TRADE AND CURRENCY UNIONS IN AFRICA

1
TRADE AND CURRENCY UNIONS IN AFRICA

• By Paul R. Masson
• Rotman School of Management
• University of Toronto
• 105 St. George St.
• Toronto, ON M5S 3E6
• Canada

2
Issues

• Africas share of world trade has fallen over the
  last 3 decades. What are the reasons?
• Can introducing common currencies help?
• Is the Andrew Rose result that a common currency
  multiplies trade by 2 or 3 consistent with
  African data?
• What are welfare effects of regional currencies
  and a single African currency?
• What other ways exist to increase African trade?

3
Africas share of world trade

• Has fallen (in value terms) from 4.1 percent in
  1980 to 1.6 percent in 2000
• Gravity model implies that GDP and distance are
  key explanatory factors
• Foroutan and Pritchett (1993) conclude that those
  factors are sufficient to explain the low level
  of Africas trade (excluding primary
  commodities).
• Gravitational force of higher GDP in Europe also
  explains low intra-African trade
• Low or negative African growth explains a
  declining global trade share

4
Recent data suggest Africas trade overpredicted
by Gravity Model

• Subramanian and Tamirisa (2003) find Francophone
  Africa undertraded in 2000 by 70, with trade
  intensity falling over time
• Anglophone countries consistent with GM
• ST suggest that CFA franc overvaluation explained
  falling trade intensity
• However, this was corrected by 1994 devaluation
  why still present in 2000 data?

5
GM also used to estimate effect of common currency

• Andrew Rose notably has found that common
  currency has a large effect on bilateral trade
• Cross-sectional results (Rose, 2000) suggest
  increase by a factor of 3
• Time series (Glick and Rose, 2002) with country
  fixed effects give somewhat lower estimate,
  around 1.7
• But Africa has one of most extensive currency
  unions, the CFA franc zone how is this
  consistent with Francophone Africa being an
  undertrader?

6
Africa sample vs. global sample

• Africa estimates are consistent with Rose results
  (Table 1)
• However, zero observations (dropped from sample)
  are very important for Africa. But if they are
  real data, they are valuable information that
  should be used in estimation.
• Even accepting currency union effect in CFA,
  predicted and actual trade with France is much
  greater than trade with Africa (Table 2)

7
Table 1.Currency effects on trade
8
Table 2. CFA Franc Zone Trade Intra-regional and
with France, 1997-98 Percent of total trade
Source Masson and Pattillo (2004, Table 4-2).
9
Some econometric issues with GM

• Ably surveyed by Baldwin (2006)
• Controlling for various country-specific factors
  (common language, colonial history, etc.) not
  adequate need to include country fixed effects
  and hence use time series evidence of entrances
  and exits from currency unions
• In Africa, CFA zone fairly stable Guinea
  abandoned zone in 1960, Mali left and rejoined
  WAEMU, and Guinea-Bissau and Equatorial Guinea
  joined WAEMU and CEMAC, respectively. But these
  are very special cases and data greatly affected
  by other factors, e.g. civil war and oil
  discovery
• Another major issue for Africa treatment of zero
  observations

10
Zero observations

• GM usually estimated in log form
• This precludes using zeros, so observations
  dropped (31 percent of intra-Africa trade sample)
• Alternatively, a small number added before taking
  logs. When Tsangarides et al. (2006) also include
  country fixed effects, currency union effect
  disappears
• Alternative is to estimate non-linear version and
  include zeros.
• This is what ST (2003) and Coe et al. (2005) do
  but dont test for currency union

11
Unresolved issues

• Are zeros true data or due to reporting problems?
  What about informal trade?
• Will Rose effect survive proper treatment of
  zeros using non-linear estimation, allowance for
  heteroscedasticity, and country fixed effects?
• What are the effects of other trade impediments?
  Longo and Sekkat (2004) find poor infrastructure
  and political tensions significantly lower
  bilateral African trade

12
Africas projects for currency unions

• African Economic Community aims for a single
  African currency by 2028 or before, using RECs as
  building blocks
• There are projects for monetary integration
  within ECOWAS, SADC and COMESA (as well as EAC),
  while other RECs have vaguer integration
  objectives (AMU and ECCAS)
• Can these projects significantly boost trade and
  increase welfare?

13
Evaluating welfare effects

• Paper extends simulation analysis of Masson and
  Pattillo (2004) by assuming a significant Rose
  effect trade is now assumed to double when using
  a common currency. This may be an overestimate,
  given econometric problems. Biases in favor of a
  common currency
• The model assumes that central banks are subject
  to fiscal pressures, and also to incentives to
  engineer beggar-thy-neighbour monetary expansions
  (in an extended Barro-Gordon model).
• Greater intra trade reduces the incentive for
  expansionary monetary policy in a currency union,
  improving welfare. So gains from a monetary union
  are enhanced by Rose effect. But fiscal
  asymmetries (as well as traditional OCA shock
  asymmetries) may make CU welfare-deteriorating
  relative to independent currencies.
• Empirical model is calibrated to replicate
  African data on inflation and fiscal discipline.
• But actual intra trade is small (Table 4), so
  doubling would not make enormous difference

14
Table 4. Exports of Regional Economic Communities
Averages 1995-2000 (In percent of each RECs
total exports)
15
Evaluating selected REC currency unions COMESA

• COMESA includes countries with varied fiscal
  requirements and trade shocks
• It has no large central country with strong trade
  links. Egypt, with by far the largest GDP, has
  few links with others
• Welfare analysis suggests that there would be
  many countries that would lose from a common
  currency even with a doubling of trade (Table 6)

16
Table 6. COMESA Net Welfare Gains from Regional
Currency
17
ECOWAS

• REC has a strategy of first creating a second
  monetary union (WAMZ) and merging it with WAEMU.
  Target date for WAMZ is 2009.
• Problem with WAMZ and full ECOWAS union is size
  of Nigeria, its different terms of trade shocks
  (as an oil exporter), and its lack of fiscal
  discipline.
• A full ECOWAS monetary union unattractive to all
  WAEMU members and several of the others, even
  with trade doubling (Table 7)

18
Table 7. ECOWAS Net Welfare Gains from Regional
Currency
19
A single currency for Africa?

• Assuming that RECs went ahead with regional
  currencies, would it make sense to merge them
  into a single African currency?
• Given weakness of inter-REC trade ties and
  differences in fiscal discipline, this would be
  unattractive to ECCAS and SADC countries (Table
  8).
• However, trade doubling would change sign of
  welfare change to positive for AMU
• Overall, this suggests that such an all inclusive
  pan-African currency could not be justified on
  purely economic grounds.

20
Table 8. A Single African Currency Average Net
Welfare Gain Relative to Hypothetical Regional
Currencies
Source authors calculations.
21
How to stimulate African trade?

• Evidence suggests African transportation costs
  too high, due to lack of roads, air and rail
  links, and poor port facilities. Resources
  should be allocated to improve transportation and
  communication links.
• Investment in infrastructure more generally and
  measures to reduce political tensions can
  certainly help trade and stimulate output
• Trade liberalization should proceed, and measures
  to create free-trade zones actually implemented.
  In practice, countries have continued to impose
  protection against neighbouring countries,
  despite agreeing not to do so.
• Fiscal discipline enhances macroeconomic
  stability and trade
• Selective expansion of existing currency and
  exchange rate unions (CFA franc zone, CMA in
  southern Africa) could provide mutual benefits,
  building on established, credible institutions.
• However, all-inclusive currency unions doomed to
  failure, given widely different features of
  African economies