Setting a new course: A look at the profound effects of expanding a key component of economic growth

The Isthmus of Panama has been used to transport goods from the Atlantic to the Pacific and vice versa for centuries. In modern times its role in facilitating international trade has been taken to new heights thanks to one of mankind’s greatest engineering feats: the Panama Canal. The canal handles around 3% of global maritime trade, including about 10% of US international sea trade, according to the Panama Canal Authority (Autoridad del Canal de Panamá, ACP). In 2014 the canal celebrates two significant milestones: the 100th anniversary of its creation and the 15th anniversary of the implementation of the Torrijos-Carter Treaties, which handed control of the canal over to Panama from the US. However, these anniversaries are overshadowed by what will be the most significant event to impact regional and arguably global trade since the canal’s construction in 1914: the completion of a third set of locks that will allow for some of the world’s largest cargo ships to pass. The canal’s importance to the economy is notable not only because of its status as a major source of revenue and jobs, but also due to its ability to stimulate growth in logistics and maritime value-added services.

Background

Though the French began construction of the Panama Canal in 1881, it was completed by the Americans in 1914 after the US acquired the rights to construct and operate the canal in 1904, following Panama’s independence from Colombia. The canal remained under US control for nearly all of the 20th century despite repeated calls for its nationalisation. US pressure on France and the UK to ditch their efforts to retake control of the world’s other vital canal – the Suez Canal – during the Suez Crisis of 1956 exacerbated calls for the nationalisation of the canal. Eventually the US would succumb to pressure from both inside and outside Panama to return control of the canal when General Omar Torrijos and President Jimmy Carter signed the Torrijos-Carter Treaties of 1977, which abrogated the Hay-Banau-Varilla Treaty of 1903 that had given the US control of the canal. The treaties established that the canal would be nationalised in 1999, though it would be operated in neutrality.

Local Impact

At noon on December 31, 1999 the Panama Canal fell under control of the ACP, the autonomous government agency still charged with its administration and operation. It is no coincidence that Panama’s greatest period of economic growth occurred after the canal’s nationalisation. Canal contributions to the national treasury has grown considerably since 1999, from $201m in 2000 to $981.8m in 2013, during which time a total of $8.6bn in contributions filled government coffers. Though the extra revenue was initially used to pay down government debt – Panama reduced its debt-to-GDP ratio from 70.4% in 2004 to 38.3% in 2013 – more recently revenue has been used to help fund national infrastructure projects, such as hospital, schools and Central America’s first subway.

In addition, the canal employs roughly 10,000 people on an annual basis, according to the ACP, while a further 30,000 temporary jobs have been created since the start of the expansion programme. However, it has been the canal’s aptitude for enticing industry that arguably has the greatest impact on the domestic economy in the long term. Panama already has a significant logistics and transportation industry, while a promising value-added manufacturing industry is also beginning to spring up (see Transport chapter).

Global Impact

Though the majority of cargo passing through the canal travels from the US to Asia or vice-versa, the canal is also an important route for cargo travelling within and between South America, North America and Europe. With its expansion in mind, logistics centres and the shipping industry at large are making significant preparations across the Americas. An influx of post-Panamax ships to new destinations in the Gulf of Mexico, the Caribbean and both the Atlantic and Pacific coasts of the Americas has ports scrambling to upgrade infrastructure to accommodate the larger ships, while logistics centres are expanding warehouse capacities and increasing personnel (see analysis).

By The Numbers

In 2012 vessels transiting the Panama Canal reached a record 333.7m Panama Canal Universal Measurement System (PC/UMS) tonnes. In 2013 this figure decreased to 320.6m PC/UMS tonnes, mainly as a result of a decline in drybulk traffic of US grain exports to Asia due to drought in the US. Over 200m long tonnes of cargo transit the waterway, and the average size of transiting vessels has increased at an accumulated annual rate of 3% since 1995. In 2013 Panamax vessels, which are the maximum size with a beam of up to 32.3 metres, reached 7035 transits, or 58% of total oceangoing transits. In September 2010 the canal registered the 1m transits, an important milestone for the 80-km canal. Nearly 14,000 vessels traverse their interoceanic journey via the canal, with the average transit time lasting between eight to 10 hours.

