Between a Hard Place and a Rock: EU Economic Partnership Agreement and Malawi

Between a Hard Place and a Rock: EU Economic Partnership Agreement and Malawi


By Collins Magalasi
cmagalasi@gmail.com




January 2007
ACRONYMS

ACP Africa, Caribbean and Pacific
COMESA Common Market for Eastern and Southern Africa
CPA Cotonou Partnership Agreement
DWP Doha Work Programme
EAC East African Community
EEC European Economic Community
EPA Economic Partnership Agreement
ESA Eastern and Southern Africa
EU European Union
GDP Gross Domestic Product
IDS Institute for Development Studies
IGAD Integrated Authority for Development
IOC Indian Ocean Commission
REC Regional Economic Community
SADC Southern Africa Development Community
WITS World Integrated Trade Solution

1. Executive Summary

Poor Malawi is under new form of siege by rich nations in the north! With the expiry of the EU/ACP Cotonou Agreement coming close, pressure for Malawi and other Africa, Caribbean and Pacific countries to enter into reciprocal free trade agreement with Europe is mounting. If Malawi goes ahead signing onto the Economic Partnership Agreements (EPA) with Europe in their current form, Malawi will be poorer than it is now as concluded by this paper. This paper challenges the claimed benefit of EPAs by looking at among others, the potential impacts of the EPA on the Agriculture, manufacturing, and services sectors in Malawi. In detail, the paper confirms that the poor country will be hit hard by fiscal revenue loss, adjustment costs, and the state of play of negotiations. Indeed one is left with questions whether Malawi by moving on from Cotonou to EPA it is not getting into a harder squeeze.

The dangers of EPAs also reach to the regional integration process in COMESA. Two consistent stories underpin this concern. The first is that the EU stands to gain significantly in terms of expanded trade into Malawi and consequently into the RECs markets. While part of this trade expansion will result from welfare creation, which is welfare improving, significant proportions of the trade gain will also be due to trade diversion from the rest of the world and from within the ESA- EPA grouping itself. As a result, while the reciprocity principle appears to be trade expanding, it will pose serious implications for deepened regional integration in Africa. Indeed, unless there are clear mitigating measures, the EPAs could seriously undermine the gains that have been achieved so far in the integration process of the continent.

The second consistent result is the potential adjustment costs that Malawi will have to bear as a result of revenue shortfalls. Given the prominence of EU imports into Malawi and the country’s reliance on tariff revenues, tariff dismantlement result in significant revenue shortfalls. The major challenge that these revenue shortfalls will pose is the adjustment costs associated with tax policy and administration reforms.

Proprietors of Washington Consensus have used formulas and models to promote free trade. This paper uses the adopted analytical tools developed by the World Bank and other international institutions - the very same proprietors of free trade - to assess and prove the potential negative impacts of the EPA on the economy in general, by looking at revenue loss, trade creation and diversion, welfare creation and adjustment costs. For result interpretation and specific sectoral impacts, the paper was informed by structured interviews of key players in the sectors concerned, and literature of previous assessment on the impact of trade liberalisation on Malawi. It is worth pointing out that these two methods are used in support of each other and not in mutually exclusive.



2. Background

The Cotonou Partnership Agreement (CPA) between the European Union (EU) and the African, Caribbean and Pacific (ACP) countries which succeeded the expired Lomé Agreement envisages the signing of Economic Partnership Agreements (EPAs) by December 2007 between the EU and ACP countries. Malawi is one of the countries that decided to negotiate this EPA under the Eastern and Southern Africa (ESA) configuration of states. The broad mutual expectation between ACP and the EU is that the EPA will be the cooperative framework under the CPA that will “aim at fostering the smooth and gradual integration of the ACP States into the World economy, with due regard for their political choices and development priorities, thereby promoting their sustainable development and contributing to poverty eradication in the ACP countries”[1]

One of the essential characteristics of this multilateral partnership is that it hopes to combine trade, development aid, and a strengthened political dimension. The key principles for this trade cooperation are reciprocity; differentiation; deeper regional integration; and coordination of trade and aid.

A huge debate has since ensued; especially on how free trade can deliver development when two unequal groupings are expected to be partners in that arrangement.

The interim period between the signing of the CPA on 23 June 2000 and the launch of the EPAs by 1 January 2008 is supposed to be the time for the negotiation process about the final form and decision making by countries whether or not to sign EPAs. There are two phases in the negotiation process. The first phase was launched on 27 September 2002.

The second phase is underway, and is progressing gingerly as the ESA grouping try to negotiate in favour of curbing some challenges that they see arising from the EPAs, and these include:

(a) How to ensure development needs are adequately addressed through the EPAs;
(b) How to manage and finance expected costs of adjustment;
(c) How to manage the expected losses of fiscal revenue;
(d) How to cope with more competition expected to arise due to the principle of reciprocity of the EPAs;
(e) How to ascertain net benefits from the EPAs, especially in LDCs, that is, incentive compatibility between EPAs and the EBA provisions that do not require reciprocity;
(f) How to deal with limited negotiations capacity because EPAs negotiations are stretching the already limited resources available to the ACP countries;
(g) How to ensure consistency between the negotiations under the EPAs and that under the Doha Work Programme (DWP), in particular, how to improve market access for agricultural and non-agricultural products to the EU that continue to impose difficulties in trade negotiations at the multilateral level.

Given this background, this paper provides an assessment, among other things, aimed at informing EPA negotiations so that they benefit to the maximum poor people in Malawi and other ACP countries and to aid the Government of Malawi to make an informed decision when the time of signing comes.

