Sink or swim?

A great sink or swim in last week’s Economist gives a whole load of examples relating to the container shipping industry that can be used to support lots of areas of AS micro theory. As the global recession’s bite sinks deeper, the shipping industry is facing significant worries.

Just over 10% of the world’s container ships are currently anchored off the coasts of South-East Asian countries - falling demand for exports has had a knock-on effect on the shipping industry, reducing demand for ships. This is a large about-turn for the industry; according to the Economist, in 2003 the daily rate for chartering ships was a mere $15 000 (!) yet by summer 2008 this figure peaked at $300 000, with the price for actually purchasing a ship rising from $18.5m to $85m over the same period. Not surprisingly, just as economic theory would predict, new shipyards sprung up, encouraged by the rising profitability.

However, the sudden crash in the world economy has left many shipbuilders, and their customers, high and dry. Supply of container ships is highly price inelastic - they take a long time to build. So, many shipbuilders, having learned from previous recessions, demand much of the payment for the ships at the time of ordering rather than on delivery. So, huge numbers of ships were ordered and paid for last year (at exorbitantly high prices), but now their buyers don’t need them yet have already paid more than the ship that will be delivered to them will be worth - a bit like negative equity.

As the article points out, in a competitive market, the fall in price due to the fall in demand should trigger a contraction in the supply of ships. However, due to the nature of supply, shipbuilders are likely to finish production of the ships that they have already started because there is nothing that they can do with a half-built ship, and at some point, demand for ships will pick up once demand for exports starts to rise again. When this will happen, however, is difficult to predict, since many economies appear to be turning more towards protectionism.