South Africa’s Comparative Advantage: EU and SADC

SOUTH AFRICA’S POSITION IN WORLD TRADE: A COMPARATIVE STUDY OF SOUTH AFRICA’S COMPARATIVE ADVANTAGE WITHIN THE EU AND SADC

INTRODUCTION

“The South African economy has undergone a gradual process of trade reform in the last three decades, the ultimate aim being to improve resource allocation by shifting policy towards a more competitive, export-oriented focus, and more specifically to diversify exports into non-gold items” (PETERSSON, 2005).

Over the last two decades the world has seen the creation of many preferential trade areas both within and across continents. Today South Africa has signed trade agreements with many countries including China, India, USA (through AGOA) and notably free trade agreements (FTAs) with the South African Development Community (SADC) and the Trade, Development and Co-operation Agreement (TDCA) with the EU. The main goal of this study is to analyze and draw a comparison between South Africa’s comparative advantage within the European Union and within the SADC FTAs and investigate the effects of these trade agreements on trade flows among the participating/ economically allied countries. This study will also analyze the credibility and relationship between South Africa’s policy of free trade and its own economic performance.

Background to the Study

South Africa signed the Trade, Development and Co-operation Agreement (TDCA) with the European Union (EU) in 1999 and with the SADC in (2000) which were intended to remove most of the trade barriers over the next decade.

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The European Union has been South Africa’s biggest trading partner both before and after Apartheid. From 1999, the European Union was a destination of more than 40% of South Africa’s exports while at the same time accounting for over 70% of South Africa’s Foreign Direct Investment (FDI). The TDCA was mainly intended to create a free-trade area between South Africa and the EU, in order to ensure that South Africa enjoyed free access to the EU market and vice versa. The Agreement provided for liberalization of 95% of the imports by the EU from South Africa within the period of ten years, and 86% of imports by South Africa from the European Union in twelve years. However vulnerable sectors both within the EU and South Africa are allowed to be protected from competition. For example, the EU is allowed to continue protecting its agricultural products against similar imports from South Africa and the agreement permits South Africa to shelter some industrial products. Thus some motor vehicle products, petroleum and petroleum products, beef, sugar, chocolate, Ice cream, dairy, chemical products, certain textile and clothing products etc, are protected against similar imports from the European Union products.

In 1994 Economic sanctions against South Africa had rendered the economy inefficient due to years of isolation from the global economy. The post-apartheid democratic government inherited many social and economic problems among which included: high unemployment especially amongst the black population most of whom lacked education, differing levels of poverty and income disparities and lack of competitiveness in the industrial sector.

All these issues required urgent attention and an almost complete restructuring of the economy, the way it was run and the adoption of policies that would help the nation emerge from decades of apartheid and international isolation. Being a complex economy that exhibited features of developing and developed nations, South Africa met strong opposition notably from some EU member countries. Later South Africa was denied trade concessions ratified in the Lomé [i] Convention that were intended for under developed countries. , However South Africa itself did not see relying on aid as an important strategy for its long term drive towards development (Perry, 2000). As a result South Africa’s government embarked on improving its competitiveness in the world economy through promoting trade by negotiating trade treaties with several countries as a tool towards sustainable growth, eradication of poverty and income inequality. South Africa and the European Union finally signed a Free Trade Area agreement in 1999 after a long period of negotiations that were characterized by all sides trying to negotiate the best deal possible for themselves. In the end, both managed to secure barriers in areas where they feared fiercest competition. For example France and Portugal already had concerns about South Africa’s wine and agricultural exports that were in direct competition in the EU market even before the TDCA was in effect and were reluctant to open their markets any further. Likewise, South Africa wanted to protect some of its infant industry especially in manufacturing. Perry (2000) notes that south Africa will had to fight for each favorable term of trade in which it has a strong comparative advantage as some countries within the European Union would have preferred to shield their individual sectors from any threatening outside competitive forces. They are only likely to engage in free trade with nations from which they expect more benefits rather than helping developing countries integrate into the world economy. Although there is no evidence yet to support Perry’s argument, such should not be swept aside without consideration.

Some of the main objectives of the TDCA include supporting South Africa in its economic and social transition, as well as promoting the country’s economic integration in the world economy (ROBLES, 2008). This being the case, the EU’s decision to impose barriers on South Africa’s wine and Agricultural exports can be seen as a sign of double standards. The South African government could have expected to receive more concessions in such sectors. .

