Challenges, opportunities of Continental Free Trade Area
Last month Heads of State and Governments for Africa signed the African Continental Free Trade Area with a view of establishing the Continental Free Trade Area (CFTA).
THE CFTA is widely seen as a crucial driver for economic growth, industrialisation and sustainable development in Africa. Despite the opportunities, challenges need to be addressed. Fears of significant tariff revenue losses and an uneven distribution of costs and benefits are among the main obstacles to the continent’s integration.
Flanking measures and flexibilities should be explored for a fair sharing of costs and benefits, to reduce adjustment costs and to attain the full long-term benefits of the CFTA.
In the long-run, trade liberalisation in the CFTA lowers trade costs and allows consumers to access a greater variety of products at lower prices.
Lower costs for imported raw materials and intermediate inputs increases competitiveness of downstream producers and promotes the generation of regional value chains. Trade liberalisation also allows firms to access a large continental market and gain from economies of scale.
In the long run, increased competitive pressures may improve firm efficiency. However, market consolidation may arise when smaller firms are exposed to stiffer competition.
While most of the potential benefits of trade liberalisation accrue in the long run, shortrun structural change through the relocation of labour, capital and other factors of production entails costs of adjustment. Short run and long run effects of trade agreements should therefore be distinguished.
Crucial private adjustment costs arise from temporary unemployment and lower wages in declining sectors, and similarly from underutilised capital. Costs of upgrading labour skills or training for new skills are also part of private adjustment costs.
For the public sector, lower tariff revenues are the most pronounced concern in many developing countries. Still, a rise in costs of social safety nets and implementation costs of trade reforms remain significant public costs of adjustment.
Most empirical studies in the existing literature on trade liberalisation tend to find that long -run gains outweigh short-run adjustment costs.
In order to quantify the implications of the CFTA, the United Nations Conference for Trade and Development (UNCTAD) in February 2018, carried out an ex-ante study. The study first considers two different long-term scenarios for the CFTA.
In a second step, it looks at the implications of different tariff reduction modalities on shortterm adjustment costs.
In doing this, the UNCTAD used the Global Trade Analysis Project (GTAP) computable general equilibrium (CGE) model to assess the long-run outcomes of the CFTA under different scenarios.
Scenario 1 (full FTA) assumes that all tariffs will be fully eliminated in the CFTA. The long-term simulations established substantial welfare gains of about US$ 16.1 billion, even after deducting US$ 4,1 billion of tariff revenue losses.
The tariff revenue loss is equivalent to 9,1 percent of current revenues. GDP is expected to grow by 0,97 percent and total employment rises by 1,17 percent.
Also, the study showed that vast majority of individual countries are expected to gain from the CFTA. Intra-African trade is estimated to grow by 33 percent and Africa’s total trade deficit is cut in half.
Scenario 2 (Special Product Categorisation) exempts certain sensitive products from liberalisation. Assuming that the sector with the highest current tariff revenue (high tariff and intra-Africa trade) would be exempted, UNCTAD simulations show a significantly reduced overall welfare gain of US$10,7 billion in the long-run.
At the same time, tariff revenue losses are reduced to 3,2 billion US$ (7,2 percent of current revenues). GDP and employment growth are lower at 0,66 and 0,82 percent, respectively. Intra-African trade is expected to grow by 24 percent, but Africa’s overall trade deficit only shrinks by 3,8 percent.
Scenario 2 results in fewer countries with tariff revenue losses beyond 20 percent. However, there is a risk that the exclusion of certain sectors by some countries will negatively impact on the export development interests of other countries. In fact, the simulations show that more countries experience welfare losses if sectors with high current tariff revenue are permanently excluded from liberalisation.
In both long-term scenarios, the largest employment growth rates are found in manufacturing industry followed by some services and agriculture sub-sectors. There is evidence that all sectors will grow, with the exception of a stagnant mining sector. This is in line with the CFTA objective for structural transformation and industrialisation.
In the short-run, UNCTAD noted that adjustment costs also depend on the modalities of tariff reductions. Here, UNCTAD distinguished three types of tariff reduction modalities.
Linear tariff cuts: In this modality, all tariffs are gradually reduced by equal shares every year until full elimination (e.g. annual tariff reductions by 20 percent, over five years). Linear tariff cuts have the advantage that the phase-in does not further distort the efficient allocation of factors and resources.
The homogenous tariff reductions across all sectors may ensure that factors efficiently move in the direction of the final equilibrium. However, this approach takes away the countries’ flexibility to postpone adjustment costs in sensitive sectors and to prepare these sectors for increased competitive pressures.
Progressive tariff cuts: This modality divides products into different groups that are liberalised at different speeds (e.g. a certain share of tariff lines is eliminated immediately, a second group of products is liberalised over a period of 5 years and a third group over a period of 8 years). This approach allows member States to eliminate tariffs for different sectors with more flexibility.
There is a risk that the immediate increase of competition in non-sensitive sectors may lead factors to move towards still protected sensitive sectors. However, when also the sensitive sectors finally liberalise, those additional production factors may have to move once again. These temporary false incentives may increase overall adjustment costs.
However, this approach provides more policy space with respect to defensive interests and allows countries to manage liberalisation in their preferred ways.
Two-phased linear cuts: This modality immediately eliminates a large share of tariffs and eliminates the rest over several years. This “shock therapy” adjustment process is likely to be particularly challenging for SMEs and least developed countries. This option leaves a low level of policy space to countries but creates a high level of predictable export opportunities right from the beginning.
Each of these three transition modalities could also include permanent product exemptions. While short-term effects and adjustment costs follow the same logic as described above, the longterm benefits would be reduced as estimated for scenario 2 (Special Product Categorisation).
Fully exempting some products from liberalisation (Scenario 2) may reduce tariff revenue losses, but lowers aggregate welfare gains and the overall ambition of the CFTA. Between scenarios for the transition period, flexibilities and policy space have to be weighed-up with predictability, efficiency and speed of the adjustment process.
While all scenarios lead to aggregate gains, policymakers need to be aware that structural change produces winners and losers across sectors and firms.
In particular, a lack of labour mobility between sectors is a key challenge for many developing countries. However, with adequate flanking policies and social safety measures, the CFTA has an immense potential to promote equitable and inclusive growth.
As member states are working on the operationalisation of the CFTA they need to consider the advantages and disadvantages of these scenarios carefully considered by taking into account longterm effects as well as short-term adjustment costs.
Asante Sana.
Dr Mugano is an Author and Expert in Trade and International Finance. He has successfully supervised four Doctorate candidates in the field of Trade and International finance, published over twenty–five articles and book chapters in peer reviewed journals. He is a Research Associate at Nelson Mandela University, Registrar at Zimbabwe Ezekiel Guti University and Director at Africa Economic Development Strategies. Feedback: Cell: +263 772 541 209. Email: gmugano@gmail.com