A. Model and methodology

The impact of the SADC FTA is estimated using the Global Trade Analysis Project (GTAP), a widely used Computable General Equilibrium (CGE) model based on neoclassical theory. The GTAP database is benchmarked to the global economy in 2001 and all results are thus presented in 2001 U.S. dollars (Appendix VI). For the purpose of this paper the GTAP database has been aggregated into the 8 regions and 6 industries listed in Table 3.

Table 3.

Region and Industry Aggregation

Table 3.

Region and Industry Aggregation

Regions	Industry
Madagascar	Agriculture and food
South Africa	Rice
Rest of SADC	Textiles
European Union (25)	Apparel
U.S.	Other manufacturing
Canada	Services
China
Rest of the world

View Table

Table 3.

Region and Industry Aggregation

Regions	Industry
Madagascar	Agriculture and food
South Africa	Rice
Rest of SADC	Textiles
European Union (25)	Apparel
U.S.	Other manufacturing
Canada	Services
China
Rest of the world

SADC members are split in three: Madagascar, South Africa, and the rest of SADC.¹⁵ The rationale for singling out South Africa is threefold. First, the Malagasy authorities expect most of the gains to come from trade and FDI with South Africa. Second, Yeats (1998) as well as Chauvin and Gaulier (2002) argued that while there is little potential to increase intra-African trade under a FTA because of the limited product complementarities, an exception may be trade with South Africa. Third, as already mentioned, 88 percent of Madagascar imports effectively liberalized under the SADC FTA are from South Africa.

The sectoral aggregation is determined by Madagascar’s expectations that the FTA will boost its exports of agricultural goods, textiles, and clothing. These industries are therefore singled out, as is the rice sector because of its importance for the Malagasy economy (rice accounts for 1/3 of agricultural production, IMF, 2005b) as well as because of the intention to increase rice exports to the SADC region.

A two-step approach is taken in this paper. First, the database was updated for the liberalization of trade in textiles and clothing in early 2005. In 2001, textile trade was constrained by many bilateral quotas on textiles and clothing. The elimination of these quotas by the United States, the European Union, and Canada led to a dramatic increase in imports of some textiles and clothing products from China, prompting the European Union and the United States to revive some quantitative restrictions. To account for this partial liberalization, all bilateral quota restrictions on textiles are eliminated except U.S. and E.U. quotas on imports. In this case, the “export taxes”¹⁶ on Chinese textiles and clothing to the U.S. and E.U. markets were halved.

Second, using this updated database, the implementation of a full SADC FTA is simulated i.e. a total and reciprocal elimination by all SADC countries of import tariffs on intra-regional trade. Two alternatives are considered:

• In the first scenario, all prices and wages are assumed to be flexible so as to maintain the current level of employment.

• In the second scenario, real wages of skilled and unskilled labor in all countries and regions are assumed to be rigid so as to allow the SADC FTA to affect the level of employment.

B. A marginal impact on GDP and welfare

A key objective of Madagascar in the SADC FTA is to promote its development. This can be proxied by impact of the SADC FTA on real GDP and welfare.¹⁷ Under all scenarios, the impact of SADC FTA on Madagascar’s real GDP and welfare is negligible (Table 4).

Table 4.

Impact on Real GDP

(in millions of 2001 U.S. dollars, percentage changes in parentheses)

Table 4.

Impact on Real GDP

(in millions of 2001 U.S. dollars, percentage changes in parentheses)

	Scenario 1	Scenario 2
Madagascar	-0.1 (0)	1.3 (0)
South Africa	34.4 (0)	595.9 (0.5)
Rest of SADC	-111.1 (-0.2)	500.6 (0.9)
European Union	-0.5 (0)	-76.0 (0)
United States	1.0 (0)	-52.0 (0)
Canada	-0.1 (0)	-0.8 (0)
China	0.4 (0)	-10.3 (0)
Rest of the World	-39.0 (0)	-201.0 (0)
World	-115.0 (0)	757.7 (0)

View Table

Table 4.

