The Pros and Cons of Free Trade Areas

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Many Africans are of the opinion that greater economic integration of the continent through Free Trade Areas will be of benefit to the continent’s growth. But is this truly the case?

In October 2014, delegates from 26 countries of three main trading blocs in Africa agreed to launch the continent’s largest free trade area in December 2014. ‘The Tripartite Free Trade Area (FTA), comprising the East African Community (EAC); the Common Market for Eastern and Southern Africa (COMESA) and the Southern African Development Community (SADC), aims to boost intra–regional trade, increase foreign investment and promote the development of cross-regional infrastructure’.[1] This Free Trade Area (FTA), ‘will have a combined population of 625 million people, a Gross Domestic Product (GDP) of USD 1.2 trillion’ and ‘will account for half of the membership of the African Union and 58% of the continent’s GDP’.[2] This trend towards regional integration is well underway as this FTA will be, ‘the launching pad for the establishment of the Continental Free Trade Area (CFTA) in 2017’. The decision to develop a Tripartite FTA occurred in October 2008 where it was agreed that FTA would be guided by the following overarching principles[3]:

  • Duty-Free and Quota-Free Market Access and no quantitative restrictions on goods that meet the Tripartite Rules of Origin.
  • Standstill Provisions and Incremental Liberalisation: Tripartite countries to present national tariffs and declare customs duty rates for all tariff lines at the start of the negotiations and should undertake not to raise customs duties on imports from other Tripartite countries before, during or after the negotiations, and to continuously reduce non-zero customs duties so that they are completely eliminated as part of the Tripartite FTA.
  • Most Favoured National Treatment where Tripartite countries should accord each other Most Favoured Nation (MFN) treatment where there is no prevention by country members from maintaining or concluding preferential or free trade agreements, either separately or together, with third countries provided such agreements do not go against the letter or spirit of the Tripartite Free Trade Agreement.
  • National Treatment: Member countries to accord the same treatment to products manufactured in other Tripartite countries once imported into their territory as that accorded to similar locally manufactured products.

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Further cooperation between member countries will include the harmonisation and coordination of industrial and health standards; combating of unfair trade practices and import surges, relaxation of restrictions on movement of business persons; development of cultural industries in the region and the development of sector strategies to increase productive capacity and link producers to buyers and consumers.[4]

UNECA indicates that there may be a 3 phase process towards the creation of a continental FTA. The on-going COMESA-EAC-SADC FTA is FTA1; The Economic Community of West African States (ECOWAS), Community of Sahel-Saharan States (CEN-SAD) and the Arab Maghreb Union (UMA) would be FTA 2 and finally the Economic Community of Central African States (ECCAS), The Central African Economic and Monetary Community (CEMAC) and possibly the Economic Community of the Great Lakes Countries (CEPGL) as FTA 3.[5] These 3 FTAs would then combine to form a Continental FTA.

This all sounds fine but what one often doesn’t see in Africa is the questioning of the principle of FTAs. Given that we’re hurtling towards FTAs with great momentum, it would be prudent to ask: how good an idea are they?

PROS OF FTAs

1. Enhances intra-regional trade and investment

FTAs encourage member countries to increase trade with each other. Further, it allows projects, particularly in infrastructure, to be designed from a regional perspective allowing for greater efficiencies and cost-sharing between governments. Private sector can also design the development of plants, factories and large industrial facilities more strategically.

2. Increased price competitiveness

The introduction of new players in home markets means expensive goods are replaced with cheaper goods due to competition.[6] This applies to goods made by countries within the FTA as well goods from outside the FTA which may have to cut prices to maintain exports to the region.[7] In a continent where poverty is a reality for many, cheap is better for most.

