globalization and macroeconomic convergence criteria … · globalization and macroeconomic...

Globalization and Macroeconomic Convergence Criteria in the

West African Monetary Zone

Festus O. Egwaikhide1 and Eric Kehinde Ogunleye2

Abstract

The West African Monetary Zone was proposed as the second monetary union in the sub-region with the aim of

harnessing the propagated benefits of monetary union. To quicken the pace of integration, some macroeconomic

convergence criteria were agreed upon by the prospective member countries. While the efforts of these countries at

meeting the criteria are commendable, globalization, a relatively new phenomenon could imbue or undermine these

efforts, if not well understood and managed. Employing the OLS estimation techniques, this paper assesses the effects

of globalization on selected macroeconomic convergence criteria with a view to eliciting our understanding in this

respect. Evidently, globalization affects all the convergence criteria, though in varying degrees that is conditioned by

size and level of integration. Specifically, prominent effects were established for exchange rate depreciation and

inflation rate. Therefore, both country-specific and zone-wide policies targeted at harnessing the real and potential

benefits of globalization and dousing its deleterious effects are imperative.

JEL Classification: F15, F33, F42 Key words: Globalization, Macroeconomic convergence, WAMZ

“The unfolding mega-trends of the world system have transformed African cooperation from a regional

necessity into a continental imperative – the urgent strategic basis for the corporate survival of the African economy” – Onimode (1992: 152)

Regional economic integration has been widely acclaimed as an important means to

improve and maximize economic outcomes for member countries globally, especially in

sub-Saharan African (SSA) countries for several reasons. One, several SSA economies

are very small and fragmented. Thus, integration will help increase market size and

opportunities for member countries. Two, deeper financial integration achieved through

economic and monetary integration would lead to greater financial stability. Three, there

are potential trade gains for member states through trade creation. Four, the enlarged

market leads to improved foreign direct investment flows from both within and outside

1 Professor and Head, Department of Economics, University of Ibadan, Ibadan, Nigeria. Email: [email protected]. 2 Research Fellow, African Center for Economic Transformation, Accra, Ghana. Email: [email protected]. The views expressed here are entirely personal to the author and do not necessarily represent those of the African Center for Economic Transformation, its President, management and funders.

mailto:[email protected]

mailto:[email protected]

Vol. 10, No.1 Journal of Monetary and Economic Integration

90

the region. Five, the larger market achieved at the back of regional integration holds the

potential for increased returns to firms as they exploit economies of scale more fully.

Aimed at harnessing these perceived dividends of regional integration as a move toward

rapid economic growth, development and transformation, the Economic Community of

West African States (ECOWAS) was established in 1975. In a move to consolidate the

gains from this regionalization and quicken the pace of integration, the Francophone

countries established a monetary union and strengthened the union with a

macroeconomic convergence and harmonization moves in 1994. Six years later, the

Anglophone countries followed suit with the formation of the second monetary zone

involving the non-CFA countries, namely, the West African Monetary Zone (WAMZ).

The WAMZ was established on 15th December 2000 with the five-member countries3

signing the Articles of Agreement and subsequent signing the Accra Declaration on April

20th 2002. The argument was that the formation of these two monetary zones within the

West Africa will make for subsequent easier merger of both currency unions into a single

monetary zone.

The purpose of the WAMZ is to guarantee the establishment of a single monetary union

characterized by a common central bank and a single currency to replace the existing

national currencies in the member countries. However, the creation of a monetary union

has raised several concerns, prominent among which are economic disruptions and

shocks that affect potential member countries unequally. These include unequal growth

patterns, unequal monetary and fiscal expansion leading to inflationary pressures, net

lending versus net borrowing and resource rich versus resource poor. To manage these

perceived challenges to economic integration and monetary union, convergence in some

critical macroeconomic variables in member states have been advocated. Macroeconomic

converge involves the setting of lower and/or upper limits or target range for selected

macroeconomic variables with the aim of guiding important aspects of current and

future policies among potential member countries. Once adopted, such targets become

the guiding philosophy for macroeconomic management policies. Thus, one of the bases

for judging the eligibility of countries for admission into a regional economic bloc is

ability to meet the set criteria.

To this end, two broad groups of macroeconomic convergence criteria have been agreed

upon in the WAMZ, namely, primary and secondary criteria. While the primary criteria

involve inflation, budget deficits, central bank financing of the deficits and gross foreign

3 The Gambia, Ghana, Guinea, Nigeria and Sierra Leone

F. O. Egwaikhide and K. Ogunleye

91

reserves, the secondary criteria entail tax revenues, wage bill, public investments from

domestic receipts and exchange rate. Since these criteria were adopted in 2000, the Zone

member countries have been making concerted efforts to meet them.

However, increasing wave of globalization4 seems to have ambiguous effects on the pace

of convergence on these variables in member countries. It has become unclear whether

globalization improves the pace of regional economic integration or reduces it.

Globalization increases contact between countries in all respects, especially on economic

issues. The issue, therefore, is whether globalization promotes regionalism or induces

shocks and contagion such as the recent global financial and economic crisis that

disrupted macroeconomic variables, thus worsening the speed of convergence in a

monetary union. Hence, globalization will either improve or worsen the pace of regional

integration in the WAMZ, depending on the effects it exerts on the macroeconomic

convergence variables. For instance, the proposed take-off date for the monetary union

has been changed a couple of times, first January 2003, then July 2005, later December

2009 and currently 2015. To a great extent, inability to meet the convergence criteria, an

important precondition for monetary union for member states is a strong factor behind

these deferrals.

This article examines empirically, the effects of globalization on regional integration in

the WAMZ by assessing the influence of globalization on macroeconomic convergence

criteria in member countries. Employing OLS estimation technique on the individual

countries across selected macroeconomic convergence criteria, it is evident that effects of

globalization on WAMZ countries depends, to a large extent, on the size, level of

development, level of integration and macroeconomic policy environment. On the one

hand, foreign capital inflow, especially in the net oil and mineral exporting and high aid-

and remittance-dependent economies, is a major determinant of exchange rate changes.

The large capital inflows have deleterious effects on exchange rate appreciation, thus

provoking Dutch disease in some of these economies. Foreign reserves accumulation

and fiscal deficit financing are also found to be strongly driven by resource availability.

Relatively bigger and better integrated economies such as Nigeria and Ghana are found

to experience stronger effects of globalization on macroeconomic convergence variables

compared to smaller and less globally integrated economies. Thus, sound economic,

4 In the literature, globalization has been defined in several ways, depending on the context. For the purpose of this

paper, globalization is viewed as a phenomenon that denotes the reduction and subsequent removal of cross-border

barriers for the purpose of facilitating the flow of capital, goods, labor and services.


92

fiscal, monetary institutional and risk management policies are important for the Zone to

harness the benefits of globalization while at the same time dousing its real and potential

deleterious effects.

The rest of the article is structured into five sections. Following this introduction are

trends in macroeconomic variables in the WAMZ countries. For lack of space, attention

will be focused on the primary criteria while a brief mention will be made of the

secondary convergence criteria. Section three focuses on the discussion of the literature

that demonstrates the real and potential relationship between globalization and

macroeconomic variables. Data and methodological issues are the focal points of section

four while section five provides a discussion of the empirical results. Section five makes

some policy suggestions and section six concludes.

MACROECONOMIC DEVELOPMENTS IN THE WAMZ

Economic growth in the WAMZ has been exceedingly strong in recent times with an

annual regional average of over 6% between 2001 and 2008. The highest regional real

GDP growth of 9% was recorded in 2003. In spite of the recent global financial and

economic crisis, regional growth performance remained strong at almost 7%, though

with a slight drop to around 6% in 2008. Looking at the country-specific scorecard, it is

evident that all the member countries performed excellently well, recording an average

annual real GDP growth of more than 5% between 2000 and 2008, except Guinea that

recorded 3% during this period (see Table 1).

Guinea‘s poor performance is explained by multiple crises, namely, oil crisis in 2007 and

2008, food crisis in 2008, the global financial crisis in 2009 and socio-political crisis

caused by the massacre of protesters in September 2009. Prior to these developments,

the country was embroiled in political crisis that continue to weaken public governance,

institutions, reform and macroeconomic policies and put the country in the bottom rung

globally on institutional governance. In addition, the country has been consistently

ranked by the Corruption Perception Index (CPI) in the bottom five for over ten years.

The 2002 failure in the reforms and liberalization process that began in 1985 has resulted

in the weak economic performance of the country since 2003. On the other hand, Sierra

Leone achieved the strongest economic growth among the WAMZ countries during the

period under review, averaging over 11%. This phenomenal growth, especially between

2001 and 2003, is expected as this is typical of post-crisis economies. It is interesting to

note that the country has consolidated on its post-crisis performance by improving the

buoyancy of its important sectors that include agriculture production, services and

exports. Macroeconomic management has also been extremely prudent in the country,

proving as the necessary lever for managing shocks and keeping the economy on course.


