Free Trade

Free Trade Area

Is it the Magic Bullet for Africa’s Industrialization?

The African Continental Free Trade Area (ACFTA) was signed by 44 African countries, including Ethiopia, in May 2018, and will cover a market of 1.2 billion people and a gross domestic product of USD2.5 trillion once it is implemented. In terms of numbers of participating countries, ACFTA will be the world’s largest free trade area since the formation of the World Trade Organization. The creation of a free trade area is expected to boost the current intra-Africa trade, which stood at 13Pct. Although officials stress that it will be a beneficial for Ethiopian goods to penetrate other African markets, many are concerned over the competitiveness of the private sector in the local market, let alone outside the country. EBR’s Ashenafi Endale reports.

Starting in mid July 2018, officials of the Ministry of Trade (MoT) held discussions with close to 60 representatives of the private sector in Bishoftu (Debrezeit). The aim of the discussion was to brief the local private sector about the benefits of the Africa Continental Free Trade Area (ACFTA) agreement which is expected to hit the ground within the next few years. Even though few Ethiopian companies have trade relation with neighbouring countries, almost all of the participants have no experience trading in a zero tariff borderless economy.

The agreement is forecasted to profit not only African countries with better industrial exports but also small and medium size companies operating in agrarian economies such as Ethiopia that are struggling to break into foreign markets. The main objective of ACFTA is to push Africa into full economic as well as political integration, which was the main agenda of the founding fathers of the Organization of Africa Union (OAU) now Africa Union (AU).

The OAU’s vision could not be realized at the most basic level due to the similarity of items produced by African countries, limited infrastructures and disharmonized legal frameworks. Although eight regional blocs were formed since the 1970s in eight geographic corners, intra-Africa trade currently stands at just 13Pct. The lofty trade related tariffs levied across African boundaries, 6.5Pct on average, are the main factors that keep most African countries from trading with each other and instead turn to transactions with countries outside the continent such as the United States and European countries where trade tariffs are around 2.5Pct on average.

However, the ACFTA seems to signal changes on the horizon. When the agreement is fully implemented, the free trade area will be the second largest single market after the World Trade Organization. Although it took many years for the AU to officially launch ACFTA in 2015 during the Johannesburg summit, everything has been moving at lightning speed after 44 African countries signed the ACFTA declaration on March 21, 2018 in Kigali.

“Helping Africa’s industrialization is the main reason for the creation of a free trade area,” says Muse Mindaye, director of the Multilateral Trade Relation and Negotiation Directorate at Ministry of Trade (MoT). “The agreement will enable countries like Ethiopia to process the available raw materials locally and enhance industrialization instead of exporting the raw materials and importing the finished products.”

With 1.2 billion people and a combined gross domestic product of USD2.5 trillion, African countries trade more with countries outside of the continent than with fellow nations. According to Ernst & Young, 80Pct of African countries export mainly raw and semi-finished products outside the continent. It is this trend the ACFTA is expected to reverse after it is ratified by the parliaments of at least 22 countries.

Eight nations have already ratified the agreement, four of whom have expressed interest in becoming the seat of the ACFTA headquarter (Ghana offered a 16-storey building complex). According to Muse, Ethiopia has already lost the chance.

The ACFTA has two negotiation phases. The first, which was covered in the Kigali agreement, includes trade-in product, trade-in service, dispute resolution and the ACFTA institutional framework. Ethiopia agreed to most of the negotiations in the first phase except on how many and which items should be zero tariff.

During the AU summit in June 2017, Ethiopia, along with six other countries, objected to the implementation of ACFTA at once, rather supporting a step by step approach in order to protect domestic industries.

The second phase, which is expected to be finalized by the start of 2019, includes intellectual property rights, trade competition and investment issues. Yet reaching a consensus still involves going through piles of nitty-gritty.

Ethiopia’s negotiating team, which included ministers, higher officials and experts, was led by Mekonnen Manyazewal, International Trade Negotiation Affairs advisor to the Prime Minister. Negotiations on tariff reduction and elimination, items that will be liberalized in the long term, and items that will never be liberalized are still ongoing and expected to be agreed in early 2019. Tourism, transport, financial and professional services are the top sectors waiting for tough negotiation in the second phase.

While some of the details of the phase one negotiations are still being discussed, one of the peak topics expected to take a long time is the negotiation between seven African countries including Ethiopia, Djibouti, Sudan and Rwanda, and the rest of the continent is over the proportion of the total 6,000 items put up for gradual tariff reduction and ultimate elimination within 10 year period. While countries aligned with Ethiopia argue that only 85Pct of the total items should be included in the list, others with more developed industries, like Kenya, are pushing for 90Pct of the items to be incorporated in the list.

