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The economics of transit

Published: Wednesday, Dec 21, 2011

Anniversary Issue 2011 (Part Five)

The economics of transit

December 21, 2011
Sadiq Ahmed

There are few topics that spark more emotions and irrational thinking

than the issue of transit access through Bangladesh for neighboring countries. Due to the dominant presence of the large neighbor India, the discussion of transit issue in Bangladesh has been hijacked by politics contributing to the confused thinking and rationale. Transit is seen by many as “concession to India” and by some as “loss of sovereignty”. This confused thinking has clouded the underlying economic issues of transit.  When the rest of the world is getting better integrated through transport network, trade and investment, Bangladesh and rest of South Asia remain isolated as a region. Legal trade among South Asian countries is very limited,investment flows are negligible and physical connectivity is highly restrictive. The lack of transit agreement for traffic between Bangladesh and other neighboring countries is a reflection of this broader anomaly. Deep suspicion, historical baggage and unhealthy politics remain as major constraints to strengthening economic relations between South Asian countries.  Similar difficulties have also constrained the relationship between Bangladesh and India.

This is a lose-lose situation. An important breakthrough happened in January 2009 in the context of the visit of the Bangladeshi Prime Minister to India and the resulting joint communiqué issued in New Delhi on January 12, 2009 by the Prime Ministers of the two countries. Among other areas of cooperation, the communiqué provides the political framework for developing a broad-based transit agreement involving initially the two countries with provisions for broadening it to include Nepal and Bhutan.  Nevertheless, controversy over the transit issue continues to prevail in Bangladesh, which is constraining the implementation of the agreements.

The objective of this article is to provide a framework that looks at the economics of transit and asks in what ways this is a right policy decision for Bangladesh.  The article will show that transit is a part of a sensible economic policy that seeks to help Bangladesh accelerate economic growth and reduce poverty.  More broadly, it is a good policy for South Asia in general and for the North-east sub-region of South Asia in particular.  The economics of transit, the article will argue, also makes good politics.   Transit access for neighbors opens up a whole host of political opportunities for addressing long-term difficult regional issues relating to immigration, water sharing, and security issues. The gains are win-win for all parties.

The economics of transit: An analytical framework

In some debates the transit issue has been too narrowly placed as a matter of charging the right “transit fee”. The “transit fee” issue is also cast misleadingly into a discussion of extracting maximum “rent from geography” as opposed to a “fee on export of services”. To avoid rent-seeking behavior owing to geographical location advantages, there are a range of international conventions under the World Trade Organizations (WTO) that guarantee freedom of transit. Compliance with these international conventions is a part of good economics as well as good politics.

Key development challenges:To look at transit from its proper analytical perspective we first need to focus on key development challenges facing Bangladesh.

  • Low per-capita income: Despite solid development performance since independence, at around $700 Bangladesh’s per capita income remains very low.
  • High poverty: Poverty has come down from over 80 percent in the early 1970s to around 31 percent in 2010. Yet this level is still very high and rural poverty is even higher at 35 percent.
  • Lagging regions: A review of the spatial distribution of development progress shows significant disparity between the leading and lagging regions of Bangladesh.
  • Vulnerability to shocks: Notwithstanding progress in tackling natural disasters and establishing social safety nets, the poor in Bangladesh remain highly vulnerable to a range of internal and external shocks.

Let us consider these characteristics and their interaction in some further detail, which will then allow us to connect the role of transit in contributing positively to a resolution of these constraints.

