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Regional focus: Going beyond regional arrangements to boost African trade

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
July 2005
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Some 30 regional trade arrangements (RTAs) now exist in Africa and each country on average belongs to four. Many of these arrangements are part of deeper regional integration ambitions, but a new IMF study argues that small market size, poor transport facilities, and high trading costs are impeding the ability of African countries to reap the potential benefits. Authors Sanjeev Gupta and Yongzheng Yang (IMF African Department) recently discussed their findings with Jacqueline Irving of the IMF Survey. They point to the need for more broad-based liberalization and streamlining existing RTAs, while improving the region’s infrastructure.

There has been much recent interest in, and debate over, the merits of RTAs. A key aim of this study, Gupta explained, was to look at the existing arrangements in sub-Saharan Africa to see whether they are meeting their goal of increasing intraregional and extraregional trade and whether they are benefiting the region, or, indeed, whether there is a need to rethink their underlying strategies. “This is an area that has not been studied in great detail for Africa,” he added, noting that trade policy is an important part of economic policy, especially in terms of its potential to promote and sustain growth.

Have RTAs helped increase intraregional trade? There seems to have been an increase in African intraregional trade over the past 25 years, but it still remains low compared with other regions. Since the mid-1990s, intra-African trade overall has been stable at about 10 percent of total African trade despite intensified efforts to integrate regionally. In contrast, intraregional trade is currently about 70 percent of total trade for Europe and 50-60 percent for parts of Asia. “In other regions, after these sorts of agreements were signed, intragional trade normally grew rapidly,” Yang said, referring to western Europe in the decades following the founding of the European Economic Community (EEC) in 1957, and East Asia more recently.

This regional variation in performance can be partly explained by the less favorable initial conditions African RTAs have faced. African economies tend to trade primary commodities and have very similar export/import structures— leaving limited scope for trade with one another. The weak complementarity among countries is evident, Yang explained. While machinery and transport equipment comprise about three-quarters of Africa’s total imports from the rest of the world, African economies can meet no more than 4 percent of the region’s import demand for these goods.

Very poor infrastructure also plays a part. According to a 2002 World Bank study, around 13 percent of sub-Saharan Africa’s roads are paved, while just over 30 percent of the roads are paved in the developing world overall. Plus, 10 of the 15 landlocked developing countries in Africa spend up to 40 percent of their export earnings on transport of the traded goods. “Strengthening Africa’s infrastructure would help promote trade, but then one could ask whether RTAs are needed to do this,” noted Gupta. He pointed out that the multiplicity of African RTAs with overlapping memberships imposes large, often conflicting obligations on these countries, most of which are already hampered by inadequate capacity.

Would currency unions help?

Some economists have argued that, absent a common currency, an RTA is limited in its ability to boost trade between its members. Andrew Rose (University of California, Berkeley), for example, has found the effect of a common currency on intraregional trade to be positive and highly significant. In a 2000 study, Rose showed that countries could increase bilateral trade by as much as three times by introducing a common currency. In a 2004 study, Céline Carrère (Université de Lausanne, Switzerland) found that currency unions in Central and West Africa reinforced the positive effects of the corresponding trade agreements on intraregional trade, while mitigating any trade diversion effects.

But Gupta and Yang emphasize that while a currency union may reduce trade transaction costs, in the absence of other necessary conditions—which, along with good infrastructure, include sound macroeconomic conditions and good implementation of RTAs—the impact of a currency union on trade would not be that strong. “One of the problems with African RTAs is that their implementation is often delayed and, once the tariffs are reduced, they are often replaced by nontariff barriers, roadblocks, checkpoints, and so on,” Yang observed.

Marginalized in world trade

So far, there appears to be scant evidence of a positive effect of African RTAs on the region’s share of world trade, which has fallen from 4 percent in the 1970s to about 2 percent at present, with a stagnating share of manufactured goods trade. “The use of trade as an instrument to improve the regional economy’s productivity and allocation of resources has not happened in Africa the way that it has in other parts of the world,” Gupta noted. In his view, this indicates a need for the region to rethink its policies.

Why haven’t RTAs increased Africa’s competitiveness in world markets? Small market size is one key reason. “One of the rationales for having an RTA is to enlarge the market,” Yang explain-ed, “but the size of sub-Saharan Africa’s regional economy is about the size of Australia, and when you exclude the largest national economy, South Africa, it’s the size of Austria.” Moreover, African RTAs have often been designed to have high external trade barriers against the rest of the world, which constricts the expansion of trade. With 90 percent of Africa’s total trade conducted with non-African countries, a very large portion of overall trade is hampered by high tariffs and other barriers. Gupta and Yang found that where an RTA does boost trade among its members, it is often at the expense of trade with economies outside the RTA. “When you do the math,” Yang recounted, “it turns out that overall trade does not increase— it may even be reduced in some cases—and so there is generally a minimal overall impact on welfare.”

open RTAs to expand trade

Pointing to evidence in other regions showing that intra-regional as well as extraregional trade grows when economies pursue broader-based, nondiscriminatory trade liberalization, Gupta and Yang recommend this course for the existing African RTAs. “Going back to the example of the founding of the EEC,” Yang recalled, “these countries did not stop at reducing internal barriers; they also participated in successive multilateral trade liberalization rounds and that helped reduce the trade diversion effect and expand their trade with the rest of the world.” To make this work in Africa, Gupta and Yang suggest, the countries would need to take action to facilitate trade, particularly by reducing infrastructure bottlenecks and border impediments. At the same time, streamlining the multiplicity of African RTAs to reduce the numerous, overlapping country memberships could help make them work better, including by reducing trading costs.

They concede, however, that greater opening of the African RTAs to the rest of the world—through multilateral and unilateral liberalization—is a difficult task. “There is an adjustment cost,” Yang continued, “and African countries would need to undertake additional reforms to be better able to respond to opportunities in overseas markets.” While diversifying the region’s commodity-based economies is one desirable route, this is a longer-term development process. More immediate measures that would make these economies more dynamic and better able to withstand adjustment costs include improving the policy environment and investment climate to attract more foreign direct investment, and improving domestic tax collection to compensate for any fiscal revenue losses that may occur as tariff barriers fall. “There is a range of steps policymakers can take to improve revenue collection from domestic tax sources,” Yang said, “but early action is needed to diversify the revenue base, to prepare the way for unilateral and multilateral trade liberalization.”

Gupta said that it is important to take a case-by-case look at how countries’ fiscal revenues would be affected by tariff reductions since, in certain circumstances, fiscal revenues have been known to increase following trade liberalization. Under a scenario in which a country maintains quantitative restrictions on imports and offers significant tax exemptions—but decides to simultaneously lower tariffs and remove tax exemptions and import restrictions—fiscal revenues could actually go up.

But it is impossible to generalize about how these economies will be affected, Gupta cautioned, and countries that do suffer severe revenue losses and balance of payments difficulties after tariff barriers fall may be eligible for temporary assistance from the IMF and other international institutions to ease the adjustment. The IMF and other sources of technical assistance can also help these countries strengthen their domestic tax systems, so that they can recoup any fiscal revenues lost to trade liberalization. And the IMF stands ready to help countries increase their share of world trade by providing advice on how they can establish and maintain macro-economic stability and improve their investment climates. It is also critical, Gupta and Yang noted, that rich countries further open their markets to African countries’ exports.

Copies of IMF Working Paper No. 05/36, “Regional Trade Arrangements in Africa: Past Performance and the Way Forward,” are available for $15.00 each from Publication Services (see page 200 for ordering details) or on the IMF’s website (http://www.imf.org).

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