Infrastructure and Regional Cooperation Haruhiko Kuroda Masahiro Kawai Rita Nangia Asian Development Bank Annual Bank Conference on Development Economics Tokyo 2006 This is a revised version of the paper presented to the Annual Bank Conference on Development Economics (ABCDE), Tokyo, May 2006. The authors would like to thank David Green, Frank Harrigan, Peter McCawley, Sudipto Mundle, Rajat Nag, and two anonymous referees for their comments on earlier versions. Guy Sacerdoti provided editorial assistance. The views expressed in this paper are those of the authors and do not necessarily reflect the views or policies of the Asian Development Bank (ADB), or its Board of Directors, or the governments they represent. Contents I The Context 2 Asia’s Trade, Investment, and Production Networks 2 Logistics, Infrastructure, and Software 7 Cross-border Infrastructure and Economic Development 10 II. Lessons from Major Cross-Border Infrastructure in Asia 12 GMS Northern Economic Corridor and Trade and Transit Harmonization 14 Nam Theun 2 Hydropower Project 16 Pacific Cooperation for Aviation and ICT 17 Indonesia–Singapore Gas Transmission 18 Lessons Learned 19 III. A Framework for Cross-Border Infrastructure 20 Political 21 Economic and Financial 22 Institutional and Software 23 IV. Conclusion: The Future of Cross-Border Infrastructure in Asia 25 Governments 26 Private Sector 27 Civil Society Organizations 27 Multilateral Institutions 28 References 30 Boxes 1 Regional Trade Expansion and its Impact on the Logistics 8 2 Infrastructure and Economic Development 11 3 Cross-Border Infrastructure - A Historical Perspective 13 Tables 1 Trends in Intraregional Trade 3 2 Foreign Direct Investments Stocks as % of Gross Domestic Product 4 3 Trends in Logistics Costs 7 Infrastructure and Regional Cooperation As late as 1750, Asia occupied an important position in the global economy not only in terms of population and production, but also trade, capital formation, productivity, and competitiveness (Sakakibara & Yamakawa 2003).1 Data show that during the 15th–17th centuries, Asia played a key role in ensuring global division of labor. Intra-Asian trade was well developed long before Europeans arrived in the region and such trade involved exclusively Asian ships, Asian merchants, and Asian goods. Several Japanese historians claim that the economic growth of Asian countries was led by intra-Asian trade (Akita 1999) and that the economic success of Japan in the late 20th century, as well as that of the newly-industrialized economies (NIEs), originated in this intra-Asian trade (Sugihara 1990). Asians developed capabilities to adapt western cultural elements to suit Asian domestic markets, such as making things smaller and cheaper or neater and cleaner. The focus of most of the analytic work on regional cooperation has been on trade and investment, including issues such as tariff and nontariff barriers to trade and foreign direct investment (FDI). With the emergence of global and regional production networks, aspects of transport and logistics have begun to attract greater attention of policy makers, academics, and experts. This paper focuses on the role of cross-border infrastructure in the process of regional integration in developing Asia. Cross-border infrastructure is defined as any international infrastructure cooperation initiative between two or more countries to strengthen cross-border connectivity. The paper is organized as follows. Section I sets the context: it presents Asia’s phenomenal growth in trade and investment in the last two and half decades. It describes how Asia—particularly East Asia—has become a dominant part of international production networks and supply chains. So far, barring a few examples from the Greater Mekong Subregion (GMS), efforts to improve the region’s connectivity have mostly been made through national infrastructure projects and national policy actions. This approach has so far worked, but is likely to be inadequate given the prospects of continued rapid growth in Asian economic activity, 1 Asia in the modern age includes: People’s Republic of China, India, Japan, and key Southeast Asian economies. 