The welfare effects of economic integration in the Tripartite Free Trade Area

Abstract

African countries continue to view economic integration as a rational response to the inevitable rise in globalisation and international trade in order to stimulate economic growth and increase economic welfare. Thus, this thesis investigated the welfare effects of economic integration in the Tripartite Free Trade Area which is an agreement between the twenty six member countries of the three regional economic communities (RECs) namely Common Market for East and Southern Africa (COMESA), the East African Community (EAC) and the Southern African Development Community (SADC). The overarching objective was subsequently divided into primary, theoretical and empirical objectives. The study employed three models, that is, two econometric models and one simulation model, in order to realise these objectives. The first model was focused on testing whether the macroeconomic variables as identified in the convergence criteria were converging or diverging. These tests included both statistical analysis and tests for stationarity. The second model employed was the augmented gravity equation which is a panel model. This augmented gravity model was aimed at establishing two things. Firstly, the model identified the factors which influence the level of intra-African trade using historical trade data between 2000 and 2015 across the 26 member countries. Secondly, the model was aimed to establishing the level of trade creation and trade diversion among the three RECs. The study conducted several procedures which include diagnostic tests which include tests for multicollinearity, tests for stationarity, Lagrange multiplier test and the Hausman test. Post estimation tests also included tests for autocorrelation and cross-dependence test. The third model employed was the World Integrated Trade Solution-Software for Market Analysis and Restrictions on Trade (WITSSMART) simulation model. The WITS-SMART simulation model was aimed at establishing the potential winners (or losers) from the TFTA both at country and sectorial level. The main findings from this thesis are as follows: Firstly, the study observed evidence of relatively strong forms of convergence of macroeconomic variables across the TFTA member countries. However, as expected, the evidence is scattered because it was detected in some but not all economies or sub-periods. Nonetheless, the thesis acknowledges the progress made by the member countries over the 15 year period in stabilising key macroeconomic variables especially inflation and service debt. Although cross-country dispersion of deficit was decreasing over time (which indicates convergence), the evidence remained weak and unstable. In general, the magnitude of convergence was stronger for monetary variables but the majority of TFTA countries were still struggling to fuse (move towards convergence) and stabilise their fiscal positions. Secondly, the empirical results of the augmented gravity model indicate that the incomes of both the importing and exporting country had a significant influence on the level of bilateral trade across the TFTA countries. However, the income of the former carried more weight at 1% level of significance whilst the income of the latter was weakly significant at 10% level. The proxy for income was the Gross domestic product (GDP). The results also indicate that the effect of weighted distance on bilateral trade was negative and statistically significant coefficient at 1% level. Country idiosyncratic factors included whether or not trading countries had a common official language, shared border and whether the country was landlocked or coastal. Language was found to be insignificant to bilateral trade levels. Countries with a shared border had a positive coefficient whilst that of landlocked was negative. Both coefficients were statistically significant coefficient at 1%. The variable of whether or not the country was a member of a free trade area (FTA) indicated the degree of economic integration (or trade liberalisation) in the economy. The FTA variable was found to be positive and statistically significant at 1% level implying that integrated countries trade more with each other than those that are not. The results also indicated the level of trade creation and trade diversion across the three RECs. The study found that there was trade created in the SADC region for the period 2000 to 2015 but the results were inconclusive for COMESA. The results also indicated that the EAC coefficient was negative and statistically significant for the EAC indicating they traded below the expected levels amongst themselves than they did with the rest of the world. The gravity results also traced changes into the regional openness dummies to provide evidence into the trade diversion effects. The EAC sign was positive and statistically significant implying that imports into the EAC from non-member countries in the rest of world (RoW) were higher than the gravity model would predict. Thus, it was difficult to statistically determine the net welfare effects for the EAC since both the regional dummy coefficient and the openness coefficient were higher than the gravity model would predict. The estimated coefficient for trade diversion for SADC was negative and statistically significant. The net effect for SADC was negative since trade diversion outweighs trade creation. Thus, SADC countries were now trading more with other SADC member states who were less efficient at producing certain commodities for the mere reason that these products had become cheaper due to tariff reduction resulting in a net welfare loss for the region. The net effect for COMESA was positive but statistically insignificant. The final model, the WITS simulation procedure indicated the countries and economic sectors which were likely to gain the most (or least) once they start implementing the TFTA. Net trade gains were found to be polarised towards a few economies. The Democratic Republic of Congo, Mozambique, Ethiopia, South Africa, Djibouti and Uganda were found to have the highest potential for positive net trade gains whilst Seychelles, Swaziland, Lesotho, Mauritius and Madagascar were found to be the least potential beneficiaries. In general, countries which were already pursuing trade liberalisation were not likely to gain much from the TFTA since they were already enjoying the trade creation benefits prior. Thus, the more closed the economy was prior to the agreement, the more it was likely to gain post liberalisation. In addition, larger economies were likely to gain more than smaller economies due to economies of scale in both production and consumption. The WITS-SMART model also found the amount of revenue losses that each of the twenty six countries were likely to lose as a result of tariff liberalisation and the overall welfare effects for each economy. At sectorial level, the WITS-SMART model indicated the levels of trade creation, diversion, net trade effects, revenue effects and overall welfare effects which are likely to accrue to each economic sector. The product classification and economic sectors which were adopted in this thesis are raw materials, intermediate goods, consumer goods, capital goods, agricultural sector, industrial sector and petroleum sector. Overall net trade gains were estimated at around USD 2.1 trillion per annum. Overall, the results indicate that trade in the industrial sector has the greatest potential with 34% followed by trade in intermediate goods with 24%. The agricultural sector has potential to contribute 18% of overall economic welfare. Trade in raw materials will likely increase 3% of total welfare whilst the petroleum sector will contribute a meagre 1% to overall economic welfare. The main contributions emanating from this study are as follows. Firstly, the study was able to show that economic integration leads to ex-post convergence of macroeconomic variables. Macroeconomic convergence is vital because it reflects if the respective economies are moving towards a similar level of development and wealth which indicates that it is not all doom and gloom for the continent. Secondly, the study was also able to the need for fiscal discipline among many economies to ensure stability and sustainability of economic growth and welfare. Convergence is significant because it implies business cycles are synchronised which makes it feasible and effective for policy makers to prescribe similar solutions across the region. Thirdly, the study also employed both econometric and simulation procedures and used different data sets to produce results which are to a larger extent, consistent. The different models also allowed the thesis to capture various dimensions and aspects on the economic integration subject which may not have been achievable with one models. Moreover, the study also focused mainly on developing and transitional economies in its empirical review which provided an opportunity to be more comprehensive in its analysis on various issues which mainly affect developing countries. Notably, the thesis specifically discussed the various issues pertaining the three RECs (COMESA, EAC and SADC) which make up the TFTA and also the challenges peculiar to the African paradigm of regional economic integration. The conclusion is that African economic integration is beneficial for Africa and countries should continue to liberalise their trade policies and integrate their systems. However, care should be taken and measures put in place to protect small and vulnerable countries and economic sectors in order to minimise polarisation of benefits. This can be done by providing special concession to key sectors especially to small economies which are largely depended on that sector, providing a systematic way liberalisation which is staggered to allow for economies to adjust, providing supplementary income to those economies which are largely depended on tariff revenue and also through subsidisation process. In the long term, there will be need to have policies such as re-skilling of labour which will accommodate the structural changes which will be brought about as a result of trade liberalisation and economic integration.