This paper is therefore designed to contribute analytical and qualitative work towards assessing the potential benefits or de-benefits from the EPAs on the part of Malawi’s industry, agriculture, and services sectors. Moreover, the paper hopes to play a crucial role as an indispensable building block for eliciting common negotiating positions, for the consultations in Malawi and Malawi’s input into the Regional Negotiating Forum.

The paper is an academic contribution the Development Economics training by the University of KwaZulu Natal and ActionAid International Malawi. Much as this is so, the paper contributes to effective participation and evidence for lobby for all people centred organizations within the ESA-EU framework, it also hopes to play a part in expediting work on alternatives as it is becoming clearer that the EPAs will not benefit small economies.

3. The Malawi Economy

Malawi is a landlocked country with an estimated GDP of 1.75 billion and a per capita GDP of $163[2] making it one of the 10 poorest countries in the world. Over 60 % of the population live below the poverty line[3]. Malawi’s growth has also been severely affected by the HIV/AIDS pandemic whereby about 16.4 % of the adult population between the ages 15 to 49 years is estimated to be infected with the virus. HIV/AIDS-related diseases account for some 70 % of hospital in-patient deaths (United Nations, 2003).

The country has a predominantly agrarian economy and is dependent on subsistence farming, with 3.5 million people wholly dependent on agriculture. Agriculture contributes between 35 to 39 % to Gross Domestic Product and over 90 % of export earnings[4]. It employs about 80 % of the labour force. This dependence on raw agricultural commodities for exports has made the country vulnerable to fluctuations in world commodity prices (over which it has no control); and has tied aggregate real GDP growth to fluctuations in the climatic conditions[5]. This is evidenced by the drop of Real GDP (at factor cost) in years when the country has experienced drought.

Table 1: ECONOMIC OVERVIEW OF MALAWI
Natural resources
Limestone, arable land, hydro power, unexploited deposits of uranium, coal, and bauxite
Agriculture products
Tobacco, sugarcane, cotton, tea, corn, potatoes, cassava (tapioca), sorghum, pulses, groundnuts, Macademia nuts, cattle, goats
Industries
Tobacco, tea, sugar, sawmill products, cement, consumer goods
Share in GDP
Agriculture: 37% Industry: 16% Services: 47%

Malawi’s growth performance has generally been weak. Between 2000 and 2001, Real GDP growth per capita registered negative digits (Table 1). Subsequently, there has been an improvement in GDP growth from 2002-04, mainly as a result of stronger showing in the agriculture sector. The slow growth of GDP was mainly due to economic mismanagement and the poor performance of the agriculture sector.
Table 2: GDP and GDP Growth

2000
2001
2002
2003
2004
2005
GDP at Factor Cost (MK millions)
13,166
12,6206
12,883
13,386
14,066
14,326
Real GDP growth per capita
-1.1
-5.9
0.2
2.0
3.1
0.0
GDP growth at Factor Cost
0.8
-4.1
2.1
3.9
5.1
1.9
Source: RBM, NSO (2006)

Tobacco is the largest export crop, followed by tea, sugar, coffee and cotton. Despite the growing anti-tobacco lobbies, growth in sales in Eastern markets has maintained demand. However, Malawi’s over reliance on raw tobacco trade makes it vulnerable to commodity price shocks as has been the experience in the past. The manufacturing sector remains small, volatile and has shrunk considerably and more visibly from 1989 with the manifestation of world bank/IMF induced ‘adjustment’ policies since 1981.

Although the agriculture sector has been making significant contributions to GDP since independence, in recent years the growth of the services sector has seen it eclipse the agri-sector in terms of contribution to the country’s GDP (see table 3 below).


Table 3: Sectoral Percentage contribution to GDP


2000
2001
2002
2003
2004
2005
Agriculture
39.5
38.8
39
39.8
38.9
34.7
Smallscale
30.8
30.6
29.9
32.3
30.3
26.3
Largescale
8.7
8.2
9.2
7.5
8.6
8.4
Mining and Quarrying
1.4
1.6
1
1.1
1.5
2.3
Manufacturing
12.9
11.5
11.3
11.2
11.4
12.5
Electricity and Water
1.4
1.4
1.4
1.4
1.5
1.5
Construction
2.2
2.2
2.4
2.6
2.8
3.1
Ownership of Dwellings
1.4
1.5
1.5
1.5
1.5
1.5
Services

41.1
43
43.4
42.4
42.5
44.4
Distribution
20.9
22
21.9
21
21.3
22.7
Transport and Communication
4.2
4.3
5
5.2
5.3
5.9
Financial and Professional Services
8
8.1
8.5
8.6
9
9.4
Private Social and Community Services
2.1
2.2
2.2
2.2
2.2
2.2
Producers of Government Services
9
9.4
9.2
9
8.7
8.7
Unallocable Finance Charges
-2.9
-3.1
-3.4
-3.6
-4
-4.5
Source: RBM, NSO (2006)


4. The Cotonou Agreement & Malawi’s Involvement

4.1 History of Africa Trade With Europe

In 1975, the 9 Member States of the EEC (the future European Union) and 46 ACP signed the first of five year agreements called Lome Conventions. This agreement defined the aid and trade relations between these two regions. It was remarkably original in that it was negotiated and ratified between “donor” countries and “beneficiary” countries. In terms of trade, the special feature of Lome Agreement was the acknowledgement that the difference in development between European countries and ACP countries must result in a difference of obligations. That led to the introduction of non-reciprocal trade preferences.