Bangladesh made rapid progress in increasing its per capita income since independence. The per capita income growth is on a rising trajectory. This has helped reduce poverty sharply.   Yet Bangladesh remains a low income country with a high incidence of poverty. While the 6 percent per year average growth rate of recent years is a positive outcome, this growth rate is lower than the rate achieved by more dynamic economies like India and China. It is now recognized that Bangladesh must accelerate its growth rate to 8 percent per year to make a more rapid progress with poverty. For this to happen, new sources of growth must be found.  While higher growth is necessary for poverty reduction, the pattern of growthis important for faster pace of reduction of poverty.  Bangladesh has experienced growing income inequality.  The spatial distribution shows pockets of poverty that are spread around in ways that will require focused efforts to remove the growth constraints in those areas.  Bangladesh is also highly susceptible to climate change and natural disasters. The lagging regions tend to be much more vulnerable to natural disasters than the leading regions.  So, a sustained poverty reduction strategy must be based on three fundamental principles.  First, it must find ways to accelerate the growth rate to 8% plus per year.  Second, the growth strategy must be broad-based so that growth can accelerate in the lagging regions by removing the growth constraints in the lagging regions. And third, the strategy must also find ways to reduce the vulnerabilities of the lagging regions owing to climate change and natural disasters.

New economics of growth: role of geography

There is now a resurgence of global interest in growth dynamics that shows that geography matters for growth. While Bangladesh decries its downstream location disadvantage emerging from the flow of international rivers, it does not celebrate its two major advantages: tremendous access to sea and being the gateway between Central/South Asia and East Asia (see Map 1)

Map 1: Geographical Advantages of Bangladesh

Map1_copy

Taking advantage of location

Access to sea: global evidence shows that countries with access to sea ceteris paribus do better than land-locked countries. By opening up existing ports and further investment, Bangladesh can tap a dynamic source of revenue and economic growth. The true potential is illustrated by development performance of internationally renowned sea ports of Rotterdam, Singapore and Hongkong.

Asian gateway: Bangladesh is conveniently located as a bridge between Central/South Asia and East Asia. Through better land, air, sea connectivity Bangladesh can become an Asian commercial hub.

It is clear that geography can be a hugely positive asset for development of Bangladesh. Exploiting this location advantage by improving and expanding port services and by providing connectivity between Central/South and East Asia can add a new source of growth for Bangladesh.

Lagging regions problem is a border area problem

The other aspect of geography that has not been well appreciated in policy discussions is the locational aspects of poverty.  Of the 30 border districts, some 29 districts are a part of the lagging regions in Bangladesh (The only exception is Jessore, see Map 2 and Table 1).

Map 2: Border Districts of Bangladesh

Map2_copy

Table 1: Per Capita Income, Literacy Rate, and Poverty Index in Border Districts


Districts

Per capita income (US $)

Literacy Rate (Aged 7 and above)

