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Economics and Strategy

Geopolitical Briefing

April 6, 2020

How COVID-19 is reshaping great power rivalry and supply chains By Angelo Katsoras

Introduction It was only a few months ago that the signing of a trade agreement seemed at last to usher in a cooling-off period in the increasingly tense rivalry between China and the United States.

In a remarkably short period of time, however, the deadly COVID-19 pandemic has dashed this hope. The war of words over the origins of the virus has succeeded in poisoning relations further and, over the long term, will make issues such as trade and intellectual property protection all the more difficult to navigate.

Moreover, just as the events of 9/11 brought about permanent changes to transportation security, the combination of COVID-19 and the general state of tension between the United States and China will bring permanent changes to how supply chain risk is managed.

How China-U.S. relations took a turn for the worse Tensions between the two countries flared up shortly after the January 23 lockdown imposed on the Chinese city of Wuhan, the epicentre of the COVID-19 outbreak. The United States was among the first countries to evacuate hundreds of its citizens from the city and impose travel restrictions. At the time, China felt this was an overreaction even though some 60 countries soon followed suit to varying degrees.1

China also took offence at comments made by U.S. officials accusing China of being slow to address the situation and of lacking transparency. U.S. National Security Adviser Robert O'Brien went so far as to say that China's delayed reaction had probably cost the world two months to prepare for the outbreak.2 China, instead, feels it deserves credit for bringing the pandemic under control within its borders. Tom Cotton, the Republican senator from Arkansas, antagonized China further by claiming that it could not be ruled out that the virus originated in Wuhan in a maximum-security bio-lab that handles the world’s most dangerous pathogens.

Tensions between the two superpowers rose another notch when China ignored U.S. requests for its disease control experts to visit Wuhan. These tensions spiked again when a spokesman for China's Foreign Ministry suggested in mid-March that the U.S. military might have been responsible for bringing COVID-19 to the Chinese city of Wuhan, where the Military World Games were held last October. The insinuation was made over a series of posts on Twitter, which, ironically, is blocked in China.

Source: “China Government Spokesman Says U.S. Military May Have Brought Virus to China,” Reuters, March 13, 2020

1 “Clash of the titans: how the coronavirus became the new China-US battleground,” South China Morning Post, March 15, 2020 2 “China Government Spokesman Says U.S. Military May Have Brought Virus to China,” Reuters, March 13, 2020

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Tensions spill over into tit-for-tat expulsions of journalists It began when the United States changed the designation of the five state-owned Chinese media outlets to foreign missions of the Chinese government. U.S. authorities felt this better reflected their true function, which they feel is the promotion of China’s interests. In short order, China expelled three reporters from the Wall Street Journal’s Beijing bureau. The Trump administration shot back by expelling 60 of the nearly 160 Chinese nationals working for the state media outlets in the United States. In turn, China’s foreign ministry retaliated by expelling almost all of the U.S. nationals working in the country for The New York Times, The Wall Street Journal, and The Washington Post.

Trade deal looking less viable by the day Even before the COVID-19 outbreak, China’s commitment to purchase $200 billion more in U.S. manufacturing, agriculture, energy and services exports over the next two years than it did in 2017 would have proved very difficult to meet for two main reasons. First, reaching the targets outlined in the deal entails an increase in exports to a single country without precedent in the history of U.S. trade. Now, with the economic impact of COVID-19 unfolding, attaining these targets now seems virtually impossible. Second, honouring the pledge to buy some $80 billion more in manufactured goods from the United States is further complicated by the fact that China would like to import the very high-tech goods that, in some cases, the United States has banned it from purchasing.

Amid the COVID-19 pandemic, America continues to target China Below are a few examples of this:

In late January, the FBI charged the chair of Harvard University’s Chemistry and Chemical Biology Department, Charles Lieber, with deliberately lying about receiving millions of dollars in funding from China.3 This is America’s highest profile arrest to date related to Chinese espionage.

