Africa needs intra continental trade and not monetary unions

 

Date: January 22, 20160

  

The first step towards our cohesive economy would be a unified monetary zone, with, initially, an agreed common parity for our currencies. – Kwame Nkrumah. 1963 Organisation of African Unity (OAU) Speech at Addis Ababa.

It is an incontrovertible fact that there is a lot that the people of Africa can gain from economic and political integration.

 Economic and political integration of African nations has been a theme in the continental discourse since Kwame Nkrumah’s inaugural speech at the Organisation of African Unity (now AU) in 1963. Prior to that, there appears to be no record of any political figure or leader calling for a monetary union. 

And since then, the monetary union debate has been at the regional level i.e. Economic Community of West African States for the ECO and East African Community’s East African Shilling. The economic benefit of a single currency is palpable: elimination of currency risk, reduced transaction costs, increased transparency and increased competition as prices of goods and services are easy to compare.
 

A monetary union is where a group of countries share a single currency and the clearest example is the Euro whose introduction were a major step for European integration and the European single market. Thus African regional economies are not the only ones aiming to use a monetary union as a means of economic, political and even cultural integration. 

However, the principle of a monetary union albeit appealing prima facie can have devastating consequences for the economies and people who share that currency if certain economic conditions are not met and it is important to understand how.

Economic research shows that for a monetary union to work successfully, the business cycle of those economies must be synchronised. A business cycle is a period of economic growth or recession and the former is characterised by high economic growth, income, employment and inflation, while the latter is the opposite of the former.

 The peaks and troughs in a business cycle are often caused by shocks. These shocks could be endogenous, exogenous or both and when two or more countries are involved, could be symmetric or asymmetric shocks. 

In fact, the problem occurs when the shocks are asymmetric i.e. when the shock affects one country or a couple of countries and not others that share the same currency. This implies that the monetary policy response required will be different for different countries within the monetary union and it is important to understand how.

Different commodities drive the economies of West Africa. Specifically, Nigeria’s economy is almost entirely dependent on oil while that of Cote D’Ivoire and Ghana is dominated by agriculture with particular emphasis on the production of cocoa beans. 

This implies that when there is negative oil price shock, Nigeria may need to hike interest rates to deal with the impact on the currency which will not be ideal for Ghana’s economy for example as it may need lower interest rates to aid farmers borrow to buy equipment and other agricultural inputs. 

In this instance sharing a currency will be detrimental to the economies of both countries due to the idiosyncratic nature of their economies. Similarly, Kenya’s economy is the largest in the East African Community and the most diversified as well accounting for 40% of the region’s GDP while Uganda and Tanzania depend on natural resources. 

Assuming Kenya’s economy goes through a boom and bust cycle, the wage gains from the boom years will have to be shed in order to make Kenya competitive again. Thus being in a currency union brings about a loss of flexibility that prevents Kenya from carrying out internal devaluation that is easily accomplished if Kenya has her own currency to devalue.

On the labour front, monetary unions work well if people are able to move from one part of the monetary zone to the other to work. 

For example Ghana’s economy is currently experiencing dumsor (persistent power outages), which is an asymmetric shock that has caused low growth and job losses. For Ghana’s economy to regain the jobs lost, Ghanaian workers must be able to work in Togo or Burkina Faso to enable Ghana attain “full employment” by matching the number of workers to the number of jobs available. 

The alternative is for Ghana to internally devalue which is easier to do if Ghana has her own currency. In fact West Africa has no problem with this aspect as research shows that it is one the most mobile regions in the world with 90% intra-regional flows while East Africa has fast-tracked mobility.

The monetary union example from US and Europe indicates that monetary policy does not work in isolation and economic theory confirms this. Monetary policy by central banks and fiscal policy by governments work together to ensure price stability. 

Assuming Tanzania and Uganda experience an asymmetric shock to government revenues due to a fall in the price of commodities, the government of Uganda and Tanzania may need to cut spending or raise taxes that impacts on the currency and affect the exchange rate of the East African Shilling which is shared with Kenya’s diversified economy. Kenya might not want to use her revenues to bail out Tanzania and Uganda, as was the case in Greece for the Euro.

 Thus for the East African Shilling to work well there will have to be a fiscal risk sharing mechanism that enables fiscal policy to be harmonised in the currency area. Moreover, African countries still suffer from the original sin and differences in borrowing patterns might cause exchange rate instability that will affect other countries in a monetary union reducing their fiscal space in the process. 

This is not to imply that African regional economies should not aim for a monetary union. Rather, this article is meant to shed light on the economics of monetary unions that in the wake of the Greek crisis gained monumental importance, as it appeared European countries had failed to consider its provisions.

African regional economies should therefore attempt to increase intra-regional and intra continental trade. In fact intra continental trade in Africa accounted for only 11% of exports between 2007 and 2011. 

Compare that to 50% in developing Asia, 21% in Latin America and the Caribbean and 70% in Europe within the same period and one gets a sense of the low volume of trade within Africa. At the time of writing this article, there was no research to suggest that this low volume of trade is due to transaction costs or an inability of firms to compare prices easily across markets.

 If that were the case, then that would have bolstered the urgent need for monetary unions. Intra regional and intra continental trade will inclusively grow the economies of Africa and deal with the problem of youth unemployment. In addition, trade amongst regional and continental African nations will enable less diversified economies to diversify and develop their product markets. 

It also enables them to take advantage of the economies of scale that is gained from accessing larger markets and provide a springboard for African countries to export globally and remain competitive. Diversified regional economies provide the required buffer to deal with global shocks as happened in the 2007/8 financial crises where there was slump in the demand for commodities.

Trade integration fosters business cycles and financial linkages. It also creates diversified economies. 

These two are at the core of the optimum currency area theory of monetary unions and I believe African regional economic blocs should focus first on trade and the gains it brings to the people while at the same time building and strengthening financial and fiscal institutions that will eventually pave the way for monetary unions that are robust, effective, sustainable and delivers for the people of Africa. At this moment, Africa needs intra continental trade and not monetary unions.     

Credit: B&FT Online

 (By Kwabena Meneabe Ackon)