Human Poverty Index

1995/1996

1999/2000

2005/
2006

1991

2001

1995

2000

Total

Female

Total

Female

Bandarban

332

339

312

23.82

13.46

31.66

23.67

51.50

39.77

Brahmanbaria

283

304

384

26.59

20.32

39.45

36.68

39.26

37.65

Comilla

252

266

319

33.14

26.03

45.98

42.63

31.88

26.72

Feni

237

262

318

40.65

33.15

54.26

51.18

30.83

28.15

Habiganj

280

299

371

24.55

18.54

37.72

33.62

37.23

34.45

Jamalpur

245

277

336

21.48

16.00

31.80

28.02

51.06

41.87

Khagrachari

236

239

284

26.32

18.86

41.80

32.65

43.86

37.58

Kurigram

235

282

319

22.33

14.70

33.45

27.55

43.14

39.42

Lalmonirhat

230

265

299

28.81

15.69

42.33

36.25

40.67

35.63

Maulvibazar

255

280

314

30.84

24.56

42.06

38.45

37.77

32.69

Mymensingh

277

305

301

25.47

19.95

39.11

36.26

40.30

34.70

Netrokona

279

303

286

25.97

20.44

34.94

31.88

39.04

37.06

Nilphamari

235

261

311

25.35

16.98

38.84

32.58

46.86

38.50

Panchagarh

249

277

337

30.58

20.79

43.89

37.33

38.71

35.03

Rangamati

539

365

319

36.48

24.68

43.59

34.21

46.24

35.74

Sherpur

242

277

326

19.49

14.09

31.89

28.55

45.15

42.98

Sunamganj

238

262

324

22.29

16.73

34.37

30.47

43.01

39.44

Sylhet

274

315

378

33.85

27.49

45.59

41.51

39.11

35.06

Thakurgaon

299

329

347

27.34

17.16

44.82

34.77

40.32

35.87

Dinajpur

280

311

383

29.85

21.27

45.67

39.99

36.24

33.31

Joypurhar

284

323

423

30.17

22.19

49.62

43.95

37.23

35.70

Naogaon

269

305

385

28.36

20.44

44.39

39.12

36.91

32.32

Nawabganj

231

255

305

23.84

19.10

35.92

34.44

41.68

39.66

Rajshahi

301

339

411

30.59

23.16

47.54

42.48

35.98

33.57

Kushtia

293

320

360

25.77

20.28

44.37

37.18

36.79

35.78

Meherpur

290

318

359

23.11

18.62

37.79

35.59

36.91

36.01

Chuadanga

283

305

336

25.24

19.56

40.88

38.08

34.02

32.11

Jhenaidah

290

317

390

25.85

18.90

44.66

40.26

35.74

32.37

Jessore

327

357

437

33.37

25.07

57.28

46.09

30.77

28.20

Satkhira

277

309

384

30.54

21.00

45.51

38.90

35.53

31.74

Bangladesh

323

355

431

32.40

25.45

45.32

40.83

 

 

                     

Characteristics of lagging regions

The lagging districts share a number of common characteristics:

  • These lagging regions are mostly border districts
  • The labor force is mostly engaged in low productivity agriculture
  • Connectivity with growth centers is limited
  • Human indicators are weak
  • High income jobs are scarce

Growth and investment in the lagging regions will benefit tremendously from reducing cross-border restrictions on trade, transport and investment. Removal of these restrictions will also facilitate agglomeration economies and production sharing arrangements as in East Asia under ASEAN plus 3.

Taking advantage of geography: Role of transit

Using Excess Capacity in Ports Makes Economic Sense: Even with existing port capacities, there is scope for adding large additional cargo traffic.  Mongla in particular is grossly under-utilized. By opening up both Chittagong and Mongla ports as international sea-ports with open access for all neighbors including India, there will be an immediate positive impact on capacity utilization and gains in port revenues for Bangladesh.

Over time, depending upon traffic flows, new capacities can be built. The concept of deep sea port in Chittagong will become a real prospect than just a dream. Without adequate traffic, which will only be possible from neighboring countries of South and East Asia, the economic viability of Chittagong sea port is suspect.

Chittagong Seaport: The present handling capacity is 32,000 TEUs and storage capacity is 79,000 metric tons. Some 57 % of the container holding capacity and 54 % of the cargo storage capacity are utilized daily on average. Therefore there is adequate unused holding and storage capacity to serve the needs of neighboring countries. Management and operation of a New Mooring Container Terminal (NCT) on Supply Operate and Transfer (SOT) basis is under process, after the completion of which 1 million TEUs of containers equivalent to 10.5 million metric tons of cargo is expected to be handled annually by 2013.

Mongla Port: The present handling capacity is 65 lac metric tons of cargo and 50,000 containers per year. In FY2010 it handled some 16.5 lac metric tons of cargo and 2065 TEUs of containers. Clearly, there is large excess capacity. Cargo can be transported in all seasons from the port through road and river ways. Containerized traffic can be transported through the IWT routes as specified under Inland Waterways Protocol Agreement.

