Potentials galore, so are barriers
conventional explanation that considers | Wednesday, 21 December 2011
conventional explanation that considers
The world economy is undergoing widespread changes and many countries are facing huge challenges in coping with these changes brought about by liberalisation and globalisation. One of the useful ways of meeting these challenges is to form mutually beneficial economic cooperation between and among neighbouring countries by making the best use of their comparative advantages and complementarities. This has resulted in the proliferation of trade blocs or regional integration agreements (RIA). More than 150 such trade blocs and RIAs have already been notified to the World Trade Organization. The concept of developing geographically and culturally contiguous zones, through economic cooperation, has also slowly gained acceptance in South Asia. The seven South Asian countries - Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka - formed the South Asian Association of Regional Cooperation (SAARC) in 1985, with Afghanistan joining as a new member recently, to promote active cooperation in the economic, social, cultural, technical and scientific fields in order to improve the quality of life of its members through accelerated economic growth and poverty reduction. The South Asian Preferential Trading Arrangement (SAPTA) was operationalised in 1995 to promote trade among SAARC member countries. Likewise, in 2004, a Framework Agreement on South Asian Free Trade Area (SAFTA) was signed to promote regional economic integration. The signing of this agreement has given a major thrust to the movement for regional integration in South Asia. Geographically, all the countries of the South Asian region, except Sri Lanka and the Maldives, are located in a single landmass making possible better economic integration. These countries are not only geographically contiguous but also culturally interlinked. The people of this region historically belong to similar cultures and a common heritage. However, the economic integration in the region is low, with only 5.5% of intra-regional trade, as explained in the following section. The question arises as to why regional economic integration is low in South Asia while it has been flourishing in many parts of the world. The conventional explanation that considers low trade complementarity as the major reason for low economic integration does not seem plausible. Had trade complementarity been the only reason for economic integration, trade between European Union (EU) countries (62% of total EU trade) could not have been so high. Experience from the EU and other regional economic arrangements suggest that trade complementarity is not the sole determinant of economic integration. It is important to understand the conditions constraining the promotion of economic cooperation in South Asia. A more clear understanding of the bottlenecks in promoting regional economic integration may help design appropriate policies and strategies to overcome them and create an enabling environment. Economics of regional economic integration: a conceptual framework The economic rationale for cooperation in an era of globalisation and multi-lateral trading system has often been raised in the literature on trade and development. Broadly, there are two diverging views. Believers of multilateralism argue that regional economic cooperation, particularly preferential trading arrangement can lead to 'trade diversion' by discrimination against non-member countries, which can divert import from low-cost foreign suppliers to high-cost regional partners and thereby reduce national welfare. Moreover, regional trading arrangements can detract from true liberalisation by creating protection against non-member countries and fragment the global trading system, which is quite opposite to economic sense. On the other hand, advocates of regional arrangement consider the above argument too narrow and put forward numerous arguments in favour of regional economic integration, highlighting its benefits. They argue that regional economic integration not only creates 'trade diversion' but also results in 'trade creation' by facilitating cross-border trade and involving small and medium entrepreneurs, which can generate welfare gain for all trading partners. Whether it creates or diverges the trade depends on many factors including competition, openness, complementarity, proximity, market size, and geographical and political unity. If regional trading arrangements are formed among natural trading partners, it creates more trade and brings welfare of member nations through more efficient resource allocation. They consider preferential regional trade arrangement as a "building block" rather than a "stumbling block" to a more liberalized global economy. Trade between geographically contiguous countries has the advantage of lower transaction costs because of proximity of markets, availability of common infrastructure, and such cultural factors as common language, customs and consumption patterns. Low transport cost facilitates more trade between neighbouring countries and thereby reinforces trade creation rather than artificially diverting them. Because of this advantage, almost 60% of the world trade is presently carried out within regional blocks on a preferential basis. Regional economic cooperation can enhance economies of scale in production through facilitating specialisation, reducing monopolies, expanding markets and thereby can reduce production cost and enhance the welfare of a nation. It can also contribute to reducing poverty through higher investments, generation of employment, increased mobility and reduced prices of consumer goods. Economic integration can also enhance the ability of its member countries to deal better with the global system of trade, finance and the ability to cope with the challenges of globalization. At the same time, regional integration can create a better climate for resolving internal differences and enhancing mutual trust to address common problems. Forming regional economic blocs also increases the potential for more productive use and management of shared resources like rivers, fishing areas, railways, hydroelectric power facilities, transportation and tourism. Despite the many benefits of regional economic integration, why has integration among different regional blocs particularly in SAARC countries which are geographically contiguous and culturally integrated, been slow? Some scholars do not agree that geographical proximity and cultural unity are the major determinants of regional integration. Rather, they consider comparative advantage as the primary determinant of regional integration. Thus, low trade complementarity and limited comparative advantage are the primary factors responsible for low level of economic integration among SAARC countries. A number of scholars, however, argue that trade complementarity is not enough for deeper economic integration. Physical and institutional conditions (such as roads, transport, communication) and rules and regulations that control and regulate movement of cross-border goods, services and people are equally important. Despite high complementarity, trade may not happen given unfavorable physical and institutional environment. Again, deeper integration may happen with limited complementarity given a better environment such as it happens in Western Europe. Differences in transport costs can also affect the volume and composition of trade. Trade complementarity, therefore, is not the only determinant of economic integration; trade facilities including physical and institutional conditions, particularly trade costs are also important. Status of economic integration under SAARC Despite commonalities and geographic proximities, the status