The United States successfully lobbied the Netherlands to stop one of its companies, ASML, from selling advanced chip manufacturing technology to China. This demonstrates how far the United States is prepared to go to prevent China from getting hold of technology needed to make the world’s fastest microprocessors.4

Under existing rules, corporations are allowed to sell to Huawei via international subsidiaries provided that their products contain less than 25% U.S.-made goods. U.S. authorities may tighten this restriction in the near future by revising the percentage down to 10%. Whatever happens, it seems more and more likely that American and Chinese companies heavily dependent on one another's markets in sectors deemed strategic will lose market share over the long term.

In early February, U.S. Attorney General William Barr stated that the United States should consider acquiring a controlling stake in either Ericsson AB or Nokia, Huawei’s biggest telecommunications equipment rivals. This, in his view, would help the United States develop a much-needed strong alternative to Huawei.5

On March 26, U.S. President Donald Trump signed into law the Taiwan Allies International Protection and Enhancement Initiative Act, which requires the United States to increase support for Taiwan on the international stage. The act was passed with strong bipartisan support in Congress. Not surprisingly, the move was decried by China, which claims Taiwan as part of its own territory.

The U.S. Department of Justice announced on February 10 that a federal grand jury had indicted four members of the Chinese People's Liberation Army in connection with the 2017 hack of the credit reporting agency Equifax. Data on over 145 million U.S. citizens was stolen.

Source: “Lessons From the 2017 Equifax Hack,” Stratfor, February 24, 2020

3 “Harvard Chemistry Chairman Charged on Alleged Undisclosed Ties to China,” Wall Street Journal, January 23, 2020 4 “Rise of TSMC gives windfall to Dutch chipmaking equipment giant,” Nikkei Asian Review, March 18, 2020 5 “The Winners from Washington’s War on Huawei,” Wall Street Journal, February 8, 2020

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COVID-19 will further reshape supply chains COVID-19 will also hasten what the trade war between the United States and China set in motion: the end of an era when most companies could concentrate the vast majority of their production activities in regions with the lowest costs. This means that companies will need to create duplicate supply chains across several countries, a process that will be both expensive and time consuming.

Predictably, the Trump administration has used the COVID-19 crisis to push companies to bring home essential manufacturing capabilities. Perhaps more surprising is the fact that this position is now being embraced by certain countries that have long criticized President Trump’s approach to globalization. Recent comments by French Finance Minister Bruno Le Maire are a case in point: "We have to decrease our dependence on a couple of large powers, in particular China, for the supply of certain products" and "strengthen our sovereignty in strategic value chains like cars, aerospace and medicines.”6

More companies to build up stockpiles

We are likely also to see companies make a partial return to the practice of maintaining large stockpiles of supplies. Recent remarks by David Collins, Chief Executive Officer of Shenzhen-based China Manufacturing Consultants and a former senior manager for Chrysler Corp. highlight what is possible. “In the 1980s, we had about $440 million worth of auto parts, six or seven weeks’ worth, sitting as backup” in the industry. That figure now is less than $50 million.” 7

Companies will be increasingly forced to fully map out supply chains

A surprising number of companies are not aware of the full depth of their supply chains. The following reports are but a few examples.

“Michael Essig, a professor of supply management at the Bundeswehr University in Munich, calculated that a multinational company such as Volkswagen has 5,000 suppliers (the so-called tier-one suppliers), each with an average of some 250 tier-two suppliers. That means that the company actually has 1.25 million suppliers—the vast majority of whom it doesn’t know.”8

The Harvard Business Review reported that it took a team of 100 people more than a year to map the supply chain of a Japanese semiconductor manufacturer (which was not named in the article) following the earthquake and tsunami of 2011.9

After the Washington Post and the Australian Strategic Policy Institute reported in March that members of the Uighur Muslim minority were forced to make shoes for Nike in China, the shoemaker responded by saying it was “conducting ongoing diligence with our suppliers in China to identify and assess potential risks related to employment of people from Xinjiang.”10 On March 11, U.S. lawmakers unveiled legislation that, if passed, would tightly restrict imports to the United States from the Xinjiang region of western China because of the alleged widespread use of forced labour.

