Economic Partnership Agreements between. Sub-Saharan Africa and the EU: A Development. Perspective on their Trade Components

Transcription

1 PRELIMINARY DRAFT FOR DISCUSSION Comments Welcome Not for Distribution or Citation Economic Partnership Agreements between Sub-Saharan Africa and the EU: A Development Perspective on their Trade Components Lawrence E. Hinkle and Maurice Schiff* Draft Africa Region Working Paper World Bank February 2004 *Caroline Freund wrote the section on trade in services and reviewed the other sections. Francis Ng helped with the statistical analysis. The authors would also like to thank the following for helpful comments on earlier drafts: Ousmane Badiane, Nancy Benjamin, Paul Brenton, Uri Dadush, Luis de Azcarate, Alan Gelb, Alberto Herrou- Aragon, Bernard Hoekman, Christiane Kraus, Jeff Lewis, Dorsati Madani, Marie- Francois Marie-Nelly, Will Martin, John Nash, Manuel de la Rocha, Salomon Samen, Claire Thirriot, Fahrettin Yagci, and Gianni Zanini The views expressed in this draft working paper are those of the authors. These views are not necessarily those of the World Bank, its Board of Directors, or the governments that they represent and should not be attributed to them.

2 Economic Partnership Agreements between SSA and the EU: A Development Perspective on Their Trade Components Abstract This working paper analyzes the planned Economic Partnership Agreements (EPAs) between the EU and Sub-Saharan Africa (SSA) from a development perspective. It examines the key issues raised by the planned EPAs, their relationship to the WTO s Doha round and the EU s Everything but Arms Initiative, the domestic reforms in SSA that would need to accompany liberalization of trade with in both goods and services, and the potential effects of the EPAs on regional integration in SSA. The EPAs will pose a number of policy challenges for SSA countries, including: the restructuring of indirect tax systems, reduction of MFN tariffs, liberalization of service imports on an MFN basis and related regulatory reforms in the services sector, and liberalization of trade in both goods and services within the regional economic communities in SSA. However, the paper finds that the EPAs also provide an opportunity to accelerate regional and global trade integration in SSA. To realize the potential development benefits of the planned EPAs, two steps are essential. First, the EU must, as it has stated, truly treat the EPAs as instruments of development, subordinating its commercial interests in the agreements to the development needs of the SSA and effectively coordinating their trade and development assistance components. Second, the SSA countries need to implement the EPA-related trade policy reforms. 1

3 Economic Partnership Agreements between SSA and the EU: A Development Perspective on Their Trade Components Executive Summary The EPA Process The EU is SSA s largest single trading partner buying on average 31% of its merchandise exports and providing 40% of its merchandise imports, and the trade relationship between SSA and the EU is important for the region s development. The Cotonou Agreement provides for negotiation of Economic Partnership Agreements (EPAs) between the EU and SSA countries, which are to go into effect in 2008 when the Cotonou Agreement expires. The planned EPAs are intended to restructure trading arrangements between the EU and the SSA countries to make them more effective in promoting EU-SSA trade, more supportive of broader development goals, and more compatible with World Trade Organization (WTO) rules. The EU has stated its desire to use the EPAs as instruments of development, and this paper analyzes them from a development perspective. The EPAs offer considerable potential benefits to SSA countries. But the planned free trade agreements with the EU will also pose a number of policy, administrative, and institutional challenges for SSA countries, including: replacing forgone tariff revenues, avoiding serious trade diversion, appropriately regulating liberalized service industries, and liberalizing internal trade within SSA s regional economic communities (RECs). To achieve pro-development outcomes through the EPAs, it is essential both that the SSA countries and organizations concerned be well prepared for these negotiations and that the EU adopt a benevolent, development oriented approach to them, subordinating its commercial interests to the development needs of the SSA countries when necessary. Relationship of EPAs to WTO s Doha Development Round The EPA negotiations between the EU and the SSA countries overlap with the multilateral negotiations of WTO s Doha Development Agenda, and there are several important interrelations between the two sets of negotiations. A pro-development outcome in WTO s Doha round would amplify the benefits from the EPA process. Many of the most difficult trade liberalization issues, particularly agricultural ones, need to be addressed in the Doha round; and more progress may be feasible on these in EPAs if the Doha round has already set a good framework for resolving them. Hence, it would be desirable if the Doha round could be successfully completed before key decisions have to be taken concerning the EPAs. 2

