Chapter V. Making Regional Trade Arrangements More Effective in Africa
- International Monetary Fund. African Dept.
- Published Date:
- April 2006
Trade policy is a critical component of an effective strategy for reducing poverty and boosting growth. In recent years, however, African policymakers have increasingly resorted to RTAs (regional trade arrangements) as a substitute for broad-based trade reform. This trend has long-term implications for the effectiveness of trade policy as a tool for poverty reduction and growth. This chapter1 examines the performance of African RTAs and explores policy options for making them more effective.
The Effects of African Trade Arrangements
Africa is home to some 30 RTAs, with each country belonging, on average, to 4. There has been a renewed push in recent years to broaden and deepen such arrangements in Africa against the backdrop of increasing regionalism worldwide and slow progress in the ongoing Doha Round of multilateral trade negotiations.
African RTAs have four key objectives: (1) promote intraregional trade, (2) improve regional competitiveness, (3) prevent and resolve conflicts in Africa, and (4) strengthen Africa’s bargaining power in international trade negotiation through collective action. Regionalism in Africa and elsewhere is an ongoing process, and it may thus be too early to judge the ultimate effects of African RTAs. But, so far, their record has been mixed.
Trade within Africa as a share of the continent’s global trade remains low (about 10 percent) and volatile compared with intraregional trade in other parts of the world. Nevertheless, African countries, on average, trade more with each other than their world trade share would suggest. This higher and increasing regional trade intensity is largely due to Africa’s marginalization in the world market rather than to the performance of intraregional trade (Figure 5.1).
Figure 5.1.Intra-Africa Trade in Total African Trade and Africa’s Share in World Trade
Source: IMF, Direction of Trade Statistics (various years).
Econometric evidence suggests that RTAs may have had a positive but uneven effect on intraregional trade, although, over the long run, the overall effect seems to have been small or insignificant.2 RTAs also appear to have caused some trade diversion, which may explain part of the decline of Africa’s share in world trade over time. Given the small share of intraregional trade in Africa’s total trade, the direct contribution of any trade diversion to overall trade performance is likely to be limited; any significant impact would have to come from the overall trade policy environment that RTAs have helped to create.
RTAs do not yet seem to have had a significant impact on Africa’s export performance in the world market. The continent’s share in global trade has declined from about 4 percent in the 1970s to about 2 percent at present. During 1970–2003, Africa’s share in global manufactured exports (about 0.5 percent) hardly changed. Its exports of textiles and clothing, often the spearhead of export growth as countries industrialize, have also failed to gain global market share. A further analysis of Africa’s non-oil export growth, using a constant market share model, indicates that Africa’s competitiveness has declined over the past three decades.3 To the extent that RTAs have not been effective in promoting overall African exports, they are unlikely to have increased Africa’s international competitiveness.
Africa’s poor record in attracting foreign direct investment also seems to indicate that RTAs have not significantly improved the region’s competitiveness. It was thought that, by enlarging regional markets, RTAs would generate higher returns on investment and, hence, attract more foreign direct investment, which would then increase the region’s ability to export. At the aggregate level, foreign direct investment inflows to Africa as a percentage of total foreign direct investment for low- and middle-income countries have declined sharply over time (Figure 5.2). In addition, the inflows are heavily skewed toward the mining industries (including the petroleum industry) and highly concentrated in just a few countries (Angola, Nigeria, and South Africa). Foreign direct investment from South Africa to other countries in the region is, however, more diversified across industries. Econometric evidence suggests that most African RTAs have not significantly increased foreign direct investment.
Figure 5.2.Foreign Direct Investment: Net Inflows in Africa
Source: World Bank, World Development Finance (various years).
RTAs may have increased intra-Africa trade, but they may not have improved welfare. Econometric analysis shows that trade diversion may have exceeded trade creation. Given the limited impact of RTAs on intraregional trade, however, their direct cost is likely to be small. Nevertheless, negotiating and implementing these arrangements, irrespective of the outcome, entail real resource costs. If the regional arrangements have also diverted attention away from broad-based trade liberalization and other domestic reform agendas, then the cost is likely to be larger.
Anecdotal evidence suggests that RTAs may have contributed to regional stability and security. One prominent African example often cited as a success is the intervention by the Economic Community of West African States (ECOWAS) in the civil conflicts in Sierra Leone, where ECOWAS troops, together with UN and U.K. troops, played an important role in disarming the rebels against the government. The international intervention eventually led to peaceful democratic elections in 2003. However, RTAs can also increase regional tension when their benefits and costs (real or perceived) are not distributed equally among members. Furthermore, RTAs are not necessarily the most effective institution for preventing or resolving conflicts. Other forms of cooperation, such as arrangements formed to address cross-border management of resources (such as water), could be more effective.