Impact on Real GDP

(in millions of 2001 U.S. dollars, percentage changes in parentheses)

	Scenario 1	Scenario 2
Madagascar	-0.1 (0)	1.3 (0)
South Africa	34.4 (0)	595.9 (0.5)
Rest of SADC	-111.1 (-0.2)	500.6 (0.9)
European Union	-0.5 (0)	-76.0 (0)
United States	1.0 (0)	-52.0 (0)
Canada	-0.1 (0)	-0.8 (0)
China	0.4 (0)	-10.3 (0)
Rest of the World	-39.0 (0)	-201.0 (0)
World	-115.0 (0)	757.7 (0)

In scenario 2, Madagascar’s real GDP would increase by 0.03 percent, while in scenario 1 it would not be affected.¹⁸ The difference lies in the impact of increased employment. In Scenario 2, the SADC FTA would increase skilled labor employment (+0.1 percent) and to a lesser extent unskilled employment (+0.05 percent). This increase in employment would not affect real wages which, in this scenario, are assumed to remain constant, although nominal wages would slightly decline (-0.05 percent) following the small negative impact on prices of the FTA (Table 5). As discussed below, the increase in employment boosts consumption, which becomes a strong contributor to the increase of the real GDP (Table 8).

Table 5.

Change in Real Wages in the SADC

(in percent)

^1/Scenario 2 is based on the assumption that there is no change in real wages of both skilled and unskilled labor.

Table 5.

Change in Real Wages in the SADC

(in percent)

		Scenario 1	Scenario 2
Madagascar
	Unskilled labor	0.02	0 1/
	Skilled labor	0.05	0 1/
South Africa
	Unskilled labor	0.26	0 1/
	Skilled labor	0.25	0 1/
Rest of SADC
	Unskilled labor	0.98	0 1/
	Skilled labor	1.11	0 1/

^1/Scenario 2 is based on the assumption that there is no change in real wages of both skilled and unskilled labor.

View Table

Table 5.

Change in Real Wages in the SADC

(in percent)

		Scenario 1	Scenario 2
Madagascar
	Unskilled labor	0.02	0 1/
	Skilled labor	0.05	0 1/
South Africa
	Unskilled labor	0.26	0 1/
	Skilled labor	0.25	0 1/
Rest of SADC
	Unskilled labor	0.98	0 1/
	Skilled labor	1.11	0 1/

^1/Scenario 2 is based on the assumption that there is no change in real wages of both skilled and unskilled labor.

The welfare impact (Appendix II) provides additional details on the impact of the SADC FTA. In both scenarios, the impact on Madagascar is marginal, albeit of different sign, and mostly due to a deterioration of the terms of trade. Only if the SADC FTA leads to an increase in employment (scenario 2) would Madagascar experience a welfare gain, because of the higher level in employment. The gain from this endowment effect would then outweigh other sources of welfare losses.

For SADC as a whole, the FTA would improve welfare by $74 million US to $1.2 billion US, but the distribution effect is ambiguous: while South Africa would gain under both scenarios, the welfare impact on the rest of SADC and Madagascar is ambiguous.

C. A trade diverting or a trade creating FTA?

Following the works of Jacob Viner (1950) and James Meade (1955), the static global welfare impact of preferential trade agreements (PTA) is measured by the gains from trade creation (an improvement in allocative efficiency due to the replacement of production and consumption of domestic goods with imports from more efficient partner countries) net of the costs of trade diversion (a welfare cost associated from switching from a non-member efficient supplier to a less efficient partner in the PTA following the discriminatory trade liberalization). From a national point of view, the formation of a PTA also affects the terms of trade and thus individual countries welfare (Collier, 1979; Pomfret, 1988). In GTAP, the gains from trade creation are reflected in the allocative efficiency, while trade diversion is reflected in the terms of trade by an increase in the true cost of imports (Gilbert and Wahl, 2002). Changes in the direction of trade also provide some indications on trade diversion and trade expansion.

