Evidence indicates that trade costs are a much more substantial barrier to trade than tariffs are, especially in Sub-Saharan Africa. This paper decomposes trade costs into: (i) trade facilitation, (ii) non-tariff barriers, and (iii) the costs of business services.

The paper assesses the poverty and shared prosperity impacts of deep integration to reduce these three types of trade costs in: (i) the East African Customs Union-Common Market of East and Southern Africa-South African Development Community “Tripartite” Free Trade Area; (ii) within the East African Customs Union; and (iii) unilaterally by the East African Customs Union.

The analysis employs an innovative, multi-region computable general equilibrium model to estimate the changes in the macroeconomic variables that impact poverty and shared prosperity. The model estimates are used in the Global Income Distribution Dynamics microsimulation model to obtain assessments of the changes in the poverty headcount and shared prosperity for each of the simulations for the six African regions or countries.

The paper finds that these reforms are pro-poor. There are significant reductions in the poverty headcount and the percentage of the population living in poverty for all six of the African regions from deep integration in the Tripartite Free Trade Area or comparable unilateral reforms by the East African Customs Union. Further, the incomes of the bottom 40 percent of the populations noticeably increase in all countries or regions that are engaged in the trade reforms. The reason for the poor share in prosperity is the fact that the reforms increase unskilled wages faster than the rewards of other factors of production, as the reforms tend to favor agriculture.

Despite the uniform increases in income for the poorest 40 percent, there are some cases where the share of income captured by the poorest 40 percent of the population decreases. The estimated gains vary considerably across countries and reforms. Thus, countries would have an interest in negotiating for different reforms in different agreements.

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Introduction

Evidence is now substantial that with the progressive global decline in tariffs over several decades, trade costs are often a much more substantial barrier to trade than tariffs. Moreover, trade costs are especially high in Sub-Saharan Africa compared to other regions in the world. For example, the World Economic Forum (2012) found that it is still considerably more expensive to trade with Africa than with other regions, and, in many cases, the cost of trading is a more important obstacle to trade development than trade policies.

Countries in Eastern and Southern Africa, however, are attempting to address the high trade costs through regional initiatives. Notably, the proposed 26 member country Tripartite Free Trade Area (Tripartite FTA) (among the East African Community (EAC), Common Market of East and Southern Africa (COMESA) and South African Development Community (SADC)) has programs in place for trade and transport facilitation and the reduction of non-tariff barriers, and has the objective in “Phase II” to liberalize trade in services. The members of the EACU also have initiatives within the EACU to similarly reduce trade costs.

In this paper, we assess the impacts of deep integration to reduce trade costs in the Tripartite FTA on poverty and shared prosperity. In order to assess the relative gains of narrowing or widening the reforms, we also assess the impacts on poverty and shared prosperity of comparable reforms by the members of the EACU applied only within the EACU and more widely if the EACU unilaterally extends the reforms to all countries, where feasible.

We decompose trade costs into three categories: costs that can be lowered by trade facilitation; non-tariff barriers; and the costs of business services. Trade facilitation addresses costs such as delays at border crossing, roadblocks for trucks and the necessity to pay bribes. Regarding non-tariff barriers, recent work by Cadot and Gourdon (2014) has shown that the old command and control non-tariff barrier measures have significantly declined, but standards as barriers to trade have supplanted them in importance. Further, poor business services for trade are also a problem. Improvements in a wide range of business services such as banking, insurance, communication and professional services such as legal, auditing, engineering and computer services would also lower trade costs. This also includes poor transportation services, such as very poor or nonexistent freight train services in many countries of Sub-Saharan Africa, delays at ports and poor air freight services in many countries.

We obtain results for poverty and shared prosperity in several African countries by first assessing the impacts on the variables that impact poverty and shared prosperity in a computable general equilibrium (CGE) model. We build on the 10 region, 19-sector global CGE trade model of Balistreri, Tarr and Yonezawa (2015) and in Balistreri, Tarr and Yonezawa (2014), hereafter BTY. The model contains Kenya, Tanzania, Uganda, Rwanda, COMESA, SADC, the United States, European Union, China and Rest of the World. Using the comparative static model of BTY, we obtain Near Term results. Using projections to 2030 for population and labor force by skill level, we extend the model of BTY to also derive estimated impacts for 2030. We use estimates from the CGE model as inputs in the Global Income Distribution Dynamics (GIDD) microsimulation model to obtain assessments of the changes in the poverty headcount and shared prosperity for each of our simulations. The GIDD is the first global macro-micro simulation tool, which combines a consistent set of price and volume changes from a global CGE model with household surveys at the global level.

Conceptual innovation is that this paper is the first global trade model to numerically assess the poverty and shared prosperity effects of regional liberalization. It is also the first to examine the poverty and shared prosperity impacts of time in trade costs differentiated by product as well as the impact of liberalization of barriers against foreign direct investors in services.

The essential data problem to assess services commitments has been the lack of estimates of the ad valorem equivalents of the barriers to foreign suppliers of services based on assessments of the regulatory regimes in place. We employ a new database of the ad valorem equivalents of barriers in eleven business services sectors in 103 countries (see Jafari and Tarr, forthcoming), which was aggregated to the sectors and regions of this model. The estimates of the ad valorem equivalents (AVEs) were possible due to the newly released World Bank survey information on the discriminatory regulatory barriers against foreign suppliers of services on these eleven sectors in 103 countries. Many results in the paper depend crucially on this database of AVEs.

In addition, this paper builds on or adapts the following three databases: (i) trade facilitation – the paper employs the database on the time in trade costs of Hummels et al. (2007) and Minor (2013). We aggregate the database to the sectors and regions of our model. Although a central finding of the studies by Hummels, Minor and their co-authors is that the AVE of time in trade varies across products, most computable general equilibrium modeling of trade facilitation issues have used a single AVE across all products. We show that this more accurate database impacts the results; (ii) foreign affiliate sales – we use the “Global Database of Foreign Affiliate Sales” developed by Fukui and Lakatos (2012). In the Tripartite region, we augmented the database with independent work; and (iii) estimates of the ad valorem equivalents of non-tariff measures developed by Kee, Nicita and Olarreaga (2009).

At the aggregate level, we find that there are substantial gains for all six of our African regions from deep integration in the Tripartite FTA or comparable unilateral reforms to all countries by the EACU to reduce trade costs; but our decomposition analysis reveals that the estimated gains and the magnitudes vary considerably across countries and depend on the reform. Thus, the regions and countries have very different stakes in the various reforms and would have an interest in negotiating for different reforms in different agreements. One striking finding is that in our Near Term model, we estimate that Kenya gains less from comparable unilateral liberalization by the EACU than from the Tripartite FTA, due in part to an umbrella of protection in services markets in the Tripartite region. For goods markets, Wonnacott and Wonnacott (1981) and Harrison, Rutherford and Tarr (2002) have shown that due to market access, there is the possibility of larger gains in preferential agreements than from unilateral liberalization. This extends their result to services markets.

Karingi and Fekadu (2009), Jensen and Sandrey (2011) and Willenbocket (2013) have executed general equilibrium assessments of the impacts of the Tripartite FTA. They focus either exclusively or primarily on preferential tariff reductions. They find small welfare changes from preferential tariff reduction in the Tripartite FTA, with many countries losing and net gains of only about 0.1 to 0.2 percent of GDP. Our estimates of the impact of tariff changes are consistent with these earlier studies; but, depending on the country or region, our estimates of the gains from reductions of trade costs within the Tripartite area are about 10 to 30 times larger than the estimated gains of preferential tariff reduction – suggesting very different stakes.