MODULE 2

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Humber College *

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SCM 3515

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Economics

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Feb 20, 2024

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Transportation for this module we will be discussing the correlation between trade and transportation. Specifically, we will look at the role of transportation in the. Growth of trade. And how trade agreements near shoring onshoring and offshoring affect economies and transportation modes? Now let's get started. You will be able to explain a ) the role that transportation plays in the facilitation of trade. B) Describe how trade agreements can affect Canada's economy and its transportation systems. C ) Explain the concept of law of 1 price. D) Describe the concepts of near shoring, onshoring and offshoring, as well as their advantages and disadvantages and how they affect the transportation industry in the overall supply chain. E) Explain how investing in transportation infrastructure will further facilitate trade between regions. F) Describe how both nearshoring and free trade agreements can result in improvements of transportation systems Transcript Why Do we trade? The answer to this question seems obvious, but still requires discussion. If all countries were completely self-sufficient, including resources, land, labour, capital and entrepreneurial ability, would countries still trade with each other? Arguably yes. Countries would still trade with each other. To increase the economic wealth of their citizens and to achieve economic growth. But the reality is that very few countries, if any, are completely self-sufficient countries trade to achieve economic growth, a measure of a country's success by selling surplus goods and services and using the abundant resources available to them. In order to. Achieve wealth from trade. There are three assumptions that must be realized. One gains from division of Labour 2 all regions and countries operate according to their comparative trade advantages and three, trade is free from government intervention. Let's talk more about each of these assumptions. DIVISION OF LABOR – The easiest way to describe the division of labour is to use an assembly line as an example. Although today's modern assembly lines are transforming into automated processes using robots, we still have assembly lines that use people to produce complex products. The principle of assembly lines is that everyone has a specific task. And they become very effective at that one task. Each person has a unique set of skills to perform the task assigned to them, rather than one person being boarding average yet performing all tasks. If we look specifically at an automotive assembly, we have one person who is effective at welding another person that is effective at seat, upholstery, upholstery, and another person that is an expert mechanic. Each person learns their specific task and performs it multiple times daily and becomes extremely productive. At their task. Alternatively, we could have one person Weld so and produce engines, however. They would prefer less. It's because they would be average at each task division of labour permits everyone to do what they do best and increase productivity. If we look at this on a global scale and each country does what they do best, each country will achieve economic growth as they produce for other countries, in addition to their own. This requires a system of trade in goods and services, which can be further explained by comparative trade advantage

COMPARATIVE TRADE ADVANTAGE Comparative trade advantage demonstrates that countries can experience gains from trade once each country specializes in the goods and services that they are most efficient at producing when compared to other countries. Say that both Canada and China produce their own wooden night stands. In Canada, it requires $12.00 of labour to produce one night stand, while in China it only requires $4.00 of labour to produce one night stand. This is due to Canada's higher labour costs versus chinas's, the lumber used to produce each night stand costs $4.00 in Canada and $8 in China. This is due to the abundance of labour in Canada versus China, who in this example must import lumber to produce the night stands. The total input costs are slightly higher in Canada than China because of the significant difference in labour costs and the obvious conclusion is that China should produce the night stands. Despite having to import lumber potentially from Canada, this is where a comparative treated event stage can be applied and will be demonstrated in the next example. Let's first consider the units of lumber and night stands produced. If Canada and China produced their own lumber and night stands domestically. Canada would be able to produce 10 million units of lumber and 4 million units of night stands. China would be able to produce 5 million units of lumber and 8 million units of night stands. This represents total production of both products of 27,000,000 units. If, on the other hand, Canada and China operated according to their comparative trade advantage, where Canada only produced what they were most efficient at plumber. And they produced 20 million units and China only produced what they were most efficient at night stands, and they produced 15,000,000 units. Then total production would increase to 35 million units. By operating according to their each countries comparative trade advantage and increasing total production, there is an opportunity to trade amongst the two countries. Canada benefits by exporting lumber to China and lower prices on imported night stands and China benefits by exporting night stands to Canada. And lower domestic prices due to production efficiencies. Lower prices on traded products

are also dependent on the next gains from trade argument assumption. Trade is free from government intervention. The 3rd and final assumption for gains from trade argument is that trade is free from government intervention for the purpose of this discussion, there are two main types of government intervention. First, our tariffs. Tariffs are taxes charged on imports and are used to protect domestic producers of goods and services and to earn tax revenue by taxing imports not only are imported goods more expensive, but domestic prices will naturally be higher because domestic prices will be. Increased to be just slightly lower than imported goods. The second type of government intervention is quotas. Quotas restrict the volume of imports and, like tariffs, are used to protect domestic producers. Quarters reduce the number of goods imported, which result in an imbalance between supply and demand, with supply being less than demand, prices will increase both tariffs and quotas result in higher prices of both domestic and imported goods. The result is reduced consumption. And less trade. This is why trade being free from government intervention is essential for gains from trade argument. Once a country realizes and takes advantage of gains from trade, we must consider the effects on transportation modes and transportation systems. But first, we will discuss the concept of law of 1 price.