Healthcare supply chains will be first to be re-localized While the United States remains a global leader in the development of new drugs, much of the manufacturing has moved offshore. The same has occurred to varying degrees in most of the other industrialized countries. Like other manufacturing operations, drug plants have been moved to Asia to take advantage of lower labour, construction, and regulatory costs.

Indeed, the United States relies on China for over 90% of its antibiotics, vitamin C, ibuprofen and hydrocortisone, 40%-45% of its heparin, and 70% of its acetaminophen. It also relies on India for 40% of its generic prescription drugs.11 India, in turn, depends on China for 70% of its pharmaceutical ingredients.12

These vulnerabilities have not gone unnoticed in China. An article posted in early March by the state news agency Xinhua, which was widely covered in the U.S. press, suggested that the world should be more appreciative of its efforts rather than blaming it for spreading the virus. It also stated that if China banned the export of drugs, “the United States would sink into the hell of a novel coronavirus epidemic”. 13

6 “Coronavirus forces Europe to confront China dependency,” Politico, March 7, 2020 7 “Companies That Got Out of China Before Coronavirus Are Still Tangled in Its Supply Chains, “Wall Street Journal, March 8, 2020 8 “Blindsided on the Supply Side,” Foreign Policy, March 4, 2020 9 “Coronavirus Is a Wake-Up Call for Supply Chain Management,” Harvard Business Review, March 27, 2020 10 “Nike to review supply chains in China after reports Uighurs forced to make shoes,” Washington Post, March 11, 2020 11 “The Coronavirus Outbreak Could Disrupt the U.S. Drug Supply,” Council on Foreign Relations, March 5, 2020 12 “If coronavirus isn’t brought to heel, economic bedlam awaits,” The Telegraph, February 22, 2020 13 “Coronavirus Spurs U.S. Efforts to End China’s Chokehold on Drugs,” New York Times, March 11, 2020

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Every nation for itself

The COVID-19 outbreak has led many countries to hoard medical supplies for themselves. From the beginning of 2020 to March 21, 54 nations either banned or limited the export of certain medical equipment and medicines.14

Here are a few examples:

China, which is essential to the world’s supply of protective medical gear, did not just stop selling masks at the height of its pandemic, it bought up much of the world’s supply. China imported 56 million respirators and masks in the first week after Wuhan was locked down.15

India, the world's leading supplier of generic drugs, recently restricted the export of 26 pharmaceutical ingredients, including acetaminophen, a common pain reliever found in Tylenol. It did this to ensure it had enough medicine to handle a potential pandemic within its borders. The United States is reportedly in talks with India to ensure access to vital medicines.16

Not only has the EU restricted exports of medical supplies, some member states had even temporarily banned exports of such supplies to other member states. “We asked for supplies of medical equipment, and the European Commission forwarded the appeal to the member states. But it didn’t work,” said Italy’s permanent representative to the EU, Maurizio Massari, in mid-February.17 However, it should be noted that in late March, Germany, France, and Austria had begun sending face masks to Italy.

In early April, a number of French politicians accused the US of buying up Chinese face masks previously ordered by France. “There on the runway, the Americans take out cash and they pay three or four times more for the orders that we had made," alleged one official. For their part, U.S. officials have denied purchasing any masks intended for delivery from China to France.18

Others point out that France has also engaged in hardball tactics. In early March, Valmy SAS, a midsize medical supplies maker in France, was reportedly unable to fulfill an order for a million masks by the UK because the French government requisitioned the supplies.19

Re-localization COVID-19 will create an outcry in the United States and other countries to repatriate large parts of their medical supply chains. In this regard, the United States is already preparing a “Buy American” executive order that will require federal agencies to purchase American-made pharmaceuticals and medical equipment when possible. A congressional bill to this effect will likely follow.

As mentioned above, France is going the same route. Bruno Le Maire, the French Minister of the Economy and Finance, stated: "We cannot continue to be 80% to 85% dependent on China for active pharmaceutical ingredients."20 The French pharmaceutical company Sanofi SA has already announced that it will create a company focused on producing pharmaceutical ingredients in France.