The Lome Convention and its system of non-reciprocal trade preferences has contributed to establishing the EU as the ACP’s premier export market. It has provided preferential access to EU markets for ACP countries manufacturing exports (like refined sugar from Malawi) and a wide range of ACP agricultural exports.

Due to the non-reciprocal nature of the Lome system of trade preferences, other countries have argued that they do not qualify as a “regional free trade arrangement” (FTA) and therefore, require a waiver from WTO regulations[6]. The current waiver expires in 2007.

In the light of these challenges, the EU decided that it needed to rethink its trade relationship with the ACP countries in order to comply more fully with WTO rules and in an attempt to find a new developmental trade perspective. The successor to the Lome Convention, the Cotonou Agreement, was to provide the framework within which this was to take place.

4.2 The Cotonou Agreement

On 23 June 2000, after 18 months of negotiations, the European Union and 77 African (including South Africa), ACP countries signed a new partnership agreement governing their aid and trade relations. The new agreement, called Cotonou, was signed for 20 years. Whilst the Cotonou Agreement lasts until 2020, its trade regime is due to be replaced by 2007 with a set of EPAs which fulfil the requirements of the World Trade Organization (WTO) for free trade agreements[7].

It was landed as the beginning of a new era in economic and political cooperation between ACP countries and the EU as it was to have poverty reduction and sustainable development as its main focus and equality of participation for its partners as one of its guiding principles. These ideas are clearly stated in the signing agreement:

“The partnership shall be centred on the objective of reducing and eventually eradicating poverty, consistent with the objectives of sustainable development and the gradual integration of the ACP countries into the world economy”

The principles underpinning the ACP-EU Partnership Agreement (Article 2 of CPA) are:
1. Equality of partners and ownership of development strategies: In principle, is up to ACP states, in all sovereignty, to determine how their societies and economies should develop.
2. Participation: Apart from central government as the main partner, partnership is open to non-state actors, which include: civil society, private sector, and local government/authorities and members of parliament through the joint parliamentary assembly.
3. Dialogue and mutual obligations: The Cotonou Agreement is supposed to create a platform of dialogue. The parties have assumed mutual obligations (e.g. respect for human rights). These will be monitored through dialogue.

At institutional level, the ACP-EU cooperation is overseen by a set of ‘joint institutions’, including the ACP/EU Council of Ministers, the Committee of Ambassadors and the Joint Parliamentary Assembly.

4.3 Economic Partnership Agreement

Article 37 of CPA provides for a new trading framework termed EPAs. Technically, an EPA will be a Free Trade Agreement between the ACP and the EU. In addition and worth pointing out is one salient characteristic of this new trading agreement - ‘reciprocity’: The ACP will have to remove tariffs on imports from the EU, in contrast to Lomé which were non-reciprocal i.e. in return for preferential access to the EU market the ACP had only to treat imports from the EU no less favourably than from other sources.

Negotiations on the ESA-EC EPA began formally on 7 February 2004 in Mauritius with the adoption of the official roadmap for the talks. The ESA side consists of Burundi, Comoros, Djibouti, DR Congo, Eritrea, Ethiopia, Kenya, Madagascar, Malawi, Mauritius, Rwanda, Seychelles, Sudan, Uganda, Zambia and Zimbabwe.

Europe[8] is the most important trade and investment partner for the ESA region as a whole as well as for nearly all the countries in the region. The EC is ESA’s largest trading partner. The average value of total trade flows between this group and the EC is about €10 billion per year. For example, latest figures show that in 2004 ESA exports to the EU were €5.1 billion, while ESA imports were €4.8 billion[9] Exports to the EC are dominated by a few products such as fish (both marine and freshwater), textiles, diamonds, vegetables, sugar, cut-flowers and tobacco.. Agriculture still represents more than half of total ESA exports. Overall, ESA exports remain largely confined to agricultural and primary goods.

ESA is confronted with at least three overlapping economic integration schemes with different political and economic priorities. The main regional integration arrangements with a trade policy agenda are the Common Market for Eastern and Southern Africa (COMESA), the East African Community (EAC) and the Southern African Development Community (SADC). COMESA has a Free Trade Area with 11 members and is working towards a customs union in 2008. EAC launched its Customs Union in January 2005. SADC has planned a Free Trade Area in 2008 and a Customs Union in 2010. The Indian Ocean Commission (IOC) and the Intergovernmental Authority on Development (IGAD) are other important regional organisations, but are sub-groups of the larger COMESA integration scheme and follow COMESA’s overall regional integration agenda.

All 16 ESA members which are negotiating an EPA belong to COMESA[10]. COMESA is the geographically widest regional organisation in Africa, with 20 members stretching from Egypt to Swaziland and including the 4 Indian Ocean ACP States. COMESA’s main areas of intervention include: standards, customs management and procedures, SPS, private sector development, investment policies, competition policy, public procurement, movement of persons, tax harmonisation, monetary harmonisation, trade (transport) facilitation, air traffic and telecom. COMESA’s functional policies cover agriculture and food security, infrastructure, transport, energy, fisheries and conflict prevention. However, progress towards the successful implementation of these regional goals has been slow and in some cases non-existent.

COMESA has a Court of Justice which establishes COMESA as a rules-based organisation, with rules which can be enforced through a court of law. In addition there are a number of specialised COMESA institutions such as the PTA Bank and the PTA re-insurance company, the leather and leather products institute and a few others.

Integration within COMESA is proceeding at different speeds but all COMESA members have agreed to the December 2008 date for the customs union. Intra-COMESA trade increased in 2004 by 10% to reach €4.8 billion, [11]which shows the potential to expand trade links between the countries of the region. COMESA is also working on the introduction of harmonised rules in areas such as transport, investment and competition.

