ECONOMIC INTEGRATION IN SOUTHERN AFRICA: CHALLENGES AND PROSPECTS FOR SOUTH AFRICA

by

MALINDA COLLINS MAFELA

MINI DISSERTATION

prepared in partial fulfillment of the requirements for the degree

MASTERS IN COMMERCE

in

ECONOMICS

at the

RAND AFRIKAANS UNIVERSITY

SUPERVISOR: Prof PDF STRYDOM

Johannesburg November 1998

ACKNOWLEDGEMENTS

I am deeply in gratitude to all those who contributed directly or indirectly to the completion of this paper:

At the very outset, I am indebted to my supervisor, Professor PDF Strydom for his guidance, advice and encouragement.

My brother, Ndivhuwo Mafela for providing moral support and technical assistance.

My family, for their forbearance with my late arrival at home, quiet acceptance of my changing moods, their motivation and for keeping the percolator going right into the small hours of the morning.

Lastly, my greatest thanks to the Almighty.

Johannesburg November 1998

TABLE OF CONTENTS

CHAPTER ONE STATEMENT OF THE PROBLEM, RATIONALE AND METHOD OF INVESTIGATION....1

1.1. STATEMENT OF THE PROBLEM 1

1.2. RATIONALE 1

1.3. METHOD OF INVESTIGATION 2

CHAPTER TWO THEORETICAL UNDERPINNINGS OF INTEGRATION .5

2.1. DEFINITION OF INTEGRATION 5

2.2. CONVENTIONAL TRADE THEORY .7

2.2.1. Perceived shortcomings of integration 2.2.2. Benefits of integration from traditional theory's point of view

2.3. NEW TRADE THEORY

7 .9

..10

2.3.1. The importance of increasing returns and imperfect competition .12

2.3.2. Other effects of trade integration (i.e. customs union) in the context of the new trade theory . .14

2.4. CONCLUDING REMARKS 17

CHAPTER THREE A REVIEW OF THE SOUTHERN AFRICAN CUSTOMS UNION 18

3.1. THE MAIN OBJECTIVE OF SACU 18

3.2. BACKGROUND INFORMATION .18

3.3. THE REVENUE SHARING FORMULA 25

3.3.1. Introduction 25 3.3.2. The original revenue-sharing agreement ...25 3.3.3. The 1969 revenue-sharing formula: The enhancement factor ..27 3.3.4. The 1976 formula: introduction of the stabilisation factor 33

3.4. THE BENEFITS AND LOSSES TO BOTH SOUTH AFRICA AND BLNS COUNTRIES ..37

3.5. ENVISAGED DIRECTIONS FOR SACU 38

3.5.1. Maintaining the status quo 38 3.5.2. Terminating or downgrading SACU into a free trade area 39 3.5.3. A broader and looser SACU .40 3.5.4. Renegotiating SACU .41

(a) Amending the existing treaty .41

3.5.5. Strengthening the integration .46 A common market 46 Economic union 51

3.6. CONCLUDING REMARKS 53

CHAPTER FOUR THE EUROPEAN UNION (EU) 54

4.1. BACKGROUND 54

4.2. PROBLEM AREAS DELAYING THE FORGING OF A TRULY LIBERAL FREE TRADE 56

4.3. ENVISAGED EU-SA FREE TRADE AGREEMENT AND WORLD TRADE

ORGANISATION (WTO) REQUIREMENTS .58

4.4. IMPLICATIONS OF THE AGREEMENT TO THIRD PARTIES (I.E. NON-PARTICIPATING ECONOMIES) 60

4.5. GENERAL OBSERVATIONS 61

CHAPTER FIVE THE SOUTHERN AFRICAN DEVELOPMENT COMMUNITY (SADC) 62

5.1. INTRODUCTION AND BCAKGROUND DETAILS 62

5.2. EMPIRICAL EVIDENCE ON THE CURRENT TRADE PATTERNS WITHIN SADC 64

5.2.1. Extraregional trade 64 5.2.2. Intraregional trade .68 5.2.3. South Africa-SADC trade . .70

5.3. THE SADC TRADE PROTOCOL . .74

5.3.1. Shortcomings and pitfalls of the trade protocol .76

5.4. WHAT WILL BE THE EFFECTS OF THE PROPOSED SADC FREE TRADE AREA ON PARTICIPATING COUNTRIES (IN THE CONTEXT OF THE NEW TRADE THEORY) .79

