metadata: authors: 0: author: Kassa,Woubet
1: author: Sawadogo,Pegdewende Nestor
count: Africa
docna: 0: docna: Trade Creation and Trade Diversion in
            African RECs : Drawing Lessons for AfCFTA
docty: Policy Research Working Paper
subtopic: International Trade and Trade Rules,Marketing,Private Sector Development Law,Private Sector Economics,Urban Solid Waste Management,Trade and Multilateral Issues,Transport Services
teratopic: Law and Development,Private Sector Development,Water Supply and Sanitation,International Economics and Trade,Transport
abstracts: cdata!: This study aims to draw key lessons for
            the African Continental Free Trade Area using evidence from
            within the region. Although drawing lessons from the rest of
            the world is essential, given the unique features of
            economies in the Africa region, the most relevant lessons
            can be drawn from the experiences of regional economic
            communities in the continent. The study draws on the eight
            regional economic communities that have been recognized by
            the African Union as pillars on which the continent will
            rely to implement the African Continental Free Trade Area.
            The study evaluates the trade creation and trade diversion
            impacts of each of the eight RECs and examines their
            performance with the goal of drawing lessons and identifying
            challenges for the success of the African Continental Free
            Trade Area. Despite significant heterogeneities, there is
            more trade creation than trade diversion and a generally
            positive impact on trade within the regional economic
            communities. Two regional economic communities in
            particular—the East African Community and the Southern
            African Development Community—outperform all the other
            regional economic communities in terms of boosting
            intra–regional economic community trade. This is mainly
            associated with the high level of investment in trade
            facilitation, the level of synergy between national and
            regional goals, the density of economic activity, and the
            advancement in the quantity and quality of regional
            infrastructure. There are also many challenges that policy
            makers should address to realize the objectives of the
            African Continental Free Trade Area and transform the
            continent. Learning from the regional economic communities
            is central. But, given the scope of the African Continental
            Free Trade Area, there is also a need to examine the
            transition from regional economic communities to the African
            Continental Free Trade Area, which is expected to be a
            sticky transition.
repnme: repnme: Trade Creation and Trade Diversion in
            African RECs : Drawing Lessons for AfCFTA
display_title: Trade Creation and Trade Diversion
            in African RECs : Drawing Lessons for AfCFTA
listing_relative_url: /research/2021/08/33376424/trade-creation-trade-diversion-african-recs-drawing-lessons-afcfta
topicv3: Private Sector Development m1326060 1921,Intraregional Trade m1326248 1175,Transport m1326661 135,Trade m1326924 698,Regional Integration m1504278 2576
publishtoextweb_dt: 2021-08-30T00:00:00Z
dois: 10.1596/1813-9450-9761
historic_topic: Law and Development,Private Sector Development,Water Supply and Sanitation,International Economics and Trade,Transport
origu: Office of the Chief Economist (AFECE)
no_of_pages: 42
author_keys: 0: author_key: 1226802
1: author_key: 1996234
model_extractions: Policy Research Working Paper 9761

# Trade Creation and Trade Diversion in African RECs

Drawing Lessons for AfCFTA _Woubet Kassa Pegdéwendé Nestor Sawadogo_ Africa Region Office of the Chief Economist August 2021
Policy Research Working Paper 9761

# **Abstract**

This study aims to draw key lessons for the African Continental Free Trade Area using evidence from within the region. Although drawing lessons from the rest of the world is essential, given the unique features of economies in the Africa region, the most relevant lessons can be drawn from the experiences of regional economic communities in the continent. The study draws on the eight regional economic communities that have been recognized by the African Union as pillars on which the continent will rely to implement the African Continental Free Trade Area. The study evaluates the trade creation and trade diversion impacts of each of the eight RECs and examines their performance with the goal of drawing lessons and identifying challenges for the success of the African Continental Free Trade Area. Despite significant heterogeneities, there is more trade creation than trade diversion and a generally positive impact on trade within the regional economic communities. Two regional economic communities in particular—the East African Community and the Southern African Development Community—outperform all the other regional economic communities in terms of boosting intra–regional economic community trade. This is mainly associated with the high level of investment in trade facilitation, the level of synergy between national and regional goals, the density of economic activity, and the advancement in the quantity and quality of regional infrastructure. There are also many challenges that policy makers should address to realize the objectives of the African Continental Free Trade Area and transform the continent. Learning from the regional economic communities is central. But, given the scope of the African Continental Free Trade Area, there is also a need to examine the transition from regional economic communities to the African Continental Free Trade Area, which is expected to be a sticky transition.

This paper is a product of the Office of the Chief Economist, Africa Region. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at wkassa1@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Trade Creation and Trade Diversion in African RECs: Drawing Lessons for AfCFTA**

Woubet Kassa and Pegdéwendé Nestor Sawadogo<sup>*</sup>

**Keywords:** Regional trade agreements; trade creation; trade diversion; African Continental Free Trade Area, regional economic communities (RECs), regional trade agreements, free trade area, customs union.

**JEL Classification :** F13, F14, F15, O19

* Woubet Kassa, Office of the Chief Economist for Africa, World Bank, <u>wkassa1@worldbank.org; Pegdéwendé Nestor</u> Sawadogo, Office of the Chief Economist for Africa, World Bank, psawadogo2@worldbank.org. Valuable feedback was received from Cesar Calderon, Fulbert Tchana Tchana and Albert Zeufack at various stages of the study. The views expressed in this paper are those of the authors, and do not necessarily reflect those of the World Bank or its Boards of Directors.
# **1. Introduction**

Can Africa’s high enthusiasm for regional integration through the Africa Continental Free Trade Area (AfCFTA) be matched by national and regional efforts to achieve its desired goals? It depends on how AfCFTA draws upon the successes and challenges faced by the regional economic communities (RECs). When it comes to regional integration in the region, the rhetoric often does not match the reality. The rising ambitions of the region to reduce poverty and promote rapid economic growth could provide additional momentum to achieve the stated goals of regional integration. However, despite some success, the experience of regional integration and RECs in the continent is fraught with failures. This study aims to draw key lessons using evidence from within the region. Though drawing lessons from the rest of the world is essential; given the unique features of economies in the Africa region, the most relevant lessons can be drawn from the experiences of regional economic communities in the continent.

