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Oil prices threaten globalization

By Dan Steinbock (China Daily)
Updated: 2008-07-09 07:26

When Thomas Friedman published his bestseller The World Is Flat in 2005, it portrayed a new world of global markets where historical, regional and geographical divisions are becoming increasingly irrelevant.

It was a very different world. US productivity still seemed relatively solid and global growth was strong.

The price of oil did climb from $10 to $95 between 1999 and 2007, but this did not have an adverse impact on global growth. Things changed this year. When the price of oil soared to $140, many saw the increases as a harbinger of a new energy shock.

On the eve of the US Independence Day, crude oil rose to a record above $145 a barrel. Goldman Sachs, Wall Street's famed investment bank, expects oil to hit $200 in the next six to 24 months.

Western analysts often attribute price hikes to the rapidly-rising demand from China and India. Yet, the struggle for energy resources has been a reality since the early 1970s.

US critics argue that the price of the dollar-denominated crude oil has been driven up in the aftermath of the War in Iraq and by the low dollar.

Politics aside, prices are ultimately driven by a classic imbalance in supply and demand. As demand is escalating and energy alternatives remain few and costly, the upward trend of oil prices has come to stay.

Soaring energy prices mean soaring transport costs, which have a potential to cancel much of the global integration the world has witnessed since the world wars.

During the past 120 years, the world has witnessed three waves of global economic integration. The first wave of global integration (1870-1910s) was triggered by falling transport costs and reductions in tariff barriers.

This wave ended with three decades of devastating political nationalism and protectionism. Extreme political nationalism and economic protectionism triggered two devastating world wars. By 1950s, exports as a share of world income were down to about 5 percent. In the process, 80 years of globalization was cancelled out.

In the postwar era, Washington was the architect of the second wave of globalization, which was driven by the new international multilateral institutions. For developed economies, this wave was spectacular. It was only with the third wave of globalization around 1980 that a large group of developing countries, led by China, broke into global markets.

In 1980 only 25 percent of the exports of developing countries were manufactures; in the late 1990s, the corresponding figure was 80 percent.

By the 1990s, the leading emerging economies took off in service exports, as well. The shift was driven by liberalization of trade and investment and continuing technological progress in transport (containerization, air freight) and communications (digitization, the Internet).

The new "flat world" made possible greater specialization and higher productivity. In the past, developed countries traded primarily with each other. Now industries have grown more concentrated geographically (think of Detroit's car industry or Hollywood's movie industry), but also more dispersed (the great car factories in China, Bollywood in India).

But there is a caveat. Each wave of globalization has been driven by falling transport costs and reductions in tariff barriers. Conversely, when transport costs have been rising, or tariff barriers have been increasing, or both, progress in globalization has been overturned.

Given the soaring prices, oil has the potential for such a reversal.

Since the postwar era, multilateral trade negotiations - particularly reduction in tariffs and non-tariff barriers - have supported dramatic surges in global trade. But, along with the new protectionist winds in the advanced economies, the greatest immediate challenge to global trade and investment may be the triple-digit oil prices.

When oil prices were still around $20 per barrel in the year 2000, transport costs amounted to an average tariff rate of 3 percent. At $150 per barrel, the rate is 11 percent, which was the average level of the 1970s. If the price hits $200, it would reflect the kind of average tariff rates that prevailed in the mid-1960s.

These estimates by CIBC World Markets indicate that a 10 percent increase in trip distance translates into a 4.5 percent increase in transport costs. In 2000, it cost $3,000 to ship a standard 20-foot container from Shanghai to the east coast in the US, including inland costs. At $200 per barrel, the transport costs could soar to $15,000.

Until recently, the great manufacturing advantage of China and India was driven by the substantial wage differential between the labor in the US and in these large emerging economies. Due to energy prices and the freight costs, the differential is diminishing faster than anticipated.

Today wage differentials must be assessed within reasonable shipping distance to the market. Further, a substantial proportion of Chinese exports to the US (furniture, apparel, footwear, metal manufacturing, industrial machinery, etc) represent goods with low value to freight ratios. Due to the soaring energy prices and freight costs, China's steel exports to the US have been falling.

The impact of high oil prices has been felt across oil-intensive industries in the US Airlines are moving toward shakeouts; the $4-a-gallon gas has forced the first fall in gas consumption since the Gulf War of 1990-91; and last June, the sales of new cars and trucks plunged to their lowest level in more than 10-15 years.

A sustained trend would reinforce the kind of trade diversion that was seen in the 1970s, which made trade more regional. American importers would substitute Latin America for East Asia, Japan would import more from China; China's Guangdong trade engine would be challenged; Mexico's maquiladora plants could thrive again, and so on.

During the past 30 years, global economic integration has supported extraordinary global growth. The take-off of large emerging economies, particularly China, has had a great positive impact on the world economy. If the cost of moving things and people continues to soar, globalization will erode and regionalization will gain.

The author is research director of International Business at the India, China and America Institute

(China Daily 07/09/2008 page9)