Intelligent. Kenyan.

Published: 4 years ago

The EAC Conundrum

The East African Community (EAC), a regional intergovernmental organization, was re-formed in 1999 by the Republic of Kenya, the United Republic of Tanzania and the Republic of Uganda after the collapse of the original EAC in 1977. The Republic of Rwanda and the Republic of Burundi became member states in 2007, and South Sudan has expressed interest in joining the community.

Its vision is a prosperous, competitive, secure, stable and politically united East Africa, and its aim is to widen and deepen integration and co-operation among partner states politically, economically, socially and culturally for their mutual benefit. So far, it has established a customs union (in 2005) and a common market (in 2010). The next phase involves the formation of a monetary union, and ultimately, a political union of the member states to form the East African Federation, a sovereign state.

So far, there has been significant progress towards meeting the full requirements of the customs union. Member states have also begun to amend their laws towards the achievement of a common market, which should come in full force in 2014. In November 2013, the five heads of state of the member states signed a protocol for a monetary union within the next 10 years to converge their currencies and expand regional trade.

To evaluate the potential for success of such a union, I feel it is important to look at the progress made in the customs union and common market, as well as compare the proposed monetary union with other long standing ones such as the United States of America, whose currency is the American Dollar, and the Eurozone, whose currency is the Euro. The Euro has experienced several crises in the last decade, and caused the wisdom behind monetary unions to be questioned. One must therefore ask: What makes the EAC monetary union different? Is it a smart move?

The EAC Customs Union

In economic theory, a Customs Union (CU) is the third stage towards economic integration after a Preferential Trade Area (PTA) and a Free Trade Area (FTA). The EAC, however, provides it as the first.

The CU, though launched in 2005, was fully ushered in towards the end of 2009, its main purpose being to ease and increase trade between member states. Formation of a CU requires member states to dismantle all barriers to trade between each other (both tariff and non tariff), implement a harmonized customs administration (including the classification of commodities, valuation of custom goods/services, procedures, documentation and rules of origin) and agree on how to share common external tariff (CET) revenue (what is charged to states outside the EAC).

Trade is at the heart of a CU, and its main objective is thus the formation of a single customs territory through which all the requirements in the paragraph above can be met. The aim of creating a single customs territory is to enable member states to enjoy economies of scale, which in turn lead to faster economic development. A CU, however, cannot lead to development without additional measures like development of infrastructure and ease to market for goods/services.

CUs come with numerous benefits. The EAC bloc has a combined population of 130 million people (as at 2010), a combined GDP of $74.5 billion (as per 2009) and currently spans 1.82 million square kilometres. Comparative figures for the USA are a population of 303.95 million people, GDP of $14.54 trillion and an area of 9.83 million square kilometres. It becomes apparent that as individual countries, we cannot hope to compete with nations such as the USA, but as a single bloc, it starts to seem possible.

A CU also levels the playing field for producers within member states by imposing standard laws and policies, customs procedures and external tariffs on goods imported from non-member states, assisting the region in the advancement of its economic development and poverty reduction agenda. It promotes intra-union FDI as well as external FDI to member states and attracts investment to the region due to minimal customs clearance bureaucracy. This is more attractive to investors than dealing with small national markets. The economic environment becomes more predictable for investors and traders in the CU, since regionally administered CET and trade policies tend to be more stable. This reduces their risk and increases their propensity to trade and invest.

Perhaps the most important benefit is the negotiating power gained at a global level, where countries are entering into negotiations as groupings as opposed to individual nations (for example, the BRICs and the EU).

CUs do have some drawbacks, though. Great competition is created among domestic firms. With this in mind, the principle of asymmetry was adopted when the phasing out of internal tariffs so as to provide firms located in Uganda, Tanzania and other seemingly disadvantaged states with an adjustment period of five years so as to lead to fairer competition when it came to forming strategic alliances with competitors, quality of human resources, production technologies and creation of competitive advantage.

Implementation of a CET has been challenging to the member countries. Customs valuation procedures vary, leading different bases for taxation. Moreover, Tanzania, a member of both the EAC and the Southern African Development Community (SADC), has taken integration commitments in both regional blocs, so it will have to implement two CETs. The four other members of the EAC are also members of the Common Market for Eastern and Southern Africa (COMESA), facing a similar challenge in terms of multiple integration commitments.

