A New Era for International Trade?

From a short-term perspective, the U.S. credit crunch and subsequent downturn is having a global impact. Asian exports already have lower growth in 2008 versus 2007, with an annual percentage growth of liner trade to the world half of what it was in 2006. The European slowdown is now well underway and it can be expected that 2009 will remain soft as well on both sides of the Atlantic. The massive growth in U.S. exports that has been reported as a strength is based on low-value goods (scrap metal) and agricultural produce; subsidized not only by the government, but also by the collapsing dollar.

The transpacific trade decline began in first-quarter 2007. American consumers had lost confidence and sharply reduced their purchases. The U.S. downturn caused the transpacific trade volumes to decline sharply from nearly 10% growth in 2006, to only 2.2% to North America as a whole in 2007. For 2008, it will remain negative.

The Asia-to-Europe trades continued to boom through most of fourth-quarter 2007. It is now clear that the European consumers, particularly those in the United Kingdom, are reacting no differently from their American compatriots. The Asia-Europe trade is being severely impacted and we are just at the beginning of a significant slowdown, with this trade expected to actually decline in 2008.

Long Term: Changes in Patterns of Globalization

The development of the world economy and trade in the past one-and-a-half decades has been characterized by economic globalization. In the wave of globalization, centers of trade move from developed countries to new manufacturing in developing countries, because both labor and environmental protection costs are lower in developing countries. Before globalization, most goods were produced at locations near the end markets. After globalization, much of the production is concentrated in low-cost locations that are far from the end markets. As a result, in the past one-and-a-half decades, we saw rapid growth of international trade.

Economic globalization has considerably increased energy consumption in two ways: it considerably increased world freight transportation demand, and it helped promote an energy-consuming lifestyle all over the world. In developed countries, low-cost imports have allowed more people to afford automobiles, air-conditioned houses with many electrical appliances, and to travel globally by air plane. In developing countries, prosperous exports have brought wealth to a small portion of the population who are then able to pursue western lifestyles. If just 30% of the Chinese and India populations reach western levels of consumption, then world consumer energy consumption will be doubled, not to mention the billions of people still aspiring to this lifestyle. So, long-term energy price increases are not surprising.

Left to operate, global market competition will see energy prices continue to rise until they effectively suppress energy consumption to meet supply. Developed countries are calling for developing countries to remove subsidies for energy consumption to let the market mechanism work. Recently, China reduced subsidies for fuel consumption, announcing increases in gas and diesel prices by 17–18%. Higher price will discourage consumption, and world oil prices dropped $2 a barrel at that announcement. If all countries were to remove their subsidies to discourage fuel consumption, world oil prices would increase at a slower pace.

Rising fuel prices have considerably increased shipping costs. For high-value and light-weight goods—such as electronics—shipping costs are still bearable. For low-value and heavy-weight goods—such as iron ore—shipping cost can now outweigh the value of the goods themselves. If fuel prices were to continue to rise, it may make it unprofitable for China to continue to import iron ore and coal from overseas, with other countries making and exporting more steel and exporting less coal and ore to China.

When wage rates increase and the local currency has appreciated in China, some investors are considering moving manufacturing to other countries with lower costs, such as Vietnam. Many of these opportunities may have already slipped away. With rising oil prices and the declining U.S. dollar causing world-wide price inflation, the increased costs of imported materials have overcome the savings from the difference in wage rates for some manufacturing. Furthermore, Vietnam is just as far as China from the market of most-developed countries. High transportation costs will deter additional manufacturers from establishing production facilities at locations that are too far away from their end markets.

High transportation costs may force manufacturers to relocate production facilities closer to material suppliers or consumption markets, depending on which transportation volume (and expense) is larger: the input materials transportation or the final product shipments. These factors are influencing changes in world trade flows in the face of rising fuel costs. The strong expansion of world trade that we have seen has helped to reduce the difference in wage rates and returns on capital between countries. This is what is called factor price equalization in international trade theory, and we are seeing evidence of this at work in world markets today. This makes some export manufacturing no longer profitable in developing countries. When more goods are produced at locations closer to their end markets, overall world trade growth may slow down, if some production reverts to domestic manufacturing.

While we will, of course, see a cyclical rebound in trade once the economies of North America and Europe rebound, longer term forces will be leading us into an era of slower growth in international trade.