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The law of 1 Price is a concept that explores the relationship between trade, transportation and handling costs, and how interregional markets will always reach an equilibrium where the only difference in price between two regions is the transfer costs. In this example. We have two regions, region A who is a low cost producer of computer monitors with an excess supply of 10,000 monitors and region B who is a high cost producer of computer monitors with excess demand of 10,000 monitors in region a monitors sell for $150.00 because of production. Efficiencies and excess supply in region B monitors sell for $200 because of the high cost of production and excess demand. If transfer costs were $10, any entrepreneur would recognize the opportunity to purchase the monitors from region A and sell them in region B for an additional profit of $40. This is the $200 less the purchase price of $150.00 and transfer costs of $10. This is called arbitrage, where you purchase an item at a lower price in one region and sell it for a higher price in another region. Arbitrage only occurs in the short term because of the concept of law of 1 price. Overtime, the price in region a increases as the excess supply is reduced and at the same time the price and region B decreases as the excess demand is reduced by the excess supply from region a region a prices increase and region B prices decrease until we reach the. Equilibrium point where the only difference in price between region A&B is the cost of transportation and handling and foreign exchange. This is known as the law of 1 price trade between two regions is based on the law of 1 price where the prices in all markets are connected through transportation. Costs and This is why, as the interregional trade model explains, transportation is considered a facilitator of trade.

This interregional trade model based on the law of 1 Price explains that transportation is a facilitator of trade rather than a factor of production. The law of 1 Price assumes a fixed transportation cost regardless of changes in volume of trade. This may be the case for marginal change. It changes in trade, however, as trade increases or decreases significantly, transportation rates will eventually change and affect demand. For example, as transportation demand increases due to increased trade, transportation rates will rise in the short to medium term. Alternatively, as transportation efficiencies are realized due to the increased volumes and new carriers enter the market to take advantage of the increased demand and higher rates, transportation supply will increase and transportation rates will then decrease. However, what we must recognize is that significant increases in transportation. It can make trade costs prohibitive. Alternatively, significant decreases in transportation rates can make trade economically feasible and opportunistic. This is why we can conclude that transportation is a facilitator of trade.

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Williams and Canada's ability to compete on a global scale now that we have established that transportation is a facilitator of trade and can affect trade volumes, we can now discuss the other factors that affect trade volumes in Canada's ability to compete on a global scale. The first factor that affects trade volumes is efficient production. Trade agreements and efficient transportation alone are not going to help Canada become internationally competitive. Canada's manufacturing industry must create production efficiencies to be price competitive while producing quality products to realize a comparative trade advantage. Canada cannot compete with low cost manufacturing countries. Such as China And instead need to take advantage of innovation and skilled labour. The second factor is if an efficient transportation infrastructure. Infrastructures are used in international trade and therefore have to be efficient to enable Canada to be competitive. We can produce the best products and services, but if we are unable to ship them worldwide, efficiently and cost effectively, Canadian companies will be less competitive and will lose sales to more competitive. This means that the Canadian government has to invest in road infrastructure such as highways, bridges, city bypasses and industrial centres. In addition, Canada's two largest rail companies, CN and CP, who own 75% of Canada rail infrastructure, need to continuously invest in improving efficiencies. To help Canadian companies compete on an international scale, the same can be said for air cargo. As e- commerce continues to grow, so does the trade volumes moved by air. Investments need to be made in airports to reduce bottlenecks and help reduce high cargo rates as volumes increase. So too does

