Fundametals of International Economics for Developing Countries: A Focus on Africa Volume 1: Trade Theory, Policy and Practice Alemayehu Geda Chapter 1:

Fundametals of International Economics for Developing Countries: A Focus on Africa

Volume 1: Trade Theory, Policy and Practice

Alemayehu Geda

Chapter 1: Introduction: An Overview of African Trade in

the World Economy Context


Volume 1: Trade Theory, Policy and Practice – Chapter 1

Fundametals of International Economics for Developing Countries: A Focus on AfricaVolume 1: Trade Theory, Policy and Practice – Chapter 1

Alemayehu Geda

1.1 HIstorical Origin of Africa’s Economic Linkage with the Now Developed Countries

Background: Classification of Africa’s Economic History (Amin, 1972)

• Pre –mercantilist period (Before 17thC)

• The mercantilist period (17thC – 1800)

• The ‘third period’ (1800 – 1880)

• The period of colonization (After 1880): The establishment of dependent African economy

Pre –Cololnial Trade




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1.1.1 Pre-conlonial Trade in Africa

Charateristics

• Diversified agricultural products

• Broad natural resource base

• High regional complementarity

• Extensive local and long distance trade

• Considerable degree of processing

• Intra –trade between herdsmen and crop producers as well as the supply of exports and the distribution of imports




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Pre-colonial Trade in Africa (Contd.)

• Comparable quality of products with that of Europe• Example: Textile manufacturing was sophisticated enough to

compete in European markets

• None of the imported goods from Europe were basic or unfulfilled needs

• The major commodities were Salt, West African Spices, Perfumes, Rasins, and Kola nuts

• Variation in the pattern of development and trade among different regions, especially between WA and ECA

o ECA was not as complex as WA but has some degree of autonomy in its economic activity. It was not as dependent on the export of commodities, particularly to Europe




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Pre-colonial Trade in Africa (Contd.)

Conclusions 1

• Africa’s interaction with the rest of the world began long before colonization.

• 16thC: Trade centers moved from the Savannah Hinterland to the coast in response to the shift of the European trade from the Mediterranean to the Atlantic.

• It was an era of economically independent and to some extent technologially frontier Africa.

Before colonization, Africa had a dense, integrated and autonomous local as well as long distance trade network dominated by African traders.




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1.1.2 The Foundation of a Commodity Exporting and External Finance Constrained African Economy

• The march to the Industrial Revolution: the beginning of the shaping of the African economy by European demand.– Example: Increasing demand for gold coins which led to the

search of gold in Africa and the need for slave labor for the American gold search.

• The onset of the Industrial Revolution: Africa lost its remaining autonomy.

o Africa was reduced to being a supplier of slave labor for American plantations.

o European expansion increased.

• New areas were incorporated under primary crop production using low cost African land and labor.




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The Foundation of a Commodity Exporting and External Finance Constrained African Economy (Contd.)

• The level of production of existing primary commodities was increased.

• Cheaper and purer iron products were imported from Europe which crowded out the market of African blacksmiths.

o Although some export cash crops were produced in ESA prior to colonization, peasant cash cropping, which was mainly a European imposed one, was developed following colonization.

• African economy was pre-designed to fulfill the requirements of the outside world; Africa’s move from the production of primary products to processing of these products was interrupted.




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• In the colonial period, the creation of a primary goods exporting African Economy was vigorously pursued as a consequence of:

(i) The Imperial Self Sufficiency Scheme

• Prior to colonization, developing European economies have been looking for a reliable raw material source and product market – Africa was the natural choice to fulfill this dual objective.

• During Colonization, European powers and their companies developed the ’imperial self sufficiency Scheme’ which strengthened the export of primary products. Examples include Cotton and Tobacco.

• At the same time, processing of primary products in Africa was discouraged, even by European – owned factories.




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• Africans were forced to abandon small scale manufacturing and large European firms were encouraged to concentrate on growing and trading agricultural products.

• African peasants moved into cash cropping because they needed cash to purchase European goods and pay taxes or simply because they were forced. In many cases, food production was intentionally limited to self –sufficiency.

(ii) WWI and WWII

• At times of war: African colonies were forced to supply commodities to finance the war – primary commodities production boasted by non – price mechanisms.

• In post war periods: reconstruction demand, rising incomes, removal of consumer demand restrictions, etc.. led to a surge in African primary commodity exports; this time through the operation of the price mechanism.




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(iii) Financing Public Utilities and Commodity Exports

• In the pre WWII period, access to capital for colonies was politically regulated.

• After WWII, FDI became a dominant form of capital inflow, which was mainly invested in plantations and mineral extraction.

• There was also a significant flow of funds to colonies as loans and grants which was mainly spent on primary commodity export enhancing infrastructure (e.g. railways and roads connecting ports to export porduction sites).

