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Tuesday, 13 March 2018

Assessing Regional Integration in Africa (3)

It is reasonable to assume that the most significant trend in this new millennium is global competitiveness

. In the face of the opportunities and challenges posed by the new paradigm of the “global economy,” nations are moving to integrate their economies with those of their neighbors, to create larger and more competitive regional economic blocs, and to engage in international trade—not just as individual states but as regional powers.

Africa’s regional integration has followed a similar pattern. A flurry of integration in the 1960s and 1970s was followed by a slowdown in the 1980s. But the 1990s saw a revitalization of regional integration efforts, culminating in the establishment, over three decades, of the African Economic Community. regional integration Benefits
Why do countries join regional integration arrangements? And to what extent do such arrangements achieve their goals? The benefits of regional integration are gains from
new trade opportunities, larger markets, and increased competition.
World Bank 2000b). Integration can also raise returns on investments, facilitate larger investments, and induce industries to relocate. Regional integration can commit governments to reforms, increase bargaining power, enhance cooperation, and improve security. But these benefits are neither automatic nor necessarily large. Regional integration arrangements must be viewed as means to improve welfare in participating countries—not as ends in themselves.

Trade creation and diversion

All formal regional integration arrangements reduce barriers (such as tariffs) to trade among member countries. Economic theory predicts that free trade will improve welfare by enabling citizens to procure goods and services from the cheapest source, leading to the reallocation of resources based on comparative advantage.
It is thus tempting to conclude that regional integration arrangements will generate welfare gains. But because they involve preferential reductions in trade barriers, regional integration arrangements are both trade creating and trade diverting. Trade creation— the displacement of higher cost domestic production by lower cost production from partner countries due to lower barriers within regional integration arrangements— increases welfare. But trade diversion—the displacement of lower cost production from nonmembers by higher cost production from partner countries due to lower barriers— reduces it. Regional integration arrangements generate welfare gains only when trade creation dominates trade diversion—an outcome that cannot be determined in advance.
Regional integration arrangements also generate two other trade effects, whose importance varies among member countries. First, such arrangements reduce government revenue from tariffs, directly through tariff cuts among members and indirectly through a shift away from imports from nonmembers subject to tariffs. The cost of this loss depends on how easily members can switch to alternative ways of raising funds, but it can be high in countries that rely heavily on tariff revenue.
Second, such arrangements may improve the terms of trade of member countries if changes in trade volumes (because of more demand for goods originating from an integration area and less demand for the same goods originating from outside it because tariffs make them more expensive) lower world prices. The greater the regional arrangement’s share in the world market, the larger the potential gain will be. But because the terms of trade gain comes at the cost of nonmembers, it has an unclear effect on global welfare.
So, do regional integration arrangements improve welfare in member countries? Econometric studies of changes in trade flows due to membership in regional integration arrangements and assessments of the general equilibrium effects of membership using computable general equilibrium models yield three main findings:
• Trade diversion is a major problem.
The best example is the Common Agricultural Policy of the European Union. Empirical estimates suggest that the cost of protection amounts to at least 12% of EU farm income. Other examples are clothing imports in the North American Free Trade Agreement (NAFTA) and capital goods imports in some Andean Pact countries (World Bank 2000b).
• The revenue losses can be substantial. For instance, Zambia and Zimbabwe could lose half their customs revenue if free trade is introduced in the South African Development Community (World Bank 2000b). Customs revenue provides 6% of government revenue for Zambia and 10% for Zimbabwe.
• Trade creation dominates trade diversion, but the gains are unlikely to be very large. The gain has been estimated to be up to 3% of GDP.

Scale and competition effects

Regional integration arrangements can benefit member countries through increased scale and competition, usually when countries, their endowments, or both are small and market size limited (Fernandez and Portes 1998; Venables 2000; World Bank 2000b). Small markets constrain the number and scale of firms or projects that can be sustained,
hindering competition among firms and the development of scale economies.
Regional integration can combine markets, enabling firms to expand and markets to be more competitive. More competition and the increased possibility of bankruptcy may induce firms to eliminate internal inefficiencies and raise productivity. The consequent reduction in staffing and more intense competition can increase worker productivity, an attractive benefit to small and low income countries—including those in Africa Several studies have computed potential scale and competition benefits of regional
integration, but actual gains have been hard to measure. The impact of regional integration on growth has also been difficult to assess (Vamvakidis 1998; Madani 2001).
A study for the Common Market of the South (MERCOSUR) suggests GDP gains of 1.8% for Argentina, 1.1% for Brazil, and 2.3% for Uruguay (Flores 1997).6 But these predict what might be expected, not what was achieved (World Bank 2000b).
Still, there appears to be a consensus—based on the evidence of the positive impacts that trade liberalization has on efficiency through scale economies and increased competition—that regional integration offers developing countries substantial benefits. But the consensus is qualified by two additional insights. First, many of these benefits can be achieved through unilateral (nonpreferential) trade liberalization. Second, full realization of these benefits requires firms to engage in more direct, intense competition, meaning countries must implement deep integration that removes protection and other barriers created by border frictions—including red tape at national borders and differences in national product standards.

Increased investment

Regional integration arrangements can increase investment in member countries by reducing distortions, enlarging markets, and enhancing the credibility of economic and political reforms. The results can raise the returns to investments, make larger (and lumpier) investments more feasible, and reduce economic and political uncertainty.
Moreover, customs unions can encourage foreign investors to engage in tariff jumping— that is, investing in one member country in order to trade freely with all members—expanding investments by local and foreign investors. Apart from its direct impact on production, increased investment—particularly foreign direct investment (FDI)—can
promote knowledge and technology transfers and spillovers, raising productivity in member countries (Blomström and Kokko 1997; Fernandez and Portes 1998; World Bank 2000b).
Empirical evidence shows that regional integration arrangements can increase investment. NAFTA substantially increased FDI in Mexico, and MERCOSUR did the same in Argentina and Brazil. The investment and investment-related benefits of regional integration arrangements exceed the costs of tariff jumping—real income losses that arise when the costs of local production, even in foreign-owned firms, exceed the costs of imports

Relocation of production

By reducing distortions and altering incentives, regional integration arrangements are likely to induce economic activities to relocate. Industries may relocate based on the comparative advantages of members relative to one another and to nonmembers. In addition, backward (demand-related) and forward (supply-related) links may generate interdependence among the location choices of different firms, triggering cumulative causation and creating agglomeration of activities. Relocation can change income levels and demand for factors of production, generating gains for some members and losses for others (Puga and Venables 1996; Venables 1999, 2000; World Bank 2000a, 2000b).
The European Union shows that regional integration arrangements can lead to income convergence. Ireland, Portugal, and Spain have made progress closing the gap with richer EU members. In the mid-1980s per capita incomes in these three countries ranged from 27% to 61% of the average income of large EU countries. By the late 1990s they ranged from 38% to 91%.
But the East African Community shows that regional integration arrangements can lead to income divergence, with comparative advantages and agglomeration effects concentrating manufacturing in Kenya at the expense of Tanzania and Uganda, leading the community to dissolve in 1977.
These experiences have led to the argument that income divergence is more likely in regional integration arrangements among developing countries, while convergence is more likely in arrangements between industrial and developing countries. But in the second case, the poorer countries must implement economic reforms to realize the potential gains, making it critical that regional integration arrangements—particularly those among low income countries—minimize the risk of income divergence, using compensation schemes or varied adjustment processes attuned to the heterogeneity of members