inefficiencies. However, without investment in airports and infrastructure in and out of the airports, those efficiencies will be eliminated. Next is efficient ports. As most of international trade has moved through Canada's ports, it is essential to invest in efficient ports to reduce bottlenecks and make the transitions from ocean to road or rail as seamless as possible. This is particularly important with the introduction of mega ships. Canada's ports are competing for international trade volumes with larger US. Ports such as New York and Los Angeles, investment in Canada's ports to handle mega ships is a requirement if we want to compete globally. We also want to make sure we have streamlined border crossing processes. The border crossing with the United States needs to be continuously monitored and evaluated to develop efficiencies. To reduce bottlenecks at the border. This will increase Canada's competitiveness with U.S. companies and help increase exports to the United States. Efficiencies include pre approval programs and digitization of border documents. Some examples include customs trade, partnership against terrorism, free and secure trade. Two, the two combined allowed registered and certified drivers and carriers expedited clearance. Next, we want to make sure we have available resources in order to compete on a global scale. Canada needs the factors of productions such as natural resources, land, raw materials, skilled labour and entrepreneurial abilities. And finally, for Canadas to compete on a global scale, we need trade agreements. Canada needs to strategic trade agreements to be competitive and to increase exports worldwide. Let's talk more about trade agreements.

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Economic development and the measure of pride agreements increased trade volumes through exports and imports, first and foremost, increased trade volumes promote economic development and the measure of. A country's success. Increased trade volumes also helped create jobs and increased tax collection. Tax collection includes corporate income tax, municipal tax, personal income tax and sales tax. With the increased tax collection, all levels of government are then able to invest in infrastructure and public services such as public transit, which, as mentioned previously, helps Canadian companies competitiveness. The increased trade volumes combined with investment in infrastructure through tax collection also creates efficiencies in production and transportation. Essentially higher volumes lead to optimization of production and shipment of goods. And finally, trade agreements provide lower prices for imported goods, lower prices for imported goods is not only good for consumers. But it also forces domestic producers. To be more competitive and improve process automation, automation and reduction of waste, further contributing to Canada's competitiveness on a global scale. Canada currently has 15 trade agreements in force and another 17 trade agreements in various stages of negotiation. Canada's most significant trade agreements are the United States, Mexico, Canada agreement, representing an approximate value of traded goods of $450 billion in 2019. And the Canada EU Comprehensive Economic and trade agreement, representing approximately $50 billion in traded goods in 2019. Here is a visual overview of the countries which currently have trade agreements in force with Canada. The map highlights the concentration of trade agreements within North America and South America and Europe. The map also highlights the abundance of opportunities available to Canada in other parts of the world. Trade agreements can affect the efficiency of transportation. This is particularly important because, as we have concluded earlier, transportation is a facilitator of trade and to facilitate the growth of trade, transportation must continuously. Improve efficiencies. Firstly, the increased

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volumes of trade derived from trade agreements helped to lower per trip costs by increasing the number of loads. As fixed cost remain the same, carriers achieve economies of scale and thereby lower the cost per load. Secondly, as carriers expand their fleets to meet the demand from increased trade volumes, the increased profits are then reinvested into projects such as transportation management, software and equipment. Further increasing efficiencies and profits. Thirdly, as carriers expand their fleets, their negotiating power with vendors increases, lowers costs, increases profits and investments and increases efficiencies. Finally, trade agreements have a significant influence on government investment in infrastructure. With the signing. Of trading minutes by the Canadian government comes the requirement to invest in infrastructure to help facilitate the increased trade. Let's talk more about that now. Infrastructure investments by governments help increase trade by reducing transportation costs and making Canadian companies more competitive in order to improve the Canadian transportation infrastructure and help facilitate trade, the Canadian government has implemented the Transportation 2030 Strategic plan. Transportation 2030 strategic plan is a trade and transportation corridor initiative that involves a $10.1 billion investment over the next decade. Some of the specific objectives of the plan include supporting the flow of goods and passengers by reducing bottlenecks and addressing capacity issues at marine ports. And the busiest rail and Hwy. corridors. Establishing standards and certifications for the safe use of technologies such as autonomous vehicles. Strengthening transportation, coordination and planning. Improving trade and transportation information systems to fill significant

information, data and analytical gaps within the transportation systems. For example, border crossings. Defying transportation investment needs for future development. Rail infrastructure is an integral part of Canada's transportation infrastructure and international trade. Real infrastructure is unique in that it is almost entirely owned by CN and CP. The government's investment in Rd. Ocean and air infrastructure is motivated by economic growth and maintaining Canada's competitiveness. The question then becomes, what is CN and CP's motivation for investing in their infrastructure? CNCP have invested approximately $1.8 billion annually in rail infrastructure over the last decade. Arguably, these investments have increased efficiencies for Canada's importers and exporters and have helped increase trade with other countries, particularly with the growth of intermodal. Transportation this private investment in infrastructure has increased efficiencies and lower transportation costs, which helps facilitate trade. From CN and CP's perspective, the significant investment in infrastructure increases rails competitiveness with Rd. by increasing efficiencies by reducing bottlenecks, digitizing documentation and using technology to automate processes. While CN and C's motivation to invest in infrastructure would be considered profit centred, the benefits of rail

