Trade and Regional Cooperation for Growth and Poverty Reduction in South Asia

Presentation to the IGC Trade Program, School of International and Public Affairs, Columbia University, New

York, March 25, 2010.

Sadiq AhmedPolicy Research Institute of Bangladesh

Table of Contents South Asia’s Progress and Challenges Growth, Poverty and Lagging Regions Cross-Border Constraints to Growth and Poverty

Reduction Trade and Regional Cooperation for Development of

South Asia’s Lagging Regions Managing the Politics of Cooperation in South Asia:

The Way Forward

A.1.South Asia’s progress and challenges Between 1960 and 1980, growth in South Asia was sluggish

(only 3.7 percent per year) due to inward looking control-oriented policies causing high dependence on low-productivity agriculture, inefficient and low levels of industrialization, weak export performance, and inadequate creation of good jobs.

South Asia’s prospects changed in the 1980s as it adopted pro-growth policies by opening up markets to international competition, replacing public sector with the private sector as the engine of growth, and improving macroeconomic management.

As a result, South Asia’s growth rate climbed to around 5.7 percent during 1980-2000, which further accelerated to 6.5 percent during 2000-2009.

Poverty has come down sharply in all countries and social indicators have improved.

A.2. Growth rates in East Asia and South Asia appear to be converging

Figure 1.1: Real GDP Growth

0.0

1.0

2.0

3.0

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6.0

7.0

8.0

9.0

1960-80 1980-90 1990-2000 2000-07

Years

Perc

ent

East Asia and Pacific South AsiaSub-Saharan Africa Middle East and North AfricaOECD

Source: World Bank's World Development Indicators.Notes: Data are averages.South Asia’s data include the 2007 growth rate, while the rest of the regions do not.

0

10

20

30

40

50

60

70

80

Headcount Index (%)

Bangladesh India Nepal Pakistan Sri Lanka

Countries

Figure 2. Poverty Reduction in South Asia 1970s-2000s

1970s

2000s

A.3. Poverty in South Asia has declined.

A.4. But personal and spatial income inequality has increased Despite strong growth and poverty reduction,

two negative developments have emerged: First, income inequality has increased. Second, there is growing income imbalance

in regions within countries and among the South Asian countries leading to the lagging regions problem.

A.5. Moving forward South Asia faces three major development challenges

How can South Asia grow even faster than in the recent past in order to reduce poverty at a faster pace ?

How can the gap between leading and lagging regions be reduced?

How can personal income inequality be lowered?

B.1.Growth, poverty, lagging regions are inter-linked

With few exceptions lagging regions exhibit higher than average poverty incidence and lower than average per capita incomes

Concentration of poverty in the lagging regions is largely a reflection of slower growth

Inequality is a more complex challenge, although growing spatial inequality might have contributed to personal income inequality

B.2. Income per capita in South Asia shows considerable disparity across countries

Figure 3: South Asia Per Capita Income 2006

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B.4. Poverty incidence is mostly higher in lagging regions

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B.5. Poverty in the lagging regions is mostly higher in all countries Nearly half a billion South Asians live in the lagging regions. In India, nearly 60 percent of the poor in live in the lagging

states. Every seventh poor Indian lives in Bihar (the state with the lowest per capita income).

In Sri Lanka, poverty rates are lower in western part (leading regions) as compared to the rest of the country.

In Nepal, poverty incidence is higher in western part (lagging region).

In Pakistan, Balochistan and NWFP (the low income provinces) have higher poverty rates than Sindh and Punjab.

In Bangladesh, the Northern part has lower income and higher poverty than the Central and Southern parts.

B.6. Income inequality rising in South Asia

South Asian experience shows growing personal income inequality.

Inequality is also rising within regions For most countries growth in inequality

across leading and lagging regions is rising faster than growth in inequality across individuals

B.7. Gini coefficient (the latest available) and the annual growth rate of gini (%)

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B.8. Annual growth rate of regional inequality and the pure individual effects for selected South Asian countries

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B.9. The tale of “two South Asias” Leading regions: characterized by rapid

GDP growth, urbanization, and integration with the global economy.

Lagging regions: rural, rely on low value agricultural and informal activities, and are not integrated with the national, regional, and global market.

B.10. South Asian experience compares unfavorably with that of developed countries

Income gap between the leading and lagging regions in South Asia is larger compared to the spatial disparities in developed countries.

For example, in India, GDP per head in the richest state (Haryana) is 5 times greater than the poorest state (Bihar). In US, the difference is 2.5 times and in Japan only 2 times.

There is evidence of strong convergence among regions in US, Japan and EU.

C.1. Cross-border constraints to growth and poverty reduction

While the problem of lagging regions is gaining public attention, domestic public policy alone will not help.

Much of South Asia’s lagging regions are either land-locked countries (Afghanistan, Nepal) or are border districts/states/provinces of the three larger countries of Bangladesh, India and Pakistan.

So, in addition to efforts to increase investment and improve governance, public policy must pay attention to the cross-border aspects of the lagging regions problem

C.2. Border constraints on lagging regions The landlocked countries of both Afghanistan and Nepal are

among the lowest per capita income group in region. Out of 14 states of India that have borders with neighbors, 12

have per capita income levels that are at or below national average.