5.5. CONCLUSION 91

CHAPTER SIX CONCLUSION .92

REFERENCES.. 97

LIST OF TABLES Page

1 Distribution of revenue in the 1910 customs union agreement .27

2 South Africa's major trading partners in 1991 56

3 Structure of exports by SADC countries (by main categories of export products) 65

4 Major exports of SADC countries, 1993 .66

5 Direction of SADC exports (1991 or most recent) 67

6 Main imports and trading partners of SADC countries 68

7 South Africa's exports to non-SACU SADC countries ..71

8 South Africa's imports from non-SACU SADC countries .73

CHAPTER 1

STATEMENT OF THE PROBLEM, RATIONALE AND METHOD OF INVESTIGATION

1.1. STATEMENT OF THE PROBLEM

The transition of South Africa to a democracy signifies large-scale changes in the

political and economic spheres. Presently one of the dominating debates in the economic

circles centres around trade integration. Academics, professional economists,

Government officials and other professional experts find themselves at loggerheads in an

attempt to identify the most beneficial trade arrangements/blocs for SA.

The fundamental aim of the paper is to analyse the effects or possible effects which

different trade blocs or arrangements might have on South Africa if is to be a member. In

cases where South Africa is already a member of a particular bloc, for example SACU,

the purpose will be to look briefly at the past history of the arrangement, and

subsequently generate debates either justifying or not South Africa's continued

participation, guided by their very past experience. And if continuation is opted for, the

circumstances under which that should happen have to be entertained as well. With

regard to organisations like the European Union (EU) and the Southern African

Development Community (SADC) where the trade arrangements involving South Africa

are still pending the aim will be to highlight the possible benefits to be accrued and losses

which might be incurred by South Africa under those agreements.

1.2. RATIONALE

South Africa was purposefully and strategically excluded for several years from the

international economic games during the apartheid days. Hence realistically it is not

practical to exclude the country completely from international economic affairs, due to

say for example, the natural resources which are available in the country, obviously some

unscrupulous economic agents from other countries will still get in touch with an isolated

country. Nigeria, Libya, Iran and Iraq are recent examples of such situations.

1

After its official readmission in the early 1990s, South Africa held may discussions and

debates concerning the manner in which it should carefully and cautiously approach the

world economy once again after years of controversial isolation. For obvious reasons,

the issue of trade integration was inevitably one of the core points of focus by the

government.

Naturally so, a couple of contradictory views were raised from various circles with the

intention of identifying the "right direction" for South Africa in as far as trade integration

is concerned. Some contributors argue for regional integration to precede other forms of

co-operation. This implies that South Africa should put more efforts in ensuring that

SACU, SADC are developed prior to trade relations with Europe, the Far East and North

America. Proponents of the view cite problems of migration, both legal and illegal to

South Africa as the main reasons for making it a point that the region develops

concurrently with South Africa. Furthermore, they state that should South Africa attempt

to improve its welfare alone in ignorance of its relatively poor neighbours, it will be

heading for a shameful disaster since these short term achievements are going to be

eroded by neighbouring citizens wanting a share as it is currently the case.

Critics still hold the notion of South Africa being a tiny island, which have to integrate

with industrialised countries so that it can massively gain from capital, skills, and

technology transfer. Quite frankly, the argument holds water to a certain degree, but it

still has to be weighed against the former. With this kind of deadlock, this is where the

main focus of the paper comes in, to objectively and critically try to mediate between the

two contrasting arguments.

