Fuel Prices Putting Globalization in Reverse?

David Butcher Jun 04, 2008

The world seems to be becoming less flat. Shipping costs between Asia have risen so much that they have eclipsed tariffs as a barrier to global trade, according to a new report that calls the cost of moving goods "the largest barrier to global trade today."

The impact of rising transportation costs, driven significantly by high oil prices, is already being seen in capital-intensive manufacturing that carry a high ratio of freight costs to the final sale price. But a new report has determined that higher energy prices are affecting transport costs at such an unprecedented rate that "the cost of moving goods, not the cost of tariffs, is the largest barrier to global trade today."

The report, released by CIBC World Markets last week, concludes that the continuing increase of energy prices poses a major threat to price stability and overseas manufacturing — to the point that such forces "may reverse the impact of globalization."

"Exploding transport costs may soon remove the single most important brake on inflation over the last decade — wage arbitrage with China," says Jeff Rubin, chief economist and chief strategist at Canada-based CIBC World Markets. "Not that Chinese manufacturing wages won't still warrant arbitrage. But in today's world of triple-digit oil prices, distance costs money."

At today's oil prices, CIBC says, "every 10 percent increase in trip distance translates into a 4.5 percent increase in transport costs."

Aggravating the problem is the fact that modern new container ships travel faster than old bulk carriers and so use up more fuel, doubling fuel consumption per unit of freight over the past 15 years.

Moreover, "the massive trend towards containerization" has effectively made shipping costs "more vulnerable to swings in fuel costs"; because container ships can be unloaded much faster than break cargo, they spend much more time at sea than in ports.

CIBC World Markets has determined that the cost of shipping a standard 40 ft. container from East Asia to the North American East Coast (including inland costs) has nearly tripled since 2000 and will double again as oil prices head towards US$200 per barrel.

When oil was $20 a barrel in 2000, transport costs were equivalent to a 3-percent U.S. tariff rate; now it's above 9 percent.

Rubin says that these forces may reverse the impact of globalization.

The report claims:

In tariff-equivalent terms, the explosion in global transport costs has effectively offset all the trade liberalization efforts of the last three decades. Not only does this suggest a major slowdown in the growth of world trade, but also a fundamental realignment in trade patterns.

Rubin says that goods with a low value-to-freight ratio will be the most sensitive to rising transport costs. Heavy commodity items — like steel — that are not particularly labor intensive are the first to be hit.

From a statement regarding the report:

Soaring transport costs, first on importing coal and iron to China and then exporting finished steel overseas, have more than eroded the wage advantage and suddenly rendered Chinese-made steel uncompetitive in the U.S. market. Underscoring this is the fact that China's steel exports to the U.S. are falling by more than 20 percent year over year, while U.S. domestic steel production has risen by almost 10 percent.

Soaring transport costs suggest trade should be both "dampened" and "diverted" as markets seek shorter, and therefore less-costly, supply lines.

"Instead of finding cheap labour halfway around the world, the key will be to find the cheapest labour force within reasonable shipping distance to your market," according to Rubin.

In that type of world, Mexico's proximity to the rest of North America, combined with its labor costs, will give it a second chance to compete with Pacific Rim production, according to Rubin, who predicts that when oil prices reach US$200 a barrel, it will cost three times as much to ship the same container from China than from Mexico.

Is all this giving too much credit to oil prices as the cause for elevated shipping costs? More to the point, do you think globalization is reversible?

Resource

Will Soaring Transport Costs Reverse Globalization?

by Jeff Rubin and Benjamin Tal

CIBC World Markets Inc., May 27, 2008