of regional economic integration in the South Asia region seems poor. The volume of trade among SAARC countries is extremely low and the share of intra-regional trade to total trade is minimal. Total intra-regional trade is USD 10.7 billion, which is only 5.5% of its total trade. Both imports from and exports to the member countries amount to USD 5.0 billion. Compared to the SAARC's global trade figures, intra-regional imports and exports constitute only 4.7% and 6.4% of total imports and exports, respectively. The low level of intra-regional trade, however, does not mean low trade complementarities or true potential of regional trade. As explained below formal trade is a small part of total trade; there is huge informal trade in South Asia. Although total intra-regional trade volume is low, landlocked mountainous countries such as Bhutan and Nepal have significant intra-regional trade primarily with India. Out of Bhutan's imports worth USD 386 million, 75.6% is from SAARC countries. Likewise, almost all (99%) of its exports are in the region. Some 53.6% of Nepal's imports are from within the region and 53.8% of exports are exported within the region. The Maldives, Bangladesh and Sri Lanka also have considerable amount of their imports dependent on regional member countries ranging from 18%-24%. However, their exports within the region are insignificant (2%-14%) of their total exports. Afghanistan's trade with SAARC countries, is 44%. Therefore, for smaller economies intra-SAARC trade is significant (RIS, 2008). The intra-regional trade of the two largest economies in the region - India and Pakistan - remains very low. India's import from the region is less than 1% and export also less than 7%. Pakistan's trade within the region is around 3% of its total trade. The volume of intra-regional trade of SAARC countries as a percentage of its total trade is probably one of the lowest among the world's regional economic groupings. While intra-EU trade is 64.5%, intra-NAFTA trade is 45.8%, and intra-ASEAN trade 22%, intra-SAARC trade is only 5.5%. While formal trade remains low: A large volume of informal trade has been going on among SAARC countries. Although there are no accurate statistics, some studies suggest that the volume of informal trade could be up to twice as large as the formal trade. Rampant informal trade is taking place in South Asia through gateway third countries. The informal trade between India and Pakistan alone is USD 3 billion and a large part of informal trade takes place through third party or gateway countries such as Dubai or Singapore. Recent studies suggest that if the informal trade is taken into account the volume of intra-regional trade would appear considerable. Recently, after signing SAFTA, intra-SAARC trade has increased slightly. Bangladesh, Pakistan and Sri Lanka's export to the SAARC region has increased significantly in 2005 and 2006 compared to 2004. India's export also increased considerably to about one-fifth though Afghanistan, the Maldives and Nepal's export growth has remained small. Potential for regional economic integration in S Asia The analysis of the previous section shows that intra-regional trade in South Asia is relatively low. This raises questions about the potential of trade and economic integration in South Asia. Although early studies were pessimistic about regional economic integration in the region due to low trade complementarity, a number of recent studies demonstrate that trade complementarity among the SAARC countries has increased in the last two decades due to changes in the production structure in different countries. Based on developing a trade complementarity index, a recent study by ADB and UNCTAD (2008) shows that trade complementarity among SAARC countries has increased considerably since 1991. Except for Pakistan, trade complementarities among Bangladesh, India and Sri Lanka viz-a-viz SAARC has increased considerably compared to 1991. This suggests increased opportunities for intra-regional trade in the SAARC region. The growing trade potential, however, has remained largely unutilised for several reasons explained in the next section. Using the gravity model, a recent study conducted by RIS (2008) shows that about 74 % of the potential of intra-regional trade has remained unutilised (Table 4). A study conducted by the State Bank of Pakistan, reported that in 2004 about one-third of Pakistan's export products were bought by India and had come through third countries, with higher prices. Similarly, Pakistan bought about US$15 billion worth of Indian goods through these so-called third countries. About 50% of those goods' prices were higher than the export value of India. It is estimated that Pakistan was losing US$400-900 million by importing those items from other sources. Pakistan and India are thereby incurring huge economic losses due to trade restrictions and trying to recover these losses by passing it on to its citizens through higher prices. Besides the potential for promoting intra-regional trade in goods, there is potential for cooperation in trade services, which is currently beyond the scope of SAFTA. Economic cooperation can help SAARC countries better harness and utilise the available natural resources as well as better adapt with the growing water stresses due to climate change. For example, South Asia, while endowed with ample water resources continues to suffer annually from both floods and droughts and faces an increasing shortage in potable and irrigation water. Greater regional cooperation in the utilisation and harnessing of transboundary rivers (such as the Ganges, the Brahmaputra, the Indus and the Meghna) can offer a long-term solution to flood mitigation as well as address water problems and other issues that cannot be addressed satisfactorily by countries acting independently. The benefits of cooperation on water, climate issues, and energy would be immense. Problems in regional economic integration Several factors constrain cross-border regional economic cooperation, transportation and communication being the vital ones. With a focus on regional infrastructure and transport network, this section highlights tariff and non-tariff barriers and administrative rules and regulations that govern the movement of goods, services, and people. Physical barriers Transport cost being the significant determinant of trade competitiveness the restricted utilisation of existing railroad and road networks in the region are explained as key physical barriers to economic cooperation. The main advantage of a regional trading arrangement is relatively low trade costs given the proportion of transport and insurance costs to total export volume. Generally, proximity and contiguity, which make surface transportation possible, help in the efficient movement of goods and services that reduces trade cost and increases trade competitiveness. Nevertheless, for various historical, political and economic reasons, surface transport in South Asia has remained fragmented despite existing rail and road networks. Poor rail connectivity Among the countries of South Asia, Bangladesh, India and Pakistan have extensive railroad networks within their respective countries. While Nepal also has a 59-km railroad network, Bhutan has no railway network. Between India and Bangladesh, the broad gauge connection is through Gede (India)-Darsana (Bangladesh) and another meter gauge connection is through Mahishasan (India)-Shahbazpur (Bangladesh). There is also a compatible railway system between Bangladesh and Nepal for cargo movement to Mongla port, Khulna, Bangladesh, using the Kathihar-Smghabad and Rohanpur railway line. Before the partition of India in 1947, the major intra sub-continental movements of goods and services used to be carried out mainly by railways. Although these