Ethiopia s Trade Relation with the EAC and Sudan

Transcription

1 Ethiopia s Trade Relation with the EAC and Sudan Ethiopian Economic Association Lead Researcher Kibre Moges Sponsored by Friedrich Ebert Stiftung May 2008 Addis Ababa

2 Table of Contents List of Tables List of Figures Abbreviations Executive Summary Page iv v v vi 1. Introduction 1 2. Challenges and Opportunities of South-South Trade Configuration of the current international trade integration Policy initiated South-South trade integration Opportunities and Challenges of trade Integration in East Africa 6 3. Economic Structure and Market Networks Economic structure Potential market size Creating market access opportunities The Trade Policy Regime in Ethiopia Trade agreements Export trade incentive schemes The Tariff Regimes Non-tariff barriers Trade Flows Export trade structure Import structure Ethiopia s trade balance with the EAC and Sudan 41 ii

3 6. Intensity of Trade Integration between Ethiopia, the EAC & Sudan Trade Complementarities between Ethiopia, the EAC & Sudan Trade Competitiveness Export diversification Revealed Comparative Advantage Trade restrictiveness Other trade costs influencing competitiveness Summary and Recommendations 62 References 67 Annex Table 1a 69 Annex Table 1b 73 Annex Table 2 78 iii

4 List of Tables Page Table 1: South-South Exports Table 2: Economic Structure of East African Countries 8 Table 3: Market size indicators 9 Table 4: Access to telecommunication services 13 Table 5: Eligibility for EU and USA GSP access 14 Table 6: Summary of MFN applied tariffs rates 22 Table 7: MFN applied duty rates by product group 24 Table 8: Frequency distribution 25 Table 9: Share of duty free imports in each product category 27 Table 10: Implicit import duty rates 28 Table 11: Annual growth of Ethiopia s export to the EAC and Sudan 34 Table 12: Import share of EAC and Sudan from Ethiopia by broad product category 35 Table 13: Major imported product categories from Kenya and Sudan 41 Table 14: Ethiopia s trade balance with the EAC and Sudan 42 Table 15: Bilateral Trade Intensity Indices 44 Table 16: Trade Intensity Mutual Indices 45 Table 17: Export structure: share of leasing export products 47 Table 18: Export Diversification/Concentration 50 Table 19: Reveled Comparative Advantage Indices 53 Table 20: Trade Restrictiveness Indices 55 Table 21: Partial indicators of external trade costs 59 iv

5 List of Figures Page Figure 1: Partial portray of East African economic cooperation galaxy 4 Figure 2: Regional export markets 30 Figure 3: Ethiopia s major export markets 31 Figure 4: African market s share of Ethiopia s export 32 Figure 5: Import growth and export capacity t finance imports 36 Figure 6: Regional import structure 37 Figure 7: Import by specific country of origin 38 Figure 8: Share of major African exports to Ethiopia 39 Figure 9: Share of Ethiopia s export to the EAC and Sudan 42 Figure 10: Number of days required to export/import 60 Abbreviations ACP African, Caribbean and the Pacific GSP General System of Preference MFN Most Favored Nations EAC East African Community COMESA Common Market for Eastern and Southern Africa SADC South African Development Cooperation WTO World Trade Organization EPA Economic Partnership Agreement EBA Everything But Arms AGOA African Growth Opportunity Act NTBs Non-tariff barriers SSA Sub-Saharan Africa LDCs Least developed countires FTA Free trade agreement GATT General Agreement on Tariff and Trade DTIS Diagnostic Trade Integration Study NBE National Bank of Ethiopia v

6 Executive Summary 1. Introduction The structure of production of an economy determines not only the composition but also the direction of trade. The current pattern of trade is dominated by transactions among advanced countries, and to some extent, between advanced and newly industrializing economies. Trade relations among poor countries is least developed. Despite the obvious advantages of geographical proximity, and historical and cultural ties, trade between bordering least developed countries is quite rudimentary. In Africa, for instance, in spite of the proliferation of regional trade and monetary blocs/cooperation, formal trade among neighboring countries is largely insignificant. This also holds for Ethiopia and its neighbors. The purpose of this study is to show trade relations between Ethiopia and its neighboring countries, namely Sudan and the EAC (Kenya, Uganda and Tanzania). 2. Challenges and Opportunities of South-South Trade The same advanced economies that dominate world industry also dominate world trade. Over the past decade and a half the EU (15), North America (NAFTA), and East Asia (Japan, South Korea and China (including Taiwan) together had a share of nearly threefourth of world trade. They also accounted for 82.1 percent of world manufactured value added and 80 percent of world manufactured trade, nearly half of which constitutes intraregional trade among countries within these regional blocs. Not only the volume, but the direction of trade too is highly skewed in favor of the same advanced economies. In Africa actual share of world trade and also intra-africa trade remain too small. The marginalization effect has led to the proliferation of South-South regional trade agreements. In Africa alone there are over 14 intra-regional trade agreements. Considering East Africa, Tanzania is, at the same time, a member of the EAC and SADC, where as other EAC members, Kenya and Uganda, are COMESA members but not of SADC. Tanzania is also a member of the Indian Ocean Rim (IOR), while Uganda is a vi