1.3. METHOD OF INVESTIGATION

The method of investigation adopted in this paper comprises basically of a study of

literature concerned with trade integration in general and those blocs which involve or

might at a later stage involve South Africa. The analysis will be largely of a theoretical

nature with some sections embodying empirical evidence. It must be emphasized that the

study of trade integration is a tricky one and sometimes confusing, as a result the relevant

2

literature at times tended to resort to complicated mathematical techniques. However,

this study, as far as is possible, avoids the use of complicated mathematics in order to

provide a simple, yet unambiguous approach to the maters at hand.

Chapter two defines the term integration from a purely economic point of view in a much

broader sense. It gives an extensive explanation of the reasons why nations or countries

have to integrate, i.e. advantages and disadvantages of trade integration. Furthermore,

pre-conditions for a successful integration are also examined. The last part of the chapter

will concentrate on the critics (i.e."new theory of international trade") of the conventional

trade theory.

Chapter three focuses exclusively on the pros and cons of the perceived most successful

trade integration ever in the whole of Africa, which is the Southern African Customs

Union (SACU). The revenue sharing formula will occupy a major portion of this section

since it has been the most controversial aspect of this agreement ever since the customs

union was formed. Interestingly, the most talked about envisaged future directions for

SACU shall be dealt with quite extensively.

Chapter four discusses the current negotiations between the European Union (EU) and

South Africa about the possible formation of a free trade area. It investigates the reasons

why it is deemed crucial for both parties to forge this kind of relationship. The perceived

strengths, spin-offs and pitfalls of this envisaged agreement will be highlighted.

Unfortunately, not much published and unpublished academic work is available yet

regarding this pending trade arrangement. Consequently, individual comments, different

institutions viewpoints, government departments information and other financial and

economics magazines are the major sources of information.

Chapter five analyses in detail the SADC FTA which is currently under discussion. It

will cover a short historical background, current trade patterns within SADC (both

extraregional and intraregional) as well as trade between South Africa and the rest of the

region. A study on the trade patterns is to be supplemented by a comprehensive

3

empirical analysis. The SADC trade protocol, with its strengths and shortcomings, will

be extensively discussed. Finally, the effects of this arrangement in the context of the

new trade theory shall receive a major attention.

Finally, chapter five summarizes the most important issues discussed in the paper and the

way forward for South Africa concerning some of these trade arrangements.

4

CHAPTER 2

THEORETICAL UNDERPINNINGS OF INTEGRATION

2.1. DEFINITION OF INTEGRATION

The term "economic integration" is used in modern literature by economists to denote the

integration of markets, and should be distinguished from a commonly-used concept of

`planning integration', e.g. some coordination of development plans, transport projects,

etc., on a regional basis. Economic integration is a process which encompass measures

designed to abolish discrimination between economic units belonging to different

national states (Balassa, 1961). It can take several forms that represent varying degrees

of integration.. The aim of economic co-operation is to promote trade and economic co-

operation among member countries. There are four hierarchical types of international

economic integration, namely:

A free trade area, which is the simplest form, whereby members remove quantitative

trade restrictions (quotas) and customs tariffs among themselves but keep separate

national barrier against trade with outside world. To monitor infiltration of external

goods in the free trade area an inspectorate is usually put in place. An example of a

free trade area is the European Free Trade Area (EFTA), Latin American Free Trade

Area (LAFTA), the North American Free Trade Area (NAFTA) and the Economic

Community of West African States (ECOWAS).

A custom union is an arrangement where members remove barriers to trade among

the member countries and adopt common set of external barrier thereby removing the

need of customs inspections at borders. The European Union is an example.