Although intra-regional trade still accounts for a very small share of total trade in Africa, it is becoming increasingly important. The establishment of AfCFTA presents major opportunities and challenges to boost intra-Africa trade. There is an emerging literature that estimates the potential impact of AfCFTA on economic growth, exports, investments, and welfare. Using a computable general equilibrium model (CGE) model, Saygili et al. (2018) estimate that full elimination of tariffs among African countries increases GDP by close to 1 percent and creates an overall welfare gain of about US$16.1 billion in the long run. The growth and welfare gains from AfCFTA could be even larger if the scope of the agreement is extended to non-tariff measures (NTMs) and trade facilitation. Depetris Chauvin et al. (2017) estimate that the elimination of tariff barriers combined with reduction of NTMs is associated with an increase in GDP of at least 5 percent. Maliszewska and Ruta (2020) find that full implementation of the WTO Trade Facilitation Agreement brings the overall welfare gains to 4.7 percent by 2030 (compared to the baseline). The volume of total exports is expected to increase by over 21 percent. However, intracontinental exports are estimated to rise by over 57 percent. There is some modest trade diversion to the rest of the world, with an export decline of around 0.5 percent outside the continent. In monetary terms, intra-continental trade grows from $196 billion in 2030 in the reference scenario to $310 billion after implementation of AfCFTA in 2030.

The assessment of the potential impacts of various agreements under AfCFTA could only be estimated ex-ante. Hence, despite all the potentials, the realization of the expected gains from AfCFTA depends on the extent of intra-regional trade under the new AfCFTA regime and subsequently on the impact of such trade on growth and welfare. To better understand if AfCFTA could yield the much-sought gains, it is essential to understand the early successes and failures of regional trade agreements both within the continent and beyond. Of course, much lessons can be drawn from other regional trade agreements including the European FTA, the North American FTA, and Association of Southeast Asian Nations (ASEAN). However, the most relevant lessons can be drawn from the experiences of past and current regional economic communities in the continent. This study focuses on drawing these key lessons from regional trade agreements with emphasis on the experiences of regional economic communities in the Africa region.

2
It draws upon the eight RECs which have been recognized by the African Union (AU) as pillars on which the continent will rely to implement AfCFTA. We evaluate the trade creation and trade diversion impacts of each of the eight RECs, examine their performance with the goal of drawing lessons and identifying challenges for the success of AfCFTA. Despite significant heterogeneities, there is more trade creation than trade diversion, and a generally positive impact on within-REC trade. Two RECs in particular – East African Community (EAC) and Southern African Development Community (SADC) - outperform all the other RECs in terms of boosting intra-REC trade. This is mainly associated with their high level of investment in trade facilitation, the level of synergy between national and regional goals, the density of economic activity and the advancement in the quantity and quality of regional infrastructure. There are also variations among the RECs in terms of whether they promote exports to the rest of the world or displace them. The key policy implications focus on two key areas - significant investment in trade facilitation and strategic sequencing of integration schemes. Given that AfCFTA is a much larger FTA compared to the existing RECs, it is important that economies use regional integration to create agglomeration economies to expand supply/production which in turn provides greater impetus to engage in GVCs. Given the costs of distance and the benefits of already existing strong trade corridors, it is imperative that integration efforts start with a focus on selected high-density corridors of trade. Expanding trade on a continental level is a daunting task but is achievable and feasible if subregional corridors of trade and production integration are strengthened to build regional value chains which serve as key hubs of GVCs. However, there are many challenges that African countries, regional and global entities need to address to realize the objectives of AfCFTA and transform the continent. We address some of these key challenges and suggest relevant policy options.

# **2. Regional Economic Communities (RECs) in Africa: Background and Key Trends**

The resurgence of regionalism and regional trading blocs has also stirred Africans towards establishing a regional trading bloc to deepen integration. The rise of (mega) regionalism is manifested by the rapidly increasing number of regional trade agreements. The number of RTAs in force has been continuously increasing worldwide, from 142 in 1999 to 176 in 2003 and then to 343 in 2021, while the number of RTA notifications is 548 in 2021 (Figure 1). This rise in regional trade liberalization has also contributed to multilateral liberalization, though it could also have fostered increased regionalization at the cost of multilateral trade.

3
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<!-- Start of picture text --> AMU CEN-SAD COMESA EAC<br>GDP) TRADE (%6 OF GDP)<br>' TRADEQHOFGDP) =, ‘ea TRADE (6OF GDP) TRADE (36 OF<br>fla | F NEMEAN aeOS BB civoMEAN om bY&,. EANNOMEAN DATA %r EANNOMEAN DATA<br>ay |<br>Tre<br>ECCAS ECOWAS ; SADC<br>éohte. TRADE(%OFGDP)MEAN >»ve) rraneqsorcop)MEAN (AD TRADE (96MEANOFGDP) dle > TRADE (96MEANOF GDP)<br>a et ey a <iEAN EAN Mes: ee<br>NO DATA NO DATA NO DATA<br>7 WY wy!<br><!-- End of picture text -->
_Table 1: Progress in market integration of African RECs_

|**REC**|**FTA**|**CU**|**CM**|**EMU**|**SU**|**FM protocol**|
|---|---|---|---|---|---|---|
|ECOWAS|||**×**|**×**|**×**|All 15|
|EAC||||**×**|**×**|3 out of 5|
|COMESA|||**×**|**×**|**×**|Only Burundi|
|ECCAS||**×**|**×**|**×**|**×**|4 out of 11|
|SADC||**×**|**×**|**×**|**×**|7 out of 15|
|AMU|**×**|**×**|**×**|**×**|**×**|3 out of 5|
|IGAD|**×**|**×**|**×**|**×**|**×**|No protocol|
|CENSAD|**×**|**×**|**×**|**×**|**×**|Unclear|

_Source:_ Authors’ elaboration based on UNECA, 2016.

Note:  - Yes, **×** - No, FTA = Free Trade Area, CU = Custom Union, CM = Common Market, FM = Free Movement of persons, EMU = Economic and Monetary Union, SU = Supranational Union.

