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Could the Coronavirus Epidemic Be the Tipping Point in the Supply Chain Leaving China?

January 28, 2020

Everyone expecting a quick resolution to the epidemic and a rapid return to pre-epidemic conditions would be well-served by looking beyond first-order effects.

While the media naturally focuses on the immediate effects of the coronavirus epidemic, the possible second-order effects receive little attention: first order, every action has a consequence. Second order, every consequence has its own consequence.

So the media's focus is the first-order consequences: the number of infected people and fatalities, government responses such as quarantines, and so on. The general expectation is these first-order consequences will dissipate shortly and life will return to its pre-epidemic status with virtually no significant changes.

Second-order effects caution: not so fast. Second-order consequences may play out for months or even years even if the epidemic ends as quickly as the consensus expects.

The under-appreciated dynamic here is the tipping point, the imprecise point at which a decision to make fundamental changes tips from "maybe" to "yes."

These tipping points are often influenced by exhaustion or frustration. Take a small business that's been hit with tax increases, additional fees, more regulatory compliance requirements, etc. When the next fee increase arrives, the onlooker might declare that the sum is relatively modest and the business owner can afford to pay it, but the onlooker is only considering first-order effects: the size of the fee and and the owner's ability to pay it.

To the surprise of the onlooker focusing only on first-order effects, the second-order effect is the owner closes the business and moves away. Invisible to everyone focusing solely on first-order effects, the owner's sense of powerlessness and weakening resolve to continue despite soaring costs and declining profits has slowly been moving up to a tipping point.

Beneath the surface, every new fee, every tax increase and every new regulation has pushed the owner closer to "I've had it, I'm out."

When the owner shuts the business, onlookers can't understand how one little extra fee could trigger such a fundamental change. The observer is only looking at the new fee as a single cause with a single consequence. In the real world, each new fee, tax increase and regulation was another link in a causal chain of consequences generating consequences.

Turning to the possible second-order effects of the epidemic in China, let's start with the decision to keep supply chains in China. The reasons to keep supply chains in China have been dwindling for years: wages and other costs have been rising, the central government has increased demands for technology sharing, the general sense that foreigners and foreign companies are no longer needed or wanted, and the trade war, which is more or less in a truce phase rather than over.

One common belief is that it's "impossible" to move supply chains out of China. This is a classic first-order effect analysis. When the supply chain gets disrupted for one reason or another and alternatives must be found, alternatives are found. What becomes "impossible" isn't moving the supply chain from China but keeping it in China.

The mistake made by those only considering first-order effects is that a modest effect "should" only generate modest consequences. For the observer focused solely on first-order effects, if the coronavirus epidemic blows over as expected, then supply chains "should" be unaffected because the effect is quantitatively modest.

But once we start considering cumulative second-order effects and potential tipping points, then the disruption of supply chains caused by the epidemic, no matter how modest, could be "the last straw" to those who had beneath the surface already shifted from "never leave China" to "maybe leave China." The epidemic could tip the decision process into "must leave China."

Consider two executives, one who looked at the longer term consequences of being dependent on production in China and began establishing alternative suppliers at the start of the trade war 18 months ago, and another exec who looked at the first-order hassles and expenses of moving out of China and stayed put to minimize short-term expenses.

Individual decisions add up to trend changes, and these charts reflect a trend change in globalization and China's share of global exports. Globalization and China's share of global exports have both plateaued and are now entering the stagnation / decline phase of the S-Curve.

Everyone expecting a quick resolution to the epidemic and a rapid return to pre-epidemic conditions would be well-served by looking beyond first-order effects and easy assumptions that the consequences of the epidemic will be near-zero.