4 In addition, in the context of the EPA discussions, SSA countries should ask the EU to take into account in its negotiating position for Doha their priority concerns that need to be reflected in the eventual WTO agreement on agriculture. SSA countries could identify existing and promising agricultural exports that are important for them (such as cotton) and ask that these specific products receive priority treatment in the EU s decoupling of agricultural support from production and eliminating of export subsidies. Any reductions in the EU s MFN tariff rates in the Doha round will reduce the the preference margin that SSA countries will have under the trade EPAs, and some SSA countries are worried about potential preference erosion. Hence, there is a risk that EPAs could create a bloc of countries that, because of short term concern about the erosion of their preferences in the EU market, could inhibit progress at the WTO in liberalizing world trade and achieving improved market access for other developing countries. Longterm competitiveness and sustainable development cannot be built solely upon special preferences allowing SSA countries to benefit from transient distortions in world trade policies, and adjustment to preference erosion is going to be necessary sooner or later in any case. The EPA process provides an opportunity to commence this adjustment in favorable circumstances as the financial cooperation component of EPAs could be used for providing adjustment assistance for countries facing significant transitional costs from preference erosion. The World Bank and IMF have also offered to help with financing any transitional costs of adjusting to preference erosion. The EU s Everything but Arms (EBA) Initiative In addition to providing trade preferences to SSA countries under the Cotonou Agreement, the EU now provides full quota-free, tariff-free access to its market to LDCs, including those in SSA, under the Everything but Arms (EBA) Initiative, which it adopted in When full market access is phased in for rice, bananas, and sugar by 2009, the EBA Initiative will grant full, unrestricted market access to LDCs for the commodities currently subject to the EU s commodity protocols with the ACP countries. Although the EBA Initiative is definitely beneficial for the LDCs, it has somewhat complicated the EPA process by creating different trading environments and negotiating incentives for the LDCs and non-ldcs in SSA, some of which are members of the same custom union or FTA. The best way to reduce these complications and facilitate regional integration in SSA would be for the EU to provide EBA market access to all SSA countries signing EPAs. Provision of EBA access to the non-ldcs in SSA under the EPAs would also give them unrestricted access to the markets now governed by the EU s commodity protocols once any transitional arrangements have expired and would effectively resolve the question of the future of the protocols. The rules of origin (RoO) under both the Cotonou Agreement and the EBA Initiative are complex and restrict SSA exports. Unless RoO are liberalized and simplified, the benefits of even full tariff-free, quota-free market access under EPAs will be limited. A 3

5 simpler, less restrictive rule of origin for the EPAs would be to give SSA exporters the choice between meeting a change of tariff heading rule or a uniform 25% value-added rule, together with liberalization of the general tolerance rule to permit 25% imported inputs and full cumulation among all ACP countries, other LDCs, South Africa, and the EU. Independent reviews of the EU s import safeguard measures (such as anti-dumping) and sanitary and phyto-sanitary (SPS) regulations (such as those on ground nuts) should also be undertaken to see if more development friendly provisions concerning these can be included in the EPAs. Preferential Reductions in Tariffs on Merchandise Imports from the EU and Accompanying Reforms in SSA Restructuring Indirect Tax Systems. An important fiscal issue raised by the EPAs is the impact on government revenues of preferential reductions in SSA tariffs on merchandise imports from the EU. Revenues from tariffs still amount to 2% of GDP in the median SSA country, and some countries depend even more heavily on tariff revenues, with these amounting to 4% to 6% of GDP. Since the EU is the largest source of imports for most SSA countries, supplying 40% of total imports on average, some countries are likely to lose significant tariff revenue from reducing tariffs on imports from the EU. For example, even assuming no trade diversion, an average country, in which tariff revenues are 2% of GDP and 40% of imports come from the EU, would lose tariff revenues equivalent close to 1% of GDP (7% to 10% of government revenues) from eliminating tariffs on all imports from the EU. The revenues losses would be significantly greater in countries that are highly dependent on tariff revenues. To protect their fiscal positions and maintain macroeconomic stability, the SSA countries will need to reform their indirect tax systems so that revenues from the VAT and non-discriminatory excise taxes levied at equal rates on imports and domestic products replace the forgone tariff revenues. Countries that face particularly large revenue losses may need to consider additional measures such as strengthening other components of their tax and revenue systems, curtailing low priority or inefficient expenditures, or seeking additional debt relief. Problematic Partial liberalization. Many SSA countries still have high and distorted MFN tariff structures, and preferential reduction of tariffs on merchandise imports from the EU under EPAs will need to be accompanied by MFN tariff reductions if the preferential reduction in tariffs is to be beneficial for SSA. Preferential tariff reductions under EPAs can, in the presence of high MFN tariffs, lead to costly diversion of trade from low cost to high cost foreign suppliers and implicit transfers of tariff revenues from SSA governments to EU exporters. In addition, as a result of the lobbying of protected domestic SSA producers during the EPA negotiation process, it can also lead to a tariff regime that maintains protective tariffs for all import-competing domestic industries while eliminating the revenues from tariffs on imports from the EU that do not compete with domestic production. Subsequent negotiation of similar such partial free 4

