25 July 2019 0 Comments

The case for Trade among Africans

A barage of media attention has been directed recently to the African Free Trade Initiative. The scope of the agreement and the reluctance of the continent’s economic powerhouses (Nigeria, Algeria, etc.)  to adhere to the agreement highlight the trade-offs at the Center of Trade liberalization. With openness comes competition which threatens local business interests. It also exposes nurturing industries to the reality of international competition and could wipe out any hope of industrialization for Poor countries. Within the African Union, the level of economic advancement and the structures of the productive sector vary widely and the incidence of openness to trade could be markedly differentiated.

Although, the Inititative should be praised, it should also be appreciated with the caution that comes with any Policy transformation of this magnitude. An objective discussion of the disruptions that such a major multilateral arrangement would bear on each economy should be had in light of International Trade Theory and Development Strategies. The main concern that will have to be addressed relates to the potential diversion of efficient commerce that this Free Trade Agreement (FTA) will induce across the continent. Relatedly, it also takes away policy tools that many decision makers need to manipulate in order to promote a sustainable growth path.

I have decided to take up this issue through a series of blog posts. First, to set the stage, I want to describe how the recent literature views the association between Trade  and economic growth. Below, I set to focus on the coordination between Export-Promotion and import Substitution policies and how they have to be coordinated to yield better economic outcomes.

Recent literature on Trade for Development…

The theory of international economics defends that trade represents a policy device for development. The gains from free exchange are known to arise from multiple channels; a higher productivity for import competing domestic firms as well as lower prices for consumers. Trade policies can be divided into two broad categories: Export promotion and Import-substitution. Export-promoting policies refer to subsidies designed to support firms engaged in the production of goods that are sold on foreign markets. They lead to welfare gains for a country if targeted at sectors that generate substantial spillovers through the entire economy. In the presence of such externalities, beneficiaries of export promotion expand beyond the scope of the initially targeted sectors. This ultimately generates positive externalities on other activities within the domestic economy, spurring a higher economic growth. Plus, to be welfare-enhancing, export subsidies should be undertaken simultaneously with appropriate investments in human capital and infrastructure to promote a higher productivity and wages for domestic workers.

From a long-run perspective, export promotion should be designed to support a progressive upgrading along the value added scale, in order to prevent the ‘’low income elasticity of primary goods curse’’. Subsidizing domestic firms involved in exports may not yield welfare gains if the targeted sectors specialize continuously in the production of primary commodities. This could result in a scenario where domestic households earn a lower purchasing power even in the face of higher exports, and may also cause a deterioration of the external balance. As a country grows the scale of a raw commodity for which it holds a comparative advantage because of trade, the increase of income for domestic households could deteriorate its current account. If say Ivory Coast increases its production of Cocoa due to new trade opportunities, the rise in household income will simply increase the demand for manufactured products that are produced overseas, which will inevitably deteriorate the country’s current account. This is the reason why a country does not want to specialize in the production of a low value bearing commodity for a long time without moving up the value-added ladder.

On the other side, to become welfare increasing, lower import tariffs have to be directed towards sectors that feature tremendous technological gaps. This instrument can be used to lower capital good prices for domestic firms that have to catch up with international standards. A selective approach which consists of imposing high tariffs on import competing goods while lowering tariffs on the inputs used in those sectors, is likely to be the most effective strategy. It helps to promote the development of the growing domestic industrial base while protecting it from global competition. The dismantling of import tariffs can also lower the price of consumption goods for households and offers them a higher variety of goods to choose from. Plus, less tariffs provide domestic firms with a broader scope of intermediate inputs to be used in production and favor a better allocation of resources, all of which should certainly lower domestic prices and enhance consumer welfare as suggested by Dornbusch (2012).

‘’While the traditional discussion often focuses on final, homogeneous goods, the case for freer trade is enriched by including the facts that trade liberalization increases the variety of goods, and raises productivity by providing less expensive or higher quality intermediate goods’’ R. Dornbusch (2012) The Case for Trade Liberalization in Developing Countries

Back on to the African Free Trade Agreement…

The African Union is made up of countries with varying levels of economic advancement. Income per capita differs substantially from rich Oil exporters (Algeria, Libya, Gabon, Equatorial Guinea), to large industrial powerhouses (South Africa, Morocco, Egypt, Nigeria) or landlocked agricultural economies (Niger, Chad, Burkina-Faso, etc.). Relatedly, the appropriate trade policy is not uniform across countries and a “one-size fits all” approach inherent to the dismantle of tariffs for goods produced on the continent might not be efficient for everyone. A major concern that such an arrangement entails, relates to the incidence it would have on the economies of small agricultural and industrially lagging economies within the Union. This group of countries will need to keep tariffs on a selected set of goods for which they have to develop a competitive advantage in order to expand their productive base. To illustrate this argument, consider two countries: Benin and South Africa. The former is a poor predominantly agricultural economy which specializes in the export of Cotton, Pineapple and Cashew Nuts. The latter is a middle income economy with an industrial sector that is relatively advanced to the point where it partakes in global auto-manufacturing supply chains. Both countries need trade to entertain a sustainable growth, but different policies might be called for at the current stage of their development. A mutual removal of tariffs on goods produced in both countries could potentially harm any industrial strategy that Benin would hope to set up to move up the income ladder. Besides, from a purely economic standpoint, Benin could find it cheaper and more efficient to import some intermediate machinery from other parts of world; whereas the African Free Trade Initiative will likely divert commerce from this first best option. I also understand that such a decision is motivated not only by an economic rationale but also by political considerations.

In my view, experiences from other similar Initiatives should also be kept in mind (European single market) and some countries specially the less advanced within the African Union must be allowed to adopt a path featuring a gradual removal of tariffs on key agricultural exports. I will discuss in Part 2 of this series how a transition period could be designed to account for the varying levels of development across the continent

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