# **2.1 Key Trends in Regional Trade across RECs**

The share of intra-African exports to total exports has doubled from less than 10% in 1990 to more than 20% in 2019. However, despite the strong positive trend in intra-African trade since 2008, the African continent remains the least integrated region in terms of trade flows (Figure 3). Africa’s low intraregional trade coexists with the region’s extremely high dependence on exports to the rest of the world. The continuously lower level of exports diversification explains this lower regional trade and higher dependence on exports to the ROW. Export dependence, defined as the share of regional exports to the RoW to total regional exports, has slowly decreased from around 90% in 1990 to less than 80% in 2019. This high export dependence also reflects the continent’s historical links with the outside world and lack of export diversification. Nonetheless, the lower level of intra-African trade could be underestimated given the omnipresence of informal trade. It could also be overestimated because of the multiple and overlapping memberships of many countries. Overall, there is significant variation in trade and other indicators of regional integration across the major RECs.

Regional integration, as measured by intra-regional exports as a share of total exports. which is the focus of this study, is deeper in EAC and SADC, followed by CENSAD, ECOWAS, and COMESA (Figure 4). The differences in the levels of intraregional export performances within the African RECs reflect many factors including the size of economies in each REC, varying levels of integration in infrastructure and policies, institutional quality to implement the agreements and the provisions in each REC, the difference in the level of the industrialization process, and the degrees of infrastructure integration and the cost of trading across borders in each REC. A closer 7
<!-- Start of picture text --> 80<br>2a<br>S<br>x Ne<br>3)<br>co)<br>&<br>> 60<br>2<br>ot<br>re)<br>2<br>an<br>% 40<br>a<br>x<br>oO<br>o<br>—<<br>2<br>8<br>7<br>‘Ss<br>@<br>£x=io] eee ee<br>o<br>0<br>1990 2000 2010 2020<br>Year<br>——— Africa ————— Asia ————— America —— Europe<br><!-- End of picture text -->
<!-- Start of picture text --> 40<br>£30<br>g<br>3<br>3S19 /A\—/N\ | ~ \\ 7 \<br>F —/ V \<br>y/<br>—<br>0 wae as<br>1990 2000 2010 2020<br>Year<br>——— saDbc ——— COMESA ——— EAC ———— ECOWAS<br>——— AMU ——— ECCAS CENSAD IGAD<br><!-- End of picture text -->

<!-- Start of picture text --> 30<br>sg<br>a2}<br>S<br>=2<br>3 .20<br>ro)a£10 ~\ VYaan/ \ ~~(Ny~ Y<br>o . 1 \ / » \V/<br>3S \ / Vv<br>ie} DSS aE<br>1990 2000 2010 2020<br>Year<br>—— sapbc ——— COMESA -——— EAC ——— ECOWAS<br>—— amu ——— ECCAS ———— _CENSAD IGAD<br><!-- End of picture text -->
_Figure 5: Trade costs in terms of tariff within RECs_ <!-- Start of picture text --> CENSAD ECOWAS<br>ECOWAS<br>SADC<br>SADC<br>IGAD<br>AMU<br>ECCAS<br>COMESA<br>AMU<br>ECCAS<br>COMESA<br>IGAD<br>EAC<br>EAC<br>0 2 4 6 0 20 40 60 80 100 12<br>Share of fully liberalized tariff lines (%)<br>Intra-REC tariff rate on imports (%)<br><!-- End of picture text --> _Source:_ Authors’ elaboration based on United Nations Economic Commission for Africa (UNECA) (2016).

In addition to tariffs, there is heterogeneity in the levels of trade costs associated with non-tariff barriers. AMU and EAC have the lowest intra-regional non-tariff costs<sup>1</sup> , while COMESA, CENSAD and SADC have the highest trade costs among all the RECs. Table 3 shows that, , trading goods within African RECs involves, on average for all tradable goods, additional non-tariff costs amounting to approximately 131%-262% of the value of goods - as compared to when each country trades these goods within its borders. AMU stands out as the REC with the lowest nontariff cost, followed by EAC. While COMESA and CENSAD show the highest levels of non-tariff cost in Africa. The extent of tariff liberalization does not serve as a clear predictor of intraregional trade in the region given that the two RECs with the highest and lowest tariff liberalization have the highest share of intra-regional trade compared to their counterparts.

_Table 3: Comprehensive Trade Costs Excluding Tariff by REC in 2017_

|**Rank**|**REC**|**Nontariff Trade Costs**|
|---|---|---|
|1|AMU|131.40|
|2|EAC|142.70|
|3|IGAD|169.05|
|4|ECCAS|174.73|
|5|ECOWAS|198.39|
|6|SADC|211.58|
|7|CENSAD|228.46|
|8|COMESA|261.97|

Note: Comprehensive trade costs excluding tariff (i.e., nontariff trade costs) includes all additional costs other than tariff costs involved in trading goods bilaterally rather than domestically. _Source: ESCAP-World Bank Trade Cost Database_ 10
# **3. Evaluating the Impact of RECs on Trade Creation and Trade Diversion**

The objective of our empirical investigation in this section is twofold. First, we examine the determinants of bilateral trade flows in the Africa region following the gravity model framework. Second, we evaluate the effects of African RECs in terms of trade creation (TC) and trade diversion (TD) in accordance with the central theoretical<sup>2</sup> framework of free trade areas.

The classic theoretical framework<sup>3</sup> in analyzing the impact of an FTA or customs union suggests that the welfare impact is ambiguous due to the contrasting welfare impacts of trade creation and trade diversion. Viner (1950) notes that trade creation increases welfare while trade diversion reduces it; pointing out that an FTA could leave countries worse off consequently. A free trade area, by allowing competition among FTA members due to reduced trade barriers, may promote a more efficient (re)allocation of resources within the FTA. This is associated with what is often referred to as trade creation - i.e. there will be a shift in the locus of production from a high-cost producer to a low-cost, relatively more efficient producer, within the FTA. There is a welfare gain associated with reduced prices, increasing consumers’ surplus within the FTA and an overall improvement in the efficiency of production within the FTA. There are two distinct effects associated with trade creation - i.e. the production effect and the consumption effect, both of which are expected to increase welfare. On the production side, we will have greater efficiency gains while also contributing to declining prices (consumption effect) and hence increased societal welfare.