6 trade agreements with additional OECD countries (as, for example, South Africa is currently doing with the US) would aggravate these problems. Simultaneous MFN Tariff Reductions. The World Bank advocates a prodevelopment outcome of the Doha round that would include developing countries achieving average tariffs of 5% for manufacturing, with a maximum tariff of 10%, and average tariffs of 10% for agriculture, with a maximum of 15%. In view of the uncertainty about the outcome of the Doha round at this point, we suggest a maximum MFN tariff rate of no more than 20%, the maximum rate currently in effect in WAEMU. The lower rates suggested by the World Bank as objectives for the Doha round would be even better for those countries that can achieve them. Because of the likely losses of revenue from eliminating tariffs on imports from the EU, the required MFN tariff reductions would need to be carried out in a revenue-neutral fashion, for which there is ample scope in most SSA countries due to the prevalence of extensive tariff exemptions and of prohibitive (minimal revenue generating) peak tariffs. The MFN liberalization should be completed before, or at the same time, as the preferential tariff reduction with the EU takes place so that trade diversion is minimized and EU suppliers do not have a chance to sell into highly protected domestic SSA markets, and thus obtain large implicit transfers of tariff revenues, until the MFN tariff is reduced. Liberalization of Trade in Services and Related Reforms Because of the underdeveloped nature of the service sector in SSA and the constraints on expanding the employment of temporary workers in the EU, SSA s major gains from liberalization of trade in services are likely to come on the import side. Liberalization of imports of services should be included as an integral part of the EPAs as these could have an important impact on productivity and growth in SSA. The priority sectors for liberalization appear prima facie to be transportation, telecommunications, and finance; and sub-sectoral studies of these need to be carried out for each sub-region in order to formulate plans for doing so. Imports of services should be liberalized on both a MFN and an intra-rec basis (including intra-rec labor flows) at the same time as they are liberalized vis-à-vis the EU in order to attract investment by the most efficient service providers and benefit from economies of scale. Accompanying reforms in the regulatory environment will also be needed, and the timing of the liberalization in various service sectors should be determined by the capacity of the SSA countries to implement the required accompanying regulatory reforms in these sectors. On the export-side, the EU will need to take a more generous approach towards services in EPAs than in previous trade agreements with developing countries for the SSA countries to benefit significantly from improved access to the EU market. Even then, the gains in the near term from increased SSA exports of services are likely to be smaller than those from liberalizing imports of services; but SSA should, nevertheless, explore what scope there is for increasing the numbers of temporary workers in the EU and for assisting the tourism sector through EPAs. 5

7 Regional Integration in SSA An important objective of the EPA process is to promote outward oriented regional integration among the SSA countries and to limit the hub and spoke effect that bilateral free trade just between the EU and individual SSA countries could have. Hence, the SSA countries are expected to form themselves into self-determined regional groups for negotiating the EPAs. Determining the nature of the EPA groupings in SSA while also supporting existing regional trade agreements (RTAs) has been no simple matter. A major reason is the high degree of heterogeneity in SSA s RTAs, which include a number of overlapping PTAs, FTAs, and customs unions (CUs) with different structures, operational rules, and implementation levels. However, the interaction of the EPA process and the political support for regional integration in SSA has provided a dynamic impetus for rationalizing this situation; and the composition of the four regional EPA negotiating groups in SSA has now largely been resolved. Significant barriers to intra-regional trade still remain within free trade areas, and even within customs unions, in SSA. The ECOWAS FTA has not yet really been implemented, and some countries in COMESA still maintain barriers to free intraregional trade. Even though CAEMC and WAEMU are customs unions, substantial obstacles to internal free trade and country deviations from the common external tariff remain in both. The EAC customs union is not yet operational but is likely to face similar problems. Only SACU is a fully functioning customs union with full internal free trade, a common external tariff observed by all of its members, and common administration of the external tariff and pooling of the revenues from it. Barriers to intra-ssa trade within CUs and FTAs may not, in themselves, be a problem in terms of negotiating EPAs as long as the CUs have a common external tariff in place. However, further intra-cu and intra-fta liberalization of trade in both goods and services would most likely benefit their members. There are several steps which should be taken in the context of the EPAs to strengthen regional integration in SSA. First, those member countries of customs unions that have not fully implemented their CU s common external tariff need to do so as soon as possible. Second, full intra-cu and intra-fta free trade in both goods and services, including intra-rec labor flows, needs to be implemented in most CUs and FTAs. And, third, SSA countries should take advantage of the good practice precedent that would be set with regards to liberalized RoO in the EPAs to adopt similar standardized, liberal RoO for the various regional trade areas in Africa. The situation with the EPAs for the SACU countries is particularly complex. Four of the five SACU countries are ACP countries and are participating in the EPA process. However, the fifth and by the far largest SACU member, South Africa, is eligible neither for the trade benefits of the Cotonou Agreement nor for an EPA. Instead, it has a separate free trade agreement with the EU, many aspects of which apply de facto to the other SACU countries. To rationalize this situation, SACU may eventually need to be included as one of the customs unions which signs an EPA. The four SACU member countries eligible for EPAs (Botswana, Lesotho, Namibia, and Swaziland) should ask the 6