The main challenge for the EPA negotiations is the overlapping membership of various regional integration organisations with diverging integration agendas; and the interplay of this scenario with having a Free Trade Area (FTA) with the EU at the same time. They are basically caused by the impossibility for any given country to be a member of two customs unions at the same time. Tanzania, Kenya and Uganda form the EAC Customs Union. Tanzania is a member of SADC, but not of COMESA, while Kenya and Uganda are members of COMESA, but not of SADC. Malawi, Mauritius, Zambia and Zimbabwe are in the SADC Free Trade Protocol with South Africa and also in the COMESA Free Trade Area. Both SADC and COMESA aspire to become a Customs Union. Based on this alone, the EPA proposal can only work if there is a strong regional integration impetus behind it. There is therefore a need for countries in the ESA region to clarify the economic integration agenda if they are to enter into any form of economic partnership with the EU.

5. Economic and Social Impacts of the EPA on Malawi

Malawi’s external trade structure paints a gloomy picture. Firstly, the country has experienced a sustained trend of current account deficits, to the magnitude of US$200-500million[12]. Secondly, over-dependency on a narrow range of primary commodities, with tobacco accounting for nearly 70% of exports, increases the country’s vulnerability to demand shocks. In recent years, there has been modest growth in non-traditional exports of textiles and garments but the overall position is far from diversified. Besides, uncertainty surrounds these products with the phasing out of WTO Multi Fibre agreement in January, 2005. The country’s other exports of tea and coffee also continue to face challenges in developed country export markets such as silent EU private sector protective tendencies, inability to meet ‘standards’, lack of economies of scale to meet demand, just to name a few . Malawi has a high product concentration, with low value addition and the reliance on imported raw materials and intermediate goods; low productivity due to lack of investment in new technology and over dependence on rain fed production in the case of agriculture; low capacity utilization; and poor infrastructure which makes transportation costs account for up to 40%-60% of total production costs thereby drastically reducing export competitiveness[13]. This is in contrast to a 17% average for developing countries and 8% for OECD countries.

Despite being a signatory to a number of bilateral, regional and international agreements, the supply-side constraints highlighted in earlier sections of this report significantly lower the effectiveness of Malawi’s capacity to exploit these markets and restrict it to a passenger status. The general conditions of trade facilitation are poor especially customs procedures.

Although Malawi has embarked on the formulation of an export strategy it still lacks a comprehensive overarching trade policy and strategy into which this export strategy should fit. A strategy whose goal would be a complete structural transformation that would end in Malawi being more competitive on the international market through among others, value addition, and elimination of supply side constraints.

In terms of trade with the EU, the table below presents an outlook of the import and export structure (2005 figures).

Table 4: HS4 main traded products imported into EU
Product
Value US$
Share of Total Imports from EU
Cumulative Percentage
H0: All commodities
122,387,052
100%
39%
H490700: Documents of title (bonds etc), unused stamps etc
7,702,182
6.3%
6%
H300220: Vaccines, human use
7,690,118
6.3%
13%
H300439: Hormones nes, except contraceptives, in dosage
7,567,681
6.2%
19%
H310590: Fertilizers, mixes, nes
6,272,056
5.1%
24%
H490199: Printed reading books, except dictionaries etc
5,059,973
4.1%
28%
H300490: Medicaments nes, in dosage
3,110,572
2.5%
31%
H840710: Aircraft engines, spark-ignition
3,017,740
2.5%
33%
H870120: Road tractors for semi-trailers (truck tractors)
2,653,316
2.2%
35%
H870323: Automobiles, spark ignition engine of 1500-3000 cc
2,635,036
2.2%
37%
H481910: Cartons, boxes & cases, of corrugated paper or board
2,388,840
2.0%
39%
Source: Comext 2005 and own calculations


The structure of EU-MALAWI indicates that Malawi is a predominantly agricultural commodity exporter to the EU, and the EU is a manufactures exporter to Malawi As such, imports and exports between the two countries are not in direct competition and are not direct substitutes, however there exists a significant level of complimentarity that will be explored in the next section[14].

Looking at overall trade statistics for Malawi they indicate that the country is a net importing country. However, Malawi has been running a trade surplus with the EU for at least the past five years. In terms of value, based on 2005 figures, the value of exports from Malawi to the EU was €172 million. Imports from the EU amounted to € 71 million. The main exported commodities were unmanufactured tobacco[15], cane sugar, tea, nuts, and raw coffee-accounting for 96% of total exports. On the importing front, the major products include medicines; fertilisers, worn clothing, tractors, motor cars, milk and cream, wheat, machinery, and malt among many others.

Trade with EU-Malawi Trade represents 0.01%[16] of EU world trade. Although this might not seem significant for the EU, for Malawi the EU market is the most important export destination especially for the major exporting commodity tobacco which is the bloodline of the economy. However, it is worthy noting at this point that the regional market (COMESA) is increasingly becoming important for the other types of exports as private sector succumb to the difficulties they are facing in accessing the EU market[17].

This has been the structure of trade between the EU and Malawi for the past thirty years or more and would continue to be the structure of trade unless Malawi would undergo structural transformation that would allow for Value Addition, Industrialisation, and the elimination of supply side constraints.

5.1 General Economic Impacts

Trade policy analysis such as that required in the evaluation of the potential impacts of EPAs largely involves analysing implications of trade policy instruments on the production structure in economies at the national and global level. Trade policy instruments such as tariffs and quotas have direct and indirect effects on the relative prices of commodities produced in a given country. As the mix of goods and services produced change, the demands for factors of production also change. Consequently, in any given economy, it is difficult to conceive a situation where the change in trade policy would affect only one sector. Due to the forward and backward linkages and their related strengths existing in a particular economy, the result is always one in which the relative mix of sectoral outputs change. This by extension affects the relative mix of the different factors of production in the different sectors.

