Benefits of the African Continental Free Trade Area agreement

Although trade flows among African states remain below their potential, an ambitious project is under way to accelerate economic integration and significantly expand intra-continental trade. Spearheaded by the African Union (AU), the African Continental Free Trade Area (AfCFTA) agreement was signed in March 2018 and aims to substantially reduce both tariff and non-tariff barriers to trade. As of December 2019 the AfCFTA had the backing of 54 out of the 55 member states of the AU.

Major Deal

The agreement stands to make the regional bloc the world’s largest free trade area in terms of the number of participating countries since the creation of the World Trade Organisation in 1995. It is expected to have a transformative impact on participating markets, with the agreement set to increase intra-African trade by 52% by 2022, according to a 2018 report from the UN Economic Commission for Africa (UNECA). The UN Conference on Trade and Development (UNCTAD) forecasts a range of long-term economic benefits from the full implementation of the deal, including overall gains of $16.1bn per year and the halving of the continent’s trade deficit, along with GDP and employment growth of 0.97% and 1.17%, respectively.

While full implementation of the deal is expected to take several more years, the AfCFTA could be an important milestone in the continent’s history, potentially laying the groundwork for a fully integrated African economy over the longer term, with people, goods and services able to move freely As an African initiative, driven by African states and institutions, the agreement stands as an economic game-changer, marking the continent’s most ambitious integration initiative to date. Neverthe- less, considerable efforts will be required on the part of the signatories in order to ensure the full benefits of the deal are realised. Currently, intra-regional trade levels are significantly lower than those of other regions of the world. Intra-African exports stood at just 16.6% in 2017, compared with 68% in Europe, 59% in Asia and 55% in the Americas, according to UNCTAD, highlighting the considerable distance the continent has to travel before it can become an integrated economic unit.

Building Blocks

With the legal framework now signed and ratified, trading under AfCFTA was scheduled to commence in July 2020, but in April local media reported that this date would likely be pushed back six months due to the Covid-19 pandemic. Of the 55 members of the AU, only Eritrea has not yet signed, and 27 states had ratified the agreement as of end-2019. Eritrea’s reluctance to join the bloc stems from its historic border conflict with neighbouring Ethiopia, which reached resolution through a July 2018 peace deal brokered between the two nations. Following the cessation of hostilities, Eritrea formally acceded to trade talks and is expected to join the new bloc in the near future.

The agreement enshrines Africa’s eight pre-standing Regional Economic Communities – regional trade blocs, each established under a separate treaty – as the “building blocks” of the AfCFTA. Many of the agreement’s precise details are still being finalised, with the deal’s different elements being discussed and implemented in phases. The first phase of the negotiations focused on goods and services liberalisation. Meanwhile, the second phase of negotiations, which covers protocols on investment, competition policy and intellectual property rights, began in February 2019 and were scheduled to conclude in June 2020. However, as of the end of April, negotiations had been delayed due to the Covid-19 pandemic. A significant milestone for the agreement came in July 2019 at an extraordinary session of the Assembly of the AU. At the meeting, countries agreed to remove tariffs on 90% of goods, with provisions made to protect 3% and phase out tariffs on an additional 7% over 10 years.

The summit also marked the moment when the agreement became operational, with the introduction of five important mechanisms that are aimed at facilitating the implementation of the free trade area. These covered online negotiations, trade information, a rules of origin regime, a payments and settlement system, as well as procedures for monitoring and eliminating non-tariff barriers. Additionally, it was agreed that the AfCFTA Secretariat – an autonomous body responsible for coordinating the implementation of the agreement – would be established in Accra, Ghana.

Perhaps most significantly, the meeting saw Nigeria sign the AfCFTA. Securing the participation of Africa’s largest and most populous economy marked a significant achievement. Nigeria’s signature followed a lengthy domestic consultation with both trade unions and private businesses. The country accounts for 17% of Africa’s GDP, ranking just ahead of South Africa, and with a domestic market nearing 200m people – as much as Ethiopia and Egypt combined – its involvement is set to significantly bolster the AfCFTA’s strength and size.

Market to Serve

The deal comes at a time of increased demand for goods and services on the continent. With a population of nearly 1bn people and an increasingly numerous and affluent middle class, the African market is expanding rapidly and presents significant potential for the future. Indeed, by 2030 the continent’s middle- and high-income cohorts are expected to grow by 100m to reach 160m, according to figures from the International Finance Corporation. Such a rapid expansion of higher-income groups will significantly boost and diversify demand for goods and services. The AfCFTA implementation therefore represents a chance to support regional production and reduce over-reliance on external trading partners.

The population of the continent is expected to increase to 1.7bn in 2030 and approximately 2.5bn by 2050, with 26% of the world’s working-age population predicted to be living in Africa by 2050, according to figures from the UN. Conversely, the working-age populations of Europe and China are on track to decline significantly over this same period. Concurrent urbanisation should see the population of the continent’s cities double to 760m by 2030 and 1.2bn by 2050, further fuelling demand growth.

