Risks and Rewards of Regional Trading Arrangements in. Africa: Economic Partnership Agreements (EPAs) Between the EU and SSA - PDF

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Draft for Discussion Comments Welcome Risks and Rewards of Regional Trading Arrangements in Africa: Economic Partnership Agreements (EPAs) Between the EU and SSA Lawrence E. Hinkle and Richard S. Newfarmer*
Draft for Discussion Comments Welcome Risks and Rewards of Regional Trading Arrangements in Africa: Economic Partnership Agreements (EPAs) Between the EU and SSA Lawrence E. Hinkle and Richard S. Newfarmer* January 7, 2005 * The authors are grateful to Maurice Schiff for his contributions to the first phase of the analytical work on EPAs, on which this paper draws heavily. They would also like to thank Paul Brenton for his inputs on the EU s preference schemes and rules of origin and Luis de Azcarate and Jonathan Munemo for reviewing and commenting on drafts. The views expressed in this paper are those of the authors. These views are not necessarily those of the World Bank, its Board of Directors, or the governments that they represent and should not be attributed to them. Risks and Rewards of Regional Trading Arrangements in Africa: Economic Partnership Agreements (EPAs) between the European Union and Africa Summary To replace the Cotonou trade preferences, which are scheduled to be phased out in 2008, the EU and ACP countries are negotiating Economic Partnership Agreements. Conceptualized as vehicles to promote development while bringing EU-ACP trade relations into compliance with WTO rules, the EPAs in Africa would have as their centerpieces negotiated reciprocal preferential trading arrangements between four regional trading blocks and the EU. The EPAs are envisaged to include mutual access to each others markets, liberalization of trade in services, a regulatory agenda to promote investment and competition, and institutional provisions to facilitate trade as well as related technical and financial assistance for trade and development. The EPAs could, if designed and implemented in their most development-friendly form, have a profound positive impact on trade and incomes -- in African countries. If the EPAs provide enhanced market access to the EU, tear down external and intra-regional trade barriers in the regional EPA groupings, and reduce institutional frictions to trade, the development gains could be great. Realizing the potential of this substantial development stimulus, however, requires surmounting some important obstacles in the fundamental design of EPAs. This paper analyzes those associated with expanding merchandise trade, including: Creating incentives for trade reform. Many African countries are reluctant to undertake needed trade-related reforms. It is unclear whether the incentives in the current EPA design are sufficient to stimulate the required trade reforms. The enticement of improved and more stable access to the EU market is weak for the 33 LDCs in SSA because they already enjoy secure duty-free and quota-free access through the EU s Everything But Arms Initiative, and so their incentive to offer reciprocal concessions is low. For their part, the 13 non-ldcs in SSA will benefit in any case from preferential access under the EU s GSP system, although the GSP preferences as not as attractive as those under the Cotonou preferences and annual ii reviews subject the GSP regime to protectionist forces and periodic product revocation. Whether offering the 13 non-ldcs complete tariff-free and quota-free market access in the EPAs plus the added security of a formal trade agreement will be sufficient inducement to elicit reforms remains to be seen. If the EU were to offer much less restrictive rules of origin for the EPAs than those under the GSP or Cotonou regimes as well as a more ambitious program of aid for trade, it might tip the incentives favorably. Reductions in export subsidies and domestic production support for agricultural products of particular interest to SSA perhaps as part of a reformulated Doha position -- could also help to increase the incentive for trade reforms. Reducing high tariffs and other border protections that would impose inefficiencies through trade diversion and monopoly pricing in EPA groupings. Many SSA countries and some customs unions still have high tariffs and other restrictions on trade. Granting preferential access to the EU while maintaining high MFN tariffs is likely both to displace more efficient sources of supply and to induce losses in tariff revenues that result in trade and income losses rather than gains for SSA countries. EPAs that ratified and consolidated high levels of protection in SSA would entail severe risks and would likely be counterproductive. These risks could be attenuated if the preferential margin granted to EU imports is limited to no more than 5% and maximum MFN tariff rates are lowered to 15% at the same time as tariffs on imports from the EU are reduced. Offsetting revenue losses resulting from lowering tariffs on imports from the EU to avoid undermining