Politics, Business & Culture in the Americas

Trade and Productivity: Unclogging Transport

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During the past two decades, most countries in Latin America and the Caribbean made considerable progress in opening up their economies, particularly as a result of slashing tariffs and non-tariff barriers either unilaterally or through trade agreements. While this has led to more productive firms and economies, much work remains if the region wants to fully exploit the productivity gains from trade.

The transport sector offers perhaps the greatest potential. Expenses arising from transportation, customs and other types of regulations, generally known as trade facilitation, are among the region’s most expensive trade-related costs. Decades of underinvestment have left the transport infrastructure in shambles, and the goods that the region exports—whether they are natural resources or time-sensitive goods such as food and certain types of apparel—are highly “transport intensive,” meaning that transport costs make up a sizeable part of the final price.

These two factors conspire to turn such costs into arguably the most important obstacle to further increasing and deepening trade in the region.

The scope for reducing transport costs today, and the likelihood of productivity gains, is much higher than the benefits seen from further reductions to tariffs. Overall, a 10 percent reduction in transport costs would boost both intra-regional exports and the number of products exported by a far greater margin than a 10 percent tariff reduction. The median expansion in intra-regional exports would be almost five times larger than that from cutting tariffs. The median increase in the number of products exported to the region would be nine times larger.

For instance, if Chile were to reduce its average manufacturing tariff and freight rates to U.S. levels, the required fall in the average tariff would be only around 10 percent while the required reduction in freight costs would be more than 50 percent. The improvement in productivity arising from a better allocation of resources would be nearly three times higher than that triggered by the cut in tariffs.

This speaks volumes about the urgency to focus on transport costs if the region wants to get serious about fostering productivity through trade.

An international comparison of Latin America’s freight rates with those of other regions show that Chile is not an isolated case. For instance, while the average ad valorem freight rate of Latin America’s exports to the United States is around 6 percent, it is only about 3.7 percent in the European Union. This result is not explained by distance to the Southern Cone alone but also reflects the realities of countries in the Caribbean and Central America that are closer to the United States.

These figures illustrate that there is plenty of room to cut transport costs. The question is: what can governments do? After all, freight rates, unlike tariffs, are not just the product of bad policies alone. Factors such as geography or the composition of trade also matter.

Two important clues arise when looking at the differences in transport costs between Latin America and other regions. First, trade composition is important.The goods that the region imports and exports—particularly products such as mineral or agricultural goods—are considerably “heavier” than those of the United States or Europe.

Therefore, poor and costly transport infrastructure can severely undercut the rents that countries can extract from exporting their natural-resource-intensive goods, leaving less money on the table relative to other regions that specialize in less transport-intensive goods.

This alone serves as a powerful reminder of the strategic importance of transport infrastructure for Latin America and the Caribbean.

The second clue: factors like port efficiency or competition in transport services are key contributors to the higher freight rates observed in the region. For instance, inefficiencies in ports and airports generally explain about 40 percent of the difference in shipping costs between the region and the U.S. or Europe. For the typical Latin American country, improving port efficiency to the U.S. level would lower transport costs by about 20 percent.

These results suggest that there is no shortage of policy areas where the region can delve more deeply. For example, many countries have yet to adopt the successful regional and global experiences for port terminal concession contracts that have brought modern operation practices and higher berth productivity. Promoting investment to expand the limited current capacity of the port network in the region is imperative.

Regarding air transportation, many countries in Latin America still operate under dysfunctional bilateral agreements. Liberalized market access in other parts of the world, achieved through “open skies” agreements, have not been matched in the region. Modernizing custom procedures, facilitating border crossings and promoting investment and competition in logistic networks are also elements of this new trade agenda.

Trade liberalization has opened up many opportunities, but the almost exclusive focus on traditional trade barriers has meant that the region has missed out on substantial productivity gains in other sectors.

An all-out effort to revamp the transport infrastructure could unlock these gains and help the region close its still-sizeable productivity gap with the developed world.

Tags: Chile, trade, transportation policy
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