7 member of the Organization of Islamic Countries (OIC). Moreover, EAC members are also members of the Cross Boarder Initiative (CBI) group. Only Ethiopia belongs to a single regional group COMESA. The immediate objective of such grouping is to expand trade among members of a group. Over time South-South trade has been increasing. In 2005, South-South exports accounted for about 45.7 percent of total developing countries exports. But this is largely due to the Asian factor. Of the total South-South export, Asia accounted for about 85 percent while the remaining smaller proportion accrued to L. America and Africa with the respective shares of 10 and 5 percent. Intraregional trade has also been increasing, though marginally in general, and poorly in Africa, in particular. Over the past decade and a half, intraregional trade in East and South Asia increased to more than 40 percent of total trade of the region; but in Latin America and Africa the corresponding figures were only 25 and 10 percent respectively. Intraregional trade variation across regions is, therefore, a reflection of the level of economic development. Despite the proliferation of policy driven intraregional and South-South trade agreements in general, no corresponding level of trade has been recorded, particularly in Africa. The same holds for East Africa; irrespective of geographical proximity, cultural and linguistic ties among communities living in each side of the borders of countries, the challenge of trade integration is paramount, primarily because of poverty. 3. Economic Structure and Market Networks Except Kenya to some extent, the economic base of all East African countries is predominantly agrarian. All, but Kenya, are least developed. The share of the modern manufacturing sector and mechanized agriculture together is not more than 20 percent of the respective national income of each of these countries. As such, the role of modern economic activities in merchandize export (except oil in Sudan) is insignificant. vii

8 Moreover, with a per capita income much lower than one thousand dollars, the import capacity of these economies is highly limited. Despite this trade limiting economic backwardness, there are a number potentially encouraging factors for trade among these East African neighbors. First, these countries together account for more than one-fourth of the total population in Africa, hence quite a large potential market. Second, over the past decade and a half, nevertheless all countries have substantially liberalized their economy, particularly so in the area of external trade. Third, given that transportation accounts for a significant proportion of trade costs (at least one-fifth of ad valorem equivalent) the recently completed Addis-Khartoum highway which now links to the already existing Addis-Nairobi motorway, creates a significant comparative advantage in terms of transport cost reduction and promoting intraregional trade among these countries. Finally, except Ethiopia, these countries have made remarkable progress in introducing modern state of the art information and communication infrastructure, a critical factor for promoting trade. 4. The Trade Policy Regimes in Ethiopia 4.1. Trade agreements Ethiopia has made a number of preferential trade agreements with many countries. Under the various Generalized System of Preference (GSP) schemes, Ethiopia is one of the beneficiaries of preferential trade access for a wide spectrum of commodities from a number of developed countries, including, among others, Australia, Canada, the European Union (EU), Japan, Norway, and the United States of America (USA). The two most important duty free market access opportunities that Ethiopia currently enjoys are the EBA and AGOA schemes. Except Kenya, which is not categorized as a least developed economy, all other neighboring countries in East Africa are beneficiaries of the EBA, and many other GSP schemes. Moreover, Ethiopia is currently negotiating to join the multilateral trading system. Except Sudan and Ethiopia, members of the EAC have already joined the WTO. Also these viii

9 countries have jointly signed an interim agreement on EPA with the EU. Ethiopia (and Sudan too, for that matter) has the opportunity to and the challenge of coming up with a consistent negotiating agenda with respect to EPA, which has to weigh the gains and pains of EPA with that of membership to the multilateral trading system Export trade incentive schemes Ethiopia has given greater attention to external trade policies than any other prevailing economic policy. Accordingly, a number of incentives have been put in place. Duties on all exports are now removed; a financial credit support system (Export Guarantee Credit Scheme) to the export sector for pre and post shipments is structured; an export trade duty incentive scheme: duty draw back scheme, voucher scheme, and bonded manufacturing warehouse scheme are made operational; and the foreign credit scheme allows foreign suppliers to extend trade credit to Ethiopian partners The tariff regimes Ethiopia has substantially reduced tariff rates across the board. The negative list used to determine eligibility for imports through the foreign exchange access has been reduced significantly. Currently, quantitative import restrictions are applied only to used clothes, harmful drugs and armaments for security reasons. Both tariff levels and dispersions have been reduced substantially. Specific tariffs have been converted into ad valorem equivalents. There are no preferential tariff offers except to Sudan. A marginal, 10 percent, reduction of the MFN rates is also offered to COMESA member countries. The tariff structure involves an average rate of 16.8 percent, and a maximum of 35 percent. While 4 percent of the tariff lines are duty free there is no any protective rate for so called sensitive products. The tariff structure also reveals that both for agricultural and nonagricultural products, just over 50 percent of the tariff lines fall below the 10 percent duty rate, while the balance fall under the 15 to 35 percent duty rate. As it stands, the tariff lines, for both agricultural and non-agricultural products, are nevertheless evenly distributed across the tariff rates with a margin towards the lower end of the tariff bracket. ix