efficiencies are realized by all Canadian companies through lower costs and increased competitiveness. Up to this point, we have discussed the effects of increased international trade and its relationship with transportation. We would be remiss if we did not discuss the rules of offshoring, nearshoring and onshoring as they relate to trade and transportation. Offshoring is the sourcing of manufacturing in low cost emerging countries such as China. Near shoring is the sourcing of manufacturing in low cost countries located closer to domestic soil, such as Mexico. Finally, Onshoring is manufacturing domestically. Recently, we have seen a slight shift from offshoring to near shoring and onshoring. The reasons for the shift are many. But here are some offshoring issues as they pertain to the offshore manufacturing leader China.

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Due to the increased demand for offshore manufacturing in China over the last 30 years, the labour costs have been increasing annually to the point where China is losing some of its low cost labour advantage. Rising fuel costs have also played a part in the shift from offshore manufacturing. Due to the length of the trips and significant amount of fuel required for each trip. There have also been many examples of proprietary theft by Chinese manufacturers contracted to produce technology driven products, which has driven some companies to source alternative manufacturing locations as supply chains strive towards lean logistics and reject reduction of waste, the high cost of inventory. Required for sourcing manufactured products offshore have forced companies to shift their attention to near shoring and onshoring, where shorter lead times result in lower safety stock. Finally, thanks to Amazon and changing consumer preferences, expected lead times have become significantly shorter. Customer satisfaction has

influenced. The shift from offshore manufacturing to accommodate these shorter lead times. In addition to the factors discussed about the issues with offshoring, the benefits of near shoring also contribute to the shift from offshoring. The first benefit is forecast flexibility. Manufacturing in Mexico for products destined for US and Canada provides forecast flexibility due to the shorter order cycle times. Instead of an order cycle time of 60 to 90 days with offshoring, nearshoring provides a much shorter cycle time and the ability to adjust forecasts on a much more frequent basis to manage changing consumer preferences more effectively. Near shoring also helps to improve customer service through shorter lead times. Last minute order changes and more effective post transaction services. The shorter order. Cycle also provides companies with the ability to adapt to changing consumer demand quicker. It takes less time to bring a product to market, change product lines, modify existing products and anticipate trends, and this provides adaptability for US and Canadian companies. Finally, availability of labour. In the example of Nearshoring in Mexico, the availability of a young and educated workforce in Mexico provides US and Canadian companies with skilled labour capable of producing highly engineered quality products. At a low cost.

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Onshore manufacturing, also known as domestic manufacturing, shares the same benefits mentioned for NEARSHORING. Onshoring realizes further benefits, such as improved quality, improved communication, and improved domestic economy. Quality is insured and closely monitored compared to offshore manufacturing, communication is improved between manufacturing, sales, finance vendors and customers due to more efficient communication channels and proximity. And finally, the domestic economy is improved by providing jobs to citizens and increasing disposable income and further spending. Despite these benefits, there are certain disadvantages of onshore manufacturing. First, it decreases international trade and specialization of labour. It also decreases. Transportation demand and all associated logistics. But it decreasing international trade, it affects the number of jobs. For example in

2013. There were 40. Million jobs in the US associated with international trade. OK. With the shift from offshoring to near shoring and onshoring, it is important to discuss what the impact is on the different modes of transportation and warehousing. When we see a shift to near shoring and onshoring, the most obvious effect on transportation is reduced. Demand for ocean shipping. Road and rail would be less affected as these modes would still be used for near shoring and onshoring, the only difference being that the direction of transportation flow will shift from East West to north-south, with near shoring in Mexico, Onshoring may see an increase in demand for Rd. as shorter, more frequent trips will be a characteristic. Of domestic production. If onshore manufacturing is centralized in one area of the United States, say New York, for example, then rail demand would increase to accommodate shipments to southern and Western states. Air may see an increase in demand due to the shorter distance and lower cost when using air cargo from Mexico to satisfy consumer preferences for faster delivery. Overall, near shoring and onshoring should result in reduced storage costs as lower safety stock levels are required due to the shorter lead times. All of that being said, we must consider the fact that there are a multitude of scenarios that can occur when shifting from offshoring to near shoring and onshoring and careful analysis is required to forecast the actual supply and demand effects of each mode. The point of this discussion is to provide you with

