Transportation and Economic Development

Authors: Dr. Jean-Paul Rodrigue and Dr. Theo Notteboom

1. The Economic Importance of Transportation

Development can be defined as improving the welfare of a society through appropriate social, political and economic conditions. The expected outcomes are quantitative and qualitative improvements in human capital (e.g. income and education levels) as well as physical capital such infrastructures (utilities, transport, telecommunications). While in the previous decades, development policies and strategies tended to focus on physical capital, recent years has seen a better balance by including human capital issues. Irrespective of the relative importance of physical versus human capital, development cannot occur without both as infrastructures cannot remain effective without proper operations and maintenance while economic activities cannot take place without an infrastructure base. The highly transactional and service oriented functions of many transport activities underline the complex relationship between its physical and human capital needs. For instance, effective logistics both relies on infrastructures and managerial expertise.

Because of its intensive use of infrastructures, the transport sector is an important component of the economy and a common tool used for development. This is even more so in a global economy where economic opportunities have been increasingly related to the mobility of people, goods and information. A relation between the quantity and quality of transport infrastructure and the level of economic development is apparent. High density transport infrastructure and highly connected networks are commonly associated with high levels of development. When transport systems are efficient, they provide economic and social opportunities and benefits that result in positive multipliers effects such as better accessibility to markets, employment and additional investments. When transport systems are deficient in terms of capacity or reliability, they can have an economic cost such as reduced or missed opportunities and lower quality of life.

At the aggregate level, efficient transportation reduces costs in many economic sectors, while inefficient transportation increases these costs. In addition, the impacts of transportation are not always intended and can have unforeseen or unintended consequences. For instance, congestion is often an unintended consequence in the provision of free or low cost transport infrastructure to the users. However, congestion is also the indication of a growing economy where capacity and infrastructure have difficulties keeping up with the rising mobility demands. Transport carries an important social and environmental load, which cannot be neglected. Assessing the economic importance of transportation requires a categorization of the types of impacts it conveys. These involve core (the physical characteristics of transportation), operational and geographical dimensions:

  • Core. The most fundamental impacts of transportation relate to the physical capacity to convey passengers and goods and the associated costs to support this mobility. This involves the setting of routes enabling new or existing interactions between economic entities.
  • Operational. Improvement in the time performance, notably in terms of reliability, as well as reduced loss or damage. This implies a better utilization level of existing transportation assets benefiting its users as passengers and freight are conveyed more rapidly and with less delays.
  • Geographical. Access to a wider market base where economies of scale in production, distribution and consumption can be improved. Increases in productivity from the access to a larger and more diverse base of inputs (raw materials, parts, energy or labor) and broader markets for diverse outputs (intermediate and finished goods). Another important geographical impacts concerns the influence of transport on the location of activities and its impacts on land values.

The economic importance of the transportation industry can thus be assessed from a macroeconomic and microeconomic perspective:

  • At the macroeconomic level (the importance of transportation for a whole economy), transportation and the mobility it confers are linked to a level of output, employment and income within a national economy. In many developed countries, transportation accounts between 6% and 12% of the GDP. Looking at a more comprehensive level to include logistics costs, such costs can account between 6% and 25% of the GDP. Further, the value of all transportation assets, including infrastructures and vehicles, can easily account for half the GDP of an advanced economy.
  • At the microeconomic level (the importance of transportation for specific parts of the economy) transportation is linked to producer, consumer and production costs. The importance of specific transport activities and infrastructure can thus be assessed for each sector of the economy. Usually, higher income levels are associated with a greater share of transportation in consumption expenses. Transportation accounts on average between 10% and 15% of household expenditures, while it accounts around 4% of the costs of each unit of output in manufacturing, but this figure varies greatly according to sub sectors.