8 EU to give them EBA market access with improved, less restrictive rules of origin. In addition, if South Africa takes the lead in gradually lowering SACU s peak tariffs on an MFN basis to a maximum of 20% as recommended for other CUs and SSA countries, a step which would probably be very beneficial for the less developed BLNS countries, South Africa should also receive improved EBA access to the EU market, even if this access might require a longer transition period for the EU than in the case of the other SACU countries. An Opportunity to Accelerate Trade Integration in SSA The EPA process offers a favorable opportunity for SSA countries to integrate into the global economy, to strengthen regional integration in Africa, and to accelerate their reform programs. The EPAs negotiating schedules and deadlines create a useful dynamic impetus for global and regional integration in a situation where progress would otherwise be halting, at best. Partial preferential liberalization of trade between SSA and the EU under EPAs would, by itself, be problematic, possibly even disadvantageous on balance, for most SSA countries because of the loss of tariff revenues and the probability of significant costly trade diversion. However, the necessity for the SSA countries to liberalize their imports from the EU in order to preserve and improve upon their preferential access to the EU market also provides an opportunity for them to accelerate the overall trade liberalization process and the opening up of their economies. The fundamental condition for realizing the potential benefits of the EPAs is to actually utilize the EPAs as instruments for development. Doing so will pose challenges for both the EU and SSA. For the EU, the challenges will be to subordinate its commercial interests in the EPAs to the development needs of the SSA countries and to effectively coordinate trade and development assistance. In particular, since much greater tariff reductions will have to be made under the EPAs by SSA countries than by the EU, the EU will need to include generous treatment of SSA exports in the trade components of EPAs in non-tariff areas such as liberalizing its rules of origin, extending market access for everything but arms to the non-ldcs in SSA, eliminating agricultural export subsidies and decoupling agricultural production support in products of particular interest to SSA, and admitting larger numbers of temporary workers from SSA under EPAs. Adequate technical and financial support for the implementation of the EPAs also needs to provided. In particular, the financial envelops for the EPAs should, in principle, increase in real terms from the Cotonou level by at least the amount needed to finance the transitional costs associated with the EPAs and related reforms in the Doha round. In addition, a pro-development outcome in WTO s Doha round would amplify the benefits from the EPA process, and it would be desirable if the Doha round could be successfully completed before key decisions have to be taken concerning the EPAs. Because of its central role in the whole EPA process, if the EU cannot rise to these challenges, the EPAs may end up doing more harm than good for SSA, at least in the medium term until the SSA countries are able to implement the necessary reforms on their own. 7

9 For the SSA countries, the key requirement is commitment to utilizing the EPAs to accelerate reforms that are necessary in the long term for integrating with the global and regional economies, that is: the restructuring of indirect tax systems, MFN tariff reductions, liberalization of services imports on a MFN basis and related regulatory reforms in the services sector, and liberalization of trade in both goods and services (including labor flows) within the regional economic communities in SSA. Moreover, there are many obstacles to expanding production of tradable goods in Africa besides those that will be addressed under the EPAs and accompanying reforms. The supply response to the EPAs reforms will be much greater if these trade reforms are followed by actions in other areas. Particularly important are (a) a competitive exchange rate policy that encourages the expansion and diversification of exports; (b) other trade facilitation measures such as reforms in customs administration; (c) improvements in the investment climate to encourage a positive response from the private sector; (d) implementation of an effective domestic competition policy; and (e ) infrastructure investment. The paper s findings and recommendations are summarized in Box 1 at the end of the conclusion. 8

10 Abbreviations ACP AGOA BLNS CAP CAEMC CEMAC CET COMESA CU EAC EBA EC ECOWAS EPA ESA EU FTA GATS GSP MFN NTB PTA REC RoO RTA SACU SADC SPS SSA TBT TRQ UEMOA UTL WAEMU WTO African, Caribbean, and Pacific countries Africa Growth and Opportunity Act Botswana, Lesotho, Namibia, and Swaziland Common Agricultural Policy Central African Economic and Monetary Community Communauté Economique et Monétaire de l Afrique Centrale (Central African Economic and Monetary Community) Common External Tariff Common Market for Eastern and Southern Africa Customs Union East African Community Everything-But-Arms European Commission Economic Community of West African States Economic Partnership Agreement Eastern and Southern Africa European Union Free Trade Agreement (or Area) General Agreement on Trade in Services Generalized System of Preferences Most Favored Nation Non-tariff barrier Preferential Trade Agreement (or Area) Regional Economic Community Rules of origin Regional Trade Agreement (or Area) Southern African Customs Union Southern African Development Community Sanitary and Phyto-Sanitary Sub-Saharan Africa Technical Barriers to Trade Tariff Rate Quota Union Economique et Monétaire Ouest-africaine (West African Economic and Monetary Union) Unilateral Trade Liberalization West African Economic and Monetary Union World Trade Organization 9

11 Table of Contents Page 1. Introduction: A Development Perspective on Trade EPAs 1.1 Development Issues Posed by the Planned Trade EPAs Objective, Coverage, and Organization of the Paper The EPA Negotiation Process and Issues 2.1 An Overview of Trade between SSA and the EU Objectives of the EPA Process Phase I of the EPA Negotiations The Phase II Negotiations The Relationship of EPAs to WTO s Doha Round 3.1 EPA and WTO Negotiating Schedules and SSA Capacity Constraints Links between MFN Tariff Reductions and Bi-lateral Free Trade Agriculture 4. The Everything But Arms (EBA) Initiative 4.1 Implications of EBA for LDCs in SSA The Non-LDCs in SSA The EU s Commodity Protocols The EU s Rules of Origin (RoO) Summary of Steps for Improving Market Access Preferential Reductions in Tariffs on Merchandise Imports from the EU and Accompanying Domestic Reforms in SSA 5.1 Potential Revenue Losses and the Restructuring of Indirect Tax Systems Factor s Determining SSA s Likely Gains or Losses from Preferential Liberalization of Merchandise Imports from the EU Problematic Partial Trade Liberalization with the EU Need for Accompanying MFN Tariff Reductions Conclusion and Recommendations Liberalization of Trade in Services and Related Reforms 6.1 Previous EU Agreements with Developing Countries on Trade in Services SSA Exports of Services to the EU Imports of Services and Regulatory Reform in SSA Technical Assistance

