Cheap Goods Don't Come Cheap Any More

by Tion Kwa, Asia Society Bernard Schwartz Fellow

Originally presented in the Straits Times, June 2, 2008

In Long Beach, California, in Elizabeth, New Jersey, and in other ports around the United States, the most potent symbol of the world's growth in prosperity is the stacks of container boxes waiting to be trucked out. For the past 20 years, America has been the engine of global growth, with its appetite for manufactured goods fuelled by the competitive pricing of faraway factories. An important element in this chain from production to consumption has been cheap trans-oceanic shipping.

Today, things are starting to change. Perhaps radically. Oil at US$130 (S$177) a barrel alters the equation. With the price of crude likely to have undergone a step-increase, shipping charges are not going to retreat from current levels. And these charges are high indeed.

According to a report by CIBC World Markets, the price of moving a 40-ft. container from Shanghai to the east coast of the US is now US$8,000, including land transport charges. In 2000, when the price of oil was US$20 a barrel, it was US$3,000. Now if oil rises to US$200, says the report, it might cost as much as US$15,000 for that container to make the same journey.

The report's authors, Jeff Rubin and Benjamin Tal, found that by converting transport costs into tariff-equivalent rates, those costs today would be equivalent to a tariff rate of more than 9 per cent. When oil was US$20 a barrel, it was 3 per cent. At US$150 a barrel of oil, the tariff-equivalent would be 11 per cent. In other words, high transport costs are undoing all the good that have been achieved by bringing down tariffs.

Shipping costs have and will continue to cut into the wage advantage of low-cost producers such as China and Vietnam, especially in inexpensive items that have a high freight cost relative to their final sale price.

An example the authors provide is Chinese steel. Only an hour and a half of labour goes into every tonne of steel. So cheap labour doesn't get you very far. On the other hand, it costs US$90 to ship a tonne of steel sheets from China to the US. So while it may still cost more to make that steel in America, American steel becomes very competitive for domestic consumption.

In fact, the report's authors point out that Chinese steel exports to the US are falling by about 20 per cent year-on-year, while American steel production has risen 10 per cent in the same period.

The authors of the CIBC report say that a result of these trends is that although arbitraging between wage costs will continue, there will be an added element in the equation. Producers will look for relatively cheap places to produce that are also close enough to final markets like the US, so that transportation costs can be lowered.

Wage-competitive economies close to large markets—such as Mexico to the US—will benefit. In other words, there will be a resort to "globalisation light."

Less clear is what happens to China and all the other places that have been the world's factory floor of choice. If these economies are to keep or moderate the decline in their market shares, they must reduce costs somehow.

This might mean state investment in efficient infrastructure that cuts energy dependency. Cheaper electricity would help. Also, better roads that cut distances to ports. Costs can also be reduced by eliminating bureaucratic red tape. And a renewed push towards cutting actual tariffs would soften the tariff-equivalent of high-priced shipping. All in all, high energy costs might well provide the incentive to clean up acts, literally and figuratively.

But it's no certainty this is going to be enough for low-cost manufactures to continue to be shipped over long distances to final markets.

Greater factory automation won't necessarily help with costs. The capital expense involved may not make sense in many cases because labour is so cheap.

What about moving up the value-added ladder? The higher the price of a finished product relative to its shipping cost, the less transportation becomes an issue. But this is neither easy nor a quick solution. And why wouldn't businesses just decide to set up factories closer to markets anyway? The point is, if you're going to start from scratch, you'll be thinking about transport costs these days.

Of course, it's still too early to know exactly how it will all play out, what the actual effect will be on global prosperity. What is easier to see is that energy prices at current levels will radically alter the way the world economy and globalisation work.

Cheap goods from half a world away may have reached its peak. As business starts to respond, the only certainty is that we're in for a choppy ride.

Tion Kwa is an editorial writer and op-ed writer on foreign affairs, business, and economics at the Straits Times in Singapore. He is a Bernard Schwartz Fellow based at the Asia Society's Washington Center, where his work focuses on trade issues between the US and Asia as well as regional security.