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The role of trade policies in building regional value chains – some preliminary evidence from Africa

The role of trade policies in building regional value chains – some preliminary evidence from Africa
Photo credit: World Bank

09 Jan 2018

Regional value chains (RVCs) are considered as an important step towards greater integration into global value chains (GVCs), but African countries trade very little value added with each other. Trade in value added within the region is still by far the lowest in comparison with Asia and Latin America, but the recent increase allows for an optimistic outlook with respect to the evolution of regional production networks.

Based on the UNCTAD-Eora GVC database,[1] this paper estimates a panel model from 2006 to 2012 for 37 African countries and sheds light on the role of trade costs in building RVCs in Africa.

First evidence is provided on the effect of (i) charged and faced tariff rates on capital goods, raw materials and intermediates and (ii) additional trade costs capturing border inefficiencies and poor infrastructure. Results indicate a significantly negative effect on foreign value added of charged tariffs on capital goods and higher time to trade. In addition, higher regulatory quality and a stronger telecommunication infrastructure seem to be positively correlated with a country’s ability to participate in RVCs.


Introduction

International trade is increasingly shaped by the existence of value chains, regionally and globally. Decreasing transaction costs have encouraged multinational corporations to outsource stages of production, retaining the most profitable phases along the supply chain. More complex products and a greater division of labor allow more countries to participate in global trade by specializing in specific tasks without the need to produce the entire product. Developing countries can leverage participation in value chains as a stepping stone towards greater integration into the global economy which promises a rise in labor productivity and total factor productivity through knowledge spillovers and technology transfer.

African countries are highly under-represented in global value chains (GVCs) although their participation has significantly increased over the course of the last decade. The example of the great world factories in Europe, North America and Asia shows that building regional value chains (RVCs) is an important step towards participation in GVCs by increasing the market for exports and imports. However, the share of intra-African trade in value added is low at nine percent, compared to 45 percent in Asia and 18 percent in Latin America. Although it is essential to understand the dynamics and characteristics of RVCs in order to implement efficient policy instruments for facilitating regional trade in value added, the literature on RVCs in Africa is sparse.

To the best of the author’s knowledge there is no study which empirically explores determinants of RVCs in Africa. The study at hand attempts to close this gap in the literature. By doing this, the analysis builds on empirical literature on African global value chain participation on the one hand. Kowalski et al. (2015) and IMF (2016) are the only two publications that empirically address the determinants of African countries’ trade in value added with the world. On the other hand, sector- and country-specific literature on African regional value chains is discussed to show that a reduction of regional transaction and trade costs is even more crucial to increasing RVC integration than gross trade since products have to cross the border twice. This is theoretically underlined by the two-dimensional fragmentation model by Kimura (2007) which centralizes service link costs as a major constraint to the fragmentation of production processes. Service link costs arise by connecting production blocks and include trade and transportation costs, as well as economic transaction costs (e.g. telecommunication costs and deficiencies in legal systems and economic institutions).

This paper purely focuses on the role of trade policies in regional trade in value added within Africa. Policy makers are usually confronted with a set of trade policy instruments in the form of different tariff rates. High tariffs on important inputs such as production equipment might be more restrictive than tariffs on raw materials, especially for resource abundant countries. Despite recent integration efforts among African countries, intraregionally applied tariffs are still high compared to cases in Asia and Latin America. In addition, time delays caused by poor infrastructure and border inefficiencies restrict intra-regional trade. For trade in parts and components, delays in arrival are even more prevalent than for trade in finished goods since the full production process could be interrupted. In light of the potential Continental Free Trade Area (CFTA) which is currently negotiated, the aim of this study in identifying the impact of these constraints becomes highly relevant.

This study uses newly published international input-output tables, obtained from the UNCTAD Eora GVC database, to quantify trade in value added between African countries and to evaluate each country’s position in the RVC. The empirical analysis concentrates on the backward integration perspective, defined as imported foreign value added (FVA) from the region embedded in a country’s exports to the region. On average, 6.0 percent (in 2012) of the value added exports to African countries are also sourced from within the region.

Southern African countries such as Namibia, Botswana and Swaziland are considered to be the most integrated countries, mainly attributed to their proximity to the regional hub, South Africa. Moreover, all African countries, except South Africa, presently import more inputs from within region than they did in 2006. Between 2006 to 2012, real imported FVA increased by 114 percent while total value added trade increased by 53 percent. The stronger increase in FVA indicates a strengthening of regional production networks. The research question that naturally arises is why some African countries have experienced a stronger increase in value added trade and have managed to integrate into RVCs to a greater extent than other countries. Given the fact that imported foreign value added from the rest of the world is approximately zero, an analysis of trade diversion from third countries towards the region is not essential and allows a pure concentration on regional preferential trade liberalization.

An extensive literature review provides a theoretical framework for the empirical analysis. Qualitative literature on Africa, as well as examples from Asia and Latin America are particularly instructive in understanding the role of trade facilitation and structural factors in building RVCs. A panel of 37 African countries from 2006 to 2012 is estimated using a fixed-effects (FE) estimator, controlling for auto-correlation and cross-sectional correlation among standard errors. The results suggest that trade barriers are significant determinants of a country’s ability to join and upgrade within RVCs. Among different tariff rates, the charged tariff on capital goods is most restrictive to imported FVA. The proxies for non-tariff barriers (NTBs) also indicate a negative effect on RVC participation. In addition, higher regulatory quality and a stronger telecommunication infrastructure are positively correlated with the evolution of RVCs.

This paper was completed during an internship in the Division for Africa, Least Developed Countries and Special Programmes at UNCTAD.


[1] Environmental Accounting Framework Using Externality Data and Input-Output Tools for Policy Analysis

Author Anja Slany
Source UNCTAD
Website Visit website
Date 09 Jan 2018
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