Sun, Jan. 30th, 2005, 05:36 pm
massinine: Speculation: Globalization vs. Peak Oil

Rapid international market liberalization is breaking down nationalist protectionism policies throughout the world. As a result, a divide between the higher wages and better living standards of the workforce in the industrial nations, against those in the cheaper developing third world, have given multinational business an incentive to move manufacturing offshore. Such a move requires significant shipping of raw materials to the manufacturing plants and finished goods to market. What happens if shipping costs exceed labor savings due to higher energy rates? Below the fold, this article explores that issue.




Speculation
Globalization vs. Peak Oil: Could rising energy rates trump cheap labor?


By J. Maynard Gelinas

Global free trade agreements have sparked concern, and even fear and outrage, among many citizens throughout both industrialized and developing nations. Some activists and labor unions fear the wage differential between industrialized and newly developing nations may drive down wages in high cost-of-living industrialized nations. Others offer concern that disparities between environmental laws in industrialized nations, and those in newly developing nations, may economically compel a repeal of environmental laws in the industrialized world. Activists term competition driving down wages, repeal of labor laws, and environmental deregulation a Race To The Bottom. A situation where normal market economics force declining standards of living for the general wage earning population, instead of passing on cost savings from increasing economies of scale in manufacturing. Another group fears the decline in national security and responsiveness after moving critical manufacturing plants, tooling, and local skill base abroad. They wonder, if large numbers of US based corporations move offshore, will this drain the responsiveness of the United States during times of emergency and international calamity?

But most economists worldwide are in agreement: Globalization is a long term good for the world economy; globalization drives down costs of manufacturing value added products and getting them to market; globalization is here to stay. Yet one argument rarely discussed is by what margin globalized free trade reduces those costs, and under what conditions a globalized market could falter in generating cheaper and cheaper goods. The linchpin is energy prices. For if the cost of energy necessary to transport raw materials, and value added goods, between labor and market were to exceed the labor savings from offshore manufacturing, globalization would become unsustainable. Businesses that had investing in expensive offshore manufacturing plants, new tooling, and training of their labor force, would soon lose money. Those industrialized nations where manufacturing had left for seemingly cheaper shores, would soon find themselves lacking in manufacturing capacity. This outcome might seem unlikely due to the incredible labor price disparities between the industrialized and developing nations. Yet energy prices have risen tremendously over the last decade, with even more dramatic short -term price volatility. Is this future really so unrealistic?

GATT: The Early Years

In 1947 twenty-three nations signed onto a new free trade treaty then known as the General Agreement on Tariff and Trade, or GATT for short, and by 1948 the treaty was ratified and in force. GATT was intended to be one of three international bodies, each tasked with separate responsibilities related to world trade and economic development. GATT handled reducing trade barriers between nations; the International Monetary Fund (IMF) was tasked with emergency debt relief, credit, and currency support during times of national economic crises worldwide; the World Bank undertook responsibility for generating sustainable infrastructure and economic development throughout the developing world by offering viable long term loans to those developing nations.

Over time member nations updated the GATT, changing provisions, adding new members, and finally evolved GATT into a new international body now known as the World Trade Organization (WTO). The WTO provides both policymaking and regulatory functions, while also offering member states binding arbitration over trade disputes. Thus the WTO functions as a worldwide economic legislative body and court for international trade policy and dispute resolution. It provides the means by which nations reduce or remove tariffs on traded goods in order to liberalize markets between them, and impose WTO sanctioned tariffs and fines as a penalty for breaking agreements. The presumed purpose being to reduce manufacturing costs, increase trade, and show real productivity gains worldwide.

Japan: A Study in Jump Starting Market Economies

As GATT membership increased across the early 1950s, Western Europe and Japan began rebuilding from the disastrous effects to their infrastructure and economies from World War II with massive funding and logistical support from the United States. Called the Marshall Plan, after General George Marshall, the principal architect and post-war administer. By the mid 1950s to early 1960s Europe and Japan were well on their way to economic recovery.

While Europe had before World War II been an economic and manufacturing nexus, prior to the war Japan wasn't a significant exporter of finished goods, or even raw materials. The United States took upon itself during and after the Japanese occupation to not only reconstruct basic infrastructure and democratic parliamentary government, but also build a market economy where before none had ever existed. A bold experiment, one many thought couldn't succeed due to the lack of cultural experience with market reforms, Japan nonetheless rebuilt and persevered. By the early 1960s Japan entered a golden age of economic growth known by the Japanese as the High Growth Era. As an example of how quickly Japan integrated into the western economy: in 1951 the US occupation officially ended, in 1952 Japan joined the IMF and World Bank, in 1955 Japan joined GATT, and by 1956 they had signed onto the United Nations; an astonishing and radical change for what had been an insular society prior to World War II.