10 The picture, however, is quite different for the EAC and Sudan. EAC maintains lower average rate and high duty free rates (36.6 percent of tariff lines). But however it imposes as high as 100 percent protective rates on some products. Also the EAC imposes relatively high duty rates on most agricultural commodities and low rate on nonagricultural products. Similarly, Sudan imposes relatively high rates, between 15 and 40 percent) on 85 percent of agricultural products, while non-agricultural products are evenly distributed across the tariff rates. This has some implication to trade among these countries: in general agricultural commodities are less traded than manufactures. And agriculture being relatively Ethiopia s only natural resource endowment, hence export, heavy tariffs in Sudan and Kenya on agricultural commodities implies relatively low trade with these economies, though this requires further investigation of the specific commodities and corresponding rates. 5. Trade Flows As noted earlier, Ethiopia s trade balance has always been heavily in the negative. What is more the structure of both exports and imports are highly skewed. The EU is Ethiopia s favorable export market. Accordingly, for over half a decade or so, on average, over onethird of the total export was destined to this market, followed by Asia (18 percent) and the Middle East (16 percent). But considering the dynamics, the shares of Asia and the Middle East are fast increasing at the expense of the EU. Considering individual markets, Germany is by far the major destination markets for Ethiopia s export, followed by Japan, Saudi Arabia, Italy and China. The structure of imports, however, differs from that of exports. In this regard, Asia has a share of one-third of Ethiopia s import; EU over one-fourth; and the Middle East about one-fifth. In the context of individual countries, China and Saudi Arabia together accounted for nearly one-third of total import (for about 15 percent each), followed by United States and India. x

11 The commodity structure of exports is also quite skewed. A handful of mainly raw agricultural products make up for the bulk of exports, including coffee, oilseeds, edible vegetables and vegetable products, hides and skins and to a smaller extent gold. These account for over 80 percent of the total export. Similarly, few largely manufactured products including petroleum oil and oil products, machinery and equipment, electrical appliances, vehicles and cereals account for over half of the total import. African countries are not Ethiopia s major trading partners, though there has been some improvement recently. Over the last five years Ethiopia s export to Africa figured about 14 percent of total. Of course, this is quite a significant share. However, this is due to some opportunistic activities by business individuals in Djibouti and Somalia that are engaged in re-exporting (mainly edible vegetables and vegetable products) from Ethiopia to the Middle East as they incur lower cost than Ethiopia for port services. Take away Djibouti and Somalia, what is left for other African s share is a small proportion 4.8 percent of total merchandize exports. As for imports, Africa share is only 5 percent of total. As for other East African neighbors, Sudan accounts for 2.4 percent of Ethiopia s total export while the rest Kenya, Tanzania and Uganda have an insignificant share (0.3 percent). Similarly, Ethiopia s import share from these countries is marginal; 1.1 and 0.8 percent of its total import value from Sudan and Kenya respectively. But note that in terms of absolute values, imports from these neighboring countries are much higher than exports. Hence, in general, trade integration between Ethiopia, on the one hand, and Sudan and the EAC, on the other, is quite rudimentary. Within this context, based on trade intensity indices, and as it stands today, for Ethiopia, Sudan is a much more important export market than the EAC. xi

12 6. Trade Complementarities and Competitiveness Why is trade integration among East African countries so weak? The prime factor is the lack of complementarities between the export bundles of one country and import bundles of another. The higher the degree of industrialization, the greater the complementarities between imports and exports of different economies. Export bundles of least developed economies are based on their respective natural resource endowments such as coffee, cotton, coco, oil, copper, etc. The type of such endowments in a given area/country is largely limited. Moreover, different countries may have similar natural resource endowments. This is typical of most East African countries. Except Sudan, whose main export commodity is petroleum oil, others Ethiopia, Kenya, Uganda and Tanzania largely export few (undiversified) and similar agricultural products and import manufactured goods. This is a typical case of absence of complementarities; there is little to trade among themselves. Complementarity is a necessary criterion for trade, but not a sufficient one. Another factor influencing trade integration is competitiveness in this context referring to cost efficiency, i.e., productivity and marketing efficiency. This is largely determined by technology, use of economies of scale, production and marketing organizational structure/skill, etc. But these factors clearly favor industrialized economies. Hence a least developed economy inevitably prefers to trade with advanced economies than otherwise. Still another element influencing trade integration is the restrictiveness of prevailing trade policy, particularly tariff and non-tariff barriers, in a given economy. Non-tariff barriers include quota, price and quantity control measures, non-automatic (discriminatory) licensing, anti-dumping, technical regulations, monopolistic measures, subsidies, etc. Based on trade restrictiveness indices, among the five East African neighbors, Sudan s tariff regime is the most restrictive on imports and also imposes strong adverse impact on domestic welfare, while that of Uganda is the least import restrictive and the lowest adverse impact imposing on domestic welfare. The rest, i.e., Ethiopia, Kenya and xii