93

Strikingly evident is the remarkable variation in economic growth of WAMZ member

countries. For instance, average real GDP growth between 2000 and 2008 ranged

between 11% in Sierra Leone and less than 3% in Guinea. This poses a great challenge in

terms of the size and performance of these potential monetary union member states. In

addition, shocks affect member states with varying degrees. Better coordination and

managing of such diverse shocks and impact is necessary for successful convergence.

Table 1: Real GDP Growth

Country 2000 2001 2002 2003 2004 2005 2006 2007 2008

Gambia, The

5.4

5.8

1.3

7.4

6.6

6.9

7.7

6.9

6.1

Ghana

3.7

4.2

4.5

5.2

5.6

5.9

6.2

6.3

7.0

Guinea

1.9

3.7

4.2

1.2

2.7

3.3

2.8

1.3

5.0

Nigeria

3.8

4.7

4.6

9.6

6.6

6.5

5.6

6.2

6.4

Sierra Leone

3.8

18.2

18.8

21.6

9.6

7.5

7.3

6.4

6.1

WAMZ

n.a.

4.9

4.8

9.1

6.4

6.4

5.6

6.1

6.4

Source: WAMZ (2003) and WAMZ Database (Accessed 3rd June, 2010)

Primary Criteria

Four primary criteria have been set for the purpose of monitoring the macroeconomic

convergence in the WAMZ member countries. They are single digit inflation rate, fiscal

balance with the exclusion of all grants not exceeding 4% of GDP, Central Bank‘s

financing of fiscal deficits must be less than 10% of total tax revenues in the previous

year, and gross reserves of member countries must be able to finance at least three

months of imports. These criteria are examined in turn with a view to ascertaining the

extent to which the member countries have performed.

Single-Digit Inflation Rate

This is a very lax criterion with substantial liberty as single digit ranges between 1 and 9. As a group, the WAMZ countries are yet to meet this convergence condition as the data for the period between 2000 and 2008 show (see Table 2). A worrying observation on this criterion is that, as a group, the WAMZ never met this convergence condition between 2000 and 2008, except in 2007 (see Table 2). The individual country performance mirrors the Zone‘s performance with highly irregular and unpredictable


94

movements in inflation rate. Throughout the period under review, there was no single year that all member countries met the criterion. The best results were achieved in 2000 – 2001 and 2006 when three out of the five countries met the criterion. The worst year was 2003 when none of the countries could live up to this condition.

Table 2: Consumer Price Inflation Rate, End Period (%)

Country

2000

2001

2002

2003

2004

2005

2006

2007

2008

Gambia, The

0.2

8.1

13.0

17.6

8.0

1.8

0.4

6.0

6.8

Ghana

40.5

21.3

15.2

23.6

11.8

13.9

10.9

12.8

18.1

Guinea

7.2

1.1

6.1

14.8

27.6

29.7

39.1

12.9

13.5

Nigeria

14.5

16.4

12.2

23.8

10.0

11.6

8.6

6.6

15.1

Sierra Leone

-2.8

3.4

-3.1

11.3

14.4

13.1

8.3

12.2

13.2

WAMZ

n.a.

15.2

11.6

22.1

11.5

13.4

11.5

8.2

15.2

Countries Meeting Criterion

3

3

2

0

1

1

3

2

1

Source: WAMZ 2003 and Database (Accessed 3rd June, 2010)

Unbridled and pro-cyclical fiscal and monetary expansions, necessitated by external

shocks, are often the explanatory factors for the high inflationary pressures in WAMZ

member countries. For instance, in 2003, the Gambian monetary authorities increased

broad money supply by over 50% while narrow money supply was increased by 83% in

addition to significant rise in unbudgeted fiscal expenditures resulting from a dip in tax

revenues. Similarly, Guinea and Nigeria increased money supply by approximately 30%

during the same period. In Ghana, inflation rate is driven largely by increases in pump

prices of petroleum products. In 2003, for instance, the pump prices of petroleum

products were raised by 95%. Thereafter, there has been at least three-time increase

between 2009 and 2010.

More important for our consideration, though, is the influence of external shocks and

factors originating from the effects of globalization. One of the main factors is

movements in international prices of goods and services which are easily imported due


95

to globalization that has resulted in trade between the Zone and other countries of the

world. Movements in the global market prices of crude oil have been a major driver of

inflation in all WAMZ countries, perhaps with the exception of Nigeria where there is

huge subsidy by the government aimed at cushioning the domestic effects of such price

movements. In most WAMZ countries, change in international market price of crude oil

is always the major reason put forward by the government for increasing the domestic

prices of petroleum products. In addition, imports of non-oil commodities that are

prone to inflation in the countries of origin is another major source, popularly referred to

as imported inflation.

The Ratio of Fiscal Balance Excluding all Grants to GDP Should be Less Than or

Equal to 4%

At the aggregate level, this criterion was met throughout the period under review.

However, country-specific data reveal a completely different story. Nigeria is the only

country that has consistently met this criterion throughout the period under review. This

is understandably so given the large inflows of oil revenues in the country. There appears

to be a continuous improvement ever since as Guinea joined Nigeria in meeting this

criterion in 2005 and The Gambia added to the list of these two countries since 2006,

leaving Ghana and Sierra Leone behind as poor performers. Fiscal indiscipline and

revenue instability are some of the major determinants of budget deficits in the Zone.

Table 3: Fiscal Balance, Excluding Grants (% GDP)

Country 2000 2001 2002 2003 2004 2005 2006 2007 2008

Gambia, The -1.7

-10.0

-9.1

-7.6

-8.6

-7.4

-2.7

-1.0

-3.3

Ghana

10.1

-13.2

-8.3

-7.5

-8.1

-6.9

-11.3

-15.6

-18.6

Guinea

5.2

-5.2

-8.1

-11.1

-6.5

-0.9

-2.0

-0.5

-1.7

Nigeria

2.5

-3.2

-3.9

-2.0

-1.2

-1.3

-0.6

-0.6

-0.2

Sierra Leone 17.3

-16.5

-11.7

-10.0

-8.6

-9.6

-8.5

-5.0

-7.9

WAMZ

n.a.

-4.2

-4.5

-2.9

-2.0

-1.8

-1.3

-1.3

-1.5


5

1

1

1

1

2

3

3

3



96

Central Bank’s Finance of Fiscal Deficit as a Percentage of Previous Year’s Tax

Revenue be Less Than 10%

There are several options available to the government in financing fiscal deficits:

borrowing from the public either locally or in foreign markets, drawing down on external

reserves and central bank financing. While these options have their associated costs,

excessive central bank financing of fiscal deficits could induce inflationary trends with

the potential to distort economic activities and ultimately stifle growth. This explains the

need to check the extent to which such options could be used to finance fiscal deficits.

Nigeria is the best performer in this criterion, consistently meeting it between 2000 and

2008, but for 2003. This is followed by Sierra Leone that has missed meeting it only

twice during the period under consideration. The possible explanation for the observed

trend is that countries with large foreign reserves achieved through commodity export

boon tend to do better on this criterion as they can fall on these reserves to finance fiscal

deficits. Moreover, countries with relatively strong financial market and institutions also

tend to perform better because they can exploit this window of borrowing from the

market.

Table 4: Central Bank Financing of Fiscal Deficit (% of Previous Year’s Tax Revenue)

Country

2001

2002

2003

2004

2005

2006

2007

2008

Gambia, The 80.7

22.4

63.1

0.0

0.0

0.0

0.0

0.0

Ghana

0.0

12.1

0.0

27.7

0.0

0.0

0.0

38.7

Guinea

0.0

27.1

16.1

23.1

0.0

81.6

0.0

0.0

Nigeria

0.0

0.0

37.6

0.0

0.0

0.0

0.0

0.0

Sierra Leone

0.0

0.0

24.3

0.0

0.0

17.9

0.0

0.0

WAMZ

0.0

0.0

38.0

-17.0

-11.2

-91.3

-1.2

4.1


4

2

1

3

5

3

5

4



97

Gross External Reserves be Greater Than or Equal to Three Months of Imports

This criterion is rooted in the belief that reserves serve as an insurance against sudden

stops or reversals in capital inflows. The WAMZ countries appear to be doing very well

in this criterion except for Guinea that has consistently failed to meet it since 2003. One

of the major factors that have helped most WAMZ countries in meeting this criterion is

the prolonged benign commodity prices in the global markets. This has helped the

countries, especially Nigeria in meeting the criterion. For instance, external reserves in

Nigeria have been consistently high with a peak of financing over 22 months of imports

in June 2008. This was achieved as a result of the consistently high prices of crude oil in

the global market. On the flip side, some of the major constraints facing Guinea in

meeting the criterion are the high volatility in the external sector and prolonged

macroeconomic weakness in the country. It is interesting to note that even the recent

global financial and economic crisis did not significantly affect the WAMZ countries in

meeting this criterion. However, Ghana also failed to meet this criterion in 2008. This

was partly due to the negative effects of the global financial and economic crisis that

resulted in dwindling official and investment flows coupled with the fall in export

demand. The fall in foreign prices of minerals due to the crisis was also responsible for

the observed slight drop in reserves in Sierra Leone. On the other hand, the little growth

in reserves observed in The Gambia was the result of the significant rise in aid flows

from both the African Development Bank and the World Bank for budget support.

