Economists say rising fuel prices prompting sourcing changes
July 3 , 2008
World Trade\Interactive
A recent report by two economists asserts that soaring fuel prices are already beginning to spur changes in global sourcing decisions. Leading off with the warning that “globalization is reversible,” Jeff Rubin and Benjamin Tal wrote in the May 27 issue of CIBC World Markets Inc.’s StrategEcon that the cost of moving goods is now the largest barrier to global trade and in tariff-equivalent terms has effectively offset all the trade liberalization efforts of the last three decades. This development suggests not only a major slowdown in the growth of world trade, they said, but also a fundamental realignment in trade patterns.
The last 30 years have seen an unprecedented increase in world trade, the report notes, and cheap fuel that kept transportation costs low was a major factor in that growth. But oil prices now account for almost 50 percent of total freight costs and over the past three years every $1 rise in those prices has led to a 1 percent increase in transportation costs. For example, the total cost of shipping a 40-foot container from Shanghai to the East Coast has risen from $3,000 eight years ago, when oil prices were $20 a barrel, to $8,000 today, with oil prices approaching $150 a barrel. Overall, transportation costs currently amount to the equivalent of a 9 percent duty rate, up from 3 percent in 2000, and the report asserts that in the not-too-distant future such costs could outweigh all the global tariff reductions that have taken place over the past 50 years.
The report uses the oil price shocks of the 1970s to illustrate that rising energy prices can lead to both a dampening and a diversion of trade. From 1974 to 1986, when higher oil prices led to a near tripling of the cost of shipping a standard cargo load from overseas, trade not only failed to grow as a share of global gross domestic product but also diverted along increasingly regional lines. In just over five years the share of non-petroleum U.S. imports from Europe and Asia fell by six percentage points while the share of imports from Latin America and the Caribbean increased by a comparable amount.
While the extent to which the current situation may lead to similar shifts remains unclear, the economists said, “we are already starting to see some change in capital-intensive manufacturing whose products carry a high ratio of freight costs to final selling prices,” particularly with respect to imports from China. A “surprisingly high” percentage of such imports fall into this category, including furniture, apparel, footwear, metal manufacturing and industrial machinery. In December 2007 Chinese exports of freight-intensive goods to the U.S. actually declined for the first time in more than a decade, and their share of total exports has dropped to 42 percent from 52 percent in 2004.
If transportation costs are making sourcing abroad more prohibitive, will manufacturing operations return to the U.S.? While that is a possibility for some products, the report highlights Mexico’s maquiladoras as a more likely beneficiary. The reason is that labor costs will remain a concern; as a result, the key for companies looking to sell into the U.S. market will be to find the cheapest labor force within reasonable shipping distance. The report states that some U.S. importers are already starting to shift from China to Mexico, noting that at the same time shipments from China are slowing imports from Mexico are still growing by more than 7 percent a year. In addition, the goods that have seen the fastest growth are those that are generally more freight-intensive and directly compete with China, such as furniture, iron and steel, rubber and paper products.
Other sources, however, say it may be too early to predict large-scale shifts in production back to the U.S. or nearby countries. “The infrastructure and production networks in Asia are well established and represent a significant investment that will not be dismantled in a hurry,” particularly if higher energy and transportation costs turn out to be short-lived, Asia Pacific Foundation of Canada President Yuen Pau Woo was quoted as saying in June 27 article in The Gazette. Canadian Manufacturers and Exporters President Jayson Myers agreed, noting that many companies could not shift production in the short term even if they wanted to because they do not have immediate alternatives. As a result, the article quoted National Bank Financial economist Stafane Marion as saying, while “the foot is coming off the accelerator” with respect to plans for outsourcing, “I don’t think we’re at the point of reversing the outsourcing phenomenon.”
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