Country-level effects on output mix and demands for factors of production can in the context of international trade be extended to the global economy. Changes in relative prices of outputs and inputs resulting in a given country’s change in trade policy are transmitted to the industries and input markets of other economies that the country trades with. Therefore, for trade policy analysis to be meaningful and for robust results to be produced, the interactions that prevail among different sectors as a result of a change in a given or group of countries trade policy instruments must be taken into account.

Since, the EPAs will potentially have these kind of impacts, the general equilibrium methodology presents itself as the most appropriate analytical framework that would allow the inter- and intra-sectoral changes in output mix and by extension the demand for different factors of production to be captured. However, the scope of this paper does not allow for this model to be utilized as it is not intended to analyse the potential impact EPAs on the ESA region. And in addition to this, such a model would only allow the assessment of the EPAs at the continental level through a hypothetical ESA-EU EPA due to data limitation with respect to representation of African countries in the GTAP database as stand-alone regions. It was therefore necessary to look for an alternative methodology that would allow analysis at the country level and also at HS 6-digit level of products classification. This paper found it necessary to consider a partial equilibrium methodology, in spite of its weakness of ignoring sectoral and regional feedbacks when trade policy instruments are changed either in a given sector or all sectors in a given country.

Given its capacity to allow analysis at high level of disaggregation, the partial equilibrium models become indispensable especially because of the interest to establish sensitive sectors either with regards to industrial or fiscal policies. The World Integrated Trade Solution (WITS/SMART) model[18] was chosen as the applied partial equilibrium framework. The WITS/SMART model brings together various databases ranging from bilateral trade, commodity trade flows and various levels and types of protection.

WITS also integrate analytical tools that support simulation analysis. The SMART simulation model is one of the analytical tools in WITS for simulation purposes. SMART contains in-built analytical modules that support trade policy analysis such as effects of multilateral tariff cuts, preferential trade liberalization and ad hoc tariff changes. The underlying theory behind this analytical tool is the standard partial equilibrium framework that considers dynamic effects constant. Like any partial equilibrium model, it allows for a pre and post analysis by taking a somewhat static picture. This is because the model has strong assumptions allowing the trade policy analysis to be undertaken on a country at a time. In spite of this weakness, WITS/SMART[19] helped to estimate trade creation, diversion, welfare and revenue effects for Malawi.



5.2 SMART Model Results

The question that this analysis sought to respond to was: what are the impacts on trade, revenue and welfare of eliminating tariff barriers that EU exports to Malawi face? In other words, what does it mean for Malawi to reciprocate on the trade preferences that it currently receives through EU’s trade preferences regime for ACP countries?

5.2.1 The simulation scenario

The only scenario simulated in this analysis looks at the reciprocity principal. Due to the weaknesses already pointed out especially the ceteris paribus assumption upon which this model operates; only one-way liberalization is possible. The results discussed here are the possible outcomes of reducing to zero the import duties that Malawi will impose on EU goods. This is not a far fetched approximation to put forward because practically, the EU and ESA countries are going to bind themselves to a schedule of reducing tariffs between themselves the idea being the creation of a Free Trade Area. Therefore although a country is a Least Developed Country and may claim some exemptions in as far as tariff reductions are concerned, for a Free Trade Area to be operational these concerns may have to be pushed aside in favour of lenient schedules for tariff reductions. As such, if Malawi signs on to a free trade agreement with the EU through EPAs, they will ultimately have no tariffs between them. In addition to this, Malawi has already liberalised to a great extent and does not maintain a significant level of tariffs on imports from EU countries.

However, referring to the present state of negotiations, the EU has stated consistently in GATT/WTO committees that it believes the Article XXIV requirement that an FTA must cover ‘substantially all’ trade can be fulfilled if both parties reduce to zero tariffs on products that account for 90 percent on average of the current trade between them. It has also indicated that it believes this average figure can be achieved asymmetrically, with the EU liberalising on more than 90 percent and its partner on less. In the specific case of the EU–South Africa TDCA, South Africa has liberalised on products accounting for 86 percent of its imports from the EU while Europe has liberalised on 94 percent. The agreement also indicates that the EU believes the Article XXIV requirement that liberalisation occur ‘within a reasonable period of time’ can be achieved through a transitional period of up to 12 years[20].

In light of the above a 100% reciprocity impact assessment might seem unrealistic or unrepresentative of a situation that is going to happen. Inspite of this possible shortfall, and in the absence of a clear and agreed definition of ‘substantially all trade’, what is of critical importance at this stage is to determine the direction of the impact (i.e. direction of the vectors of trade creation, diversion, and welfare). It is important for instance to gauge in which direction the trade being created is going; in which direction the trade being diverted is going; and most importantly the direction in which the welfare benefits are heading. In as much as the magnitudes are an important part of a quantitative assessment, in-light of the short falls that a partial equilibrium tools presents and in-light of the discussions in the negotiations thus far, they may only serve as a proxy for the 90% liberalisation. Thus this study places greater emphasis on the direction that the vectors of trade creation, diversion, welfare take in its interpretation of the results.