Japan undertook a risky policy of accepting World Bank loans and carefully supporting a fledgling electronics and automobile manufacturing and export industry. As a result, Japanese corporate giants such as Honda, Sony, and Mitsubishi, grew by leaps and bounds from next to nothing. Within the span of two decades from 1960 through to 1980 what had been tiny startups grew to such massive proportions that they out competed in quality and price most any company in the industrialized nations. As a result, both the people of Japan and those living in western democracies’ GDP per-capita grew far greater than if they had remained insular trading partners. And by the late 1960s a policy transition toward general tariff reduction and free trade began.

By the 1980s the western industrialized nations wanted a repeat of their success with Japan across the Asian corridor. Attempts to jump-start the economies of South Korea, Taiwan, Hong Kong (then a British colony), Thailand and others followed. The same plan of financing infrastructure and corporate development, in order to build a manufacturing base for exports, was implemented. Because these formerly agrarian nations had little economic development, labor costs were cheap, the governments willing, and stable expansion likely. As a result these nations saw enormous economic growth from the1980s leading into the new century. Unfortunately, they also saw dramatic environmental damage from new high-technology manufacturing processes releasing dangerous chemicals, large increases in wage and living standards diversity throughout the population, and in some cases massive popular unrest. But economists saw only economic growth and a burgeoning middle class supplanting a former agrarian economy. They continued calling for fast market liberalization and flexible labor, which in time became the mantra of most economists, worldwide.

The Flexible Labor Force Mantra

Market liberalization throughout the Asian economies jaws meant to ump-start depressed and non-industrialized economies with heavy and fast investment in manufacturing facilities. Combined with an excess of cheap labor, they would out-compete businesses producing similar goods in industrialized nations, where labor costs were much higher. With oil prices low, businesses could transport raw materials to newly created manufacturing plants in the developing world, and then once again to market in the industrial nations. Any increased shipping costs were paltry compared to the massive savings from reduced wages and lax environmental and safety regulations. Economists began calling labor markets in the developing world ‘flexible’, due to the tremendous leverage to set labor policy large business commanded with the relatively small and poor governments of the third world. Industrial world labor markets were thus deemed ‘inflexible’, due to their greater worker safety and environmental regulations and much higher wage standards. Flexibility became shorthand for “cheaper”, which any competitive market strives to gain. This essentially created a labor arbitrage scheme between world markets, with work shifting to the cheapest labor market on demand, and business reaping the gains at the expense of labor. Thus, the policy exploited a labor cost differential between newly industrializing and post-industrial nations.

Economists realized the potential for disruption throughout industrialized world labor markets as a result of these policies. However, their presumption was that in time the labor force in formerly pre-industrial nations would increase their earnings per-capita such that they too could afford the things they manufacture. While in the industrial world, as traditional manufacturing shifted offshore, businesses would employ labor toward new high-technology initiatives requiring specialized education and training. In time, market equilibrium would form a unified market between these nations based on liberal free-trade policies. Then both business and labor would reap the rewards of globalization.

Market reformers thus ask: If this policy toward economic development and free trade was such a success throughout postwar Europe and the former agrarian Asian states, why not finish the process worldwide? Why keep trade barriers at all if liberal free-market reforms could be implemented everywhere? Would not the benefits be realized everyone as well?

Yet as manufacturing flourished throughout the developing world, so did it wither in the industrialized nations. Manufacturers throughout the industrialized world found themselves unable to compete due to higher relative labor costs and more restrictive environmental regulations. This led to massive labor restructuring as whole manufacturing industries shifted production overseas. US steel production, for example, increased by less than ten percent from 1960 to 1999:

US Production: 90,100,000 in 1960 vs. 97,400,000 in 1999, metric tons


Overseas Imports: 3,240,000 in 1960 vs 32,400,000 in 1999, metric tons


while imports increased dramatically (see page 5), representing a significant shift away from local production and toward imports. Automobile, chemical and materials manufacturing, and even high technology computer and chip makers followed suit, leaving fewer and fewer manufacturing jobs available to workers in industrialized nations.

But, free market economists argued, a flexible labor force constantly retraining for new jobs and new value added technologies will – in time - keep workers in industrialized nations fully employed exploiting new ideas, creating new products, and thus maintaining a high standard of living for all. This mantra was repeated across the 1980s as manufacturers laid-off workers in droves throughout the United States. Euphemistically referred to as corporate downsizing, at the same time many workers were unable to keep up with a rapid economic transition, leaving large swaths of formerly employed middle class workers unable to find good paying jobs. Yet by the mid 1990s it appeared those economists were right all along. The economy grew, new technologies such as the Internet and ubiquitous computing began showing real productivity gains, and then the economy took off explosively.

That the economy of the late 1990s was a vast bubble of overproduction no economist doubts today. Yet after the bubble burst, with another wave of corporate downsizing and recession, almost all economists still repeat the same mantra: flexible labor will retrain workers for new economic challenges, readying them for new employment opportunities, while the rest of the world does work industrialized nations simply need not perform any longer. Over time the international markets and wage differentials will equalize in a harmonious orgy of free trade. Even if one assumes this is true, what happens should energy prices increase dramatically, or even just remain highly volatile? A marginal increase would just add to the cost of shipping raw materials into manufacturing plants, further adding to the cost of shipping value added goods back to market; the additional cost simply tacked onto the final price. But what would happen if energy prices skyrocketed? What if energy rates climbed sharply like during the 1973 energy crisis, only instead of declining down to previous levels over time they remained high and continued to climb? Then, things get sticky for globalization and businesses that base their profit on the labor cost differential between far reaching lands.

