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The new geography of trade: Globalization’s decline may stimulate local recovery

Photo credit: Brian Summers Hurricane Igor damaged these railroad tracks in Newfoundland in September 2011. Climate change affects global supply chains through increased intensity and frequency of major storms, which damage low-lying coastal rail lines, aPhoto credit: Brian Summers Hurricane Igor damaged these railroad tracks in Newfoundland in September 2011. Climate change affects global supply chains through increased intensity and frequency of major storms, which damage low-lying coastal rail lines, a

It is an article of faith that global trade will be an ever-growing presence in the world. Yet this belief rests on shaky foundations. Global trade depends on cheap, long-distance freight transportation. Freight costs will rise with climate change, the end of cheap oil, and policies to mitigate these two challenges.

At first, the increase in freight costs will be bad news for developed and developing nations alike but, as adjustments in the patterns of trade occur, the result is likely to be decreased outsourcing with more manufacturing and food production jobs in North America and the European Union. The pattern of trade will change as increasing transportation costs outweigh traditional sources of comparative advantage, such as lower wages. The new geography of trade will not result from policy or treaties but from the impact of changing environmental conditions due to the growth of the human economy. Global trade can be disrupted by many kinds of natural disaster: the tsunami and nuclear emergency in Japan slowed auto production in the United States, and Australian floods lowered coal exports to China.1,2 The supply chains of global production and distribution are more vulnerable than we would like to admit. Up to now, we have adapted to disruptions and global trade has continued to expand. But greater challenges to global trade lie ahead. Continual growth, or even maintenance, of the current physical volume of trade is unsustainable.

Many goods will be manufactured closer to where they are consumed, as supply chains become more regional and local.3 Petroleum- and transport-intensive products, such as imported food, clothing, appliances, and building supplies will become more expensive; lifestyles and consumer purchasing in developed nations will shift to reflect these changes. Export-oriented nations relying on a limited number of exports to pay for imported necessities will need to become more self-reliant in meeting basic needs.

Oil Supply and Cheap Fuel

The price of crude oil rose from $28 per barrel in 2003 to over $147 in the summer of 2008. In 2008 20 airlines (mostly regional freight carriers) went bankrupt.4 Fuel costs rose from 15 to 35 percent of airline (freight and passenger) operating expenses.5 In the first two months of 2011, air carriers increased fares four times to adjust for rising oil prices.6

In 2007–2008, the cost of trans-Pacific shipping of a standard container by sea went from $3,000 to $8,000.7 In 2010, with oil at half its 2008 price, the Danish shipping company Maersk cut its top cruising speeds in half to reduce fuel costs.8,9 According to economists Jeff Rubin and Benjamin Tal, every $1 per barrel increase in crude oil prices results in a 1 percent increase in freight transportation costs.7

As economic growth resumes, the demand for oil will increase. The International Energy Agency predicted a 2.5 million barrel per day increase for 2011, the biggest one-year increase in 30 years.10 Chinese oil demand is expected to grow over 10 percent due to economic growth and coal shortages.11 Furthermore, recent decisions in Japan and Germany to decommission nuclear power plants may increase the demand for diesel fuel to run electric generators.12

A number of factors limit oil supply’s ability to both keep up with demand and limit oil price instability. Deepwater drilling is likely to be more expensive in the Gulf of Mexico due to new regulations and higher insurance costs following the Deepwater Horizon oil spill.13,14 Deepwater oil will provide at least 25 percent of world supply by 2020.15 The failure to invest in sufficient upstream production facilities has also made an oil-supply crunch likely.

Political unrest in the oil-rich Middle East creates uncertainty about oil prices due to fears of supply disruptions.

