Globalization and transportation costs – Killing the era of cheap trade

The cost of transporting people has gone through the roof with gasoline and airline prices well exceeding the inflation rate. Of course, we should only be worried about inflation ex food and energy.

An inflation issue that has strong ramifications for the global economy is the overall cost of transportation of goods and services. Supply shocks for a given commodity are usually not considered part of the core inflation rate because it is believed that these shocks will be temporary and adjust through changes in production or demand. A central bank does not want to monetize a shock if it is believed to be temporary. That is why monetary policy is driven by core inflation. But if a supply shock is big enough or lasts long enough to have an impact on the price of other inputs, then there will be a general rise in prices. The conventional wisdom is that the energy price shock will not lead to higher core inflation because the amount of oil used per dollar of GDP has fallen since the large oil shocks of the 1970’s; therefore, there should be less concern about the crude oil price increase. Of course, this argument is based on shocks that are less than 100% and for shocks that will last for relatively short time period like a year. We have now been with $100 oil for only four months but market analysts are not forecasting any steep decline. The story of peak oil seems to be resonating more with investors. Conventional wisdom has not accounted for global trade and the cost of transportation.

Globalization and the world as a flat place is based on the idea that it cheap to move goods anywhere in the globe. It is also cheap to move people to do deals in this globalized world, but the reality is that the cost of moving goods for trades in on the way up and this will kill trade much faster than any political rhetoric. Trade gains have always been associated with changes in technology in three areas, the movement of capital, labor and goods. When shipping costs decreased in the 19^th century through steam power, trade boomed. When air freight became a reality, trade jumped. The cost of container shipping led to another cut in costs and more trade. The costs now of moving all goods have gone up in the last year and there is no technology to offset this price shock.

Capital costs have gone up with the uncertainty across countries about the credit crisis. There will be a greater home bias when there is more uncertainty. Market frictions have increased. More importantly, the cost of moving labor and goods have skyrocketed and this is drag on trade.

In a service economy, a cost of business is travel to see clients regardless of quality of the telecommunications. Trips are not going to happen as frequently as the price of fuel continues to advance. Local venders will have an advantage, so trade will become more biased to the home country.

In the goods economy, the just in time manufacturing processes will be push aside for holding larger bulk inventory. There is less reason to send partial loads of goods long distances if the cot per unit is increasing. Similarly, there will be a cost advantage for local vendors. In many businesses where the margins are especially low, an increase in the marginal cost of shipping will cut the profits significantly. Items which have more bulk or take up more space in right will be produced by more local manufacturers. This problem will be especially hard on places like China where components are brought to the factory assembled and then shipped to a final market. Prices for bulk shipments of inputs like ore and metals which have been imported to China will skyrocket. These trade issues will play out even in the EU where satellite countries on the periphery of core Europe will see a loss of their comparative advantage.

The cost issue is already showing up in import prices ex-petroleum increasing at a pace over 6% year-over-year. This is after spending 2007 in the 2-3% range. Imports numbers are also slowing. Just when US manufacturing should be able to capture new business given the fall in the dollar and good productivity, the cost of shipping will deter trade. This will be a major theme for the rest of the year.