A quarterly magazine of the IMF

December 2006, Volume 43, Number 4

Unblocking Trade
Sanjeev Gupta and Yongzheng Yang

To underpin growth, Africa needs to adopt a comprehensive approach to boosting trade

Despite its improved economic performance in recent years, Africa is still lagging on trade. Since 1970, trade (exports plus imports) in sub-Saharan Africa (SSA) has grown at three-fourths the world rate and only about half Asia's rate. Africa's share in world trade has thus fallen from 4 percent in the 1970s to 2 percent today (see Chart 1). Its trade openness (measured by the trade-to-GDP ratio) has also grown more slowly than that of any other major developing region, and, in 2001, Africa supplanted Latin America as the region of the world least open to trade.

Africa's growth still falls short of the 7 percent required for Africa to achieve the Millennium Development Goal of halving poverty by 2015. What more can one of the poorest regions of the world do to boost living standards? Trade, which has not reached its potential as an engine of growth, is essential, despite the setback to the Doha Round trade talks.

Shifting trade patterns

Africa's exports remain dominated by primary commodities, with fuels accounting for about 40 percent and agricultural products for more than 25 percent. Only a few countries, such as Zambia and Kenya, have achieved some diversification of their exports, and the share of manufactured goods in Africa's total exports has stagnated at about 30 percent (see Chart 2), well below that in other developing regions. Moreover, manufactured exports from African countries have a narrow base and low value added; often, they are semiprocessed raw materials or products that have preferential access to industrial countries.

However, recent surges in the world demand for commodities may have turned Africa's concentration in commodities into a temporary advantage. Although Africa's main trading partners remain industrial countries, the share of its exports to developing countries has more than doubled since 1990 (see Chart 3). As Asia industrializes, its demand for natural resources increases, and Africa has responded to the export opportunity. Asia now receives about 25 percent of Africa's exports. China and India—which are undertaking major investments in the African continent—together account for about 10 percent of both SSA exports and imports, 25 percent more than these two countries' share in world trade.

Developing countries are taking more of Africa's textiles and clothing—often regarded as a spearhead of manufactured exports—auguring well for the future growth of this sector. Manufactured goods dominate imports from both developing and developed countries. Within manufactured imports, consumer goods dominate imports from developing countries, although imports of machinery and equipment from China and India are significant. Imports of consumer goods tend to compete with local products, causing concern among local producers, but African consumers have benefited from their low cost.

Obstacles to export expansion

Africa's poor export performance to date has many roots.

Unstable macroeconomic situation. Until recently, SSA countries had high inflation and large deficits in government budgets and external current accounts, which have been blamed for the region's low exports and poor overall economic performance. The human resource base and infrastructure have also been weaker in Africa than in other developing regions, as have the legal and regulatory framework and governance. These problems, combined with the high incidence of policy distortions, have raised the costs of doing business in Africa.

Anti-export bias. This bias persists despite the removal of many nontariff barriers and a drop in the average tariff—from 22 percent in 1997 to 15 percent in 2006. The average tariff is still the highest among developing regions (see Chart 4) and masks large variations among countries (ranging from a few percent to close to 40 percent) and commodities (from zero to well over 100 percent).

Cascading tariff structure. Tariff rates typically increase with the degree of processing of a product. The cascading tariff structure disadvantages the primary sector, particularly agriculture, which has also been plagued by depressed producer prices because of state monopolies on export marketing—a phenomenon that is now far less common—and because of import restrictions and subsidies in industrial countries. The tariff structure also encourages import substitution in the manufacturing sector.

Unsuccessful policies. Africa has attempted to emulate the export incentive schemes applied in Asia and elsewhere and has tried to attract foreign direct investment (FDI) by, for example, creating investors' advisory councils. However, these policy moves appear to have had a limited effect on either trade or FDI. Export incentive schemes, which are prone to rent-seeking activities, are difficult to manage everywhere. But African countries have had far fewer successes than other countries, and their successes have often been with products that have preferential access to industrial countries, as is the case in Lesotho, Madagascar, Malawi, and Swaziland.

