The maritime economy is enormously complex, so the first task is to simplify the model by singling out those factors that are most important. This is not to suggest that detail should be ignored, but rather to accept that too much detail can hinder a clear analysis. In the initial stages at least we must generalize. From the many influences on the shipping market we can select ten as being particularly important,five affecting the demand for sea transport and five affecting the supply. These are summarized below.As far as the demand for sea transport is concerned (the ‘demand function’), the five variables are the world economy, seaborne commodity trades, average haul,political events and transport costs. To explain the supply of shipping services (the‘supply function’), we have identified the world fleet, fleet productivity, ship building deliveries, scrapping and the freight rates. This model has three components, demand (module a), supply (module b) and the freight market (module c) which links the two by regulating the cashflow from one sector to another.
Demand Supply
1. World Economy 1. World Fleet
2. Seaborne Commodity Trade 2. Fleet Productivity
3. Average Haul 3. Shipbuilding Production
4. Political Event 4. Scrapping and losses
5. Transport Cost 5. Freight rates
The mechanics are very simple. On the demand side, the world economy, through the activity of various industries, generates the goods which require sea transport. Developments in particular industrial sectors may modify the general growth trend (e.g. a change in the oil price, which influences oil demand), as may changes in the distance over which the cargo is transported,giving a final demand for shipping services measured in ton miles. The use of ton miles as a measure of demand is technically more correct than simply using the deadweight of cargo ships required, since it avoids making a judgement about the efficiency with which ships are used. That belongs more properly to the supply side of the model.On the supply side, in the short term, the merchant fleet represents the fixed stock of shipping capacity. At a point in time only part of this fleet may be trading.Some ships may be laid up, or used for storage. The fleet can be expanded by new building and reduced by scrapping. The amount of transport this fleet provides also depends on the efficiency with which ships are operated, in particular speedand waiting time. For example a fleet of tankers steaming at 11knots and returning from each cargo voyage in ballast carries less cargo in a year than the same size fleet of bulk carriers steaming at 14 knots and carrying a backhaul for all or part of its journey. This efficiency variable is generally referred to as fleet productivity and is expressed in ton miles per dwt per annum. Finally, the policiesof shippers, banks and regulators all have an impact on how the supply side of the market develops.
Dynamic links in the model
The fulcrum pointer represents the balance of supply and demand. Any imbalance feeds through into the third part of the model, the freight market, which links supply and demand. In effect the freight rate mechanism is the ‘switch box’ which controls the amount of money paid by shippers to shipowners for the transport they supply. When ships are in short supply,freight rates are bid up and cash flows into the bank accounts of ship owners.Eventually the increased cash flow starts to affect the behaviour of both the shippers and shipowners. This is the behavioural part of the model. The shipowners will probably start ordering new ships, while the shippers look for ways to cut their transport costs by delaying cargoes, switching to closer suppliers or using bigger ships. When there are too many ships, rates are bid down and shipowners have to draw on reserves to pay fixed costs such as repairs and interest on loans. As reserves diminish some owners are forced to sell ships to raise cash. Prices of ships fall to a level where shipbreakers offer the best price for the older ships, reducing supply.Changes in freight rates may also trigger a change in the performance of the fleet,through adjustments to speed and layup. This link between market balance and freight rates is one of the most important economic relationships in the model and it is controlled by shipowners who decide how to respond. Because of this behaviourial element mathematical models can never be totally relied upon to simulate the freight market.This model gives shipping market cycles their characteristic pattern of irregular peaks and troughs. Demand is volatile, quick to change and unpredictable; supply is ponderous and slow to change; and the freight mechanism amplifies even small in balances at the margin. Thus the ‘tortoise’ of supply chases the ‘hare’ of demand across the freight chart, but hardly ever catches him. In a market with these dynamic we must expect ‘balance’, in the sense of steady earnings over several years, to be quite rare. Such periods have been few and far between during the last century.This is the market model which controls shipping investment. We will examine the three sections of the model. In principle, supply will follow demand if decision-makers are successful in judging what the future level of demand will be and take the necessary actions to adjust the available supply.