13 Tanzania have, nevertheless, equal and moderate restrictiveness on imports as well as on domestic welfare. What is perhaps more interesting, however, is the conspicuously high margin reflected by the indices estimated using both tariffs and non-tariff barriers. With the exception of Uganda, import restrictiveness imposed by non-tariff measures in all countries is considerable. In Tanzania and Sudan in particular, the contributions of non-tariff measures to the overall level of restrictiveness are higher than the contributions of tariffs. Note also that trade restrictiveness imposed by non-tariff barriers is substantially high in advanced economies. Note that, as it stands, trade restrictiveness is not exclusive. It is equally applicable to all trading partners. For instance, Sudan s high restrictiveness may create deterrence to imports not only from East African neighbors but also from all its trading partners around the world. Hence it is a common factor. It should also be underlined that the restrictiveness factor applies where trade agreements do not exist. But Sudan and Ethiopia have free trade agreements; so have EAC members. Hence the implication of the trade restrictiveness relevant to tariff would not hold in these two cases. However, excessive restrictions due to non-tariff measures will inevitably create trade diversion. Summary and Recommendations The bulk of world trade constitutes manufactured products. As such, industrialized economies that dominate world industry also dominate world trade. Moreover, poor countries whose exports are highly concentrated in a small number of primary commodities generally find limited markets in their own and other developing countries. For both reasons, developing countries that are still dependent on primary products can benefit less from regional trade integration with partners at similar stages of development than those that have already achieved a more diversified production structure. As such, the share of South-South trade, particularly among least developed and between developing and least developed countries is marginal. xiii

14 The contribution of consciously initiated Regional trade agreements to South-South trade cannot address the fundamental cause for lack of trade integration, namely lack of industrialization, though it can manage to overcome some minor obstacles to trade. The same reason holds for lack of trade integration between Ethiopia on the one hand, and Sudan and the EAC on the other. Today, though both tariffs and non-tariff components of the external trade regimes require further measures, such as downward adjustment of tariffs and removing certain non-tariff barriers, the former can hardly be regarded as prohibitive for trade among these East African neighbors. Moreover, the EAC is already implementing its customs union protocol; Sudan and the EAC are both members of the COMESA FTA; and Ethiopia and Sudan have also signed an agreement to conduct trade on a duty free basis for all industrial and agricultural goods originating from the respective countries. Hence, the role of tariffs as barrier to trade has no impact except on trade between Ethiopia and the EAC. Despite these measures, however, trade flows between Ethiopia and the rest is quite marginal. Particularly, Ethiopia s export to these countries is quite small, though increasing fast with Sudan in recent years. Rather, these countries conduct trade in bulk with their traditional trade partners: mainly the EU, Japan, Saudi Arabia, USA and recently emerging Asian countries China, India and South Korea. A number of factors account for this. First, the NTBs are still regarded as restrictive compared to those prevailing in other countries, including trading partners. This implies that the costs of trade among these East African neighbors are higher than the corresponding costs of trade with major trading partners. As such, it is logical for each of these East African countries to trade closely with low cost partners rather than among themselves. But, even more important than these are the benefits of trade agreements between each of these East African neighbors and their major trading partners, which allow exports of the former to enter xiv

15 duty free into the latter markets under various Generalized System of Preferences (GSP) schemes. Ethiopia is one of the beneficiaries of preferential trade access for a wide spectrum of commodities from a number of developed and newly industrializing countries. As such, the benefits of trade among these East African neighboring countries weigh much less than those with advanced economies. But, the fundamental factor limiting trade integration is the lack of trade complementarities. Ethiopia, the EAC and Sudan export largely homogenous products, except petroleum fuel from Sudan and some low technology manufactures from Kenya. Except for leather and leather products, Ethiopia has little natural resource advantage on which its export depends over the EAC and Sudan. As such, Ethiopia s export to these countries is highly limited and would remain so for a long time to come, until significant diversification takes place. For the same reasons, these countries import similar goods manufactured products from advanced economies. Natural resource endowments of these East African countries are largely closely similar. Therefore, the degree of trade complementarities is quite low. Ethiopia s import from Kenya largely constitutes simple and low technology manufactures. But note that even these products are competitively exported by other countries. In fact, further trade expansion between Kenya and Ethiopia could be challenging due to other competitive exports from advanced economies, particularly from the EU, come EPA. What clearly emerged from the Reveled Comparative Advantage Index is that nevertheless all these East African neighbors have comparative advantage and disadvantage in similar groups of products with few exceptions. Except in fuel and simple manufactured products where Sudan and Kenya respectively enjoy relative advantages, in all other groups of products all countries together have either a comparative advantage or disadvantage. For instance, nevertheless, all countries have comparative advantage in food and agricultural raw materials and disadvantage in chemical products, machinery and transport equipment. xv

