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TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

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Page 1: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

TRADE AND CURRENCY UNIONS IN AFRICA

By Paul R. MassonRotman School of Management

University of Toronto105 St. George St.

Toronto, ON M5S 3E6Canada

Page 2: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Issues

• Africa’s share of world trade has fallen over the last 3 decades. What are the reasons?

• Can introducing common currencies help?• Is the Andrew Rose result that a common

currency multiplies trade by 2 or 3 consistent with African data?

• What are welfare effects of regional currencies and a single African currency?

• What other ways exist to increase African trade?

Page 3: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Africa’s share of world trade

• Has fallen (in value terms) from 4.1 percent in 1980 to 1.6 percent in 2000

• Gravity model implies that GDP and distance are key explanatory factors

• Foroutan and Pritchett (1993) conclude that those factors are sufficient to explain the low level of Africa’s trade (excluding primary commodities).

• Gravitational force of higher GDP in Europe also explains low intra-African trade

• Low or negative African growth explains a declining global trade share

Page 4: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Recent data suggest Africa’s trade overpredicted by Gravity Model

• Subramanian and Tamirisa (2003) find Francophone Africa undertraded in 2000 by 70%, with trade intensity falling over time

• Anglophone countries consistent with GM• ST suggest that CFA franc overvaluation

explained falling trade intensity• However, this was corrected by 1994

devaluation; why still present in 2000 data?

Page 5: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

GM also used to estimate effect of common currency

• Andrew Rose notably has found that common currency has a large effect on bilateral trade

• Cross-sectional results (Rose, 2000) suggest increase by a factor of 3

• Time series (Glick and Rose, 2002) with country fixed effects give somewhat lower estimate, around 1.7

• But Africa has one of most extensive currency unions, the CFA franc zone: how is this consistent with Francophone Africa being an “undertrader”?

Page 6: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Africa sample vs. global sample

• Africa estimates are consistent with Rose results (Table 1)

• However, zero observations (dropped from sample) are very important for Africa. But if they are real data, they are valuable information that should be used in estimation.

• Even accepting currency union effect in CFA, predicted and actual trade with France is much greater than trade with Africa (Table 2)

Page 7: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Glick and Rose (2002)

Masson and Pattillo (2004)

Tsangarides et al. (2006)

country fixed effects

Sample World Africa Africa

Currency effect

3.67 3.63 1.73

Table 1.Currency effects on trade

Page 8: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Table 2. CFA Franc Zone Trade: Intra-regional and with France, 1997-98Percent of total trade

Region WAEMU CEMAC Total CFA

Intra-regional

Actual 9.4 2.8 7.8

Predicted w/o CU dummy

1.3 1.0 1.2

Predicted with CU dummy

2.5 2.5 2.2

With France

Actual 43.4 32.9 38.7

Predicted w/o CU dummy

41.0 36.5 39.5

Predicted with CU dummy

42.7 38.2 41.2

Source: Masson and Pattillo (2004, Table 4-2).

Page 9: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Some econometric issues with GM

• Ably surveyed by Baldwin (2006)• Controlling for various country-specific factors (common

language, colonial history, etc.) not adequate; need to include country fixed effects and hence use time series evidence of entrances and exits from currency unions

• In Africa, CFA zone fairly stable; Guinea abandoned zone in 1960, Mali left and rejoined WAEMU, and Guinea-Bissau and Equatorial Guinea joined WAEMU and CEMAC, respectively. But these are very special cases and data greatly affected by other factors, e.g. civil war and oil discovery

• Another major issue for Africa: treatment of zero observations

Page 10: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Zero observations

• GM usually estimated in log form

• This precludes using zeros, so observations dropped (31 percent of intra-Africa trade sample)

• Alternatively, a small number added before taking logs. When Tsangarides et al. (2006) also include country fixed effects, currency union effect disappears

• Alternative is to estimate non-linear version and include zeros.

• This is what ST (2003) and Coe et al. (2005) do; but don’t test for currency union

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Page 11: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Unresolved issues

• Are zeros true data or due to reporting problems? What about informal trade?

• Will Rose effect survive proper treatment of zeros using non-linear estimation, allowance for heteroscedasticity, and country fixed effects?

• What are the effects of other trade impediments? Longo and Sekkat (2004) find poor infrastructure and political tensions significantly lower bilateral African trade

Page 12: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Africa’s projects for currency unions

• African Economic Community aims for a single African currency by 2028 or before, using RECs as building blocks

• There are projects for monetary integration within ECOWAS, SADC and COMESA (as well as EAC), while other RECs have vaguer integration objectives (AMU and ECCAS)

• Can these projects significantly boost trade and increase welfare?

Page 13: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Evaluating welfare effects• Paper extends simulation analysis of Masson and Pattillo (2004) by

assuming a significant Rose effect: trade is now assumed to double when using a common currency. This may be an overestimate, given econometric problems. Biases in favor of a common currency

• The model assumes that central banks are subject to fiscal pressures, and also to incentives to engineer beggar-thy-neighbour monetary expansions (in an extended Barro-Gordon model).

• Greater intra trade reduces the incentive for expansionary monetary policy in a currency union, improving welfare. So gains from a monetary union are enhanced by Rose effect. But fiscal asymmetries (as well as traditional OCA shock asymmetries) may make CU welfare-deteriorating relative to independent currencies.

