Are we going to abandon China?

One of the questions pondered by investors these days is if the Covid-19 pandemic is going to cause a reset in global supply chains. After the SARS outbreak in 2003, the Covid-19 is the second pandemic that started in China and led to significant interruptions of global supply chains. Could it be that companies now think about diversifying their supply chains and moving some factories from China to other countries or even back to their home countries?

Nobody can know the answer to this question, but if exposure to other catastrophes is any guide then I wouldn’t get my hopes up. The American Economic Journal recently published an interesting article that looked at the impact of floods on economic activity in coastal regions. Floods are increasingly devastating because not only does climate change lead to sea level rise but rising population and increasing urbanization lead to a larger number of people living in flood plains and coastal areas. The chart below shows data about displaced people from 1988 to 2014. While there was a decline in the early years of the 2010s, the annual reports of large reinsurance companies indicate that flood damages have steadily increased again in recent years.

Floods displacing more than 100,000 people

Source: Kocornik-Mina et al. (2020).

What the researchers did was to measure the GDP impact on flooded areas with the help of satellite images measuring light emissions. They found that after a flood incident that displaced more than 100,000 people, light emissions dropped by 2% to 8%. But once the flood was over, light emissions recovered within a year. This, as well as other measurements all indicate that people do come back to flooded areas quickly. And people don’t learn, they don’t move away. Even in cases where an area was flooded more than once, they came back afterward. In essence, the benefits of living in a city with ready infrastructure and job opportunities dominate the threat from floods and other natural catastrophes.

And because people seem to be unable to adapt to increased catastrophe risk, I am not hopeful that businesses will divert their supply chains either. Just like people return to flooded areas because they think that is where jobs are, so will businesses return to China because that is where they can produce most easily. After all, the infrastructure is already there while in other countries they would have to first build the infrastructure and find the workers with the skill you need. And these initial costs are such a big hurdle that it takes a lot more than a pandemic or a flood to divert supply chains.