Table 5: Gross Foreign Reserves (Months of Imports)

Country 2000 2001 2002 2003 2004 2005 2006 2007 2008

Gambia, The 7.5

8.2 5.2 4.6 5.0 5.2 4.9 5.5 6.1

Ghana

0.8

1.4 2.7 5.0 4.6 4.1 4.1 4.0 2.2

Guinea

2.2

2.9 2.4 1.1 0.7 0.6 0.5 0.4 0.6

Nigeria

13.6

8.9 6.2 4.9 11.6 11.6 14.4 13.4 13.8

Sierra Leone 2.8

2.2 -0.4 2.0 4.2 3.8 4.9 4.5 4.2

WAMZ

n.a.

7.3 5.3 4.7 9.6 10.0 12.3 11.6 11.2


n.a.

3

3

3

4

4

4

4

3



98

Secondary Criteria

The secondary convergence criteria are five in number. These are: (1) tax revenue as a

ratio of GDP should be greater than or equal to 20%; (2) wage bill to tax revenue must

be less than or equal to 35%; (3) public investment as a ratio of tax revenue must be

greater than or equal to 20%; (4) real exchange rate stability must be maintained within a

band of 15%; and (5) real interest rate must be kept positive.

A cursory look at the countries suggests that their performance in the secondary criteria

largely mirror performances in the primary criteria. Ghana is the only country that has

been consistent in meeting the tax revenue criterion since 2003, reaching 25.4% in 2008.

No other WAMZ country has ever met this criterion at any point in time. This failure

demonstrates the weakness of domestic resource mobilization machineries in the

WAMZ countries. The impressive result in Ghana is informed by the country‘s relatively

more sophisticated tax collecting system, priding itself as the only country with highly

functional and effective VAT system in the Zone. Indeed, while its VAT rate is 15%,

Nigeria has a VAT rate fixed at mere 5%. This tends to demonstrate the notion that

resource rich countries are relatively poor in mobilizing non-resource tax revenues

compared to their relatively less resource endowed countries (Ogunleye and Fashina

2010). This is further corroborated by the fact that Sierra Leone – another highly

resource endowed economy – consistently performed worse on this criterion, generating

less than 10% between 2000 and 2008 except in 2001 and 2008.

Nigeria is the best performer on the wage bill, meeting this criterion throughout the

entire period except in 2002. This was followed by The Gambia and Guinea that missed

meeting this criterion only in 2001 and 2002, for the former, and 2001 and 2003, for the

latter. Ghana never for once met this criterion. This is a result of the country‘s salary

structure. Apart from Nigeria that consistently met the domestic revenue criterion, no

other country was able to meet this requirement apart from Ghana in 2006, 2007 and

2008. Guinea managed to achieve this feat in 2003 with a very close shave of 19% the

following year. Harsh business environment that makes establishing and managing

business very cumbersome is a candidate explanation. Apart from Ghana that

consistently recorded negative real interest rates throughout the entire period, the

performance on this criterion was mixed for all the countries. Nigeria barely recorded a

positive rate in 2007 and Sierra Leone in 2001 and 2002. High inflation rates that

characterized these economies explain this poor performance. In the case of exchange

rate depreciation, Sierra Leone was the best performer, meeting this criterion during the

entire period except in 2008 when it overshot by mere 0.3% point. This trend analyses

demonstrates varying performance across the countries and macroeconomic criteria,

demonstrating individual peculiarities of the economies in the Zone.


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LITERATURE REVIEW ON GLOBALIZATION AND ECONOMIC INTEGRATION

Globalization has been understood differently under varying contexts, given its

multidimensional nature straddling political, economic, and cultural issues. Giddens

(1990) defines globalization as the intensification of worldwide social relations linking

distant localities in such a way that local happenings are shaped by events occurring

many miles away and vice versa. The implication of this definition is that globalization

can be thought of as a process of integration of goods and capital markets across the

world in which barriers to international trade and foreign investment are significantly

reduced. Several drivers of globalization have been identified. These include

technological developments that improve information flows and reduce transport costs,

change in policy attitudes that favor liberalization of foreign investment rules, diminish

protectionism, and ease migration. This definition suggests deep integration of the world,

thus the use of expressions like ‗global village‘. Globalization begins with liberalization in

three important activities in quick succession, first in international trade, then FDI and

finally financial flows.

The literature contains several channels through which globalization could positively and

negatively affect economic performance. These can be broadly categorized into the direct

and indirect channels. Some of the direct channels include: innovations through

competition; augmenting low domestic income, savings and capital formation; transfer of

technology from industrialized to developing economies; reduction in cost of capital and

cost of financial intermediation through risk sharing; and domestic financial sector

development. On the other hand, the indirect channels are promotion of specialization,

commitment to better economic policies and improvement in institutions.

There is a great debate on the impact of globalization, especially financial and economic

globalization on macroeconomic variables with some studies establishing positive

impact, others negative relationship and yet others mixed effects. For instance,

employing capital account liberalization as a measure of financial openness, Quinn (1997)

and Klein and Olivei (2006) find a positive relationship between financial openness and

economic growth. In contrast, Grilli and Milesi-Ferretti (1995), Kraay (1998), Rodrik

(1998), and Edison, et al (2002) could not establish any relationship between these

phenomena. Other studies, such as Arteta, et al (2003), Chanda (2005) and Ogunleye

(2008a) find that the effect is mixed or fragile.

Despite the expected laudable positive effects of globalization on the economies of

developing countries, evidence also abounds on its negative effects. For example, Levine


100

and Schmukler (2003) posit that the internationalization of firms, a product of financial

globalization, reduces the liquidity of the remaining firms in the domestic market (See

also Alexander et al, 1987; Domowitz et al, 1998 and 2001; Hargis, 1997 and 2000; Hargis

and Ramanlal, 1998; Karolyi, 1996 and 2002; Moel, 2001; Schmukler and Vesperoni,

2003; and Smith and Sofianos, 1997). Globalization can also lead to crises given the

imperfections in international financial markets. This is because integrated economies are

more prone to crises and contagion spreads more rapidly in such economies as we have

witnessed in the recent global financial and economic crisis. The imperfections in highly

integrated markets can generate herding, bubbles and irrational behavior, speculative

attacks and crashes among other things. Imperfections in international capital markets

can lead to crises, especially balance of payments crisis even in countries with sound

fundamentals.

Countries that are dependent on foreign capital could experience financing difficulties

and sharp economic downturn if there are sudden shifts and reversals in foreign capital

inflows resulting from global activities. When countries rely excessively on foreign capital

inflows relative to their ability to generate financial resources in the domestic economy,

they become vulnerable to sudden reversals of capital flows and, consequently, to

liquidity crises. One of the most important of such crises is, of course, financial crisis

(Demirguc-Kunt and Detragiache 1999 and Glick and Hutchison 2001). Indeed, the

experiences of most African countries including the WAMZ during the recent global

financial and economic crisis are clear evidential demonstration of this argument.

The key mover of economic and regional integration is the view that sovereign interests

are best promoted through regional actions (ECA 2002). Indeed, regional integration in

Africa has been viewed as the first step toward global integration. Generally, regional

integration is often cast in the context and scope of deepening and widening (see

Weintraub 1994, Hoberg 2000 and Gomez and Gunderson 2002). While the former

involves the expansion of the range of market exchanges for goods and services achieved

through reduction in tariff and non-tariff trade barriers, the latter involves the extension

of these measures across countries and regions.

There are dissenting views on the effects of globalization on inflation dynamics. Thus,

opinions on such effects have been dubbed gradual and limited (Kohn 2005) while

others have seen it as modest (Yellen 2006). Some believe that globalization has helped

tame inflationary pressures through more intense global competition that prevents firms

from engaging in wanton increase in prices. There has also been fragmentation in the

production of manufactures in favor of emerging labor cost effective countries especially

of Asia, and integration of lower-cost producing emerging markets such as China and


101

India into the global trading system. Others believe that there is very little reason to

believe that globalization has changed the structure of the Phillips curve or the level of

inflation in the long-run (Ball 2006). IMF (2006) identified a few channels through which

globalization influences inflation. These include: policy incentives; trade integration and

price level declines; increased productivity growth and aggregate supply; and inflation

response to domestic output fluctuations (see Romer 1993, Fischer 1997, Rogoff 2003

and 2006, and Tytell and Wei 2004).

In both empirical and policy debates, trade integration has been identified as the basic

channel through which globalization affects inflation (Sbordone 2008). Exploring this

channel further, Benigno and Faia (2010) narrowed this effect down to an increase in the

impact of import prices on the overall price index due to an increase in the number of

foreign products in domestic markets and an increase in the dependence of the pricing

strategies of domestic firms on foreign components, due to the increase in competition

with foreign firms. Earlier, Bernanke (2007) hinges the relationship on reduction in the

market and pricing power of domestic enterprises coupled with lower import prices of

both intermediate and final goods that force down general price level.

