Authors : Hippolyte Fofack
Type of publication : Academic report
Date of publication : 2020
Although intra-African trade has increased in recent years, Africa still trades more with the rest of the world than with itself and compares unfavorably with other regions in intra-regional trade intensity. The relative contribution of Africa to global trade fell to about 2.8 percent in 2019, down from 4.3 percent in 1970, perhaps reflecting the significant technological changes in the composition and drivers of global trade and growth.
A potential economic and globalization game changer in this scenario is the African Continental Free Trade Agreement (AfCFTA), which entered into force on May 30, 2019, as the world’s largest free trade area since the establishment of the General Agreement on Tariffs and Trade (GATT) more than 70 years ago.
The focus of the AfCFTA has largely been on eliminating nontariff barriers. However, several other measures are essential, including mitigating short-term fiscal adjustment costs and reviving national development banks, to inject the patient capital needed to sustain the process of structural transformation and tackle supply-side bottlenecks; strengthening the security and development nexus to consistently optimize the allocation of scarce resources is essential for both structural transformation and long-term peace and security.
Assessing the game-changing nature of the AfCFTA
Intra-African trade is set to enjoy its most impressive rate of expansion during implementation of the AfCFTA. Preliminary estimates show that cross-border trade could increase by $34.6 billion (52 percent) by the end of the second decade, and a further $85 billion if trade facilitation, rather than just tariff liberalization, is undertaken as a complementary measure during implementation.
Furthermore, empirical evidence from the most recent African trade data shows that industrial products and manufactured goods exhibit the greatest intra-African trade potential. These newly revealed drivers of intra-African trade include mineral products, machinery, motor vehicles and parts, chemicals, and fertilizers. This finding suggests that prospects for further expanding intra-regional trade and accelerating the process of industrialization are highly correlated.
In addition to increasing industrial productive capacities to meet the growing demand for manufactured goods that dominate intra-African trade, the AfCFTA will facilitate the development of national, regional, and continental value chains that have been the key drivers of growth and efficient vectors of integration in existing global value chains (GVC) and more generally into the global economy.
Preliminary estimates show that cross-border trade could increase by $34.6 billion (52 percent) by the end of the second decade, and a further $85 billion if trade facilitation, rather than just tariff liberalization, is undertaken as a complementary measure during implementation
In Africa, the benefits of trade integration are likely to be just as significant if the AfCFTA is successfully implemented. Until now, the fragmentation of African markets has resulted in costly diseconomies of scale and pulled down the economic potential of the whole continent. The economic benefits and returns of the trade agreement could include rationalizing the existing eight overlapping regional economic communities.
Fast-tracking implementation of the AfCFTA: Lifting the constraints
Realizing the growth and development potential associated with the AfCFTA requires strong political commitment to implement the policy and structural reforms that can address the myriad supply-side constraints confronting the region. These constraints are visible across product, labor, and financial markets as well as in the realm of technology and innovation.
If strict enforcement of the same rules of origin is not followed by the rapid development of productive capacities to expand industrial output and manufactured goods, it could ironically become a major constraint to economic growth rather than an accelerator of industrialization. In particular, this situation may likely arise if the small- and medium-sized enterprises (SMEs) across the region are not able to meet the value-added threshold required to receive AfCFTA tariff preferences.
African banks’ support of the private sector, especially SMEs, has been very weak, with most highly liquid financial institutions preferring to invest in risk-free government securities. In general, total outstanding loans have been extremely low across the region, and significantly less than averages in other regions of the world. Even in Nigeria, one of the continent’s largest economies, domestic credit extended to the private sector by banks and other financial institutions has accounted for only 15.6 percent of GDP—significantly lower than in other countries.
Empirical evidence from other regions of the world shows that the growth of intra-regional investment has been a major catalyst for intra-regional trade and macroeconomic stability. In the Asia and Pacific region, growing trade and investment linkages have supported the development of regional value chains and strengthened the foundation for economic resilience in the face of both market and policy induced uncertainties in today’s global economic and trade policy environment.
Overcoming the deficit of infrastructure, which has been a major constraint to both economic growth and intra-African trade expansion, will become ever more critical during the implementation of the AfCFTA. Such an effort will include both physical and digital infrastructure, which, in the current fragmented African markets, have been major constraints to economic transformation and industrial production, as well as to the distribution of goods.
More than 97 percent of Africa’s infrastructure deficit is in trade-enabling infrastructure (in energy, transportation, and logistics). Shortcomings in the power sector alone are estimated to drain between 2 and 4 percent of African countries’ GDP every year, reflecting the cross-cutting nature of energy in powering growth across all sectors of economic activity.
In the agriculture sector, for instance, developing reliable transportation networks and logistics to connect regions with surplus production, with regions experiencing food deficits, has the potential to raise incomes of rural farmers and increase intra-regional trade. But, in the absence of reliable infrastructure networks and logistics, the surplus production could result in post-harvest losses and further deter any prospects for boosting agricultural productivity.
Another type of infrastructure that requires sustained investment and commitment from African leaders during the implementation of the AfCFTA is “soft” infrastructure, especially the development of technical and engineering skills, which are crucial for driving the process of industrialization and expanding manufacturing output. In a rapidly changing global economy in which technological advances and innovation have become the major drivers of competitiveness and global growth, moving up the development ladder has become highly correlated with upward movement along global value chains.
More than 97 percent of Africa’s infrastructure deficit is in trade-enabling infrastructure (in energy, transportation, and logistics). Shortcomings in the power sector alone are estimated to drain between 2 and 4 percent of African countries’ GDP every year, reflecting the cross-cutting nature of energy in powering growth across all sectors of economic activity
Phasing out nontariff barriers is the third challenge that African governments must address to boost the development impact of the AfCFTA. While the agreement has prioritized the removal of physical and fiscal barriers to trade, evidence increasingly shows that the persistence of nontariff barriers that have stifled cross-border trade in the past could continue to be a major impediment during implementation of the trade agreement.