physical links are still there, very little cross-border movement by rail is taking place these days for different reasons. Following the 1965 war, the railway connection between India and Pakistan has been disrupted. Similarly, the railway network for trade between Bangladesh and Nepal could not be used due to lack of agreement to allow Nepalese third country trade via India. As a result, Nepal has to incur relatively high freight costs due to congestion in Kolkata (India) port. No container trains run between India and Pakistan and between India and Bangladesh. As a result, it takes 45 days to transport a container from Delhi (India) to Dhaka (Bangladesh) as the container has to move via Singapore, which otherwise could have been in just two to three days by rail involving a distance of around 2000 km. However, passenger train services have resumed recently between India and Pakistan: the Samjhauta (Friendship) Express runs twice a week connecting Lahore (Pakistan) with Atari (India) and another link was established along the Karachi-Khokrapur-Munabao route that runs only once a week. Poor road connectivity In South Asia, road transport is dominant and its importance is growing in all countries. Most of the trade between India and its neighboring countries of Bangladesh, Bhutan and Nepal takes place along land routes. However, no goods movement by road is allowed between India and Pakistan. The border between India and Bangladesh has ten road-based check posts. But all freight traffic by road to and from Bangladesh need trans-shipment at the border as trucks from other countries are not allowed to travel on the road networks of Bangladesh due to differences in the axle load limit Similarly, India does not allow Bangladeshi trucks to travel to India. The trade agreement between India and Nepal has a list of 22 border posts for the movement of goods between the two countries and 15 are authorized for transit traffic (ADB 2006 b). Out of these, only six are consistently being used as low traffic because India's territory is limited to fixed hours of the day. India allows "Kakarvitta (Nepal)-Panitanki (India) - Fulbari (India) - Banglabandha (Bangladesh)" corridor for only bilateral trade between Nepal and Bangladesh. Currently, the level of traffic in this route is very low (less than four trucks per week) as third country trade is not allowed through this route (Rahmatullah, 2006). The roads in Bhutan are in good condition, but their narrowness and winding nature do not allow high speeds or axle loads. As a result, goods are normally transported within the country by trucks with capacities below 10 tons, which incur additional costs. India allows trucks from Nepal and Bhutan to operate on designated transit routes within India. However, Nepalese trucks need permit for every trip to India, and their validity is only for three months. Renewing the permit incurs additional time and costs. India permitted Bhutan to use Phuntsholing (Bhutan)-Changrabandha (India)-Burimari (Bangladesh) for its trade with Bangladesh. However, this corridor is not allowed for third country trade and Bhutanese third country trade faces congestion problems at Kolkata (India) port. Passenger movement by road and rail is poor in South Asia due to poor cross-border connectivity. Bus services between India-Bangladesh, and India-Pakistan, are operating on a very limited scale. Poor transportation and communication, as illustrated above, imposes direct costs on cross-border trade and thus limits the ability of landlocked country products to compete in the global markets. For example, the southern border of Tripura (India) is only 75 km away from Chittagong (Bangladesh) port. As access for Indian goods is not allowed at Chittagong port; goods from Tripura have to cross 1,645 km to reach Kolkata. The trans-shipment of freight traffic by road at the borders of the neighbouring countries incurs additional trade costs. For instance, a truck from Kathmandu (Nepal) to Dhaka (Bangladesh) requires four to five days to cover a distance of just 1,194 kilometres due to trans-shipment and delays in custom procedures (Subramanin and Arnold, 2001). Transferring cargo at borders not only requires additional time and money, it also causes damage to goods. Poor maintenance of cross-country infrastructure also increases transport costs in freight movement. As a result, average transport cost is relatively high in cross-border trade. The average transport cost on the Kolkata-Petrapole route between India and Bangladesh, for example, is 40% higher than on other highways. Policy barriers Tariff barriers Tariff plays an important role in regional and international trade. During the last few decades, South Asian countries have been liberalising the trade regime and moving their economies away from protectionism towards greater trade openness and global economic integration. Under SAPTA, efforts have been made to reduce tariff since 1990. Although tariff has been reduced considerably to certain products under the SAPTA initiative, the overall tariff rate is still high Although very recently some improvement has been made in trade liberalisation under SAFTA whose implementation started in July 2006, tariff negotiation has moved from product-based to negative lists and other procedures such as rules of origin; sensitive lists are being negotiated, but much improvement has not taken place in terms of trade liberalisation as the negative list has remained long. Non-tariff and para-tariff barriers Like tariff, non-tariff and para-tariffs barriers are also significantly high in South Asia. Although Article 3 of the SAFTA Agreement clearly states that "SAFTA shall involve free movement of goods between countries through, inter alia, the elimination of tariffs, para-tariffs, and non-tariff restrictions on the movement of goods, and other equivalent measures" the issue of non-tariff and para-tariff barriers had not been addressed significantly. Non-tariff and para-tariff barriers are lowest in the mountain states of Bhutan and Nepal. While Nepal has limited para-tariff barriers, Bhutan has none of these barriers. Bangladesh, India, Pakistan and Sri Lanka have different non-tariff and para-tariff barriers. For example, importers of North East India have to go to Kolkata to fulfill banking formalities for imports from Bangladesh. Likewise, Bangladesh has also imposed restrictions on certain importable items from India in terms of specified entry points. India has granted Most Favoured Nation (MFN) status to Pakistan, but Pakistan has yet to reciprocate this. The Pakistani authorities, on the other hand, claim that Indian customs authorities are biased against Pakistani consignments and are thus denying market access to Pakistani goods in India. Administrative Barriers Besides poor infrastructure and tariff and non-tariff barriers, considerable difficulties exist in cross-border trade in South Asia resulting into high trade costs due to administrative rules, regulations and procedures involved. Limited transportation routes, poor infrastructure facilities, non-availability of rail wagons, and procedural clearances, impose high administrative burden and transaction costs in cross-border trade. Existing procedures and formalities for cross-border movement of goods in South Asia are cumbersome, time consuming, and obstructive. As a result, the average time to move an export container to the nearest port, fulfilling all customs, administrative, and port requirements is much higher in South Asian countries compared to the East Asian countries. Not only international trade but also regional trade takes inordinately longer time. The average time required to clear goods with Indian and Bangladeshi customs is about three times the length of time goods are moved around in the developed world. Most of the