In Pakistan, per capita income is lower than average in the border provinces of North-West Frontier, Balochistan, and rural Sindh.

In Bangladesh, the border districts tend to have lower than average per capita income than the national average.

Most of the lagging regions in income terms are also lagging in terms of having higher than average incidence of poverty and/or poorer human development indicators.

C.3. Most land-locked and border regions are lagging in per capita income

Map 1: Per Capita Income in South Asia

Leading Regions

Lagging regions

AFGHANISTAN

INDIA

PAKISTAN

NEPAL

BANGLA-DESH

SRI LANKA

BHUTAN

Map 2: Distribution of Poverty in South Asia

Leading Regions

Lagging Regions

N/A

AFGHANISTAN

INDIA

PAKISTAN

NEPAL

BANGLA-DESH

SRI LANKA

BHUTAN

C.4. Most landlocked/border regions have higher poverty rates than regional/national averages

C.5. Key socio-economic characteristics of the border lagging regions

These lagging land-locked/border countries/states/provinces/ districts have an estimated 400 million people of which an

estimated 200 million people are poor (reference year of 2005). This is about 50 percent of South Asia’s estimated total number of poor for the year 2005.

Much of the population is rural (90 percent) and most are engaged in low-productivity agriculture.

The human development indicators tend to be below the comparable national average and many indicators are lower than the average in South Asia.

Infrastructure is on average poorer than rest of the respective countries and poorer than the average for South Asia

The border regions on average tend to be more vulnerable to water shortages and flooding problems than other parts.

C.6. Apart from being poor, the lagging regions share a number of common vulnerabilities

First and foremost is the vulnerability to natural disasters. The loss of life and income is tremendous and it is the poor who suffer most.

A related vulnerability is the water constraint on irrigation and transport.

South Asia’s poor rely heavily on Indus-Ganges-Brahmaputra water basins that are subject to frequent water shortages and floods creating serious challenges for poverty reduction.

D.1.South Asia must address the lagging regions problem in order to achieve both high and inclusive growth

South Asia has made progress, but growing forward the challenge is complicated by the fact that growth is concentrated in leading regions while poverty is concentrated in lagging regions

To achieve higher and more inclusive growth, public policy must concentrate on raising growth and human development in the lagging regions

Rising inequality between regions suggest that higher income growth in lagging regions might help reduce personal income inequality.

The focus of public policy also needs to recognize that much of South Asia’s lagging regions are either land-locked countries or are border districts/states/provinces.

D.2. Trade and cooperation can be instrumental in raising growth in the lagging regions and lowering vulnerability

Trade and regional cooperation can help accelerate growth and reduce poverty by supporting market integration for goods and factor services

Better physical connectivity and trade in energy will lower transaction costs and ease the energy constraint, thereby promoting private investment

Water cooperation will raise farm productivity and reduce vulnerability of the lagging regions

D.3. Market integration for higher growth The extent to which economic agents take advantage

of market is impacted positively by density, but negatively by distance and division

By reducing distance and division, market integration both within and between countries, brings economic agents in lagging regions closer to the density of leading regions, promoting positive spillover effects which enhance spatial multipliers.

South Asia has significant room to benefit from better market integration globally, across countries within South Asia, and within countries

D.4. South Asia’s international trade has grown but trade remains heavily restricted

Figure 1.2: Real Growth in Trade of Goods and Services

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1995-99 2000-04 2005-06 2007Years

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East Asia Pacific South AsiaSub-Saharan Africa Middle East and North AfricaOECD

Source: World Bank's World Trade Indicators 2008.Note: Data for 1995-99, 2000-04, and 2005-06 are averages.

Figure 1.3: Trade Tariff Restrictiveness Index

0.0

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15.0

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2000-04 2005-06 2007

Years

MFN

appl

ied

tarif

fs

East Asia Pacific South AsiaSub-Saharan Africa Middle East and North AfricaOECD

Source: World Bank's World Trade Indicators 2008.Note: Data for 2000-04, and 2005-06 are averages.

D.5. Regional trade is even more heavily restricted through a host of non-tariff barriers

Within South Asia market integration is the lowest in the world; regional trade is less than 2 percent of GDP in South Asia as compared with 40 percent for East Asia

Border barriers to trade and services have mostly disappeared in the rest of the world

In contrast, divisions across countries have increased dramatically in South Asia

Thus, in 1948 South Asia’s share of intra-regional trade as a share of total trade was 18 percent. In 2000-07 it fell to only 5 percent.

D.6. Poor trade logistics reduce global and regional trade in South Asia Globally, South Asia performs poorly on trade

logistics. Intra-regionally it is even worse due to various extra restrictions

D.7. Removal of trade barriers will promote agglomeration benefits Yet, geographical configurations of South Asia

contain huge agglomeration potential to propel growth

East Asia is an example of a region with a high-level of intra-regional trade and intra-industry trade that enabled firms to internalize externalities arising from agglomeration.

The seamless interaction of improved trade, better connectivity and converging institutions can accelerate growth in South Asia’s lagging regions.