South Africa appears to benefit from net trade creation:

(i) Trade creation would be rather large, as suggested by allocative efficiency gains (Appendix II) and the replacement of some (relatively inefficient) domestic production by imports notably rice and apparel (Appendix IV). For example, the value added of the rice sector would decrease by about 2 percent, while imports of rice would increase by 3 percent (exports would also decline). Similarly, the value added of the apparel industry would decline by 0.4 to 1.3 percent while imports would increase by about 8 percent. The decline in output is limited by an increase in exports of 4 percent.

(ii) Trade expansion (i.e. an expansion of exports to partner countries) provides additional gains, as indicated by an increase in export prices (Table 6) as well as a 25 percent jump in exports to SADC (Appendix III). Interestingly, the simulations suggest that, because of supply side constraints, the increase in SADC demand for South African products would not be fully met by an increase in production (South Africa’s real GDP is simulated to be higher by 0.8 to 1.4 percent following the implementation of the FTA) but would also lead to a reduction in exports to third countries.

Table 6.

Change in the Terms of Trade ^{1/ 2/}

(In percent)

^1/Changes in terms of trade on non-SADC countries (as well as import and export prices) are close to zero.

^2/Because GTAP differentiates products by country of origin, changes in the terms of trade can be decomposed in three components: (i) changes in world prices; (ii) changes in regional export prices; (iii) changes in regional import prices. Given the small share of the SADC region in total trade, the SADC FTA has virtually no impact on world prices and only (i) and (ii) are reported here.

Table 6.

Change in the Terms of Trade ^{1/ 2/}

(In percent)

		Scenario 1	Scenario 2
Madagascar	Terms of Trade	-0.07	-0.06
	Px	-0.05	-0.05
	Pm	0.02	0.01
South Africa	Terms of Trade	0.68	0.72
	Px	0.67	0.71
	Pm	-0.01	-0.02
Rest of SADC	Terms of Trade	-0.31	-0.41
	Px	-0.11	-0.21
	Pm	0.20	0.21

^1/Changes in terms of trade on non-SADC countries (as well as import and export prices) are close to zero.

^2/Because GTAP differentiates products by country of origin, changes in the terms of trade can be decomposed in three components: (i) changes in world prices; (ii) changes in regional export prices; (iii) changes in regional import prices. Given the small share of the SADC region in total trade, the SADC FTA has virtually no impact on world prices and only (i) and (ii) are reported here.

View Table

Table 6.

Change in the Terms of Trade ^{1/ 2/}

(In percent)

		Scenario 1	Scenario 2
Madagascar	Terms of Trade	-0.07	-0.06
	Px	-0.05	-0.05
	Pm	0.02	0.01
South Africa	Terms of Trade	0.68	0.72
	Px	0.67	0.71
	Pm	-0.01	-0.02
Rest of SADC	Terms of Trade	-0.31	-0.41
	Px	-0.11	-0.21
	Pm	0.20	0.21

^1/Changes in terms of trade on non-SADC countries (as well as import and export prices) are close to zero.

^2/Because GTAP differentiates products by country of origin, changes in the terms of trade can be decomposed in three components: (i) changes in world prices; (ii) changes in regional export prices; (iii) changes in regional import prices. Given the small share of the SADC region in total trade, the SADC FTA has virtually no impact on world prices and only (i) and (ii) are reported here.

(iii) Trade diversion does not appear to be an issue for South Africa. Its import prices are not increasing and imports from third countries would increase. The reason is that the scope of trade diversion is limited: SADC exports to South Africa are concentrated in a few products that account only for a limited share of its imports (excluding trade with other SACU countries, South Africa’s import from SADC accounts for only 2.1 percent of its imports).

By contrast, South Africa’s weights in its partners imports is larger (about 5 percent for Madagascar) and its exports are more diversified. Therefore, a FTA with South Africa can lead to trade diversion for other SADC countries. This is indeed what the simulations suggest for both Madagascar and the rest of SADC. First, their import prices would increase (Table 6). Second, their imports from South Africa would increase significantly while imports from the rest of the world would contract (Appendix III).

