# **_1. Introduction:  Understanding the Impact of Physical Barriers to Trade_**

As tariffs and other formal barriers to trade have fallen across developing and industrialized regions, transport and logistics costs have become, in many cases, the biggest cost factor in the final price of delivered goods.<sup>2</sup> Likewise, efficient and cost-effective transport infrastructure, freight and logistics services, intermodal and cross-border connectivity what—might be referred to as the physical components of trade—are becoming ever more important catalysts for development and regional integration. As evidenced by the experience of the European Union, integration of markets and regional infrastructure networks stimulates growth. These reduced barriers to trade facilitate the gains from structural change, speeding up technology transfer, underwriting marketsize effects on research and development (R&D), and stimulating investment and innovation through reduced transaction costs.<sup>3</sup> Improving the efficiency of connections between demand centers and production and distribution points connects rural and small producers to markets, creates employment opportunities for the manufacture of traded goods, and reduces the delivered prices of staples, inputs to production and household goods.

The recent signing of a free trade agreement among Central American countries, CAFTA-DR (hereinafter “CAFTA”), represents an important step towards regional trade integration, particularly for the six contiguous countries of the region.<sup>4</sup> However, a number of infrastructure and logistics-specific challenges need to be resolved for the region’s countries to be able to reap the full benefits of CAFTA and to integrate not only with each other, but also with the rest of the global economy. A series of logistics supply chains of goods moving through and into Central America analyzed by the World Bank reveals that poor road conditions, lack of scale economies in freight haulage and bottlenecks at the region’s border crossings, mostly attributed to customs delays, present the key burdens for trade of agricultural products across the region.<sup>5</sup> This is consistent with logistics supply chain analyses conducted throughout Latin America and the Caribbean (LAC) in recent years. In other parts of the LAC Region, the effect of delays in customs clearance are significant, for instance, resulting in an increase in transport costs by between 4 and 12 percent. This is equivalent in cost to an approximately 50 percent increase in the physical distance that a good must travel to reach its destination.

Obstacles to increased intraregional trade are also posed by the quality of roads and trucking services that effectively increase the “real distance” to both domestic and export markets. In Costa Rica, domestic businesses have identified road quality as one of the three main impediments to their growth and productivity, with poor road quality causing direct losses from

> 2 For example, Schwartz, et al (2009) find average ad valorem tariffs for food imports in LAC have decreased to a range of 3 to 12 percent of product value while international maritime and road haulage costs alone constitute about 20 percent of the FOB value of goods.  The total of all logistics costs can be greater than 50 percent of a good’s value, depending on product and trade route.

> 3 Academic research has also shown that openness to trade results in dynamic benefits through productivity growth, with a small contribution coming through increased investment (see Dowrick and Golley, 2004).  The strategy of trade liberalization, in turn, is often accompanied by policies that promote export diversification that, similarly, is believed to be a positive driver of growth (Hesse 2009).

> 4 For the purposes of this study, Central America is defined as the six Spanish-speaking countries that lie between Mexico and Colombia:  Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and Panama.

> 5 Fernández, R. and S. Flórez (2010 - Forthcoming)

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