Sometime in the late 1990s, the tag line in an advertisement for a failed telecom venture magically morphed into a popular mantra for globalization: Geography is history, it evocatively said.
There is enough truth in this neat little phrase for it to be taken seriously. The past two decades have seen the rise of a global economy that is almost seamlessly linked across thousands of miles. Distances did not matter too much. This allowed companies to scour the world in their relentless search for low costs.
Global supply chains were born. Management gurus and economists usually roll out a long list of factors that helped this process — reforms in emerging markets, global trade deals, new business models that shattered integrated companies and much else.
There is one other factor that most people forget to mention when they discuss the success of globalization: low transport costs. It makes sense to make components in Korea, assemble them in China, and then ship them to consumers in the US only if the costs of moving widgets across the world are a minor part of overall production costs.
The inexorable climb in oil prices has rattled this pillar of globalization. The cost of shipping stuff across the oceans has shot up. By some estimates, the cost of sending a tonne of soya bean from South America to China is almost the same as the cost of procuring it from farmers. Suddenly, it looks as if geography is not quite history; distance matters.
Earlier this month, three of the world’s largest mining companies signed deals with Chinese and Japanese steel makers for the supply of iron ore. Distance was a big factor in these negotiations. A lot depended on whether the ore was being sent from Brazil (by Vale) or from Australia (by Rio Tinto and BHP Billiton).
The Australian miners managed to negotiate higher price increases for their iron ore because it costs less to ship it from their mines to China. They basically got the Chinese to share the “freight advantage” that Australian ore has over that shipped from Brazil. The spurt in global shipping costs has shattered the traditional rule that there would be one global price for iron ore. Prices depend on distance.
The big question, then, is what does all this mean for globalization? The Wall Street Journal had reported earlier this month that rising transport costs are forcing some US companies to bring production back to North America. Jeff Rubin and Benjamin Tal, two economists with CIBC World Markets, have written a much-cited report that asks whether soaring transport costs will reverse globalization.
“Globalization is reversible. Higher energy prices are impacting transport costs at an unprecedented rate. So much so that the cost of moving goods, not the cost of tariffs, is the largest barrier to global trade today… The explosion in global transport costs has effectively offset all the trade liberalization 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,” they wrote in a 27 May report.
The regular talk about the threats to globalization hovers around the usual suspects, from the Doha deadlock to the wave of rising protectionism in the West. Few have bothered about rising transport costs till now. Rubin and Tal estimate that, at current prices, transport costs are equivalent to a 9% import tariff. And, lest we forget, the link between globalization and transport costs is an old one. The drop in haulage costs allowed minerals and food to be shipped in cheaply to Europe and helped the first round of globalization at the end of the 19th century.
A lot will depend on what is being moved. Trade in low-value items that are moved across great distances will be hit the most. More valuable goods will be less affected by rising transport costs. And the movement of voice and data beamed across wires and satellites will not suffer at all; the Indian outsourcing industry is safe from this particular quake.
What follows for the rest of this column is more of a thought experiment. Let us ask ourselves a few questions.
One, will trade and supply chains be reconfigured along regional rather than global lines? And where should India look to: West Asia or East Asia?
Two, is the debate on how currencies should be priced to promote exports a bit irrelevant at this juncture?
Three, if global trade has helped bring down prices, then will the rollback of globalization because of high transport costs push up inflation and interest rates?
Far out stuff? Perhaps. It is clearly too early to conclude that the rise in fuel and transport costs will be the death knell of Globalization Ver 2.0. But what if oil goes to $200 a barrel? And what about $250? A lot of tradable stuff may suddenly become non-tradable. This is an eventuality worth speculating about. Both companies and policymakers would do well to be alive to the possibility.
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