Unfavorable business environment. Although African countries have reduced most-favored-nation (MFN) tariffs, they could do much more to improve the business environment. Unless this environment improves, policy reforms will not stimulate trade. For example, losses from power interruptions average 6–7 percent of sales in Ethiopia and Zambia, and 10 percent or more in Eritrea, Kenya, and Senegal. A round-trip between Nairobi and Mombasa, which should take no more than 24 hours, requires an average of 2.5 days instead because of road congestion and delays at weigh bridges. A study by Eifert, Gelb, and Ramachandran (2005) spotlights Africa's slow progress in reducing the costs of doing business in the manufacturing sector. Corruption is also a significant deterrent to business investors.

Lack of competitiveness. Africa's relatively high prices for nontradable goods and services make its tradables sector less competitive. The Eifert study estimates that overall prices (determined by prices of nontradables if prices of tradables are set by the world market) in a group of African countries are 31 percent higher than would be predicted by their income levels. In contrast, China is 20 percent lower and South Asia 13 percent lower than the predicted levels. This real exchange rate overvaluation, together with skill shortages and technology gaps, probably explains why Africa's manufacturing firms are so much less productive than firms in other regions.

High indirect costs. These costs—which include energy, land, transportation, telecommunications, security, insurance, and marketing—substantially reduce African firms' net value added (gross value added minus indirect costs), squeezing their profits (see Chart 5). The root cause of indirect costs is often the weak legal and regulatory framework. In countries with low indirect costs, net value added typically accounts for over two-thirds of gross value added, whereas these costs typically reduce African firms' net value added to about half of gross value added. Thus, most African countries could improve profit margins more by reducing indirect costs as a share of total costs to the level of Senegal (a high performer with relatively high productivity although significantly less efficient than China) than by halving labor costs.

Regional arrangements are not helping

African countries have recently intensified their efforts to expand trade with their neighbors through regional trade arrangements (RTAs). In fact, although African countries are currently negotiating with the European Union on economic partnership agreements (EPAs), most RTAs are among African countries. There are now some 30 on the continent, with each SSA country belonging, on average, to 4.

In principle, RTAs can bring significant benefits to African countries, especially landlocked countries whose trade can be facilitated by RTA transit arrangements. But, with only a few exceptions, such as the Southern African Customs Union and the recently improved West African Economic and Monetary Union, Africa's RTAs are poorly designed and implemented. Most deal only with tariffs, and even tariff reductions are often subject to extensive exemptions and long transition periods. Fearing the loss of revenues, some countries have delayed reducing tariffs; other countries have found it difficult to fulfill the multiple, often conflicting, commitments arising from membership in several RTAs.

Many RTAs run the risk of trade diversion because of member countries' relatively higher MFN tariffs, which induce members to import more from each other rather than shop for the most competitive prices. However, since the RTAs tend to cover only a small proportion of member countries' trade, the potential for trade diversion is relatively small. The EPAs now being negotiated also need to be watched closely. Despite their potential for bringing larger benefits through deeper integration (for example, enhanced regional infrastructure and policy harmonization), EPAs could cause much greater trade diversion because of the European Union's greater weight in SSA's trade.

Africa's RTAs are unlikely to expand regional trade much further relative to the region's overall trade. Though at 10 percent intracontinental trade appears low, trade among African countries is already six times as intense as the region's average trade with any other country (measured by the ratio of the share of intra-African trade to Africa's share in world trade) despite the fact that the economic structures of African countries are less complementary. In the mid-1990s, machinery and transport equipment accounted for 75 percent of African imports but for less than 4 percent of intra-African trade. Africa's heavy concentration in commodity trade means fewer opportunities for product differentiation and trade associated with manufacturing industries.

Nor can African RTAs expand market size enough to exploit economies of scale. Measured at market exchange rates, SSA's total GDP is about the same as Australia's; excluding South Africa, the continent's largest economy, GDP is not much higher than Austria's. In addition to most RTAs' nontariff barriers, the effective market size created by RTAs is diminished by minimal market integration, impeded by poor transport, internal trade barriers, and other bottlenecks. For example, on the 1,000-kilometer highway between Lomé, Togo, and Ouagadougou, Burkina Faso, there are some 34 checkpoints—close to one every 25 kilometers.

