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The Impact of the Oil Shock: Trade Networks Shrink

This is a guest blog post by Donald Stadler, an American living and working in London:

Washington Post economics columnist Robert Samuelson recently wrote a piece about the trade impact of the oil shock on the US, quoting economist Jeffrey Rubin of CIBC World Markets, who predicts that oil will go to $225 a barrel/$7 a gallon before this is finished.

Apart from the obvious impact on per-liter fuel prices in Europe (I have heard of diesel prices as high as £1.99 a litre in the UK), there are some interesting side effects on world trade.

The bottom line is that shipping cheap manufactures thousands of miles make much less sense than it has this past decade. Since 2000 the cost of shipping a 40 foot shipping container from East Asia to the US has gone from $3000 to $8000, and if oil prices go to $200 a barrel this will go to $15,000 per container.

Some production will be brought back to the US and Europe, and other production will go from Asia to nearby low-wage countries like Mexico (for the US) and Poland/Bulgaria/Romania, and perhaps Russia and Turkey (for the EU). This may be good news for factory workers in Italy and in depressed areas of Germany and the UK.

Inflationary pressures will be higher without cheap Asian manufactures to offset rising prices on fuel and food.

In Asia India should gain relative to China, because India exports more services and fewer goods than China does. Countries which export high-quality manufactures (Germany, Japan, France, the Netherlands, US) should benefit compared to China, because such manufactures tend to have higher value compared to the shipping costs. Low-bulk manufactures (think microchips) will see particularly little impact. Japan should also benefit compared to China because high-quality Japanese goods won't be as badly hurt by high shipping costs.

In the short term China seems to be the biggest loser, with other Asian exporters also seeing some impact. China may be obliged to develop domestic market and possibly other Asian markets for it's goods, or increase the quality and price of it's manufactured  goods to offset increased shipping costs. China currently buys Brazilian iron ore and ships it home for smelting; it may have to look for Asian sources or do the smelting in Brazil because shipping now more than doubles the cost.

Biofuels made from 'waste products' have become commercially viable at this price point. The cost to make these may be as low as $1 a gallon. If that is true Samuelson advocates that western governments set a floor price of between $50 and $80 a barrel for oil by setting a tariff which only goes into effect if world oil prices fall below this level. This will assure domestic producers of alternate fuels that their investments will have a chance of being competitive - that OPEC cannot drive them out of business by dropping the price of oil as it did during the 80's.

In a more general sense this will shrink trade networks somewhat.  It makes sense to look for local substitutes for goods which once came from Asia, or from the US to Europe or vice versa,


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franchie on :

thanks goodness there will be a global happy end

Joerg on :

"German toymaker Steiff announced this week that it is relocating production to Germany from China. Experts disagree on whether this is an example of a new trend, or simply the exception to the rule." [url],,3462948,00.html?maca=en-AI-2414-html-box[/url]

Detlef on :

"Der Spiegel" published an article a few months ago citing a Fraunhofer institute study. According to them around 20% of German companies outsourcing production come back home inside a few years. Citing infrastructure problems, retaining educated workers, quality problems and the like. Although not advertising the fact because they feel that they should be embarrassed by not taking advantage of globalisation. (IIRC it was also published on the international Spiegel website.) IIRC they also cited a poll concerning outsourcing among German companies. Don´t remember the exact numbers but if I remember correctly around 20% of German companies outsourced because other companies did it. Following the herd. :) And another 20% outsourced because of pressure from Asian countries. Kind of like, if you don´t produce here we won´t give you access to our markets.

Joe Noory on :

Actually DW-World had a nice piece from a trade show in China where a passel of German business types were unanimous, OVERWELMINGLY unanimous that they were NOT there for cheap labor, but for markets, markets, markets! Look - whatever, Papito. There is one thing they all must realize though. In a global contraction, the workshops of the world contract too, reducing pricing, and still making outsourcing worth your while. All the while, the RELATIVE market dynamics remain about the same, unless the goods you're selling are worth too much. (a.k.a. being monetized in Euros)

SC on :

Oh, there's always an happy ending - at least for someone. It's the getting there that's the problem. I wonder if China, for example, will be as flexible in the face of the changes described as hoped. Then there are the secondary effects if hope is realized: If Asia does become a sop for excess Chinese capital, that will be felt in many other parts of the world outside of Asia.