A common market is a form of integration where free mobility of capital, labour,

goods and services are allowed among member countries. Member countries operate

a single market. There are no tariffs and quotas between the members of a common

market. A common system of taxation, and of laws governing production,

5

employment and trade is instituted. For instance, in a common market, you could

have a set of laws governing product specification, industrial technology, health and

safety, employment and dismissal of labour, merger and take-overs etc. An example

is the European Common Market.

4. An economic union, which is at the top of the hierarchy and which involves the

harmonisation of economic policies, e.g., monetary, fiscal, and welfare policies as

well as policies towards trade and factor migration. Belgium and Luxemburg formed

such a union since 1921 (Lindert and Kindleberger, 1982). The European Union is

moving towards an economic unity which includes monetary union. Some authors

include a step further, namely, political union, but this is not within the realm of

economics.

There are a number of conditions which, it seems, need to be met if economic integration

is to succeed (Robson, 1987). These are:

(1) A supranational authority should be established with real powers to make

governments of member countries implement the decisions of the authority.

All member countries should perceive that they are gaining from the

arrangements.

Particular attention should be paid to ways and means of overcoming the tendency

of manufacturing industry to polarise in the most industrially advanced country of

the grouping.

Governments should be prepared to cede some of their sovereignty to the

supranational authority.

Member countries should be' in broad agreement on economic systems, i.e.

integration cannot succeed between market and centrally planned economies.

Political differences within the grouping should be containable.

A preliminary step to economic integration is a preferential trade area in which member

countries agree to the gradual reduction of customs tariffs with the aim of eventually

becoming a free trade area. In this paper, trade integration shall mean either customs

6

union or a free trade area. When considering the pros and cons of integration two forms

of integration shall be looked at. The formation of a custom union can cause an increase

or decrease in the welfare of both the member nations or the world (Balassa: 1961,

Lipsey: 1968 and Lindert & Kindleberger: 1982). The static effects of a customs union

are trade creation and trade diversion which are going to be analysed below.

2.2. CONVENTIONAL TRADE THEORY

2.2.1. Perceived shortcomings of integration

The conventional treatment of economic integration stems from Viner' s (1950) theory of

customs unions, and revolves around whether or not the protected industries in each

country prior to integration are competitive. By competitive is meant that these countries

(call them A and B) are producing similar types of manufactured products. This

competition leads to trade being created within the customs union in these goods, but

imports from the rest of the world in other goods continue so that little or no trade

diversion occurs. Trade diversion is where consumption shifts from a lower cost

producer outside the customs union to a higher cost producer within the union. This

analysis assumes static supply and demand curves which are not responsible to dynamic

changes in the real world. It also assumes that there is a marginal reduction in tariffs.

But if the protected industries in A and B prior to integration are complementary, i.e.,

they are producing dissimilar products, trade is not taking place in their products between

A and B, the removal of tariffs within a customs union will cause trade diversion: the

previously lower-cost (and hence more efficient) suppliers from the rest of the world will

be supplanted by producers within the custom union.

This theory has recently been reexamined by Wonnacott and Lutz (1989) in the light of

world trading conditions, their study concluding that the trade diversion argument

requires some reassessment for three main reasons: These are:

(i) Economic integration may produce economies of scale. Production costs in A and

B could then be roughly equal to, or perhaps even lower than, those in the rest of

the world.

7

If the industries of A and B are protected mainly by quotas than tariffs, trade

diversion need not reduce efficiency.

If the costs of producing complementary goods in A and B prior to union are higher

than in the rest of the world, this could be the result of overvalued exchange rates.

Then, the lower monetary costs of imported goods from the rest of the world may not

necessarily be coterminous with lower economic costs.

Nevertheless, empirical research shows that countries which have a similar composition

of GDP and structure of manufacturing tend to be one another's best customers. The

conclusion reached by Wonnacott and Lutz (1989), therefore, broadly reinforces the

conventional view that economic integration has the best prospects if it occurs among

countries which (i) are at similar levels of industrial development, (ii) have competitive

industrial sectors, (iii) have the potential to develop complementary industrial sectors,

and (iv) already conduct a significant proportion of their foreign trade among themselves.