delays occur at the border crossings for custom clearance, fulfilling other formalities, and trans-shipment. Border-crossing problems arise because of the distance of customs clearance centres from the border; lack of storage, loading, unloading; and lack of transshipment facilities. For instance, the sanitary and phyto-sanitary testing laboratory in Kolkata (India) is 1000 km away from the customs facility at Birgunj (Nepal). As such, exporters have to wait for weeks for test results and in the process pay additional fees while vehicles are detained. The problem is exacerbated by complicated procedures and Continued from page 16 lack of efficient customs operations, including lack of transparency of procedures for inspection, informal payments and inadequate preparation of customs document by the exporters. At least 22 documents are required for cross-border trade. The main reasons for high transaction costs in Indo-Nepalese and Indo-Bangladeshi trade are delays caused by complex customs and transit procedures. The complicated procedures furthermore provide opportunities for corruption. To expedite the process, the traders often bribe the concerned authorities. Because of these difficulties, intra-regional trade and investment remains far below the potential level. Mountainous countries like Nepal and Bhutan suffered the most as they have to completely depend on their neighbouring countries' infrastructure for their export/import. Discussion and conclusion Although South Asian countries made a major thrust for economic integration, the pace of its implementation remains slow. Against the conventional explanation given by economists, this study reveals that low trade complementarity is not the only reason for a low level of economic integration in South Asia. Recent studies suggest that there are significant potentials for promoting intra-regional trade and economic cooperation. Between India and Pakistan alone, there is a potential for a five billion dollar trade. But current trade between the two countries is 70% percent lower than that of two other similar economies. The study reveals that intra-regional trade does not solely depend on complementarity. Many other factors including tariff and non-tariff barriers, physical infrastructure, transport and communication facilities and administrative rules and regulations play important roles in intra-regional trade. Despite good intentions and efforts, South Asian countries have failed to create a conducive environment for regional trade. Although, with the efforts of SAPTA, customs duties and import tariffs have been reduced recently, non-tariff and para-tariff barriers are still high. The four major economies in the region - India, Pakistan, Bangladesh, and Sri Lanka have maintained different non-tariff and para-tariff barriers which has hindered intra-regional trade significantly. Besides tariff and non-tariff barriers, considerable difficulties exist due to administrative rules, regulations and procedures involved in intra-regional trade in South Asia. Existing procedures and formalities for cross-border movement of goods are cumbersome, time consuming, and obstructive, which have increased trade costs and encouraged informal trade. The huge amount of informal trade going on in the region is a clear indication. Promotion of trade not only depends on the tariff liberalisation but also on the quality of infrastructure and logistic facilities. Transportation and communication is vital for trans-border regional trade. While the main advantage of regional trade is low trade costs, due to relatively low transport cost, it is not true in case of South Asia. Trade costs are relatively higher because of weak infrastructure, poor transportation network and weak logistic facilities and corruption. The problem of transportation of goods has been further compounded by poorly maintained cross-border transport connectivity. As a result, there is always excessive delay in cross-border transportation. This has been further reinforced by the lack of logistic facilities such as equipment, parking and storage facilities, internal container depots and trans-shipment facilities at cross-border points. Lack of transit facilities through the neighbouring countries to access the nearest port or market centres has further thwarted intra-regional trade by increasing trade cost. In some cases, this increases trade cost up to 60%. The trade cost has been further increased by the policy of not allowing trucks of neighbouring countries which require trans-shipment at the border. Transport bottlenecks not only inhibit trade but also inhibit movement of people including inter-regional and international tourists as well as inhibit investment and other economic and social collaboration. South Asian countries are losing on many fronts due to non-cooperation. Trade and investment goes hand-in-hand. Had South Asian countries been able to strengthen economic integration, it could have used and managed the shared resources like rivers, fishing areas, railways and hydroelectric power facilities, transportation, and tourism in a more productive way. Regional cooperation can also help tap oil and gas resources available just outside South Asia to manage its energy and power needs more efficiently. For example, supplying power from Pakistan's national electricity grid to neighbouring power deficient Indian states or supplying Bangladeshi gas to the power-deficient industrial Kolkata (India) could pave the way for economic growth and opening up long-term regional energy trade and investment in the region. For deeper economic integration to take place, it is necessary to create an enabling environment by removing physical, institutional and policy as well as administrative barriers. It is necessary to expand transport and communication infrastructure and harmonize rail and road systems. Transit facilities need to be given to neighbouring countries across the territories of the member countries. To promote improved connectivity, South Asian countries should come up with a common transport policy with a comprehensive framework for optimum utilisation of common facilities and to improve connectivity. Along with developing physical and institutional facilities, it is also important to change the mindset of policy makers. South Asian countries have often overemphasised political sensitivities over economic rationality. While political harmony is a pre-requisite for economic integration, it is important to understand that economic cooperation and political harmony are mutually reinforcing. Experiences from Asia and elsewhere suggest that the movement of people across countries and economic interdependence can create a better climate for dismantling walls of distrust and creating a better climate for resolving political differences. Looking at the experiences from other regions, South Asian countries also need to further their cooperation in order to widen economic opportunities for the region's people. It is time to move beyond the traditional commodity trade and harness the benefits of economic cooperation in areas such as infrastructure, transportation, communications, hydropower, power sharing, and manpower development. Labour and capital markets also need to be integrated and developed. For this, an integrated approach is needed towards removing physical, institutional, and policy and administrative barriers in order to facilitate trade and economic cooperation, one that promotes regional economic integration and justifies its potentials. ........................................................... The write-up is an abridged version of an article, titled Regional Economic Integration is South Asia: Challenges and opportunities. Mr. Golam Rasul is head, economic analysis division, International Centre for Integrated Mountain Development, Kathmandu, Nepal. He can be reached at [email protected]
