Introduction

Infrastructure services play a significant role in trade costs by reducing distribution margins, lowering prices, and raising consumer welfare.¹ They also lower transaction costs, add value, and increase profitability for exporters while expanding linkages to global distribution networks. Infrastructure is a significant determinant of both export levels and the likelihood of exporting at all (Francois and Manchin, 2007).

Nordas and Piermartini (2004) highlight four interactions between trade costs and infrastructure: (i) Direct monetary outlays are partly determined by charges for infrastructure services; (ii) Timeliness is influenced by infrastructure and geography; (iii) Risk of damage, losses and higher insurance costs rises when infrastructure is poor; and (iv) Market access may be limited by transport or telecommunications.

Infrastructure development can increase exports at the intensive margin (deepening existing shipment levels) and the extensive margin (new products or destinations). Expansion through new, small shipments from small firms at the extensive margin requires different transportation infrastructure than deepening existing trade flows.

Four recent changes in trade affect demand for transportation services: (i) changes in the weight to value ratio of traded goods; (ii) demand for timeliness; (iii) newly traded products and trade routes, generally involving smaller shipments; and (iv) production fragmentation in geographic terms. Hummels (forthcoming) finds that the relationships are interlinked as, for example, declining weight/value ratios and vertical specialization in new, fragmented production networks yield new air cargo flows. Meanwhile, interactions between changing composition and volume of trade influence the bankability of infrastructure investments.

When differentiated among commodity groups, the weight to value ratio is a major determinant of transport cost, suggesting that road, rail, and sea transport modes may be in increasing order of preference for heavier cargos. Hummels and Skiba (2004) found that a 10 percent increase in the product weight to value ratio results in a four percent increase in shipping costs.

The composition of freight charges varies significantly across countries and commodity categories. The share of total freight charges accounted for by inland freight is generally less than that of ocean freight, but can be greater. The actual balance depends on the country, suggesting an inland focus for traderelated infrastructure priorities for some countries. As land and labor costs rise near coasts in the People's Republic of China (PRC), investors are looking to locate production facilities farther inland but are hampered by poor infrastructure connections that raise trade costs to and from those areas. In particular, railway construction is crucial for inland provinces where a greater share of production is of bulk commodities.

The PRC has experienced fluctuating trends in freight and insurance costs for ocean trade but a steady decrease in those for air cargo. In 2002, the ad valorem costs of air freight and insurance fell below those of sea freight and insurance, and have remained lower since. Over the period from 1990 to 2004, the share of air cargo was relatively constant in terms of weight but about tripled in terms of value (Ma and Zhang, forthcoming).

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