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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, e-mail pubrights@worldbank.org. 4 CONTENTS Acknowledgments 8 Abbreviations 8 Executive Summary 9 Why trade matters for Afghanistan 9 Afghanistan’s trade (under)performance 9 Insufficient production capacity: Afghanistan’s largest constraint for production and trade 10 Improved logistics and trade-related infrastructure are prerequisites for improved Afghan trade 12 Services trade: a more conflict-resilient strategy worth the long-term pursuit 13 Transit trade: a high-stakes, high-risk option for development 15 Commodity transit trade 15 Energy transit trade 16 1. Introduction 17 1.1 Background and motivation 19 1.2 Scope of the report 24 References 25 2. Afghanistan’s trade in goods (under) performance: Determinants, challenges, and future opportunities 27 2.1 Current patterns of Afghanistan’s trade 29 Trade balance 30 Export and import concentration 32 Specialization patterns 34 Labor sophistication of Afghan exports 35 2.2 Assessing Afghanistan’s trade performance 38 2.3 Supply-side factors limiting trade performance 42 Agricultural sector 45 The carpet industry 48 2.4 The role of export delays in explaining Afghanistan’s underperformance 50 2.5 What would it take to reduce export delays? 52 Annex 2A 54 References 58 3. Afghanistan’s services trade: National reform and international cooperation 59 3.1 Services trade regime 62 Sector commitments under the General Agreement of Trade in Services (GATS) 63 3.2 Services trade patterns 66 Education 70 Health 71 Developing a strategy for policy reform and cooperation 72 Financial services: Remedying the consequences of regulatory failure 73 Annex 3A 76 References 77 5 CONTENTS 4. Transit trade: Leveraging location into a comparative advantage 79 4.1 Transit trade in goods: Potential benefits and related challenges 81 The prerequisites 82 Regional cooperation and transit trade 84 4.2 Afghanistan as a transit hub in the regional energy market 85 Renewable energy as a longer-term opportunity for Afghanistan 86 4.3 Exploiting synergies to create the infrastructure for transit services 88 References 90 Boxes Box 1.1: A framework for the relationship between trade and conflict 20 Box 1.2: The opium trade—Afghanistan’s leading economic activity and illicit export commodity 23 Box 2.1: How to measure the labor sophistication of Afghanistan’s exports 37 Box 2.2: Estimating Afghanistan’s trade potential with gravity equations 40 Box 2.3: Medium-to-long-term policy agenda to support trade and competitiveness 44 Box 2.4: Policy actions to improve competitiveness of the agricultural sector in Afghanistana 47 Box 2.5: Suggested interventions for Afghanistan’s carpet industry 49 Box 2A.1: Afghanistan’s trade performance determinants 56 Box 3.1: The SILK-Afghanistan Program 71 Box 3.2: The potential of telemedicine in Afghanistan 71 Box 3.3: The Kabul Bank Crisis 74 Box 4.1: Main infrastructure projects for energy transit in Afghanistan 85 Box 4.2: Hydroelectricity and trade in Afghanistan 87 Box 4.3: Infrastructure sharing for optical fiber networks 89 Tables Table 2.1: Exports from Afghanistan to its 20 largest destination markets, 2014 (US$ thousand) 32 Table 2.2: Afghan imports from the 20 most important origin markets, 1995–2014 (US$ thousand) 33 Table 2.3: Top-five export sectors in Afghanistan, 1995–2014 (HS2) 34 Table 2.4: Top-five import sectors in Afghanistan, 1995–2014 (HS2) 35 Table 2.5: Share of firms exporting at least 1 percent of sales directly or indirectly in 2013–14, Afghanistan and comparators (%) 41 Table 2.6: Overview of customs data on Afghan exports, 2013–14 42 Table 2.7: Time to export distribution across countries, 2005–14 (days) 50 Table 2.8: Obstacles to Afghan exports, 2008 and 2014 (% of firms) 51 Table 2.9: Time needed to reduce export delays by more than 50 percent compared to 2005, selected countries (years) 53 Table 2A.1: Top-10 HS-6 exports from Afghanistan to the United States, 2005 and 2014 55 Table 2A.2: Top-10 HS-6 product codes exported from Afghanistan to the United States, by sector, 2014 55 Table 2A.3: Distribution of the regressions residuals 56 Table 4.1: Afghan Telecom published wholesale IP transit pricing, December 2015 88 Figures 6 CONTENTS Figures Figure 1.1: Growth of real GDP and output sectors in Afghanistan, 2006–15 (%) 19 Figure 1.2: Trade-to-GDP ratio in Afganistan. 2011-15(%) 22 Figure 2.1: Afghanistan’s trade balance in goods, 1994–2014 (US$ billion) 29 Figure 2.2: Diversification of exported and imported products in Afghanistan, 1995–2014 30 Figure 2.3: Cumulative distribution of Afghan-traded HS6 product categories, 2014 (%) 31 Figure 2.4: Cumulative distribution of Afghan export destinations and import origins, 2014 (%) 31 Figure 2.5: Cumulative distribution of Afghanistan’s export basket to the world, 2000 and 2014 (PRODY index) 36 Figure 2.6: Sectoral composition of Afghanistan’s export basket over time and by destination market, 2000–14 (US$ million) 38 Figure 2.7: Multilateral exports and market access for Afghanistan, 2001 and 2014 (US$ thousand) 39 Figure 2.8: Multilateral imports in Afghanistan, 2001 and 2014 (US$ thousand) 40 Figure 2.9: Bilateral exports and market access in Afghanistan, 2001 and 2014 (US$ thousand) 42 Figure 2.10: Sector contribution to growth in Afghanistan, 2006–15 (%) 45 Figure 2A.1: Multilateral exports of intermediate and capital goods from Afghanistan, 2001, 2005, and 2014 54 Figure 2A.2: Multilateral imports of intermediate and capital goods to Afghanistan, 2001, 2005, and 2014 54 Figure 3.1: Developing a long-term strategy for national reform and international cooperation in services in Afghanistan 62 Figure 3.2: Overall STRI for Afghanistan in a global context of 107 countries 63 Figure 3.3: STRI for selected South Asian countries and Afghanistan 64 Figure 3.4: STRI by sector for selected South Asian countries and Afghanistan 65 Figure 3.5: STRI for transportation sector for selected South Asian countries and Afghanistan 66 Figure 3.6: Trade in commercial services in Afghanistan, 2008–15 67 Figure 3.7: Breakdown of trade in other commercial services in Afghanistan, 2008–15 68 Notes 92 7 ACKNOWLEDGMENTS This report was prepared by a team led by Nadia Rocha, Senior Specialist, Social Urban Rural Resilience Global Practice) and Margaret Economist (Trade and Competitiveness Global Practice), which A. Wilson (Consultant, Social Urban Rural Resilience Global Practice). included Jagath Dissanayake (Consultant), Batshur Gootiiz (Consultant, Trade and International Integration, Development The report benefitted form the overall guidance and support provided Research Group), Cecilia Heuser (The Graduate Institute, Geneva), by Claudia Nassif (Lead Country Economist, Afghanistan). We also Claire Hollweg (Economist, Trade and Competitiveness Global Practice), thank Shubham Chaudhuri (Country Director, Afghanistan), Esperanza Lionel Fontagne (Université de Paris), Manuel Marcias (Université Lasagabaster (Practice Manager, Trade and Competitiveness South François Rabelais de Tours), Aaditya Mattoo (Practice Manager, Trade Asia Region), Jose Guilherme Reis (Practice Manager, Trade and and International Integration, Development Research Group), and Competitiveness Global Practice), Hazem Ibrahim Hanbal (Senior Daniel Mirza (Université François Rabelais de Tours). Contributions Agriculture Specialist, Agriculture South Asia Region), Mir Ahmad for chapter 2 on trade in goods were provided by Mohammad Ahmad (Water Resources Specialist, Water South Asia), Richard Sulaiman Akbari (Trade and Competitiveness South Asia Region) Spencer Hogg (Program Leader Afghanistan), Robert Saum (Director, and Ahmad Khalid Khoshal (Consultant). Chapter 3 on services has Regional Integration and Partnerships South Asia Region), Gonzalo greatly benefited from insightful conversations with Ahmed Rostom Varela (Senior Economist, Trade and Competitiveness Global Practice), (Senior Financial Sector Specialist, Finance and Markets South Asia and the peer reviewers Dorsati Madani (Senior Economist, Operations Region), Aminata Ndiaye (Young Professional, Finance and Markets Policy and Country Services), Daniel Reyes (Senior Economist, Trade South Asia Region), Omar Joya (Economist, Finance and Markets and Competitiveness Global Practice), and Rashmi Shankar (Practice South Asia Region), and Rajendra Singh (Senior Regulatory Specialist, Manager, Trade and Competitiveness Africa West Region), for their Transport and ICT South Asia Region). Contributions for chapter 4 on valuable suggestions and comments. The report was edited by energy transit trade were provided by Jie Li (Senior Climate Change Michael Alwan and Diane Stamm. ABOUT THE AUTHOR: Nadia Rocha in a Senior Economist in the Trade and Competitiveness Global Practice at the World Bank. Prior to joining the Bank in 2016, Nadia worked for five years in the Economic Research and Statistics division of the World Trade Organization. She was seconded to serve as a Senior Advisor on trade to the Colombian Ministry of Trade during 2015. Nadia holds a Ph.D in International Trade from the Graduate Institute of Geneva, a MA in Economics from Pompeu Fabra University of Barcelona and a BA in economics from Bocconi University in Milan. Her current work focuses on regionalism, trade costs, global value chains, and trade and gender. ABBREVIATIONS APTTA Afghanistan-Pakistan Transit Trade Agreement MOCAT Ministry of Transport and Civil Aviation ASYCUDA Automated System for Customs Data MoU Memorandum of understanding BASAs Bilateral Air Services Agreements MRRD Ministry of Rural Rehabilitation and Development CEPII Center for Prospective Studies and NSW National Single Window International Information, Centre d’Études Prospectives NTFC National Trade Facilitation Committee et d’Informations Internationale OPGW Optical Power Ground Wire DAB Afghanistan Central Bank, Da Afghanistan Bank PCGs Partial Credit Guarantees EU European Union STRD Services Trade Restrictions Database FDI Foreign direct investment STRI Services Trade Restrictions Index FMIC French Medical Institute for Children TAPI Pipeline Turkmenistan-Afghanistan-Pakistan-India Pipeline GATS General Agreement of Trade in Services TFA Trade Facilitation Agreement GDP Gross Domestic Product TIP trade information portal GVCs Global Value Chains TUTAP Turkmenistan-Uzbekistan-Tajikistan- HCI High Commission on Investment Afghanistan-Pakistan HPPs Hydropower plants UNODC United Nations Office on Drugs and Crime LPI Logistics Performance Index USAID Agency for International Development MAIL Ministry of Agriculture, Irrigation and Livestock VET Vocational Education and Training MCIT Ministry of Communications and Information Technology WTO World Trade Organization MEW Ministry of Energy and Water 8 EXECUTIVE SUMMARY Why trade matters exacerbate conflict and governance risks and impede broader for Afghanistan economic development. Promoting production and exports of more labor-intensive goods and services might instead reduce With further declines in international assistance the risk and intensity of conflict through increases in real expected over the coming years, the Government incomes and employment. This report brings new evidence of Afghanistan faces a new challenge: enabling new on the opportunities and challenges for development in the growth drivers. One such driver is trade. Decades of civil areas of trade in goods, trade in services, and transit trade. It war and military occupation that culminated in the fall of the also provides recommendations for an appropriate sequencing Taliban in 2001, have devastated Afghanistan. High levels of of policy reforms and strategic infrastructure investment to conflict destroyed infrastructure, displaced a significant share support potential growth in these sectors. of the population, incentivized informal and illicit economic activities, and jeopardized the delivery of public services. After The main findings of this report suggest that government 2001, the country entered a phase of reconstruction where high intervention should focus on two complementary areas: levels of economic growth have been largely fueled by foreign competitiveness and connectivity. First, Afghanistan’s aid. Since 2014, Afghanistan has once again been in a phase largest constraint is insufficient production capacity. Second, lack of transition, this one characterized by the withdrawal of the of economic diversification and high concentration of exports United States and other allied forces and accompanying cuts in and imports in terms of products and number of destinations has military and development spending. As the economic stimulus prevented Afghanistan from fully exploiting its trade potential. of reconstruction gradually disappears, Afghanistan must look Third, poor logistics and trade infrastructure, rather than lack to alternate avenues for more sustainable growth. of market access, are responsible for Afghanistan’s trade underperformance. Improvements in trade facilitation and logistics Trade could be an important channel for accelerating could therefore have a positive impact on Afghanistan’s trade in growth in Afghanistan. Trade is believed to promote the the short -to medium- term. Fourth, service sector development efficient allocation of resources, allow a country to realize is constrained because of Afghanistan’s small domestic markets, economies of scale and scope, facilitate the diffusion of as well as limited endowments of skills and capital. In the long knowledge, foster technological progress, and encourage run, these constraints could in principle be alleviated by greater competition in both domestic and international markets. regional and global integration. Fifth, the potential of transit trade in Aided by large reductions in trade barriers and technological commodities and energy might be modest and slow to materialize. advancements, developing countries have become the drivers Realizing these benefits requires efficient logistics, well-designed of global trade in recent years. There is now little dispute that, and maintained infrastructure, and a propitious framework of in the long run, economies more open to trade show stronger regulation and regional cooperation. economic growth and overall development performance. A plausible trade-driven growth scenario for Afghanistan Afghanistan’s trade should promote economic and export diversification. (under) performance For a while, development of mineral resources has been thought to be the best avenue to improve trade and growth Trade has played a limited role as an engine for growth in for Afghanistan. However, despite its potential, it is uncertain Afghanistan. Rather than supporting growth, trade performance whether the development of the extractive sector will has been reflecting the reconstruction process in a country afflicted contribute to the Afghan economy in the short- to medium- by conflict. In the last two decades, the country’s trade balance has term. In addition, reliance on extractive industries can both been negative. The structural trade deficit in goods and services has 9 EXECUTIVE SUMMARY remained around 35 percent of GDP in recent years, reaching to reduced domestic supply of inputs (wool supply, dyes, 42.5 percent in 2015, and official figures indicate exports yarn, washing chemicals). Evidence from the private sector amounted to only 7.5 percent of gross domestic product also suggests that high levels of conflict were related with (GDP) in 2015. Due to its narrow production base, Afghanistan reallocation of production of products such as skins and depends heavily on imports of primary and processed goods. carpets into safer countries. Lack of export diversification is associated with lower levels of labor sophistication—as At present, Afghanistan’s trade potential in goods measured by wage, value added, share of skilled workers, is limited. A gravity analysis suggests that Afghanistan and human capital, for Afghanistan. Afghanistan’s export underperforms in trade, even compared to its neighbors and development lags regional performers. Its export basket is countries at similar levels of development. In addition, Afghan associated with products that pay lower wages, generate trade underperforms in most of its destination markets, lower value added, and have low capital intensity. suggesting that there are barriers to export that are common to most of the destinations. Firm-level analysis suggests that low export capabilities are high barriers to trade and that only Insufficient production capacity: 6.7 percent of Afghan firms export, compared with averages Afghanistan’s largest constraint for the South Asia region (13 percent) and the developed for production and trade world (36 percent). Lack of supply is one of the main determinants High levels of trade concentration render Afghanistan of export underperformance in Afghanistan. The susceptible to external shocks, making trade country’s export base is still extremely narrow, reflecting it’s diversification an important element of the policy limited agricultural production and very small manufacturing agenda. Afghanistan exports a limited number of goods to base. The GDP share of both agriculture and industry is on a restricted list of destinations. The top-10 export products average 20 percent and has not increased over time. Top account for more than 70 percent of total exports. The top- exported products such as fruits and nuts represented only five destinations—Pakistan, India, the Islamic Republic of one-fourth of agricultural GDP in 2015. Other traded products Iran, Turkmenistan, and Germany—account for 87 percent of such as textiles, wood, and paper represented less than 1 exports. On the import side, 20 imported goods represented percent of manufacturing GDP. nearly 43 percent of the country’s total imports in 2014, and 66 percent of Afghanistan’s imports originated from only five Persistent conflict has prevented Afghanistan from accruing partners. the advantages related with economic diversification. The poor economic environment (including weak rule of law, low Recent specialization patterns suggest reduced levels of education and training, and underdeveloped financial prospects for future export diversification. sectors) reduces the incentives to invest in manufacturing and Afghanistan’s specialization has, in the last decade, routes. It also limits workers’ ability to improve their productivity, moved away from products such as carpets and textiles, both in terms of quantity and quality of their products. Indeed, toward a concentration in agricultural products. Factors highly differentiated goods produced by manufacturing sectors explaining a decrease in specialization of Afghan are much more sensitive to transaction costs produced by production and exports away from the textile industry violence. In this context, peace-enhancing policies would be include lack of insertion of Afghanistan in related global important drivers of diversification toward non-farm and non- value chains (GVCs) and increased costs of production due primary resources goods. 10 EXECUTIVE SUMMARY A heavy regulatory burden and perceived risks to investing and resources, intervention should focus on the development of operating in the country and lack of human capital have limited selected value chains with the highest potential. These were Afghanistan’s production capacity. Afghanistan ranked 183rd out identified by the forthcoming World Bank Agribusiness study of 189 economies in the World Bank’s Doing Business Report 2016. High and the Agriculture Sector Review conducted by the World costs of doing business in Afghanistan are reflective of the regulatory Bank in 2014, as irrigated wheat, horticultural crops, and burden and perceived risks to investing and operating in the country. livestock production. They all enjoy comparative advantage Low levels of local and foreign investment have been driven by the and could be the first movers of the agricultural sector security environment as much as by the business environment, driving toward substituting imports, which would assist in increased up the risk premium and deterring risk-averse investors. Afghanistan’s food security and open new export opportunities. Increases inability to attract high-value foreign direct investment (FDI) has in competitiveness should also be coupled with action plans prevented the country from taking advantage of new and better to enhance female participation in agricultural activities, sources of finance, knowledge, and access to markets. With respect given that they represent a significant source of income for to human capital, mediocre education outcomes—whether due to the female population. inadequate quality, misalignment with labor demand, or limited access to educational services—have prevented producers from improving Three complementary actions could improve agricultural 1 the quality of their products and therefore from diversifying production productivity in the short -to medium- term : and exports toward higher-quality and more sophisticated products: • Improvement of adequate irrigation facilities. producers cannot recruit labor with appropriate skills, which in turn Afghanistan’s irrigated lands can be substantially dissuades investment in more productive processes and technologies. increased with the rehabilitation of traditional irrigation systems. Around one-third of traditional irrigation Improving the main supply-side challenges is key for systems have been rehabilitated so far. Investing in new Afghanistan to gain from trade. The first step could be irrigation systems (canals, dams, and so forth), although improving the business climate by reforming and streamlining more cost-effective, would take more time to benefit the business regulations, increasing transparency of the tax system, agricultural sector. High-level coordination among line and providing better access to main services such as electricity ministries (Ministry of Energy and Water [MEW]; Ministry through facilities such as industrial parks. Providing producers of Agriculture, Irrigation and Livestock [MAIL]; Ministry and exporters better access to finance is also important and of Rural Rehabilitation and Development [MRRD]) and could be done through domestic regulatory reform and risk- improvement of irrigation water management through sharing schemes (see specific recommendations in the services definition of a legal and regulatory framework and section). A medium-to-long-term agenda that will support trade strengthening irrigation associations are also key. and competitiveness more broadly should aim at attracting FDI • Better access to high-quality inputs. Efforts should and human capital improvements. Implementing such policies focus on the creation of an effective regulatory system will not happen in the short-term and would only be feasible and on strengthening the capacity of the MAIL to in an environment where conflict and political insecurity are enforce certification of seeds and veterinary medicines significantly reduced. and vaccines, among others; control banned pesticides; constantly monitor domestic supplies; and prevent Increased productivity in the agricultural sector is also imports of low-quality and hazardous agricultural inputs. fundamental to meet domestic demand, substitute • Better access to technology. To deliver better imports, and potentially promote exports in the technologies for farmers and increase yields and short -and medium- term. Given the limited government productivity, the capacity of the national research 11 EXECUTIVE SUMMARY system needs to be strengthened, for example, of export delays. It took Afghan exporters 86 days on through the rehabilitation and strengthening of the average to ship their goods in 2014, compared to 33 days existing network of research stations, and research on average for South Asia, 21 days for Pakistan, 25 days for collaborations with international research centers the Islamic Republic of Iran, 21 days for China, and 17 days working in similar agroecological areas. Afghanistan is for India. The estimated cost to export is US$1,922 per too small to undertake a wider range of research on all container in South Asia, and US$5,045 in Afghanistan. The agricultural areas. World Bank’s Enterprise Surveys suggest that nearly half of surveyed firms see transport as a major or severe obstacle to Actions to enhance productivity in the textile industry export. In addition, there is an increasing share of surveyed could also reposition Afghanistan as one of the firms reporting customs and trade regulations as a major or main exporters of carpets. To improve international severe obstacle to export. Around 85 percent of total time competitiveness of the carpet industry in Afghanistan, spent to export is related to documentary compliance, and 15 upgrades are needed all along the supply chain. percent is due to border compliance. Interventions are needed to increase the access to quality raw materials, facilitate the establishment of sophisticated Improvements in trade facilitation could enhance processing units, and improve the quality of design. exports in the short-term. A simulation exercise suggests Government support in terms of provision of serviced that reducing export times to 25 days could increase overall land in industrial parks for carpet weaving and processing exports by 20 percent, which corresponds to US$152 million would also be helpful. Finally, export promotion and per year. Reducing export delays coupled with Afghanistan branding activities would help Afghan carpet producers productivity converging to regional levels could lead to a more better position their products in international markets. than six-fold increase in exports. Productivity- and investment- enhancing policies aimed at expanding the scale and quality of agricultural production would increase export performance. Improved logistics and trade-related Trade facilitation would also improve the accessibility of inputs infrastructure are prerequisites and thereby increase the competitiveness of manufacturing for improved Afghan trade industries such as processed foods and beverages, which represent almost the totality of manufacturing GDP and Poor trade facilitation and logistics, rather than lack around 10 percent of total GDP. of market access, are trade barriers that account for Afghanistan’s trade underperformance. Afghanistan is a Three complementary methods could improve trade logistics: landlocked country with complex topography, underdeveloped road infrastructure, and high transportation costs. At the • Improve efficiency of documentation requirements and intensive margin, most of the unexplained underperformance processes. The number of documents and authorizing of Afghan exports is associated with export delays. At the signatures required for trade operations should be extensive margin, the extremely long time it takes to export reviewed for consistency with international good practice from Afghanistan is preventing exporters from reaching new and, where practical, substantially reduced or eliminated. markets. In the medium-term, the Government of Afghanistan should work to automate all trade-related requirements Firm-level surveys suggest that delays at the border, and procedures into a National Single Window (NSW) followed by domestic transportation, are the main causes system. The NSW system should automate the 12 EXECUTIVE SUMMARY application, processing, and issuance of all trade-related In regional cooperation, existing trade agreements permits and licenses administered by Afghan government with regional partners can be deepened and agencies. The NSW system should also link permit-issuing expanded. This would facilitate visa processing agencies with the Automated System for Customs Data and improve transport and logistics, and help with (ASYCUDA) to allow for the seamless integration of all the harmonization and simplification of customs clearance processes, including a collective approach to procedures in line with international standards and risk management and inspection activities. regional commitments. In the case of Pakistan, the • Reduce waiting times at the border. While many delays main destination and transit country for Afghanistan’s at the border are the result of actions taken by neighboring exports, a strengthening of the dialogue between the countries rather than Afghan authorities, opportunities exist two countries to accelerate de-bottlenecking of the to review and rationalize border operations to eliminate Afghanistan-Pakistan Transit Trade Agreement (APTTA) inefficiencies. These include improving cooperation and would be fundamental to reduce uncertainties related information sharing among the various government agencies to merchandise transportation and to more broadly mandated to operate at the border; operationalizing ensure gains from trade. the ASYCUDA World’s advance declaration and manifest functionalities to allow prescreening of consignments prior to their arrival at the border; reducing congestion by Services trade: a more separating pedestrian and truck traffic; expanding border conflict-resilient strategy capacity and related infrastructure (scanners, weighbridges, worth the long-term pursuit warehouses, and so forth); and implementing cargo tracking to better manage the risks associated with movement of The evolution of services trade in Afghanistan in recent goods between the border and Inland Clearing Depots. years has been shaped by conflict-related foreign • Improve interagency cooperation on trade facilitation presence and reconstruction efforts. Until 2012, the matters. Consistent with the commitments of the World balance in services trade was positive, but it has remained Trade Organization Trade Facilitation Agreement, it is negative ever since the beginning of the reduction of recommended that the