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CPEC: trade prospects

Updated December 26, 2016

The China-Pakistan Economic Corridor comprises a collection of road, rail, and pipeline projects currently under construction to connect Kashgar in China with Gwadar in Pakistan.

The project intends to rapidly expand and upgrade Pakistan’s infrastructure, as well as deepen and broaden its economic links with the People’s Republic of China.

The CPEC will affect Pakistan’s trade flows through multiple channels. First, it will reduce behind- the- border trade costs and bring about a shift in the modes of transportation.

Second, it will strengthen economic integration with the world’s largest trading nation, China.

Finally, it was give a boost to intra-country trade within Pakistan.

More than 86pc of the country’s exports occur through sea (column 4), the use of air and land transport is relatively limited (Table 1).

While Pakistan has access to the sea only through Karachi, its manufacturing is unevenly distributed in the hinterlands. Owing to long internal transportation, the country’s geography becomes a natural non-policy barrier to trade through sea.

Shipping a standard freight container’s load from Sialkot to Karachi involves internal transportation of more than 1,000 kilometres. These high costs of internal transportation potentially act as an implicit tax on exports and put firms at a comparative disadvantage in international markets.

The CPEC project will provide a network of road and railways to link remote manufacturing facilities to the Karachi and Gwadar seaports. The improved connectivity will reduce the costs of transportation and curtail travel time.

Furthermore not only will it enhance competitiveness of existing firms, it will also incentivise exports.

Moreover the project will also lead to the expansion of the export product set. For instance, Pakistan’s northern areas produce vegetables and fruits, such as apples, apricots and cherries. But due to a lack of good connectivity, most of this produce cannot be exported.

The CPEC will link the northern areas to airports in Peshawar, Rawalpindi, and Lahore. This will give a boost to the export of agricultural

commodities, as most of these products are transported by air owing to their perishable nature.

This improved connectivity to sea port and airports is just one aspect of the CPEC’s influence on trade flows. Another important change would occur in the modes of shipment (Table 1).

A large fraction of Pakistan’s trade with China — $16bn — occurs through the sea route: 97pc through sea, 2pc by air and 1pc by land.

The CPEC would bring a shift in the modes of transportation. A substantial fraction of trade with China will be diverted to the land route following the completion of the project. While sea transport is relatively cheap, road transport is the cheapest.

Moreover, it will link the country to the One-Belt-One-Road project and provide direct access to the markets of Central Asia and Europe as well. It may be noted that essentially the CPEC is not a bilateral project but has regional dimensions.

Second, the CPEC will give a tremendous boost to Pakistan’s trade with China.

The landscape of international trade has changed drastically in the past decade as the centre of gravity of production and trade has shifted towards Asia. China has emerged as one of the largest trading nations in the world. Last year, of the total world trade of $19tr, China alone accounted for more than 10pc.

Because of China’s emergence as a factory of the world, most developed and developing countries have re-oriented their trade towards it. Recently, after taking over as the Prime Minister, Teresa May’s first port of call of was Beijing because, in the wake of Brexit, the UK is keen to deepen its trade relations with this large economy.

Being a neighbouring country, Pakistan is well placed to strengthen its trade relationship with China. Trade between two countries follow Newton’s law of gravity in that it is directly proportional to the mass of the countries (GDP) and inversely proportional to distance.

Physical distance and associated travel time between China and Pakistan is going to fall drastically due to this land route, and the GDP of both economies will rise sharply; both factors boosting bilateral trade.

Many studies suggest that a 1pc increase in the income of an importing nation increases the trade of the exporting country by 1pc as well. Therefore, the gains in trade will occur not only from the reduction in distance and travel time but through the channel of engagement with the larger market of China as well.

Besides the improvement in international trade flows, a substantial shift is expected in the intra-country trade between various regions of Pakistan.

Pakistan’s firms sell two-third of their output in the local market. This domestic trade is highly concentrated in various geographical regions. For instance, Karachi based firms sell large quantities in Karachi; the same is true for those based in Lahore or Faisalabad.

This pattern will change with the improvement in regional connectivity. The construction of high speed railways in Japan enabled many firms to outsource production to suppliers in remote parts of the country to reduce labour costs.

Transit development will bring about an economic boom in relatively under developed areas of the country as well.

In conclusion, the CPEC will reduce the cost of doing business in Pakistan and improve competitiveness of its firms. This reduction in behind-the-border trade costs will give a boost to trade flows and increase integration with China.

However, to exploit the full potential of the CPEC, the country needs to focus on reducing trade costs at the border by rationalising tariffs, and those beyond the border, by negotiating trade agreements.

—The author is an empirical trade economist pursuing a PhD in the University of Nottingham, UK.

salamat.ali@alumni.lse.ac.uk.

Published in Dawn, Business & Finance weekly, December 26th, 2016