From commodities to manufacturing

Experiences from other regions of the world suggest that Africa's concentration in commodity exports may be temporary. Many developing countries that are now dynamic exporters of manufactured goods initially relied on exports of primary commodities. This is true of resource-rich countries (such as Chile, Indonesia, Malaysia, and Thailand) and of some resource-poor economies (Republic of Korea and Taiwan Province of China). As recently as the mid-1980s, China, too, relied on exports of primary commodities, including oil—a major import that drives its trade with Africa.

But as exports of primary commodities increased and growth accelerated, these dynamic exporters shifted from import substitution to export promotion in manufacturing industries. As they brought down import tariffs, they created a second-best environment for the export sector through incentive schemes (for example, export processing zones and the rebate or exemption of duties on imported materials for export production), using them essentially to offset the remaining anti-export bias of their trade regime. Some have attracted significant FDI, which has helped them upgrade domestic technology and fill in gaps in management and marketing skills.

A plan for boosting trade

To make trade work, African countries need to pursue change on several fronts. They must maintain macroeconomic stability and improve physical infrastructure and the human resource base. Structural reforms that bring down the costs of doing business—including by strengthening governance, the legal and regulatory framework, and the financial sector—are also key. The best way to create a favorable environment for trade growth will, however, vary from country to country; each should formulate its plan in terms of its own poverty reduction and growth strategy. But, the focus should be on tackling supply constraints and responding to shifting global demand.

All African policymakers should continue liberalization on a nondiscriminatory basis. To reduce the risk of trade diversion arising from RTAs, African countries need to slash their MFN tariffs. African exporters must have access to the cheapest imports so that they can compete globally; they need to bring in foreign technology and know-how and use foreign machinery and equipment, which are often unavailable from RTA partners. Although trade liberalization entails adjustment costs for local industries, it also improves economic efficiency over the long term, which should outweigh the costs, particularly if other domestic reforms are also carried out.

Concerted efforts are needed to reduce external tariffs, especially in customs unions. Such efforts are particularly important because of the current impasse in the World Trade Organization (WTO) negotiations. Africa's trade liberalization needs to move forward and should extend to nontariff barriers, especially the roadblocks and checkpoints that impede cross-border trade. Some RTAs need to simplify their rules of origin and make them more transparent. Similar clear rules should also be incorporated into EPAs. The current EPA negotiations with the European Union offer a unique opportunity to streamline RTAs and, in some cases, merge or abolish them. The African Union has on its agenda the streamlining of RTAs.

As part of broad trade reforms, SSA countries should continue to facilitate trade at customs points, simplify customs procedures, and improve trade logistics (for example, transport and warehousing). Improving customs administration would also mitigate potential revenue losses from tariff reductions, including in the context of the EPAs. Broadening the tax base by eliminating exemptions will be particularly important.

African countries should embrace the opportunities and challenges presented by the integration of other developing countries with the global economy. Expanding their trade with other developing countries will help offset the effects of preference erosion in industrial countries. A failed Doha Round will not eliminate preference erosion because industrial countries continue to reform their trade policies, and RTAs may proliferate even faster.

They should also reduce the costs of doing business to attract FDI from developing countries, not only to resource industries but also to manufacturing industries (where developing country technologies may be more appropriate because they are labor intensive). African policymakers must also be alert to any domestic backlash against closer trade and investment ties with developing countries and be ready to point out that these ties will benefit their economies.

As for the international community, it should increase aid for trade to help Africa reduce trade bottlenecks (including regional ones) while trying to revive the WTO negotiations. Aid for trade in the form of technical assistance, project finance, and adjustment support for trade reforms will allow African countries to respond swiftly to the opportunities created by trade reforms. Such aid could also facilitate regional cooperation in addressing gaps in infrastructure, coordinating the regulation of public goods, and achieving economies of scale.

Increased aid for trade could be delivered through the enhanced Integrated Framework for Least Developed Countries. Under this multilateral initiative, diagnostic trade integration studies have been carried out for a number of SSA countries, detailing their trade strategies. These strategies should be implemented as part of national strategies for poverty reduction and growth. Indeed, only by adopting a holistic approach can African economies succeed.