Government of Afghanistan formally international presence in the country. In recent years, mandate customs and other key border management services exports have been dominated by construction agencies to maintain a National Trade Facilitation Committee (over 36 percent of total exports of services in 2015), (NTFC) to provide a formal mechanism for enhanced reflecting the effect of the war and reconstruction efforts interagency cooperation and improved dialogue with the involving foreigners. Imports have been dominated by private sector. The NTFC would ensure all trade-related payments for transport services, probably linked to the agencies work collectively to streamline, harmonize, and payment of shipments of imported goods. simplify trade procedures. It would also assist government agencies to strike a better balance between their control and If relatively peaceful and secure conditions were facilitation objectives. While a focus on revenue collection is established, then services trade and investment understandable given Afghanistan’s heavy reliance on trade could leverage Afghanistan’s locational advantages taxes, evidence from across the globe strongly confirms that through services exports, and could also boost overall efficiency gains achieved through trade facilitation reforms economic performance through services imports. One of are typically accompanied by improved revenue collection Afghanistan’s immediate advantages is its central location performance. at a crossroads of vital trade routes between South and 13 EXECUTIVE SUMMARY Central Asia. This makes transit services a natural candidate and should help to identify priorities for action. These for services exports from Afghanistan. If challenges in priorities could include: attracting foreign investment were overcome, foreign • Enhanced transparency about opportunities investment in transport and communication infrastructure and measures affecting consumption abroad, and services could boost the domestic economy besides through publication of information, and establishment transit exports, especially if it can be directed to exploit of enquiry or contact points locally and in trading synergies among sectors and is coordinated with partners. infrastructure development in neighboring countries. • Simplified procedures for consumption of health Services imports broadly conceived can eventually play care and education abroad, by creating “single a role in building both the hard and soft infrastructure windows” that handle all formalities, allow for electronic needed to enhance domestic production, and boost export applications, and fast-track procedures. capability. For example, the consumption by at least some • Lower costs of export-related services provision, Afghan citizens of foreign health and educational services by ensuring that various fees and charges connected could boost their human capital in the medium -to long- to visas and other administrative requirements are not term and equip them to engage productively in both the excessively high and are related to the true costs of domestic and global economy. Trade openness in sectors those services. such as finance would also increase efficiency through • Working toward recognition (unilateral or mutual) competition and enhanced intermediation and risk sharing, of technical standards, qualification and licensing and would incentivize innovation that improves access to requirements, and procedures to reduce the transaction finance and inclusion. costs of developing human capital value chains starting with some priority countries. Trade constraints in health and educational services • An assessment of where it is feasible and desirable could be alleviated by greater regional and global to develop intermediate professional categories, integration and cooperation, and by domestic regulatory such as non-physician clinicians, who can provide a reform. In health and educational services, there are likely broad range of basic services at locally affordable prices to be gains from deeper cooperation across the region and are less likely to emigrate abroad or to urban areas. and beyond, for example, via recognition of qualifications, collaboration agreements among institutions, and Constraints around financial services could be simplified visa procedures for patients and professionals. addressed through domestic regulatory reform and Such cooperation can facilitate the development of regional risk-sharing schemes. Domestic regulatory reform could value chains to create human capital. Basic education encourage greater domestic and foreign participation and training could be provided within Afghanistan, while in financial services, leading to greater efficiency and more advanced education, for example, specialization in depth, and enhanced access to finance for firms, farms, areas of medicine and engineering, could be obtained in and households. Setting up a risk-sharing facility (for neighboring countries. Better use of technology should example, partial credit guarantees) in the short-term would also be considered as a way of consuming imports of also satisfy the appetite for increased private sector services in health and education. investment to fuel economic growth and job creation. A future work program in this area could be structured A reform strategy that leverages the potential role of the around recent initiatives on trade facilitation in services financial services sector for the rest of the economy, while 14 EXECUTIVE SUMMARY also addressing risks and challenges, should stress the in the merchandise transiting the country will therefore following areas: increase the ability to sustain conflict. Rent seeking at the • Improvement of the regulatory framework, to border can also be a source of conflict related with transit promote openness while avoiding a pace of innovation trade. Cumbersome scanning and goods examination in the sector that undermines the regulatory capacity procedures allow for exploitation of traders and the business of the central bank. community. • Improvement of the existing deposit insurance scheme, particularly as openness is furthered. Potential gains from commodity transit trade • Implementation of partial credit guarantees, may be slow to materialize. Realizing these benefits supported by a strong regulatory framework for the requires efficient logistics, well-designed and maintained operationalization of such a facility, and a public entity infrastructure, and a propitious framework of regulation with a clear mandate and governance structure for and regional cooperation. There are long waiting times at this specific facility. borders and complex customs procedures. Infrastructure is also likely to be a serious constraint: Afghanistan’s transportation (road and railroads) network is severely Transit trade: a high-stakes, underdeveloped. With its challenging terrain and after high-risk option for development decades of internal conflict, globally and within the region, Afghanistan shows nearly the weakest performance in the Commodity transit trade logistics and transportation category of the World Bank’s 2 Logistics Performance Index, ranking 158th out of 160 Transit trade in goods is often emphasized as an countries in 2014. obvious opportunity for Afghanistan, but, until recently, it has not been clear how large this potential A sensible approach to transit trade development is. This analysis estimates that US$5.7 billion of trade in should also be based on careful prioritization of goods could potentially transit through Afghanistan. Gains infrastructure investment. This strategy should: for the country could grow to an estimated 5 percent of that • Resolve existing congestion at important trade amount (US$285 million per year), around 1 percent of GDP. points (see trade facilitation recommendations). Gains from transit trade are realized through the collection • Meet emerging needs in domestic productive of transit revenues, and through job creation in associated sectors (agriculture and mining). Implementation activities, such as rest stops and servicing. There could of plans to connect all provinces via highways should also be indirect benefits of increased transit trade, through also aim to connect regional and local roads to the reductions in transport costs for Afghan traders. national transportation network. These plans include, for example, the completion of the National Ring Transit trade is highly susceptible to conflict or insecurity Road, which, when finished, will connect resource- that create opportunities for predation and extortion rich regions in Afghanistan and neighboring countries along transport routes. As in the case of natural resources more directly. abundance, transit trade could potentially increase the • Create partnerships with the private sector. risk of conflict through what is called the rapacity effect: Public-private initiatives aimed at improving both insurgent groups and the government may fund their infrastructure would decrease the weight of the activities by taxing goods moving across borders. Increases infrastructure bill in the government budget. 15 Transit trade potential is also shaped by sensitive Full completion and operationalization of large-scale political and geopolitical considerations that are not infrastructure projects such as CASA-1000, TAPI entirely under Afghanistan’s control. Considering recent pipeline, and Turkmenistan-Uzbekistan-Tajikistan- international and regional developments, Afghanistan should Afghanistan-Pakistan power project are essential focus its efforts on: for Afghanistan to fully benefit from energy transit • Updating the APTTA. A revised version of the APTTA trade. Although Afghanistan is not in the lead on these should assimilate Tajikistan in the agreement and projects, the government should constantly monitor the contemplate factors such as the shift to a transport trade developments of the proposed energy transit projects regime based on reciprocity. Also, the enforcement of and be prepared to respond positively if action is required. measures aimed at minimizing the incidence of customs A plan to respond to partner concerns regarding security, fraud and avoidance, and monitoring and curbing informal location of offtakes, cost sharing, transit tariffs, and other trades would be key. matters should be implemented. • Deepening and expanding existing agreements with regional partners. Improvements in visa regimes, Domestic electrification should be a priority for harmonization, and simplification of custom procedures Afghanistan. Rough estimations suggest that investment would be fundamental to facilitate transit trade. in hydrogeneration and major transmission infrastructure • Improving harmonization of transportation standards could potentially move Afghanistan to become a net among countries. This has been a recurring challenge, for energy exporter by 2026. However, large-scale generation example, in planning new railways, since there are three plants for renewable energy, such as hydropower, may be different gauges in neighboring countries. difficult to finance under the fragile security conditions prevailing in Afghanistan. A more effective strategy would be to focus on domestic transmission to achieve full Energy transit trade electrification of the country in the medium -to long- term. Improved power supply is an important component of Afghanistan has a geographic advantage for developing a modern and efficient infrastructure network becoming an energy transit hub that would boost that can support increased output of goods and services, economic growth and revenue. Energy transit trade employment opportunities, and, potentially, enhanced could add 3.1 percent to export growth annually and security. contribute US$530 million to revenue by 2030 (1 percent of GDP). Simulation results also suggest that by prioritizing public investment in hydrogeneration and major transmission infrastructure, Afghanistan could become an exporter of renewable energy by 2026. Building regional connectivity for energy transit trade can deliver important revenues for the country and help meet its own acute domestic shortages. Major regional energy projects, like the Turkmenistan-Afghanistan-Pakistan-India (TAPI) 3 4 Pipeline and Central Asia and South Asia (CASA)-1000 , are evidence of the commitment of countries in the region to integrate and will help build regional connectivity. 16 17 1.INTRODUCTION KEY MESSAGES: • Afghanistan’s growth rates have dropped significantly in recent years. During 2013–18, growth rates are predicted to be only around 4 to 6 percent. With further declines in international assistance expected over the coming years, the Government of Afghanistan faces new challenges to enabling new growth drivers such as trade. • Trade as a growth driver in a fragile country like Afghanistan needs to be compatible with the objective of reducing conflict and supporting political stability. A plausible trade-driven growth strategy should promote economic and export diversification by focusing on two complementary areas: competitiveness and connectivity. • Despite the potential the extractive sector presents for Afghanistan with respect to trade and development, there are uncertainties going forward, at least in the short run. Current estimates suggest that as of 2015, the country earned only US$30 million from its mineral sector for a third straight year, far less than earlier projections of US$1.5 billion. • Improving trade competitiveness in both goods and services is a fundamental step for Afghanistan to diversify exports away from conflict-enhancing sectors. Increased market access and regional integration in goods and services are also key for trade to be a channel for growth and prosperity in Afghanistan. 18 1.INTRODUCTION 1.1 Background and motivation which leads to an optimization of production processes and the development of new products. Complementary policies— Afghanistan’s growth rates have dropped significantly in recent regarding infrastructure, skills, institutions—can enhance years. The country sustained exceptionally high economic the impact of trade on growth and poverty. Aided by large growth, averaging 9 percent per year, from 2003 to 2012. reductions in trade barriers and technological advancements, Growth was mainly fueled by large aid flows that drove the developing countries have become the drivers of global trade. demand for and consumption of goods and services, which were There is now little dispute that, in the long run, economies mostly imported. Since the end of the reconstruction period, more open to trade show stronger economic growth and international assistance has been declining. This is reflected overall development performance. in slower growth rates, averaging only around 2 percent per year from 2013 to 2015 (see figure 1.1). During 2013–18, growth But trade as a growth driver in a fragile country like 5 Afghanistan needs to be compatible with the objective of rates are predicted to be only around 4 to 6 percent. With further declines in international assistance expected over the reducing conflict and supporting political stability (Collier and coming years, the Afghan government faces new challenges to Rohner 2008; del Castillo 2011). A careful assessment of the enabling new growth drivers such as trade. existing channels though which trade development could impact conflict in Afghanistan is fundamental to assess which Trade could be an important channel for accelerating growth trade strategies are better in terms of conflict resilience (see in Afghanistan. In general, trade is believed to promote the box 1.1). Trade development must also be plausible in the efficient allocation of resources; allow a country to realize context of high trade costs and continued exposure to conflict economies of scale and scope; facilitate the diffusion of risks. Providing realistic scenarios for trade development and knowledge; foster technological progress; and encourage regional integration is crucial for an appropriate sequencing of competition in both domestic and international markets, policy reforms and strategic infrastructure investment. Figure 1.1: Growth of real GDP and output sectors in Afghanistan, 2006–15 (%) 50 40 30 21 20 14.4 Percent 13.7 8.4 10 5.6 3.6 6.1 3.7 1.3 0.8 0 -10 -20 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Real GDP Agriculture Industries Services Source: Calculations based on Central Statistics Organization data. 19 1.INTRODUCTION Extractive industries are generally recognized as the most year during the same period (World Bank 2013). Moreover, important sectors of the Afghan economy, with the potential Afghanistan’s reserves of oil and natural gas could be worth to drive growth and generate jobs through production and more than US$220 billion. However, the direct impact on trade. Projections suggest that mineral resource development job creation may be limited for the extractive sector, where could eventually generate between US$700 million and rents are not necessarily appropriated domestically. The US$1.5 billion in government revenue by 2020–24, and exports sector may create some 10,000 to 20,000 direct jobs, which from the sector could reach US$10 billion to US$12 billion per is marginal on the Afghan scale. Box 1.1: A framework for the relationship between trade and conflict There are three main mechanisms for how trade-related changes in commodity prices can affect conflict. The opportunity cost effect holds that changes in real incomes, for example, driven by trade price fluctuations, alter the incentives for participating in conflict by changing the return on participation in violence compared with more productive activities. The rapacity effect refers to the incentive to fight for control of valuable economic resources. And the resource effect recognizes that both government and rebels may fund their activities by taxing the production of commodities, so that changes in their value affect the ability to sustain conflict (Calì, 2015) Recent empirical literature on the impact of economic shocks on conflict suggests that conflict reduces the negative impact of increases in export commodity prices (see, for example, Carter and Bates 2012; Bruckner and Ciccone 2010). This negative relationship supports the opportunity costs hypothesis: that is, the costs for individuals of participating in hostilities or violent acts are equal to the income they should forego. Therefore, the higher the income level, the higher the cost of conflict (Collier and Hoeffler 2004). The negative relationship between income levels and shocks and conflict might also reflect the lack of state deterrence of conflict in low-income countries: when income is low, so is the state’s ability to collect fiscal revenues and thus to contain possible rebellions through military force or by buying off rebels (Fearon and Laitin 2003). Export prices increases can also help rebel groups finance their rebellion if they fight for and win control over these commodities (or a part of them). This “rapacity effect” has found empirical support in recent within-country evidence (Berman et al. 2015; Dube and Vargas 2013; Maystadt et al. 2014). Analysis across countries on exported natural resources, such as oil and mineral commodities, also supports the rapacity effect: an increase in the value of these exports of 10 percent raises the risk of conflict by 2.2 percent on average across countries. The higher the value of resources that can be easily appropriated through fighting, such as minerals and oil, the greater the incentive to fight over them (Calì 2015). Whether opportunity cost or rapacity effects predominate depends on several factors, including the value of the resources that can be appropriated through fighting, the level of capital intensity, and the geographic concentration of the resources (Dal Bó and Dal Bó 2011). For example, specialization in point-sourced export commodities versus agricultural commodities could lead to different outcomes in terms of conflict. The strength of the effect of commodity exports on conflict also depends on country-specific characteristics. Changes in economic conditions have a much greater potential for generating conflict where there are deep-seated, historical grievances among groups; where economic inequality is high; and where government institutions are weak or corrupt. Beyond commodity prices, other trade-related shocks may be relevant for conflict as they can determine substantial changes in individual incomes. A few studies suggest that rising demand from neighboring countries reduces the probability of conflict and its intensity (Berman and Couttenier 2015; Bruckner and Ciccone 2010; Chaudion, Peskowitz, and Stanton 2012). This evidence is consistent with the opportunity cost hypothesis. Some evidence is also emerging on the role of trading partners’ trade policy in affecting the intensity of conflict. Specifically, trade is particularly effective in preventing conflict when it occurs under international trade agreements (Berman and Couttenier 2015; Bhavnani and Jha 2011). This result is consistent with the idea that a high volume of trade between two neighbors A and B increases the costs to A of a conflict in B, thus reducing the likelihood that A would intervene to foment civil conflict in B (and vice versa). It also supports the idea that trade may raise the level of trust between the peoples of neighboring countries (Rohner, Thoenig, and Zilibotti 2013). 20 1.INTRODUCTION Reliance on extractive industries can both exacerbate estimates suggest that, as of 2015, the country earned only conflict and governance risks and impede broader economic US$30 million from its mineral sector for a third straight year, development (Sachs and Warner 1999). Potential revenues far less than earlier projections of US$1.5 billion. The shortage from the development of high-value, capital-intensive, and in revenue from mining is due to disputed contracts, lack concentrated extractive resources could increase the likelihood of governance, and political uncertainty. In contrast, illegal of different groups fighting over them (see the rapacity effect mining seems to have become a source of political patronage in box 1.1). The way in which export revenues are managed is and conflict in Afghanistan. Reports indicate that up to 10,000 therefore a key factor in determining their effect on conflict natural wealth deposits fall outside government control and risk. Evidence from countries located in unstable regions, may face looting (Najafizada 2015). with a recent history of conflict and with weak governance, suggests two general approaches for reducing conflicts A more plausible trade-driven growth scenario should promote induced by extractive industries in Afghanistan: (a) effective economic and export diversification. Promoting production limitations on the spending of revenues by government, and exports of labor-intensive goods and services might and (b) transfer of revenues into productive sectors. In the reduce the risk and intensity of conflict through increases first case, transparency of government expenditures would in real incomes and employment (see the opportunity cost help reduce potential discrimination against some groups, hypothesis in box 1.1). Additional revenues from trade in goods and thus limit the resentments and disputes that can result and services might also circumvent and partially compensate in civil conflict. Regional integration through international for the negative effects of conflicts. As shown by Anderson arrangements can help reduce nontransparent government (2015) and Mirza and Verdier (2008), if trade could enable access to resource revenues, thus reducing the incentive to countries to specialize toward formal activities (and thus away fight for control of these revenues. from informal ones), then labor may well switch to the better- remunerated formal sector. However, changes in relative In the second case, use of revenues for development of prices because of trade can also destroy opportunities and extractive industries should follow a resource corridor jobs in declining sectors, and the people affected by these 6 approach. The corridor approach enacts “a sequence of losses may, under certain conditions, turn to violence as a investments and actions to leverage a large extractive source of income. Further analysis of the production structure industry investment in infrastructure, goods and services, and trade opportunities for Afghanistan should help identify into viable economic development and diversification along a set of products with export potential that are less prone to a specific geographic area” (World Bank 2013). Exploiting conflict because the opportunity cost channel appears more synergies between the extractive sector and other economic predominant. activities can be a significant source of inclusive growth from a sector that otherwise might be an enclave of isolated Improving trade competitiveness in both goods and services activities. The resource corridor approach will be even more is a fundamental step for Afghanistan to diversify exports valuable if it complements interventions in agriculture and away from conflict-enhancing sectors. Afghanistan’s export agribusiness, the other drivers of growth in the coming base is still extremely narrow, reflecting the country’s limited decade. agricultural production and small manufacturing base. Not surprisingly, ongoing conflict and lack of governance are major Despite the potential the extractive sector presents for reasons for the country’s stalled development. Afghanistan Afghanistan with respect to trade and development, there are trade has also historically been modest. Over the last two uncertainties going forward, at least in the short run. Current decades, the trade balance of the country has been negative, 21 1.INTRODUCTION with an average structural trade deficit in goods and services and transit agreements with countries from Central Asia, 8 of 35 percent of GDP. In 2015, the trade deficit grew to 42.5 the Islamic Republic of Iran, and Pakistan, aimed at percent (figure 1.2) and official exports were only 7.15 percent granting unrestricted transit for goods within the territories of GDP (see box 1.2 on opium trade in Afghanistan). There is of the contracting countries. Afghanistan also joined the also the large, unrecorded export of opium, estimated at 7 World Trade Organization (WTO) in December 2015. An to 8 percent of GDP in 2015. However, even factoring in illicit existing tariff structure characterized by low rates reflects 7 exports, Afghanistan underperforms in exports. The import- Afghanistan’s intention to strengthen its trade profile heavy trade balance reflects large aid inflows for the country’s through WTO accession. Its membership will also provide 9 reconstruction and recovery efforts. The relatively high import the landlocked country with the right to transit. Prospects level has been driven by the demand for goods in donor- for transit trade have also motivated Afghanistan to funded projects—particularly oil, machinery, household items, participate in several important infrastructure initiatives. and food (World Bank 2012). One example is the World Bank–supported CASA-1000 project, which will connect Afghanistan, Pakistan, Tajikistan, Increased market access and regional integration in goods and the Kyrgyz Republic with an electricity transmission 10 and services is also key for trade to be a channel for growth system. However, the process of regional integration and prosperity in Afghanistan. Several important initiatives has been slowed and shaped by sensitive political and to promote trade and regional integration are underway. geopolitical considerations that are not entirely under Afghanistan has been pursuing a set of multilateral trade Afghanistan’s control. Figure 1.2: Trade-to-GDP ratio in Afganistan. 2011-15(%) 60 40 20 Percent 0 2011 2012 2013 2014 2015 -20 -40 -60 Exports of goods and services (% of GDP) Imports of goods and services (% of GDP) Trade balance Source: Calculations based on the World Bank’s World Integrated Trade Solutions (WITS) database. 