Changing Supply Lines

Stephen DeAngelis

August 12, 2008

Globalization is all about the movement and flow of resources, capital, people, ideas and so forth. Rising fuel prices, however, are changing the routes some of those flows are following [“Shipping Costs Start to Crimp Globalization,” by Larry Rohter, New York Times, 3 August 2008].

“When Tesla Motors, a pioneer in electric-powered cars, set out to make a luxury roadster for the American market, it had the global supply chain in mind. Tesla planned to manufacture 1,000-pound battery packs in Thailand, ship them to Britain for installation, then bring the mostly assembled cars back to the United States. But when it began production this spring, the company decided to make the batteries and assemble the cars near its home base in California, cutting more than 5,000 miles from the shipping bill for each vehicle. ‘It was kind of a no-brain decision for us,’ said Darryl Siry, the company’s senior vice president of global sales, marketing and service. ‘A major reason was to avoid the transportation costs, which are terrible.'”

In a couple of recent posts, I have noted how changes in supply lines have dramatically and negatively affected economies that had thought they had permanently benefited from globalization [see Looking for Jobs that Last and Colombia Embraces Globalization]. In those posts, I noted that globalization integrates trade by disintegrating production chains and dispersing them across economies. But as the costs of transportation increase, the length of supply lines is beginning to decrease. As a result, globalization is beginning to look more like regionalization. Rohter continues:

“The world economy has become so integrated that shoppers find relatively few T-shirts and sneakers in Wal-Mart and Target carrying a ‘Made in the U.S.A.’ label. But globalization may be losing some of the inexorable economic power it had for much of the past quarter-century, even as it faces fresh challenges as a political ideology. Cheap oil, the lubricant of quick, inexpensive transportation links across the world, may not return anytime soon, upsetting the logic of diffuse global supply chains that treat geography as a footnote in the pursuit of lower wages. Rising concern about global warming, the reaction against lost jobs in rich countries, worries about food safety and security, and the collapse of world trade talks in Geneva last week also signal that political and environmental concerns may make the calculus of globalization far more complex.”

As Rohter notes, rising transportation costs are returning geographical challenges to the place they have historically occupied. Although transportation companies and manufacturing plants decry the changing landscape, many environmentalists are cheered by the changes.

“‘If we think about the Wal-Mart model, it is incredibly fuel-intensive at every stage, and at every one of those stages we are now seeing an inflation of the costs for boats, trucks, cars,’ said Naomi Klein, the author of The Shock Doctrine: The Rise of Disaster Capitalism. ‘That is necessarily leading to a rethinking of this emissions-intensive model, whether the increased interest in growing foods locally, producing locally or shopping locally, and I think that’s great.'”

Regionalization is good for many product chains, but it could also slow globalization’s advance into areas that are currently mired in poverty, such as Africa. As I pointed out in the posts mentioned earlier, supplier companies need to position themselves within the logistics paths of production chains in order to benefit from globalization. As those logistics lines shrink, they are likely to bypass some geographical regions that are anxiously awaiting for the rest of the world to discover them. Without being embraced as part of disintegrated production chains, these regions will never attract enough capital to build up a sustainable regional economy. The changes have already started to occur.

“Many economists argue that globalization will not shift into reverse even if oil prices continue their rising trend. But many see evidence that companies looking to keep prices low will have to move some production closer to consumers. Globe-spanning supply chains — Brazilian iron ore turned into Chinese steel used to make washing machines shipped to Long Beach, Calif., and then trucked to appliance stores in Chicago — make less sense today than they did a few years ago. To avoid having to ship all its products from abroad, the Swedish furniture manufacturer Ikea opened its first factory in the United States in May. Some electronics companies that left Mexico in recent years for the lower wages in China are now returning to Mexico, because they can lower costs by trucking their output overland to American consumers.”

Such dramatic changes in so short a period of time make it more important than ever for companies to involve themselves in alternative futures planning. Companies need to consider a number of possibilities about the future because no one can predict how the competitive landscape is going to change with any certainty. One thing that will remain important is wringing out as many efficiencies in the global supply chain as possible. To do that, there is going to have to be a lot more information sharing, even among competitors. Rohter notes how rising fuel prices have affected shipping costs.

“The cost of shipping a 40-foot container from Shanghai to the United States has risen to $8,000, compared with $3,000 early in the decade, according to a recent study of transportation costs. Big container ships, the pack mules of the 21st-century economy, have shaved their top speed by nearly 20 percent to save on fuel costs, substantially slowing shipping times. The study, published in May by the Canadian investment bank CIBC World Markets, calculates that the recent surge in shipping costs is on average the equivalent of a 9 percent tariff on trade. ‘The cost of moving goods, not the cost of tariffs, is the largest barrier to global trade today,’ the report concluded, and as a result ‘has effectively offset all the trade liberalization efforts of the last three decades.’ The spike in shipping costs comes at a moment when concern about the environmental impact of globalization is also growing. Many companies have in recent years shifted production from countries with greater energy efficiency and more rigorous standards on carbon emissions, especially in Europe, to those that are more lax, like China and India.”

