Chapter

Chapter 4. Making Trade an Engine of Development

Author(s):
Sanjeev Gupta, Kevin Carey, and Ulrich Jacoby
Published Date:
October 2007
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Evidence indicates that sub-Saharan Africa is performing below its export potential. Its export growth derives both from fuels and manufactures, but manufactures are confined to a few resource-based products and are concentrated in southern Africa. Whereas the trade of landlocked countries measures relatively well against the benchmark, that of coastal and resource-intensive countries falls short. Outside of fuels and manufactures, most sub-Saharan African countries remain dependent on primary exports whose value has grown very sluggishly.

Evolution of Trade Patterns and Income Growth: Experiences Outside Africa

Experiences in other parts of the world demonstrate a variety of trade pattern trajectories with income growth. Six economies whose resource endowments early in their development resembled those of sub-Saharan African countries were chosen to indicate how sub-Saharan Africa’s trade patterns might evolve. Argentina and New Zealand have large agricultural sectors; Chile has a dominant extractive industry; and Thailand, China, and Indonesia participated in the East Asian manufacturing trade boom and thus may offer guidance on how sub-Saharan Africa could make the transition to labor-intensive manufacturing.31Figure 9 presents some key aspects of evolving trade patterns from 1985 to 2005 for these countries, with a more detailed breakdown in Appendix Figure A1.

Figure 9.Selected Economies: Major Product Category Shares of Total Exports

(Percent)

Source: UN Comtrade.

Increasing per capita income does not necessarily require a transition to predominantly manufacturing-based exports. None of the three non-Asian countries has seen a manufacturing export surge. Although the manufacturing share is higher in Chile than in Argentina or New Zealand, this is partly because the copper sector is included in manufacturing. In Argentina and New Zealand, where agriculture is still important, manufacturing accounts for about one-third of exports, up just modestly since 1985. Nevertheless, as Johnson, Ostry, and Subramanian (2007) emphasize, growth in manufactured exports is characteristic of rapid growers in East Asia. This may reflect complex linkages among institutional development, the export pattern, and pro-growth policies; in particular, how the export pattern affects growth will depend on the quality of institutions, which itself changes as the economy grows.

Natural resource–based exports are significant in several middle- and higher-income countries. Agriculture can be a major component of exports even in those economies. In 2005, food and beverages were still 40 percent of total exports for Argentina, 50 percent for New Zealand, and 20 percent for Chile (Figure 9). Chile is unusual among the six in that the export share of raw materials has increased since 1985 from one-fourth to nearly one-third of total exports. Though the share has declined in other countries, it is still about 10 percent in Argentina and New Zealand.

In East Asian countries manufacturing has come to dominate exports. In 1985, food and beverages accounted for nearly half of exports from Thailand, and fuels accounted for a third of exports from China and nearly 70 percent from Indonesia (Appendix Figure A1, panel d). The manufacturing share of exports from East Asia has since grown extremely rapidly; it nearly doubled in Thailand and tripled in Indonesia and China. By 2005 it had in fact reached nearly 90 percent of China’s total exports.

The success of East Asia is attributable to facilitating the accumulation of capital and skills, reducing trade protection, and reducing transport costs (Martin, 2005; and Rodrik, 1994). Improvements in the education system can facilitate the accumulation of skills, but skills are productive only when complemented by capital. Foreign direct investment has helped, but a domestic pool of savings and an effective financial sector are also important for fostering private investment. Trade liberalization promotes manufacturing exports not least because modern manufacturing networks often involve simultaneous importing and exporting of related products (Jones, 2000).

Constraints on Manufacturing in Sub-Saharan Africa

The inability to take advantage of economies of scale and poor infrastructure are common constraints to expanding trade. Sub-Saharan African markets are often characterized either by a relatively large number of small, high-cost, localized firms or by just a few firms that have significant domestic market power and little pressure to become more efficient. Local firms are also hampered by such well-documented indirect costs as poor quality of electricity and telecommunication, limited access to financing, and poor governance. Data underlying the World Bank Investment Climate Assessments indicate that such indirect costs account for more than 20 percent of total costs in Mozambique, Zambia, Eritrea, Tanzania, Kenya, and Ethiopia compared with less than 10 percent of total costs in China, Nicaragua, and Bangladesh (Eifert, Gelb, and Ramachandran, 2005). Because tackling these constraints all at once is difficult, countries have sometimes established export processing zones; however, these cannot be protected from a poor business climate and they can become magnets for rent seeking.