The transmission mechanism for the trade effects is simple: the elimination of existing tariffs on EU imports reduces the prices that consumers will face compared to domestic substitutes and the responsiveness of demand to the price change influences the amount of trade created or diverted. The substitutability of the EU goods for domestic goods is implicitly assumed. The Armington assumption[21] at HS 6-digit level is that goods imported from different countries are imperfect substitutes. It is also assumed that the supply response to the price reduction will allow the EU producers and exporters to meet any demand arising in the importing countries as a result of price reduction. That is, export supplies are perfectly elastic which means that world supplies of each variety of the goods by origin are given.

5.3 Trade creation and diversion effects

The partial equilibrium effects of reciprocal trade preferences between EU and Malawi, through ESA are shown clearly in Table 9. The results presented on the trade effects indicate there will be significant trade creation for the EU goods. Overall, the EPAs reciprocity principal, with all things being equal, will lead to expansion of trade. Another critical observation is that trade diversion does not exceed trade creation, meaning that there will be positive trade effect as a result of the EPAs. However it is worth noting that the trade creation indicated in the table is in favour of the expanded EU exports into Malawi within ESA. The created trade in the classical sense imply supplanting of domestic production in Malawi i.e. lower production from the productive sectors (agriculture/agro-processing, manufacturing, services)[22].

Trade diversions indicated on the other hand signify the level of trade that is shifted from the rest of the world including other ESA countries to the EU producers. Given similar conditions, the rest of the world would more efficiently produce the diverted trade, but because of the tariff reductions on EU imports, the more inefficient EU producers are favoured over the more efficient rest of the world producers.

The results presented in Table 9 can be interpreted as follows. If Malawi were to dismantle the tariffs it imposes on the goods from the 25 member-countries of the enlarged EU, trade worth US$15.1 million would be created in favour of the EU. This arises from the point raised above, that more efficient EU producers and exporters will supplant producers who have not yet built their competitive edge to produce ( and not yet benefiting from economies of scale or in some cases not present) in Malawi. While this created trade is considered to be welfare enhancing since it expands the consumer surplus and choice, the tariff dismantlement will also lead to a net trade diversion of US$6.5 million[23]. The EU captures this diverted trade; hence the overall EU’s trade gain of US$21.6 million. Of the US$6.5million worth of diverted trade, 17 percent is trade that before the tariff dismantlement originated from the COMESA region, the REC in which Malawi is a member. The tariff dismantlement by Malawi, while it appears to be trade expanding overall, has three potential negative implications. First, the overall diverted trade will be welfare decreasing for Malawians as it was originally from more efficient non-EU rest of the world. Secondly, there is significant loss within the regional economic community, and thirdly it will surplant Malawi domestic producers[24].

Thus, looking closely at the simulation results presented in the table, it is clear that producers in Malawi will face serious competition from the EU as the country becomes a market for EU exports. History has proved that the Malawi producer has failed to withstand such competition and has succumbed to such pressures. Malawi will lose out on 17% of trade from its neighbours and partners in COMESA as it is diverted to the EU.

MALAWI
Trade Creation
Net trade diversion
Diverted trade
EU’s trade gain

15,124,010.00
-6,545,825.00
-331,774.00
21,669,845.00


5.4 Revenue Implications

Malawi relies to a great extent on its revenues collected from import duties. After the RSA, the EU serves as a significant source of imports and is therefore a major component of the import taxes base. The elimination of the import tariffs on EU-sourced imports is therefore an important factor in the economic analysis of EPAs. Table 9 indicates the likely losses in revenue due to the reciprocal treatment of EU goods into Malawi’s market. The results of WITS/SMART simulations indicate Malawi would forego US$7,100,420.00 of tax revenue under the reciprocal arrangement for trade policy between the EU and ESA nations.[25]

This foregone revenue in itself presents a major challenge on Malawi’s ability to reciprocate on the trade preferences obtained from the EU. The reliance on trade taxes is dictated both by the simplicity of their administration and also their use as part of industrial policy[26]. In terms of their use due to ease of collection, the country is likely to find it difficult even in the short-term to come up with ways to replace the foregone revenues. This is likely to be made more difficult by the low productivity (both in terms of elasticity and buoyancy) of the alternative taxes to the import duties. The speed within which tax policy and administration changes can be effected to raise productivity of the other taxes to fill the shortfall from import taxes becomes a major determinant of the practicability of the reciprocal principle of the EPAs.

The adjustment costs of undertaking tax policy and administration reforms are likely to weigh heavily on Malawi. This is because the nature of these adjustment costs is such that they are not only financial, but involve also human resources. Administration of income taxes and consumption taxes such as the VAT are more human capital demanding than the administration of import duties.

Moreover, the EPAs generated revenue shortfalls will also have economic, social and political dimensions in as far as public service delivery is concerned. The fact that Malawi will most likely need to resort to income and consumption taxes will introduce growth and equity issues. Policy makers will be faced with the unwelcome option of having to rely on income taxes, which tend to have a more defined negative relationship with economic growth. And on the aspect of equity, consumption taxes are likely to be more regressive.

To further put this loss in perspective consider the following: The National Budget allocations for Protected Pro-poor Expenditure on Agriculture (Food Security Initiatives, Agricultural Extension, Technology Generation and technical services) for the past three years has been around US$7million annually.

The above results are consistent with other analysis[27] who found that annually the government coffers would be losing US$7.5 million from reciprocity via EPAs. They went on further to simulate scenarios where some tariff lines (of concern to the EU) would be exempted from reductions. The level of protection for which the simulations were carried out was 10% and 20% of tariff lines, respectively based on the importance to revenue criteria. The criteria was restricted to revenue because the Government of Malawi has not yet stated which criteria (e.g. revenue loss, food security, protection of manufactures, etc) it is likely to base its tariff line protection on.