Madagascar would experience net trade diversion. Although the increase in import prices is marginal (Table 6), Madagascar imports would switch from non-SADC suppliers to SADC suppliers. Imports from South Africa would increase by about 9 percent and imports from the rest of SADC by 2 percent, while imports from non-SADC would decline by 0.5 percent (Appendix III). This trade diversion does not appear to be offset by trade creation since (i) efficiency gains are negligible; (ii) total trade would barely increase (+0.4 percent at most, Appendix II); and (iii) domestic production does not appear to be affected significantly by imports (Appendix IV).

In sum, simulations suggest that the SADC FTA would have a different impact on its various members: it would be more trade diverting than trade creating for Madagascar and the rest of SADC, but more trade creating than trade diverting for South Africa. The impact on the world is ambiguous and limited. The world welfare would decline by 115 millions US dollars in scenario 1 but would increase by 757 millions in the scenario 2. In both cases, SADC area trade with the rest of the world would decline hinting that the FTA may be, on a net basis, trade diverting.

D. Why the SADC FTA does not boost Madagascar GDP

This section aims at explaining why the impact of the SADC FTA on Madagascar’s real GDP is extremely limited by reviewing two channel by which trade liberalization may affect GDP: increase in trade and investment.

As already mentioned, the SADC FTA impact on trade (and thus on the economy) is expected to be limited because the trade liberalization it implies is limited. Indeed, simulations indicate that export volume growth is marginal at about 0.5 percent for both Madagascar and South Africa and 4 percent for the rest of SADC. Because this increase is accompanied by an increase in the volume of imports (Table 7),¹⁹ net exports do not contribute to increase Madagascar GDP and even tend to have a negative impact for South Africa’s and the rest of SADC’s (Table 8).

Table 7.

Change in Volume of Trade of SADC members

(in percent)

Table 7.

Change in Volume of Trade of SADC members

(in percent)

		Scenario 1	Scenario 2
Madagascar
	Exports	0.4	0.5
	Imports	0.3	0.4
South Africa
	Exports	0.5	0.4
	Imports	2.1	2.8
Rest of SADC
	Exports	3.8	4.4
	Imports	4.9	5.9

View Table

Table 7.

Change in Volume of Trade of SADC members

(in percent)

		Scenario 1	Scenario 2
Madagascar
	Exports	0.4	0.5
	Imports	0.3	0.4
South Africa
	Exports	0.5	0.4
	Imports	2.1	2.8
Rest of SADC
	Exports	3.8	4.4
	Imports	4.9	5.9

Table 8.

Decomposition of the Change in Real GDP

(in percent)

Table 8.

Decomposition of the Change in Real GDP

(in percent)

		Scenario 1	Scenario 2
Madagascar
	GDP	0.00	0.03
	Consumption	-0.02	0.01
	Investment	0.01	0.02
	Exports	0.10	0.10
	Imports	-0.09	-0.10
South Africa
	GDP	0.0	0.5
	Consumption	0.2	0.6
	Investment	0.2	0.5
	Exports	0.2	0.2
	Imports	-0.6	-0.7
Rest of SADC
	GDP	-0.2	0.9
	Consumption	-0.3	0.6
	Investment	0.5	0.8
	Exports	1.6	1.8
	Imports	-1.9	-2.4

View Table

Table 8.

Decomposition of the Change in Real GDP

(in percent)

		Scenario 1	Scenario 2
Madagascar
	GDP	0.00	0.03
	Consumption	-0.02	0.01
	Investment	0.01	0.02
	Exports	0.10	0.10
	Imports	-0.09	-0.10
South Africa
	GDP	0.0	0.5
	Consumption	0.2	0.6
	Investment	0.2	0.5
	Exports	0.2	0.2
	Imports	-0.6	-0.7
Rest of SADC
	GDP	-0.2	0.9
	Consumption	-0.3	0.6
	Investment	0.5	0.8
	Exports	1.6	1.8
	Imports	-1.9	-2.4

Investment may be another channel through which trade liberalization may affect GDP.²⁰ This is one of the main benefit from SADC that the Malagasy government is expecting from the SADC FTA. Table 8 indicates that investment would indeed positively help to increase the real GDP. However, its impact is limited and smaller than in South Africa or the rest of SADC. Capital account, which reports changes in the saving and investment balance, would improve marginally (by 0.1 to 0.2 percent) owing to a limited increase in inflows of foreign capital.

