Making regional cooperation work for South Asia's poor

2 Making Regional Cooperat ion Work for Sout h Asia’ s Poor Sadiq Ahmed and Ej az Ghani 1 1. INTRODUCTION S outh Asia continues to grow rapidly, and its largest economy, India, approached near double-digit growth in 2006–07. This is a remarkable transformation of a region whose countries have been infamously dubbed a “basket case.” Well up to the late 1970s, South Asia, which includes eight countries—Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka—was known for conflict, violence, and widespread and extreme poverty. In the initial years after independence, the South Asian countries adopted import substitution growth strategies with heavy trade protection, curbed the growth of private firms, and introduced restrictive labor laws to protect workers. After some 30 years, the outcome of these policies turned out to be quite different from what the leadership had in mind. South Asia delivered sluggish growth, continued dependence on low-productivity agriculture, low levels of industrialization, weak export performance, and inadequate creation of good jobs. Between 1960 and 1980, South Asia grew at only 3.7 percent per year. Much of the labor force was engaged in low-income activities in agriculture and informal services, and some 45 percent of the population lived below the poverty line. Regional Cooperat ion Work for Sout h Asia’s Poor 31 South Asia’s prospects changed in the 1980s as it adopted pro-growth policies. It opened up markets to international competition, replaced the public sector with the private sector as the engine of growth, and improved macroeconomic management (Ahmed 2006). The results were impressive. South Asia’s annual gross domestic product (GDP) growth rate climbed to around 5.7 percent during 1980–2000, and further accelerated to 6.5 percent during 2000–07. It is now the second-fastest-growing region in the world, after East Asia. Growth rates in South Asia and East Asia appear to be converging (Figure 2.1). In 2007, India experienced a remarkable GDP growth of 9 percent, close to that of China. Other South Asian countries such as Bangladesh, Pakistan, and Sri Lanka experienced growth rates of 6.5 percent. Private investment has boomed, supported by rising national saving rates in South Asia. The region now attracts global attention because of rapid growth, global outsourcing, and skill-intensive service exports. Rapid growth has been instrumental in reducing poverty in South Asia. Poverty has come down sharply in all countries (Figure 2.2). Progress has been made in improving human development, and social indicators compare favorably with countries in other regions with similar income levels (Ahmed 2006). FIGURE 2.1 Real GDP Growth Source World Bank’s World Development Indicators. Note Data are averages. South Asia’s data include the 2007 growth rate, while the rest of the regions do not. 32 Sadiq Ahmed and Ej az Ghani FIGURE 2.2 Poverty Reduction in South Asia, 1970s–2000s Source World Bank regional database. Note Poverty estimates use national poverty lines. The respective dates are as follows: Bangladesh (1975 and 2005); India (1974 and 2005); Nepal (1977 and 2004); Pakistan (1970 and 2005); and Sri Lanka (1976 and 2005). While there is much to celebrate, two negative developments have emerged: (a) evidence of growing income inequality in South Asia, and (b) a growing imbalance among regions within countries and among the countries themselves. With fairly large and open borders, the growing imbalances in incomes and opportunities among South Asian countries present similar social and economic problems to the prosperous neighbors as the imbalances within these countries. Poverty, income growth, and lagging regions are interrelated. South Asia’s experience shows that the incidences of poverty and income growth are strongly and negatively correlated (Figure 2.3). With few exceptions, lagging regions exhibit a higher than average rate of poverty and lower than average per capita incomes. The growing divergence between lagging and leading regions suggests that lagging regions on average are growing more slowly than leading regions. So, a substantial part of the poverty and lagging regions challenge is a growth challenge. Two major development issues face South Asia: (a) How can South Asia grow even faster than in the recent past? (b) How can FIGURE 2.3 Growth–Poverty Correlation in South Asia Regional Cooperat ion Work for Sout h Asia’s Poor 33 Source Staff estimates using data from Figures 2.4 and 2.5. 34 Sadiq Ahmed and Ej az Ghani lagging regions accelerate growth to catch up with growth in the leading regions? The problem of inequality is, however, a more complex challenge. Growth acceleration in the lagging regions might help reduce inequality. But this is only part of the larger task of making growth more inclusive. A pattern of growth that benefits income growth for the poor, higher employment elasticity of growth, and strengthened public service delivery, including better social protection policies, all need to be core elements of a strategy to lower income inequality. 2. GROWTH ACCELERATION, LAGGING REGIONS, 2 AND INEQUALITY: A FRAMEWORK The experience of East Asia shows that growth supported by factor accumulation as well as productivity improvements can lead to higher growth (Gill and Kharas 2007). South Asia’s experience is similarly positive (Ahmed 2006). Additionally, it has two key assets—demography and geography—that have not yet been fully utilized. It has a young labor force. More workers will join the labor force over the coming decades. Though the small size of the manufacturing sector has prevented the region from converting this demographic dividend into an opportunity, the large and potentially productive labor force could be the catalyst that attracts regional and global production centers to South Asia, as firms move in response to wage differences and globalization benefits lowincome countries. South Asia’s geography also has the potential to accelerate growth. It has the highest population density in the world, and the second largest proportion of population living in the border areas after Europe. High population density and better access to markets can benefit growth by allowing South Asian firms to take advantage of agglomeration economies. Despite these benefits of geography—density and distance—South Asia’s true growth potential has not been realized because of the lack of market integration within and across countries. South Asia accounts for only 3 percent of the world surface area, but it sustains an extraordinary 20 percent of the world population, nearly 1.5 billion people. It has the highest population density in the world, yet it has one of the lowest urbanization rates. There are indeed large differences across countries in South Asia. In 2005, India (which accounts for 74 percent of the regional Regional Cooperat ion Work for Sout h Asia’s Poor 35 population) produced close to 80 percent of the South Asian GDP. Pakistan (13 percent of South Asian population), Bangladesh (10 percent), Sri Lanka (1 percent), and Nepal (2 percent) accounted for 11 percent, 6 percent, 2.3 percent, and 0.7 percent of the regional GDP, respectively. Afghanistan, Bhutan, and Maldives collectively accounted for less than 1 percent of South Asia’s GDP. The differences in per capita income are large, ranging from a high of US$2,700 for Maldives (for 2006 measured in current US dollars) to a low of only US$250 for Afghanistan (Figure 2.4). Even if the small economies of Maldives and Bhutan are excluded, the per capita income gaps are quite large. FIGURE 2.4 South Asia Per Capita Income, 2006 Source World Bank 2008e. The income gap at the national level carries through at the subnational level (Figure 2.5). During the period 1993–2004, GDP growth in the leading states in India grew at twice the rate of the lagging states. The average annual growth rate for the leading states (Andhra Pradesh, Gujarat, Haryana, Karnataka, Kerala, Maharashtra, Punjab, Tamil Nadu, and West Bengal) was 5.9 percent. The average growth rate for the lagging states (Bihar, Madhya Pradesh, Orissa, Rajasthan, and Uttar Pradesh) was 3 percent per year. In Sri Lanka, the leading regions grew at an annual average rate of 6.5 percent during 1996–2005, while the lagging regions (Sabaragamua, Central, Uva, and North Western) grew at an average rate of 1.5 percent per year. In