• To finance their huge loans to their ‘mother’ countries, African colonies had no much choice but to stick to exporting commodities. A typical example is the ‘peasant path’ practice.




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Conclusion 2

The colonial era created a primary commodity exporting and external finance constrained Africa through two channels:

By directly contributing to the expansion primary commodities production and export.

By bringing the situation of indebtedness, which further stressed the importance of primary commodity export a source of foreign exchange to finance the debt.




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1.1.3 The Three Macro –Regions of Colonial Africa: The Amin –Nzula Catagory

• Although the end result was the creation of a primary commodity exporting economy, colonizers followed different patters in different regions of Africa. Excluding North Africa, Nzula et al (1979) and Amin (1972) divided Africa into three macro regions, mainly based on how the colonial powers settled the ‘land question’. These are:

(i) Africa of the Labor Reserves (East and Southern Africa):

Mineral extraction and settler agriculture was accompanied by the intentional creation of a reserve labor force. This was done using many instruments including inter –regional migration and taxation. Such strategy lowered the cost of labor to subsistence levels, which in turn increased the competitiveness of the exports from the region.




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1.1.3 The Three Macro –Regions of Colonial Africa: The Amin –Nzula Category (Contd.)

(ii) Africa of the Colonial Economy (British and French West Africa):

In this region, commodity production did not take place in the form of plantations. Land remained in the hands of small peasants while the commodity sector was governed by Europeans. It was not necessary to develop formal plantation agriculture since it was possible to control production by monopolizing the export sector.

(iii) Africa of the Concession –owning Companies (Belgian Congo and French Equatorial Africa):

In this region, home –backed European companies controlled the economic system reducing the indigenous population to semi –slavery.




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To conclude, colonization affected African development and trade structure in the following major ways:

Exports and imports were fixed with the ‘mother’ country.

Capital investment in the colony was determined by the interests of the ‘mother’ country.

Colonizing powers ensured a supply of cheap labor using different mechanisms.

As a consequence of the primary commodities export economy realized by colonization, technological growth stagnated in Africa.

The pattern of trade imposed by colonization persists till to date: most African countries are exporters of primary commodities and importers of manufactured products.




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1.2 Openness in Africa: Recent Pattern of Trade and Finance

• There is no straight forward way to define openness and evaluate it in a certain economy. Economists have developed arbitrary indicators such as Exchange Rate overvaluation, Relative price distortions, Tariffs and Quotas, Share of Trade in GDP, and Parallel Market Premiums.

• According to Sachs and Warner (1995), an economy can be categorized as OPEN if:

(i) Average tariff rates are below 40%

(ii) Average quota and licensing coverage of import is less that 40%

(iii) A parallel market exchange rate premium is less than 20%

(iv) No extreme controls on export exist

(v) The country is not considered a socialist country




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1.2 Openness in Africa: Recent Pattern of Trade and Finance (Contd.)

Africa in the eye of the above indicators (Note: Not all indicators an be computed for Africa)

– Significant share of exports/imports to GDP.

– Limited financial integration with rest of the world in terms of FDI, high percentage of aid and loan to GDP however.

– Limited intervention on international trade: lower subsidy and taxes.

• There fore, we can say that Africa was ‘open’ at least starting from the early 90s (Please refer to Table 1&2 in the text).

• Growth was positively related to opennness (Please refer toTable 2 in the text).




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1.2.1 Openness in Africa: The Pattern of Trade

• The growth of the volume of Sub Saharan Africa’s exports decelerated from 15% in the early days of independence to 3% now, which is below the average for other parts of the world.

• The share of SSA in total world export values has steadily declined, by more than half in the period 1980 to 2001.

• The export structure is characterized by the dependence in primary commodity exports. According to World Bank and UNCTAD estimations, more than half of African exports are made up of three principal primary commodities (Table 6 and Fig. 2 in the text).




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1.2.1 Openness in Africa: The Pattern of Trade (Contd.)

• Dominance of primary commodities in Africa’s export is making African countries vulnerable to global economy because:

– Such commodities are characterized by low income elasticity of demand.

– Their prices are volatile and secular declining.

– They come from sectors with limited scope for technological progress.

• The dependence of exports in primary commodities reflected in three interdependent phenomena: A decline in TOT, instability in export earnings, and absolute decline in demand and supply (See tables 6a and 6b in the text).

• African countries are dependent on few developed nations as destination of their exports. Of the developed regions, Europe is the dominant trading partner. Therefore, what happens with the developed world has a huge impact on Africa.




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1.2.2 Openness in Africa: The Pattern of International Finance Flows

A. FDI, Other Private Capital Flows and Capital Flight

• Africa’s share of world FDI is very low.

