Something I wrote yesterday which I think may be of interest to dailykos readers. Would love any opinions on the validity of this thought experiment... thanks!
Many feel concern over the long term consequences of global free trade agreements. 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 force repeal of environmental laws in the industrialized world in order to compete economically; both primarily referred to as Race To The Bottom arguments. And there are those who claim that by moving critical manufacturing plants, tooling, and local skill base abroad, US based corporations drain the responsiveness of the United States during times of emergency and international calamity; an argument based on national security and self defense. 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 falters in generating cheaper and cheaper goods. And that linchpin is energy pricing.
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 now 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 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, European nations and Japan began rebuilding from the disastrous effects of World War II to their infrastructure and economies with massive funding and support from the United States as part of the post-war Marshall Plan. 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 survive 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. By accepting World Bank loans and carefully supporting a fledgling electronics and automobile manufacturing and export industry, what we now know as Japanese corporate giants such as Honda 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 with most any company in the industrialized nations. As a result both the people of Japan and the western democracies GDP per-capita grew far greater than if they had remained insular trading partners. And by the late 1960s a policy toward tariff reductions and free trade began between Japan and the western democracies.
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 by following the same plan of financing infrastructure and corporate development in order to build a manufacturing base for exports. 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 also saw enormous economic growth from the1980s leading into the new century and calling for market liberalization became the mantra of western nation economists worldwide.
The Flexible Labor Force Mantra
Market liberalization throughout the Asian economies mixed an approach of jump starting depressed economies by heavy and fast investment in manufacturing facilities, combined with excess cheap labor, to out compete companies producing similar goods in industrialized nations where labor costs were much higher. Thus, the policy exploited a labor cost differential between newly industrial and post-industrial nations, combined with cheap overseas shipping, to manufacture cheaply and get products to market in the industrial nations; essentially an arbitrage scheme. The 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. Other than a few hiccups, this policy turned out to be a resounding success.
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 free market reforms worked so well before? Assuming low energy prices for shipping raw materials and value added goods worldwide, investors should realize greater profits from manufacturing abroad than manufacturing locally due to lower labor costs abroad.
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 lead 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 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. 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. Yet today, with another wave of corporate downsizing following a popped bubble 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. But what happens should energy prices increase? A marginal increase would just add to the cost of shipping raw materials into manufacturing plants, and further add to the cost of shipping value added goods back to market; the additional cost simply added to 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 who 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 from manufacture 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 which 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 Thought Experiment
Assume that peak oil is here today and that humanity will see only higher oil prices until 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; war may break out over control of remaining high quality energy assets. This unpredictability in energy rates leads to the potential for severe short term adverse economic consequences for those who invest in excess plant capacity in the under developed world.
Assuming a world where the last fossil fuels left are simply more expensive to extract and refine than it costs to collect non-fossil fuel energy through biofuel, solar, wind, nuclear, etc, the cost differential between collecting renewable energy tomorrow compared with the same energy output from fossil fuels today represents the gradient between the feasibility of globalization today versus the long term tomorrow. 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.
A Gloomy National Security Scenario
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. Or it may not. This is just a gloomy scenario.
Conclusion
Beyond the traditional argument outlaying risks associated with labor arbitrage and declining environmental standards, peak oil combined with globalization may 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.