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?

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

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?

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”?

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)

Glick and Rose (2002) Masson and Pattillo (2004) Tsangarides et al. (2006) country fixed effects Sample World Africa Currency effect Table 1.Currency effects on trade

Table 2. CFA Franc Zone Trade: Intra-regional and with France, Percent of total trade RegionWAEMUCEMACTotal CFA Intra-regional Actual Predicted w/o CU dummy Predicted with CU dummy With France Actual Predicted w/o CU dummy Predicted with CU dummy Source: Masson and Pattillo (2004, Table 4-2).

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

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

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

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?

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

Table 4. Exports of Regional Economic Communities Averages (In percent of each REC’s total exports) Destination of Exports RECAMUCOMESAECCASECOWASSADC European Union Rest of World AMU COMESA ECCAS ECOWAS SADC

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)

Table 6. COMESA: Net Welfare Gains from Regional Currency Welfare gain/loss GDP share w no trade expansion w trade doubling Angola DR Congo Egypt Ethiopia Kenya Madagascar Malawi Mauritius Namibia Seychelles Sudan Swaziland Uganda Zambia Zimbabwe

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

Table 7. ECOWAS: Net Welfare Gains from Regional Currency Welfare gain/loss GDP share w no trade expansion w trade doubling WAEMU members Relative to existing WAEMU Benin Burkina Faso Cote d’Ivoire Mali Niger Senegal Togo Non-WAEMU countries Relative to independent currencies Gambia Ghana Guinea Nigeria Sierra Leone

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.

Table 8. A Single African Currency: Average Net Welfare Gain Relative to Hypothetical Regional Currencies REC No trade expansionWith trade doubling AMU COMESA ECCAS ECOWAS SADC Source: author’s calculations.

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