port and Me Facilitation l~~~~~~~~aur 2001 DIRECTIONS IN DEVELOPMENT Integration of Transport and Trade Facilitation Selected Regional Case Studies T. R. Lakshmanan Uma Subramanian William P. Anderson Frannie A. Leautier THE WORLD BANK WASHINGTON, D.C. Copyright © 2001 The International Bank for Reconstruction and Development / THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, USA All rights reserved Manufactured in the United States of America First printing January 2001 1 2 3 4 03 02 01 00 The findings, interpretations, and conclusions expressed in this book are en- tirely those of the authors and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Execu- tive Directors or the countries they represent. The World Bank does not guaran- tee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. 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For permission to reprint individual articles or chapters, please fax a request with complete information to the Republication Department Copyright Clear- ance Center, fax 978-750-4470. All other queries on rights and licenses should be addressed to the Office of the Publisher, World Bank, at the address above or faxed to 202-522-2422. Cover design by Grammarians. ISBN 0-8213-4884-1 Library of Congress Cataloging-in-Publication Data has been applied for. Contents Foreword vii Acknowledgments ix 1. Transport and Trade Facilitation: An Overview 1 T. R. Lakshmanan Regional Trading Blocs 2 Overview 2 Transport and Trade Facilitation 6 The Components of an Advanced TTF System 8 Lessons Learned 10 2. Transport and Trade in the North American Free Trade Agreement 13 T. R. Lakshmanan and William P. Anderson NAFTA: The Scope and Evolution of Trade Integration 14 Overview of NAFTA 20 Transportation and Trade Facilitation under NAFrA 21 Economic Deregulation: Prerequisite for Seamless Cross-Border Transportation 22 Rules of the Road: The Complex Problem of Technical Regulation 28 Borders as Barriers 30 Conclusion and Lessons Learned 32 iii iv CONTENTS 3. Transport Integration in the European Union 35 William P. Anderson Historical Overview 36 Institutions of the European Union 39 Transportation in the European Union 40 Interoperability 44 Market Access 45 Developing Trans-European Networks 47 Conclusions 48 4. Transport and Trade in Mercosur 51 T. R. Lakshmanan Treaty of Asuncion 53 Mercosur Partners and Their Evolving Integration 55 Transport Privatization and Deregulation 63 Transport Privatization in Argentina 63 Transport Infrastructure 67 Transport Integration and Activity Restructuring 68 5. Southern African Development Community: The Maputo Corridor 71 William P. Anderson The Maputo Development Corridor 73 The Development Corridor Concept 73 History and Context of MDC 74 Plan, Operation, and Potential Benefits 76 Institutional Problems 79 6. Transport, Logistics, and Trade Facilitation in the South Asia Subregion 81 Uma Subramanian Profile of the Subregion 83 Transportation and Logistics Arrangements in the Subregion 91 Transport Infrastructure 94 Cross-Border Procedures 97 Ports 98 Conclusion 103 CONTENTS V 7. Urbanization and Regional Trade in South Asia: Issues and Options 111 Frannie A. Leautier Globalization of Trade and the Economic Geography of City Location 112 Changes in Demographics and Income Disparities in Cities and Countries 116 Urbanization 120 Decentralization and Governance 121 Good Governance and Cities' Comparative Advantages 122 Measures of the Importance of Local Governments 123 Potential Challenges 125 Conclusions 126 8. Rotterdam: A Strategic Hub in the Global Trade-Transport Chain 127 T. R. Lakshmanan From Fishing Port to European Mainport 128 Rotterdam: A Statistical and Economic Profile 129 Rotterdam: Strategic Positioning in the Global Transport Networks 132 Conclusions 138 References 139 Foreword Globalization trends worldwide are shrinking distances, enabling coun- tries to connect through markets, trade, information, finance and invest- ment. Technological advances in information, communication and transportation have facilitated these processes. Alongside, numerous regional trade blocs have emerged, as countries seek comparative advantages and ease their entry in to world markets. Developing countries face a unique opportunity to participate competi- tively in this global and regional production and trading system, offering value-added services, skills resident in their human resources, as well as other resources. However, this opportunity depends on the ability of these countries to meet international market standards that increasingly em- phasize high quality and just-in-time delivery. This book examines experiences of interrelated transport and trade integration in selected regional trade blocs. The case studies range from advanced systems (Europe and North America) to more nascent efforts (Southern Africa and South Asia). The genesis for this book comes from an international workshop on transport and trade facilitation sponsored by the World Bank/ESCAP (Economic and Social Commission for Asia and the Pacific). The workshop was a forum for policy dialogue with government and private sector stakeholders in South Asia as these coun- tries are beginning to position themselves to participate in regional and global markets. Creating and maintaining efficient regional transport and trade facili- tation systems are complex tasks that are often politically sensitive, since they involve both infrastructure provision and management as well as infrastructure policy issues. However, such systems are crucial if the vii Viii FOREWORD transport and logistics gaps are not to adversely influence critical eco- nomic sectors, that in turn would affect economic growth, employment and therefore, poverty. We hope that this book would provide guidance and increase the knowl- edge base for developing countries and regions during these periods of transition. James P. Bond Acting Vice President Private Sector Development and Infrastructure The World Bank Acknowledgments This report was prepared under the task team leadership of Uma Subramanian. The authors for various chapters are T.R. Lakshmanan, William P. Anderson, Frannie A. Leautier, and Uma Subramanian. We gratefully acknowledge inputs from Marc Juhel, Ron Kopicki, and Stephan von Klaudy. Gladys Stevens provided administrative assistance. ix 1 Transport and Trade Facilitation: An Overview T. R. Lakshmanan Technology has been a major driver of globalization in recent times. In- formation technologies (IT)-representing a confluence of computer and communication technologies-are transforming transport and trade in the twenty-first century. Although trade and the spread of economic ac- tivities across national borders have been increasing for a century or more, new developments in the enabling and space-shrinking technolo- gies of transportation and communication are fundamentally transform- ing space-time relationships worldwide. These technologies make possible the management and coordination of globally distributed economic activities that are diverse in nature. They permit increasing division of labor in the production processes as the component activities are further disaggregated and spatially reallocated. This partition of production processes (the slicing of the "production value chain") across national borders results in different stages of production being carried out in many countries. Raw materials and components may come from two different countries, with assembly in a third, and marketing from yet other countries in response to consumer signals from around the world. Parts and components are "sourced" internationally (a process likely to be expanded with growing Internet use); they ac- counted for $800 billion in trade in the early 1990s (World Bank, 2000b). Indeed, the whole process is globally coordinated. A significant portion of global value added is in the resultant global production networks. These networks offer economic opportunities to all countries, espe- cially in the developing world. If they invest in transport and communi- cation systems that are effective, developing countries can plug into these networks. They can benefit from the spatial dispersion of manufactur- ing activities and, over time, from the associated service activities-all of which lead to expanded trade. Trade growth confers on the develop- 1 2 INTEGRATION OF TRANSPORT AND TRADE FACILITATION ing countries the benefits of globalization-increased market access for their exports, acquisition of new technology through international trans- fers, and the efficiency gains in the overall economy resulting from in- creased competitive pressures. Under the impetus of declining transport costs and declining tariffs, trade has grown much faster than income since World War II. During the 1990s, trade in goods and services grew twice as fast as global GDP. In an affluent economy such as that of the United States, trade grew three times as fast as GDP in the past quarter century. During the 1990s the share of global trade attributable to the developing countries climbed from 23 percent to 29 percent (World Bank, 2000b). Indeed, international trade flows are penetrating deeper into the work- ings of most economies, linking them to one another and modifying their economic structure and productivity In the increasingly competitive economic environment worldwide, more and more countries offer high- value and low-cost production capacity and speedy time-definite deliv- ery of goods at competitive prices. Regional Trading Blocs In this context a surge has occurred in the formation of regional trading blocs. Each trade bloc represents a cluster of neighboring countries that link their economies and seek to create dynamic comparative advan- tages to facilitate their insertion in the global economy on favorable terms. Figure 1-1 compares the population and GNP of five regional trading blocs: the North American Free Trade Agreement (NAFTA) signatories (Canada, Mexico, and the United States), the fifteen-member European Union (EU), the Common Market of the South (Mercado Comin del Sur or Mercosur), the South Asian Association for Regional Cooperation (SAARC), and the Southern African Development Community (SADC). The NAFTA signatories and the European Union represent the two largest economies at a global level. Mercosur-comprising Argentina, Brazil, Paraguay, Uruguay, and two associate members (Bolivia and Chile)-is the largest economy among developing economies. In popu- lation size, SAARC is dominant, with the NAFTA countries, the Euro- pean Union, and Mercosur serving as medium-size regions. Figure 1-2 shows intraregional trade as a share of total trade in the large trading blocs. It is a crude measure of the tendency to direct trade toward other bloc members. Overview The following chapters analyze the scope and status of the interrelated processes of trade and transport integration in all five trading blocs. For TRANSPORT AND TRADE FACILITATION: AN OVERVIEW 3 Figure 1-1. Population and GNP of Case Study Economies, 1998 Population in millions 1,200 1,000 800 600 - 400 200 -i NAFTA EU Mercosur SAARC SADC GNP in billions of U.S. dollars 10,000 9,000 - 8,000 - 7,000- 6,000- 4,000- 0 NAFTA EU Mercosur SAARC SADC Note: The figure compares the economies of the North American Free Trade Agreement countries, the European Union, the Common Market of the South (Mercado Comin del Sur or Mercosur), the South Asian Association for Regional Cooperation, and the Southern African Development Community. Source: World Bank (2000c). 4 INTEGRATION OF TRANsPoRT AND TRADE FACILITATION Figure 1-2. Intraregional Trade as a Percentage of Total Trade in the Large Trading Blocs, 1962-94 Percent 70 EU-15 _ - . 60 _ . - - _ _ 50 Mercosur 40 -- - 30 20 NAFTA 10 1962 1965 1970 1975 1980 1985 1990 1994 Year Source: Frankel (1997). each trade bloc we review the economic and institutional evolution in the region, present an economic profile of the component members, and assess the nature and extent of trade integration. Chapter 2 surveys trade and transport integration in the NAFTA re- gion comprising Canada, the United States, and Mexico. NAFTA repre- sents the culmination of a long process of trade liberalization that had spawned border-spanning industrial complexes and extensive intra-in- dustrial cross-border trade. Recent reform of the elaborate and diver- gent economic regulations governing transport in the three countries has conferred economic benefits and has been a prerequisite for the pro- motion of seamless cross-border goods flow. However, residual economic regulation in the form of cabotage continues to hinder efficient transborder operations. Activities in nontransport matters (such as safety issues, interdiction of drugs, pests, and diseases, and illegal immigra- tion) impose time-intensive inspections. The chapter describes the cooperatve efforts under way to reduce these nontariff barriers to cross- border freight flow in the region. Chapter 3 addresses the European Union, the oldest and most highly developed of the world's regional trading blocs. Despite more than forty TRANSPORT AND TRADE FACILITATION: AN OVERVIEW 5 years of history, it is only fairly recently that steps have been taken to- ward true integration in the transportation sector. Various institutional and technological factors had to be overcome to guarantee true interoperability of infrastructure systems, the seamless movement of goods across international frontiers, and more open markets in trans- portation systems, including cabotage in freight movements. The chap- ter stresses the role of supranational institutions-in this case the European Court of Justice and the European Commission-in bringing about greater integration. Chapter 4 is devoted to Mercosur, the largest trading bloc comprised entirely of developing countries-Argentina, Brazil, Paraguay, and Uru- guay with Chile and Bolivia as associate members. Since the creation of Mercosur, there has been a significant and growing interdependence among member economies, with intra-Mercosur trade growing twice as fast as trade with non-Mercosur countries. Efforts are under way to im- prove the physical and nonphysical infrastructure of transport/trade chains in member countries so that trade growth may continue. This chapter describes some significant efforts at transport service liberaliza- tion and deregulation and provides two examples of the benefits of trans- port integration across Mercosur, as global firms restructure their production and distribution activities in a single market, realizing gains in a virtuous cycle of lower costs, increasing trade, greater economies of scale and scope, and more growth. Chapter 5 on the Southern African Development Community pays particular attention to the Maputo Corridor. This is a project to create an efficient transportation and communication corridor from the industrial heartland of South Africa to the port of Maputo in Mozambique. The Maputo Corridor exemplifies the development corridors approach, which seeks to expedite international movements of goods and people across international borders while encouraging diversified economic develop- ment in infrastructure-rich corridors. Although this project is ongoing, it already is possible to assess some of its achievements. Chapter 6 focuses on transport and logistics within a South Asia sub- region: Bangladesh, Bhutan, Nepal, and eastern India. As the countries position themselves to participate in the global market following recent liberalization policies, they face serious transportation and logistics im- pediments that have strong implications for economic growth and pov- erty alleviation in the subregion. The impediments affect the costs of doing business and impair intraregional trade as well as opportunities to participate in international markets. Using detailed logistics cost data, the chapter confirms that the flows of goods traded within the region, especially from landlocked countries, are seriously impaired not only by physical infrastructure bottlenecks but also by policy and procedural 6 INTEGRATION OF TRANSPORT AND TRADE FACILITATION impediments in the logistics chain-such as red tape and corruption in customs, delays and pilferage in ports, highly restrictive bilateral proto- cols on cross-border movement of vehicles, and poor modal interfaces. Chapter 7 explores how recent globalization trends have affected ur- ban centers in South Asia. In particular, the chapter examines urbaniza- tion in the context of evolving trade and transport relations within the South Asia subregion. Using trade patterns among contiguous countries in the subregion, the chapter discusses city performance and competi- tiveness and provides a peep into the future of the cities. The final chapter is a case study of Rotterdam, a successful major hub that has maintained its position as the world's largest port for four de- cades. Rotterdam's ability to retain this preeminent position despite vast changes in the structure of the global economy and the transport sector derives from its twofold approach to trade and transport. First, the port of Rotterdam has marshaled the knowledge and competencies neces- sary to offer its customers and industrial tenants state-of-the-art services. Second, it has successfully evaluated the larger economic and transpor- tation environment, making in each new era the needed physical, hu- man, and institutional investments. There are clear lessons in Rotterdam's experience for managers of ports and airports in developing countries as they organize their trade-transport chains. Since the notion of "transport and trade facilitation" (TTF) used here in a trading bloc context is not yet formally developed, we clarify in the next section the cluster of ideas embraced by the term. Transport and Trade Facilitation The explosive growth of merchandise trade in many regional trading blocs is a response to the reduction of tariffs and other barriers to intraregional trade. Indeed, the environment for goods flow in recent years has been transformed in affluent industrial countries. Transport is becoming faster, more flexible, and (with jet transport, fast container ships, improved container-handling practices, and intermodal systems) more predictable within a narrow time range. Transport and informa- tion industries are being privatized and deregulated. Logistical innova- tions, such as just-in-time and quick-response services, are reengineering business systems as well as production and commodity flow systems. Containers and cargoes can be tracked around the world by automatic identification devices and are continually "visible" in transit to shippers and carriers. What is more, the slow and tedious paper trail that tradi- tionally has accompanied goods to secure clearances across borders from customs, revenue agencies, and financial intermediaries is being replaced by Electronic Data Interchange (EDI) and e-commerce. Customs agen- TRANSPORT AND TRADE FACILITATION: AN OVERVIEW 7 cies, finance ministries, and regulators are beginning to reinvent their practices in this new environment. The continuity and future growth of trade in Mercosur, or in other trading blocs comprised of developing countries, depend on the effi- ciency and speed of cross-border transportation of goods, and on the harmonization and simplification of the information processing accom- panying those goods. In other words, Mercosur, SAARC, and SADC must move quickly toward the acquisition of the state-of-the-art transport and trade facilitation system noted earlier. The greater the gap between the state-of-the-art TTF system and the system available in a trading bloc, the greater the penalty that specific regional trading bloc will pay in terms of forgone trade and economic growth. An inadequate trade and transport facilitation system in Mercosur, or in any other regional trading bloc, creates an efficiency penalty Interna- tional agencies estimate that antiquated types of trade administration and the failure to adopt IT-supported trade facilitation (and the down- stream effects of those systems) account for 7 percent of the value of the goods (Schware and Kimberley, 1995). If developing countries in Mercosur or in the free trade areas in South Asia and South Africa have substandard TTF systems, they cannot par- ticipate effectively in the global production networks. As noted earlier, the increasing division of labor in the global economy leads to a parti- tion of the production "value chain" among production locales that are spatially distributed in many countries. One third of world trade in the mid-1990s occurred within global production networks (World Bank, 2000b). Manufacturing industries continue to be reallocated in these networks from industrial countries to developing regions. Therefore, trade expan- sion is likely, not only in goods but also in services. Unimproved trans- port and trade facilitation systems can reduce trade and thereby restrict the benefits of globalization-expanded markets for exports, the acqui- sition of new technology, and the favorable effect of competition on the efficiency of domestic producers. The long-term benefits of a superior TTF system lie beyond the cost- reduction and trade expansion benefits already noted. There is great potential for cross-border integration of manufacturing and service ac- tivities and for exploiting the economies of scope and scale in the larger market. In time, self-sustaining economic expansion results. Although such developments take time, they can set in motion a sequence of cu- mulative processes that lead from falling costs to output increases to incentives for the creation of spatial agglomerations of production (cit- ies) to rising output and profits, in turn attracting more production to these cities. 8 INTEGRATION OF TRANSPORT AND TRADE FACILITATION The Components of an Advanced TTF System An advanced trade and transport facilitation system (table 1-1) reduces the barriers to transport and cross-border transit in two ways: through physical infrastructure (transport infrastructure and facilities, and com- munication infrastructure that complements transport infrastructure) and nonphysical infrastructure (knowledge and competencies applied to the physical infrastructure). The latter include knowledge about how to transport and communicate in specific legal, economic, financial, and political frameworks and how such frameworks can improve trans- port and trade. Physical Infrastructure The physical infrastructure of an advanced TTF system has transport components as well as information components. Both will be discussed in this section. An effective intermodal transport system will reduce the physical constraints of potentially cost-effective corridors linking neigh- boring countries. Effective corridors and efficient intermodal facilities are abundant in the NAFTA countries and in the European Union, but numerous barriers to cross-border movement exist in Mercosur and in the SAARC and SADC regions. These constraints include physical bottle- necks on road networks (for example, missing links, absence of ferry crossings, and narrow and unsturdy bridges); poor maintenance; mul- tiple gauges in the rail system; inadequate dredging, poor lighting, and bad positioning of navigation aids in inland waterways; and inadequate transshipment/storage and container facilities at cross-border stations. Table 1-1. Components of an Advanced Transport and Trade Facilitation System Physical infrastructure Transport subsystems Information subsystems Nonphysical infrastructure (knowledge and competencies in transport and tradefacilitation) Overall governance of transport and trade facilitation Business logistical systems Financial coordination Governance of physical flows Source: The author developed this classification. TRANSPORT AND TRADE FACILITATION: AN OVERVIEW 9 Developing countries often lack investment in micro-infrastructure (for example, poorly developed physical facilities for parking, handling, and storage at customs areas in border crossings). These inadequacies lead to costly delays in customs clearance. Investments in railway modern- ization, highway improvements, upgrading of ports and inland water- ways and airports, and intermodal coordination should address these transportation infrastructure deficiencies. Information technologies now make possible the rapid collection, trans- fer, and analysis of "intelligence" associated with the merchandise be- ing traded. This accelerated information processing and information exchange promotes preclearance and prereconciliation at various stages of trading transactions. Costs are much lower than those of the tradi- tional paper systems, and incompatibilities of technology, time, and dis- tance are more easily resolved. Information is exchanged between computers by Electronic Data Interchange. The EDI associated with international transport substitutes the legal transmission of electronic information in the customs process for paper inputs-leading to major savings in time and money. Implementation is done using the UN/EDIFACT document standard. The Internet and elec- tronic commerce services can play an important role in a reengineered trade facilitation process within countries and across borders. Nonphysical Infrastructure Four aspects of the nonphysical infrastructure in an advanced trade and transport facilitation system are noteworthy: overall governance of trans- port and trade facilitation, new logistical systems for businesses, finan- cial coordination, and physical flows. Each will be examined in turn. Efficient cross-border movement of cargo requires legal, institutional, regulatory, and administrative innovations. Examples include: * Deregulation of transport services • Removal of cabotage and other residual economic regulations * Privatization of transport infrastructure * Reform of the commercial legal framework * Reinvention of the customs function * Adoption of international standards and trade practices. Business capabilities are enhanced by new logistical systems that of- fer fast, reliable, and low-cost service. These systems also can provide competitive advantage by slashing costs (minimum inventory), quick- ening market feedback, and expanding market reach. Financial coordination is improved by trade-friendly banking prac- tices and new payment systems. Risk-reduction innovations can reduce 10 INTEGRATION OF TRANSPORT AND TRADE FACILITATION the costs of linking the shipper and the customer. Organizational inno- vations can create efficient entities for marketing and distribution in the rapidly evolving global marketplace (box 1-1). Finally, an advanced trade and transport facilitation system governs physical flows. Knowledge and competencies in TTF can harmonize the size and weight of cross-border vehicles, promote seamless intermodal freight flows across borders, reengineer inspection activities, and lessen delays in noncustoms inspections. Lessons Learned The following chapters present case studies on the NAFTA countries, the European Union, Mercosur, the Southern African Development Com- munity, and the South Asia subregion. From these studies of regional trading blocs important lessons can be learned. First, a regional trading bloc with a high level of economic integration and high volumes of trade cannot be achieved as the result of a single free trade agreement. Even North America and Europe, highly industri- alized regions with a long history of open trade, did not attain such an outcome in one fell swoop. Rather, economic integration has evolved, as in NAFTA, over several decades, largely because of policies that have promoted development of border-spanning industrial complexes result- ing in intra-industry trade of high-value goods. In the case of Canada and the United States, free trade was promoted initially by a sectoral trade agreement (the Auto Pact of 1965) and later, in 1988, by the Canada- U.S. Free Trade Agreement. In the case of Mexico and the United States, policies by both governments facilitated, over time, free trade in the bor- der areas (the Maquiladora system). Similarly, trade today between the fifteen members of the European Union is the result of slow and steady progress. The European Union's high level of integration (not only in trade but also in labor market, mon- etary, social, and environmental policy areas) has evolved over four de- cades-from the humble beginnings of the 1951 European Coal and Steel Community (ECSC) to the Treaty of Rome (1960) and the Mastricht Treaty (1992). These agreements have eliminated some of the remaining trade barriers and created opportunities to expand well-established trade re- lationships. In the case of developing countries that band together to form a re- gional trading bloc, there is a further history-induced frictional factor. As a consequence of past semicolonial trade links to Europe and North America, Mercosur member countries have had stronger trade and fi- nancial links with European and North American economies than with one another: intraregional trade in this part of the world has been a small TRANSPORT AND TRADE FACILITATION: AN OVERVIEW 11 Box 1-1. Best-Practice Trade and Transport Logistics In recent years cross-border trade has grown enormously, and interna- tional business-to-business transactions via the Intemet have increased rapidly. In response, a variety of innovations have appeared to improve the efficiency of the supply chain worldwide and to harmonize foreign trade rules and regulations as well as payment issues. In order to be more responsive to their customers, the developers of these logistical systems in the United States are developing strategic partnerships with their cli- ent businesses. Closer collaboration between the users and developers of logistical software has had several benefits. Global Positioning Satellite (GPS) technology is transforming the effec- tiveness of current transportation services. New systems blend three ex- isting capabilities: planning and scheduling logistics software, in-cab communication systems for scheduling and monitoring trucks, and elec- tronic links between the firm developing logistics systems and the re- tailer supply chain. GPS technology can help businesses monitor the location of trucks and dispatch them to ensure faster delivery and better stock of merchandise at the retailers' shops. Comprehensive systems can manage the entire supply chain, in the process blurring the distinction between production, transport, and dis- tribution activities. Sowinski (2000) describes new logistical software that brings together diverse information on raw materials, input suppliers, factories, transport vehicles, and points-of-sale in real time. These infor- mation and analytical systems can help businesses (1) make decisions on how many warehouses or plants to build and where, and what modes of transport to use; and (2) compute tradeoffs between production run length and inventory costs, thus making it easier to assess when to open or close production lines. New logistical systems that can support efficient cross-border supply chains offer information not only on transport, insurance, and other costs, but also on cross-border transit of goods. A New York firm offers clients information via the World Wide Web-a low-cost source of access to per- tinent export regulation information. The resulting Automated Export System (AES) is certified by the U.S. Customs Service and the Foreign Trade Division of the U.S. Census Bureau to permit electronic filing of export documentation used by exporters and freight forwarders. Other systems supply exporters with more than 700 international trade docu- ments in 21 languages and a variety of international banking require- ments for trade activities. They help small and medium enterprises lower the time and cost of cross-border trade and transport. Source: Sowinski (2000). 12 INTEGRATION OF TRANSPORT AND TRADE FACILITATION share of total trade. Inward-looking trade regimes and import substitu- tion development strategies during the past three or four decades weak- ened intraregional economic links. In the case of South Asia, partition of the Indian subcontinent in the postcolonial era into a number of countries has, over time, severed or restricted transport movements along traditional transport corridors (for example, the Calcutta-Bangladesh-Assam corridor ). In addition to the trade and transport facilitation policies noted in this book, special ef- forts are needed to overcome historical intraregional transport frictions within Mercosur and in Southern Africa and South Asia. Such efforts in the developing-country trading blocs will modify earlier orientations and promote the exploitation of new economic complementarities among these countries. The benefits of proximity and lower transport costs can then be enjoyed. Over time, such developments will stimulate trade cre- ation, rationalization of economic activities within the entire bloc, and overall expansion. Real progress toward fuller economic integration may require strong supranational institutions. Although the European Union has eliminated border checks and achieved full cabotage in some service categories, member countries clung for years to the status quo of fragmented trans- port infrastructure and regulation. Government ownership of major trans- port carriers and the role of transport policy in advancing national economic goals are two reasons for this resistance to change. A suprana- tional institution, the European Court of Justice, played a critical role in breaking down the national prerogatives that had prevented a Common Transport Policy within the European Union for thirty years. In the case of air transportation, the European Commission advocated regulatory reform that was opposed by all member states in 1979. After almost a decade of debate and litigation, regulatory reform was implemented. Before the signing of the North American Free Trade Agreement in 1994, the member countries engaged in preparatory work that included extensive economic deregulation of the transport sector and privatization. Customs practices were reformed as well. The recent acceleration of trans- port integration in EU countries reflects similar reforms of the legal, regu- latory, and administrative aspects of the transport sector. It is imperative for Mercosur countries, and for the South Asian and Southern African regions, to engage in similar reforms. Only then can developing-country trading blocs acquire favorable access to global production networks where so much value is being created. 2 Transport and Trade in the North American Free Trade Agreement T. R. Lakshmanan and William P. Anderson The North American Free Trade Agreement (NAFTA), signed on Janu- ary 1, 1994, created the largest trading bloc in the world. By abolishing all tariffs over a ten-year period, and by eliminating certain administra- tive nontariff barriers such as import licenses and local content rules, NAFTA was designed to open the borders separating Canada, Mexico, and the United States to the free exchange of goods and services. NAFTA represents the culmination of a long process of trade liberal- ization. In the pre-NAFTA era, there was tariff free movement of goods within a specific sector between Canada and the United States, and within designated zones between Mexico and the United States. Consonant and complementary policies in transportation deregulation and privatization in the same period also helped to lower trade barriers. The result was development of border-spanning industrial complexes producing large volumes of trade in high value-added manufactured goods. By remov- ing most of the remaining barriers to cross-border goods movement, NAFTAprovides opportunities to expand and extend trade relationships that were already well established at the time of its implementation. Despite the comprehensive nature of NAFTA and the favorable his- tory that led up to it, trade within this area is not completely "free" in the sense that cross-border movement of goods is no more costly than the movement of the same goods over the same distance within a coun- try. If this is not the case, then internationally traded goods will be at some competitive disadvantage to domestically traded goods. Despite NAFTA, there are still a number of factors that may hinder the free move- ment of goods across borders and therefore the full potential of free trade may not be realized. Such factors embraced by the term nontariff barriers include: 13 14 INTEGRATION OF TRANSPORT AND TRADE FACILITATION 1. the threat of illegal movements of undocumented people, drugs, and materials that may transport pests or disease, resulting in the need for time-consuming inspections at borders; 2. inconsistency in technical and safety-related transportation regula- tions such as vehicle size and weight restrictions; and 3. residual economic regulations as related to cabotage and restric- tions on certain product movements. The focus of this chapter is on the remaining barriers in the NAFTA transport and transit facilitation system. Thus, our concern is with the second and third categories, which prevent the seamless integration of national transportation systems, and to a limited extent the first category, which can result in impediments to the movement of goods. We will identify transportation factors that act as barriers to trade, explain and assess their current situation, and describe measures that are being taken to mitigate their impacts. While the chapter addresses issues involving the broader freight trans- portation sector, it places particular emphasis on trucking, the dominant mode of freight transportation in North America. In the United States trucking accounts for more than 70 percent of the goods moved by value and more than 50 percent by weight (U.S. Department of Transporta- tion, 1997b, table 9-5). As the next section of the chapter will show, trade across the U.S.