Pakistan, the difference in the growth rates between the leading and lagging regions is less striking. The leading 36 Sadiq Ahmed and Ej az Ghani FIGURE 2.5 Per Capita Income in South Asia, 2004 (Constant US$) Sources India, Directorate of Economics and Statistics of respective State Governments; Sri Lanka, Central Bank of Sri Lanka; Bangladesh, Statistical Yearbook of Bangladesh; Nepal (household income per capita), CBS (Central Bank of Sri Lanka) and World Bank staff calculations using NLSS I and II; Pakistan, World Bank staff; Bhutan, Afghanistan and Maldives, World Development Indicators. Regional Cooperat ion Work for Sout h Asia’s Poor 37 regions of Punjab and Sindh experienced an average annual growth rate of 2.3 percent during 1991–2000, while the lagging regions of Balochistan and the North West Frontier Province (NWFP) grew at an average annual rate of 1.8 percent. In Bangladesh, the leading regions (Dhaka and Chittagong) grew at an annual average rate of 3.15 percent year while the lagging regions (Barisal, Rajshahi, Khulna, and Sylhet) grew at an average annual rate of 2.73 percent during 1990–99. Nepal’s growth since 2000 has averaged a paltry 3 percent, around half of the South Asian regional average. Conflict, poor road connectivity, and urban bias associated with earlier growth spurts have resulted in a clear divide between lagging regions and the Kathmandu valley. The above picture suggests that, despite the differences in economic size and population, South Asian countries face similar development challenges arising from large spatial disparities. South Asia’s leading regions are leaving lagging regions behind, as exemplified by the phrase “two South Asias.” The leading regions are characterized by rapid GDP growth, urbanization, and integration with the global economy. The lagging regions remain rural, rely on low-value activities, and are not well integrated with the national, regional, and global markets. The development experience of South Asia, where rapid GDP growth has been accompanied by high regional disparities, contrasts with the regional experience of high-income market economies. There is evidence of strong convergence among regions in the European Union, Japan, and the United States.3 The income gap between the leading and lagging regions in South Asia is much larger compared with the spatial disparities in industrial countries. In India, GDP per head in the state where it is highest (Haryana) is five times greater than in the state where it is lowest (Bihar). In the United States, the difference is only 2.5 times, and in Japan only two times. Regional disparities are indeed expected to change over time with the level of development. The big issue is whether future developments in South Asia will bring about convergence or divergence between the leading and lagging regions. Given the strong negative relationship between income and poverty illustrated in Figure 2.3, it is hardly surprising that most lagging regions show higher than average rates of poverty (Figure 2.6). Nearly half a billion people live in the lagging regions of South Asia. Nearly 60 percent of the poor in India live in the lagging states. Every seventh poor Indian lives in Bihar, a lagging state. Sri Lanka shows disturbing regional disparity in poverty rates between the western region (a leading region) and the rest of the country. Nepal’s western region (lagging region) has a substantially higher poverty incidence than the more prosperous Kathmandu valley. 38 Sadiq Ahmed and Ej az Ghani FIGURE 2.6 Poverty Incidence in South Asia (Headcount %) Sources Pakistan, World Bank staff; Sri Lanka, HIES 2002; Nepal, NLLS 2003–04; Bangladesh, HIES 2005; Bhutan, International Monetary Fund; Maldives, Asian Development Bank. Notes For India, data for poverty headcount rates are based on 2004–05; for Sri Lanka data for poverty are based on 2002; Pakistan on 2005–06; Bangladesh on 2005; Nepal on 2003–04; Bhutan on 2000; Maldives on 2004. Regional Cooperat ion Work for Sout h Asia’s Poor 39 In Pakistan, interprovincial disparities in poverty incidence between the leading regions (Sindh and Punjab) and the lagging regions (NWFP and Balochistan) are huge. Why some areas develop and others remain underdeveloped is determined by three key drivers: movement of productive factors, transportation costs, and scale economies. These drivers are derived from spatial economics—that is, the study of where economic activity takes place and why (Fujita et al. 1999; World Bank 2008d). Drawing on these works, an ongoing World Bank study is looking at the interactions between geography, institutions, and trade, and how these interactions promote or constrain growth in the lagging regions of South Asia. Geographic, institutional, and trade differences are larger in South Asia than in Europe, Japan, and the United States. In Japan, nearly 97 percent of people live within 100 kilometers of the coast. In Europe, more than half the population lives within 100 kilometers of the coast or an oceannavigable waterway. The United States is more like India, with a large proportion of the land area away from coast. But because of high labor mobility and efficient agriculture in the United States, a high proportion of the population lives close to the coast. In India, factor mobility has not been able to arbitrage geographic disparities. Disparities between the leading and lagging regions are high not because of geography but because of poor market integration resulting from high transportation costs, poor connectivity between regions and countries, low factor mobility, and regulatory restrictions that prevent firms from taking advantage of the scale economies. There are two types of geography—first- and second-nature geography. First-nature geography favors some regions by virtue of proximity to rivers, coasts, ports, and borders. Economic activity may concentrate in coastal urban areas because of proximity to the domestic and external markets, and better logistical links between foreign suppliers and customers. First-nature geography explains why some leading regions are located in coastal areas (Maharashtra, Gujarat, and Tamil Nadu in India, and Karachi in Pakistan). Real GDP per capita growth rates for the coastal states in India grew at 4.5 percent per year during the 1990s compared with 2.5 percent for the landlocked states. Second-nature geography is determined by human-made infrastructure. Physical infrastructure influences the interactions among economic agents. Improved infrastructure lowers transportation costs, encourages mobility of labor, goods, capital, and ideas, and increases the size of the market. These interactions give rise to scale economies. As agricultural productivity increases, it releases labor and capital from rural areas, which migrate to urban areas to take advantage 40 Sadiq Ahmed and Ej az Ghani of agglomeration forces. Regions with a higher urbanization rate tend to have higher productivity. These forces can generate virtuous circles of self-reinforcing development. Empirical studies identify second-nature geography (physical infrastructure) as a key causal factor in explaining levels and trends in regional disparities (Kanbur and Veneables 2005a). Clearly, South Asia has yet to take advantage of the growth benefits of its demography and geography. In addition to the lagging regions problem, South Asia also exhibits growing income inequality. Figure 2.7 shows economic inequality as measured by the Gini Coefficient.4 Inequality in South Asia is rising but less than in East Asia.5 This is apparent when comparing the growing inequality between the rich and the poor in India versus China. Nepal FIGURE 2.7 Gini Coefficient (the Latest Available) and the Annual Growth Rate of Gini Sources World Bank staff estimation using household income and expenditure surveys of each country. Source data for Bangladesh, HIES 1991–92 and 2005; Pakistan, PIHS 1998–99 and PSLM 2005–06; India, NSSO 50th and 55th rounds; Sri Lanka, HIES 1990–91 and 2002; Nepal, NLLS 1996–97 and 2003–04. Data for all East Asian countries are in the World Bank’s data department; and survey years are 1993–2004 for China; 1999–2004 for Indonesia; 1992–2004 for Vietnam. Regional Cooperat ion Work for Sout h Asia’s Poor 41 and Sri Lanka have the highest levels of inequality in South Asia. They also have the highest growth in inequality. Pakistan and rural India have the lowest levels of inequality. Is inequality between regions, that is, spatial inequality, also rising? For most countries, growth in inequality across leading and lagging regions is rising faster than growth in inequality across individuals. Figure 2.8 reports regional inequality at the sub-national level using the Theil inequality measure.6 The Figure shows that regional inequality is rising at a much faster pace than pure inequality in all countries except for Nepal and, to some extent, India. Regional inequality generally increases as an economy shifts from agriculture to manufacturing. Some signs of regional convergence are evident in Nepal and India, as the extremely poor areas in Nepal and India have achieved faster growth rates in consumption. Poorer parts of Nepal and India have benefited from remittance flows as workers have moved to areas of higher economic density either at home or abroad. FIGURE 2.8 Annual Growth Rate of Regional Inequality and the Pure Individual Effect for Selected South Asian Countries Source World Bank staff estimates using household income and expenditure surveys of each country. 