22 1.INTRODUCTION Box 1.2: The opium trade—Afghanistan’s leading economic activity and illicit export commodity Afghanistan is the world’s largest source of opiate production, accounting for 80 percent of the world’s illicit opiates and heroin in the last decade (UNODC 2016a). For much of the rural population, the opium poppy economy is an essential source of basic livelihoods and human security (Felbab-Brown 2016). In a 2016 survey by the United Nations Office on Drugs and Crime (UNODC 2016b), 71 percent of opium growers gave an economic reason for growing opium, and 28 percent identified income-related reasons but framed their answers under agronomic and ecological reasons. a Opiates produced in Afghanistan are mainly intended for export. In 2013, for instance, 96.3 percent of the total net value of opiates was exported and only about 3.97 percent of opiates was consumed domestically. The value of exported opiates corresponded to 14.4 percent of GDP that year (Ministry of Counternarcotic 2014). The net value of opiates was equivalent to 12.6 percent and 10 percent of GDP in 2014 and 2015, respectively (UNODC 2015). The primary transit routes for Afghan opiates have been Pakistan, the Islamic Republic of Iran, and Central Asia. However, the so- called “southern route” via the Islamic Republic of Iran and Pakistan is expanding. Heroin is being smuggled through the area south of Afghanistan, via the Near and Middle East and Africa, as well as directly from Pakistan (UNODC 2014). Subsequently, Afghan opiates reach the main destination markets, which are West and Central Europe, and the Russian Federation. Afghan heroin, in contrast, is trafficked to every region of the world except Latin America (UNODC 2016b). Between 2002 and 2008, a yearly average of 150 tons of Afghan heroin was transited through Pakistan, 105 tons through the Islamic Republic of Iran, and 95 tons through Central Asia (UNODC 2010). In terms of production and share of GDP, opium’s importance has been declining since 2007, when it reached a record production of 8,200 tons. Currently, production is closer to 3,700 tons (UNODC 2012), or 3.3 percent of GDP in farm-gate value, compared to 13 percent of GDP by farm-gate value in 2007. Average opium GDP growth has been only slightly higher than non opium GDP growth in recent years, suggesting that opium has not been an important driver of economic growth. However, opium is still Afghanistan’s most important cash crop and, therefore, has significant implications for income and consumption patterns of rural, poor households. Studies such as by Katzman and Rosen (2014) suggest that Afghanistan’s drug trade is unlikely to slow drastically in the foreseeable future, and the country will remain the primary source of opium poppy cultivation and production of opiates for years to come. Many organizations have tried to tackle the issue of opium poppy cultivation, for example, by offering “alternative livelihood” programs. However, there is little agreement on the effectiveness of these measures. In Helmand province, where 47 percent of total opium poppy cultivation occurred in 2015, the alternative livelihood programs significantly reduced poppy cultivation, results that persisted after the programs ended (UNODC 2016a). However, it is also argued that reduced poppy cultivation in Helmand has been mainly due to the falling price of opium. The alternative livelihood programs, it is argued, are poorly designed, ineffective, and rarely generate sustainable income. Finally, the alternative livelihood programs are sometimes criticized for not reaching out to all poppy farmers and for benefiting only growers living close to cities (Felbab-Brown 2016). a . “Opiates” is the generic name given to a group of naturally occurring drugs derived from the opium poppy (Papaver somniferum) such as opium, morphine, and codeine; semisynthetic substances such as heroin (which are opiates in the strict definition); and opioids, which are “opiate-like,” wholly synthetic products such as methadone, pethidine, and fentanyl (see UNODC, https://www.unodc.org/unodc/en/illicit-drugs/definitions/). Given Afghanistan’s limited resources for development, it is for an appropriate sequencing of policy reforms and strategic essential to provide realistic scenarios for trade development infrastructure investment that will improve trade connectivity and regional integration. Such scenarios are the foundation and firms’ productivity in the country. 23 1.INTRODUCTION 1.2 Scope of the report and finance. These sectors, although still underdeveloped, might be an important driver of growth, not just through This report explores different avenues for trade development services exports, but through their role in building both the and regional integration in Afghanistan. The report analyzes hard and soft infrastructure needed to facilitate accumulation opportunities and challenges for growth in the areas of of human capital and enhance competitiveness. trade in goods and commodities, services trade, and transit trade. The policy implications deriving from the analysis will Chapter 4 investigates the extent to which the government be presented and discussed in terms of actions that the can turn the disadvantages of being landlocked and having Government of Afghanistan could take or prioritize to improve a limited agricultural output into a comparative advantage by trade in areas with greater trade potential. Finally, the developing the potential of transit trade in goods and energy. report draws on the existing literature to try to evaluate the The potential gains from transit trade are estimated using data conflict and governance risks associated with the different on international trade statistics under a set of assumptions types of specialization that Afghanistan could choose for its regarding the amount of trade flows that most likely could development. cross Afghanistan before reaching their destination. The discussion on energy transit potential is mainly based on Chapter 2 assesses the potential for trade in goods. It uses information regarding cross-border, large-scale infrastructure a standard gravity model to estimate the determinants of projects for transit of energy that are underway in the region. export and import development at the intensive and extensive The chapter also provides insights on developing connectivity margins for merchandise and commodity trade. The chapter across services infrastructure, especially transport, energy, also provides some simulations on the potential impact of and communications. border and beyond-the-border trade barriers on exports, and discusses the role of factors such as conflict on export development. The results provided in this chapter are based 11 on standard statistics on formal economic activity. Evidence suggests, however, that around 40 percent of Afghanistan’s total trade takes place informally across the border among small merchants and traders (PAJCCI 2012). These transactions are not recorded in standard trade statistics and therefore are not reflected in the analysis in chapter 2. Chapter 3 illustrates how international cooperation on services could help Afghanistan alleviate the problem of skills deficiency in the country. The chapter begins with a discussion of the current regime and patterns of trade in services. The information on Afghanistan’s services trade policies is primarily drawn from Afghanistan’s WTO Accession General Agreement on Trade in Services schedules, given the lack of information on domestic services regulations. The chapter then focuses on the long-term potential and challenges for services sectors, such as education, health, 24 1.INTRODUCTION REFERENCES Collier, P., and A. 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World Bank. 2012. “Afghanistan Diagnostics Trade Integration Study, November 2012.” World Bank, Washington, DC. http:// 26 2 AFGHANISTAN’S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES 27 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES KEY MESSAGES: • Lack of supply is the main cause of Afghanistan’s export underperformance. The high concentration of production (and exports) in primary products and low levels of competitiveness reflect the economy of a fragile country with high levels of ongoing conflict. • After controlling for supply constraints and conflict, most of the underperformance of Afghan exports is associated with poor logistics and trade-related infrastructure rather than lack of market access. • Even with existent infrastructure, export flows could be improved by 20 percent in the short-term by tackling export delays related to customs and border procedures or high risks during transportation. • In the long-term, reducing export delays, coupled with Afghanistan’s productivity converging to regional levels, could lead to a more than six-fold increase in exports. 28 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Can trade in goods be an engine of growth for Afghanistan? how supply-side constraints, conflict, and lack of governance Current patterns of trade suggest that Afghanistan has little have played a significant role in trade underperformance; to offer the world. Afghan exports (and imports) are highly empirically assesses which trade barriers are currently preventing concentrated in a handful of primary products with low value Afghan exporters from reaching international markets and how and sophistication. Ongoing conflict and lack of governance, the removal of such barriers could improve trade in the short run; by limiting agricultural output and generating structural discusses the different avenues to address trade barriers; and constraints to industry and manufacturing, have been the considers the long-term policies needed for Afghanistan’s trade main reasons for low levels of competitiveness and the lack of potential to fully materialize. diversification of the Afghan economy. 2.1 Current patterns Although improving trade competitiveness is a long-term objective, of Afghanistan’s trade12 solutions exist for Afghanistan to improve its trade performance and, therefore, gain from exports of existing products in the short- Trade balance term. Which policies would allow Afghanistan to improve its trade potential in the short-term? Where should the Government of Over the period 1995–2014, the trade balance in goods of Afghanistan invest to start realizing the benefits from trade while Afghanistan was in deficit (see figure 2.1). Statistical evidence improving its overall competitiveness? Does the government need suggests that aid channeled to the country has mainly been to continue investing in (hard) infrastructure to benefit from export used to import a variety of consumption goods (and equipment), development? without playing its usual role of fostering firm competitiveness. An examination of the evolution of the export and import This chapter assesses the determinants of Afghanistan’s patterns of Afghanistan over time suggests that the usual underperformance in trade. The chapter uses stylized facts on channels through which trade is fostering productivity have not current patterns of Afghanistan’s production and trade to assess been working. Figure 2.1: Afghan trade balance in goods, 1994–2014 0 US$ billion -5 -10 -15 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Imports Exports Trade balance Source: Calculations using BACI data from CEPII. 29 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES During the period 1995–2001, both import and export values (their 2009 level) while exports reached their highest level of goods were very low, suggesting a weak integration during 1995–2014 at more than US$0.7 billion. Still, the trade of Afghanistan in the international market for goods. The imbalance is extremely large. It can be sustained only by evolution of the trade balance between 2002 and 2011 inflows of aid or foreign capital channeled to activities with a characterizes an economy opening to trade and having limited revealed comparative advantage for the country. access to a larger variety of consumption, intermediate, and investment goods. Significant increases in imports (from less than US$1 billion in 2002 to more than US$12 billion in 2011) Export and import concentration included a marked expansion of the number of imported product categories (figure 2.2). These categories almost Afghanistan exports a limited number of goods to a restricted tripled in a decade, up to 3,000 in 2011 before stabilizing at list of destinations. Data on exports and imports by partner 13 14 around 2,600 in 2014. The number of countries from which and product between 1995 and 2014 show that in 2014, goods originated also increased significantly, from 60 partner exports were concentrated in a handful of products such countries in 2001 to 100 in 2011. In principle, beyond matching as dried fruits and nuts, coal, and cotton, representing the needs of the final consumer, the import of new varieties 25.5 percent, 11.4 percent, and 10 percent of total exports, Figure 2.2: Diversification of exported and imported products in Afghanistan, 1995–2014 3,500 Number of goods (HS6) 3,000 2,500 2,000 1,500 1,000 500 0 2000 2008 2006 2009 2004 2005 2003 2002 2007 1998 1996 1999 1995 2001 2010 1997 2014 2013 2012 2011 Exported HS 6 Imported HS 6 Source: Calculations using BACI data from CEPII. of goods leads to productivity gains through decreases in respectively. The top-10 exported product categories the costs of inputs and access to new technologies. Since represented more than 70 percent of Afghanistan’s total imported inputs enhance firm productivity, they can also play exports (figure 2.3). This compares to 5.31 percent for low- a critical role for firm export performance, and eventually help and middle-income countries and 12.72 percent for the South increase exports. Asia Region. For comparator countries such as Pakistan, Kazakhstan, Azerbaijan, and Rwanda, the top-10 exported A sharp decrease in imports has been recorded from 2011 products represent, respectively, 31 percent, 78 percent, 95 onward. In 2014, imports amounted to almost US$6.5 billion percent, and 75 percent of total exports. 30 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES With respect to export destinations, the top-five destinations include mineral fuels and oils, wheat, and sugar, representing, (Pakistan, India, China, the Islamic Republic of Iran, and Turkey) respectively, 15 percent, 6.4 percent, and 5 percent of total imports account for 87 percent of total Afghan exports. For low- in 2014. Just 20 imported goods represented 43 percent of total and middle-income countries and South Asia, the top-five Afghan imports. This share for the top-20 imports is lower for destinations represent, respectively, 40 percent and 38 percent comparator countries: Pakistan at 40 percent, Kazakhstan at of exports (figure 2.4). The top-five destinations in Pakistan, 17 percent, Azerbaijan at 19 percent, and Rwanda at 26 percent. Kazakhstan, Azerbaijan, and Rwanda represent, respectively, The share for the top-20 imports is, on average 11, percent for low- 43 percent, 48 percent, 56 percent, and 61 percent of exports.15 and middle-income countries and 22 percent for the South Asian region. In addition, 66 percent of Afghanistan’s imports originated Imports are also concentrated in a small number of products and from only 5 partners. For both low- and middle-income countries come from a limited number of countries. Top imported products and the South Asia region, 59 percent of imports came from 5 Figure 2.3: Cumulative distribution of Afghan-traded product categories, 2014 Concentration of exports Concentration of imports Goods(hs6) Goods(hs6) 100 100 80 80 Share of total export value(%) Share of total import value(%) 60 60 40 40 20 20 0 0 1 5 9 13 17 21 1 5 9 13 17 21 Number of exported goods Number of imported goods Source: Calculations using BACI data from CEPII. Figure 2.4: Cumulative distribution of Afghan export destinations and import origins, 2014 Source: Calculations using BACI data from CEPII. Note: Product categories are defind using the 6 digits Harmonized System classification. 31 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES partners. These shares are slightly lower for comparator countries: States and European countries. Since then, a dramatic increase Pakistan 54 percent, Kazakhstan 63 percent, Azerbaijan 52 has been observed both in absolute and relative terms of the share percent, and Rwanda 55 percent. of Afghan exports to China, the Islamic Republic of Iran, and Turkey. These countries received around 8 percent of total Afghan exports Afghanistan’s biggest trading partners are mostly neighbors and/ in 2014. The rise of China as a trade partner has been driven by the or war-involved partners. Table 2.1 presents the value of Afghan dramatic expansion of the Chinese market for imports. exports (in US$ thousands) during 1995, 2005, and 2014 to the top-20 destinations. Pakistan and India are the most important In 2005, the United States represented the third most destinations of Afghan products. Exports to these partners have important destination of Afghan exports. However, exports been increasing and represented around 80 percent (50 percent to the United States decreased by almost 70 percent and 32 percent, respectively) of Afghan exports in 2014. Between between 2005 and 2014. Trade flows recorded as exports 1995 and 2005, a large share of Afghan exports went to the United to the United States reflect goods and services provided to TABLE 2.1: Exports from Afghanistan to its 20 largest destination markets, 2014 Destination Exports (US$ thousand) 1995 2005 2014 Share of total 2014 (%) Pakistan 0 50,462 373,585 0.501 India 8,064 53,695 242,814 0.326 China 72 1,510 21,346 0.029 Iran, Islamic Rep. 0 5,971 18,072 0.024 Turkey 63 8,118 16,387 0.022 Germany 8,046 3,664 15,759 0.021 Russian Federation 0 3,773 12,416 0.017 Finland 2,163 10,706 10,076 0.014 United States 5,100 24,060 7,869 0.011 Italy 594 1,965 6,636 0.009 France 1,495 744 4,768 0.006 Spain 248 1,313 4,011 0.005 United Kingdom 1,748 720 3,529 0.005 Jordan 197 768 2,609 0.003 Netherlands 193 84 1,840 0.002 Belgium 17,086 7,343 981 0.001 Egypt, Arab Rep. 269 3,021 657 0.001 Denmark 3,686 3,322 205 0.000 Source: Calculations using BACI data from CEPII. 32 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES 16 U.S. troops stationed in Afghanistan, rather than exports Similarly, Afghan imports are also very dependent upon to North America. Indeed, table 2A.1 in Annex 2A shows that close and/or war-involved partners. In 2014, Pakistan was 9 of the 10 top products exported to the United States by the main source of imports (Afghanistan mostly imported Afghanistan are war related. These are concentrated mainly cement, sugar, and wheat flour from Pakistan) followed in the machinery and mechanical appliances category. Most of by China (fabrics and rubber). The Islamic Republic of Iran these products do not show up in 2014 exports, highlighting (peat), India (fabrics and pharmaceutical products), the the withdrawal of U.S. troops from the country. In 2014, export Russian Federation (petroleum oils), and the United States flows to the United Sates reflected Afghanistan’s comparative (telephone sets and meat and edible meat offal) comprised advantage and were mainly constituted by products such as another 30 percent of Afghanistan total imports in 2014 carpets and other vegetable-related products. (see table 2.2). TABLE 2.2: Afghan imports from the 20 most important origin markets, 1995–2014 Origin Imports (US$ thousand) Share of total 1995 2005 2014 2014 Pakistan 0 1,064,648 2,200,224 0.378 China 11,268 51,166 709,143 0.122 Iran, Islamic Rep. 0 482,254 450,364 0.077 India 18,034 146,586 438,716 0.075 Russian Federation 0 104,393 407,567 0.070 United States 2,692 251,076 399,205 0.069 Kazakhstan 0 163,900 333,499 0.057 Azerbaijan 0 11,677 275,990 0.047 Turkey 489 111,157 186,219 0.032 Germany 15,995 140,134 150,912 0.026 Netherlands 1,653 79,295 64,525 0.011 Korea, Rep. 20,439 59,621 58,724 0.010 Thailand 12,204 57,925 47,028 0.008 United Kingdom 11,271 25,800 43,468 0.007 Japan 84,383 76,291 31,938 0.005 France 13,155 30,455 22,413 0.004 Uzbekistan 0 0.000 United Arab Emirates 0 464,864 0.000 Kenya 0 19,425 0.000 Source: Calculations using BACI data from CEPII. 33 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Specialization patterns production and export dependence in primary commodities leaves the country exposed to price- and partner-specific shocks. In the last decade, Afghanistan’s specialization has moved away from products such as carpets and textiles and toward A decrease in the specialization of Afghan exports away from a concentration in agricultural products. In 1995, there was the textile industry might have been affected by the lack of strong export specialization in textiles and textile articles, insertion of Afghanistan in related global value chains (GVCs). especially wool and carpets: the corresponding top-three Reduced domestic supply of inputs (wool supply, dyes, yarn, HS-6 product categories represented more than 30 percent washing chemicals) has also resulted in increased costs of of total Afghan exports. In contrast, textile items were no production due to heavy reliance on imports from Pakistani longer present among the top-five exported sectors in 2014 suppliers (Pain and Ali 2004). Evidence from the private sector (see table 2.3). In 2014, agricultural products represented 50 also suggests that high levels of conflict were related to the percent of total Afghan exports. Mineral fuels and oils also reallocation of the production of products such as skins and represented a significant share of Afghan exports in 2014 (10 carpets to safer countries. The textile and textile product percent). Conflict and fragility have played an important role industry has repeatedly been identified as the first step on in the specialization patterns of the Afghan economy. Civil the development ladder, conducive to more complex industries war and lack of security have been responsible for too much or tasks, such as assembly or production of simple electric concentration in subsistence products (products with a market or electronic appliances. By withdrawing from the textile demand and that can be consumed rapidly and locally), which industry and returning to agriculture, Afghanistan has reduced appear to be the only rewarding types of investment activities the prospects for future export diversification (for a more remaining during war. comprehensive analysis of the carpet industry see section 2.4). TABLE 2.3: Top-five export sectors in Afghanistan, 1995–2014 (HS-2) Rank 1995 2005 2014 1 Wool and fine or coarse animal hair Edible fruits and nuts Edible fruits and nuts 2 Carpets and rugs Iron and steel (waste and scrap) Iron and steel (waste and scrap) 3 Edible fruits and nuts Furskins and artificial fur Mineral fuels, oils, waxes 4 Furskins and artificial fur Oil seeds and oleaginous fruits Cotton 5 Sugars and sugar confectionery Coffee, tea, mate, and spices Lac, gums, resins Source: Calculations using BACI data from CEPII. An improvement in the ranking of agricultural products since 1995, Import development reflects the post-reconstruction process (mainly fruits and nuts and oils and seeds) points to the exploitation more than GVC participation. Import patterns reflect a change of certain comparative advantages. However, these goods usually in the nature of products from low to high value over time. have low value added and weak backward and forward links with Specifically, a dramatic change in imported product content other sectors, and thus little technological spillover. In general, has been observed over the last two decades (table 2.4). In 34 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES 1995, much of the imports of electrical equipment probably skilled workforce. Afghanistan is, however, exporting greater reflected a change in household preferences. In 2005, just volumes of products associated with lower levels of human after the war and in a period of increasing openness for capital (years of schooling) and greater levels of physical Afghanistan, other types of manufactured products seemed capital per worker. to enter the country (cars and components, as well as route, train, or airport infrastructures and related goods). In Figure 2.5 illustrates some positive shifts in the product contrast, by 2014, a net change in imports can be observed, distribution for physical capital per worker and negative shifts with products of first necessity (energy, pharmaceuticals, for human capital (years of schooling). Exports of products and commodities) dominating the ranking. This shift mirrors associated with greater levels of physical capital per worker are the precarious state of the economy in the later period. In not in line with the country’s comparative advantage, and are addition, the limited value of intermediary imported inputs very possibly related to re-exports, for example, the data show suggests weak integration in GVCs and confirms that exports of video recording apparatus and bulldozers or levelling increasing imports might not translate into productivity gains. tools. The lower levels of human capital per worker can be TABLE 2.4: Top-five import sectors in Afghanistan measured at the HS 2-digit level, 1995–2014 (HS-2) Rank 1995 2005 2014 1 Rubbers and articles of rubber Mineral fuels, oils, waxes, etc. Mineral fuels, oils, waxes, etc. 2 Electrical machinery and equipment Vehicles other than railway Sugars and sugar confectionery 3 Man-made filaments Electrical machinery and equipment Milling industry products 4 Tobacco Plastics and plastic articles Vehicles other than railway 5 Animal or vegetable fats Articles of iron or steel Electrical machinery and equipment Source: Calculations using BACI data from CEPII. Labor sophistication attributed most notably to increases in exports of agricultural of Afghan exports products and foodstuffs, such as vegetables, fruits and nuts, and vegetable oils. The greater levels of physical capital per Empirical studies show that what a country exports and where worker are associated with greater exports of mineral products it exports affect the level and composition of labor demand in as well as stones and glass, including steatite, coal products, 17 the exporting country and its economic growth performance. and ferrous and copper waste and scraps. The trends in figure 2.5 indicate that the level of labor 18 sophistication —as measured by the wages, value added, Lack of export diversification in terms of destination markets is share of skilled workers, and human capital—embedded in related to lower levels of labor sophistication for Afghanistan. Afghan exports to the world has changed little since 2000. Exports to South Asia are heavily concentrated in primary Few notable shifts have occurred across the distribution of products (vegetables, fuels, metals, and minerals). Stone and export products between 2000 and 2014 for median value glass exports are more important to the United States than added, median wage, output per employee, and share of the European Union (EU) and South Asia, as are agricultural 35 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Figure 2.5: Cumulative distribution of Afghanistan’s export basket to the world, 2000 and 2014 (PRODY index) 1 1 .8 .8 .6 .6 .4 .4 .2 .2 0 0 8 9 10 11 12 13 8 9 10 11 12 13 PRODY median wage (PPP thousands) PRODY median value added (PPP thousands) 2000 2014 2000 2014 1 1 .8 .8 .6 .6 .4 .4 .2 .2 0 0 11 13 15 17 0 .2 .4 .6 .8 1 PRODY output per employee (PPP millions) PRODY skilled workers (share of workforce) 2000 2014 2000 2014 1 1 .8 .8 .6 .6 .4 .4 .2 .2 0 0 2 4 6 8 10 12 8 9 10 11 12 13 PRODY human capital (years of school) PRODY physical capital per worker (USD thousands) 2000 2014 2000 2014 Sources: Calculations based on mirror data from UN Comtrade, World Bank Business Environment and Enterprise Performance Surveys, and Shirotori, Tumurchudur, and Cadot (2010). Note: The PRODY index is the global trade-weighted average labor-market outcome covering all countries in the world that export the product. 36 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES products and textiles. Exports to the EU-28, in contrast, which case however, some of the products such as machinery and in 2000 were concentrated in textiles and leather, showed more electricals might be related to re-exports of goods previously diversity in 2014. These exports included vegetable products, imported into Afghansitan. Government policies should hides and skins, machinery and electricals, textiles, metals, and therefore promote diversification of Afghanistan’s export basket chemicals (figure 2.6). Thus, the EU exports reflect higher wages, to export destinations such as the EU, which are associated skill, human capital, and physical capital content. Also in this with greater levels of labor sophistication. Box 2.1: How to measure the labor sophistication of Afghanistan’s exports The Sophistication of Products (EXPY) index of labor sophistication can be used to measure trade-weighted average labor- market outcomes of the goods and services that appear in Afghanistan’s export basket. These measures extract information from labor market conditions and other characteristics of economies that specialize in certain products exported to certain markets. Based on these observations, it is possible to draw inferences about how products and regional trade patterns can impact employment, wages, and skill demand in Afghanistan. A country’s EXPY is calculated in two steps for each of the six labor-market outcomes (wage, value added, skill ratio, output per employee, human capital, and physical capital), following Hausmann, Hwang, and Rodrick (2007). The first step calculates for each product a PRODY value, or the global trade-weighted average labor-market outcome covering all countries in the world that export the product. For example, we can calculate a wage PRODY reflecting the average international wage of countries that export the product, a skill PRODY reflecting the average share of skilled workers of countries that export the product, and so on. The second step then weights the PRODYs appearing in Afghanistan’s export basket by the share of each product in Afghanistan’s total exports, denoted EXPY. The formulas are: where is exports from country in sector is total exports of , and is the labor- market outcome. These resulting EXPYs reflect the global average labor-market outcome of goods that appear in Afghanistan’s export basket. The PRODYs and EXPYs are calculated using mirror data from United Nations Comtrade database; the World Bank’s World Business Environment Survey and Enterprise Surveys; and Shirotori, Tumurchudur, and Cadot (2010). For each of these labor-related EXPYs for Afghanistan, we (a) look at how their levels have evolved over time since 2000; (b) consider variations in labor sophistication across different destination markets, comparing the average for all Afghan exports (that is, destined to the “world”) to those destined to the European Union-28, the United States, and South Asia; (c) make bilateral comparisons of labor sophistication with a range of regional exporters, including Pakistan, Kazakhstan, Azerbaijan, Niger, Turkey, and the Russian Federation; and (d) repeat each of the above analyses across the entire distribution to see which products are driving the observed differences. 37 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Figure 2.6: Sectoral composition of Afghanistan’s export basket over time and by destination market, 2000– 14 Source: World Bank calculations based on mirror data from United Nations Comtrade. 