The currency union effect on intra-regional trade in Economic Community of West African States (ECOWAS)

Author:Anokye M. Adam
Position:School of Business, University of Cape Coast, Cape Coast, Ghana and Accra Institute of Technology Campus, Open University Malaysia, Accra, Ghana, and
SUMMARY

Purpose – The purpose of this paper is to investigate the currency union (CU) effect on aggregate intra-trade in the Economic Community of West African States (ECOWAS) and on bilateral trade among individual countries using the gravity model. Design/methodology/approach – Using panel dynamic ordinary least square, we examined the short- and long-run CU effect on aggregate intra-ECOWAS trade and bilateral trade among ECOWAS countries from 1995 to 2010. Chow... (see full summary)

 
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Introduction

Following the nineteenth century’s network of treaty ports formation by the Western powers and the treaty of Rome in 1957, which led to the birth of the European Economic Community (EEC), there has been a renewed wave of proliferation of economic-integration arrangements. There are apparent reasons for this development. Economic integration is seen as a rapid, all-inclusive and least-cost way to accelerate economic development. It is known that unified, regional economies expedite the pooling of risks between otherwise vulnerable economies, lessen wars, stimulate intra-regional trade and allow the countries within the region to exploit complementarities and entrench competitiveness. By so doing, they attract investments needed for the development of modern industries, while ensuring better access to markets and technology. Besides, the heat of globalization and its unintended externalities have really shown that no individual country can walk alone. Finally, the argument for trade-competition effects, market-size hypothesis and many others reinforce the need for such integration arrangements. Mundell’s (1961) economic thought about the ability to deal with asymmetric shocks through a regional economic integration arrangement, as opposed to the micro-nationalistic thinking which projected national sovereignty, is gaining acceptability.

In West Africa, regional cooperation dates back to the pre-independence era. The first attempt at economic integration is the creation of the West African Currency Board (WACB) in 1912 under the British colonial authority, which comprised Ghana, Nigeria, The Gambia and Sierra Leone. The WACB collapsed, following the independence of the participating countries, in spite of trade expansion success and gave way to a new economic arrangement – the Economic Community of West African States (ECOWAS). The ECOWAS was born out of the proposal made by the Economic Commission for Africa (ECA) in the mid-60s for the formation of regional groupings. The present-day ECOWAS was formed, from the Treaty of Lagos, on 28 May, 1975, by 15 West African countries: Benin, Burkina Faso, Cote d’Ivoire, Gambia, Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Mauritania, Niger, Nigeria, Senegal, Sierra Leone and Togo. In 1976, Cape Verde joined ECOWAS, and in 2001, Mauritania withdrew, having announced its intention to do so in December, 1999 (ECOWAS Commission, 2011), bringing the current ECOWAS membership to 15, which includes Benin, Burkina Faso, Cape Verde, Cote d’Ivoire, Gambia, Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leone and Togo.

At inception, the purpose of creating ECOWAS was to promote cooperation and development in all areas of economic activity, abolishing trade restrictions, removing obstacles to the free movement of persons, goods and services and harmonizing regional sectoral policies. This was affirmed when ECOWAS adopted the ECOWAS Trade Liberalisation Scheme (ETLS) as the main operational tool for promoting the West Africa region as a Free Trade Area in 1990 and signed a revised ECOWAS Treaty designed to accelerate economic integration and to increase political cooperation in 1993 in Cotonou. However, the overriding objective remains the establishment of a Common Market and the creation of a Monetary Union, characterised by a single currency and a common central bank. A single monetary zone for the ECOWAS member states was envisaged by 2003 under which convergence criteria included the following:

  • A ceiling on central bank financing of budget deficits of 10 per cent of the previous year’s tax revenue.
  • The maintenance of a single-digit inflation rate for all countries.
  • A restriction of the budget deficit to no more than 5 per cent of gross domestic product (GDP), reducing progressively to 3 per cent thereafter.
  • Countries with floating exchange rates were to reduce variability of nominal exchange rates to These criteria, necessary for the sustainability of any monetary union experiment, failed to be met by participating countries. However, the West African users of the Communauté Française d’Afrique (CFA) Franc (formerly Colonies Françaises d’Afrique Franc), which survived till today, turned into the monetary union, West African Economic and Monetary Union (WAEMU), in 1994. The WAEMU, also known as UEMOA from its name in French, Union Économique et Monétaire Ouest-Africaine) gathered eight West African states: Benin, Burkina Faso, Cote d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal and Togo. Guinea-Bissau, the only former Portuguese colony, became the WAEMU’s eighth (and only non-Francophone) member state in 1997.
  • Following the lack of progress in meeting the criteria set by ECOWAS to facilitate the ECOWAS-wide monetary union, a two-truck approach to integration in the sub-region was agreed upon at the 22nd Summit of the Authority of Heads of State and Government of ECOWAS held in Lome, Togo, in 1999. A second monetary zone in West Africa involving non-members of the Union Economique et Monétaire Ouest-Africaine could be created to facilitate the integration process, as it would be easier to merge the two regional currencies that would emerge into a single currency by 2004. In April 2000, five countries, The Gambia, Ghana, Guinea, Nigeria and Sierra Leone, signed the Accra Declaration, seeking to establish the Second Monetary Zone in West Africa, which is the West African Monetary Zone (WAMZ). They were later joined by Liberia in February 2010. The currency of the WAMZ will be “the ECO”.

    The success of the WAMZ will intensify the ECOWAS course towards financial integration which aimed at the establishment of the ECOWAS Central Bank and the introduction of the common currency by 2020. The overriding aim of the currency union (CU) is to increase trade and investment in West Africa through the creation of a bigger market for the participating countries; reduction in transaction cost; and elimination of exchange risk among the participating countries. The issue of whether a common currency is a tool for the promotion of trade and investment as envisaged or it is an initiative of futility has been extensively examined, especially from the point of its effect on trade, and it has mixed conclusions. Some authors conclude there is a significant effect of a CU on trade ( Rose, 1999 ; Glick and Rose, 2002 ; Rose and Stanley, 2005 ; Agbodji, 2008 ; Zannou, 2010 ; Ezekwesili, 2011 ), while others maintain the effect has been negligible ( Persson, 2001 ; Pakko and Wall, 2001 ).

    The few studies that have looked at the CU effect on aggregate intra-ECOWAS trade recorded positive effect ( Zannou, 2010 ; UNECA, 2010 and Ezekwesili, 2011 ), indicating that CU is good for intra-regional trade. It is instructive to note that the benefit may not be uniform among the union members; there may be likely winners and losers. For example, countries that derive their competitive advantage from the existing situation are likely to lose it, which can create distortion in their trade with ECOWAS. The purpose of this study, therefore, is to investigate the CU effect on aggregate intra-trade in the ECOWAS and on bilateral trade between individual countries and ECOWAS, using the dynamic panel-gravity model.

    The rest of the paper is organised as follows. Section 2 provides the review of related literature. Section 3 discusses the gravity-model methodology, data and estimation technique. Section 4 presents the estimates of CU on aggregate intra-ECOWAS and on trade between individual countries and the rest of ECOWAS, and finally, the conclusion and policy recommendations are presented in Section 5.

    Literature

    The debate on a CU’s ability to increase international trade has been increased in international macroeconomics, especially since Rose (2000b) , (2000a) found potentially large effects in historical monetary unions. This has opened a new chapter for empirical studies on common-currency effect on trade as distinct from that of exchange-rate variability. Rose found an extremely large positive impact of CU on trade, using the gravity model. His estimate showed that two countries sharing a common currency trade three times as much as they would with different currencies. According to de Nardis and Vicarelli (2003) , the finding of Rose remained substantially unchallenged in a set of subsequent sensitivity analysis aimed at checking the robustness of the finding to different specifications and methods of estimating the basic equation. The sample of countries in the dataset used by Rose included 186 countries, dependencies, territories, overseas departments, colonies and so forth; there were a number of CUs, comprising one large and developed country with a number of much smaller countries or territories. This, Lockwood (2000) argued, is different from that of most regional groupings that gives rise to monetary unions such as the European Monetary Union, hereafter referred to as EMU. Rose himself said that

    In 330 observations two countries trade and use the same currency. Many of the countries involved are small, poor, or both, unlike most of the EMU-11. Thus, any extrapolation of my results to EMU may be inappropriate since most currency union observations are taken from countries unlike those inside Euroland, see Rose (2000b) , pp. 15, 2000a .

    For further analyses of CU membership on trade, Rose and van Wincoop (2001) used a structural model developed by Anderson and van Wincoop (2003) to address the issue of country-specific idiosyncrasies that came up from Rose’s work. This approach, which was applied only to countries with complete bilateral data, reduces the effect of CUs on trade to about two and a half (i.e. two countries sharing a common currency trade two and...

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