-Canada and U.S.-Mexico borders is mostly in relatively high value manufactured goods and components, a market segment in which trucking is even more dominant. Furthermore, some of the most important problems involved in cross-border transportation integration arise in the trucking mode. The chapter begins with an economic overview of the NAFTA part- ners and existing trade relationships and a review of some of the main provisions of the agreement. We then discuss three major issues related to transportation and trade: economic regulation, technical regulation, and border crossings. The chapter concludes with lessons learned from the NAFTA experience that can be applied to other free trade areas. NAFTA: The Scope and Evolution of Trade Integration The three NAFTA partners are a diverse group in terms of size, level of development, and the role of trade in their economies. While Canada and the United States both rank among the highest income countries in the world, Canada is dwarfed by the United States in terms of popula- tion and GNP (table 2-1). International trade is more critical to the Cana- dian economy, as indicated by the ratio of total trade to GDP. Thus, the TRANSPORT AND TRADE IN THE NORTH AMERICAN FREE TRADE AGREEMENT 15 Table 2-1. Statistical Comparison of the NAFTA Countries, Selected Years, 1990-98 Indicator Canada Mexico U.S. GNP, 1998 (billions of U.S. dollars) 612.2 380.9 7,921.3 Average GNP growth rate, 1990-98 2.2 2.5 2.9 GNP per capita, 1998 (U.S. dollars)' 24,050 8,190 29,340 Total trade as percentage of GDP, 1996 73 42 24 Population, 1998 (millions) 31 96 270 Average percentage population growth, 1990-98 1.4 2.0 1.1 a. Adjusted for purchasing power parity. Source: World Bank (2000b). United States and Canada roughly fit the classic "large country/small country" case of international trade theory. Mexico is a relatively low- income country that has been experiencing rapid economic growth in recent years. Given its large population, rapid economic growth, and opportunities for economic integration with its richer neighbors, Mexico could be one of the most important international markets in the twenty- first century Figure 2-1 traces the growth of the three economies in the 1993-97 period and the growing importance of trade in all the economies. Canada and the United States now have the largest bilateral trade relationship in the world, but this was not always the case. Between the time the United States became an independent country in 1776 and the mid-nineteenth century, the U.S.-Canadian Colony commercial relations were strained. After a short thaw between 1846 (when Britain adopted a policy of free trade) and the American Civil War (when Britain was sus- pected of helping the southern states), U.S.-Canadian trade was open and unrestrained. After the Civil War, the United States abrogated this free trade regime unilaterally. Later, in 1879, the then-autonomous Ca- nadian Government instituted a policy of tariff barriers-partly to pro- tect its nascent manufacturing industries (against a more robust U.S. production sector) and partly to unify a geographically vast country by diverting North-South international trade flows to East-West domestic trade. Over time this policy led to an expansion of interprovincial trade, large and efficient industries (steel, agricultural machinery, and other key sectors), and a "branch plant" economy with U.S. interests owning half or more of Canadian manufacturing capacity Tariff barriers have declined over time, due partly to the General Agree- ment on Tariffs and Trade (GATT) but more significantly to the U.S.- Canada Auto Pact of 1965. This was an agreement to eliminate all tariffs 16 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Figure 2-1. GNP and Trade as a Percentage of GDP in Canada, Mexico, and the United States, 1993 and 1997 Billions of U.S. dollars Trade as a percentage of GDP 9,000 80 8,000 GNP _ 70 -4- Trade 7,000 - 60 6,000 _ _0 5,000 -40 4,000 -30 3,000 -20 2,000 1,000 _ 10 O m m 9 F77 ,,7z,o, t1;; 0 -~~~~~~~~~~~~~~~~~0 1993 1997 1993 1997 1993 1997 Canada Mexico United States Sourrce: Data are from World Bank (2000b). on automotive products and components, thus allowing Ford, Chrysler, and General Motors to rationalize their North American production sys- tem. The agreement included provisions to ensure an equitable market share for Canadian production plants. The importance of this Auto Pact in shaping U.S.-Canada trade relations is evident in the fact that auto- motive products now dominate U.S.-Canada trade. More generally, a trade regime in which intra-industry trade and trade in intermediate goods play prominent roles emerged as a result of that agreement. More comprehensive trade liberalization was achieved under another NAFTA precursor, the Canada-U.S. Free Trade Agreement of 1988 (CUSFTA), which was intended to phase out by 1998 all Canada-U.S. tariffs. While CUSFTA served as a model for the removal of barriers to trade in services, transportation services were not covered under CUSFTA because the United States was still implementing a broad program of TRANSPORT AND TRADE IN THE NotEm AMERICAN FREE TRADE AGREEMENT 17 transportation deregulation and Canada was just beginning a similar program at the time under this agreement. Even before CUSFTA, Canada's international trade was dominated by its relationship with the United States. By 1998, the United States was the destination of 84 percent of Canada's exports (by value) and the ori- gin of 77 percent of Canada's imports. This fact, coupled with Canada's high ratio of trade to GDP, indicate the extraordinary degree to which the Canadian economy is dependent upon the U.S. economy. Table 2-2 breaks out Canada-U.S. trade by broad commodity groups, revealing a trade pattern quite different from the pattern in the late nine- teenth and early twentieth centuries, when Canada exported primary commodities and its industrial sector was poorly developed. At present more than 70 percent of Canada's exports to the United States are manu- factured goods, of which most are machinery and transportation equip- ment coming largely from the industrial provinces of Ontario and Quebec. U.S.-Mexican relations are based on shaky historical foundations. Mexico lost roughly half of its territories (including California) to the United States as the outcome of a war fought between the two countries in the 1840s. Subsequent U.S. intervention (sometimes of a military na- ture) in Mexican affairs led a succession of Mexican governments to be highly suspicious of their northern neighbor. Nevertheless, the Mexican economy is highly dependent on the United States, not only because of the size of the American market, but also because the American earn- ings of Mexican emigrants-both permanent and temporary-contrib- ute significantly to Mexico's aggregate income. The most important pre-NAFTA development in Mexico-U.S. trade relations has been the creation of "Maquiladora" assembly plants. Lo- cated in Mexico, these plants use mostly U.S. components and produce almost exclusively for the U.S. market. They permit American manufac- turers to use low-wage Mexican labor in the assembly phases of produc- tion that require relatively low skill levels. Under the customs provisions enacted by the U.S. and Mexican gov- ernments, Mexico allows U.S. components to enter duty-free and be held in-bond at the Maquiladora site, so long as the finished products are re- exported. Upon shipment from the Maquiladora, U.S. customs charge duty only on the Mexican value-added content of the assembled product. From the Mexican perspective, this system generates employment and income. From the U.S. perspective, it makes U.S. producers more com- petitive while preserving jobs in component manufacturing. Thus, de- spite the absence of any formal treaty, complementary U.S. and Mexican policy measures have created a mutually beneficial trade relationship. Due in large part to this system of production, exports from Mexico are primarily in the manufacturing categories (table 2-3). Despite the 18 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Table 2-2. U.S. Trade with Canada, 1993 and 1997 1993 1997 Millions Millions U.S. exports of dollars Percent of dollars Percent Food and live animals 5,573 5.5 6,879 4.5 Beverages and tobacco 148 0.1 320 0.2 Crude materials, inedible, except fuels 3,144 3.1 4,453 3.0 Mineral, fuels, lubricants, and related materials 1,257 1.2 2,420 1.6 Animal and vegetable oils, fats, waxes 89 0.1 229 0.1 Chemical and related products N.E.S. 8,419 8.4 13,093 8.7 Manufactured goods classified chiefly by material 12,431 12.4 19,652 13.1 Machinery and transport equipment 54,273 54.2 82,961 55.3 Miscellaneous manufactured articles 10,458 10.4 14,773 9.8 Other 4,397 4.4 5,344 3.6 Total 100,190 100.0 150,124 100.0 1993 1997 Millions Millions U.S. imports of dollars Percent of dollars Percent Food and live animals 4,899 4.4 7,434 4.4 Beverages and tobacco 1,138 1.0 823 0.5 Crude materials, inedible, except fuels 8,417 7.6 11,983 7.1 Mineral, fuels, lubricants, and related materials 11,772 10.6 17,908 10.7 Animal and vegetable oils, fats, waxes 219 0.2 379 0.2 Chemical and related products N.E.S. 5,499 5.0 9,514 5.7 Manufactured goods classified chiefly by material 17,765 16.0 27,336 16.3 Machinery and transport equipment 48,999 44.1 72,101 42.9 Miscellaneous manufactured articles 5,255 4.7 10,306 6.1 Other 6,958 6.3 10,266 6.1 Total 110,921 100.0 168,051 100.0 Source: U.S. Department of Commerce (various years). extreme economic differences between Canada and Mexico, the U.S.- Canada and U.S.-Mexico trade profiles are relatively similar. Both are dominated by intra-industry trade of manufactured goods arising from a high degree of integration with U.S. production systems. There is a fundamental difference, however, between these two bilateral trade re- TRANSPORT AND TRADE IN THE NORTH AMERICAN FREE TRADE AGREEMENT 19 Table 2-3. U.S. Trade with Mexico, 1993 and 1997 1993 1997 Millions Millions U.S. exports of dollars Percent of dollars Percent Food and live animals 2,460 5.9 3,074 4.3 Beverages and tobacco 150 0.4 82 0.1 Crude materials, inedible, except fuels 1,808 4.3 2,956 4.1 Mineral, fuels, lubricants, and related materials 1,044 2.5 2,006 2.8 Animal and vegetable oils, fats, waxes 212 0.5 375 0.5 Chemical and related products N.E.S. 3,470 8.3 6,343 8.9 Manufactured goods classified chiefly by material 5,529 13.3 9,319 13.1 Machinery and transport equipment 19,760 47.5 35,810 50.2 Miscellaneous manufactured articles 5,361 12.9 8,394 11.8 Other 1,843 4.4 3,019 4.2 Total 41,635 100.0 71,378 100.0 1993 1997 Millions Millions U.S. imports of dollars Percent of dollars Percent Food and live animals 2,680 6.7 3,917 4.6 Beverages and tobacco 320 0.8 704 0.8 Crude materials, inedible, except fuels 652 1.6 978 1.1 Mineral, fuels, lubricants, and related materials 4,869 12.2 8,449 9.8 Animal and vegetable oils, fats, waxes 27 0.0 29 0.0 Chemical and related products N.E.S. 772 1.9 1,551 1.8 Manufactured goods classified chiefly by material 2,903 7.3 6,642 7.7 Machinery and transport equipment 20,732 51.9 47,312 55.1 Miscellaneous manufactured articles 5,245 13.1 12,953 15.1 Other 1,730 4.3 3,337 3.9 Total 39,930 100.0 85,872 100.0 Source: U.S. Department of Commerce (various years). lationships. U.S.-Canada trade is between two highly developed coun- tries and is therefore comparable to the intra-industry trade between mem- bers of the European Community (EC). By contrast, economic integration between the United States and Mexico is of a specific form dictated by the large differences in wage and skills levels between the two countries. 20 INTEGRATION OF TRANSPORT AND TRADE FACILITATION In assessing the potential and progress of NAFTA, it is important to keep in mind trade history. NAFTA was introduced at a time when a particular form of trade involving industrial complexes that span the borders between the United States and its two neighbors had already evolved over a period of decades. (Trade between Canada and Mexico is still very small.) Thus NAFTA creates an opportunity to expand and extend trade relationships that are already well established. Overview of NAFTA NAFTA is a highly comprehensive trade area agreement. It covers not only tariff elimination but also a number of highly contentious issues, including nontariff barriers, direct foreign investment, trade and ser- vices, government procurement, and intellectual property rights. Despite its broad scope, the agreement contains a variety of exceptions and safe- guard measures. One of the most important aspects of NAFTA is its pro- visions for dispute resolution. Tariff Elimination. NAFTA requires all tariffs on industrial goods to be eliminated within ten years of its implementation date (that is, by 2004). A few Mexican tariffs on agricultural goods will be eliminated over a fifteen-year period. Since NAFTA does not impose common external tariffs, transparent rules of origin prevent any fourth country from reducing tariff burdens by exporting to one NAFTA partner and then re-exporting to another partner with a higher external tariff. NAFTA content rules prevent trans- shipment of goods after only minor processing. Despite the basic prin- ciple that all tariffs should be eliminated, safeguard provisions allow any NAFTA partner to reinstate its tariffs if imports cause serious injury to a domestic industry. Nontariff Barriers. Administrative nontariff barriers, such as the issu- ing of import licenses that can effectively act as quotas, are eliminated under NAFTA. While accepting that technical product standards may vary across countries, NAFTA stipulates that they not be used as ob- stacles to trade. Specific provisions include the right of firms in one coun- try to participate in the standard-setting procedures of another and appointment of a committee to promote the harmonization of standards. Trade in Services. NAFTA allows free trade in the majority of service sectors. Major exclusions include marine and air transportation and ba- sic telecommunications. The fact that services are "covered" under NAFTA does not mean that all restrictions to trade have been eliminated. TRANSPORT ANTD TRADE IN THE NoRTH AMERICAN FREE TRADE AGREEMENT 21 For example, as we explain later in this chapter, the definition of land transportation as a tradable service under NAFTA does not mean that all restrictions to cross-border truck and rail operation have been removed. Investment. Under NAFTA, foreign and domestic investors have the same rights in most cases. Certain sectors are exempt, including mari- time and telecommunications, and each country may prohibit foreign investment in specific activities based on national security. Because of provisions in the Mexican constitution, the energy sector and railroads are exempt in that country Government Procurement. NAFTA significantly expands the opportu- nities for firms in one country to bid on government contracts in an- other. Significantly, Mexico's state-controlled industries (oil and gas, electricity) are opened up to foreign procurement. A variety of restric- tions, such as small and minority business set-asides in U.S. government contracts, remain. Personnel. NAFTA does not provide for free movement of labor across borders. It does, however, make it easier for businesspeople to move between countries, so long as it is on a temporary basis. Dispute Resolution. One of the most important features of NAFTA is the establishment of fair, transparent, and timely resolution of disputes. NAFTA panels can be convened to settle disagreements concerning the application of rules of origin, NAFTA content rules, or the application of antidumping measures. NAFTA panels also have authority over disputes related to environmental practices in border areas. Transportation and Trade Facilitation under NAFTA Under NAFTA, the production and transportation firms in the United States, Canada, and Mexico have begun to rationalize their production and logistical systems to suit a single North American market. This drive for rationalization and increasing trade have generated, in turn, demand for more economic harmonization and fewer obstacles to free trade. Some aspects of transportation, however, still impede free trade. In transportation NAFTA sought to make U.S.-Mexico transborder operations comparable to U.S.-Canada operations. Reciprocal entry in the trucking industry was to be permitted until December 1995 to zones in border states, later to border states, and by 2000 to all states and all over Mexico. Yet more than half a decade into NAFTA, in transborder 22 INTEGRATION OF TRANSPORT AND TRADE FACtLITATION traffic there remain many subtle and not so subtle barriers that translate into higher costs. Why is this so given the convergence since the 1970s in economic regulation and the liberalized environment for transport in the three countries-particularly between the United States and Canada where the business practices are similar and the infrastructures are compatible? It is worth noting that the three countries have domestic transporta- tion systems that reflect their differing public policy and regulatory re- gimes. The technical and safety-related regulations (for example, vehicle size and weight standards) that have developed in each country over the years to govern domestic transportation are divergent enough to provide barriers to transborder traffic. Many of these standards are complex and multidimensional. To resolve inconsistencies requires con- siderable effort. The work of the Land Transportation Standards Sub- committee (LTSS) is a case in point. Reform of the elaborate and divergent economic regulations govern- ing transport in the three countries has been a prerequisite for the pro- motion of a seamless cross-border freight flow. In North America, transport deregulation and privatization have complemented trade lib- eralization in an effort to promote transport integration. Despite the eco- nomic regulatory reform that has occurred in Canada, Mexico, and the United States, economic regulation in the form of cabotage rules contin- ues to hinder efficient transborder operations. Activities in nontransport matters (such as interdiction of drugs, pests, and diseases, and illegal immigration) lead to time-consuming border inspections. The rest of the chapter explores these nontariff barriers. It details their nature and complexity, their current status, and the steps that are being taken to lower nontariff barriers and mitigate their effects. Economic Deregulation: Prerequisite for Seamless Cross-Border Transportation The public policy regimes in transport in North America have included a high level of economic regulation for nearly a century. Transportation carriers, which are integrated with fixed facilities and vehicles and enjoy network economies, were able to engage in monopoly pricing, market segmentation pricing, and similar actions that seriously disadvantaged shippers and communities. Since 1887, when the Interstate Commerce Commission (ICC) was cre- ated, the United States has regulated railroads to ensure a normal rate of return to them on their assets while balancing the advantages of ship- pers and equity of service to communities. To this end the ICC engaged in elaborate control of investment, pricing, and operations in the rail- road industry. It specified the conditions of entry and exit, and it created TRANSPORT AND TRADE IN THE NORTH AMERICAN FREE TRADE AGREEMENT 23 a complex rate structure, and even rules of operations. During the 1930s similar economic regulation was extended to motor carriers and airlines. Canadian carriers have also been subject to economic regulation, though more lightly than U.S. carriers and predominantly at the provincial level. Mexico also regulated through the award of transport concessions, the grant of route capacity, and freight rate structures. By the 1970s the adverse effects of such intrusive regulation had be- come very evident in the poor financial performance of U.S. railroads and high truck rates in the LTL (less than truckload) sector. Economic analyses have shown that price and entry regulations introduce ineffi- ciency by creating a vicious cycle of artificially high prices, high service quality competition, and the resultant losses due to raised costs (Dou- glas and Miller, 1974). Three sets of such regulatory distortions have proved costly. First, in both road and rail, rates were set above marginal costs-costing the economy $1 billion annually (Winston, 1985). Second, the entry and exit regulations cost the carriers dearly: the prohibition on railroads exiting from poorly performing lines led to annual production cost inefficiencies of $2.5 billion (Winston, 1985). Third, restrictions such as disallowing backhauls and designation of routes led to X-inefficiency costs of several billion dollars (Winston, Corsi, and Grimm, 1990). The restrictions also hindered productivity growth, technical change, and improvement of service quality The resulting drive for deregulation led in short order to regulatory reform in the United States of airlines (1978), railroads (1980), and mo- tor carriers (1980). Entry conditions were eased; freedom to price was promoted; reliance on the market and competition were encouraged. Canada followed suit with passage of the National Transportation Act of 1987 (NTA), the Shipping Conferences Exemption Act (SCEA), the Motor Vehicle Transport Act, and amendments to other legislation such as the Railway Act. In Mexico transport was deregulated in the late 1980s as part of an economic restructuring intended to promote domestic investment- friendly policies. Liberalization of the motor carrier industry occurred in 1989. This permitted greater pricing freedom, opened the market to private carriers, and allowed Maquiladora operators to use their own fleets to move goods in both directions. Major changes occurred in the United States in the conduct, perfor- mance, and structure of airlines, trucking, and railroads after deregula- tion-more competition among all modal carriers, lower prices, wider service offerings, and new entry into most geographic and product mar- kets (figures 2-2 and 2-3). Carriers have been able to rationalize their networks, improve the efficiency of their operations, and set rates in line with competitive market conditions. There was a significant change in 24 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Figure 2-2. Operating Costs of Less-than-Truckload and Truckload Carriers, Selected Years, 1977-95 Costs in 1995 dollars per vehicle mile 6 g Less-than-truckload carriers 5 * Truckload carriers 4 3 0 1977 1987 1993 1995 Year Source: Morrison and Winston (1999). the cost structure of the railroad industry following deregulation, with productivity growing at well over 2 percent a year (Bereskin, 1996). Several studies have shown that average airfares (in constant dollars) have fallen since 1978, and competition stays rigorous on most city-pair routes, though concentration has gone up in the industry (U.S. General Accounting Office, 1990; NRC, 1991). U.S. domestic airfares adjusted for distance have been consistently lower in the past two decades than in Europe, Asia, or the world (figure 2-4). Shippers, confronting technological change and globalization, have begun to coordinate their production activities more effectively with their transportation services. Productivity gains have resulted. The experi- ence in Canada since 1987 has been broadly similar, with competitive pressures lowering rates in international air traffic, railroads, and truck- ing (figure 2-5.) Trucking deregulation in Mexico in 1989 increased com- petition and lowered rates-29 percent lower a few years later (Strah, 1995). It also promoted expansion of intercity routes and the vehicle fleet. TRANSPORT AND TRADE IN THE NORTH AMERICAN FREE TRADE AGREEMENT 25 Figure 2-3. Railroad Operating Costs per Revenue Ton-Mile, 1980-95 Costs in 1995 dollars per ton-mile 0.06 0.05 0.04 003 0.02- 0.0l x0 x0 x cox x ooco cc co oO 0o 01 cr, 0 ON a aS Oe a \ a, U a ar C7 a oE CD a C -dear Source: Morrison and Winston (1999). One class of these barriers pertains to the remaining economic regula- tion, in particular, cabotage. Cabotage refers to the ability of foreign ve- hicles and labor to transport goods within a country. The cabotage rules and regulations that limit the freedom of foreign transportation carriers instituted by customs and immigration departments are typically sym- metric. Such rules involve the use of labor and equipment of one coun- try in the other. For example, foreign drivers cannot carry domestic freight, and the use of foreign equipment is restricted to domestic move- ments that are incidental to international movements. The existence of these cabotage-rule barriers increases the cost of transborder transport. Railroads are less affected by cabotage restrictions, though they, too, in- cur additional costs because of the need to change crews at the border. U.S. restrictions on trade in domestic water transportation represent another cabotage barrier. In the large, multicoastal U.S. economy, for- eign participation in its intercoastal trade is restricted by the 1920 Jones Act. The Jones Act-justified by the need to secure a sufficient merchant 26 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Figure 2-4. Difference between International Fares (U.S.-Foreign) and U.S. Domestic Fares Adjusted for Distance, Selected Years, 1978-96 Fare difference (percent) 100 90 - Asia 80 , N _ 70 / ' 60 1 50 -''.XEurope 40 30 'Wo_-rl,,d / 10 --------' - 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 Year Source: Morrison and Winston (1999). marine capacity for U.S. defense needs-reserves the shipping cabotage traffic to U.S.-built and registered ships that are predominantly owned and crewed by U.S. nationals. The U.S. maritime carriers and other stake- holders have excluded these provisions from the GATT and NAFTA. The Jones Act permits domestic shippers to levy rates substantially above comparable world prices, effecting thereby a massive transfer from U.S. users of water transport to U.S. maritime carriers-a welfare cost around $3 billion in 1989 according to an analysis of the Jones Act (Francois and others, 1996). Aviation is an important component of foreign trade. In 1995 it ac- counted for $355 billion or 27 percent of U.S. trade-60 percent of which is hauled in U.S. carriers (U.S. General Accounting Office, 1996). The rapid growth in international air freight services reflects the emergence of global systems of producing and distributing goods and the associ- ated "just-in-time" inventory and supply chain management systems. Such services are handicapped, however, by the bilateral international aviation agreements that specify traffic rights-the routes, the number TRANSPORT AND TRADE IN THE NORTH AMERICAN FREE TRADE AGREEMENT 27 Figure 2-5. Canadian Railroad Costs, 1980-91 Costs in 1986 cents per revenue ton-mile 6 Canadrian National Rail 4 3 2 1- o I I 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 Year Source: IBI, Consulting. of flights on each route, and the number of airlines that can fly them. "Open skies" agreements recently negotiated by the United States with European countries, such as Germany and the Netherlands, have re- laxed such restrictions on transborder airline traffic. In 1995 the United States and Canada signed the Open Skies Agreement under which carri- ers in each country were given full access to destinations in the other, procedures for international fare approval were streamlined, and gates at some of the busiest U.S. airports were dedicated to Canadian flights. The agreement extended both to passenger and all-cargo air services. The agreement with Mexico (1991) is not "open," but it liberalized trade to include open routes, no capacity restrictions, freedom to transfer cargo for "onward flights," and operational flexibility. The agreement restricted the number of airlines allowed to operate (one on any city pair segment) as well as double approval pricing. As economic regulatory barriers fall, cabotage and other barriers re- main (for example, technical regulations governing vehicle size and weights, driver certification and hours of service, and safety). As the 28 INTEGRATION OF TRANSPORT AND TRADE FACILITATION rules on these matters diverge in the different countries (because of past national decisions on bridges, infrastructure, or social and political is- sues governing transport), the resulting inefficiencies in transborder ar- eas will spur the demand for uniformity and harmonization. Inconsistencies in transport regulations between countries that are part of a Free Trade Area will generate economic inefficiencies and disparate opportunities, thereby generating demand for harmonization. As pro- duction and transportation firms in all three countries rationalize their operations across the NAFTA region, transport nontariff barriers will cause inefficiencies and spur political demand for their relaxation. Be- cause transportation carriers are required to operate around these re- strictions, they have the direct effect of higher costs; the long-term indirect effect would be less competitive and efficient activities in the logistics industry and the consequent loss of productivity in the NAFTA region. Rules of the Road: The Complex Problem of Technical Regulation In addition to economic regulation, transportation is subject to a host of technical regulations and standards. These include: * Size and weight regulations for trucks * Size, weight, and other technical standards for locomotives and other railroad stock * Age, language, licensing, and health regulations for vehicle operators * Conventions for road signs and traffic signals * Procedures for ensuring vehicle safety * Procedures governing transportation of hazardous goods. In all of these cases, the three NAFTA partners have different regula- tions, standards, and procedures that have evolved over many years. Consequently, the cost of moving goods across borders is higher than the cost of moving the same goods the same distance domestically. This is one form of nontariff barrier. Inconsistencies in truck size and weight regulations are a good ex- ample. These regulations are imposed for two reasons. The first is that excessively large vehicles will not operate effectively in mixed traffic streams, resulting in congestion, delays, and accidents. The second is that oversized vehicles result in accelerated wear and damage to road infrastructure and may result in the failure of bridges. Truck size and weight regulations can be complex. For example, regu- lations may specify not only the gross weight of the truck, but also the weight per axle, the way the weight is distributed to the front and back axles, and the distance between the axles. Truck length regulations may TRANSPORT AND TRADE IN THE NORTH AMERICAN FREE TRADE AGREEMENT 29 Table 2-4. Maximum Gross Vehicle Truck Weights in the NAFTA Countries (kilograms) Truck type United States Canada' Mexico Tractor-Semitrailer (5 axles) 36,288 39,500-41,500 44,000 Tractor-Semitrailer (6 axles) 36,288 46,500-53,000 48,500 Double trailer (6 axles) 36,288 47,600-43,500 47,500 a. Range of provincial regulations. Source: North American Free Trade Agreement Land Transportation Standards Sub- conunittee, October 1997. specify overall length, the length of tractor and trailer independently, or even the length of the trailer beyond the back-most axle. Unfortunately, there are significant inconsistencies in these regulations in the three NAFTA partners. Even on the most basic dimension-gross truck weight-there is no consistency (table 2-4). The United States lim- its all trucks to a gross weight of 36,288 kilograms (80,000 pounds). Both Mexico and Canada allow higher weights for all categories of trucks, and they increase the weight limit for trucks with more than the stan- dard five axles. This inconsistency is due mainly to conservative assump- tions by U.S. officials about the maximum weight that can be supported by bridges. To make matters worse, different regulations may apply in different places. For example, Canadian regulations are set at the provincial level, and despite recent efforts at standardization some variation remains across provinces. There are also some state-level variations in the United States, and different regulations apply on different parts of the highway network. (This is especially true for regulations applying to trucks haul- ing more than one trailer.) These inconsistencies can add significantly to the cost of cross-border transportation. Indeed, some Canadian trucking firms must maintain separate fleets of trucks for shipments into the United States and for domestic shipments (Prentice and Wilson, 1998). Each country must en- sure that trucks entering its territory are not in violation of its rules. This implies border inspections, which add to the cost of border operations and may contribute to costly border delays. Recognizing the potential problems arising from inconsistencies in technical regulation of transportation, policymakers added a provision to NAFTA that established the Land Transportation Standards Subcom- mittee with responsibility for harmonization in all of the categories of technical regulation listed earlier. To date, significant progress has been 30 INTEGRATION OF TRANSPORT AN-D TRADE FACILITATION made in the regulation of vehicle operators and in harmonization of road signs and signals. The issue of safety compliance, especially with refer- ence to Mexican trucks coming into the United States, still presents prob- lems, as we explain later in this chapter. A special working group has concluded that complete harmoniza- tion is probably an unrealistic goal for a number of reasons. For one thing, carriers in all three countries have considerable investments in fleets designed for compliance with national regulations. Infrastruc- ture design and construction in each country are based on assump- tions that embody the national regulations. Finally, as with any question of harmonization, there is an important political dimension. Since in- ternational freight accounts for a relatively small percentage of truck- ing activity in the United States, the U.S. government is unlikely to change its regulations substantially. The other two partners, however, may see the adoption of U.S. rules as tantamount to sacrificing their political autonomy. Borders as Barriers Border crossing areas may be subject to long delays. This is partly be- cause most national frontiers are crossed by a relatively small number of road and rail links, resulting in traffic bottlenecks. Furthermore, inspec- tion and documentation activities that must occur as vehicles cross the border are time consuming. If delays at borders are long enough, they can add significantly to transport costs. Labor must be paid, and valu- able vehicle capital must sit idle while waiting at the border crossing. Canada and the United States have traded large volumes of goods for a number of decades, and in the process both governments have worked cooperatively to develop relatively efficient border-crossing routines. The border crossings along the U.S.