The death of the death of distance

Recently, there's been some chatter in the news and blogosphere about the how the high price of oil is putting some serious dents in the 'death of distance' theory, a subset Tom Friedman's ubiquitous 'flat worldism' (or is it flatism? I can never remember: I gave up trying to finish the World is Flat on my third try.) The gist of it is: high shipping costs mitigate the advantages you would get from delocalizing production, and if oil prices don't fall, we will see a reversal of a key component of globalization in the future.

Anyways, this is rather old hat - I remember reading a lot of doomsaying about transportation costs earlier this summer when it looked like oil was on a runaway train to $200. But the issue clearly still has traction, as oil prices are unlikely to drop signficantly anytime soon. Research shows that shipping costs clearly play a big role in determining trade volumes. For starters, we have the standard gravity model, which predicts trade volumes based on two variables: GDP size of the two trading nations and the distance between them. Perhaps unsurprisingly, as distance increases, trade declines. And for anyone who truly wants to get into the nitty gritty, I direct you to this NBER paper, which uses the gravity model to show how rising shipping costs helped destroy the last great era of globalization (give or take 1870-1914.)

My first thought is that the price of oil will have to get substantially higher to really reverse global integration. You don't create delocalized production chains overnight - they're the result of significant research and preparation, and they usually take the form of foreign direct investment. FDI, which often represents tangible physical investment, is by nature fairly illiquid. Also, shipping is still a fairly low portion of overall production costs, and certainly much less than labor costs. It would take very high shipping costs for the (cost of shipping + cost of labor in developing country) to exceed (cost of labor in rich country).

Still, there have been complaints that price-sensitive industries are under pressure. Chinese textiles and basic manufactures reportedly produced the slimmest of profit margins. This is a concern, but only if it's an industry-wide problem. In this case, the price of these goods will go up; if not, it will weed out inefficient producers very, very fast.

In my opinion, these concerns are most important in the 10-15 year outlook. If oil prices continue to trend upwards as they have for the past decade, what effect will that have on delocalized production? It's really difficult to make any sort of accurate forecast that far into the future, but one thing seems clear to me. If shipping costs become prohibitive, the biggest losers wouldn't be first-world consumers, it'd be third-world countries that rely on their comparative advantage in labor for economic development.

Don't let this keep you up at night (unless you happen to manage supply chain logistics for a living), but it's certainly something to keep an eye on. Both from a development standpoint and a business standpoint.