On the other hand, there is the possibility of trade diversion - i.e. a shift in the locus of production from more efficient production by non-members of the FTA to inefficient producers within the FTA, depending on the extent of the external tariffs. The impact of trade diversion could be stronger if members raise external tariffs following the FTA. Within the underpinning theoretical framework, this is harmful due to the global efficiency losses. The effect within the FTA, however, could be positive if the ’production’ gains of the new exporter outweighs the loss in consumer welfare of the old producer. The net impact of an FTA depends on the totality of trade diversion and trade creation, which is largely an empirical question. According to the classical theoretical framework, , an FTA is more likely to have a favorable impact on welfare if trade creation exceeds trade diversion. However, this has largely been focused only on the static gains from trade, without due regard to the dynamic<sup>4</sup> and arguably more important long-term gains. Considering the dynamic and long-term impacts could change the outcome and even trade diversion could yield increased FDI, employment and growth. We evaluate the 8 RECs by estimating the trade creation and trade diversion impacts.<sup>5</sup> The baseline econometric model is given by: l l l i 0 i D i D i i i (1) ii ii ii II ii MM ii<sup>+ αα</sup> XX<sup>DDXX</sup> ii<sup>+ ll</sup> ii<sup>+ ll</sup> ii<sup>+ ll</sup> ii<sup>+ θθ</sup> ,ii where l l lli represents the total exports from country = ψψ + ψψ XX + αα + αα to country in year . i is a set of control variables including standard gravity variables such as distance, contiguity, and ,ii ,ii membership of an RTA. The distance variable represents the distance between the most ll ii jj tt XX populated cities in partner countries while contiguity is a dummy variable taking the value of 1 if 11
two countries share a common border and 0 if not. The membership of an RTA is a dummy variable which takes 1 if a given country is a member of an RTA and 0 otherwise. These gravity variables capture the effects of trade barriers on bilateral trade flows. We capture historical and cultural linkages between trading partners by including a dummy variable which take the value of 1 if two partners countries have a common language, and a dummy variable equals to 1 if two partners countries have had the same colonizer. We also include the gross domestic product (GDP) to proxy market size both for importer and exporter . are importer , exporter and time dummy, respectively. ii ii ii jj ii ll ; ll and ll jj To properly isolate TC and TD, we follow Carrère (2006) and Martínez-Zarzoso et al. (2009) by ii tt

- To properly isolate TC and TD, we follow Carrère (2006) and Martínez-Zarzoso et al. (2009) by defining three dummies<sup>6</sup> (with their associated coefficient in parentheses):  DI ( ) which takes the value of 1 if the origin and destination country belong to a common REC and 0 otherwise. It captures intra-REC trade. II

- DM ( αα ) which take the value of 1 if the destination country belongs to a REC and the origin country to the RoW (and 0 otherwise). It captures REC imports from the RoW. MM

- DX ( αα ) which equal to 1 if the origin country belongs to a REC and the destination jj country to the RoW (and 0 otherwise). It captures REC exports to the RoW. ii XX

- αα ii

- The effects of RTAs on trade creation and trade diversion could be captured from the coefficients jj as follows.  Pure TC, that is an increase in intra-regional trade while imports from ROW remain unchanged. This reflects a situation where >0 and ≥0 and ≥0.

- Pure TD reflects an increase in intraregional trade which is fully offset by a decrease II MM XX

- in intraregional imports from the RoW. There is pure TD if αα αα >0 = αα <0

- Both TC and TD when intra-regional trade increases more than imports from the ROW II MM

- decrease. The presence of both TC and TD is observed if αα >0 and αα <0 and >0 = <0. II MM II

- αα αα αα

- XX

- Table 4 presents results of the basic gravity model estimates without disaggregating the trade αα

Table 4 presents results of the basic gravity model estimates without disaggregating the trade creation and trade diversion impacts. Economic size proxied by GDP is a significant determinant of bilateral trade. An increase in country’s GDP leads to a strong increase in bilateral trade. A strong economic activity is an important driver of bilateral trade. Countries trade more when their bilateral trade costs proxied by distance are low. Trading partners closer to each other or countries that share a border tend to have higher levels of bilateral trade in comparison to more distant partners. These results are in line with the findings of most gravity models estimated in the literature as they reveal that transportation costs are important determinants of bilateral trade between countries (Longo and Sekkat, 2004; Carrere, 2006; Vicard, 2009; Francois and Manchin, 2013). Consequently, reducing the cost of transportation is crucial to increase bilateral trade.