“Ethiopia’s position is to put 10Pct of the total items into a sensitive list while five percent should be off limits, on top of liberalizing 85Pct of the items,” explains Muse. “Negotiations are still underway.”

Lisanework Gorfu, director general of the Trade Relations and Negotiation Directorate at MoT says not all the items will be made tariff free at once, explaining, “It starts with hundreds of items from the initial year and increases progressively and reaches the agreed percentage within ten years.”

Even though the items have not been made official yet, Ethiopia intends for almost all of the items manufactured by its emerging industries to be liberalized, according to sources. “For sure, we have competitive advantages in sub-sectors like leather and textile,” argues Muse.

Indeed, Ethiopia has been focusing especially on labour-intensive industrial products that take advantage of the country’s relative abundance of labour and low wages. These include leather and footwear as well as textile and garment products and agro-processing. But the performance of these sectors has been minimal in the past. For instance, although the country planned to earn one billion dollars from the export of textiles and garments, and USD 500 million from leather and leather products per year on average in the first phase of the Growth and Transformation Plan (GTP I) period in 2014/15, the performance remained at USD99 million and USD132 million, respectively, far below the planned targets.

During the GTP II period, the country has planned to manufacture USD2.18 billion worth of textiles and garment products and earn USD779 million in export revenue by the end of the plan period in 2019/20. On the other hand, leather and leather product manufacturing targets have been set at USD 2.06 billion, with the aim of generating export earnings of USD707 million during the same period. However, the current export revenue, which hasn’t surpassed USD200 million combined, indicates the immaturity of the sectors.

Getachew Biratu, general manager of Akaki Garment says trading with African countries will have a tremendous effect on Ethiopia’s private sector, more than trading with European and other countries. “The establishment of a free trade area will help to reduce trade costs and allow consumers to access a variety of products at lower prices,” he indicates. “When the cost of importing raw materials and intermediate inputs decreases, it will boost competitiveness and enable the generation of regional value chains.”

However, Getachew argues that tapping this potential is an overwhelming task for companies in Ethiopia. “Persistent challenges ranging from lack of finance, poor logistics infrastructure, and unsustainable energy supply, to foreign currency shortages limit the abilities of local companies. On top of this, the lack of commitment from the government to strengthen the private sector and make it ready for international competition has dragged down the performance of local enterprises.”

Despite this, Agazi Gabreyesus, secretary general of the Garment and Textile Manufacturers Association articulates that the creation of a free trade area is a big opportunity for the small and medium industries. “We have many industrial items that meet international standards already. Ethiopian textile and garment industries have developed good experience in standard compliance and better packaging by exporting to the United States and Europe countries,” he argues. “They can penetrate the African markets.”

Globally, countries seeking to benefit from another economy’s comparative advantages integrate their economies through six schemes: Preferential Trade Area, Free Trade Area (FTA), Customs Union, Common Market, Monetary Union and Political Federation. FTAs, such as ACFTA, are especially widely seen as crucial drivers of economic growth, industrialization and sustainable development for most African countries since they can remove barriers that hinder easy transaction of goods among countries. However, an FTA only eliminates trade barriers such as tariffs while a customs union creates a common external tariff to protect local industries of member countries.

English political economist David Ricardo, who developed a theory in 1817 to explain why countries engage in international trade, stated that a comparative advantage occurs when a country produces a good or service for a lower opportunity cost than other countries. While opportunity cost measures a trade-off, a nation with a comparative advantage makes the trade-off worth it. The profits of buying their good or service offset the disadvantages. The country may not be the best at producing something. But the good or service has a low opportunity cost for other countries to import. So in principle, the net result of joining a FTA will be better income and ultimately high wealth and well-being for every member of the FTA.

Although officials seemed confident during the meeting in Bishoftu and insisted the opportunity must be seized in spite of any disadvantages that might come along, many are concerned over the competitiveness of the private sector in the local market, let alone outside the country. “Limited raw materials are available locally,” argues Megersa Regasa, a businessman involved in meat export. “Even supplying the available inputs in the market in a sustainable manner is hard in Ethiopia.”

Drawing from his experience, Megersa says his company could not get continuous supplies of livestock although Ethiopia is known for its abundance farm animal resources. “We cannot find quality cattle on the market. Even when we find the right livestock the price is so high, it lowers our competitiveness in the international market. I don’t see how the local private sector can be competitive under such circumstances.”

Studies conducted on the issue also reveal that the effects of free trade are not always positive. For instance, Ethiopia is one of the 19 members of Common Market for Eastern and Southern Africa (COMESA) established in 2000. Ethiopia entered COMESA by reducing tariffs by 10Pct on the total 6,000 items in order to boost its exports to COMESA member countries.

