Will rising fuel costs reverse globalization?
Published Monday September 8th, 2008
As much as we would like it to be, the world is never a stable place for very long. After the technology bubble and the terrorist attacks of 9/11 in the early years of this decade, we managed to eke out about five years of relative economic stability. Now we understand that the U.S. was only incubating its current credit crisis, and that rising commodity prices - especially for oil and food - are raising the spectre of inflation once again.
A subject of lively debate among economists and business analysts today is the effect of rising oil prices on globalization. Rising oil prices translate into higher fuel costs, and that in turn drives up shipping costs. Ninety per cent of global demand for crude is based on the need for transportation fuels. In a world of triple-digit oil prices, could it cost less to manufacture products more expensively at home rather than ship cheaper products half way around the world? Could rising oil prices slow, stall, or even reverse the trend of globalization?
Economists Jeff Rubin and Benjamin Tal from CIBC World Markets took an in-depth look at this issue in May 2008. They estimated that the extra shipping costs from East Asia at then-current oil prices were the equivalent of imposing a 9 per cent tariff on East Asian goods entering North America. At oil prices of $200 per barrel, the tariff-equivalent rate would rise to 15 per cent. It has already become more economical to produce steel in North America than to ship the raw materials to China and ship the finished product back. Rising fuel prices might be a world trade killer, and the authors cited precedents from the 20th century that support their argument.
Ironically, China, one of the major beneficiaries of globalization to date, is pursuing domestic policies that make globalization more difficult for other countries. The retail price of gasoline is heavily subsidized there; China won't allow a product like gasoline that could be so inflationary at world prices to derail its economic boom.
With US$1.7 trillion in reserves, China can continue subsidizing gasoline for a long, long time. However, in doing so, it helps keep world oil prices high because its huge domestic demand can rise without the dampening effect of market pricing. That may be the equivalent of "shooting oneself in the foot" when it comes to world trade.
If you are the owner of a small- to medium-size enterprise in Canada, a big question is: How do I factor rising fuel prices and shipping costs into my globalization strategy? Instinctively, you will know how important shipping is to your business model.
In the last edition of its newsletter, BDC presented case studies for two companies pursuing globalization strategies - a software developer in New Brunswick and an office furniture manufacturer in Ontario with production offshore. The software developer should not be affected much by rising shipping costs, but the furniture manufacturer could definitely be affected and might need to adjust its business strategy accordingly.
Rising oil prices provide a powerful case for proximity. Mexico should become more attractive for outsourcing manufacturing of goods where transportation to market is a substantial part of the cost, such as heavy industrial equipment, furniture and clothing. By the same reasoning, the U.S. should become even more attractive to Canada as an export market.
Unfortunately, the slowing U.S. economy is currently reducing demand for goods and services. A Canadian company relying on the U.S. as the cornerstone of its globalization strategy runs the risk of missing the strong engines of demand that exist right now in East Asia, South Asia, Latin America, and Eastern Europe. As the U.S. and other mature economies slow down, these emerging economies may weaken at the margins but the fundamental forces driving their growth will likely last another 15 to 20 years or longer.
The key growth driver in these emerging economies is the immense population shift out of rural areas toward better jobs in the cities. The rapid growth of cities is causing a massive urban infrastructure build-out. Urbanization and rising incomes have also unleashed demand for many of the things that people in mature economies already enjoy, such as better housing, transportation and consumer goods. The result is a tidal wave of business opportunities, the likes of which has not been seen since the 1950s when North America experienced similar growth for similar reasons.
Although these business opportunities will be more expensive to access in a world of high fuel and shipping costs, a globalization strategy could still be crucial for many companies. The question boils down to: Can you afford to go there, or can you afford not to go there? Can your company successfully pursue a globalization strategy that minimizes the effects of rising fuel prices, or do rising fuel prices negate any possible advantages that your company might offer?
It would be nice to live in a stable economic environment for more than a few years at a time. Since we cannot, we must continue pursuing strategies that are in the best long-term interests of our businesses. For Canadian small- to medium-size enterprises, I strongly believe those strategies must include globalization. Our economy's long-term success depends on it.
Edmée Métivier is executive vice-president, financing and consulting, for Business Development Bank of Canada.
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