The impact of investment is limited partly because scenarios 1 and 2 assume that the endowment in capital is fixed. As discussed in section G, when this assumption is relaxed the contribution to growth in scenario 1 does not change but the contribution in scenario 2 increase, but remains limited, from 0.02 to 0.08 percent (Table 12). The actual impact could be, however, larger because the model make no allowance for dynamic gains that may affect investment and the inflows of FDI. Past experience suggest that that following the trade reform of the second half of the 1980’s Madagascar experienced a significant increase in FDI inflows (Harrison and Revenga, 1995). However, this experience may not be relevant since the increase in FDI may be more related to the introduction of export processing zones (EPZ) in 1989 rather than the outcome of tariff cuts.

E. A substantial change in the structure of trade

Although the SADC FTA would have only a limited impact Madagascar’s total trade, it would affect significantly the trade structure.

First, the direction of trade would be substantially altered. Trade between SADC members would increase substantially at the expense of trade with third countries (Table 9). While Madagascar’s total trade would barely increase (0.4 percent at most), its trade with SADC would increase by about 5 percent, while its trade with the rest of the world would decline.²¹ Results confirm the prediction from the literature that the increase in Madagascar trade with SADC would be driven with trade with South Africa (+12.5 percent). In particular, exports to South Africa are expected to double (Appendix III). In contrast, Madagascar trade with the rest of SADC would increase by less than a percent with Madagascar’s exports to that region dropping by 8 percent. This drop suggests that the impact of the Madagascar preferential access to many SADC countries under the COMESA FTA would be eroded by the formation of the SADC FTA²² and/or that the limited product complementarity prevents a significant expansion of trade between Madagascar and the rest of SADC. The fact that intra-rest of SADC trade expands significantly would suggest that the former factor may be more important.

Table 9.

Change in the Geographical Structure of Trade

(in percent) ^1/

^1/Total trade is the sum of imports and exports measured at world price.

^2/For details, see Appendix III.

Table 9.

Change in the Geographical Structure of Trade

(in percent) ^1/

		Scenario 1	Scenario 2
SADC	Total trade	2.7	3.2
	Intra-SADC	25.8	27.1
	Trade with third countries	-1.8	-1.5
Madagascar 2/	Total trade	0.3	0.4
	Trade with SADC	4.8	5.1
	Trade with third countries	-0.2	-0.1
South Africa	Total trade	1.6	1.9
	Trade with SADC	22.6	23.7
	Trade with third countries	-1.4	-1.2
Rest of SADC	Total trade	3.6	5.2
	Trade with SADC	29.0	30.3
	Trade with third countries	-2.7	-2.1

^1/Total trade is the sum of imports and exports measured at world price.

^2/For details, see Appendix III.

View Table

Table 9.

Change in the Geographical Structure of Trade

(in percent) ^1/

		Scenario 1	Scenario 2
SADC	Total trade	2.7	3.2
	Intra-SADC	25.8	27.1
	Trade with third countries	-1.8	-1.5
Madagascar 2/	Total trade	0.3	0.4
	Trade with SADC	4.8	5.1
	Trade with third countries	-0.2	-0.1
South Africa	Total trade	1.6	1.9
	Trade with SADC	22.6	23.7
	Trade with third countries	-1.4	-1.2
Rest of SADC	Total trade	3.6	5.2
	Trade with SADC	29.0	30.3
	Trade with third countries	-2.7	-2.1

^1/Total trade is the sum of imports and exports measured at world price.

^2/For details, see Appendix III.

Second, the product pattern of Madagascar trade would change. Madagascar would not become the region’s bread basket: agricultural and food exports and production (including rice) would not be affected by the SADC FTA but instead imports would increase (Appendixes IV and V) leading to the deterioration in the sector trade balance (Table 10).

