Written By: Dr. Zafar Mahmood
Trade costs, incurred locally and across the international borders, significantly affect international trade. Trade costs effectively form an important barrier to trade and thus impede the realization of gains from trade liberalization. Thus, any program of trade liberalization must take into account the role of trade costs. Owing to the importance of trade costs in explaining the size and direction of trade, experts are now increasingly focusing on its cost. Consequently, it has become an area of key interest within the modern stream of trade literature.
Global experience shows that countries that made concerted efforts to reduce trade costs have undoubtedly benefited, in terms of surge in their export earnings. Some of them have gained both comparative advantage and competitiveness and consequently are able to turn around their trade pattern.
One would like to ask a pertinent question, what exactly are the trade costs? They include all the costs incurred in getting goods to the final user, excluding the cost of producing the good itself. Hence, trade costs include transportation charges (both freight and time costs), policy barriers (tariffs and non-tariff barriers), information costs, contract enforcement costs, costs associated with the use of different currencies, local distribution costs (wholesale and retail) and legal and regulatory costs.
Sources of trade costs can be divided into two main categories. First category includes entirely bilateral factors of separation between the exporter and the importer, which are more dependent on factors like geographical distance, common border or sharing a common language than particular policy choices. The second category is composed of factors linked to international connectivity such as air or land or maritime transport services, tariffs and non-tariff measures, and other factors that facilitate or hinder trade.
Evidence shows that with growing multilateralism and regionalism in the world, countries have considerably reduced the tariff rates, on average less than five percent for rich countries, and with a few exceptions are on average between 10 to 20 percent for developing countries. With a drastic fall in tariffs on the one hand, there are, on the other hand, some other barriers to trade that are still hampering the trade performance. Most important amongst them are barriers relating to infrastructure and its quality.
Poor institutions and poor infrastructure distort strategic trade policy focus and objectives, not only in terms of the traditional mechanisms of tariffs and quotas but also of infrastructure and logistics, the so-called “behind the border issues.” Thus, besides the differences in economic size, technologies and factor endowments, the differences in trade costs, which act as a friction to trade, is an important reason as to why some countries trade more than others.
In an increasingly globalized and networked world, trade costs are of great importance from a trade policy perspective. This is because they act as a determinant of the pattern of bilateral trade and investment as well as of the geographical distribution of production. Moreover, they also determine a country’s ability to take part in regional and global production and supply chain networks. Many countries are eager to reap the benefits that such networks can bring, including trade and investment-linked technological spillovers and stronger employment demand in manufacturing industries. Understanding the sources of trade costs, and in particular the types of policies that can reduce such costs, is thus a key part of debate over production and supply chain networks going forward.
International trade costs are large and vary widely across countries and sectors. These costs are, in general, higher in developing countries than developed countries. This is mainly due to the existence of substantial tariffs and non-tariff measures accompanied by poor quality infrastructure, dysfunctional transport and logistics. Trade costs affect the balance between different sectors of an economy. Splitting up these costs help identify which area needs to be focused on in terms of policy decision. For example, if no account is made of trade costs and trade policy decision is solely based on comparative advantage then all resources will be diverted towards one particular sector at the expense of other sectors; thus creating a bias against other sectors of the economy.
Pakistan’s major trading partners are China, USA, UK, Saudi Arabia, Malaysia, Japan, Germany and UAE. EU has now emerged as Pakistan’s largest trading partner. Total trade between the two amounts to about $10 billion with Pakistan’s share in EU market of about 0.09% and the share of EU in Pakistani market is 11.39%. Pakistan also has strong trade ties with Asian countries like China, UAE, Saudi Arabia, and Malaysia. Main reason behind massive trade of Pakistan with Asian countries is lower transportation costs, similarities of consumer tastes and trading priorities.
The size of Pakistan’s current trade doesn’t truly reflect its full trade potential. This is mainly because the direction of Pakistan’s foreign trade, which is trade cost dependent, has not changed much over the time. Keeping in view the trade potential of Pakistan, it is imperative for Pakistan to pay serious attention to the issue of higher trade costs. Only then it will improve its position in global supply chain networks to realize the gains from international trade.
Trade cost estimates for Pakistan show a decline over the time. That is a good omen to realize the full trade potential of the country. The agricultur related trade costs are comparatively higher than non-agricultural, mainly due to the existence of policy barriers, including high tariffs and non-tariff barriers as well as trade related measures that hinder entry of imported agricultural products in the country. It is also because the processing and storage costs of agricultural commodities are higher than such costs for manufactured goods.
Reduction in trade costs can be attributed to improvement in port infrastructure and shipment. An index reflecting shipping connectivity for Pakistan shows an improvement from 19% in 2003 to 32% in 2012. As more than 95% of total freight trade of Pakistan is sea borne; thus, an improved and efficient port infrastructure that would reduce trade costs, would definitely promote trade.
Bilateral trade costs between Pakistan and UAE are the lowest, followed by Bangladesh, Saudi Arabia, Malaysia, UK and China, while the highest is with India.
Despite significant reduction in trade costs in recent times there remains a substantial room for lowering them further. High bilateral trade costs with some of the larger trading partners in particular calls for measures to reduce trade costs between trading partners. Thus, our policymakers need to address the dynamics of higher trade costs to improve country’s absolute and relative position in global trade.
Since higher trade costs lower the competitiveness of trade firms and limit the potential benefits of trade as well as impair trade prospects; it is, therefore, imperative for policymakers to take policy actions in the following direction to reduce trade costs:
• Effectively implement the commitments made in the WTO’s trade facilitation agreement, which Pakistan has recently signed; in particular by reducing red tape at the border crossing.
• Expedite clearance of all type of goods particularly perishable goods at border crossings.
• Improve port connectivity, cargo handling and means of transportation, i.e., through roads, railways and air links.
• Non-tariff barriers must be streamlined and harmonized with international standards.
• Reduce the cost effect of longer distance on trade with partner countries by developing soft connectivity through internet, publicity campaign and electronic media.
The writer is a Professor of Economics at School of Social Sciences and Humanities at NUST, Islamabad.