Why Europe Finds It Hard to Break Chinese Supply Chains

global economy to you. And that's what the chief economy is for renaissance Capital. Charlie Robertson thinks will be the most important effect of COVID nineteen for emerging market economies. Developing countries will come out of the crisis faster than many people expect, in his view, and the lasting effect will come not from the disease itself or the direct impact on the global economy, but from President Donald Trump not getting form or years to put up trade barriers

and discourage global investment. I was speaking to Mr Robertson and the chief economist of the World Trade Organization, Robert Koopman, this week in a panel for City Week, an event organized by City and Financial Global More on that in a few minutes, but first I wanted to give you some on the ground perspective on the future of global trade. You might remember, in the early months of the COVID crisis,

a lot of commentators declared the end of globalization. Governments, especially in Europe, started talking about the need for strategic autonomy. Never again would companies or countries want to get caught short in key medical supplies or discover that key inputs to major industries or came from a single factory in Wuhan. Production will be brought back home. They said, supply chains would shrink, ties with China would be cut. Well, that

was the theory. Life has turned out to be more complicated, and those ties with China in particular have turned out to be quite hard to sever A group of Bloomberg reporters from across Europe have been looking for firms who are rethinking their supply chains as a result of COVID nineteen. Their story was published this week, and I'm glad to say that one of those reporters, Pyota Skolimowski, is with me now. He's in Frankfurt and also spends a lot

of time covering the European Central Bank, Pyotta. Welcome to Stephanomics. So what did you find out in this story? So it's not so easy for these firms to cut their ties with China high Stephaniely. Indeed, it's it's a tough one despite the fact that Europe is really trying to wean its economies off from the dependence on China and

other Asian companies are Asian suppliers. We talked to a few companies, one in Italy, for example, producer of shoes, where the chairman of the company basically said, well, Chinese workers are are just better at doing what he called jim shoes. But but the fact here is is actually costs, so he has production costs in China are still sevent seventy five percent lower than in Italy. So that's a big factor of why he's not really eager to move

everything to Italy. So as as long as there are no subsidies from the government or support in one form or another of lower taxes for example, and he's not going to move production closer to home. And it also applies to other sectors where as a matter of fact, they are key to to to the strategy of of

shortening supply chains in Europe, for example, pharmaceutical companies. We talked to one of the executives who said, well, actually China dominates one of the market for ingredients to what he called active ingredients for for drugs that his company is producing. So it's really difficult to suddenly move away from that and just go and and mind suppliers somewhere else.

And finally, there's also another factor that simply companies in Europe reli very heavily on exports, so China is not really only just a supplier of components, supplier of elements to their cars. It's a big booming market, so they cannot really afford to not to be there, and they're

already building a big supply chain around China. They as an example, they volks Wagon actually bought two companies or shares in two companies that have to do with battery cells and another with electric cars in China just at the at the peak of the of the COVID pandemic in April. It sort of tells you that obviously there is a push to to shorten supply chains, but there are factors that that are kind of pushing into the opposite direction, which will make it harder for companies to

make it a big change in the strategy. Yeah, and I have to say that is something that we have heard coming out of Asia as well, and our reporters and analysts who are involved in the tech industry as a similar message that the likes of Apple have invested so much in these quite sophisticated supply chains and it's much easier said than done to start disentangling from China in particular, there's just a sunk costs involved apart from

apart from anything else. But let's hear I think we we do have a bit of that interview that you did with the German pharmaceutical executive Peter Goldschmidt, who is chief executive of the generic pharmaceutical maker Status, So let's

hear from him. Now, why you really start thinking about moving victory doing test transfer into higher cross areas where no one knows who is able to pay it, and before before this creates an additional risk because of tech transfer is also a risk we should really think about relatively in my view, easier fast fixes. I mean, are you also trying to say that actually there is because you mentioned forty percent of all active parmaceutical ingredients are Chinese.

I mean, there is really no alternative to China as a supplier of a key ingredient in what you're producing. No. I look, the point is there are of us a lot of alternatives. I could start and buying an API company and start producing this also in Germany. The only problem I have is unanormous circumstances. No one will buy

it from me because I'm too expensive. The reason why it is in China is that the quality China has delivered, most organizations obviously in Europe couldn't compete on a price letter. That's why we have this situation. And of course if people would think, hey, that's an attractive business I should go to, then more people would do it. But obviously

the business is not so attractive. So if the governments are building uh the substitutes in order that you have prices that you can have a company, and API is a is a worldwide business, you can produced just API for Ostia. You could do it. It's the question who pays the price. Everything is technically absolutely possible, absolutely no doubt. It's just a question of time and money. So in that sense, you think that government in its hopes or

actually Europe hide. If you look at the whole strategy these days, there's going to build of a disappointment that this is not going to be first of all a quick process and secondly there will have to be a lot of steps before we even even even go there in terms of and maybe there are after a quick fixed solutions like the storage of API, for example in a gift country, and then you have an assigned producer in a crisis time who has then to make sure

that they can produce the volume based on this API right before you do like this big picture. I mean, my problem in the discussion is not that this could be a possible solution that you bring more whatever kind of reduction pharmacy in production back to Germany. It's a political decision which costs money and has implications on our direct crisis in Germany. The Otho Skolomowski, thank you very much.