The benefits of increased bargaining power arising from RTAs should not be exaggerated. Collective efforts would increase Africa’s bargaining power only if the African countries formed a common position, in terms of both what concessions they seek from their trading partners and what they are willing to offer them. However, African countries do not always have a common interest or position. For example, cotton-exporting countries in western Africa are expected to benefit from the removal of textile quotas imposed by some industrial countries, while garment-exporting African countries are expected to lose from the quota removal. Some countries in the latter group have aligned themselves with other developing countries that are also expected to lose from the quota removal in an effort to extend the quota restrictions against the interests of the cotton-exporting countries.
What Can Be Done?
The generally poor record of African RTAs suggests that African countries need to go beyond such arrangements to stimulate growth through trade. Further trade reform is needed to accelerate and sustain growth in Africa. Most of the RTAs lack the preconditions for success because of limited initial intraregional trade, weak complementarity in resource endowments, and inadequate transport infrastructure and local capacity.4 The design of the existing RTAs is generally weak, often characterized by high external tariffs, failure to deal with nontariff barriers, and a lack of attention to trade facilitation. In some cases (for example, WAEMU), however, efforts have been made to address these issues with the help of international financial institutions and some donor governments. For virtually all African RTAs, implementation, often delayed, has been weak; the delays result partly from overlapping memberships and conflicting commitments.5
Thus, to improve the performance of African RTAs, a broad approach is required to tackle a range of design and implementation problems, as well as to create the preconditions for successful regional trade integration.6 Specifically, African countries would benefit from the following:
Reducing trade barriers against non-RTA members when pursuing RTAs. Most favored nation liberalization, either unilateral or multilateral, is even more important in the presence of RTAs.7 Such liberalization efficiently promotes both intraregional and extraregional trade (Box 5.1).8 Lower external trade barriers reduce the risk of trade and investment diversion. While multilateral liberalization would be more beneficial, African countries should not wait for it because unilateral liberalization can also bring substantial benefits.9
Strengthening the domestic supply response to take advantage of unprecedented opportunities to export to world markets. African countries typically face very low protection in industrial countries, either because most favored nation tariffs (except on agricultural products) are already low or because African goods have extensive preferential market access.10 To increase the domestic supply response, African countries need to continue to undertake structural reforms as well as most favored nation trade liberalization. They must also improve infrastructure and upgrade workers’ skills.
Reducing transport costs within the region. Shipping a car from Japan to Abidjan, Côte d’Ivoire, costs $1,500, whereas shipping the same car from Addis Ababa, Ethiopia, to Abidjan costs $5,000 (ECA, 2004).11 In general, each additional day a shipment is in transit is equivalent to an extra 0.8 percentage point increase in applied tariffs.12 Africa needs to devote more resources to regional infrastructure. 13 Such investment is also necessary to enhance domestic competition in an integrated regional market.
Strengthening cross-border, sectoral cooperation in areas of common interest. The cost of crossing a border in Africa can be equivalent to the cost of traveling more than 1,000 miles inland, whereas in Europe the cost is equivalent to traveling 100 miles. African countries could also cooperate in a range of other areas, such as energy, water resources, research and education, environment management, and the prevention and resolution of regional conflicts. Unlike preferential trade agreements, such cooperation does not lead to trade diversion.
Participating more actively in multilateral trade liberalization. Many studies indicate that Africa stands to gain substantially from multilateral trade liberalization.14 To reap such benefits, African countries need to undertake liberalization as other countries do. The Uruguay Round was a missed opportunity for Africa.
Box 5.1.Regional Trade Integration With and Without RTAs: The EU and East Asia
The experiences of the EU and East Asia in regional trade integration represent two success stories. The two regions have, however, taken different paths to success: EU integration has been driven by formal institutional arrangements, whereas East Asian integration has been a result of “natural” market forces. But both stories highlight the importance of initial economic conditions and most favored nation reductions on external trade barriers.
The EU, successor to the European Economic Community (EEC), created in 1957, has pursued not only the elimination of trade barriers between its member countries, but also the reduction of barriers against nonmembers. Before the EEC was established, tariffs in its original members were high and nontariff barriers were prevalent. Through successive rounds of multilateral trade liberalization under the auspices of the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization (WTO), the average most favored nation tariff on manufactures has been brought down to about 4 percent, although tariffs on agriculture remain high (22 percent). In 1957, intra-EEC trade was already about 30 percent of its total trade. The formation of the EEC led to sharp increases in intraregional trade, and, by the early 1970s, intra-EEC trade had reached 60 percent of total EEC trade. While intraregional trade has increased, trade with the rest of the world has also increased, albeit less rapidly. Beginning with trade, the EU has successfully moved to deeper economic and political integration and extended its membership over time.
Successful economic integration has also contributed to greater regional stability.
