Once upon a time, most economists thought that tariffs, quotas and exchange controls were the alphas and omegas of trade policy. Hence their consensus recommendations: slash tariffs, eliminate quotas, float the exchange rate and commerce would blossom. Not quite so! It turns out that trade costs decisively separate countries that participate fully in the world economy and countries that are marginalised. Perhaps the biggest new idea is that trade transaction costs are not simply a matter of geography and fate. Targeted policies – grouped under the label of trade facilitation – can sharply cut the burden even for landlocked countries. Singapore takes first place in trade facilitation rankings, not only because of a fantastic natural port but also because of superb governance. More surprising, perhaps, is that landlocked Austria ranks 11th, entirely owing to government emphasis on quality infrastructure and efficient border management.
Even the international politics of trade facilitation are positive. The potential gains from trade facilitation are so large and 'self-balanced' that it has been one of the brighter spots of the otherwise dim Doha Round of negotiations at the WTO. Even 'narrow' investments in trade facilitation lead to enormous rates of return. Helble et al. (2009) estimate that every dollar spent in aid-for-trade recipient countries on reforming trade policy and regulation (e.g. customs clearance, technical barriers, etc.) increases the country’s trade by $697 dollars annually.
While agreement on trade facilitation tops the list of any potential 'early harvest' package, Brazil, South Africa, and India have led a push against this proposal, arguing that any deal on trade facilitation must be coupled with an agreement on agriculture reform. Most recently, support is gathering for a stand-alone trade facilitation agreement outside the auspices of the WTO.
Global value chains
One reason why trade facilitation gets more attention these days is that most countries have cut their tariffs, liberalised their quotas, and floated their exchange rates. Just as lowering the water level of a lake reveals sunken trees and hidden boulders, so reducing border barriers reveals trade transaction costs. But another transformative change is also at work, i.e. the spectacular growth of global value chains that span national boundaries (World Economic Forum 2012).
No longer is the bulk of global commerce confined to raw materials (iron ore, petroleum) and finished manufactures (autos, airplanes, apparel). In between are vast webs of trade in intermediate goods and services, linked in value chains with ingredients from multiple countries, and coordinated by numerous business trips and data exchanges. In fact, 60% of global commerce involves intermediate products, and 30% of the total is conducted between affiliates of the same multinational corporation. All this raises the importance of trade costs, both because they are incurred more than once in the trip from producer to consumer, and because each multinational can easily calculate the amount that trade transaction costs are subtracting from its global profits.
Trade lost through high trade transaction costs
World Bank researchers have pioneered the quantification of hard and soft infrastructure deficiencies in the realm of trade facilitation. Hard infrastructure covers ports, airports, roads and rail lines– all critical for connecting a country to the outside world. Less visible but no less important are the soft infrastructures of border and logistics management (shipping, air transport, telecommunications, business environment). We’ll get to measures of strong and weak infrastructure in a moment, but let’s start with the trade losses resulting from weak infrastructure.
Table 1 presents estimates drawn from Portugal-Perez and Wilson (2010). The authors used factor analysis to construct four new aggregate indicators of a country’s trading environment. They then used a standard gravity model to simulate the impact of these indicators on trade facilitation and export growth. The indicators are broken down into 'hard' and 'soft' infrastructure. Port characteristics are largely a matter of hard infrastructure; inadequate services are a mixture of hard and soft (internet access and usage); whereas customs administration and regulation are purely soft infrastructure.
In making their calculations, the authors did not assume that every country attains Singapore’s outstanding performance; instead, they simply assumed that countries lift each indictor halfway to the region’s top performer in each category. For example, if Mongolia improved its infrastructure to half the level of Malaysia – which has the best infrastructure in East Asia – then exports of Mongolia would increase by 59%. The potential trade gains are spectacular. The assumed improvement in trade facilitation could boost the merchandise exports of all sample countries (which excludes most developed economies) by $1,137 billion.
Table 1. Estimated gains from trade facilitation improvements to merchandise exports
|Region||Export gains ($ billion)||Export gains (percentage)|
|East Europe and Central Asia||202||16.7|
|Latin America and Caribbean||301||29.5|
|Middle East and North Africa||30||20.0|
Source: Author's own calculations and Wilson and Portugal-Perez (2010).