Asante 1997 noted that the European Union is even more likely to benefit than South Africa because of adjustment costs originating from a general reduction of tariffs and from protectionism in Agriculture by the EU. He further stresses that South Africa tariffs are about five to six times higher than those of the EU. By removing tariffs on imports, South Africa looses five to six times worth of revenue than the EU. Losing so much tax revenue and still be able to run the economy and compete effectively, will require South Africa to have a significant comparative advantage over the EU in the production of various commodities so that the losses in revenue are covered by gains from exports.

This paper is therefore directed at identifying sectors in which South Africa experiences a higher comparative advantage over any other member of the European Union. We would therefore expect these sectors to have free access to the European markets without import duties being levied on them. Literally, attaining such trade terms would mean that South Africa has strong bargaining power in the EU because it can manipulate policies that favor its competitive exports in the free trade zone.

It is argued that when countries form a Free Trade Area by removing protectionist barriers (e.g. tariffs on imports, import quotas, and subsidies on local industries), they strengthen greater trading relations among themselves. This sometimes results in increased production of goods and services as firms no longer target domestic demand but also reach the foreign market. Access to the EU and SADC markets in this case will always be determined by how diversified S. Africa’s and its trading partners’ economies are, because it makes no point for countries to engage in trade of products that they can effectively produce for themselves. Diversification ensures that a country is more likely to produce what other countries do not. If member countries trade in similar products, then there should be a higher degree of intra-industry trade for the exchange of goods and services to be successful. This calls for more research and the adoption of efficient technologies that make it possible for countries to successfully differentiate those products that are more or less identical. Product differentiation means that countries can produce an identical product but with noticeable differences in terms of branding, durability and value added.

One of the major reasons behind forming Free Trade Area with SADC and the EU is to enable South Africa to successfully integrate into the world economy (ROBLES, 2008). For South Africa’s major trading partners in the EU for example, forming a free trade area involves removing barriers to trade and making few adjustments in order to allow free movement of goods and services because they already possess the prerequisites for surviving trade competition under an open economy. However, for a developing economy like South Africa, successful integration into the EU and World market involves a very wide range of policies. For example increasing production and diversification, adopting new production technologies in order to increase value added to intermediate inputs, facilitating local agricultural production to successfully compete with subsidized European Agriculture, fighting crime and boosting local demand in order to increase investor confidence, and developing the local transport system. Implementation of all these policies is a gradual process that requires not only money and time but also a population that is equally skilled and well off enough to participate in production and again absorb the increased proceeds from higher production and trade.

According to Mthembu (2008), countries in Sub-Saharan Africa depend on taxes on trade to generate between a quarter and a third of their national revenue. By Forming Free Trade Areas South Africa hopes to increase its share of world exports by importing low cost technology and transforming it into goods and services that can be exported at a higher value and price and through producing at a higher volume and enjoying higher economies of scale, thereby gaining more foreign exchange and employment that will accelerate the growth of the economy. However this comes at a cost of lost tax revenues. Although it is true that when a country trades more, it can increase its share of world exports and demand and gain more power on the final world prices and supply, this is not always the case. Opening up to trade does not automatically guarantee economic success (Krugman, 1996, Rodrik. 2005, Rodrik, 2008). Thirlwall (2000) points out that trade between developing and developed countries has often resulted into trade diversion rather than creation. Rodrik (2005), amongst others, has suggested that countries should only open up to free trade when they have a very strong local industry that can compete on the world market. It is only when nations have a strong economic base that they can start benefiting from international trade. Conversely, many other studies have concluded that international trade has been a vital force behind the economic breakthrough of different countries (Hachicha 2003, Dhawan and Biswal 1999, Ahmed et al. 2007, Tang 2010) by not only increasing local production but also by provoking growth between regions.

In South Africa’s case, we need to examine the relationship between its external trade and growth by analyzing the causal relationship between international trade and economic performance. If it is found that it is growth that causes exports, then the South African policy should be redirected altogether from focusing on international trade to other strategies for increasing domestic economic growth

Conclusion

At this stage, the most important issue for South Africa is not whether to trade or not but rather it is about how to trade and with which products. The over all gains from trade could be huge if the trade pattern with the EU and SADC provides products in which South Africa has a strong competitive advantage and free access to the respective markets. With a favorable trade environment, South Africa would with no doubt achieve sustainable growth and integration into the world economy. This study therefore will examine whether the two free trade agreements cited have had either positive or negative impact on the trading patterns for South Africa by studying the growth characteristics of trade flows between South Africa and each individual free trade area shortly before and after their inception. If we find that South Africa’s exports have been decreasing while imports continue to grow, then South Africa should push for more favorable trade conditions. These conditions would be slightly different if the imports are mainly composed of capital goods.

