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Contributions from
the Column
Focus
Regional integration in Africa
The price is not right yet
ACP countries need reforms
Mercosul dilemmas
ASEAN + 3
ECOWAS’ unfinished agenda
01/2007
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Institutionally immature
Assessment of the first years
Whether a country benefits from trade liberalisation or not depends on how easily entrepreneurs can take advantage of new opportunities. If it is too difficult to start new businesses or to employ staff, trade-led growth strategies cannot succeed. Therefore, regulations and governance are very important. Many African countries are not yet in a position to take advantage of the Economic Partnership Agreements, which the EU is striving for.
[ By Axel Borrmann and Matthias Busse ]
Since 2004, the European Union has been renegotiating trade relations with six regional groupings among those countries in Africa, the Pacific and Caribbean (ACP), for which the EU has been granting preferential market access for decades. However, such non-reciprocal preferences are not compatible with WTO rules. In Cotonou in 2000, both the EU and the ACP committed themselves to concluding reciprocal trade agreements as part of a comprehensive package, which also includes development assistance and is called Economic Partnership Agreements (EPAs).
The new agreements are scheduled to enter into force on 1 January 2008. For those ACP countries that may not feel in the position to enter into an EPA, an alternative framework for trade has to be provided, which is equivalent to their existing situation and in conformity with WTO rules. So far, no ACP country has requested such an arrangement.
The EPA objectives go beyond EU-ACP trade. In the past, the trade performance of ACP countries has been poor and their trade-related policies ineffective. Accordingly, EPAs are geared towards integrating ACP countries into the world market in general as well as towards enhancing intra-regional trade within the various groupings. On both fronts, the ACP track record is poor. There is very little trade among these countries, and their share in world exports has fallen to around one percent.
These trends reflect the fact that Least Developed Countries (LDC) generally hardly benefit from trade opportunities. Half of the 79 ACP countries are LDCs. In spite of preferential tariffs, the ACP members did not even retain their market position in the EU. The real reason is supply-side constraints. Most ACP countries lack the productive and technological capacities, marketing skills, transport infrastructure as well as the appropriate technical and sanitary regulations they would need to exploit opportunities abroad. So far, ACP trade policies and EU assistance have been insufficient to cope with these problems.
The EPAs are a new attempt to address these issues. A core objective is intra-regional integration. A sensible first step would be for ACP groupings to eliminate intra-regional trade barriers. Simultaneously, ACP access to EU markets should improve beyond the level granted earlier by EU trade preferences. Remaining EU tariffs (especially in agriculture) should be reduced, and so should other critical barriers, including rules of origin, technical standards, quotas, subsidies et cetera. At a later stage, ACP countries should then gradually dismantle their tariff and non-tariff barriers on imports from the EU.
EPAs are not only meant to liberalise the trade in goods. Topics on the negotiation agenda also include the trade in services, regulation of investment and competition, institutional provisions to facilitate trade as well as technical and financial assistance. The programme is ambitious, and it is agreed that ACP countries should enjoy a sufficiently long transition period, an appropriate product coverage (taking into account sensitive sectors) and asymmetry in the timetables for reducing trade barriers in ACP countries and in the EU respectively.
Striving for trade-led growth
It is very difficult to estimate with accuracy what impact EPA s will actually have. This is due only in part to the weak statistical basis typical of LDCs. On top of that, conventional analyses are often based on standard assumptions, which may not be fulfilled in reality. It is frequently assumed, for instance, that production factors, such as labour and capital, can move at no cost between industries within a country. This view is naive. Reallocating capital and/or labour from (declining) import-competing sectors to the (expanding) export sectors is associated with adjustment costs.
In a similar sense, efficiently operational market mechanisms, ensured by high-quality institutions, cannot be taken for granted. Without them, however, smooth structural adjustment is impossible. Indeed, regulatory competence is essential for trade-led growth strategies to succeed.
Empirical research has shown that there is a significant link between trade, institutions and growth. Of 17 institutional aspects, two are particularly important, if dismantling trade barriers is to lead to economic success: the costs of starting new businesses and labour-market flexibility. They are decisive for how smoothly factor resources can be reallocated within a country. If it is expensive to start a new firm, local entrepreneurs will hardly take full advantage of new export opportunities. If labour-market regulations are strict, it will be difficult to move staff form one industry to another. Of course, other institutional and regulatory indicators are also relevant, including government effectiveness, corruption control, democratic accountability, political stability et cetera. But they matter only to a lesser extent.
