A. Madagascar Trade Liberalization

2. Madagascar has been liberalizing its trade regime on an unilateral and regional basis. Unilaterally, it reduced its simple average most favored nation (MFN) tariff from16.2 percent at the end of 2005 to 13.5 percent in 2006 and then at 12.9 in 2007, slightly below SSA average of 13.0 percent. On a regional basis, Madagascar is a member of the COMESA since 1993 and was one of the nine countries forming the COMESA FTA in 2000. In 2004, Madagascar became the 14^th SADC member and, in 2007, intends starting phasing out its tariff on imports from SADC. In a first phase, customs duties on 78 percent of tariff lines will be eliminated and duties on 7.7 percent additional tariff lines will be reduced. The remaining duties will be almost fully eliminated by 2012. The phasing out of Madagascar tariff on SADC import will discriminate between South Africa and the rest of SADC. Nonetheless the differences between tariff on South Africa imports and rest of SADC will be minimal (Table II.1).²

Table II.1

Planned Reduction in Madagascar Customs Tariff on SADC Imports

(Simple tariff average, in percent)

¹Countries that are both members of COMESA and SADC already had preferential access to the Malagasy market under the COMESA. Other countries faced MFN tariffs averaging 13.5 percent.

Source: Staff calculation based on the tariff reduction agreed in October 2006.

Table II.1

Planned Reduction in Madagascar Customs Tariff on SADC Imports

(Simple tariff average, in percent)

	2006	2007	2008	2009	2010	2011	2012
M.F.N. tariff	13.5	12.9	…	…	…	…	…
South Africa	13.5	2.6	2.5	1.2	1.2	0.6	0.0
Rest of SADC	- 1	2.6	2.6	1.2	0.61	0.0	0.0

¹Countries that are both members of COMESA and SADC already had preferential access to the Malagasy market under the COMESA. Other countries faced MFN tariffs averaging 13.5 percent.

Source: Staff calculation based on the tariff reduction agreed in October 2006.

View Table

Table II.1

Planned Reduction in Madagascar Customs Tariff on SADC Imports

(Simple tariff average, in percent)

	2006	2007	2008	2009	2010	2011	2012
M.F.N. tariff	13.5	12.9	…	…	…	…	…
South Africa	13.5	2.6	2.5	1.2	1.2	0.6	0.0
Rest of SADC	- 1	2.6	2.6	1.2	0.61	0.0	0.0

¹Countries that are both members of COMESA and SADC already had preferential access to the Malagasy market under the COMESA. Other countries faced MFN tariffs averaging 13.5 percent.

Source: Staff calculation based on the tariff reduction agreed in October 2006.

B. The SADC FTA: A limited Trade Liberalization for Madagascar

3. The liberalization of the SADC FTA is limited. At first glance the SADC FTA will lead to a significant liberalization of imports. SADC countries account for 12.5 percent of Madagascar imports. However, in practice, the liberalization will be much more limited: only 5.6 percent of Madagascar imports will benefit from the tariff cut. The reason is overlapping membership (Table II.2). Four SADC countries (including Madagascar’s main trading partner in SADC, Mauritius) are also members of the COMESA FTA. As a result, their exports to Madagascar already benefit from a duty-free access. Since Madagascar imports from SADC are extremely concentrated (Mauritius and South Africa account for 93 percent of Madagascar imports from the bloc), South Africa accounts for 88 percent of the trade that will actually be liberalized. Appendix II.1 provides more details on Madagascar trade with Africa.

Table II.2.

SADC and COMESA: Overlapping Memberships

¹IMF’s Direction of Trade database.

Table II.2.

SADC and COMESA: Overlapping Memberships

SADC Members	that are also Members of the COMESA	and of the COMESA FTA	Share in Madagascar imports (in percent, 2005) 1
Angola	X		0.0
Botswana			0.0
Democratic Republic of the Congo	X		0.0
Lesotho			0.0
Madagascar	X	X
Malawi	X	X	0.2
Mauritius	X	X	6.7
Mozambique			0.0
Namibia			0.0
South Africa			4.9
Swaziland	X		0.4
Tanzania			0.3
Zambia	X	X	0.0
Zimbabwe	X	X	0.0

¹IMF’s Direction of Trade database.

View Table

Table II.2.

SADC and COMESA: Overlapping Memberships

SADC Members	that are also Members of the COMESA	and of the COMESA FTA	Share in Madagascar imports (in percent, 2005) 1
Angola	X		0.0
Botswana			0.0
Democratic Republic of the Congo	X		0.0
Lesotho			0.0
Madagascar	X	X
Malawi	X	X	0.2
Mauritius	X	X	6.7
Mozambique			0.0
Namibia			0.0
South Africa			4.9
Swaziland	X		0.4
Tanzania			0.3
Zambia	X	X	0.0
Zimbabwe	X	X	0.0

¹IMF’s Direction of Trade database.

4. Moreover, empirical literature suggests that the potential from African regional trade agreements to increase trade may be low.