• Given the huge growth of FDI flow to developing countries in the period between the early 80s to the early 90s, the relative share of flow to Africa declined though it grew to some extent in absolute terms. This declining share is partly because of the negative image investors have about Africa.

• The distribution of FDI across African countries is highly skewed, with the main recipients being some Afro –Arab and West African countries.

• The main sources of FDI are France, UK, Germany and US while the favorite target sectors are oil, gas, metals and other extractive industries.




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1.2.2 Openness in Africa: The Pattern of International Finance Flows (Contd.)

• Deviations from the declining share of FDI were related to investment in countries with new resource discovery.

• Private capital flows declined from 9% in the early 80s to 1.6% in the mid 90s. Even though the trend and perception is changing recently, this sharp decline is attributed to the deceleration of private loans starting from mid 80s.

• Although small in magnitude, portfolio equity flows are also growing in the recent past. The operation of these funds is also expanding from South Africa to other countries.

• Bank flows are significantly growing with the exception of South Africa and Tanzania. The main reasons for this are lender’s preferences following economic trends, rapid increase of foreign exchange holding, domestic financial sector problems and perception of high country risk.




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• Increases in bank flows are associated with the dominance of foreign banks.

• The main reasons for the resent increase in portfolio flows are:

– Global/Push factors: trend in OECD countries to invest in emerging markets and increasing number of institutional investors.

– Better perception of investors about Africa.

– Attractive socio-economic environment: political and macroeconomic stability, good governance, economic growth and regional integration, growing financial sector, and existence of motivated labor force.

– Declining risk and increasing returns, especially for non-equity flows (bonds and treasury bills).




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• Openness also means capital flight. A recent study showed that the continent has the highest incidence of capital flight, even higher than that of the Middle East. If Africa could attract back its private wealth in advanced countries, the private capital stock could increase by 64%.

• This high level of capital flight is explained by:

– Overvalued exchange rate

– High risk rating of international investors

– The high level of indebtedness of the continent (Note: Some studies have found that indebtedness has no significant effect of capital flight)




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B. Bilateral and Multilateral Flows and Africa’s External Debt Problem

• Openness in Africa is also manifested by resource flows in the form of aid and debt.

• The total external debt has increased nearly twenty –five folds from 1971 to 2004.

• Although Africa’s debt as a proportion of the total of developing countries is low, the relative debt burden born by African countries is extremely heavy compared to their capacity, especially their export earning.

• Starting 1990, Africa’s net flows are negative and rising: there is flow of resources from Africa to the developed world!

• Aid grants to Africa are highly ‘tied’. For example, in the 90s, 35% of grants to Africa went to ‘technical experts’ that usually come from developed countries.




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• Even though the actual size of the debt does not usually represent an economic problem by it self because it is mitigated by short term arrangements, the debt burden has serious implications. The main ones are:

– Debt service erodes foreign exchange reserves and hence crowds -in imports.

– The ‘debt overhang’ problem: lower investment due to lack of confidence of investors.

– Fiscal stress, which could result public investment decline.

• Given their poor performance and huge debt burden, African countries are incapable of securing economic growth and alleviating poverty while simultaneously serving their debt.

• African debt problem is mainly a trade problem.




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1.2.3 The Asian Drivers (China and India) and the Changing Pattern of African Trade

• The impact of the Asian Drivers (China and India) is a challenge and an opportunity

• Trade b/n African and China surged from $3 billion in 1995 to $32 billion last year ( though Africa make up only 2.3 % of China’s world trade).

• This constitutes about 10% of Africa’s world trade. This trade is expected to double by 2010.

• For some it is important: in 2005: for Sudan 70% which was 10% in 1995, Burkina Faso about 33% which was none before; Ethiopia about 13% which was none before

• China is also contributing about $1 billion out of 15 billion Africa received in 2004.

• For some China’s investment is huge. China promised to invest about $4 billion in Nigeria (in return for oil rights)

• offer Angola $4 billion concessional credit – debt being to be paid in oil




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1.2.3 The Asian Drivers (China and India) …. Cont’d

• pattern of trade is shifting from traditional partner the EU away to Asia/US• EU declining from 44 to 32% & US increase from 11 to 19% - 1995-2005). • We look at it through the vector of trade and FDI

– (A) Competitive Impact – (B) Distributional Implications– (C) Complementary Impacts and Primary Sector Locking Effect on Africa

– (D) The Aggregation Effect (The Adding-up Effect):

• competitive threat comes:– s stock of skilled and productive low-cost labour– rapidly growing technological capability – massive scale and agglomeration economies– Most studies found large crowding out effects from China.– A number of studies however said the competitive threat to SSA is limited to

few countries (eg Lesotho




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• Given the current pattern, we may point out the following major pointers for policy and research.

