Economic Research Forum (ERF)

Development Gains from Arab-African Trade Integration

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Despite their proximity, trade and investment flows between the Arab countries and sub-Saharan Africa are very low. This column reports analysis of the potential development gains from deepening economic integration between groups of countries within and across the two regions. Existing and proposed free trade agreements that can help to promote stronger growth include the Arab customs union, the continental free trade area of the African Union, the pan Arab free trade area and the tripartite free trade area, which links three regional economic communities in Africa

In a nutshell

African countries can be clear allies in the Arab region’s push for greater trade, growth and job creation.

While completion of free trade agreements with traditional partners does have positive effects, the difference is more notable when agreements are generalised across the entire Arab region.

Development gains will steadily increase if Arab countries move from an initial regional integration initiative, to expanding trade agreements with external parties such as African states, and finally extending to all members of both regions.

Africa is among the world’s fastest growing economic regions, with an average annual GDP growth rate of 5% between 2004 and 2014. Drivers of this success include improved macroeconomic conditions, ending armed conflicts, a better business climate, trade facilitation and other developments.

Over a similar period, GDP growth in the Arab countries has been fluctuating and declining: from 6.8% in 2012 at the peak of the global commodity boom to 2.3% in 2017. Diversification of Arab economies from oil dependence to competitiveness through higher connectivity to the world economy through global value chains is becoming a necessity.

Since the mid-1990s, the Arab and African regions have been pursuing a variety of initiatives for economic integration. The most ambitious projects in the Arab region are the pan Arab free trade area (PAFTA), which has already been implemented, and the planned Arab customs union (ACU).

Many Arab countries are also active in African integration agreements. The tripartite free trade area (TFTA), which links three regional economic communities in Africa, also involves three Arab countries – Egypt, Libya and Sudan. Tunisia recently joined the common market for Eastern and Southern Africa (COMESA), while Mauritania and Morocco are working on the possibility of joining ECOWAS, the economic community of West African states. Being in both the TFTA and the planned ACU could mean conflicting memberships, which may prevent a common trade policy.

Our research analyses the effects of a set of scenarios on deepening Arab trade integration with Africa, in the perspective of the TFTA, negotiations towards the ACU and the continental free trade area (CFTA) recently signed by the African Union.

Arab and African trade performance

Both the PAFTA and TFTA regions feature natural resources as driving forces of trade portfolios. In 2014, over 80% of PAFTA exports consisted of fuels, and over half of TFTA exports consisted of stones, metals and minerals. In contrast with natural resources, production and export of higher value-added goods, such as machinery, electronics, processed textiles and other goods, will create more positive effects on employment and incomes, and contribute to structural transformation.

Trade flows between PAFTA countries and their main partners hint at agreements that could be strengthened and improved. As of 2011, the largest share of PAFTA trade was with the association of South East Asian nations (ASEAN), the European Union (EU) and other smaller partners. The TFTA accounts for an insignificant proportion despite its proximity and overlapping memberships. There is thus clear potential to expand this small but promising trade relationship.

Trade costs are central among the factors that prevent the deepening of Arab and African trade. Estimates using a gravity model over the period 2000-11 reveals that Arab exports face added costs equal to between one and three times the original value of the goods exported, placing a huge strain on exporters, reducing competitiveness and preventing the success of trade agreements.

These costs are extremely high for the value-added categories of machinery, chemicals and food and beverages. Costs facing Arab exports to the rest of Africa are increasing, in contrast with the falling costs of exports to other regions. Even in a best-case scenario of falling export costs to Africa, the fall is less dramatic than that of exports to other regions.

Another component of trade costs is the efficiency of transport services and customs procedures, which have a heavy impact on cross-border transactions, deter investors and prevent the Arab and African regions from meeting their trade potential. Furthermore, non-tariff measures continue to affect exports of Arab countries.

From TFTA to a Pan Arab-Africa free trade agreement

The TFTA and PAFTA regions, if joined together, will bring about significant economic gains, allow for progress in regional integration, create productive jobs and higher incomes, and help countries reorient from commodities to manufactures.

The TFTA involves eliminating tariffs and non-tariff barriers, and allows for different paces of adoption based on country characteristics. Yet several details, such as rules of origin, dispute settlement and the threat of low-cost product flooding, have all prevented members from immediately getting on board with the project.