Container ships account for the largest number of transiting vessels, totalling 3100 in 2013. They also contribute the most to toll revenues, accounting for 51.4% of total toll revenues. Most container ships are destined for ports along the eastern coast of the US. Up to 2003 bulk carriers were the most common type of vessel transiting the canal, but in 2013 bulk carriers barely edged out container ships with a total 2903 transits. Liquid bulkers came in third with 2469, followed by refrigerated (110), general cargo (902), vehicle carriers (766) and passenger vessels (206). The primary users in 2013 with regards to the origin and destination of goods were once again the world’s two largest economies. In terms of long tonnes of cargo, the US is the largest user of the canal, with 65% of cargo passing through the waterway being either destined for or originating from the US. China came in second with 22.11%, followed by Chile (13.81%), Japan (9.52%), the EU (9.5%), Colombia (8.33%) and South Korea (8.01%).

The Expansion

To accommodate progressively larger cargo ships, as well as ensuring the canal continues to capture its share of increased trade amid rising globalisation, the Panama Canal expansion project was announced in 2006. At $5.25bn, the expansion of the canal is the largest single investment in the country’s history. The design and construction of the new locks was awarded in 2009 to an international consortium referred to as Grupo Unidos por el Canal (GUPC) and consisted of Spain’s Sacyr Vallehermoso, Italy’s Impregilo, Belgium’s Jan de Nul and Panama’s Constructora Urbana. While a dispute over cost overruns briefly put the project on hold in early 2014, a resolution was reached in late February when GUPC claimed cost overruns had reached $1.6bn. Consequently, GUPC and the APC started negotiations to resume work, and by March 2014 the two parties had reached an agreement, signalling an end to the dispute. Several sources in Panama told OBG that one effect of the dispute could be to delay completion of the expansion beyond its 2015 scheduled date, although APC continued to forecast that the works would be completed on time.

The $2.3bn worth of financing that was required for the waterway expansion was provided by the Japan Bank for International Cooperation ($800m), the European Investment Bank ($500m), the Inter-American Development Bank ($400m), the International Finance Corporation ($300m) and the Andean Development Corporation ($300m). At the time of writing dredging at both entrances on the Pacific and Atlantic side had been completed. However, the largest expense of the development programme is the construction of the new set of post-Panamax locks, which come at a cost of $3.2bn. The new set of locks will create an additional lane and double the canal’s capacity. The existing canal consists of two sets of locks that make up the two-lane system serving Panamax vessels in place today.

Both locks contain three chambers (each with an additional three water-saving basins), a lateral filling and emptying system, as well as rolling gates. To access the Pacific side of the canal, roughly 50m cu metres of earth was excavated along the initial 6.1-km path, while additional dredging was required at both canal entrances and the entrances to the Culebra Cut and Gatun Lake. Gatun Lake, which was artificially created in the 1900s to serve the canal, is being expanded as its maximum operating water level is raised from 26.7 to 27.1 metres to hold additional water storage of 165m cu metres.

According to estimates by the ACP, 22.5% of the world’s container ship fleet could not fit through the canal in 2014. The canal’s current set of locks (304.8 metres long; 33.5 metres wide; 12.8 metres deep) are able to handle Panamax ships (294.1 metres long; 32.3 metres wide; 12.04 metres deep), while the new set of locks (427 metres long; 55 metres wide; 18.3 metres deep) will handle post-Panamax ships (366 metres long; 49 metres wide; 15.2 metres deep).

Post-Panamax ships have more than twice the capacity of Panamax ships, carrying a maximum of 13,000 twenty-foot equivalent units (TEUs) compared to the current maximum of 5000 TEUs. The overall expansion programme was 73% complete as of February 2014, according to ACP reports.

Ports

The Panama Canal is flanked at both entrances by several ports – the Port of Cristobal and the Port of Balboa – both of which have been run by the Panama Ports Company (PPC) since 1997. The Port of Balboa is located in Panama City by the canal’s Pacific entrance, while the Port of Cristobal primarily services the Colón Free Zone (CFZ) by the Atlantic entrance. The PPC is currently investing $1bn to increase the combined annual capacity of both ports to 6.5m TEUs.

The Manzanillo International Container Terminal, Colón Container Terminal, Port of Singapore Authority Terminal and more infrastructure is being built at both entrances. Even so, many see limited port capacity as a constraint to expanding the logistics, re-export and value-added service providers.

Terrestrial Infrastructure

In addition to the construction of ports on both sides of the canal, a significant amount of investment has been poured into infrastructure to support the country’s increasingly important logistics industry. This has included major projects to expand and renovate the national highway system, the construction of a railway running parallel to the canal, and most importantly, the establishment of large free zone areas from which logistics and manufacturing companies may base re-export operations. Several canal-related infrastructure projects are also being completed as part of the wider expansion programme, including the construction of a third bridge crossing over the canal located at the Atlantic entrance, which in early 2014 had accumulated obligations of $381.96m and costs of $14.3m.

