High hopes for the African Continental Free Trade Area
The start of the African Continental Free Trade Area has come with high hopes. But free trade agreements in themselves are no silver bullet for backward economies. Infrastructure investments and institutional reforms will be key for the development to accelerate.
In a nutshell
- Africa’s continent-wide free trade agreement has taken effect
- Reform will also be needed to reap the economic benefits
- Several African regimes have reason to resist such reforms
- The free trade area may not bring the growth many hope for
The African Continental Free Trade Area (AfCFTA) entered into operation as of July 7, 2019. Forty-four countries signed the agreement to create the intra-African free trade zone in March 2018 at the African Union (AU) summit in Kigali, Rwanda. Since then, several other states have signed on, making 54 out of 55 AU members party to the deal. Notably, economic giant Nigeria signed in July at the AU summit in Niamey, Niger. Twenty-seven countries have ratified the agreement (22 were needed for it to come into force). The project creates a single market with a customs union, allowing the free movement of goods, capital and businesspeople.
There is a profound link between trade, peace and development: Strengthening trade links typically brings economic gains and tends to secure political stability, since it renders war increasingly counterproductive. Western Europe’s post-World War II reality was built on similar foundations, an initiative that history has proven successful. The recent steps toward Africa’s economic unification could unlock development opportunities, but only if several significant obstacles are removed. While the project looks attractive on paper, as always, the devil is in the details.
Despite several regional agreements such as the Economic Community of West African States (ECOWAS) or the Common Market for Eastern and Southern Africa (COMESA), Africa is still economically fragmented. Trade between African nations amounts to only 16 percent of the continent’s international trade. Intracontinental trade is about 37 percent in North America, 50 percent in Asia and over 60 percent in Europe. The AU hopes AfCFTA will take the African figure to 32 percent within a decade.
Eliminating Africa’s economic fragmentation could enable its firms to seize economies of scale.
With 1.2 billion people and a total gross domestic product of $2.5 trillion, eliminating Africa’s economic fragmentation could enable its firms to seize economies of scale and offer opportunities for new companies to develop. The economic case for “defragmenting” the continent’s economy is therefore very strong. It could unlock vast potential for entrepreneurial opportunities.
The benefits of a larger market were described nearly 250 years ago by no other than Adam Smith. Widening the extent of the market enables a deeper division of labor and finer specialization across society. This phenomenon occurs especially because a larger number of people (a bigger demand or market) means fixed production costs related to specialization investment (both in terms of human training and machines) can be spread out. This more intense specialization helps spur productivity as innovation kicks in, and finally incomes rise.
Higher incomes themselves also represent an increase in market size – through greater capacity to purchase – reinforcing the process of specialization, productivity gains, higher incomes and so on. This increased specialization occurs not only within firms but also between firms, with new specialist firms emerging and more business-to-business spending. Increased competition spurs more competitiveness – an important incentive for innovation. This process is actually the foundation for sound, industrially diversified, economic development. Eliminating barriers to a large African market thus seems key.
The AfCFTA is part of the AU’s Agenda 2063, which also includes projects such as a continental high-speed rail network, an African commodities strategy, an African passport and a single African air-transport market. The AfCFTA sets forth several objectives for trade liberalization to spur development and industrialization.
Facts & figures
African Continental Free Trade Area: signatories and ratifying countries
The first phase of the AfCFTA focused on trade liberalization of goods and services. It covers three main areas: The first is a trade protocol on goods: customs cooperation, trade facilitation, sanitary and phytosanitary measures, rules of origin, tariff reduction (on 90 percent of goods, with 3 percent permitted to be excluded and 7 percent – sensitive goods – to be included at a slower pace) and nontariff barriers. The second is a protocol on services and the third is dispute settlement procedures. The agreement’s second phase deals with competition policy, intellectual property and investment.
Thanks to the AfCFTA, continental trade could grow by a third to a half – even by 80 percent according to an International Monetary Fund study last May. The IMF study found “welfare gains” could be increased by about 2 percent in the case of full tariff elimination with a 35 percent reduction of nontariff barriers. According to the same study, the increase in tax collection due to the growth of consumption and incomes would more than offset very modest losses in tariff revenues. And the rest of the world would also gain from the AfCFTA. In June, a United Nations Conference on Trade and Development report estimated global GDP could rise by 1 to 3 percent.
For substantial economic development to occur, more than increased trade among countries on the continent is needed – a range of important conditions must be present. Those who expect positive outcomes to occur automatically, or for free trade treaties to provide a silver bullet to economic distress, may be severely disappointed.
Trade liberalization is not only about reducing tariff barriers. It is much broader. The AfCFTA treaty does include various procedures to make the project viable. However, several of these, both in the first and second phases, have not yet been implemented and could cause endless negotiations and postponements. On top of that, liberalizing trade should also involve some kind of institutional reform. The challenges here are considerable.