-Mexican frontier are plagued by long delays, and many Mexican trucks must be sent back due to violations of various U.S. regulations. Large volumes of freight movement at the U.S.-Mexican border are a more recent development, so there has been less time to work out the kinks. Illegal immigration and the transport of drugs in commercial ve- hicles also are major concerns. Finally, the Mexican truck fleet is in a relatively poor state, and Mexican carriers and drivers are not well in- formed on U.S regulations, so many trucks fail inspection. The situation along the Mexican border has presented a major im- pediment to full implementation of NAFTA provisions. NAFTA speci- fies a timetable for providing full freedom of truck movement across the U.S.-Mexican border. Initially, Mexican trucks were allowed to operate only in a relatively small commercial zone extending a few miles into TRANSPORT AND TRADE IN THE NORTH AMERICAN FREE TRADE AGREEMENT 31 the territory of the four states that border Mexico. (Mexican goods bound for destinations outside this zone must be transferred to American trucks.) The NAFTA agreement set a deadline of December 1995 for Mexican trucks to be allowed to make deliveries throughout the territories of the border states and U.S. trucks to have similar access to Mexican border states. Mexico and the United States were to have an arrangement simi- lar to the one that now exists between Canada and the United States. The 1995 deadline was delayed to 2000, but as of this writing, the access for Mexican trucks that was planned for 2000 had not yet been granted. The main reason for this delay is that the U.S. government and espe- cially the governments of the bordering states fear that Mexican trucks will not meet U.S. regulations and may therefore cause accidents and damage infrastructure. This would not be a problem if effective surveillance could be applied to prevent noncompliant trucks from entering the United States. The inspection process, however, must necessarily be highly complex because various federal agencies (Customs, Immigration and Naturalization, Department of Agriculture, Food and Drug Administration) all have concerns about what may cross the border in trucks. Inspection of the trucks themselves (as opposed to their contents or personnel) comes un- der the jurisdiction of state Departments of Transportation, which re- ceive limited assistance from the U.S. Department of Transportation. The checking by border states of trucks for size and weight violations and for safety violations (such as worn tires, improperly secured loads, inadequate brakes) is handicapped by the few inspectors assigned and by the micro infrastructural facilities available. With these limited facili- ties it is only possible to conduct spot inspections. As a result of these spot checks, roughly 50 percent of the trucks inspected have been put out of service due to some violation. Therefore, it is not surprising that state officials are reluctant to allow Mexican trucks to travel farther into their territories until either a more stringent inspection process can be put in place or a much lower rate of violation can be observed in spot checks. There is considerable potential for new information and communica- tion technologies that come under the general heading of Intelligent Transportation Systems (ITS). These systems can speed border crossings by eliminating much of the need for paper handling. They facilitate re- mote reading of truck identification and cargo information and basic checks on weight, length, height, and width while the truck is in motion. In addition, electronic databases can be used to identify trucks and driv- ers with previous violation histories so that inspection efforts can be con- centrated on them. Cooperative efforts are now under way to encourage the Mexican government to follow domestic inspection procedures that are more con- 32 INTEGRATION OF TRANSPORT AND TRADE FACIULTATiON sistent with U.S. procedures. The objective of these efforts is to bring the general condition of the Mexican fleet up to a level where U.S. officials will permit it to have broader access to U.S. highways. Conclusion and Lessons Learned The high volume of trade in North America is not the result of a single free trade agreement. Rather, it has evolved over three decades due in large part to policies that have promoted the development of border- spanning industrial complexes, resulting in intra-industry trade of high value-added goods. In the case of Canada and the United States, this is the outcome of a sectoral trade agreement, the Auto Pact of 1965, while in the case of Mexico and the United States, it is the outcome of policies by both governments facilitating the development of the Maquiladora systems. Agricultural and resource commodities, which often figure prominently in public discussions of North American trade, make up a relatively small portion of the overall trade picture in the NAFTA area. In light of this, it would be a mistake to imagine that the level of eco- nomic integration observed in North America will swiftly improve when tariff barriers are eliminated in some other part of the world. NAFTA is essentially a means of eliminating remaining trade barriers to create opportunities to expand and extend already well-established trade relations. Despite the elimination of tariffs, truly "free" movement of goods across international frontiers is not a realty. Even if administrative nontariff barriers such as import licenses are removed and product standards are harmonized, a number of factors that are not normally associated with trade policy can create nontariff barriers that retard the cross-border flow of goods and prevent the full benefits of trade liberalization from being realized. In particular, factors that retard the integration of freight trans- portation systems within the free trade area and cause major delays in cross-border freight movements can serve as significant barriers to trade. In North America processes of transport deregulation and privatization have played complementary roles with trade liberalization to promote transport integration, but significant impediments to cross-border move- ment still remain. Areas of public policy that relate to border security (such as drugs and illegal immigration) also may pose major impedi- ment to free movement across borders. Among the specific lessons learned from the NAFTA experience are the following: * Some of the greatest potential for trade within a free trade area lies in intra-industry trade in high value-added goods arising from cross- TRANSPORT AND TRADE IN THE NORTH AMERICAN FREE TRADE AGREEMENT 33 border integration of manufacturing industries. This type of inte- gration may take decades to occur and may involve more than just the elimination of tariffs. It requires the development of an effec- tive cross-border transit facilitation system. * Inconsistencies in the economic regulation of transportation can im- pede the free movement of goods across borders. While in North America deregulation and privatization occurred in the years lead- ing up to NAFTA, some residual regulations-especially in the form of cabotage rules or restrictions on the movement of certain goods- still increase the costs of cross-border shipment. * Harmonization of technical standards, such as truck size and weight regulation, is a mundane issue that may not command much atten- tion while the free trade treaty is being negotiated. The complexity of this issue, however, means that it may take a long time to sort out once the agreement has been made. This should at least be recog- nized when implementation timetables are drawn up. * Agreement concerning technical standards is not enough. Methods of inspection and enforcement must ensure that each partner in the agreement adheres to the standards. Sufficient resources must be devoted to inspection activities at the border and elsewhere. * The need to prevent undesired movements across borders-as in the case of drugs or illegal immigrants-can result in long delays that add significantly to the costs of international shipments, and therefore constitute one of the most important barriers to trade. Coordination between different government agencies to speed up border movements is critical. * Factors that lead to delays at borders not only increase transporta- tion costs, but also make it impossible to reap the productivity ben- efits associated with timely delivery services, as in the case of just-in-time inventories. 3 Transport Integration in the European Union William P. Anderson The European Union (EU) is the oldest and most highly evolved of the regional trading blocs that have developed in the second half of the twen- tieth century' Comprising fifteen countries with combined populations of 375 million, it is of comparable size to the North American Free Trade Area (NAFTA). It has achieved, however, a much higher level of eco- nomic integration among its member states than has NAFTA. For one thing, there is much freer movement of labor across borders within the EU area than within the NAFTA area. Furthermore, EU member states must relinquish jurisdiction over a broader range of economic, social, and environmental policy areas. Given the large number of national borders within the EU area, the integration of transportation markets and infrastructure and the harmo- nization of transportation policies are important preconditions for achiev- ing free movement of goods and people. Establishment of a common transportation policy was a clearly stated goal in the founding docu- ments. Little progress was made, however, on transportation policy dur- ing the first three decades of the European Union's existence. A number of factors account for this-most notably the presence of state-owned suppliers of transportation services and the desire by member govern- ments to use transportation policy to promote their separate national economic programs. The picture has changed considerably in the period after 1986, during which the European Union has launched programs to open up national markets in transportation services to competition from all member states 1. "European Union" is the most recent name for what was once called the "European Economic Community" and later called the "European Community." 35 36 INTEGRATION OF TRANSPORT AND TRADE FACILITATION and committed billions to projects that link up national infrastructure systems. This transition from inaction to activism is interesting not only for the types of policies that it entailed, but also for the roles played by the EU's powerful supranational institutions in bringing it about. Historical Overview The European Union is an institution that rose from the ashes of the Second World War. Its genesis had as much to do with promoting peace through interdependence as with reaping the gains from trade envisioned in economic theory It evolved-as its early promoters had hoped it would-from a narrow sectoral and geographical jurisdiction to an economy-wide institution with members comprising most of the non- communist states of Europe. Its precursor organization was the European Coal and Steel Commu- nity (ECSC), founded in 1951 to promote free movement of iron and steel as well as related raw materials such as coal and ore across bor- ders. The impetus came from the French and German governments. They were joined by the Benelux countries (Belgium, the Netherlands, and Luxembourg), whose borders straddled critical iron and steel regions. The three nations had already established a custom union among them- selves. Italy, which was anxious to build connections with the rest of Europe, also joined. (These countries came to be known as "the Six.") The goals of the ECSC were to promote efficiency in the basic industries and to thwart the formation of national cartels. It also wanted to prevent France and Germany from clashing over access to critical industrial re- sources, as they had in the years leading up to the war. After a successful experiment with coal and steel, the governments of the Six embarked on a much broader integration project. The Treaty of Rome, which was signed in 1958, established the European Economic Community (EEC).2 Under the treaty the Six agreed to a common exter- nal tariff and the phased elimination of all tariffs on goods traded within the EEC over a period of twelve years. But the treaty went beyond these traditional trade liberalization measures. It reduced barriers to free move- ment of people, capital, and services; reduced nontariff barriers such as inconsistent technical standards; established common policies in the ar- eas of agriculture and transportation; and created two development in- stitutions: the European Social Fund and the European Investment Bank (McCormick, 1999). 2. A second treaty, also signed by the Six in 1958, established the European Atomic Energy ConmLmurity TRANSPORT INTEGRATION IN THE EUROPEAN UNION 37 Achieving the program of the Treaty of Rome was a time-consuming and uneven process. Gradual progress was made on the harmonization of technical standards and the removal of restrictions on international labor movements, but neither of these tasks could be considered com- plete at the end of the 1990s. The Common Agricultural Policy did not come into force until 1968, and an effective Common Transport Policy came much later (see below). Still, rapid growth in within-bloc trade and improvement in all devel- opment indicators attested to the success of the European Economic Community. During the 1970s and 1980s, other European countries saw the benefits of membership. After two vetoes by French governments under Charles de Gaulle, Britain's application for membership was fi- nally accepted, and Britain, Ireland, and Denmark became full members in 1973. Three Southern European Countries-Portugal, Spain, and Greece-were added in the 1980s, bringing the membership to twelve. Finally Austria, Sweden, and Finland joined in the 1990s, bringing the total to fifteen. Future enlargement is likely, especially since many former members of the Soviet bloc (such as Poland, Hungary, and the Czech Republic) have shifted their economic orientations to the West. Turkey, with its huge market and rapidly industrializing economy, is also anx- ious to strengthen its European ties through membership. Table 3-1 indicates that the enlargement of the EU area led to a more heterogeneous set of member states. The three new members from South- ern Europe (Spain, Portugal, and Greece) have per capita incomes far below those of either the Six or new members from the North. There is also significant variation in the importance of trade in national econo- mies. Total trade as a percentage of GDP is relatively low in Greece, Italy, Spain, and the United Kingdom when compared with Belgium, the Neth- erlands, and Ireland. All fifteen countries, however, trade at least 50 per- cent of both imports and exports within the Fifteen. The Treaty on European Union, signed in Maastricht in 1992, marked a major step toward greater and more general integration of the member states. While the EEC had addressed certain elements of social policy, such as common rules on labor hours and conditions, its actions were generally limited to those meant to promote economic integration. Un- der the 1992 Treaty, jurisdiction was extended to areas less directly linked to the economy, such as consumer protection, public health, education, and (with Britain opting out) social policy It also established the con- cept of European citizenship, allowing a national of any member state to live in any other member state, and set goals of achieving common poli- cies for immigration and refugee status. On the economic front it set up the process for the most ambitious of all steps toward full integration: the establishment of a common currency The 1992 Treaty is generally Table 3-1. Demographic and Economic Characteristics of the EU Fifteen, by Country, 1998 GDP per Total Population GDP capita Exports Percentage Imports Percentage trade as a Population growth (billions (thousands (billions of exports (billions of imports percentage Country (millions) (1990 = 100) of ECUs) of ECUs) of ECUs)' to EU 15 of ECUs)' to EU 15 of GDP EU 15 374.6 103.8 7,472.5 19.9 1,976.2 63 1,896.4 62 52 Belgium 10.2 103.1 223.6 21.9 159.5 76 148.8 71 138 Denmark 5.3 102.9 150.9 28.5 43.8 67 41.9 70 57 Germany 82 105.4 1,910.3 23.3 482.5 56 413.4 58 47 Greece 10.5 105 107.8 10.3 9.5 52 25 66 32 C., Spain 39.3 101.8 507.7 12.9 93.3 71 111.6 68 40 x0 France 58.7 105 1,274.5 21.7 286 62 274.5 68 44 Ireland 3.7 103 76 20.5 58.3 70 38.3 62 127 Italy 57.5 101.5 1,046.7 18.2 215.6 56 192.5 62 39 Luxembourg 0.4 113.2 15.5 38.8 Netherlands 15.6 106.5 336.7 21.6 191.1 79 179.1 57 110 Austria 8.1 106.2 189.9 23.4 57.2 64 62 74 63 Portugal 9.9 99.3 95.7 9.7 21.6 82 32.9 77 57 Finland 5.1 104.2 115.5 22.6 39 56 29.4 66 59 Sweden 8.8 105.5 202.6 23 74.5 57 60.5 69 67 United Kingdom 59 103.5 1,220.4 20.7 244.3 58 286.5 53 43 a. Values for Belgium and Luxembourg are combined. Source: European Commission (2000a, tables 1.3 and 1.4). TRANSPORT INTEGRATION IN THE EUROPEAN UNION 39 viewed as the date from which the "European Community" became the "European Union." Institutions of the European Union One factor that distinguishes the European Union from NAFTA is that the former is equipped with a set of powerful, supranational institu- tions that can make policy and even override the policies of member states. NAFTA has established independent review panels on domes- tic content rules and the environment, but they have narrow mandates, and most contentious issues must be addressed via intergovernmental negotiations. The most conspicuous of the EU institutions is the European Commis- sion, which is essentially the executive branch of the EU. There are twenty-two Directorates-General within the Commission with mandates for specific areas of administration such as external affairs, industry, environment, fisheries, and transport. These are assigned to a somewhat smaller group of Commissioners (some assume a portfolio of more than one Directorate). Commissioners are appointed by the member states, but they may not be members of the current government and must swear in their oath of office to put EU interests ahead of national interest. The Commission has a president who is appointed for a five-year term, re- newable once. In addition to its administrative responsibilities, the Commission ini- tiates all EU legislation. Bills are passed from the Commission to the European Parliament for approval and amendment. Since it does not have the power to initiate legislation, the Parliament is a relatively weak body It is, however, of symbolic importance as the only directly elected legislature of any supranational institution, and its powers have increased gradually, especially as a result of the 1992 Treaty. Final approval of legislation is by the Council of Ministers, which is made up of representatives of the member state governments. The com- position of this council actually depends upon the proposal under con- sideration. For example, legislation relating to the Common Transport Policy would be approved by the transport ministers of the fifteen states, while legislation relating to the Common Agricultural Policy would be approved by the agriculture ministers. The Council of Europe, compris- ing the heads of government (prime minister or president) from each member state, takes up very high level issues. The EU also has its own judicial institution, the European Court of Justice. The ECJ has the critical responsibility of ruling on whether the laws and actions of national governments are consistent with EU law and whether laws implemented by the EU according to the legislative 40 INTEGRATION OF TRANSPORT AND TRADE FACILITATION process described above are consistent with the Treaty of Rome and all later EU treaties. History has shown that the European Court of Justice plays a critical role in bringing the goals expressed in the treaties to frui- tion. This is especially true in the case of transport policy, which is dis- cussed below. While these supranational institutions give the EU a degree of author- ity that is greater than that of other trade blocs, its power is limited by the principle of subsidiarity, which prevents the EU from interfering in policy decisions that can be taken effectively at the national level. As already stated, however, the range of policy areas where joint decisionmaking is considered more effective has expanded steadily throughout the history of the EU. Transportation in the European Union The goal of establishing a common transportation policy was stated ex- plicitly in the Treaty of Rome. For almost thirty years, however, many observers viewed harmonization of transportation systems within the EU as a conspicuous failure (Button, 1993; McCormick, 1999; European Commission, 1999). Before reviewing the reasons for this situation and the corrective actions that have been taken in recent years, we offer some background on transportation within the EU Fifteen. Commercial transportation services account for approximately 4 per- cent of the combined GDP of the EU Fifteen. This rises to 7 percent if own-account operations and private transportation are included, mak- ing transportation larger than either the agriculture or steel sectors (Eu- ropean Commission, 1999). But this understates the general importance of transportation in the EU economy, as high-quality freight and passen- ger service between member states play critical roles in realizing the economic benefits of increased economic integration. Figures 3-1, 3-2, and 3-3 provide a statistical overview of the level and modal distribution of transportation activity related to movements within the EU. (Figures 3-1 and 3-2 include U.S. domestic transportation data for the purpose of comparison.) Figure 3-1 indicates that despite the fact that the population of the European Union is greater than that of the United States, the level of internal personal transportation (measured in passenger kilometers) is higher in the United States. This reflects in part the more compact settlement pattern in the EU and is probably also at- tributable in some measure to lower rates of car ownership and other factors affecting personal mobility. While passenger car travel is domi- nant in both, rail and public transit have larger shares in the European Union, while air travel is more important in the United States. Unlike in personal transportation, rail plays a smaller role in EU freight transportation than it does in U.S. freight transportation (figure 3-2). On TRANSPORT INFEGRATION IN THE EUROPEAN UNION 41 Figure 3-1. Passenger Transport within the European Union and the United States, 1997 Billions of passenger kilometers 8,000 7,000 _ 6,000 - * Tram/metro 5,000 _ _ Railway 4,000 - * Bus/coach 3,000 - 2,000 - O Passenger car 1,000 r 0- European Union 15 United States Source: European Commission (2000a, table 9.4). the other hand, a much higher proportion of EU goods is shipped by sea. (Note that sea transportation here refers only to domestic and inter- EU shipments.) The evolution of this modal breakdown for freight is illustrated in figure 3-3. Total ton kilometers roughly doubled between 1970 and 1997, with nearly all the growth occurring in two modes: road and sea. The decline of rail in both relative and absolute terms reflects a large measure of substitution of road transportation for rail. It may also be the case that the relatively poor level of interoperability among national rail- ways has prevented rail from capturing a significant share of the rapidly growing intercountry trade. One likely explanation for the growth of sea transportation is the addition of the United Kingdom, Ireland, Swe- den, and Finland, all of which trade with the rest of Europe primarily by sea. The addition of Portugal, Spain, and Greece probably contributed to this trend because of the limits on land transportation across the Pyrenees and Balkans. 42 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Figure 3-2. Freight Transport within the European Union and the United States, 1997 Billions of total metric ton kilometers 6,000 Sea 5,000 * Oil pipeline 4,000 - O Inland navigation 3,000 Rail 2,000 - Road 1,000 _ 0 European Union 15 United States Source: European Commission (2000a, table 9.4). Creating an integrated transportation system within the EU area re- quires progress on three interrelated objectives: interoperability, free market access, and interconnection. Interoperability refers to the har- monization of technical standards for infrastructure elements ranging from rail gauge to air traffic control systems as well as rules applying to service providers such as truck size and weight restrictions. Free market access refers to the removal of restrictions that prevent providers of trans- portation services based in one member state from operating in another. Interconnection refers to the problem of linking up national infrastruc- ture networks. Connections among these networks were relatively sparse because many borders coincide with physical barriers such as moun- tains, rivers, and seas. The lack of connections also reflects the fact that national networks have been developed primarily to meet the domestic needs of member states. The reasons for slow progress in achieving these goals are varied, but most relate to the traditional mandate of national governments in trans- TRANSPORT INTEGRATION IN THE EUROPEAN UNION 43 Figure 3-3. Goods Transport within the European Union, 1970-97 Billions of total metric ton kilometers 3,000 Sea 2,500 *Pipelines 2,000HInland waterway 1,500 URail 1,000 EH Road 500 0 1970 1980 1990 1997 Source: European Commission (2000a, table 4.2). portation policy and their unwillingness to transfer authority to the EU. For example, nearly all national governments were owners of major trans- portation suppliers, including railways and airlines, and therefore they had interests in preserving their local monopoly powers. Furthermore, transportation policy is frequently used as a means of pursuing national economic goals. The role of subnational and even local governments in transportation complicates the process of harmonization further. Thus, the member states had some interest in preserving the status quo of policy fragmentation. By the 1980s, groups representing consumers of transportation ser- vices who were increasingly frustrated with high costs and poor quality began to bring both political and judicial pressure on the European Union to take action. In 1985 the European Court of Justice had ruled that the European Commission had failed to act appropriately to implement the Common Transport Policy required under the Treaty of Rome. This rul- ing related specifically to opening up national transportation markets to 44 INTEGRATION OF TRANSPORT AND TRADE FACILITATION suppliers from other member states, but it marked a major turning point after which the Commission and Parliament became more active in all aspects of transportation policy Between 1987 and 1992 major new legislation was enacted regarding air, marine, road, rail, and inland water transportation. This legislation dealt mostly with issues of market access and interoperability, as well as common work rules for transportation employees. In the 1990s, how- ever, the Commission began to focus more on issues of interconnection. For example, a 1993 White Paper on growth, competitiveness, and em- ployment emphasized the transformations in production systems, meth- ods of organizing work, and consumption patterns that were already being adopted in North America and Asia. Economic fragmentation and adherence to traditional practices made it difficult for European busi- nesses to manage complex value chains and spawn small innovative firms, placing the EU in a weak competitive position vis-A-vis other major production regions. Repeating a goal that had already been enshrined in the 1992 Treaty on European Union, the White Paper called for the development of inte- grated and complementary information, transportation, and energy Trans-European Networks (TENs). This led to the announcement in 1994 of a major infrastructure program specifically geared to filling gaps in the existing European transportation networks. Interoperability Achieving interoperability in transportation systems involves two re- lated tasks. The first is to see that all new infrastructures incorporate a common set of design standards. The second is to ensure that equip- ment and employees operating on existing infrastructure meet a com- mon set of technology and safety standards. The program for achieving interoperability in high-speed train (HST) networks is an example of the first task. Because most ongoing HST projects receive some support under the TEN program (see below), the European Union is well placed to ensure consistency of technical standards. However, under the "new approach" to interoperability, the goal is to establish only those common standards that are necessary to achieve a smooth interface between systems, rather than stifle innovation by insisting on a full set of common specifications. A body known as the European Association for Inter-operability is charged with proposing an appropriate set of Technical Specifications for Interoperability (TSI). This body is made up of representatives from railways and related industries, rather than officials from either the Com- mission or member state governments. The TSI are submitted to the TRANSPORT INTEGRATION IN THE EUROPEAN UNION 45 Commission, which approves them after consultation with an expert committee (European Commission, 1999, Doc. 1.1.2). Adopting and enforcing a common set of road vehicle weight and dimension standards are preconditions for interoperability. A new set of standards was adopted in 1996 to apply to vehicles operating through- out the EU. These include the maximum length, height, and weight for different categories of trucks, including "road trains" that can be as long as 18.75 meters and weigh up to 44 metric tons (European Commission, 1999, Doc. 2.13.1). Given the complex nature of these regulations, checks at borders to ensure that incoming trucks meet regulations can be time consuming. Given the high level of harmonization of EU standards, however, it has been determined that such checks are no longer necessary Since all EU trucks must conform to common standards, there is no reason to treat domestic and foreign trucks any differently. Thus foreign trucks can be subjected to the same spot-checking procedures that are used for do- mestic trucks, and authorizations for cabotage can be checked at the same time. Border checks for control of both authorization and size and weight rules were eliminated at the end of 1989 (European Commission, 1999, Doc. 2.11.1). Market Access Rules of market access for transportation services have been conten- tious since the inception of the EU. The final language of the Treaty of Rome left considerable room for interpretation. For example, while the Treaty committed the member states to a Common Transport Policy, it did not call for a common market in transportation. Also, specific ref- erence was made only to road, rail, and inland waterways, leaving the impression that air and sea transport were excluded from EU control. Furthermore, competition (antitrust) rules contained language exclud- ing transportation. Air transportation is an especially interesting case. Until the 1980s, all member states had ownership interests in national flagship airlines. These airlines had long been considered instruments of national economic policy, and influential public sector unions dominated their labor forces. Furthermore, national airlines were a matter of prestige for most states. Member states were loath to allow competition that might threaten the viability of national flagship carriers, despite the fact that most of them lost money Regulation on intercountry service was handled via bilateral arrange- ments whereby the two national governments designated carriers, de- fined timetables, set fares, and divided the revenues (O'Reilly and Sweet, 46 INTEGRATION OF TRANSPORT AND TRADE FACILITATION 1998). For the most part, independent carriers were closed out of these routes. Foreign carriers were given access only to major national air- ports, with service to regional airports limited to national carriers. Impetus for change came primarily from business groups, which ar- gued that the poor quality and high cost of air travel within the Euro- pean Union was a major barrier to economic integration and global competitiveness. They had a sympathetic ear in the European Commis- sion: its 1979 attempt to institute a program of airline liberalization had been thwarted by the member states. By the middle of the 1980s, busi- ness groups also had the support of two member governments-the United Kingdom and the Netherlands-that had begun their own de- regulation initiatives. An example of the objections of member states is provided by Greece, which argued that economic, regional development, and security priori- ties depended upon year-round service between the mainland and the Greek islands. If independent operators were allowed into this market, they would offer services only during the lucrative summer tourist sea- son, leaving the unprofitable months to the national carrier. A key event in the breakdown of the old system came when the French government prosecuted some independent airlines offering domestic services below the regulated fares. A French court referred the case to the European Court of Justice, which found that although air travel was protected from some elements of competition policy, it was not com- pletely immune and that the European Commission had some authority regarding airline practices. In the aftermath of this decision, the Commission attempted for the second time to reform air travel. It did not propose a wholesale Ameri- can-style deregulation, but rather that national regulation regarding in- tercountry flights be removed in favor of a EU regulatory regime. Under a new set of rules agreed upon in 1987, many of the old restrictions re- mained, but avenues for greater competition were created including: * permission for carriers to offer restricted service with fares dis- counted below the reference rate approved by the two member states; * a requirement that each state permit more than one airline from another state access to its airports (although not necessarily more than one to the same airport); * under some restrictions, permission for carriers to offer service to a regional airport in another country; and * under carefully controlled circumstances, permission for an airline from one country to provide service between two other countries. Note that an airline in one country still cannot offer service between two points within another country or cabotage (O'Reilly and Sweet, 1998). TRANSPORT INTEGRATION IN THE EUROPEAN UNION 47 The result of this transformation is a more competitive and efficient environment but not a fully deregulated one. This environment led to a restructuring of the industry, including the emergence of cut-rate carri- ers and a number of international alliances. The benefits have been greater choice and lower fares for EU air travelers (McCormick, 1999). In those areas of transportation services where governments have been less involved in the supply side, much greater strides have been made toward achieving a true common market. Transportation of freight by road (trucking) is a good example. Under 1992 regulations, any operator with a "community authorization" has unlimited access to the market for freight movement between member states. This includes trips begin- ning or ending in the state where the carrier is based and trips between any other two states. The liberal community market access rules also extend to cabotage. Starting in 1990, any carrier with a "community cabotage authorization" can carry goods within any state in the EU