China seeking to change the narrative on COVID-19 Not too long ago, China was overwhelmed by the COVID-19 epidemic and had accepted medical donations from several dozen countries. Now that the pandemic is seemingly under control there, it is aggressively trying to reposition itself from being known as the incubator of the pandemic to being the global leader in the battle against the virus by, among other things, shipping medical supplies to several countries.

Meanwhile, the United States has been conspicuously absent on this front as it struggles with medical equipment shortages of its own. China’s French embassy didn’t hold back any punches in trying to point this out in the following tweet: “When the epidemic started to explode everywhere, it was China who the entire world asked for help, and not the United States, the ‘beacon of democracy. “It is China who lent a helping hand to more than 80 nations. Not the United States.”21

However, China’s public relations campaign has hit some bumps. For instance, a number of governments, including Spain and Turkey, have found the equipment received to be either defective or substandard. Notably, the Netherlands was forced to recall 600,000 of the 1.1 million face masks it bought from China.22 Moreover, resentment lingers over China’s initial response to the pandemic, which included silencing whistleblowers and locking down Wuhan only after five million people had already left the city.

14 “Tackling Coronavirus,” World Trade Alert, March 11, 2020 15 “The World Needs Masks. China Makes Them — But Has Been Hoarding Them,” New York Times, March 13, 2020 16 “Trump administration in talks with India to avoid U.S. drug supply shortage,” NBC News, March 30, 2020 17 “The EU Is Abandoning Italy in Its Hour of Need,” Foreign Policy, March 14, 2020 18 “US official denies claim that Americans buying up France's masks,” AFP, April 2, 2020 19 “The World Needs Masks. China Makes Them — But Has Been Hoarding Them”, New York Times, March 13, 2020 20 “Coronavirus outbreak hitting German supply chains with fears of economic paralysis,” Deutsche Welle, February 27, 2020 21 “China Asserts Claim to Global Leadership, Mask by Mask,” The Wall Street Journal, April 1, 2020 22 “Coronavirus: Countries reject Chinese-made equipment,” BBC, March 30, 2020

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China has also sought to further burnish its virus-fighting credentials by publishing a book in early March entitled “A Major Power’s Battle Against the Epidemic”, which heaped praise on the leadership for its decisive action in reining in the outbreak. However, authorities were forced to delay the launch of the book after facing a wave of criticism on Chinese social media for the initiative. Consequently, we can expect the book to be re-edited for release a little further down the road.

Source: Australian, March 2020

Conclusion Instead of fostering cooperation, COVID-19 is creating further tension between the United States and China that will long outlast the pandemic. It will also intensify the competition over whether China’s authoritarian system of governance or America’s democratic model is best at managing crises like the COVID-19 epidemic and delivering economic growth.

Where supply chains are concerned, COVID-19 and the mutual distrust between the two superpowers will fray the ties between Chinese and American companies even further. It also marks the end of an era when companies could concentrate the vast majority of their production in regions of the world with the lowest costs without taking into account resiliency in the face of potential black swan events like COVID-19. All of this will force many companies to undertake the costly task of building up duplicate and regionally diversified supply chains.

The health sector’s supply chains will be ground zero for these trends. Persistent shortages during the virus pandemic will push many countries to work towards producing a significant portion of their medicine supply within their own borders. While this will help ensure security of supply in times of crisis, producing medicines in a multitude of locations will reduce economies of scale and significantly add to costs.




Montreal Office Toronto Office 514-879-2529 416-869-8598

Stéfane Marion Matthieu Arseneau Warren Lovely Chief Economist and Strategist Deputy Chief Economist Chief Rate Strategist, Economics and Strategy [email protected] [email protected] [email protected]

Krishen Rangasamy Paul-André Pinsonnault Marc Pinsonneault Taylor Schleich Senior Economist Senior Economist Senior Economist Associate, Rates Strategist, Economics and Strategy [email protected] [email protected] [email protected] [email protected]

Kyle Dahms Jocelyn Paquet Angelo Katsoras Economist Economist Geopolitical Analyst [email protected] [email protected] [email protected]

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