Ethiopia’s exports through COMESA, however, showed a decline especially in recent years from USD276.5 million in 2012 to USD234 million in 2017. On the other hand, imports from COMESA member countries increased from USD235.47 million to USD303 million in the same period. As a result, experts advise that countries considering taking this route should carefully study the potential costs and benefits in the context of their specific political and economic circumstances.

Mesut Saygili, economist at the United Nations Conference on Trade and Development in his study entitled ‘Challenges and Opportunities of Tariff Reductions’ published in February 2018, also indicated that there are challenges that require attention before joining a FTA. For the private sector adjustment costs will arise due to the need to upgrade capacities and excel in a FTA. On the other hand, revenues from tariffs will decline on top of increasing public expenditure to undertake trade reforms. As a result, Saygili stresses that enough preparation should be taken endure the pressure that come in the form of relocation of labour, capital and other factors of production.

For countries with little preparation, according to Saygili, the amount of losses will be enormous while the duration of the transition period might be infinite. In addition, without sufficient financial and institutional capacity, the advantages of a FTA cannot be shared in an equitable manner. To relieve the burden especially from the private sector, Saygili recommends that least developed and landlocked countries like Ethiopia should consider introducing support initiatives and increase infrastructure investments.

Lisanework, however, stresses that this is the right time for Ethiopia to take the opportunity provided by the FTA. “So far, Ethiopia exports through tax free export quota schemes provided by the United States and the European Union. Those are tough markets for Ethiopian products to enter. Plus they can be terminated at any time. Therefore, it is essential for Africa to create its own market for its products.”

Tilahun Abay, director of the Communication and Planning Directorate at Metals Industry Development Institute, on the other hand, argues that even though many think Ethiopia’s competitive edge lies in leather and textile sub-sectors, the country has built huge capacity in the metal sub-sector that compete and satisfy the demand in many African countries.

Currently, Ethiopia has that capacity to produce ETB25.6 billion worth of basic metal, electronics, automotive and engineering products. However, the actual production stands at 55Pct of the capacity, due to a lack of raw materials and sustainable energy supply. “Five big industries found big market opportunity in Sudan last year. However, they could not take the opportunity because of lack of raw materials.”

Despite this, Tilahun remains optimistic about the opportunities ACFTA might bring. “Even Nigeria, the biggest economy in Africa, imports mobile phones largely from Ethiopia, which means our companies engaged especially in mobile, stove, TV, decoder and electric fitting assembly can completely win African markets. The only thing our industries have to do is produce in bulk so as to cut back production costs and offer products at reasonable prices.”
Of course, few assembling plants are significantly improving their capacity. For instance, Mesfin Industrial Engineering (MIE) inaugurated an assembly plant for Peugeot automobiles two years ago. MIE is a pioneer in Ethiopia and East Africa in the production of prefabricated petroleum storage tanks at its own plant. Belayab Motors also entered into an agreement with South Korean car manufacturer KIA Motors Corporation in 2016 to assemble cars in Ethiopia.

Pointing to such developments, Tilahun says the only countries which have better capacity than Ethiopia in the metal sub-sector are South Africa and Egypt. “South Africa’s industries are competitive because they can source raw materials such as metal ore locally. Ethiopia can compensate for the lack of raw material from the local market by utilizing the huge scrap metal available in neighbouring countries such as Somalia, Djibouti and Sudan.

Of course, one of the ways ACFTA can benefit countries with low raw material bases is by facilitating the easier supply of inputs to companies who then export. For instance, before exporting cars overseas, manufacturers in Ethiopia can source inputs from neighbouring countries, under the agreement.

On top of this, Ethiopia is undertaking a feasibility study to extract an estimated 10 million ton of iron ore per year, according to Tilahun. “Its cost is expected to be around USD4 billion. Since the capital is huge the project will be implemented as a joint venture. China has showed big interest.”

Despite the stiff competition expected to face local enterprises, officials indicate Ethiopia is among the countries expected to benefit greatly from the ACFTA, due its large population and growing consumer base. “Many investors will prefer Ethiopia to install factories in order to access the African markets,” Tilahun adds.

Besides attracting investors, Asnakech Tefera, senior Planning, Monitoring and Evaluation expert at Addis Ababa Chamber of Commerce and Sectoral Associations stresses that the local private sector must try work towards developing fresh business ideas and creating new opportunities. “Mostly they do businesses blindfold, without knowledge,” she says. “ACFTA is good opportunity for the private sector since it reduces government interference and even gradually changes the country’s policy to free market and open economy, in addition to paving the way for Ethiopia to join the WTO.”

6th Year • July 16 – Aug. 15 2018 • No. 64

Ashenafi Endale

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