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Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Pol i c y Re s e a rc h Wo r k i n g Pa p e r 4627 Economic Partnership Agreements and the Export Competitiveness of Africa Paul Brenton Mombert Hoppe Richard Newfarmer The World Bank Poverty Reduction and Economic Management Network International Trade Department May 2008 WPS4627 Policy Research Working Paper 4627 Abstract Trade can be a key driver of growth for African countries, as it has been for those countries, particularly in East Asia, that have experienced high and sustained rates of growth. Economic partnership agreements with the European Union could be instrumental in a competitiveness framework, but to do so they would have to be designed carefully in a way that supports integration into the global economy and is consistent with national development strategies. Interim agreements have focused on reciprocal tariff removal and less restrictive rules of origin. To be fully effective, economic partnership agreements will have to address constraints to regional integration, including both tariff and nontariff barriers; improve trade facilitation; and define appropriate most favored nation services liberalization. At the same time, African countries will need to reduce external tariff peak barriers on a most favored nation basis to ensure that when preferences for the European Union are implemented after transitional periods, they do not lead to substantial losses from trade diversion. This entails an ambitious agenda of policy reform that must be backed up by development assistance in the form of aid for trade. This paper a product of the International Trade Department, Poverty Reduction and Economic Management Network is part of a larger effort in the department to contribute to the discussion of trade policy, competitiveness and export growth. Policy Research Working Papers are also posted on the Web at The author may be contacted at The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. Produced by the Research Support Team Economic Partnership Agreements and the Export Competitiveness of Africa 1 Paul Brenton, Mombert Hoppe and Richard Newfarmer International Trade Department The World Bank MSN MC H Street St. NW Washington DC Tel: (202) , Fax: (202) The views expressed in this paper are those of the authors only and should not in any way be attributed to the World Bank. We are very grateful for the comments of Shuby Andriamananjara, Gerrit Faber, Larry Hinkle, Elke Kreuzweiser and Jan Orbie. 1 1. Introduction Trade has been a key driver of growth in countries that have been successful in achieving high rates of growth over the past three decades, such as those in East Asia. If they are to accelerate their growth, trade will have to perform the same role for African countries. Designing policies that promote trade and trade competitiveness must therefore be at the heart of growth strategies for African countries. Economic partnership agreements (EPAs) with the EU could be instrumental in a competitiveness framework, but to do so they have to be designed carefully. Any successful EPA will need to take into account critical features of the new global economy: intense new competition emanating from large developing countries such as China, India and Brazil; simultaneous rapid growth of these economies opening up new dynamic market opportunities; explosive growth of services trade, creating new opportunities in the global market and offering new avenues for diversification away from primary commodities; the increasing importance of domestic institutions, policies and infrastructure in affecting productivity and the ability of a country s firms to compete in international market. In this new global context, the EPAs create an opportunity to undertake domestic reforms that support global competitiveness. A broad template for such reforms would include (i) reforms that improve the incentive framework especially by reducing tariff and non-tariff barriers to remove bias against exporting, (ii) increase access to and lower the costs of backbone services, such as telecoms, transport, energy and finance and (iii) address nontariff barriers and weak trade supporting institutions, including standards, customs, and trade promotion agencies and design effective mechanisms to assist the restructuring of domestic firms with the potential to be globally competitive. The EU can contribute by helping to design and support African countries in effectively implementing the provisions of a pro-development EPA. In this context Aid for trade associated with EPAs (and the multilateral discussions) can help build infrastructure and the institutional capacity that is necessary to remove NTBs, facilitate trade, regulate services and support trade promotion and firm restructuring. The first order of business is to reduce barriers to regional integration and allow African firms the opportunity to exploit nearby markets as a springboard to the global market. Typically these barriers also directly limit access to the global market. EPAs can play an important role in leveraging coherent regional reforms and in putting in place mechanisms that allow for coordinated development support from EU countries. The priority of delivering effective regional integration was recognized in the initial objectives of the EPA negotiations and was strongly identified as such by the EU Trade Commissioner in several speeches. In a context of wanting to have in place WTO consistent agreements when the Cotonou Agreement expired, the EU pushed hard in 2007 to define interim agreements that focus 2 primarily on reciprocal tariff reductions to satisfy GATT Article XXIV requirements. 