And finally, there is peak oil, when production flow rates hit a maximum and decline thereafter. This has already occurred for the majority of oil producing nations and will soon happen for global oil production. Saudi Arabia, Mexico, Canada, and Venezuela are approaching national oil peaks at the same time that their domestic demand for oil is expected to rise significantly.16,17 These exporters will either reduce exports or, like Indonesia and the United Kingdom, become oil importers.17 World Energy Outlook 2010 stated that global conventional oil production peaked in 2006 and is expected to decline from 70 million barrels per day to less than 16 million in 2035.18

We use oil faster than we discover new resources. Global oil discoveries peaked in the 1960s.19 The American Joint Forces Command predicts that “By 2012, surplus oil production capacity could entirely disappear.”20 According to the United Kingdom Energy Research Centre, “more than two-thirds of current crude oil production capacity may need to be replaced by 2030 … equivalent to a new Saudi Arabia coming on stream every three years.”21 The near- and long-term results will be rising transportation fuel costs, oil-price volatility, and a declining quantity of conventional oil fuels.

Impact of Electric Power Shortages

Electric power shortages and rising prices will also change the pattern of global trade and supply chains. Low-wage exporting economies are generally much less energy efficient than high-income industrial economies. As electricity rates rise with higher fuel costs for coal and oil, production costs will increase faster in low-wage countries than in developed industrial economies. According to energy analyst Thomas Christiansen, “China’s use of energy per unit of gross domestic product is three times that of the United States, five times Japan’s, and eight times Britain’s.”22,23 Rising coal, oil, and electricity prices erode the comparative advantage of low-wage exporters.

Photo credit: Patrick Kelley/U.S. Coast Guard. In May 2010, gas from the damaged Deepwater Horizon wellhead is burned by the drillship Discoverer Enterprise in a process known as flaring. Because of new regulations and higher insurance costs following the Deepwater Horizon oil spill, deepwater drilling will likely become more expensive in the Gulf of Mexico.Photo credit: Patrick Kelley/U.S. Coast Guard. In May 2010, gas from the damaged Deepwater Horizon wellhead is burned by the drillship Discoverer Enterprise in a process known as flaring. Because of new regulations and higher insurance costs following the Deepwater Horizon oil spill, deepwater drilling will likely become more expensive in the Gulf of Mexico.

Moreover, climate-related drought and lowered river flow have reduced hydroelectric power production in some export-oriented nations. In China, reduced rainfall in agricultural areas has prompted plans to divert water from the Three Gorges Dam away from hydroelectric production to irrigation.24 Reduced hydroelectric power has interrupted textile production in Pakistan, oil refining in Venezuela, and appliance production in China. As reported by RTÉ News in May 2011, “Businesses in coastal areas and some inland provinces have grappled with power cuts and full blackouts since March due to surging demand and a drop in hydroelectric output.”25 Climate change is linked to the massive floods in Australia that cut coal exports to China and put upward pressure on Chinese coal prices.26

Finally, when there are hydroelectric power shortages, individuals and manufacturers rely on gasoline or diesel generators, if they can afford the fuel. According to TheWorldnet.info, “In most countries, electricity shortages quickly translate into increased demand for gasoline and diesel as organizations strive to keep computers, elevators, hospitals, refrigeration, and even factory production functioning with back-up generators. Pakistan probably is suffering the worst from electricity shortages, the country simply does not have enough foreign exchange to import large quantities of expensive fuels.”27

Climate Change and Transportation Infrastructure

Climate change undermines global trade directly by its effects on transportation infrastructure and indirectly by its impact on energy infrastructure and prices. A 2010 Lloyd’s report stated, “Environmental change (extreme weather events,…changing sea levels and melting glaciers) will generate great threats to critical infrastructure and to transport routes.”28 Though reduced during the recession, CO2 emissions rose dramatically in 2010 to the highest recorded level.29 One manifestation of climate change is increased intensity and frequency of major storms. Hurricanes and typhoons damage low-lying coastal rail lines, airports, oil and gas pipelines, highways used to connect ports and distribution networks, and port facilities—all essential parts of global supply chains.30,31 They seriously affect ships and planes in transit. Heavy rainfall events are increasing in many parts of the world. Insurance claims for flood damage are rising faster than those for other natural disasters.32 Rising sea levels will submerge coastal highways and port facilities.33,34

The damage to roads threatens global trade: roughly 40 percent of the U.S.-China supply chain consists of roads from factories to ports and from ports to distribution networks.7 If freight transport is significantly interrupted, rerouted, or slowed, costs will rise for both manufacturers and retailers using distribution systems that require goods to arrive as they are needed in production or on retail store shelves. The heat effects of climate change also reduce engine efficiency, increase cargo refrigeration needs, and therefore raise fuel costs for trucks, trains, ships, and planes.35 Climate change is thus expected to interrupt and slow freight transportation and make it more expensive.