The world economy is undergoing widespread changes and many countries are facing huge challenges in coping with these changes brought about by liberalisation and globalisation. One of the useful ways of meeting these challenges is to form mutually beneficial economic cooperation between and among neighbouring countries by making the best use of their comparative advantages and complementarities. This has resulted in the proliferation of trade blocs or regional integration agreements (RIA). More than 150 such trade blocs and RIAs have already been notified to the World Trade Organization. The concept of developing geographically and culturally contiguous zones, through economic cooperation, has also slowly gained acceptance in South Asia. The seven South Asian countries - Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka - formed the South Asian Association of Regional Cooperation (SAARC) in 1985, with Afghanistan joining as a new member recently, to promote active cooperation in the economic, social, cultural, technical and scientific fields in order to improve the quality of life of its members through accelerated economic growth and poverty reduction. The South Asian Preferential Trading Arrangement (SAPTA) was operationalised in 1995 to promote trade among SAARC member countries. Likewise, in 2004, a Framework Agreement on South Asian Free Trade Area (SAFTA) was signed to promote regional economic integration. The signing of this agreement has given a major thrust to the movement for regional integration in South Asia. Geographically, all the countries of the South Asian region, except Sri Lanka and the Maldives, are located in a single landmass making possible better economic integration. These countries are not only geographically contiguous but also culturally interlinked. The people of this region historically belong to similar cultures and a common heritage. However, the economic integration in the region is low, with only 5.5% of intra-regional trade, as explained in the following section. The question arises as to why regional economic integration is low in South Asia while it has been flourishing in many parts of the world. The conventional explanation that considers low trade complementarity as the major reason for low economic integration does not seem plausible. Had trade complementarity been the only reason for economic integration, trade between European Union (EU) countries (62% of total EU trade) could not have been so high. Experience from the EU and other regional economic arrangements suggest that trade complementarity is not the sole determinant of economic integration. It is important to understand the conditions constraining the promotion of economic cooperation in South Asia. A more clear understanding of the bottlenecks in promoting regional economic integration may help design appropriate policies and strategies to overcome them and create an enabling environment. Economics of regional economic integration: a conceptual framework The economic rationale for cooperation in an era of globalisation and multi-lateral trading system has often been raised in the literature on trade and development. Broadly, there are two diverging views. Believers of multilateralism argue that regional economic cooperation, particularly preferential trading arrangement can lead to 'trade diversion' by discrimination against non-member countries, which can divert import from low-cost foreign suppliers to high-cost regional partners and thereby reduce national welfare. Moreover, regional trading arrangements can detract from true liberalisation by creating protection against non-member countries and fragment the global trading system, which is quite opposite to economic sense. On the other hand, advocates of regional arrangement consider the above argument too narrow and put forward numerous arguments in favour of regional economic integration, highlighting its benefits. They argue that regional economic integration not only creates 'trade diversion' but also results in 'trade creation' by facilitating cross-border trade and involving small and medium entrepreneurs, which can generate welfare gain for all trading partners. Whether it creates or diverges the trade depends on many factors including competition, openness, complementarity, proximity, market size, and geographical and political unity. If regional trading arrangements are formed among natural trading partners, it creates more trade and brings welfare of member nations through more efficient resource allocation. They consider preferential regional trade arrangement as a "building block" rather than a "stumbling block" to a more liberalized global economy. Trade between geographically contiguous countries has the advantage of lower transaction costs because of proximity of markets, availability of common infrastructure, and such cultural factors as common language, customs and consumption patterns. Low transport cost facilitates more trade between neighbouring countries and thereby reinforces trade creation rather than artificially diverting them. Because of this advantage, almost 60% of the world trade is presently carried out within regional blocks on a preferential basis. Regional economic cooperation can enhance economies of scale in production through facilitating specialisation, reducing monopolies, expanding markets and thereby can reduce production cost and enhance the welfare of a nation. It can also contribute to reducing poverty through higher investments, generation of employment, increased mobility and reduced prices of consumer goods. Economic integration can also enhance the ability of its member countries to deal better with the global system of trade, finance and the ability to cope with the challenges of globalization. At the same time, regional integration can create a better climate for resolving internal differences and enhancing mutual trust to address common problems. Forming regional economic blocs also increases the potential for more productive use and management of shared resources like rivers, fishing areas, railways, hydroelectric power facilities, transportation and tourism. Despite the many benefits of regional economic integration, why has integration among different regional blocs particularly in SAARC countries which are geographically contiguous and culturally integrated, been slow? Some scholars do not agree that geographical proximity and cultural unity are the major determinants of regional integration. Rather, they consider comparative advantage as the primary determinant of regional integration. Thus, low trade complementarity and limited comparative advantage are the primary factors responsible for low level of economic integration among SAARC countries. A number of scholars, however, argue that trade complementarity is not enough for deeper economic integration. Physical and institutional conditions (such as roads, transport, communication) and rules and regulations that control and regulate movement of cross-border goods, services and people are equally important. Despite high complementarity, trade may not happen given unfavorable physical and institutional environment. Again, deeper integration may happen with limited complementarity given a better environment such as it happens in Western Europe. Differences in transport costs can also affect the volume and composition of trade. Trade complementarity, therefore, is not the only determinant of economic integration; trade facilities including physical and institutional conditions, particularly trade costs are also important. Status of economic integration under SAARC Despite commonalities and geographic proximities, the status of regional economic integration in the South Asia region seems poor. The