High oil prices will reverse globalisation and alter the ‘geography of manufacturing’, says CIBC economist Benjamin Tal
HONG KONG: High oil prices —- of the sorts the world witnessed recently —- are inevitable in the future, and when that happens, the geography of manufacturing will be altered, with more and more industries leaving China to sourcing centres closer to their consumers, says CIBC World Markets senior economist Benjamin Tal.
“We’re starting to see evidence that Chinese exports of freight-intensive goods are beginning to slow under the pressure of rapidly rising transport costs,” Tal told DNA Money from Toronto. “If energy prices remain elevated, and we believe they will, there is a clear possibility that you will see more and more industries leaving China. It’s a slow and gradual process, and it will have a significant impact on specific industries.”
For instance, for the steel industry today, transport costs can make a difference between ‘Made in China’ and ‘Made in the US’, says Tal. “The same argument can be made for US companies to produce goods in countries that are competing with China and are closer to North America. For instance, Mexico can compete with China in furniture manufacture. And it seems that American importers are starting to do the math and are shifting some business from China to Mexico.”
A recent CIBC study, co-authored by Tal and ‘maverick’ economist Jeff Rubin, argued that rising transport costs would reverse the trend of globalisation in favour of ‘regionalisation’. “Soaring transport costs suggest trade should be both dampened and diverted as markets seek shorter, and hence, less costly supply lines... Instead of finding cheap labour halfway across the world, the key will be to find the cheapest labour force within reasonable shipping distance to your market.”
And in any case, says Tal, at the margin and in some areas, China is not the cheapest place to do business anymore. Wages are rising in China and the huge differential between Chinese labour and North American labour is shrinking. And when you include all the aspects of manufacturing and transporting goods, the equation changes.”
Tal cites the precedent of what happened to global trade during the two previous oil shocks. “Trans-oceanic transport costs literally exploded during the two OPEC price shocks,” he recalls. “The cost of shipping a standard cargo load overseas almost tripled, just as it did over the past few years.” Ultimately, he notes, soaring transport costs were borne by consumers, and markets responded by substituting goods that could be sourced from closer locations rather than from halfway around the world carrying hugely inflated freight costs.
“In a world of triple-digit oil prices, distance costs money,” reasons Tal. And while trade liberalisation and technology may have “flattened the world” (in the words of author Thomas Friedman), rising transport prices will “once again make it rounder”.
“Everything’s okay as long as transport costs are not significant enough,” says Tal. “But when they are, the world is no longer flat.”
Tal reckons that the recent slideback in oil prices from their historic highs of a few weeks ago doesn’t alter the merits of his underlying argument. “We believe that oil prices will remain elevated, and in fact go higher again,” he says. “It’s not a question of tomorrow. It’s a long-term story. We believe there’s a major disagreement between supply and demand, therefore energy prices will remain elevated and go higher, which in turn means transport prices will become more and important for companies.” For now, he and Rubin are standing by their call that oil prices will touch $225 a barrel by 2012.