A single customs territory was put in place in 2013, but only three of the member states, Kenya, Uganda and Rwanda, are party to it. Tanzania and Burundi were left out. This territory also includes the implementation of one stop border posts, a single tourist visa as well as the use of identity cards (IDs) as travel documents within the three states. This is expected to start in January 2014, with operational requirements being finalized by June 2014. While this is commendable, leaving out two member states eventually slows full economic integration and does little to boost their spirits.

By and large, however, significant progress has been made by the EAC towards CU status. Success in this area may be said to be imminent.

The EAC Common Market

Despite the challenges encountered in implementing the CU, the EAC created a Common Market (CM) in 2010. The plan is to implement the Protocol progressively until 31 December 2015. The CM Protocol calls for liberalization of the labour market, capital market and services market, since the goods market has already been liberalized by the CU Protocol.

The CM seeks to integrate member states’ markets into a single market in which there is free mobility of factors of production – persons, labour, goods, services and capital – and the right of establishment and residence in any part of the region. This is in addition to the achievements of the CU, which it integrates and supplements. This requires a great number of institutional and legislative reforms, as well as harmonization across the region. Implementation of the CM is guided by four key principles: non-discrimination of nationals of other member states on grounds of nationality, equal treatment of nationals of other member states, transparency in matters concerning the other member states and sharing information for the smooth implementation of the protocol.

A CM provides several benefits to member states. There is increased productivity due to the free movement of factors of production across borders. This leads to increased competition in the market, which in turn leads to cheaper consumer goods and an increased choice of products. Goods and services acquire a larger market size (130+ million people), giving manufacturers and service providers economies of scale in production, which leads to cheaper goods. This single, large market is also more attractive to investors than a smaller national market.

Cross-border trade becomes easier as a result of harmonized trade policies across member states, and cross-border travel becomes cheaper and easier due to removal of visa requirements. Individuals have freedom to work anywhere within the territory, in accordance with the labour laws of individual member states, and both firms and individuals have freedom to provide services (such as legal and medical services) across the territory. Individuals also have the freedom to stay and move freely within the territory of other member states for a period of six months, as well as the freedom to pursue economic activities as self-employed persons across the region.

However, this is not without drawbacks. At the moment, implementation of a CM within the EAC has not gone beyond the signing and ratification of the Protocol. Several national laws (such as labour, employment, immigration and competition laws) have to be amended so as to be compatible with the CM. Some member states have amended a few relevant laws (such as Rwanda’s immigration and labour laws, and Kenya’s immigration laws) but few, if any, have implemented them. The need for domestic policy harmonization at this level is much greater than at CU level, as the full benefits of a CM can only be achieved if the Protocol is fully implemented by all member states.

Kenya and Uganda closely border Horn of Africa, which experiences severe droughts and famine, high poverty levels, terrorism, internal conflicts and political instability. Kenya is also a destination and transit point for human trafficking. The number of refugees from neighbouring countries (Somalia, South Sudan and Ethiopia) further worsens the situation. This is a major hindrance to the free movement of persons and labour in the EAC region as it makes other member states more exposed to trafficking, smuggling and other types of human rights abuses.

Language barriers may also be a problem, especially in Francophone countries like Burundi and Rwanda, and in Tanzania where Kiswahili is predominant. Some member states may be reluctant to open up their labour markets to other member states. Fears of job loss are present, especially in the other four countries excluding Kenya. Locals losing jobs to foreigners may lead to a lack of support for the CM. Kenyans are feared to cross the border and take jobs currently belonging to locals as they are more competitive in the labour market.

When it comes to CM status, the EAC is lagging behind. This may very well be the biggest hurdle in the path towards monetary union, as it involves factors of production whose mobility is currently hindered by barriers, especially non tariff barriers like bureaucracy at borders. Perhaps it would have been wiser to focus more time and effort towards this, as it will smooth the path towards a monetary union.

The EAC Monetary Union (EAMU)

In November 2013, the EAC heads of states signed the Monetary Union Protocol whose aim is to strengthen economic cooperation through a single currency for all EAC members. Other than that, it also aims to attract foreign investment to the region and reduce reliance on aid. The proposed currency is the East African Shilling and the aim is to have the EAMU ratified by 2014, and up and running by 2023.