Based on the IDS methodology[28], and using data coming from Euro stat on imports into Malawi, if the negotiations agree on a 20% mark up for the exclusion list (80 per cent liberalisation), this would translate to approximately US$ 1,664,035.71 (Malawi Kwacha 232,965,000) revenue loss on the other hand, if the hand if the mark up will be 10% or 90% liberalisation, the loss would be US$ 3,380,107.14 (Malawi Kwacha 473,215,000).

5.5 Welfare implications of the EU-ESA EPA

Welfare enhancing properties of trade liberalization have always made it an attractive policy and an excuse by the proponents of liberalization to unleash it on countries as a common denominator for development. Nonetheless, measuring the welfare accruing to a country as a result of trade liberalization has not been simple.

Empirical investigation of this question due to measurement problems has therefore not been a straight forward matter. Welfare changes arising from tariff changes have been analysed within the context of consumer and producer surpluses[29]. In addition, implicit welfare changes derived from government revenues arising from tariffs alterations can also be considered on top of the consumer and producer surpluses. In the case of Malawi, the welfare implications (consumer surplus) is US$ 2,105,759.00[30]

The WITS/SMART model applied to measure welfare implications of the reciprocal principle of the EPAs under estimates the total welfare change in that it quantifies only the consumer surplus change but ignores the producer surplus movements. Thus, the results reported in Table 10 are for the consumer surplus changes due to the EPAs reciprocity. The results indicate that Malawi stands to gain in terms of consumer welfare, and would lose out completely on producer surplus.

Weighed against the revenue loss, the trade expansion effect and positive welfare changes present the EPAs as potentially beneficial arrangements the country. However, these are static results and the welfare results do not account for the producer surplus loss that occurs due to the supplanting of domestic producers in Malawi by the EU producers. Moreover, the partial analysis ignores the changes in the economic structure, which in a dynamic sense are likely to have tampering effects on the potential gains indicated from the partial analysis.


6. Conclusion

The main conclusions that can be drawn from the results and the discussion are that country’s opening up to the EU will accrue benefits in favour of the EU and at the expense of Malawi. Irrespective of the magnitude or money value of loss to the Malawi Economy (which will be depended on the level of liberalisation the negotiations parties agree to), the above analysis shows that the direction of the benefits is in favour of the EU players and not Malawi.

Hence, trade created will be in favour of EU exports and consequently the EU producer; Trade diverted from other countries with-in and with-out the agreement will be towards the EU; Malawi will lose revenue, and welfare (for consumers from increased commodity choice) is most likely to be eroded by reductions in Malawi’s producer surplus as producers are surplanted from the economy, resulting in low production levels and consequently lower incomes.

One could therefore hypothesise that the situation would be different (in the sense that Malawi would have an offensive trading possibility) if Malawi was a competitive producer. And this is what might have prompted DFID-Malawi (2005) and some respondents from the private sector in Malawi to state that in the mean time the country should concentrate on regional integration and trade, as they build their capacity to trade competitively and profitably for the benefit of the county’s growth and development.

“Logistically alone, we do not see the EU as a profitable market…we would rather concentrate on our neighbours and brothers before we can think of anyone else or anywhere else”. Simon Itaye - Chairman, Malawi National Working Group on Trade Policy

The respondents further propose that EPAs should look beyond 12 years as the possible dates for introducing reciprocity. Before then, unrestricted market access, deeper ESA integration, structural transformation will have provided sufficient room for supply capacities and exports diversity to be built in the country. Not allowing for this would be tantamount to maintaining the status quo as expressed in the literature review section of this report and thus on the overall Malawi would not stand to gain from any form of trade cooperation with the EU.

The dangers to the regional integration process in COMESA emerged also as potential challenges against the EPAs. Two consistent stories underpin these concerns. The first outcome is that the EU stands to gain significantly in terms of expanded trade into Malawi and consequently into the RECs markets. While part of this trade expansion will result from trade creation, which is welfare improving, significant proportions of the trade gain will also be due to trade diversion from the rest of the world and from within the ESA- EPA grouping itself. As a result, while the reciprocity principle appears to be trade expanding, it will pose serious implications for deepened regional integration in Africa. In deed, unless there are clear mitigating measures, the EPAs could seriously undermine the gains that have been achieved so far in the integration process of the continent.

Another consistent result is the potential adjustment costs that Malawi will have to bear as a result of revenue shortfalls. Given the prominence of EU imports into Malawi and the country’s reliance on tariff revenues, tariff dismantlement result in significant revenue shortfalls. The major challenge that these revenue shortfalls will pose is the adjustment costs associated with tax policy and administration reforms.

A detailed analysis and accounting of potential adjustment costs would have to be implemented to assess the burden of the EPAs on the fiscal economy[31]. Interviews through this research showed that Government of Malawi has not done adequate impact assessments or analysis as to the level of adjustment costs. Such an analysis would be critical before the country signs on to an EPA with the EU, as adjustment costs stand to undermine any ‘gain’ and exaceberate negative impacts from the EPAs[32]. However, looking at some of the impacts above, Government will have to be prepared to foot the bill for adjustment in the production sectors as they are surplanted by more efficient EU producers; structural transformation, as they try to make the country competitive, The EPAs, if no appropriate measures are put in place to forestall the macroeconomic imbalances that are likely to result from falling revenues, and these other adjustment costs may undermine developmental objectives, that are the only hope for the majority poor people of Malawi.
Having experienced underdevelopment in the past 50 years, and having lived through the hard times under Cotonou Agreement, Malawi needs to break off the chains of exploitation. But offering it EPA is like inviting Malawi from the hard place into a rock.

