Trade Liberalization and Economic Development: Lessons for Africa

By Henri Kouam & Dr. Fabien Sundjo (Download pdf version)

Trade Liberalization and Economic Development: Lessons for Africa

Summary

What happens when countries lower their tariff & import duties and open up their economy to other countries? This policy brief looks at the impact of trade liberalization on economic development, drawing from broad-based international literature. It shows how free trade can positively impact economic development, boost incomes, and improve standards of living.

The African Continental Free Trade Area will stimulate intra-regional trade and help countries like Cameroon address acute development challenges. However, the expected positive results will depend on its successful implementation.

Introduction

Achieving the Sustainable Development Goals and successfully eradicating poverty is contingent on several factors, among which levels of trade openness and trade are important factors.

Trade liberalization is an essential prerequisite for economic development, and the African Continental Free Trade Area will not only boost intra-African trade, but it will also equally create the foundations for sustainable economic development, regional integration, and a faster pace of industrialization (Ndung’u and Signé 2020). According to the World Bank (2020), the AfCFTA has the potential to lift 30 million people out of extreme poverty by 2035. This will contribute to the achievement of SDG number 1 by lifting millions of marginalized groups in Africa out of poverty. The same report shows that full implementation of the agreement could boost incomes across the continent by 7%, or close to 450 billion dollars in 2014 prices and exchange rate.

The agreement will also stimulate intraregional trade, which will benefit from proximity and better prices of products currently imported from other continents. Additionally, the agreement will increase employment opportunities and wages for unskilled workers, whose jobs will be formalized as they transition to better-paying jobs related to other industries such as manufacturing, logistics, and transports. There is a strong link between sustainable development and economic growth, with evidence across Asia, Europe, and North America.

Importance of Trade Liberalization

Trade Liberalization Will Boost Industrialization and Intra-African Trade

Trade liberalization pushes countries to specialize due to greater competition and more efficient use of resources. In addition, local producers benefit from economies of scale, which enables them to serve larger markets. However, the long-run effects of growth are determined by the amounts of investment, which are a precursor to industrialization (Danquah, 2018). Secondly, there is a strong correlation between international trade and investment as trade allows for increased specialization and technology transfers (Levine and Renelt, 1992; Awususi &  Awolusi, 2014).

For example, trade liberalization will attract foreign direct investment into a country and can also boost investment in Research and Development. This is important for Cameroon’s pharmaceutical industry that currently meets only 5% of the national needs and imports over 90% of its pharmaceuticals. Additionally, a large portion of pharmaceutical products of about 40% on the market comes from contraband and illicit supply. Considering this, trade liberalization can attract FDI in the pharmaceutical industry, which will not only satisfy local demand but also eradicate smuggling and illicit supply.

The share of intra-African trade is currently very low compared to other regions of the world. According to Vera Songwe, Executive Secretary, United Nations Economic Commission for Africa, the share of intra-African exports as a percentage of overall exports increased from about 10% in 1995 to 17% in 2017. These numbers are much lower compared to those in Europe (69%), Asia (59%), and North America (31%), as indicated by Brookings (2020). The AfCFTA will have the inevitable effect of boosting intra-regional trade, creating millions of jobs through FDI or industrialization, and reducing the prices that consumers pay on goods and services due to greater competition.

International Trade as a Welfare-Enhancing and a Pro-Poor Instrument

Trade liberalization is not only welfare-enhancing for sub-Saharan Africa but is equally pro-poor enhancing. By “pro-poor,” we mean that it is likely to benefit the least well-off. International trade will lead to welfare gains for SSA through specialization that will be driven by price competition and greater innovation spillovers. This is beneficial to consumers in poor countries, who tend to have lower incomes. By increasing access to new products and new varieties, be it final or intermediary goods, both producers and consumers in SSA can enhance their welfare. In addition, trade boosts innovation through the international exchange of technical information, and this minimizes loss through improvements in methods of production. While critics often point out that competition through trade will stunt the growth of the nascent industry, we believe that this claim is probably not true, as we demonstrate below.

According to economic theory, international trade leads to welfare gains through specialization in the production and exchange of goods and services and through the availability of a greater variety of final and intermediate goods, as competition will induce domestic producers to innovate and invest, thereby stimulating growth. This can help reduce the vulnerability of the SSA economy to negative external shocks that could adversely affect the poor.

With respect to employment, the AfCFTA will likely improve employment in SSA, as increased demand between countries will, in turn, mean increased demand for inputs for further production. In this sense, the trade will benefit unskilled labor, the most abundant factor of production, leading to poverty reduction. This channel is very important because most people derive their income solely from the labor market. Thus, trade is pro-poor because the benefits of trade can easily trickle down to the poor.