Globalization and the openness it induces seem to have similar effects on emerging

economies as it appears to have tamed the upward trend in inflation. This is because the

low-skilled workers provided by these countries, prominent among which are China and

India, and geographic shift of production toward them have led to an increase in global

supply of low-cost goods and services (Ahearne et al 2003). Thus, notable multinational

enterprises have opened major production facilities in these areas, moving in capital to

take advantage of the cheap labor and relatively benign economic and business

environment. Such large scale and relatively cheap production have resulted in relatively

low cost of production and subsequently reduced inflation.

The effects of globalization on interest rates, monetary and fiscal policies results from

the way and manner in which it alters the monetary and fiscal policy environment, with

serious implications for the design and formulation of policies. For one thing,

globalization limits the freedom of Governments in the application of monetary and

fiscal policies. This becomes more challenging given the large financial flows induced by

financial globalization. Indeed, with large capital flows due to financial globalization,

simultaneously maintaining fixed exchange rates and independently conducting monetary

policy have become highly impossible. The rising tide of globalization has further

reinforced the ―impossible trinity‖ – simultaneously maintaining fixed exchange rates,

independent monetary policy and free capital mobility. This trend has led to the large

scale desertion of pegged exchange rates in recent times (Fischer 2001). In addition,


102

international financial dependence in which there is global competition for savings and

investment suggests that interest and exchange rates be made reactive to international

interest rates differentials. Growing globalization demands better understanding of the

traditional monetary policy mechanisms of exchange rate and credit channels that appear

to have been influenced by this growing phenomenon. As was amply demonstrated

during the recent global financial and economic crisis, globalization increases the risks of

contagion, even to the most remote economies of the world. For instance, disturbances

and policy decisions in the Unites States sub-prime market became a global phenomenon

affecting almost all economies of the world. Thus, the conduct of monetary, financial

and fiscal policies must take cognizance of international dependence, actions and

inactions in other parts of the world.

The conclusion so far on the effects of globalization on macroeconomic convergence

criteria, policies, variables and performance is that countries must double their efforts if

they must harness and maximize the real and potential benefits offered by globalization

and minimize its possible negative effects. Thorough understanding of the way and

extent to which globalization has altered the behavior of macroeconomic aggregates

should inform a proactive policy that will leverage on the benefits offered by

globalization while minimizing its risks.

DATA AND METHODOLOGICAL ISSUES

The Data

The globalization variable is obtained from the 2010 KOF Index of Globalization that measures all dimensions of globalization. Following Clark (2000), Norris (2000) and Keohane and Nye (2000), KOF Index of Globalization‘s working definition of globalization is ―the process of creating networks of connections among actors at multi-continental distances, mediated through a variety of flows including people, information and ideas, capital and goods. Globalization is conceptualized as a process that erodes national boundaries, integrates national economies, cultures, technologies and governance and produces complex relations of mutual interdependence‖. Measures of globalization are decomposed into three broad categories: economic, social and political globalization, weighted 37%, 39% and 25%, respectively. In addition, a composite index of globalization is developed that integrates all the three. In all, the 2010 version of this database is derived from 24 different variables and covers the period 1970 – 2007. Economic globalization is made up of data on actual flows and on restrictions. While data on actual flows comprises of trade, foreign direct investment flows, foreign direct investment stock, portfolio investment and income payments to foreign nationals, all measured as percentage of GDP, data on restrictions is made up of hidden import


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barriers, mean tariff rate, taxes on international trade measured in percentage of current revenue and current account restrictions.

Flows of ideas and information are the focus of social globalization. This variable is

made up of three major components, namely, data on personal contact, information

flows and cultural proximity. The elements of the data on personal contact are telephone

traffic measured as the sum of international incoming and outgoing telephone traffic in

minutes per person, transfers measured as percentage of GDP, international tourism

calculated as the sum of arrivals and departures of international tourists as a share of

total population, foreign population comprising the number of foreign or foreign-born

residents in a country as a measure of total population and number of international

letters sent and received per person. Data on information flows is captured by number of

people with access to internet connection per 1000 persons, television availability per

1000 persons and trade in newspaper measured as the sum of exports and imports in

newspapers and periodicals in percentage of GDP. Similarly, data on cultural proximity is

developed from an index of number of Macdonald‘s Restaurants per head, number of

Ikea per person and trade in books measured as the sum of exports and imports of

books and pamphlets as a percentage of GDP.

Lastly, political globalization dwells on the degree of political cooperation and integration

among countries and is composed of absolute number of embassies in a country,

membership of a country in international organizations, participation in UN security

Council missions measured as the number of personnel contributed per head and

number of international treaties entered into by a country, taking account only of

documents signed between two or more states and ratified by the highest legislative body

of each country since 1945.

In the KOF Index of Globalization database, globalization is measured on a scale from

1–100 where higher value denotes greater integration while lower value suggests less

globalization. To restrain the possible effects of extreme data points and volatility over

time, the underlying variables are divided into percentiles. For the purpose of this paper,

the composite index of globalization is employed. Subsequent analysis will examine

globalization in its disaggregated form with a view to establishing the relative importance

of these measures of globalization in explaining the dynamics of macroeconomic

convergence in WAMZ countries.

The data on inflation, foreign reserves, exchange rates, real interest rates, GDP per

capita, government expenditures and debt, current account balance as a percentage of

GDP, domestic savings measured in percentage of GDP, value of exports measured in


104

US dollars, capital flows, lending interest rates, foreign economic activities, interest rate

differentials, foreign inflation rate, and nominal effective exchange rates are all sourced

from the Africa Development Indicators 2010 CD-ROM and International Financial

Statistics June 2010 CD-ROM.

Given the primary focus of this paper, our preoccupation will be on the effects of

globalization on the macroeconomic convergence variables in the WAMZ countries.

From the literature, the effects of globalization on these variables are ambiguous; it could

either improve or worsen them. Thus, the a priori effects of globalization on the

macroeconomic convergence variables are sometimes indeterminate. Given the gamut

of macroeconomic variables examined in the paper, eclectic theories underlining each

variable is employed. The modeling of each variable is based on standard practice in the

literature involving the determinants and dynamics of each variable. The empirical results

for each country show the choice of variables in each model.

Empirical Models

The analytical method for this paper is based on the short-run OLS technique with

robust standard errors. Given the new thinking on long-run econometric analysis

employing cointegration and error correction techniques, this methodology provides a

superior means of analysis. However, this technique requires large sample size in terms

of data points. But given data availability that spans 1980 to 2007 and the fact that the

focus of policies on macroeconomic convergence criteria in the WAMZ countries is a

recent phenomenon, there is no sufficient data for such long-run analysis. In this

situation, long-run analysis will be meaningless. Therefore, OLS technique is the most

appropriate methodology in this case. The analyses ensure that sufficient specification

and estimation diagnostic tests are employed to confirm the consistency and reliability of

the estimated results.

The empirical models for this investigation are eclectic, informed by the wide array of

macroeconomic variables and issued being investigated. While the literature provides the

major impetus for structuring the models, our understanding of the nature, structure and

specific underlying socio-economic fundamentals in each WAMZ country, and data

availability provide the final input for the models.

Inflation The theoretical and empirical models of inflation are wide, varying and growing, given

the dynamics of the global economy and its impact on national economies. Such models

cut across several theoretical postulations and different schools of thought – monetarist,

structuralist and fiscal. Sometimes these models are cast in the context of cost-push and


105

demand-pull. Added to this is the globalization phenomenon. Based on these, several

country- and region-specific models of inflation have been investigated (see, for instance,

Sekine 2001, Hofmann 2006, Khan and Schimmelpfennig 2006, Borio and Filardo 2007,

Diouf 2007 and Cheung 2009). In specifying our model for investigating the effects of

globalization on inflation convergence criterion, we take cognizance of these

developments and most particularly the peculiar nature and structure of the WAMZ

countries being investigated. Thus, the following model is proposed for investigation.

*

1( , , , , , )

tf g i n y G

(1)

represents the inflation rates in the countries. This is measured as the consumer price

index in all the countries except Sierra Leone where the only available measure is the

GDP deflator. 1t

captures inflation expectations which is inflation rate in the

previous period. The foreign inflation rate is denoted by *

and measured as the average

wholesale price index of the five largest European economies5, the UK and US. This

variable is included to capture the extent to which foreign inflation influences domestic

inflation given the import-dependent nature of WAMZ countries. Our variable of

interest – globalization – is symbolized by g and remains as earlier defined. Nominal

interest rate is designated as i while n refers to the nominal effective exchange which

by construction is a weighted average of bilateral exchange rates relative to currencies of

major trading partners. Size of the economy is signified by y and measured as GDP

per capita. The effects of fiscal activities are represented by G that stands for fiscal

expenditure and debt. Given the knowledge from the literature, the a priori effect of

globalization on inflation is uncertain. However, it is pertinent to expect that

globalization and its accompanied international competition would lower markups and

thus inflation.