• First, China and India’s growth is creating a demand surge for African commodities. However, the continent need not be left worse off, as has been the case historically, once the boom ends. Thus, deals must be made to sustain it, say, through down-streaming linkages and local partnership

• What is important for Africa may not relate to the static gain and loss but to future industrialization of African and the space left by China and India

• In this regard it is important to think and act on the possible impact of the Asian drivers’ trade and FDI impact in locking African countries in the primary commodity

• Moreover, the demand boom for commodities may lead to problems of management of such resources (such as the Dutch Disease effect and possibly conflict among the political elite)

• Second, despite the possible threat alluded above, there is a need to change from defensive mind set about China and India to one that is more embracing, and one in which the Africans determine the terms of engagement




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• Third, Africans need to develop dynamic capability to scan changing environments, to developing appropriate strategic response (eg. Joint venture with them)

• Forth, the distributional implications of this trade are also worth examining. This is because trade liberalization is generally associated with inequality and change in distribution of income across economic agents. This might have both social and political implications – conflict among the elite or economic agents

• Finally, despite the general similarity in the pattern of trade and finance among African countries and their integration in the global economy, including the Asian drivers, it is essential to underscore that each country is unique in its own way (The need to make trade and industrial policestailored made to suit each African country’s uniqueness).




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1.3 Africa in the Global Context: A world Accounting Matrix Framework

• Although the share of Africa’s trade in the world is as low as 2%, it constitutes as high as 60% of Africa’s GDP (table 7 in text).

• Increasing globalization means that the closed small country assumption is macroeconomic modeling is no longer realistic. Therefore, an open economy macroeconomic framework should be adopted to assess the macro and trade features of African countries.

In such framework:

Y + M = C + I + G + X (1)

Subtracting ‘Net Factor Payments and Current Transfer to Abroad’ (N) and rearranging:

Y = C + I + G + X – M - N (2)




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1.3 Africa in the Global Context: A world Accounting Matrix Framework (Contd.)

• Even though there is lack of detailed data for African economies, the cornerstone of this open economy accounting framework is the link between national accounts and the balance of payment.

• A major problem of most developing economies how to finance the investment required to attain a high growth rate. This can be formulated as:

I = S + F (3)

Where I is the gross domestic investment, S national saving and F net capital inflows. The later is equal to the deficit of the current account of balance of payments; that is:

F = M – X + N (4)




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• Combining (3) and (4) by disintegrating into public (g) and private (p) sectors, and rearranging:

(Ig – Sg) + (Ip – Sp) = M – X + N = Fg + Fp (5)

• Identity (5) links the domestic investment and savings gap with the current account deficit or surplus, and hence the resulting inflow or outflow required to finance it. The right hand side of the equation underscores the importance of the ‘International Economy Relation’. Such relation can be grasped by examining:

– Global imports and exports

– Global saving and investment

– Global flow of funds position

These relationships can be systematically organized by the World Accounting Matrix (WAM).




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WAM and Africa’s position in the World Economy

• Data problem is at the center of the Global balance of payments inconsistency as summarized by WAM.

• The WAM approach assumes the existence of a direct link between current and capital account flows, as well as the domestic resource gap and balance of payments. This means:

– World current account should sum to zero.

– World foreign saving should sum to zero because some countries will be in surplus and others in deficit.

– Global saving should equal to global investment.




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• The above points can be summarized as follows:

(1.1)

(1.2)

(1.3) Where S= Gross national saving, I= Gross domestic investment, E= Export of goods and non-factor services, M= Import of goods and non-factor services, R= Net factor income and current transfer from abroad, FA= Change in total external financial assets, FL= Change in total external financial liabilities, RES= Change in reserves, EO= Errors and omissions.

• The WAM rests on equation (1.1).




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0)RM(E)I(S ii

n

i

n

iiii

)( iiiiiiiii EOΔRESΔFLΔFARMEIS

n

i0)]iEOiRES()iΔFLiFA[(


• The WAM improves global accounting framework in a number of specific aspects:

– It ensures consistency of trade and financial data at a global level.

– It offers data for detailed analytical work by explicitly allowing for aggregation or disaggregation.

• According to a 1990 WAM (Table 8 in text):

– The bulk of Africa’s trade is directed to developed countries.

– Africa has a considerable trade deficit: Its exports to developed countries are less than its imports from these countries.

– Africa has a significantly low level of saving.

– There is an outflow of funds from SSA to international organizations and OECD countries while North African countries have net inflow.




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End of Chapter 1

© Alemayehu Geda, 2007




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Fundametals of International Economics for Developing Countries: A Focus on Africa Volume 1: Trade Theory, Policy and Practice Alemayehu Geda Chapter 1:

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