2.2 Assessing Afghanistan’s Export potentials are presented in figure 2.7, which plots each trade performance export flow of a country against its corresponding measure of capabilities and market access (that is, the sum of its GDP and Afghanistan’s trade performance can be assessed by comparing that of all partners weighted by the inverse of the distance to 20 the country’s observed export (or import) flows with an expected the country). Afghanistan’s neighbors are (orange) squares 19 norm (also called trade potential). Potential exports for and countries comparable in terms of GDP per capita are (green) 21 Afghanistan (and other countries) can be represented by a triangles. Other countries are represented by dots. The fitted measure that accounts for the capability of a country and its line provides a benchmark against the actual performance of market access (see box 2.2 for more details). Exports from a given Afghanistan. Any deviation from the fitted line points to a residual, country are more likely when the capabilities of the exporting which is a variance that cannot be explained by the controls used. country are high and foreign demand strong and accessible Deviations below the line suggest trade underperformance, and 22 (market access). deviations above the line suggest trade overperformance. 38 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Figure 2.7 shows that Afghanistan underperforms, even gravity forces (that is, importing country demand and compared to its neighbors and to countries at similar levels capabilities of exporting countries adjusted for transport of development. Trade underperformance is persistent after costs). In general, Afghan exports are still much below controlling for the presence of war-related trade and informal their potential, compared to countries of similar size, 23 trade. Similar figures are also obtained when classifying level of development, and remoteness from trade 24 products by type of use: except for primary products, where partners. However, Afghan imports converge to their Afghanistan’s performance is in line with expectations, a natural prediction over time. This is an important result, clear underperformance shows up when considering capital suggesting that specific obstacles to imports are relatively goods, intermediary goods, and consumer final goods (see mild compared to exports. A more detailed analysis of the Figure 2.7: Afghanistan’s export potential, 2001 and 2014 Note: Regression fit: R²=0.86 Note: Regression fit: R²=0.92 AFG Share in Sum of square residuals: 0.031. AFG Share in Sum of square residuals: 0.033. Residuals rank of AFG: 177/190 Residuals rank: of AFG: 170/190 Source: Calculations using BACI data from CEPII. Annex 2A, figure 2A.1). Afghanistan’s trade underperformance potential of import flows of intermediary products and is more severe than presented in figure 2.7, because the capital goods used by Afghan producers plots an “inverse estimations do not consider that a significant share of U-shape” over time of Afghanistan’s import performance Afghan exports are not locally produced but are simply for such products. This suggests that Afghanistan is not 25 transiting the country. importing enough for production and exporting and that instead import flows reflect foreign presence due to war Figure 2.8 plots trade potentials for import values by (see Annex 2A, figure 2A.2). comparing actual imports with potential imports, the latter being simply defined as the outcome of simple At the firm level, the low proportion of exporters of all Afghan 39 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Figure 2.8: Afghanistan’s import potential, 2001 and 2014 Source: Calculations using BACI data CEPII. Box 2.2: Estimating Afghanistan’s trade potential with gravity equations In its general version (here adapted from Head and Mayer [2014]), the gravity equationa represents tra de flows between two countries and by the following relation: (B2.2.1) where represents the export value from to , captures the capability of country to export to all destinations, and expresses bilateral accessibility between and . The variable expresses the characteristics of the destination market that affect imports from all sources. It can be shown further that , where is the total expenditure of country and measures the average accessibility of consumers in to supplies the rest of the world (also referred to as the degree of competition in country ). Equation B2.2.1 can be aggregated to express total exports of a given country, like Afghanistan, to the world. Summing over all destinations j and rearranging, the following expression is obtained for total exports ( ): (B2.2.2) where is the market access of country to the world, as it represents the sum of expenditures addressed to , weighted by the relative bilateral access between country and , compared to all other exporters to (that is, ). It is interesting to see that two elements determine total exports of a country , its capability ( ), and its market access to the world. From theory to the data To predict total exports of a country (that is, to estimate its potential exports), the capabilities of that country and its access to world markets are proxied by the multiplication of the GDP of the exporter and the sum of GDPs of importers, respectively, weighted by the inverse of their distance to the exporter. In the same manner, another simple prediction can be obtained of bilateral exports by multiplying the GDP of an exporter with that of the importer and dividing by the distance between them. By comparing predicted (bilateral) values to actual (bilateral) flows, one could deduce a country’s over- or underperformance. Note: a. The gravity model has been used extensively in international trade due to its intuitive empirical and theoretical appeal. Anderson and van Wincoop (2003), Feenstra (2004), and Baldwin and Taglioni (2006), among others, present exhaustive literature reviews on the gravity equation as applied to international trade. 40 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES companies, and their poor performance in export (red) dots are bilateral trade values for Afghanistan. markets, suggest low export capabilities and high barriers The fit represents the bilateral trade predicted by the to trade. According to the World Bank’s Enterprise gravity variables. Most of the red Afghan dots happen 26 Surveys, only 6.7 percent of the 410 surveyed Afghan to be under the prediction, especially in 2014. This result firms were exporters in 2014 (table 2.5). This share is low confirms that Afghanistan underperformance is present compared with averages for the South Asia region (13 in most of the destination markets. Notice that most of percent) and Organisation for Economic Co-operation the top 20 main destinations of Afghanistan’s exports are and Development countries (36 percent). In addition, below the predicted line (see green triangles), suggesting data from Afghan customs’ authorities show that on that Afghanistan has not been able to fully exploit these average a firm exported only two to three products to markets. The fact that barriers to export faced by Afghan 27 one or two destinations at most (table 2.6). Low export producers are affecting most of the destinations similarly performance is consistent with low foreign investment, suggests that lack of market access is not responsible which can provide an important conduit for acquiring for Afghanistan’s trade underperformance. Indeed, knowledge and technology. Foreign direct investment Afghanistan does not appear to be facing high tariffs from (FDI) flows into Afghanistan—mostly originating from the the rest of the world. In fact, table 2.5 shows that it faces United Arab Emirates and China—were less than 1 percent relatively lower tariffs than its neighbors do. Besides, of GDP in recent years. Afghanistan has important tariff preferences from the EU and the United States, two of the largest markets In figure 2.9, bilateral exports are plotted using a simple outside its neighbors (respectively, 0.012 percent and 1.7 gravity benchmark, defined as the capability and market percent average tariffs). The only two important markets access of each exporting country (see box 2.2 for further for Afghanistan where it still faces high tariffs are Pakistan details). Each dot is a bilateral trade value and the darker (13 percent) and the Islamic Republic of Iran (26 percent). TABLE 2.5: Share of firms exporting at least 1 percent of sales directly or indirectly, Afghanistan and comparators, 2013–14 Export destination Share of firms (%) Pakistan 18.60 Afghanistan 6.70 Kazakhstan 5.00 Azerbaijan 1.90 High income: OECD 35.70 South Asia 12.90 Source: World Bank Enterprise Surveys. Note: Shares for Afghanistan are from 2014. Shares for Pakistan, Kazakhstan, and Azerbaijan are from 2013. A total of 410 enterprises were surveyed in Afghanistan in 2014. The sectors covered are manufacturing (40 percent), retail (20 percent), and services (40 percent). OECD = Organisation for Economic Co-operation and Development. 41 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES TABLE 2.6: Overview of customs data on Afghan exports, 2013 14 Year Number of Number of Number of Total value of Number of Number of companies destinations goods (HS-8) exports (US$ goods destinations thousand) per firm per firm 2013 686 55 303 364,178 2.92 1.40 2014 943 56 303 449,196 2.54 1.38 Source: Afghan custom authorities. Note: Goods are classified using the 8 digit Harmonized system classification (HS8) Figure 2.9: Bilateral exports and market access in Afghanistan, 2001 and 2014 Source: Calculations using BACI data from CEPII. 2.3 Supply-side factors the agricultural (and industrial) share of total output and limiting trade performance contribution to GDP growth has been decreasing over the years (see figure 2.10). Top exported products such as fruits Lack of supply is one of the main determinants of export and nuts represented only one-fourth of agricultural GDP in underperformance in Afghanistan. The country’s export 2015 . Other traded products such as textiles, carpets, wood, base is still extremely narrow, reflecting its limited and paper represented less than 1 percent of manufacturing agricultural production and small manufacturing base. GDP. These figures suggest that Afghanistan has very The combined GDP share of agriculture and industry has little to offer to international markets and that supply-side been on average 20 percent during 2006–15. And although constraints need to be addressed for Afghanistan’s trade 28 agriculture remains central to the Afghan economy, potential to materialize. 42 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Persistent conflict has prevented Afghanistan from Policy actions aimed at improving Afghanistan’s accruing the advantages derived from economic production capacity include improving the business diversification. The poor economic environment climate by reforming and streamlining business (including weak rule of law, low levels of education regulations, increasing transparency of the tax system, and training, and underdeveloped financial sectors) and providing better access to main services such as reduces the incentives to invest in manufacturing electricity through facilities such as industrial parks. and routes (Brück 2004; Deininger 2003). It also limits Producers and exporters will also need better access workers’ ability to improve their productivity, both in to finance through domestic regulatory reform and terms of quantity and quality of their products. Indeed, risk-sharing schemes (see specific recommendations highly differentiated goods produced by manufacturing in chapter 3). A medium-to-long-term agenda aimed sectors are much more sensitive to transaction costs at improving economic diversification should support produced by violence (see Mirza and Verdier 2014). FDI attraction and human capital improvements. In this context, peace-enhancing policies would be Implementing such policies will take time. This is important drivers of diversification towards non-farm particularly true in an environment of conflict and and non-primary resources goods. political insecurity. Rather, Afghanistan should view these actions as a medium-to-long-term policy A heavy regulatory burden and perceived risks to investing and agenda that will support trade and competitiveness operating in the country and lack of human capital have also more broadly (see box 2.3). limited Afghanistan’s production capacity. Afghanistan ranked 183rd out of 189 economies in the World Bank’s Doing Business In the short -to medium- term, polices aimed Report 2016. High costs of doing business in Afghanistan at improving economic diversification and are reflective of the regulatory burden and perceived risks competitiveness should focus on sectors where to investing and operating in the country. Low levels of local Afghanistan has a comparative advantage. The and foreign investment have been driven by the security analysis below focuses on the supply-side constraints environment as much as by the business environment, driving and potential solutions for the agricultural sector and up the risk premium and deterring risk-averse investors. The the carpet industry. These sectors are important for inability of Afghanistan to attract high-value FDI has prevented Afghanistan’s economy in terms of production and the country from taking advantage of new and better sources potential trade. Increased competitiveness in these of finance, knowledge, and access to markets. sectors would not only help to substitute imports and improve potential exports, but could also have With respect to human capital, mediocre education a positive impact on conflict, given their relatively outcomes—whether due to inadequate quality, high labor intensity and therefore their positive misalignment with labor demand, or limited access to impact on employment and wages as production educational services—have prevented Afghan producers increases (see box 1.1 for more details on the links from improving the quality of their products and therefore between conflict and trade). Increased productivity from diversifying production and exports toward higher- in the agricultural sector and the carpet industry will quality, more sophisticated products. That is, producers also lead to higher diversification in terms of export cannot recruit labor with appropriate skills, which in turn destination markets, and therefore would decrease dissuades investment in more productive processes and Afghanistan’s vulnerability to demand shocks in technologies. neighboring countries. 43 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Box 2.3: Medium-to -long- term policy agenda to support trade and competitiveness Foreign Direct Investment Attracting foreign direct investment (FDI) and capital investment in tradable sectors, through favorable (but non distortionary) investment incentives, could help Afghanistan expand its product offerings up the value chain. Afghanistan’s fragility and ongoing conflict could negatively impact investment prospects and longer-term strategy. FDI can bring essential knowledge and technology and access to new markets, but high levels of conflict and lack of security can make attracting investment in Afghanistan more difficult. Conflict weakens governance, undermines economic development, and threatens both national and regional stability. Investors must consider the return on their investment relative to the risks they are taking, especially political risks such as expropriation, currency convertibility and transfer restrictions, breach of contract by the sovereign, and war and civil disturbance. Despite deteriorating security situations, there are still investors seeking business opportunities in fragile and conflicted countries, so long as the investment yields a sufficiently high rate of return, plus a risk premium. Investors appear more focused on unexpected and arbitrary changes in government policies against their investments, rather than the security issue itself. There is concern, for example, about cumbersome processes for renewal of licenses and permits, paying taxes, and various contracts signed with the government. The government should encourage and facilitate foreign investments by mitigating the risks related to regulatory and policy uncertainty. Human Capital Afghanistan has dramatically increased investment in human capital since 2001, but much still needs to be achieved. For example, the number of primary school students has increased from 770,000 in 2001 to more than 6 million today. As described in chapter 4, limitations in the provision of education and health services constrains the country’s human capital accumulation. Only around 50 percent of children attend secondary school, and literacy rates are among the lowest in the world. Reduced access to health and educational services has been especially pronounced in conflict-affected areas. Policies that target education can improve economic diversification and labor sophistication. Skills mismatches can be a significant constraint on firms, and increasing productivity and innovation requires enhancing the quality of the labor force. In Afghanistan, there are important concerns regarding education quality and perceived mismatches between investment in skills and labor market demands. Unmet demand for qualified labor in manufacturing could keep wages relatively high, reducing firms’ competitiveness and diversification. A large pool of skilled and competitive labor is also an essential component both for attracting investment in higher-value activities, and for enabling firms to upgrade the quality of their goods and services. Increased demand for educational services, particularly in higher education, has outpaced supply. The Afghan Ministry of Higher Education and the United States Agency for International Development estimated that in 2012 approximately 75,000 high school graduates did not gain admission to an institution of higher learning because of insufficient places. In addition, there are few MA and PhD programs in the country, and there is a shortage of qualified faculty. A strong emphasis on general education allows workers to better adapt, which is critical in a world where technologies come and go quickly. Supporting these goals requires policies to increase educational attainment; more support for basic education; curriculum reform as necessary to meet market demand, including soft and entrepreneurial skills; and aligning vocational training to private sector demand, particularly export-oriented private sector demand. A good example is the educational reforms in the country of Georgia. They have a long-term plan (2014–24) to develop a consolidated education sector strategy, spanning from early childhood education to higher education. This consolidated sector promotes the notion of lifelong learning and quality education for all. Similar efforts in Afghanistan could over time reduce the country’s skills gaps and mismatches. Enhancing management capacity and staff training could also help address the skills and education gap. Policies could address challenges such as firm incentives to invest in training, strengthening vocational education and training (VET) quality, and stronger engagement of the private sector on VET and life long-learning needs. Investment in adult education is also limited in Afghanistan. In response, the government could expand second-chance vocational training, and adult education programs to improve labor productivity. 44 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Figure 2.10: Sector contribution to growth in Afghanistan, 2006–15 80 70 60 50 40 Percent 30 20 10 0 -10 -20 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Agriculture Industries Services Source: Calculations based on Central Statistics Organization data. Agricultural sector percent of the national workforce, including women and landless farmers. Although only 12 percent of Afghan land Agriculture plays a significant role in the lives of poor people, is arable (much of which was restored after being damaged 90 percent of whom are living in rural areas of Afghanistan. It by decades of conflicts), the agricultural sector has the is the primary or secondary income source of approximately greatest potential to drive economic growth, increase 50 percent of Afghan households and employs about 40 government revenue, and create jobs. 45 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Agricultural production growth is constrained by lack of extortion practices along the highways increase the cost adequate facilities, limited access to high-quality inputs, of agricultural products for domestic markets and exports. and insufficient use of research and technology, among In the 2014 World Bank Enterprise Surveys, 42 percent of other factors. Currently, Afghan on-farm production is surveyed firms highlighted these problems as impeding mainly rainfed. Agricultural yields are usually higher factors. These costs can be reduced by improving road (two to three times) on irrigated land compared with infrastructure and increased security on highways. In rainfed areas; hence, irrigation is extremely important addition, investing in refrigerated trucks and air cargo for the country. In addition, agricultural inputs (such as capability may increase initial transportation costs, but fertilizers, seeds, pesticides, breeding materials, and such facilities are fast and reliable means of transporting veterinary medicines) are both imported and supplied exportable commodities to end markets. domestically by the private sector. However, most of the supplied inputs are of low quality, resulting in lower To meet domestic demand, substitute imports, and yields and productivity. Compared to other South Asian potentially promote exports, policies should focus on countries, Afghanistan’s crop and livestock yields are enhancing productivity and promoting investment to low, as is the general productivity of agricultural land. expand the scale and quality of agricultural production. This is again caused by the absence of agricultural Given that government resources is limited, intervention research and technology in the country. should prioritize development of selected value chains such as irrigated wheat, horticultural crops, and livestock Private sector businesses have limited access to serviced production. The Agriculture Sector Review conducted land, credit, and quality electricity. Thus, businesses by the World Bank in 2014 identified these value chains lack some elements of a supportive environment for as having the highest potential for development. They their operations, new investments, and expansion. This all enjoy comparative advantage and could be the first situation needs to be improved for agrobusiness to movers of the agricultural sector toward substituting grow and contribute to exports and import substitution. imports with improvement in productivity, which would In addition, government regulation and tax rates and assist in increasing food security for the rest of the administration are constraints to most businesses in population in the agricultural sector. Afghanistan. In 2014, senior management reportedly spent 10 percent or more of their time dealing with Complementary actions to enhance productivity in the government regulations, compared to an average of 7 short -to medium- term include enhancement of crop percent in other South Asian countries. Similarly, nearly irrigation facilities, better access to high-quality inputs 46 percent of business owners surveyed reported that and technologies, and improvement of business climate tax rates were a major constraint to doing business, (see box 2.4 for specific policy recommendations in these while 39 percent reported that tax administration was areas). Given that female workers represent around 40 29 a major constraint. percent of the workforce in the agricultural sector, steps to increase agricultural sector competitiveness should Lack of connectivity at rural levels and among tertiary include action plans to enhance women’s participation roads, unavailability of cold storage facilities, and in agricultural activities (World Bank 2011). 46 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Box 2.4: Policy actions to improve competitiveness of the agricultural sector in Afghanistana Production-side recommendations: 1. Irrigation facilities (The World Bank is currently involved through the On-Farm Water Management Project) Afghanistan’s irrigated lands can potentially be increased to more than 4 million hectares in the next 10 years through: • Rehabilitation of irrigation systems. Ninety percent of irrigation systems in the country are traditional and are badly damaged due to conflicts. Only one-third of the traditional irrigation systems have been rehabilitated so far. • Investing in new irrigation systems (canals, dams, and so forth). This strategy, although less costly compared to rehabilitation, will require more time to benefit the agricultural sector. It will also require high-level coordination among line ministries (including the Ministry of Energy and Water; the Ministry of Agriculture, Irrigation and Livestock [MAIL]; and the Ministry of Rural Rehabilitation and Development). • Investing in strong institutions and polices to improve irrigation water management. These include defining a legal and regulatory framework, strengthening irrigation associations, and strengthening the irrigation department of the MAIL to manage the irrigation network. 2. Agricultural research and technology (Some of these recommendations are being addressed under the World Bank Agriculture portfolio in Afghanistan) To deliver better technologies for farmers and increase yields and productivity, the capacity of the national research system needs to be improved in the short -and medium- term through: • Rehabilitation and strengthening of the existing network of research stations; and outsourcing research to international and national research centers working in similar agro-ecological areas. 3. Access to high-quality inputs (Some of these recommendations have been addressed under the World Bank’s Agriculture Portfolio in Afghanistan) • Efforts should focus on the creation of an effective regulatory system and on strengthening the capacity of the MAIL to (a) enforce certification of seeds, veterinary medicines, vaccines, and so forth; (b) control banned pesticides; (c) constantly monitor domestic supplies; and (d) prevent imports of low-quality and hazardous agricultural inputs. 4. Business climate: • Reforming the regulatory framework: Streamlining licensing processes, documentation, and customs procedures requested for exporting. The goal is to expand the domestic agroprocessing industry and reduce the time and cost of exporting commodities. • Serviced land facilities in industrial parks, greater access to electricity: Food manufacturing and processing businesses lack adequate access to serviced land facilities such as industrial parks. Access to quality, uninterrupted electricity will help boost private sector investments and expand business operations. • Access to credit: Implementation of risk-sharing practices, particularly partial credit guarantees, would increase access to finance for the real economy by improving the information available on borrowers and by building the credit origination and risk management capacity of participating lenders (see chapter 3). 