3. Every country is bound to benefit due to different areas of specialisation

Ideally, each country has a comparative advantage in different areas of production and this allows partner countries to gain as a result of specialisation.[8]

4. Increased performance

Because FTAs engender specialisation in goods and services in which the nation has comparative advantage, ‘countries are able to take advantage of efficiencies generated from economies of scale and increased output’.[9] Further when, ‘firms face increased competition from rivals producing similar goods and services they usually lift their performance to the benefit of consumers in all participating countries’.[10]

5. Variety and Innovation

The FTAs will give African consumers access to a wider variety of goods and increased competition will spur, ‘companies to innovate and develop better products and to bring more of their goods and services to market, keeping prices low and quality high in order to retain or increase their market share’.[11]

development

6. Investment efficiency

Fragmented African markets may have engendered the inefficient duplication of plants/ factories/ in different countries. [12] Integration allows for investment, particularly capital intensive investments, to be made in a manner that is most strategic at a continental level.

 7. Countries with similar economic structure stand to gain from each other

Integration can facilitate intra-industry trade between economies that produce similar products. In Europe it allowed firms in the same industry (in this case motor industry) to, ‘specialise in parts of a production process that they previously undertook in its entirety, or to concentrate on particular market segments’.[13]

 8. Economic and political reform

FTAs can lock member countries into economic and political reforms particularly if those policies or rules are stipulated within the agreement.[14] This is particularly the case for African countries that want to reassert their commitment to policy reforms and improving the underlying conditions of the economy in order to attract investment.[15]

9. Security

FTAs will enable Africa to not only enhance trade between countries on the content, they may well create a, ‘web of positive interactions and interdependency’ which is, ‘likely to build trust, raise the opportunity cost of war, and hence reduce the risk of conflicts between countries’. FTAs can help countries develop a ‘culture of cooperation’ on common issues in intra-regional security that can be addressed through common defense strategies and mutual military assistance.[16]

 10. Makes Africa economically stronger and more attractive

Africa is currently fragmented into 47 small economies each with its own regulatory structure and each of which present small potential markets. Integration will make Africa a larger more integrated and larger market making it more attractive to investors both within and outside the FTA. Further, FTAs create a platform that increases Africa’s visibility and bargaining power when negotiating agreements giving the continent space to make more lucrative deals.

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CONS OF FTAs

1. Facilitates the flow of illicit trade

It is not a stretch to surmise that as borders come down and the flow of goods, services and people is facilitated across nations, illicit goods can more easily get through the porous borders as well.

2. Increased security threats

While FTAs may allow better coordination between security arms of member governments, the relaxation on borders and free movement of people may allow individuals from terrorist organisations as well as criminals to more easily expand their activity beyond the borders of one country into another.

3. Increase in structural unemployment

Structural unemployment may arise in industries in some member countries that are in, ‘direct competition with other lower-cost trading partners due to a loss of comparative advantage’. [17]

 4. Risk of Trade Diversion

If African countries move to free trade between themselves but, ‘maintain significant tariffs vis-à-vis the rest of the world it may well result in trade diversion and welfare loss’.[18] This is additionally detrimental because FTAs can prevent innovation and creativity from non-member countries entering the FTA zone if tariffs are prohibitive.

diversion5. Can Magnify Inequalities

Africa is varied with regard to the stage at which each country stands in terms of economic development, size and strength. FTAs risk creating a scenario where, ‘more developed countries within the regional integration scheme dominate the market because they may have a head start’.[19] The playing field is not level and this may create momentum that magnifies the discrepancies in economic development on the continent.

 6. Creates difficulties for new industries and sectors

‘Developing or new industries may find it difficult to become established in a competitive environment with no short-term protection policies by government’[20]. Therefore, nascent industries may fail given the access to local markets by economies in which such industries are more developed.

7. Diplomatic tensions

Africa’s FTAs may benefit some member countries more than others and even though these benefits may only accrue in the short term, it risks the development of tension between governments and citizens of countries that are benefitting and those that are not yet seeing benefits. This dynamic will have to be carefully managed.

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 8. Increase in transaction costs

FTAs increase the complexity of the trading system and can raise transaction costs for business; ‘for example, complicated rules of origin are required to prevent third country products entering via the other party’.[21] Thus business may have to spend more time and money ensuring compliance to the introduction of new rules and regulations.