Transit between Two Points of India through Bangladesh: The principles of transit between two points of India through Bangladesh are no different from the use of port services.  Bangladesh will be exporting a service—use of road, rail and waterway infrastructure – and the traffic will pay a service charge that is again based on the principle of cost recovery and rate of return on investment.  This principle is fully consistent with WTO guidelines 
Addressing the lagging regions problem through transit:   Implementation of the transit access policy has tremendous positive implications for addressing the lagging regions problem. As we saw earlier, most of the lagging regions are located in the border areas with low connectivity with growth centers.  We have already witnessed the positive effects of such investments as the Jamuna Bridge for better connectivity of lagging regions to growth centers.  Investments in infrastructure that connect Bhutan, Nepal and India with the ports in Bangladesh as well as to eastern India will also help improve connectivity for the relevant lagging regions of Bangladesh.
Benefitting From trade Creation: Importantly, such infrastructure will reduce the cost of trading within the North-east sub-region and promote more trade.  Evidence suggests that infrastructure costs are often a greater barrier to trade within South Asia than trade restrictions.   Estimates suggest that a 10% fall in transaction costs at border has the effect of increasing a country’s exports by about 3%. Presently, Bangladesh has a huge trade deficit with India because of very low exports. With cooperation exports can grow from $350 million to $800-900 million per year. Transit access will support trade creation by reducing trade logistic costs. This will also create the basis for eliminating remaining NTBs, which should help exports to other parts of India. Opening up will also boost exports to Bhutan and Nepal. Bangladeshi enterprises will have a particularly favorable cost advantage in doing business in the markets of India’s Northeastern states especially in transport-intensive activities such as agricultural products and construction materials.

Transit requires new investments in infrastructure

Needless to say, to convert these ports into international ports a range of investments will be needed in terms of road, river and rail networks to establish connectivity between regional countries (India, Bhutan and Nepal in the first instance).  Investments in port capacities, port facilities, dredging etc will be needed.  Costs can be fully recovered along with a reasonable rate of return on investment through port fees and other infrastructure use charges.  If Rotterdam, Singapore and Hongkong can make money from exporting port services, there is no reason why Bangladesh cannot.

A summary of the total investment needed over the next 10 years is indicated in Table 2. The required investments are massive (in excess of US $7 billion). While some of the investments are underway, substantial additional investment will be needed. A major policy priority will be to identify the possible financing options and their implementation.

Table 2.  Indicative Estimates of  Infrastructure Cost for Transit Access

Transport Infrastructure Type

Estimated  cost

Roads

119,412

Rail

320,234

Inland Water Transport

11,715

Chittagong Port

18,509

Mongla Port

27,986

Land Port

1,505

Total estimated investment

4,99,261

Total estimated investment (US$ million)

7,132

Principles of transit fee: International Conventions on freedom of transit

  • Convention and Statute on Freedom of Transit, Barcelona, 1921.
  • Convention on the High Seas, Geneva, 1958.
  • United Nations Transit Trade of Land Locked States, New York, 1965.
  • World Trade Organization-The General Agreement on Tariffs and Trade (GATT), 1994.

Article V of the GATT 1994 lays down the following agreed principles governing transit trade:

  • “There shall be freedom of transit through the territory of each contracting party via the routes most convenient for international transit, for traffic in transit to or from the territory of other contracting parties. No distinction shall be made which is based on the flag of vessels, the place of origin, departure, entry, exit or destination, or any circumstances relating to the ownership of goods, of vessels or any other means of transport”
  • “Any contracting party may require that traffic in transit through its territory be entered at the proper custom house, but, except in cases of failure to comply with applicable customs laws and regulations, such traffic coming from or going to the territory of other contracting parties shall not be subject to any unnecessary delays or restrictions and shall be exempt from customs duties and from all transit duties or other charges imposed in respect of transit, except charges for transportation or those commensurate with administrative expenses entailed by transit or with the cost of services rendered.”

“All charges and regulations imposed by contracting parties on traffic in transit to or from the territories of other contracting parties shall be reasonable having regard to the conditions of traffic.”