The added value and employment effects of transport services usually extend beyond those generated by that activity; indirect effects are salient. For instance, transportation companies purchase a part of their inputs (fuel, supplies, maintenance) from local suppliers. The production of these inputs generates additional value-added and employment in the local economy. The suppliers in turn purchase goods and services from other local firms. There are further rounds of local re-spending which generate additional value-added and employment. Similarly, households that receive income from employment in transport activities spend some of their income on local goods and services. These purchases result in additional local jobs and added value. Some of the household income from these additional jobs is in turn spent on local goods and services, thereby creating further jobs and income for local households. As a result of these successive rounds of re-spending in the framework of local purchases, the overall impact on the economy exceeds the initial round of output, income and employment generated by passenger and freight transport activities. Thus, from a general standpoint the economic impacts of transportation can be direct, indirect and induced:

  • Direct impacts. The outcome of improved capacity and efficiency where transport provides employment, added value, larger markets as well as time and costs improvements. The overall demand of an economy is increasing.
  • Indirect impacts. The outcome of improved accessibility and economies of scale. Indirect value-added and jobs are the result of local purchases by companies directly dependent upon transport activity. Transport activities are responsible for a wide range of indirect value-added and employment effects, through the linkages of transport with other economic sectors (e.g. office supply firms, equipment and parts suppliers, maintenance and repair services, insurance companies, consulting and other business services).
  • Induced impacts. The outcome of the economic multiplier effects where the price of commodities, goods or services drops and/or their variety increases. For instance, the steel industry requires cost efficient import of iron ore and coal for the blast furnaces and export activities for finished products such as steel booms and coils. Manufacturers and retail outlets and distribution centers handling imported containerized cargo rely on efficient transport and seaport operations.

Transportation links together the factors of production in a complex web of relationships between producers and consumers. The outcome is commonly a more efficient division of production by an exploitation of geographical comparative advantages, as well as the means to develop economies of scale and scope. The productivity of space, capital and labor is thus enhanced with the efficiency of distribution and personal mobility. Economic growth is increasingly linked with transport developments, namely infrastructures, but also with managerial expertise, which is crucial for logistics. Thus, although transportation is an infrastructure intensive activity, hard assets must be supported by an array of soft assets, namely labor, management and information systems. Decisions have to be made about how to use and operate transportation systems in a manner that optimize benefits and minimize costs and inconvenience.

2. Transportation and Economic Opportunities

Transportation developments that have taken place since the beginning of the industrial revolution have been linked to growing economic opportunities. At each stage of societal development, a particular transport technology has been developed or adapted with an array of impacts. Historically, five major waves of economic development where a specific transport technology created new economic, market and social opportunities can be suggested:

  • Seaports. Linked with the early stages of European expansion from the 16th to the 18th centuries, commonly known as the age of exploration. They supported the early development of international trade through colonial empires, but were constrained by limited inland access. Later in the industrial revolution, many ports became important heavy industrial platforms. With globalization and containerization, seaports increased their importance as a support to international trade and global supply chains.
  • Rivers and canals. River trade has prevailed through history and even canals were built where no significant altitude change existed, since lock technology was rudimentary. The first stage of the industrial revolution in the late 18th and early 19th centuries was linked with the development of canal systems with locks in Western Europe and North America, mainly to transport heavy goods. This permitted the development of rudimentary and constrained inland distribution systems, many of which are still used today.
  • Railways. The second stage of industrial revolution in the 19th century was linked with the development and implementation of rail systems enabling more flexible and high capacity inland transportation systems. This opened up substantial economic and social opportunities through the extraction of resources, the settlement of regions and the growing mobility of freight and passengers.
  • Roads. The 20th century saw the rapid development of comprehensive road transportation systems, such as national highway systems, and of automobile manufacturing as a major economic sector. Individual transportation became widely available to mid income social classes, particularly after the Second World War. This was associated with significant economic opportunities to service industrial and commercial markets with reliable door-to-door deliveries. The automobile also permitted new forms of social opportunities, particularly with suburbanization.
  • Airways and information technologies. The second half of the 20th century saw the development of global air and telecommunication networks in conjunction with economic globalization. New organizational and managerial forms became possible, especially in the rapidly developing realm of logistics and supply chain management. Although maritime transportation is the physical linchpin of globalization, air transportation and IT support the accelerated mobility of passengers, specialized cargoes and their associated information flows.

