There go the supply chains

by Alex Evans | Aug 10, 2009 | Climate and resource scarcity, Economics and development

The FT has a big splash this morning on how concerns about future climate policy and the global downturn are both driving a move away from global supply chains and towards more regional ones.

Companies are increasingly looking closer to home for their components, meaning that for their US or European operations they are more likely to use Mexico and eastern Europe than China, as previously. “A future where energy is more expensive and less plentifully available will lead to more regional supply chains,” Gerard Kleisterlee, chief executive of Philips, one of Europe’s biggest companies, told the Financial Times.

Mr Kleisterlee said businesses needed to find ways to build an economy on a sustainable basis ahead of the Copenhagen summit on climate change later this year, with “a review of global logistics and transport” one of the important steps. He said that until now cheap transport costs had meant “Mexico wasn’t competitive with China for supplying the US”. But he now forecasts that companies such as Philips will use countries such as Ukraine for supplying Europe rather than Asia.

Nor are climate regulation and the downturn the only drivers towards a more regional world – there’s also the prospect of a return to very expensive oil in the near future. If you’re wondering what that means for global supply chains, look no further than what started to happen during 2007:

…competitiveness in steel had already shifted away from Chinese exports and back to North American producers. Soaring transport costs – first on importing iron ore to China from Australia or from halfway around the world in Brazil, and then on exporting finished steel overseas to North America – added as much as an additional $90 onto the cost of what was then $600 per ton of hot rolled steel. That more than offset the Chinese wage advantage on what, thanks to technological change, had become as little as an hour and a half of labor time for that ton of steel.

For the first time in over a decade, made-in-America steel had become cheaper than Chinese imports in the US marketplace. Long before the recession blew up the US steel market, Chinese exports to the US fell 20% between July 2007 and March 2008 – and US steel production was up 10% over the same period. All of a sudden American steel producers were winning back their home market. Who would have thought that tripil digit oil prices could breathe new life into America’s rust belt?

That’s Jeff Rubin, in his very highly recommended new book on what peak oil will mean for globalisation (regular readers will remember his CIBC World Markets research paper on Could Soaring Transport Costs Reverse Globalisation a little over a year ago) – go buy it.

If I were the Chinese government, I’d be worried. First you see your export sector getting hammered by triple digit oil prices.  Then even when they crash to less than half of their pre-spike levels (though n.b. still way above their pre-2000 average of 10 or 20 dollars a barrel, even in the biggest recession since 1929), you find that the downturn’s still driving a shift towards regionalisation in trade.

Time to start investing heavily in a more endogenous growth model, perhaps…