The Costs of Trade

Despite globalization and the rapid increasein trade over the past 40 years, the costsof trading remain substantial – particularly fordeveloping countries. Because ofthose costs, the actual volume of internationaltrade is far less than economic theory wouldpredict in the absence of significant barriers totrade. Trade within countries is muchmore intense than between countries. If tradecosts were insignificant, the propensities totrade nationally and internationally would beequal. In fact, crossing a national borderappears to dampen trade flows even in regionssuch as the EU, where formal trade barriersand customs posts have been removed.Finally, the retail prices of particular goodstend to diverge with distance, and this differenceis much higher when the two locationsbeing compared lie on either side of a nationalborder.

The tax equivalent of trade costs can rangefrom 30 to 105 percent, depending on the sector. High trade costs discourageinvestment and constrain the ability of localfirms to integrate into global production chains.

Cost raising barriers may be linked in circlesof causation, with significant impacts dueto scale economies in transport. For example,a reduction in tariffs or a decline in costs at theport may stimulate trade that can offer opportunitiesfor transport companies to operate atmore efficient levels of scale. And if there is effectivecompetition in the transport sector, thiscould lead to lower transport prices and moretrade, and so on. A reduction in corruption and delays at the border may stimulate trade, add to government revenues, and allow for a reduction in tariffs to achieve a given revenue target, which again stimulates trade.

Landlocked countries that face high barriers in moving their imports and exports through neighboring countries have no choice but to pursue bilateral or regional solutions. These need not be embedded in a regional preferential trade agreement (PTA), but to be effective for small countries, agreements must provide for the settlement of disputes. Such provisions are likely to be more effective if they are part of a broad and comprehensive agreement.

Finally, removing institutional obstacles to crossing borders has a more certain benefit than reducing intra-regional barriers, because it saves real resources. Trucks that make more deliveries to the port are more productive. Interventions that lead to higher productivity have the greatest impact on trade and welfare—and on further increases in productivity. In contrast, removing revenue-generating tariff barriers on a preferential basis can lead to trade diversion and reductions in welfare.