 9. Increased vulnerability to external shocks

A Continental FTA fosters, ‘closer trade links among member countries, and as a result increases the interdependence of their economies. This means that a recession in one country may quickly spread to other countries, which are its trading partners’.[22] Further, as African more intimately links itself to the global economy while also increasing intra-African economic integration, there is a risk that economic downturns in the global economy will spread over Africa more rapidly than would have been the case without regional and continental FTAs.

 10. The interface between Corruption and FTAs

Corruption may well find a new lease of life through FTAs in Africa. Because member countries get preferred access, unscrupulous traders may seek to gain entry into markets by repackaging external goods as those for member countries. This may present a new avenue of collecting illegal dues, particularly by government officials. Corruption remains a monster on the continent and FTAs may present a new and lucrative avenue through which this beast is fed.

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Therefore, it is clear that Africa can both gain and lose from FTAs. It is important that Africans enter this era of economic integration cognizant of these dynamics in order to ensure the process goes as smoothly as possible, that losses are minimised and benefits are maximised.

Endnotes

[1] Samuel Njihia (2014), ‘Africa’s largest free trade area to launch in December’, Business Daily http://www.businessdailyafrica.com/Africa-largest-free-trade-area-launch-December-/-/539546/2500008/-/wd82nr/-/index.html

[2] Samuel Njihia (2014), ‘Africa’s largest free trade area to launch in December’, Business Daily http://www.businessdailyafrica.com/Africa-largest-free-trade-area-launch-December-/-/539546/2500008/-/wd82nr/-/index.html

[3] COMESA-EAC-SADC Tripartite (2009), ‘Focal area 1: The Tripartite Free Trade Area (FTA)’, http://www.comesa-eac-sadc-tripartite.org/intervention/focal_areas/tripartite_fta

[4] COMESA-EAC-SADC Tripartite (2009), ‘Focal area 1: The Tripartite Free Trade Area (FTA)’, http://www.comesa-eac-sadc-tripartite.org/intervention/focal_areas/tripartite_fta

[5] UNECA (2011), ‘Study On The Establishment Of Inter-Recs’ Free Trade Areas In Africa Drawing On Lessons From The COMESA-SADC-EAC FTA experience’, http://www.uneca.org/sites/default/files/uploaded-documents/CTRCI-VII/tripartite_comesa_eac_sadc_fta-study-final-report.pdf

[6] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[7] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[8] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[9] Edge, Ken (1999) Free trade and protection: advantages and disadvantages of free trade (), Charles Sturt University, http://www.hsc.csu.edu.au/economics/global_economy/tut7/Tutorial7.html

[10] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[11] Denise H. Froning (2000), ‘The Benefits of Free Trade: A Guide For Policymakers’, Heritage Foundation, http://www.heritage.org/research/reports/2000/08/the-benefits-of-free-trade-a-guide-for-policymakers

[12] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[13] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[14] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[15] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[16] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[17] JC Economics, ‘Analyse the impact of FTAs on the Singapore economy and assess the extent to which the impact of FTAs has been positive’, jc-economics-essays.blogspot.com/2012/08/analyse-impact-of-ftas-on-singapore.html

[18] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[19] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[20] Edge, Ken (1999) Free trade and protection: advantages and disadvantages of free trade (), Charles Sturt University, http://www.hsc.csu.edu.au/economics/global_economy/tut7/Tutorial7.html

[21] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[22] JC Economics, ‘Analyse the impact of FTAs on the Singapore economy and assess the extent to which the impact of FTAs has been positive’, jc-economics-essays.blogspot.com/2012/08/analyse-impact-of-ftas-on-singapore.html

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One thought on “The Pros and Cons of Free Trade Areas

    Suji said:
    November 5, 2014 at 11:53 am

    The points made are potent. I think time for Africa’s integration has come, just like a woman in labour. If this does not happen, the individual economies are likely to decline especially given the small middle-class in all the countries in the proposed CFTA. Only they should be careful not to repeat EU’s mistakes.

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