D.8. Infrastructure is a serious constraint to South Asia’s growth and lagging regions

South Asia’s 3 infrastructure deficits: Service deficit. Power outages and water shortages

regularly occur. Rural roads are impassable in lagging regions.

Policy deficit. Distorted pricing, poor sector governance and accountability, and weak cost recovery have hampered private sector to invest more in infrastructure.

Cooperation deficit. Lack of cooperation between South Asian countries have constrained the development of energy resources and raised transport cost

D.9. Better infrastructure for growth in the lagging regions Improved infrastructure that enhances connectivity

and contributes to market integration is the best solution to promoting growth as well as addressing the rising inequality between regions

South Asian growth relied more heavily on services sector relative to manufacturing, thereby constraining good job creation.

Future growth must rely more aggressively on manufacturing to create more and better jobs

Better infrastructure and agglomeration prospects of regional cooperation will benefit the manufacturing sector

D.10. Regional cooperation for infrastructure development Regional cooperation can promote infrastructure in

three priority areas: telecoms and internet; energy; and transport

A regional telecom network and a high-bandwith, high speed internet-based network could help improve education, health and innovation

It would also facilitate better flow of ideas, technology, investments, goods and services

More broadly, this would strengthen the competitiveness of South Asia in the services export sector

D.11. The benefit from energy trade is especially large Afghanistan and Nepal are sitting on water resources that

could potentially generate some 24,000 MW of electricity from Afghanistan and 83,000 MW from Nepal

Exploitation of this potential can unlock the energy constraints in India, Bangladesh, Pakistan.

Afghanistan and Nepal, the two poorest South Asian countries will benefit tremendously as well from higher income from hydro-power

Yet less than 1 percent is actually used due to lack of cooperation. Indeed without borders development of South Asia’s hydro-power would be perhaps the highest return investment.

D.12. South Asia’s tremendous hydro-power potential

D.13. Gains from energy trade: Power grid connectivity in Bangladesh

D.14. Remove restrictions on transport border crossings Cross-border transport restrictions are a huge constraint on

trade and investment in South Asia In most cases ad-valorem transport costs exceed the applied

tariff, suggesting that transport costs are a higher barrier to intra-regional trade than tariff

These costs reflect regulatory barriers mainly, but also poor infrastructure

Unhindered access to regional ports will raise income for all countries

Along with removal of transport restrictions, investment in transport network can change the growth prospects for South Asia’s lagging regions

D.15. Remove restrictions on transport border crossings Cross-border transport restrictions are a huge constraint on

trade and investment in South Asia In most cases ad-valorem transport costs exceed the applied

tariff, suggesting that transport costs are a higher barrier to intra-regional trade than tariff

These costs reflect regulatory barriers mainly, but also poor infrastructure

Unhindered access to regional ports will raise income for all countries

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D.17. Regional cooperation for reducing vulnerabilities for South Asia’s poor

South Asia’s poor would probably gain most from regional cooperation in water and climate change. The Indus Basin Agreement between India and Pakistan is an example.

Cross-border cooperation on water between India, Bangladesh, and Nepal offers the only long-term solution to flood control and water shortages in Bihar, UP and Bangladesh

A cooperative solution between Afghanistan and Pakistan on the sharing of the Kabul river hold tremendous potential for resolving water shortages in both countries

D.18. An example from Bangladesh: For water security and climate change, cooperative solution only way out for Bangladesh

41

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)

Importantly, all three rivers, especially the Ganges and the Brahmaputra, flow thru upstream India. Other upstream countries 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

42

E.1.Managing the politics of trade and cooperation in South Asia: key constraints

The gains from cooperation are obvious. What are the key constraints?

First and foremost is the prevalence of a number of regional disputes (Kashmir problem, Talibans issue)

Second is the lack of good information and analysis in the public domain about the benefits of cooperation

Third is the internal political interests in countries that are divided along nationalistic, religious and ethnic lines that substantially complicate regional cooperation agenda

Finally, the bilateral approach to regional cooperation has raised suspicions in smaller countries of India’s dominance

E.2. Managing the politics of cooperation in South Asia: the way forward International experience shows that political constraints

and historical conflicts need not be permanent barriers to cooperation (EU)

Presence of a dominant country should also not be a problem (China and ASEAN)

Fortunately the environment for cooperation is improving in South Asia as economic progress has created better political space and a greater realization the cooperation is necessary for progress in the lagging regions and for addressing the infrastructure constraints

The recent initiatives taken by Bangladesh and India to remove trade and transit barriers is a huge step forward and could show the way for the future

E.3. Managing the politics of cooperation in South Asia: the way forward

The next step is to identify concrete bankable projects where multi-country cooperation would yield tangible benefits for citizens.

The immediate priorities are: trade facilitation; regional transport; energy trade and water cooperation

Cross-border transactions must be depoliticized and pursued on a commercial basis

Enabling national and international private investors to participate in these transactions hold the most promise of success than bilateral political deals

International financial institutions can also play a useful role by bringing global good practices, by providing technical assistance to smaller countries and by mobilizing external financing.