  • “With respect to all charges, regulations and formalities in connection with transit, each contracting party shall accord to traffic in transit to or from the territory of any other contracting party treatment no less favorable than the treatment accorded to traffic in transit to or from any third country.”
  • The main point is that transit trade cannot be subject to any custom duties or fees/charges that are purely transit related unless some cost is incurred by the host country.
  • The economic rationale for these is that: (i) Custom duties are levied in the country of destination where the goods are actually used. Hence there is no reason to pay these duties in the transit stage as well. (ii) A pure transit is fee is like a rent on geography. It is tempting to argue that a host country should charge a transit fee as a percentage of cost saving for the landlocked country owing to the transit access. However, this argument is misleading as international conventions define rights and obligations in matters of sharing common resources such as water, air and land and sea routes. These conventions are aimed at minimizing the disadvantages conveyed by geography.
  • However, the genuine cost of providing transit access by the host country must be recognized and compensated by the guest country. These costs are identified in Article V to include: (a) transportation services (if used); (b) administrative expenses (e.g. costs of inspections etc); and (c) charges for use of services. Transit may involve the use of port services, road services, or rail network services from host countries.  These are economic services the provision of which requires real resources in terms of investment in fixed assets as well as financing of operation and maintenance. Accordingly, guest countries are obliged to pay user fee for these services in the transit process.

Principles of user charges

  • The generally accepted principle is to price an infrastructure service based on long run social marginal cost.  This comprises of financial costs (investment cost, maintenance cost, and administrative cost) as well as social costs (damage to environment, congestion, etc.)
  • The challenge in practice is to convert this principle into practical user pricing that is also consistent with the objectives of: ease of estimation and updating; easy to collect the fees with minimum collection cost; and allowing full financial cost recovery to eliminate the burden on the treasury.

Example from roads: Road user charges are comprised of the following elements:

a) Road Damage costs: Road damage is basically caused by heavy vehicles as the damage to the road pavement increases to the fourth power of the axle load. Therefore road damage costs should be proportional to the damaging power (measured in terms of Equivalent Standard Axles).  Properly designed this should take care of road construction and maintenance costs.

b) Accident Externalities: Accident externalities arise when extra vehicles on the road increase the probability that the other road users will be involved in an accident. Accident probability depends to a large extent on distance, driving time and the type of the other traffic.

c) Congestion Cost: Congestion costs arise because additional vehicles reduce the speed of the other vehicles and hence increase their journey time.

d) Environmental Costs: The road use of vehicles has various spillover effects on the environment including emission, water pollution, land use effects, and noise and vibrations.

Principles of transit charges for other infrastructure: Similar principles apply to transit charges for use of rail infrastructure and waterways. It is important to distinguish the use of infrastructure from the use of services. Most often transit involves only use of infrastructure (road network, port facilities, rail network and river network).  Transit fees must distinguish the cost of providing access to these infrastructures from the cost of transport services.

Implications of transit agreement for dynamic gains in Bangladesh

The transit agreement is obviously beneficial for facilitating more trade, in helping Bangladesh take advantage of its geography in terms of access to sea, and positive implications of transit access for better connectivity of the lagging regions to regional growth centers. The transit agreement needs to be looked at the broader context of more and better regional cooperation with India and other neighbors.  From a dynamic point of view the transit agreement has long-term implications for three other areas of economic outcomes:

  • Promotion of investment through removal of restrictions on investment.
  • Easing the energy constraint through trade
  • Stronger dialogue and cooperation on water resources

Higher investment: Better physical connectivity and higher trade will also provide better investment opportunities.  Given present low levels of development, the investment opportunities in India’s 7-sisters states of the Northeast are quite large. In view of its location advantage, Bangladesh should have huge comparative advantage vis-à-vis other Indian states in terms of transport cost for reaching out markets in India’s 7-sister states.  There are already some examples of very positive experience of Bangladesh investors in these Northeastern states.  These include the experiences of the Pran Group of industries and Naseer Glass. Better infrastructure and lower transaction costs will further boost opportunities including possibility of benefitting from contract farming and agro industries.