Thank you well. As it happens, I put exactly this question about the future of global supply chains to the chief economist of the World Trade Organization, Robert Kopman in my city Wheek panel that I mentioned at the start, and we also had Charlie Robertson, chief economist for Renaissance Capital. On that panel, he was much more outbeat about the future of emerging market economies than others I've talked to

on Stephanomics in recent weeks. I guess when you listen to him, you do need to remember that his firm specializes in investing in emerging market economies, so you can judge for yourself whether his story stacks up. But I started by asking Robert Koopman about his forecast for and beyond. We hear the projection for a global trade for declining in an optimistic scenario of about thirteen percent, anywhere up

to thirty two percent in a pessimistic scenario. The latest data suggests we're more on track for the optimistic scenario, a trade decline of around twelve thirteen maybe four percent, with a slow recovery. Though for one and into two. I think the drivers of the slow recovery or weakness expected weakness and consumption, and particularly expected weakness and investment.

We don't think that firms are gonna have a very confident view of the future of the global economy, and I think that UH investment is going to be relatively weak. Investment is a significant driver of global trade going forward. I think the likely recovery for trade is a trade will probably get back to close to its long term average growth rate of about one and a half times global GDP growth. But I think it's going to be

a regal globalization. It's going to be a reorganization of globalization that we've seen in the past twenty or thirty years, probably more regional supply chains, a lot more digital trade than we've seen in the past that's been growing fast. I think it's gonna it's growing faster now and continue to grow fast. And I think you'll see more flexible production processes, maybe regional agreements to help to respond to spikes in demand as a result of either health prices

or climate crisis. So we'll see. I think this reorganization of globalization maybe um with slower growth, and the long term implications of slower trade growth usually means slower productivity growth in the future, so we have significant concerns around that.

There's been a lot of conversation about what happens to global supply chains as a result of this crisis and the immediate After all the immediate stages of the crisis, a lot of talk about bringing production home or at least diversifying supply chains, not just in response to COVID but also worries around around China. But we've had some

of our reporting this week. In fact, in Europe we're looking at companies who have been trying to shorten the supply chains and struggling and realizing that it's going to be just too costly to do that. They've got too much wedded to the very sophisticated approach they had before. So what is your view when you talk about reorganization of globalization, is that diversification of supply chains? What is it? Do you think it's mainly diversification. Most global supply chains

are regional. You think about automobiles. Of automobile supply chains are regional, but there can be that one part, that one critical part that is from outside the region that could be difficult to procure domestically but called up the entire product. I think they'll find ways to diversify those supply chains, not bring that want to obscure but very important product to some local production facility. I do think they'll use inventories, will night see, particularly for those kinds

of products. Firms will change their just in time inventory approach to something that's a little more balanced. They'll still use just in time for those things that they don't think are that disruptive or that they can easily diversify UM and have multiple suppliers, but for those things, those products, those components that they can't my my suspicion is they'll

carry more inventory of that. And keep in mind, you know, the started as a supply shock in China, but you know you can have a fire or a hurricane in the Gulf of Mexico that knocks out your domestic supply chain just as badly. UM. So you know, I don't think that the strategy you're reshoring really holds up in the long term, but weaker growth, weaker investment that does

undermine their integration and globalization. Charlie Robertson, I know that you're looking at strategy from a global perspective of renaissance, and I wonder how do you think about the recovery and particularly the fact that we now are in this what you might call a messier stage where some countries are coming in and out of lockdown. We're potentially having second waves. We're not sure about the consumer. How the consumer is going to behave in these first few months

of recovery. How are you seeing things? Yeah, I'm chief economists of an emerging market Frontier Bank, Renaissance Capital, so I'm gonna have to focus mostly on that. But what what's been striking to us is the success that emerging markets have had in fighting the disease, at least in East Asia. Um, and it's worth remembering the two thirds of emerging markets equities are don't have the virus anymore. That's China, Career, Taiwan, Thailand, they make up of M

S c I emerging markets. They have no virus, so it's not even an issue of a V shape or a W shape or anything else. Everyone can go back to restaurants, everyone can go back onto planes, travel, etcetera. At least internally is back to normal. So it looks pretty v shaped in in what is two thirds of emerging markets, either they've beaten the virus or they said there's nothing we can do to stop the virus. Either way,

I think their economic recoveries are going to look somewhat better. Charlie, I'm struck by, um what you were saying about em because when I talked to our emerging market economists, it's quite a bleak picture that comes out of it. Not for some of the countries that you were talking about, but when you talk about India or so that, large parts of Africa, a big some parts of Latin America.

