Visible hands or invisible hands: who should build the ports in developing countries?

3 April 2017
From our ‘Thinking outside the box’ series
More than 80% of international trade is carried by sea. The supply of quality maritime infrastructure and services are critical to the global economy. However, developing countries face challenges when building up modern port systems.

More than 80% of international trade is carried by sea. The supply of quality maritime infrastructure and services are of critical importance to the global economy. As of early 2015, there was 89,464 commercial vessels world-wide with a total tonnage of 1.75 billion. Large container ships are expensive to build, costing up to US$200 million for the largest models. In addition to the huge capital costs, there are also various costs for labour, maintenance, insurance, inspection and fuel. Since large ships are very expensive to hire and operate, it is important to have efficient port systems so that ships can spend more time on the sea instead of at the berth. However, the construction of ports are costly, and involves lengthy planning, consultation and construction periods. Port operation and management also needs specialised labour and expertise. All these requirements impose major challenges to developing countries that have an ambition to build up modern port systems. In addition to the huge investments, there is also significant risk associated with the demand and cost within the maritime sector. The Baltic Dry Index, a measure of the shipping price for dry bulk goods, dropped from over 10,000 to below 1,000 following the 2008 financial crisis. In 2016, the 7th largest container shipping carrier, Hanjin Shipping Co, filed for bankruptcy. The general decline in shipping and trade has put huge pressure on ports, as they have significant sunk/fixed costs and rely on shipping carriers to bring in cargo. With huge investments and associated risks, it is often difficult for the private sector to undertake very large port investments independently, especially in developing countries with relatively less efficient capital markets. As a result, many countries have relied on governments or state enterprises for port investment and development. However, state enterprises are often not efficient nor adaptive to changing market conditions, which may led to unsatisfactory investment outcomes - as well learnt, careful planning is as important as deep pockets in the maritime industry. Government involvement also discourages market competition, another necessary factor that promotes efficiency and corrects management misjudgement. Although state enterprises and government investments are quite common in the maritime industry, there has been no consensus to what extent governments should be directly involved in port development.

The Republic of Indonesia is a good example of an ambitious plan to upgrade the system of ports. Indonesia consists of approximately 17,500 islands, divided into 34 administrative provinces over five main islands and four archipelagos. The country shares land borders with Malaysia, East Timor and Papua New Guinea, and marine boundaries with Singapore, Philippines and Australia. As the world’s largest archipelago country, marine shipping is a major transportation mode for Indonesia. The Indonesian president, Joko Widodo, has declared in several occasions that he wants to develop the country into a strong maritime nation, and will put high priority on investments and development of the maritime sector. One program, called Pendulum Nusantara, was proposed by the state corporation PELINDO 2 in 2012 and is expected to be finished by 2018. This program plans to develop six main hub ports connected with regular shipping services, and to develop the Port of Sorong into an international gateway in the West Pacific. The development of the new Sorong port alone is anticipated to cost about US$245 million. Meanwhile, there is another even more ambitious plan proposed by the government, the Maritime Highway Initiative, which aims to build 24 strategic ports (5 hubs and 19 feeder ports) and the build-up of new ships to be deployed on the routes linking ports. The ports of Belawan and Bitung are also to be expanded into international hubs. It has been reported that this big project would receive approximately US$49 billion over 5 years.

Despite such tremendous investments planned for, it seems that there has not been much coordination between the two programs. If these plans are indeed implemented independently and as the current plans indicate, there can be substantial network and capacity redundancy, a wasteful outcome for a developing country such as Indonesia. There has been no general agreement on the development strategy for the Sorong port neither. The port was planned as an international gateway in the Pendulum Nusantara program, but was designed as a feeder port only in the Maritime Highway Initiative.

Good planning often starts with detailed data analysis. Yet in Indonesia, as in many other developing countries, it is not easy to compile accurate and consistent data. For example, the national statistics record “Statistical Yearbook of Indonesia 2015” reports the amount of unloaded cargo in Maluku province in 2015 to be over 1.7 million gross tons. However, Maluku’s own province record, “Maluku Dalam Angka 2015” states that the amount of unloaded cargo was slightly less than 0.8 million gross tons. Few reports, at least in the public domain, have estimated the detailed Origin-Destination cargo flows in the country. An immediate solution for these problems seems to be more government intervention and coordination: to compile more reliable and detailed data; to sponsor in-depth study and planning; to coordinate the investment plans of different companies. Although such a “social planner” approach seems intuitive and reasonable, increased involvement and intervention from the government could raise concerns of inefficiency, bureaucracy, corruption and state monopoly, especially for an industry characterized with lumpy investments and high risks. Numerous studies have suggested that the free market, or the “invisible hand” as named by economists, is the best solution in the long term. Government interventions, the “visible hand”, should be only called for when there is a clear market failure.

Recently we have carried out a study on the network configuration and port investment strategies for Indonesia. Our study suggests that the best shipping network and port investment plan changes over time. A hub-and-spoke shipping network is good for the current low level of shipping demand. However, in the long term a point-to-point configuration with additional domestic hub ports will be a better choice. Such a pattern might make some progressive policy options viable: government intervention in the early stage may be justified, which may avoid duplicate investments and thus increase the utilization and return of infrastructure investment. In the long term, since multiple hubs will be needed anyway, it is possible to rely more on market-based mechanisms which are often more responsive and efficient, and brings inter-port/inter-firm competition. That is, the optimal decision may evolve dynamically with market conditions. Visible hands with government intervention may be needed in the early stage to get the basic infrastructure done and jump-start the industry growth. As the market grows, there is enough room to accommodate competition and more private investors, when the invisible hands are more sustainable. If this plan is indeed feasible, there is a need for policy makers to think far in advance, and be prepared to change their own policies even at the time of developing such policies.

Dr Xiaowen Fu is an Associate Professor in the Institute of Transport and Logistics Studies at the University of Sydney.

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