Dual memberships between the PAFTA and the TFTA are not necessarily conflicting. The TFTA clearly stipulates that members will not be prevented from joining other free trade areas as long as privileges are extended to all TFTA members. As is happening with the movement from regional economic communities towards the TFTA and the CFTA, the creation of larger trade groups incorporating members of differing blocs can help reduce the confusion of overlapping arrangements by bringing all countries together under common guiding principles.

But details on how African and Arab countries will engage in trade must be established. The extension of the ACU may lead to complications due to the transition from a framework based on rules of origin to one based on a common external tariff.

Specifically, can the TFTA and ACU overcome the confusion inherent in overlapping trade regimes, such as the sharing of members between COMESA and the PAFTA? And what details will be worked out regarding most favoured nation rates and common external tariffs?

Our research shows important gains from deepening Arab-African trade integration, building on the potential of expanded trade and reduced trade costs. Our quantitative exercise – involving a baseline and two scenarios – addresses two questions:

  • What is the relative impact of various factors for Arab economic integration?
  • And which path to economic integration provides the highest development payoff?

The first scenario features deeper Arab economic integration through the implementation of a customs union only among the countries involved in the Euro-Med partnership as a first step towards the ACU. It assumes that all Southern Mediterranean countries will remove the remaining tariffs on their imports from each other and with the rest of their partners: the EU, the European free trade area (EFTA), Turkey and the United States.

Accordingly, in the first transition period, tariffs on imports from all of these partners will be removed progressively over the period 2017-20. In the second period 2021-25, the rest of the Arab countries will implement a customs union based on the lowest tariffs applied by members of the Agadir declaration, taking account of bound rates that should not be exceeded.

The second scenario assumes pan-Arab economic integration through the implementation of the ACU and the extension of trade preferences towards non-PAFTA African countries. In addition to the first scenario, in the second period (2021-25), a pan Arab-African free trade area will be implemented, and free trade agreements signed by some Arab countries will be generalised to all Arab countries. As a result of higher efficiency in trade operations, trade costs (excluding tariffs) will be reduced at an annual rate of 5% during the whole simulation period.

Results of the removal of various barriers to bilateral trade of the top 20 exported goods at the country-level reveal a significant boost to Tunisia-Africa and Egypt-Africa exports. Goods that largely flow to regions other than Africa have the greatest potential to increase. But even with strong policy actions, barriers to trade are complicated to remove, and comprehensive reforms are required to reduce their restrictive effects.

The results of the two scenarios indicate a number of changes – Arab GDP grows at 2.9% per annum in the baseline and first scenario, and at 3% in the second, translating to a cumulative 0.9% increase in GDP between 2017 and 2025. Import figures increase at a constant 2.1% per annum in both the baseline and first scenario, and exports decrease slightly from 2.9 to 2.8%. But both witness significant increases under the second scenario, growing annually at 2.7 and 3.2% respectively.

Private consumption, investment and fiscal revenues increase where integration gains are reinforced with the rest of the world. Indeed, annual growth rates stand higher than the baseline by the second scenario and in some cases by the first scenario. This is expected as preferential agreements usually induce trade diversion, which will be reduced as far as preferences are granted to more partners.

While integration results in significant output gains, the impact on employment is conditioned by different effects in different sectors. Accordingly, our simulation suggests that Arab integration triggers changes in relative employment, but the consolidated effect on aggregate employment may be small.

Conclusions

We see the benefits of stronger integration within the Arab region through the ACU and the extension of trade preferences to external partners, particularly through Arab-African integration. While completion of free trade agreements with traditional partners does have positive effects, the difference is more notable when agreements are generalised across the entire Arab region.

Development gains will steadily increase if Arab countries move from an initial regional integration initiative to expanding trade agreements with external parties such as African states, and finally extending to all members of both regions. The results also confirm that reduction and/or harmonisation of trade costs is another important ingredient for development gains.

While many countries have unilaterally pursued trade agreements with external parties, it is important to ensure that PAFTA and ACU rules are applied consistently across all members. Given the potential benefits, policy-makers need to reach agreements that are as integrated and expanded to as many members as possible.

African countries, consolidating under the TFTA and the CFTA, can be clear allies in the Arab region’s push for greater trade, growth and job creation. Further studies should explore the sector-specific potential of greater linkages and closer agreements.

 

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