Fifteen. These authorizations were issued under an increasing quota system until 1998, when all quo- tas were removed (European Commission 2000b). Complementary rules with respect to licensing of and work rules for drivers and other em- ployees are also in place. There are provisions to protect national trucking industries from ex- treme damage from foreign competitors with either community or com- munity cabotage authorization. If a significant number of domestic firms are found to be in danger of severe financial damage, a crisis period is declared during which market access is restricted. The restrictions are imposed for six months, renewable once (European Commission, 1999). Developing Trans-European Networks As part of its Trans-European Networks (TEN) initiative, the EU em- barked in the 1990s on a program to encourage transportation infrastruc- ture projects that fill the gaps in existing Europe-wide networks. The total cost of filling the gaps in transportation and energy networks was estimated to be in excess of 400 billion ECUs over fifteen years, only a small proportion of which could be provided from EU funds. A program assessed proposed projects on the basis of their contribution to the ob- jectives of the TEN initiative and selected a limited number to which EU support would be provided up to a limit of 10 percent of total project costs. This is in contrast to earlier practice when limited funds were dis- tributed at the discretion of the Directorate General for Transport across many infrastructure projects proposed by member states (Kinnock, 1995). Under the new program the funds are in the form of co-financing for feasibility studies, fees for loan guarantees, interest rate subsidies, and (in limited circumstances) direct investment grants. The remaining 90 48 INTEcRA-nON OF TRANSPORT AND TRADE FACiLITATION percent of funds must come from member states and the private sector under public-private partnership arrangements (Kinnock, 1995). In 1994, fourteen priority projects, with total combined project costs of 90 billion ECUs, were designated for EU support (up to a maximum of 9 billion.) They are listed in table 3-2. Six are high-speed rail projects, only one is for airport facilities, and the rest are for conventional rail, road, and multimodal projects. Each of these project can be viewed in terms of its contribution to creating a truly trans-European transportation sys- tem. For example, Project 1 adds two new North-South segments to an existing high-speed corridor between Nuremberg and Munich so that an integrated rail corridor for both freight and passengers is available from Northeast Germany to the economic heartland of Italy. This is complementary to Project 6, a high-speed corridor from southern France to the Adriatic. Project 13 attempts to bring Ireland closer to the mainland of Europe by means of a land-sea link across Great Britain. The objective is to pro- vide high-quality road/ferry service linking the three largest cities in Ireland (Cork, Dublin, and Belfast) to the East Coast English Ports with well-established ferry services to ports in Belgium and the Netherlands. In a similar way Project 11 seeks to link the northern periphery of the EU with mainland Europe, but in this case by means of a bridge/tunnel project for both rail and highway connection between Sweden and Den- mark. The benefits of this link will be extended throughout Scandinavia by means of Project 12, which establishes multimodal corridors linking the main centers of Sweden and Finland and providing superior access to the non-EU states of Norway and the Russian Federation. Conclusions The experience of the European Union as it tries to develop an integrated transport system provides some valuable lessons for other trading blocs. The EU has achieved some things-such as elimination of border checks and full cabotage in some service categories-that NAFTA may not achieve for decades. Still, the process has been painful and remains very incomplete after almost fifty years. One important lesson is that member states have strong incentives to cling to the status quo of fragmented transportation infrastructure and regulation. Ownership of major supply entities is one reason. Privatization in groups such as the Common Market of the South (Mercado Comin del Sur, or Mercosur) should make the process of transportation integration simpler. Also, transportation policy is an instrument for pur- suing national economic goals that member governments will not relin- quish easily. TRANSPORT INTEGRATION IN THE EUROPEAN UNION 49 Table 3-2. Trans-European Networks: Fourteen Priority Transportation Projects Project and route 1. High speed train/combined transport North-South (Berlin-Verona) 2. High speed train (Paris-Brussels-Cologne-Amsterdam-London) 3. High speed train South (Madrid-Barcelona-Montpellier/Madrid-Vitoria- Dax) 4. High speed train (Paris-eastern France-southern Germany; includes Metz-Luxembourg branch) 5. Conventional rail/Betuwe Line combined transport (Rotterdam-German border) 6. High speed train/combined transport France-Italy (Lyon-Turin-Milan- Venice-Trieste) 7. Greek motorways: PATHE (North-South axis: Rio-Antirio to Bulgarian border) and via Egnatia (East-West axis, Igoumenitsa to Turkish border) 8. Multimodal link (integrated road, rail, maritime, and air facilities) between Iberian Peninsula and Central Europe 9. Conventional rail link (Cork-Dublin-Belfast-Lame-Stanraer) 10. Air hub for northern Italy (Malpensa Airport) with intermodal facilities for road and rail 11. Fixed rail/road link between Copenhagen, Denmark, and Malmo, Sweden-Oresund fixed link (bridge-tunnel) 12. Nordic triangle: integrated road and rail system connecting major cities in Denmark, Sweden, and Finland, with sea link between Sweden and Finland 13. Ireland-United Kingdom-Benelux road and ferry service link 14. High speed train/combined transport West Coast Main Line (United Kingdom) Source: European Commission (1998). The second, and related, lesson is that achieving major integration goals may require strong, supranational institutions. The European Court of Justice has played a critical role in breaking down traditional national prerogatives that stood in the way of a Common Transport Policy for thirty years. In the case of air transportation, the European Commission put forth an argument for regulatory reform that was opposed by all member states in 1979 but after almost a decade of debate and litigation came into force. 4 Transport and Trade in Mercosur T. R. Lakshmanan The contemporary development landscape is undergoing radical changes in the context of technological advances in communications, transporta- tion, and production, and in a global economy where services, informa- tion, and knowledge are an increasing portion of economic value. Multinational companies depend on production chains that span sev- eral countries. Materials and components from different countries are assembled in yet another country, with distribution and marketing in other locales in response to worldwide consumer signals. This slicing of the "value chain" leads to an increasingly competitive global economic environment. A rising number of countries can offer high-quality, low- cost production as well as speedy, time-definite delivery of goods at com- petitive prices. In response, many countries have clustered together in regional trad- ing blocs and strive to create dynamic comparative advantages to facili- tate their insertion in the global economy on favorable terms. The European Community (EC) and the North American Free Trade Agree- ment (NAFTA) signatories (the United States, Canada, and Mexico) il- lustrate this development. In keeping with this trend, four countries in South America-Argentina, Brazil, Paraguay, and Uruguay-signed the Treaty of Asuncion on March 26, 1991, to create on January 1, 1995, the Common Market of the South (Mercado Comin del Sur or Mercosur). Chile and Bolivia joined as associate members in 1996; they participate in the Free Trade Area (FTA) but not the common external tariff (CET) or the planned Common Market. Mercosur has several antecedents in Latin America. The first is the Latin American Free Trade Association (LAFTA), created in 1960 to elimi- nate trade barriers and also to foster the then-prevalent import substitu- tion strategy (IS) of industrialization through the provision of economies 51 52 INTEGRATION OF TRANSPORT AND TRADE FACILITATION of scale with the larger markets of the FTA. However, this multilateral agreement did not take root since the IS strategy, while achieving a sig- nificant level of industrialization, led to highly protected national mar- kets: the tariff levels ranged in this era from 41 percent in Brazil to 110 percent in Argentina (Coffey, 1998). LAFTA and its successor (the Latin American Integration Association or ALADI), which tried to liberalize trade and coordinate macroeconomic policies, were consequently de- layed and postponed, as the import substitution model collapsed in Latin America in the 1980s. In the 1980s and 1990s, however, economic and political developments converged to speed up the creation of Mercosur. First, in the emerging global economy and cross-country production networks, trade liberal- ization offers great benefits for Latin American countries: new export markets, international technology transfers, increasing efficiency through heightened competition, and integration into the global production net- works noted above, which account for a third of all world trade (World Bank, 1999). Integration into global production value-chain networks is feasible if the Latin American countries liberalize and improve their trans- portation and communication systems so that they offer fast and reli- able delivery of goods and coordination across borders. In the absence of worldwide liberalization, regional trade agreements are second-best solutions (if they lead to drops in consumer and producer prices). Second, the creation of Mercosur was prompted by developing coun- tries' growing perception that the Uruguay Round Agreement, which incorporated agriculture into multilateral trade negotiations, was not very helpful to them. It did not offer much market access for Latin American countries that export agricultural commodities without sub- sidies (OECD, 1998). Third, the deep economic crisis in the Southern Cone countries and their increasingly marginal role in world trade took on the character of security issues in the late 1980s. The consequent drive to be a more ac- tive participant in world trade provided another stimulus to the cre- ation of Mercosur. Finally, in some countries there were supportive political changes (such as democratization processes, security and peace concerns in the South- ern Cone, and a changing perception of the state's role in the economy) that promoted deregulation and liberalization of trade regimes. These changes set in motion in Argentina and Brazil a variety of presidential- level initiatives in economic integration, foreign policy, and security co- operation. As large trading blocs emerged in North America, Europe, and East Asia, Latin American decisionmakers' desire not to be cut off from the ongoing reconfiguration of the global economy strengthened incentives to seek and pursue closer economic links among themselves (Manzetti, 1994). TRANSPORT AND TRADE [N MERCOSUR 53 Treaty of Asuncion The creation of Mercosur by the Treaty of Asuncion in 1991 thus repre- sents a confluence of powerful economic and political developments on the global and regional levels (Manzetti, 1994; Roett, 1999; Hirst, 1999). As a consequence, in contrast to the experience of other Free Trade Ar- eas such as NAFTA, where economic integration was achieved gradu- ally through a series of stages (Lakshmanan and Anderson, 1999), Mercosur countries bypassed several intermediate steps when they ini- tiated a common market in 1995 and planned for a Customs Union by 2006. A Common Market among the participating members is foreseen eventually. The key objective of the Treaty of Asuncion is the integration of Mercosur economies and an increase in the competitiveness of the inte- grated economies by facilitating the free flow of goods, services, and factors of production among the member countries. The treaty also was intended to promote a variety of supporting policies, including privatization, deregulation, reduction of the public sector's role in the economy in order to attract foreign direct investment, and coordination of member countries' macroeconomic policies to ensure economic sta- bility and adequate competitive situations. The specific provisions of the treaty cover four main areas: tariff elimination, a common external tariff, coordination of macroeconomic policies, and an institutional struc- ture for dispute resolution. Tariff Elimination Tariffs were reduced according to schedule in order to attain a zero tariff for Argentina and Brazil by January 1995 and for Uruguay and Para- guay by January 1996. Furthermore, import quotas and nonquantitative restrictions were to be phased out under the Treaty of Asuncion. Chile's agreement to become an associate member allows it to retain its external tariff of 11 percent on virtually all imports from nonmembers of Mercosur. A significant aspect of the Chile agreement is the physical integration protocol, which allows for the development of cross-border projects, mostly mining and infrastructure, that can be undertaken immediately without extended negotiations between the governments of the affected countries Common External Tariff The creation of a Customs Union required the establishment of a com- mon external tariff in goods. As Coffey (1998) notes, CET will become applicable for capital goods by 2001 and for telecommunications and 54 INTEGRATION OF TRANSPORT AND TRADE FACILITATION information by 2006. Some sectors, such as autos, textiles, and sugar, will remain subject to national rules until a common regime can be agreed upon. Government procurement and some sensitive industries are still not part of a common trade policy. Although advances have occurred in CET development and imple- mentation, complex issues arise because of differences in the industrial mixes of the member countries. The Mercosur region is a net exporter of most agricultural products at internationally competitive prices. There- fore, CET for these commodities was set by Mercosur at relatively low levels-in part to neutralize the highly subsidized agricultural exports from North America and Europe (OECD, 1998). Differences in the composition of manufacturing in the member coun- tries raised tough issues. Argentina does not have significant industries in capital goods, computers, or consumer goods, and it levies zero tariffs on these goods; Brazil, the only producer of computers and the largest producer of capital goods, would like protection for a period during which structural adjustment could provide Brazilian producers the abil- ity to compete at zero tariff. A period of transition was agreed upon-an average tariff of 14 percent for capital goods until 2001, and a 16 percent tariff for computers and some telecommunications goods until 2006. There are also national lists of exceptions to CET. The exceptions list for Brazil is weighted in the chemical and petrochemical sectors, milk products, and raw materials for the textiles industry; in Argentina, the weighting is in the steel and chemical, paper, and footwear sectors; in Paraguay and Uruguay, the exceptions are in the agricultural sectors (Mye and Palagonia, 1996). Common external tariffs covered 87 per- cent of the tariff items in 1997, and Mercosur is expected to be a true Customs Union by 2006 (Pereira, 1999). Coordination of Macroeconomic Policies Members of Mercosur agreed to cooperate through coordination of their economic policies, such as fiscal and monetary policies, foreign exchange, and capital movements. In addition, they strive to harmonize sectoral policies in agriculture, manufacturing, services, transport and commu- nications, and customs. Institutional Structurefor Dispute Resolution The institutional structure for dispute resolution is not yet well articu- lated. It includes the highest ranking body, the Common Market Coun- cil, comprising member countries' foreign and economic ministers; the implementing organ, GMC (Grupo Mercado Comun); an effective sys- TRANSPORT AND TRADE IN MERCOSUR 55 tem of panels for dispute settlements; and a technical body for the analy- sis and resolution of pending disputes within Mercosur and with third parties. Mercosur Partners and Their Evolving Integration Mercosur is the largest trading bloc comprised entirely of developing coun- tries. Figure 4-1 compares its market size and that of NAFTA, the Euro- pean Union, and several large countries. In 1998 Mercosur represented a $1.2 trillion economy with 233 million inhabitants and a per capita in- come of US$6,932. Mercosur member countries are a diverse lot in terms of physical size, demographic levels and composition, level of income, industrial com- position, and the role of trade in their economies. Brazil and Argentina dominate this bloc, accounting for 82 percent of the physical area, 83.6 percent of the population, and 90.8 percent of the GNP. Chile, Argen- Figure 4-1. GNP of Mercosur and of Other Selected Markets, 1998 Billions of U.S. dollars 10,000 9,000 _ 8,000 7,000 6,000- 5,000 4,000 - 3,000- 2,000 - 1,000 -F 0- NAFTA EU Japan Mercosur China India Russian Federation Source: World Bank (2000b). 56 LNTEGRATION OF TRANSPORT AND TRADE FACRLITATION tina, and Uruguay are more urbanized and have the higher per capita incomes. International trade is more important in the smaller countries, ranging from 43 percent of the GNP in Bolivia and Uruguay to 60 per- cent in Chile and 100 percent in Paraguay Tables 4-land 4-2 show the progress of selected economic indicators in the 1990s. The 1990-98 period was one of demographic expansion and considerable growth of incomes and trade. It is worth noting that trade is not a large portion of GNP in Argentina and Brazil. The trade performance of Mercosur since the signing of the Treaty of Asuncion in 1991 is impressive, indicating a significant and growing interdependence among the member economies. While trade with non- member countries increased between 1991 and 1997 (from US$69.3 bil- lion to US$138.2 billion), expanding at 12 percent and above the world average, trade within Mercosur quadrupled during the same period (from US$10.3 billion to US$41.3 billion), as derived from table 4-3. In this part of the world intraregional trade has been a low portion of total trade because the member countries' semicolonial trade links to European and North American economies historically have been stron- ger than their trade links with one another. Yet intramember trade (as a percentage of total trade) has risen. In 1997 it accounted for 24.9 per- cent of exports and 21.4 percent of imports. The largest expansion oc- curred between Brazil and Argentina. Argentina is now the second trading partner of Brazil after the United States. After a quarter cen- tury of unsatisfactory efforts at trade integration, this explosive growth in intraregional trade augers well for Mercosur. The recent growth rates of intraregional exports in Mercosur are higher than those of other Western Hemisphere regions' exports and reflect well on Mercosur's trade integration prospects (table 4-4). The composition of intramember trade is weighted heavily (more than in extraregional exports) toward industrial products that exhibit moder- ate to high technological intensity (table 4-5). In 1996, commodities and semiprocessed goods accounted for 43 percent, and manufactured goods for 56 percent, of total intramember exports (Markwald and Machado, 1999). If one examines the technological intensity of exports, intra- Mercosur exports have a higher proportion of the middle levels of tech- nical intensity than exports to the European Union or to Asia, which seem to draw mostly low technology goods. NAFTA occupies an inter- mediate position, with a higher share of manufactured goods, especially labor-intensive goods, as well as aircraft purchases from Brazil. This combination of rapid quantitative growth of intraregional trade and a trade composition rich in capital-intensive goods is ground for an optimistic assessment of Mercosur's performance. In the larger context of developing economies, the promising evolution in trade is a particu- Table 4-1. Selected Economic Indicators of Mercosur, by Year, 1990-95 Indicator 1990 1991 1992 1993 1994 1995 Per capita income (U.S. dollars) 2,943 3,105 3,201 3,435 3,889 4,764 Exports (billions of U.S. dollars) 46.8 46.3 50.7 54.7 63.0 71.4 Imports (billions of U.S. dollars) 27.3 31.8 38.0 45.2 58.6 74.5 Trade balance (billions of U.S. dollars) 19.5 14.5 12.7 9.5 4.4 -3.1 Current account (billions of U.S. dollars) 0.76 -2.5 -1.6 -9.2 -12.6 -21.5 International reserves (billions of U.S. dollars) 13.8 16.4 34.4 46.5 53.9 66.7 Trade as a percentage of GNP 13.0 13.0 13.0 13.0 15.7 15.0 Source: OECD (1998). Table 4-2. Demographic and Economic Characteristics of Mercosur, by Country, 1996-98 Indicator Argentina Brazil Paraguay Uruguay Chile Bolivia Total Area (millions of square kilometers) 2.8 8.5 0.4 0.2 0.8 1.1 13.8 Population (millions) 1996 34.7 164.0 5.0 3.2 14.5 7.6 229.0 1998 36.0 166.0 5.2 3.3 14.8 7.9 233.2 GNP' 1996 282.2 701.5 9.0 17.8 59.1 6.9 1,076.5 1998 324.1 758.0 9.2 20.3 71.3 7.9 1,190.8 GNP per capitab 1998 10,200 6,160 3,650 9,480 12,890 2,820 6,932 Percentage of the population in urban areas, 1998 89 S0 55 91 84 63 Growth rates, 1990-98 (percent) zo GNP 5.3 3.3 2.8 3.9 7.9 4.2 Gross domestic investment 12.5 3.9 3.6 8.3 13.9 6.9 Exports of goods and services 9.3 5.6 7.3 8.0 9.8 6.7 Exports' 1996 23.8 47.7 2.7 2.4 15.3 1.1 93.0 1998 29.4 60.3 4.3 4.3 20.6 1.4 120.3 Importsa 1996 22.1 47.7 2.7 2.4 15.3 1.1 93.0 1998 35.0 79.8 5.0 4.5 22.2 2.0 148.5 Trade as percentage of GNP 1998 19.8 18.5 100 43.3 60 43 Foreign direct investment' 1997 6.6 19.7 0.3 0.2 5.4 0.6 32.8 a. Billions of U.S. dollars. b. U.S. dollars at purchasing power parity. Source: World Bank (2000b, 230-71). TRANSPORT AND TRADE IN MERCOSUR 59 Table 4-3. Intraregional Trade in Mercosur, 1991-97 Growth per year, 1991-97 Trade 1991 1997 (%) Exports Total (billions of U.S. dollars) 45.9 82.9 10.4 Within Mercosur (percent) 11.1 24.9 26.3 Outside Mercosur (percent) 88.9 75.1 7.3 Imports Total (billions of U.S. dollars) 34.3 96.7 18.9 Within Mercosur (percent) 15.3 21.4 25.7 Outside Mercosur (percent) 84.7 78.6 17.4 Source: The data were adapted from Markwald and Machado (1999, 63). larly gratifying experience for a mid-size trading bloc comprised en- tirely of developing economies. Does this suggest that the integration project-established to exploit the economies of scale and gains from specialization (as well as to use the larger regional market as a platform from which Mercosur could be inserted competitively into the global economy)-is progressing toward those goals? One study comes to a contrary inference, suggesting that there has been trade diversion, since the dynamic products of Mercosur intratrade are in capital-intensive sectors in which member countries have not had strong export performance (Yeats, 1997). Critics of the Yeats study take the view that it would have been more accurate (in determin- ing the balance between creation and diversion of trade) to look at mem- bers' imports (Markwald and Machado, 1999). Table 4-4. Western Hemisphere Exports, 1996 and 1997 (percentage change) Region Destination 1996 1997 Mercosur Within Mercosur 18.4 21.4 Outside Mercosur 3.5 7.9 NAFTA Within NAFTA 10.6 10.7 Outside NAFTA 4.6 6.7 Latin America Within Latin America 4.5 21.6 Outside Latin America 11.3 9.3 Source: Safadi and Yeats (1993). Table 4-5. Exports of Industrialized Goods from Argentina and Brazil, by Level of Technological Intensity, 1992-96 (percent) Outside Mercosur, 1996 Annual growth, 1992-96 Inside Inside Outside Level of technological intensity Mercosur, 1996 NAFTA EU Asia Mercosur' Mercosurb Low 31.4 54.7 74.2 71.8 22.2 8.2 Low-average 26.0 19.1 12.9 17.8 21.2 2.3 Average-high 39.6 16.1 10.0 10.3 21.8 2.5 High 3.0 10.1 2.9 0.7 27.5 5.6 a. 21.9 percent for all industrial goods. b. 6.2 percent for all industrial goods. Source: Markwald and Machado (1999, 6). TRANSPORT AND TRADE IN MERCOSUR 61 Table 4-6. Intra-industry Trade, 1992 (percent) United European Country Brazil Argentina States Union Brazil - 73.0 64.0 55.0 Argentina 56.0 - 30.0 23.0 Source: OECD (1998, 24). While the potential dynamic advantages of integration have not yet been realized in the few years Mercosur has been in operation, intra- industrial linkages within manufacturing sectors have already improved. Since intra-industrial trade is a major source of dynamism in global trade and in the global economy, the increase in intra-industrial trade between Brazil and Argentina is heartening, even though this process started be- fore 1991 when Mercosur was instituted (OECD, 1998). Table 4-6 shows the extent of intra-industry trade in 1992. Table 4-7 traces the progress of intra-industrial trade by major sector between 1992 and 1996 using an intra-industry trade index that distin- guishes between bilateral flows between Brazil and Argentina and trade flows with nonmember countries. The trade index is stable in the chemi- cal and related products sector; it increased in the mechanical and trans- portation equipment sector and in the Standard International Trade Classification (SITC) manufacturing sectors 6 & 8-revealing a mature pattern of trade among members (Markwald and Machado, 1999). While it may be too soon to expect a full flowering of Mercosur 's potential, there is room for cautious optimism regarding trade integration in the alliance. Transport margins on intramember trade including Chile are lower than those on trade with Europe and North America, especially trade with the two large countries (Brazil and Argentina) by about 6 percent- age points. This 6 percent margin is viewed as a rather small advantage to intraregional trade in view of the policy-based barriers to trade in Mercosur (Amjadi and Winters, 1997). While geographic proximity may, in theory, confer a cost advantage, several other transport system at- tributes will affect transport costs. For example, in marine transport where terminal costs are much higher than freight rates, a shorter distance may lead to greater transport costs. Second, transport cost increases stem from a lack of sophistication and the low physical and human capital inten- sity of transit facilitation services (poor transport connectors, deficient information systems, underdeveloped risk mechanisms, unreformed customs and other border procedures, and the quality of a variety of other transit facilitation services). Third, a substantial cost increase may Table 4-7. Intra-industry Trade Index for Mercosur Partners, 1992-96 Trade within Mercosur (bilateral trade, Brazil-Argentina) 1996 trade Value Share Intra-industry trade indicator SITC' Description (US$ billions) (percent) 1992 1993 1994 1995 1996 5 Chemical and related products 1.16 9.8 61 46 50 57 62 6 Manufactured goods classified by raw material 1.68 14.1 17 22 27 42 46 7 Mechanical and transportation equipment 4.14 34.7 41 58 65 73 66 8 Other manufactured articles 0.43 3.6 36 29 33 60 62 a. Standard industrial trade classification. Source: Markwatd and Machado (1999, 71). TRANSPORT AND TRADE IN MERCOSLR 63 derive from the inefficiencies of (frequently state-owned) transport and telecommunications monopolies. Mercosur countries are rapidly improving their trade-transport chain to lower such costs. Chile is organizing itself along with its Asian and Pacific competitors for Electronic Data Interchange (EDI). Other coun- tries lag behind in trade facilitation and domestic EDI, except for Brazil. Prompted by its history of explosive inflation, Brazil has developed elec- tronic banking and a financial EDI user base. Private sector agencies and industry bodies in Brazil are beginning to develop business systems EDI. Schware and Kimberley (1995) suggest that Brazil can create an effective trade-transport chain by building upon its financial information tech- nology base. To accomplish this objective, Brazil needs an appropriate legal framework, a shared vision within the public sector of electronic commerce, and collaboration and reform of its activities by customs and other public sector agencies to facilitate seamless cross-border freight flow. Improvements in transport infrastructure lower transport costs. The newly constructed railway between Argentina and Brazil is expected to double transport capacity and save considerable time, with a 40 percent lowering of costs. The increase in investments in highways, railroads, and ports that has accompanied recent transportation privatization efforts in Argentina and other countries is fueling the expansion of transport capacity. Transport Privatization and Deregulation Transport service liberalization and deregulation-a necessary precur- sor to an efficient trade-transport chain-occurred in the 1990s in Mercosur countries. They were propelled by the inability of their pub- licly offered transport services to improve operational efficiency and services, to arrest cost increases, to attract new investment, to achieve quality maintenance, or to lower public subsidies. Transport industries- along with other industries such as telecommunications and utilities- were privatized to varying degrees in member countries. Argentina was one of the leaders in privatization. During the early 1990s, it sold off various public enterprises, including the Aerolineas Argentinas (one of the largest airlines in Latin America), railroads, and important turnpikes. Brazilian railways were privatized more recently and lag behind the lib- eralization efforts of their Argentine counterparts (Zinn, 1999). Transport Privatization in Argentina Argentina, together with Chile and Mexico, went farther than most Latin American countries in liberalizing various parts of the transport 64 INTEGRATION OF TRANspoRr AND TRADE FACILITATION sector.t Unlike in the power and telecommunications sectors, which were sold outright, Argentina granted transport concessions of ten to thirty years, with ownership and control of assets retuming to the government at the end of the concession. The concession dealt with the problems that motivated privatization without limiting the government's future op- tions or flexibility. Further, concession contracts in rail transport (which is a "natural monopoly") must be carefully prepared in order to avoid complex regulatory structures.2 Ferrocarriles Argentinos (FA), the state-owned railroad company, was broken up into three different components-freight, intercity passenger, and commuter rail-and privatized in that order. Of the 31,000-kilome- ter freight rail network, 23,000 kilometers were viewed as commercially viable. (The rest was offered to provincial governments to take up or to abandon.) The 23,000 kilometers were offered as separate concessions- mostly in separate corridors radiating out of Buenos Aires. Table 4-8 lists five of these rail freight concessions that went into effect in 1993. Although the busy Buenos Aires-Mar del Plata intercity passenger line garnered four bids, it was temporarily operated by the provincial government during preparation for future offers of private concessions. Most of the remaining intercity rail passenger services were abandoned. Ferrocarriles Argentinos's 900-kilometer urban commuter railroad that centered on Buenos Aires (1 million passengers a day) and the munici- pally owned subway system (0.5 million riders per day) were privatized. The intercity highway system-about 9,830 kilometers that averaged at least a daily traffic volume of 2,000 to 2,500 vehicles per day-was offered up as concessions. The concessionaires could levy tolls in return for undertaking a specified program of maintenance and capacity en- hancements (table 4-9). A similar concessions program for improving major access roads of major metropolitan areas was added. In the early 1990s, many of the restrictive regulations and laws gov- erning working practices at ports and waterways and on vessels were abolished. Before then Argentine port and waterway shipping charges were among the highest in the world for the poor services of a public agency Special new port authorities composed of governments and ship- pers were created, and port terminals were leased as concessions. A major consequence of rail privatization was savings in railroad sub- sidies, which had averaged US$1.4 billion annually in the 1980s. After privatization, the new private intercity freight companies received no subsidies, while the urban commuter and subway concessionaires were to receive an average of less than $100 million per year over twelve years. 1. This section is based on Gomez-Ibanez (1997). 2. The government established specialized regulatory agencies to stage the competi- tion, carry out final contractual negotiations, and monitor and enforce contracts. Table 4-8. Winning Bids of Rail Freight Concessions Promised Jobs to Ferrocarriles Demand fee to Argentinos projections Length Date of Number govern- Invest- workers (millions of tons) Concession (kilometers) Private concessionaire takeover of bids ment' ments' Number Percent Year 1 Year 2 Rosario-Bahia 5,163 Ferroexpresso Pampeano (FEPSA) November 1, 1991 2 48.4 234 1,500 85 3.4 6.1 ON Blanca Ul Mitre 4,520 Nuevo Central Argentino (NCA) December 23, 1992 2 33.5 386 2,322 78 4.2 7.9 San Martin 5,493 Buenos Aires al Pacifico (BAP) August 26, 1993 2 36.4 369 2,271 83 2.9 4.7 Urquiza 2,751 Ferrocarril Mesopotamico October 22, 1993 1 2.8 64 1,255 76 0.9 1.9 Roca 4,791 Ferrosur Roca March 12, 1993 1 18 173 1,133 86 2.7 6.4 Total 22,781 139.1 1,226 6,912 82 14.1 27.0 Note: Investments are for first fifteen years only. a. Millions of U.S. dollars. Source: Gomez-Ibanez (1997). 