12
_Table 4: Gravity model Controlling_ _<u>for MRT.</u>_

||**Ordi**|**nary Least Squar**|**es (OLS)**|**Poisson**|**Pseudo Maximum**<br>**(PPML)**|**Likelihood**|
|---|---|---|---|---|---|---|
||**[1]**|**[2]**|**[3]**|**[4]**|**[5]**|**[6]**|
|**Ln (Exports)**|**Full**<br>**sample**|**Africa↔RoW**|**Intra-Africa**<br>**trade**|**Full**<br>**sample**|**Africa↔RoW**|**Intra-Africa**<br>**trade**|
|ln(GDP importer)|0.59<sup>***</sup>|0.64<sup>***</sup>|0.43<sup>***</sup>|0.54<sup>***</sup>|0.86<sup>***</sup>|0.08|
||(0.01)|(0.03)|(0.04)|(0.02)|(0.07)|(0.06)|
|ln(GDP exporter)|<br>0.59<sup>***</sup>|<br>0.62<sup>***</sup>|<br>0.72<sup>***</sup>|<br>0.59<sup>***</sup>|<br>0.82<sup>***</sup>|<br>0.34<sup>***</sup>|
||(0.01)|(0.04)|(0.06)|(0.02)|(0.07)|(0.08)|
|ln(distance)|<br>-1.56<sup>***</sup>|<br>-1.48<sup>***</sup>|<br>-1.89<sup>***</sup>|<br>-0.61<sup>***</sup>|<br>-0.83<sup>***</sup>|<br>-0.56<sup>***</sup>|
||(0.01)|(0.02)|(0.04)|(0.01)|(0.04)|(0.05)|
|Border|<br>0.73<sup>***</sup>|<br>1.94<sup>***</sup>|<br>1.47<sup>***</sup>|<br>0.58<sup>***</sup>|<br>1.16<sup>***</sup>|<br>1.18<sup>***</sup>|
||(0.02)|(0.05)|(0.05)|(0.02)|(0.07)|(0.07)|
|Common colonizer|<br>0.77<sup>***</sup>|<br>0.29<sup>***</sup>|<br>0.57<sup>***</sup>|<br>0.28<sup>***</sup>|<br>0.05|<br>-0.15<sup>**</sup>|
||(0.01)|(0.03)|(0.05)|(0.03)|(0.07)|(0.08)|
|Common language|<br>0.74<sup>***</sup>|<br>0.71<sup>***</sup>|<br>0.61<sup>***</sup>|<br>0.15<sup>***</sup>|<br>0.53<sup>***</sup>|<br>0.80<sup>***</sup>|
||(0.01)|(0.03)|(0.04)|(0.02)|(0.06)|(0.06)|
|Regional Trade|<br>0.56<sup>***</sup>|<br>0.83<sup>***</sup>|<br>0.94<sup>***</sup>|<br>0.52<sup>***</sup>|<br>0.36<sup>***</sup>|<br>1.17<sup>***</sup>|
|Agreement|||||||
||(0.01)|(0.03)|(0.05)|(0.02)|(0.05)|(0.06)|
|Constant|<br>-4.14<sup>***</sup>|<br>0.28|<br>3.05<sup>***</sup>|<br>-7.72<sup>***</sup>|<br>-3.22<sup>***</sup>|<br>-1.63<sup>**</sup>|
||(0.29)|(0.64)|(0.49)|(0.25)|(0.49)|(0.68)|
|N|<br>496975|<br>91402|<br>30252|<br>994815|<br>258231|<br>69448|
|R2|0.733|0.565|0.596|0.833|0.497|0.665|
|Importer/FE|YES|YES|YES|YES|YES|YES|
|<br>Exporter/FE|YES|YES|YES|YES|YES|YES|
|Time/FE|YES|YES|YES|YES|YES|YES|

Standard errors in parentheses<sup>*</sup> _p_ < 0.10,<sup>**</sup> _p_ < 0.05,<sup>***</sup> _p_ < 0.01 Results also show that RTA membership is positively and significantly related to bilateral trade flows over the period 1990-2019. The formation of RTAs, by removing trade barriers - tariff and non-tariff barriers - improves bilateral trade between countries, ceteris paribus.

The implication of the findings from the basic gravity model including the significant role of the high density of economic activity and low distance as well as the role of RECs are important for the strategic prioritization of selected corridors of trade and integration. Because, given that AfCFTA is a continental FTA, it is going to be daunting to think of regional integration on the bigger continental scale. There is a need to strategically prioritize key corridors of trade along proximity in selected corridors in addition to key regions and sub-regions where the density of economic activity is relatively higher. Reflected in this prioritization is the need to build on the already high levels of regional integration either in East, Southern and West Africa, where based on density and proximity, the sub-regional components of AfCFTA can emerge from and provide the springboard to deepen the continental integration. The existing RECs provide the sub-regional foundation to jump-start and deepen regional integration at the continental level. That is why the RECs are central in the success of AfCFTA.

Table 5 presents a summary of the results for the model that identifies the impact of RTAs in the Africa region on trade creation and trade diversion. Overall, African RECs tend to create more 13
trade than they divert. TC dominates TD (in terms of imports) in six RECs out of the eight RECs. However, there are some heterogeneities within RECs. Our interpretation here focuses on the coefficients associated with three dummies capturing TC and TD effects of RTAs since the coefficients of the traditional gravity variables do not differ significantly from those in Table 4.

If we consider SADC, TC is more important than TD. SADC has generated a positive and significant intraregional bilateral trade flows. Similarly, SADC members exports to the rest of the world (RoW) has increased, suggesting a trade creation from exports to the RoW. However, the Africa sample indicates that there is trade diversion effect within SADC (with respect to both exports and imports) as its member countries import and export less to the rest of Africa following its formation. There is no evidence of trade diversion or trade creation effect with respect to imports following the formation of SADC trade bloc since the member countries of this regional community have not significantly changed their import from the RoW following the bloc’s creation. This is an encouraging trend with respect to regional integration in Africa and particularly SADC that, increased trade between members also promotes trade with the rest of the world. This scenario could lead to the rise of regional value chains that would foster agglomeration economies to serve as loci of production and hence promote exports to the RoW. One key implication of this finding for SADC is that it may not be economically feasible to deepen trade between countries, when the rationale has not been well established. Starting with the RECs and related key trade corridors should precede all other integration efforts under AfCFTA.

Within CEN-SAD, intraregional TC outweighs TD in terms of both exports and imports, though the TC effect is much smaller than what we find for SADC (more than three times smaller). The formation of CEN-SAD has generated a positive and significant intraregional trade. Similar to what we find in SADC, there is also no trade diversion effect with respect to the rest of the world, while there is TD effect with respect to other African non-members of CEN-SAD. This suggests, both exports and imports from other African countries decline as a result of the FTA. This may sometimes come at the cost of loss in efficiency and hence welfare.

ECOWAS is the only REC where we do not find any positive intraregional trade associated with the FTA. ECOWAS exhibits higher TD than TC (mostly TD in terms of imports and exports). Indeed, there is trade diversion effect in terms of exports to the RoW given that ECOWAS member countries have reduced their exports to the RoW following its creation. In addition, there is trade diversion effect in terms of imports from the RoW because ECOWAS member countries seem to import less from non-member countries following its formation. This evidence suggests that ECOWAS may have not succeeded in expanding trade within the FTA as envisioned. If we isolate the West African Monetary and Economic Union (UEMOA) member countries which share a common currency, the results show that there is intraregional TC. UEMOA member countries trade more among themselves as compared to other ECOWAS member countries. In addition, there is TC from imports while no evidence on TD from exports exists. TD in the ECOWAS reflect restrictive unilateral trade policies in Nigeria and similar member countries in ECOWAS. The more recent disputes<sup>7</sup> in the region from alleged smuggling and illicit trade implies the very high levels of trade barriers in the region and the challenges of associated regional trade.