2 investment, and trade. The paper argues that the needs for reducing transport and logistics costs, developing economic agglomeration and connecting production clusters and markets will be key drivers of demand for cross-border infrastructure in Asia over the next few decades. Addressing the region’s logistics challenges will hence require attention to cross-border infrastructure. Section II reviews four case studies of cross-border infrastructure in Asia. This exercise reveals that most cross-border infrastructure projects and programs are very complex, and that there is a need for a comprehensive framework to deal with inherent challenges facing cross- border infrastructure. Section III offers a conceptual framework to address political, economic and financial, and institutional challenges for cross-border infrastructure development. It emphasizes that the “software” component is inseparable from the “hardware” component if actual cross-border connectivity is to be improved. Section IV identifies key actions that need to be taken by various stakeholders—such as the Asian governments, the private sector, civil society organizations, and multilateral institutions like the Asian Development Bank (ADB)—in connecting Asia. I. The Context Asia’s Trade, Investment, and Production Networks Developing Asia’s economic performance in the last few decades has been impressive.2 As a group, the region has grown at an average rate of 7% since 1980. Poverty has declined rapidly: there were 300 million fewer people living in poverty in 2003 compared with 1990 (ADB 2005). Strong growth of exports and foreign direct investments has been an important driver for most Asian economies. Trade, investment, and regional integration. Over the past 20+ years, developing Asia’s exports to the world have grown at the rate of 12.5% per annum—or from a level of $162 billion in 1980 to $2.3 trillion in 2005.3 The region now accounts for a quarter of world exports. In recent years, this strong export growth has been marked by a rapid increase in intraregional trade, with its share rising from 35% in 1980 to 55% in 2005 if Japan is included, and from 22% to 2 Developing Asia refers to all 43 developing member countries of the Asian Development Bank. 3 Computation based on the data on direction of trade, International Monetary Fund, 2006. 3 45% excluding Japan.4 This share is higher than in the North American Free Trade Agreement (NAFTA) region, although it remains somewhat lower compared with the European Union (Table 1). Table 1: Intraregional Trade Shares* (%) Regions 1980 1985 1990 1995 2000 2001 2002 2003 2004 2005 East Asia (incl. Japan) 34.6 37.1 43.0 51.7 51.9 51.5 53.4 54.5 55.1 54.5 Emerging East Asia 22.1 27.5 32.8 39.0 40.4 40.7 43.0 43.7 44.1 44.7 Asian NIEs 6.4 6.5 11.9 15.5 15.5 14.9 15.5 15.0 14.4 13.5 ASEAN 17.9 20.3 18.8 23.9 24.5 23.9 24.3 23.8 23.8 24.0 NAFTA 33.8 38.7 37.9 43.1 48.8 49.1 48.4 47.3 46.4 45.0 European Union-15 60.7 59.8 66.2 64.2 62.3 62.2 62.5 63.0 62.2 60.1 *Intraregional trade as share of total trade. Source: Kawai 2006. ASEAN = Association of Southeast Asian Nations; Asian NIEs = newly industrialized economies; NAFTA = North American Free Trade Agreement The initial growth in trade that was sparked by Asia’s newly-industrialized economies (NIEs)—Republic of Korea (Korea); Hong Kong, China; Taipei,China; and Singapore—and then by the middle-income Association of Southeast Asian Nations (ASEAN) members has continued with the People’s Republic of China (PRC) becoming an important player in regional and global trade. As a result of its robust trade growth, the PRC now accounts for 30% of regional trade. More recently, there has been a surge in Asian trade from other exporters such as India and Viet Nam. Much of this is due to rapid trade liberalization in these economies since the 1980s— particularly in the 1990s and beyond—within the WTO and APEC frameworks. Most economies not only reduced tariffs and nontariff barriers but also simplified customs rules and regulations (Dollar & Kraay 2001). Notable is the fact that the expansion of East Asian trade has been accompanied by a rapid rise in FDI, reflecting liberalization of FDI regimes in the region’s economies and multinational coorporations’ global strategies. Multinational corporations began to establish production networks across East Asia through FDI—generating trade in capital goods, parts, components, semifinished and finished manufactures across East Asia. 4 East Asia includes 15 economies including the 10 ASEAN members (Brunei Darussalam, Cambodia, Indonesia, Lao People’s Democratic Republic, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Viet Nam); the PRC: Hong Kong, China; South Korea; Taipei,China; and Japan. Emerging East Asia excludes Japan. 