42 Sadiq Ahmed and Ej az Ghani Can South Asia achieve both high and inclusive growth? Good examples of factors that can contribute to high and inclusive growth include labor mobility, better job creation, skills and education, and resolution of internal conflict. Inclusive growth is not about balanced growth but shared opportunities. Spatial disparities in growth are inevitable when growth accelerates and countries make the transition from being an agricultural to an industrial economy. The challenge for public policy is to identify the growth constraints in the lagging regions and remove them. The strongest indicator of inclusive growth is poverty reduction. As mentioned earlier, all South Asian countries have reduced poverty. Going forward, however, poverty reduction is likely to be complicated by the fact that growth is increasingly concentrated in the leading regions, while poverty is concentrated in the lagging regions. The large concentration of poor in the lagging regions suggests that public policy must concentrate on raising growth and improving human development in these lagging regions. The evidence that regional inequality is rising also suggests that higher income growth in lagging regions might help reduce income inequality. 3. CROSS-BORDER CONSTRAINTS TO GROWTH AND POVERTY REDUCTION The lagging regions challenge requires recognition of another factor of geography that has been largely neglected in public policy debates: many of the South Asia’s lagging regions are either landlocked countries (for example, Afghanistan and Nepal) or are border districts, states, or provinces of the three larger countries of Bangladesh, India, and Pakistan. This is obvious from Figure 2.5, Map 2.1, and Table 2.1, which show the following results: The landlocked countries of both Afghanistan and Nepal are among the lowest per capita income group in the region (Figure 2.5). Out of 14 states of India that have borders with neighbors, 12 have per capita income levels that are at or below the national average (Arunachal Pradesh, Assam, Meghalaya, Mizoram, Nagaland, Tripura, Manipur, West Bengal, Bihar, Uttar Pradesh, Jammu and Kashmir, and Rajasthan). The only exceptions are Punjab and Gujarat (Figure 2.5 and Map 2.1). Regional Cooperat ion Work for Sout h Asia’s Poor MAP 2.1 43 Per Capita Income in South Asia Source Created by the author. Based on Figure 2.5. Notes (a) Leading/lagging regions are defined at the national level based on per capita incomes above or below the national average. (b) Afghanistan, Bhutan, and Maldives show national averages because sub-national data are not available. (c) This map is not to scale and does not depict the authentic boundaries of India. In Pakistan, per capita income is lower than average in the border provinces of NWFP, Balochistan, and rural Sindh. As in the case of India, Pakistan’s Punjab is an exception. Similarly, urban Sindh is richer than the national average because of the dominance of the port city of Karachi (Figure 2.5 and Map 2.1). 44 TABLE 2.1 Districts Bordering north-east Bandarban Brahmanbaria Comilla Feni Habiganj Jamalpur Khagrachari Kurigram Lalmonirhat Maulvibazar Mymensingh Netrokona Nilphamari Panchagarh Rangamati Sherpur Sunamganj Sylhet Literacy rate (age 7+) Population Per capita income (US$) Economic mass (US$) Human poverty index Poverty mass Both sexes Female 298,120 2,398,254 4,595,557 1,240,384 1,757,665 2,107,209 525,664 1,792,073 1,109,343 1,612,374 4,489,726 1,988,188 1,571,690 836,196 508,182 1,279,542 2,013,738 2,555,566 339 304 266 262 299 277 239 282 265 280 305 303 261 277 365 277 262 315 101,062,680 729,069,216 1,222,418,162 324,980,608 525,541,835 583,696,893 125,633,696 505,364,586 293,975,895 451,464,720 1,369,366,430 602,420,964 410,211,090 231,626,292 185,486,430 354,433,134 527,599,356 805,003,290 39.77 37.65 26.72 28.15 34.45 41.87 37.58 39.42 35.63 32.69 34.70 37.06 38.50 35.03 35.74 42.98 39.44 35.06 118,562 902,943 1,227,933 349,168 605,516 882,288 197,545 706,435 395,259 527,085 1,557,935 736,822 605,101 292,919 181,624 549,947 794,218 895,981 31.66 39.45 45.98 54.26 37.72 31.80 41.80 33.45 42.33 42.06 39.11 34.94 38.84 43.89 43.59 31.89 34.37 45.59 23.67 36.68 42.63 51.18 33.62 28.02 32.65 27.55 36.25 38.45 36.26 31.88 32.58 37.33 34.21 28.55 30.47 41.51 Sadiq Ahmed and Ej az Ghani Population Mass, Economic Mass, and Poverty Mass: Bangladesh Districts Bordering India’s North-east and West Bengal, 2000 329 311 323 305 255 339 320 318 305 317 357 309 758 355 399,529,704 821,926,350 273,482,808 729,363,275 363,457,110 775,250,286 556,849,600 188,076,648 307,174,650 500,698,330 882,344,778 576,193,536 6,451,510,824 35.87 33.31 35.70 32.32 39.66 33.57 35.78 36.01 32.11 32.37 28.20 31.74 26.51 435,597 880,333 302,270 772,886 565,283 767,704 622,627 212,976 323,389 511,281 696,978 591,857 2,256,327 Source Massum 2008. Note Population data refer to 2001, per capita income data refer to 1999–2000, and human poverty index refers to 2000. 40.32 36.24 37.23 36.91 41.68 35.98 36.79 36.91 34.02 35.74 30.77 35.53 35.87 33.31 35.70 32.32 39.66 33.57 35.78 36.01 32.11 32.37 28.20 31.74 Regional Cooperat ion Work for Sout h Asia’s Poor Bordering West Bengal Thakurgaon 1,214,376 Dinajpur 2,642,850 Joypurhar 846,696 Naogaon 2,391,355 Nawabganj 1,425,322 Rajshahi 2,286,874 Kushtia 1,740,155 Meherpur 591,436 Chuadanga 1,007,130 Jhenaidah 1,579,490 Jessore 2,471,554 Satkhira 1,864,704 Dhaka 8,511,228 Bangladesh 124,355,263 45 46 Sadiq Ahmed and Ej az Ghani In Bangladesh, the border districts tend to have per capita incomes lower than the national average (Table 2.1). In terms of income, most lagging regions are also lagging in terms of having a higher than average incidence of poverty or poorer human development indicators (Figure 2.6, Maps 2.2 and 2.3, and Table 2.1). Detailed analyses of these lagging regions indicate the following socioeconomic characteristics (Government of India 2008; Massum 2008; World Bank 2005a, 2005b, 2005c, 2007b, 2008a, 2008b): MAP 2.2 Distribution of Poverty in South Asia Source Created by the author. Based on Figure 2.5. Notes (a) Afghanistan, Bhutan, and Maldives show national poverty rates. (b) This map is not to scale and does not depict the authentic boundaries of India. Regional Cooperat ion Work for Sout h Asia’s Poor MAP 2.3 47 Distribution of Poverty by Leading and Lagging Regions Source Created by the author. Based on Figures 2.5 and 2.6. Notes (a) Afghanistan, Bhutan, and Maldives show national poverty rates. (b) This map is not to scale and does not depict the authentic boundaries of India. ” These lagging landlocked and border countries, states, provinces, and districts have an estimated 400 million people, of whom an estimated 200 million are poor (reference year of 2005). This is 48 Sadiq Ahmed and Ej az Ghani ” ” ” ” about 50 percent of South Asia’s estimated total number of poor for the year 2005. Much of the population is rural (90 percent), and most are engaged in low-productivity agriculture. The human development indicators tend to be below the comparable national average, and many indicators are lower than the average in South Asia. Infrastructure is, on average, poorer than the rest of the respective countries and poorer than the average for South Asia. The border regions, on average, tend to be more vulnerable to water shortages and flooding problems than other