A closer look at the significant impact of transport costs on Latin American and Caribbean trade.
BY MAURICIO MESQUITA-MOREIRA, CHRISTIAN VOLPE AND JUAN S. BLYDE
Trade barriers were clearly "the elephant in Latin America’s living room" in the late 1980s. At the time, their removal was not only necessary but also inexorable, given the prevailing political climate and limited administrative resources. But one legacy of this liberalization juggernaut was the neglect of other less visible, and therefore politically unattractive, "trade facilitation" issues such as transportation.
If this neglect made sense in the late 1980s, it clearly does not today. Transportation costs have emerged as an issue of unprecedented strategic importance in the region for three reasons:
- The success of the trade reforms in drastically altering the relative importance of policy versus non-policy barriers in a rapidly transforming world economy.
- The growing geographical fragmentation of production and time sensitiveness of trade.
- The rise of huge labor-intensive and resource-scarce markets.
For most Latin American countries transport costs are significantly higher than tariffs. This is true for both import and exports, and especially for intraregional trade. The importance of transport issues is even more overwhelming when we consider the time costs of shipping (i.e. depreciation and inventory costs). (...)
The region spends nearly twice as much as the United States to import its goods, and ...the trends in transportation costs are mixed. While Latin America and the Caribbean (LAC) is closing the gap with the developed countries in ocean freight costs, this gap is growing for the increasingly important airfreight. ...Airfreight expenditures in LAC are sharply higher than other exporters to the U.S., particularly China. In fact, 2006 airfreight costs were well above the 1995 level, by as much as 36 percent in sub regions such as the Caribbean. In contrast, China and the other exporters managed to keep costs below the 1995 mark despite the rise in petroleum prices. Mercosur and Chile have done better than other LAC sub regions, but the exceptional gains of the 1990s were rapidly reversed in the 2000s.
The region’s exports to the U.S. and other key markets are on average more "transport intensive" than those of its competitors. The reason is that the region increasingly relies on two key comparative advantages: abundant natural resources and proximity to the world’s largest markets.
LAC’s transport costs are considerably higher than those of developed economies. Much of the difference is due to the composition of the region’s exports--and to a lesser degree imports--which are considerably "heavier" than those of the United States or Europe. But composition is only part of the story. Once we get out its influence, we see that factors related to infrastructure efficiency actually explain the bulk of the difference between LAC and its developed partners.
Figure 2.4 breaks out the various determinants that account for differences in ocean shipping prices between the Netherlands, whose port facilities rank among the top in the world, and selected LAC countries in their exports to the United States. First, we see that LAC’s exports to the U.S. pay freight rates that average 70 percent higher than those from the Netherlands. The chart then shows that the main factors explaining the differences in the transport costs are weight-to-value ratios and port efficiency, followed by the degree of competition among shipping companies and, to a lesser extent, volumes of trade. Only minor roles can be attributed to differences in the level of containerization and demand elasticity (market’s sensitivity to price changes). Finally, differences in import tariff rates, trade imbalance and distance from markets tend to work in favor of Latin America because, on average, its exports face lower tariffs in the United States, are associated with more favorable trade imbalances, and must travel shorter distances than imports from the Netherlands. We should note that, in line with economic theory, import tariffs should raise freight rates since they reduce the impact of transports costs on the final price of the product, giving shippers a powerful incentive to increase their margins. (...)
The question posed here is how much transport costs would be reduced if countries in the region had the same levels of port efficiency, tariff rates and shipping competition as the United States. The answer is that, for the typical Latin American country, improving port efficiency to the U.S. level would lower costs about 20 percent. Reducing tariff rates and increasing competition to the U.S. levels would further reduce transport costs by 9 and 4 percent, respectively
Airfreight rates display even higher disparities between LAC and the Unite States, although determinants remain similar. In Table 2.5, the first row shows that airfreight rates for LAC’S imports are more than twice those of the United
States. The other rows show the relative impacts of each factor. Setting aside the contribution of the weight-to-value ratio, a large part of the difference in the shipping prices is once again explained by infrastructure efficiency. The lesser efficiency of LAC airports compared with those in the United States explains around 40 percent of the difference in shipping charges. The role of import tariffs is also important. Higher tariffs in LAC account for on average about 17 percent of the differences in shipping costs
This body of evidence suggests a number of conclusions. First, the prominent role played by weight in explaining LAC’s higher shipping costs means that the region is destined to pay more for transportation (on an ad valorem basis), whatever the quality of its infrastructure. This reinforces the point made earlier about transport intensity: Export composition plays a strategic role in LAC’s transport costs.