Another important argument for resisting trade integration is that the associated removal

of tariffs undermines the development of infant industries because of low costs imports

(El-Agraa and Jones, 1989). This is called the infant industry argument. This is based on

the argument of sufficient economies of scale which states that industries may be

presently producing at a high cost because they are in their infant stage whereas outside

competing industries will have gained economies of scale. Empirical evidence on this

argument has mixed results and it is difficult to exactly say that there are advantages or

lack of them.

Trade integration cause trade diversion as tariffs are eliminated between member

countries. If tariffs are introduced they can assist in reducing aggregate unemployment.

With the imposition of tariffs, consumers are forced to shift from consumption of foreign

goods to domestically produced goods (El-Agraa and Jones, 1989). The tariffs will

stimulate an increase in demand, domestic industries will expand their output, hire more

labour and contribute to reduction of unemployment. Increase in employment will

8

generate more disposable income via the Keynsian multiplier effect and other industries

will expand and increase employment.

The expansionary multiplier effects may be dampened because of retaliatory tariffs from

affected countries which may have been excluded from trade integration. Domestic

export may decline, coupled with foreign currency depreciation of the excluded countries

provided there is a flexible exchange rate policy in trading parties. The net effect will be

appreciation of the domestic currency of a country that has imposed a tariff reducing

exports and increasing aggregate unemployment.

2.2.2. Benefits of integration from traditional theory's point of view

Advocates of integration argue that trade creation enhances overall efficiency in the

customs union whereas trade diversion reduces it. With regard to welfare gains when

there are large reduction in tariffs the assumption of demand and supply curves will not

hold (Lipsey, 1968). Meade (1955), Lancaster (1980) and Lipsey (1968) have argued

that there are welfare gains only when some tariffs are reduced instead of being

completely eliminated. A customs union is more advantageous and likely to raise welfare

when the volume of trade is more within the union than with the outside world. There are

more welfare gains from a custom union if more domestic trade is conducted within the

union than from foreign trade (Lipsey, 1968).

Besides looking at national welfare gains or losses, it is important to compare net national

loss to consumer loss. Lindert and Kindleberger (1982: 124) have argued that trade

barrier cost some groups a lot more than their net cost to the whole nation. Tariffs

redistribute income from consumers of the imported product to others in the society.

Empirical evidence on this argument has been shown as positive but small. However, the

analysis needs to focus on multilateral effects of tariffs not only on the national income,

but related industries.

The argument of internal economies of scale is a major dynamic advantage of trade

integration. Customs union increases market size of a country allowing a country to

9

exploit economies of scale. Small countries may gain from enlargement of markets.

Increased trade may lead to external economies of scale which lead to improvement of

infrastructure e.g. better roads, railways, financial services and so on which might result

in increased benefits.

The customs union may develop better bargaining powers with the external world and a

gain in better terms of trade. If the member countries forming the union are producing

similar commodities there is bound to be benefits in efficiencies due to increased

competition within the union (Lipsey, 1968). This notion of forced efficiency is possible

in non-complementary economies.

Integration may allow a more rapid spread of technology within the union. If a country

via trade integration produces more, profits rise and this allows a company to acquire

new technology. Schumpeter and G.K. Galbraith have argued that "fatter profits margins

can accelerate technological improvements by giving larger firms greater resources and

security for spending on research and development" (cited in Lindert and Kindleberger,

1982: 126).

Trade integration removes trade barrier and the associated administrative costs. Trade

barrier ties up resources that societies could have used in some other ways. Such funds

are used to employ customs officials at borders. Changes in tariff rates are also costly to

government and they add to administrative costs.