parts. A review of history suggests that not all areas were lagging and poor all the time. For example, both Afghanistan and Nepal prospered in the eighteenth and nineteenth centuries on the basis of free trade and commerce with neighbors, including Central Asia, the Middle East, the Indian subcontinent, and China. Over the years, conflict and border restrictions removed this key source growth. A more dramatic example is that of India’s north-east (the so-called seven sisters). The partition of the Indian subcontinent into Pakistan and India brought havoc to the economies of these seven sisters, especially the booming state of Assam, by cutting off its sea access and sharply increasing the transport distance with the rest of India (Box 2.1). The Kashmir valley was a prosperous and peaceful tourist resort until conflict between Pakistan and India took its toll. The Federally Administered Tribal Areas of Pakistan (FATA) and the NWFP were similarly prosperous and peaceful trading outposts until regional and global conflicts converted many parts of these border areas into conflict-prone, security risk regions with low per capita incomes, high incidence of poverty, and low human development indicators. Apart from being poor, the lagging regions also share a number of common vulnerabilities. First and foremost is their vulnerability to natural disasters. Figure 2.9 shows the impact of natural disasters in terms of the share of GDP lost. South Asia has lost a significant amount of its GDP because of natural disasters. This loss has been especially significant for Bangladesh, Maldives, Pakistan, and Sri Lanka. The impact of natural disaster is particularly strong in South Asia because of its high population density. The losses typically are not insured in the financial market. It is the poor who are adversely affected by disasters. FIGURE 2.9 Percentage of National GDP Damaged by Select Natural Disasters Regional Cooperat ion Work for Sout h Asia’s Poor 49 Source United Nations, International Strategy for Disaster Reduction. Available online at http://www.unisdr.org/disaster-statistics/top50.htm (accessed on 17 September 2009). 50 Sadiq Ahmed and Ej az Ghani BOX 2.1 Bangladesh and India: A Tale of Two Border Regions India’s north-east and West Bengal lag behind the rest of India in per capita gross state domestic product (GSDP). So do the Bangladesh districts adjoining West Bengal and India’s north-east. India’s north-east and Bangladesh districts bordering the above region and West Bengal have considerable similarity, such as being predominantly agricultural, with agriculture accounting for the largest share of employment; having a narrow manufacturing base; and having low levels of consumption of electricity, which significantly constrain their growth prospects. The three hill districts of Bangladesh have large shares of tribal population, as do three states of India’s north-east, and people of both sub-regions have been practicing the same low-productivity agricultural technology that featuring shifting cultivation called Jhum for generations. The two regions formed a single economic entity under British rule, shared common infrastructure, and developed close links that contributed to the economic growth of both regions. The partition of British India in 1947 into two separate states (India and Pakistan) and the two regions dividing into two countries that did not maintain friendly relations caused havoc to the economy of India’s north-east, as a sudden snapping of all economic ties made its economy extremely vulnerable, in addition to converting it into a virtually landlocked region. The adjoining Bangladesh (then East Pakistan) districts also suffered by losing their traditional sources of supplies and markets for their products; however, because they retained most of the common infrastructure, including access to the sea and thereby to the outside world, their situation was not as bad. Their growth performance, however, indicates that they performed relatively poorly compared with most other Bangladesh districts. Bangladesh districts bordering West Bengal also performed relatively poorly. With the emergence of Bangladesh as an independent country in 1971, it was expected that the linkages earlier lost would be restored, but little progress has been made so far in this direction. It is, however, believed that improved economic linkages between India’s north-east and West Bengal, and the adjoining Bangladesh districts, would promote development of all these regions. Source Massum 2008. A second and related vulnerability is access to water for irrigation and transport. An estimated 400 million people, many of whom are poor, directly or indirectly depend on the water flows of the three mighty rivers of Indus–Ganges–Brahmaputra for their livelihood. Frequent water shortages (and floods) create serious challenges to maintaining the income level of these large numbers of poor. Regional Cooperat ion Work for Sout h Asia’s Poor 51 4. REGIONAL COOPERATION TO SUPPORT DEVELOPMENT OF SOUTH ASIA’ S LAGGING REGIONS Cooperation can be a powerful way to raise growth, reduce the gap between leading and lagging regions, and reduce vulnerabilities for the poor. By focusing on the income of the poor both through the growth mechanism and by reducing vulnerability, regional cooperation can be helpful in lowering income inequality. Specifically, in the context of the framework developed in Section 3, it can be argued that South Asia has the potential to accelerate growth and reduce poverty by exploiting four underutilized spatial features of the region: geography, transportation, factor mobility, and scale economies. Regional cooperation can facilitate this process. ” ” First, as mentioned earlier, South Asia is densely populated, with a significant proportion of the population living close to the borders between countries. After Europe, South Asia has the largest concentration of people living close to the border. It has the maximum “city pairs” within 50 kilometers with a population of more than 25,000 people.7 Almost all the South Asian countries share a common border with the largest regional partner (India). Regional integration initiatives will unlock the growth benefit of geography and support income convergence across regions and countries. Regional trade is more sensitive to transport costs, scale economies, and factor mobility than global trade. Second, South Asia suffers from high trade and transportation costs compared with other regions because of border restrictions and poor transport. The cost of trading across borders is nearly double for India and Bangladesh compared with China. It is more than three times higher for Afghanistan, Bhutan, and Nepal. The quality of transport infrastructure in South Asia, especially the highway networks, is poor. Truck operating speeds are low, delays at state and provincial check posts are frequent and can be long, and delivery times are consequently subject to significant variation. The regions away from the main trade corridors have the poorest infrastructure and face the greatest constraints. Raising the level of the infrastructure and reducing regulatory barriers to trade, whether international or national, will help integrate the 52 Sadiq Ahmed and Ej az Ghani ” ” lagging regions into both the national and global economies, reducing the relative advantages of the coastal states. Third, factor mobility, and in particular migration rate, is low in South Asia. Only 2 million people migrate every year in India from rural to urban areas, compared with nearly 20 million people in China. Increased agricultural productivity could reallocate labor and capital from low-value activities (agriculture) to high-value activities (manufacturing and services sectors) and support growth. Fourth, South Asian firms are disproportionately small. They are unable to reap the benefits of scale economies because of labor and regulatory restrictions that prevent them from growing. The policy changes aimed at taking advantage of the interactions between geography, transportation, factor mobility, and scale economies not only will lift growth in the lagging regions but also will support higher growth rates at the country level and in South Asia. These ideas are developed in greater detail next. 4.1 Regional Cooperat ion for Support ing Growt h in t he Lagging Regions In terms of policy focus, the two main ways that regional cooperation can foster higher growth in South Asia, and especially in the lagging regions, are by promoting market integration and by improving infrastructure. 