with Walter Kemmsies
The freight movement industry has had a lot to worry about — the drawn out, often hesitant economic recovery, a changing landscape due to infrastructure investments and larger ships, and more recently, some speculation that world trade has reached its peak. The arguments for a flat or negative trend for world trade are that factories that moved to China from the United States would return to the United States, and that the world economy is going to become regional rather than global as national governments enact protectionist policies. World trade may be peaking, but before buying into any argument it’s important to consider why world trade increased in the first place.
Over the last 64 years, World Trade Organization data has shown that global trade in manufactured goods has grown on average nearly twice as fast as global gross domestic product growth, which indicates economic growth isn’t the only driver of increased trade. If anything, there’s a virtuous feedback cycle whereby trade growth drives economic growth, which in turn results in more trading activity. This virtuous cycle is a confluence of structural trends that has increased both the demand for, and efficiency of, trade through scale economies. More efficient or lower cost trade allows the world economy to reduce production inefficiencies by sourcing from lower cost locations and therefore reach a higher level of efficiency and output.
The drivers of global trade have been shifting demographics, falling trade barriers and transportation infrastructure improvements such as the containerization of trade. Investments in larger vessels designed to optimize services between regions is the most recent development that further supports global trade growth. Larger vessels provide better economies of scale which allows lower freight rates to be charged. These factors will continue to induce companies to relocate production facilities to areas with higher demand growth and/or lower labor costs, including potential shifts into new regions like South Asia, Central America and/or North America. These trends have been euphemistically labeled as offshoring, near-shoring or re-shoring. However, they are all part of the same overall trend — globalization (global organization of production and distribution) of the world economy.
Outsourcing was a major driver of U.S. imported container growth over the last decade and recent data on re-exports shows this also helped U.S. exports a little. For example, it has been estimated that 40 percent of the value of U.S. imports from Mexico comes from inputs sourced in the United States. Nonetheless there has been what economists call import substitution — U.S. consumption of goods has been increasingly met by products made in other countries. This is likely the reason for the “jobless recovery” of 2001-2007, and North Carolina, historically a U.S. furniture manufacturing center, becoming for the first time a net importer of furniture in 2006.
Most, but perhaps not all, outsourcing continues to be profit-motivated as opposed to simply focused on cost reduction. Developing economies have younger populations than mature industrialized nations. Younger people spend more of their income on goods than older people do. However, incomes in developing economies are lower. Companies operating in aging developed economies needed to shift their operations to countries with younger populations because those markets were growing faster. Companies that have moved their production operations offshore to access faster growing markets have also been able to increase their profits by importing their foreign-made goods into the United States. This has been helped by declining transportation costs and increasing reliability of supply chains.
Outsourcing of low-value products such as apparel and disposable plastic utensils began decades ago. This has been extended to higher value goods such as automobiles and continues on a global scale. These trends reflect the globalization of industries which began in a few industries like finance and raw materials such as oil and now extends to the manufacturing of an increasing range of goods. But there are exceptions. Some products, such as window fixtures, that are specific to the U.S. market were also offshored; however, given that raw materials costs are often cheaper in the United States and transportation costs are higher from far-flung locations it is likely that such production will be repatriated from other locations.
Overall, the United States offers many advantages as a production location. It has an abundance of fuel products and therefore lower energy costs, highly efficient agricultural production and low-interest rates which makes investment in automation financially viable. Low natural gas prices not only keep electricity costs down, it is also a cheaper feedstock than petroleum in the production of plastics — a key input for manufactured goods.
These three industries — agriculture, capital goods and energy — are likely to drive U.S. economic growth during this business cycle. It is likely that U.S. exports will grow faster than imports. This is needed to correct the substantial and unsustainable trade deficit.
As the United States increases its exports it will support the long running trend towards globalization of the world economy. But this will not occur without investment in freight export infrastructure. More efficient freight movement reduces the cost of trade which increases the demand for trade. As long as highways are improved, railroads invest in capacity, ocean carriers use larger vessels designed to meet the needs of major trade lanes, and ports improve air and water draft as well as throughput capacity, globalization of industries can continue and world trade will keep growing.
Kemmsies is chief economist at Moffatt & Nichol, an infrastructure engineering firm. He can be reached at (212) 768-7454 or by email.
This column was published in the June 2014 issue of American Shipper.