2.3. NEW TRADE THEORY

Isaksen (1993) states that the traditional general equilibrium approach to international

trade is a powerful and elegant intellectual construct, capable of yielding many useful

insights about a trading world economy. The only good reason for challenging the

traditional approach is that it does not seem to do an adequate job of explaining the world

and alternative approaches seem to offer an opportunity to do better.

10

Helpman and Krugman (1985: 02) identified four major ways in which conventional

trade theory seems to be inadequate in accounting for empirical observation: its apparent

failure to explain the volume of trade, the composition of trade, the volume and role of

intrafirm trade and direct foreign investment, and the welfare effects of trade

liberalisation.

According to Helpman and Krugman (1985: 02) conventional trade theory explains trade

entirely by differences among countries, especially differences in their relative

endowments of factors of production. This suggests an inverse relationship between

similarity of countries and the volume of trade between them. In practice however,

nearly half the world's trade consists of trade between industrial countries that are

relatively similar in their relative factor endowments. Further, both the share of trade

among industrial countries and the share of this trade in these countries incomes rose for

much of the post war period, even as these countries were becoming more similar by

most measures.

Krugman (1995) argues that if differences between countries were the sole source of

trade, one would expect the composition of trade to reflect this fact. In particular,

countries should export goods whose factor content reflects their underlying resources.

This is in fact by and large true of countries net exports. But to casual observation, and

on more careful examination, actual trade patterns seem to include substantial two-way

trade in goods of similar factor intensity. This intraindustry trade seems both pointless

and hard to explain from the point of view of a conventional trade analysis.

With regard to intrafirm trade and direct foreign investment, the problem with

conventional trade theory is that it is simply an inappropriate framework (Helpman and

Krugman; 1985: 03). In the perfectly competitive, constant-returns world of traditional

theory there are no visible firms and thus no way to discuss issues hinging on the scope

of activities carried out within firms. Again, in reality much international trade consists

of intrafirm transactions rather than arm's length dealings between unrelated parties, and

multinational firms are a prominent part of the international landscape.

1 1

Helpman and Krugman (1985) argue that studies of trade liberalisation seem to suggest

that conventional trade theory misses important aspects of the welfare effects of trade.

Standard models associate trade with a reallocation of resources that increases national

income in aggregate but leaves at least some factors with reduced real income. What

seems to have happened in such important episodes of trade liberalisation as the

formation of the EEC and US-Canadian auto pact is quite different, however. Little

resource reallocation took place; instead, trade seems to have permitted an increased

productivity of existing resources, which left everyone better off. The above-discussed

empirical weaknesses of conventional trade theory become understandable once

economies of scale and imperfect competition are introduced into the analysis.

2.3.1. The Importance of Increasing Returns and Imperfect Competition

Helpman and Krugman (1985) states that the new approaches to trade break with

traditional analysis by stressing the importance of increasing returns and imperfect

competition in understanding how the international economy works. The reason why the

role of increasing returns is being emphasized is that economies of scale seem to allow a

straightforward explanation of different empirical puzzles. Consider the problem of trade

between similar countries. If there are country-specific economies of scale, such trade

poses no puzzle. Even if differences in factor rewards or technology do not create an

incentive for specialization and trade, the advantages of large-scale production will still

lead countries to specialize and trade with one another.

Increasing returns to scale also provide a simple explanation of intraindustry trade. It

seems apparent that specialization which takes place to realize economies of scale rather

than because of differences in factor rewards can easily involve two-way trade in goods

with similar factor content. Imagine a sector whose product is differentiated. Suppose

that every variety is produced with increasing returns to scale. Also assume that these

economies of scale are relatively small so that the industry can accommodate many

producers, each one producing a different variety. Then, following Chamberlin (1933), it

is natural to expect in this industry a market structure known as monopolistic

12

competition; that is, every firm chooses a variety and its pricing so as to maximize

profits, taking as given the variety choice and pricing strategy of the other producers in

the industry. In this case every firm ends up producing a different variety of the product.

