Distance Does Matter

Space, as historian Fernand Braudel wrote, is "the enemy number one". Human ability to conquer physical space has shaped globalisation that began with the domestication of camels and the harnessing of winds for sailing ships. The shrubs and the wind were free.

Since then, humans have shrunk the world by using solar energy stored under the earth in the shape of coal and petroleum. Oceans became highways for giant container ships, one of which can carry the contents of 20-mile long convoys of trucks.

The ever-rising capacity and falling costs of transportation effectively removed the barrier of distance. Today, almost every product is made of global components that have travelled thousands of miles before reaching consumers. Even frozen chicken and fish are shipped from the US and Europe to China to be chopped and filleted before returning neatly packaged in cellophane wrappers to supermarket shelves. As the freight rises, businesses will have to pay more heed to the distance from the factory floor to the shop floor.

There have been oil shocks before, but once the precipitating events settled down, prices fell. The end of the Suez crisis, Iran's freeing of American hostages, and the conclusion of the first Iraq war were harbingers of lower prices.

The current surge appears to be of a different order. Although violence in Nigeria, one of the major oil suppliers, and, perhaps, speculation have pushed up prices somewhat, a whole host of systemic factors such as tight supply and growing thirst for oil by countries such as China and India do not suggest a return to happier times.

The galloping cost of transportation, which is equivalent to a tax on the merchandise, will slow down international trade. A Canadian Bank study estimates that in 2000 when oil was $20 per barrel, transport cost was equivalent to a 3 per cent US tariff. Today's extra shipping cost from East Asia is the equivalent of imposing a 9 per cent tariff on these goods entering the US. And at oil prices of $200 a barrel, the study estimated, the tariff-equivalent rate will rise to 15 per cent.

While lighter products with a high value-to-freight ratio, such as electronics and components, may escape such de facto tariff burdens, goods with low value-to-freight ratios, such as apparel, shoes or industrial machinery, will not.

With the additional cost passed on to the consumers, the demand for certain types of imports will drop. Chinese export of steel to the US, for example, has been declining, giving a new lease of life to the US's domestic steel. If the freight cost for a tonne of Brazilian ore to China rises to approach the price per tonne of iron ore from nearby Australia, China may switch to the Australian ore even at a higher gross price.

The most significant changes are likely to be felt in the elaborate supply chain production system and outsourcing of manufacturing. In the late 1990s, US corporations moved much of their labour-intensive manufacturing from Mexico to China, and sent finished goods back to the US. Low transportation cost made labour arbitrage a profitable option. With freight costs rising, Mexico might yet get back some of its manufacturing and assembly clients.

Nobody expects the manufacturing industry that left the US for low-wage countries to return. But rising freight might give a further boost to the trend of making products closer to the market than oceans away. Regional rather than global production networks are likely to become more important. The oil shock is also likely to promote energy efficiency and automation to produce goods locally. It might have an even greater impact on what the world eats. While the already expensive food will cost more to be delivered to the world's poor, it will provide a fillip to the rising call in the US and Europe for locally grown organic food.

As the cost of delivering raw materials rises, the burden will fall more on emerging industrial countries, fuelling inflation and reducing their abilities to produce low-priced goods. Developing countries that have benefited from cheap air travel by riding the wave of global tourism are likely to see a sharp drop in their earnings and millions employed in the tourism and hotel industry might be looking for new jobs.

As the cost of fighting the old enemy space grows, be ready for some fundamental shifts.