Regional spillovers in sub-Saharan Africa: Exploring different channels
After close to two decades of strong economic activity, overall growth in sub-Saharan Africa decelerated markedly in 2015-16 as the largest economies experienced negative or flat growth. Regional growth started recovering in 2017, but the question remains of how trends in the economies stuck in low gear will spill over to the countries that have maintained robust growth.
This note illuminates the discussion by identifying growth spillover channels. The focus is on trade, banking, financial, remittance, investment, fiscal, and security channels, which are the most prominent and most likely to transmit growth trends across borders.
In addition to bringing together findings from a broad array of existing research, the note identifies countries that are the most likely sources of regional spillovers and those that are most likely to be impacted, and provides estimates for the size of these channels.
It finds that intraregional trade and remittance flows are an important channel for growth spillovers, while banking channels are less important but will remain a risk going forward.
Finally, the note documents other important spillover channels through financial markets contagion, revenue-sharing arrangements in fiscal unions, commodity-pricing policies, corporate investment, and forced migration.
Regional Trade Links Gaining Strength
Regional trade links are steadily gaining strength. Countries that absorb most intraregional exports and hence have the highest potential to generate regional spillovers are identified, as well as countries that are more exposed to spillovers from other countries in the region. The note also discusses the following findings:
Intraregional trade has steadily increased in intensity over time. It represented 6 percent of total exports (1 percent of GDP) in 1980 before taking off in the early 1990s and eventually reaching 20 percent (4 percent of GDP) in 2016.
The key players in the total demand for intraregional exports (that is, the countries with the potential to generate the largest regional spillovers) are highly concentrated. Ten countries account for 65 percent of total regional demand.
Some countries are highly exposed to intraregional demand. Exports to the top 10 destinations represent between 5 percent and 10 percent of source-country GDP.
Subregional trade accounts for most of sub-Saharan African regional trade. Southern Africa Customs Union (SACU) subregional trade alone represents half of total sub-Saharan Africa intraregional trade. Moreover, in the cases of the Southern Africa Development Community (SADC) and the SACU, subregional trade represents more than 80 percent of their member countries’ intraregional trade.
Econometric analysis shows that bilateral trade is more likely to be hindered by distance and sociocultural differences in sub-Saharan Africa than in the rest of the world, which explains why most regional trade occurs within subregions. Moreover, econometric estimates suggest that about half of the growth in regional trade over 1980–2016 stems from subregional trade integration, in particular within the East African Community (EAC) and the SADC.
The growth of regional trading partners has a significant effect on individual countries’ growth, even after controlling for variables capturing co-movement at the global and regional levels. Econometric estimates suggest that a 5 percentage point increase in the export-weighted growth rate of intraregional partners is associated with about a 0.5 percent increase in the average sub-Saharan African country’s growth.
The Changing Pattern of Remittance Flows
Remittances from within sub-Saharan Africa are becoming relatively more important. The key players in terms of regional remittance outflows (with the potential to generate the largest regional spillovers) are identified, as well as the countries most exposed to remittance spillovers. In further analysis, the note also finds:
Growth in regional remittances has outpaced the growth of other external sources of financing such as aid, foreign direct investment (FDI), and remittances from the rest of the world.
Remittance flows are rather concentrated in a few corridors, and in some countries regional remittance inflows represent a substantial share of income. In particular, Côte d’Ivoire and Ghana are important sources for West Africa, and South Africa is an important source for Southern and East Africa.
Recent reductions in the cost to send money across borders are associated with the development of mobile money and explain part of the observed increase in regional remittances. The cost of sending remittances in sub-Saharan Africa are the highest in the world, implying that there is room for further cost reductions and increases in regional remittances.
Growth in countries that send remittances is found to be significantly associated with growth in receiving countries. A 5 percent increase in the growth of remittance partners is estimated to raise growth by 0.5 percent, although this is partially outweighed by trading partners’ growth spillovers.
The Foreign Direct Investment Channel – South Africa Rules the Roost
South Africa is the dominant source of regional FDI. This note analyzes the corporate sector and discusses the following:
Firms from South Africa that are searching for diversification opportunities in relatively faster growing regional African markets dominate the landscape.
The lion’s share of investment is in services, trade, and the financial sector. Significant unintended spillovers exist from fiscal policies in the largest countries. The note covers how these fiscal channels develop via large fluctuations of tax receipts in customs unions and via negative externalities arising from different fuel pricing policies in neighboring countries.
The SACU revenue-sharing formula ties member countries’ fiscal revenues to economic developments in South Africa. While providing certainty for current revenue, the formula leads to high levels of volatility over the medium term. As a result, it complicates fiscal management in the smallest countries (Lesotho and Swaziland).
Subsidized fuel in Nigeria leads to widespread smuggling and to the erosion of the tax base in Benin and Togo. For instance, for Benin, only about 15 percent of the fuel consumed is purchased on the formal (taxed) market.
This paper has been prepared by Francisco Arizala, Matthieu Bellon, Margaux MacDonald, Montfort Mlachila, and Mustafa Yenice as part of the IMF’s Spillover Notes series. Read more in the accompanying blog, Trade and Remittances Within Africa, also available in French and Portuguese.