The demand for sea transport
We have suggested that ship demand, measured in ton miles of cargo, is mercurial and quick to change, sometimes by as much as 10–20 per cent in a year. Ship demand is also subject to longer-term changes of trend. Looking back over the last two or three decades, there have been occasions when ship demand has grown rapidly over a sustained period, as happened in the 1960s, and others when ship demand stagnated and declined—notably, for example, the decade following the1973 oil crisis.
The world economy
Undoubtedly, the most important single influence on ship demand is the world economy. It came up repeatedly in our discussion of shipping cycles. Fifty years ago, in his review of the tramp market, Isserlis commented on the similar timing of fluctuations in freight rates and cycles in the world economy.
That there should be a close relationship is only to be expected, since the world economy generates most of the demand for sea transport, through either the import of raw materials for manufacturing industry, or the trade in manufactured products.It follows that judging trends in the shipping market requires up-to-date knowledge of developments in the world economy. The relationship between sea trade and world industry is not, however, simple or direct. There are three different aspects of the world economy that may bring about change in the demand for sea transport, the business cycle, the ‘trade elasticity’ and the trade development cycle.The business cycle lays the foundation for freight cycles. Fluctuations in the rate of economic growth work through into seaborne trade, creating a cyclical pattern of demand for ships. The recent history of these trade cycles is evident which shows the close relationship between the growth rate of sea trade and industrial production over the thirty years 1963–95. Invariably the cycles in the OECD economy were mirrored by cycles in sea trade. Note in particular the two deep recessions in sea trade in 1975 and 1981–83 which coincided with recessions in the world economy. Since world industrial production creates most of the demand for commodities traded by sea, this is hardly surprising. Clearly the business cycle is of major importance to anyone analysing the demand side of the shipping market model.Nowadays most economists accept that these economic cycles arise from a combination of external and internal factors. The external factors include events such as wars or sudden changes in commodity prices such as crude oil, which cause a sudden change in demand. Internal factors refer to the dynamic structure of the world economy itself, which, it is argued, leads naturally to a cyclical rather than a linear growth path. Five of the more commonly quoted causes of businesscycles are:
- The multiplier and accelerator. The main internal mechanism which creates cycles is the interplay between consumption and investment. Income (GNP)may be spent on investment goods or consumption goods. An increase in investment (e.g. road building) creates new consumer demand from the workers hired. They spend their wages, creating even more demand (the investment multiplier). As the extra consumer expenditure trickles through the economy,growth picks up (the income accelerator), generating demand for even more investment goods. Eventually labour and capital become fully utilized and the economy over-heats. Expansion is sharply halted, throwing the whole process into reverse. Investment orders fall off, jobs are lost and the multiplier and accelerator go into reverse. This creates a basic instability in the economic‘machine’
- Time-lags. The delays between economic decisions and their implementation can make cyclical fluctuations more extreme. The shipping market provides an excellent example. During a shipping market boom, shipowners order ships that are not delivered until the market has gone into recession, when the arrival of the new ships at a time when there is already a surplus further discourages new ordering just at the time when shipbuilders are running out of work. The result of these time-lags is to make booms and recessions more extreme and cyclical.
- Stock building has the opposite short-term effect. It produces sudden bursts of demand as industries adjust their stocks during the business cycle. The typical stock cycle, if such a thing exists, goes something like this. During recessions financially hard pressed manufacturers run down stocks, intensifying the downturn in demand for sea transport. When the economy recovers, there is a sudden rush to rebuild stocks, leading to a sudden burst of demand which takes the shipping industry by surprise. Fear of supply shortages or rising commodity prices during the recovery may encourage high stock levels,reinforcing the process. On several occasions shipping booms have been driven by short-term stockbuilding by industry in anticipation of future shortages or price rises. Examples are the Korean War in 1952–3, the dry cargo boom of 1974–5, and the mini tanker booms in 1979 and summer 1986, both of which were caused by temporary stockbuilding by the world oil industry.
- Some economists argue that cycles are intensified by mass psychology. Professor Pigou put forward the theory of ‘non-compensated errors. If people act independently, their errors cancel out, but if they act in an imitative manner a particular trend will build up to a level where they can affect the whole economic system. Thus periods of optimism or pessimism become self-fulfilling through the medium of stock exchanges, financial booms and the behaviour of investors.
