Can rising oil prices undermine the benefits of globalisation?

June 3rd, 2008

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Right now, there is much talk about price inflation. As you read the news media headlines, you will get to see a lot of talk about the soaring oil and food prices. There are rumours that the Fed is going to raise interest rates to fight inflation. Some people are comparing today with the infamous stagflation of the 1970s. We have heard of inflation in the Middle East, China, Singapore, South Korea and even Japan. It seems that the world is infected with the inflation bug.

Today, we read a news article, China, Starbucks and inflation, of which one of its paragraphs caught our attention:

“In many rural economies, you have farmers who go in their trucks with the produce they grow to the market to trade it,” said Lawrence Eagles, head of the International Energy Agency’s oil industry and market division. “But if it no longer becomes profitable because of the cost of gas, they’re going to simply return to subsistence farming, which would be a significant development.”

It is obvious that if most of these rural farmers return to subsistence farming, the price of food will rise, thanks to the rising price of oil. This led us to mull about the inflation problem.

Nowadays, we live in the modern age of globalisation. One of the characteristics of globalisation is specialisation. Countries specialise in producing things that they are particularly skilled at or can do so at a relatively lower cost than the others (see the theory of comparative advantage). Individually, our jobs are becoming more and more specialised. We see more and more experts at narrower and narrower fields of discipline.

No doubt, globalisation can bring about a lot of prosperity and wealth (and a lot of other negative side effects as well). For example, we have a case whereby Australia grows macadamia nuts (because it has a comparative advantage), ships them to China for packing (where the low cost of labour allows packing to be done at a much lower cost) and them ships them back to Australia for sale. Producing and packing macadamia nuts in either country alone will result in higher costs. But thanks to the globalisation, we can enjoy lower prices than otherwise.

But we see a weak point in globalisation. In the above example, it only works if the cost of shipping things is not prohibitive. As oil prices rises, the cost of shipping increases. As shipping cost increases, the benefits of specialisation and comparative advantage cannot be exploited just as easily.

Using the quote from the above-mentioned news article, we can imagine that with specialisation and comparative advantage, the farmers specialise in growing food for the city dwellers, while the city dwellers specialise in producing white goods in the factories for the farmers. Both benefits. But as the price of transport shoot up, this cosy arrangement can potentially break down.

So, as we can all see, this is another example of to show that much of the prosperity and comforts of modern life depends cheap and abundant energy. Take that away, and the good life as we know will be under threat.

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