Monday, January 12, 2015

Transport Costs, Trade, Trading Networks, and Infrastructure

Often times, we hear economists talk about trade and its benefits/costs. However, they don't seem to understand all of the costs, benefits, and risks involved. They also (almost always) ignore transport costs and trade networks. This is also a problem when we talk about infrastructure because we rarely talk about how transport costs will be impacted by infrastructure even though, often times, the purpose of infrastructure is to reduce transport costs. This post will be split up into four separate parts:
1. Transport Costs
2. Trade and Trading Networks
3. Infrastructure
4. Impacts of Infrastructure

1. Transport Costs:

First, I'll start off with the most basic fact: the cost of shipment via trade is much cheaper than shipment via land. There are many reasons why, including physical factors like friction (buoyancy) and infrastructure development. For the purposes of this blog, I'm going to ignore the reasons why because I'm not a civil/mechanical engineer who specializes in fluid dynamics and because that's not what I'm interested in looking at. Just by the cost of operation, transport by land is 10-15 times the cost of transport by water. When you add in the cost of the infrastructure like road/rail networks required to make trade by land possible, it's uncommon to see trade by land cost about 50 times more in flatland. In highlands/deserts/harsh terrain, this cost can be 100 times more expensive. The chart shown on the left is for American transport costs.

Also note that not only is water easier to trade across, but rail is cheaper for shipping items than truck. On top of this, the construction of a rail network is also cheaper than construction of a road network. So when we talk about constructing infrastructure in our country as an investment, we must look at all of these factors.

First off, I'll start by discussing the impacts that navigable waterways can have. In the US, the cost of maintenance for all waterways is <$3 billion/year according to the Army Corps of Engineers. The cost of maintenance for the interstate road network (which only accounts for ~25% of the total driven miles) is >$150 billion/year. If we add in the costs of constructing the roads, the service stations, and the insurance costs, it easily becomes >$300 billion/year. In other words, transport via water is just orders of magnitude cheaper.

2. Trade and Trading Networks:
Once we understand transport costs, it becomes easy to see how trading networks develop. The most obvious consequence is that natural trade networks end up being built in areas that're near a coastline that can be navigated or navigable rivers. This is exactly how almost every single ancient civilization began. The primary reason was transport costs and the mobility of populations across these networks.

Even today, almost all (I can't think of one that's not) financial centers are built around either navigable waterways or near a coastline. This is not a coincidence. Much of the trade and capital generation centers around these regions simply because of transport costs and access points for particular countries or regions. The easiest and cheapest way to get to a distant country is via water. When we add in oceans, it becomes impossible to develop networks to navigate across these things and air transport is expensive for lots of reasons.

Basically, the most obvious place for civilizations, cultures, and cities to cluster around are near navigable waterways.
Note: Capital cities are the exception to this rule. Capital cities can hold together mainly because that's where the guns are and that's where the taxes go to. They do not need to be economically beneficial (and often times aren't).

3. Infrastructure:
Now, is this to say that these roads shouldn't be built or maintained? Of course not. These roads allow for transportation and trade networks that wouldn't be available. Basically, it's not always a great idea to build roads and bridges in the name of "investment". Socialists/statists particularly like to make these kinds of claims like there's no possible downside from building infrastructure, but if the trade networks and other economic benefits don't provide enough value for all of the costs involved, you end up seeing massive value destruction. This is particularly important when we're talking about building connecting infrastructure for sparsely populated areas with harsh terrain.

Another problem with "investment" in infrastructure is the possible destruction of natural trade networks. For example, the Chinese government decided to stick a dam in the middle of the Yangtze River (Three Gorges Dam), which is the only navigable river in China that isn't located in Southern China. They said it would generate enough power to pay for everything. However, the costs associated with the project include environmental damage, social impacts, and a spike in transport costs that's never included in the cost of the infrastructure project from all of the possible trade that was made impossible by the construction of the dam. Edit: Note that the dam was designed to reduce navigation costs by allowing large ships to pass across, but it will make the river completely unnavigable until the dam to Shanghai in a few decades.

On the other hand, there are also projects like the Erie and Panama Canals. The Erie Canal allows for a trade network to be formed and allows for more trade by water. In other words, the construction of the Erie Canal allowed for an increase in capital generation. The Panama Canal allowed for the Atlantic and the Pacific Oceans to be linked without having to circle Argentina or Canada (trade around those areas is difficult and can be impossible depending on the time of year and weather patterns). If it weren't for the Panama Canal, trade between the East and West Coast of the US would be much more difficult.

4. Impacts of Infrastructure:
One major role for infrastructure is in the security of a country. Often times, the security structure provided by having better water transport systems or better irrigation systems is invaluable. Having a road network can not only help trade, but help the transportation of military vehicles across long spaces which may be necessary from a national security standpoint.

Infrastructure can also be useful in properly managing natural resources (ex. water) and in securing supply lines for trade or for military purposes and in securing the transfer of key resources like food and energy to large population centers. Infrastructure can also help provide and keep trade networks open. It can create new trade networks and can be very beneficial economically.

Infrastructure spending to manage water systems better, to prevent soil erosion, energy infrastructure to secure the transportation of natural resources can be extremely valuable. It's best if these infrastructure projects are kept localized and small in order to be kept efficient. Large scale infrastructure projects can, often times, end up being a complete waste because of small, unforseen errors that can either cause blow-ups, large cost overruns, or other unforseen consequences.

Basically, the importance of the way infrastructure projects are designed and undertaken is extremely important. The best way to deal with infrastructure is to decentralize the scale of the projects as much as possible. However, this isn't always possible and infrastructure must sometimes be centralized. Ideally, centralization in infrastructure should be done primarily for defense purposes.

The consequences of poor infrastructure can end up with results like water depletion, soil erosion, farmland destruction, or a collapse in economic activity stemming from a destruction of the trade networks.

Note: Keep in mind that for trade and trade networks, you don't necessarily need roads or rail from point A to point B everywhere. If you have a point C that's closer to point A and links to point A (or a point D near point A) via water, all you have to do is build a network to get from point A to point C and then take it from point C to point A (via point D if necessary). In other words, a small amount of infrastructure can do quite a bit of good, but a further ramp-up in infrastructure can be quite dangerous.

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