• Empirical model is calibrated to replicate African data on inflation and fiscal discipline.

• But actual intra trade is small (Table 4), so doubling would not make enormous difference

Page 14: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Table 4. Exports of Regional Economic Communities

Averages 1995-2000 (In percent of each REC’s total exports)

Destination of Exports

REC AMU COMESA ECCAS ECOWAS SADCEuropean

UnionRest of World

AMU 2.74 0.67 0.11 0.45 0.06 71.78 24.19

COMESA 0.77 5.47 0.74 0.19 5.94 41.25 45.64

ECCAS 0.61 0.67 1.89 0.68 0.95 43.76 51.45

ECOWAS 1.01 0.56 1.61 9.08 1.25 37.15 49.34

SADC 0.19 8.28 0.83 0.79 10.28 36.87 42.76

Page 15: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Evaluating selected REC currency unions: COMESA

• COMESA includes countries with varied fiscal requirements and trade shocks

• It has no large central country with strong trade links. Egypt, with by far the largest GDP, has few links with others

• Welfare analysis suggests that there would be many countries that would lose from a common currency even with a doubling of trade (Table 6)

Page 16: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Table 6. COMESA: Net Welfare Gains from Regional Currency

Welfare gain/loss

GDP share

w no trade expansion

w trade doubling

Angola 0.0465 0.1893 0.1973

DR Congo 0.0382 0.1303 0.1443

Egypt 0.5273 0.0038 0.0236

Ethiopia 0.0418 0.0980 0.1136

Kenya 0.0681 -0.0086 0.0117

Madagascar 0.0245 -0.0313 -0.0102

Malawi 0.0129 0.0581 0.0756

Mauritius 0.0279 -0.2191 -0.1920

Namibia 0.0234 -0.1084 -0.0846

Seychelles 0.0039 0.2572 0.2578

Sudan 0.0644 0.0494 0.0673

Swaziland 0.0090 -0.1259 -0.1015

Uganda 0.0416 -0.0505 -0.0287

Zambia 0.0222 0.0326 0.0511

Zimbabwe 0.0485 0.0665 0.0837

Page 17: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

… ECOWAS

• REC has a strategy of first creating a second monetary union (WAMZ) and merging it with WAEMU. Target date for WAMZ is 2009.

• Problem with WAMZ and full ECOWAS union is size of Nigeria, its different terms of trade shocks (as an oil exporter), and its lack of fiscal discipline.

• A full ECOWAS monetary union unattractive to all WAEMU members and several of the others, even with trade doubling (Table 7)

Page 18: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Table 7. ECOWAS: Net Welfare Gains from Regional Currency

Welfare gain/loss

GDP sharew no trade expansion

w trade doubling

WAEMU members

Relative to existing WAEMU

Benin 0.0340 -0.0671 -0.0622

Burkina Faso 0.0406 -0.0272 -0.0234

Cote d’Ivoire 0.1706 -0.0991 -0.0934

Mali 0.0407 -0.0368 -0.0327

Niger 0.0301 -0.0478 -0.0434

Senegal 0.0749 -0.1023 -0.0965

Togo 0.0215 -0.0645 -0.0596

Non-WAEMU countries Relative to independent

currencies

Gambia 0.0061 -0.0270 -0.0210

Ghana 0.1078 0.0363 0.0380

Guinea 0.0597 -0.0405 -0.0320

Nigeria 0.4037 0.0481 0.0468

Sierra Leone 0.0104 0.0478 0.0501

Page 19: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

A single currency for Africa?

• Assuming that RECs went ahead with regional currencies, would it make sense to merge them into a single African currency?

• Given weakness of inter-REC trade ties and differences in fiscal discipline, this would be unattractive to ECCAS and SADC countries (Table 8).

• However, trade doubling would change sign of welfare change to positive for AMU

• Overall, this suggests that such an all inclusive pan-African currency could not be justified on purely economic grounds.

Page 20: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

Table 8. A Single African Currency: Average Net Welfare Gain Relative to Hypothetical Regional Currencies

RECNo trade expansion With trade doubling

AMU -0.0011 0.0104

COMESA 0.0395 0.0484

ECCAS -0.0128 -0.0012

ECOWAS 0.1125 0.1062

SADC -0.0739 -0.0778

Source: author’s calculations.

Page 21: TRADE AND CURRENCY UNIONS IN AFRICA By Paul R. Masson Rotman School of Management University of Toronto 105 St. George St. Toronto, ON M5S 3E6 Canada

How to stimulate African trade?

• Evidence suggests African transportation costs too high, due to lack of roads, air and rail links, and poor port facilities. Resources should be allocated to improve transportation and communication links.

• Investment in infrastructure more generally and measures to reduce political tensions can certainly help trade and stimulate output

• Trade liberalization should proceed, and measures to create free-trade zones actually implemented. In practice, countries have continued to impose protection against neighbouring countries, despite agreeing not to do so.

• Fiscal discipline enhances macroeconomic stability and trade• Selective expansion of existing currency and exchange rate unions

(CFA franc zone, CMA in southern Africa) could provide mutual benefits, building on established, credible institutions.

• However, all-inclusive currency unions doomed to failure, given widely different features of African economies