66 INTEGRAnON OF TRANSPORT AND TRADE FACILITATION Table 4-9. Intercity Highway Concessions Basic toll range Number November, 1994 Length of toll (U.S. dollars Corridor Concessionaire (kilometers) booths per vehicle) I Semacar, S.A. 665 3 2.6-3.3 2 Semacar, S.A. 297 2 1.8-1.9 3 Caminos del Oeste, S.A. 508 3 2.1-2.5 4 Caminos del Oeste, S.A. 697 3 2.5-3.1 5 Nuevos Rutas, S.A. 421 2 2.6 6 Covico, U.T.E. 479 3 1.2-3.4 7 Servicios Viales, S.A. 242 2 2.5-2.6 8 Servicios Viales, S.A. 694 3 1.9-2.5 9 Servicios Viales, S.A. 298 2 1.5 10 Covicentro, S.A. 332 2 1.9-2.1 11 Covinorte, S.A. 714 3 2.6-3.1 12 Concanor, S.A. 481 3 2.1 13 Virgen de Itati, S.A. 946 6 1.2-3.3 14 Rutas del Valle, S.A. 280 2 1.8 16 Camino del Abra, S.A. 404 3 1.2-2.4 17 Nuevas Rutas, S.A. 540 3 2.2-2.3 18 Caminos del Rio Uruguay, S.A. 618 4 1.6-4.1 20 Red Vial; Centro, SA. 309 4 1.0-1.6 Source: Gomez-lbanez (1997). These savings derived from a combination of increased labor productiv- ity and abandonment of lightly used (intercity passenger) services and lines. Ridership increased between 1993 and 1994 in urban commuter rail (45 percent) and subway (18 percent). The freight volume reached the levels of the 1980s, but some of the freight lines had difficulties stem- ming from the intense competition from truck services, which were helped by geography and public policy. Since the average lengths of haul were relatively short (500 kilometers), trucks could compete with the six rail networks that also overlapped. The tax field was not level: the diesel fuel used by heavy trucks was not taxed and gasoline was heavily taxed. Furthermore, rail companies had to lower rates in response to truckers doing so. All this affected adversely rail revenues and their potential for investment and track maintenance. There is concern that freight conces- sionaires were disinvesting in the networks, thereby lowering speeds (for intercity passenger service) and service levels (Gomez-Ibanez, 1997). The physical condition of the privatized highways has improved sig- nificantly, and the cost of maintenance was moved off the government TRANSPORT AND TRADE IN MERCOSUR 67 budget. However, there is no direct evidence that the cost of road main- tenance is lower for the private sector (Gomez-Ibanez, 1997). Road us- age has climbed, partly due to road improvements and mainly from economic recovery. The mix of privatization and deregulation in ports and waterways sharply dropped port charges and barge and ocean shipping tariffs. Ship- ping costs for containers from Argentina to northern Europe fell from 30 percent to 70 percent between 1991 and 1993; for grain and bulk ship- ments, a savings of 10 percent materialized. The savings were largely derived from increasing labor productivity. Employment at the ports of Buenos Aires fell from the pre-privatization level of 8,000 to 2,500. The concession for the Atlantic Ocean-Santa Fe waterway was expected to maintain the channel at less cost than the public agency had spent, while obliged to maintain deeper channel depth North of Buenos Aires (Gomez- Ibanez, 1997). Transport Infrastructure Although Mercosur countries have rail networks extensive enough to offer a major mode for freight shipments, the service potential is ham- pered by the rail network's multiple gauges-not only between coun- tries but within countries. This nonstandardization of gauges leads to costly transshipments. Zinn (1999) notes that this barrier has led in one case to an intermodal innovation: Interferra, a firm operating railroads in Argentina and Brazil, is planning to link the petrochemical-produc- ing region in Salvador (Brazil) to Pacific ports in Chile using road railers (cars with both rail and truck wheels). Although road railers have a lower capacity than a regular rail car, they can easily be converted from rail to road carrier and vice versa. However, motor carriers dominate freight traffic in Mercosur-90 per- cent according to Zinn (1999). This dominance reflects the superior road network in Argentina and Brazil, which have emphasized highway con- struction and the development of the automobile industry since the 1950s. The high quality of motor transport equipment, maintenance, labor, and infrastructure maintenance services contributes to the dominance of motor carrier transportation in Mercosur. As a consequence, in Mercosur even low-value cargo typically moved by water or rail (such as grains and minerals) is moved by motor carrier in member countries. The inland waterway system known as the Paraguay-Parana system offers an economical alternative to transporting low-value bulk cargo by trucks. The Paraguay River runs from western Brazil through the Sao Paulo state to the Argentine border where it merges with the Parana River with links to the Atlantic Ocean via the port of Buenos Aires. This 68 INTEGRATON OF TRANSPORT AND TRADE FACILrrATION Table 4-10. Selected Indicators of Transport within Mercosur, by Country, 1996,1997 Rail freight (kilometer ton per millions Air passengers, of dollars of GNP)' 1996 Country 1996 1997 (thousands) Argentina 36,412 7,913 Bolivia 37,118 1,784 Brazil 56,068 22,012 Chile 15,882 5,998 3,633 Paraguay 261 Uruguay 10,455 16,125 504 a. In purchasing power parity. Source: World Bank (2000b, 264). waterway system, located at the center of a vast region accounting for 30 percent of the GDP, transports the regional agricultural commodi- ties and minerals-increasing the region's trade more than twelve times in ten years (Zinn, 1999). If appropriate dredging and lock systems around dams are completed, these types of freight can move from Compinas (sixty miles West of Sao Paulo) to Buenos Aires at half the cost of truck transportation. The differences in the technical standards for truck sizes between Ar- gentina (59 feet) and Brazil (60 feet, 8 inches) represented a harmoniza- tion problem. When Mercosur adopted the 59-ft. standard, the Brazilian truck fleet was disadvantaged (Zinn, 1999). Table 4-10 displays selected indicators of transport performance within Mercosur. Transport Integration and Activity Restructuring As the transport and transit facilitation systems improve in Mercosur, the direct effects of improvement-in terms of a virtuous cycle of lower costs, increasing trade volume, and economies of scale and scope in dis- tribution and production activities-set in motion adaptive responses by various economic agents in the trade bloc. These agents-producers, shippers, carriers, distributors, and other facilitators-begin to see Mercosur as an integrated market rather than as a set of separate mar- kets, and they reconfigure their activities accordingly. It is during this restructuring and rationalization of production and distribution activi- TRANSPORT AND TRADE IN MERCOSUR 69 ties that further economies of scale and scope can emerge to continue the virtuous loop. Such long-term consequences represent the full ben- efits of trade liberalization and a supportive trade-transport chain. Some large North American corporations that operate global produc- tion and distribution networks have seized the integration opportuni- ties offered by Mercosur and begun to integrate their prior nation-based activities into a Mercosur-wide framework. The rest of this chapter briefly describes the future-oriented supply chain systems developed in Mercosur by Kodak and Kellogg (Zinn 1999). Supply chains represent a network of firms that carry out production, distribution, and other sup- porting activities that link the producer and the consumer. Kodak: Multicountry Warehousingfrom a Single Location Taking advantage of the rise of the Mercosur trading bloc, Kodak has integrated its once separate national warehousing operations into a trade- bloc-wide operation. Now it distributes its high-value, low-volume, and low-weight products to one large market (Mercosur and Peru) supplied from a single warehouse in Brazil. The major advantages of a multi- country facility derive from economies of scale in distribution and the resultant cost savings from higher volumes and from the more efficient use of transportation assets, warehousing equipment, and software. Fur- thermore, a single large location can offer the customer a high level of stock availability per inventory investment. Zinn (1999) notes another reason for Kodak's choice of a location in Brazil (the largest national market)-a tax incentive Brazil offers for imported products earmarked for re-export. Kodak was able to increase its negotiating leverage by consolidating shipments to fewer oceanic ports. In addition, the cost of supporting the expansion of Kodak's business into new markets is lowered when prod- ucts are supplied from a centralized facility. The feasibility of Kodak's strategy of a single facility for a trade bloc is clearly contingent on a seamless trade-transport chain. First, cost-effec- tive transportation and complementary information must be available to serve a large market from a single location. Other barriers Kodak had to overcome include the high costs of operating through Brazilian ports (as compared to international levels), the excessive documentation bur- den, the longer cycle times at customs, which is not open 24 hours a day, and the delay-inducing propensity of multiple governmental agencies to work in sequence rather than in parallel. Only when such barriers are fully lowered in Brazil can smaller companies with products of lower value/weight ratios than Kodak sells follow its strategy of trade-bloc- wide service from one warehouse. 70 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Kellogg's: Integrated Supply Chainsfor Brazil and Argentina Kellogg's-producing in Argentina and Brazil and importing from the United States, Mexico and South Africa-designed a supply chain for the joint Argentina-Brazil market. Such a supply chain's design depends on Mercosur-wide criteria for allocating production, a reasonably free flow of goods between Argentina and Brazil, and the extensive use of third-party logistics for local warehousing and distribution and for op- erating the main distribution centers (DCs) close to the largest markets of Sao Paulo and Buenos Aires. This chapter cannot do justice to this complex system. Instead, it will outline the types of obstacles to the effi- cient implementation of this supply chain in the Mercosur environment. The key to success in the Kellogg's system is the speed, reliability, and the cost of shipment across the Brazil-Argentina border. The key obstacles are lack of harmonized documentation between Argentina and Brazil, tax legislation that makes it cheaper to serve customers from a more distant out-of-state warehouse than from an in-state warehouse, and the involvement of customs in every shipment on both sides of the border. As more global and regional corporations develop similar transport chain innovations, greater operational efficiencies and lower transport costs will ensue in Mercosur. If at the same time, appropriate invest- ments in transport and communication infrastructure take place and cross-border processes-customs, inspections, harmonizations of stan- dards, and documentation-are reformed to world-class levels, Mercosur can look forward to the dawn of an era of seamless intrabloc trade and transport. 5 Southern African Development Community: The Maputo Corridor William P. Anderson The Southem African Development Community (SADC) was established in 1992 as a cooperative effort of the governments of Angola, Botswana, Lesotho, Malawi, Mozambique, Namibia, Swaziland, Tanzania, Zam- bia, and Zimbabwe. It grew out of a predecessor organization of Front- line States founded in 1981 to oppose and economically isolate the apartheid government of South Africa. With the political transforma- tions in the region, South Africa became a member of SADC in 1994. This greatly changed the Community: South Africa in 1998 accounted for about 80 percent of its total GDP. During the late 1990s, the Demo- cratic Republic of Congo and the Indian Ocean nations of Mauritius and Seychelles also joined the Southern African Development Community. By 1998 the SADC states had a combined population of 180 million and a combined land area of 9 million square kilometers (Kaombwe, 1998). The states, asymmetrical economically because of the member- ship of South Africa, were heterogeneous in a number of other ways as well (table 5-1). The Southern African Development Community includes landlocked states (Swaziland, Lesotho, Botswana) and island nations (Mauritius and Seychelles). Per capita GDP is highest in the Indian Ocean states, and in the remaining states it varies from about $3,000 and $4,000 (Botswana, South Africa) to roughly $200 or less (Malawi, Mozambique, Democratic Republic of Congo). Some states (Angola, Namibia, and Swaziland) are highly trade dependent. Mozambique is notable for its low level of exports, despite its maritime location. All except Mauritius and Seychelles form a contiguous mass occupying the southern third of the African continent. The objectives of SADC include economic and social development and the alleviation of poverty; promotion of economic and political 71 72 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Table 5-1. Financial Profile of the Southern African Development Community, by Country, 1998 Population GNP GDP per Exports' Imports' growth (billions capita as per- as per- Population rate, of U.S. (U.S. centage centage Country (millions) 1992-98 dollars) dollars) of GDP of GDP Angola 12.0 3.1 4.1 340 57.1 69.0 Botswana 1.6 2.4 5.6 3,600 35.0 33.8 Democratic Rep. of Congo 48.2 3.2 5.3 110 23.8 22.0 Lesotho 2.1 2.2 1.2 570 33.5 124.7 Malawi 10.5 2.6 2.1 200 32.5 45.6 Mauritius 1.2 1.1 4.3 3,700 64.8 65.0 Mozambique 16.9 2.4 3.6 210 11.7 24.2 Namibia 1.7 2.6 3.2 1,940 63.1 63.3 Seychelles 0.08 1.5 0.51 6,450 67.1 77.4 South Africa 41.3 2.0 119.0 2,880 25.8 24.5 Swaziland 1.0 3.1 1.4 1,400 101.5 94.6 Zambia 9.7 2.6 3.2 330 29.4 38.4 Zimbabwe 11.6 2.6 6.4 610 40.3 41.7 a. Of goods and services. Source: "At a Glance," World Bank web site, www.worldbank.org/data/countrydata/ countrydata.html. liberties; peace and security; and regional economic integration. With the end of apartheid in 1994 and the end of the civil war in Mozambique in 1993, the opportunity for SADC to focus its attention on economic integration as a means of promoting development goals improved. Given the relative youth of the Community, the weak economic ties among member states, the lack of a strong tradition for economic co- operation, and the poor condition of international transportation and communication infrastructure, it is still at a very early stage of devel- opment as a trade bloc. One area where significant strides are being made is in the establish- ment (or reestablishment) of transportation infrastructure corridors con- necting member states especially connections between SouthAfrica and other states. While these strides are largely the outcome of bilateral rather than Community-wide agreements, they are an important prerequisite for increased regional integration. The corridors are being developed along the lines for policy harmonization established under the 1996 SADC Transport Protocol, which stressed the need for private sector participa- tion and the role of transportation in economic integration. The most ambitious of the corridor projects is the Maputo Development Corridor (MDC), created in 1995. SOUTHERN AFRICAN DEVELOPMENT COMMUNITY: THE MAPUTO CORRIDOR 73 The Maputo Development Corridor Trade blocs in affluent parts of the world face the problem of integrating and facilitating movement across existing infrastructure systems. By contrast, trade blocs in developing regions are faced with an absolute shortage of infrastructure-especially cross-border infrastructure. Ma- jor cross-border infrastructure initiatives in these trade blocs serve the dual role of supporting increased trade between countries and promot- ing economic development along infrastructure-rich corridors within countries. One such initiative is the Maputo Development Corridor. The MDC is a joint effort by the governments of South Africa and Mozambique, both members of the Southern African Development Com- munity. Rather than blazing a new trail, the MDC seeks to reestablish the once-vital corridor linking South Africa's inland industrial heartland around Johannesburg and the capacious Indian Ocean port of Maputo in southern Mozambique. This corridor had fallen into disuse and disre- pair in the past few decades when political and military events precluded cooperation and trade between the two countries. The Maputo Development Corridor has the obvious benefit of link- ing an established industrial region inland with its most advantageous outlet to foreign markets. The goals behind the MDC initiative, how- ever, are much broader. It is hoped that the MDC will promote new types of economic development in areas where economic prospects have been limited by poor accessibility to resources and markets. Thus, MDC is a prime example of the development corridor concept, which plays an increasing role in the economic strategies of low- and middle-income regions. The Development Corridor Concept The poor state of transport corridors linking marine ports with interior regions severely limits growth prospects in many low-income countries. This is especially true in Africa, where many of the regions with the great- est development potential-that is, regions with rich resource bases- are located in the interior, and the general state of roads and rail there is poor and often deteriorating. Since most African economies are not very diversified, imports of fuels, chemicals, spare parts, and material are often critical to economic development. This problem is greatest for land- locked countries because national infrastructure systems are not well integrated, border procedures are inefficient, and regional conflicts of- ten rule out cross-border shipments. For many critical industrial inputs, c.i.f. (cost, insurance, freight) prices may be 50 to 70 percent higher than f.o.b. (free on board) prices, and there are long delays in goods delivery attributable primarily to the overland segments of shipments (World 74 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Bank, 1995). Naturally this increases production costs and delays in get- ting products to international markets, and it reduces the competitive- ness of local producers. Improvement in coast-to-interior corridors is an important precondition for export-driven development. This is only part of the story because it only takes account of activities occurring at opposite ends of the corridor. In affluent countries there are many examples of concentrated economic development occurring along the length of a corridor. Examples include industrial regions extending along waterways such as the Ruhr in Germany or along highways such as the Route 128 high-technology corridor in the United States. Further- more, such corridors may straddle international borders. An example is the automotive production region concentrated along major highways; it extends from the U.S. Great Lake States into the Canadian province of Ontario and produces the largest cross-border flow of goods in the world. In such cases economic vitality is enhanced not only by improved ac- cessibility to external resources and markets but also by high levels of accessibility within the corridor. Ease of interaction among firms leads to efficient movement of intermediate goods, rapid diffusion of technologi- cal and market information, and the evolution of skilled and specialized labor forces upon which new firms can draw. The development corridor concept essentially seeks to reproduce this pattern of highly integrated and self-reinforcing growth in low- or middle-income countries. The development corridor is defined as that area in the vicinity of a new infrastructure route "spine" (Development Bank of Southern Africa, 1998). This spine may be a highway, rail line, or even a pipeline or electric transmission corridor, but ideally it will com- prise an integrated system of some or all of these infrastructure elements supported by a modern communications system. Within this corridor imported inputs will be cheaper, access to international markets will be better, interconnections among firms will be stronger, the movement of labor resources will be freer, and the diffusion of innovations will be faster. The hope is that economic development will be fostered not only at opposite ends of the corridor but throughout its length. History and Context of MDC As late as 1975, the port of Maputo was the main outlet to international trade for the industrial region around Johannesburg. Both road and rail links were established on an East-West orientation, extending mostly across the South African province of Mpumalanga and also across the southern Maputo province of Mozambique, which includes the port. The economic isolation of the apartheid government and the civil war in Mozambique made this link impractical, and shipments were diverted to a more expen- SOUTHERN AFRICAN DEVELOPMENT COMMUNITY: THE MAPUTO CORRIDOR 75 sive route via Natal. As a result, Maputo port volumes fell from 11 million tons in 1975 to 1.6 million tons in the mid-1980s. They recovered to more than 3 million tons in the late 1990s (von Klaudy, 1999b). Reestablishment of the traditional transport link is clearly in the inter- est of both countries, since it would increase the competitiveness of in- dustries currently operating in South Africa and return substantial revenues to the port of Maputo. Furthermore, in line with the develop- ment corridor concept, reestablishment of the transport "spine" has the potential to promote development outside the traditional industries and locations in both countries. Through years of neglect and disuse, how- ever, the main elements of the infrastructure, especially in Mozambique, had become inadequate for the task. A major investment project was needed to reestablish the link. In 1995 the transport ministers of South Africa and Mozambique agreed to a massive infrastructure project to rehabilitate, and in some cases rebuild, the road and rail infrastructure system along the Maputo Corridor extending from Witbank in South Africa to the port of Maputo. The corridor serves areas of South Africa with high development po- tential but with severe problems of poverty, unemployment, and misal- location of population. In the 1990s more than 65 percent of the gross provincial product of the Mpumalanga province was contributed by the mining, manufacturing, and electric, gas, and water sectors. However, the population of the province is largely rural and unevenly distributed. Forty percent of the people of Mpumalanga are crowded into the former homeland areas, which occupy only 10 percent of the land. Thirty per- cent live in formal urban areas, which are the location of most industrial employment, but a growing number are migrating from the countryside to informal urban areas with limited development opportunities. Un- employment in the province reached more than 17 percent in the 1990s. The province is well endowed with natural resources, allowing many new avenues for development. Many of the resources are exported in the form of raw materials, with relatively little fabrication or processing (Development Bank of Southern Africa, 1998). Maputo province, which includes the city and port of Maputo, has more than 50 percent of the Mozambican population. This share in- creased substantially during the civil war as people fled the northern rural areas. The provincial economy, dominated by manufacturing and service activities, has been unable to absorb the rapid growth in the labor force. Unemployment ballooned in the 1990s to over 20 percent compared with a national rate of around 8 percent (Development Bank of Southern Africa, 1998). Thus, both the Maputo province and Mpumalanga province are in need of new urban economic activities to absorb an already concentrated 76 INTEGRATION OF TRANSPORT AND TRADE FACILITATION and underemployed population. Their development advantages are complementary: Mpumalanga has a rich resource base, while Maputo has good accessibility to world markets. In general, the potential devel- opment advantages provided by the corridor include: * Reductions in the cost and time delay of transportation within South Africa and Mozambique, and with world markets; * Economies of scale through aggregation of resources distributed throughout the corridor; * Vertical integration through interactions among firms in comple- mentary activities along the corridor; * Access to new international markets, such as the market for fresh produce in the Middle East and the growing world tourism market (Development Bank of Southern Africa, 1998). In order to achieve these advantages in a way that would benefit the population and be within reasonable fiscal bounds, the agreement be- tween South Africa and Mozambique stated four goals: * To enhance and where necessary rehabilitate the transport infra- structure from Witbank to Maputo on the basis of a public sector- private sector partnership; - To maximize investment in the corridor area and to ensure that the sustainable growth and development that arises therefrom is ad- equately supported by integrated infrastructure development; • To maximize the social development impact of investment in the Maputo Development Corridor, particularly to disadvantaged com- munities; * To ensure environmental sustainability of the project by develop- ing policies, strategies, and frameworks that encompass a holistic, participatory, and integrated approach to environmental manage- ment (Development Bank of Southern Africa, 1998). The last two goals reflect the concern that the MDC should not merely reproduce past economic patterns based on export-oriented resource ex- traction yielding highly inequitable benefits and with the potential of severe environmental degradation. Plan, Operation, and Potential Benefits The MDC project has four major transportation infrastructure compo- nents: upgrading and construction of road link from Witbank to Maputo; improvement of rail service from Johannesburg to Maputo, along with lines connecting Maputo to Zimbabwe and Swaziland; upgrading port and harbor operations in Maputo; and establishment of a modern, inte- SOUTHERN AFRICAN DEVELOPMENT COMMUNITY: THE MAPUTO CORRIDOR 77 grated border post to speed movements between South Africa and Mozambique. The transportation components of the project are comple- mented by the upgrading of telecommunications systems in the corri- dor, programs to enhance development of small and medium enterprises, and the promotion of major industrial projects in the corridor. The toll road is being developed under a concession contract signed in May 1997 between the two governments and Trans African Conces- sions (TRAC), a private sector consortium owned largely by two South African road contractors and the international construction firm Bouygues. Under the contract, TRAC takes responsibility for the design, construction, rehabilitation, financing, operation, and maintenance of the toll road. Thus broad responsibilities-along with considerable financial risk-are ceded to a private sector partner. Most of the new construction is on the Mozambique end of the road. The concession con- tract includes construction of a new border post at Ressano Garcia / Komatipoort (Trans African Concessions, n.d.). The total cost of the toll road is about US$320 million. As of mid-2000 the road project was on schedule for completion by the end of the year. The newly constructed segment in Mozambique was scheduled to open in August 2000. The construction has created 4,700 permanent, casual, and temporary jobs, many of which are for persons trained in special constructions schools set up by Trans African Conces- sions.1 Construction of the border post, which is critical to providing effective road service, has been delayed because of disagreements among government agencies in South Africa. Progress on rail and port improvements has been slower than on road improvements. The rail corridor within South Africa was already well established, so the improvements are largely in Mozambique. Port and rail operations in Mozambique are currently operated by the state orga- nization Portos e Caminhos de Ferro de Mocambique (CFM). The plan, however, is to make three concession contracts with private groups to operate rail-port systems. These include rail links to Swaziland and Zim- babwe as well as to South Africa. Negotiations are under way with po- tential concessionaires, and one concession for the rail line to Ressano Garcia (along the main spine of the MDC) is in place. The process has experienced considerable delays, which are attributable in part to the poor state of Mozambique's infrastructure and government institutions as a result of the civil war. 1. Stephan K. L. von Klaudy, memo regarding minutes of team meeting December 6, 1999: "End-of-Millenium Update on Corridor Projects and Developments." The World Bank. 78 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Besides the toll road, the most important development in the corridor is the Mozal aluminum smelter in Maputo, which has been built at a cost of US$1.4 billion by South African and British interests. This facility began producing aluminum for export in June 2000, and this will have a massive effect on Mozambique's balance of trade. Power is supplied from sources in South Africa. Another massive metals project in the plan- ning state is the Maputo Iron and Steel Plant (MISP) that would exploit natural gas from the Pande fields in Mozambique. There is still, how- ever, uncertainty as to whether this project will go forward.2 It remains to be seen whether more modest and spatially distributed economic development benefits will come about as the transportation infrastructure elements come into service. Despite the mineral wealth of the South African interior, only very basic iron and steel production oc- curs. There are no facilities to produce the cold-rolled steel that is used in various fabricated metal and other manufacturing industries. The Development Bank of Southern Africa (1998) has suggested that with improved transportation services it may be possible to develop a com- plex of higher value-added steel-based industries within the corridor, rather than exporting the steel in a relatively raw form. The same ap- plies to other minerals-based industries. However, such development will require significant progress in skills enhancement and support for the establishment of small and medium-size enterprises. Even rural areas might benefit from a shift to agricultural products that are more highly valued on international markets. Both the Mpumalanga province and the Maputo province have appropriate agri- cultural resources for the production of fresh fruits and vegetables that could be exported through the port of Maputo to markets in the Middle East (Development Bank of Southern Africa, 1998). This naturally would require a high level of performance along the entire transportation corri- dor, including rapid border crossings and port operations. Development along these lines would go a long way toward meeting the goal of ex- tending the benefits of the MDC to a broader segment of the population. Tourism is another area in which transportation infrastructure devel- opment may support rapid growth. Tourism is already a major boon to the economy of the Mpumalanga province, contributing 14 percent of total employment. More than one million visitors are attracted every year, especially to the lowveld area, and annual growth exceeds 10 per- cent. Tourism growth in Mozambique was precluded during the war period, but today some believe that the coastal areas could become the most important tourist zone in southern Africa (Development Bank of 2. Ibid. SOUTHERN AFRICAN DEVELOPMENT COMMUNITY: THE MAPUTO CORRIDOR 79 Southern Africa, 1998). High-quality transportation and communication could make it possible to provide packaged tours of the two areas. Institutional Problems The MDC initiative began in 1995 and is still ongoing; most of the high- way infrastructure project was completed by mid-year 2000, with the remaining elements slated for completion by the end of the year. Thus far, progress is impressive. There are, however, a number of areas where proposed activities are either behind schedule or are failing to meet expectations. For the most part, these problems stem more from inad- equate institutional arrangements than from technological or logistical difficulties. Some of these problems reflect the asymmetry of population size, level of affluence, and business sector experience between Mozambique and South Africa. Both the public and private sectors in Mozambique fear that the benefits from the MDC, in terms of construction contracts and economic development, will accrue disproportionately to South African firms. Indeed, the Maputo Corridor Company, which was envisioned in 1995 as a jointly managed enterprise to manage corridor activities, was never implemented by Mozambique? Others problems arise from the inefficient state of Mozambican insti- tutions after a long period of warfare. For example, rail and port devel- opment in Mozambique will involve a transfer of the activities of CFM to private concessionaires, who will surely operate with a much smaller labor force, leading to massive redundancy among CFM's employees. Making the transition in a way that minimizes the blow to displaced workers is a major challenge in the contracting process. Moreover, a re- cent study (Linfield, 1999) concluded that the institutional structure put in place by both countries for the MDC is ill suited to the task. In addition to the development and rehabilitation of transport facili- ties, the investment priorities of MDC include: * Upgrading water, sanitation, health care, and education in low-in- come communities; * Provision of local roads and footpaths to increase accessibility within the corridor; * Provision of infrastructure for developing industrial areas such as drainage, water, and waste disposal; and * Environmental interventions such as coastal zone management and fuelwood management. 3. Ibid. 80 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Broad responsibility for the Maputo Development Corridor was given to the Transport Ministries, and their expertise in these areas is lim- ited. The structure of oversight and management is dominated by federal government officials, despite a move toward devolution of trans- port and development-related activities to the municipal and provin- cial levels of government. Thus, the ability to implement plans is severely retarded. Some institutional reform has already occurred. In South Africa re- sponsibility for the MDC was transferred from the Department of Trans- port to the Department of Trade and Industry, which has incorporated MDC into its Spatial Development Initiative programs. A more novel institutional development is the Borderlands Committee (BC), created in 1998. It includes representatives of provincial and local governments. Swaziland, which had previously been left out of MDC decisionmaking despite its proximity to the corridor, also participates. The Borderlands Committee has actively promoted issues of local concern to the corridor, including border facilitation along the lines of the SADC Protocol, envi- ronmental management, and development of tourism and other services. The Maputo Development Corridor, despite the foregoing institutional problems, exemplifies successful international cooperation within the SADC to promote mutual economic benefit and, in time, greater eco- nomic integration. The main thrust of this initiative has been the cre- ation of physical infrastructure systems. Without them, integrated, diversified, equitable, and sustainable economic development is impos- sible. The ultimate success of the MDC, however, may well depend upon the ability to develop nonphysical infrastructure such as smooth border operations, good business logistics systems, and other knowledge and competencies in transportation and trade facilitation. 6 Transport, Logistics, and Trade Facilitation in the South Asia Subregion Uma Subramanian Recent trends in globalization, supported by technological advances in information, communication, and transportation, have decentralized production and distribution activities worldwide. This decentralization process offers economic opportunities to all countries, particularly de- veloping countries, by allowing them to provide value added services and low-cost raw material or human resource skills. In turn, these coun- tries benefit from improved market access for their exports, acquisition of knowledge and new technology through international transfers, effi- ciency gains in the economy resulting from increased competitive pres- sures on domestic economic activities, and greater employment opportunities. The ability of countries to grow rapidly depends on their capacity to link with global and regional markets. In turn, this capacity depends on connectivity and the efficiency and speed with which goods and services can be moved from production centers to final markets, ensuring high-quality and "just in time" delivery in response to market demand. These are important parameters in the emerging global market where market expectations have risen substantially in the past few years. Within regions or countries, efficient transport and logistics systems offer new possibilities for linking isolated and landlocked regions to markets, developing the resource base, integrating manufacturing and service activities across borders, and increasing employment. By facili- tating access to a larger regional market, they could help countries ben- efit from economies of scale. By providing market access to rural areas, they enable rural producers and small industries to deliver quality prod- ucts within an acceptable time and at a competitive cost. These changes have significant implications for opening up South Asia, one of the poor- est regions in the world. 