Energy Makes World Trade Move Round

No one disputes that it takes energy, usually in the form of processed petroleum, to transport raw materials and processed goods to market. For most of the twentieth century petroleum has been cheap and plentiful, driving down manufacturing and transport worldwide. Globalization is thus wedded to cheap energy and cheap transportation. But there's a storm brewing, and it's called the Hubbert Peak Oil Analysis (Summary). In the 1950s Dr. M. King Hubbert definied a few simple rules to calculate fixed natural resource extraction rates, showing that production tends to increase over time until it hits a peak point of extraction. Beyond that, production declines until finally the cost of extraction exceeds resource valuation in the open market, or resource availability is finally exhausted. When this analysis is applied to oil extraction it turns out peak oil is neigh, and humanity faces declining oil reserves until they're finally exhausted. Some predict peak oil is happening now, others say within ten to twenty years. Whenever it happens, one thing is certain - energy rates will rise as a result.

What happens if energy rates rise so high that the cost of shipping raw materials and processed goods in a global market exceeds savings from cheap labor abroad? And what happens if energy prices shoot up significantly before investors realize their return on these new manufacturing facilities? Further, what happens to those industrialized nations, who handed off their manufacturing base to the newly developing world, once it's more expensive to manufacture and ship value added goods than to manufacture locally? And finally, how much would energy rates have to rise in order for this market force to take effect?

Good questions.

A Gloomy National Security Scenario

Assume that peak oil is here today and that humanity will see only higher oil prices unless vast new supplies are discovered. In the old globalized world of cheap energy, the return on capital sunk into building new manufacturing facilities in newly developed nations would greatly exceed any potential return from manufacturing locally. Thus investment abroad should break even faster than local investment, generating greater profits faster than otherwise. But if one assumes that oil and natural gas supplies are near peak output today, the exploitation and extraction of fossil fuels thus dwindling in the near future, then rapid and significant energy price hikes are likely soon. These energy hikes probably won't happen in a slow bell curve up as supplies dwindle, but instead may spike chaotically up and down without regard to total potential output over time. Energy producers may profiteer by reducing extraction, refining and delivery; newly developed nations may increase domestic oil demand, thus reducing worldwide supply. With China industrializing quickly, consuming more oil daily in the process, the world is already seeing dramatic lags in excess oil extraction and refining, which combined with war, led to extreme price volatility across 2004.

If Hubbert is right, over time fossil fuels left will become more energy expensive to extract and refine than whatever usable energy is created in the process. At this point collecting and distributing alternative non-fossil energy such as bio-fuel, solar, wind, and nuclear, will become the only available option. The cost differential between collecting this energy, compared with the same energy output from fossil fuels, represents the gradient between the feasibility of cheap-oil globalization versus a long-term sustainable globalization supported by alternative fuel. Should it turn out that energy prices in a world with only renewable energy available are so great that higher local labor prices in the industrialized world trump previous cheap energy used in transport of goods, investors will face tremendous loss potential. And that's assuming a stable economic worldwide environment, without resource wars or public dissent. Investors may face risk exposure in a way no economist promoting globalization seems to have predicted. And that’s assuming a stable and organized global transition to renewable fuel. Should war may break out over control of any remaining high quality energy assets, extreme volatility in energy prices are certain. Thus, the potential for severe long-term adverse economic consequences for those who invest in excess plant capacity in the under developed world seems almost certain.

Imagine a world ensnared by global energy and resource conflict, newly developed nations such as China and India nationalizing corporate sponsored manufacturing infrastructure toward their own purposes, and past industrial giants like the United States unable to compete because of poor long term economic policy planning. A coordinated economic attack by the newly developed world could threaten United States and the developed world by forcing developed nations to respond through massive local manufacturing facilities investment during times of high energy rates. Combined with a huge trade imbalance and massive international debt this opens up the possibility of economic warfare leading to dissolution of the WTO, IMF, and World Bank, and all international agreements related to those bodies. Ultimately, bankruptcy for the United States and other developed nations may result.

Conclusion

Beyond the traditional argument outlaying risks associated with labor arbitrage and declining environmental standards, peak oil combined with globalization may also represent a serious potential economic and National Security threat from peak oil as well. It's an interesting thought, one worth pondering, but the question remains: How much higher must energy prices rise before globalized trade becomes economically unfeasible compared to local manufacturing? It would take a qualified economist crunching numbers to answer that question. But it's a question well worth asking, and a potential worldwide threat to society well worth discussing.

This article was originally posted as a diary entry on DailyKos, nine months ago. It appears to have been deleted there due to a disk crash or other problem. After a recent edit pass, it's been reposted here. Read, enjoy, and comment if you so desire.

Comment at the Cabaret Doltaire

Text Copyright ©2004, J. Maynard Gelinas

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