Here are some informative science-based links on the coronavirus, courtesy of longtime correspondent Cheryl A.:

Another Decade, Another Coronavirus

New coronavirus can cause infections with no symptoms and sicken otherwise healthy people, studies show

Map of Global Case of Wuhan Coronavirus

Coronavirus contagious even in incubation stage, China’s health authority says

Preliminary Risk Assessment of Coronavirus Spreading

Preliminary estimation of the basic reproduction number of novel coronavirus (2019-nCoV) in China, from 2019 to 2020

Containing new coronavirus may not be feasible, experts say, as they warn of possible sustained global spread

How fast can biotech come up with a vaccine for the latest outbreak?

DNA sleuths read the coronavirus genome, tracing its origins and looking for dangerous mutations


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Recent entries:

Could the Coronavirus Epidemic Be the Tipping Point in the Supply Chain Leaving China? January 28, 2020

Is the Market Grossly Underestimating the Potential Impact of the Coronavirus Epidemic? January 27, 2020

Some Practical Questions about the Coronavirus Epidemic January 26, 2020

Don't Be Too Sure January 24, 2020

The Future of What's Called "Capitalism" January 23, 2020

If the Martians Teleported the Davos Crowd to a Distant Moon, Who Would Mourn and Who Would Cheer? January 22, 2020

Calling Things by Their Real Names January 21, 2020

If Promoting Wealth Inequality and Social Breakdown Is Evil, The Fed Is Evil January 17, 2020

No Matter How Much Money the Fed Prints, We Still Can't Afford Nice Things January 15, 2020

Instability Rising: Why 2020 Will Be Different January 14, 2020

409Ks, 90% Gains, The Fed and Darth Vader's Warning January 12, 2020

Just a Friendly Heads-Up, Bulls: The Fed Just Slashed its Balance Sheet January 11, 2020

The Fed Can't Reverse the Decline of Financialization and Globalization January 10, 2020

Was Marx Right about Capitalism Destroying Itself from Within? January 8, 2020

Is This "The Top"? January 6, 2020

The Two Charts You Need to Ignore or Rationalize Away in 2020 (Unless You're a Bear) January 3, 2020

The Fed's "Not-QE" and the $33 Trillion Stock Market in Three Charts January 2, 2020

Grab-Bag Resolutions 2020 January 1, 2020


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"There is no security on this earth; there is only opportunity."
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"Where there is ruin, there is hope for treasures." (Rumi)

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"History doesn't have a reverse gear." (CHS, 12/22/15)

Smith's Law of Conservation of Risk: Every sustained action has more than one consequence. Some consequences will appear positive for a time before revealing their destructive nature. Some consequences will be intended, some will not. Some will be foreseeable, some will not. Some will be controllable, some will not. Those that are unforeseen and uncontrollable will trigger waves of other unforeseen and uncontrollable consequences. (July 8, 2014)(thanks to Lew G. for retitling the idea.)

Smith's Neofeudalism Principle #1: If the citizenry cannot replace a kleptocratic authoritarian government and/or limit the power of the financial Aristocracy at the ballot box, the nation is a democracy in name only.

The Smith Corollary to Metcalfe's Law (The Network Effect): the value of the network is created not just by the number of connected devices/users but by the value of the information and knowledge shared by users in sub-networks and in the entire network. (CHS, 4/6/16)

My Credo of Liberation: I no longer care if the power centers of our society--the distant, fortified castles of our financial feudal system--are changed by my actions, for I am liberated by the act of resistance. I am no longer complicit in perpetuating fraudulent feudalism and the pathology of concentrated power. I no longer covet signifiers of membership in the Upper Caste that serves the plutocracy. I am liberated from self-destructive consumerist-State financialization and the delusion that debt servitude and obedience to sociopathological Elites serve my self-interests. (Thank you, Klaus-Peter L., for reminding me)

"We've become a culture of excuses rather than solutions: solutions always require sustained effort and discipline." (CHS 4/9/16)

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"Creativity = problem solving = value creation." (CHS 6/4/16)

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"We live in a system of human emotions that masquerades as a science (economics)." (CHS 1/1/18)

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