Oil Substitutes and Climate Mitigation

There are substitutes for conventional oil: coal-to-liquid conversion, gas-to-liquid conversion, corn ethanol and other biofuels, hydrogen, tar sands, and shale oil. Many are technically feasible but all suffer from one or more major problems. They often need large-scale investment and long lead-in periods. Some require subsidies or higher production prices per barrel than conventional oil. Many cause serious environmental damage and high greenhouse gas emissions. Several place great demands on scarce freshwater supplies or require high energy inputs for production.36,37

Energy expert Robert Hirsch and his colleagues estimate that a crash oil mitigation program that begins when oil peaks will have a three-year lag before it adds noticeably to fuel supply. Such a crash program would restore liquid fuel supply close to peak levels within twenty years under the best assumptions.38 Given current supply constraints leading to the loss of cheap oil, and lack of serious policy discussion, investment in alternative sources will not be sufficient to significantly replace diminishing oil supplies in the decades immediately ahead. Thus, even feasible technologies will not avoid higher fuel costs and limited fuel supplies for global freight transport.

The principal way to mitigate climate change is to reduce greenhouse gas emissions as fast as possible. Meaningful climate policies (such as carbon taxes or cap and trade) would raise fossil fuel prices to cut consumption and emissions.

Freight transport may be hard hit by such policies because both air freight and maritime shipping have heavy carbon footprints. In transporting freight by air, each ton of jet fuel burned produces 3.2 tons of CO2.39 As for maritime shipping, container and other transport ships burn bunker fuel, a sludgy, highly polluting petroleum product.

It will be difficult to cut the greenhouse gas emissions from long-distance freight transportation while maintaining the same ton-miles of freight transported per year. There are no commercial low-carbon fuels with the performance characteristics, affordability, and quantitative availability to replace bunker fuel for ships or jet fuel for air freight.39

The basic policy for creating incentives for better efficiency and for using low-carbon fuels is a meaningful (and increasing) price on carbon generally. If such policies were implemented, burning bunker oil and jet fuel would become much more expensive, thus increasing the costs and reducing the competitive advantage of global production and trade. This carbon pricing would occur in addition to supply-based increases in oil prices.

Prospects: Bad News and Good

If large-scale mitigation of peak oil and climate change is not feasible soon, what will happen? Given current investments in the existing pattern of trade and the high costs of reorienting it, change will be resisted, with resulting widespread economic disruption. But change will occur. Clearly, increased fuel costs and higher transport risks will cause supply chains to shorten and long-distance trade to decline. Initially, there will be shifts in transport modes—truck to rail, air to water and rail—designed to preserve trade routes. But more fundamental adaptations are already starting to take place to reduce or replace long-distance trade. Beginning with the oil price and transport cost increases in 2007–2008, some companies began rethinking their global supply chains, and a few shifted to local suppliers. Some manufacturers have opened new furniture, steel, and auto plants in the United States or Mexico to feed the U.S. market.40 In May 2011, Volkswagen inaugurated its huge Passat assembly plant in Tennessee, “as part of our effort to manufacture more products locally.”41 The plant is expected to generate, directly and indirectly, 12,000 jobs. These changes in supply chains are motivated by considerations of corporate profits.