No single transport mode has been solely responsible for economic growth. Instead, modes have been linked with the economic functions they support and the geography in which growth was taking place. The first trade routes established a rudimentary system of distribution and transactions that would eventually be expanded by long distance maritime shipping networks and the setting of the first multinational corporations managing these flows. Major flows of international migration that occurred since the 18th century were linked with the expansion of international and continental transport systems that radically shaped emerging economies such as in North America and Australia. Transport played a catalytic role in these migrations, transforming the economic and social geography of many nations.

Transportation has been a tool of territorial control and exploitation, particularly during the colonial era where resource-based transport systems supported the extraction of commodities in the developing world and forwarded them to the industrializing nations of the time. The goal to capture resource and market opportunities was a strong impetus in the setting and structure of transport networks. More recently, port development, particularly container ports, has been of strategic interest as a tool of integration to the global economy as the case of China illustrates. There is a direct relationship between foreign trade and container port volumes, so container port development is commonly seen as a tool to capture the opportunities brought by globalization. The growth of container shipping has systematically been 3 to 4 times the rate of GDP growth, underlining a significant multiplier effect between economic growth and container trade. However, this multiplying effect has substantially receded since 2009, underlining a maturity of the diffusion of containerization. Further, technological and commercial developments have incited a greater reliance on the oceans as an economic and circulation space.

Due to demographic pressures and urbanization, developing economies are characterized by a mismatch between limited supply and growing demand for transport infrastructure. While some regions benefit from the development of transport systems, others are often marginalized by a set of conditions in which inadequate transportation plays a role. Transport by itself is not a sufficient condition for development. However, the lack of transport infrastructures can be seen as a constraining factor on development. The lack of transportation infrastructures and regulatory impediments are jointly impacting economic development by conferring higher transport costs, but also delays rendering supply chain management unreliable. A poor transport service level can negatively affect the competitiveness of regions and their economic activities and thus have a negative impact on the regional added value, economic opportunities and employment. Tools and measures are being developed to assess and compare the performance of national transportation systems. For instance, the World Bank published in 2007 its first ever report which ranked nations according to their logistics performance based on the Logistics Performance Index.

3. Economic Returns of Transport Investments

A common expectation is that transport investments will generate economic returns, which on the long run should justify the initial capital commitment.Like the majority of infrastructure projects, transportation infrastructure can generate 5 to 20% annual return on the capital invested, with such figures often used to promote and justify investments in transportation infrastructure. However, transport investments tend to have declining marginal returns (diminishing returns). While initial infrastructure investments tend to have a high return since they provide an entirely new range of mobility options, the more the system is developed the more likely additional investment would result in lower returns. At some point, the marginal returns can be close to zero or even negative, implying a shift of transport investments from wealth producing to wealth consuming. A common fallacy is assuming that additional transport investments will have a similar multiplying effect than the initial investments had, which can lead to capital misallocation. The most common reasons for the declining marginal returns of transport investments are:

  • High accumulation of existing infrastructure. In a context of high level of accessibility and transportation networks that are already extensive, further investments usually result in marginal improvements. This means that the economic impacts of transport investments tend to be significant when infrastructures were previously lacking and tend to be marginal when an extensive network is already present. Additional investments can thus have limited impact outside convenience.
  • Economic changes. As economies develop, their function tends to shift from the primary (resource extraction) and secondary (manufacturing) sectors towards advanced manufacturing, distribution and services. These sectors rely on different transport systems and capabilities. While an economy depending on manufacturing will rely on road, rail and port infrastructures, a service economy is more oriented towards the efficiency of logistics and urban transportation. In all cases transport infrastructure are important, but their relative importance in supporting the economy may shift.
  • Clustering. Due to clustering and agglomeration, several locations develop advantages that cannot be readily reversed through improvements in accessibility. Transportation can be a factor of concentration and dispersion depending on the context and the level of development. Less accessible regions thus do not necessarily benefit from transport investments if they are embedded in a system of unequal relations.