Formal regional trade schemes are a recent phenomenon only in east Asia,1 which has pursued trade liberalization largely on a most favored nation basis. The region’s first integration arrangement, the Association of South East Asian Nations (ASEAN), established in 1967, was designed only to facilitate trade, with its primary focus on regional security. Nevertheless, with the shift from an inward-looking to an outward-looking growth strategy in the late 1950s (Japan began after World War II and China in the late 1970s), the region has consistently opened its markets to the rest of the world on a nondiscriminatory basis. Trade has since expanded rapidly. In 1956, the year for which data are available for all countries except China and Malaysia, total East Asian exports were only 4.6 percent of world exports, of which Japan contributed 2.6 percent. By 2003, the region accounted for more than 23 percent of world exports. At the same time, exports within East Asia as a share of the region’s total exports rose from 23 percent to 47 percent. Rapid export growth to industrial country markets has generated demand for imports within the region, and income and resource diversity among the countries has enabled them to specialize according to their global comparative advantage. Thus, East Asia’s trade integration has succeeded without much trade diversion.1East Asia includes China, Hong Kong SAR, Indonesia, Japan, Republic of Korea, Malaysia, the Philippines, Singapore, Taiwan Province of China, and Thailand.
Only a little over 2 percent of tariff lines in Africa are bound, often at levels well above the applied rates. Binding African tariffs at levels close to the applied rates would increase the credibility of Africa’s trade policy.15
Taking early action to bolster domestic tax mobilization. Revenue losses are important concerns for African policymakers designing and implementing an RTA, because trade taxes remain an important source of government revenue in most African countries despite tariff reductions in recent years.16 Since the 1980s, the revenue-to-GDP ratio in sub-Saharan Africa has remained virtually stagnant, while the resource needs for the provision of public services and infrastructure have increased sharply. Evidence suggests that although appropriate macroeconomic policies can minimize revenue losses from trade liberalization, low-income countries have difficulty recovering such losses partly because international competition in tax incentives has reduced both the corporate tax rate and the base.17 Nevertheless, because intraregional trade in most RTAs typically accounts for about 10 percent of total trade, the potential revenue losses from RTAs are generally small unless the common external tariff is also reduced when a customs union is formed. On the other hand, with average tariffs amounting to 17 percent at present, further MFN tariff cuts can result in significant revenue losses.18 Thus, the need to strengthen the domestic tax base has become more urgent, as negotiations on multilateral trade liberalization in the WTO and on the free trade agreements (FTAs) with the EU under the Economic Partnership Agreements (EPAs) proceed.
Streamlining regional trade arrangements to eliminate conflicting commitments. The current negotiations on FTAs with the EU represent an opportunity to begin a streamlining process. For example, some countries could reduce their multiple memberships to a single one; small and unsuccessful RTAs could be absorbed by the large ones that have been designated to represent groups of African countries in negotiating FTAs with the EU.19
This chapter draws on Yang and Gupta (2005).
See Yang and Gupta (2005) for details.
Thus, most African RTAs, even if successfully implemented, would have only limited potential to expand intraregional trade because countries in the region can meet only a small share of regional import demands (Yeats, 1998; AfDB, 2000). With low product complementarity among African countries, even three of the largest, most diversified economies in the region—South Africa, Egypt, and Kenya— might not function as growth poles in the COMESA and Southern African Development Community (SADC) (Khandelwal, 2004).
For example, some eastern African countries (Uganda, Burundi, and Kenya) are involved in two planned customs unions (COMESA and the Eastern African Community).
See Jebuni (1997).
Also see World Bank (2004a).
Subramanian and others (2000) find that, for Africa, a 1 percentage point reduction in trade taxes leads to an increase in trade of between 0.7 and 1.1 percentage points.
Rules of origin reduce African exporters’ ability to take full advantage of preferential access (Mattoo, Roy, and Subramanian, 2002). In addition, technical standards and sanitary and phytosanitary measures in industrial countries may act as trade barriers and impose substantial compliance costs on African exporters.
Land transportation is more expensive than sea transportation, and this accounts for part of the cost difference.
Whether African countries give investment priority to regional infrastructure should be based on a cost-benefit analysis. However, if the promotion of intraregional trade is the objective, then there is a second-best argument for investment in favor of intraregional trade.
The World Bank (2004a), for example, estimates that Africa would gain as much as US$24 billion from global merchandise trade reform.
A recent study by Kowalski (2004) also finds that binding tariffs closer to the applied rate could significantly increase trade.
Trade taxes generate almost one-third of all government revenues in African countries (Agbeyegbe, Stotsky, and WoldeMariam, 2004).
Ebrill, Stotsky, and Gropp (1999) find that trade tax revenues tend to fall with tariff levels whenever the latter—measured as the ratio of trade tax revenue to import value—are below 20 percent, whereas Khattry and Rao (2002) estimate this threshold to be about 40 percent. Ancharaz (2003) finds that fiscal dependence on trade taxes makes trade reform less likely to happen.
According to the current plan, four regional EPA negotiating groups—each represents a subgroup of African countries—will be formed in Africa to negotiate FTAs with the EU (Hinkle and Schiff, 2004).