Manufacturers may relocate production closer to either suppliers of key raw materials or major markets to minimize transportation miles and costs.42,43 In 2008 some steel mills in the United States increased domestic production by directly importing iron ore from Brazil. This system bypassed the expensive trans-Pacific shipment of iron ore from Brazil to China and then of steel from China to the United States.7,40

The resurgence of domestic manufacturing in developed nations could provide employment growth, especially for blue-collar workers. However, employment may decline in current low-wage manufacturing exporters as rising transportation costs make them less competitive.

Nations may respond with protectionist policies to changes in trade patterns. In 2008, as food prices rose (due in part to extreme weather, corn ethanol production, and rising oil prices), several grain-exporting nations banned exports of cereal crops.44 In June 2011 China banned the export of diesel fuel in order to have enough on hand to power electric generators in the face of expected brownouts.18 With rising transport costs, nations are likely to subsidize energy or manufacturing to preserve exports and jobs. Such export bans and subsidies contravene provisions of the World Trade Organization and many trade treaties such as NAFTA.

While corporations have responded to rising oil prices with some changes in supply chains, national governments have not responded in kind. Current climate-policy negotiations are ineffective despite rapidly growing greenhouse gas emissions. Only the United Kingdom and Sweden have identified oil depletion as a key economic issue and begun to discuss responses. Trade policies such as the Korea and Colombia Free Trade Agreements with the United States are predicated on the assumption of cheap fuel, low transportation costs, and transportation-compatible weather patterns—in other words, business as usual. Thus, there are at present few national and no international policy responses to the imminent threats to global trade.

There is, however, a second, more local, noncorporate response. This response is found in the Relocalization and Transition Towns movements now springing up in many developed countries. It is a bottom-up response that includes individuals and municipalities planning for a post-peak-oil future and altering their way of life, buying locally made products as much as possible, reducing consumption and acquisition, and increasing self-sufficiency within communities that produce many of the goods and services they consume. The resurgence in the numbers of young people going into farming in the United States is an example.

Relocalization strategies include local currencies, community land trusts, decentralized alternative energy development, water conservation and reuse, local food production, and new, locally oriented business networks.

Photo credit: Jason Rodman. Relocalization strategies include local currencies, community land trusts, decentralized alternative energy development, water conservation and reuse, and local food production. Shanghai, China, now produces much of its own vegetables within its urban limits.Photo credit: Jason Rodman. Relocalization strategies include local currencies, community land trusts, decentralized alternative energy development, water conservation and reuse, and local food production. Shanghai, China, now produces much of its own vegetables within its urban limits.Patterns of adaptation will differ from place to place. Initially, there will be heavy and unpredictable impacts on many developing nations that currently depend on foreign cash earned for commodity exports, or that import much of their food. Yet every country is different.

Even large urban complexes can provide a surprising quantity of their own food. In China, concerns over rising food prices (and food safety) have caused a boom in online sales of vegetable seeds.45 Shanghai now produces much of its own vegetables within its urban limits, as do cities in sub-Saharan Africa.46

If a developing country imports many goods and services, it has to pay for them, probably in part with money earned from commodity exports. When those exports are reduced by high shipping costs, some countries will have the capacity to rapidly increase local production of essentials for local consumption. Others, less fortunate, will take longer.

It is now critical for economic planners, laypersons, and governments to recognize that long-term energy and climate realities will impose limits on the global movement of goods. Trade pacts, like the U.S.-Korea Free Trade Agreement, and business models, like Walmart with its transoceanic supply chains, will make less sense as the foundations of global trade are undermined. This is not the result of either ideology or policy. Only when we accept these realities can we design and rebuild less vulnerable patterns of production and trade throughout the world. Nearly every country has existing examples of sound, regional development that can be used as models.

Global trade will not disappear, but as it wanes and as supply chains shorten, the importance of regional and local economies will increase. Manufacturing and food production for domestic consumption in the United States and other developed nations (and regions within nations) will regain an importance not seen since the first half of the twentieth century. Security strategies will be adjusted to reflect the increased role of domestic production in national affairs. We should plan now for these inevitable changes. Crises bring more than trouble—they bring opportunities.

Acknowledgments

We thank Anne-Marie Slaughter for her encouragement and helpful suggestions.

References

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