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Looking at COMESA, results show that intraregional TC is more important than TD from exports on average. Considering bilateral trade between COMESA member countries with their partners worldwide, intra-COMESA trade has increased following the creation of this trade bloc. However, intra-COMESA trade has decreased when it comes to bilateral trade between its member countries with the rest of Africa. Moreover, the formation of COMESA has generated a TD effect in terms of exports given that its member countries have reduced their exports to the RoW. Yet, our result show that there is no evidence of either TC or TD effect with respect to imports since imports of COMESA member countries from non-member countries have not significantly changed in the aftermath of its creation.

TC is stronger than TD within ECCAS. ECCAS has generated a positive and significant intraregional bilateral trade flows. Similarly, there is TC effect with respect to exports because ECCAS members exports to the RoW have increased. However, there is no evidence of either TC or TD effect with respect to imports since the member countries of this regional community have not changed their import from the RoW following the bloc’s creation. If we consider only Central African Economic and Monetary Community (CEMAC) member countries (a monetary union within ECCAS), the coefficient of intraregional TC is higher than that of TC within ECCAS. This result suggests that the deepness of an RTA is critical to reap the benefits of regional integration. However, contrary to ECCAS, there no evidence of TC from exports within the CEMAC.

Furthermore, within EAC, intraregional TC is more important than TD from exports on average. For instance, intra-EAC trade has increased following the creation of this trade bloc. However, the formation of EAC has generated a TD effect in terms of exports given that its member countries have reduced their exports to the RoW. Finally, we find that there is no evidence of either TC or TD effect with respect to imports since imports of its member countries from nonmember countries have not significantly changed in the aftermath of its creation.

Finally, TC is more important than TD within IGAD. For instance, IGAD has generated a positive and significant intraregional bilateral trade flows. In the same vein, IGAD members exports to the RoW has increased, suggesting a trade creation from exports to the RoW. Similarly, the formation of IGAD trade bloc has generated TC effect from imports since the member countries of this regional community have increased their import from the RoW following the bloc’s creation. However, the Africa sample indicates that there is TD effect with respect to imports as its member countries imports less to the rest of Africa following its formation.

Most of the RECs in this study have contributed to increasing intra-regional trade as a result of the FTA. Many of the results could also be compared to Carrere (2006), Martinez-Zarzoso et al. (2009) and to Coulibaly (2009). Their results provide evidence of a positive intra-bloc effects in EU and NAFTA in the 1980s and 1990s. Similar to Carrere (2006), we find that African RTAs have generated trade between member countries. Carrere (2006) shows that UEMOA and SADC succeeded in generating net TC with an increase in the propensity to import from the RoW over the period 1962-1996. Another study, Longo and Sekkat (2004) finds contrasting evidence that RTAs schemes were not able to increase intra-African trade. Our study and that of Carrere (2006) 15
and Coulibaly (2009) show that African RTAs result in increasing intra-regional trade among members.

To summarize, TC effect is stronger than the TD effect in most RTAs in Africa. However, TD effect dominates TC effect in some RTAs. Drawing upon these results, the success of the AfCFTA will critically depend on its ability to address the obstacles to trade creation over the continent. EAC and SADC have particularly succeeded not only in expanding trade between members, but also expanding exports to the rest of the world as a result of FTAs. This is critical to the success of other RECs and AfCFTA. Because, trade with regional partners and the rest of the world should be considered as complements and not substitutes. Countries need to deepen integration while at the same time expanding exports and trading with the rest of the world. Regional integration should be a mechanism to increase local supply capacity to engage in global trade to improve access to markets and other suppliers.<sup>8</sup> _Table 5: Summary on the effects of RECs on TC and TD in Africa_

|_RTAs_|_Effects_|_Intraregional_|_From imports_|_From exports_|_Dominant_|
|---|---|---|---|---|---|
|SADC|TC|yes|no|Yes|TC|
||TD|no|no|No||
|CEN-SAD|TC|yes|no|No|TC|
||TD|no|no|No||
|ECOWAS|TC|no|no|No|TD|
||TD|no|yes|Yes||
|COMESA|TC|yes|no|No|TC|
||TD|no|no|Yes||
|ECCAS|TC|yes|no|Yes|TC|
||TD|no|no|No||
|EAC|TC|yes|no|No|TC|
||TD|no|no|Yes||
|IGAD|TC|yes|yes|Yes|TC|
||TD|no|no|No||

**_Note:_** yes(no) indicates that there is TC or TD either within the region (intraregional), from imports (imports), from exports (exports) or not. The Dominant effect is given by adding up the significant coefficients of our three dummies variables which capture TC and TD for each REC. We discard AMU because of missing data.

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# **4. Lessons and Challenges in Transitioning from RECs to AfCFTA**

Most of the RECs in the Africa region has not achieved their goals of expanding regional trade at scale and creating a network of trade and production structures that enhances the spillovers from economies of scale and larger connected markets. AfCFTA faces the same challenges that served as barriers to RECs success in the region. Significant challenges stand in the way of achieving the goals of transforming the economies of its members through increased trade and increased integration in services, infrastructure, communications, and other spheres of economic activity. These range from building the necessary institutions to carve out conducive agreements and implementing them, to realizing them through national and regional strategies that require significant investment in resources and political commitment. In the following sections, drawing from the experiences of the RECs, we discuss the key challenges that African governments, multilateral and regional organizations, and businesses need to address to realize the objectives of AfCFTA and transform the continent. We also highlight key areas of success among RECs and draw relevant lessons for AfCFTA.