Table 10.

Change in Madagascar Trade Balance

(in millions of 2001 US dollar)

Table 10.

Change in Madagascar Trade Balance

(in millions of 2001 US dollar)

	Scenario 1	Scenario 2
Food	-1.4	-1.5
Rice	0.0	0.0
Textiles	1.9	2.1
Clothing	0.9	1.0
Other manufacturing	-2.0	-2.3
Services	0.3	0.1
TOTAL	-0.3	-0.6

View Table

Table 10.

Change in Madagascar Trade Balance

(in millions of 2001 US dollar)

	Scenario 1	Scenario 2
Food	-1.4	-1.5
Rice	0.0	0.0
Textiles	1.9	2.1
Clothing	0.9	1.0
Other manufacturing	-2.0	-2.3
Services	0.3	0.1
TOTAL	-0.3	-0.6

However, the textiles and clothing industries would be the major beneficiaries of the SADC FTA. Total exports would increase (Appendix V) leading to an expansion of production (Appendix IV). The expansion of trade in textiles and clothing is, as expected, explained by trade with South Africa. Exports of textiles to South Africa would jump by more than 500 percent and exports of clothing by 200 percent. Suggesting an increase in intra-industry trade, imports from South Africa would also increase by respectively about 58 and 116 percent. In contrast, trade in textiles and clothing with the rest of SADC and the rest of the world would not be affected much. Reflecting the current small share of South Africa in the country exports, Madagascar total exports of textiles will be limited to about 1 percent and exports of apparel to 0.5 percent.

The development in intra-SADC trade in textiles and clothing is particularly important because it would help Madagascar maintain a preferential treatment under the African Growth and Opportunity Act (AGOA), a U.S. unilateral trade preference program. The AGOA’s third-country provision provides duty- and quota-free access for African apparels made from non-African and non-U.S. fabrics. After the expiration of the third-country provision, initially scheduled in September 2007 but recently extended until 2012, only apparel made with African or U.S. fabrics would become eligible to the preferential access. This would be a serious challenge for Madagascar because the supply of domestic fabrics is limited and the industry imports its inputs mostly from Asia.²³ The extension of the provision will give more time to Madagascar apparel industry to adjust by diversifying both its sourcing of fabrics (local production as well as developing intra-African trade) as well as its export markets (such as South Africa).²⁴ Simulations suggest that on both sides, the SADC FTA may be beneficial.

The results for textiles and apparel industries are quite dramatic and consistent with other studies (Chauvin and Gaulier, 2002). However, the actual increase may be more limited because the SADC Trade Protocol treats textiles and clothing as a sensitive industry which will be liberalized more slowly than other products. Moreover, SADC’s strict rules of origin (Kandhelwal, 2004) and the willingness of South Africa to protect its textiles and clothing (Chauvin and Gaulier, 2002) might prevent a strong expansion of intra-SADC trade.

F. Resource allocation: A shift to the textiles and clothing industry

Although the impact of the SADC FTA on overall GDP is limited, changes in the structure of trade would affect the structure of production. In Madagascar, the real value added of the textiles and clothing industries would expand by about 0.9 and 0.3 percent respectively. The value added of other goods would decline slightly (Appendix IV). The rest of SADC would also benefit from the opening up of the South African market in textiles and clothing. In contrast, the expansion of South Africa’s net imports in textiles and clothing would lead to a decline in its value added of the labor-intensive clothing industry (from -0.4 to -1.3) while the value added of the more capital-intensive production of textiles would increase (up to 0.9 percent). The main winner in food and food processed products would not be Madagascar (-0.1 percent) but South Africa (+1.4 to +1.9 percent) while the impact of the rest of SADC is ambiguous (-0.5 to +0.4 percent).

The change in the composition of production leads to a change in the demand for factor of production. In particular, under both scenarios, employment of both skilled and unskilled labor in Madagascar would shift to the textiles and clothing industries (Table 11). When total employment grows (scenario 2), the magnitude in the increase in employment in the textile and clothing industries remains the same but would not come anymore at the expenses of other sectors. In particular employment in other manufacturing would not decrease but increase slightly. In this case, the SADC FTA would have another benefit for Madagascar. It would not lead to a concentration of production but instead favor its diversification.