81 82 LNTiGRATION OF TRANSPORT AND TRADE FACILITATION Ready-made garments and carpets, Nepal's top export commodities, have markets in Europe and the United States. Bangladesh's primary export, garments and knitwear, are transported to U.S. markets. Bhutan and Nepal are seeking regional markets for agricultural products in Bangladesh and India. The northeastern Indian states' horticultural prod- ucts are currently confined to local markets or informally traded across borders for low prices but could find markets in Bangladesh. Similarly, the northeastern states of India could obtain fish, for instance, from Bangladesh instead of having fish transported from other Indian states (for example, Andhra Pradesh, West Bengal). The Indo-Bangladesh trade groups as well as policy research groups in the countries have identified the possibility for collaborative ventures in fertilizer, cement, and gas- based industries.' As the South Asian countries position themselves to participate in glo- bal markets and strengthen their regional markets, transport costs and time must be reduced. Logistics inefficiencies translate into higher priced commodities and weaken these countries' credibility and position in the global market. In discussions of regional transport and logistics systems, this funda- mental question is often asked: to what extent does the economy of the transit country benefit from improvements in transport and logistics systems? The country providing the transport infrastructure could, in principle, recover its investment through appropriate charges to the tran- sit vehicles and cargo while deriving additional value added from complementary services provided to these transport activities. The value added is the greatest where the transit country provides an efficient in- ternational seaport gateway and some of the trucking or rail services used in the logistics chain. A more critical question of direct relevance to South Asia is frequently asked: to what extent do transport-logistics improvements benefit the poorer members of society? Benefits to them would derive from better access to domestic and foreign markets for local products and from the employment associated with upgrading the transport infrastructure. The medium- and long-term benefits are the continuity and even expansion of employment in economic activities or industries that, without better logistics, would not have been established or would rapidly lose market share. The extent and allocation of benefits would be affected, of course, by the following: 1. Indo-Bangladesh Dialogue: Economic and Trade Cooperation, 1995, report on a meeting hosted by the Center for Policy Dialogue, Bangladesh, and the Center for Policy Research, India, as part of ongoing dialogue among nongovernmental and research groups. TRANSPORT, LOGISTICS, AND TRADE FACILITATION IN THE SOUTH ASIA SUBREGION 83 * How well the isolated and landlocked regions are served * How labor intensive the new economic activities are * How the charges are structured (that is, who pays and who benefits) * How efficient the logistic systems become that will help minimize the cost to the economy. As South Asia looks outward toward global markets and greater trade and investment relationships within the region, it could benefit from the experiences of countries in other regional trade blocs such as the Com- mon Market of the South (Mercado Comin del Sur or Mercosur), the North American Free Trade Agreement (NAFTA) signatories, and the Southern African Development Community (SADC). Rotterdam port is a successful hub that has maintained its position as one of the world's largest ports for four decades. There are clear lessons in Rotterdam's experience for managers of ports and airports in South Asia as they or- ganize their trade and transport chains. 2 This chapter focuses on transportation and logistics issues in a subre- gion of South Asia covering Bangladesh, Bhutan, Nepal, and eastern and northeastern India. In the profile of the subregion that follows, we present an overview of economic growth indicators (table 6-1) and so- cioeconomic indicators (table 6-2). Subsequent sections of this chapter highlight transportation and logistics issues in the subregion that not only affect intraregional trade but also international trade, with strong implications for economic growth and poverty alleviation. Profile of the Subregion T'he South Asia subregion covering Bangladesh, Nepal, Bhutan, and east- ern and northeastern India is home to almost half a billion people and is among the most densely populated areas in the world. More than half the population lives on less than $1 a day, and socioeconomic indicators (such as infant mortality, life expectancy, and adult and female literacy) are among the lowest in the world. During the next twenty-five years this population is expected to double, exacerbating poverty, social ten- sion, and environmental degradation unless strategies for encouraging faster economic growth are conceived and implemented. Though the subregion has abundant natural resources in the form of minerals, water, and energy resources, they are largely untapped be- cause of poor connectivity and inadequate access to markets. Both Nepal and Bhutan are landlocked countries, as are the seven northeastern 2. In this volume see chapters 2, 4, 5, and 8. 84 LNTEGRATION OF TRANSPORT AND TRADE FACILIrATION Table 6-1. Economic Growth Indicators, South Asia Indicator India Bangladesh Nepal Bhutan Area (thousands of square kilometers) 3,288 144 147 47 Population (millions) 1980 687 87 14 n.a. 1998 980 126 23 0.8 Average annual growth rate (%), 1997-98 2.0 2.1 2.5 n.a. GNP, 1998 (billions of U.S. dollars) 427.4 44.2 4.9 0.4 Average annual growth rate (%), 1997-98 6.2 5.9 2.7 8.2 GNP per capita, 1998 (U.S. dollars) 440 350 210 470 Average annual growth rate (%), 1997-98 4.3 3.2 0.3 6.8 GNP per capita at purchasing power parity (U.S. dollars) 2,071 1,330 1,079 1,446 Trade as percentage of GNP 1970 8.0 17.0 13.0 n.a. 1998 25.0 33.0 58.0 n.a. n.a. Not available. Source: World Bank (1999). Indian states. The northeastern region of India is connected to the rest of India by a narrow congested land corridor between Bangladesh and Nepal.3 This landlocked region, a natural hinterland to Chittagong port, trades with the rest of India and the world through this congested strip of land. The costs of transporting goods to and from the northeastern region are consequently high. According to the report of the Committee on Clause Seven of the 1990 Assam accord, Assam was spending almost as much in transporting essential commodities such as food-grain, fish, and edible oils from "mainland" India as the costs of the commodities (Verghese, 1996). Tea from Assam is shipped to Europe via Calcutta port. The transportation cost includes a trucking distance of more than 1,400 kilometers through the land corridor around Bangladesh to Calcutta port. The traditional tea route for Assamese tea via Chittagong port would 3. This corridor is known in the subregion as the "chicken's neck." Table 6-2. Socioeconomic Indicators, South Asia Subregion Percentage Percentage Infant Under-5 lieac ae GNP per of popula- of popula- mortality mortality Life Illiteracy rate, capita, tion living tion living rate, per rate, per expectancy for adults (age dollars, on less than on less than 1,000, 1,000, at birth, 15 and older), 1997 Area 1998 $1/day $2/day 1997 1997 1997 Males Females The Subregion India 430 47 87.5 71 88 63 33 61 Bangladesh 350 50.3 86.7 75 104 58 50 73 Nepal 210 n.a. n.a. 83 117 57 44 79 Bhutan 430 n.a. n.a. 63 n.a. 61 n.a. n.a. Other countries cJGo Indonesia 680 7.7 50.4 47 60 65 9 20 China 750 22.2 57.8 32 39 70 9 25 Argentina 8,970 n.a. n.a. 22 24 73 3 4 Brazil 4,570 23.6 43.5 34 44 67 16 16 Burkina Faso n.a. n.a. n.a. 99 169 44 n.a. n.a. Namibia n.a. n.a. n.a. 65 101 56 n.a. n.a. Regions East Asia and Pacific 990 n.a. n.a. 37 47 69 9 22 Latin America and Caribbean 3,940 n.a. n.a. 32 41 70 12 14 Sub-Saharan Africa 480 n.a. n.a. 91 147 51 34 50 South Asia 430 n.a. n.a. 77 100 62 36 63 n.a. Not available. Note: South Asia includes all the countries in South Asia as categorized in the World Development Report. Sources: World Bank (1999c, 2000b). 86 INTEGRATION OF TRANSPORT AND TRADE FACILITATION cut the distance by almost 60 percent. Third-country trade for both Nepal and Bhutan is also routed through this corridor to Calcutta port with associated delays and costs. Historically, South Asian countries have had restrictive trade policy regimes with stringent barriers, quantitative and tariff restrictions on trade, restrictions on foreign capital investments, and a predominant role of the public sector in the direct production of goods and services and in regulating the private sector. Consequently, the place of trade in national income has been low. Foreign direct investment flows to the South Asian region have risen in the past decade but are low compared with those to other regions in the world (figure 6-1). The trade restrictions also applied to cross-border and regional trade, which explains why trade among India, Bangladesh, Nepal, and Bhutan has been traditionally low. Figure 6-2 presents regional exports as a per- centage of total exports for selected regional trade blocs. The percentage of exports among countries within the South Asian Association for Re- gional Cooperation (SAARC) remained at or below 5 percent of total exports worldwide between 1980 and 1997. This pattern differs mark- Figure 6-1. Foreign Direct Investment in Selected Regions, 1990 and 1997 Millions of U.S. dollars 70,000 1990 60,000 1997 50,000 40,000 30,000 * 20,000 10,000 _ 0 South East Asia Latin Sub- Middle Europe Asia and the America Saharan East and and Pacific Africa North Central Africa Asia Source: World Bank (1999c). TRANSPORT, LoGISTICS, AND TRADE FACILITATION IN THE SOUTH ASIA SUBREGION 87 Figure 6-2. Exports within Regional Trade Blocs as a Percentage of Total Exports, 1980-97 Percent 80 70 APEC 60 European Union 50 NAFTA 40 30 ._Mercosur 20 - . - _ _ . - - :. . - eSoAs 0 _- _ _ I l SAARC 1980 1985 1990 1994 1995 1996 1997 Note: The figure compares the exports within regional trade blocs as a percentage of total exports of the Asia-Pacific Economic Cooperation, the European Union, the North American Free Trade Agreement countries, the Common Market of the South (Mercado Comin del Sur or Mercosur), the Southern African Development Community, and the South Asian Association for Regional Cooperation. Soorce: World Bank (1999c). edly from other trade blocs such as Mercosur, NAFTA, and SADC. Intraregional exports within Mercosur and SADC were comparable to SAARC in 1985 but in the past fifteen years both trade blocs have in- creased intraregional exports by twofold or more. As seen in table 6-3, in all four countries intraregional trade is only a fraction of total third-coun- try trade. Furthermore, this trade is concentrated in a few key commodi- ties and demonstrates a significant level of dependence of the smaller countries on India. Table 6-4 shows the top ten commodities traded be- tween India and Bangladesh in 1996, 1997, and 1998. For instance, tex- tile yarn that dominates India's exports to Bangladesh is a primary raw material for Bangladesh's garment sector. The low official intraregional trade is accompanied by significant in- formal trade among the countries concerned. It is estimated that unoffi- cial exports from India to Bangladesh are approximately equal to official 88 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Table 6-3. Intraregional Trade in South Asia, 1998 Exports Imports Millions of Percentage of Millions of Percentage of Intraregional trade U.S. dollars' total exports U.S. dollarsa total imports India's trade with Bangladesh 1,038 1.9 65 0.2 Nepal 324 0.6 147 0.5 Bhutan 12 0.0 15 0.1 Other countries 52,967 97.5 28,958 99.2 Total 54,341 100.0 29,185 100.0 Nepal's trade with India 146 32.9 440 30.7 Bangladesh 10 2.3 6 0.4 Bhutan n.a. 0.0 n.a. 0.0 Other countries 288 64.9 988 68.9 Total 444 100.0 1,434 100.0 Bangladesh's trade with India 55 1.4 1,179 16.1 Nepal 18 0.5 14 0.2 Bhutan n.a. 0.0 5 0.1 Other countries 3,749 98.1 6,115 83.6 Total 3,822 100.0 7,313 100.0 Bhutan's trade with India 11 9.4 9 6.6 Bangladesh 4 3.4 n.a. 0.0 Nepal n.a. 0.0 n.a. 0.0 Other countries 102 87.2 128 93.4 Total 117 100.0 137 100.0 n.a. Not available. Note: Data for 1998 Bhutan trade are not available. Therefore, data for 1997 are used. a. Calculated based on an exchange rate of Ngultrum 36.313 to one U.S. dollar. Sources: IMF (1999a, 1999b). exports. A large portion of the unofficial exports (85 percent) is in the form of border trade between West Bengal and Bangladesh and consists mainly of food items, live animals (cattle), and consumer goods. The unofficial flow from Bangladesh into India is dominated by synthetic yam, electronic goods, and spices. A sizable percentage (44 percent) of the unofficial imports consists of gold and/or Bangladesh currency to pay for Indian goods that are then smuggled into Bangladesh. The bor- ders between India and Nepal are also porous. According to one esti- Table 6-4. Key Commodities Traded in the South Asia Subregion, 1996, 1997, 1998 (thousands of U.S. dollars) 1996 1997 1998 Commodities Percent Commodities Percent Commodities Percent India export to Bangladesh Total trade 100.0 Total trade 100.0 Total trade 100.0 Textile yam 31.4 Textile yam 27.3 Textile yarn 27.3 Cotton fabrics, woven 7.2 Rice 12.3 Rice 12.3 Rice 4.7 Cotton fabrics, woven 7.7 Cotton fabrics, woven 7.7 Motor vehicle parts and accessories 4.6 Lime, cement, building products 4.7 Lime, cement, building products 4.7 Iron, steel, plate, sheet 3.4 Iron, steel, plate, sheet 2.8 Iron, steel, plate, sheet 2.8 Lime, cement, building products 3.3 Coal, lignite, and peat 2.4 Coal, lignite, and peat 2.4 Stone, sand, and gravel 2.7 Motor vehicle parts and accessories 2.1 Motor vehicle parts and accessories 2.1 Cycles, etc., motorized or not 2.5 Rubber tyres, tubes, etc. 2.0 Rubber tyres, tubes, etc 2.0 Rubber tyres, tubes, etc. 2.2 Textile, leather machinery 2.0 Textile, leather machinery 2.0 Aluminium 2.0 Feeding stuff for animals 1.9 Feeding stuff for animals 1.9 Bangladesh export to India Total trade 100.0 Total trade 100.0 Total trade 100.0 Fertilizers, manufactured 92.0 Fertilizers, manufactured 92.7 Inorganic elements, oxides, etc. 44.0 Articles of plastic 7.1 Petroleum products 3.8 Fertilizers, manufactured 38.2 Tea 0.2 Tea 1.2 Tea 5.6 Alcohols, phenols, etc. 0.1 Alcohols, phenols, etc. 0.9 Iron, steel, plate, sheet 2.7 Fish, fresh, chilled, frozen 0.1 Metal tanks, boxes, etc. 0.5 Leather 1.7 Other machinery for special industry 0.1 Leather 0.2 Metal tanks, boxes, etc. 1.6 Under garments not knit 0.1 Textile articles 0.2 Mens outerwear not knit 1.2 Leather 0.1 Articles of plastic 0.1 Under garments not knit 0.8 Metal tanks, boxes, etc. 0.0 Special transactions 0.1 Petroleum products 0.8 Petroleum products 0.0 Floor coverings, etc. 0.1 Womens outerwear nonknit 0.5 Source: UN COMTRADE data, 1998. 90 INTEGRATION OF TRANSPORT AND TRADE FACILITATION mate, informal trade during the late 1970s and 1980s could have been eight to ten times more than the officially recorded trade. In the late 1980s and early 1990s, all of the countries in the subregion began to lower their protective trade barriers and adopt policy reforms that have made these economies more open to the rest of the world and to each other. The South Asian Association for Regional Cooperation- India, Pakistan, Bangladesh, Sri Lanka, Maldives, Nepal, and Bhutan- was established in 1985. It began with the SAARC Preferential Trading Arrangement (SAPTA) and is currently pursuing measures to establish the South Asian Free Trade Area (SAFTA). The push toward regional cooperation in South Asia is occurring in the context of important macroeconomic changes in these countries- growing liberalization, deregulation of industries and markets, reduc- tion in the role of the state, and an expanding role for the private sector. While these processes are still nascent, there has been a steady increase in trade as a percentage of GDP (figure 6-3) and a growing economic dynamism that is reflected in robust income growth in the past decade, second only to that of East Asia (World Bank, 2000b). The share of trade to GDP for South Asia was 25 percent in the 1990-94 period. Export per- Figure 6-3. Total Trade as a Percentage of GDP, Selected Regions Percent 60 1975-79 50 1990-94 40 30 20 10 0 World OECD Developing Latin East South countries countries America Asia Asia Source: Bandara and McGillivray (1998). TRANSPORT, LOGISTICS, AND TRADE FACILITATION IN THE SOUTH ASIA SUBREGION 91 Figure 6-4. Real Export Growth in Bangladesh, India, and Nepal Percent 18 16 - 1981-90 1991-95 14 - 12 - 10 - 8- 12 0 Bangladesh India Nepal Source: Bandara and McGillivray (1998). formance following trade reforms showed much improvement; Bangladesh's export growth is particularly impressive (figure 6-4). The share of manufactured exports as a proportion of total goods exports also grew rapidly Though intraregional trade is only a fraction of total trade and the growth rate of intraregional trade as percentage of total trade has been slow, in terms of absolute value there has been a multifold increase in intraregional trade. Between 1988 and 1998, India's exports to Bangladesh increased in value terms more than sixfold, while exports from Bangla- desh to India multiplied four to five times. A similar pattern emerges for Nepal-India trade. Trade between Bangladesh and Nepal and between Bangladesh and Bhutan also rose, though not as steeply. Transportation and Logistics Arrangements in the Subregion With economic liberalization, private sector dynamism in South Asia is also rising. Domestic as well as international business communities are actively pursuing improvements in investments and trade in the region. A fundamental requirement clearly recognized and expressed by the 92 INTEGRATION OF TRANSPORT AND TRADE FACIUTATION private sector is the need for streamlined transportation, trade facilita- tion, and logistics systems that would enable seamless movement of goods and services within the region and to export markets in Europe and the United States that demand high-quality products and "just in time" deliveries. However, transport and logistics impediments continue to constrain economic activities in South Asia. The key transport and logistics impediments in the subregion are dis- cussed below using data from selected sample commodity flows that were examined in detail for a transport logistics cost study by the World Bank (Subramanian and Arnold, forthcoming).4 The analytic framework applied in the evaluation of commodity movements on existing and pro- posed transit routes considered data on both the cost and time associ- ated with the entire logistics chain, including the time and cost for cross-border procedures and moving cargo through seaports.5 Excessive delays occur in moving cargo through the ports of Calcutta and Chittagong for international trade.6 Port congestion has led to inef- ficient handling of the cargo. Contributing to the delays are cumber- some customs procedures. Vessels cannot operate on a fixed day-of-the week schedule because of the uncertainty regarding the turnaround time in the port. This adds to the time for ocean shipment of containers be- cause the movement of the feeder vessels cannot be coordinated with that of the mother vessels. Containers must wait in Singapore for up to a week on average (Subramanian and Arnold, forthcoming). Land border crossings also involve time delays and logistics costs that are significant. Inefficient customs operations cause unnecessary queu- ing delays for inspection and customs clearance. Moreover, facilities are inadequate for transfer of cargo between vehicles and for storage of car- goes that are being consolidated at the border. Poor physical planning and uncoordinated operations cause serious congestion at the busier 4. The strategic commodities and routes selected for this study provide opportunities for landlocked areas to reach local and regional markets or are critical commodities that link the subregion to the global market. 5. The logistics cost model enabled two types of analyses. The first identifies the critical impediments along a logistics chain-physical gaps and constraints, policies, procedures, commodity type and market conditions-and then determines where efficiency improve- ments in the short term can bring about significant returns. The second type of analysis compares existing routes with alternative routes (and modes) that have been proposed by the private sector, are being considered by the concerned governments, or have poten- tial for growth. The comparative analysis also allows a dynamic analysis of how im- provements in the components of both logistics chains would affect overall benefits and route selection. 6. Haldia port, India, was not included in the selected routes, although its role in han- dling the cargoes studied (tea, for example) is increasing rapidly. TRANSPORT, LoGIsTncs, AND TRADE FAcrLITATON IN THE SouTH ASIA SUBREGION 93 crossings-for example, Petrapole (India) to Benapole (Bangladesh)- and lead to long delays at the less developed crossings where there is no customs office or customs official in residence (for example, the Banglabandh border in Bangladesh for Nepalese trade cargo). Limitations on routes for transit cargo (regardless of which country owns the trucks) prevent shippers from taking the routes that offer the best balance of time and cost and from selecting the port that offers the least cost shipping to the overseas destination. This is true for regional movements also. As in other regional trading blocs, in the South Asia subregion the bilateral protocol and transport/transit arrangements reflect low lev- els of mutual trust and confidence. For instance, no foreign vehicle is allowed on Bangladeshi roads. As a result all commodities transported by road to Bangladesh from the neighboring countries are transshipped at the border (transferred to Bangladeshi trucks). This greatly adds to the congestion, delays, and transportation costs at the border cross- ings. Nepalese trucks are allowed access only on dedicated routes within India; Indian trucks are allowed to enter Nepal and must de- part within 72 hours. Commodities to the northeastern Indian states from the rest of India still get routed around Bangladesh through the narrow land corridor mentioned earlier (the "chicken's neck"). The transportation cost and, in particular, time could be reduced significantly if the subregion would allow transit access for in-bond movement of Indian trucks through a dedicated corridor through Bangladesh! In this case there would be no transfer of cargo from Indian to Bangladeshi trucks at the border crossings. Table 6-5 compares costs and time for transportation of representative freight of all kinds (FAK) via two routes: the current route (via the "chicken's neck") and a potential transit route via Bangladesh by road. The latter route reduces the costs of transportation by 25 percent and cuts travel time by almost 50 percent. Transportation by railway and inland waterways offers similar savings for high bulk cargo. There is no bilateral agreement as yet between Bangladesh and India to move con- tainer traffic. By one estimate, it takes 45 days to move a container from Delhi to Dhaka: the container is moved via Tughlakabad to Mumbai and then shipped to Singapore, where it is brought by feeder ships to Chittagong port and then to the Dhaka inland container depot (ICD) by rail. The 2,000 kilometers between Dhaka and Delhi could be covered in 7. Countries in Europe and Central Asia allow free access for transit traffic from neigh- boring countries. 94 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Table 6-5. The Cost and Time of Exporting Freight of all Kinds from Calcutta to Agartala, India, by Two Routes Route through All India routea Bangladeshb Cost Time Cost Time Indicator (U.S. dollars) (hours) (U.S. dollars) (hours) Transport and handling Inland transport 760 180 263 41 Cargo handling 278 18 270 20 Cross-border processing Cargo transfer - - 0 0 Customs inspection - 75 12 Trade-related logistics Time cost of goods 73 96 Insurance or pilferage and damage 240 180 Documentation and forwarding 60 240 Bank processing for Letter of Credit 96 96 Key results Transport logistics cost 1,507 1,220 Transport logistics time 198 73 - Not applicable. Note: The shipment value is $24,000 and the shipment size is 8 tons. a. The route is Calcutta-Raiganj-Siliguri-Gauhati-Karimganj-Agartala. b. The route is Calcutta-Petrapole-Benapole-Daulatdia Ghat-Aricha Ferry- Narayanganj-Bhairab Ferry-Brahmanbaria-Ashuganj-Akhoura-Agartala. Source: Subramanian and Arnold (2001). two to three days according to estimates from the railways, but a bilat- eral protocol between the two countries would be needed. Transport Infrastructure Roads. Road transport is the principal mode for freight movements in the subregion. Medium-size trucks (a payload of 7 to 10 tons) operate on two-lane asphalt roads at relatively low average speeds (200 to 400 kilo- meters per day). The roads poorly maintained and congested in many parts. Only recently has India begun to upgrade its four major intercity roads to dual carriage ways. The movement of containers on the Indian roadways is limited not only by the design and condition of the roads and traffic congestion but also by nonphysical barriers to moving con- TRANSPORT, LOGISTICS, AND TRADE FACILITATION IN THE SOUTH AsLA SusRcGION 95 tainers out of the port.8 In Bangladesh the weight limits on the bridges between Chittagong and Dhaka, the main corridor for containerized goods, prevent the use of tractor-trailers. India's load limit for trucks is 10 tons per axle. Bhutan and Nepal have similar limits. Bangladesh currently applies a limit of 8.2 tons, but this is expected to increase to 10 tons. Trucking services in all four coun- tries are provided almost entirely by small private-sector owners and operators. Strong competition produces relatively low freight rates. These rates and the lack of strict inspection standards discourage the use of new trucks. The size of vehicles is limited by the capacity of the bridges, many of which are old, narrow, and in need of strengthening. The limits on total gross vehicle weight vary among the countries, but they are below the level required for efficient operation of larger trucks and trac- tor-trailers. The combination of weight limits and road conditions makes it expensive to move bulk commodities long distances by road unless the trucks are overloaded. Most of the trucks used in cross-border move- ments are two- to three-axle (six- or ten-wheel) trucks carrying payloads up to 18 tons. Trucks carrying bulk cargoes are generally overloaded, causing damage to poorly maintained roads. Despite the differences in road dimensions and national limits on gross vehicle weight, there are no physical hindrances on the movement of trucks between the countries. Any constraints on cross-border move- ments are caused by insufficient capacity on the roads approaching the border, inadequate waiting area and customs checkpoints, and the lack of effective transit protocols. For example, Bangladesh does not allow trucks from other countries to travel on its roads. India reciprocates but does allow trucks from Nepal and Bhutan to operate on designated transit routes. Indian trucks are allowed into Nepal and are given a limit of 72 hours to carry cargo and return to India. Railways. For a number of commodity routes, such as bulk cargoes between India and Bangladesh and transit cargo from Nepal, rail has a competitive advantage. The rail networks in India and Bangladesh are a mix of broad and meter gauge (Subramanian and Arnold, forthcoming, table 2.2). In India about one-third of the system is double tracked, and the Indian railways is making concerted efforts to convert its network to broad gauge in the Eastern region. The network is mainly meter gauge in eastern Bangladesh and predominantly broad gauge in the western 8. These containers adhere to standards set by the International Organization for Stan- dardization, which is based in Switzerland. 96 INTEGRATION OF TRANspORT AND TRADE FACILITNTION part of the country, but the construction of the dual gauge rail link across the Jamuna Bridge, the extension of dual-gauge operations to Dhaka, and the planned introduction of dual-gauge track between Chittagong, Akhaura, and Tongi will substantially improve the coverage of the broad- gauge system. These developments could also provide a direct link be- tween Chittagong and Nepal, as well as eastern India. Several other harmonization measures as well as additional border-crossings are un- der way or are being planned that will provide additional linkages be- tween the western and eastern parts of Bangladesh and across the subregion. There is a protocol for the interchange of rail wagons across the India- Bangladesh border that sets out the charges for the exchange of wagons and establishes a target wagon balance. Rail track does not appear to create a physical constraint for the movement of trains across the border, but Indian and Bangladeshi wagons have different coupling and brak- ing systems that restrict operating speeds for Indian trains hauling Bangladeshi cars. Freight trains in India are typically 40 wagons in length compared with 35 wagons in Bangladesh. This means that Indian trains must be broken into two sections; the second section must wait for up to a week for another locomotive. The constraints on regional freight movement by rail have less to do with technical physical constraints than with inefficiencies of the rail- way systems, which have lowered their share of freight traffic in the past few decades even within the countries. Both Indian and Bangladesh railways are publicly operated. Despite recent efforts to improve perfor- mance, they continue to suffer from overstaffing, poor maintenance, and old rolling stock. Bangladesh Railways also suffers from poor utilization of equipment. In India the movement of containers by railroad has in- creased substantially following the formation of Container Corporation of India and the procurement of a large fleet of cars for transporting standardized boxes. In Bangladesh the transport of containers is limited by the lack of cars and the operating commitment of the railroad. There are some block train movements between Chittagong and the Dhaka ICD, but these account for a very small portion of the containers handled at Chittagong (Parkash, 2000). Problems with rail services, charges, and port regulations limit the boxes that can be moved between the port of Chittagong and the Dhaka ICD to about 15 percent of the total volume moved through Chittagong. Inland Water Transport. Inland waterways provide a potential lower cost alternative for low value bulk cargo by truck in the subregion. Bangladesh and India signed an Inland Water Transport transit protocol in 1980. The protocol allowed Indian barges to transit Bangladesh be- TRANSPORT, LOGIsTIcs, AND TRADE FACILITATION IN THE SouTH AsiA SUBREGION 97 tween West Bengal and Northeast India, but it prohibited transshipment of Bangladeshi cargo en route. In October 1999 a revised protocol was introduced that allows Indian barges to transport cargo between the two countries, provided that both countries share the transportation of cross- border trade and transit cargo on an equal tonnage basis. Despite low costs and the absence of cross-border transshipment requirements, inland waterway transport is at a competitive disadvan- tage because of its low travel speeds (which average less than 50 kilo- meters per day due to the limitations on night navigation) and physical constraints on routes. Inefficiencies at border crossings in the subregion are attributable not only to protocol requirements, such as the one re- quiring transshipment at the border. Two other factors exacerbate the problem: (1) documentation and procedural inefficiencies for customs clearances and (2) physical infrastructure constraints (poorly designed warehouses, narrow access roads, and so on) that do not support effi- cient utilization of existing capacity. Cross-Border Procedures The existing procedures in the subregion are both cumbersome and time consuming, and they reflect the conservative trade policies that have characterized the region for decades. Customs clearance procedures can add significant costs and delays even though they represent a relatively small part of the logistics chain. Poorly defined or complex procedures and documents reduce transparency, especially when the approval of many people is required. Consider the key border crossing point Benapole (Bangladesh) to Petrapole (India) through which more than 80 percent of trade gets routed. Severe congestion results in long queues of trucks on both sides of the border (as many as 1,500 trucks) and waiting times of one to five days. As seen in table 6-6, yam imports from Calcutta to Dhaka require an average travel time of about 270 hours. More than 85 percent of the time is spent at the border crossing on queuing, customs clearance, and transferring cargo to Bangladeshi vehicles. Many of the documents submitted to customs at the border crossings in the subregion are similar to those commonly required at other inter- national borders (such as invoices, packing lists, certificates of origin, letters of credit, and quarantine forms for plants and foods), while oth- ers are less common and specific to local requirements (such as import licenses, export permits, and various certificates). Since simplified pro- cedures for in-bond movements and modem regulations for the carriage of goods have yet to be developed, equipment interchange certificates for containers and railway cars are needed and registration forms for vehicles and drivers moving across the border. The more fundamental 98 INTEGRATION OF TRANSPORT AND TRADE FACILITATON Table 6-6. The Cost and Time of Importing Yam by Truck from Calcutta, India, to Dhaka, Bangladesh Indicator Cost (U.S. dollars) Time (hours) Transport and handling Inland transport 516.00 17 Cargo handling 525.00 24 Cross-border processing Cargo transfer 80.00 156 Customs inspection 97.00 73 Trade-related logistics Time cost of goods 158.26 Insurance or pilferage and damage 380.00 Documentation and forwarding 285.00 Bank processing for Letter of Credit 152.00 Key results Transport logistics cost 2,193.26 Transport logistics time 270 Note: The shipment value is $38,000 at Benapole (landing port). Source: Subramanian and Arnold (2001). problem is that the basic customs documents, such as transit, export, and import declarations, vary from country to country and must be pre- pared separately for each side of the border and submitted in multiple copies, with several signatures required. A standardized format would not only reduce the paperwork but also encourage more consistent pro- cedures and greater coordination between customs officials on either side of the border. Although the requirements for the Nepal-India move- ments have been reduced in the past few years, considerable improve- ments are still needed. Ports Ports in the subregion pose a major constraint to international trade, affecting both national and regional economies. Exporters from South Asia cannot guarantee "just in time" deliveries in the global market. A country's competitive position in the global markets is affected by its reliability in delivery time and cost. The value of the cargo per unit vol- ume or weight, its susceptibility to damage from handling, and physical perishability and commercial shelf life greatly influence delivery time and cost. Commodities that are either physically perishable (for example, TRANSPORT, LoGIsrcs, AND TRADE FACILITATION IN THE SourH ASIA SUBREGION 99 fruit, flowers) or have a short commercial shelf life (for instance, gar- ments because of changes in fashions or trends) limit the feasible deliv- ery time. Transport logistics impediments en route, particularly at ports, ad- versely affect delivery time and costs. Carpet exports from Kathmandu to Germany, for instance, take almost 50 days to reach a European port (table 6-7). Similarly, the average time to move "time sensitive" ready- made garments from Dhaka, Bangladesh, to Los Angeles is about 35 days (table 6-8). Exports of ready-made garments are highly market sen- sitive in terms of cost and time because they have a short commercial life and are vulnerable to damage or loss. Carpets, on the other hand, have longer "shelf" life and are slightly less sensitive to damage but quite susceptible to loss. Since they are high-value commodities, how- ever, they tie up capital when there are long delays in reaching final market. As seen in the case of carpet exports from Nepal and garment exports from Bangladesh, the delays at Calcutta and Chittagong ports play a predominant role. Congestion within the ports, leading to inefficient handling of cargo, and cumbersome customs procedures add to the Table 6-7. The Cost and Time of Transporting Carpets by Truck- Liner Vessel from Kathmandu, Nepal, to Bremen Port, Germany Indicator Cost (U.S. dollars) Time (hours) Transport and handling Inland transport 480.00 117 Cargo handling 260.00 74 Ocean freight 1,200.00 528 Cross-border processing Cargo transfer 261.00 164 Customs inspection 405.00 20 Trade-related logistics Time cost of goods 1,252.00 Insurance or pilferage and damage 675.00 Documentation and forwarding 450.00 Bank processing for Letter of Credit 360.00 Key results Transport logistics cost 5,343.00 Transport logistics time 903 Note: The shipment value is $90,000 and the shipment size is one 20-foot equiva- lent unit. Source: Subramanian and Arnold (2001). 