Trade Openness and Environmental Sustainability

Concerns about environmental sustainability have attracted research and policy attention at both the local and national levels. The 2030 Sustainable Development Goals have explicitly expressed the need for environmental sustainability as a precondition for economic development. Based on this trade-environment nexus, research at the theoretical and empirical levels has been very encouraging in informing policymakers on the right trade policy decision.

Many trade-skeptics have argued that liberalization of trade will degrade the environment and have argued for protectionism in return. According to these critics, trade liberalization will not lead to the attainment of the SDGs such as access to clean water (SDG 6), Affordable and Clean Energy (SDG 7), Sustainable Cities and Communities (SDG 11), and  Climate Action (SDG 13). Furthermore, mass production and current patterns of consumption have illustrated how trade liberalization can degrade entire ecosystems, natural water bodies.

Indeed, trade openness can augment production due to an increase in demand, which will in turn increase energy consumption, and all other things being equal, greenhouse gas emissions will increase due to excess carbon-emitting (Nordic Africa Institute (2008) and Ross & David (1992)).

This claim is only partially true, as it can be overturned by simply invoking the composition effect or the Factor Endowment Hypothesis, which is very beneficial for SSA with respect to the environment. Free trade causes countries to specialize and gain a competitive advantage in specific industries or skills. In the case of SSA, free trade will allow countries to move from raw materials to semi-finished and finished products. Awususi and Awolusi (2014) and Danquah (2018).

For example, and in the case of SSA, the trade will increase demand for labor-intensive goods and services, and because the production of labor-intensive goods does not increase emissions, pollution will decrease. This is what is referred to in the literature as the FEH. Following this axiom, developed countries, as a result of the capital-intensive methods used, will have more pollution than SSA. Intriguingly, the reason why this does not occur is simply that SSA countries have lenient environmental regulations, which lead to the agglomeration of ‘dirty’ pollution-intensive industries, whereas developed countries with strong environmental laws will attract only industries with ‘cleaner’ products. The problem is not the trade liberalization itself but the lax laws in SSA.

Secondly, better production methods will equally reduce the environmental effects of trade. This effect results from the propensity toward cleaner production processes since trade increases wealth and trade increases access to improved technologies. (Jeffrey and Rose (2005) and Martin (2005)).

Trade liberalization will spread energy-efficient and environmentally friendly technology across countries, which will ultimately reduce greenhouse gas emissions and lower pollution.

Empirical studies have shown that trade inevitably leads to a better environment. Among them, Frankel and Rose (2005) found that increased wealth resulting from trade increased access to improved technologies. In the same vein, Wolf (2005) and Bhagwati (2000), using empirical evidence, have suggested that trade is beneficial primarily not because of its effect on wealth through improved production efficiency but rather because this wealth improves investment in environmental protection measures.

Environmental economists have illustrated the implications of trade on the environment even as the benefits of free trade are contingent on the extent of technological progress and the quality of institutions. The quality of such institutions will determine the nature of support that is given to domestic firms in Cameroon. In order for technology to successfully diffuse to economic sectors across the economy, institutions should emphasize the need for greater agility in their processes.

Policy Recommendations

1. First, policymakers should prioritize trade facilitation measures, such as a common digital portal for determining rules of origin, approving phytosanitary checks, and as well as providing useful guidance to exporters. In doing so, operational efficiency will accelerate the implementation of AfCFTA and ensure the benefits of AfCFTA are spread across society. Standardizing border and trade policies over time will equally stimulate intra-regional trade by lowering non-tariff barriers.
2. Second, governments should inform, educate, and raise awareness of the benefits of free trade. At the same time, financial inclusion should include extending trade finance to vulnerable groups such as women and youths.
3. Third, non-tariff barriers such as indiscriminate controls and burdensome requirements should be re-designed to reinforce security whilst facilitating cross-border trade across travel corridors. For example, all documents should be registered with authorities at the beginning of the journey to reduce friction across the Cameroon-Nigeria border.

Conclusion

Trade liberalization is a prerequisite for economic development, and experience from other regions shows that free trade is synonymous with faster economic growth.  If successfully implemented, the AfCFTA will boost intra-regional trade, create jobs for millions of Africans, and facilitate regional integration. Our findings show that free trade will benefit, for example, Cameroon and Nigeria, although the extent of these benefits depends on trade facilitation measures.

In addition, trade liberalization will also support the achievement of a number of SDGs. The case for reducing tariff and non-tariff barriers in trade between Cameroon and Nigeria trade cannot be understated.

References

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