A quiet intersection in Shanghai. The effects of the extended lockdowns in China are still rippling through the global economy, and Europe could be among the hardest hit if the disruptions persist. Photo: AP
The View
by Ludovic Subran
The View
by Ludovic Subran

The cost of China’s zero-Covid policy is climbing, for Europe especially

  • Beijing’s continued insistence on zero Covid could see Europe facing heavy losses as raw material shortages and supply chain disruptions weigh on exports
  • The rising cost of trade comes when Europe is already dealing with the crisis in Ukraine, making its road to recovery even more uncertain
With Chinese provinces that account for nearly a quarter of national GDP under partial or full lockdown in March and April, the cost of China’s zero-Covid policy is climbing – and not just for its own economy. Europe is also set to pay a higher price.

First, Europe will feel the pinch from slower trade growth in 2022 as the lockdowns pressure demand from China. Even if national mobility in China roughly returns to normal over the course of this month, the global economy could face an export shortfall of US$140 billion, out of which European exporters would lose US$20 billion versus US$13 billion for American exporters.

And if the lockdowns in China last as long and are as intense as those enforced in the first wave of the pandemic in 2020, the global loss of exports could rise to as much as US$345 billion – US$50 billion for Europe, US$33 billion for the United States. This is on top of the US$480 billion in global exports to Russia and the euro zone lost as a result of the war in Ukraine.
To add to this, lockdowns are extending supply chain disruptions, which will have serious knock-on effects for companies given China’s critical position in global value chains. Nearly US$1.3 trillion worth of Chinese inputs are used around the world, especially in the electronics and automotive sectors.

Companies in Europe are more vulnerable than their American peers when it comes to relying on intermediate inputs from abroad. While their exposure is similar at the aggregate level – inputs coming from China account for nearly 1 per cent of output in both Europe and the US – the product mix is not in favour of Europe.


Shanghai plans to start lifting months-long lockdown in June

Shanghai plans to start lifting months-long lockdown in June

This is particularly the case for semiconductors, an omnipresent input that has faced acute shortages globally since 2021 and for which nearly 90 per cent of global exports come from Asia. Europe’s need for chips mostly comes from the automotive and industrial sectors, which together account for about 20 per cent of global chip sales.

Because chips used in cars and industrial machinery rely mostly on well-established manufacturing technologies, they are comparatively less profitable to make than the computing, memory or telecoms chips used in the average smartphone.

So when manufacturing capacities are running at full speed, semiconductor foundries have a natural incentive to prioritise their largest and most profitable customers at the expense of secondary, less-profitable ones.

In addition, when it comes to raw materials such as tin, copper, zinc and magnesium, which are used extensively in the electronics, metal products, construction and automotive sectors, China is pivotal for Europe.

A shock like the economic slowdown seen in 2015 and 2016, which sparked a 10 per cent drop in EU imports from China, could drag down the European metal sector by more than 6 per cent and the automotive and transport equipment sector by more than 3 per cent.

What next for China’s zero-Covid stance as lockdowns spark economic worries?

China’s sustained zero-Covid policy is also adding pressure on an already-strained network of global shipping. High-frequency data suggests that port congestion in China since March is close to the worst levels observed in the second half of 2021. This is likely to keep suppliers’ delivery times and freight rates elevated throughout 2022.

This international context throws into sharp relief the consequences of Europe’s chronic underinvestment in production and shipping capacities. When it comes to port infrastructure, Europe has consistently missed the “well-developed and efficient by international standards” mark assigned by the World Bank.

The US does not fare much better in this regard. With US$17 billion of additional spending planned for port infrastructure and waterways and US$25 billion for airports, though, it is racing ahead to address repair and maintenance backlogs and reduce congestion.

In contrast, Europe still lacks large-scale infrastructure investment plans. The largest shares of its post-crisis Recovery and Resilience Facility are set to go towards climate policy and the energy transition, as well as upgrading digitalisation infrastructure and healthcare.

A container terminal at the port of Rotterdam, in the Netherlands. Europe is beginning to feel the consequences of years of chronic underinvestment in production and shipping capacities amid a global shipping crisis. Photo: Reuters
It is striking that trade infrastructure does not make it to the top of the EU’s priority list despite the wake-up call from the war in Ukraine. The conflict is forcing Europe to respond as one to challenges such as procuring gas together, fast-tracking new energy investments and responding to the urgent cost-of-living crisis.

All these factors are compounding the effects of the war, which has snarled the supply of key raw materials such as wheat and oil and sent commodity prices surging. Put together, the situation is adding fuel to the inflation fire in Europe, which is facing the highest price pressures since the 1970s.

With a higher-than-expected feed-through from elevated producer prices to core goods, the euro zone could see inflation at 6.5 per cent this year.

While the worst of the Omicron crisis in China is now probably behind us, the zero-Covid policy is likely to remain in place for the rest of the year. This could create new pressure points and keep the cost of trade elevated in 2022. For Europe, this raises a critical question about what kind of normalisation lies ahead. With warning lights flashing, the continent could face a much bumpier road to recovery.

Ludovic Subran is the chief economist of Allianz and a member of the Council of Economic Advisors to the French prime minister