The Panama Canal Railroad actually existed long before the canal, with construction beginning in 1850 while the country was still under the control of Colombia. The railroad was later expanded and served a vital role in transporting equipment, labour and earth during the construction of the existing canal. The railroad was once again reconstructed in 2001 after the government handed control of the railway to the Panama Canal Railway Company, a joint venture between Kansas City Southern Railroad and Mi-Jack Holdings, through a 50-year concession awarded in 1998. The railroad received a significant upgrade to the tune of $80m recently and operates both passenger and freight service acting as an intermodal link between port terminals on either side of the canal, as well as the CFZ. In addition to the railroad running parallel to the canal, two highways – the Panama-Colón Expressway and the Transistmica – provide another option for interoceanic travel via land that each take less than one hour.

The CFZ is itself a significant piece of the puzzle as it is the second-largest free zone in the world following Hong Kong, while its tax and legal incentives have ensured investment from companies in the logistics and manufacturing sectors looking to take advantage of the constant flow of goods. In 2013 the CFZ alone handled $27.9bn worth of commercial goods, while the addition of the more specialised Panama Pacifico Special Economic Area on the other side of the canal will also ensure adequate infrastructure for logistics, manufacturing and technological firms in the future.

Toll Change

The transfer of power from the US to Panama marked a significant alteration to administration from the US operation of the canal on a break-even basis to Panama’s more business-like approach. Indeed, tolls have increased 14 times throughout history and six times during Panama’s 15-year administration. Yet recent toll increases have been accompanied by improved quality of service, infrastructure developments and the adoption of pricing mechanisms that adopt widely used industry measures. More changes are afoot as the ACP continues to adapt its toll system to complement the addition of post-Panamax ships following the completion of the expansion programme.

As canal revenues continued to grow it became necessary for the government to decide how and where to funnel the extra funds coming in. In 2012 the current administration decided it would begin to channel additional finances into a long-term investment fund known as the Panama Savings Fund, a sovereign wealth fund. The fund draws on all distributions from the ACP to the national treasury in excess of 3.5% of the nominal national GDP. In essence, extra funds are now being used to garner returns on investments and as a rainy day insurance fund to be used in the event of natural disasters or grave economic circumstances. With tolls, and the canal’s contributions to government coffers, expected to rise on the completion of the expansion project, the fund is expected to swell alongside them.

The Challengers

Naturally the primary competition to the canal comes in the form of alternative trade routes, which for ships crossing the Western hemisphere are mainly the intermodal logistics network of the US, the Suez Canal and rounding Cape Horn at South America’s southernmost tip. The canal also faces competition from potential future trade routes. Warmer waters caused by increasing climatic shifts could increase traffic in the Arctic Ocean north of Canada, known as the Northwest Passage.

Another competitor could emerge as neighbour Nicaragua considers the economic feasibility of constructing its own canal. Initial estimates indicate such a project would cost at least $18bn, nearly double the country’s national GDP of $10.5bn, according to the World Bank, though the total cost could balloon to as much as $40bn to develop the 200-km waterway. Outside financing for the canal would thus be necessary, and prominent Chinese businessman Wang Jing has emerged as the most likely source. Though feasibility studies are being carried out and the administration has passed a canal law establishing a concession, significant political opposition, which primarily stem from national sovereignty violations as Jing’s firm would operate the canal for the first 50 years, could stifle the deal even before any sort of conclusions are made regarding its feasibility. Nonetheless, in December 2013 the appeals against the canal law establishing a concession were dismissed by the Supreme Court of Nicaragua. While both of these alternative routes could eventually pose a direct threat to the canal, establishing either route would take at least a couple of decades, plus the aforementioned significant investment.

Outlook

The Panama Canal and its expansion are far more important to the wider economy than only the direct revenues and employment figures taken alone would suggest. Indeed, the government of Panama is positioning itself as a “Hub of the Americas” in more ways than one. In addition to being the region’s focal point of commerce, the government has also been pushing to establish itself as a financial, air transport and logistics centre.

Just as the nationalisation of the Panama Canal changed the country’s long-term overall economic competitiveness, so too will the completion of its expansion projects. Not only are revenues from the canal expected to double by 2020, fuelling continued public sector spending on infrastructure and social programmes, the expansion will secure what is now one of Panama’s primary economic resources for the long term.