Reserves Accumulation

There is no consensus on the theoretical and empirical model of reserves behavior across

countries. In most cases, countries have different motivating factors for reserve

accumulation, prominent among which are exchange rate and market stability, liquidity,

creating buffer for a ‗rainy day‘ and maintaining credibility and credit worthiness.

Generally, several determinants of the reserve accumulation behavior of countries are

5 These are Germany, France, Italy, Spain and Netherlands


106

identifiable and include vulnerability to external shock visible through the current and

capital account positions, exchange rate regime and opportunity cost of holding reserves

(see, for instance, Heller 1966, Iyoha 1976, Landell-Mills 1989, Archer and Halliday 1998,

Lane and Burke 2001, Mendoza 2004, Gosselin and Nicolas 2005, Stiglitz 2006,

Aizenman et al. 2007, Elhiraika and Ndikumana 2007, Osabuohien and Egwakhe 2008,

Yeyati 2008 and Olokoyo et al 2009). Based on the literature and peculiarities of WAMZ

countries, we estimate the following model:

( , , , , , , )f g k i t c y (2)

The volume of reserves measured in percentage of GDP is typified by while g

denotes globalization, our variable of interest. The extent to which capital controls

influence reserves accumulation is represented by capital flows ( k ) while lending rate ( i) captures the opportunity cost of accumulating reserves. The total value of trade (exports and imports) is denoted by t and c represents the current account balance.

Output per capita ( y ) is included to control for the level of economic development and

is measured as GDP per capita. Globalization induces increased trade that might lead to a rise or fall in reserves accumulation, depending on whether the country is a net importer or net exporter.

Exchange Rate Several variables have been identified to determine the changes in exchange rates.

Concentrating on recent empirical analytics given the dynamics of determinants of

exchange rate, similar cross-country determinants are identifiable. Grants inflow was

identified by Rajan and Subramanian (2005) as important, especially in aid-dependent

economies, resulting in real exchange rate overvaluation. Similar findings were

established by Elbadawi et al. (2008) in a cross-country study, confirming that foreign aid

inflows lead to appreciation of the equilibrium real exchange rate (for more studies that

have established similar results, see Saadi-Sedik and Petri 2006). In a panel study, Lane

and Milesi-Ferretti (2006) found that large external liabilities that result in large external

resource flows lead to exchange rate depreciation while grant-based resource inflows

induces real exchange rate appreciation. A converse result was, however, established by

country-specific studies that posit that resource inflows rather lead to real exchange rate

appreciation (see Ogun 1995, Sackey 2001, Li and Rowe 2007). In addition to grants,

Saadi-Sedik and Petri (2006) have identified remittances as additional explanatory

variables. In a completely different finding, Berg et al. (2007) and Lee, et al (2008)

submitted that capital inflows into SSA countries do not induce real exchange rate


107

appreciation; it rather leaves the exchange rate stable or depreciated. For our empirical

estimation, the following model is specified:

( , , , , , , )x f g tr k id y d (3)

Exchange rate changes is denoted by x , g represents globalization, tr represents the

value of trade, k refers to capital flows defined as total inflows of FDI, private capital,

aid and remittances. Inflation is represented by , while id measures the difference

between interest rate in the respective countries and the average interest rates in the five

biggest economies of the EU, the UK and US. Economic output, measured as the GDP

per capita, is captured by y while d symbolizes output difference. The latter is

measured using the same technique as was done for the interest rate difference but using

GDP per capita. Exposure to international fluctuations in trade, capital flows and

contagion is expected to increase movements in exchange rate that could either be

appreciation or depreciation, overall. Thus, the overall effects of globalization on

exchange rate movements are ambiguous as it depends on the peculiar nature and

structure of the economy under consideration.

Real Interest Rates

Economic theory provides little guidance on a universally acceptable model for real

interest rates (Upper and Worms 2003). Thus, several empirical models have been

developed to investigate the dynamics of this variable. Blanchard and Summers (1984),

Barro and Sala-i-Martin (1990) and Al Awad and Goodwin (1998) are among the earliest

studies to proffer that international financial integration is a prominent determinant of

real interest rates. Orr et al (1995) identified surprise inflation, profitability, fiscal deficit, a

measure of risk, and the current account position as notable determinants. Pain and

Thomas (1997) and Wu (1999) established strong effects of interest rate differentials on

real interest rates movement. For the purpose of this paper, the following model is

estimated:

( , , , , , , , )e

R f g G c r x s (4)

For equation (4), R represents the real interest rates, g

is the globalization index, G

denotes the total government expenditures and debt, while c symbolizes the current

account balance. Expected inflation is characterized by e

while r typifies risk. Our


108

measure of risk is total summed magnitudes of all interstate societal and interstate major

episodes of political violence plus the sum of all societal (civil and ethnic) Major

Episodes of Political Violence (MEPV) magnitude scores for all neighboring states. The

latter is added in recognition of the fact that the risks in any country is affected not only

by its own conflict outbreaks and dynamics, but also by conflict in its immediate

proximity – neighboring states – and in general proximity – the ―politically-relevant‖

regional system (for detailed description of the composition and computation of this

dataset, see Marshall 2010). Nominal effective exchange rate is represented by x while

s symbolizes savings, measured as gross domestic savings.

Interdependence induced by globalization equilibrates, dampens and spreads shocks and

reduces booms and bursts as scarcity and excesses are shared across countries. This is

especially true for financial resources. Thus, globalization reduces risks associated with

investments and business cycles and enhances investors‘ confidence (Wu 2006). Since

these are all components of real interest rates, globalization is thus expected to reduce

real interest rates. Moreover, globalization, especially financial globalization, has induced

increased global savings through financial resource pooling. This has made available

significant financial and loanable resources available, expectedly leading to reduced real

interest rates.

EMPIRICAL ANALYSIS

The empirical analyses will be undertaken for both primary and secondary criteria for

which data are available over a reasonable length of time to enable meaningful analyses.

Inflation rates, foreign reserves, exchange rates and real interest rates are available for the

Gambia, Ghana, Nigeria and Sierra Leone while similar analyses will be done for Guinea,

but for real interest rates. The estimated results for each country are presented in

individual tables. For the Gambia, Ghana and Nigeria, the estimations are based on data

that spans 1980 to 2007, while Guinea covers 1990 to 2007. To imbue confidence in the

reliability of our findings, the estimated results are subjected to rigorous diagnostic tests.

It is a common knowledge that if the error term is serially correlated, the estimated OLS

standard errors are invalid and the estimated coefficients will be biased and inconsistent.

The Durbin-Watson (D-W) Statistic and Breusch-Godfrey (B-G) serial correlation LM

tests (up to order two) are undertaken to check for existence or absence of serial

correlation while Ramsey RESET test is conducted to investigate stability of the models.

Jarque-Bera (J-B) statistic is employed for testing normality in addition to the standard

tests of the overall explanatory power of the models using adjusted 2

R and F-statistic.

The results show that all the models are free from all forms of specification and


109

estimation errors, thus indicating consistency and reliability of the results. Consequently,

the estimated coefficients reflect the true (efficient and unbiased) relationship in the

models.

Gambia

The empirical outcomes for The Gambia suggest that globalization has significant effects

only on exchange rate dynamics (see Table 6). While globalization reduces inflation,

increases foreign reserves and raises real interest rate, these effects are not statistically

significant. For real exchange rate, the effects of globalization leads to appreciation of the

Dalasi and this is statistically significant. The results demonstrate that the overall effect

of globalization on exchange rates in The Gambia is appreciation of the Dalasi.

One major factor that limits the effects of globalization on The Gambian economy as

reflected in the empirical results is its small size and limited state of integration with the

rest of the world in addition to its trade policy. Due to its small size, The Gambia has

very little share in global trade. This is made worse by the nature of its main exports –

groundnut – accounting for about 70% of total exports. In addition, the level of

integration of the economy with the world has been relatively slow. For instance, The

Gambia did not become a member of the World Trade Organization until recently –

23rd October 1996. This limits the extent of economic integration and adoption of

international best practices in trade policy. The maximum external tariff was 90% in 1998

and was not reduced to 18% until 2000. Similarly, the number of tariff bands was 30 and

was not reduced to three until the same period. Indeed, the trade regime was not

substantially liberalized until very recently. In addition, the country did not become

eligible for the AGOA initiative until 1st January 2003. Thus, size, level of integration

and policy are important determinants on the extent to which the effects of globalization

have been felt in The Gambia. Low financial integration in The Gambia also limits the

extent to which globalization influences real interest rates. Before opening the banking

sector for some Nigerian banks very recently, the level of integration of the financial

sector with the world was very limited.

The level of development is another factor that limits the effects of globalization on

macroeconomic convergence criteria in this country. The Gambia ranks among the least

developed countries of the world with a per capita income of US$320 in 2001. In fact,

nearly 50% of the population lives below the poverty line, with the incidence of poverty

much higher (60% or more) in rural areas. In almost all human development indicators,

The Gambia performed below the SSA average, ranking among the lowest in the Human

Development Index. Globalization, especially economic globalization, thrives on

available opportunities. International multinational corporations, the driver of


110

globalization, are interested in large markets and opportunities that would further

promote cost reduction and increased market.