Note: Estimates are based on World Bank simulations which assume each country improves its trade environment quality halfway to the top performer in that region. See Wilson and Portugal-Perez (2010), Figure 4. Potiential trade gains are calculated from 2011 trade data using the IMF's Direction of Trade Statistics (accessed June 2012).
Trade transaction costs and trade performance
The World Bank first published its Logistics Performance Index for the year 2007. The index is on a 5.0 point scale, covering 150 countries and 5,000 individual components (roughly 33 per country). For convenience, the components are grouped under seven categories: customs, infrastructure, international shipments, logistics competence, tracking and tracing, domestic logistics costs, and timeliness. In 2007, the best performer was Singapore, with an overall score of 4.19 and the worst was Afghanistan with 1.21.
An outstanding instance of logistics improvement between 2007 and 2012 was Morocco, as the 2012 Logistics Performance Index report indicates:
“Morocco’s Logistics Performance Index rank jumped from 113 in 2007 to 50 in 2012, having implemented a comprehensive strategy to improve logistics and connectivity and take advantage of the country’s proximity to Europe. Combining border management reform with large physical investments in the Tangier-Med Port, the strategy fostered the emergence of Morocco’s just-in-time exports to Europe (especially textiles, electronics, and automotive components). Morocco’s fast rise in the Logistics Performance Index highlights the payoffs of such a comprehensive approach.”
As might be expected, logistics scores improve with per-capita GDP. More interesting, however, is that logistics outperformers enjoy faster trade expansion, more rapid economic growth, and more diversified exports. Illustrative is the export growth comparison between outperformers and underperformers over the period 2005 to 2010. The 2010 report identifies ten outperformers and ten underperformers (after adjusting for income levels) among non-high income, non-oil-producing countries. Table 2 compares their respective export growth experience. On average, outperformers’ exports grew about twice as fast as underperformers’.
Table 2. Export growth, LPI ranks and trade facilitation components of overperforming and underperforming countries
Sources: Export Growth from World Bank's World Development Indicators (June 2012), World Integrated Trade Solution (June 2012) and the International Monetary Fund's Director of Trade Statistics (June 2012); Trade facilitation components from World Bank's Connecting to Compete (2007 & 2012).
Note: * = not available for 2012. Pulled from Connecting to Complete (2010)
An examination of the index components does not reveal any magic bullet. In reality, all seven components are important. For example, India, which experienced 121% growth in exports from 2005 to 2010, scored relatively high on logistics quality and competence in 2012, and relatively low on infrastructure. Vietnam, whose exports grew by 121% over the same time period, scored relatively high on international shipments and relatively low on logistics quality and competence.
Since 2008, the World Economic Forum has been issuing a similar index, i.e. the Enabling Trade Index. The index covers aspects of the trading environment that go well beyond logistics. It breaks down the nine 'pillars' of trading environment into four sub-indexes: market access, border administration, transportation and communication infrastructure, and business environment.
An encouraging finding from both indices is that average performance has improved in recent years, despite the breakdown of WTO negotiations in the Doha Round. The average Logistics score increases from 2.7 in 2007 to 2.9 in 2012. Similarly the average Enabling Trade score rose from 4.12 in 2008 to 4.14 in 2012. Average performance has particularly improved among low-income and low-middle-income countries. One reason is that new regional trade agreements are flowering. More than 160 have been notified to the WTO and come into force since 2000. But the more important reason is that many developing countries see their own advantage served by cutting trade transactions costs, just as many developing countries unilaterally reduced their tariffs purely from self-interest in the 1980s and 1990s.
Trade pays off in higher income
The reason economists celebrate trade is not a simple-minded love of watching ships cross the Pacific or cargo planes land at Charles de Gaulle. The reason is that increased trade demonstrably raises income and improves living standards. Averaging several estimates indicates that an increase in two-way trade of 10% generally boosts GDP by 1.6% (Hufbauer et al. 2012). This is a handsome payoff, but certainly within reach when a country takes dedicated steps to facilitate trade.
Table 3. Estimated GDP gains from substatial improvements in trade facilitation
|Country||GDP per capita change ($)||GDP per capita change (%)|
Source: Wilson, Mann and Otsuki (2003)
Trade facilitation may have little of the glamour of headline-hitting trade talks, but recent research suggests that it packs a powerful economic punch. Moreover, it may be the best way and perhaps only way forward for the world trade system in today’s difficult political climate.
The views expressed here are the opinions of the authors. The underlying research was supported by the World Bank.
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