External impediments to trade are important but difficult to quantify. Among them are the costs of searching for and verifying business opportunities, setting up marketing channels, and creating access to communications and logistics systems for receiving and delivering orders. Informal means of relieving these, such as the use of ethnic networks and personal contacts, have been significant for Indian firms in sub-Saharan Africa; Chinese firms have tended to rely more on government-to-government links or targeted investments in the natural resource sector.32 Finally, poor transport infrastructure and multiple border crossings and administrative checkpoints are a major impediment to trade. For example, an Indian firm operating in Ghana found that the transportation cost per container from Accra to Lagos ($1,000) was so high that it was better to invest directly in Nigeria than to export to it (Broadman, 2007).

Integration into global production networks could help boost sub-Saharan Africa’s nonprimary exports. Global trade patterns reflect the growing importance of intra-industry trade because production can be more dispersed than in the past (World Bank, 2004; and Broadman, 2007). Intra-industry trade networks can be classified into two types: producer-driven (directed from upstream) and buyer-driven (directed from downstream). Buyer-driven networks may be better suited for sub-Saharan Africa because they require less vertical integration, are less capital-intensive, and are often interested in areas where sub-Saharan Africa already has some capacity, such as tourism, horticulture, and the production of clothing, food, and furniture. Yet in sub-Saharan Africa the process of integration into production networks tends to be led by foreign, not domestic, firms. For the most part, the constraints on integration into global production networks are the same as the constraints on business development generally.

Attempts to build the textile industry in sub-Saharan Africa have revealed structural constraints that often offset the comparative advantage. As a cotton producer, sub-Saharan Africa has the potential to move up the value chain in textile production. The global trade regime provided incentives to the industry through AGOA and the decisions of Asian producers to relocate production to sub-Saharan Africa to circumvent industrial country quotas. Yet the textile industry in sub-Saharan Africa continues to struggle with high production costs (transport, electricity, and so forth), the limited supply and higher cost of domestically produced yarn, and restrictive rules of origin in trade. Even when use of cheaper Asian yarn was allowed, as under AGOA, the example of Lesotho reveals an industry with an extremely fragile cost base that is vulnerable to exchange rate appreciation.

Coastal countries are the best placed to participate in the global manufacturing export boom, but except for South Africa they have made little progress.33 The manufacturing that does take place is often linked to resources and cannot be viewed as emerging intra-industry trade, though it is not surprising that sub-Saharan Africa’s manufacturing base is linked to its comparative advantage in resources. Landlocked countries depend on agriculture and raw materials exports; transportation to ports is a significant burden on the development of manufacturing. And although resource-intensive countries have been the strongest beneficiaries of the global commodity boom, the result has been less product diversification in these countries even as regional diversification of their trade has grown.

The current orientation of the global trade regime facing sub-Saharan Africa limits the ability of the region as a whole to benefit from preferential trade arrangements. The tendency toward regionalism in global trade has led to hub-and-spoke trading patterns in which sub-Saharan African countries are at best one spoke for a large global trade partner (Yang and Gupta, 2005). The key preferential trade arrangements, AGOA and EBA, limit their full benefits to sub-Saharan Africa’s least developed countries (Box 2). Although these countries in principle thus face no export restrictions to the United States and European Union, they also have the least capacity to build significant manufacturing capability. The restrictive rules of content in the trade arrangements (except for the AGOA textile provisions) make it difficult for a beneficiary country to partner with a low-cost provider of inputs (likely to be an Asian country) that has more manufacturing capacity but is not eligible for AGOA or EBA. This makes sub-Saharan African countries less attractive as, for example, an assembly base for supply chains that include countries ineligible for trade preferences; such operations would face a more unfavorable trade regime (for example, tariff escalation and tariff-rate quotas) that impedes the growth of their manufacturing and processing sectors.34 As agricultural exporters, however, sub-Saharan African countries bear the costs of agricultural protection and subsidies, which restricts their market access and depresses the price of export commodities such as cotton.