This is not good news for developing countries, especially those that counted on building their industrial capacity using dirty industrial age technologies. Critics of globalization, Rohter reports, are delighted by these developments and have started writing about the death of globalization. They are probably writing a premature eulogy.

“Many leading economists say such predictions are probably overblown. ‘It would be a mistake, a misinterpretation, to think that a huge rollback or reversal of fundamental trends is under way,’ said Jeffrey D. Sachs, director of the Earth Institute at Columbia University. ‘Distance and trade costs do matter, but we are still in a globalized era.’ As economists and business executives well know, shipping costs are only one factor in determining the flow of international trade. When companies decide where to invest in a new factory or from whom to buy a product, they also take into account exchange rates, consumer confidence, labor costs, government regulations and the availability of skilled managers.”

For the billions of people suffering from extreme poverty the death of globalization would also spell the end of hope. As I noted in one of the posts mentioned above, transportation costs have affected different economic sectors in different ways. Rohter discusses some of these changes.

“The industries most likely to be affected by the sharp rise in transportation costs are those producing heavy or bulky goods that are particularly expensive to ship relative to their sale price. Steel is an example. China’s steel exports to the United States are now tumbling by more than 20 percent on a year-over-year basis, their worst performance in a decade, while American steel production has been rising after years of decline. Motors and machinery of all types, car parts, industrial presses, refrigerators, television sets and other home appliances could also be affected. Plants in industries that require relatively less investment in infrastructure, like furniture, footwear and toys, are already showing signs of mobility as shipping costs rise. Until recently, standard practice in the furniture industry was to ship American timber from ports like Norfolk, Baltimore and Charleston to China, where oak and cherry would be milled into sofas, beds, tables, cabinets and chairs, which were then shipped back to the United States. But with transportation costs rising, more wood is now going to traditional domestic furniture-making centers in North Carolina and Virginia, where the industry had all but been wiped out. While the opening of the American Ikea plant, in Danville, Va., a traditional furniture-producing center hit hard by the outsourcing of production to Asia, is perhaps most emblematic of such changes, other manufacturers are also shifting some production back to the United States.”

Transportation costs have also contributed to the current food crisis.

“Soaring transportation costs also have an impact on food, from bananas to salmon. Higher shipping rates could eventually transform some items now found in the typical middle-class pantry into luxuries and further promote the so-called local food movement popular in many American and European cities.”

To learn a bit more about the local food movement and some of the challenges associated with it, you can read my earlier post titled The Return of Family Farms? Rohter reports that rising transportation costs are creating a so-called “neighborhood effect.” This effect, as noted above, is already changing supply chains and it may also mark a return to warehousing and inventories as “just-in-time” logistics systems become strained.

“Global companies like General Electric, DuPont, Alcoa and Procter & Gamble are beginning to respond to the simultaneous increases in shipping and environmental costs with green policies meant to reduce both fuel consumption and carbon emissions. That pressure is likely to increase as both manufacturers and retailers seek ways to tighten the global supply chain. ‘Being green is in their best interests not so much in making money as saving money,’ said Gary Yohe, an environmental economist at Wesleyan University. ‘Green companies are likely to be a permanent trend, as these vulnerabilities continue, but it’s going to take a long time for all this to settle down.’ In addition, the sharp increase in transportation costs has implications for the ‘just-in-time’ system pioneered in Japan and later adopted the world over. It is a highly profitable business strategy aimed at reducing warehousing and inventory costs by arranging for raw materials and other supplies to arrive only when needed, and not before. Jeffrey E. Garten, the author of ‘World View: Global Strategies for the New Economy’ and a former dean of the Yale School of Management, said that companies ‘cannot take a risk that the just-in-time system won’t function, because the whole global trading system is based on that notion.’ As a result, he said, ‘they are going to have to have redundancies in the supply chain, like more warehousing and multiple sources of supply and even production.’ One likely outcome if transportation rates stay high, economists said, would be a strengthening of the neighborhood effect. Instead of seeking supplies wherever they can be bought most cheaply, regardless of location, and outsourcing the assembly of products all over the world, manufacturers would instead concentrate on performing those activities as close to home as possible.”

Opponents of globalization will undoubtedly crow over these developments. I’m not one of them. I believe the world can become a better place because of globalization, not in spite of it. Within a few decades, globalization should reach places it has yet to touch. That timeline could be pushed back if transportation costs rearrange the landscape of the global supply chain to extent implied in Rohter’s article. Those concerned with the development of places like Africa would do well to start considering how a regional trading regime could still help create sustainable economies in some of the world’s poorest places.