47 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Box 2.4: continued Trade and markets recommendations: • Post-harvest handling: Poor post harvest handling (packing, processing, cleaning, storage, and so forth) of agricultural products is a constraint to businesses and results in the loss of at least 30 to 35 percent of crops. To increase crops’ shelf life, prevent losses, and increase supply of products to domestic and international markets, it is important to improve post- harvest activities. • Building storage and warehouse facilities: Incentivize private sector investment in cold storage and warehousing facilities in provinces and at customs ports for exporters, so that the shelf life of perishable exportable commodities is increased. • Provision of grading and processing facilities: Extensive grading and processing facilities for all exportable agricultural products are lacking in the country. Grading and processing facilities are extremely important for promotion of exports from Afghanistan and yielding maximum profit. Building of standard grading and processing facilities would help export promotion and import substitution. • Provision of standard and quality certifications: The private sector should be incentivized to invest in well-equipped quality control and testing laboratories that issue standard-quality certificates of agricultural exportable commodities. Strengthening institutional and legal frameworks governing certification is also vital for export promotion. • Functional market intelligence: Establish online platforms for gathering and disseminating market information for Afghan exporters. • Marketing for promotion of exports: Marketing campaigns in the form of trade fairs, agricultural exhibitions, and business-to- business matchmaking in and out of the country are vital. They facilitate promotion of domestic sales, exports, and the flow of information regarding processed agricultural products. Marketing campaigns will help Afghan exporters meet end buyers and promote their exports to high-value markets by complying with their quality requirements. Sources: World Bank (2014); World Bank, forthcoming. The carpet industry The carpet sector provides direct and indirect employment— at different levels of its value chain—to millions of workers, Afghan carpets are famous and in high demand in world who are mostly women. With the influx of returnees from markets for their quality and for being handmade. The top- Pakistan and the Islamic Republic of Iran, it is assumed 10 export destinations for Afghan carpets include the United that many carpet weavers will return to the country, and States, the United Kingdom, Ukraine, Turkey, the United Arab that they can immediately be employed in the sector and Emirates, Sweden, India, Saudi Arabia, the Russian Federation, potentially intensify carpet production. However, partly due and Pakistan. Fully 99 percent of Afghan carpet production is to falling demand for Afghan carpets domestically and in the exported, mostly in semi finished form. Since 2001, Afghanistan world markets recently, many carpet businesses witnessed has been exporting, on average, approximately US$93 million contraction and subsequently went out of business. worth of carpets every year. As mentioned in section 2.2, Afghanistan recently decreased its specialization in the carpet Three main factors have contributed to falling international industry. After reaching a peak (US$215 million) in 2005–06, the and domestic demand for Afghan carpets in recent years. First, value of carpet exports consistently declined until 2012–13. In low-quality raw materials and inadequate processing facilities 2015–16, they constituted 16 percent of total exports (Central have damaged the quality of Afghan carpets and hence the 30 Statistics Organization Statistical Yearbooks 2001–16 ). competitiveness of the industry. Although Afghanistan produces 48 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES high-quality wool (an essential raw material for carpets), domestic In terms of exports, factors such as lack of branding and inadequate production only satisfies 40 percent of demand.. The other information about international market demand and product 60 percent of raw materials (usually of low quality) are mostly standards prevent carpet producers from fully reaping the benefits imported from Pakistan, the Islamic Republic of Iran, and China. of trade. More than 80 percent of carpets produced in Afghanistan Carpet processing facilities (cutting, washing, dying, drying, are exported as intermediate goods for processing, at low prices. scissoring, and so forth) are also limited in Afghanistan and fall After processing, they are re-exported to high-end markets with short of local processing demands. As a result, more than 80 labels other than “made in Afghanistan” and at higher prices. percent of semi-finished carpets are exported to Pakistan for final Furthermore, carpets that make it to international markets directly processing and re-exporting. from Afghanistan face severe competition from rivals (Pakistan, the Islamic Republic of Iran, Turkey, India, Nepal, and China). Afghanistan’s Second, the industry has suffered from inconsistency of design. carpet rivals display innovation in design and color combination, use Because Afghan carpets are mostly hand-made, they generally superior technology and machinery for weaving and processing, and lack consistency of design and color, and therefore do not maintain consistency of designs that are preferred by consumers. meet international bulk demands by consumers. Furthermore, innovative producers fear their designs will be copied by other To improve international competitiveness of the carpet industry producers and/or processors, due to low enforcement of and in Afghanistan, upgrades are needed all along the supply chain. lack of awareness about copyright laws. Such producers avoid Interventions are needed to increase the access to quality raw processing their carpets in Afghanistan and prefer sending them materials, facilitate the establishment of sophisticated processing to Pakistan for finishing. units, and improve the quality of design. Government support in terms of provision of serviced land in industrial parks for carpet Third, there is only weak government support for carpet producers weaving and processing would also be helpful. Finally, export and exporters in terms of serviced land, marketing, technical promotion and branding activities would help Afghan carpet assistance, transportation, and other factors necessary to a thriving producers to better position their products in international markets carpet industry. Lack of an enabling environment adversely (for a more detailed description of policy actions for the carpet affects production of Afghan carpets and hence their exports. industry see box 2.5). Box 2.5: Suggested interventions for Afghanistan’s carpet industry 1. Production and processing: • Improve the supply of raw materials, through facilitating investments in local production of chemicals that are used as raw materials for carpet production as well as production of dyes from natural materials that are produced locally. • Establish sophisticated processing units the inadequate availability of which increases production costs and adversely affects direct exports from Afghanistan. • Provide serviced land in industrial parks for carpet weaving and processing, which will reduce costs for carpet producers and hence increase their competitiveness in local and international markets. 2. Design quality: • Incentivize the private sector to invest in carpet weaving and processing machinery, which will improve design consistency and reduce production costs and time. • Enforce copyright laws to safeguard innovations of the private sector in carpet production and help expand private sector businesses. 3. Export promotion: • Establish online platforms to increase market information and awareness, which are essential for Afghan carpet exporters and export promotion. 49 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES TABLE 2.7: Time to export distribution across countries, 2005–14) Number of days to export Quartiles 2005 2010 2014 1st decile 10 9 9 1st quartile 17 13 12 2nd quartile 23 19 17.1 3rd quartile 34 26 25 9th decile 52 41 40 Min 6 4 6 Max 102 80 86 Afghanistan 67 74 86 Source: Calculations using BACI data from CEPII. 2.4 The role of export delays over the years and are the highest across all comparator in explaining Afghanistan’s countries in this report (see table 2.7). In 2014, it took Afghan underperformance exporters 86 days on average to ship their goods, compared to 33 days on average for South Asia, 21 days for Pakistan, 31 For this report, an analysis was performed on the role played 25 days for the Islamic Republic of Iran, 21 days for China, and by different trade determinants (geographic location, institutions, 17 days for India. The estimated cost to export in 2014 was markets access, and export time delays) in explaining the gap US$1,922 per container in South Asia compared to US$5,045 between predicted trade (that is, if Afghanistan behaved like in Afghanistan. The country’s export delays have worsened the mean of countries at the same level of development and over time, from 67 days in 2005 to 86 days in 2014. exhibiting the same trade costs) and observed trade. The analysis suggests that, once controlling for supply constraints The World Bank’s Enterprise Surveys shed some light on the and conflict, most of the unexplained underperformance of problems affecting trade logistics in Afghanistan. Nearly half Afghan exports is associated with time export delays. of surveyed firms highlighted transport as a major or very severe obstacle to export in both 2008 and in 2014 (see table The estimation of bilateral exports toward markets already 2.8). High transportation costs may be caused by factors such served by Afghan exporters (intensive margin of trade) as lack of competition among the truck companies, which shows that the predicted-observed trade gap is considerably cannot be internalized by small producers. Another obstacle 32 reduced when controlling for export delays. This means is illegal taxes paid by truck drivers along transport routes, that the across-destination variations in time to export is the which increase costs of transportation for exporters, rather factor that better explains Afghanistan’s underperformance than lack of infrastructure. For example, melon exporters in export markets. take less than one day (14 hours) to get from Kabul to the 33 Torkham border crossing, a distance of 235 kilometers. Afghanistan’s export delays are mainly due to poor logistics Improvements in infrastructure would have a limited impact and trade-related infrastructure. These have increased on export delays. In contrast, a reduction in the blockages of 50 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES TABLE 2.8: Obstacles to Afghanistan’s exports, 2008 and 2014 Transport, % Customs and trade regulations, % Type of obstacle 2008 2014 2008 2014 Minor 26 24 32 20 Moderate 26 29 34 28 Major 29 27 24 28 Very severe 20 20 10 24 Source: Calculations from the World Bank’s Enterprise Surveys. Afghan merchandise in neighboring countries (for weeks and How do poor logistics and infrastructure translate into export sometimes months) would significantly reduce transportation losses? The estimated relation between export time and trade costs and delays (as highlighted in a private sector roundtable values points to striking results. A simple calculation based that took place in August 2016). on the previous regressions suggests that, at the intensive margin, a decrease in time to export to levels comparable Information from the World Bank’s Doing Business database for to the region (25 days) would lead to a 20 percent increase 2015 suggests that in documentation procedures, around 85 in exports—US$152 million additional exports per year for percent of total time spent to export is related to documentary Afghanistan. These results are based on current productivity compliance (time for obtaining, preparing, processing, and levels of Afghan exporters and therefore do not take into submitting documents) and 15 percent is due to border consideration supply-side constraints that Afghan producers compliance (documents strictly related to customs clearings). An are currently facing. More significant improvements in exports increasing share of surveyed firms are reporting customs and will be obtained through reductions in export delays if supply trade regulations as a major or very severe obstacle to export constraints are also tackled. The combination of enhanced (53 percent in 2014 compared to 34 percent in 2008) (table 2.8). competitiveness in the exporting sector and reduced time to trade will make it possible to grow Afghanistan’s untapped The negative impact of export delays on Afghan trade trade potential. Our estimation results suggest that also captures the existence of high-intensity conflict in the improvements in export times and productivity of Afghanistan 34 country. Violence and insecurity increase the premium that toward averages similar to neighboring countries would lead 35 producers must pay to insure their merchandise against to a more than six-fold increase in exports. Such an immense conflict risks along the transportation routes. In addition, change suggests that dealing with supply-side constraints uncertainty regarding customs and borders operations also and improving trade competitiveness is imperative for increases the costs of exporting. Recent empirical literature Afghanistan to benefit from trade. suggests that in areas of high conflict, the economic and social benefits of improving the quality of routes and trade- Results at the extensive margin, defined as the ability to related infrastructure might be negated, and in some cases export new products or reach new destinations, suggest that reversed (Ali and others 2015). Peace-enhancing policies extremely long export delays are preventing exporters from should accompany trade facilitation efforts to improve reaching new markets. Enormously high export times prevent 36 logistics and infrastructure to ensure a positive impact on non-star products —usually horticultural goods exported exports (and imports) in Afghanistan. mainly to neighboring countries and in very low quantities—from 51 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES entering new export markets. The associated trade costs are would provide traders with up-to-date information on all taking an important toll on the participation of less-advantaged relevant rules, regulations, fees, forms, procedures, and so businesses, which are hardly coping with these delays. Given forth associated with import, export, and transit activities. the present export delays, the most difficult markets will be Implementation of the proposed NSW and TIP would help reached only by the producers of star products. These are at both the intensive margin, for existing exporters or products for which Afghanistan has a comparative advantage, destinations, and at the extensive margin, for potential new and which represent 80 percent of Afghan exports (in value exporters and destinations. Both initiatives are consistent terms). They include fruits and nuts—grapes and figs (dried and with the WTO Trade Facilitation Agreement (TFA) that came fresh), and pistachios—and onions. into force in February 2017. Second are improved waiting times at the border. While many 2.5 What would it take border delays result from actions taken by neighboring countries to reduce export delays? rather than Afghan authorities, opportunities exist to review and rationalize border operations to eliminate inefficiencies. These Three complementary methods for improving logistics and include improving cooperation and information sharing among the trade-related infrastructure could be envisaged. First are various government agencies mandated to operate at the border; improved documentary requirements and import, export, and operationalizing the ASYCUDA World’s advance declaration and transit procedures and processes. The number of documents manifest functionalities to allow prescreening of consignments and authorizing signatures required for trade operations should prior to their arrival at the border; reducing congestion by be reviewed for consistency with international good practice separating pedestrian and truck traffic; expanding border capacity and, where practical, eliminated or substantially reduced. In the and related infrastructure (scanners, weighbridges, warehouses, short -to medium- term, the Afghani government should work and so forth); and implementing cargo tracking to better manage to automate all trade-related requirements and procedures the risks associated with under-bond movement of goods between into a national single window (NSW) system. The NSW system the border and inland container depots. should automate the application, processing, and issuance of all trade-related permits and licenses administered by Afghan Third is improving interagency cooperation on trade facilitation government agencies. The NSW system should also link matters. Consistent with WTO TFA commitments, the permit-issuing agencies with the worldwide Automated System government of Afghanistan should mandate customs and 37 for Customs Data (ASYCUDA) to allow for the seamless key border management agencies to maintain a National integration of all clearance processes, including a collective Trade Facilitation Committee (NTFC) as a formal mechanism for approach to risk management and inspection activities. enhanced interagency cooperation and improved dialogue with the private sector. The NTFC would ensure that all trade-related A collective approach to risk management would deliver a agencies work collectively to streamline, harmonize, and simplify significant reduction in trade transaction costs, eliminate trade procedures based on a priority list identified jointly with the the need for numerous time-consuming visits to various private sector. The establishment of a fully functioning NTFC, government agencies, and reduce opportunities for rent supported by an NTFC Secretariat, would also help government seeking associated with face-to-face contact between agencies strike a better balance between their control and officials and the private sector. As a first step, attention facilitation objectives. Currently, customs and other trade-related should be paid to improving information dissemination agencies focus almost exclusively on their revenue collection through the introduction of a trade information portal (TIP). and community protection and border control objectives at the Through user-friendly and easy-to-search website, the TIP expense of equally important trade facilitation objectives. 52 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES While a focus on revenue collection is understandable given that and logistics, and help with the harmonization and Afghanistan relies heavily on trade taxes, evidence from across simplification of customs procedures in line with international the globe strongly confirms that efficiency gains achieved standards and regional commitments. In the case of Pakistan, through trade facilitation reforms are typically accompanied the main destination and transit country for Afghanistan’s by improved revenue collection performance. This is due to exports, a strengthening of the dialogue between the two better targeting of high-risk consignments, thus allowing low- countries to accelerate de-bottlenecking of the Afghanistan- risk consignments to be cleared more rapidly; more efficient Pakistan Transit Trade Agreement would be fundamental to administration of concessions and exemptions; improved reduce uncertainties related to merchandise transportation, incentives for voluntary compliance given to the private sector; and to more broadly ensure gains from trade (see chapter 4). improved interagency cooperation and information sharing; more effective post-clearance audit procedures; and reduced How long would it take to reduce export delays? Experience 38 opportunities for corruption. from least-developed and other developing countries over the last decade suggests that benefits from a reduction in export Existing trade agreements with regional partners can be times can take at least five years to materialize. It took from 1 deepened and expanded to enhance regional cooperation. to 7 years for these comparator countries to reduce their time This would facilitate visa processing and improve transport to export (in days) by more than 50 percent (see table 2.9). TABLE 2.9: Time needed to reduce export delays by more than 50 percent compared to 2005, selected countries Time to export in Reductionin Reduction in Time it took Country 2005 (days) export delays (%) export delays (days) (years) Armenia 37 51.3 19 5 Colombia 34 58.8 20 3 Costa Rica 36 61.1 22 4 Dominican Republic 17 52.9 9 6 Egypt, Arab Rep. 27 55.6 15 5 Georgia 54 77.8 42 1 Ghana 47 55.3 26 1 Grenada 19 52.6 10 7 Jordan 28 53.6 15 6 Lao People’s Dem. Rep. 55 54.5 30 7 Madagascar 49 51 25 3 Rwanda 60 51.7 31 5 Source: Calculations based on World Bank’s World Integrated Trade Solutions database. 53 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Annex 2A Figure 2A.1: Afghanistan’s export potential: intermediate and capital goods (2001, 2005 and 2014) Source: Calculations using BACI data from CEPII. Figure 2A.2: Multilateral imports of intermediate and capital goods to Afghanistan, 2001, 2005, and 2014 Source: Calculations using BACI data from CEPII. 54 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES TABLE 2A.1: Top -10 HS-6 exports from Afghanistan to the United States, 2005 and 2014 2005 2014 Rank HS-6 code Export value HS-6 code Export value 1 845490 7,476.212 570110 3,210.435 2 848330 5,870.413 121190 2,555.62 3 848180 2,123.402 830249 456.076 4 570110 2,008.625 80620 152.2508 5 853710 1,682.063 401699 135.942 6 844250 912.428 300210 125 7 852910 856.731 870850 113.864 8 842839 810.796 91020 104.199 9 901832 715.955 170490 91.211 10 852520 523.735 401693 89.632 Source: Calculations using BACI data from CEPII. Note: Products are defined using the 6-digit Harmonized System product classification. The products very likely related to expenses by the U.S. Army and related logistics are in red. TABLE 2A.2: Top-10 HS-6 products codes exported from Afghanistan to the United States, by sector, 2014 HS-6 code HS-2 code Description 845490, 848330, 848180, 853810, 84, 85 Machinery and mechanical appliances, 844250, 842910, 842839, 852520 electrical equipment, etc. 570110 57 Carpets 901832 90 Optical, photographic, medical or surgical instruments, etc. 300210 30 Pharmaceutical products 870850 87 Vehicles, aircraft, vessels and associated transport equipment 121190, 080620, 08, 09, 12 Vegetable products 401699, 401693 40 Rubber and plastics 170490 17 Prepared foodstuffs Source: Calculations using BACI data from CEPII. Note: Products very likely related to expenses of the U.S. Army and related logistics are in red. 55 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES TABLE 2A.3: Distribution of the regressions residuals Distribution of residuals Regression without time to export Regression with time to export Distribution of the Afghan residuals Distribution of the Afghan residuals within within the total residuals distribution the total residuals distribution % % 1st quartile 49.79 1st quartile 36.10 2nd quartile 24.69 2nd quartile 26.97 3rd quartile 13.99 3rd quartile 18.68 4th quartile 11.52 4th quartile 18.26 Share of negative residuals for Afghanistan Share of negative residuals for Afghanistan 72% 62% Mean value of residuals for Afghanistan Mean value of residuals for Afghanistan −1.18 −0.52 Source: Calculations using BACI data from CEPII. 56 2.AFGHANISTAN´S TRADE IN GOODS (UNDER) PERFORMANCE: DETERMINANTS, CHALLENGES, AND FUTURE OPPORTUNITIES Box 2A.1: Afghanistan’s trade performance determinants To assess the obstacles that might curb trade of one country with another, after accounting for size and geography the following specification is estimated: where log represents the log of bilateral exports between country i and country j. represents exporter i capabilities such as size and level of development, which are proxied by the log (Population) and the log (GDP per capita). is related to the importer’s characteristics in terms of its propensity to import, and in a symmetrical manner is proxied by the size of its demand, again through the log(Population), and the level of development via GDP per capita. Other unobserved determinants that can also affect an exporter’s capability to export to the rest of the world and an importer’s capability to import from the rest of the world are captured by a set of exports and import fixed effects . Time fixed effects are also included to control for time-varying characteristics affecting equally all the countries equally. The variable measures by how much trade could be distorted between two countries due to transaction costs. Here three types of transaction costs are considered. 1. Cost specific to the bilateral relation. This is represented by the extent of transport costs between countries, the difficulties to communicating, conflicts or disputes between them, or simply due to bilateral commercial policies set by either of the parties toward the other. These variables are approximated by the log(Distance), a dummy equal to 1 if both partners share a same frontier (contiguity) or share a same common official language (comlang_off), and zero otherwise; a dichotomic variable of Military Interstate Dispute (MID); and a bilateral tariff variable (log(tariffs)). 2. Costs deriving from specific characteristics of the exporter, independently from the importer. First, some variables related to the quality of institutions of the country are introduced. These include the rule of law variable (rol), to which we also add variables describing the existence or intensity of internal conflicts (variables civil war, or the log of deaths per capita from civil war, ldeathspc). Other variables specific to the export activity by itself are also introduced. A first proxy introduced is a dummy variable indicating whether the exporter is landlocked. Another important variable specific to the exporting activity is the length of time to export. 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More generally, the development of services trade has been inhibited by the low human capital endowments and the challenges in attracting foreign direct investments. • If relatively peaceful and secure conditions were established, then services trade and investment could help build both the hard and soft infrastructure needed to enhance domestic production, boost export capability, and facilitate the accumulation of human capital. Services trade in three key areas could be particularly important for Afghanistan: connectivity, and health and educational services. • Foreign investment in transport and communications infrastructure and services could enhance connectivity both domestically and internationally. Such investment would facilitate not just trade in goods, services, and ideas, but could also create the basis for Afghanistan to become an exporter of transit services to its neighboring countries (as discussed in chapter 4). But it may only be feasible to attract significant foreign investment if security conditions improve. • The consumption by at least some Afghan citizens of foreign health and educational services could help boost domestic human capital accumulation in the long run. International cooperation and improvements in the technologies of digital delivery could facilitate these services imports. A future work program in this area could be structured around recent initiatives on trade facilitation in services. • Underdeveloped local financial institutions form a bottleneck for local business development. Domestic regulatory reform could encourage greater domestic and foreign participation in financial services, leading to enhanced access to finance. Key reforms in this direction are the improvement of the deposit insurance scheme, implementation of partial credit guarantees, and continued work on a regulatory framework that balances openness and the regulatory capacity of the central bank. 60 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION Services and services trade are clearly important for related uncertainty was eradicated, foreign investment Afghanistan’s economy, comprising in 2015 nearly 60 in transport and communications infrastructure and 39 percent of its GDP and 55 percent of its exports. But services could enhance connectivity both domestically can services trade become a driver of development for and internationally. Such investment would facilitate not Afghanistan? This chapter reviews the state of services just trade in goods, services, and ideas, but could also trade and policy in Afghanistan. It finds that, if relatively create the basis for Afghanistan to become an exporter of peaceful and secure conditions were established, transit services to its neighboring countries (as discussed greater foreign participation in Afghanistan’s services in chapter 4). The consumption by Afghan citizens of sectors could eventually create a basis for the country’s foreign health and educational services through each of engagement in the global economy as an exporter of both the modes could boost their human capital in the long goods and services. run and eventually equip them to engage productively in both the domestic and global economy. Greater foreign Services include sectors of vital economic significance like participation in financial services could also lend greater communications, transport, finance, distribution, health, efficiency, depth, and resilience to financial intermediation, and education, and tourism. Services “trade” has a far- and is likely to enhance access to finance for firms, farms, reaching definition that encompasses the four modes and households. 40 through which international transactions can take place: Given the deep reach of international integration in • Cross-border trade in road, rail, and air transport, which services, it is difficult to draw a line between services are lifelines for a landlocked country like Afghanistan; “trade” policy and other areas of services policy. Such a • Consumption abroad of health and educational distinction may be unnecessary because the gains from services by Afghan citizens, as well as consumption services trade liberalization often depend on how it is by foreigners of tourism services—which today takes combined and sequenced with domestic policy reform. the form of sales of services to foreign security and aid It may be convenient to think of three broad goals of providers but could one day take a more conventional services reform: efficiency (static and dynamic), stability, form of tourism; and improved access. Three broad instruments of services • Commercial presence through foreign direct investment reform can be defined: liberalization (of domestic and (FDI) in banking, communication, transport infrastructure, foreign participation), improved regulation (prudential and distribution—which are key backbone sectors for the and pro-competitive), and policies to enhance access. A economy; and large part of a reform program in services is necessarily • Temporary migration both inward and outward of national and unilateral. But international engagement can individual service providers, like construction workers, help in three ways: reciprocal liberalization of access to doctors, and teachers. markets (for example, in transport); enhanced credibility of policy (through binding commitments); and regulatory It should be evident, therefore, that services are critical cooperation and infrastructural coordination (for example, to Afghanistan’s overall economic performance and in communications and transport). This chapter explores the well-being of its people, and that constraints on only a few dimensions for Afghanistan, but the flow chart service sector development because of small markets shown in figure 3.1 illustrates how a full-fledged strategy and limited endowments could be alleviated by greater for national reform and international cooperation could be regional and global integration. In particular, if conflict- developed. 