volume of trade among SAARC countries is extremely low and the share of intra-regional trade to total trade is minimal. Total intra-regional trade is USD 10.7 billion, which is only 5.5% of its total trade. Both imports from and exports to the member countries amount to USD 5.0 billion. Compared to the SAARC's global trade figures, intra-regional imports and exports constitute only 4.7% and 6.4% of total imports and exports, respectively. The low level of intra-regional trade, however, does not mean low trade complementarities or true potential of regional trade. As explained below formal trade is a small part of total trade; there is huge informal trade in South Asia. Although total intra-regional trade volume is low, landlocked mountainous countries such as Bhutan and Nepal have significant intra-regional trade primarily with India. Out of Bhutan's imports worth USD 386 million, 75.6% is from SAARC countries. Likewise, almost all (99%) of its exports are in the region. Some 53.6% of Nepal's imports are from within the region and 53.8% of exports are exported within the region. The Maldives, Bangladesh and Sri Lanka also have considerable amount of their imports dependent on regional member countries ranging from 18%-24%. However, their exports within the region are insignificant (2%-14%) of their total exports. Afghanistan's trade with SAARC countries, is 44%. Therefore, for smaller economies intra-SAARC trade is significant (RIS, 2008). The intra-regional trade of the two largest economies in the region - India and Pakistan - remains very low. India's import from the region is less than 1% and export also less than 7%. Pakistan's trade within the region is around 3% of its total trade. The volume of intra-regional trade of SAARC countries as a percentage of its total trade is probably one of the lowest among the world's regional economic groupings. While intra-EU trade is 64.5%, intra-NAFTA trade is 45.8%, and intra-ASEAN trade 22%, intra-SAARC trade is only 5.5%. While formal trade remains low: A large volume of informal trade has been going on among SAARC countries. Although there are no accurate statistics, some studies suggest that the volume of informal trade could be up to twice as large as the formal trade. Rampant informal trade is taking place in South Asia through gateway third countries. The informal trade between India and Pakistan alone is USD 3 billion and a large part of informal trade takes place through third party or gateway countries such as Dubai or Singapore. Recent studies suggest that if the informal trade is taken into account the volume of intra-regional trade would appear considerable. Recently, after signing SAFTA, intra-SAARC trade has increased slightly. Bangladesh, Pakistan and Sri Lanka's export to the SAARC region has increased significantly in 2005 and 2006 compared to 2004. India's export also increased considerably to about one-fifth though Afghanistan, the Maldives and Nepal's export growth has remained small. Potential for regional economic integration in S Asia The analysis of the previous section shows that intra-regional trade in South Asia is relatively low. This raises questions about the potential of trade and economic integration in South Asia. Although early studies were pessimistic about regional economic integration in the region due to low trade complementarity, a number of recent studies demonstrate that trade complementarity among the SAARC countries has increased in the last two decades due to changes in the production structure in different countries. Based on developing a trade complementarity index, a recent study by ADB and UNCTAD (2008) shows that trade complementarity among SAARC countries has increased considerably since 1991. Except for Pakistan, trade complementarities among Bangladesh, India and Sri Lanka viz-a-viz SAARC has increased considerably compared to 1991. This suggests increased opportunities for intra-regional trade in the SAARC region. The growing trade potential, however, has remained largely unutilised for several reasons explained in the next section. Using the gravity model, a recent study conducted by RIS (2008) shows that about 74 % of the potential of intra-regional trade has remained unutilised (Table 4). A study conducted by the State Bank of Pakistan, reported that in 2004 about one-third of Pakistan's export products were bought by India and had come through third countries, with higher prices. Similarly, Pakistan bought about US$15 billion worth of Indian goods through these so-called third countries. About 50% of those goods' prices were higher than the export value of India. It is estimated that Pakistan was losing US$400-900 million by importing those items from other sources. Pakistan and India are thereby incurring huge economic losses due to trade restrictions and trying to recover these losses by passing it on to its citizens through higher prices. Besides the potential for promoting intra-regional trade in goods, there is potential for cooperation in trade services, which is currently beyond the scope of SAFTA. Economic cooperation can help SAARC countries better harness and utilise the available natural resources as well as better adapt with the growing water stresses due to climate change. For example, South Asia, while endowed with ample water resources continues to suffer annually from both floods and droughts and faces an increasing shortage in potable and irrigation water. Greater regional cooperation in the utilisation and harnessing of transboundary rivers (such as the Ganges, the Brahmaputra, the Indus and the Meghna) can offer a long-term solution to flood mitigation as well as address water problems and other issues that cannot be addressed satisfactorily by countries acting independently. The benefits of cooperation on water, climate issues, and energy would be immense. Problems in regional economic integration Several factors constrain cross-border regional economic cooperation, transportation and communication being the vital ones. With a focus on regional infrastructure and transport network, this section highlights tariff and non-tariff barriers and administrative rules and regulations that govern the movement of goods, services, and people. Physical barriers Transport cost being the significant determinant of trade competitiveness the restricted utilisation of existing railroad and road networks in the region are explained as key physical barriers to economic cooperation. The main advantage of a regional trading arrangement is relatively low trade costs given the proportion of transport and insurance costs to total export volume. Generally, proximity and contiguity, which make surface transportation possible, help in the efficient movement of goods and services that reduces trade cost and increases trade competitiveness. Nevertheless, for various historical, political and economic reasons, surface transport in South Asia has remained fragmented despite existing rail and road networks. Poor rail connectivity Among the countries of South Asia, Bangladesh, India and Pakistan have extensive railroad networks within their respective countries. While Nepal also has a 59-km railroad network, Bhutan has no railway network. Between India and Bangladesh, the broad gauge connection is through Gede (India)-Darsana (Bangladesh) and another meter gauge connection is through Mahishasan (India)-Shahbazpur (Bangladesh). There is also a compatible railway system between Bangladesh and Nepal for cargo movement to Mongla port, Khulna, Bangladesh, using the Kathihar-Smghabad and Rohanpur railway line. Before the partition of India in 1947, the major intra sub-continental movements of goods and services used to be carried out mainly by railways. Although these physical links are still there, very little cross-border movement by rail