100 INTEGRAUON OF TRANsPoRT AN-D TRADE FACILITATON Table 6-8. The Cost and Time of Transporting Cotton Garments by Truck-Liner Vessel from Dhaka, Bangladesh, to Los Angeles Indicator Cost (U.S. dollars) Time (hours) Transport and handling Inland transport 130.00 24 Cargo handling 311.00 28 Ocean freight 1,262.00 564 Cross-border processing Cargo transfer 33.90 170 Customs inspection 95.00 36 Trade-related logistics Time cost of goods 608.00 Insurance or pilferage and damage 480.00 Documentation and forwarding 120.00 Bank processing for Letter of Credit 192.00 Key results Transport logistics cost 3,231.00 Transport logistics time 822 Note: The shipment value is $48,000 and the shipment size is 1 20-foot equivalent unit. Source: Subramanian and Arnold (2001). delays of waiting for feeder vessels that cannot operate on a fixed day- of-the-week schedule because of uncertainty in turn-around time at the ports. Containers from Calcutta and Chittagong are transshipped via Singapore or Colombo. Feeder services are provided by independent operators that transport boxes for several large container lines. The time required for the feeder movement and transshipment is about eight days-three days of sailing time and five days in the transshipment port waiting for the mother vessel. For large shipments of neo-bulk cargoes, the cost of ocean transport is dependent on the size of the vessel. This is determined by the depth of the port as well as the size of typical consignments. The draft limitations at Calcutta, Haldia, Chittagong, and Mongla are 7.5, 8.4, 9, and 4 (7.5 at anchorage) meters, respectively. The routing of neo-bulk cargoes is gen- erally determined by the availability of railroad and inland water access to the port having adequate depth. The protocols for handling transit cargo from other countries appear to be well established for these ports. The principal barriers to efficient transfer are the slow handling rates, restrictive labor practices, poor operational controls, and cumbersome customs procedures. TRANSPORT, LoGISTCS, AND TRADE FACILITATION IN THE SOUTH AsIA SUBREGION 101 Bangladesh is currently implementing a preshipment inspection and valuation for selected imports at their port of origin in order to reduce the time required for customs inspection. Although this should improve trans- parency and reduce informal payments, it will not significantly reduce the time required for customs clearance because many of the delays are associated with the preparation of customs documents and inspections. Improving port performance would bring direct benefits not only for regional commodity movements but, more importantly, for national eco- nomic development. The critical importance of an efficient gateway port for Bangladesh is obvious. The performances of Calcutta and Haldia ports have strong implications for the revitalization of Calcutta and West Bengal. More efficient ports, such as the Jawaharlal Nehru Port Trust (JNPT) at Nhava Sheva on the western coast of India, may offer a more cost-effective option for traders from eastern India and Nepal or Bhutan to reach European markets. The time and cost savings obtained at the port itself as well as during the ocean haul may compensate more than adequately for the longer distance the exporters would need to carry cargo to reach the port. Table 6-9 compares the current route for Nepalese carpet exports (via Calcutta port to Germany) and a potential route through JNPT. The JNPT route indicates a 14 percent savings in transport costs and a reduction in travel time from nearly 38 days to 26 days (Subramanian and Arnold, 2001). A significant part of the time savings comes from the fact that Calcutta, unlike the JNPT, is a feeder port. Shipments from Calcutta are first taken to Singapore port and then loaded on to the international shipping lines to Europe after an average wait of 5 to 7 days at Singapore, whereas international shipping lines directly serve JNPT. However, the higher level of efficiency at JNPT (an average wait of 1.5 days compared with the 6-day wait at Calcutta port) should be noted. More problematic than the total transport logistics time is the uncer- tainty of the actual time of the shipments due to the unreliability of the system. As interest in minimizing inventories and shortening reorder times has increased, so has concern for the reliability of shipment time and cost. Each link in a logistics chain poses a risk of additional delay and additional informal payments. Unfortunately, information on this variation is difficult to collect. Shippers' estimates in the subregion indi- cate that transport logistics costs could increase by 10 to 12 percent and logistics time by 40 to 60 percent for a significant percentage of consign- ments over the period of a year because of delays at the following points in the logistics chain: * Claiming shipment at the gateway port. A bottleneck here can oc- cur because of late notification that the ship has arrived, long prepa- 102 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Table 6-9. The Cost and Time of Exporting Carpet from Kathmandu, Nepal, to Bremen, Germany, by Two Routes Traditional route' Alternative routeb Cost Time Cost Time Indicator (U.S. dollars) (hours) (U.S. dollars) (hours) Transport and handling Inland transport 480.00 117 740.00 88 Cargo handling 260.00 74 463.00 155 Ocean freight 1,200.00 528 750.00 336 Cross-border processing Cargo transfer 261.00 164 125.00 37 Customs inspection 405.00 20 202.00 7 Trade-related logistics Time cost of goods 1,252.00 864.00 Insurance or pilferage and damage 675.00 675.00 Documentation and forwarding 450.00 450.00 Bank processing for L/C 360.00 360.00 Key results Transport logistics cost 5,343 4,629 Transport logistics time 903 623 a. The route is Kathmandu-Birgunj/Raxaul-Calcutta Port-Bremen. b. The route is Kathmandu-Bhairawa-Nautanwa-Moradabad-Mumbai (JNPT)-Bremen. Source: Subramanian and Arnold (2001). ration time for assembling documents for customs clearance, or other reasons. Port clearance time can increase by an average of 14 days. * Port terminal processing. Equipment breakdowns can increase pro- cessing time by three days, and a port labor strike can cause delays of more than a week. * Customs clearance at the port. Incorrect documentation, a broken seal necessitating a container inspection, or uncertainty over the dutiable amount of the import item, can increase the clearance time by one day to more than a week. * Egress from and access to the port. Frequent political strikes and transport industry strikes outside the port cause congestion and inhibit mobility, thereby increasing the transit time by one day or several days. TRANSPORT, LoGISTICS, AND TRADE FACILITATION IN THE SOUTH AsIA SuBREGION 103 * Road-line haul between the port and the border crossing or des- tination. Delays of one day to more than 15 days can result from truck accidents, truck breakdown, police inspection or harassment, the driver visiting home if it is along the route, truck bans in the city, ferry crossings, and other issues. * Land exit or entry port in the transit country. Congested traffic access and egress, late arrival of sealed cover, and local political strikes can increase the processing time by one to several days. * Land entry or exit port in the destination country. Incorrect or incomplete documentation, or disagreement over the description or classification of the goods as well as the valuation of the goods subject to customs duty, can increase the clearance time by two days to more than a week. Conclusion After evaluating the intraregional and international trade trends in the subregion, we suggest the following ways in which India, Bangladesh, Nepal, and Bhutan can achieve more efficient transport logistics. Seaports are very important factors in determining route selection because of the long delays and high costs for transferring cargo through the ports. The elimination of unnecessary customs procedures and de- lays in cargo handling will cause cargo to be routed through more effi- cient seaports. Customs clearances lead to unnecessary delays and informal payments. However, they do not have as great an impact on time and costs as other procedures at border crossings and ports. The uncertainties associated with the delays and costs of clearing customs can often be traced to in- adequate preparation of customs documents by the shipper. Customs limitations on working hours, the low supply of officials at the border to clear consignments, the limited number of gates for receiving cargo, and the lack of transparency of procedures for inspection all reduce efficiency and create animosity. With simplified procedures, standardized docu- ments, and limited inspections, especially for transit cargo, the conges- tion at the border could be substantially reduced or eliminated. The constraints at land border crossings would be significantly reduced if protocols were established for unrestricted movement of cargo across borders in-bond. Instead, there is a provision preventing Indian, Nepalese, or Bhutanese trucks from moving across the Bangladesh bor- der. India has reciprocal but restricted agreements with Bhutan and Nepal that allow trucks to move across the border. These constraints add to the cost of transport, not only because of the labor and losses involved in transferring cargo between vehicles but also because the shipper cannot 104 INTEGRATION OF TRANSPORT AND TRADE FACILITATION choose the least-cost provider, and the transport companies cannot posi- tion themselves to obtain backhaul cargo other than at the border. High-value exports from Nepal to the Pacific Rim require fast han- dling at Calcutta, Chittagong, and Haldia, whereas shipments to Eu- rope and the East Coast of the United States require direct (intermodal) connections to the Jawaharlal Nehru Port Trust JNPT). Both types of shipments require containerization of the cargoes at the earliest point in the logistics chain. The ability to ship in containers will be substantially improved with the operationalization of the three inland container de- pots on the Nepalese border. A direct rail link from Birgunj to the JNPT would provide the greatest efficiency gains among the alternatives considered. Truck routes via Bangladesh can offer reductions in time and cost for medium-value goods moving between East India and Northeast India if the cargo can be moved in-bond, and there is coordination between cus- toms checkpoints at border crossings on both sides of Bangladesh to sig- nificantly reduce delays and eliminate transshipment. The savings to the shippers should be sufficient to support tolls to cover the cost for road maintenance resulting from the increase in transit traffic. For trade in high value goods between India and Bangladesh, trucks will continue to be the dominant, if not exclusive, mode. Travel time will be the major concern, and route selection will be based on reducing door- to-door delivery time. Significant improvements in rail operations would be needed if this mode were to capture some of this traffic. Trucking is provided almost entirely by the private sector, and it uses old vehicles with relatively low power-to-weight ratios, suitable for short-haul traf- fic but not for the long-haul movements of bulk and unitized cargoes. The rates for trucking services are competitive within the countries and between the countries, although India has the competitive advantage that it does not have to import trucks. The rates are held down by em- phasizing low labor costs and inexpensive equipment rather than through efficient utilization of more expensive, higher capacity equipment. This is unlikely to change in the future until the road network is improved and until regulations regarding truck loads and safety are enforced. Intraregional shipments of fruits, vegetables, and other perishable products from Bhutan and Nepal to India and Bangladesh require much better logistics. More emphasis is needed on reducing delivery time, in- creasing reliability of delivery, and minimizing losses en route to enable local manufacturers to compete for the supply of perishable products. Improvements can be achieved by allowing the cargo to move in a single truck from origin to destination and by ensuring that clearance time at the border on both sides does not require several hours. TRANSPORT, LoGIsTncs, AND TRADE FACILITATION IN THE SoUTH AsIA SUBREGION 105 The extension of the broad gauge network in India and the develop- ment of a dual gauge network in Bangladesh will broaden coverage and lessen delays. If the Indian and Bangladesh railways continue to inte- grate their systems and extend their broad gauge networks, then they might capture some medium-value cargoes. However, delays will con- tinue at the border unless compatible rolling stock is introduced, and the shortage of locomotives ends. If these capital investments can be combined with more efficient operations as has been achieved by the Container Corporation of India, the railroads may be able to provide the quality of logistics services required by higher value goods. At a mini- mum, the railways will be able to hold their market share in their core business, the haulage of low-value bulk commodities, because of the higher costs for trucking and the longer transit times for inland water. Inland waterways could play a more prominent role in the transport of the low-value bulk cargoes that move between Calcutta and North and East Bangladesh which is not yet served by broad gauge rail. The inland water transport network in Bangladesh is of considerable impor- tance for domestic shipments but less relevant for the movement of transit traffic. Very low travel speeds could be compensated for by improve- ments in channel markings to allow for nighttime navigation and im- provements in port operations to reduce turnaround time. However, this mode is expected to continue to attract only low value cargoes that can afford long delivery times. An exception is the proposed container on barge service between the proposed Patenga port and Dhaka that would take advantage of the poor rail container service and lack of efficient road connections for containers on this major corridor. Another excep- tion is if the countries agree to Numaligarh refinery (Assam) products routed through Bangladesh to West Bengal. Box 6-1 presents important recent efforts to improve transport logis- tics links in the subregion. As the countries more toward more open economies and expanded trade, both regional and international, in higher-value, finished goods, several critical issues still must be ad- dressed. International markets are increasingly demanding tighter and more reliable deliveries. It is clear that without improved logistics, the subregion will not only miss out on new markets but will suffer a de- cline in market share in existing markets. What improvements are most important? Six recommendations are offered in the remainder of the chapter. Some require action at the re- gional level; others, at the national level. First, establish or amend bilateral transit protocols to allow for the movement of transit cargo across borders under bond without trans- shipment or inspection, reducing the constraints at land border cross- 106 INTEGRATION OF TRANSPOIRT AND TPRADE FACILITATION Box 6-1. Recent Developments in Transportation in the Subregion In the area of transport and trade facilitation, the following important developments clearly indicate the beginnings of change at the turn of the century: * A "subregional quadrangle" consisting of Bangladesh, Bhutan, In- dia, and Nepal was formed in 1998 under the South Asian Associa- tion for Regional Cooperation. Its purpose is to examine development opportunities in several sectors. * "Champions" (people who have a stake in lobbying the govern- ment and authorities) have emerged to promote economic growth and development through improved investments, trade, and trans- portation in the subregion. In 1998 the Chambers of Commerce of Bangladesh, Bhutan, India, and Nepal signed a joint memorandum of understanding to this effect. * India and Bangladesh renewed the Inland Waterways Transit Treaty in October 1999. This removed some of the anomalies that have existed for the past few decades, allowing for a more equitable transit opportunity that would benefit both countries. * The Bangladesh and Indian governments launched a direct bus ser- vice between Dhaka and Calcutta in March 1999. * Transshipment for Indian cargo through Bangladesh is being de- bated in Bangladesh. If well-conceived and regulated, this effort could benefit the eastern and northeastern parts of India and Bangladesh. * India and Bangladesh railways are engaged in sustained efforts to integrate their railway systems. Both railways have completed the work for opening the Petrapole-Benapole border crossing in addi- tion to the three existing crossings on the western side of Bangladesh. On the eastern side of Bangladesh, plans to connect rail links be- tween Akhoura (Bangladesh) and Agartala (India) have already been agreed to by the two countries. * The Phulbari treaty was signed in 1998 by the governments of Bangladesh, Nepal, and India. The treaty allows Nepalese goods access to Bangladesh markets through a dedicated transit route via India. Pre-shipment inspection (for selected imports) was introduced in spring 2000 on a mandatory basis in Bangladesh. Source: Subramanian and Arnold (2001). TRANSPORT, LOGISTICS, AND TRADE FACILITATION LN THE SOUTH AsLA SUBREGION 107 ings. The new or amended protocols also should allow flexible routing for vehicles carrying transit cargo or imports through defined border crossings and replacement of the movement of transit cargo in trucks convoys to flexible movement against specified time limits. Second, simplify and standardize the documents and clearance pro- cedures required for cargo crossing land borders or exported or imported through the seaports. Reforms in this area would include the following: * The use of secure seals for wagons or containers carrying transit cargo; few or no inspections of cargo at the border other than check- ing of the seals. * Common vehicle inspection and licensing procedures for trucks used to transport cargo across borders. * Automatic weighing of vehicles at border points. * The Transports Intemationaux Routiers (TIR) system for the car- riage of goods approved by customs authorities. * Simple procedures and risk assessment strategies to replace cur- rent cargo inspection practices. * Round-the-clock clearance of cargoes at high-density interchange points like Petrapole-Benapole and Gede-Darsana. * Development of full rake sidings, night unloading facilities, and terminal facilities at major loading and unloading points. * Clearer assignment of liabilities. This permits tighter integration of intermodal movements and reduces barriers to entry for potential third-party logistic providers. It also makes railroads and trucking companies improve the quality of their service to limit their expo- sure from loss or damage of cargo. Third, improve mechanisms for monitoring the movement of the cargo. To achieve this objective, countries should consider the following: * Joint checking of cargoes at the origin and destination * Electronic Data Interchange (EDI) between customs facilities within the country and across borders e Identification numbers, bar codes, or other forms of electronic iden- tification for trucks and cargo containers * The use of a freight operation information system for real-time monitoring of trains, wagons, and cargo * Tracking systems for transit cargo carried by trucks * Implementation of a smart card system for expediting all the trans- actions associated with cross-border movements. Fourth, expedite the transfer of responsibility for transport operations and services (but not necessarily infrastructure) from the public sector 108 INTEGRATION OF TRANSPORT AND TRADE FACILITATION to the private sector. In addition, reduce the level of regulation of the providers of third-party logistics in a way that will encourage competi- tion and allow for vertical integration of such services as transport, stor- age, consolidation, documentation, and clearance. Modern regulations should be introduced to govern the liabilities associated with the car- riage of cargo by different modes. (See box 6-2 for private sector views.) Box 6-2. Transport Logistics Improvements and the Private Sector The private sector in Bangladesh, Bhutan, Nepal, and eastern and north- eastern India is actively pursuing improvements in trade relations and transport logistics to ensure a smoother flow of goods and cost-effective services within the subregion. The Chambers of Commerce of the four countries have established a joint forum to examine and promote invest- ment, trade, and the economic growth of the subregion. It is called the Emerging East Initiative. Participants from the subregion expressed strong dissatisfaction with the existing state of freight transportation to regional and international markets and the lack of consultation with users in bilat- eral and multilateral discussions on cross-country route and mode choices. In their view areas where the private sector could expand its role include operation and management of land-ports and logistics services facilities; the development of container transport, container operations, and facili- ties; cargo-handling facilities and services; freight-forwarding; customs clearance; financial services; storage and warehousing; and general tran- sit and shipping services at sea ports and land border crossings. The pri- vate sector delegates' proposal for government action in trade facilitation included these recommnendations: * Harmonize government trade and transport policies and regula- tions in the subregion * Amend transit treaties and protocols to allow for a freer choice of transport routes and service providers * Institute a program of modernization for customs and cross-border facilities * Increase the use of container transport by removing institutional impediments, such as the protocol between India and Bangladesh * Construct ICDs in the region to encourage container transport out- side of the main India rail transport corridors. * Improve the access to credit and financial intermediation services in the region. The actions recommended in this report build upon the general theme of consultation with the private and public sectors and would require action at the national and regional levels. Source: World Bank (1999). TRANSPORT, LOGISTICS, AND TRADE FACILITATION IN THE SOUTH ASIA SUBREGION 109 Fifth, invest in the transport network to improve the quality of logis- tics services. Investments, however, should be a lower priority than ad- dressing procedural problems. The lower ranking is due in part to the recognition that these are long-term problems and will require major capital investment and increased private sector participation if they are to be solved. Sixth, increase the use of containers for shipment of goods by devel- oping ICDs that allow cargo to be stuffed and destuffed closer to the point of origin or the point of destination. Finally, introduce electronic data interchange and business-to-busi- ness e-commerce to reduce logistics costs and time and overall transac- tion costs. The changes that offer the largest benefits in terms of improved logis- tics are the revision of the current bilateral transit protocols, flexibility in transit cargo routing, and the increase in productivity at the seaports. Those offering significant benefits for both transit traffic and domestic traffic are improvements in the productivity of the railways and privatization of the transport services. The improvements in packaging, deregulation of logistics providers, and expansion of cyber trade offer the best long-term opportunities for reducing transaction costs and pro- viding the quality of logistics required for high-value cargoes. // ,w-- South Asia Intermodal Transport Network New 0 Selected Cities Rivers Delhi t ® National Capitals InteEa4rtnal Boundaries/ N.J.K. NEPAL K0 Kathmandu \jLr-.. / H t 0 200 3?/ 400 Kilometers ~~~~ ® / ( ®~~~~~~~~~~~~~~~~~0 200 Milep; T imp1ur Lucknow i-, *-- 0 Kanpur0 1.J -N BANGLADESH . I N D I A ; Dhaka y-l j Bhopal L. Calcutta0 * 0Khulna \ I Chitta'gong0 \ This -ap nas produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information (4 shomn on this map do not imply, on the part of The World Bank BAY OF Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. BAN GA IBRD 31252 BENGAL ~~~JANUARY 2001 7 Urbanization and Regional Trade in South Asia: Issues and Options Frannie A. Leautier Economic growth in the past forty years has been closely associated with five phenomena: urbanization, industrialization, trade liberalization, technical change, and the emergence of new organizational forms. These arguments can be found in theoretical expositions, empirical evidence, as well as in the popular economic literature that drives conventional wisdom. For examples of such arguments see Aghion, Caroli, and Garcia- Penalosa (1999), Yergin and Stanislaw (1998), and World Bank (2000b). The Asia region is undergoing high rates of urbanization and extremely high rates of industrialization, linked to increased international and re- gional trade. Unique organizational forms, such as the Grameen Bank in Bangladesh, co-exist with state and private sector organizations, play- ing an important role in the process of development. With respect to urbanization, urban growth rates of more than 3 percent per year are about at the same level as average global growth rates, but due to the high concentration of populations in urban areas, the absolute numbers of urban residents are orders of magnitude larger than in any other re- gion of the world. By 2025, it is predicted that the region will have a majority of its people living in cities and towns (UNCHS Global Urban Observatory Database). This transformation is phenomenal, particularly because an increas- ing number of poor will be living in urban areas. The size and urgency of the problem require different ways of managing cities and their re- lated transportation and infrastructure requirements. There are very few sustainable cases of good management of the demand pressures for ser- vices in the cities of developing countries. Furthermore, macro and fi- nancial crises have cast doubt on well-held concepts and approaches. Countries that had achieved well-functioning cities with steady improve- 111 112 INTEGRATION OF TRANSPORT AND TRADE FACILITATION ment over a period of twenty to thirty years have seen the collapse of city functions in the wake of the financial crises of the 1990s. Examples include Thailand, Indonesia, and Malaysia, which are now grappling with the emergence of the new urban poor. The increased pace of urban- ization and its linkages to globalization have renewed interest in the process of urbanization and its links to economic growth. The major dif- ference in the resurgence is the unit of analysis, which has shifted from nations to regions and from regional economies to the global economy Cities have become the key point of entry for activities on the global scale. Increased globalism has affected the functioning of cities and their hinterland economies in four important ways: * Globalization of trade, with implications for the economic geogra- phy of city location * Changes in demographics and income disparities in cities and coun- tries * Urbanization, densification, and city productivity * Increased decentralization and awareness of governance. Each of these shifts in the formation and functioning of urban centers will be discussed in turn. Globalization of Trade and the Economic Geography of City Location It has been observed that when you liberalize trade, you subject the coun- try and its companies to extemal competition-fostering increased effi- ciencies and raising productivity. Well-functioning cities and their related infrastructure are critically important in companies' efforts to reduce costs and increase competitiveness. Therefore, there is a need to improve the performance of cities and their infrastructure in order to allow com- panies to remain in business locally, hence benefiting the local popula- tion, as well as to attract other companies to invest in one city over another. Advances in intemational logistics have expanded the scope of inter- national trade in goods and services. Global sourcing by manufacturing and service firms puts countries and cities in competition with each other. Comparative and competitive advantages are affected by transport en- dowment, policy, and performance. Cities can combine city govemance and amenities with regional transport services to attract a variety of eco- nomic activities linked to global trade. Nadiri and Mamuneas (1994) describe the link between company de- cisions to locate and city infrastructure services (such as road, rail, and air transport), as well as other services (such as water and electricity). URBANIZATION AND REGIONAL TRADE IN SOLTH ASIA: ISSUES AND OPTIONS 113 Anas and Lee (1988) and Anas, Lee, and Murray (1996) have focused on developing countries and the cost of doing business in them. Transportation costs and access to immobile factors are key determi- nants of the comparative and competitive advantages of geography and location (Krugman, 1998). High transport costs can present barriers that result in little inter-regional trade, forcing the concentration of people in multiple urban centers of roughly equal size. According to Krugman, low transportation costs, on the other hand, tend to allow dispersion of economic activity to even-sized urban centers, or they can lead to con- centration in megacities. Looking at patterns of urbanization in Asia, one can observe a co-existence of regions with high transportation costs and those with access to cheaper transport. The proliferation of small towns in countries such as Bhutan and Nepal, which are landlocked and hence dependent on their neighbors, is telling. Compare these small towns with the megacity phenomenon in Bangladesh, which stems from the challenges of climate and geography and their impact on the fluidity and interconnectedness of land transport systems. How has this new globalism affected Asia, and what effect has it had, in particular, on the poorest subregion of Asia, which is composed of North East India, Nepal, Bhutan, and Bangladesh? In this chapter a sur- vey of the trade patterns among contiguous countries in a subregion of Asia is used to assess the impact of increased trade among countries and its relation to city performance. Trade patterns between countries in the region have changed dramati- cally, indicating regionalization in the midst of globalization. For example, export trade from Nepal to India doubled between 1996 and 1998 with a similar doubling of imports to Bangladesh from Nepal. Exports from India to its neighbors increased but to a smaller extent during the same period. Furthermore, huge trade imbalances between the countries exist (tables 7-1 and 7-2). For example, India exports fifteen times more than it imports from Bangladesh, and it exports two times more than it im- ports from Nepal. The impact of these imbalances on the demand for skills within each national economy and the implications for city growth and income disparities need to be investigated, but this issue is beyond the scope of this chapter. Is an emergence of comparative and competitive forces among coun- tries shaping these shifts? Infrastructure endowments, the main attractor of trade activity in the past, no longer seem to be sufficient to deliver de- velopment and comparative advantage, as can be seen when looking at the perfornance of infrastructure in the countries within this subregion. When one compares the trade patterns to the conditions of road and rail infrastructure, one can see interesting patterns emerge. Nepal and Bhutan, the two landlocked countries with severe geographical chal- lenges because of their location in the Himalayas, have roads in much 114 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Table 7-1. Regional Pattern of Exports, 1996, 1997, 1998 (millions of U.S. dollars) Export pattern 1996 1997 1998 India to Bangladesh 832 647 1,038 India to Nepal 158 147 324 Nepal to India 67 92 146 Nepal to Bangladesh 7 9 10 Bangladesh to India 21 37 55 Bangladesh to Nepal 0 1 18 Source: IMF (1999a, 1999b). better condition than the roads in neighboring India and Bangladesh (table 7-3). The dedication to better road maintenance in Nepal and Bhutan may be driven by the pressure importers and exporters face be- cause of high transport costs from transiting across large distances in these countries, which also do not have rail access inland (table 7-4). Bangladesh, a country with severe climatic challenges, is abundantly served by ports and inland water transport systems. Therefore, trans- portation services can continue even with severe climate-related disrup- tions such as floods. The criticality of poorly performing roads and rail systems is reduced, since there are exit options for Bangladesh to use in terms of alternative modes of transport, as well as access to a world outside the region. One still needs to ask the question whether these transport mode options and access to an outside world have reduced the pressure to improve the efficiency of land transport systems that are critical for regional trade. A similar question can be posed of India, which has a large domestic economy that is relatively well protected and hence less subject to pressures to trade with others within the region. Table 7-2. Regional Pattern of Imports, 1996, 1997, 1998 (millions of U.S. dollars) Import pattern 1996 1997 1998 India from Bangladesh 58 39 65 India from Nepal 49 71 147 Nepal from Bangladesh 12 8 6 Nepal from India 442 436 440 Bangladesh from India 1,018 796 1,179 Bangladesh from Nepal 6 11 14 Source: IMF (1999a, 1999b). URBANIZATION AND REGIONAL TRADE IN Soum ASIA: ISSUES AND OPTIONS 115 Table 7-3. Road Infrastructure and Performance, 1988 Density in kilometers Condition Country per million persons (percent paved) India 893 20 Bangladesh 59 15 Nepal 139 40 Bhutan 223 50 Source: World Bank (1994). Other potential linkages between regional trade and the performance of cities and their related infrastructure are much more complex. It has been observed that more efficient regional transport systems, including in-land logistics services, as well as cities that afford better conditions for living because of superior management and investment, would en- hance the chances that companies locate in one city and its subregion relative to another (Nadiri and Mamuneas, 1994). Such choices would, in turn, affect the demand for labor in the respective subregion as well as the income levels. However, not all company locations are expected to result in greater growth of a city. Aghion, Caroli, and Garcia-Penalosa (1999) show that it depends on the starting level of income of a city, the share of skilled labor relative to unskilled labor in the city, and the na- ture of the trade relations between a country and its neighbors. In par- ticular, reduced transport costs and efficiencies from a well-functioning city in a country that exports primary products to a richer country would reduce the relative price of material inputs in the importing country, leading to further opportunities for growth for the importing country It could also lead to changes in income disparities between skilled and unskilled labor: unskilled labor in the country exporting primary mate- rials would gain a premium relative to skilled labor in that country and unskilled labor in the neighboring country, inducing reductions in in- Table 7-4. Rail Infrastructure and Performance, 1988 Rail traffic Diesels in use Country (kilometers per million $ GDP) (percent of diesel inventory) India 593 90 Bangladesh 41 73 Nepal None None Bhutan None None Source: World Bank (1994). 