12 6.5 Conclusion Regional Integration in SSA and the Geographical-Organizational Aspects of Trade EPAs 7.1 The Roles of FTAs and Customs Unions in Trade EPAs Role of Existing Intra-SSA FTAs Questions Concerning Customs Unions in SSA 7.3a SACU and South Africa b CAEMC and WAEMU c The East African Community Reforms Needed in Intra-SSA Trade Policy Summary Conclusion 8.1 An Opportunity to Accelerate Trade Integration in SSA Next Steps: Analysis and Preparation of Key Country and Sub-regional Reforms Next Steps: Issues to Raise with the EU..71 Box 1: Summary of Findings and Recommendations...72 References..77 Tables and Figures Table 1. Membership of Sub-Saharan African Countries in Regional Trade Blocs, the WTO, and the LDC Grouping..80 Table 2. Provisions Relating to Services in EU Trade Agreements Figure 1. Main African Regional and Sub-regional Economic Integration Agreements 11

13 Economic Partnership Agreements between Sub-Saharan Africa and the EU: A Development Perspective on Their Trade Components 1. Introduction: A Development Perspective on Trade EPAs 1.1 Development Issues Posed by the Planned Trade EPAs The planned Economic Partnership Agreements (EPAs) between the European Union (EU) and Sub-Saharan Africa (SSA) are an outgrowth of the EU s efforts to reformulate the Cotonou Agreement with the African, Caribbean, and Pacific (ACP) countries to make it more effective in promoting ACP-EU trade, more supportive of broader development goals, and more compatible with World Trade Organization (WTO) rules. EPAs are to consist of a trade component and a technical and financial cooperation component. The EU has stated its desire to use the EPAs as instruments of development. The EPAs are expected to support economic development in the ACP countries by establishing free trade agreements with them and by strengthening the regional trade blocs among them, as well as through the technical and financial support components of the EPAs. Moving forward with the EPAs has been complicated by two factors. First, the original schedule of the multilateral trade negotiations in WTO s Doha Development Round, which covers many of the same issues as the planned EPAs, envisaged these being completed by the end of The original completion date would have permitted the outcome of the Doha round to be taken into account in the EPA negotiations. Although a new deadline has not yet been set, completion of the WTO negotiations will almost certainly be delayed, and it is difficult at this point to foresee exactly what their outcome will be. Second, the EU s recent Everything But Arms (EBA) Initiative now provides full quota-free and duty-free access to the EU market for the least developed country (LDC) members of the ACP, whether they enter into EPAs or not, but not for the non- LDC ACP countries. Thus, for the LDCs in SSA, the free trade aspect of the proposed EPAs amounts to some extent to giving the EU preferential access to their own markets in order to obtain under an EPA the same preferential access to the EU that they receive from EBA whether or not they participate in an EPA. The non-ldc ACP countries, in contrast, face stronger negotiating incentives: they need the EPAs in order to maintain or improve upon the preferential access to the EU market that they currently have under the Cotonou Agreement but which will expire when that agreement ends in

14 In addition to the complications created by the likely delays in the completion of the Doha round and the EBA initiative, implementing free trade with the EU will itself pose a number of policy and administrative challenges for SSA countries, including among others: replacing forgone tariff revenues, avoiding serious trade diversion, and appropriately regulating liberalized service industries. A clear understanding of the various analytical issues raised by the trade components of the planned EPAs is thus important for ensuring that the development objectives of the EPA process are attained. An additional reason for the SSA countries to think long and hard about the development impact of the EPAs is that they may very well set precedents for future trade relations between the US and SSA, and possibly subsequently for those with other members of the OECD and SSA as well Objective, Coverage, and Organization of the Paper Audience and Objective. This paper started out as an internal Bank study to provide background analysis for use of Bank staff in their economic and sector work and dialogue with SSA countries and regional economic communities. As we came to appreciate the importance and complexity of the issues involved, however, we realized that it would be worth distributing the paper to SSA countries, regional organizations, and others concerned with the planned EPAs. The paper examines the trade components of the planned EPAs between SSA and the EU from a development perspective. It addresses the question of how EPAs should be designed in order to maximize their long term development impact. The paper s objective is to clarify the implications of some of the options being considered by the EU and SSA countries and to propose some alternative ones for consideration. In this paper we have not, however, tried to quantify the likely impact of the EPAs on key development variables such as GDP (welfare), growth, job creation and skills development, and poverty reduction. Merely sorting out clearly the numerous complex issues and qualitatively identifying the most import considerations has been challenging enough. This paper assumes that both the EPA process and the Regional Economic Communities (RECs) in SSA are political/historical realities. 2 As will become apparent shortly, the EPAs are likely to turn out to be fairly complex undertakings that test the analytical, negotiating, and administrative capacity of the SSA countries. Hence, one question actively debated during the preparation of the paper was whether the whole EPA approach makes sense or should be replaced by a simpler combination of multilateral 1 The growing trade ties between the US and SSA include the trade preferences accorded by the US s African Growth and Opportunity Act (AGOA) and the negotiation of a FTA between the US and SACU. The extension, broadening, and strengthening of AGOA and the eventual creation of an FTA between the US and Africa has recently been recommended by the Commission on Capital Flows to Africa (2003) in a study sponsored by various institutions, including the Institute of International Economics. 2 Regional Economic Community is a general term used in SSA to describe regional customs unions. free trade areas, and other preferential trade areas. In other contexts, the term regional trade areas (RTAs) is applied to the same types of organizations. The two terms are used interchangeably here. 13