Pamela on :

I read the Samuelson piece Donald refers to and I think Donald's analysis is excellent. I would like to add 2 more factors. 1. The price of steel has skyrocketed, making the cost of new ship building almost prohibitive. As ships themselves become scarcer, the price for those available will climb. 2. The International Maritime Organization has approved new rules (to be phased in) that will ban the use of 'bunker' fuels on ships in most parts of the world. "Bunker" fuel is basically the dregs left after refining and is very cheap. So, the fuel that will be required for shipping will become even MORE expensive than the futures markets dictate. You can read more about this ruling here.

Joe Noory on :

I don't see how constructing scarcity (which is the entire endgame of the envirnomental argument) doesn anything for anyone. It inpoverishes (feeble "green economy" argument notwithstanding,) it's intellectually stifling, in fact it's everything you would imagine antithetical to the "cosmopolitain". You know what? I'm all for it. Speed it up. Try EVERY damn flavor of the week "solution" right away, and all at the same time, because the anti-trade, greenie, "home-grown" everything nativism that used to fuel factories but now fuels a near religious air of "[url=]progressive[/url]" indignation also supresses growth, and needs to be crash-tested. [url=]Rock on[/url], my friends - so we can see just how much we really like it: [i]There’s something horribly cringing in the fashion of minimizing one’s effect on the world. By all means, we can conserve energy, but must we inflict our eco-alarmism on children quite so wantonly? Suicide is the quickest way to reduce your effect on the environment, as someone said. That’s hardly a helpful message for the kiddies. We have friends in Canada who are so intent upon leaving only mouselike traces behind that they have [b]confined themselves voluntarily to a single square mile[/b]. This might sound charming: Two people sacrificing whatever swagger and swashbuckle they might have enjoyed, so as to compensate the cosmos for the rest of us stinking parasites. Yet isn’t it awful, that centuries of human achievement should produce such guilt? The square-milers make me think of a cartoon vacuum cleaner that eventually sucks itself up its own tube and vanishes with a little “pop.” Adults are free to live in as shrunken a preindustrial manner as we like.[/i]

Pamela on :

Suicide is the quickest way to reduce your effect on the environment, as someone said. Check out the Voluntary Human Extinction Movement. I'm not making that up.

Don S on :

In the UK we mostly cremate - not sure that's particularly green.

Nanne on :

You are conflating the environmental movement and reality in a rather odd way. Or: just because reality is moving in a direction that is pleasing to the ideology of some environmentalists, is no reason to deny it. Resources are becoming more scarce. For nearly all resources, in the economic sense of scarcity as a function of demand and supply and, for many, in the popular usage sense of absolute availability becoming more problematic. Alternatives that can substitute for the resources that underpin the current economy - in economic terms: backstop technologies - are not developed well enough to provide the same level of welfare, and often have problems of their own. This leads to the conlcusion that the global economic system is in a thermodynamic crisis, as summarised rather well [url=]by John Robb[/url]. So, again, we have entered into a time of consequences. It is childish to blame those consequences on the Cassandras who warned about them, just because a few of these people show an unseemly [i]Schadenfreude[/i] or would like for us all to pick up rakes.

Don S on :

Joe, I don't think imposing a floor tax on oil qualifies as 'constructing scarcity'. We've been here once already during the 70's, and that time OPEC drove all the alternatives to oil out of business by dropping the price of oil below their production costs. By setting a tax to ensure that oil prices don't fall below $80 a barrel we can make it economical for other methods to be developed - by removing the risk that OPEC can do it to them again. It doesn't remove competition from other kinds of energy sources however. Right now it's boom and bust. In the past decade oil prices have varied between $10 and $140 a barrel. The economy can grow at $80 a barrel but $140 is recession territory - do we wish Iran and Venezuela to have that kind of power over the global economy? And remember that $80 isn't necessarily a floor - if the frankenfuels idea works out it could well be below that figure.

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