4 FDI inflows to developing Asia rose more than 28 times in the 25 years 1980–2005. In 2005, East Asian economies accounted for over 59% of all FDI inflows in developing economies (UNCTAD 2006). Today, one of the most important destinations of FDI remains the PRC—from a meagre $57 million in FDI in 1980, the PRC attracted over $60 billion in 2005. In addition, countries such as Viet Nam and Cambodia are also beginning to attract FDI (Table 2). Most FDI in Asia has been in new, greenfield investments concentrated in manufacturing, though there has also been an increase in cross-border mergers and acquisitions, largely in services. Table 2: Foreign Direct Investment Stocks (% of Gross Domestic Product) Economy 1980 1985 1990 1995 2000 2001 2002 2003 2004 2005 Japan Inward 0.3 0.3 0.3 0.6 1.1 1.2 2.0 2.1 2.1 2.2 Outward 1.8 3.2 6.6 4.5 5.8 7.2 7.6 7.8 7.9 8.5 Korea, Rep. of Inward 2.1 2.3 2.1 1.9 8.1 9.6 9.2 9.0 8.1 8.0 Outward 0.2 0.5 0.9 2.1 5.8 6.8 6.5 6.5 5.8 4.6 China, People’s Inward 0.4 2.0 5.4 14.4 17.9 17.5 17.1 16.2 14.9 14.3 Rep. of Outward — 0.3 1.2 2.5 2.6 3.0 2.9 2.6 2.4 2.1 Hong Kong, Inward 73.2 75.2 59.4 50.1 275.4 257.5 208.2 239.2 277.6 299.9 China Outward 0.5 6.6 15.7 55.6 234.9 216.5 191.6 213.0 246.5 264.7 Taipei,China Inward 5.8 4.7 6.1 5.9 5.7 13.5 10.0 13.0 12.8 12.1 Outward 31.4 21.4 19.0 16.1 21.5 25.2 27.3 29.3 29.9 28.1 Singapore Inward 52.9 73.6 82.6 78.2 123.1 143.1 157.3 160.2 150.2 158.6 Outward 31.7 24.8 21.2 41.8 62.1 85.1 98.6 100.1 94.5 94.1 Brunei Inward 0.4 0.8 1.1 12.4 89.8 106.0 127.0 161.0 135.9 145.2 Darussalam Outward — — — 6.3 10.3 11.0 11.3 10.4 8.7 8.7 Malaysia Inward 21.1 23.7 23.4 32.3 58.6 38.6 38.9 40.4 39.3 36.5 Outward 0.8 4.4 6.1 12.4 23.6 9.5 10.7 11.4 11.7 34.0 Thailand Inward 3.0 5.1 9.7 10.5 24.4 28.9 30.1 33.3 29.7 33.5 Outward 0.0 0.0 0.5 1.4 1.8 2.3 2.0 2.1 2.1 2.3 Philippines Inward 3.9 8.5 7.4 8.2 16.9 14.5 15.3 15.2 14.9 14.4 Outward 0.5 0.6 0.3 1.6 2.1 1.0 1.0 1.5 1.9 2.1 Indonesia Inward 6.5 6.7 7.7 10.2 16.5 10.8 4.1 5.0 4.4 7.7 Outward 0.0 0.1 0.1 2.9 4.6 *** *** *** — 5.0 Viet Nam Inward 32.9 24.8 25.5 34.5 65.7 69.9 73.7 71.8 66.3 61.2 Outward — — — — — — — — — — Cambodia Inward 1.8 1.6 2.2 10.8 46.9 50.7 50.9 49.9 47.2 45.6 Outward — — — 4.2 5.7 6.2 6.2 6.2 5.8 4.8 Lao PDR Inward 0.3 0.0 1.5 11.9 32.1 33.1 33.1 30.6 26.6 24.5 Outward — — — 0.4 1.6 1.6 1.5 1.4 1.2 1.0 Myanmar Inward 0.0 0.0 1.6 5.3 9.3 8.1 7.6 7.8 7.9 43.6 Outward — — — — — — — — — — Source: UNCTAD (2005a, 2006). 5 The United States (US), European Union (EU), and Japan have been active developed country investors in East Asia, forming production networks and supply chains. In the last 15 years, the four Asian NIEs have emerged as important sources of FDI in ASEAN and the PRC. For example, Hong Kong, China is the largest investor in the PRC. More recently, middle- income ASEAN countries—such as Malaysia and Thailand—have actively invested in low- income ASEAN members and the PRC. A web of FDI activities by global multinational corporations and regional firms, together with advances in information and communications technologies, have led to the growth of regional production networks and well-functioning supply chains in such sectors as textiles, electronics, and automobile parts.5 A key contributor to Asia’s industrial upgrading has been the participation of local enterprises in regional networks set up by multinational firms. Through their roles as suppliers of parts and components, and as purchasers of specialized processing equipment, these local firms gain access to important production technology, process and management know-how, and global distribution systems. Thus, East Asia has been able to create a virtuous cycle of regional trade and investment through the medium of production networks (UNCTAD 2005a). Regional economic integration through market forces. It is now recognized that there is no unique or single, “correct” way to integrate economies with global and regional markets as the speed and the primary drivers of integration vary across regions. The early architects of the EU saw economic interdependence—rather than military coordination—as the most important factor for political cooperation. EU member countries sought to create a single market by policy- driven convergence of market rules. Strong regional institutions were created and granted powers in fields such as education, health, taxation, labor, employment, and transportation. Private sector activities—trade and investment—helped, but it was really the governments and their economic policies that drove the integration process in Europe. Creation of supranational institutions deepened this process further. East Asia’s integration also started with the formation of regional institutions—ASEAN being one of the most important ones. The organization has, however, remained relatively weak: the political will that was so important in European integration was not present in the support provided to ASEAN by its members because of their inherent preference for national sovereignty. 