In the soon-to-come world of triple-digit oil prices, distance will cost money. All of a sudden geography will become a lot more important to trade patterns than it has been in the ever-shrinking global economy.
That’s about to have a profound impact on where we source goods. The cost of shipping goods from Mexico or Central America to US markets is half the cost of shipping them from China, where most of them come from today.
How important those transport costs are in relation to total costs, and, hence, competitiveness, depends on one factor—the price of oil. Because no matter whether you move goods around the world by air, ship, rail or truck, you’re burning the same fuel.
Oil prices have diverted trade before, and they will again. After the first OPEC oil shocks, the share of non-petroleum US imports that came through transoceanic trade fell by 6 percentage points, while the share of imports from Latin America and the Caribbean rose by an equivalent amount. That shift, involving billions of dollars of trade diversion, occurred in little over half a decade.
In my book, Why Your World Is About To Get A Whole Lot Smaller, I argued that soaring transport costs driven by triple-digit oil prices will reverse the globalizing trends in our economy that occurred in the age of cheap oil.
New research by the United Nations Economic Commission for Latin America and the Caribbean (ECLAC) commissioned by the Canadian Foundation for the Americas tested my hypothesis by looking at the impact of different oil prices on regional competitiveness for eight industries.
In all eight industries studied (the production of baseballs, beer, circuit breakers, cotton clothing, gaskets and seals, optical fiber cables, orange juice and tobacco), researchers found that the import share in the American market from producers in Mexico, Central America and the Dominican Republic increased with higher oil prices.
As oil prices rose from $60 to $150 per barrel, the shift in US market share toward those countries steadily increased as transport costs became more and more important in determining relative competitiveness. In the case of cotton clothing, market share rose from 50 per cent to over 80 per cent. Increases in market share by nearer Central American suppliers came largely at the expense of market share held by distant Asian suppliers.
If the trade diversion suggested by past oil shocks and the recent analysis by ECLAC holds, much of the huge trade imbalance between China and the US could rapidly unwind, as transport costs shift sourcing much closer to home. At the same time, Mexico’s maquiladora plants may soon get another opportunity to shine as increasingly important suppliers to the American market.
While Mexico and Central America can’t compete with China for the lowest wage rates, they may not have to. Soaring transport costs may soon become the great equalizer, bringing factories much closer to the markets they serve.