Therefore, each transport development project must be considered independently and contextually. Since transport infrastructures are capital intensive fixed assets, they are particularly vulnerable to misallocations and malinvestments. The standard assumption is that transportation investments tend to be more wealth producing as opposed to wealth consuming investments such as services. Still, several transportation investments can be wealth consuming if they merely provide convenience, such as parking and sidewalks, or service a market size well below any possible economic return, with for instance projects labeled “bridges to nowhere”. In such a context, transport investment projects can be counterproductive by draining the resources of an economy instead creating wealth and additional opportunities.

Since many transport infrastructures are provided through public funds, they can be subject to the pressures of special interest groups, which can result in poor economic returns, even if those projects are often sold to the public as strong catalysts for growth. Further, large transportation projects, such as public transit, can have poor cost control mechanisms, implying systematic budget overruns. Infrastructure projects in the United States are particularly prone to these engineered fallacies. Efficient and sustainable transport markets and systems play a key role in regional development although the causality between transport and wealth generation is not always clear. To better document and monitor the economic returns of transport investments, a series of indicators can be used, such transportation prices and productivity. Investment in transport infrastructures is thus seen as a tool of regional development, particularly in developing countries.

4. Types of Transportation Impacts

The relationship between transportation and economic development is difficult to formally establish and has been debated for many years. In some circumstances transport investments appear to be a catalyst for economic growth while in others, economic growth puts pressures on existing transport infrastructures and incite additional investments. Transport markets and related transport infrastructure networks are seen as key drivers in the promotion of a more balanced and sustainable development, particularly by improving accessibility and the opportunities of less developed regions or disadvantaged social groups. At start there are different impacts on the transport providers (transport companies) and the transport users. There are several layers of activity that transportation can valorize, from a suitable location that experiences the development of its accessibility through infrastructure investment to a better usage of existing transport assets through more efficient management. This is further nuanced by the nature, scale and scope of possible impacts:

  • Timing of the development. The impacts of transportation can precede (lead), occur during (concomitantly) or take place after (lag) economic development. The lag, concomitant and lead impacts make it difficult to separate the specific contributions of transport to development. Each case appears to be specific to a set of timing circumstances that are difficult to replicate elsewhere.
  • Types of impacts. They vary considerably as the spectrum ranges from the positive to the negative. Usually transportation investments promote economic development while in rarer cases they may hinder a region by draining its resources in unproductive transportation projects.

Cycles of economic development provide a revealing conceptual perspective about how transport systems evolve in time and space as they include the timing and the nature of the transport impact on economic development. This perspective underlines that after a phase of introduction and growth, a transport system will eventually reach a phase of maturity through geographical and market saturation. There is also the risk of overinvestment, particularly when economic growth is credit driven, which can lead to significant misallocations of capital. The outcome is a surplus capacity in infrastructures and modes creating deflationary pressures that undermines profitability. In periods of recession that commonly follow periods of expansion, transportation activities may experiment a setback, namely in terms of lower demand and a scarcity of capital investment. Because of their characteristics, several transport activities are highly synchronized with the level of economic activity. For instance of rail freight or maritime rates were to decline rapidly, this could be an indication of deteriorating economic conditions.

Transport, as a technology, typically follows a path of experimentation, introduction, adoption and diffusion and, finally, obsolescence, each of which has an impact on the rate of economic development. The most significant benefits and productivity gains are realized in the early to mid diffusion phases while later phases are facing diminishing returns. Containerization is a relevant example of such a diffusion behavior as its productivity benefits were mostly derived in the 1990s and 2000s when economic globalization was accelerating.