2 The interim agreements also include an important relaxation of the rules of origin for certain products, but especially clothing, which had previously restricted preferential access to the EU market for African exporters. A number of African countries signed these interim agreements either collectively (as with the EAC) or individually. Other countries are expected to sign shortly, while other countries such as Senegal and Nigeria have been strongly critical of the interim agreements and have expressed reluctance to signing. If EPAs are to realize their development potential, it is important that these interim agreements do not become de facto EPAs -- otherwise the opportunity for such agreements to address constraints to competitiveness and integration into global markets and to be a key mechanism in supporting development in Africa will be lost. Bilateral reductions of tariffs is unlikely to be effective in driving rapid growth to the extent they leverage only minimally the domestic and regional reforms that are necessary to overcome the barriers that limit integration into the global economy. Many African countries have seen a very weak supply response to preferences in the past and this is unlikely to change unless these supply constraints are ameliorated. Worse, there is a real risk that removal of tariffs against the EU without broader tariff reform and in the presence of substantial NTBs to regional trade will lead to economic losses for African countries. Further, there are real concerns that the current patchwork of agreements will undermine regional integration. With the exception of the EAC, countries in the same regional bloc have signed agreements with the EU that have different product exclusion lists which will necessitate strict controls on the movement of EU products within regional groupings to ensure that a product exclusion in one country is not undermined by preferences for the same product in a partner country. 3 The EU Commission has asserted that these WTO-consistent market access agreements will be a stepping stone to deeper agreements in the future. However, whether the second stage of such a process will actually materialize remains to be seen as African countries may well lose the bargaining power domestically to obtain progress on competitiveness issues that came from market access concessions. 4 This paper elaborates on ways EPAs could be designed to drive growth through effective regional integration and integration into the global market. A first section highlights the trade challenge that African countries face and makes the point that preferences have not been effective in preventing the substantial decline in world market share of African countries. A second section describes opportunities that the new wave of globalization is opening up to African countries. A third section briefly discusses what this means in terms of a strategy to attain global competitiveness and suggests design features of an EPA that would complement and support competitiveness reform programs. 2 These require that the parties to a free trade agreement remove tariffs on substantially all (interpreted by the EU to mean 80% of mutual trade) trade under a defined and reasonable timetable. 3 See, Stevens et al (2008) 4 See, for example, Francesco Rampa, Love is blind? A two-stage agreement risks being an EPA tight rather than an EPA light, ECPDM, ICTSD_Love-is-blind-A-two-stage-agreem%E2%80%A6.pdf 3 2. The trade challenge facing African countries The trade preferences that have been granted to the ACP countries by the European Communities under the Yaoundé, Lomé, and Cotonou Agreements for the last 30 years will expire in Negotiations for a new WTO consistent trade agreement have been taking place for the last 5 years. To limit the demands of negotiating agreements with each ACP country the EU has pursued negotiations to establish six Free Trade Areas (FTAs). To date, negotiations have advanced only slowly and there is considerable debate as to how EPAs should be designed and what elements and commitments they should contain. Before proceeding to these issues it is important to reflect upon the impact of current and previous EU development agreements. We focus our description of past trends on Eastern and Southern Africa (the ESA-region in the EPA negotiations). The trade challenges that we highlight for ESA are probably broadly similar to those facing most of the other EPA regions. The average share of global merchandise exports of the ESA countries was small 25 years ago -- but has by now fallen to half its original level (Figure 1). Most of the decline occurred in the 1980s with a leveling off in the 1990s but little subsequent rebound. The performance of the average ESA country stands in stark comparison with the average of a group of 16 fast growing countries 5. It is the trade and growth performance of these countries that African countries will have to replicate over the next 20 years if the targets that they have set for poverty reduction are to be achieved. On average, the fast-growing countries of the past two decades have seen their share of global exports rise rapidly (a 3- fold increase over the past 25 years), fuelling the sustained growth that these countries have enjoyed. The figure highlights the importance of trade for the fast growing countries and shows the lacklustre export performance of the average country in the ESA region. Given the small (economic) size of most countries in Sub-Saharan Africa, the role that trade can play for the achievement of robust and sustained economic growth is particularly important. The figure indicates the enormous potential for sustained growth of exports from the ESA region. 5 This group contains non-oil exporting countries that have grown at an average annual rate of growth of 4.5 per cent of more over the past 25 years. The averages are unweighted so that country size does not influence the measure. The sixteen countries are Botswana, Sri Lanka, Chile, Indonesia, Pakistan, Mauritius, Uganda, Burkina Faso, India, Thailand, Malaysia, Taiwan, Cambodia, Singapore, Korea, Rep., and China. 4 Figure 1: In contrast to the fast growing countries of the past 20 years, ESA countries have lost share of the global market for merchandise Average share of world merchandise exports (% of US$ current) Average HP % 1.0% Average High Performing 16 Average ESA 0.04% 0.04% 0.03% 0.8% 0.03% 0.6% 0.4% 0.2% Average ESA 0.02% 0.02% 0.01% 0.01% 0.0% % Source: Bank staff calculations, based on data from IMF World Economic Outlook, Ethiopia and Eritrea counted as one country Figure 2 shows a similar story for exports of services. The average ESA country has had a very low and declining share of the global market for services. This is in contrast to the fast growing countries, which have, on average, almost tripled their share of the world market over the past 25 years. Hence, the challenge for ESA and other ACP countries is to provide a trade policy climate in which to attain the sustained increases in exports of both goods and services and rising global market shares that have driven growth in the high performing countries. These figures also suggest a lack of effectiveness of current and previous agreements with the EU in supporting sustained growth of exports or in dealing with the constraints that have undermined the share of ESA countries in the world market. In other words, this weak performance occurred despite preferential access to the EU and other markets. Preferences alone have not helped to strongly integrate ESA into the global economy. With decreasing margins of preference due to continued multilateral liberalization, they are even less likely to help in achieving this objective in the future. 