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African Continental Free Trade Area: Challenges and opportunities of tariff reductions

African Continental Free Trade Area: Challenges and opportunities of tariff reductions

07 Feb 2018

In 2012, the 54 Member States of the African Union agreed to establish the Continental Free Trade Area (CFTA) by 2017. The CFTA is widely seen as a crucial driver for economic growth, industrialization and sustainable development in Africa.

Eliminating tariffs can help African countries boost economic growth, transform their economies and achieve the SDGs. Furthermore, the positive impact of the CFTA is expected to be even greater if non-tariff measures are addressed, informal trade is integrated into formal channels and the agreement includes trade in services as well.

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. Countries with large productive capacities in manufacturing may experience significant economic growth and welfare gains while small economies and LDCs may face substantial fiscal revenue losses and threats to local industries. An uneven distribution of benefits and costs among member States may prolong the negotiations and hinder its implementation. Sufficient flanking measures and flexibilities are therefore needed to enable the redistribution of benefits and a fair sharing of costs by member States.

In order to deal with these potential challenges, the AU member States are considering different tariff reduction modalities and other mitigating mechanisms. Fear of significant tariff revenue losses and possible uneven distribution of other costs and benefits are two main challenges ahead of the CFTA.

This paper analyses the potential adjustment costs and potential benefits of the CFTA tariff reductions under different scenarios. In the long-run, trade liberalization 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 liberalization 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 liberalization accrue in the long run, short-run 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.

Recommendations

The CFTA is an important step towards integrating economies of African countries, boosting intra-African trade and attaining sustainable development in the continent that is consistent with African Union Agenda 2063 and global goals on sustainable development. Liberalization of trade in goods and services may entail adjustment costs for the African Union member States that are, however, typically outweighed by significantly higher long-term gains.

Two long-term scenarios are discussed in this study. One scenario eliminates all tariffs on intra-African trade, while the other allows the permanent exemption of sensitive products from tariff liberalization.

Long-term gains are estimated at about US$16 billion annually in the ambitious scenario where all tariffs are eliminated. Permanently exempting products from liberalization will reduce overall gains. If each country can exempt one sector, total gains drop to US$11 billion; exempting three sectors already cuts overall gains in half to US$ 8 billion. The lower gains when sensitive sectors are exempt from liberalization result from high concentration of intra-African trade on few products. It is a typical result of scenarios where some tariff lines are exempt as shown in many studies during the WTO Doha round negotiations. There is a risk that product exemptions in some African markets may stifle the growth opportunities of others, particularly vulnerable economies. Therefore, product exemptions should be carefully reviewed by the member States to enable all members to benefit from the CFTA.

In both scenarios employment is increasing, including in agriculture, and the increase in intra-African trade of about 30 per cent contributes to structural transformation as more sophisticated products with a higher technological content are produced and traded. African countries can benefit from expanded markets for African goods and services, free movement of factors of production and more efficient allocation of resources which can promote economic diversification, technological progress and human capital development.

During a transition period, adjustment costs in the form of falling tariff revenues, temporarily rising unemployment and decreasing economic activities in some sub-sectors are likely to occur due to a reallocation of resources. Adjustment costs and the duration of the transition period can vary between countries. Furthermore, the benefits of the free trade area may not be shared equally if the financial and institutional capacity of countries is insufficient in dealing with adverse effects on labour force and small enterprises. In particular, a lack of labour mobility between sectors is a key challenge for many developing countries. Support programmes, such as Aid for Trade and infrastructure investments, could be considered to help the most affected countries, in particular least-developed, landlocked and small economies.

Even though tariff revenues are an important income source for some governments, the estimated loss of below 10 per cent should not be seen as an absolute loss for countries. Lower tariffs will not only allow consumers to have access to cheaper products but also producers to better enter other African markets. In addition, firms will have access to cheaper raw materials and intermediate goods from other African countries which will reduce their cost of production. Therefore, a tariff revenue loss mainly signifies redistribution of income from governments to consumers and producers. The CFTA, moreover, produces welfare gains well beyond tariff losses.

Using quantitative models to assess the effect of trade policy changes has limitations and results derived from them, therefore, should be carefully looked at. Apart from the general limitations of CGE models, here, the selection of the sensitive products was based on assumptions and the GTAP product level.

This study focused on assessing the effects of tariff reductions. However, to achieve the ambitious targets set by the governments, economic integration among African countries needs to go beyond tariff reduction and include, inter alia, improvement of efficiency and connectivity of trade logistics infrastructure, facilitating movement of labour as well as capital, eliminating non-tariff barriers and harmonizing regulatory measures, and promoting the integration of member States to regional and global value chains in Africa.

Trade liberalization can also pose some challenges for governments in promoting competition in local markets as some firms that are taking advantage of economies of scale may grow faster than others and capture dominant positions in markets. In order to ensure a smooth transition during these episodes, complementary policies such as consumer protection and competition policies need to be put in place.


This paper was prepared by Mesut Saygili, Ralf Peters and Christian Knebel from the Division on International Trade in Goods and Services, and Commodities, UNCTAD.

Author Mesut Saygili, Ralf Peters and Christian Knebel
Source UNCTAD
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Date 07 Feb 2018
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