Eliminating tariffs on 90 percent of existing intra-regional trade flows would significantly increase regional trade over time. However, policies addressing nontariff bottlenecks such as customs services, clearance procedures, freight services and warehousing management could be up to four times more effective in boosting intra-African trade.
Financing the transformation of African economies to fast-track implementation of the AfCFTA
Effectively mobilizing the resources required to accelerate the process of industrialization and transformation of African economies is the fourth challenge that must be overcome to ensure a successful implementation of the AfCFTA in the short and medium term, and more generally to deliver “The Africa We Want” in the long term.
Leaders in a growing number of countries, especially in emerging developing market economies, are calling for the revival of public investment banks to support the injection of the patient capital needed to accelerate the process of industrialization and expand the scope of manufacturing output. In addition to enhancing the process of industrialization and value addition, the revitalization of national development banks is also particularly important for catalyzing private investment.
As the lifeblood of growth and trade, finance may be the fuel needed to power the diversification of sources of growth and trade during implementation of the AfCFTA—especially in a region where percapita income and domestic savings remain very low and capital markets are largely too embryonic to effectively carry out the needed financial intermediation functions. National development banks should be part of the emerging financial infrastructure for economic transformation, because both short- and long-term finance is required to reduce the risks of maturity mismatch and procyclicality of financing to keep countries on a path of fiscal and debt sustainability during the implementation of the continental trade-integration reform.
Mitigating the AfCFTA fiscal adjustment costs
Empirical evidence shows that the long-term benefits of the AfCFTA for the region at large are significant and largely outweigh the potential losses associated with the continental trade-integration reform. But the short-term adjustment costs could undermine the support for the reform at the national level— especially among the most vulnerable member countries—and ultimately derail implementation during the second and most critical phase of the project. These short-term costs are varied and include both private adjustment costs through labor and capital markets and public sector adjustment costs through fiscal channels.
The AfCFTA is likely to entail additional expenses. Such expenses may result from the reallocation of resources arising from the implementation of a free trade agreement and include the training and retraining costs associated with the obsolescence of skills in labor markets. Transitional costs of shifting capital across sectors, as well as the suboptimal utilization of existing capital stock and productive equipment that could undermine economic growth are also possible expenses.
Signing the AfCFTA agreement was a political act with no immediate fiscal implications for signatories. Doing so has galvanized the continent and strengthened the foundation for the trade integration framework articulated decades ago by the Organization of African Unity. However, effectively implementing the continental free trade agreement could entail huge costs, especially short-term fiscal adjustment costs, for the most vulnerable countries
The deepening process of trade integration and the elimination of tariffs will affect these countries differently. Analytically, the countries that are most vulnerable to fiscal adjustment shocks also are the ones with high intra-regional trade intensity. These nations are likely to suffer disproportionately large revenue losses following the elimination of tariffs on 90 percent of currently taxed intra-regional trade flows, during the implementation of the AfCFTA. Therefore, the AfCFTA could be a mixed blessing for some members in the early phases of implementation.
Signing the AfCFTA agreement was a political act with no immediate fiscal implications for signatories. Doing so has galvanized the continent and strengthened the foundation for the trade integration framework articulated decades ago by the Organization of African Unity. However, effectively implementing the continental free trade agreement could entail huge costs, especially short-term fiscal adjustment costs, for the most vulnerable countries. These costs could transform the initial win-win continental trade-integration project into a win-loss trade-integration outcome, if sudden tariff revenue losses and other adjustment costs become a source of persistent macroeconomic instability.
Strengthening the security and development nexus for AfCFTA implementation
Mutually-reinforcing defense and development initiatives could beget a virtuous cycle of peace and prosperity, sustained by the proper allocation of scarce resources towards the type of productive investments needed to crowd-in private capital and address supply-side constraints. Alleviating these restrictions will bolster intra-African trade, which, even by developing-region standards, remains dismally low.
Historically, the consequences and socioeconomic costs of insecurity have been a major challenge to growth and integration. These could re-emerge as acute downside risks in the pursuit of a more stable security and development nexus during the AfCFTA’s implementation. Rebalancing the scales of Africa’s security and development nexus to optimize the allocation of scarce resources will be vital in addressing the region’s large trade and infrastructure financing gap.
Rebalancing the scales of Africa’s security and development nexus is a daunting task, but it is one that the region’s leaders must seize with both hands. To quote again the late, great Kofi Annan, “There will be no development without security, and no security without development and both depend on respect for human rights and the rule of law.”
It is fair to tout the AfCFTA as an economic and globalization game changer. Economies of scale and competitiveness gains associated with the reform could accelerate the process of industrialization in Africa and the diversification of its sources of growth, which could lift its living standards closer to those in high-income countries. The AfCFTA is also expected to boost both extra- and intra-African trade. Preliminary estimates say that the other significant potential gains of the reform will be the strengthening of Africa’s bargaining power in international trade negotiations.
However, there are several challenges associated with ongoing efforts to deepen economic integration through the elimination of tariffs and the progressive liberalization of trade: an infrastructure deficit, securitization of development, fiscal adjustment costs, supply-side constraints, financing of African trade and development, and the stickiness of nontariff barriers that could reduce the overall gains. These challenges will become even more apparent during the implementation phase of the AfCFTA. Until now, the emphasis has been on the potential costs of nontariff barriers, as well as logistical and infrastructure constraints.
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