16 As such these facts provide a clear picture regarding the lack of trade complementarities, implying the challenge for further trade integration among these economies. Greater trade complementarities, hence, higher level of trade integration, come only with industrialization. However, to improve trade integration to some extent and to promote Ethiopia s export interest and the pace of industrial development, certain further measures, which includes the following could be undertaken. Though tariffs and non-tariff measures in developing countries are part and parcel of industrialization strategies and should be considered in that context, the level of tariffs could still be reduced, at least selectively, and most non-tariff barriers safely removed in all these countries, particularly in Sudan, in order to further promote trade integration. Currently Ethiopia incurs high trade deficit with both Sudan and the EAC. Though the volume of import from these countries is quite small compared to total, the deficits as proportion of imports from the respective counties are quite large, and should not be maintained for long. To sustain a reasonable trade balance, Ethiopia should make vigorous export drive into these countries, particularly into Sudan. A number of issues need to be clearly addressed before going for EPA. Ethiopia is aspiring to join the WTO in the near future, and signing the interim agreement (if Ethiopia decides to do so) is expected to come earlier than the former. However, experiences have shown that large countries may use their bargaining power in regional agreements to obtain concessions from small countries that they might not obtain in more balanced multilateral negotiations. It should, therefore, be underlined that as reciprocity is likely to disarm small economies of the development oriented policy space currently at their disposal (at xvi

17 least theoretically), Ethiopia has to make sure that the EPA with the EU should at least provide same degree of benefits, if not more, that could be granted by the WTO for LDCs. Moreover, the development element of EPA should go beyond the so called aid for trade to address the supply side constraints without which Ethiopia s trade status would make little change. EPA has to be taken for what it is worth. Ethiopia has the choice to proceed signing the interim agreement (if it did) either with other countries as a group perhaps with Sudan or Djibouti or both, or on its own. However, approaching EPA as a group (with one or two countries) might not deliver any extra benefit than going for it individually. The major benefits often argued for, such as stronger bargaining power, cost sharing/reduction, technical assistance, etc, don t seem to have much significance in this particular case. Two or three less developed countries as a group make little difference from negotiating individually. In fact the costs could even outweigh the possible benefits. Sudan and Ethiopia may not have converging interest with respect to commodity preference, timetable and speed of tariff reduction, etc, thereby creating trade-offs and loss of benefits either for one or both countries. Moreover, the political economy context of these two countries, at least currently, is quite different. xvii

18 1. Introduction A given stage of development of an economy corresponds to a specific production structure and composition of trade. But the importance of trade increases with economic development. At an early stage (pre-industrialization), trade plays a key role as a source of acquiring mainly manufactured finished products and also less sophisticated capital goods and intermediate inputs; during industrialization trade is a vital source of acquiring technologically advanced capital goods and instruments, and intellectual properties; at a higher stage its critical role is to provide markets for high tech finished products thereby facilitating economies of scale and specialization, and hence accumulation of wealth. Moreover, the structure of production determines not only the composition but also the direction of trade. The current pattern of trade is dominated by transactions among advanced countries and between advanced and newly industrializing economies. Trade relations among developing countries is least developed. Despite the obvious advantages that geographical proximity and historical and cultural ties provide, trade between bordering developing countries (perhaps with the exception of East and South-East Asian countries) is quite rudimentary. In Africa, for instance, in spite of the proliferation of regional trade and monetary blocs/cooperation, formal trade among neighboring countries is largely insignificant. In this regard, Ethiopia is not different from others. Its trade relation with neighboring countries, such as Sudan, Kenya, Tanzania and Uganda is very weak. Similar to all other least developed countries, its major trading partners for long have been those remotely located advanced economies, particularly the EU, Japan and USA, and recently China. The purpose of this study is to show trade relations between Ethiopia, on the one hand, and Sudan, Kenya, Uganda and Tanzania, on the other. It also attempts to identify the comparative trade advantage of the former vis-à-vis the latter five, which could serve as a basis for designing a strategy to promote trade among these neighboring countries.

19 2. Challenges and Opportunities of South-South Trade 2.1 Configuration of the current international trade integration The same advanced economies that dominate world industry also dominate world trade. Over the past decade and a half ( ), the EU (15), North America (NAFTA), and East Asia (Japan, South Korea and China (including Taiwan) accounted, on average, for 35.2, 17.8 and 19.1 percent of World trade respectively (UNCTAD, p42, 2007). Thus these regional blocs together had a share of nearly three-fourth of world trade. They also accounted for 82.1 percent of world manufactured value added and 80 percent of world manufactured trade, nearly half of which (40.2 percent) constitutes intraregional trade among countries within these regional blocs. Trade within these regional blocs is driven mainly by growth dynamics and supported by the respective trade agreements. Hence, given that manufactured goods constitutes the bulk of world trade whose production is dominated by advanced economies, not only that the share of trade of developing countries is quite marginal, but the direction of world trade is also highly skewed configured largely among advanced economies and between advanced and newly industrializing countries. Moreover, this is reinforced by the traditional trade theory, which is the basis for the theoretical justification of the existing international economic order: economic welfare is maximized under global free trade, which ensures that production is located according to comparative advantage and inline with the most efficient use of global resources (hence liberalization), based on the underlying assumptions, particularly those of fully employed resources, diminishing returns, perfect information and competition and instantaneous production. But these analyses of regional trade agreements in the context of comparative advantage, which have been extensively propagated for over a quarter of a century, were not able to prove that they lead to an overall improvement in the welfare of developing countries. And this is the legacy of the colonial division of labor which maintains the vertical dependence of developing countries on the North. 2