4.1.1 Market Integration Market integration allows economic agents to interact across spatial scales: local, regional, and international. The extent to which economic agents take advantage of market integration is affected positively by density but negatively by both distance and division (Fujita et al. 1999). A high level of economic density implies “thick markets” in the exchange of goods and services, as well as in the informal exchange of ideas. This creates productivity advantages for firms and welfare advantages for workers. By contrast, a high level of distance to density denies economic agents the opportunity to access these markets with consequent negative impacts on poverty and well-being.8 Likewise, divisions—created by conflict, transport costs, and both formal and informal barriers to trade—separate economic agents in one country from the advantages of density in other countries. Regional Cooperat ion Work for Sout h Asia’s Poor 53 By reducing distance and division, market integration, both within and between countries, brings economic agents in lagging regions closer to the density of leading regions, promoting positive spillover effects that enhance spatial multipliers.9 Given that South Asia is the most densely populated region in the world, it is well placed to bring areas close to the market and bolster the value of the spatial multiplier. Market integration (global, regional, and within country) can ignite growth, as countries benefit from increased demand, agglomeration, and scale economies; improved factor mobility; and the free flow of ideas and technology. Market integration can pull weak countries toward income levels that they would be unable to achieve in isolation. Landlocked countries, in particular (Afghanistan, Nepal), can benefit from cross-country growth spillovers and neighborhood effects. Neighboring countries can provide mutually beneficial economic linkages, spillovers, and complementarities that allow groups of countries to increase their incomes. The region has significantly more room to benefit from market integration globally, across countries within South Asia, and within country. Globally, South Asia’s rapid GDP growth benefited from rapid expansion in trade. It has experienced one of the fastest growth rates in trade (Figure 2.10) averaging 10.8 percent in 2007, following growth FIGURE 2.10 Real Growth in Trade of Goods and Services Source World Bank’s World Trade Indicators (World Bank 2008d). Note Data for 1995–99, 2000–04, and 2005–06 are averages. 54 Sadiq Ahmed and Ej az Ghani of almost 12 percent during 2005–06, which was the highest among all regions. Yet, the region has more room to benefit from trade. Despite recent reforms, South Asia continues to have the most restrictive tariff policies compared with other regions (Figure 2.11). Among developing countries, South Asia has the most protective agricultural trade policies. South Asia’s global integration, measured by trade as a ratio of GDP, was 49 percent in 2007, which although higher than its late 1990s ratio of 20 percent, is the lowest among developing countries (World Bank 2008a). FIGURE 2.11 Trade Tariff Restrictiveness Index Source World Bank’s World Trade Indicators (World Bank 2008d). Note Data for 1995–99, 2000–04, and 2005–06 are averages. Within South Asia, market integration is the lowest in the world as reflected by intraregional trade between countries being less than 2 percent of GDP for South Asia compared with 40 percent for East Asia. Border barriers to trade and services have mostly disappeared in the rest of the world but not in South Asia. Divisions across countries in South Asia have increased dramatically over the last four decades.10 In 1948, South Asia’s share of intraregional trade as a share of total trade was 18 percent. In 2000–07, it fell to 5 percent of total trade. Cost of trading across borders in South Asia is high. At the Petrapole–Benapole, one of the main borders between Bangladesh and India, trucks wait for more than 100 hours to cross the border. It takes 200 signatures in Nepal to trade goods with India, Regional Cooperat ion Work for Sout h Asia’s Poor 55 and some 140 signatures in India to trade goods with Nepal. It is estimated that trade between India and Pakistan, currently at US$1 billion,11 could jump to US$6–10 billion, if divisions were removed. Divisions in South Asia have been aggravated by conflict. The geographic configurations of South Asia contain huge agglomeration potential to propel growth.12 East Asia is an example of a region with a high level of intraregional and intra-industry trade that enabled firms to internalize externalities arising from agglomeration. Firms exporting to the regional markets in South Asia are more constrained by the quality of connectivity and productivity-enhancing infrastructure.13 It is the seamless interaction of improved trade, better connectivity, and converging institutions that can accelerate growth in the lagging regions and that can benefit the slower-growing and smaller landlocked regions and countries. In Latin America, Brazil’s growth creates export opportunities for Bolivia. In Africa, resource landlocked countries piggybacked on the growth of Kenya. In East Asia, Thailand is an important market for Cambodia and Laos People’s Democratic Republic. Growth benefits of market integration are likely to be large but unequal. India, a large country, with a big home market, can get by with more restrictive borders, because the size of its economy and population provides the incentive to importers and exporters to overcome these barriers. It is the small, landlocked countries, like Afghanistan, Bhutan, and Nepal, that will benefit most from improved access to the markets of others. Small countries depend more on openness to overcome the disadvantage of size: small population, small markets, and inability to take advantage of agglomeration and scale economies. Even within India, the peculiar geography that isolates the seven north-eastern states (the so-called seven sisters) from mainland India, with Bangladesh located in between, suggests that market integration requires trade and transit arrangements with neighbors to benefit all regions that are lagging and isolated from the growth centers. Tradable economic activities are inherently scalable in the sense that small economies can expand output without running into diminishing returns (unlike domestic services). Rapid economic growth, associated with modern sector export growth, can be “lumpy” (Venables 2006). Spatially, it can be uneven, with production being concentrated in some countries, regions, or cities. In product space, specialization is likely to increase, with regions specializing in a few tasks rather than production of integrated products. Examples of specialization from South Asia include information and communication technology (ICT) service export from Bangalore in India; shirts, trousers, and hats exported 56 Sadiq Ahmed and Ej az Ghani from Bangladesh; and exports of bed linen and soccer balls from Pakistan. Temporally, rapid growth will happen only once some threshold level of capabilities has been reached. Some countries may experience growth before others, resulting in sequential rather than parallel growth. The benefits of market integration, however, cannot be achieved without improving the infrastructure. 