Before establishing a monetary union, it must be established that it is an optimal currency area (OCA). An OCA is a geographical area that can maximize economic efficiency by sharing a single currency if four main criteria, among others, are met: a high degree of flexibility in wages and prices, high mobility of labour, a high degree of intra-regional trade and a system in place to adjust the region during asymmetric shocks (changes in economic conditions that differently affect different countries in the region, making it difficult to make fiscal policy beneficial to all member states.)

The USA is an example of a successful monetary union. Labour is highly mobile, and wages adjust to changes in demand and supply. The USA sets fiscal policies at both national and state levels, allowing it to better respond to asymmetric shocks. The more apt comparison for the EAC would be the European Monetary Union (EMU), whose conditions are more similar to those of the EAC. The EMU does not have an EMU-wide fiscal policy. Labour is also not as mobile in the as in the USA due to language and cultural barriers, and wages are not flexible. Many economists have argued, based on these factors, that the EMU does not meet the criteria for forming a monetary union (MU).

Even with the recent Euro crisis, African states are keen to move towards monetary unions – The EAC with its shilling and the West African Economic and Monetary Union (UEMOA) with a proposed currency called the Eco, to be adopted by the year 2020. This points to the fact that currency unions, if they work out, are extremely beneficial.

Transaction costs are reduced, as there is no longer any need for currency exchange in the MU. Firms no longer need to incur foreign exchange transaction costs, and this leads to a GDP boost in the region. This in turn leads to less exchange rate uncertainty, which will likely boost intra-region trade and FDI, as exchange rate uncertainty is usually a deterrent to investors. The large market size provided by the MU is another incentive to investors.

A single currency makes the prices of goods across the region comparable, making it easier for consumers to buy in the cheapest markets. Firms have to reduce their prices to remain competitive. This then lowers the rate of inflation

A standard monetary policy run by the union’s central bank, as well as a statistics office to control the currency, lead to the possibility of government failure having a very low impact on interest rate decisions, thus reducing interest rates on bills, bonds and other investments across the region. This goes hand in hand with the reduction of inflation and putting policies in place to reduce inflation. Both low interest rates and low rates of inflation lead to a faster growing economy.

MUs come with huge drawbacks as well. One is the loss of independent monetary policy. Member states of the EAMU pass control of monetary policy to the East African Central Bank (EACB). The EACB has the mandate to set interest rates as well as other aspects of monetary policy for the whole region, rather than individual countries of the EAMU.

Individual governments will be unable to make the trade-off between inflation and unemployment in the short term. For example, to reduce the rate of unemployment in Kenya, the government could choose a low interest rate, which in turn lowers inflation and allows the unemployed to find jobs due to the reduced cost of doing business. Member states will no longer be able to make such decisions.

Asymmetric shocks, as defined above, are changes in economic conditions that differently affect different countries in the region, making it difficult to make fiscal policy beneficial to all member states. For example, the demand for a key product in Kenya, like sugar, may drop due to cheaper prices by competition. This would lead to sugar producers in Kenya reducing their members of staff (increasing unemployment) so as to reduce costs and the market price of sugar. Labour mobility within the EAC is still low, as compared to the USA and the EMU. The EACB would be unable to act unless all the countries in the EAMU are affected similarly (or symmetrically).

The economic structures and degree of development need to be close enough among the EAMU member states to be able to maintain a single currency. Without this, there may be extremely high levels of unemployment or decline in real income, similar to what is happening the Eurozone.

The EAC member states must first attain the set macroeconomic criteria and maintain them for at least three consecutive years before embarking on the actual implementation of the EAMU. Core inflation is capped at 5%. Fiscal deficits, excluding grants, should be no more than 6% of GDP and the tax-to-GDP ratio should be a minimum of 25%. Once these criteria are been met, member states must also meet macroeconomic convergence criteria, which entails maintaining a maximum headline inflation of 8%, a ceiling on fiscal deficits (including grants) of 3% of GDP, a ceiling on gross public debt of 50% of GDP on net present value terms as well as a reserve cover of four-and-a half months of imports. Only then can member states undertake the adoption of a single currency.

These criteria, as well as the ten years’ implementation period, are thought to be sufficient to address the aforementioned challenges. However, the EAMU may still be difficult to attain. It requires the convergence of the economies of the states involved. We are yet to achieve free trade through the common market, and the region is quite diverse economically, in terms of GDP, economic growth, business terms and conditions. Harmonization of exchange and interest rates across member states will probably have negative effects on their economic growth and stability.