15 (MFN) trade liberalization in SSA and improved EU preferences for SSA countries. In the end, we concluded that, although EPAs and the current regional trade areas in SSA may not be the best arrangements from an economic point of view, there are strong political forces supporting their continuation and that the EPA process has already gathered substantial momentum in SSA and the EU. Conversely, in the absence of EPAs, there appears to be no political dynamic that is likely to lead in the medium term to improved EU preferences for the SSA countries (particularly for the non-ldcs), nor to MFN trade liberalization in SSA, nor to as rapid progress toward regional integration. Therefore, the analytical problem was posed here as one of maximizing the long term development impact of EPAs and the RECs in SSA, rather than of replacing them with potentially superior, but improbable, multilateral trade arrangements. 3 Coverage. The paper s focus is primarily on the SSA countries, including South Africa as well as the SSA members of the ACP group. However, many of the findings are likely to apply to non-african ACP countries as well as to SSA, and some of the options discussed have broad implications for the ACP group as whole. The depth of coverage of different topics is also uneven, a reflection in large part of variations in the amount of work that Bank staff have previously done on these. On some issues such as the liberalization of merchandise trade, rules of origin, and regional integration, on which the Bank has done substantial amounts of work, we make fairly specific recommendations. For other issues on which less work has been done, such as liberalization of trade in services and non-tariff policies limiting SSA s access to the EU agricultural market, we make more general suggestions and identify further analytical work needed to arrive at specific recommendations. Although, where relevant, the relationship between the trade and the financial components of the EPAs is considered, we have not tried here to analyze the financial and technical cooperation components of the EPAs. Organization of the Paper. The remainder of the paper is organized as follows. Section 2 reviews the status of the EPA negotiation process and identifies many of the issues that are considered subsequently. Section 3 discusses the relationship between the EPA negotiations and the WTO s Doha Development Round. Section 4 deals with the European Union s EBA initiative and its implications for SSA and the trade components of the EPAs. Section 5 analyzes the preferential reductions under the EPAs of SSA tariffs on merchandise imports from the EU and discusses the accompanying domestic reforms that would be needed in SSA. Section 6 considers trade in services. Section 7 examines the geographical-organizational aspects of trade EPAs with SSA s heterogeneous customs unions and FTAs and related measures to promote intra-ssa trade. Section 8 concludes and considers the next steps. 3 The potential development costs and benefits of EPAs for SSA are judged against counterfactual assumptions (summarized in Section 8) about SSA s probable preferential access to the EU market in the absence of EPAs and the likely course of trade liberalization and regional integration in SSA countries. 14

16 2. The EPA Negotiation Process and Issues This section reviews the EPA negotiation process and identifies many of the issues that are analyzed in the following ones. The section begins with a brief overview of trade between SSA and the EU and within SSA to establish the context for the rest of the paper. It then discusses the objectives of the EPA process and Phase I and Phase II of the negotiations. The section argues that to achieve pro-development outcomes through the EPAs, it is essential both (a) that the SSA countries and organizations concerned be well prepared for these negotiations and (b) that the EU adopt a benevolent, development oriented approach to the negotiations, subordinating its commercial interests to the development needs of the SSA countries when necessary. 2.1 An Overview of Trade between SSA and the EU Trade is quite important for most of the SSA countries, with total exports and imports of goods and non-factor services accounting, respectively, for 29% and 34% of GDP on average. 4 Partly for historical reasons, the European Union is SSA s major trading partner; and free trade agreements with the EU could have a substantial impact on most of SSA. In the average SSA country, merchandise exports accounted for 24% of GDP in 2001, 31% of which were to the EU. There is significant variation from the average: 18 SSA countries sold between 50% and 80% of their merchandise exports to the EU, while the EU accounted for less than 15% of the exports in 4 countries. In the average SSA country, exports of non-factor services were about 1/5 the level of merchandise exports, accounting for an additional 5% of GDP; but no data were available on the share of SSA s non-factor service exports going to the EU. Similarly, merchandise imports amounted to 24% of GDP in the average SSA country in 2001, with 40% of these being purchased from the EU. Five countries obtained more than 50% or more of their merchandise imports from the EU, headed by Gabon at 78%, while 4 countries obtained less than 20% of their imports from the EU. Imports of non-factor services amounted to an additional 10% of GDP; but, as with exports of non-factor services, no data were available on the share of imports of nonfactor services coming from the EU. In contrast, because the EU s economy is so much larger than those of the SSA countries, trade with Africa is much less important for the EU than it is for Africa. Africa accounts for only 1.4% of the EU s total merchandise exports and 1.7% of its merchandise imports. Thus, the impact on the EU of free trade arrangements with Africa is likely to be quite limited and easier for the EU to adjust to than for Africa. The differences in economic size and the relative importance of EU-SSA trade to the two sides place the EU in a much stronger bargaining position than SSA. 4 The averages cited in this section are population-weighted means unless otherwise noted. 15