61 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION Figure 3.1: Developing a long-term strategy for national reform and international cooperation in services in Afghanistan Source: Based on Mattoo and Payton (2007). 42 3.1 Services trade regime Database (STRD), which contains information on the services regimes of over 100 countries in 18 sectors. The The potential gains from trade in services reform are large 41 STRD also contains a simple and transparent Services Trade and widespread for most countries. Even exploiting the Restrictions Index (STRI) that ranges from 0 (completely open) opportunities arising from goods trade liberalization requires to 100 (completely closed) to summarize policy information better services. But policy makers, negotiators, researchers, (see Annex 3A for additional details). and the private sector have regularly encountered difficulties in identifying and comparing services policies and regulation While Afghanistan has not yet been surveyed in the STRD, across sectors and countries. To facilitate this analysis, the the available evidence suggests that it is already fairly open 43 World Bank has published the Services Trade Restrictions in services trade. The main services sectors covered by 62 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION the STRD are examined: financial, telecom, retail distribution, insurance services. In banking via commercial presence, transport, and professional services. Afghanistan’s STRI of Afghanistan merely requires that banks that seek to 26.9 was close to the “world” average STRI for 107 countries receive deposits be internationally reputable. There are of 27.1, and below what would be expected given its GDP per no restrictions on foreign investment, but investment in capita (figure 3.2). Afghanistan has much more open policies insurance activities is subject to approval by the High than other countries in the South Asia region—with a regional Commission on Investment (HCI), in consultation with 44 average STRI of 40.1—except for Pakistan, which also has respective government ministries. relatively open policies (figure 3.3). • Telecommunications: The Private Investment Law of 2005 Figure 3.2: Overall STRI for Afghanistan in a global context of 107 countries 100 ETH 80 ZWE IND IRN 60 QAT STRI index PHL EGY BHR KWT DRC IDN THA PAN MYS OMN BGD TUN NPL VNM JOR BWA LBN SAU 40 LKA DZA NAMCHN BLR MWI UGA ZAF VEN TZA YEM CRIMEX MLI KEN URY AFG LSOCIV PAK CMR NGA UKR ITA FRA NOR RWA TURRUS JPN FIN UZB BRA CHL PRTKOR BEL KHM HND ZMB MAR ALB CAN DNK 20 BDI MOZMDG SEN GHA GTM COL HUN GRC USA KGZ PRY PER MUSKAZ CZE ESP DEU AUT AUS SWE BGR GBR NIC BOLARM MNG DOM LTU IRL GEO POL NZL NLD TTO ECU 0 5 6 7 8 9 10 11 12 Log of GDP per capita, 2013 Sources: World Development Indicators and STRI where available. Note: The figure references 2013 GDP per capita (constant 2005 international US$). The STRI ranges from 0 (completely open) to 100 (completely closed). The STRI for all countries other than Afghanistan is based on World Bank surveys collected between 2008 and 2011. Afghanistan’s overall STRI is indicated in red in this figure. Information on Afghan services trade policies is primarily drawn from Afghanistan’s WTO Accession Schedule of November 2015 (WTO 2015), the Private Investment Law of 2005 (AISA 2005), and the Law of Civil Aviation (AISA 2014). Sector commitments under the General (AISA 2005) allows foreign investment in telecommunications Agreement of Trade in Services without any limits on foreign equity participation. But investment in telecommunications infrastructure and facilities Afghanistan is remarkably open in financial services and is subject to approval by the HCI, in consultation with respective telecommunications, but remains restrictive in transport government ministries. (see figure 3.4). The main reservations listed in Afghanistan’s • Transport: Given that it is landlocked, the country would accession schedule are the following: particularly benefit from policies that allow FDI and competition • Financial services: Like many other countries, Afghanistan has in the transportation sector. Figure 3.5 shows, that for some 45 made no commitment to allow cross- border supply of lending transport modes, there is room for the following improvements : services by retail banks or cross-border supply of life and nonlife • Air transport: Afghanistan’s air transport sector has 63 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION Figure 3.3: Services Trade Restrictiveness Index, Afghanistan and selected South Asian countries Source: World Bank STRD where available. Note: IND = India, BGD= Bangladesh, NPL= Nepal, LKA = Sri Lanka, AFG = Afghanistan, PAK = Pakistan. Policy information for all countries except Afghanistan is from the World Bank survey on services trade integration of 2008. Information on Afghan services trade policies is primarily drawn from Afghanistan’s WTO Accession Schedule of November 2015 (WTO 2015), the Private Investment Law of 2005 (AISA 2005), and the Law of Civil Aviation (AISA 2014). a relatively restrictive STRI of 67.5, mainly due to thus retaining the right to impose restrictions. However, restrictive Bilateral Air Services Agreements (BASAs) the Private Investment Law of 2005 allows foreign with its trading partners. The profile of cross-border air investment in the road and railroad sectors, even though passenger services shows the country currently has 16 specific conditions are imposed on a case-by-case basis BASAs. According to the WTO’s Air Services Agreements and subject to HCI approval. Projector database, the average restrictiveness scores of the BASAs is quite high, equivalent to an STRI of 75. 46 • Professional services: To conduct audits, firms and natural For commercial presence, the current policy allows foreign persons are required to be locally established and present. investment in air transport services, but licensing and With respect to domestic law, foreign lawyers can only specific requirements related to ownership and operation represent foreign natural persons and legal entities that are subject to the approval of the Ministry of Civil Aviation are headed by foreign nationals. For individual presence 47 and Tourism. (mode 4), intra-corporate transfers can stay for up to • Afghanistan did not make any commitment for the road one year and stays can be extended without limitations. and rail sectors in its Accession Schedule (WTO 2015)— There is no commitment for contractual service suppliers 64 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION and independent professionals, and the commitment for In professional services, Afghanistan requires a local persons, who provide direct services and service sellers, presence to perform audits, but that may be on prudential stipulates that these persons can stay up to 180 days grounds. The requirement that foreign lawyers can only during a one-year period. represent foreign natural persons and legal entities may be more restrictive, as is the stipulation that persons As noted, Afghanistan is relatively open in most sectors. The who provide direct services can stay only up to 180 days STRI score penalizes Afghanistan in sectors like financial during a one-year period. Given the country’s limited services, telecommunications, and road transport—not for depth in domestic professional services, allowing greater the existence of explicit restrictions but because it chooses ease of entry for foreign professionals may enhance the to retain discretion in allowing new entry. In each sector, entry competitiveness of domestic firms and the welfare of requires approval of the HCI, in consultation with respective households. Furthermore, the local presence of foreign government ministries. It would be desirable to ensure professionals may have positive spillovers for domestic that such approval is based on transparent, objective, and professionals and accelerate the development of predictable criteria. indigenous capacity. Figure 3.4: Services Trade Restrictiveness Index, by sector, Afghanistan and selected South Asian countries Source: World Bank STRD where available. Notes: Absence of a bar indicates the STRI is zero; financial services include banking, insurance, and reinsurance sectors. Telecom includes fixed and mobile telecom, and transportation includes maritime shipping, rail, road, and maritime auxiliary services. The professional services sector includes accounting, auditing, and legal advisory services in foreign law and domestic law. Policy information for all countries except Afghanistan is from the World Bank survey on services trade integration of 2008. Information on Afghan services trade policies is primarily drawn from Afghanistan’s WTO Accession Schedule of November 2015 (WTO 2015), the Private Investment Law of 2005 (AISA 2005), and the Law of Civil Aviation (AISA 2014). 65 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION Figure 3.5: Services Trade Restrictiveness Index: transportation sector, Afghanistan and selected South Asian countries STRI index Source: World Bank STRD where available. Notes: AFG and NPL are landlocked; there are no STRI for maritime transport. Policy information for all countries except Afghanistan is from the World Bank survey on services trade integration of 2008. Information on Afghan services trade policies is primarily drawn from Afghanistan’s WTO Accession Schedule of November 2015 (WTO 2015), the Private Investment Law of 2005 (AISA 2005), and the Law of Civil Aviation (AISA 2014). In air transport, Afghanistan’s bilateral air service agreements goods and it does not cover road transport vehicles from third are relatively restrictive, but the country has allowed fairly countries. Afghanistan has recently made efforts to secure open access to foreign airlines. However, it is possible that the more broad-based openness as a condition for maintaining government faces similar pressures as in road transport to openness. This shift to a transport trade regime based on secure greater openness to foreign markets for its own service reciprocity could lead to a cooperative outcome that would providers. This is again an area where regional cooperation help secure greater openness for Afghan services providers could help secure wider and more durable openness. to neighboring markets as well as enhanced competition on bilateral routes. In road transport, Afghanistan has been remarkably open and negotiated relatively open agreements. However, some of these agreements are asymmetric. For example, the proposed 3.2 Services trade patterns Afghanistan-Pakistan Transit Trade Agreement allows Afghan trucks to transport exports up to the Indian border, but it does Even though services trade is important for Afghanistan, as not allow them to return through Pakistan carrying Indian for other countries, Afghan trade patterns in services are 66 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION harder to describe and analyze than those of goods. This is remained negative since then, the deficit does not seem because of the nature of services and the different modes to be increasing. This reversal in the balance of trade through which international transactions in services take in services roughly coincides with the beginning of the place. In addition, for most countries, the information on reduction of the international presence in Afghanistan. trade in services is obtained from their balance of payments and does not include bilateral trade data or trade through Analyzing the breakdown of this evolution sheds some commercial presence (including FDI). Afghanistan faces light on whether there are certain sectors in which some additional challenges in this sense, because detailed, Afghanistan is beginning to specialize. Figure 3.6 shows disaggregated data on trade in services are only available the evolution of services trade, including a broad sectoral 48 from 2008 onward. breakdown. Imports are dominated by payments for “transport” services by Afghan residents to nonresident Figure 3.6 presents the evolution of services exports, transporters, probably linked to the payment of shipments imports, and the corresponding balance of services trade of imported goods. Recall that the item transport of goods for Afghanistan since 2008. Until 2012, the net balance in is often partially estimated based on cost, insurance, and total services trade was positive, and even though it has freight imports. Figure 3.6: Trade in commercial services in Afghanistan, 2008–15 Source: Trade Map—International Trade Statistics (ITC 2016). 67 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION Figure 3.7: Breakdown of trade in other commercial services in Afghanistan, 2008–15 Source: Trade Map—International Trade Statistics (ITC 2016). Figure 3.7 takes a closer look at the elements of From the existing patterns of Afghanistan’s exports in “other commercial services.” Exports are dominated by services, it is hard to infer which services could be a significant “construction,” with over 36 percent of total exports of driver of growth. The trends observed seem to be a byproduct services in 2015. This category most likely reflects the of the temporary presence of foreigners associated with the payment by nonresidents of services that are provided conflict and reconstruction efforts. Such trends are hard to by residents in the construction sector, and could be due sustain unless these or other sectors are further developed. to the war and reconstruction efforts involving foreigners. The importance of conflict-related foreign presence in the evolution of services exports seems apparent then, not only 3.3 Realizing Afghanistan’s in its timing, but also in its composition. “Other business services trade potential services,” “financial services,” and “telecommunications” each accounted for between 13 percent and 9 percent of When considering services exports as a potential driver for total exports of commercial services in 2015. Afghanistan’s development, note that many countries with a 68 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION Figure 3.8: Mean years of schooling, Afghanistan and comparator countries, 2014 Source: Adapted from the United Nations Development Programme’s. Human Development Index. revealed comparative advantage in services are also relatively Jones, and Crotty 2013). Evidence for Afghanistan shows well endowed with human capital (Goswami, Mattoo, and very limited FDI over recent years, with average inflows of 0.4 Sáez 2012). As can be seen in figure 3.8, Afghanistan is not percent of GDP between 2012 and 2015 compared to 1 percent 49 well endowed in this respect today, suggesting that exports for the rest of South Asia. Both the low human capital of human-capital-intensive services may not be an obvious endowment in Afghanistan and the challenges the country potential driver of growth for Afghanistan in the short run. currently faces in attracting FDI severely limit the potential of services trade in the short -and medium- term. Keeping Similarly, when considering services imports as a potential these limitations in mind, the following sections explore some driver for Afghanistan’s development, note that in many examples of potential candidates for services exports and instances services imports depend crucially on FDI. As imports. documented in the literature, FDI is not likely to flow to conflict and post-conflict territories (Arbatli 2011), and, when it does, it One of Afghanistan’s immediate advantages is its central is mostly associated with the extraction of resources (Driffield, location at a crossroads of vital trade routes between 69 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION South and Central Asia. This makes transit services a higher education. For example, the Ministry of Higher natural candidate for services exports from Afghanistan, Education and the USAID estimated that in 2012 provided there is the required domestic (public and approximately 75,000 high school graduates did not private) and foreign investment in the creation of the gain admission to an institution of higher learning needed infrastructure. While many of the current national because of insufficient places. In addition, there are few and regional infrastructure initiatives would appear to MA and PhD programs in the country, and, consequently, be paving the way for Afghanistan to become a transit there is a shortage of qualified faculty. This means hub, this path is not without challenges. These include that students at higher education levels often pursue susceptibility to conflict, the need for accompanying graduate and post-graduate degree programs abroad. national regulation and international cooperation, and In 2014, over 17,000 students were enrolled in higher large investment requirements when compared to the education abroad, mainly in the Islamic Republic of Iran potential gains. These challenges are analyzed in detail (53 percent), India (14 percent), Turkey (8 percent), Saudi in chapter 4. Arabia (7 percent), and the United States (3 percent). Despite remarkable progress since 2002, inadequacies To bridge this gap, some universities have started to in the provision of services such as education and health collaborate with institutions in Sweden, Germany, the still limit the country’s human capital accumulation. United States, and the United Kingdom to establish International cooperation could help, as discussed MA programs. International agencies have also started below. Our final example relates to financial services. to target the issue, through, for example, the Higher This chapter illustrates how domestic regulatory reform Education Development Project by the World Bank that is desirable in itself, and could also encourage the entry funds post-graduate and PhD programs for faculty of more domestic and foreign services providers, thus members. Other promising initiatives in this direction improving access to finance. seek to leverage new technologies and regional cooperation to address shortages in post-high school education opportunities. Education An example of the former is the Afghan German Even though literacy and primary and secondary Management College, which offers business and participation and completion rates are still very low entrepreneurship education via an internet learning in Afghanistan, progress in education since 2002 has platform with contents produced by lecturers in been remarkable. For example, enrollment in general Germany, effectively tackling faculty and infrastructure schools increased from an initial 1 million students to 9 shortages. An example of the latter is the memorandum million in 2015. As of 2015, there were 30 times as many of understanding (MoU) signed by the Islamic Republic high school graduates as in 2002 and over 30 times as of Iran, Afghanistan, and Germany earlier this year, many students enrolled in public universities. through which German and Iranian partner institutions will assist Afghan universities in modernizing their While this explosive growth was accompanied by a existing mining-related study programs. This MoU will large increase in the supply of educational services also allow Afghan mining professionals and students to (particularly in the private sector), they are still limited participate in courses and exercises in several Iranian compared to the increased demand, particularly in institutions. Initiatives of this sort can help overcome 70 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION Box3.1: The SILK-Afghanistan Program Between 2002 and 2009, the Virtual Silk Highway Project provided high-speed internet access via satellite to teaching and research establishments in Afghanistan, Armenia, Azerbaijan, Georgia, Kazakhstan, Tajikistan, the Kyrgyz Republic, Turkmenistan, and Uzbekistan. The aim of the project was to facilitate local, regional, and international communication between academic institutions, and to encourage collaboration in research and education. Between 2009 and 2010, the project was handed over to the European Union a for sponsorship in some Central Asian countries under the Central Asian Research and Education Network. It remained with the North Atlantic Treaty Organization and the United States Department of State in the case of Afghanistan as the SILK-Afghanistan Program. Throughout 2015, the SILK-Afghanistan Program continued to cover about 90 percent of the bandwidth costs of the 34 Afghan universities that joined, now connected via fiber optic cable instead of satellite. Member institutions continued to increase their regional and global links as Afghanistan joined the Trans-Eurasia Information Network in 2014. This initiative enables Afghan scholars to gain qualifications through multimedia-based distance learning, and allows researchers to work on international projects. The initiative encourages collaborative research and diminishes incentives for skilled workers to leave. It also allows universities to widen the scope of their online library services, electronic learning environments, and supercomputing facilities. Source: NATO 2015. a. http://caren.geant.org/Pages/Home.aspx. shortages not only in qualified faculty and higher lacks access to medical care. Medical supplies are insufficient, education, but also in technical skills that may be more there are infrastructural deficiencies, and there is a marked immediately needed by firms (see box 3.1). shortage of health care workers, particularly female ones. This has led Afghans to seek medical care abroad, mostly in India Health and Pakistan. While there are no official estimates of the size of this group, informal accounts indicate that as many as 2,000 In the case of health care services, even with new health people traveled abroad daily for medical treatment in 2015, and facilities built in Kabul in recent years, much of the population that a total of US$300 million was spent this way annually. Box 3.2: The potential of telemedicine in Afghanistan Telemedicine involves the use of broadband technology that provides real-time, high-speed access for the transfer of medical imaging, video, data, and voice. Applications include the ability to send real-time X-rays, ultrasounds, and computerized axial tomography scans for evaluation. This sort of technology also enables e-learning and learning through video conferencing. Some initiatives in this direction have been started in Afghanistan to address shortcomings in the supply of health care services. The Afghan Telemedicine Project started in 2007, only in Kabul, as a partnership between Roshan (a mobile phone provider), the French Medical Institute for Children (FMIC, a health facility in Kabul), the Aga Kahn University Hospital in Karachi, and the American technology company Cisco. In 2009, the project expanded beyond Kabul to provincial hospitals. This initiative allowed FMIC, and later other hospitals, to offer advanced diagnostic services in radiology and ultrasound by providing real-time access to specialists and training expertise from abroad. More recently, several international firms have started to provide medical consultations in dermatology, infectious diseases, neurology, and orthopedics, as well as diagnostics of medical imaging, via telemedicine services and in collaboration with professionals and institutions around the globe. Source: Aga Khan Development Network (2016) 71 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION This sort of “medical tourism” is fraught with difficulties for Developing a strategy patients. They face high costs, visa requirements, language for policy reform and cooperation constraints, and must travel long distances to get health care. There have been some initial attempts to alleviate the situation To develop precise policy recommendations, both for through cooperation, for example, from Indian hospitals offering unilateral reform in Afghanistan and cooperative initiatives training programs for Afghan doctors. in the region and beyond, it is necessary to identify the precise impediments to trade in education and health Even when the challenges of post-conflict reconstruction services, and to assess how they increase transactions are overcome, it may not be possible or even desirable for costs for Afghanistan. A future work program in this area Afghanistan to aim to develop all aspects of education could be structured around recent initiatives on trade and health services, considering the scale of economies facilitation in services, such as the recent submission by in both fields and the limited size of the country’s market. India to the WTO (WTO 2016). The interest of countries Both for health and educational services, much stands like India and Pakistan in enhancing exports of services to be gained from deeper cooperation across the region may coincide with Afghanistan’s interest in reducing and beyond. Such cooperation can facilitate, first, the impediments to such trade. development of regional value chains to create human capital. Thus, in some areas, individuals may acquire Facilitating trade in health and education will require the earlier, more basic qualifications in Afghanistan actions in the following areas: and travel to other countries to obtain more advanced qualifications. International recognition of qualifications • Enhanced transparency about opportunities in the at each stage of study would greatly facilitate mobility areas of health and education services, for example, and reduce transaction costs of moving from one by ensuring publication and availability of information, educational institution to another. including by establishing enquiry or contact points locally and in trading partners. Cooperation could also facilitate the development of value • Simplifying procedures for consumption of health care chains in professional services, such as those related to and education abroad, for example by creating, locally health care. Thus, simpler treatments could be provided locally or in trading partners, “single windows” that handle all in rural areas by professionals with basic qualifications— formalities, allow for electronic applications, and fast- such as nurse practitioners—while more sophisticated track procedures. treatment could be provided in urban centers or neighboring • Ensuring that various fees and charges connected to countries. The development of intermediate professional visas and other administrative requirements are not categories and the mutual recognition of credentials, as well excessively high and are related to the true costs of as formal collaboration agreements between institutions, those services. would all help. Simplified visa procedures for patients and • An assessment of where it is feasible and desirable professionals, as well as students and professors, would to develop intermediate professional categories, such reduce transaction costs. In addition, the availability of as nonphysical clinicians, who can provide a broad affordable, high-speed, cross-border internet links, coupled range of basic services at locally affordable prices and with widely available domestic access to broadband internet, are less likely to emigrate abroad or to urban areas. It could widen the scope for opportunities, such as the ones may be more feasible to develop such qualifications described in boxes 3.1 and 3.2. in collaboration with neighboring countries, like India, 72 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION which are also looking for ways to promote universal firms do not generally have), and only 3 percent of them basic health care and education. used banks to finance investments. • Working toward recognition (unilateral or mutual) of technical standards, qualification and licensing The limited access to bank financing is coupled with requirements, and procedures. Such recognition at underdeveloped local institutions, domestic savings various stages of the licensing and qualification of that are lower than the demand for capital, and lack professionals is critical to reducing the transaction of diversification in financing sources, forming a costs of developing human capital value chains, where bottleneck for local business development. In many individuals can acquire the relevant human capital in instances, the void left by the formal financial system different locations in a cost-effective manner. is filled by traditional informal money service providers, the hawalas . They have lower transaction costs, can leverage informal networks, are less sensitive to the Financial services: security situation than formal financial institutions, and Remedying the consequences were not affected by the Kabul Bank crisis, since they of regulatory failure are not regulated or supervised. There are multiple risks and costs associated to the informal status of hawalas , The banking sector in Afghanistan is currently composed such as higher rates than formal lenders, consumer of three state-owned banks, nine private full-fledged protection issues, and money laundering concerns, banks, and three branches of foreign commercial among others. banks. Arguably, because of the Kabul Bank crisis (see box 3.3), the financial sector has remained fragile and The crisis demonstrated that appropriate regulation and plays a limited intermediation role. Asset quality of the institutional capacity are vital in leveraging the gains of banking system remains a concern, with increasing liberalization. Since the crisis, the Afghanistan Central nonperforming loans (7.8 percent of gross loans in 2014, Bank (Da Afghanistan Bank [DAB] and the Ministry of rising to 12.1 percent in 2015 and 15.2 percent in 2016). Finance have worked, with support from the World Bank, Given the volatile operating environment, banks have to carry out audits of commercial banks to assess their tended to be very liquid (71 percent of total assets financial position and develop action plans to deal with were liquid in 2015) and highly capitalized (10.4 percent any weaknesses. In addition, the DAB has worked to capital-to-assets ratio in 2016, compared to 7.5 percent modernize its payment system, which will contribute in India and Pakistan), limiting lending to the private to the safety and efficiency of the financial sector sector (World Bank 2016g). and facilitate efficient government payments. More recent efforts have focused on upgrading the DAB’s In 2015, domestic credit to the Afghan private sector capacity for financial supervision and strengthening was 4 percent of GDP (figure 3.9), compared to 15 the country’s financial infrastructure. Banks are being percent in Pakistan and 21 percent in Tajikistan, and encouraged to institute stronger internal controls and far below the region’s average. Only 44 percent of all risk management. There is a recognition that, for the Afghan manufacturing firms had a bank account in 2014, Afghan banking sector to play a meaningful role in far below the shares of neighboring countries (figure financing the country’s growth, it is necessary to create 3.10). Less than 5 percent of manufacturing firms had a strong regulatory framework and institute reforms to access to loans (since most loans require collateral that ensure financial stability. 