• First, Foroutan and Pritchett (1993) on intra-SSA trade and, more recently, Chauvin and Gaulier (2002) on intra-SADC trade use gravity models to estimate bilateral and regional trade potential. Both conclude that, although small, the actual level of intra-African trade is not below its potential.

• Second, past experience shows that the actual intra-regional trade liberalization was limited in Africa because of (i) import-substitution policies; ³ (ii) tariff-revenue constraints; (iii) inequal distribution of costs and benefits of integration; (iv) severe distorsions in the trade regimes of many African countries; (v) high transaction costs due to inadequate infrastructures; (vi) limited product complementarities; ⁴ and (vii) institutional constraints as well as conflicting goals due to African countries’ membership in several regional groups. Moreover, the complementary policies (macroeconomic stability, appropriate exchange rate, investment policies, …) that are crucial to ensure that trade liberalization promotes growth were often not implemented (Chauvin and Gaulier, 2002; Foroutan, 1993; Hallaert, 2004; Khandelwal, 2004; SADC 2006, Yeats, 1998).

C. CGE Simulations ⁵

5. Quantifying the economic impact of a regional trade agreement requires a general equilibrium analysis. Using the Global Trade Analysis Project (GTAP) model described in Appendix II.2, four scenarios on the impact of the SADC FTA are simulated. They differ regarding assumed rigidities in the labor and capital markets.

• 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 are assumed to be rigid so as to allow the SADC FTA to affect the level of employment;

• In the third scenario, the real price of capital is fixed so as to allow the SADC FTA to affect the level of capital;

• In the fourth scenario, both real wages and real price of capital are fixed.

6. Under all scenarios, Madagascar static gains from a full FTA (i.e., eliminating all tariffs on intra-SADC trade) are limited. At most, real GDP would increase by 0.4 percent (Table II.3) and welfare by at most 17.5 million US dollars. The first scenario can be interpreted as the outcome of the SADC FTA if there is, initially, full utilization of both capital and employment or if rigidities prevent to move to the full employment. Other scenarios relax this assumption for employment (scenario 2), capital (scenario 3) or both (scenario 4). These scenarios are alternative closures, but they have policy implications. If there are rigidities in the economy that affect the utilization of capital and/or labor, complementary policies that would remove these rigidities will increase the gains from the SADC FTA. The latest investment climate assessment published by the World Bank documents the various 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).

Table II.3.

Impact of the SADC FTA on Real GDP

Table II.3.

Impact of the SADC FTA on Real GDP

		Scenario 1	Scenario 2	Scenario 3	Scenario 4
Real GDP (in percent)		0.00	0.03	0.02	0.43
	Consumption	-0.02	0.01	-0.01	0.38
	Investment	0.01	0.02	0.01	0.08
	Exports	0.10	0.10	0.09	0.22
	Imports	-0.08	-0.10	-0.07	-0.25

View Table

Table II.3.

Impact of the SADC FTA on Real GDP

		Scenario 1	Scenario 2	Scenario 3	Scenario 4
Real GDP (in percent)		0.00	0.03	0.02	0.43
	Consumption	-0.02	0.01	-0.01	0.38
	Investment	0.01	0.02	0.01	0.08
	Exports	0.10	0.10	0.09	0.22
	Imports	-0.08	-0.10	-0.07	-0.25

7. Although the SADC FTA would have only a limited impact Madagascar’s total trade, it would affect significantly its trade pattern and thus the structure of production.

• First, the direction of trade would be substantially altered. Trade between SADC members would increase substantially at the expense of trade with third countries. While Madagascar 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. This points to the possibility of a trade diversion. Results also confirm that the increase in Madagascar trade with SADC would be driven by trade with South Africa (+12.5 percent). In particular, exports to South Africa are expected to double. 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.

• Second, the product pattern of Madagascar trade would change. While, despite the hope that Madagascar would become the region’s bread basket (IMF, 2006), agricultural and food exports and production (including rice) would not be affected by the SADC FTA. The textiles and clothing industries would be the major beneficiaries of the SADC FTA. Total exports would increase leading to an expansion of production of apparel (0.5 percent) and of textiles (1 percent). 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 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 Madagascar exports, the total impact on Madagascar exports of textiles will be limited to about 1 percent and of 0.5 percent for apparel.

D. Multilateral Liberalization

8. The gains from the SADC FTA are limited for Madagascar. But, this does not mean that trade liberalization cannot foster significantly its growth. The gains from the SADC FTA are small because

• It is actually a small trade liberalization covering less than 6 percent of Madagascar imports; and

• A regional liberalization is a discriminatory liberalization and, as such, involves costs.

9. 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 II.4 presents a scenario under which the full liberalization of intra-SADC trade is combined with a partial and small (10 percent) multilateral reduction in applied tariff. The result then appear much larger and consistent with Vamvakidis’ 1998) conclusion. Vamvakidis found that economies have grown faster on average and have a higher investment share after a nondiscriminatory liberalization but not after joining a preferential agreement.

Table II.4.