But distance generally plays only a minor role, making it even more urgent to improve the region’s logistic chains. If distance does not matter that much, competitors can easily overcome the advantage of LAC’s proximity to large markets if the region’s transport infrastructure falls short. How exactly should the government tackle this infrastructure gap?
This question takes us to third insight. As far as we can see — and we do not have the whole picture because we didn’t look at transport costs within countries… — the region can reap the highest returns by improving the efficiency of its ports and airports. In fact, a full 40 percent of the differences in shipping costs between LAC and the United States and Europe are due to differences in port and airport efficiency.
Another important step would be to increase competition among shipping companies, although the potential for gains here would appear much more modest than that related to infrastructure efficiency. But this should not be read as an endorsement of the status quo, nor of the current state of government regulations in the region. In reality, it is difficult to measure competition in the shipping industry, and particularly for airfreight. Nevertheless, it is clear than an anachronistic web of bilateral air service agreements are resulting in costly competitive distortions in the airline industry. Analysts often use the expression "spaghetti bowl" to describe the myriad of trade agreements governing trade in goods in the region. Yet, when these distortions are compared to those arising from airline industry regulations, the spaghetti bowl appears to be just a side dish. Brazil’s recent proposed "open air agreement" for South America would certainly be a step in the right direction.
Finally, a less intuitive insight concerns the impact of import tariffs on transport costs. Higher tariffs mean that transport costs are less visible to consumers and producers since they reduce the share of these costs in the total price of goods, giving shippers a powerful incentive to increase their margins. Our estimates suggest that reducing LAC’s average tariff rate to the level of the United States can cut ocean shipping costs by an average of 9 percent. Countries with tariffs above the average, such as Argentina and Brazil, would reap the bulk of the gains. Even higher gains can be expected in airfreight. (…)
WHAT ARE THE TRADE GAINS?
Even now, with the China-led commodity boom, LAC’s share of world trade clearly remains below its potential, both in volume and in diversity.
Our sector-level estimates confirm that an effort to bring down import tariffs and freight rates simultaneously can substantially increase both the volume and diversity of goods traded by the region. When we isolate the impact of these costs from other trade factors, we find that a 10 percent decrease in freight costs and tariffs would boost LAC’s imports by 50 percent. But behind this average impact lies substantial variations from one sector to another. The effect ranges from 5.5 percent in the case of salt, sulfur and stones to 96.6 percent in the case of leather articles. In general, the average increase of bilateral imports brought about by a 10 percent decline of trade costs would be larger for manufacturing (48.4 percent) than for minerals and metals (47.1 percent) and agricultural products (42.9 percent). (…)
We also find significant impacts on exports. Our estimates suggest that a 10 percent cut on trade costs would raise intraregional exports by more than 60 percent on average. As in the case of imports, there is substantial variation across sectors, with the largest effect in tin (169.2 percent) and the smallest in salt, sulfur and stones (3.6 percent). On average, the expansion associated with a 10 percent decline of trade costs would be larger for manufacturing (66.3 percent) and minerals and metals (69.2 percent) than for agricultural products (54 percent). (…)
Lower trade costs not only increase trade volume, but also produce sizeable gains in the diversity of goods being traded. According to more conservative estimates, a 10 percent decline in average trade costs would be associated with a 9 percent increase in the number of products imported and an expansion of more than 10 percent in the number of products exported to the region. For Argentina, on average, a 10 percent decline in costs would increase by 210 the country’s exports (broadly defined) to other LAC countries. For Brazil, Colombia and Peru the figures would be 253, 53 and 51 products, respectively.