It feels like the risk is that this crisis is going to shut the door on a lot of countries who were on their way into the emerging market and potentially beyond little make it much harder for them to continue to progress, and actually they could lose ten or fifteen years of progress as a result of this. Is that fair? I mean, you talked about the countries that have already emerged to some extent, and they are well

represented in the MSc I index and everything else. But those that hadn't built their capacity by the risk is they're not going to be able to now in the conditions of the next piece because they're going to be so hit by this crisis. Isn't that a concern? I mean, the numbers I've been talking about in places like sub Sahara, and what I've been struck by is that the average age of those dying in the UK is about eighty years old, and the percentage of Nigerians aged two or

more is zero. The number of Kenyans aged eighty or more is also zero, and that they're just not going to be hit in that way. UM. What I think has actually been much more damaging than the virus for sub Sahara or lower income countries has been this trend towards protectionism, the lack of trade, the discouragement of foreign direct investment globally in recent years. And I think perhaps the most important change that's going to come upout as

a result of this virus is the political change. In November in the States, we put out a piece a month or two ago saying that no US president is ever re elected after a recession in his first term. And I've been saying that and upsetting my Democrat friends in New York for some years about Trump and saying that he was going to win this election because there was no recession in the States. Um, And they were

very unhappy with me saying that. Of course, that's change now, and he has symbolized protectionism more than anybody else in the global economy. But actually he's really made a difference. You've seen FDI foreign direct investment flow into America and not flow out of America. You've had negative FDI or in fact, if you like, FDI flows net into the States for the last two years, and that has meant

no FDI into emerging markets. Who wants to set up a factory in emerging markets when there could be a big tariff war set against you, um, and it's it's really hurt growth. Um. So I think there's political change that now I think inevitable in November. It is going to be very important. Not that America and Chinese relations are going to be perfect. They were not, and that's going to be a rivalry that will continue for years.

But a normal country facing a rival like China would be building alliances to the rest of the world, not imposing tariffs on them. Vietnam should be America's best friend right now. India should be America's best friend right now. And I think that's what will likely come from the change of president in November. One I don't think is gonna We're not gonna see big FDI in there's a global recession. No one's gonna be putting money into anywhere,

including emerging markets. It's not going to be great from that perspective. But I think this protections theme which has

been so painful and has supported the stronger dollar. Of course as well, that protectionist theme that's turning at the end of this year, and I think that's probably the most bullish US for emerging markets of all m that's going to come out of this this unexpected virus and the impact on the global economy and Robert Coopman, you know, if you're sitting in a TV economist of the w d O, do you share Charlie's view that if you see Trump defeated in the election, that one could continue

to have challenging relations between the US and China, but it wouldn't necessarily in fit the global trading system, because I think that's that's an interesting point Charlie made that. I think I hadn't heard other people tend to say that the US China battle will infect everything else and make the global trading system a much more protection is much more fractured place. But how do you see it? Um, I don't think that the election is going to necessarily

bring about big positive effects in the trade area. There are scarring effects. I think, just like we're talking about the COVID crisis. The political scarring effects from the the Trump policies are likely to remain. Um. I think there will be somewhat mitigated and perhaps and I do hope I'm wrong, significantly mitigated. But the debate around trade started to change, um you know, in the mid um and

Trump has certainly taken that rather aggressively forward. There's this focus on US China, do not forget about US du Those stresses are pretty significant, and they've been there for a long time and normally the two regions countries have worked well together to keep those sort of um channeled into something like the w t O Dispute Body or competing regional trade agreements, you know, so they've been somewhat productively managed. But I think that's gonna be something that

remains to be seen how that works out. There will be a change in administrations in in the fall, actually change an administration. When happened until the beginning of the new year, a couple of things, the trade war, tariffs

and the uncertainty around that. So the terrorists on China costly to the US, somewhat costly to China caused a lot of trade diversion, contributed to uncertainty, But the bigger contributor to uncertainty was auto teriffs on the EU, general trade policy from the United States, the sort of weakening of the centrality of the w t O in the in the trading system, which was largely pushed by US positions in the G twenty. But all of those effects

were relatively small. The COVID effects are huge. I mean, they're just massive compared to the trade war tariffs, but both have potential long term implications for growth UM. A big concern from COVID for me is automation. I think firms are gonna try to find ways to substitute for human workers as much as possible. On the service side, we can easily distribute those workers, perhaps through remote work.

That's a bit harder. In manufacturing, I think we'll see significant investments in manufacturing that could undermine than UM a lot of workers and their ability to find good work, good paying jobs. Thanks for listening to Stephanomics. We'll be back next week with more on how COVID nineteen is transforming the global economy. Remember you can always find us on the Bloomberg Terminal website, app or wherever you get your podcasts and For more news and analysis from Bloomberg Economics,

you should follow as Economics on Twitter. This episode was produced by Magnus Hendrickson and the story we spoke about at the start of the program was written by Flavia Rotundee, Jeanette Newman, Joo Lima, and Pyota Skolimowski. Was also edited by Alas Shaheen. Special thanks to Charlie Robertson, Pyotas Olimowski, Robert Kopman, and City and Financial Global. Lucy Meekin is the acting executive producer of Stephanomics and the head of Bloomberg Podcast is Francesca Levy. M