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Latin American economies stymied by high transportation costs, IDB study shows

High transportation costs in Latin America and the Caribbean undermine trade and have harmful impacts on the productivity of the entire economy, protecting inefficient companies and preventing competitive producers from expanding their output, according to a newly release study by the Inter-American Development Bank.

The region as a whole spends nearly twice as much as the United States in freight expenses to import its goods. Most Latin American countries have higher freight rates when exporting to the United States than countries in the Far East and in Europe. This is alarming, particularly when considering countries that are very close to the United States, like those in the Caribbean. (See graphs below)

In a ranking of 22 countries in the region, Paraguay, and Argentina are among the countries with the highest freight costs as a share of exports to the United States, which in part is explained by the long distances. But even more distant regions in the world, like China or Oceania, have lower freight rates than most countries in the Latin America including Guyana or Guatemala. Latin America and the Caribbean ports are among the world’s least efficient, the study said.

The findings are part of the upcoming IDB book The Age of Productivity: Transforming Economies from the Bottom Up. The IDB will unveil the results of the book during its Annual meeting March 20-23, in Cancun, Mexico. The book, part of the series Development in the Americas, the IDB’s annual flagship publication, offers a comprehensive analysis of productivity levels in the region, its impact on economic growth and recommendations for policymakers on how to address the causes of low productivity.

Free trade can boost productivity because it exposes producers to greater competition, forcing them to cut costs and increase their efficiency while providing greater access to more and better inputs, particularly capital goods. However, high transportation costs distort allocation of resources, preventing the region from reaping the full productivity benefits from greater trade liberalization.

Traditionally, tariffs have been one of the biggest impediments for higher productivity but its relative share of total trade costs has decreased over the past decade after the region began opening up their economies to more trade. Currently, transport costs are more than four times larger than tariff costs in Latin America and the Caribbean, representing a bigger trade barrier than tariffs, the study said.

“Bringing tariffs down, as most of the countries in the region did in recent times, , is not likely to be enough. Transport costs have to be reduced in tandem to bring the full positive effects of trade on productivity” said Juan Blyde, one of the economists working on the book. “A reduction in these trade costs must be a priority for the region, particularly when countries are trying to consolidate their economic position in a world that has begun emerging from a financial crisis.”

Impact on Productivity

High transport costs protect inefficient producers, lowering their likelihood to exit, and limit the expansion of efficient plants, lowering their likelihood to export. Transportation costs represent one aspect behind the low productivity levels observed in Latin America and the Caribbean, the study said.

Statistical analysis for Brazil and Chile show that transportation costs reduce plant efficiency and distort the allocation of resources in the economy, which affects the overall level of productivity in nations. A 10 percentage point cut in freight costs will raise plant productivity by 0.5 and 0.7 percent in Brazil and Chile respectively.

A decrease in freight costs will also raise aggregate productivity by making the inefficient firms more likely to exit and the efficient firms more likely to export. For example, a 10 percentage point cut in freight costs increases the probability that an inefficient firm will exit in Chile by 1.5 percent and the probability of exporting by 4 percent.

Both tariffs and freights matter, but the scope for reducing transport costs today is much larger than for tariffs. For instance, Chile would need to cut its freight rates by more than 50 percent to match U.S. levels while tariffs would have to be cut by only 10 percent to reach the same levels as in the United States.

The size of the problem

Freight costs account for 6.6 percent of region’s import value, nearly twice as much as the 3.4 percent in the United States, according to the author’s calculations. Costs vary widely among countries in the region, with costs in landlocked Paraguay being nearly triple the costs of the United States as a share of imports.

Freight expenditures as a share of exports show that proximity does not always translate into lower freight rates. Panama and Guatemala, for example, have freight costs when exporting to the United States that are nearly twice as much as the countries forming the European Union, despite being close to the United States. Latin America and the Caribbean freight costs are much higher than other distant regions of the world including China and Oceania, according to the graph below.

The lack of efficiency in the infrastructure in ports and airports explain about 40 percent of the difference in shipping costs between Latin America and the United States and Europe. The low degree of competition among shipping companies and inefficient transportation systems domestically, including increasing traffic congestion in large metropolitan areas, also contribute to the high costs.

The region’s ports have the lowest productivity levels when compared with ports in North America, Western Europe, the Middle East and Asia. Port efficiency is related not only to the quality of their physical facilities, but also to the various other support activities, such as pilotage, towing and tug assistance, or cargo handling.

In addition, both port and airport efficiency also depends on aspects such as the clarity of port procedures, the accuracy of their information systems or the existence of legal restrictions, such as requiring special licenses to perform loading and unloading operations.

What governments can do?

The study says a reduction in transportation costs will require not only better infrastructure but also a regulatory framework that promotes investment and competition. Increased efficiency of ports and airports and improved regulation must be the top priorities of governments in the region, the study said.

The government must encourage greater competition among shipping companies and decentralize port operations while ensuring important investments happen, such as dredging a channel to allow for larger vessels with lower operating costs to enter a port.

In terms of air freight, airport efficiency and regulation are at the heart of the region’s problems. Latin America must pursue more aggressively open skies agreements because they promote competition and help cut air transportation costs, the study said. In addition, the study says that the region must ensure adequate airport regulation to deal with the quality of services while increasing privatization efforts.

“The timing of such an agenda could not be more opportune given that the region is still struggling to raise productivity and consolidate its re-encounter with growth,” Blyde said. “Reducing transportation costs is surely not an answer for all the region’s economic problems, but it can certainly contribute to enhance trade and to foster productivity.”