Less developed countries could block necessary reforms under the pretext that they are losing out.
Some countries that are more economically open today could naturally gain more from the agreement. They are better equipped to seize economies of scale given both their industrial base and human capital. Leaders of other, less developed countries could therefore decide to negotiate even more favorable tariff reduction schedules and more exceptions. Zimbabwe already requested a period of 15 to 20 years to phase out its tariffs. These countries would actually linger on or block necessary reforms under the pretext that they are losing out.
The special Most-Favored Nation (MFN) clause of the AfCFTA could actually exacerbate this phenomenon, as it is not unconditional and automatic (a concession granted to one country by another should be granted to all). Instead, it is reciprocal: countries would be treated differently and thus obtain different rights, leading to complexity and uncertainty rather than harmonization. The definition of which goods fall under the 10 percent exemption for the tariff elimination could lead to endless negotiations.
At the same time, such negotiating behavior could hide a lack of genuine dedication. After all, opening up trade will weaken the position of several autocrats and dictators: competition would disrupt the crony economic system they have put in place. Moreover, increased economic freedom usually leads to more political freedom (China notwithstanding) – another threat to many African leaders. Considering all this, and the way many of these leaders have flouted the pledges to clean up corruption that they made to obtain foreign aid, it is easy to remain skeptical as to whether they are genuinely committed.
Bowl of spaghetti
Economist Jagdish Bhagwati once described the proliferation of free trade agreements as a bowl of spaghetti: the map of various bilateral and regional agreements looks very complex indeed. In Africa, the existing regional economic communities sometimes overlap. Some countries belonging to them have signed but not ratified the AfCFTA agreement, while others have done both. Yet the four existing custom unions should, in principle, negotiate as a bloc. The question of who will negotiate what with whom remains. Moreover, some countries belonging to these customs unions are less developed countries that will receive special treatment.
Some experts fear that the AfCFTA will add layers of complexity to the rules, rather than simplify them.
The potential for catch-22 situations should not be underestimated. In this context, the best idea would be to harmonize toward simplicity, and to avoid adding anything that could complicate matters. More fragmented institutional rules for entrepreneurs and businesses at the continental level would hinder progress. However, some experts fear that the AfCFTA will add layers of complexity to the rules, rather than simplify them.
Rules of origin – the criteria to define a product’s territorial origin and added value, thereby determining its eligibility for AfCFTA preferential tariffs – are a major topic of phase I. They are still on the table and could prove very problematic depending on how strictly their value-added threshold is defined.
Advanced countries with a fairly industrialized base can probably provide more such products. Less developed countries and their small, under-industrialized manufacturing businesses may need to import components from outside, indirectly benefiting foreign players. Higher thresholds would be disruptive for them. Negotiating the rules of origin thresholds could thus prove complicated and time-consuming.
And let us note that phase II aspects (competition policy, intellectual property, investment) have barely been touched yet – leaving these questions unresolved and open to, again, potential endless negotiations.
Nontariff barriers to trade are as important as tariffs – probably even more important in Africa’s case. For example, in many of these countries, the rule of law is weak, meaning corruption is a big problem. One nontariff barrier to trade is military or militia corruption at the border, a cost for exporters and importers. Without serious commitment to enforcement, such barriers will remain in place.
Quality of infrastructure is also a crucial condition for trade. Africa’s roads are generally in poor condition. Facilitating trade requires usable roads. The same goes for the supply of electricity. This again relates to the degree of government accountability in performing public works. Though many African countries could use maritime routes for export and import, many African ports are run down or technologically behind, preventing more direct trade.
More generally, African countries’ institutional environment is problematic for business and trade. Take Algeria – not the poorest African country. The World Bank’s 2019 Doing Business report ranks it 157th in ease of doing business, and 173rd in ease of trade across borders. It notes that time to export in terms of border compliance is 80 hours – that compares to 12.5 hours in the rich, developed countries of the Organisation of Economic Co-operation and Development (OECD). In terms of documentary compliance, the figures are 149 hours versus 2.4. Documentary compliance in the cost to import is 16 times more expensive than in OECD countries: $400 versus $24.90.
The Democratic Republic of the Congo, ranked 184th in the report and 188th for cross-border trade, is even worse: for exports, the cost of compliance with procedures is $2,223 versus $605 for the sub-Saharan Africa average, and versus $139 in OECD countries – 16 times more expensive. When it comes to imports, compliance is 30 times more expensive than in the OECD. This offers an idea of how big the hurdles to reducing nontariff barriers really are.
It thus seems that the crucial condition for the AfCFTA to deliver its promises is good governance. Pressure from partners within the trade area could stir movement toward it – but a large dose of optimism seems necessary to believe that will happen.