The observed strong influence of globalization on real exchange rate is the result of the

exchange rates liberalization policy of The Gambia which began progressively as far back

as 1986, making the dalasi freely convertible and subject to national and global market

factors. The monetary authorities intervene only on rare occasions purposely to

smoothen excessive fluctuations. Another important factor is the prominence accorded

to tourism as the highest foreign exchange earner. The stable and mild inflow of foreign

currencies through tourist arrivals has helped maintain stability in exchange rate between

the Dalasi and other major world currencies.

Our empirical findings further show that real GDP per capita and real interest rate have

statistically significant negative relationship with inflation. This suggests that a rise in

income and interest rates leads to a reduction in inflationary pressures in The Gambia.

Bank lending channel is the possible transmission mechanism through which this occurs

given its effects in reducing total money supply. On the other hand, capital flows

expectedly increases inflation rate. Total government expenditure and trade exerts

statistically significant influence on foreign reserves while exchange rate movements

reduce it. Appreciation in exchange rates make exports more expensive. This

phenomenon also makes The Gambia more expensive as tourist destination for

prospective tourists. These factors reinforce each other to reduce foreign exchange

earnings and reserves accumulation. The positive and statistically significant impact of

government expenditure and debt on foreign reserves could be as a result of the

government channeling its expenditures and debts to developing foreign exchange

earning activities such as tourism and export-oriented agriculture production.

In addition to globalization, income also induces statistically significant appreciation in

the Dalasi while capital flows, output differentials and interest rate differentials stimulate

depreciation. The case of output differential is very interesting. It suggests that as its

trading partners experience higher output relative to the country – suggesting higher

dependence on them perhaps for aid, loans and investment – higher capital inflows from

these partners tends to depreciate the domestic currency. Government expenditure and

debt is a major determinant of increased real interest rate in The Gambia. This could be

the result of the high total credit extended to the government that tends to reduce

available credit, thus raising interest rate.


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Table 6: Globalization and Macroeconomic Convergence in The Gambia

Inflation Foreign Reserves

Exchange Rate

Real Interest Rate

Globalization -0.0543 (0.4792)

0.0432 (0.0535)

-1.5660*** (0.4193)

0.1447 (2.1113)

Real GDP Per Capita -0.1175* (0.0568)

-0.0025 (0.0056)

-0.8786*** (0.2571)

Total Government Expenditure and Debt

-1.8330 (13.1871)

3.5166*** (0.8059)

2.9665*** (0.9485)

Current Account Balance 0.0120 (0.0279)

Inflation 0.0557 (0.0321)

Domestic Savings -0.2834 (0.3683)

Trade 0.0304** (0.0126)

0.1882 (0.2305)

Capital Flows 4.6505* (22.7995)

-2.5075 (2.3006)

0.1986** (0.0732)

Lending Interest Rate -0.0326 (0.0683)

Real Interest Rate -0.3150* (0.1699)

Output Differentials 6.1470*** (0.8049)

Foreign Reserves -0.0423 (0.0803)

Money Supply -0.6789 (1.3346)

Interest Rate Differential 0.0302* (0.0142)

Foreign Inflation Rate 0.6967 (0.7319)

Exchange Rate -0.2249*** (0.0723)

-3.5241*** (1.1978)

Nominal Effective Exchange Rate

-0.0376 (0.0479)

Inflation Expectations -0.0771 (0.1707)

-0.0040 (0.0132)

Risk 0.1077 (0.3618)

Diagnostic Tests Adjusted R2 0.7187 0.7994 0.9856 0.5351 F-Statistic 8.6666 12.9524 13.5696 2.3021 Serial Correlation

D-W 2.0944 1.6046 1.9647 2.4621 B-G 0.8218 0.3274 0.9828 0.7240

Jarque-Bera statistic 0.1417 0.6884 0.6350 0.1104 Ramsey‘s RESET Statistic 0.0000 0.0074 0.0178 0.0011 No of Observations 28 28 28 28


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Ghana

Globalization has statistically significant effects on all the macroeconomic convergence

criteria in Ghana during the period under investigation (see Table 7). It raises inflation,

foreign reserves and real interest rates and induces depreciation in the real exchange rate.

The effect of globalization on real interest rates is contrary to theoretical expectations.

However, this could be explained by the relatively less integrated nature of the financial

sector until recently. Before the recent liberalization of financial activities, especially the

banking sector that led to the proliferation of some Nigerian-owned banks, the banking

business in Ghana was dominated by a few multinational banks – Standard Chartered

and Barclays Bank – that greatly dominated the sector. This was complemented by a few

local banks that had very limited share of the market. This phenomenon is a prominent

explanation for the high interest rate spread in the economy that subsists up till now.

Thus, the limited integration of the sector in terms of opening for competition is a

candidate explanation for this perverse relationship.

In the same vein, the channel through which globalization increases inflation rates in Ghana is perhaps through foreign imports as explained by the statistical significance of the foreign inflation rate. This is plausible because Ghana is a high import dependent country. Thus, the inflationary component of the goods and services imported from these foreign countries might have increased inflation in the domestic economy. Another interesting feature is the fact that globalization induces appreciation in the Ghana Cedi. One possible channel through which this occurred is increased overall capital flows into the Ghanaian economy, especially aid and remittances. When such large capital inflows remain unsterilized, it exerts pressure on the currency that induces appreciation. This is a probable potent explanation given the history of Ghana as high aid and remittance dependent economy. Inflation expectation exerts statistically significant effects on inflation rate in Ghana, suggesting that high inflation expectations provokes high inflation rate while low inflation expectations leads to a realization of low inflation rate. This is a very important advantage because it makes it easier for the monetary authorities to effectively model inflation in the economy. Exchange rate significantly reduces foreign reserves in Ghana, suggesting that the government may be using the foreign reserves as a lever for managing the exchange rate of the Ghana Cedi vis-à-vis other major currencies of the world, notably the US Dollar. It is also noteworthy that increased government expenditure reduces real interest rate most probably through increased money supply.


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Table 7: Globalization and Macroeconomic Convergence in Ghana

Inflation Foreign Reserves

Exchange Rate

Real Interest Rate

Globalization 2.9599** (1.2733)

6.2819* (3.1497)

0.9536*** (0.3421)

0.8887** (0.4086)

Real GDP Per Capita -0.3766 (0.4630)

2.7391 (3.3341)

0.0005 (0.0016)


-17.2005 (9.4757)

0.5024** (0.2135)

-8.00E-09*** (1.83E-09)

Current Account Balance 0.0766** (0.0301)

-0.4787 (0.3608)

Inflation 0.0004 (0.0009)

Domestic Savings 1.1538 (0.4761)

Trade -1.0440 (1.3391)

0.0303 (0.0944)

Capital Flows -12.4481 (8.3576)

-0.1947 (0.5836)

-0.0457 (0.0928)

Lending Interest Rate

Discount Rate 0.2323 (0.2078)

Output Differentials 1.1515** (0.5997)

Foreign Reserves 0.0086 (0.0137)

Interest Rate Differential -0.0105 (0.0026)

Foreign Inflation Rate 2.2599* (1.1225)

Exchange Rate -1.3745* (0.7140)

Nominal Effective Exchange Rate 0.0063 (0.0125)

-8.74E-05 (3.48E-05)

Inflation Expectations 4.8704*** (1.9703)

-0.0177 (0.0520)

Risk -3.7141* (2.1616)


D-W 2.9850 2.2960 1.9711 1.9724 B-G 0.5086 0.5516 0.3898 0.9710



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Guinea

Assessment of the effects of globalization on macroeconomic convergence criteria could

be done for only three variables for Guinea due to data availability. For all of these

criteria, statistically significant effects were found only for foreign reserves. In this case,

globalization increases foreign reserves accumulation. The possible channel through

which this occurs is most likely to be the rich mineral economy and exports that is typical

of the country. Guinea is a richly endowed economy with minerals that include bauxite,

iron ore, diamond, gold and uranium. It has been estimated that the country possesses

an estimated 25% of the world's proven reserves of bauxite. In fact, bauxite and alumina

production is believed to be generating about 80% of Guinea's total foreign exchange.

This mineral wealth has attracted many multinational mining companies, especially

American firms. These have been joined in recent times by Chinese competitors that are

also interested in these minerals. Thus, through the activities of these multinational firms,

Guinea has been integrated into the global economy and has reaped billion of dollars in

exports of minerals. Part of the foreign exchange earned must have been utilized to

shore up the foreign reserves, thus explaining the positive significant relationship.