Africa’s rapid economic expansion has been well documented since the turn of the century. Sub-Saharan Africa’s economy grew from $300bn in 2000 to $1.6trn in 2017, driven by high service sector growth, which has expanded by an average of 6.6% per year over the last decade. The continent has been home to some of the world’s fastest-growing markets and the business environment has also improved. However, in the IMF’s April 2020 outlook, growth in sub-Saharan Africa was forecast at -1.6% in 2020 due to the Covid-19 pandemic. Sub-Saharan Africa has been in the process of introducing a record number of reforms in recent years, which is helping improve the ease of doing business in the region. For example, the average time to register a business dropped from 59 days in 2006 to 23 days in 2019.

Business executives across the continent are broadly optimistic about AfCFTA. In OBG’s most recent Africa CEO Survey, which interviewed 787 top executives in eight African markets in 2018, 72% thought that the AfCFTA would have a positive or very positive impact on intra-regional trade levels. These developments are collectively providing significant economic opportunities for both regional and international businesses and investors.

Manufacturing Boost

The agreement should bring a wide range of benefits to African citizens and entrepreneurs. In addition, it can help to substantially drive much-needed job creation on the continent – particularly in the area of manufacturing. Industrial exports are forecast to benefit the most from the agreement, according to UNECA. In 2018 some 60% of the continent’s population was under the age of 24, while only 3m jobs were created for the 10m-12m young Africans entering the job market every year. Generating jobs and higher rates of employment is therefore urgently needed in order to advance social and economic prosperity. The implementation of AfCFTA has the potential to double the size of the manufacturing sector, creating 13m-16m new jobs and helping to bridge the employment gap, according to figures from US-based think tank the Brookings Institution.

Nevertheless, the continent still faces a number of challenging hurdles that it will need to overcome in order to achieve this potential. For example, Africa currently has quite a low manufacturing and processing capacity, with limited integration in global value chains. Furthermore, the continent’s main exports are oil and minerals, which are often processed outside of their country of origin, as many African states have not yet established the necessary industries to process them.

The creation of regional value chains – assisted by the dismantling of trade barriers between African countries – can help to expand regional industrial capacity and increase the value added of Africa’s exports. Indeed, development models dependent on the export of primary commodities have proven to be vulnerable due to price volatility. In 2018 more than 75% of external exports were extractive exports, according to UNECA. For example, cocoa accounts for one-third of Côte d’Ivoire’s export earnings, while crude oil comprises approximately 95% of Nigeria’s total exports. This renders these economies vulnerable to changes in international market prices as well as other exogenous shocks. In addition, it has a negative impact on employment, given that extractive goods are less labour-intensive than manufactured and processed goods. This dependence demonstrates the need to restructure economies in order to achieve a more diversified and sustainable export base.

Powerful Bloc

The AfCFTA could further enable African states to transition towards a collective bargaining bloc, negotiating as one market and strengthening Africa’s common voice in global trade deals. This would support negotiations with major powers such as the EU and China, with whom African countries usually negotiate as single entities. Collective bargaining would boost Africa’s trading position in the world market and strengthen the continent’s appeal as a global trading partner. With Nigeria and South Africa now signed up, negotiating with the AfCFTA will provide greater access to the region’s largest economies.

Overcoming Obstacles

While opportunities abound, significant questions remain over the pace and extent of the AfCFTA’s implementation. Africa is a highly fragmented continent, with its composite economies at significantly different stages of socio-economic development. Furthermore, many African nations have long suffered from a lack of economic integration and regional cooperation, much of which is a holdover from colonial era trade structures and transport networks.

One of the most challenging problems is that transport and telecoms infrastructure between Africa and the rest of the world is more developed than it is within the continent itself. Furthermore, many African countries’ bilateral relations are starting from a relatively low level, so they still have some way to go. Despite the numerous attempts to seek closer regional integration, this goal has so far remained largely elusive, and Africa’s fragmented trade structures have persisted.

The extent of this challenge is well documented. Kenya, for example, is one of the world’s biggest producers of flowers. However, if you were to buy a bouquet of Kenyan flowers in Nigeria, it is likely that they would have first been processed in the Netherlands. Conversely, Nigeria is one of the world’s largest producers of palm oil, but Kenya tends to buy most of its palm oil from Malaysia. In the case of Morocco, African imports and exports account for only 3% and 5%, respectively, of the country’s total. Limited linkages can be seen in physical infrastructure as well. Variation in railway gauges between countries often means that shipments need to be offloaded at the border, which can cause significant delays. It is similarly often far easier in terms of both flight path availability and cost to fly between Africa and Europe than between two locations within Africa.