73 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION Figure 3.9: Domestic credit to the private sector by banks in Afghanistan and comparator countries, 2015 (percent of GDP) Source: World Bank 2016g. Box 3.3: The Kabul Bank Crisis Modern banking and the credit culture that accompanies it is new to Afghanistan. For centuries, and to this day, the population has relied on informal money service providers to transfer cash and provide limited lending and deposit services. Starting in 2002, the government and the international community promoted the formalization of financial services. This encouraged rapid growth of the formal banking sector, from two state-owned commercial banks and four state-owned development banks in 2003 to 10 privately owned commercial banks, two state-owned commercial banks, and five branches of foreign commercial banks in 2009. But banks struggled to develop normal banking practices and skills. The legal and accounting infrastructure to support non-relationship lending was nonexistent, weak, or untested. An ineffective judiciary and corruption hampered establishing or recovering collateral and enforcing contracts. As the banking system in Afghanistan grew, asset quality and governance suffered. While there were considerable efforts to build the financial sector in terms of its institutional and legal framework, the supervisory capacity struggled to catch up, exposing the banking sector to systemic risks. Concerns over soundness caused a run on Kabul Bank in early September 2010, during which the bank lost about half of its US$1.3 billion in deposits. With one-third of the banking system’s assets in Kabul Bank, the crisis threatened the stability of the financial system. The rapid initial intervention of the central bank prevented a full-blown crisis, but to end the crisis, the government had to provide US$825 million to cover the deposit guarantee (about 5 percent of GDP). Subsequent crisis management was slow in tackling difficult issues such as asset recovery and the privatization of the resulting bank, the New Kabul Bank. The evidence of fraud and money laundering uncovered in this scandal highlighted the relevance of the diligent implementation of prudential regulation, the importance of the development of local capabilities alongside reforms, and the risks of rapid banking sector growth with inexperienced supervision or weak rule of law. Besides the immediate fiscal costs, the Kabul Bank crisis had far-reaching negative effects on intermediation, as it had by far the largest and most effective branch network in the country. The crisis also called into question the central bank’s supervisory capabilities. Moreover, it undermined confidence in the banking sector (preference for cash increased and deposit growth came to a halt), and further overburdened banking supervision. Sources: Adapted from IMF (2011) and World Bank (2015b). 74 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION It is also acknowledged that openness in this sector has a context such as Afghanistan’s. It can increase public the potential to increase efficiency through competition, confidence in banks, leading to more deposits, which enhanced intermediation, and risk sharing, and to incentivize can enable more lending. This is particularly relevant innovation that improves access to finance and inclusion. But considering the long-lasting trust issues generated by openness can also pose additional challenges to stability and the Kabul Bank crisis. In addition, a deposit insurance increased risks. A future work program for financial services scheme can cushion the banking sector and depositors that leverages the potential role of the sector for the rest against unforeseen risks inherent to openness, such as of the economy, while also addressing risks and challenges, speculative or predatory strategies by foreign banks. should stress the following areas: • Increasing access to finance for the real economy through • Continued work on a regulatory framework that supports risk-sharing practices, particularly partial credit guarantee openness, and also emphasizes the need to avoid a (PCG) schemes. A PCG scheme provides third-party credit pace of innovation in the sector that undermines the risk mitigation to lenders with the objective of increasing regulatory capacity of the central bank. Such a framework access to credit for small and medium enterprises or should also guard the sector against agents looking other target groups. This is accomplished through the 50 absorption of a portion of the lender’s losses on the loans for arbitrage opportunities, questionable funds, or predatory behavior, that are likely to be attracted to the made to the target group in case of default, in return for context of conflict and uncertainty in the country. a guarantee fee. The popularity of PCGs is due partly to the fact that they are typically market-based arrangements • Improvement of the existing deposit insurance scheme, that facilitate credit allocation, therefore involving less room particularly as openness is furthered. A well-functioning for distortions in credit markets than more direct forms of deposit insurance scheme has multiple advantages in intervention such as state-owned banks or directed lending. Figure 3.10: Share of manufacturing firms with a checking or savings account in Afghanistan and comparator countries, 2013–14 (percent of total) Afghanistan (2014) 44 Pakistan (2013) 58 Tajikistan (2013) 76 Nepal (2013) 86 Bangladesh (2013) 86 India (2014) 87 Kazakhstan (2013) 92 Kyrgyz Republic (2013) 95 Uzbekistan (2013) 97 % of total number of firms Source: World Bank 2016g. 75 3.AFGHANISTAN´S SERVICES TRADE: NATIONAL REFORM AND INTERNATIONAL COOPERATION PCGs can potentially play an important role, especially Annex 3A in countries with weak institutional environments, by improving the information available on borrowers The STRI survey focuses mainly on policies that would (in coordination with credit registries). PCGs can also affect the entry and operations of foreign services suppliers help build the credit origination and risk management differentially. In each sector, the survey covers the most capacity of participating lenders (for example, through relevant modes of supplying that service. Examples technical assistance to set up dedicated units). include cross-border trade in financial, transportation, and professional services; commercial presence or FDI in each services sector; and the presence of service-supplying In Afghanistan, due to the high level of risks and individuals in professional services. A specific set of measures uncertainty that hamper private sector investments into was determined to evaluate each sector–mode combination. productive activities, the existence of a risk-sharing facility (or PCG fund) would allow the government to gradually For each of these sets, each country’s policy regime is and cautiously allow banks to lend to the economy, while mapped onto five (numbered) categories: completely open building their capacity (in credit appraisal, risk management, (0)—no restrictions at all; completely closed (100)—no entry loan recovery, and so forth). Given the currently limited allowed at all; virtually open but with minor restrictions (25); intermediation role of banks, setting up such a facility would virtually closed but with very limited opportunities to enter and help increase outreach to smaller enterprises with high job- operate (75); and a final residual “middle” category of regimes creation potential, rather than large businesses. that allow entry and operations but impose restrictions that are neither trivial nor virtually prohibitive (50). The results for each sector are aggregated across modes of supply Setting up a risk-sharing facility in the short-term would using weights that reflect their relative importance. For each help address several of the market failures identified in country, sector restrictiveness indexes are aggregated using this report, and satisfy the appetite for increased private sector GDP shares as weights. Finally, the regional STRIs are sector investment to fuel economic growth and job computed as simple averages of the country indexes within creation. Concrete next steps in this direction would be respective regions. For a detailed explanation of how the STRI (a) updating relevant regulations to provide a legal and was constructed and data collected, see Borchert, Gootiiz, regulatory framework for the operationalization of a risk- and Mattoo (2012a). sharing facility; (b) setting up a public entity with a clear mandate, governance structure, and management for this specific facility at the early stage of its operations, with the option to scale it up with private funding in the future; and (c) building institutional capacity for the management of the facility. 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Policies to improve transit trade should resolve existing congestion at important trade points, meet emerging needs in local productive sectors (agriculture and mining), and involve partnering with the private sector. • Second, transit trade potential is also shaped by sensitive geopolitical considerations that are not entirely under Afghanistan’s control. • Building regional connectivity for energy transit trade could provide Afghanistan with electricity to meet its own acute domestic shortages and could add 3.1 percent to export growth annually and contribute US$530 million to revenue by 2030 (1 percent of GDP). • Full completion and operationalization of large-scale infrastructure projects such as CASA-1000 (Central Asia-South Asia, electricity), TAPI (Turkmenistan- Afghanistan-Pakistan-India, natural gas), and TUTAP (Turkmenistan-Uzbekistan- Tajikistan-Afghanistan-Pakistan, electricity, under negotiation) are essential for Afghanistan to fully benefit from energy transit trade. • In the medium -to long- term, factors such as lack of synchronization of power systems across countries, potential decreased demand for energy from neighboring countries, and concerns over political instability may decrease Afghanistan’s attractiveness as an energy route. • With respect to renewable energy, rough estimations suggest that investment in hydro generation and major transmission infrastructure could propel Afghanistan to become a net energy exporter by 2026. In practice, large-scale generation plants for renewable energy such as hydropower plants may be difficult to finance under the fragile security conditions prevailing in Afghanistan. A more effective strategy would be to focus on domestic transmission to achieve full electrification of the country in the medium -to long- term. 80 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE Transit trade in goods is often emphasized as an obvious that are removed (together with the criteria used for the economic opportunity for Afghanistan, but the scope of the removal) are the following: potential is still unclear. Afghanistan has many locational disadvantages, but being landlocked may be turned into an • Contiguous countries: China, the Islamic Republic of Iran, advantage if routes of commerce transit through the country. and Kazakhstan. Due to its geographic situation, a substantial part of imports • Countries that have borders with these contiguous or exports from Central Asian countries might transit through countries: the Russian Federation, Iraq, and Turkey. Afghanistan. • Southeast and East Asian countries that can transit through China: Mongolia, the Republic of Korea, Japan, Afghanistan also has a geographic advantage for becoming Myanmar, the Lao People’s Democratic Republic, an energy transit hub that would boost economic growth, Cambodia, Vietnam, Thailand, Malaysia, and Indonesia. jobs, and revenue, considering the increasing energy needs • Countries that can access Tajikistan, Turkmenistan, of South Asia and the resources available in Central Asia. Uzbekistan, or the Kyrgyz Republic through the Caspian Sea: Azerbaijan, Georgia, and Armenia. How far is Afghanistan in terms of its logistics and connectivity from being a hub for transit trade in goods? What challenges Finally, to account for the fact that some merchandise is does the country face to materialize its energy transit trade shipped by air, trade flows with unit values belonging to the potential? top 20 percent of the distribution are excluded from the transit trade computation. Here the assumption is that high This chapter will assess the potential for transit trade in unit value (US$ per ton) products are shipped by air, therefore, goods and energy. It discusses the feasibility of each of these bypassing the necessity of transiting through Afghanistan strategies in terms of necessary investments in infrastructure, (Hummels 2007; Hummels, and Schaur 2013). as well as governance and security conditions. It also provides policy recommendations related to cooperation and regional The above computations lead to a subset of trade flows from integration in support of transit trade. and to the original group of selected countries (Tajikistan, Turkmenistan, Uzbekistan, and the Kyrgyz Republic) composed of goods transported to their final destination by 4.1 Transit trade in goods: road or by boat. In the latter case, the merchandise might Potential benefits and transit by road through Afghanistan to get to (or from) an related challenges international port. To estimate the international trade flows that could The previous calculations estimate that US$5.7 billion of trade potentially transit through Afghanistan, flows of exports could potentially transit via Afghanistan. This figure may seem (to third countries) and imports (from third countries) are high, especially compared to total Afghan exports of US$700 examined for the set of Central Asian countries neighboring million that same year (2014). Although the value added Afghanistan (Tajikistan, Turkmenistan, Uzbekistan, and generated domestically by this commerce might be limited the Kyrgyz Republic). Trade flows are excluded for all the compared to the value of the goods shipped, being on a route partner countries for which import and export flows are of commerce could be a source of income. The growth of transit highly unlikely to transit through Afghanistan, since for transport through the country could yield direct economic these countries better routes are available. The countries benefits, for example, via the collection of transit revenues, and 81 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE job creation in associated activities, such as rest stops and the relevant authorities, as 80 percent of the and servicing. There could also be indirect benefits of complaints were never acknowledged and addressed increased transit trade, through reductions in transport by the relevant authorities (Ahmed and Shabbir 2016). costs for Afghan traders (because transport costs typically decline as trade volumes increase), or through Recent empirical literature also shows that infrastructure higher productivity of local producers that benefit from improvements may not produce a net benefit. Although improved connectivity. rebuilding conflict-damaged infrastructure, or even constructing new infrastructure, to improve transit trade Gains from commodity transit trade may be modest. could induce economic and social benefits, these may 51 Rough estimates suggest that the gains for be negated or in some cases reversed (Ali and others, Afghanistan (deriving from duties and tariff at the 2015). Therefore, the multiple transit infrastructure borders, catering for truck drivers, margins on refueling, improvements that are being designed should plan for and so forth) may be up to 5 percent of the total transit unintended consequences. Combining such investments trade value, meaning, in this case, US$285 million per with a commitment to enhanced security is desirable. In year. Moreover, additional costs of transit trade due to addition, both in Afghanistan and in the region, internal extra use of road infrastructure, for instance, need to conflict needs to be resolved and a framework for broader 52 be calculated and considered. cooperation needs to prevail over geopolitical tensions between countries, so that Afghanistan can leverage the 54 Of all modalities of trade, commodity transit is the most potential gains of transit trade. vulnerable to the ongoing context of insecurity, as it provides opportunities for predation and extortion along transport routes. As in the case of natural resources abundance, transit trade could potentially increase the risk The prerequisites of conflict through what is called the rapacity effect: both rebel groups and the government may fund their activities Potential gains from merchandise transit trade may be by taxing goods moving across borders. Increases in the slow to materialize. Realizing these benefits requires merchandise transiting the country will therefore increase efficient logistics, well-designed and maintained the ability to sustain conflict (Calì 2015). infrastructure, and a propitious framework of regulation and regional cooperation. Globally and within the Rent seeking at the border can also be a source of region, Afghanistan shows the weakest performance in conflict related to transit trade. Cumbersome scanning the logistics and transportation category of the World 55 and goods examination procedures allow for exploitation Bank’s Logistics Performance Index (LPI), ranking of traders and the business community. According to 158th out of 160 countries in 2014 (see figure 4.1). a recent survey, transit goods are being repeatedly examined at various stages, and only 15 percent of Logistics efficiency in Afghanistan is challenged by the firms surveyed could file any complaints under the long waiting times at borders and complex customs Afghanistan-Pakistan Transit Trade Agreement (APTTA) procedures (see chapter 2). Infrastructure is also due to difficult grievance redressal mechanisms that likely to be a serious constraint, as Afghanistan’s entail high transaction costs. There also appears to be transportation (roads and railroads) network is currently a communication gap between the business community very underdeveloped. With its challenging terrain and 82 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE Figure 4.1: Logistics Performance Index: logistics and transportation rank, Afghanistan and neighboring countries, 2014 Source: Derived from the World Bank Logistics Performance Index. Figure 4.2: Logistics Performance Index: infrastructure, Afghanistan and comparator countries, 2014 2.8 2.8 2.8 2.6 2.6 2.4 2.4 2.4 2.2 2.1 2.0 1.9 1.8 1.8 1.1 2007 2010 2012 2014 2016 Afghanistan South Asia World Source: Derived from World Bank Logistics Performance Index. Note: The infrastructure index is one of the components of the LPI. This index scores the quality of trade and transport infrastructure of countries on a scale of 1 to 5, with 5 representing the best quality. 83 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE after decades of internal conflict, Afghanistan has consistently be complemented by increased regional cooperation ranked in the lowest group of the LPI infrastructure index, well and supporting agreements. Afghanistan participates below South Asia and the world average (see figure 4.2). In in a trilateral transit agreement with India and the addition, achieving a competitive edge in transportation and Islamic Republic of Iran that is organized around logistics will require large investments in transportation and Chabahar and its road and rail links to the Afghan border infrastructure, which will compete with infrastructure border. In addition, the APTTA has been in place in demands in productive sectors. its current form since 2010. This agreement allows for the use of airports, railways, and ports for transit A sensible approach to transit trade development could trade along specific routes, but it faces barriers to full be based on the following prioritization of infrastructure implementation, for example, in the form of expensive investment: (a) resolve existing congestion at important bank guarantees and border delays. In addition, this trade points, (b) meet emerging needs in productive sectors agreement has certain limitations: it allows Afghan (agriculture and mining), and (c) partner with the private sector. trucks to transport exports up to the Indian border, but does not allow them to return through Pakistan Several promising initiatives in this respect have been carrying Indian goods, and does not cover road launched in recent years. Afghanistan has designed transport vehicles from third countries. and started implementing plans to connect all provinces via highways, which will also connect regional and local Increased geopolitical uncertainties in the region have roads to the national transportation network. These plans slowed the pace of transit-related reforms and regional include, for example, the completion of the National Ring cooperation. Accelerating the resolution of the APTTA Road, which, when finished, will connect resource-rich and completing the assimilation of Tajikistan in the regions in Afghanistan and neighboring countries more agreement are needed. A revised version of the APTTA directly. Rail and air transport have also shown signs of should contemplate factors such as the shift to a 56 improvement. transport trade regime based on reciprocity, which could help secure greater access for Afghan services providers These internal developments in the road, rail, and to neighboring markets as well as enhanced competition aviation networks will not only improve transportation on bilateral routes. Measures to minimize the incidence within Afghanistan, but will also allow the country to of customs fraud and avoidance, and monitor and curb better leverage the major infrastructure initiatives being informal trade, should also be enforced. implemented in the region. These include the Lapis Lazuli 57 Corridor and the One Belt One Road Initiative, as well as Finally, deepening and expanding existing agreements the developments in and around the Chabahar (the Islamic with regional partners to improve visa regimes, Republic of Iran) and Gwadar (Pakistan) ports. harmonization, and simplification of custom procedures would be fundamental to facilitating transit trade. Another aspect of cooperation necessary for transit Regional cooperation trade to succeed is the harmonization of transportation and transit trade standards among countries. This has been a recurring challenge, for example, in planning new railways, For these infrastructure initiatives to be successful in since there are three different gauges in neighboring furthering transit trade in Afghanistan, they need to countries. 84 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE 4.2 Afghanistan could add 3.1 percent to export growth annually and contribute as a transit hub in the US$530 million to revenue by 2030 (1 percent of GDP). regional energy market There are already several cross-border, large-scale infrastructure Located between resource-rich Central Asia and fast-growing projects for transit of energy underway in the region (see box South Asia, Afghanistan has a geographic advantage for 4.1). They include the CASA-1000 (Central Asia-South Asia, becoming an energy transit hub. This would boost economic electricity), TAPI (Turkmenistan-Afghanistan-Pakistan-India, growth, jobs, and revenue, considering the increasing energy natural gas), and TUTAP (Turkmenistan-Uzbekistan-Tajikistan- needs of South Asia and the resources available in Central Afghanistan-Pakistan, electricity, under negotiation). Although Asia. Building regional connectivity for energy transit trade these ground-breaking agreements are evidence of the can facilitate Afghanistan’s development as a “bridge” linking commitment of countries in the region to integrate, there the energy reserves of Central Asia with the growing demand are still some uncertainties and challenges that need to be of South Asia. Energy transit connectivity can also provide addressed for Afghanistan to fully benefit from energy transit Afghanistan with electricity to meet its own acute domestic trade. Poor infrastructure, geopolitical tension among countries, shortages. Simulation results suggest that energy transit trade and security issues are some of the prominent issues. Box 4.1: Main infrastructure projects for energy transit in Afghanistan CASA-1000 In 2015, the Kyrgyz Republic, Tajikistan, Afghanistan, and Pakistan signed the historic Central Asia-South Asia (CASA)-1000 agreement. With an estimated cost of US$953 million, the CASA-1000 project aims to transmit 1,300 megawatts of electricity from the Kyrgyz Republic and Tajikistan, via Afghanistan, into Pakistan, of which Afghanistan will utilize 300 megawatts for domestic use. The remaining 1,000 megawatts of electricity will eventually reach Pakistan to remedy the severe shortage of power the country faces during summers. The Kyrgyz Republic and Tajikistan have substantial amounts of surplus power in the summer that would remain idle if not used. The CASA-1000 will bring the surplus power to Pakistan, generating transit fees for Afghanistan and enhancing its growth prospects, in addition to addressing its domestic electricity shortage. The project provides access to clean energy and creates jobs, and will also bring approximately US$45 million in annual transit fees to Afghanistan (Kabul Times 2014). TAPI The ambitious Turkmenistan-Afghanistan-Pakistan-India (TAPI) project was first signed by the governments of Turkmenistan and Pakistan in March 1995. However, the project stalled due to unrest in Afghanistan and tensions between India and Pakistan. Negotiations restarted in 2010 and the four countries finally signed the agreement for construction of the pipeline in early 2016. The TAPI pipeline is expected to cost US$10 billion. It will transport natural gas from the Yolotan gas field in Turkmenistan, via Afghanistan and Pakistan, to India, over a distance of 1,735 kilometers, 735 kilometers of which would be on Afghan soil. The project will transport 33 billion cubic meters of gas per year for 30 years. The project not only benefits Pakistan and India, but will also help Turkmenistan diversify its export of natural gas. Afghanistan will receive US$400 million annually in transit fees. The project is expected to create approximately 12,000 jobs in the country. TUTAP The Turkmenistan-Uzbekistan-Tajikistan-Afghanistan-Pakistan (TUTAP) project aims to transmit 2,600 megawatts of power (Kabul Times 2014) from Turkmenistan, Uzbekistan, and Tajikistan to Afghanistan and Pakistan. Although TUTAP is in its initial stages of negotiation, it is expected to unlock Afghanistan’s potential as the transit hub in the region, bringing in jobs and contributing to growth. 