116 INTEGRATION OF TRANSPORT AND TRADE FACILITATION come disparities in the exporting country, while sharpening income dis- parities in the importing country, if both countries start off with the same ratio of skilled to unskilled labor. Nepal and Bhutan have a lower incidence of poverty than Bangladesh. (See discussion later in chapter of table 7-9.) The trade relations between the countries coupled with the better functioning land transport in Nepal and Bhutan may be the key explanatory factors here. Changes in Demographics and Income Disparities in Cities and Countries Regional trade affects city growth and performance. Urbanization and industrialization, it also has been argued, result in an increase and then a decrease in income inequality. Simon Kuznets (1955) found an inverted U-shaped relation between income inequality and GNP per capita. This result was interpreted as describing the income inequality that arises as city residents begin to earn more than rural residents, when companies employ city residents at higher wages in industrial production. A rever- sal in this trend is expected once cities grow to the point that they attract more rural labor. Another argument relates to the increased demand for production of agricultural goods in cities. This contributes positively to growth in rural areas, thus reducing the disparity between urban and rural incomes and raising incomes overall. Countries can be caught in a vicious cycle of urbanization, low eco- nomic growth, and rising income disparities. Stagnation in agriculture results in the inability of the rural sector to support higher demand in cities. Such countries would then import agricultural products to feed city residents, and income disparities would continue to grow (figure 7-1). Many countries in Asia and Africa are facing high urbanization rates with little or no positive impact on growth. This appears to support the vicious-cycle hypothesis. To determine a way out of the quandary caused by urbanization, increased inequality, and low growth, these countries should examine both the performance of cities and the pattern of trade with other countries. It is rare to find an analysis of trade liberalization and/or privatization that is posited in the context of the competitive- ness of cities in a country and what they have to offer to companies wishing to locate or invest there. The varying patterns of regional demographics in Asian cities high- light the dilemma these cities face (table 7-5). Cities in Asia and the Pa- cific have more than double the city populations in other regions. Although the average pace of growth of Asian cities is about the same as the average growth rate of cities in developing countries, because of the URBANIZATION AND REGIONAL TRADE IN SOuTH ASIA: ISSUES AND OPTIONS 117 Figure 7-1. The Vicious Cycle of Urbanization, Low Economic Growth, and Rising Income Disparities Urban demand for food and agricultural products raises rural incomes Stagnation in agriculture or productivity growth in rural areas pushes people to cities. If cities cannot absorb them, urban poverty worsens. Source: Author's construction using evidence from World Bank (20030a). starting size of populations in Asian cities, the order of magnitude of change is more serious. High concentrations of population, measured by persons per hectare, are another attribute of Asian cities, with average densities of 237 per- sons per hectare compared with 168 for typical cities in developing coun- tries. A high concentration of residents in large cities should contribute to higher income growth, lower income disparities, and eventually higher productivity, with an expected reversal in the dynamics predicted by Kuznets (1955). Table 7-5. Varying Patters of Regional Demographics, 1993 Average Average Average city growth density population per year (Persons Region (in thousands) (percent) per hectare) Asia and the Pacific 3,100 3.2 237 Developing countries 1,480 3.5 168 Worldwide 1,500 3.1 154 Source: UNCHS (1995b). 118 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Table 7-6 compares the income disparities and city product (dollars per person) in Asia to other regions. Income disparities, measured by the ratio of the 20th highest income percentile to the 20th lowest income percentile, are much lower in Asian cities. The ratio of 6.7 for Asian cities is much lower than that of 10.7 for other cities in the world. Asia as a region has also grown at a very fast rate in the past twenty years, lend- ing credence to the second phase of the Kuznets hypothesis. However, the productivity of Asian cities, measured by the city product per per- son of $1,059, is considerably lower than the average of cities in devel- oping countries ($1,546), and the worldwide average ($4,411). This means that there is a lot of untapped potential for productivity in Asian cities that can be unleashed. The trick is to find the right approach to making cities much more productive. Within-region demographics can shed light on the arguments posed so far. The similarity of average growth rates in Asian cities to the world- wide average growth rate of cities camouflages distinct patterns of growth within Asia. The growth rate of Asian cities varies widely depending on size and density as well as other factors. High rural-urban migration has fueled fast and uncontrolled urban growth in many Asian cities, which have attracted rural residents seeking employment because of the lack of opportunities in rural areas. Population concentration in increasingly large metropolitan areas is a phenomenon noted earlier. It highlights the growing importance of secondary cities and towns. Table 7-7 demonstrates some of these trends, which can be character- ized as centripetal and centrifugal forces driving city growth (Krugman, 1998). A city such as Lahore is characterized by medium density, high growth, and high city product relative to other cities in the region. Chittagong is characterized by medium density and fast growth but low city product. This suggests that these two cities attract residents in a dispersed manner, with low densification and more spatial spread than in other cities in the region. There are also opportunities for Lahore and Chittagong to improve their productivity. A look at the city transporta- Table 7-6. Income Disparities and City Product, 1993 City product Region Income disparitya (dollars per person) Asia and the Pacific 6.7 1,059 Developing countries 10.7 1,546 Worldwide 10.7 4,411 a. The ratio of the 20th highest income percentile to the 20th lowest income percentile. Source: UNCHS (1995a). URBANIZATTON AND REGIONAL TRADE IN SOUTrH AsLA: ISSUES AND OrIONS 119 Table 7-7. Centripetal and Centrifugal Forces in Urbanization Patterns in the South Asia Region, 1993 Density City product Population (persons per Growth rate (dollars city (in thousands) hectare) (percent) per person) Mumbai 10,265 603 2.04 275 Chittagong 2,400 61 5.34 218 Bhiwandi 553 934 22.88 341 Lahore 4,509 37 3.59 428 Colombo 4,390 86 0.49 1,036 Source: UNCHS (1995b). tion and services as well as congestion and air quality, which are well- known problems, may be necessary for these cities to improve their pro- ductivity. Issues related to the management of these cities may be critical as well. Bhiwandi, with a density of close to 1,000 persons per hectare, is grow- ing at close to 23 percent per year. The city product of Bhiwandi is much higher than that of Chittagong but lower than that of Lahore. What is happening in Bhiwandi to deliver this type of performance? The pres- sures of managing a city growing and densifying at such high rates as Bhiwandi, starting from a low base of 553,000 persons, are daunting. The skills needed in these cities to manage such high levels of growth are in short supply. Yet something about Bhiwandi is attracting business and residents. What about Colombo with a city product that is much higher than any other city in table 7-7? What does Colombo do to deliver such high performance while remaining low density and relatively small. How has it avoided becoming a megacity? One answer may be the Sri Lankan government's investment in transport infrastructure in rural areas that connect to Colombo. The policies on urban density in Colombo and the implications for land markets may be another clue. Bombay, with more than 10 million people, high density, and a growth rate above 2 percent per year, exemplifies the opposite complexity of managing megacities. Fast-growing small towns and continued growth and densification of megacities present very different management chal- lenges as well as complex demands for transport and infrastructure. How do firms view these pattems of city development and performance? How do the management and investment decisions made by cities affect firms' decisions on where to locate? 120 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Urbanization Another unique phenomenon is the increasing concentration in large cities across all countries in the Asia region. There are 25 cities with a population of more than 1 million in the Asia region compared with 86 cities of that size worldwide (table 7-8). The distribution of cities by city size in Asia is telling. Asia is well known for its megacity phenomenon. Seventy-six percent of the cities in the region have a population above 300,000. Almost 60 percent are classified as megacities-that is with popu- lations above 1 million, and growing. In short, urbanization in Asia, with its megacity phenomenon, is distinctly different from that of other regions. Why does Asia have a larger concentration of megacities than all other regions of the world, including industrialized countries? Is it because of trade liberalization and industrialization a la Kuznets (1955), or because of transport costs and geography a la Krugman (1998)? The answer will influence the type of policies needed to tackle the challenges of poverty reduction facing these cities. Urban poverty is growing faster than the rate of urban growth in South Asia (table 7-9). Population pressure, country size, and regional inequali- ties shape the pattern of development and define the role of transport in the region. Cities are beginning to function as "systems of cities." The quality of city management interacts with transport policy and perfor- mance to shape further urbanization. Cities such as Colombo are able to achieve higher city product with low densification and low growth rates. What is the link to hinterland transport services and the regional economy that allows such produc- tive outcomes? How differently do companies and municipal authori- ties need to serve Bombay compared with Colombo or Bhiwandi? What is the role of transport in such a pattern of regional and city growth and performance? These are all questions that can be addressed by looking at the other shifts mentioned earlier. Table 7-8. Number of Cities by Size, 1993 City population Less than 300,000 to More than Region 300,000 1 million 1 million Asia and the Pacific 9 8 25 Industrial countries 8 13 13 Worldwide 77 66 86 Source: UNCHS (1995b). URBANIZATION AND REGIONAL TRADE IN SOUTH ASIA: ISSUES AND OPTIONS 121 Table 7-9. Demographic Characteristics of Selected Asian Countries Area Percentage of Population (in thousands Per capita population (in millions) of square GNP below Country 1998 kilometers) (in U.S. dollars) poverty line India 980 3,288a 430 35.0 Bangladesh 126 144 350 35.6 Nepal 23 147 210 42.0 Bhutan 0.8 47 430 - Not available. Note: These figures do not reflect official World Bank policy a. Including part of Kashmir. Source: World Bank (2000b). Decentralization and Governance Decentralization of government also has an impact on city size. Coun- tries that are decentralized politically and administratively tend to have more even-sized cities than do those that are centralized. It is argued that the concentration of political power in centralized countries leads to concentration of economic power in the capitals of those countries and/or states and hence to the phenomenon of megacity formation (Krugman, 1998). Dhaka in Bangladesh stands outs as a dominant city, indicating a rela- tively low level of decentralization in Bangladesh, and Asia as a region has a predominance of megacities, indicating that the region overall may be more centralized politically than other regions of the world. Focusing on the degree of decentralization and transport costs in a globalizing world is important if cities are to tap into the potential of the global economy. There are a number of forces at play that are driving the process of decentralization. In particular, the constrained fiscal environment at the central government level has driven decentralization in the Asia region and around the world. As national governments seek to rationalize their expenditures, they continually push for accountability at lower levels of government (Prud'homme, 1995). Within the South Asia region, there is growing reliance on local bodies in service delivery, but these bodies have weak management capacity and do not have sustainable finances. The capacity of local governments to manage their cities affects the comparative advantage of cities. Well- managed cities attract business and residents since they are able to cater 122 INTEGRATION OF TRANSPORT AND TRADE FACILITATION to the demand for services. The size and importance of local bodies shape the competitive position of cities as well as the quality of their manage- ment. Intercity and intracity transport is key to tapping the potential of these governance advantages. Good Governance and Cities' Comparative Advantages The Kathmandu-Biratnagar-Dhaka-Chittagong corridor is used to illus- trate the connection between good governance and a city's comparative advantage in capturing regional trade and international investment. This corridor goes through four key cities, three of which are major cities in their countries: Kathmandu in Nepal and Dhaka and Chittagong in Bangladesh. The traffic in this corridor in 1998 was estimated at 420,000 tons per year, with a potential to double (Stevens and Cook, 1999). Op- tions for transport in the corridor include transportation by road if using Chittagong port, or transportation by rail and road if using Calcutta. These options enable Chittagong and Calcutta to compete for regional trade outflows and inflows. The performance not only of the ports but also of the cities becomes critical. Chittagong may be as productive a port as Calcutta, but if Calcutta is a better managed city, it could attract business away from the port of Chittagong and vice versa. This case illustrates the interlinkages between the performance of transport ser- vices and city management. Table 7-10 highlights other factors in this example. Kathmandu, with a population of 472,000, is growing at 5.8 percent per year. For effective growth in Kathmandu, the performance of Biratnagar, Dhaka, Tangail, and Chittagong is critical, as are good transportation links between these cities. Regional trade makes cities in one country dependent on the per- formance of cities in other countries with which they are linked by trade. Table 7-10. City Performance, 1993 Annual City product Population Income growth rate (dollars per City (in thousands) disparity' (percent) person) Kathmandu 472 5.8 Biratnagar 138 - 3.4 Dhaka 6,610 6.88 5.5 219 Tangail 158 6.88 3.4 172 Chittagong 2,400 6.88 5.3 261 - Not available. a. The ratio of the 20th highest income percentile to the 20th lowest income percentile. Source: UNCHS (1995b). URBANIZATION AND REGIONAL TRADE IN SOUTH ASIA: ISSUES AND OPTIONS 123 Measures of the Importance of Local Governments The ability of a city to manage its responsibilities depends on the impor- tance afforded to local governments. Three measures of the importance of local governments are examined: the size of the employee base, finan- cial management and transparency, and the autonomy of cities in na- tional economies. Size of Employee Base Dhaka has a sizable workforce at the city level, close to three times that of Kathmandu and Chittagong (table 7-11). This means that the local government in Dhaka has the potential to administer power at the city level. How this will positively affect Kathmandu depends on regional externalities beyond the management of Dhaka as a city. For Kathmandu to continue to grow, it may need to depend on Dhaka's performance; of course, Kathmandu does not have any influence on the governance or management of Dhaka, except potentially through trade and transport. The size of the employee base in Dhaka could be a hindrance to reforms if reforms, such as privatization of water services in the city, are difficult and resisted by the local government employees. Therefore, greater size does not always mean improved performance. Financial Management and Transparency In addition to measures of importance of a local government, defined by the size of its employee base, we can look at indicators of performance of a local government that are more direct, such as financial manage- ment and transparency Three readily accessible indicators of financial management and trans- parency are the revenue per capita, capital expenditures per capita, and Table 7-11. Local Government Importance, 1993 Local government employees City per 1,000 poopulation Kathmandu 2.46 Biratnagar 1.58 Dhaka 6.15 Tangail 0.72 Chittagong 2.17 Source: UNCHS (1995b). 124 INTEGRATION OF TRANSPORT AND TRADE FACILITATION the percentage of works at the city level that is contracted out to the private sector. On all three indicators Dhaka ranks by far the highest (table 7-12). Dhaka spends per capita almost as much as it collects in the form of revenue per capita, and it relies more heavily than the other cities in the table on the private sector to carry out the works. This raises the question of the very large size of Dhaka's employee base and how it is deployed. Tangail spends a lot more per capita than it raises in rev- enues, indicating a high reliance on central government transfers and thus a potential for increasing its autonomy should it choose to do so. Chittagong and Kathmandu spend a lot less per capita than they collect in revenues, raising a number of questions as to what happens to the revenues. Such intercity comparisons in performance in a globalizing world will determine more and more the degree to which residents and businesses choose to locate in these cities. Globalization will pressure cities to improve the level of services they provide to their residents, and it will also exert pressure on companies that choose to locate in these cities. We will begin to see more of the effects of this type of pressure as companies locate internationally on the basis of city performance rather than country performance and as re- gional economies become linked more closely. Autonomy of Cities in National Economies The autonomy of city governments is also a critical determinant of how residents and businesses view cities and the related demand for infra- structure and transport services. In Kathmandu, Biratnagar, Tangail, and Chittagong the central government can shut down local governments (table 7-13). Furthermore, with the exception of Tangail and Chittagong, the central government can remove all councillors in those cities. Other indicators of autonomy include the ability to set and charge taxes, the Table 7-12. Financial Management and Transparency, 1993 Percent Revenue Capital expenditure contracted to per capita per capita the private City (1993 U. S. dollars) (1993 U. S. dollars) sector Kathmandu 8.4 3.82 Biratnagar 5.5 1.98 45 Dhaka 27.7 25.33 74 Tangail 1.4 14.94 32 Chittagong 9.2 1.97 41 Source: UNCHS (1995b). URBANIZATION AND REGIONAL TRADE IN SouTH ASIA: ISSUES AND OFTIONS 125 Table 7-13. The Power of the Central Government, 1993 The central government can City Close local government Remove councillors Kathmandu Yes Yes Biratnagar Yes Yes Tangail Yes No Chittagong Yes No Note: No data were available for Dhaka. Source: UNCHS (1995b). ability to borrow, and the ability to contract out (table 7-14). Cities in Bangladesh seem to have more autonomy to carry out these functions than those in Nepal. Although Nepali cities have reduced autonomy, they may enjoy ad- vantages in inter-regional networks of services. This illustrates the im- portance of balance between local autonomy and regional perspective in making determinations of service delivery to support higher growth. Potential Challenges The cities in South Asia face many challenges. Because of the constraints that go with managing a megacity, Dhaka may not be able to react in an agile and flexible manner to the demands of residents or companies wish- ing to conduct business there, and it may have difficulty instituting change because of the large size of its employee base. Dhaka can be over- taken by a city such as Tangail, which may prove to be more agile. Megacities in the region such as Mumbai need to pay attention to this phenomenon as it may pose a threat to their ability to attract certain Table 7-14. The Power of the Local Government, 1993 The local government can City Set taxes and charges Borrow Contract Kathmandu Some Some All Biratnagar Some Some All Tangail All All All Chittagong All All All Note: No data were available for Dhaka. Source: UNCHS (1995b). 126 LNTEGRATION OF TRANSPORT AND TRADE FACILITATION types of businesses, with implications for their ability to grow and to reduce income disparities. Govemance, as measured by transparency and autonomy, may give advantage to Tangail and Biratnagar over Dhaka and Kathmandu. All cities need to be aware that governance structures strongly influence whether they will have sustained capacity to grow and to reduce in- come inequalities. With the fickleness demonstrated by international capital markets, cities will increasingly become the stage on which inter- national competition takes place. Chittagong city may be performing well, but issues need to be resolved in Chittagong port to protect its position relative to Calcutta. Port cities have a special function in relation to each other. Most countries focus policy reforms on the port sector, and on liberalization of trade, rather than on, or in addition to, the performance of port cities. Conclusions How does a country incorporate these global trends into a strategy for regional development and trade that has cities and their management at center stage? Since cities can be very significant in leveraging the effect of globalization, it would be prudent to lay out the basic elements of such a strategy. It has four parts. First, draw up holistic frameworks that sharpen strategic vision, rec- ognizing the schizophrenic aspects of urban development that can si- multaneously lead to economic growth and a reduction in income disparities. This would require forging coherence between the commu- nity desire for results at the city level, private sector interests in profits, and national interests in trade and competitiveness. Countries would need to develop and tolerate the co-existence of city-wide and region- specific solutions that could be vastly different. Second, introduce long-term system-wide approaches rather than project approaches to investment in urban areas and regional transport, with a focus on development impact. This would allow countries to use their endowments in infrastructure and the wealth in human and physi- cal capital resident in their cities, as well as their capacity to manage cities in a globalized world. Third, learn from others and focus on long-term institutional build- ing, understanding that change requires a process of transforming ur- ban societies. National and regional institutions are also needed to unleash the potential of regions to attract economic activities. Fourth, move toward regional rather than national programs, under- standing spatial aspects and "systems of cities." Economic and geographi- cal boundaries, rather than national boundaries, pose the greatest constraints in the twenty-first century. 8 Rotterdam: A Strategic Hub in the Global Trade-Transport Chain T. R. Lakshmanan Rotterdam became the largest port in the world in 1962. Since then it has maintained its premier rank in the global port system during a period of turbulent change: a shift worldwide from a material- and energy- intensive industrial structure to a knowledge-intensive industrial struc- ture, globalization of manufacturing processes and organization of production and related services, relocation of industries across national borders and the emergence of global production networks, and major changes in transport and the complementary information technologies that support this worldwide production and trading system. Such economic transformations in the scale, geographic location, and industrial mix of production imply vast and complex changes in the con- text and scope of the transportation function. The volume, composition, origin, and destination of cargo have changed, as well as the speed, price, reliability, and timeliness of movement-in other words, what moves, how it moves, and where it moves. Clearly, the maritime industry and port operations had to be restructured to function efficiently in this dy- namic environment. Rotterdam's continued dominance as a transport hub in the global transport system is a tribute to its ability to strategically position itself for growth in a changing economy. It exemplifies a major transport facil- ity that assesses the broad economic and transport environment, plans ahead, and invests in physical technologies and infrastructures and in human and institutional capital that promote the port's adaptability for growth and leadership. The aim of this chapter is to highlight the factors that underlie Rotterdam's success as a major hub in the world's trade-transport chain. Two distinct and related activities serve as a metaphor for the port's 127 128 INTEGRATION OF TRANSPORT AND TRADE FACILITATION history of strategic alertness, flexible adaptation, and success: (1) the planning and provision of the best-practice trade-transport chain ser- vices for port users today, and (2) strategic redefinition of the port's fu- ture functions and investments that maintain growth in a dynamic context. Specifically, the planning and provision of the state-of-the-art trade- transport chain services for port users are accomplished through timely investments in transportation and information infrastructures and in non- physical infrastructure (knowledge and competencies in transport and trade facilitation). The latter involves restructuring and reform of the following: * Overall governance of transport and trade facilitation into, in, and from the port * Logistical operations in the port * Operational coordination of different port users, and * State-of-the-art techniques for controlling physical flows in the port. Rotterdam has made financial and organizational investments in the emerging markets (for example, the Czech Republic) in its hinterland, and it has developed innovative support services for the coordination of production and distribution activities of global corporations that are ten- ants of the port-thereby stimulating future growth. This chapter reviews Rotterdam's history as a port that has built on its physical and locational resources, its commercial linkages to major Eu- ropean economic centers, and its timely investments in physical, human, and institutional capital. A statistical and comparative economic profile of Rotterdam is then presented. In the final section we offer a case study of a port that has reinvented itself as a major hub in the global economy by providing best-practice trade-transport chain services for port users and by redefining the port's function in the future. From Fishing Port to European Mainport The history of Rotterdam from its humble beginnings in 1328 as a fish- ing port on the River Rotte to its current position as Mainport Europe is remarkable. Rotterdam was a prosperous old Dutch port, its fortunes tied to the growth and the decline of the commercial hegemony of the Dutch Republic from 1500 to 1800. In the nineteenth century, with the industrialization of the United Kingdom and Germany, demand increased for transport of raw materials and finished goods. In 1864 Rotterdam started the construction of a navigation channel without locks directly to the sea (Nieuwe Waterweg), and it was selected as the import and export port for the German coal and steel industry. This marked the be- ROTTERDAM: A STRATEGIC HUB IN THE GLOBAL TRADE-TRANSPORT CHAIN 129 ginning of bulk transport in the port. During the decades leading up to the Second World War, investments in the form of deeper channels and tank storage and industrial land consolidated the port's position and enabled its emergence as a petrochemical production site. The reconstruction of the port after wartime bombing provided a newer vintage of port capital stock, an expansion of petroleum operations, and the establishment of a large chemical industry and the world's biggest oil industry complex. As the European economy recovered from the war, Rotterdam port became in 1962 the biggest port in the world. Since then the port has continued to offer state-of-art-services to its users by responding to major changes in the industry: it increased ship size-deepening Nieuwe Waterweg to 62 feet in 1969, with progressive increases to the current depth of 72 feet; it organized a container ship- ment company (ECT) and its facilities in reclaimed land at Maasvlakte; and it developed the port as a global distribution center. Rotterdam: A Statistical and Economic Profile Rotterdam has long been the busiest route for exporting and importing goods into Europe, given its deep harbor stretching 30 miles inland, its central location vis-A-vis the continent's 350 million consumers, its di- verse facilities (multi-user, multimodal, and dedicated facilities that can handle sixth-generation vessels), and its progressive business spirit and know-how. The connections that Rotterdam has developed to the important cities in its hinterland in terms of attractive time-distance and services add to its appeal to its far-flung customers. Door-to-door delivery from Rotterdam is available to most European destinations by efficient intermodal transport. Goods are delivered from Rotterdam to most European markets within 48 hours. It offers nonstop shuttle trains to many cities, feedership ser- vice to 110 European ports, and scheduled barge service via a dense network of inland waterways to other cities. Table 8-1 illustrates the range of frequently scheduled intermodal connections from Rotterdam to close- in cities like Bramerhaven (Germany) or to distant places such as Lisbon, Istanbul, and St. Petersburg. Rotterdam dominates the European port world, handling nearly three times as much tonnage as Antwerp, the next port (figure 8-1). As noted earlier, Rotterdam is also the world's largest port-well ahead of Asian ports like Singapore and Shanghai (figure 8-2), and it continued its growth in the 1990s. The composition of Rotterdam's cargo is heavily weighted toward liq- uid bulk goods (petroleum), and dry bulk goods (ores, scrap, coal, Table 8-1. Rotterdam's Multimodal Connections to Selected European Cities, 1998 Road Rail Inland waterway Short-sea (time in days (time in days (time in hours feeder Kilometers from from Rotterdaml from Rotterdam/ from Rotterdam/ (frequency City Rotterdam frequency) frequency per week) frequency per week) per week) Copenhagen 797 1 / daily 1.5 / 5 n.a. 8 Prague 960 1/ daily 1.5 /5 n.a. n.a. Bramerhaven 418 0.5 / daily 1.5 / 5 60 / 3 9 Milan 1,294 1.5 / daily 2 / 5 n.a. n.a. Basel 800 1/ daily 1/ 5 72 / 7 n.a. Oslo 1,350 2 / daily 4 / 5 n.a. 11 St. Petersburg 2,720 3 / daily 13 / 5 n.a. 2 Lisbon 2,245 2.5 / daily 6 / 5 n.a. 9 Istanbul 3,000 3 / daily 10 / 2 n.a. 3 n.a. Not applicable. Source: Port of Rotterdam (1998b). ROTTERDAM: A STRATEGIC HUB IN THE GLOBAL TRADE-TRANSPORT CHAIN 131 Figure 8-1. Total Throughput in Main EU Ports, 1995-98 Millions of metric tons 350 Rotterdam . 300 250 200 150 Antwerp 100…… - - - - - -- - - - - - - - Hamberg 50 London 0 1995 1996 1997 1998 Year Source: Rotterdam Port Information Centre, February 2000. agribulk) associated with the manufacturing sector of Mainland Europe (figure 8-3). As Peters (1993) notes, worldwide trends suggest less liquid cargo, steeper proportional increases in dry cargo volumes, and a steady growth in general cargo in international sea trade. These trends in dry bulk goods and general cargo are reflected in Rotterdam, but the de- clines in liquid cargo have not occurred. The large volume of petroleum passing through Rotterdam (with appropriate complementary invest- ments on land and physical facilities by the port) has enabled it to be- come a major petrochemical industrial complex. The general cargo, particularly container traffic, while growing, is less significant in Rotterdam than in leading Asian ports. Rotterdam is the fourth largest container port in the world behind Singapore, Hong Kong and Kaoshsiung (figure 8-4). Of the 10,000 hectares that form the total port area, half is land, which is split between industry and a massive infrastructure of railroads, high- ways, pipelines, and storage tanks. Industrial development has been an important part of port activities at Rotterdam. Much of the oil landed in the port is processed at one of the four refineries at the port, while 50 132 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Figure 8-2. World's Major Cargo Ports, 1995-98 Millions of metric tons 350 Rotterdam 300 Singapore 250 _ _ _ ….. . . . .-.- , _...... 200 Shantghai ................ ... .... ... , , , , , , , ... ..1 150 Antwerp Nagoya Hong Kong 10 01 50 Hamberg Marseilles Pusan Yokohama 0 1995 1996 1997 1998 Year Source: Rotterdam Port Information Centre, February 2000. percent is piped to Flushing, Antwerp, or Germany (Port of Rotterdam, 1998). The refinery and chemical industries that dominate the port in- dustrial complex are being buffeted by technical and organizational change, at a time when the broader economic context for port and mari- time activities is also in flux. Rotterdam: Strategic Positioning in the Global Transport Networks The Changing Center and Scope of the Global Transport Networks Changes in the global transport networks and in the Rotterdam port in particular derive from two broad sources: transformations in the produc- tion system and transformations in the transportation system. The former has three important elements: globalization of manufacturing services; ROTTERDAM: A STRATEGIC HUB [N THE GLOBAL TRADE-TRANSPORT CHAIN 133 Figure 8-3. Total Throughput by Commodity at Port Rotterdam, 1995-98 Millions of metric tons 160 C1 Dry bulk goods 0 Liquid bulk goods U General cargo 140 120- 100 80 -. 40 1995 1996 1997 1998 Year Source: Rotterdam Port Information Centre, February 2000. volatility of demand because of production system changes; and the shift to high-value production and outsourcing. Globalization of manufacturing services is driven by the search among OECD countries for countries offering lower factor costs. As a result, in the past two decades many intermediate manufacturing and assembly activities have relocated to developing countries. Likely consequences of this trend (in the context of a trend toward inventory reduction) are twofold: diminishing demand for long-haul ocean transport of many primary commodities from developing countries to industrialized econo- mies and greater demand for small, high-value, speedy shipments. The "half-life" of an increasing number of products is shortening, and new products appear quickly, with important consequences for trans- portation. The inputs and outputs of production will rapidly change as well as the locations where they must be transported to and from. The challenge for Rotterdam, if it is to maintain its leadership, is to prepare 134 INTEGRATION OF TRANSPORT AND TRADE FACILITATION Figure 8-4. World's Major Container Ports, 1995-98 Thousands of TEUs 16,000 14,000 Hong Kong i