Table 8: Globalization and Macroeconomic Convergence in Guinea Inflation Foreign Reserves Exchange Rate

Globalization 0.5379 (1.5850)

0.2111** (0.0741)

0.2045 (1.2195)

GDP Per Capita 0.0216 (0.2694)

0.0219* (0.0115)

-5.5567 (4.0353)

Total Government Expenditure and Debt -3.2572 3.0359

-1.5465 (0.4483)

Inflation -0.0188 (0.0291)

Trade 0.0034 (0.0110)

1.0451*** (0.2244)

Capital Flows 4.3452*** (1.2531)

8.2865 (5.0379)

0.3084* (0.1637)

Foreign Reserves -0.0570 (0.1823)

Interest Rate Differential -0.0092* (0.0049)

Foreign Price Level 0.9126 (1.6701)

Output Differential 8.9008** (3.5070)

Exchange Rate 0.0156** (0.0055)

Inflation Expectation -0.0612 (0.2675)

Money Supply -1.4052 (1.6694)

Price of Bauxite 0.2846*** (0.0987)

Diagnostic Tests Adjusted R2 0.7469 0.7159 0.9684 F-Statistic 3.3207 9.5696 6.6163 Serial Correlation D-W 2.0743 1.9876 2.1734

B-G 0.6584 0.8865 0.7589 Jarque-Bera statistic 0.5591 0.6325 0.5770 Ramsey‘s RESET Statistic 0.0033 0.0442 0.0067 No of Observations 18 18 18

http://en.wikipedia.org/wiki/Guinea

http://en.wikipedia.org/wiki/Bauxite


115

Capital flows is a significant determinant of inflation in Guinea. This is likely the result of

the capital flows originating from mineral exports that were allowed to filter into the

domestic economy unsterilized. This is especially true if such capital flows are not

invested in expanding productive capacities with a view to easing the supply-side

constraints. This fact is corroborated through the estimated positive relationship between

exchange rate and inflation, meaning that exchange rate depreciation reduces the

inflationary pressures in the economy. Similarly, trade – predominantly mineral exports –

induces appreciation in the domestic currency. This suggests that the economy may be

manifesting the Dutch disease, a typical syndrome in most mineral exporting African

countries.

Nigeria

Globalization is a statistically significant factor influencing the behavior of the entire

macroeconomic convergence variables under consideration in Nigeria (see Table 9). It is

especially noteworthy that globalization induces a rise in foreign reserves and exchange

rate depreciation. This is expected given the high integration of the Nigerian economy

through several channels. One of this is the oil sector. The Nigerian economy has been

globally integrated for a long time through the activities of multinational oil firms

operating in the oil sector. Activities in this sector have made the country to reap billions,

perhaps trillions of petrodollars over the past decades (Ogunleye 2008b). The increased

activities in this sector – until the recent lull due to the Niger Delta crisis – coupled with

steadily rising world market price of crude oil provokes large inflows of capital. The

inappropriate macroeconomic, fiscal and monetary management policies involving the

large foreign currency inflows earned Nigeria the reputation of being a classic example of

an economy plagued by Dutch disease. This explains the observed currency appreciation

in the estimated results. By the same token, inappropriate policies have also made the

foreign currency inflows to filter into the real sector, causing the observed high inflation.

It is interesting to note, however, that Nigeria had used the proceeds from oil exports to

build large foreign reserves. In fact, Nigeria is the only country within the Zone and

perhaps in SSA that had acquired reserves that could cover almost two years of imports.

Even though this has been significantly run down in recent times, it has provided a lever

and policy space for the economy to maneuver as exchange rate management tool in the

face of the recent negative effects of the global financial and economic crisis. It is hope

that the rebound in the international market price of oil and resolution of the Niger

Delta crisis will help the country to return to the path of high reserves accumulation.


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Table 9: Globalization and Macroeconomic Convergence in Nigeria Inflation Foreign

Reserves Exchange Rate Real Interest

Rate

Globalization 4.1596** (1.4930)

1.0193*** (0.2233)

0.9164*** (0.3172)

3.9576** (4.4847)

Real GDP Per Capita 0.3629** (0.1532)

-0.0900 (0.096)

0.0013 (0.2811)


5.6682* (2.5360)

-0.5861 (0.6245)

Current Account Balance 0.0760 (0.0818)

8.8117

Inflation 0.0869 (0.3700)

Domestic Savings Trade Exports -3.8063***

(11.7135) -3.8023***

(1.0669) Capital Flows 7.8316***

(2.1054) 9.6174*** (3.2469)

-1.9511** (8.8804)

Lending Interest Rate Real Interest Rate -0.8952***

(0.1858) -0.1969 (0.4751)


Foreign Reserves -4.6528*** (0.9786)

Interest Rate Differentials -0.9135 (1.0110)

Foreign Inflation Rates -0.44025 (0.4682)

Exchange Rate -0.0722 (0.0420)

Nominal Effective Exchange Rates

-0.0003 (0.0009)

0.0137 (0.0396)

Inflation Expectations 0.3955*** (0.1270)

0.0211 (0.2583)

Crude Oil Price 0.7634*** (0.0425)

-0.4127*** (0.1324)

Money Supply -2.5180 (1.2616)

Risk 6.7782 (3.2002)


D-W 2.4722 2.0865 1.9291 2.5512 B-G 0.1204 0.9312 0.6179 0.6074



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The positive effects of globalization on real interest rate could be the result of the limited

opening of the banking sector to foreign operators. Most of the banks operating in the

country are locally owned with a reduction in the number with the recent consolidation.

It remains to be seen whether the consolidation with its attendant reduction in number

of banks will help lower or raise interest rate in the long run. A possibility is that it might

not since the number of well respected and innovative banks is few and could, therefore,

easily collude. Another possible explanation is that the financial integration of the

banking sector and the nature of banks operating there are more interested in real sector

investment rather than extending loans since the latter is less profitable given the nature

of borrowers in the market. In addition, the banks appear to be interested in foreign

financial market transactions in more mature emerging economies given the relatively

lower risks and higher returns in these economies. This action reduces the amount of

loanable funds available in the domestic economy, thus driving up interest rates.

A very critical issue emanating from the empirical results for Nigeria is the need for

proper management of oil proceeds. It could be seen that crude oil price is a major factor

determining currency appreciation in the country. Also important is fiscal discipline as

total government expenditure and debt are major factors contributing to real exchange

rise.

Sierra Leone

Sierra Leone is characteristic of economies where the effects of globalization on

macroeconomic convergence criteria are moderate. The most prominent effects are

established for exchange rate where globalization induced statistically significant

appreciation in the domestic currency. Again, proceed from mineral export is the most

potent channel through which this impact occurs. This position is further corroborated

by the statistically significant effect of globalization on foreign reserves. The recent

discovery of oil could, however, presents both opportunities and challenges for the

country in its design and management of macroeconomic variables. While the increased

revenues would be helpful in accumulating foreign reserves, it could also induce

exchange rate volatility and further deepen the Dutch disease. Therefore, the country

requires institutional and policy readiness in managing such external shock to avoid

undesirable consequences.


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Table 10: Globalization and Macroeconomic Convergence in Sierra Leone Inflation Foreign Reserves Exchange Rate Real Interest Rate

Globalization 1.3227 (1.2600)

0.2491* (0.1325)

-2.5467*** (0.7724)

-2.7175 (1.3089)

Real GDP Per Capita 0.1478 (0.1199)

-0.0109 (0.0096)

-1.7811 (0.4962)


0.8822** (0.4047)

8.1514*** (4.6316)

Current Account Balance

0.1874*** (0.0314)

-0.4708 (0.3187)

Inflation 0.2842** (0.1056)

Domestic Savings 0.0336 (0.3766)

Trade -0.0411 (0.0305)

0.3833 (0.3174)

Capital Flows -3.6054 (3.1110)

1.0239*** (0.1859)

Lending Interest Rate -0.0498** (0.0209)

Real Interest Rate -1.6266*** (0.2495)


Foreign Reserves 0.2318** (0.1092)

Money Supply -2.2951** (0.9924)

Interest Rate Differentials

0.2377* (0.1238)

Foreign Inflation Rates -0.5696 (0.6876)

Exchange Rate -0.0009 (0.0009)

Nominal Effective Exchange Rates

-0.0002 (0.0002)

0.0009** (0.0004)

Inflation Expectations 0.0814 (0.1107)

0.0342 (0.0880)

Risk -1.4661 (1.3348)


D-W 1.5806 2.0742 1.9595 2.1941 B-G 0.2652 0.3590 0.4574 0.5347

Jarque-Bera statistic 0.9036 0.6794 0.8087 0.5814 Ramsey‘s RESET Statistic

0.0006 0.0000 0.0254 0.0037

No of Observations 28 28 28 28


119

To encapsulate the empirical findings, a major trend emerging from the results suggests

that the larger the economy, the stronger the effects of globalization on the

macroeconomic convergence criteria. This is amply clear as it can be observed that

globalization exerts significant effects on macroeconomic criteria in economies like

Nigeria and Ghana as opposed to relatively smaller economies of The Gambia, Guinea

and Sierra Leone. Another interesting observation is that effects of globalization on

exchange rate are most prominent, turning out to be statistically significant in all the

countries. Rather than inducing a reduction in inflation rates, globalization rather

aggravates inflation in all the WAMZ countries except The Gambia. It is clear that the

effects of globalization on macroeconomic convergence criteria are similar but not

symmetric in all the WAMZ countries. This demonstrates the need for both country-

specific and Zone-wide policies in managing the effects of globalization so that its

positive impact is leveraged upon while effectively managing its deleterious effects.

