggest challenges are labor, domestic logistics, and mobility.
In February and March of 2020, the impact was on the production side where factories were ordered to stop and close. Now two years later, most production is ok, but the impact is on the logistics side. Factories cannot ship, and customers cannot receive.
Restrictions started in Southern China’s Shenzhen in February, and the lockdown of the entire province of Jilin, and then rolled out across the country to Shanghai, Guangzhou, Xian, and other major areas. These are a mix of complete initial lockdowns (Jilin and Shenzhen), other types of lockdowns in Shanghai and Xian,to other forms of restrictions such as needing a PCR result within 24 hours to enter a city or take a flight.
With the shutdown of factories on a large scale in different parts of China, including Foxconn, Tesla, and Toyota, there are trickle down effects across the entire supply chain. The severity of the impact depends upon the jurisdictional rules put in place on a location-by-location basis. While some factories are closed in one province, under similar circumstances they may remain open in another.
For example, some Foxconn facilities in Zhengzhou remained open with minimal impact while those in Shenzhen were closed.
In a normal year, after the Chinese New Year Festival holiday and bonuses are paid, workers often look to change jobs or locations. This has been difficult to do in the last few years due to restricted movement. With the January outbreak in Xi’an, as well as the latest outbreaks around the country, company recruitment has been greatly affected, and job mobility decreased. Even college graduates, who would be in the process of campus recruitment, are finding it challenging to get inquiries, or even calls and emails answered.
These restrictions are leading to labor shortages, especially among factories and other production parts of supply chains. This in turn is leading to delays in product delivery and invoicing, and could affect normal manufacturing processes such as quality, prototype development, and cost control.
When Shenzhen locked down, production lines were forced to stop and workers at major e-goods manufacturers were not only required to remain on the factory campus, but also required to take unpaid leave for a period of time. To fight against mobility issues, factories are turning to “bubble operation” or “closed-loop” management to minimize the impact. Most major campuses are self-contained environments with food shopping and medical care, but smaller factories would not have such luxuries. In order to avoid losing labor in an increasingly competitive market, labor was not allowed to leave the campus during the entire lock-down. Some factories have seen a large percentage of workers that cannot return due to mandatory testing, isolation, or quarantine requirements. Others have rented hotel rooms for staff to stay so they do not have to travel between cities or from their home to work.
Another challenge is China is still primarily closed to the outside world, with only certain cities and international flights available. Shanghai itself is closed to international flights until May 1st at the earliest. This has created further chaos getting talent and knowledge into the country to deal with supply chain and production issues, and further squeezes air freight capacity for goods.
The CAAC, China Aviation Administration of China, diverted over 120 international flights that would have normally landed in Shanghai. These flights were redirected to other regional airports in an effort to minimize the impact of Zero-COVID testing and processing during a difficult time for the city of Shanghai. This impacted domestic carriers primarily, because international carriers faced impossible difficulties such as lack of equipment, staff, and flight permissions at regional airports. This has recently changed as some airlines, such as Delta, are stopping all service out of Shanghai until further notice.
Inside China, restrictions on movement have forced some workers to leave jobs as they cannot return to the work location. Still others have refused to return to work, as it is increasingly difficult to travel between cities and provinces. With the need for a green QR code, not having been in an area with COVID in the last 14 days, and a recent PCR or Antigen test, travel is extremely challenging to undertake. Those that do not fulfill these requirements can be refused exit off of a highway, travel tickets, hotel stays, or even entry into certain buildings. Many freight drivers have been caught by changing rules and then forced off the roads; others are refusing to drive into certain areas. Another challenge is the system is so overwhelmed even if you do get tested results may not be available in the required timeframe.
Some businesses have been able to negotiate with local authorities to allow some flexibility for travel and production, especially for critical production in key industries (medical devices as an example). This process involves government auditors who review business processes, and evaluate how the company controls COVID such as people moving into the loop bubble. The plan is to rotate staff every 7-10 days, but this is a temporary solution.
Looking Forward: What happens after this wave is over?
Logistics issues inside China should subside fairly quickly and while outbound shipping will be delayed, it is not offline as with previous outbreaks in Ningbo or Yantian. If there are continued lockdowns, this could change the situation quickly.
Regulations will be eased for businesses that might be late on loan payments, or companies that are not able to pay taxes to the government. The central and local governments will likely push stimulus into the system the rest of the year to hit growth targets and to ensure that businesses are up and running. We are already seeing Shanghai commit to 140 billion RMB ($22 billion) worth of tax subsidies to firms in the city.
Once business returns to normal, expect production and other problems inside China due to logistics issues, material shortages, labor, and mobility challenges. This will lead to continued impact on production and getting goods to market. Commodity prices will increase more than expected for the rest of 2022, and the first half of 2022 will have slower economic growth. If there are rolling lockdowns into May, expect the GDP to fall short of government targets. It could be anywhere from half to a full percent less than the current 5.5% target.
One key difference now with 2020, is the fatigue factor with the pandemic. This time it seems more real. The general sentiment in China is that this stage will last for some time. The government is taking serious counter measures if there is a close contact and/or positive case. In areas and cities that haven’t had much COVID in the last two years, there are much harsher measures than before. This is driving much of the lockdowns and mobility restrictions. Once these are lifted, logistics and other challenges will start to ease.
The final question is will China relax its Dynamic Zero-COVID policy due to these outbreaks or in general? The answer is no, there is no indication of any relaxation, even temporarily, from the Zero-COVID approach. Expect the policy to remain until after Chinese New Year of 2023 at the earliest, and most likely some form of it will continue through 2023.