20 2.2. Policy-initiated South-South trade integration As of July 2007, there are about 380 trade agreements, including PTAs, notified to the WTO regardless of whether they are bilateral, sub-regional or regional (UNCTAD, 2008). Currently Africa alone has 14 intraregional trade agreements, largely overlapping (Oliva, M. 2008). Of the 53 African states only six belong to a single regional economic community; 26 to two; another 20 to three and one to four. Considering East Africa alone there are a number of multiple and overlapping trade agreements. As shown in Figure 1, for instance, Tanzania is at the same time a member of the EAC and SADC, where as other EAC members, Kenya and Uganda are COMESA members but not of SADC. Tanzania is also a member of the Indian Ocean Rim (IOR), while Uganda is a member of the Organization of Islamic Countries OIC). Moreover, EAC members are also members of the Cross Boarder Initiative (CBI) group. Only Ethiopia is a member of a single regional economic bloc COMESA. The driving force behind this sudden acceleration may have been due to the slow progress in the multilateral trade negotiations in the previous Uruguay ( ) and the current Doha round which led more countries to pursue Regional trade agreements in order to promote trade through trade liberalization. It seems that the current multilateral negotiations demand a much larger number of countries to reach consensus than was the case under the GATT. Consequently many countries find it more reasonable and/or beneficial to pursue the bilateral/regional Regional trade agreements, which can be concluded with a more limited number of counterparts, in a relatively shorter period of time and at less cost. Also, the shift of the United States toward Regional trade agreements might have spurred others to follow suit. 3

21 Fig. 1: Partial portray of East African economic cooperation galaxy ECCAS SADC EAC Tanzania Burundi Rwanda Kenya Uganda Sudan IGAD Somalia COMESA Ethiopia However, though currently not a major barrier, such overlapping intraregional membership status may, in the future, create some constraint with respect to satisfying commitments to (regulations of) different regional blocs. Such overlapping membership may involve challenges such as weak implementation of commitments, incompatibility of agreed trading schemes, duplication of efforts, and lack of transparency, credibility and predictability of the trade regime in place. The initial objective of such a grouping is to expand trade among members of a group. Over the past decade and a half, the share of intraregional trade in total trade of regional blocs has been increasing, though not significantly. For instance, intraregional trade in Latin America accounted for about 25 percent, in Africa for about 10 percent, and in East and South-East Asia for more than 40 percent of total trade (UNCTAD, p93, 2007). The latter, however, is largely due to Japan, China and South Korea that are not members of 4

22 any regional group. However, intraregional trade significantly varies for different groups and countries within a group. In the case of Africa, for instance, between 2000 and 2006, intraregional trade of some groups such as SADC, UEMOA and ECOWAS was between 7 to 10 percent; for COMESA it was about 5 percent; and for CEMAC, less than 2 percent (Ibid, p95). Moreover, these figures conceal wide differences in the share of trade among countries within each group. South-South trade has been increasing over time. As shown in Table 1, in 2005, South- South exports (row wise) amounted to about $ billion, and accounted for about 45.7 percent of total developing countries exports. But this is largely due to the Asian factor. South-South trade varies across regions. In the case of developing Asia, just over half (51 percent) of its exports went to the South; as for Africa and developing Americas, exports to the South accounted for 30 and 27 percent of their total exports, respectively. Table 1: South-South exports 2005 ($ billion) Export/import South South Trade Total export Asia Africa Americas Total to World Asia Africa Americas Total Source: UNCTAD, South-South trade in Asia, 2008, p2. Of the total South-South export, Asia accounted for about 85 percent while the remaining smaller proportion accrued to L. America and Africa with a respective share of 10 and 5 percent. In 2005 Asia received 58 percent of South-South exports from Africa, and 32 percent from the Americas. Trade between Africa and the America s only accounted for a minor share (just over 1 percent) of total South-South export. Hence, with Asia accounting for the largest shares of South-South exports and imports, South-South geographical trade 5

23 flows exhibits a hub-and-spoke pattern with Asia being an incontestably most important trade hub among developing countries. Also, the bulk of South-South trade occurs among countries within the same region Asia. Intra-Asian South-South exports in the same year amounted to $1.3 trillion, which is 79 percent of total South-South trade exports. This amount is also equivalent to 47 percent of its total export and 92 percent of its export to developing countries. Similarly, intraregional trade in L. America accounted for 16.7 percent of total exports or 61.7 percent of South-South exports of the region. In Africa, intraregional trade is least developed accounting in the same year for only 9.4 percent of the region s total export or 31.3 percent of exports to developing countries, largely to Asia. Therefore, intraregional trade variation across regions is a reflection of the level of economic development. Similar to the case for a single economy, the higher the level of economic development of a region, the higher is the intensity of intraregional trade. Hence, despite the proliferation of intraregional trade agreements in Africa, no corresponding level of trade has been recorded. This implies that while policy-driven trade agreements may increase trade among members, it may not significantly do so on its own. Trade agreements per se, whether bilateral or plurilateral, do not automatically lead to increased trade among the parties. A static view of the effects of intraregional agreements could be misleading Opportunities and challenges of trade integration in East Africa Sharing same geographical location and closer historical and cultural ties create additional potential advantages to strengthen trade relations among neighboring countries. Of course, according to conventional economic analyses, based on its underlying assumptions, particularly those of fully employed resources, diminishing returns and perfect competition, countries can be modeled as dimensionless points, where factors of production are instantly moved without costs, geographical, historical and cultural factors bear little relevance to trade relations among countries. However, in the 6

