High shipping costs cast a shadow

The impact of high shipping costs is disproportionately larger for small islands like Malta, which heavily rely on imports that arrive by sea.

The global economy is being threatened again by high freight rates, which are likely to continue in the coming months. Freight rates had slumped to their lowest level in October 2023, subsequent to Covid-19, when the going rate for a 40-foot container was only $1,342. Since then, the global freight rate has gradually increased, hitting over $2,600 in January, the highest value on record.

Despite the nine-member US-led naval task force in the Red Sea, Houthi attacks persist. Global freight has suffered disruptions as container carriers rerouted away from the Suez Canal, resulting in extended lead times and potential port congestion. Freight rates surged, with Asia – North Europe rates up by 256% while Asia -Mediterranean (that includes Malta) prices tripled. Shipping rates for East Asia to the Mediterranean jumped to $5,871 per 40-foot container (FEU) on 25th January, from $1,873 per FEU on 14th December, according to Xeneta.

First of all, one needs to understand how it all began in 2019. As many workers started working from home during the Covid-19 pandemic, online shopping and increased computers sales all placed unprecedented demand on supply chains worldwide.  A large swing in containerised trade flows was met with supply-side capacity constraints, including container ship carrying capacity, container shortages, labour shortages, and Covid-19 restrictions across port regions and congestion at ports.

This mismatch between surging demand and de facto reduced supply capacity  led to record container freight rates on practically all container trade routes. Shipping costs then continued soaring throughout 2021 as consumers unleashed pent-up savings to buy new merchandise while the pandemic continued to snarl the world’s supply chains. Container rates have more than quadrupled since the start of the pandemic.

The Freightos Baltic Index (FBX) shows how global container rates reached record heights. The cost of shipping a 40-foot container (FEU) unit touched $11,000 in September 2021, compared to just $1,300 before the pandemic. With 90% of the world’s merchandise shipped by sea, it exacerbated global inflation that is already proving more troublesome than anticipated. They then began to pull back from their record in September 2021 and had declined by 16%, mostly due to falling rates for trans-Pacific eastbound routes, the main sea link from China to the United States.

But rates remained highly elevated.  Peter Sand, chief analyst at the freight rate benchmarking platform Xeneta, does not expect container shipping costs to normalise in the immediate future.  “This means the higher cost of logistics is not a transitory phenomenon,” Sand said. “For inflation, that means trouble… The element of shipping, in overall prices, small as it may be, is much bigger than ever before, and it could be a permanent lift to prices going forward.”

Certain supply constraints do not have immediate fixes: backlogs and port delays, labour shortages in related occupations, supply chain disruptions moving inland, and shipping industry challenges such as a slow capacity growth and the concentrated market power of a few carriers.

When economists talk about bottlenecks, they typically refer to points in a supply chain that slow down production. As The Economist put it recently, the global economy is at present providing a rather literal example of the metaphor: “It is as if someone has put a cork in the Suez and Panama canals.”

Impact on small islands

The impact of high shipping costs is disproportionately larger for small islands like Malta, which heavily rely on imports that arrive by sea. They lead to larger increases in the final price of imported intermediate goods and low-value-added products, apart from which exports could become less competitive. Moreover, the final prices of products that are highly integrated into global value chains, such as electronics and computers, are also more affected by higher freight rates.

Worldwide, the high rates impacted low-value-added items such as furniture, textiles, clothing, and leather products, the production of which is often fragmented across low-wage economies at a great distance from major consumer markets.  Consumer price increases of 10.2% on these items became common.  Increases also occurred in the prices of rubber and plastic products (+9.4%), pharmaceutical products and electrical equipment (+7.5), motor vehicles (+6.9%), and machinery and equipment (+6.4%).

This sparked a rise in inflation starting in 2021 and accelerating in 2023.  Looking at a select number of countries which have highly open economies reveals how price rises ranged from just 14.2% cumulatively  over four years in Cyprus to 51.7% in Hungary and 34.1% in Slovakia.  Malta had a 15.45% rise.  By the way, this shows how effective was the Maltese Government’s anti-inflation policy, containing the increase to 6.15 p.p. below the EU average.