The Eurozone/EMU, despite having a longer period of implementation and similar stringent monetary policy, has faced significant challenges. Its main flaws have been the lack of fiscal union and the flouting of limits set by the Stability and Growth Pact, which details limits on deficits, GDP and debt.

The current debt crisis is as a result of some member states in the EMU having too much debt, widely varying (and some uncompetitive) economies all sharing a single currency and lack of a single fiscal authority with a supervisory/enforcement role and full powers to the same. The countries with too much debt, such as Greece, Portugal, Spain and Italy, all risk being unable to pay it back, which would then lead to massive bank collapses. Worse still, there is a risk that some countries, possibly the stronger economies, may pull out of the Eurozone to avoid economic collapse. This would also lead to many banks collapsing in Europe, and possibly in the USA as well (as they hold a lot of European debt, especially in France and Italy). Europe would go into depression, while the rest of the world would go into recession.

The current state in the EMU is one of high rates of unemployment and hardship, high interest rates and increasing welfare. This only worsens the crisis. Austerity measures (taken in response to the crisis) make economic growth difficult to achieve. Governments are also forced to guarantee their banking sectors, making the states even more leveraged, and making the countries in question unsuitable investment destinations. It is a vicious cycle of debt and economic instability. The EMU, since 2011, has undertaken several measures to get out of its crisis, but it is still in the red.

While the EAC proposes to have tight fiscal policy control, the possible collapse of the Eurozone/EMU should make us wary of entry into the EAMU without total success at CU and CM level. In addition to this, we would need to maintain tight control over monetary and fiscal policies, but this would still not prevent individual countries from taking on too much debt and lying about it, putting the rest of the region at risk. Some have predicted that monetary unions will fail in most circumstances. While a crisis or the collapse of the EAMU may not have far reaching consequences like the USA and Eurozone debt crises, it would cripple member states’ economies were it to happen.

The EAC is also not yet at the level of global importance both the EU and the USA enjoy, therefore efforts to bail us out if such crises were to occur here would be few, if any. It is very possible that we would be left to stew in our own mess, perhaps with interventions only from COMESA, SADC and other African economic unions and countries.

Conclusion

At this point, the question is whether the benefits of the EAMU outweigh the drawbacks, as well as whether member states will be able to work together to converge their economies. This has been put in doubt by the emergence of the “Coalition of the Willing” and the side-lining of Tanzania, especially when it has genuine concerns about the speed at which integration is being pursued. The EAMU has a long way to go, and the ten year implementation period may not be realistic, given that there have been delays in implementing both the customs union and the common market.

References

“Is East Africa an Optimum Currency Area?”, By Mkenda B.K., Retrieved from https://gupea.ub.gu.se/bitstream/2077/2675/1/gunwpe0041.pdf

“Macroeconomic Shock Synchronization in the East African Community”, By Mafusire A. & Brixiova Z, African Development Bank Group, Retrieved from http://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/Working%20Papers%20Series%20156%20-%20Macroeconomic%20Shock%20Synchronization.pdf

“Protocol On The Establishment Of The East African Customs Union”, By the East African Community Secretariat, Retrieved from http://www.eac.int/legal/index.php?option=com_docman&task=doc_download&gid=183&Itemid=47

“Protocol On The Establishment Of The East African Community Common Market”, By the East African Community Secretariat, Retrieved from http://www.eac.int/index.php?option=com_docman&task=doc_view&gid=362&Itemid=163

“Regional Trade Integration in East Africa: Trade and Revenue Impacts of the Planned East African Community Customs Union”, By Castro L., Kraus C. & Rocha M., Retrieved from http://www.worldbank.org/afr/wps/wp72.pdf

“The East African Community After Ten Years – Deepening Integration”, Edited by Davoodi H.R., Retrieved from http://www.imf.org/external/np/afr/2012/121712.pdf

“Towards an Economic and Monetary Union Progress on the EAC Monetary Union”, By Bukuku E.S., East African Community Secretariat, Retrieved from http://www.eac.int/news/index.php?option=com_docman&task=doc_view&gid=271&Itemid=78

“Treaty For The Establishment Of the East African Community”, By the East African Community, Retrieved from http://www.eac.int/index.php?option=com_docman&task=doc_download&gid=158&Itemid=163

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