Box 2.EU–Sub-Saharan Africa Trade Arrangements

Trade arrangements between the European Union and sub-Saharan Africa are in transition. The Everything But Arms (EBA) initiative allows tariff- and quota-free imports from the world’s least developed countries, which includes many though not all countries in sub-Saharan African. EBA operates within the World Trade Organization (WTO) Generalized System of Preferences (GSP); as a GSP arrangement, it does not require reciprocal trade concessions. The Cotonou Agreement (the successor to the Lomé Convention) grants special tariff preferences to the African, Caribbean, and Pacific (ACP) countries, many of which are former colonies of EU countries. The group of ACP countries is larger than that eligible for EBA preferences only.

New Economic Partnership Agreements are supposed to be in place by the end of 2007. It was ruled that the Cotonou ACP arrangement does not comply with WTO rules because of the preferential nonreciprocal access given to ACP countries beyond those that would have been covered by a GSP arrangement. However, Cotonou was granted a waiver to continue while Economic Partnership Agreements are negotiated between the European Union and regional trade groupings in the ACP. The four African groupings are West Africa (ECOWAS plus Mauritania); Eastern and Southern Africa (a subset of COMESA); Southern Africa (linked to SADC); and Central Africa (CEMAC plus São Tomé and Príncipe and the Democratic Republic of the Congo). South Africa has a separate bilateral EU free trade agreement but is participating in the SADC negotiating group.

Current trade arrangements seem to have had little success in broadening the African export base. The sub-Saharan African share of the EU market for its exports has declined in spite of various trade arrangements and is concentrated in primary commodities. The overlap between agreements has also been problematic. For example, because Cotonou covers more countries, it can offer more favorable rules of origin than EBA—but EBA is more liberal in terms of quota-free access. Rules of origin for both are highly complex and restrict cross-border production. Exclusion of South Africa from both EBA and Cotonou has been difficult to reconcile with its role as an economic hub in the region. Furthermore, special arrangements for certain products, notably sugar and rice, have had a big impact on selected sub-Saharan African countries.1

Sub-Saharan African countries appear to have some apprehensions about Economic Partnership Agreements. Because Economic Partnership Agreements must be based on reciprocal concessions to be WTO-compatible, they imply increased market access for EU exporters to African countries. Countries also face customs revenue losses because tariffs on EU imports are reduced.2 For instance, customs receipts for the West African Economic and Monetary Union would fall from about 4 percent of GDP to less than 2 percent from the combined effect of the Economic Partnership Agreements and an ECOWAS common external tariff. In fact, the European Union is seeking a gradual phase-in of its reciprocal access to ACP countries to give them time to transition to less distortionary sources of revenue and build up local capacity.

The European Union has emphasized that Economic Partnership Agreements will be part of a regional integration strategy to make African markets more attractive for all producers. One goal is an integrated export industry structure; this will include support for dismantling the extensive nontariff barriers and liberalizing investment and trade in services. Economic Partnership Agreements also offer African countries an opportunity to rationalize what is already a complex overlap of regional trading agreements; the average sub-Saharan African country is a member of four such agreements. However, partial implementation of Economic Partnership Agreements without more comprehensive reforms could present risks, because domestic markets would still be distorted, but with more trade diverted to the European Union.3 Finally, there is concern that the Economic Partnership Agreement groups are not aligned with sub-Saharan Africa’s own regional configuration; the SADC straddles several Economic Partnership Agreements, and there are likely to be continued South African exceptions to the Economic Partnership Agreement process. Countries might also face conflict between participation in an Economic Partnership Agreements and obligations in a regional trade agreement.