24 real world where increasing returns, external economies and variable transaction costs associated with transportation and tariff barriers, proximity does provide some real economic advantages, such as (transaction) cost savings, availability of specialized inputs (both capital and intermediate goods) and skills, tacit knowledge which is built up (and disseminated) through repeated interaction and spillover of various kinds. It is also a fact that most countries trade relatively more with their neighbors than with more distant trading partners, of similar socio-economic development level. At the national level, the influence of historical and geographical forces leads to a home bias, which shows that national boarders continue to exert a strong hold on the location of economic activity (Rose, A. and Engel, C., 2002). 1 As those relations extend abroad, there is a strong neighborhood bias. On another level, the influence of historical and geographical forces is manifested through the variety and mixture of institutional responses, including by the state, consistent with growing cross-boarder exchanges or increasing economic interdependence (Greenway, D. and Milner, C., 2002). 2 Form this perspective, not only because of the advantages of proximity but also because of communities having similar cultural and linguistic ties residing on both sides of the borders, the prospect of greater trade relations and eventual economic integration between Ethiopia and its neighboring countries, such as Sudan, Kenya, etc, is, in the distant future, inevitable. However, as noted in the preceding section, and similar to all other developing economies, East African countries at their existing stage of economic development, 3 encounter formidable challenges that tend to limit the extent of trade among themselves. 1 Quoted in UNCTAD Quoted in UNCTAD It is also important to recognize the critical role of peace in the region for trade flows. 7

25 3. Economic Structure and Market Networks 3.1. Economic structure The volume of trade of an economy at a given period of time, as noted above, could be determined by many factors, at the center of which is, however, the overall level of development or industrialization. This can be partly captured by the per capita income and prevailing economic structure. Table 2: Economic structure of East African countries (% of GDP) Ethiopia Kenya Sudan Tanzania Uganda Agriculture Industry Mining Manufacturing * Services Trade Other services 12.0** 35.0 Source: World Bank, World Development Indicator; National Bank of Ethiopia, Vol. 23, No 3, 2007/08; * manufacturing employing more than 10 workers and operating with some form of machinery ** includes both domestic and external trade + Impact of of Kenya s Tourism Sector Table 2 reflects the economic structure of Ethiopia and neighboring countries. The majority share of traditional agriculture (including handicrafts and other traditional services (though not indicated in the Table due to lack of data) for all economies, except Kenya whose structure is heavily influenced by tourism and relatively better industrial capacity, indicates the prevalence of an agrarian economy. In the case of Ethiopia oer 40 percent of the national income is generated in the rural areas, where the dominant activity is agriculture, mainly, farming and livestock breeding. In fact, traditional activities, i.e, activities employing unskilled manual labor, which also prevail in many other sectors outside agriculture, account for a considerable share of the national income. As a result 8

26 modern real sectors, mining and manufacturing, account for a marginal share of GDP 0.6 and 3.1 percent respectively. Hence, the role of the modern sector, in merchandize export is inevitably insignificant (see also section on Trade Flows). This also holds for other countries listed in the Table, with the exception of Kenya, to some extent. Moreover, as shown in Table 3, per capita incomes of all countries are quite low most of them much below US $1000. Hence, their capacity to import in general is highly limited. These facts imply, not only that the volume of trade would inevitably be quite small, but also as a country exports what it produces, exports would be dominated by agricultural commodities and imports by manufactures. This defines, to a large extent, the trade relationship that would exist among these countries for long time to come Potential market size The size of a country s population matters to trade and investment. Other things being equal the larger the population, the larger the market size. With about 79 million consumers in 2007, Ethiopia creates one of the largest domestic markets in Africa (Table 3). Among its East African neighbors, its population is nearly double of the next largest population, Tanzania, with a total of about 40.4 millions. Ethiopia, Kenya, Sudan, Tanzania and Uganda together constitute quite a large market potential with a total of about 227 million consumers, which is about one-fourth of total African population. Table 3: Market size indicators (2007) Indicators Ethiopia Kenya Sudan Tanzania Uganda Total Population (millions) GDP ($ billions) Per capita income (GDP $) Poverty head count ratio (% of population) 44.2* * ---- Source: World Development Indicators database, September 2008 * for