SADC and Multilateral Liberalization ¹

¹The multilateral cut simulated is a uniform and non-discriminatory 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 II.4.

SADC and Multilateral Liberalization ¹

		Real GDP (change in percent)	Welfare (in millions of U.S. dollars)	Welfare (in dollars per capita)
Scenario1	SADC only	0.0	-1.0	-0.1
	SADC and a multilateral tariff cut	0.1	27.9	1.6
Scenario2	SADC only	0.0	0.5	0.0
	SADC and a multilateral tariff cut	1.5	94.7	5.3

¹The multilateral cut simulated is a uniform and non-discriminatory 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 II.4.

SADC and Multilateral Liberalization ¹

		Real GDP (change in percent)	Welfare (in millions of U.S. dollars)	Welfare (in dollars per capita)
Scenario1	SADC only	0.0	-1.0	-0.1
	SADC and a multilateral tariff cut	0.1	27.9	1.6
Scenario2	SADC only	0.0	0.5	0.0
	SADC and a multilateral tariff cut	1.5	94.7	5.3

¹The multilateral cut simulated is a uniform and non-discriminatory 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.

E. Fiscal Impact

10. The CGE simulations ignore the fiscal implications of the SADC FTA. The fiscal impact is crucial for Madagascar because the country has one of the lowest tax revenue-to-GDP ratios in the world (about 10.7 percent of GDP in 2006) and about half of the tax revenue is tax on international trade.⁶ Thus, Madagascar will have to find domestic measures to offset the losses in government revenue from regional tariff reductions.

11. In order to assess the fiscal impact, data on imports from the pre-shipment inspection company Société Générale de Surveillance (SGS) have been used.⁷ SGS data, which were available at the HS-6 digit level for January-November 2006, allow to distinguish tax exempt export processing zones (EPZs) imports and dutiable imports.

12. This paper focuses on imports from South Africa since they account for almost 90 percent of Madagascar imports that will be affected by the tariff cut. It appears that revenue on taxes on South Africa imports are larger than South Africa’s share in Madagascar imports would suggest because:

13. As a result, assuming constant import weights, the phasing out of tariffs on South African imports would lead to a reduction in Madagascar revenues from customs tariff of 7.7 percent. Since the customs duty enters in the basis of other taxes levied on imports, the cut in tariff will affect the collection of excise taxes as well as VAT. However, the revenue on imported petroleum will not be affected because the specific tariff levied on these products will not be cut. Overall revenue of taxes on international trade would decrease by 2.6 percent in 2007 up to 3.1 percent in 2012 (Table II.5).⁹

Table II.5.

Revenue Losses on Imports from South Africa ¹⁰

(In percent of the respective tax receipts)

Table II.5.

Revenue Losses on Imports from South Africa ¹⁰

(In percent of the respective tax receipts)

	2007	2008	2012
Customs duties	7.7	7.9	8.9
Tax on petroleum products	0	0	0
Excise Tax	5.8	5.8	7.0
VAT	0.9	0.9	1.1
Total (taxes on international trade)
	2.6	2.7	3.1

View Table

Table II.5.

Revenue Losses on Imports from South Africa ¹⁰

(In percent of the respective tax receipts)

	2007	2008	2012
Customs duties	7.7	7.9	8.9
Tax on petroleum products	0	0	0
Excise Tax	5.8	5.8	7.0
VAT	0.9	0.9	1.1
Total (taxes on international trade)
	2.6	2.7	3.1

14. This revenue loss should be considered as a lower bound because

15. In contrast, customs reforms and the move from preshipment inspection to the TradeNet system are likely to improve the customxs efficiency and thus the collection of taxes on international trade. TradeNet, is an electronic platform linking the various trade parties (importers, trade forwarders, customs, central bank, …) which will facilitate and reduce the cost of customs procedures. Singapore and Ghana have implemented it have experienced improved revenue (Engman, 2002).

F. Conclusion

16. The SADC FTA will only have a limited impact on Madagascar’s real GDP and welfare because less than 6 percent of the country’s imports will be liberalized. Most of the impact will come from trade liberalization with South Africa. Nonetheless, the SADC FTA will alter Madagascar’s trade structure. Madagascar’s trade with South Africa would increase substantially under the SADC FTA but the impact on trade with the rest of SADC is limited and trade with third countries would decline. Most of the change in trade is due to changes in trade in textiles and clothing that would be the main beneficiaries of the SADC FTA.

17. Although the economic impact is expected to be limited, the fiscal cost appears somewhat larger. Assuming fixed imports weight, the revenue of taxes on international trade, which account for about half of Madagascar tax revenue, would decline by about 3 percent in 2007 ¹¹ and possibly slightly more. Thus, Madagascar will have to find domestic measures to offset the losses in government revenue from regional tariff reductions because, unlike many African regional agreements such as SACU or COMESA, SADC has no provision for compensating fiscal losses (Walkenhorst, 2006) except that countries affected by the tariff cut would have a privileged access to the SADC regional development fund (SADC, 2006).