## **4.1 It Takes More Than Tariff Liberalization**

Effective regional integration is more than simply reducing or eliminating tariffs - it is mainly about removing the key trade barriers and reducing the direct and indirect costs of trading across borders. These include regulatory frameworks, the state of regional infrastructure and logistics, efficiency of borders and customs operations, the quality of complementary services to trading both within and across borders. Despite the significant liberalization the region has seen over the last three decades, regional trade still remains restricted to a few corridors and at very low levels. Though many factors play a role, much of the low regional trade is associated with the higher cost of trade in the region, much higher than any other region.

A significant part of the drag on trade costs derives from the higher cost and time associated with the inland transit<sup>9</sup> of merchandise from production to point of exit at the border and the crossborder transactions. In 2019, out of the bottom ten economies with the worst logistic performance index (LPI),<sup>10</sup> eight were from Africa, the other two being Afghanistan and Haiti. These include Angola, Burundi, Niger, Sierra Leone, Eritrea, Libya, Zimbabwe and Central African Republic. Only South Africa, Botswana, Kenya, Rwanda, Côte d’Ivoire, Tanzania, Uganda and Malawi have a relatively higher logistic performance index, in some cases, even higher than nonAfrican middle-income economies. Except Côte d’Ivoire, all the African economies with a higher LPI are members of either SADC or EAC. Among RECs, EAC is the top performer in terms of customs efficiency and border management while AMU has the lowest score. In addition, the quality of trade and transport-related infrastructure is higher within the EAC compared to the other African RECs. Between the RECs, ECOWAS registers the lowest score for the quality of trade and transport-related infrastructure. Although the LPI indicators are low in Africa on average, the RECs with relatively higher customs efficiency and border management, better quality of infrastructure and timely shipments experience a strong intra-regional trade flow.

Figure 6 presents a correlation between the share of intraregional export to total exports and trade costs measured by: (i) the time to export (in hours) and (ii) the cost to export (in terms of 17
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# **Why are some RECs more regionally integrated than others?**

**_A. The Case of EAC:_** Integration in infrastructure, better alignment of national and regional priorities often reflected in the degree of political commitment for regional integration and density of economic activity are key drivers, though other factors also play a role. Geographical proximity explains a good share of bilateral trade flows between partner countries. In addition, socioeconomic factors (common language), historical links and economic factors played a key role in promoting trade and integration within REC. The success of regional integration in EAC lies on an adequate infrastructure (e.g., transport networks, information and communication technologies-ICT). Investing in digital infrastructure is critical to bolster intraregional trade in a highly technological world with strong linkages in economic, finance, trade, and social development.

EAC regional integration hinges on its higher levels of infrastructure developments also associated with density of economic activity. EAC stands out as the most densely populated region in Africa with roughly 170 people per square kilometer of land area over the period 19902019 (the less densely populated region being the AMU with around 31 people per square kilometer of land area). The success of EAC is also driven by the Customs reforms it has undertaken (including the Single Customs Territory, One-Stop Border Posts, and the electronic cargo tracking system.). For instance, customs officers from Rwanda, Uganda, and Burundi are deployed and are operating in Kenya and Tanzania. Similarly, Tanzania has deployed officers in Nairobi and Mombasa. This initiative has simplified the administrative burden and reduced turnaround time of trucks from Mombasa to Kampala and from Mombasa to Kigali. These reforms, by reducing the time of customs clearance in the region, have helped boost intraregional trade. In short, investments in joint customs processes, in easing the costs of transactions across borders, and concerted effort to address continuously emerging issues due to the national governments’ adoption of regional integration as part of national development efforts has been central to the success of EAC. Although EAC is the top performer among the African RECs in terms of trade, there still exist ample room for improvement in terms of infrastructural integration for a successful implementation of the AfCFTA.

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# **Why are some RECs more regionally integrated than others?**

**_B. The case of SADC:_** Cross-border infrastructure combined with a One-Stop-Border Post initiative<sup>11</sup> have contributed to boost intra-SADC trade by eliminating trade barriers through reduction of clearance time and cost. Development corridors within this region have driven industrial growth (mainly in landlocked countries) by providing cheaper alternative transport routes to seaports. As an illustration, the highway linking South Africa and Mozambique has contributed to improving the businesses of many entrepreneurs in these two countries. SADC’s Integrated Regional Electronic Settlement System (SIRESS)- a SADC electronic payment system developed by member States to settle regional transactions among banks within the countrieshas boosted intra-SADC as well as SADC trade with non-SADC members by reducing transactions clearing time between banks and across different currencies. This has also enhanced the production of goods and services in this region. The success of SADC in boosting intraregional trade also lies on the implementation of regional electricity market in this region. An excellent example of a successful regional infrastructure is the Southern African Power Pool (SAPP)- a cooperation of the national electricity companies in Southern Africa under the auspices of SADCwhich has given planners and managers additional options to meet growing demand since 1995. In sum, all these investments in the much-needed infrastructure could explain the above subpar intra-SADC performance in regional trade and integration.

# **4.2 Fragmentation and Thick Borders Make Regional Integration a Necessity and a Challenge**

With a population size slightly smaller than either of China or India, Africa is home to 54 countries, more than any other continent. The high level of fragmentation presents a significant geopolitical challenge for AfCFTA and poses additional costs to African economies. Most of the economies are small, with half of the region’s economies with a GDP less than US$10 billion. Close to 30 percent of the countries (16 countries) are landlocked. The high cost of trading faced by landlocked countries is well documented. Trading costs for an average landlocked country are 40-50 percent higher than those for a representative coastal country. Severe economic and geographic fragmentation of economies leading to limited scale economies has long restricted economic expansion by restricting large-scale investment. Small markets often restrict competition and result in monopoly power creating incentive for incumbent firms to actively pursue strategies that deter the entry of new firms.<sup>12</sup> This contributes to low productivity and limited potential to reap the benefits of economies of scale associated with large size. The fragmentation of African economies makes regional integration a challenge. The stark fragmentation that characterizes Africa, geographically and in economic size and disparity and the associated costs is one of the key reasons why regional integration is even more important to troubleshoot the region’s economy.