17 Intra-regional trade within SSA is also limited, amounting to only about 12% of the average SSA country s merchandise exports and 7% of its merchandise imports. Intra-SSA trade is particularly important for landlocked SSA countries and for a handful of coastal countries (such as South Africa, Nigeria, Cote d Ivoire, and Kenya) that have significant manufacturing capacity. Import tariffs are still an important source of revenue in many SSA countries, and free trade arrangements with the EU could have significant fiscal implications for some countries. Import tariff revenues amount to about 2% of GDP and 15% of government revenues in the median SSA country. However, in the one-third of the SSA countries which are most dependent on tariff revenues, import tariffs are still 3% to 6% of GDP and account for 25% or more of government revenues (see Hinkle and associates, 2003, for an analysis of tariffs in SSA). For any of these latter countries which obtain a third or more of their imports from the EU, free trade arrangements could lead to revenue losses of 1-2% of GDP Objectives of the EPA Process Starting in the 1970s, the EU provided unilateral preferential access to its market to Sub-Saharan Africa and other ACP countries under the Lomé Conventions (I through IV). Because these did not entail reciprocal preferences (that is, because the EU did not benefit from preferential access to the ACP countries) and because they were not part of the EU s general system of preferences (GSP), the Lomé Conventions did not conform to GATT rules. In order, among other reasons, to bring its trade relations with the ACP countries into line with its GATT/WTO commitments, the EU entered into the Cotonou Agreement with them in June This agreement provides for replacing the unilateral trade preferences that the EU accords to the ACP with economic partnership agreements involving reciprocal obligations. EPAs are to consist of a trade component and a technical and financial cooperation component. The primary component of the trade EPAs is to be the establishment of free trade areas between the EU and each of the regional EPA negotiating blocs. The latter are self-determined groupings of the 77 ACP countries, which are encouraged to form regional blocs for pursuing regional integration and negotiating EPAs with the EU (with a total of about 6 to 12 EPAs envisaged). According to the Cotonou Agreement s timetable, the EPA negotiations are to be completed by December 2007, and the EPAs are to come into force as of January 2008, 5 Up to date, consistent data on tariff revenues in SSA are costly and time consuming to obtain because these have to be obtained from the governments concerned on a country-by-country basis. The data published in the IMF s Government Finance Statistics are for total taxes on international trade and include VAT, sales taxes, excise taxes, etc. on imports as well as tariff revenues. Since free trade agreements reduce tariffs on imports but not VAT and excise taxes on these, it is important to distinguish between these when analyzing the revenue effects of free trade agreements. 16

18 although there is some recognition that these deadlines may slip and they could be modified by mutual agreement. Replacement of Unilateral Preferences with Free Trade Agreements. The Cotonou Agreement thus provides for replacing the existing relationship of unilateral preferential access by ACP countries to EU markets with reciprocal free trade agreements between the EU and the SSA countries in order to make EU-ACP trade relations compatible with WTO rules. The WTO-compatibility problem arises because the EU s special unilateral preferences for the ACP countries under the Cotonou Agreement, like those under the preceding Lome Agreements, are inconsistent with WTO s enabling clause. This clause permits industrial countries to give unilateral preferential treatment to only two groups of countries: to LDCs or to all developing countries. Hence, the EU needed to obtain waivers from the WTO first for the Lome Agreement in 1994 and then for the Cotonou Agreement at Doha in Even with the waivers, some aspects of the Cotonou regime are vulnerable to disputes in the WTO. The EU s commodity protocol governing preferential trade in bananas with the ACP countries has already been successfully challenged in the WTO. Recently, the EU s sugar protocol has similarly been challenged. India has subsequently challenged the EU s GSP on the grounds that it illegally discriminates between different non-ldc developing countries. Note, by the way, that the trade preferences provided to both African LDCs and non-ldcs under the US s Africa Growth and Opportunity Act (AGOA) also do not appear to be WTO-compatible and could be challenged on the grounds that they violate the non-discrimination provision of the enabling clause. WTO-compatibility is thus an important consideration for the EU. There is a significant risk that the EU might not be able to obtain a waiver for continuing the Lome- Cotonou type preferences after 2007 or would have to make costly trade concessions to non-acp countries in order to do so. Without a waiver, the EU might be required to compensate non-acp developing countries if it continues the Cotonou-type preferences for ACP countries after In addition, the EU is also concerned about the evolution of the rule-based world trading system and remaining in good standing with it. Hence, the urgency of bringing the Lome-Cotonou preferences into compliance with WTO rules weighed heavily in the EU s launching of the EPA process and has been a key factor in determining its timetable. 6 In contrast, for many policy makers in SSA countries, which, because of their small size, do not have as high a profile in the WTO as the EU, have thus far been exempted de facto from many WTO disciplines, and have not been affected by the disputes over the commodity protocols, WTO-compatibility is often perceived as a less immediate concern. 6 Another way of dealing with the problem of the incompatibility of the Cotonou Agreement s market access preferences for the ACP countries with WTO s enabling clause would be for the EU to improve the preferences under its GSP scheme so that they are identical to Cotonou preferences. However, such a change would involve granting the same market access to the large and potentially very competitive developing economies (such as China, Brazil, and India) as to the non-ldcs in SSA (such as Kenya, Cote d Ivoire, and Cameroon). This approach would probably be problematic for both the EU, which would expect a quid pro quo from the larger developing economies, and the ACP countries, which would be concerned about preference erosion. 17