Statement of the problem

Trade with the European Union provides South Africa with diverse trading opportunities by allowing it free access to a very wide market composed of 25 different economies. On the other hand, given the fact that South Africa is a developing economy, gains from trade are limited by lack of competitive advantage in manufacturing, transport costs and the European Union’s protection of Agriculture and intellectual property rights.

From another perspective however, South Africa is in a better position to trade with SADC than it is with the European Union. This is because South Africa’s economy is more advanced than most SADC countries in terms of technology, capital, financial institutions and skilled labor, which ought to give South Africa more competitive advantage. So, following the classical theory of trade, should South Africa work on increasing its trade with SADC rather than with the EU because it is more likely to always import more than it exports to the European Union but export more than it imports from the SADC?

1.4. Objectives of the study

To understand and determine South Africa’s comparative advantage in the European Union and SADC.

To determine whether FTA’s have indeed created trade for South Africa or led to trade diversion.

To analyze the validity of South Africa’s liberalization of trade as the Major drive towards sustainable economic growth by analyzing the causal relationship between exports and GDP.

1.5. Research hypotheses

South Africa’s comparative advantage in the EU is limited to Mining and Agriculture.

South Africa enjoys more comparative advantage in the SADC than in the EU

Exports cause economic growth for South Africa.

There has been more trade creation between South Africa’s trade with the EU than with SADC.

Research methodology

This chapter presents the master plan of the study entailing procedures that will be followed so as to obtain the goals of the research.

Study population, Sample size and source of data

The study will be conducted on a population of two Free Trade Areas (FTAs) namely Southern Africa Development and Cooperation (SADC) and the European Union.

In order to determine the comparative advantage of South Africa in the above mentioned FTAs, we shall consider a sample size of fifteen countries from the EU countries that trade with South Africa more than the others. The data from the other remaining countries will be used in calculations of aggregates where necessary. The EU has 27 member countries and representing and analyzing trade data for each member would be very tiresome and time consuming. All of SADC countries on the other hand will be included in the study.

Data collection methods and Analysis

The study will involve both qualitative and quantitative methods of data collection. Documents will be reviewed in order to gather views by different researchers on a given topic and then analyze their views from our perspective.

We shall also gather trade data specifically from web-based databases (for example United Nations and SADC’s international trade databases) of all countries involved in this study.

The obtained data will then be arranged in related patterns and logical order that would allow for regression analysis and hypothesis testing.

According to Linda (2008) Data processing involves summarizing, aggregation, validation, tabulation and analysis of data in order to extract useful information. The obtained data will be processed and analyzed using Microsoft Excel and SPSS 18 data processing software packages.

Objectives, Indicators, Data source, Data collection techniques and methods of data analysis (summary)

Objective

Indicator

Data

Sources

Collection technique

Method of analysis

To understand and determine South Africa’s comparative advantage in the European Union and SADC.

The share of South Africa’s exports in the trade area as opposed to the share of exports of other partners within the reference area.

W.T.O database and other documents (according to their availability)

documentary review of (monthly, quarterly, semi and annual bulletins)

Balassa index of comparative advantage

To determine whether FTA’s have indeed created trade for South Africa or led to trade diversion

Changes in Trade flows and trade volumes between South Africa and the reference area since 1994 to 2009

W.T.O database and other documents (according to their availability)

documentary review of (monthly, quarterly, semi and annual bulletins)

The Gravity model

To analyze the validity of South Africa’s trade policy by analyzing the causal relationship between exports and GDP

Relationship between changes in exports and changes in GDP

W.T.O database and other documents (according to their availability)

documentary review of (monthly, quarterly, semi and annual bulletins)

Granger causality test

Balassa index of revealed comparative advantage (RCA)

In order to determine the comparative advantage of South Africa in the EU and SADC we shall use the comparative export performance index commonly known as balassa index. The Revealed comparative advantage (RCA) index is used to determine whether a country’s trade flows have been increasing or decreasing within a specified period of time. The index can also be used to identify products that a country is producing more effectively than the other trading partners. More still, the index identifies industries in which a country is performing poorly. This can be helpful especially when a country wants to make policies that would promote the competitiveness of those industries. Therefore, the RCA index provides very important information about a country’s general trade with the rest of the world.