Table 11.

Demand for Factor of Production in Madagascar

(percentage change) ^1/

^1/First figure refers to scenario 1 and the second to scenario 2.

Table 11.

Demand for Factor of Production in Madagascar

(percentage change) ^1/

	Unskilled Labor	Skilled Labor	Capital
Food	-0.1/0	-0.1/0	-0.1
Rice	-0.1/0	-0.1/0	-0.1
Textiles	1.0	0.9/1.0	0.9/1.0
Clothing	0.3/0.4	0.3/0.4	0.3
Other manufacturing	0	-0.1/0	-0.1/0
Services	0/0.1	0/0.1	0

^1/First figure refers to scenario 1 and the second to scenario 2.

View Table

Table 11.

Demand for Factor of Production in Madagascar

(percentage change) ^1/

	Unskilled Labor	Skilled Labor	Capital
Food	-0.1/0	-0.1/0	-0.1
Rice	-0.1/0	-0.1/0	-0.1
Textiles	1.0	0.9/1.0	0.9/1.0
Clothing	0.3/0.4	0.3/0.4	0.3
Other manufacturing	0	-0.1/0	-0.1/0
Services	0/0.1	0/0.1	0

^1/First figure refers to scenario 1 and the second to scenario 2.

Table 12.

Impact of the decline in the price of capital

(In percent)

Table 12.

Impact of the decline in the price of capital

(In percent)

Contribution to Growth		Scenario 1	Scenario 1b	Scenario 2	Scenario 2 b
GDP		0.00	0.02	0.03	0.43
	Consumption	-0.02	-0.01	0.01	0.38
	Investment	0.01	0.01	0.02	0.08
	Exports	0.10	0.09	0.10	0.22
	Imports	-0.08	-0.07	-0.10	-0.25

View Table

Table 12.

Impact of the decline in the price of capital

(In percent)

Contribution to Growth		Scenario 1	Scenario 1b	Scenario 2	Scenario 2 b
GDP		0.00	0.02	0.03	0.43
	Consumption	-0.02	-0.01	0.01	0.38
	Investment	0.01	0.01	0.02	0.08
	Exports	0.10	0.09	0.10	0.22
	Imports	-0.08	-0.07	-0.10	-0.25

G. What can be done to maximize the gains from the SADC FTA? The role of domestic policies and multilateral liberalization

Scenario 1 assumes that the quantity of each endowment is fixed. This can be interpreted as an initial situation where there is full utilization of resources or a situation where rigidities prevent a full utilization of existing endowments. In this scenario, the impact of the SADC FTA is mainly to reallocate resources between sectors. Scenario 2 relaxes the assumption for labor, and assumes that the level of employment can change. This assumption appears realistic given the structure of the labor market in Madagascar. The labor force is limited at 8.3 million on a population of 18.1 million (MIGA, 2006), 82 percent of the labor force was employed in the agricultural sector and only 13.4 percent in the formal sector (Government of Madagascar, 2006). Under scenario 2, the losses occurred under scenario 1 turn into gains because of the increase in employment (Appendix II) and its impact on consumption (Table 4). But in both cases the impact is negligible.

In this section, the assumption of fixed endowment in capital is relaxed for both scenarios 1 and 2.²⁵ When this modification affects the scenario 1 (scenario 1b) the results are similar to those of a relaxation of the assumption of fixed level of employment (scenario 2): the SADC FTA increase real GDP by a small 0.02 percent of GDP and the increase in investment remains negligible. However, when the SADC FTA can affect both the level of endowment in labor and in capital, the results become somewhat larger albeit still small: the GDP would increase by 0.4 percent and investment by 0.08 percent (Table 12). The bulk of the contribution to a higher GDP comes from more consumption. The welfare impact of endowment is also magnified. Not only is the endowment effect related of employment large ($10 million US) but there is also an impact of larger endowment in capital (about $8 million dollars). As a result, the welfare impact of the SADC FTA for Madagascar would switch from a loss of $1 million US in scenario 1 to a gain of $17.5 million. This represents a gain increasing from about $0.06 to $1 US per capita.