5 The discussion on production networks draws on Carruthers et al 2003; Fujita and Hisa 2004; and Kawai 2005. 6 Compared with Europe, Asian economies had very different levels of economic development in terms of per capita incomes, industrial structures, market infrastructures, institutional and human capacities, and governance standards. As a result, Asia has not chosen to establish strong regional institutions driving the integration process. East Asian integration has largely been private sector-driven, assisted by strong market forces in trade and investment. This integration was strengthened by multinational corporations and Asian business houses, without much direct institutional support from regional governments.6 This market-driven integration has added pressures to distribution structures requiring complex logistics services. Rising demand for logistics is changing the conventional perspective of comparative advantage, implying that logistics and transportation are more closely integrated with supply chains than previously thought. What seems evident from the East Asian experience is that not only does a combination of abundant skilled labor, capital investment, and advanced technology determine the sustainability of decentralized production systems, but so does transportation and logistics support. Most East Asian economies invested significant amounts of resources in industrial and social infrastructure to improve connectivity within networks and with external markets—which such decentralized production systems demanded. These responses were largely focused on improving the national connectivity with foreign partners to serve the needs of outward-oriented industrialization. Logistics, Infrastructure, and Software Logistics costs as barriers to trade. Several complex factors determine overall transport and logistics costs. In the US, between 1950 and 1980, for example, average transit time fell from 40 days to about 10 days—one of the important factors leading to the reduced logistics cost (Rodrigues et al 2005). Table 3 presents global trends in logistics costs—technological advances have reduced overall costs for the US, but not for Europe, PRC, or India. In the PRC and India, in particular, land transport costs remain quite high due to inadequate national transport and communications infrastructure, uncompetitive transport and logistics sectors, and high fuel costs. 6 East Asian exporters have thus made broad-based gains in competitiveness in local markets against many major non-regional suppliers (ADB 2003). 7 Developing countries have yet to create efficient multimodal transportation networks7 and significantly improve the efficiency of existing road or rail systems. Unlike tariff and other trade barriers, domestic transport and logistics costs—key determinants of where production activities gravitate—vary widely across countries. Given these costs of logistics, a number of developing countries in Asia are actually closer to industrial countries in terms of economic distance than their regional neighbors. Table 3: Trends in Logistics Costs Economy 1997 2000 2002 $ billion % of GDP $ billion % of GDP $ billion % of GDP North America 1,035 11.0% 1,240 10.6% 1,203 9.9% Europe 884 12.2% 1,100 12.8% 1,229 13.3% China, People’s Rep. of 718 16.9% 975 17.7% 1,052 17.9% India 236 15.4% 433 17.0% 487 17.4% Source: Rodrigues et al (2005). For example, the deficiencies of Central Asian transport systems—high costs coupled with the low quality of transport and logistics services—have meant that 16–19% of the total value of exports and imports is absorbed by transport costs.8 In particular, the cost and availability of transport permits and visas for vehicle operators to travel cross-border are a major barrier in Central Asia, hampering regional connectivity—it can cost as much as $400 for a driver from a non-Commonwealth of Independent States (CIS) country to enter Uzbekistan, in addition to various other charges such as road taxes, axel load charges, insurance, and visa charges.9 A multi-country study shows that a 20% reduction in logistics costs would increase the trade to gross domestic product (GDP) ratio by more than 10% in Cambodia, Lao People’s Democratic Republic (Lao PDR), and the PRC; by more than 15% in Mongolia; and by more than 20% in Papua New Guinea (Carruthers & Bajpai 2002). 