- Random shocks which upset the stability of the economic system may contribute to the cyclical process. Weather changes, wars, new resources, commodity price changes, are all candidates. These differ from cycles because they areunique, often precipitated by some particular event, and their impact on theshipping market is often very severe. One of the most prominent examples was the 1930s depression, which followed the Wall Street crash of 1929. More recently examples, the effects of two oil price shocks which happened in 1973 and 1979. On both occasions,industrial output and seaborne trade suddenly declined, setting off a shipping depression. Some economists think the whole cyclical process can be explained by a stream of random shocks which make the economy oscillate at its ‘resonant frequency’.To help in predicting business cycles, statisticians have developed ‘leading indicators’ which provide advance warning of turning points in the economy. For example, the OECD publishes an index based on orders, stocks, the amount of overtime worked and the number of workers laid off, in addition to financial statistics such as money supply, company profits and stock market prices. It is suggested that the turning point in the lead index will anticipate a similar turning point in the industrial production index by about six months. To the analyst of short-term market trends such information is useful, though few believe that business cycles are reliably predictable. Two quotations serve to illustrate the point:No two business cycles are quite the same; yet they have much in common.They are not identical twins, but they are recognisable as belonging to the same family. No exact formula, such as might apply to the motions of the moon or of a simple pendulum, can be used to predict the timing of future (or past) business cycles. Rather, in their rough appearance and irregularities, they more closely resemble the fluctuations of disease epidemics, the vagaries of the weather, orvariations in a child’s temperature.
A remark that can perhaps be made about industrial cycles in general is certainly applicable to the shipping industry:
- It is certain that these cycles exist;
- Their periodicity—the interval from peak to peak—is variable; and their amplitude is variable;The position of the peak or of the trough of a cycle in progress is not predictable.An ad hoc explanation can usually be found for each period of prosperity and for each phase of the cycle if sufficient knowledge is available of the conditions at the time .. but it is impossible to predict the occurrence of the successive phases of a cycle which is in progress, and still more so in the case of a cycle which has not yet commenced.
In conclusion, the ‘business cycle’ in world industry is the most important cause of short term fluctuations in seaborne trade and ship demand. However business cycles,like the shipping cycles to which they contribute, do not follow in an orderly progression. We must take many other factors into account before drawing such a conclusion.
The trade elasticity of the world economy
We now turn to the long-term relationship between seaborne trade and the world economy. Over a period of years does sea trade grow faster, slower, or at the samerate as industrial output? Economists use the concept of ‘elasticity’ to describe this relationship. The trade elasticity is the percentage growth of sea trade divided by the percentage growth in industrial production. For most of the last 30 years the trade elasticity has been positive, averaging 1.4. In other words, sea trade grew 40 per cent faster than world industry. However, if we study the year-by-year pattern, we detect a change, starting in about 1975. Until the early 1970s, the elasticity was fairly steady at about 1.6, but during the next period 1976–90 the average fell to 1.4, and in the early 1990s it became highly volatile.
It is important to be aware that such changes are possible. There are two reasons why, over long periods, the trade elasticity of individual regions will probably change. The first is that balance of demand to available local resources of food and raw materials is likely to change over time. This happens when domestic raw materials are depleted, forcing users to turn to foreign suppliers—for example iron ore for the European steel industry during the 1960s and crude oil for the USA market during the 1970s and 1980s. Or the cause may be the superior quality of foreign supplies, and the availability of cheap sea transport. Secondly, industrial development brings changes in demand for bulk commodities such as iron ore,which make up a large part of seaborne trade. As industrial economies mature,economic activity tends to become less resource intensive, and the emphasis switches from construction and stockbuilding of durables such as motor cars to services such as medical care and recreation, with the result that there is a lower requirement for imported raw materials. This contributed to the slower import growth of Europe and Japan during the 1970s and 1980s.
Another reason is that the mix of countries generating industrial growth may change—new countries emerge or others decline in importance. For example, the industrial growth of Japan in the 1960s had an impact upon sea trade that greatly exceeded its importance as an industrial nation Japanese imports generated 54 percent of the growth of the world deep sea seaborne dry cargo trade between 1965and 1972. An even more extreme pattern was seen in the early 1990s, as South Korea and other Asian countries moved along the industrial path, producing the very high trade elasticities. This accounts for the very high trade elasticity in 1991–3. As the world economy grows and develops, the value of the trade elasticity will change.