tools and knowledge to know what to analyze and how it affects the relationship between trade and transportation. As discussed in the previous section, transportation and trade will always be correlative. As trade increases, there will always be a correlating growth in transportation. However, trade is only feasible if the transportation costs are less than the difference in price between regions. For this reason, efficient transportation plays an integral role in trade between regions. Transportation’s Role in Trade In order for international trade to exist, regions must have the following qualities: 1. Gains from division of labour 2. All regions operate according to their comparative advantage and 3. Trade is free from government intervention. Without these attributes, regions would have no incentive to import or export with other regions and would simply strive to become self-sufficient. Globalization has proven that regions do exhibit these characteristics and supply chains continue to grow across the globe. With the continuous improvement in transportation systems and the existence of these characteristics, regions are able to sell their excess supply and contribute to the domestic economy.

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The first quality requires each region to specialize in a certain skill that other regions lack. Otherwise regions would have to be self-sufficient. For example, some regions specialize in manufacturing and have access to a skilled labour pool. Other regions may specialize in resource based activities due to the availability of such resources. To demonstrate, consider a manufacturing plant employed to build cars. Within that plant there are skilled workers that are trained to perform specific tasks. This includes welders, assembly line workers, upholsterers and tool operators. Each department has specialized skills however the departments are reliant on each other to produce the finished product. Today ’ s industrialized world is dependent on different regions ’ specialization. Comparative advantage means that one region can produce the same product more efficiently than another region. For example, China or Mexico are able to manufacture products at a lower cost than other regions due to their lower wages and long work hours. Once a region identifies an opportunity to increase exports through international trade, the region will focus on their comparative advantage and market their benefits to other regions. Those other regions will recognize the benefits provided by the advantaged region through lower prices and better products for their consumers. In order for trade to be feasible between regi ons, transportation costs must be less than the difference between the two regions ’ production costs. Otherwise, there would be no advantage to purchase from another region. The only situation where a higher cost is feasible is if the product is of a higher quality and can be sold at a higher price. Normally gains from trade are only possible when governments enter into trade agreements and reduce tariffs and quotas. Otherwise, prices will not be competitive due to the high tariffs and quotas implemented by governments to protect the domestic market . As mentioned, transportation costs can also be an impediment to the price of imports. The higher price will eliminate any incentive to conduct trade between regions if consumers are not willing to pay the premium. The reduction of import fees through trade agreements results in the growth of international trade and allows countries to take advantage of another country’s specialized skill set and/or products that would not be available domestically. Interregional Trade Law of One Price (LOOP) is a concept that demonstrates that the difference in prices between markets are all tied to differences in logistics costs. Trade creates a derived demand for transportation and is considered a facilitator or driver for growth in transportation. According to the i nterregional trade model , transportation is a facilitator of trade rather than an input factor. Trade between regions is made possible by differences in production processes and costs. If region A can produce a product cheaper then region B, exporting the product to region B is feasible assuming

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the transportation costs, warehousing costs and handling costs fall within the difference in prices between regions. In this situation, region A producing a cheaper product has excess supply where the region B has excess demand, resulting in a need for trade between the two regions. All of this assumes that the exchange rate is fixed and trade is free from tariffs and quotas. Effects of Trade on Supply and Demand Why does region A have excess supply? Prices are determined by supply and demand. If prices were higher, consumers would purchase less while producers would want to increase production to take advantage of the higher prices. This causes excess supply. For region B, if prices go down, consumers will purchase more while producers would cut back production due to the lower profits, thereby creating excess demand. In the event that prices decrease in region B due to competition, recession or decreased demand, region A will decrease production until demand exceeds supply. The higher demand increases prices, production will then increase and the equilibrium price in region B will be met. In other words, eventually the quantity of exports supplied will be equivalent to the quantity of imports demanded. The fluctuation of transportation costs (fuel, wages etc) would also affect the level of trade. If transportation costs increase, region A would export less as the prices in region B would increase and demand is decreased. This is why transportation is considered a facilitator of trade. Relationship Between Trade and Transportation With the industrialization of markets all over the world, globalization has become a reality. The globalization of the world’s markets demonstrates that different regions have goods and services to offer at competitive prices and are able to provide these to other regions due to efficient transportation systems and excess supply. Readings:  Concepts of Transportation Economics Chapter 3  Nearshoring Latin America: A Closer Look  The Pros and Cons of Onshoring  Nearshoring Fuels Mexican Manufacturing Growth  Canada’s Gateways - National Policy Framework for Strategic Gateways and Trade Corridors  The Role of Transportation Networks in Moving Canadian Trade

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MODULE 2

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