4.1.2 Infrastructure Infrastructure is like second-nature geography, which can reduce the time and monetary costs to reach markets and thus overcome the limitations of physical geography (Kanbur and Venables 2005a). Improved infrastructure that enhances connectivity and contributes to market integration is the best solution to promoting growth as well addressing rising inequality between regions. The Ganga Bridge in Bihar in India is a good example of second-nature geography. The bridge has reduced the time and monetary costs of farmers in the rural areas in north Bihar to reach markets in Patna, the largest city in Bihar. The Jamuna Bridge in Bangladesh is another good example of spatially connective infrastructure. The bridge has opened market access for producers in the lagging north-west areas around the Rajshahi division. Better market access has helped farmers diversify into high-value crops and has reduced input prices. So far, South Asia has achieved impressive growth rates despite poor infrastructure. This growth may be difficult to sustain in the future. Poor infrastructure and restrictive labor laws (to be discussed later) are among the major factors that have restrained the growth of manufacturing sector and prevented firms from growing (Fernandez and Pakes 2008). Table 2.2 shows that the manufacturing share of value added in India is smaller than that share in other large developing economies, although it is similar to that share in smaller countries with GDP per capita similar to that of India (such as Vietnam). As Table 2.3 shows, however, the growth of value added in manufacturing in India is noticeably lower than that in these smaller similar income countries. Indeed the sectoral growth comparisons in Table 2.3 are rather striking. The growth of value added in services in India is comparable to that in China, and about 10 percentage points higher than that in other countries. In rather stark contrast, the growth of value added in manufacturing in India is only about half that in China and Vietnam. The service sector in India has done well because it relies less on transportation and is less energy intensive than manufacturing. South Asia Regional Cooperat ion Work for Sout h Asia’s Poor TABLE 2.2 57 Industry and Manufacturing Share of Employment and GDP across Countries Employment in Value added industry as in industry % of total as % of employment GDP in 2000 in 2000 India Brazil China Indonesia Pakistan Vietnam Low-income countries Lower-middle-income countries 18.2 19.3 23 17.3 18 12.4 12.3 18.5 Value added in manu- 2002 GDP facturing as per capita % of GDP (in 2000 in 2000 US$) 26.3 28 45.9 45.9 22.6 36.7 26.6 38.3 15.6 17.1 34.7 27.7 14.8 18.6 14.1 24.2 480 3,473 1,106 844 532 444 Source World Development Indicators 2005 (World Bank 2005d). Note Industry includes not only manufacturing, but also mining and quarrying (including oil production), construction, and public utilities (electricity, gas, and water). Lower-income countries and lower-middle-income countries are defined based on the World Bank classification. TABLE 2.3 India Brazil China Indonesia Pakistan Vietnam Growth in Sectoral Value Added across Countries Growth in value added in manufacturing (%) Growth in value added in agriculture (%) Growth in value added in services (%) 1995–2000 2000–05 1995–2000 2000–05 1995–2000 2000–05 48.4 26.5 57.3 –2.4 20.9 31.9 50.3 31.8 61.2 35.7 29.9 40.0 28.1 5.7 57.6 14.6 17.1 70.3 38.4 5.6 67.4 27.5 56.6 73.8 13.7 17.3 18.5 7.0 26.5 24.2 14.9 23.7 21.2 17.3 12.0 20.7 Source World Development Indicators, various years, World Bank. has the highest share of services in its exports at 31 percent, which is higher than high-income member countries of the Organization for Economic Co-operation and Development (OECD). ICT exports and global outsourcing have benefited from the use of the Internet, which has reduced information transmission costs dramatically. While other countries can emulate India’s successful efforts to boost services export, sustained high growth will require a substantial effort to raise manufacturing growth in all South Asian countries. In general, poor infrastructure has constrained the growth of labor-intensive manufacturing firms in South Asia and has 58 Sadiq Ahmed and Ej az Ghani prevented the region from making use of its most important asset, its people. South Asia suffers from three infrastructure deficits. First, it suffers from a service deficit, as the region’s infrastructure has not been able to keep pace with a growing economy and population. Power outages and water shortages are a regular occurrence in India and Bangladesh. Rural roads are impassable in lagging regions in India (for example, Bihar, Uttar Pradesh) and Sri Lanka. India has 6,000 kilometers of four-lane highways and China in the last 10 years has built 35,000 kilometers of four- to six-lane highways. Every month, China adds power capacity equivalent to what exists in Bangladesh. Second, South Asia suffers from a policy deficit, given highly distorted pricing, poor sector governance and accountability, and weak cost recovery. It is estimated that eliminating the financial losses from the power and water sectors alone would provide a substantial chunk of the incremental funds for infrastructure investment that India needs. Third, South Asia suffers from a cooperation deficit. India, one of the energy-thirstiest nations sits next to an immensely energy-rich neighbor, Nepal. Yet, because of inadequate cooperation with India, Nepal has barely exploited its hydropower potential. Similarly, India, which has attracted global attention in ICT, contrasts with other South Asian countries that are lagging in ICT. In South Asia, only 7 percent of the international calls are regional compared with 71 percent in East Asia. South Asia needs to overcome a huge gap in infrastructure. South Asia has invested only 3.5 to 4 percent of GDP per year in infrastructure over the period 2000–05. This is lower than what the East Asian countries have invested: Vietnam and China had investment rates of around 8 percent to 10 percent of GDP. In 1980, India actually had higher infrastructure stocks—in power, roads, and telecommunications—but China invested massively in infrastructure, overtaking India by 1990, and the gap is currently ever widening. It is estimated that for the South Asia region to sustain a growth target of 8 percent, it will require an investment in infrastructure amounting to 7.6 percent of GDP (Harris 2008). To achieve a higher growth rate in the 10 percent range will require an even more rapid pace of investment to modernize the infrastructure. Much of the infrastructure investment gap has to be financed at the national level along with necessary improvements in sector policies and institutions. Yet regional cooperation can be of great help to meet a significant part of this need. The three priority areas for regional cooperation include telecoms and Internet networking, energy, and transport. Regional Cooperat ion Work for Sout h Asia’s Poor 59 A regional telecom network and a high-bandwidth, high-speed Internetbased network could improve education, innovation, and health. A regional network would facilitate better flow of ideas, technology, investments, goods, and services. It also would facilitate greater interactions between knowledge workers in areas such as high-energy physics, nanotechnology, and medical research. Untapped positive synergies at the regional level would result from information sharing and competition in ideas among universities, non-university research and teaching entities, libraries, hospitals, and other knowledge institutions. It also could aid the building and sharing of regional databases, and could help address regional problems, including multi-country initiatives such as flood control, disaster management, climate change, and infectious disease control. Importantly, such an effort could help spark higher and more sustainable regional growth. Regional cooperation in telecoms and Internet access could strengthen the competitiveness of South Asia in the services-export sector. India has established itself as a global player in ICT and outsourcing. Other countries in South Asia potentially could benefit from neighborhood and spillover effects. The expansion of services exports would contribute to growth and job creation, and other sectors would benefit from improved technology and management (Hamid 2007). The services-export sector, although less infrastructure intensive than manufacturing, needs different types of infrastructure than the traditional export sectors. For these exports, investment is needed in fiber optic highways, broadband connectivity, and international gateways and uplink facilities. Increased investments in tertiary education and in technical and English proficiency also are needed. South Asia needs to remove barriers to trade in ICT services, eliminate restrictions on the flow of intraregional foreign direct investment (FDI), and remove visa restrictions on the flow of people. The potential gains from regional trade in energy are substantial. This is best seen by looking at Map 2.4, which shows South Asia’s potential sources of hydropower and its demand. Map 2.4 illustrates a powerful story. Afghanistan and Nepal are sitting on water resources that could potentially generate some 24,000 megawatts of electricity from Afghanistan and an