public finance in the SSA countries. Many countries within EPA groups derive 10-30% of their revenues from import tariffs. Since the EU is a major source of these imports, granting it duty-free access would significantly reduce the revenue base of government. This loss could be offset through a combination of value-added and excise taxes collected at the border and domestically, but the required restructuring of indirect tax systems and related improvements in tax administration require institutional changes that will take time. In addition, to provide for necessary growth in public revenues some countries may need to maintain a revenue tariff of 5-10% on imports from the EU. iii Reducing intra-regional barriers to trade in existing customs unions and FTAs. All regional trade arrangements in Africa, save for SACU, have internal barriers to trade such as restrictive rules of origin and other controls that impede trade and protect existing industries. Although the interests behind these barriers will constitute formidable political voices against internal liberalization, achieving the regional integration objectives of the EPAs will require SSA countries to remove current barriers to intra-regional trade. Reconciling common external tariff proposals with diverse levels of regional integration. EPAs in their initial conception were envisaged to be agreements between the EU and customs unions that have the common external tariffs. However, the EPA country groupings in Africa exhibit considerable variation in degrees of integration; and few, if any, are capable in the medium term of reducing internal border barriers or in coordinating their trade regimes to the extent required in a full customs union. This diversity suggests that ultimate designs of the various different EPAs will have to permit flexible combinations of customs unions and free trade agreements. Allowing for enough flexibility to accommodate differing conditions among countries within each EPA grouping. The four EPA groupings of countries all comprise some LDCs along with non-ldcs. EPA groups also comprise small countries along side one or two dominant large countries. Commitment to trade reform, both in terms of external and intra-regional liberalization, also differs substantially. Accommodating these diverse interests may require enough flexibility in program design to allow for some differences in the trade regimes in the same EPA, at least in initial phases. There are many obstacles to expanding production of tradable goods in Africa in addition to the trade-related reforms noted above, and the readiness of individual countries to use the EPA process to leverage a wide range of reforms will be critical in determining their success. The investment and supply responses to the EPAs reforms will be much greater if they are followed by actions in other areas. Particularly important are (a) a competitive exchange rate policy that encourages the expansion and diversification of exports; (b) liberalization of services imports and related regulatory reforms in the services sector; (c) institutional reforms in customs administration and other areas of trade facilitation; (d) improvements in the investment climate iv to encourage a supply response from the private sector; and (e) infrastructure investment. From the perspective of individual countries, some of the foregoing reforms may, in fact, be higher priorities than the EPA-related trade reforms. It may be possible to address some of these supply-side and behind-the-border reforms (investment, competition policy, trade facilitation) by including trade in services and some of the Singapore issues in the EPA process, and this possibility merits serious examination. 1 However, others reforms may have to be tackled unilaterally by the countries concerned if they are to benefit fully from the EPA process. 1 The potential role of trade in services, investment, and competition in EPAs will be examined in a subsequent paper. v Risks and Rewards of Regional Trading Arrangements in Africa: Economic Partnership Agreements (EPAs) Between the EU and SSA Table of Contents 1. Introduction: A Development Perspective on EPAs.. 1 Page 2. The Empirical Context: An Overview of Africa s Trade with the EU 3 3. EPAs as Envisaged by the Cotonou Agreement and Phase I of the EPA Negotiations 5 4. EPAs and Regional Trade Blocks in SSA SSA s Access to the EU Market: EPAs, the Everything-but-Arms Initiative, and WTO s Doha Round The EU s Access to SSA Markets: Reductions in Tariffs on SSA s Imports from the EU and Necessary Complementary Reforms in SSA Conclusion: An Opportunity to Accelerate Trade Integration in SSA?. 34 vi Risks and Rewards of Regional Trading Arrangements in Africa: Economic Partnership Agreements (EPAs) Between the EU and SSA 1. Introduction: A Development Perspective on EPAs The Cotonou Agreement, signed in June 2000 between the EU and the African, Caribbean, and Pacific (ACP) countries, provides for negotiation of Economic Partnership Agreements (EPAs) between them. The negotiations are to be completed by