The European Union has sought to alleviate concerns about the impact of Economic Partnership Agreements with offers of broad-based market access to participating countries and promises of more effective aid for trade. The most recent proposal (April 2007) envisages EBA-level access for all ACP countries, with phase-ins for only rice and sugar and separate arrangements for a few exports from South Africa. From the perspective of EBA countries, this would erode some preferences but also reduce the obstacles to integration with non-least-developed ACP countries. Nevertheless, rules of origin for inputs sourced outside ACP countries would still be strict, although obtaining more liberal rules of origin is a key point of negotiation for sub-Saharan Africa. AGOA is the prime example of an arrangement under which strict rules of origin are waived. Although African countries have so far expressed little interest in pursuing non–Economic Partnership Agreements, the alternatives for the least developed countries are limited to the EBA; other countries would have access only through the more general GSP provisions. Access under GSP is much less favorable than what an Economic Partnership Agreements would offer, and the rules of origin would be even stricter than now.

1 Under Cotonou’s Sugar Protocol, ACP countries can obtain the (high) internal EU sugar price up to a specified quota, with some additional access above the quota at preferential tariff rates. The European Union’s scaling down of its sugar sector supports has imposed significant adjustment on the ACP countries that enjoy this access (such as Mauritius and Swaziland). On the other hand, EBA will offer unrestricted duty-free access to the EU sugar market by 2009. Rice is subject to tariff-rate quota restrictions.2 Revenue will also be lower in areas where a customs union is being formed parallel to an Economic Partnership Agreement as in West and Central Africa.3 As with RTAs within sub-Saharan Africa, the risk of trade diversion is lessened by parallel most-favored-nation liberalization.

Sub-Saharan Africa’s own external trade policies do not help. The restrictive external trade regimes of African countries, including high tariffs and other trade barriers, contribute to the undertrading reported in Chapter 3. Particularly noteworthy are the high tariffs on imported intermediate goods, such as fabric, which place sub-Saharan African firms at a cost disadvantage.35 The historic emphasis on import protection shifted relative prices against exporting sectors, discouraging their production. Tariffs on imported intermediate inputs raised the cost of producing exportable goods, and regional trading arrangement incentives to source inputs regionally in compliance with rules of origin placed exportable products at a cost disadvantage on world markets. In a recent working paper, Tokarick (2006) presented export-tax equivalents of tariff barriers in various countries (based on 2001 data). According to the estimates, the tariff structures of Malawi, Mozambique, and Tanzania imposed an effective tax on their exports of about 10 percent.

Policy Recommendations

Most countries in the region have neither managed to achieve a labor-intensive manufacturing export surge, nor been able to climb up the value chain of their commodity-based exports. To improve their prospects for doing either, the following policies should be helpful.

Maintaining macroeconomic stability, building infrastructure, and reducing the cost of doing business are universally essential to promoting growth and trade. They would also help the region gain a share of the growing outsourcing of services by industrial countries (see Box 3).

Box 3.International Service Outsourcing to Sub-Saharan Africa

International service outsourcing (ISO) refers to companies procuring services in foreign countries (Amiti and Wei, 2004). It is estimated that ISO generates $160 million–$200 billion a year, and its annual growth rate exceeds 20 percent (Bartels, 2005). ISO ranges from relatively low-value-added data coding and customer service (call centers) to more sophisticated business processing (billing services, claims processing) to high-value-added information technology and professional services (accounting, health care, engineering).

ISO to sub-Saharan Africa has so far been marginal. It is concentrated in just a few countries and in low-value-added activities. Call centers in Ghana, Kenya, and Senegal employ several thousand people (Day, 2005; and Lacey, 2005). South Africa as the regional leader has more than 30,000 call center jobs, but that is still only 0.5 percent of call center jobs worldwide (Lacey, 2005).

Sub-Saharan Africa has considerable disadvantages in building the ISO sector but it has some advantages over better-known ISO locations. The challenges it must confront are formidable: high telecommunication costs, unreliable supplies of electricity, poor transport infrastructure, lack of skilled workers, and relatively high wages (Zachary, 2004). Yet countries in sub-Saharan Africa benefit from dedicated employees who prize their jobs, falling phone rates due to a new fiber-optic connection to Europe, and European time zones. South Africa in particular can draw on a reservoir of business skills from its mature insurance and banking sectors (McLaughlin, 2004; and Farrell, 2006).