is taking place these days for different reasons. Following the 1965 war, the railway connection between India and Pakistan has been disrupted. Similarly, the railway network for trade between Bangladesh and Nepal could not be used due to lack of agreement to allow Nepalese third country trade via India. As a result, Nepal has to incur relatively high freight costs due to congestion in Kolkata (India) port. No container trains run between India and Pakistan and between India and Bangladesh. As a result, it takes 45 days to transport a container from Delhi (India) to Dhaka (Bangladesh) as the container has to move via Singapore, which otherwise could have been in just two to three days by rail involving a distance of around 2000 km. However, passenger train services have resumed recently between India and Pakistan: the Samjhauta (Friendship) Express runs twice a week connecting Lahore (Pakistan) with Atari (India) and another link was established along the Karachi-Khokrapur-Munabao route that runs only once a week. Poor road connectivity In South Asia, road transport is dominant and its importance is growing in all countries. Most of the trade between India and its neighboring countries of Bangladesh, Bhutan and Nepal takes place along land routes. However, no goods movement by road is allowed between India and Pakistan. The border between India and Bangladesh has ten road-based check posts. But all freight traffic by road to and from Bangladesh need trans-shipment at the border as trucks from other countries are not allowed to travel on the road networks of Bangladesh due to differences in the axle load limit Similarly, India does not allow Bangladeshi trucks to travel to India. The trade agreement between India and Nepal has a list of 22 border posts for the movement of goods between the two countries and 15 are authorized for transit traffic (ADB 2006 b). Out of these, only six are consistently being used as low traffic because India's territory is limited to fixed hours of the day. India allows "Kakarvitta (Nepal)-Panitanki (India) - Fulbari (India) - Banglabandha (Bangladesh)" corridor for only bilateral trade between Nepal and Bangladesh. Currently, the level of traffic in this route is very low (less than four trucks per week) as third country trade is not allowed through this route (Rahmatullah, 2006). The roads in Bhutan are in good condition, but their narrowness and winding nature do not allow high speeds or axle loads. As a result, goods are normally transported within the country by trucks with capacities below 10 tons, which incur additional costs. India allows trucks from Nepal and Bhutan to operate on designated transit routes within India. However, Nepalese trucks need permit for every trip to India, and their validity is only for three months. Renewing the permit incurs additional time and costs. India permitted Bhutan to use Phuntsholing (Bhutan)-Changrabandha (India)-Burimari (Bangladesh) for its trade with Bangladesh. However, this corridor is not allowed for third country trade and Bhutanese third country trade faces congestion problems at Kolkata (India) port. Passenger movement by road and rail is poor in South Asia due to poor cross-border connectivity. Bus services between India-Bangladesh, and India-Pakistan, are operating on a very limited scale. Poor transportation and communication, as illustrated above, imposes direct costs on cross-border trade and thus limits the ability of landlocked country products to compete in the global markets. For example, the southern border of Tripura (India) is only 75 km away from Chittagong (Bangladesh) port. As access for Indian goods is not allowed at Chittagong port; goods from Tripura have to cross 1,645 km to reach Kolkata. The trans-shipment of freight traffic by road at the borders of the neighbouring countries incurs additional trade costs. For instance, a truck from Kathmandu (Nepal) to Dhaka (Bangladesh) requires four to five days to cover a distance of just 1,194 kilometres due to trans-shipment and delays in custom procedures (Subramanin and Arnold, 2001). Transferring cargo at borders not only requires additional time and money, it also causes damage to goods. Poor maintenance of cross-country infrastructure also increases transport costs in freight movement. As a result, average transport cost is relatively high in cross-border trade. The average transport cost on the Kolkata-Petrapole route between India and Bangladesh, for example, is 40% higher than on other highways. Policy barriers Tariff barriers Tariff plays an important role in regional and international trade. During the last few decades, South Asian countries have been liberalising the trade regime and moving their economies away from protectionism towards greater trade openness and global economic integration. Under SAPTA, efforts have been made to reduce tariff since 1990. Although tariff has been reduced considerably to certain products under the SAPTA initiative, the overall tariff rate is still high Although very recently some improvement has been made in trade liberalisation under SAFTA whose implementation started in July 2006, tariff negotiation has moved from product-based to negative lists and other procedures such as rules of origin; sensitive lists are being negotiated, but much improvement has not taken place in terms of trade liberalisation as the negative list has remained long. Non-tariff and para-tariff barriers Like tariff, non-tariff and para-tariffs barriers are also significantly high in South Asia. Although Article 3 of the SAFTA Agreement clearly states that "SAFTA shall involve free movement of goods between countries through, inter alia, the elimination of tariffs, para-tariffs, and non-tariff restrictions on the movement of goods, and other equivalent measures" the issue of non-tariff and para-tariff barriers had not been addressed significantly. Non-tariff and para-tariff barriers are lowest in the mountain states of Bhutan and Nepal. While Nepal has limited para-tariff barriers, Bhutan has none of these barriers. Bangladesh, India, Pakistan and Sri Lanka have different non-tariff and para-tariff barriers. For example, importers of North East India have to go to Kolkata to fulfill banking formalities for imports from Bangladesh. Likewise, Bangladesh has also imposed restrictions on certain importable items from India in terms of specified entry points. India has granted Most Favoured Nation (MFN) status to Pakistan, but Pakistan has yet to reciprocate this. The Pakistani authorities, on the other hand, claim that Indian customs authorities are biased against Pakistani consignments and are thus denying market access to Pakistani goods in India. Administrative Barriers Besides poor infrastructure and tariff and non-tariff barriers, considerable difficulties exist in cross-border trade in South Asia resulting into high trade costs due to administrative rules, regulations and procedures involved. Limited transportation routes, poor infrastructure facilities, non-availability of rail wagons, and procedural clearances, impose high administrative burden and transaction costs in cross-border trade. Existing procedures and formalities for cross-border movement of goods in South Asia are cumbersome, time consuming, and obstructive. As a result, the average time to move an export container to the nearest port, fulfilling all customs, administrative, and port requirements is much higher in South Asian countries compared to the East Asian countries. Not only international trade but also regional trade takes inordinately longer time. The average time required to clear goods with Indian and Bangladeshi customs is about three times the length of time goods are moved around in the developed world. Most of the delays occur at the border crossings for custom clearance, fulfilling