Transportation investments, if relying upon new technologies, can go through what is called a “hype phase” with unrealistic expectations about their potential and benefits. Some projects are eventually abandoned as the technology proves ineffective at addressing market or operational requirements, or is simply too expensive for the benefits it conveys. Since transportation is capital intensive, operators tend to be cautious before committing to new technologies and the significant sunk costs they require. In addition, transport modes and infrastructures are depreciating assets that constantly require maintenance and upgrades. At some point, their useful lifespan is exceeded and the vehicle must be retired or the infrastructure rebuilt. Thus, the amortization of transport investments must consider the lifespan of the concerned mode or infrastructure.

5. Transportation as an Economic Factor

Contemporary trends have underlined that economic development has become less dependent on relations with the environment (resources) and more dependent on relations across space. While resources remain the foundation of economic activities, the commodification of the economy has been linked with higher levels of material flows of all kinds. Concomitantly, resources, capital and even labor have shown increasing levels of mobility. This is particularly the case for multinational firms that can benefit from transport improvements in two significant markets:

  • Commodity market. Improvement in the efficiency with which firms have access to raw materials and parts as well as to their respective customers. Thus, transportation expands opportunities to acquire and sell a variety of commodities necessary for industrial and manufacturing systems.
  • Labor market. Improvement in the access to labor and a reduction in access costs, mainly by improved commuting (local scale) or the use of lower cost labor (global scale).

Transportation provides market accessibility by linking producers and consumers so that transactions can take place. A common fallacy in assessing the importance and impact of transportation on the economy is to focus only on transportation costs, which tend to be relatively low; in the range of 5 to 10% of the value of a good. Transportation is an economic factor of production of goods and services, implying that it is fundamental in their generation, even if it accounts for a small share of input costs. This implies that irrespective of the cost, an activity cannot take place without the transportation factor. Thus, relatively small changes in transport cost, capacity and performance can have substantial impacts on dependent economic activities.

An efficient transport system with modern infrastructures favors many economic changes, most of them positive. The major impacts of transport on economic factors can be categorized as follows:

  • Geographic specialization. Improvements in transportation and communication favor a process of geographical specialization that increases productivity and spatial interactions. An economic entity tends to produce goods and services with the most appropriate combination of capital, labor, and raw materials. A region will thus tend to specialize in the production of goods and services for which it has the greatest advantages (or the least disadvantages) compared to other regions as long as appropriate transport is available for trade. Through geographic specialization supported by efficient transportation, economic productivity is promoted. This process is known in economic theory as comparative advantages.
  • Large scale production. An efficient transport system offering cost, time and reliability advantages enables goods to be transported over longer distances. This facilitates mass production through economies of scale because larger markets can be accessed. The concept of “just-in-time” in supply chain management has further expanded the productivity of production and distribution with benefits such as lower inventory levels and better responses to shifting market conditions. Thus, the more efficient transportation becomes, the larger the markets that can be serviced and the larger the scale of production. This results in lower unit costs.
  • Increased competition. When transport is efficient, the potential market for a given product (or service) increases, and so does competition. A wider array of goods and services becomes available to consumers through competition which tends to reduce costs and promote quality and innovation. Globalization has clearly been associated with a competitive environment that spans the world and enables consumers to have access to a wider range of goods and services.
  • Increased land value. Land which is adjacent or serviced by good transport services generally has greater value due to the utility it confers to many activities. Consumers can have access to a wider range of services and retail goods while residents can have better accessibility to employment, services, and social networks, all of which transcribes in higher land value. In some cases, transportation activities can lower land value, particularly for residential activities. Land located near airports and highways, near noise and pollution sources, will thus be impacted by corresponding diminishing land value.

Transport also contributes to economic development through job creation and its derived economic activities. Accordingly, a large number of direct (freighters, managers, shippers) and indirect (insurance, finance, packaging, handling, travel agencies, transit operators) employment are associated with transport. Producers and consumers take economic decisions on products, markets, costs, location, prices which are themselves based on transport services, their availability, costs, capacity, and reliability.

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