The index of revealed comparative advantage is stated as shown below:

xij: exports of product j from country i

Xi: total exports from country i

xaj total exports of product j from the reference area (e.g. the world)

Xa: total exports from reference area

The values of the index range zero to Infinity. If the index takes on a value that is less than one implies that the country has a revealed comparative disadvantage in the product. Similarly if the index takes on a value that exceeds one, the country is said to have a revealed comparative advantage in that product. It is possible for more than one country to have comparative in the same product. In this case, a country with a higher value of the index has the strongest advantage because it can produce the product in question more effectively than the other countries.

Causality test

The variable of investment will be added to the equation of the growth model because of its significance in enhancing economic growth. The function of the model will be expressed as GDP = f(X,Inv) where GDP represents economic growth, X and Inv represent export and investment respectively.

GDP=bo + b1X + b2Inv + E

According to Studenmunds (1987) the granger causality test should not be applied to non stationary data because sometimes it may produce misleading results. Therefore before testing for causal relationship between exports and Growth, we shall test for stationarity of the underlying data series by testing for the unit root by applying the ADF test. The ADF test determines whether or not the variables follow a stationary trend.

If the time series is non stationary, then we shall carry out a cointegration test to determine whether there is a long term relationship between the variables.

The gravity model

In order to determine whether FTAs have created or diverted trade, two models are usually applied; the Computable General Equilibrium (CGE) and the Gravity model of bilateral trade. The CGE is suitable for the analysis of trade among countries before the removal of trade barriers. The Gravity model on the other hand is used to analyze trade after the removal of trade barriers among countries (Cenart 2003)

The gravity model originated from Newton’s law of Universal Gravitation 1687 which states that the ability of one object to attract other particles is positively related to its mass and the mass of the other objects and negatively related with the distance between them. More than 270 years later, in 1962 Jan Tinbergen suggested the application of the same model to the analysis of trade flows among countries by stating that bilateral trade is positively related to GDP and negatively related to distance. The model takes the form below:

Fij = β0 MiMj/Dij

Where i,j = trading partners

F = Trade flows

M = Economic Mass (measured in GDP and population) of a country

β0 = Constant

Rewriting the above formula in a linear equation we introduce logs and the error term in order to allow for the estimation using OLS.

Fij = β0 + β1(Mi + Mj) + β2(Pi + Pj) – β3Dij + E

LogFij = β0 + β1(LogMiMj) + β2(LogPiPj) – β3LogDij + E

Where D represents the distance between South African Port to the trading partner’s port of entry; P represents population of a given country. By introducing dummies for FTAs, the model can capture whether the trade area enhances or restricts bilateral trade…..

We shall analyze the change in the importance of the coefficients after every two years since 1997 up to 2009. The subscript j will be used to represent South Africa’s data while subscript i will represent data for other trading partners.

Trade creation and trade diversion (specification of the gravity model)

Different studies have used the gravity model to explain creation and diversion of trade by Free Trade Areas (citation)

Scope of the study

The study will be focused on South Africa’s trade with the European Union and SADC countries before and after their formation; that is between the periods 1995 to 2009

Significance of the study

The establishment of those sectors in which South Africa has a strong advantage will help stakeholders to motivate further liberalization where they have been denied especially in the European Union and also design policies to improve efficiency in the production of those commodities in which South Africa is currently doing poorly but still has the potential to improve.

Further more, the establishment of the relationship between free trade and South Africa’s economic performance will help to add an insight into South Africa’s trade policy. The findings of the study can be based upon to design policies that can do better to achieve a good economic performance. The study is also expected to provide useful inputs to researchers and others who have a keen interest in South Africa’s trade with the rest of the world.

Organization of the study

The research work will consist of five chapters and they will be arranged as follows:

Chapter one will consist of the introduction, background to the study, statement of the problem, objectives of the study, the research hypotheses, the significance of the study, scope of the study and finally the organization of the study.

The second chapter will comprise of literature review of various studies by other researchers on this subject.

The third Chapter will explore methodological aspects of how data was obtained and analyzed.

The fourth chapter will present research findings, provide data analysis and interpretation.

The fifth chapter will give summary of the findings, a conclusion and recommendations as well as suggestions for further research in relation to the topic.