The key to attracting ISO to sub-Saharan Africa is public investment in infrastructure and education. Good infrastructure reduces setup and operating costs for most businesses and is of particular importance for ISO, an industry that depends heavily on reliable communication links. Local employees who possess the necessary skills are also crucial. Because countries in sub-Saharan Africa often lag behind countries elsewhere in providing infrastructure and education, public investment in these areas would benefit not only the outsourcing industry but also the economy as a whole.

Sub-Saharan African countries should proceed with trade liberalization through a gradual but substantial reduction in MFN tariffs around the region and in the external tariffs in regional trading agreements.36 This will improve resource allocation while limiting incentives to circumvent customs. It will also reduce the risk of trade diversion in regional trading agreements and the EU Economic Partnership Agreements. Of course sub-Saharan Africa would also benefit from global trade liberalization, especially improved access to Asian markets, where it currently lacks the preferential access it has to the European Union and the United States. In general, MFN tariff reductions are a much more powerful instrument than RTAs for achieving gains from trade, because all trade, not just trade within the RTA, is affected.

Hallaert (2007) finds, for example, that Madagascar would benefit more from phaseout of customs tariffs for the SADC trade if it were accompanied by MFN tariff reduction; SADC accounts for just 6 percent of Malagasy imports, but there is substantial potential for trade diversion with an SADC-only liberalization.

RTAs should seek to broaden their product coverage to all goods and services. They should also promote liberal rules of origin; requirements for high domestic or regional value added are difficult for sub-Saharan African exporters to meet. The Economic Partnership Agreements now being negotiated with the European Union may be a way to address nontariff barriers in RTAs. Policy reforms that help draw more firms into the formal sector are essential for boosting exports, because the logistical requirements of exporting are difficult, if not impossible, for an informal sector firm to meet (Krueger, 2007).

Reducing shipping costs is an important objective for sub-Saharan Africa. Although direct global shipping costs have declined over time and are the least constraining element on sub-Saharan Africa’s trade linkages, there are indirect costs related to infrastructure quality and institutions, such as port charges, customs clearing, and internal freight. These, which often far exceed international freight costs, are a major source of relative cost differentials between countries (Martin, 2005). Moreover, a global reduction in shipping costs does not necessarily translate into an equivalent reduction for sub-Saharan Africa because the East Asian trade boom has reoriented fleets toward the Pacific Ocean. One study (Hummels, 2001) estimates that each extra day of shipping time adds 0.8 percent to ad valorem costs—an important consideration when picking up cargo in a sub-Saharan African port requires a detour from a regular shipping route. Delays before shipping also have an adverse impact. Djankov, Freund, and Pham (2006) use the World Bank’s Doing Business data to estimate that each additional day’s delay before shipping reduces trade by 1 percent. Delays are particularly costly for time-sensitive perishable goods of the type that sub-Saharan Africa is likely to be exporting.

Coastal countries should work to boost their attractiveness to global intra-industry trade networks. That means tackling the domestic portion of indirect costs like transportation and logistics, especially such bottleneck areas as customs clearance. Trade liberalization can help attract multinational firms whose operations are spread throughout the world. Liberalizing their trade with neighboring landlocked countries can help coastal countries become regional hubs for distribution or assembly. RTAs help, but the emphasis should be on deepening agreements through progress on nontariff barriers rather than adding new RTAs.37 Because international trade networks are increasingly involved in services as well as goods, improvements in telecommunications are also critical.