estimated 83,000 megawatts from Nepal. These countries together account for 40 percent of South Asia’s presently installed capacity. Bangladesh, India, and Pakistan are all power-deficit countries, especially India. The growing electricity constraint is threatening the ability to sustain rapid growth. Yet, less than 1 percent of the region’s electricity-generating potential has been used so far. The reason for this 60 Sadiq Ahmed and Ej az Ghani energy constraint is the lack of cooperation and absence of energy trade among South Asian countries. Indeed, if one were to imagine South Asia without borders, perhaps the highest priority investment would have gone to develop the hydropower resources. While all countries would benefit from the development of South Asia’s hydropower resources, Afghanistan and Nepal, the two poorest South Asian countries, would benefit most. MAP 2.4 Distribution of Hydro-power Potential Source Created by the author. Based on World Bank 2008c. Note This map is not to scale and does not depict the authentic boundaries of India. Regional Cooperat ion Work for Sout h Asia’s Poor 61 After decades of insignificant cross-country electricity trade and the absence of any trade in natural gas through pipelines, regional political leaders and businesspeople recently have evinced a great deal of interest and enthusiasm in cross-border electricity and gas trade, not only within South Asia but also with its neighbors in the west (Central Asia and Iran) and in the east (Myanmar). South Asia has two regional energy clusters. The eastern market includes India, Bangladesh, Bhutan, Nepal, and Sri Lanka, extending to Myanmar; the western market includes Afghanistan, India, and Pakistan, extending to Central Asia and Iran. India bridges these two clusters. Some activities are under way, including a successful hydropower trade between Bhutan and India in the eastern market and an ongoing project in the western market that will bring electricity from Tajikistan and Kyrgyzstan to Afghanistan and Pakistan.14 To promote such energy trade, governments need to continue reducing political and security tensions; consider energy trade as an enhancement of energy security and political and economic cooperation; continue energy sector reforms; improve commercial performance of the utilities; improve the credibility, competence, and accountability of regulation; adopt sustainable (cost-reflective) tariffs and a social protection framework; promote commercial approach to energy trade; encourage private sector participation in the form of public–private partnership (PPP) structures in cross-border investments; help the transit countries (especially Afghanistan) integrate; reach water-sharing agreements; seek accession to international agreements (such as the Energy Charter Treaty); strengthen regional institutions at both political and technical levels; and identify priority trade-oriented investment projects and pursue their implementation. The success of the India–Bhutan electricity trade should offer useful lessons to other countries in the region. Restrictions in transport border crossings are a major constraint to global and intraregional trade in South Asia. Removing these restrictions would boost trade within South Asia as well as lower costs for international trade in general, as many landlocked countries and regions would benefit from access to the closest ports. Currently, efforts to improve trade facilitation and transport networks are being pursued in a fragmented manner, and where cross-border issues are involved, little cooperation exists. Establishing corridor-based approaches for improving the trade, such as a transport arrangement for intraregional trade, would be essential to improve the efficiency of regional transport and to reduce trade costs. 62 Sadiq Ahmed and Ej az Ghani 4.2 Regional Cooperat ion Reducing Vulnerabilit ies of Sout h Asia’ s Poor South Asia’s poor would probably gain most from regional cooperation in water and climate. This is again obvious from Map 2.4. From the Himalayas, where glacier melt is already changing water flows in ways that remain to be understood, to the coastal floodplains of Bangladesh and Pakistan, South Asian countries need to adapt to climate change. The melting of Himalayan glaciers, leading to the disastrous prospect of reduced water availability in the South Asian rivers, the frequency of floods and cyclones, and the evidence of rising sea level, have given South Asia a wake-up call for collective action for managing climate change to reduce vulnerability and poverty over the longer term. Actions only at the national level cannot provide sustainable solutions as much of the water flows from upstream countries of Afghanistan, China, parts of India, and Nepal to Bangladesh, most of India, and Pakistan. Finding sustainable solutions for flood control, irrigation, and river transport will require cooperation with upstream countries. Thus, cross-border cooperation on water between India, Bangladesh, and Nepal offers the only long-term solution to flood mitigation. The benefits of cooperation are clear. For example, watershed management and storage on Ganges tributaries in Nepal could generate hydropower and irrigation benefits in Nepal and flood mitigation benefits in Nepal, India (Uttar Pradesh, Bihar) and Bangladesh; water storage in north-east India could provide hydropower and flood benefits in India and Bangladesh; and both would provide increased and reliable dry season flows. Specific cooperation between Bangladesh, India, and Nepal on the Ganges presents an emerging and promising opportunity. Similar benefits of water cooperation exist between India and Pakistan and between Pakistan and Afghanistan. The success of the Indus Water Treaty between Pakistan and India has already demonstrated that cooperation that benefits people can withstand all political obstacles. Building on this success, other water disputes and potential water markets could be developed through a similar cooperative solution. Afghanistan sits on the upper riparian of some five water basins that have huge potential for irrigation and hydropower benefits that could well transform Afghanistan’s economy. Yet, little of the critical investment required to transform this natural resource into a productive asset for the benefit of the people of Afghanistan has been made thus far. As a result, Afghanistan is a severely water-constrained economy with a serious power shortage as well. A key constraint is a lack of a framework for water-sharing agreements with Regional Cooperat ion Work for Sout h Asia’s Poor 63 its neighbors. The Kabul River Water Basin Project is a high-priority project that will yield substantial hydropower and irrigation benefits for both Afghanistan and Pakistan. A key requirement for this project to move forward is a riparian agreement between Afghanistan and Pakistan. Again, a cooperative solution will result in a win–win situation for both countries. More generally, regional cooperation can be instrumental in facilitating the design and implementation of effective country-level strategies to address a range of global public goods; to improve water management, disaster management, and climate and environmental management; and to combat HIV/AIDS, narcotics and drug trafficking, and security and arms trade. Geographic proximity and common borders mean common action in these areas will eliminate negative externalities, reduce transaction costs of monitoring and implementation, and allow learning from shared best practices. South Asia needs to strengthen its regional governance institutions. This governance is vital to manage the provision of regional public goods and common pooled resources. South Asia suffers from numerous prisoners’ dilemmas, such as free riding and overuse of resources, because of a lack of effective institutions. This problem can be overcome by engaging the government, the private sector, nongovernmental organizations, and communities in formal and informal social institutions (networks, norms, and sanctions) based on collective action. 