5 Figure 2: Whilst fast growers have used trade in services to drive growth, ESA countries have been less successful Average HP % Exports of service as share of world services trade (% of US current dollars) Average ESA 0.04% 0.8% 0.7% 0.6% 0.5% Average for HP % 0.03% 0.02% 0.4% 0.3% 0.2% 0.1% Average for ESA 0.02% 0.01% 0.01% 0.0% % Source: Banks staff calculations, based on data from W orld Economic Outlook, Ethiopia and Eritrea counted as one country There are three key reasons why preferences have not been effective in stimulating a significant export response in ACP countries. 6 First, preferences have not dealt with, and may have distracted attention away from, the key supply side constraints that limit access to all markets. Brenton and Hoppe (2007), for example, find that whilst preferences for clothing have supported exports to the EU and US they have not overcome the negative impact of weak governance in Africa on the sourcing decisions of global buyers. The conclusions from a review of the range of diagnostic trade integration studies 7 that have been undertaken in least developed countries concludes that the principal constraints to trade are typically those that limit access to and raise the costs of the key backbone services that are critical for competitiveness (transport and logistics, energy, finance, telecommunications). These problems are compounded by poorly designed structures of incentives that constrain the flow of resources into their most productive uses and weak and ineffectual trade supporting institutions, such as customs, standards, export promotion agencies, trade ministries themselves, and the often existing fragmentation of authority with regard to trade related issues between a number of ministries, coupled with a lack of communication between stakeholders. Second, and related, preferences margins for many of products currently exported by African countries are typically small and have, and will continue, to be eroded, by multilateral trade liberalization and the EU s predilection to sign free trade agreements. It should be pointed out that 46 percent of exports from Africa to the EU are concentrated in 6 Ollareaga and Ozden (2005) suggest that preferences may actually have hindered integration of poor countries into global markets, showing that those countries that received preferences tended to have liberalised their own trade policies less than those developing countries that had not received preferential access to OECD markets. 7 See Biggs (2007) 6 oil products. Of the remaining non-oil exports, 58 percent enter the EU under a zero MFN tariff rate (this percentage is similar for both LDCs and non-ldcs). The value of preferences that many in individual ACP countries perceive is often far in excess of reality. For example, looking at the 13 non-ldcs which may lose some of their preferential access to the EU if they do not sign an EPA and revert to the GSP, the value of preferences under Cotonou amounted to only 3.9 percent of their exports to the EU or EUR 782 million in The value of EU preferences for African LDCs is less at 2.1 percent of their exports to the EU. 9 (The appendix provides a more detailed discussion of the value of EU preferences under Cotonou and the GSP.) Third, for products where margins of preference have been substantial, such as clothing, market access has been severely limited by restrictive rules of origin imposed by the EU. Prior to the end of the Agreement on Textiles and Clothing, exports of apparel from African least developed countries (LDCs) to the EU stagnated despite preferences, whilst exports to the US under AGOA grew very strongly (Figure 3). Exports of apparel from African LDCs to the EU and US were almost equal in 2000, but the value of exports to the US in 2004 was almost four times greater than the value of exports to the EU. Source: USITC and Eurostat The key factor explaining why exports to the US grew much faster than to the EU is the rules of origin. EU rules stipulated production from yarn. This entails that a double transformation process must take place in the beneficiary with the yarn being woven into fabric and then the fabric cut and made-up into apparel. These rules prohibit the use of imported fabric, although cumulation provisions allow for the use of inputs produced in the 8 Under the GSP the value of their preferences would fall to 0.5 percent of their exports or EUR 103 million, a loss of EUR The value of ACP/GSP preferences for all African countries (excluding South Africa) equals 2.6 (3.3) percent of their respective exports. South Africa accounts for about a third of all SSA exports to the EU. 7 EU and other ACP countries. To obtain preferences, apparel producers had to use local, EU or ACP fabrics. They could not use fabrics from the main fabric-producing countries in Asia and still qualify for EU preferences a binding restriction, since few countries in Africa have competitive fabric industries. Until the recent EPA agreements, the EU rules did not allow producers in low-income African countries the flexibility they currently have had under AGOA to source fabrics globally. It is worth remembering that the EU granted preferences to African countries for apparel subject to these strict rules of origin for more than 20 years under the Lome and then Cotonou agreements. However, these strict rules did little to encourage the development of an efficient fabric industry in Africa, the main justification for their imposition, 10 and are likely to have severely constrained the impact of preferences in stimulating the clothing industry. 11 This is because a competitive and thriving clothing sector is the most important driver for a local textile industry. By limiting the ability of the clothing firms in Africa to source inp
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