An institutional assessment of the ACP countries reveals that the majority of them are not prepared for EPAs and other forms of trade liberalisation – whether bilateral, regional or global. The majority still lack decisive institutional prerequisites. If that were not the case, they could have already taken advantage of trade opportunities in the past.
Nonetheless, there are striking differences in ACP countries’ institutional quality. The conditions are most unfavourable for the group of least developed ACP countries – unsurprisingly. Institutional quality, whether in the ACP or elsewhere, closely correlates with per-capita incomes. While most of the Caribbean and Pacific countries seem reasonably well equipped institutionally for trade liberalisation, three quarters of the African ACP countries do not. In particular, Western and Central Africa are in a very bad shape (see box ).
That the level of institutional development is poor in most ACP countries does not imply that they will never be able to benefit from increasing market integration with the rest of the world, either through the EPAs, regional, multilateral or unilateral tariff liberalisation. At present, however, trade-liberalisation in itself will not boost their development.
Accordingly, institution building should be a central topic in current EPA negotiations and the subsequent implementation phase. Better institutions would help LDCs to benefit from trade in general, as well as contribute to their economic and social development in general. However, one should not under-estimate the challenge of institutional reform.
Most ACP countries start at a very low level of formal institutional development, and they are facing an enormous scope of other reform requirements. Therefore, improvements will not be easily achievable in the short or medium run. Even if reform efforts focus on the most important institutional indicators with respect to trade, the agenda remains daunting. After all, many issues must be dealt with if the conditions for starting businesses is to improve. They include property rights, competition law, taxation, financial-market regulation and others. Tackling them all will take considerable time and effort.
Traditions matter, too
In general, institutions tend to persist over time, although they are not immutable. They typically change incrementally. Today’s formal and informal institutions result from history, culture, political systems, economic structure and power. Whether more efficient institutions can be introduced, largely depends on the interests of those who have the power to devise new rules and on the kind of opposition they face.
Reform strategies must also take into account informal institutions, traditions for instance. Obviously, economic performance and efficiency will increase once the informal sector is finally run along efficient, formal rules. But informal rules are part of any society’s social capital, and they often compensate for the deficiencies of formal institutions. Therefore, they must be respected. By their very nature, however, informal institutions are less prone to be changed by political deliberation than are formal ones.
Institutional reform is unlikely to succeed and survive if undertaken only in response to external pressure. The general commitment of political leaders to good governance and their will to really change matters is crucial for successful reform. Improvement will only begin once political leaders have fully recognised the importance of institutional reform. Trade liberalisation, however, may prove an obstacle to reform if relevant decision-makers, in view of imminent change, become locked into established mind-sets. That is what will probably happen if EPAs are designed and implemented without taking into account all stakeholders affected.
Indeed, it is vitally important to engage all relevant stakeholders, whether from the public or private sector. In the area of trade reform, for instance, those developing countries, which broadened their policy-making processes in the sense of actively involving the private sector, have generally performed better than those that did not. Once stakeholders find they can adequately participate in designing and implementing new rules, a promising basis for change can emerge.
To implement institutional reform in the ACP countries is a great challenge. That is all the more so given the tight EPA time schedule. Substantive EPA negotiations started only in 2004. The agreements are supposed to enter into force at the beginning of 2008, with an implementation period spanning to 2020. Time pressure is immense, as many institutions have to be in place at the latest when trade is actually liberalised. It is debateable, to say the least, whether the time frames for trade liberalisation and institutional reform really match. There is an obvious risk of the EPA agenda over-burdening ACP countries.
On the other hand, awareness is growing – both in the EU and the ACP – of the basic institutional framework being crucial. The EU Commission has indicated its willingness to support institution building in ACP countries. ACP countries should take the EU at its word, and continue to refer to its commitment, as stated in the Cotonou Agreement, to provide financial and technical support for reforms.
Ultimately, however, the success of EPAs will primarily depend on the ACP countries’ own efforts. They have to provide and sustain the political, economic and institutional environment that is not only indispensable for the EPA process, but also for their development in general.
Axel Borrmann
is Senior Economist with the
Hamburg Institute of International Economics, HWWA.
axel.borrmann@hwwa.de
Matthias Busse
is Head of the Research Group Trade & Development,
Hamburg Institute of International Economics, HWWA.
matthias.busse@hwwa.de
Literature:
Axel Borrmann and Matthias Busse, 2006:
The institutional challenge of the ACP/EU Economic Partnership Agreements, HWWI-Research, Paper 2-3, July 2006, ISSN 1861-504X, http://www.hwwi.org/fileadmin/hwwi/Publikationen/Research/
Paper/Handel_und_Entwicklung/HWWI_Research_Paper_2-3.pdf
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