7 In efficient multimodal transportation networks, goods move from one mode of transport to another seamlessly, without storage or human handling in between. 8 A recent study (ADB 2006c) indicates that regional cooperation in trade, transport, and customs transit in the Kyrgyz Republic would yield a potential cumulative gain for the period 2006–2015 amounting to $2.1 billion at 2002 prices. 9 Actual transport costs and time are often much higher than the “ideal world” costs (UNDP 2005b). The “ideal world” condition is based on balanced transport flows, competitive markets for transport services, smooth border crossings, low transit fees, and no visa problems or unofficial payments. 8 So far, these costs have not affected the overall competitiveness of Asian products, because some production clusters are located near ports and in coastal areas. This will become a major challenge in the years to come when manufacturing firms need to move inland due to congestion and other factors. It is estimated that in the PRC, inland provinces such as Shaanxi would have to incur additional land transportation costs of over $1,500 per 20-foot equivalent unit (TEU) of electronic goods to Qingdao port for exports. Though no comprehensive databases are available on the land transport costs of traded goods, several studies provide location-specific information. Almost 63% of the cost of transporting goods from Chongqing in the PRC to the west coast of the US is incurred before arriving at the PRC port for export (Carruthers & Bajpai 2002). Asia’s cross-border infrastructure and software. Given these logistics and transport challenges, there is potential for improving regional cross-border infrastructure to reinforce regional production and trade. Most of the initial production networks were supported by Box 1: Regional Trade Expansion and its Impact on the Logistics During the 1960s and 1970s, the Republic of Korea (Korea) had one of the most competitive manufacturing sectors based on cheap and highly-skilled labor. However, as labor costs increased, Korea gradually lost its international competitiveness. With the emergence of the People’s Republic of China (PRC) as a dominant low-cost producer with strong logistics systems, some of Korea’s manufacturing-based industries shifted to the PRC. From a small base of US$42 million in FDI in 1991, the PRC accounted for nearly 38% of all Korean FDI outflows (US$2.2 billion) in 2004. Several vertically-integrated production networks were created. South Korean enterprises attempted to retain as much as possible high value-added activitieslocally and as a result there was a significant impact on the freight flows between the PRC and Korea. The PRC, which accounted for only 2.9% of Korean trade in 1991, became the most important trade partner in 2004 with 16.6% of Korean trade. Given its geographical proximity, the Yellow Sea Rim area became one of the most important components of bilateral supply chains. Container throughput for the Yellow Sea ports (Qiangdao, Tianjin, and Dalian) increased more than 15 times in 1990–2003—this trend is significant compared with global flows that increased only 1.7 times. Korean port throughput also increased 5.4 times as a result of regional trade and PRC transshipment at Korean ports. In 2000, a regionally specialized container shipping service started and by 2003, a total of six freight-only lines created a logistics network to cater to regional trade. This regional network of Yellow Sea ports increased its share of trade, from 22.6% in 1994 to 32.2% in 2004. This, along with several other similar examples, indicates that regional connectivity and logistics improvements have been largely handled within a bilateral structure of trade and production networks. Source: Lee & Rodrigue 2006. national governments that invested in building national infrastructure in their countries with appropriate port linkages to the global and regional economy. The East Asian economies—the NIEs, middle-income ASEAN countries, and more recently the PRC and Viet Nam—have invested significant capital resources, building necessary national infrastructure to support these production networks. These networks have enjoyed an initial comparative advantage, but this is not guaranteed as the efficiency of East Asia’s logistics lags behind (ADB et al 2005). Overall quality and quantity of infrastructure in Indonesia, Philippines, Thailand, and to some extent