Increased price levels

In its Review of Maritime Transport for 2021, the United Nations Conference on Trade and Development (UNCTAD) said that the surge in container freight rates, if sustained, could increase global import price levels by 11% and consumer price levels by 1.5% between then and 2023. “The impact is expected to be more significant for smaller economies that depend heavily on imported goods for much of their consumption needs,” it said.

Nicholas Sly, an economist with the Kansas City Fed, has done research that found that, in the past, a 15% increase in shipping costs led to a 0.10 percentage point increase in core inflation after one year. Shipping rates, he said, currently are a persistent — rather than temporary or transitory — challenge.

What’s more, tight container capacity and port congestion mean that longer-term rates set in contracts between carriers and shippers are running an estimated 200% higher than a year ago, signaling elevated prices for the foreseeable future.

Large customers of sea-borne cargo like Walmart Inc. or Ikea have the clout to negotiate better terms in those deals or absorb the added expense. Smaller importers and exporters — especially those in smaller countries — that rely on carriers to haul everything from electronics and apparel to grains and chemicals, can’t easily pass those costs along or weather long periods of stretched cash flows.

The situation is throwing a spotlight on the market concentration of shipping lines, and their legal immunity from antitrust laws.  The latest salvo was that of the British International Freight Association, which called on the UK government to investigate “distorted market conditions” within the global container-shipping market. The British freight lobby pointed to the fact that just 10 container lines based in Asia and Europe control nearly 85% of the capacity for shipping goods by sea. Twenty-five years ago, the top 20 companies controlled about half of the global capacity.

On the other hand, one also has to keep in mind that the operators in this capital-intensive business have been losing money for many years.  They believe there is nothing wrong in ocean-freight carriers pulling in estimated profits of $150 billion in 2021 — a nine-fold annual jump after a decade of difficulty eking out any gains.  A return to pre-pandemic shipping rates will require greater investment in infrastructure, digitalization in the freight industry, and implementation of trade facilitation measures.

At a time when it appeared that the European Central Bank was at last defeating inflation, the latest shipping problems are making policymakers nervous.  The shipping snarl-up is not yet on the same scale as last time. Although the FBX is rising, it is only at a quarter of the peak reached in 2022. In September 2021 respondents to a survey of purchasing managers conducted by S&P Global Ratings, a data provider, were 17 times more likely than the long-run average to say that shipping costs were contributing to higher prices. In the latest survey they were only three times more likely.

A repeat of pandemic-era inflation is unlikely but renewed increases in global shipping costs may actually add to consumer price inflation over the next several months, should these increases ultimately pass through into higher final goods prices. “Such an outcome would reinforce our expectation for progress on reducing global core CPI inflation to stall this year.

Consumer prices change slowly and it would take months for them to respond to rising transportation costs if at all, says Chris Rogers, head of supply chain research at S&P Global Market Intelligence.  Freight rates remain far below pandemic peak in September 2021.

In most cases, transportation costs on average represent about 4% to 5% of the price of a good, according to Mark Hopkins, senior director of economic research for Moody’s Analytics.  “Even if you double the transportation costs, we’re not talking about something that for some of these goods is going to be really noticeable,” says Hopkins. 

However, this could dash market expectations that the ECB will start slashing interest rates in March.  Forecasters had been expecting the rate on the ECB’s main refinancing operations (MROs) to remain at 4.5% in the first quarter of 2024 before easing from the second quarter of 2024, reaching 3.75% by the fourth quarter of 2024 and falling further to 3.0% in 2025 and 2.75% in 2026.  Time will tell whether these expectations materialise.

Malta highly disadvantaged

As always, Malta is highly disadvantaged position in relation to other Mediterranean islands such as Sicily, Sardinia, Corsica, and Crete.  Express Trailers – the country’s largest logistics firm – has noted that “international road transport to Malta is not a subsidised service and does not qualify for EU or local funds”, unlike other islands which benefit from EU regional funds.

It is easy to blame the inflation in the price of almost everything on dominant trading and anti-competitive behaviour, but such accusations should be underpinned by evidence.  Subsequent to the disgraceful complete capitulation of the Maltese Competition and Consumer Affairs Authority (MCCAA), the European Commission’s impending investigation will throw light on the matter.

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