5. MANAGING THE POLITICS OF COOPERATION IN SOUTH ASIA: THE WAY FORWARD The potential benefits of economic cooperation are obvious. Global examples of successful cooperation agreements reinforce the point that possible gains for South Asia from effective cooperation and partnerships can be substantial. In particular, the experience of East Asia is illustrative of the potential gains that can be achieved from more and better cooperation. Cross-border physical connectivity has improved tremendously through land-, sea-, and air-based transport networks; private sector–led vertical integration of production networks has spurred industrial productivity and growth; and e-commerce is flourishing. Yet, the actual experience with cooperation in South Asia so far has been rather dismal. Following are the key constraining factors: 64 Sadiq Ahmed and Ej az Ghani ” ” ” ” First and foremost is the prevalence of a number of regional disputes. These include the long-standing conflict between India and Pakistan over Kashmir, which has continued to strain relations between these two large neighbors. The Afghanistan–Pakistan relations are constrained by allegations of support for the Taliban from sources in Pakistan. Similarly, securing the immigration and security issues in the India–Bangladesh border areas is another source of concern. Second is the lack of good analysis and information in the public domain about the benefits of regional cooperation. Unfounded populist negative perceptions in the smaller countries contribute to the misconception that increased cooperation will simply result in greater domination of India in the political and economic matters of these countries. A third factor has been the internal political interests in countries that are divided along nationalistic, religious, and ethnic lines, which substantially complicates policymaking that involves cross-border dialogue and cooperation. Fourth, and perhaps most important, the approach to international cooperation has been seriously flawed in that this has been largely seen as a bilateral politically driven agenda rather than a crossboundary commercial investment. The bilateral political approach has partly contributed to suspicions in smaller countries of India’s dominance. International experience suggests that political constraints and historical conflicts need not be permanent barriers to development cooperation. Neither is the presence of a dominant member country a necessary threat to cooperation and shared gains. For example, the members of the European Union have fought numerous wars in the past, many of them far more intense, long drawn, and expensive in terms of loss of human lives and material resources than conflicts in South Asia. Similarly, member countries diverge considerably in economic strength. Yet these European countries have found it mutually advantageous to come together and formulate a formidable economic union. In East Asia, the economic dominance of China has not prevented effective regional cooperation with the much smaller East Asian countries. Fortunately, the political environment for cooperation in South Asia is now changing. Historically, the regional cooperation efforts in South Asia culminated in the formation of the South Asian Regional Cooperation Regional Cooperat ion Work for Sout h Asia’s Poor 65 (SAARC) in 1985. Until recently, SAARC has functioned basically as an annual event for heads of governments to meet with declarations of cooperation intentions but with limited implementation because of conflict and political difficulties. Armed with recent economic successes, the political space for better regional cooperation is now growing in South Asia. The last two SAARC meetings have succeeded in bringing the countries closer than ever in recognizing the merits of regional cooperation and taking significant actions to realize these benefits. The next step is to identify concrete bankable projects in which multi-country cooperation would yield tangible benefits for citizens. The immediate priority areas are well known: promote trade facilitation by removal of all trade barriers; improve regional transport by removing transit restrictions and opening up port facilities for international trade; promote trade in energy in all possible ways, including hydropower, gas pipelines, and regional grid facilities; and pursue water cooperation to resolve flooding and irrigation problems. Cross-border transactions must be depoliticized and pursued on a commercial basis. Enabling national and international private investors to participate in these transactions holds more promise of success than bilateral political deals. International financial institutions can play a useful role by bringing global good practices, by providing technical assistance to smaller countries, and by mobilizing external financing. Where legal agreements are needed, these can be best pursued multilaterally to avoid any perceptions of dominance. It is not realistic or necessary to expect that all political and social conflicts will have to be resolved first before meaningful cooperation can happen. Indeed, economic cooperation is a powerful means to resolve political and social conflicts. Trust and goodwill at the citizen level also can be a credible way to resolve conflicts. Economic cooperation by raising citizens’ welfare can be instrumental in building this trust. Political forces can provide the impetus by reducing policy barriers to regional integration. NOTES 1. The authors are with the World Bank in Washington, DC. Parts of the analysis of this chapter draw from an earlier paper (Ahmed and Ghani 2009). The views expressed in this chapter are those of the authors and do not necessarily reflect the views of the World Bank Group. Research assistance from Veronica Milagros Minaya is gratefully acknowledged. Errors are the sole responsibility of the authors. 66 Sadiq Ahmed and Ej az Ghani 2. A lagging region is defined as a poor region that does not grow as fast as the others, and its per capita income is low compared with national averages. 3. See European Union 2007, which provides evidence on convergence occurring both at the national and regional levels within European Union. 4. We are grateful to Nobuo for this work. 5. Based on their survey of evidence of more than 50 developing nations, Kanbur and Venables (2005a, 2005b) argue that the uneven spatial impact of trade and globalization played a major role in the increase in regional and urban spatial inequalities in developing countries in recent years. Moreover, they argue that, in addition to geographic remoteness, the backward regions and rural areas suffered from an inequitable distribution of infrastructure, public services, and policies that constrained the free migration of peoples from backward places. 6. The Theil inequality measure has a convenient property: it can be decomposed into inequality across areas, or “regional inequality,” and inequality between individuals, after controlling for the former, or “pure between-individual inequality.” 7. We are grateful to Souleymane Coulibaly for the data on city pairs. 8. Distance here is to be interpreted as an economic and social concept, rather than a purely physical concept. As such, a location that is physically close to a region of high density can, in principle, still be economically distant. This will be the case, for example, if the quality of spatially connective infrastructure linking the two areas is poor or there are economic, social, and institutional barriers to commuting and the free flow of labor between the areas. 9. A spatial multiplier is a concept that captures the additional beneficial effects that result from a policy change as a result of the feedback from spillovers between neighboring regions. 10. Borders and divisions are not the same thing. Borders define a nation-state whereas divisions influence the flow of people, goods, services, capital, ideas, and technology across borders. 11. Includes both formal and informal trade. 12. For example, given the large economies of scale in services industries (for example, telecoms), incentives to invest are greater if the markets are not segmented from other neighboring countries. 13. Based on data from S. Coulibaly. 14. This is the Central Asia-South Asia (CASA) energy project that seeks to sell 1,000 megawatts of surplus power from Tajikistan and Kyrgyzstan to Afghanistan and Pakistan. The project is being developed in cooperation with a number of multilateral financial institutions, including the World Bank. REFERENCES Ahmed, Sadiq. 2006. Explaining South Asia’s Development Success: The Role of Good Policies. Washington, DC: World Bank. Ahmed, Sadiq, and Ejaz Ghani. 2007. South Asia: Growth and Regional Integration. 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