The reason for the stronger impact in scenario 2b compared to scenarios 1b and 2 is the following. Labor and capital are complementary inputs for a firm. Thus, in scenario 2, the possibility to increase employment is limited by the availability of capital and the gains from the SADC FTA remain marginal although larger than in scenario 1. For the same reason, the increase in the stock of capital is limited in scenario 1b by the availability of labor. By contrast, if both the level of employment and of capital are allowed to increase, this constraint disappears and the impact of the SADC FTA becomes larger.

Scenarios 1b and 2b represent different assumptions regarding the initial utilization of endowment in Madagascar. Scenario 1 can be seen as the outcome of the SADC FTA if there is full utilization of both capital and employment or if rigidities prevent to move to the full employment. Other scenarios relax this assumptions for employment (scenario 2), capital (scenario 1b) or both (scenario 2b). However, these scenarios have policy implications. If there are rigidities in the economy that affect the utilization of endowments, complementary policies that would remove these rigidities will increase the gain from the SADC FTA. The latest World Bank’s investment climate assessment provides details on rigidities affecting the use of both labor and capital and thus suggests possible complementary policies. For example, 67 percent of firms surveyed quote the cost of finance as a major or severe constraint, 59 percent the access to finance, 31 percent the skills and education of workers and 15 percent labor regulations (Shah and al., 2005).

Under all scenarios, the gains from the SADC FTA are limited.²⁶ However, this does not mean that trade liberalization cannot foster significantly Madagascar’s growth. The gains from the SADC FTA are small because (i) it is actually a small trade liberalization; and (ii) a regional liberalization is discriminatory liberalization and, as such, involves costs. A multilateral trade liberalization would both increase the coverage of the trade liberalization and eliminate the costs associated with trade diversion. For illustrative purpose, Table 13 presents a scenario under which the full liberalization of intra-SADC trade is combined with a partial and small (10 percent) multilateral reduction of the applied tariff. The result then appear much larger and appear consistent with Vamvakidis’ (1998) conclusion. Vamvakidis found that economies have grown faster on average and have a higher investment share after a nondiscriminatory liberalization, both in the short and long run, but not after joining a preferential agreement.

Table 13.

SADC and multilateral liberalization ^1/

^1/The multilateral cut simulated is a uniform and nondiscriminatory 10 percent cut in the applied customs tariff rate of all regions on all goods. For SADC, the cut is limited to trade with non-SADC countries while intra-SADC trade is fully liberalized.

Table 13.

SADC and multilateral liberalization ^1/

		Real GDP (change in percent)	Welfare (in millions of U.S. dollars)	Welfare (in dollars per capita)
Scenario 1	SADC only	0.0	-1.0	-0.1
	SADC and a multilateral tariff cut	0.1	27.9	1.6
Scenario 2	SADC only	0.0	0.5	0.0
	SADC and a multilateral tariff cut	1.5	94.7	5.3

^1/The multilateral cut simulated is a uniform and nondiscriminatory 10 percent cut in the applied customs tariff rate of all regions on all goods. For SADC, the cut is limited to trade with non-SADC countries while intra-SADC trade is fully liberalized.

View Table

Table 13.

SADC and multilateral liberalization ^1/

		Real GDP (change in percent)	Welfare (in millions of U.S. dollars)	Welfare (in dollars per capita)
Scenario 1	SADC only	0.0	-1.0	-0.1
	SADC and a multilateral tariff cut	0.1	27.9	1.6
Scenario 2	SADC only	0.0	0.5	0.0
	SADC and a multilateral tariff cut	1.5	94.7	5.3

^1/The multilateral cut simulated is a uniform and nondiscriminatory 10 percent cut in the applied customs tariff rate of all regions on all goods. For SADC, the cut is limited to trade with non-SADC countries while intra-SADC trade is fully liberalized.