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Oil and the end of globalization

Economist Jeff Rubin makes a strong case for the inevitable return of $140 per barrel oil before long due to the decline in easy-to-find conventional oil and the increasing consumption by China, India, and other developing nations. And he makes a strong case that the root cause of the recent economic meltdown had more to do with spiking oil prices than bad loans. The only thing keeping oil prices under $100 now is the continuing world recession. But even more interesting is his conclusion that the oil price increases will mean the end of globalization as we know it and a return to a more localized and hopefully more sustainable economy.

So how do we adapt? How do we grow in an economy of triple digit oil prices? We change the nature of our economy. In a world of triple-digit oil prices, distance costs money. The global economy, where we produce one thing at one end of the world, to be sold at the other end of the world, doesn’t make any economic sense, because in too many cases, what will be penny-wise, will soon become pound-foolish. The wage “arb”, what we save on wages, we will more than squander on bunker fuel.

Take the steel industry, for example. Just before the recent recession, some very curious things were happening in the US market. When oil prices got to be over $100 barrel, all of the sudden, Chinese steel exports to the US fell at double-digit rates. And all of the sudden, US steel production was up. And all of the sudden, US Steel Corp., which was one of the biggest dogs in the market, all of the sudden its share price doubled.

What was going on? I’ll tell you what was going on. For the first time in 20 years, it was cheaper to make steel in the United States than to import it from China. Why? Consider what China has to do to send you steel. First, it has to ship iron ore from Brazil, across the Pacific Ocean, turn it into steel, which is itself a very energy-intensive process, then ship it back, across the Pacific Ocean, to you. At $20 barrel, that works. At $100 barrel, that doesn’t work. It added on $60 to $70 dollars, to the cost of a ton of hot-rolled steel. How much labor time do you think there is in making steel these days? One and a half to two hours. The transit costs all of a sudden exceeded the labor costs. Who would dream that triple digit oil prices would breathe new life into our hollowed-out Rust Belt? But in a world where distance costs money, that is exactly what is going to happen.

Take food. Last year, China exported $6 billion of food to America, everything from apples to frozen chicken wings, bringing a whole new meaning to having your Chinese food delivered. Steel doesn’t have to be refrigerated. Hopefully, frozen chicken wings do. What do you think powers that refrigeration unit? Bunker fuel! The same thing that is powering the boat. The world of triple digit oil prices–it won’t matter that farm labor is cheaper in China than in the United States, because the cost of bringing those frozen chicken wings to us will be too expensive.

It’s not like we are going to stop using steel in America, and it is certainly not like we are going to stop eating. What we are going to have to do is make our own steel. What we are going to have to do is grow more of our own food. Unfortunately, much of our agricultural land has been paved over with suburban sprawl. Just as triple digit oil prices will breathe new life into our hollowed out Rust Belt, triple digit oil prices will turn those far-flung suburbs and exurbs back into the farmland they were, thirty to forty years ago. The very same economic forces that gutted our manufacturing sector, that paved over our farm land, when oil was cheap and abundant, and transport costs were incidental, those same economic forces will do the opposite in a world of triple digit oil prices. And that is not determined by government, and that is not determined by ideological preference, and that is not determined by our willingness or unwillingness to reduce our carbon trail. That is just Economics 100.

Triple digit oil price is going to change cost-curves. And when it changes cost curves, it is going to change economic geography at the same time. I know that the world of triple digit oil prices has been the domain of the apocalypse. For many people, the advent of peak oil and triple digit oil price means the end of our economy. For some, civilization as we know it. I don’t share that pessimism. I don’t share that outlook. I’m an economist. I believe in the power of prices.

Sure, if we continue to want to get our frozen chicken wings from half-way around the world, where labor is cheap, if we want to get our steel from half way around the world, if we want to commute back and forth eighty miles to work in our SUVs, peak oil won’t just be a recession, peak oil will be peak GDP, and that will be apocalyptic. But as I say, I am an economist, and I believe in the power of prices. I believe we are going to change. I believe that we are not going to end up importing food from half-way around the world, or steel from half-way around the world. I don’t think we are committed, irrevocably, to suburban sprawl.

And we might just find that that new smaller world around the corner is a whole lot more livable, and a whole lot more sustainable, than the big “oily” one we are about to leave behind.

Source: http://www.aspousa.org/index.php/2010/11/jeff-rubin-oil-and-the-end-of-globalization/

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