The African Continental Free Trade Agreement: Welfare gains estimates from a general equilibrium model

The African Continental Free Trade Agreement: Welfare gains estimates from a general equilibrium model
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10 Jun 2019

In March 2018, representatives of member countries of the African Union signed the African Continental Free Trade Area (AfCFTA) agreement, providing a framework for trade liberalization in goods and services which is expected to eventually cover all African countries.

Using a multi-country, multi-sector general equilibrium model, the authors of this IMF Working Paper estimate the welfare effects of the AfCFTA for 45 countries in Africa. The model simulations use a comprehensive database comprising output, trade flows, and import tariff and non-tariff barriers (NTBs) for 26 sectors in all countries considered. Simulations include full elimination of import tariffs and a 35 percent reduction in NTBs.

Results reveal significant potential welfare gains from trade liberalization in Africa. As intra-regional import tariffs in the continent are already low, the bulk of these gains come from lowering NTBs. Overall gains for the continent are broadly similar under the three model specifications used, with considerable variation of potential welfare gains across countries in all model structures.

The authors find that the welfare gains from combined tariff elimination and NTB reduction is about 2 to 4 percent, depending on the model structure used and the extent of NTB reduction considered. Because existing intra-African tariffs are already generally low, overall gains from tariff elimination in the continent are quite modest, with the bulk of gains stemming from the reduction in NTBs.

Policy Implications

There are several policy implications of these results that should be considered to realize the full potential welfare benefits of the provisions contained in the AfCFTA. These include:

AfCFTA members should adopt a well-articulated and phased program for reducing all NTBs to the maximum extent feasible. The simulations assume partial, albeit significant, elimination of NTBs, and there is much to be gained from further reduction in these barriers. The NTB reduction program should include addressing a broader array of barriers that hinder trade, including infrastructure gaps, and an improvement in the business environment in Africa. The quality of ports, air transportation, and other measures of infrastructure where efficiency is relatively low in Africa compared with other regions, need to be addressed. The reduction in ground transportation costs is especially critical to encouraging intraregional trade, given the geographic configuration of the continent. Other areas, such as customs efficiency and other administrative procedures required for international trade, also need an overhaul to improve efficiency. In addition, creating an enabling business environment would be particularly relevant to facilitate intraregional trade. In this area, the reduction in the cost and time necessary to create new businesses is important. Finally, concerted efforts are required to increase financial depth and inclusion in Africa to bring it on par with other regions, as well as promoting access to trade financing or bank funding to create or expand businesses. It is expected that all these efforts and initiatives will help to promote the AfCFTA agenda.

AfCFTA members should limit the extent and scope of carve outs for tariff reductions. This a very relevant consideration since the AfCFTA proposes to liberalize only 90 percent of the tariff lines. Intra-African trade is concentrated in a few products, and much of it is already tariff-free, being concentrated in the existing free-trade areas. If a substantial portion of the remaining trade is contained in the remaining 10 percent of tariff lines, the potential welfare benefits of the AfCFTA would be reduced, especially if potentially exempted sectors are the most protected. To fully realize welfare benefits from the AfCFTA, member countries need to liberalize 100 percent of the tariff lines, even if this is completed in a phased manner over the medium term.

In the long run, to fully leverage the economic opportunities of the AfCFTA, policy makers would need to adopt supporting policies to encourage structural transformation. In particular, countries will need to lower their dependence on commodities and move up the value chain. Policies to encourage structural transformation could include training programs for workers to ensure a smooth reallocation of labor and capital to sectors that are more likely to grow, such as manufacturing. It is only in this way that the continent would be able to use the AfCFTA as a mechanism to claim its place in the global value chain.

Finally, there are at least three areas in which the analysis presented in this paper could be extended in future work. First, the model is static, so it is unable to provide guidance on the potential dynamic supply-side responses to the AfCFTA, such as increased private and public investment. As mentioned above, a significant reduction in infrastructure gaps will require substantial public investment. The effects of this could be modeled more thoroughly in a dynamic setting that allows comparison of costs and benefits from it, including those resulting from lower trade costs. A dynamic model could also take account of higher foreign direct investment flows into the region in response to the increase in unified market size derived from the agreement. These responses would further raise the welfare and income gains from the AfCFTA. Second, while the model considers the distribution of income or welfare changes across countries, it focuses on economy-wide changes at the national level, and does not consider domestic income distribution effects. These effects can be economically and socially important and deserve to be examined, and adequate responses to them provided. Third, work can be extended to capture some specific characteristics of African economies, including a broad coverage of the informal economy and informal trade between countries, as well as imperfect factor mobility across sectors.

This paper was prepared by Lisandro Abrego, Maria Alejandra Amado, Tunc Gursoy, Garth P. Nicholls, and Hector Perez-Saiz. IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF.

Source International Monetary Fund
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Date 10 Jun 2019
  8 minute read
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