December 2007, the EPAs are to go into effect in January 2008, and their implementation is to be phased in gradually over the subsequent 10 to 12 year period. The planned EPAs are intended to reformulate trade preferences accorded to the ACP countries under the Cotonou Agreement and the previous Lome Conventions to make them more effective in promoting ACP-EU trade, more supportive of broader development goals, and more compatible with World Trade Organization (WTO) rules. EPAs are also supposed to help coordinate the EU s trade relations with the ACP countries with its technical and financial development assistance to them. The EU has repeatedly emphasized its desire to use the EPAs as instruments of development. The EPAs are expected to support economic development in the ACP countries by establishing free trade agreements with them and by strengthening the regional trade blocs among them, as well as through better coordination with the EU s technical and financial cooperation programs. Although the EPAs offer considerable potential benefits for sub-saharan African (SSA) countries, implementing free trade with the EU will, as discussed in subsequent sections of this paper, pose a number of policy and administrative challenges for SSA countries, including among others: replacing forgone tariff revenues, avoiding serious costly trade distortions, and liberalizing 1 internal trade within SSA s regional economic communities (RECs). 2 Another reason to think long and hard about the development impact of the EPAs is that they may very well set the pattern for future trade relations between SSA and other industrial and middle income countries. Objective and Organization of this Paper This paper examines the planned EPAs between SSA and the EU from a development perspective. 3 It assumes that both the EPA process and the Regional Economic Communities (RECs) in SSA are political-historical realities. Although EPAs and the current regional trade areas in SSA may not be the best arrangements from an economic point of view, there are strong political forces supporting their continuation; and the EPA process, although controversial, has already gathered substantial momentum in both the EU and SSA. The analytical problem is thus posed as one of maximizing the long term development impact of EPAs and the RECs in SSA. This paper seeks to clarify some of the issues being considered by the EU and SSA countries and to suggest changes needed to make EPAs internally consistent and development friendly. The paper focuses primarily on issues related to the treatment of trade in goods (merchandise) in EPAs. The implications of including trade in services and the Singapore issues investment, competition, trade facilitation, and procurement in the EPAs will be considered in a related paper currently under preparation. The remainder of the paper is organized as follows. Section 2 gives a brief overview of trade between the EU and SSA. Section 3 reviews the status of the EPA negotiation process and identifies many of the issues that are considered subsequently. Section 4 examines the 2 Regional Economic Community is a general term used in SSA to describe regional customs unions, free trade areas, and other preferential trade areas. In other contexts, the term regional trade areas (RTAs) is applied to the same types of organizations. The two terms are used interchangeably here. 3 The terms pro-development and development friendly are used in this paper to refer to policies that will accelerate growth and trade integration in Africa. 2 geographical-organizational aspects of trade EPAs with SSA s heterogeneous customs unions and FTAs and the measures needed to promote intra-ssa trade. Section 5 deals with SSA a access to the EU market, the European Union s EBA initiative, and the relationship between the EPA negotiations and the WTO s Doha Round. Section 6 discusses the EU s access to SSA markets, the reductions of SSA tariffs on merchandise imports from the EU under the EPAs, and the complementary domestic reforms that would be required in SSA. And Section 8 examines the conditions for the EPAs to benefit SSA and accelerate its integration into the global economy and concludes. 2. The Empirical Context: An Overview of Africa s Trade with the EU Trade is quite important for most of the countries in sub-saharan Africa (SSA), with total exports and imports of goods and non-factor services accounting, respectively, for 29% and 34% of GDP on average. 4 Partly for historical reasons, the EU is Sub-Saharan Africa s (SSA) largest single trading partner, buying an average 31% of SSA a merchandise exports and providing 40% of its merchandise imports. The trade relationship between SSA and the EU is thus important for the region s development, and proposed free trade agreements (FTAs) under the planned Economic Partnership Agreements between the EU and SSA could have a significant impact in most of SSA. In the average SSA country, merchandise exports accounted for 24% of GDP in 2001, 31% of which were sold to the EU. Despite the trade preferences accorded to SSA under the Lome and Cotonou Agreements, SSA s share of the EU market for its exports has declined in parallel with the decline in its share of world exports. The share of the SSA EPA countries exports in the EU 4 The averages cited in this section are population-weighted means unless otherwise noted. Figures for the EU are for the EU 15 before the EU s recent enlargement. 