BINDING CONSTRAINTS TO REGIONAL COOPERATION AND INTEGRATION IN SOUTH ASIA 1 Gilberto M. Llanto 1 Gilbert Llanto is a Senior Fellow at the Philippine Institute for Development Studies and Professorial Lecturer, National College of Public Administration and Governance, University of the Philippines. The invaluable research assistance of Lawrence Nelson C. Guevara is gratefully acknowledged. The author would like to thank Muhammad Ehsan Khan and the participants in the workshop on Regional Cooperation and Integration Issues held at the Asian Development Bank on July 13, 2010 for their comments and suggestions. This paper does not in any way reflect the official view or position of the Asian Development Bank on the topic at hand. 1 EXECUTIVE SUMMARY To be meaningful, economic growth must be inclusive but the challenge is how to accomplish this goal. The presence of a wide poverty divide in the midst of rapid economic growth has prompted a rethinking of growth strategies and interventions for poverty reduction. Many countries are exploring cooperation and integration at the regional and global levels in their pursuit of inclusive growth and South Asia is no exception. Policy makers in the South Asian region believe that there is a significant case for greater cooperation and integration in South Asia, which is expected to contribute to more rapid growth, poverty reduction and greater political stability for the region. Various scholars have noted South Asia as “experiencing a new economic era” today. However, although a regional cooperating body was established in the region more than 25 years ago in the form of the South Asian Association for Regional Cooperation (SAARC), the level of integration in South Asia still remains low. There are many reasons behind the failure to achieve regional cooperation and integration in the region and identifying the most binding constraint or constraints was deemed to be the first critical step in mapping out a workable strategy to achieve sustainable regional cooperation and integration. In line with this objective, the South Asia Regional Department (SARD) of the Asian Development Bank conducted a High Level Forum (HLF) on Emerging Vision for Shared Prosperity: South Asia and Beyond in April 2009 and Post-HLF country consultations in Bangladesh, Bhutan, Maldives, Pakistan Nepal and Sri Lanka. The HLF identified the following priority areas for deepening RCI in the region: (1) Transport Corridors (2) Energy Trade and (3) Trade Facilitation. Taking off from the aforementioned consensus about the priority areas, which are perceived to be the most critical barriers to South Asian regional cooperation and integration, this report attempts to identify the binding constraints to achieving more efficient transport corridors, regional energy trade and trade facilitation in the region. The growth diagnostics approach of Hausmann, Rodrik and Velasco provided a convenient framework for a constraint analysis of each of those priority areas. The constraint analysis of those priority areas revealed the following: Trade Facilitation. While the region’s total trade volume has been increasing for the past ten years, intra-regional trade remains very low. The pace of tariff reforms under the existing South Asia Free Trade Agreement (SAFTA) has been very slow and overshadowed by fragmented bilateral agreements within the region as well as outside of the region. For trade facilitation to spur regional cooperation and inclusive growth, the following significant constraints should be addressed: (1) high tariff walls; (2) inefficiencies in ports operation and logistics performance; (3) inefficient custom and regulatory environment, and land or cross- border procedures; and (4) unresolved regional and internal political conflicts and strife. Eliminating high tariff walls and non-tariff barriers, simplifying customs and border requirements and improving the trade-related infrastructure will facilitate greater trade and interaction among countries of the region, which in turn will enable the region to realize the potential benefits of intra-regional as well as inter-regional trade. Energy Trade. South Asia’s energy sector is diverse with a relatively developed coal-reliant Indian energy sector, relatively underdeveloped energy sector in Bhutan and Maldives and a hydro-rich energy sector in Nepal and Sri Lanka. The South Asian region is a net energy importer and fast growing demand for energy makes energy security a major concern. The i electricity and gas shortage in the region has been described as persistent and recurring. Without a resolute action on the part of policymakers, it will hamstring growth in the region. There is great potential for energy trading within the region but intra-regional energy trade is low. Policymakers should address the following significant constraints: (1) inadequacy of domestic energy supply for energy trade; (2) inadequacy of private sector participation; (3) poor energy utility operational performance; (4) inadequacy of cross-border energy trade infrastructure; (5) immaturity of domestic energy sector regulatory frameworks; (6) inadequate access to finance and a reliable business environment; and (7) inadequacy of project development information. Transport Corridors. Strong and well-connected transport infrastructure is crucial for unlocking economies of scale and improving competitiveness, especially for the landlocked countries in the region. The fragmented nature of South Asia’s transport system however, has rendered the critical transport corridors inefficient. South Asia’s transport corridors generally are characterized by poor road conditions, lack of intraregional connectivity between the national road networks, undeveloped rail and inland water freight transport, and inadequate road and rail connectivity to ports. On the other hand, the lack of transit agreements and protocols is also considered as a binding constraint. The development of those transport corridors has been identified as a key to bring down the cost of transport of people and goods and improve the competitiveness especially of landlocked countries. While some of the constraints can be addressed at the national and bilateral levels, the full potential of the transport corridors can only be realized thru regional cooperation and integration. The public sector can do much to improve the state of transportation corridors but exploring various modalities under public-private partnerships will unlock private capital and expertise for much-needed investments in transport corridors. Cost of Finance. Private sector investment and the cost of finance were also highlighted as relevant cross cutting issues inasmuch as lack of private sector investments in the various sectors has been repeatedly identified as a major constraint. The dominance of the banks and bank loans and the state of capital markets in the region indicate that the financial system in South Asia is still relatively underdeveloped. However, while some reforms are needed to make the financial system more efficient, the cost of finance in the region is not considered as a critical constraint. The report suggests that other factors such as regional instability or conflict, poor infrastructure, weak regulatory frameworks may have been more critical constrains to growth and poverty reduction than just borrowing costs. Political conflicts and unresolved regional issues were identified as major crosscutting concerns that have constrained trade facilitation, energy trade and the development of transport corridors. Addressing them by countries in the region is a key issue. Moving forward, greater cooperation and integration in South Asia is possible. However, the region can only reap the benefits of cooperation and integration (e.g. rapid growth, poverty reduction and greater political stability) once the binding constraints to regional cooperation and integration are addressed. ii CHAPTER 1 THE BENEFITS OF REGIONAL COOPERATION AND INTEGRATION AND BINDING CONSTRAINTS: SOUTH ASIAN PERSPECTIVES I. INTRODUCTION 1. Inclusive growth is the rallying call of the development community, composed of developing country governments and multilateral and bilateral donor institutions in the face of deep and pervasive poverty, which has trapped millions of households in seemingly perpetual state of helplessness and vulnerability. The presence of a wide poverty divide in the midst of rapid economic growth has prompted a rethinking of growth strategies and poverty reduction interventions. Economic growth to be meaningful, to matter must be inclusive and the challenge is how to accomplish this goal. The traditional view that an economy can export its own, individual and unilateral way to growth through the exploitation of the opportunities offered by globalization and trade liberalization will not be a sufficient strategy for sustained growth and rapid reduction of poverty levels, especially in the post- global financial crisis period and in a world in the crest of competition and concerns about climate change and demographic transitions. Relentless, individual or unilateral pursuit of export markets, which benefited and transformed the economies of Japan, Taiwan and South Korea, the East Asian miracle, may no longer be an adequate pathway for growth and poverty reduction for many developing economies. 2. Today, many countries are exploring cooperation and integration at the regional and global levels in their pursuit of inclusive growth. The ASEAN countries’ transformation into