19 Free trade agreements between developed and developing countries are governed by WTO s Article xxiv rather than its enabling clause, which applies to unilateral preferences and preferential agreements between developing countries. Article xxiv requires that the countries forming an FTA liberalize substantially all trade within a reasonable length of time. Although precise definitions of the foregoing two terms have not been established, substantially all trade is generally interpreted to mean 90% of trade or more and 10 years is considered to be a reasonable length of time except in special cases. Although GATT and the WTO have thus far been notified by their members of more than 100 free and preferential trade agreements under the enabling clause and Article xxiv, none of these has yet been found not to be in conformity with GATT-WTO rules. Because the EPA negotiations are expected to involve reciprocal concessions by both sides, they will provide an opportunity for SSA to negotiate with the EU about trade issues that are important to it. To achieve pro-development outcomes through the EPAs, it is essential both that the SSA countries and organizations concerned be well prepared for these negotiations and that the EU adopt a benevolent, development oriented approach, subordinating its commercial interests to the development needs of the SSA countries when necessary. Differentiation between LDCs and Non-LDCs. In addition to reciprocity, a second guiding principle of the Cotonou Agreement in the area of trade is differentiation. The last part of Article 2 of the Cotonou Agreement states (in the form of a bullet): differentiation and regionalization: cooperation arrangements and priorities shall vary according to a partner's level of development, its needs, its performance and its long-term development strategy. Particular emphasis shall be placed on the regional dimension Part 1 of Article 85 then adds that: The least-developed ACP States shall be accorded a special treatment in order to enable them to overcome the serious economic and social difficulties hindering their development so as to step up their respective rates of development. As discussed in Section 4 below, the EU s subsequent adoption of the EBA initiative has, in fact, already provided immediate full quota-free, tariff-free access to the EU market for the LDCs in the ACP group independently of the EPA process (except for bananas, rice, and sugar, for which full access will be phased in gradually by 2009). Hence, there is no real need for the 33 LDCs in SSA to enter into EPAs just to maintain their preferential access to the EU market; and doing so may not be in their interest unless the EPAs provide significant additional development benefits. In contrast, after the Cotonou Agreement expires on December 31, 2007, SSA s 14 non-ldcs would have to provide the EU with preferential access to their markets in order to maintain their preferential access to EU markets. ACP countries have the choice of refusing to enter into an EPA with the EU. In this case the non-ldcs would lose their preferential access to EU markets when the Cotonou Agreement expires and revert to the more limited preference available under the 18

20 EU s GSP. They would also forego the opportunity to directly negotiate with the EU over trade issues particularly important for them. In contrast, the market access of the SSA s 33 LDCs that benefit from the EBA initiative would presumably not be greatly affected if they decided not to enter into EPAs with the EU. Hence, in the Phase I negotiations discussed below, the ACP countries requested that a way be found to preserve the current preferential market access of non-ldcs that do not conclude EPAs. Regional Integration. A third objective of the EPA process is to promote outward oriented regional integration among the ACP countries and limit the hub and spoke effect that bilateral free trade just between the EU and individual ACP countries could have. As noted above, the ACP countries are expected to form themselves into selfdetermined regional groups for negotiating the EPAs. Traditionally, the 77 ACP countries have been divided into 6 broad regional groupings: the Caribbean, the Pacific, and four loosely defined African sub-regions western, central, eastern, and southern Africa. Although the EPA process offers an opportunity to advance outward oriented regional integration in SSA, determining the nature of the EPA groupings in SSA while also supporting existing regional trade agreements (RTAs) has been no simple matter. A main reason is the high degree of heterogeneity in SSA s RTAs, which include a number of overlapping PTAs, FTAs, and customs unions (CUs) with different structures, operational rules, and implementation levels. Table 1 shows the current membership of SSA countries in various trade blocs and indicates which are LDCs and members of WTO. Figure 1 shows the resulting spaghetti bowl of SSA s overlapping regional and sub-regional economic integration arrangements. 7 However, the interaction of the EPA process and the political energy behind regional integration in SSA has provided a healthy impetus for rationalizing this situation; and the composition of the regional EPA negotiating groups in SSA has now largely been resolved as explained below in Section 7. Coordination of Trade and Aid. A fourth objective of the planned EPAs, which are to include a financial and technical cooperation component as well as the free trade agreements between the EU and SSA, is to more effectively coordinate trade and aid. The EU is one of SSA s largest aid donors. Thus, the financial and technical cooperation components of the EPAs can, in principle, provide for substantial assistance for overcoming problems and take advantage of opportunities created by the improved market access and trade liberalization. A number of trade-related areas in which technical and financial cooperation could play a useful role are noted in the sections below as they are discussed, and these are subsequently summarized in the concluding section. The opportunity for effectively coordinating trade and aid with a major trading partner and donor is a distinct advantage of the EPA process relative both to multilateral trade negotiations and to most other bilateral trade negotiations, where the link between aid and trade is non-existent or, at best, tenuous. However, coordinating the programs of two large aid and trade directorates with different constituencies and different 7 See de la Rocha (2003) for more on this issue. 19