27 But admittedly, this is a neighborhood with a highly limited purchasing power. In these countries the majority of the population earn their livelihood from less monetized subsistence sector. In Ethiopia about 84 percent of the population lives on subsistence agriculture. As shown in Table 1, the per capita incomes (GDP) of even the relatively better-off countries, Sudan and Kenya, are only $1235 and $786 respectively quite low by any standard. Ethiopia with a per capita income of only $245 is the poorest. Moreover, income distribution is highly skewed. 4 Where as a relatively large potential market size exists, much has to be done to realize it in practice Creating market access opportunities Market liberalization: The structural adjustment program which has been extensively practiced by African countries since the second half of the 1980s, mainly forced these East African countries to open up their economy for external trade. The economic reform program launched in Ethiopia in the early 1990s has gone a considerable distance towards building a market economy. A major emphasis of the liberalization measure was on external trade, exchange rate, and reinstating private actors into the modern sector of the economy lifting investment barriers and privatization. Accordingly significant reduction in tariff rates, and removal of some non-tariff barriers, deep devaluation of the domestic currency (Birr), opening up the financial sector for domestic private investment, and privatization programs were initiated. Over the years, most East African countries have shown significant improvement in customs procedures, investment codes, etc. Such liberalization measures, therefore, have already created a better conducive environment for trade than had been before, though much more need to be done in these countries, particularly in Ethiopia and Sudan Market infrastructure physical access: A growing literature has gathered empirical evidence of the negative impact of trade costs on a country s trade performance. High trade costs adversely affect the competitiveness of exports and lower 4 For Ethiopia and Uganda for which data is available head poverty count in 2000 were as high as 44 and 33 percent respectively. In terms of poverty alleviation very little improvement has been recorded in Ethiopia since then. 10

28 consumer welfare of importing countries as they increase the price of imported goods. Transport cost is one of major trade costs that limit trade competitiveness. Obviously, transport costs rise with distance, as each mile traveled requires additional fuel, manning and capital expense. A rough estimate of trade costs for industrial countries in 2004 figures 170 percent (in terms of ad-valorem equivalent), of which transport cost accounts for a 21 percent advalorem equivalent freight costs and time value (Anderson, E. and Wincoop, V. 2004). 5 Costs for developing countries would understandably be much higher than for advanced economies. For instance, SSA countries have the highest costs for both imports and exports about twice as high as in OECD countries (Portugal-Perez, A. et al, p5, 2008). Despite the contribution of technical improvements lowering trade costs, such as introduction of containerization in maritime transport, shipping costs from African countries to main world markets can be considerably higher compared to other regions. Indeed, maritime transport exhibit important economies of scale. Larger trade flows are conducive to scale economies in shipping, thereby lowering transport costs. However, for small exporters, Africa for instance, shipping costs are relatively very high. A study estimates that doubling trade quantities leads to a 12 percent reduction in shipping cost (Hummels, D. and Skiba, A. 2004). 6 Moreover, the presumably low-value export from developing countries, especially from Africa, inflates transport costs to a container when expressed in ad-valorem terms, i.e. as a proportion of the value of exports. Hence, in light of the significance of transport costs, the recently completed Addis- Khartoum highway which now links to the already existing Addis-Nairobi (and further to Uganda and Tanzania) motorway creates a significant comparative advantage in terms of transport cost reduction and promoting intraregional trade among these East African neighbors. This is of particular interest for landlocked Ethiopia and Uganda. Expansion 5 Quoted in Portugal-Perez, et al, p4, Quoted in Portugal-Perez, et al, p6,

29 of trade may further motivate this community to extend the railway running through the EAC member countries to Ethiopia and Sudan. It should also be noted that the proposed African highway network which links 83 major cities at a length of about 100,000 km would significantly reduce transport costs and increase intraregional trade three fold: from the current US $10 billion to about $30 billion per year, while initial investment costs would be moderate over the course of the investment cycle (Portugal-Perez, et al, p13, 2008) Information and Communication infrastructure: The role of telecommunication as an essential instrument to facilitate international trade is widely acknowledged. Telecommunication service does more than just connecting people, business, or markets efficiently. It facilitates the transfer of technology and knowledge by expanding the range of tradable services and the ability to export those services. Modern means of telecommunication such as mobile, internet, etc, will enable trading partners to participate fully and efficiently in international trade, particularly if implemented by increased liberalization of cross-border supply of many electronically deliverable services. Number of mainlines, mobile telephone, internet access, and quality of operation are found to be important components of trade communication infrastructure and determinants of trade costs. It is now much easier and cheaper than ever before to obtain information on foreign market conditions, product standards, and consumer preferences. This should lower the costs of entering foreign markets, and promote trade at the margin. An empirical evidence estimates that a 10 percent increase in the number of a country s web hosts is associated with an export gain of around 0.2 percent (Freud and Weinhold, 2004). The internet also significantly reduces the fixed costs of market entry, such as obtaining information on product requirements or preferences. Ethiopia is one of the very few countries in Sub-Saharan Africa in which all telecommunications networks are operated by a state monopoly and virtually all telecommunications services are provided by the same. The state is the exclusive provider of local, domestic, and international voice services, cellular mobile, internet, and 12