Landlocked countries should emphasize reduction in transportation costs and deeper regional integration, in particular with coastal countries. This would facilitate adding value to their traditional exports and allow them to better exploit their preferential access to the European Union and the United States. Improved regional infrastructure will also expand market size, but it will be effective only if border and other checkpoint procedures are rationalized. A special emphasis on streamlined trade logistics would greatly benefit landlocked countries. Although it may not be currently feasible for these countries to build major manufacturing capacity, they could expand domestic processing of agricultural and raw materials in line with the experience of higher-income countries that continue to specialize in agriculture. For example, tea and coffee have declined to minor shares of sub-Saharan African exports, even though they are sold as premium products in industrialized countries. The export of low-value primary products is particularly ineffective for sub-Saharan Africa when total transport costs are so high, creating a large wedge between the final sales price and the primary producer. Beverage exporters could capture more value by packaging, branding, and grading these exports, but they will need assistance from partners to build up their capacity in those areas. Promotion of manufacturing should be based on existing advantages and should focus on enhancing local capacity rather than interventions like subsidies or export taxes. For example, domestic production of cotton yarn would lessen the burden of rules of origin in preferential trade agreements and mitigate uncertainty about the future renewal of AGOA, with its more liberal rules of origin. However, efforts to expand yarn production within the public sector have not been successful, and the record of export taxes on raw cotton shows that they penalize cotton growers.

Resource-intensive countries should tackle constraints on their export processing industries. However, many of sub-Saharan Africa’s resource exporters have small populations, which limits their ability to diversify their economies, and Dutch disease effects make it more difficult for industrial sectors of their economies to be internationally competitive. However, these countries often lack the capacity to add more value to their resource endowments. Diamonds are shipped from southern Africa to Europe (and, increasingly, India) for grading and polishing. Oil is exported in crude form for refining in a third country and then re-imported for retail sale. Metals and ores leave the region immediately after extraction for use in manufacturing processes in other parts of the world. Experiences outside sub-Saharan Africa show that it is possible to remain relatively specialized in resource-based exporting at higher income levels, but this is contingent on moving up the value chain. However, attempts to encourage local processing through export taxes or controls on raw commodities have not been successful: some of the burden is borne by domestic suppliers, and the implicit subsidy to the processing stage gets dissipated in rents. In fact, constraints may not be industry-specific and may instead relate to a generally restrictive business environment. Because developing downstream industries is often capital-intensive, openness to foreign investment is particularly important; this is one area the Economic Partnership Agreement process is designed to tackle.

Sub-Saharan African countries will need assistance in boosting their capacity to compete in global export markets. Many of the hurdles to exporting derive from technical and quality standards needed for entry to certain markets; this is especially so for attempts to move up the value chain in processing of primary products. Sub-Saharan African countries would benefit from cooperation with partners in industrialized countries in building this capacity. The scope for seeking out partnerships with Asian firms is significant as their home labor costs rise and given their successful experience in entering western markets; nevertheless, sub-Saharan Africa will be an attractive base for these firms only if the general environment for doing business improves. In addition, the new Economic Partnership Agreements with the European Union open the way for enhanced capacity-building strategies such as aid for trade. Regional harmonization of standards would also help reduce trading costs and expand the effective size of the market available to otherwise segmented sub-Saharan African firms.

The latter three countries, along with Chile, are included in the list of sustained growers identified by Johnson, Ostry, and Subramanian (2007); that is, countries that around 1960 had income and institutional quality levels similar to sub-Saharan Africa today, and therefore that might be indicative of growth prospects for sub-Saharan Africa.

Access to ethnic networks may explain why firms controlled by minority entrepreneurs tend to outperform those controlled by majority entrepreneurs in eastern and southern Africa (Ramachandran and Shah, 1999).

Collier (2006) argues that sub-Saharan Africa’s coastal countries should have entered labor-intensive manufacturing in the 1980s, when East Asia was beginning to transition to this mode of exporting. Entry into the sector now is much more difficult because the agglomeration effects reaped by East Asian countries are difficult to replicate when there are established competitors.

The rules of origin for AGOA, EBA, and the EU Cotonou Agreement—that is, determining how much third-country content is admissible while retaining preferential access—are complex and differ in important ways. Cotonou has quite liberal rules of origin but in other respects is more restrictive than EBA or AGOA; this complexity imposes an additional compliance burden on beneficiary countries.

An extreme example in this regard is Nigeria, which bans imported fabric.

The average effective tariff in sub-Saharan Africa is still the highest among developing regions, though it has fallen from 22 percent in 1997 to 15 percent in 2006. The average masks large variation among countries and commodities.

Hinkle and Newfarmer (2006) note that the negotiation of EPAs with the European Union will require clarification of conflicting obligations under overlapping RTAs of which a country may be a member.

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