other formalities, and trans-shipment. Border-crossing problems arise because of the distance of customs clearance centres from the border; lack of storage, loading, unloading; and lack of transshipment facilities. For instance, the sanitary and phyto-sanitary testing laboratory in Kolkata (India) is 1000 km away from the customs facility at Birgunj (Nepal). As such, exporters have to wait for weeks for test results and in the process pay additional fees while vehicles are detained. The problem is exacerbated by complicated procedures and Continued from page 16 lack of efficient customs operations, including lack of transparency of procedures for inspection, informal payments and inadequate preparation of customs document by the exporters. At least 22 documents are required for cross-border trade. The main reasons for high transaction costs in Indo-Nepalese and Indo-Bangladeshi trade are delays caused by complex customs and transit procedures. The complicated procedures furthermore provide opportunities for corruption. To expedite the process, the traders often bribe the concerned authorities. Because of these difficulties, intra-regional trade and investment remains far below the potential level. Mountainous countries like Nepal and Bhutan suffered the most as they have to completely depend on their neighbouring countries' infrastructure for their export/import. Discussion and conclusion Although South Asian countries made a major thrust for economic integration, the pace of its implementation remains slow. Against the conventional explanation given by economists, this study reveals that low trade complementarity is not the only reason for a low level of economic integration in South Asia. Recent studies suggest that there are significant potentials for promoting intra-regional trade and economic cooperation. Between India and Pakistan alone, there is a potential for a five billion dollar trade. But current trade between the two countries is 70% percent lower than that of two other similar economies. The study reveals that intra-regional trade does not solely depend on complementarity. Many other factors including tariff and non-tariff barriers, physical infrastructure, transport and communication facilities and administrative rules and regulations play important roles in intra-regional trade. Despite good intentions and efforts, South Asian countries have failed to create a conducive environment for regional trade. Although, with the efforts of SAPTA, customs duties and import tariffs have been reduced recently, non-tariff and para-tariff barriers are still high. The four major economies in the region - India, Pakistan, Bangladesh, and Sri Lanka have maintained different non-tariff and para-tariff barriers which has hindered intra-regional trade significantly. Besides tariff and non-tariff barriers, considerable difficulties exist due to administrative rules, regulations and procedures involved in intra-regional trade in South Asia. Existing procedures and formalities for cross-border movement of goods are cumbersome, time consuming, and obstructive, which have increased trade costs and encouraged informal trade. The huge amount of informal trade going on in the region is a clear indication. Promotion of trade not only depends on the tariff liberalisation but also on the quality of infrastructure and logistic facilities. Transportation and communication is vital for trans-border regional trade. While the main advantage of regional trade is low trade costs, due to relatively low transport cost, it is not true in case of South Asia. Trade costs are relatively higher because of weak infrastructure, poor transportation network and weak logistic facilities and corruption. The problem of transportation of goods has been further compounded by poorly maintained cross-border transport connectivity. As a result, there is always excessive delay in cross-border transportation. This has been further reinforced by the lack of logistic facilities such as equipment, parking and storage facilities, internal container depots and trans-shipment facilities at cross-border points. Lack of transit facilities through the neighbouring countries to access the nearest port or market centres has further thwarted intra-regional trade by increasing trade cost. In some cases, this increases trade cost up to 60%. The trade cost has been further increased by the policy of not allowing trucks of neighbouring countries which require trans-shipment at the border. Transport bottlenecks not only inhibit trade but also inhibit movement of people including inter-regional and international tourists as well as inhibit investment and other economic and social collaboration. South Asian countries are losing on many fronts due to non-cooperation. Trade and investment goes hand-in-hand. Had South Asian countries been able to strengthen economic integration, it could have used and managed the shared resources like rivers, fishing areas, railways and hydroelectric power facilities, transportation, and tourism in a more productive way. Regional cooperation can also help tap oil and gas resources available just outside South Asia to manage its energy and power needs more efficiently. For example, supplying power from Pakistan's national electricity grid to neighbouring power deficient Indian states or supplying Bangladeshi gas to the power-deficient industrial Kolkata (India) could pave the way for economic growth and opening up long-term regional energy trade and investment in the region. For deeper economic integration to take place, it is necessary to create an enabling environment by removing physical, institutional and policy as well as administrative barriers. It is necessary to expand transport and communication infrastructure and harmonize rail and road systems. Transit facilities need to be given to neighbouring countries across the territories of the member countries. To promote improved connectivity, South Asian countries should come up with a common transport policy with a comprehensive framework for optimum utilisation of common facilities and to improve connectivity. Along with developing physical and institutional facilities, it is also important to change the mindset of policy makers. South Asian countries have often overemphasised political sensitivities over economic rationality. While political harmony is a pre-requisite for economic integration, it is important to understand that economic cooperation and political harmony are mutually reinforcing. Experiences from Asia and elsewhere suggest that the movement of people across countries and economic interdependence can create a better climate for dismantling walls of distrust and creating a better climate for resolving political differences. Looking at the experiences from other regions, South Asian countries also need to further their cooperation in order to widen economic opportunities for the region's people. It is time to move beyond the traditional commodity trade and harness the benefits of economic cooperation in areas such as infrastructure, transportation, communications, hydropower, power sharing, and manpower development. Labour and capital markets also need to be integrated and developed. For this, an integrated approach is needed towards removing physical, institutional, and policy and administrative barriers in order to facilitate trade and economic cooperation, one that promotes regional economic integration and justifies its potentials. ........................................................... The write-up is an abridged version of an article, titled Regional Economic Integration is South Asia: Challenges and opportunities. Mr. Golam Rasul is head, economic analysis division, International Centre for Integrated Mountain Development, Kathmandu, Nepal. He can be reached at [email protected]