POLICY RECOMMENDATIONS

WAMZ countries should begin by creating competitive economies that would be

followed by leveraging on the benefits of globalization among themselves through the

creation of efficient and non-distortionary markets for products and factors of

production, including freer movement of capital, labor and persons. This will help

broaden economic, market and investment base of these economies and help create

competitive advantage. In fact, promoting trade and investment through sound

economic, fiscal, monetary, institutional and risk management policies are the only sure

way to benefit from globalization in the Zone. One important consideration in this

respect is for the region to cut a market niche for itself especially in the area of crude oil

given the weight of Nigeria in this respect and the discovery of oil in Ghana, Sierra

Leone and in the potential member country – Liberia.

One way to dampen real exchange rate volatility in WAMZ countries would be for the Central Bank to increase foreign reserves accumulation. This would serve as a two-edge sword in achieving macroeconomic convergence criteria involving reduced fluctuations in exchange rate and improved reserves accumulation. As amply demonstrated in the case of Nigeria during the recent global economic and financial crisis, the high foreign reserves accumulation was the lever employed by the country to maintain stability in its Naira against major world currencies, especially the American dollar. In addition, some of the Central Banks of these countries are still in the habit of issuing paper-denominated domestic currency in their bid to sterilize the potential negative effects of capital inflows. This should be stopped forthwith and replaced by the use of dollar-denominated paper backed by the Central Bank. This policy action would help tame an upward trend in


120

domestic interest rates. Resource rich countries like Nigeria, Guinea and Sierra Leone – this also applies to Ghana with the new oil discovery – should intensify efforts at creating and managing a credible fund for shoring up foreign reserves during boom in a transparent and accountable way. Due to limited capacity and fear of being hijacked by the elites, such fund could be placed under the jurisdiction of a supranational institution such as the African Development Bank or ECOWAS Bank for Investment and Development. To dampen foreign exchange volatility, WAMZ countries should reduce foreign aid dependency and improve domestic resource mobilization and use. This suggests that particular attention must be paid to domestic taxation and savings. The challenge in this respect is the large informal sector and hard to tax activities in these countries that tend to limit the tax base and tax revenues collectible. They should also be mindful of the nature of capital flows into the economy, focusing on technology-inducing and beneficial capital flows aimed at developing domestic productive capacities. So much needs to be done on improving domestic resource mobilization in the WAMZ countries. Some of the required policy actions include enhanced political commitment in designing and implementing national and WAMZ-wide strategies for improving mobilization of domestic resources, development of local capacity in all facets of domestic revenue collection and management. Also important are tax reforms that reduce complications in tax assessment, computation and collection and broaden the tax base to include the hard-to-tax informal sectors, promotion of tax reforms that foster a move away from the current trend of tax exemptions, concessions and holidays. There is also need for harmonization of tax policy and procedures, provision of sufficient incentives for tax collectors, higher level tax bureaucrats and institutions through rewards and punishments for erring tax officials and payers. Policies aimed at promoting domestic investment should be pursued through improvement in the business climate. Each country should undertake a domestic resource assessment with a view to understanding the peculiar nature and structure of their economies and appropriate policy for dealing with them. The West African Monetary Institute (WAMI) should help broker and champion this process.

Fiscal discipline is very important for meeting the macroeconomic convergence criteria in WAMZ countries. The countries should work assiduously to ensure fiscal policy repositioning that would be flexible and help respond to emerging challenges. For countries with high debt such as Ghana, Guinea and Nigeria, where debt sustainability is a real issue, fiscal adjustments that take cognizance of the deteriorating fiscal positions is imperative. The large need for poverty-reducing, infrastructure development and employment creation fiscal expenditures coupled with easier access to financial market and its resultant excessive borrowing should be well balanced to ensure responsible and disciplined fiscal expenditures. Fiscal frameworks and institutions should, therefore, be strengthened to promote monitoring and evaluation of fiscal policies, effects and


121

outcomes. Each country should look inward to know what is best for it given its peculiarities.

Central Bank autonomy is imperative for monetary policy design and implementation. It is autonomy that would empower the monetary authorities to implement monetary policy goals that would cut across all the macroeconomic convergence criteria free from political encumbrances. In WAMZ countries, central banks of most countries are hardly independent, perpetually operating under either the Presidency or the Ministry of Finance. This limits their legal, goal and instrument independence. To illustrate with the case of Nigeria, during the recent global economic and financial crisis, the central bank decided to bail out the banking sector, thereby dousing the negative effects of globalization on the economy. However, the extent to which the central bank could go was limited by its independence. Even when some very important far reaching decisions were taken, they were subjected to serious limitations. WAMZ countries should concentrate on institutional reforms that would help in developing stronger and more independent central banks equipped to perform its macroeconomic management role. Moreover, there is need for fiscal and monetary policy coordination to avoid fiscal dominance that could be inimical to achieving macroeconomic convergence. Fiscal dominance is still a problem in most WAMZ countries and has the potential to weaken the possible positive effects of globalization on macroeconomic convergence. In this case, monetary policy is simply directed at financing fiscal deficit through money creation. Even when such fiscal expenditures are financed through the domestic money and capital market, the higher demand may increase cost of borrowing in the domestic market, thereby inducing interest rates volatility. This would most certainly crowd out the private borrowers. The usual result of such action is inflation, interest rates and exchange rates volatility. One would observe that most WAMZ countries suffer from this syndrome. In most of these economies, fiscal expenditure is driven by the needs for social infrastructure, job creation and poverty reduction. In most cases, neither the available resources are sufficient to finance this expenditures nor is the government credible enough to engage in external borrowings. Thus, money creation through the central bank becomes the only available means of finance. Therefore, WAMZ countries need to create a framework for ensuring that fiscal dominance is contained and does not inundate macroeconomic convergence policy goals. This requires creating a synergy between fiscal and monetary authorities to ensure harmonization of policy goals, prominent among which should be dousing the possible negative effects of globalization on macroeconomic convergence criteria. Again, while WAMI should be the prime mover at the Zone-wide level, each country should establish fiscal-monetary policy coordination units for this purpose.


122

Given the variation in size, level of development and of global integration, stronger

economies such as Nigeria should assist the relatively smaller economies to efficiently

manage the effects of globalization on their economies. This will help promote equity

and shared costs of integration by offering to absorb some of the exogenous shocks

emanating from globalization on the relatively smaller economies. This is the major route

to ensuring viability of the WAMZ countries and improving their resilience in the face of

globalization. WAMI should be more dogged in its mandate to fast-track the

convergence through more innovative strategies and programmes aimed specifically at

leveraging on the benefits of globalization on convergence and mitigating its real and

potential risks.

CONCLUSION

Globalization could be a positive or negative force on WAMZ‘s efforts to achieve

macroeconomic convergence and ultimately monetary integration. Whichever of these

would occur will depend on the nature of each member country and the available

policies for harnessing its real and potential abundant opportunities and mitigating its

negative effects. Thus, understanding the nature of effects is important for management.

This article has elicit our understanding in this respect. It is clear that effects of

globalization on WAMZ countries depends, to a large extent, on the size, level of

development, level of integration and policy environment aimed at managing

developments in macroeconomic variables. On the one hand, foreign capital inflow,

especially in the net oil and mineral exporting and high aid- and remittance-dependent

economies, is a major determinant of exchange rate changes. On the flip side, same large

capital inflows have had deleterious effects on exchange rate appreciation, thus

provoking Dutch disease in these economies. Therefore, there is need for proper

balancing in the management of capital flows so that foreign reserves accumulation is

minimized while avoiding exchange rate overvaluation that has plagued these economies

for a long time. This will help to stimulate international competitiveness of the Zone.

On a general note, there is need for strong political will to pursue monetary integration

objective in the WAMZ countries by making it a top priority. Competitive advantage

should be created as the first step to benefiting from the positive effects of globalization.

This would require more reforms that will make the Zone a hub for trade and foreign

investment. This should take cognizance of the real and potential supply-side bottlenecks

that remain a daunting challenge in the region. Fiscal expenditures should be targeted at

easing the supply-side constraints. Indeed, both local (public and private) and foreign

resources should be directed towards relaxing supply-side and capacity constraints.

Countries with large windfalls from crude and mineral exports should take advantage of


123

the additional resources available to them to achieve this and use the proceeds to

proactively counter external shocks.

Moreover, more resolute efforts must be made to assess existing arrangements for

meeting the convergence criteria, incorporating the possible positive and negative effects

of globalization. Furthermore, efforts are needed to strengthen the existing arrangements

for coordinating macroeconomic policies by reinforcing peer-group surveillance of the

convergence criteria and the national economic policies aimed at achieving these. Focus

should be on fiscal-monetary policy coordination that prevents fiscal or monetary

dominance. The country should work more closely and intensely to harmonize standards,

regulations and policy for achieving set objectives. Lessons should be shared between all

member countries with respect to best practice in managing the effects of globalization

on macroeconomic variables. These concerted efforts will help fast-track the

convergence speed and ultimately deliver a virile and successful second monetary

integration in West Africa.


124

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