3 market has fallen steadily from 3% in 1985 to 0.9% in 2003, a reflection of competitiveness problems and supply constraints as well as restrictive rules of origin under the Lome Conventions and the Cotonou Agreement and declining real prices of some primary commodities. Inclusion of South Africa, SSA s largest economy and exporter, which has a separate free trade agreement with the EU and is not eligible for an EPA, raises SSA s share of the EU export market by 0.5% but does not alter the declining trend. There is also significant variation from the average in the EPA countries: 18 SSA countries sold between 50% and 80% of their merchandise exports to the EU, while the EU accounted for less than 15% of the exports in 4 countries. SSA s exports to the EU are heavily concentrated in petroleum and primary products, and there has been little diversification of SSA merchandise exports to the EU under the Lome and Cotonou Agreements. In the average SSA country, exports of non-factor services were about 1/5 the level of merchandise exports, accounting for an additional 5% of GDP; but no data were available on the share of SSA s nonfactor service exports going to the EU. Similarly, merchandise imports amounted to 24% of GDP in the average SSA country in 2001, with 40% of these being purchased from the EU. Five countries obtained 50% or more of their merchandise imports from the EU, headed by Gabon at 78%, while 4 countries obtained less than 20% of their merchandise imports from the EU. Merchandise imports form the EU are composed primarily of manufactures, machinery, and equipment, although agricultural products are important in a few cases. Imports of non-factor services amounted to an additional 10% of GDP in the average SSA country; but, as with exports of non-factor services, no data were available on the share of imports of non-factor services coming from the EU. In contrast, trade between Africa and the EU is much less important for the EU than it is for Africa because the EU s economy is much larger than the economies of the SSA countries. Africa accounts for only 1.4% of the EU s total merchandise exports and 1.7% of its merchandise imports. 4 Thus, the impact on the EU of free trade arrangements with Africa is likely to be quite limited and much easier for the EU to adjust to than for Africa. The differences in economic size and the relative importance of EU-SSA trade to the two sides would give the EU a much stronger bargaining position than SSA if the negotiations were conducted strictly on commercial terms. Intra-regional trade within SSA is also limited, amounting to only about 12% of the average SSA country s merchandise exports and 7% of its merchandise imports. Intra-SSA trade is particularly important for landlocked SSA countries and for a handful of coastal countries (such as South Africa, Nigeria, Cote d Ivoire, and Kenya) that have some manufacturing capacity. Import tariffs are still an important source of revenue in many SSA countries, and free trade arrangements with the EU could have significant fiscal implications for some countries. Import tariff revenues amount to about 2% of GDP and 15% of government revenues in the median SSA country. However, in the one-third of the SSA countries which are most dependent on tariff revenues, import tariffs amount 3% to 6% of GDP and account for 25% or more of government revenues (see Hinkle, Herrou-Aragon, and Kubota 2003 for an analysis of tariffs in SSA). For any of these latter countries which obtain a third or more of their imports from the EU, free trade arrangements with the EU could lead to revenue losses of 1-2% of GDP. 3. EPAs as Envisaged by the Cotonou Agreement and Phase I of the EPA Negotiations Starting in the 1970s, the EU provided unilateral preferential access to its market to Sub- Saharan Africa and other ACP countries under the Lomé Conventions (I through IV), and the Cotonou Agreement (June 2000) provides for a continuation of this preferential access until Under the Cotonou preferences, all imports of manufactured goods from the ACP countries enter 5 the EU duty-free but are still restricted by what are fairly demanding rules of origin for small low income economies. Many ACP agricultural products also enter the EU duty-free except for 990 tariff lines covering agricultural and processed agricultural products produced in the EU, which are granted only small tariff preferences. The most valuable preferences for SSA have been those extended to a few traditional primary exports sugar, meat, and fish some of which are governed by separate commodity protocols. To bring the EU s trade relations with the ACP countries i
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