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The large number of small countries, with a multiplicity of rules and procedures, as well as the difficulties associated with crossing borders for goods, services, and people, remains one of the biggest challenges for the success of AfCFTA. This is a challenge specific to the continent that can only be addressed if countries in the region commit to minimize the costs of this high fragmentation by streamlining policies, harmonizing customs rules and procedures, and sacrificing some level of sovereignty in rule making and implementation in favor of regional frameworks. Through focused policies and investments, the costs of fragmentation and distance can be reduced by improved regional infrastructure - roads, air travel, harbors, communication, energy, and financial services - with the goal of facilitating easy mobility of goods, services, people, and knowledge.

# **4.3 Shallow Trade Agreements**

Almost all RECs in Africa focused on goods and lack relevant provisions for liberalizing services trade between member countries as well as the flow of investment. RTAs in other parts of the world including the EU, North America and Asia have a relatively higher number of RTAs with services and investment provisions, while Sub-Saharan Africa (SSA) has the lowest number (Mattoo et al., 2020). There is considerable variation in investment provisions across RTAs with SSA having only one Preferential Trade Agreement (PTA) with investment provisions compared to 57 in Latin America and the Caribbean (LAC) (Mattoo et al., 2020). Various countries grant members national treatment on the entry of investment in all regions except in SSA, where local governments retain discretion regarding the entry of investment<sup>14</sup> . Africa has the lowest number of free trade areas with services provisions. Regional integration under AfCFTA should cover services, investment as well as competition policy in addition to goods. This should be effective not only in the agreements and provisions but also through deliberate policies to promote services trade and investment flows in the region. Because, the free flow of investment and services are essential in facilitating the emergence of regional value chains.

# **4.4 Avoiding a Sticky Transition from RECs to AfCFTA**

One of the core principles of AfCFTA is that the RECs serve as building blocks for the AfCFTA, and the program aims to ’resolve the challenges of multiple and overlapping memberships’ between the eight RECs functioning at various levels of integration. The RECs may remain active during the operation of AfCFTA, although ’in the event of inconsistency, the AfCFTA agreement shall prevail’. Still, the multiplicity of rules across RECs and the discrepancy with the AfCFTA rules remain a big challenge. The transition from RECs to AfCFTA is expected to be challenging, and members need to develop strategies to maximize the gains from existing RECs while restricting the costs of disparities in regulations and rules governing each REC in the transition to AfCFTA. For example, recent efforts to establish the Tripartite Free Trade Area (TFTA), at the same time AfCFTA is becoming operational, by merging SADC, EAC and COMESA, while a positive development in fostering regional integration on a bigger scale, could also restrict the pace of adoption and deepening of AfCFTA. Hence, there is a need to avoid AfCFTA from becoming one of the overlapping RECs rather than the all-encompassing FTA it is destined to become.

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Still, the RECs present significant opportunity in prioritizing integration across the region. Even though AfCFTA is a continental free trade area, much of the deeper trade integration will be across key regional corridors with a relatively higher economic density. These include key trading corridors along SADC in Southern Africa; EAC and IGAD in East Africa; and Nigeria and neighbors in West Africa. Though regional trade overall is low, about 80 percent of all intra-Africa trade flows through RECs and trade across different RECs has been extremely low. This implies the key role the existing RECs could play in serving as key corridors of regional trade upon which the AfCFTA can build on.

For Africa, the gains from regional integration either through RECs or AfCFTA goes beyond the static analysis of trade creation and trade diversion. Much of the benefits arise from the dynamic gains associated with the potential to exploit economies of scale advantages both in production and markets, to build regional value chains and promote industrialization giving rise to _Factory Africa_ , and to promote the transfer of technology through increased trade and FDI flows. To achieve these, AfCFTA members must develop strategies to maximize the gains from prioritizing trade within the existing RECs, while restricting the intricate political challenges of multiple rules and regulations governing each REC in the transition to AfCFTA<sup>15</sup> . Setting a clear path to this transition is essential to the success of AfCFTA, which also depends on the success of RECs to deepen trade and integration in the region. Both at the national level and at the REC level, countries may need to sacrifice some level of national and sub-regional sovereignty in policy making and expand the horizons of trade liberalization and ease the cost of trading associated with multiple and overlapping rules, regulations and other domestic policies.

# **5. Conclusion**

In this paper, we evaluate the effects of African RECs with respect to trade creation (TC) and trade diversion (TD). Despite significant heterogeneities, there is more trade creation than trade diversion, and a generally positive impact on within-REC trade. Except ECOWAS, the effect of regional integration is dominated by trade creation. The absence of any intra-REC trade effect associated with ECOWAS could be explained by the existence of significant barriers to trade (tariff and non-tariff barriers) between members. Two RECs - EAC and SADC - outperform all the other RECs in terms of boosting intra-REC trade. This is mainly associated with their high level of investment in trade facilitation, the level of synergy between national and regional goals, the density of economic activity and the advancement in the quantity and quality of regional infrastructure. There are also variations among the RECs in terms of whether they promote exports to the rest of the world or displace them. In this respect SADC presents an exemplary instance where trade integration leads to increased exports to the rest of the world. This provides the ideal form of regional integration regional entities should aim for. That is, deepen integration to promote trade and linkage with global value chains and distance partners particularly the key centers of high economic density including North America, the EU and East Asia. The key policy implications focus on two key areas - significant investment in trade facilitation and strategic sequencing of integration schemes. Given that AfCFTA is a much larger FTA compared to the 23
existing RECs, it is important that economies use regional integration to create regional value chains to expand supply/production which in turn provides greater impetus to engage in GVCs. Given the costs of distance and the benefits of already existing strong trade corridors, it is imperative that integration efforts start with a focus on selected high-density corridors of trade. We also find that many structural factors impede the process of integration and could explain the limited effects of RTAs in inspiring intra-Africa trade. These factors include tariff and nontariff barriers, high fragmentation and thick borders, and shallow trade agreements. Our findings suggest that policy makers should focus on eliminating obstacles (tariff and non-tariff barriers) to trade to reap the benefits from the implementation of the AfCFTA. Given that AfCFTA is a continental scheme, fostering trade is going to present a more daunting task compared to the existing RECs. It is hence essential to ensure a smooth transition from RECs to AfCFTA and avoid the possibility that AfCFTA could remain another overlapping REC in the region.

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