Easing the energy constraint through trade:  Energy is a major constraint on the growth of the Bangladesh economy.  South Asia’s North East Sub-region has tremendous untapped hydro-power potential (See Table 3). Through proper grid connectivity and transmission lines, the scope for power trade to relieve Bangladesh energy constraint is tremendous.

Table 3: Hydro-Power Potential in Northeast South Asian Countries


Country

Hydropower potential (MW)

Installed Capacity (MW)

Utilization (%)

Bangladesh

1897

230

12.1

Bhutan

16,280

432

2.6

India

148,701

25,587

17.2

Nepal

42,130

527

1.2

Total

209,008

26,776

12.8

Bangladesh has already taken a major positive step by reaching agreement with India to allow in the short-to medium term 250 MW of power import from India through Bheramara-Bahrampur grid connectivity (See Map 3).  Over the longer-term, this could move up to 1000MW of power imports. Importantly, grid connectivity with India opens up possibility for power trade with Nepal and Bhutan.  Additionally, opening up of power trade will likely facilitate new investments from India’s private sector into Bangladesh for power as well as primary fuel.

Map 3

Map3

Water security and climate change:  On the negative side of geography, the location of Bangladesh makes it especially vulnerable to climate change and natural disasters as it lies at the bottom end of the flow of the three mighty rivers Ganges-Brahmaputra-Meghna (See Map 4).  Importantly, all three rivers, especially the Ganges and the Brahmaputra, flow through upstream India.  Other countries that are also upstream and have an impact on water flows are China and Bhutan (Brahmaputra) and Nepal (Ganges).  It is obvious from geography that the only viable solution to Bangladesh’s water problems and vulnerability to climate change is through a cooperative solution with upstream neighbors (India, Nepal, Bhutan and China). Arguably, without water cooperation long-term solution to poverty reduction in Bangladesh is not possible.

Map 4: Major River Basins Affecting Bangladesh

Map4

Water cooperation is possibly the most difficult outcome and is long term in nature.  Transit has been a thorny issue for India for a long time. Removing this sticky point opens up a whole host of possible and pragmatic options for resolving the water sharing issues.  Even though difficult, with careful design and investment water cooperation can be a win-win for all.  The Indus River Treaty and the Nile River Basin Agreement are good examples of how with sustained efforts even warring nations can be brought together to share water equitably.  Strategically, cooperation in other three areas (trade and investment; transport; and energy) can set the basis for more considerate and equitable resolution of water disputes. All riparian's, particularly the poor can benefit through enhanced productivity (irrigation, fisheries, and navigation/access) and reduced costs (floods, droughts, cyclones). Benefits are maximized if the most optimal technical options can be adopted regardless of national boundaries; financial costs and output benefits are shared equitably; and cooperation focuses on bundling opportunities linked to water management (institutions, infrastructure etc).

Both Ganges and Brahmaputra have tremendous technical potential for upstream multipurpose infrastructure to cap flood peaks, raise dry season flows for irrigation, reduce saline intrusion in vulnerable ecosystems (e.g. Sundarbans); increase hydropower availability and clean energy source; and enhance navigability/access.  Data exchange can enhance disaster preparedness. One specific policy action to help build regional water cooperation in the short term is to initiate joint water resources management initiatives/ investment projects.  There are two possible projects.  First is linking Northeastern India and Bangladesh (including Brahmaputra basin institution building).  The second is linking West Bengal and Bangladesh (restoration of Ganges Dependent Areas to support endangered livelihoods/ fragile Sundarbans ecosystems).  Over the medium to long term, broad regional investments on Ganges and/or Brahmaputra could be explored.  This will entail joint equity, ownership and management – including the bundling of institutional development, legal framework, and infrastructure investments.

..........................................................

Dr. Sadiq Ahmed is vice chairman of Policy Research Institute, a private think-tank. He can be reached at:  sahmed1952@live.com

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