85 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE In the medium -to long- term, the following factors can affect prone to rent-seeking activities and extortion. In addition, lack of the attractiveness of Afghanistan as an energy transit route. human capital and fiscal resources would impede progress on First, importing power from Central Asia incurs significant costs energy generation and transmission projects. because power systems are not synchronized within Central Asia and with Afghanistan. Second, although Pakistan currently While development of large-scale HPPs may appear to offer has acute energy needs, the country is now redoubling efforts significant economic benefits, the reality is that their economic 58 to build its own large hydropower projects. Moreover, gas benefits in terms of expenditures in either construction or operation sector reforms are underway in Pakistan, which, if successful, are limited. Also, potential savings from foregone electricity imports may result in more gas being available for power generation. In are moderated by the seasonality of the HPPs’ output, particularly addition, Pakistan is actively exploring imports from the Islamic their inability to cover electricity demand during the winter months. Republic of Iran, in addition to pursuing the TAPI pipeline. Third, Assessment of the potential revenue benefits from hydro exports cost, feasibility, and concerns over political instability may result must account for the fact that hydro needs to be supplemented in financing difficulties, which in turn could significantly affect by additional domestic thermal generation or imports. Therefore, investment decisions (World Bank 2016). the capital needed to develop the HPPs should not displace investments in other domestic supply. Potential benefits would Full completion and operationalization of the different also depend on the decisions of other counties, such as Pakistan’s infrastructure initiatives is essential for Afghanistan to fully steps regarding energy generation and transmission (see box 4.2 benefit from energy transit trade. Although Afghanistan is on hydroelectricity and trade). not in the lead on these projects, the government should constantly monitor the developments of the proposed energy Given the possibly limited benefits of HPPs, a more effective transit projects (CASA-1000, TUTAP, TAPI) and be prepared to strategy would be to focus on domestic transmission to achieve respond positively if action is required. A plan to respond to full electrification of the country in the medium -to long- term. partner concerns regarding security, location of offtakes, cost Indeed, a key aspect of Afghanistan’s development is continuing sharing, transit tariffs, and other matters should be put in place. to extend electricity supply to unserved and underserved parts of the country, through a combination of grid extension, mini- grids, and stand-alone generation. Improved power supply is Renewable energy as a longer- an important component of developing a modern and efficient term opportunity for Afghanistan infrastructure network that can support increased output of goods and services, employment opportunities, and potentially Afghanistan is rich in solar, wind, biomass, and hydro. The most enhanced security. likely large-scale developments would build on the country’s substantial hydroelectric capacity. Simulation results suggest The government’s primary policy focus now is the expansion that investment in hydro generation and major transmission of import capacity from Turkmenistan and interconnection infrastructure could move Afghanistan from being a net energy of the Northern Electric Power System and Southern Electric 59 importer to an exporter by 2026 (ADB 2013). While technically Power System, both of which are donor financed. Given that feasible, pursuing such a strategy would involve considerable costs implementation has been slow, the government should and risks. Large-scale generation plants for renewable energy investigate whether any of its agencies represent a barrier such as hydropower plants (HPPs) may be difficult to finance under to these projects moving forward, and if so, take corrective the fragile security conditions prevailing in Afghanistan. Insecurity action. Mini-grids and stand-alone generation are largely may make infrastructure projects (such as dam construction) more donor financed under the auspices of the Ministry of Rural 86 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE Box 4.2: Hydroelectricity and trade in Afghanistan With its mountainous terrain and extensive river system, Afghanistan is estimated to have recoverable hydroelectric potential of more than 23,000 megawatts (MW). The clear majority of this potential (roughly 20,000 MW) is in the northeast on the Amu Darya, Panj, and Kokcha Rivers. A further 1,900 MW are located to the east of Kabul, with over half of this on the Kunar River near the border with Pakistan. The Balkh and Jowzan regions in the northwest have approximately 800 MW of potential, and the remaining 500 MW of Afghanistan’s hydroelectric potential lies in the west-central region. Current plans for development of Afghanistan’s power generation capacity include a significant role for hydroelectricity. The Power Sector Master Plan has proposed adding seven new hydropower plants (HPPs) totaling approximately 1,550 MW by 2032. Domestic hydro would represent 41 percent of total supply and 67 percent of domestic supply. The largest plants are at two sites on the Kunar River (Kunar A and B), with a planned combined capacity of 1,089 MW at an estimated capital cost of US$2.7 billion. Together, the plants would generate 6,260 gigawatt-hours of energy each year. Integrating potential hydroelectric generation into Afghanistan’s supply system poses challenges. Proposed plants, including Kunar, do not include significant storage, and hence their output over the course of the year varies with the flow in the rivers, typically highest during the early summer. The Kunar cascade, for example, would operate at only 22 to 24 percent of capacity during the winter months, which is also the country’s period of peak demand. To make up the winter supply shortfall, additional thermal and import transmission capacity will be needed, which in turn will sit idle during the summer months. Using hydro resources to provide electricity for export has also been suggested as an option, with Kunar as the primary candidate. Afghanistan badly needs revenue, and several arguments can be put forward in favor of building one or more projects either exclusively or partially for export. Among other benefits, the projects will attract financing, create job and skill development opportunities, and possibly show profitability. Every premium of 1 cent per kilowatt-hour in the export price over the cost of alternative sources of supply would generate almost US$63 million per year in net incremental revenue. The reality, however, is likely to be less than expectations. A large HPP such as Kunar would be among the costliest private-sector-financed electricity projects in recent years, and it would be a departure for international finance institutions to allocate such large sums to a single project in a low-income country. Many of the physical risks are unknown because no geotechnical studies have been conducted, although a comprehensive feasibility study could address some of these uncertainties. Security risks are high not only within that region of Afghanistan, but also in the adjacent Khyber Pakhtunkhwa Province of Pakistan, and community engagement would be a priority. Local impacts of the project are not likely to be substantial. Construction contractors in Afghanistan will not have the heavy equipment needed to work on the plant, and skilled labor is also in short supply. It is more likely that an international contractor would be engaged on an “engineer, procure, construct” basis, and the successful bidder will likely contract both heavy equipment and skilled labor from elsewhere. Technical components like turbines, generators, and controls will also be imported, leaving very little of the project’s acquisitions available to domestic suppliers. Impacts after construction are also likely to be minimal, as HPPs require little in the way of operational staff. Finding an export market for such a project looks promising since Pakistan, whose highest demand falls during the summer months, is short of peaking capacity. At present, Pakistan’s average supply cost is reported to be US$0.13 per kilowatt-hour, although ongoing capacity additions will help reduce this average. But there are alternative sources of peaking energy available to Pakistan apart from hydro imports from Afghanistan. Intraregional transmission projects (CASA-1000 and TUTAP) will provide access to electricity from Tajikistan, Uzbekistan, and Turkmenistan. Pakistan could also build gas turbines to provide its own peaking energy using domestic gas, or imports from Turkmenistan and the Islamic Republic of Iran. While hydro exports from Afghanistan could likely compete with these options, there are questions as to whether the return would justify the risks. For example, there is a risk that neighboring countries will object to Afghanistan’s use of power imports to serve domestic demand while exporting hydro at an attractive price. Source: World Bank (2017) 87 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE Rehabilitation and Development. However, a new agency called and sector have experienced tremendous growth in the last the Ministry of Energy and Water is being set up to deal with 15 years, with fiber optic, wireless, and satellite infrastructure investments in renewable energy. The government should projects being undertaken, as well as a large deployment of ensure that the actions of these agencies are coordinated mobile services. For example, the construction of the domestic to facilitate continued smooth implementation of these optical fiber network (Backbone Ring Project) started in 2007 community-level programs. and currently connects 20 of the country’s 34 provincial capitals, with five more connections under way and five additional ones In addition, feasibility studies for major hydropower projects planned. Regulation has kept up; the Open Access Policy for should be upgraded. These studies should focus on increasing the optical fiber network was enacted in 2012, aiming to achieve the share of domestic resources (and renewable energy) in nondiscrimination in access for providers, transparency, and the national power supply, rather than studying high-risk cost-based pricing. export markets. Feasibility studies will be costly, especially for sites with incomplete data. Given its limited fiscal resources, Despite this progress, there are still significant obstacles, the government of Afghanistan should pursue grant or particularly in terms of international connectivity and low concessionary financing from bilateral and multilateral donors. broadband internet penetration rates, for both mobile and fixed access. Estimates indicate that there are currently only between 30,000 and 50,000 fixed high-speed internet 4.3 Exploiting synergies to subscribers, and 1.9 million 3G mobile internet subscribers create the infrastructure (compared to 408,000 fixed-line and 19.7 million active GSM for transit services mobile subscribers). Fixed internet service is priced at US$73 per month (compared to the country’s average annual GDP Afghanistan has a potentially important role to play in improving per capita of US$624 in 2015), while mobile 3G data offers the regional connectivity of high-capacity, domestic, fiber optic more affordable options (for example, US$8.7 for 5GB with networks. The country’s telecommunications infrastructure Afghan Wireless, Etisalat, and Salaam). TABLE 4.1: Afghan Telecom published wholesale IP transit pricing, December 2015 Description Price per Mbps per Price per Mbps month for ISPs and month for per GSM operators individual (US$) customers (US$) Unprotected capacity via Pakistan, terminated at Kabul 96 120 Unprotected capacity via the Islamic Republic of Iran 153 180 Unprotected capacity via Uzbekistan 320 336 Protected capacity (if available) 240 256 Europe or United States as low as US$1 Source: Terabit Consulting 2016. Note: Other sources mention costs of US$20 for Pakistan and US$169 for Uzbekistan. GSM = Global System for Mobile Communication; IP = internet protocol; ISP = internet service provider; Mbps = megabits per second. 88 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE One of the reasons broadband penetration and connectivity Addressing these shortcomings would complement other remains a challenge for Afghanistan is that international access to development policies and, as the literature has found for other the internet usually occurs via undersea fiber optic, with limited to countries, better broadband could boost local output, employment, 60 no competition in international transit provision. Afghanistan, being productivity, and trade. In addition, better broadband could a landlocked country, must pay high international transit prices position Afghanistan as a competitive data transfer provider through its terrestrial cross-border links to the Islamic Republic of for its neighbors. This could benefit the region by lowering Iran, Turkmenistan, Uzbekistan, Tajikistan, and Pakistan (see table data transmission time between Europe and Asia by over 30 4.1). This translates into high prices for consumers, resulting in low milliseconds (from its current 130 milliseconds). internet penetration rates, even as mobile penetration is high. Political instability and security issues have also constrained use A cost-effective and efficient means of rapidly improving and investments in the broadband market (for example, some international connectivity in Afghanistan would be the network segments between Ghor Mach and Karukh are out of commercialization of the optical fiber installed along the planned service due to security concerns). infrastructure projects mentioned in the previous section. Electricity Box 4.3: Infrastructure sharing for optical fiber networks Traditionally, electricity networks are equipped with an optical power ground wire (OPGW), which is a high- Figure B3.2.1: voltage distribution cable with optical fibers in its center (see figure B4.3.1). These fibers connect the electricity Optical Power Ground provider’s facilities for internal communications purposes, including measuring the volume of electricity being Wire (POGW) transferred. This information can be transmitted through one single fiber strand. Cables have at least six fiber strands, leaving a significant fraction of the installed fiber optic capacity idle. Together with OPGW, similar, newer cable technologies can also be installed on low -and medium- voltage polls. These include all dielectric self-supporting cable, independent fiber optic cables, and mixed phase or optical conductors such as an optical phase conductor. These new cable technologies have made it possible for broadband Source: The Fiber Optic operators to lease capacity from electricity companies and provide fiber to homes over power lines Association at a much cheaper cost than deploying underground cables. http://www.thefoa.org/tech/ref/ OSP/cable.html. Unlike buried fiber, these aerial cables are exposed to the environment and are vulnerable to extreme weather. Furthermore, their metal coating is designed to attract lightning strikes to avoid damage to the power transmission lines. However, power transmission infrastructure provides greater security than traditional buried fiber optic lines; it is much less likely to be subjected to Figure B3.2.2: accidental cable cuts, vandalism, or deliberate destruction. Gap in commercial fiber Similarly, pipelines and transport infrastructure, such as railway lines and highways, can be equipped (Kazakhstan-Russia) with optical fiber cables for internal communications purposes (for example, tolls and train stations). Other purposes include managing signaling devices to control the transit of vehicles. Again, unused capacity in these installations can be leased out. Systematizing the installation of ducts in energy and transport infrastructure is a low-cost strategy for expanding fiber optic networks. For example, the estimated cost of bridging a 23-kilometer gap in the fiber optic network on the border between Kazakhstan and the Russian Federation (see figure B3.2.2) varies under different scenarios: (a) the cost of rolling out stand-alone fiber is US$425,000, (b) the cost of rolling out fiber if ducts were installed when building the road or railway is US$250,000, and (c) the cost of “liberating” existing fiber if already installed in ducts when building the road or railway is US$115,000. Source: Puig Gabarro, Matto and Singh (2016). Source: Gabarro, Mattoo, and Singh 2016. 89 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE transmission lines, oil and gas pipelines, and railways typically install optical fiber networks for their own telecommunications requirements, thus allowing any surplus capacity to be used on a commercial basis by telecom operators (see box 4.3). Infrastructure sharing is already being implemented in some of the major infrastructure projects, such as TAPI and CASA-1000, via the 61 project Digital CASA. Such projects will facilitate the installation of fiber optic cable and other network equipment in provinces currently not connected, and will also establish additional cross-border links. In terms of domestic impact, estimates suggest that an additional eight million inhabitants can be connected. Regionally, it would improve transborder connectivity among all CASA-1000 members, and, inter-regionally this could eventually, be a component of an alternative Europe-to-Asia terrestrial connection. These examples illustrate the importance of encouraging cross-sector infrastructure sharing to accommodate duct and/ or fiber installation. To this end, it will be critical for the Ministry of Communications and Information Technology to coordinate with the Ministry of Public Works, the Ministry of Transport and Civil Aviation, and the Afghanistan Railway Authority (where applicable), as well as with regional authorities. Coordination will help avoid retrofitted installation of fiber along new infrastructure projects, which can create significant costs, logistical challenges, and delays. 90 4.TRANSIT TRADE: LEVERAGING LOCATION INTO A COMPARATIVE ADVANTAGE REFERENCES World Bank. 2014. Logistics Performance Index. http://lpi. worldbank.org/international/global/2014. ———. 2016. “Energy Security Trade-Offs Under High Uncertainty: Resolving Afghanistan’s Power Sector Development Dilemma.” ADB (Asian Development Bank). 2013. “Afghanistan Power Sector Report No. ACS19167. World Bank, Washington, DC. https:// Master Plan” Project No. 43497. Asian Development Bank, openknowledge.worldbank.org/handle/10986/26312. 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Geneva: United Nations Conference on Trade and Development. 91 NOTES 1 16 The World Bank is currently collaborating with the Government The presence of U.S. residents in a foreign country (such as of Afghanistan in some of these areas through programs such Afghanistan) corresponds to a situation of extraterritoriality in as the Water Management Project and the Agriculture Portfolio terms of balance of payments. Internal sales to U.S. agents are a of Afghanistan. priori considered as exports to the United States. 2 17 http://lpi.worldbank.org/international/global/2014. The export structure tends to vary by destination market. Exporting to high-income countries, where consumers 3 https://www.adb.org/projects/44463-013/main. have a relatively high preference for quality, stimulates the production of high-quality goods, and increases the demand 4 http://www.casa-1000.org/. for skilled labor (Brambilla, Lederman, and Porto 2012). Hausmann, Hwang, and Rodrik (2007) provide evidence that 5 Forecast done under the “baseline” scenario included in the types of products countries export matter for economic World Bank, (2016). growth. Finally, Verhoogen (2008) shows that more productive plants produce and export higher-quality goods than less 6 The government has recognized the importance of such productive plants, and they pay higher wages to maintain a an approach in the National and Regional Resource Corridor higher-quality workforce. Program, a National Priority Program. 18 For an illustration on how to compute labor sophistication, see box 2.1. 7 See box 1.2 on the opium economy. 19 All the presented estimations use mirror data to partially 8 A new Transit Trade Agreement was signed in 2010 with address the problem of unrecorded trade: exports that Pakistan, replacing the 1965 Agreement. are not recorded in Afghanistan but are recorded in the receiving country will be included in the analysis. In addition, 9 Afghanistan would provide transit conditions as established estimations are run including figures from informal trade. under Article V of the GATT 1994 to WTO members on a most Results still confirm Afghanistan underperformance, both at favored nation basis. the aggregated and at the bilateral level. 10 20 TAPI, agreed in 2015, will connect the Turkmenistan-Afghanistan- The fit corresponds to the norm of flows predicted by the Pakistan-India Pipeline with a natural gas pipeline. In addition, market access and appears to explain between 86 and 92 agreements have recently been signed on three transport percent of the changes in flows across countries. infrastructure projects: the Chabahar port development agreement 21 (which will connect India and Afghanistan via the Islamic Republic Comparing countries in terms of GDP per capita helps control of Iran); the Lapis Lazuli Route (which will connect Afghanistan, for the diversification of the economy, while comparing countries Turkmenistan, Azerbaijan, Georgia, and Turkey); and the Five in terms of geographic location helps control for natural Nations Railway Corridor (linking China and the Islamic Republic of disadvantages (for example, climate). Iran via Afghanistan, Tajikistan, and the Kyrgyz Republic). 22 The presented methodology is based on existing data 11 A survey from the Pakistan-Afghanistan Joint Chamber of on trade flows and therefore cannot be used to assess the Commerce and Industry in 2012 suggests that Afghanistan’s potential of extractive products such as coal, oil, and gas for the business community considers informal trade to be around country, given that these minerals are still in the discovery phase US$1.5 billion per year. Pakistan’s business community claims or are at a very early stage of extraction. In addition, these that the volume of the informal trade between the two countries products have a different dynamic in terms of trade flows is at least 40 to 50 percent of the formal trade. determinants compared with the rest of the goods. A more extensive analysis on the potential of the extractive industries 12 Data used for this section comes from the BACI world trade can be found in Report No: ACS1205 (World Bank 2013). dataset (provided by the CEPII and based on UN-COMTRADE files). 23 If one drops goods that may be traded because of the war, 13 The total number of product categories is 5,000+. for which we observed a steep growth after 2001 (for example, aircraft, vehicles, and pharmaceutical goods), then we obtain 14 Products are classified at the HS-6 level. similar figures (not shown for the sake of simplicity). Also, figures do not significantly change once we include potential informal 15 Figures are available upon request. trade between Afghanistan and Pakistan. 92 NOTES 24 38 The different types of use are taken from the Broad Economic Supporting evidence is available from numerous World Bank- Categories classification. financed customs and trade facilitation projects in countries as diverse as the Russian Federation, Vietnam, the Philippines, 25 Data from Afghan customs suggest that transit trade Cambodia, the Lao PDR, and Kazakhstan. All achieved improved represented around 8 percent of Afghan exports in 2014. customs revenue performance while simultaneously reducing clearance time. 26 www.enterprisesurveys.org/. 39 World Bank World Development Indicators, 2015 (databank. 27 Export value figures appear to be much lower than those obtained worldbank.org/wdi), and International Monetary Fund Balance from UN Comtrade (see the subsection under section 2.1 on trade of Payments Statistics, 2015 (http://www.imf.org/en/Data), balance). This “missing” registration of 40 percent might reflect respectively. underreporting by Afghan customs authorities. A more plausible 40 explanation of this difference, however, is that the “missing” trade value This definition of services trade that includes four modes of is goods in transit that might not be reported by customs in the files delivery was formalized in the WTO’s General Agreement on that were provided to us. Finally, sales to the UN and other nonresident Trade in Services (GATS). firms and organizations present in Afghanistan might not be reported 41 as exports by customs either, since products do not cross the border. For an example of the far-reaching gains of reform in the services sector, see Arnold et.al. (2016), who present an analysis 28 Thirty percent of households still depend on agriculture as of how the reform in services in India has had a positive effect on their main income source, and 96 percent of the manufacturing manufacturing productivity. sector is reliant on agricultural inputs. 42 http://iresearch.worldbank.org/servicetrade/home.htm. 29 World Bank Business Enterprise Survey 2014; http://www. 43 enterprisesurveys.org/. This conclusion is based on the following sources: Afghanistan’s Private Investment Law of 2005 (AISA 2005), the Law of Civil 30 http://cso.gov.af/en. Aviation (AISA 2014), and Afghanistan’s Accession Schedule (WTO November 13, 2015; https://www.wto.org/english/thewto_e/acc_e/ 31 Box 2A.1 in Annex 2A presents the augmented gravity equation used to a1_afghanistan_e.htm, accessed on October 4, 2016). estimate the role played by each of the trade determinants in explaining 44 the trade residuals (the gap between predicted and observed trade). This is based on Afghanistan’s Private Investment Law of 2005, Article 5, provision 4 (http://www.aisa.org.af/Content/Media/ 32 Table 2A.4 in Annex 2A shows that the share of negative Documents/New-Investment-Law1112014171155607553325325.pdf). residuals for Afghanistan and their mean value are considerably 45 reduced (from 50 percent to 36 percent) when controlling for export Note that, although landlocked, Afghanistan included maritime time delays. Ultimately, the mean value of negative residuals is sectors in its Accession Schedule. For maritime shipping, it halved, meaning that time to export is alone accounting for a large committed to completely open trade through cross-border part of the problems faced by Afghan exporters. supply and commercial presence. For maritime auxiliary services, the commitment to openness includes cargo handling, storage, 33 Doing Business database, 2015; http://www.doingbusiness.org/. and freight agency services. 34 46 Here productivity is proxied by income per capita. This information for cross-border air services agreements is based on WTO’s Air Services Agreements Projector database 35 Productivity and income per capita are closely related in an open (https://www.wto.org/asap/index.html, accessed on October 30, 2016). economy. Given that the Afghan GDP per capita is very low, and 47 with an elasticity of total exports to GDP per capita that is estimated This information is based on the Law of Civil Aviation (AISA 2014), above unity (1.2), moving from US$633 per capita to US$3,200 on Articles 5 and 7 (http://www.aisa.org.af/Content/Media/Documents/ average leads mechanically to a six-fold increase in Afghanistan’s 809CivilAviationLaw1382511201419 2636277553325325.pdf). trade (1.2*3200/633), even without reductions in trade costs. 48 This constraint reflects limitations of the most commonly used 36 They include melons and watermelons, beans, and lentils, and data sources: IMF BOPS (IMF 2016a), the International Trade represented less than 1 percent of Afghan exports in 2014. Center (ITC) Trade in Services database, and the WTO. There are some databases that have estimated data for previous years (for 37 http://www.asycuda.org/. example, the CEPII CHELEM). 93 NOTES 49 59 Based on the series Foreign Direct Investment, Net Inflows (percent In the model, the export surplus arises because of a large of GDP) from World Development Indicators (Word Bank 2016g). HPP (Kunar) coming online, and disappears within a few years as domestic demand grows to absorb it. 50 The inflow of foreign currency from the aid, and the short- 60 term balance-of-payments stability brought by it, coupled See, for example, Fernandes et al. (2015) for China; Bankole, with a stable, managed, fixed exchange rate, creates some Osei-Bryson, and Brown (2015) for Africa; and Bertschek et al. opportunities for arbitrage for foreign banks. (2016) for an updated survey. 51 61 Hummels (2007) shows that freight rates per dollar of Given the availability of OPGW fiber with a relatively high fiber merchandise transported in industrialized countries are on count, the construction of new fiber along the CASA-1000 route average around 5 percent. UNCTAD (2015) gives a figure is not expected to be necessary. between 9 percent (Asia) and 11 percent (Africa). In this report, it is assumed that freight rates for Afghanistan are around 10 percent (average between Asia and Africa). Revenues from rates in Afghanistan will range between 3 transportation freight percent and 5 percent, depending on how much of such revenues will go to the government. 52 A proper cost-benefit analysis will provide a more accurate value of the benefits of transit trade for Afghanistan. 53 The survey includes firms and traders from Pakistan that are currently trading with Afghanistan and Central Asia. 54 Evidence suggests that regional trade agreements lower the risk of conflict when trading with neighbors (Calì 2015). Also, deeper agreements are more peace enhancing; financial integration and monetary interdependence may play a more important role in promoting peace than trade alone (Gartzke et al. 2001). 55 http://lpi.worldbank.org/international/global/2014. 56 In rail: an independent national Afghanistan Railway Authority (AfRA) was established in 2012 and the Afghanistan National Railway Plan was designed (over 5,000 kilometers of railways by 2030). In air: only the airports in Kabul and Herat are up to international standards, but updates to airports in Mazar-e-Sharif, Jalalabad, and Kandahar are already planned. In addition, in 2015, the air space and traffic control was transferred to the Afghanistan Civil Aviation Authority, created in 2014). 57 Examples include the Chabahar agreements with the Islamic Republic of Iran and India; and the Ashgabat transport agreement between Oman, the Islamic Republic of Iran, Turkmenistan, Uzbekistan, and Kazakhstan. 58 For example, the 1,320 MW Tarbela 4 extension is now under construction and a further 1,320 MW for Tarbela 5 is under consideration. The much larger 4,350 MW Dasu hydropower project is also nearing construction start, with financing in place for the 2,160 MW Phase I project nearing close, and preliminary work now underway. 94 96