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
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.
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.
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.
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.
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.
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.
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.
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