APPENDIX 1

IDS Methodology Ideology and Assumptions

The Institute of Development Studies (IDS) has developed an analytical framework for assessing the impact of EPAs on revenue (international taxes) with the aim of supporting an informed national debate in members of the ACP group. It is part of an IDS project to help countries assess the implications of ‘reciprocity’.

Rightly or wrongly, reciprocity is perceived as a ‘cost to be borne in order to gain the ‘benefits’ of aid and trade preferences for exports. The extent to which an EPA would be a ‘good deal’ for any country will depend on the relative scale of these potential costs and benefits.
If Malawi reduces its tariffs on imports from the EU, this will have potential ‘revenue’ and ‘competition’ effects. The scale of these will be determined by the extent to which imports increase and their price in the domestic market falls. Their distribution (between sectors, producers and consumers) will be set by which tariffs are reduced.

The revenue effect of EPAs is easiest to describe and hardest to calculate. Most ACP countries rely heavily on import taxes to raise government revenue because they are relatively easy to collect. Reducing tariffs will tend to reduce revenue (unless alternative, administratively more difficult, taxes replace them), but not necessarily in a linear fashion. If a country levies an import duty of 20 percent on imports of $1 million it will raise revenue of $200,000; if the tariff is cut to 10 percent but the value of imports jumps to $2 million, exactly the same level of revenue will be raised.

Just as the scale of the revenue effect will depend partly on what happens to the flow of imports, so will the scale of the competition effect. If, following the tariff cut, importers reduces prices on the domestic market, sales can be expected to rise –putting pressure on domestic producers of competitive goods. Imports will increase and domestic production of the competitive goods decline. But a tax cut does not always feed through into a price cut! If prices do not fall (e.g. because suppliers increase their margins) there will be no increased competition for domestic suppliers.

Naturally this depends on the levels of tariff reductions. Thus the broader assumptions of the IDS methodology are that:
One about the proportion of imports that can be excluded from liberalisation;
the other that the country will wish to exclude the products that currently face the highest tariffs.
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[1] See Article 34 of Cotonou Partnership Agreement
[2] Over the past 5years, Per capita GDP has been hovering at an average of US$ 200
[3] As defined by the World Bank
[4] Business Climate Survey 2005 shows Agriculture trade in terms of exports is about 99% raw commodities
[5] Malawi’s agriculture is dependent on rain and thus vulnerable to erratic weather patterns.
[6]These are set out in WTO Article XXIV in relation to goods and the analogous GATS Article V in relation to services.

[7] EPAs will remain in existence past the 2020 timeline.
[8] See Ministry of Trade and Private Sector, Government of Malawi
[9] Source: Comtext 2004
[10] Note that there are a number of COMESA members that are not part of the ESA group. E.g. Egypt, Swaziland, and Angola
[11] See COMESA 2005 Annual Report
[12] See National Economic Reports.2000-2004
[13] See MGDS 2005, National Economic Reports,
[14] For example, Malawi produces tobacco which is an industrial input for EU Cigarette manufacturers.
[15] Tobacco accounted for 66.5% of total exports to the EU in 2005
[16] Source EuroStat
[17] See COMESA 2005 Annual Report
[18] See derivations and methodology in appendix 1
[19] http://www.wits.worldbank.org/
[20] The Commission for Africa Report recommends a minimum of 20 years.
[21] This is economic term referring to model of analyzing imperfect substitution between home and foreign goods in consumption, often examining the role of product, industry, political, and 'home bias' factors as determinants
[22] The results from structured interviews presented further below qualify as to which sector this impact will mostly pertain to and to the nature of surplantation.
[23] It is worth recalling that the current indications are that there will be 90% liberalization, as such these figures are not exact; however again it is worth noting that this is a partial equilibrium analysis that does not consider dynamic implications of tariff dismantlement. Considering dynamic impacts, the magnitude may be higher considering the direction of the vectors.
[24] This outcome is confirmed by the private sector in Malawi, who were part of this study process.
[25] WITS/SMAT simulations
[26] A practical case in point: Malawi is currently building a fertilizer plant in Kanengo, Lilongwe. The aim of this industrialization drive is to enable the poor Malawian to access cheaper fertilizers at national level in the mid to long term. At this time, the country imports fertilizers from the EU and as such has low (or zero tariffs) on these imports to allow their affordability to poor farmers. However, when the plant is ready, it would be in the interest of the Government and people of Malawi to protect it from competition coming from cheaper, established (with economies of scale), producers of the EU so as to unleash its mid to long term benefits. The aim of protection here will be to enable the plant to overcome high start up costs, build capacity that will enable production of cheaper fertilizers for the farmer in the mid to long term and in the process promote sustainability, self sustenance and livelihoods. Tariff policy is one such mechanism that can be used to protect this fertilizer plant.

[27] See MEJN 2006, McGrath (2003)
[28] See Appendix 1: IDS Methodology
[29] The debate on Consumer vs. Producer Surplus is the most common and heated in as far as trade policy goes. Whose benefits should trade policy prioritise? The producer or the consumer? The consumer basic argument has been the right to choice and the presence of competition that lowers down prices. On the other hand producers have argued that they should be prioritized because they provide incomes through employment and also government revenue through corporate taxes.
[30] WITS/SMART Model
[31] Such an exercise would prove difficult in the absence of an Economic Partnership Agreement- Ministry of Finance (Malawi)
[32]“ It is about adding and subtracting sums-if the costs are greater than the benefits, why would anyone want to agree to sign on to such a scenario?” Temwa Gondwe-MEJN