Strengthening Linkages

The most critical enabling factor for the AfCFTA will therefore be infrastructure. This will require scaling up investment and improving connections between and within countries so goods and services can access markets. While some notable progress has been made in this direction, much remains to be done. The African Development Bank (AfDB) estimates annual infrastructure investment of $130bn-170bn is needed across the continent but highlights that there is currently an annual financing gap of $68bn-108bn. These figures are only set to increase further, as economic development advances and populations grow. Nevertheless, international investment, particularly from China, has provided some relief over recent years. Between 2005 and 2019 the country’s investments and contracts in sub-Saharan Africa totalled more than $300bn, with the lion’s share of this capital going to construction and infrastructure projects.

The widespread development of roads, ports, railways and special economic zones has made significant headway. For example, Djibouti has seen massive volumes of investment channelled into its transport and logistics networks over the past few years, including three new ports, a railway line to Addis Ababa and the development of Africa’s largest free trade zone. While Djibouti is a small country – with a population of just 900,000 – it is strategically located, bordering one of the world’s busiest trade routes and one of the continent’s most dynamic economies, namely Ethiopia.

Kenya, meanwhile, is also embarking on a number of key transport network projects, including the Lamu Port-South Sudan-Ethiopia Transport corridor and the Northern Corridor, which are set to link the landlocked countries of the Great Lakes Region in East Africa. These development projects are being facilitated through the upgrade of important roads and the construction of an extensive standard-gauge railway network linking Nairobi to Mombasa, in addition to a crude oil pipeline.

While the North African region has traditionally looked more towards Europe, the US and the Middle East for its main trading relations, Morocco is now looking to further position itself as one of the main exporters of the continent’s goods. The country is actively seeking to strengthen its trade links with other states on the continent and has increased investment in sub-Saharan African countries. The signing of the AfCFTA has also helped make Egypt a more attractive destination for investment, particularly from Asian investors looking for greater access to other African markets.

Protectionism

While free trade introduces multiple benefits for participating countries, there are also costs associated with the transition to a more liberalised trading framework. Major concerns include the uneven distribution of benefits from free trade and a lack of preparedness for heightened levels of market competition, sparking some calls for protectionism. Nigeria’s hesitation to sign the AfCFTA agreement and the recent closure of its land borders serve as prominent examples of such opposition to liberalisation. In October 2019 the country closed its land borders to all movement of goods in a move aimed at curbing rice smuggling and protecting domestic farmers from cheaper imports. This has raised concerns over the prospects for further integration and free trade across the region, especially as the border closure occurred just three months after Nigeria signed the AfCFTA deal.

While the country remains hesitant of undermining local manufacturers and entrepreneurs, it nevertheless has a great deal to gain from increasing its access to the wider African market. To avoid further incidents of this nature, effective instruments need to be put in place across the continent to effectively manage the transition to trade liberalisation. Furthermore, efforts need to made to ensure a uniform level of compliance over tariffs across Africa’s Regional Economic Communities.

As greater trade integration is achieved and foreign firms enter the markets of other countries on the continent, certain domestic firms and groups of workers will undoubtedly face pressures. As such, in order to avoid a backlash to the AfCFTA, each state will need to implement policies to ameliorate the worst impact of these trade shocks, such as trade adjustment assistance programmes and social policies to protect workers who may lose their jobs in the face of new competition.

Ensuring that jobs and businesses are able to adjust to increased market pressures should constitute a top priority for signatories of the deal, given the significant political consequences of inaction in this area. The Nigeria border closure incident also indicates that specific institutional arrangements will be required to effectively settle any future trade disputes. These short-term, but nonetheless significant, transition costs will continue to be a challenge for African leaders moving forwards.

Overcoming the politics of trade protection in Africa will be crucial at a time when some of the world’s most developed economies are positioning themselves towards disengaging from similar blocs and adopting a more protectionist stance. UNCTAD estimates that the continent’s governments will collectively face tariff revenue losses of $4.1bn annually, equivalent to 9.1% of current revenue, which some may be reluctant to forgo. The AfCFTA has already sought to reduce tariff revenue losses and adjustment costs by exempting sensitive products from early liberalisation.

Greater Cooperation

In order to achieve the successful implementation of the AfCFTA agreement, continuing cooperative efforts will be required. The deal will take time to manifest on the ground and for businesses and citizens to experience the full benefits of greater integration. The EU, for instance, took several decades to be fully realised and was also implemented in progressive phases. Increased investment in both infrastructure and human capital will be necessary alongside the implementation of the agreement itself.

Improving the governance and transparency will significantly contribute to enhancing the continent’s investment climate, while investing in education will bring much-needed skills in science, technology and digital training. Furthermore, greater efforts to the region’s resolve security issues and regional conflicts will be important as well, as increased trade integration and economic development both require peace and stability. Lastly, the bloc will need to create institutions that are equipped to effectively deal with trade disputes. Although full realisation of the AfCFTA will take time, particularly given the delays being caused by the Covid-19 pandemic, the signing of the deal clearly demonstrates the will is there.