These figures further strengthen the case for a broader trade agenda. …Transports costs typically account for the largest share of the trade costs included in these estimates. In the case of intraregional imports and exports, and of exports to the United States, they account on average for more than 70 percent of the LACs’ trade costs, even without factoring in time costs. But now we go a step further to determine the separate impact of both freight and tariff rates on the trade volume and diversification of each LAC country in our sample. Specifically, we examine how much export volumes and diversification would change in each country if either transport costs or tariffs were reduced by 10 percent. (…)
For all LAC countries, the positive impact of a 10 percent reduction in transport costs on intraregional exports and on the number of products exported far exceed those of a similar reduction in tariffs. In particular, such a reduction in transport costs would lead to a median expansion of intraregional exports almost five times larger, and to a median increase in the number of products exported to the region nine times larger, than that from tariffs. This result is hardly surprising. For while the LAC countries have made substantial progress in liberalizing intraregional trade over the last two decades, investment in infrastructure, especially in cross-border, trade-related projects, has been low. (…)
Moving to the sector level, our estimates indicate that lowered transport costs in - manufacturing - would result in the highest average percentage increase of exports in Brazil, Chile, Colombia, Ecuador, and Uruguay. In Argentina, on the other hand, the largest effect would be felt in - minerals and metals-. In Bolivia, Paraguay, and Peru, most of the gains would be in agricultural exports. But it should be noted that most countries show a substantial variation across sectors within each group of activities, making it difficult to identify a clear cross-grouping pattern.
The overwhelming importance of freight costs over tariff reduction is also seen in LAC’s exports to the United States. Here again, transport costs strongly influence trade volumes and diversification. For instance, Figure 3.12 shows that the ratio of the effects of transport costs on export volumes to the effects of tariffs has a median value (over countries and sectors) of 12, with even higher median ratios for two countries that enjoy preferential access to the U.S. market, Peru (48 times larger) and Colombia (24 times larger). We found a similar pattern regarding the number of products being exported to the United States.
REALITY ON THE GROUND
Case studies vividly show how an inefficient transport network hurts a country’s trade. In Ecuador, for example, we see how the advantages of proximity and the time sensitiveness can be undermined by shortcomings in infrastructure. In Brazil, we see a commodity boom in which farmers should be reaping major benefits, but where dysfunctional logistics are eating away a substantial part of their rents.
The case study of Argentina shows the importance of major transportation investments in efforts to export new products to new markets, a factor that is often overlooked. Mexico provides a cautionary tale about the importance of non-policy trade costs for countries where proximity, interacting with local resources, plays a key role in their comparative and competitive advantages. (…)
Of course, it is one thing to argue that transport costs should be brought into the trade agenda, and quite another to overcome the formidable political and technical hurdles that stand in the way. For example, politicians know that announcing a trade agreement has far greater potential for getting voters’ attention than building ports and railroads. Similarly, a grand plan to move the country into the "knowledge society" tends to generate much more publicity than moves to reduce delays at border crossings or deregulate air transportation.
On the technical front, governments must resist the temptation to turn a decision to improve transport infrastructure into a license to launch any project, whether it has real merit or not. All transport projects must undergo rigorous cost benefit analysis and adhere to fiscal, macroeconomic and environmental standards.
Another challenge is finding resources to carry out projects. Although the recent commodity boom filled the coffers of resource-rich countries, most LAC governments still cannot provide funding for their urgent social and economic agenda. Public and private partnerships are far from a panacea—particularly because of contractual intricacies and contingent liabilities—but experiences such as those of Chile and Brazil suggest that they can be an interesting way to reconcile the need for state coordination and intervention with the lack of managerial and financial resources.
Finally, transport projects that involve two or more countries present special challenges, such as externalities and failures in coordination. There seems to be a clear role here for regional initiatives such as the Initiative for Integration of Regional Infrastructure in South America (IIRSA) and the "Proyecto Mesoamérica", formerly known as Plan Puebla Panama (PPP). With the support of multilateral finance institutions such as the Inter-American Development Bank (IDB) and the Andean Development Corporation (CAF), these initiatives are helping governments in the region to coordinate and finance infrastructure projects. The challenges are far from trivial but the payoff is clear: a region better positioned to use trade to fuel economic growth and raise standards of living.
The authors work at the Inter-American Development Bank. This column is based on an excerpt from a longer article in the Journal of Globalization, Competitiveness and Governability published by Georgetown University and Universia. Republished with permission from the journal.