Now imagine a demand structure within which there is a taste for variety. This may arise

because people like variety or because every person likes a particular product but

different people like different products. Then for every pair of countries that actively

produce varieties of the good, one should expect to observe intraindustry trade. Under

monopolistic competition, which is the natural market structure under these

circumstances, each country will produce different varieties of the product, while every

variety is demanded in both countries. In this regard product differentiation provides a

good explanation of intraindustry trade.

The relationship between increasing returns, intrafirm trade, and direct foreign

investment is more indirect, relying on less well-formalized insights, but it still seems

clear. Whenever there are inputs such as headquarters services and intermediate goods

that are both produced under increasing returns and specific to particular users, there will

be strong incentives to avoid the problems of bilateral monopoly by integrating upstream

and downstream activities in a single firm. If at the same time there are incentives, such

as differences in factor rewards, for locating upstream and downstream activities in

different countries, the result will be multinational firms engaging in intrafirm trade.

The experience of trade liberalizations that produce all-round gains without significant

resource reallocation is not all paradoxical in a world characterized by increasing returns,

where intraindustry specialization and trade may produce gains in efficiency through an

increased scale of production (Krugman, 1994).

Increasing returns then, seem to be useful for explaining important features of the

international economy. Yet they have only recently been integrated into the basic theory

of international trade because except under very special circumstances increasing returns

are inconsistent with perfect competition. Since there is no generally accepted theory of

13

imperfect competition, this has seemed to prevent the study of trade in the presence of

increasing returns from being more than a collection of special cases.

Turning next to the welfare effects of trade, a general method will also be adopted. It is

known that in the world of constant returns and perfect competition gains from trade are

ensured. Once increasing returns and imperfect competition are introduced there are both

extra sources of potential gain and risks that trade may

actually be harmful (Helpman and Krugman, 1985). The new approach derives cost-

oriented sufficient conditions for gains from trade. The form of these sufficient

conditions typically reveals key welfare effects over and above those captured by

traditional models. For example, in models with oligopolistic firms a sufficient condition

for gains from trade is that an appropriately weighted average of output per oligopolistic

firm rises as a result of trade; this condition reveals that increased competition in

oligopolistic industries can be a source of gains.

2.3.2. Other effects of trade integration (i.e. customs union) in the context of the new trade theory

Sodersten and Reed (1994: 343), in their analysis of the terms of trade effects of customs

union formation, notes that a discriminatory tariff reduction in a member country

unambiguously improves the terms of trade of the partner country. The implications may

be summarized as follows:

Suppose that the two countries forming the customs union (H and P) are large with

respect to each other and to the rest of the world (W). On forming the customs union, H

will discriminate in favour of P in some goods, and this will improve P's terms of trade

with both H and W. At the same time, P discriminates in favour of H in other goods,

which will improve H's terms of trade with both P and W. The net effect on the terms of

trade between the two member countries is indeterminate, but the effect on the terms of

trade facing W is unambiguous: the rest of the world must suffer a terms of trade loss on

its trade with the customs union. That of course means that the customs union as a whole

must gain on its (reduced) trade with the rest of the world, but one cannot tell whether

both H and P will gain, or whether one will gain and the other lose.

14

Another possible source of gain arising from the size of the customs union is in the area

of international policy-making. A group of countries that are individually unable to exert

much influence may be able to do so if they can present a united front to the rest of the

world. Membership of a customs union is one way of achieving such a goal. The

individual member country may be large enough within the customs union to influence

the union's policy stance, and the customs union may be large enough to influence

decision-making at the global level (Sodersten and Reed, 1994).

According to Krugman (1985), regional trading blocs, being larger than their

components, will have more market power in world trade; this may tempt them to engage

in more aggressive trade policies, which damage the trade between blocs and may

(through a kind of Prisoners' Dilemma) leave everyone worse off. Furthermore,

Krugman, in his beggar-thy-neighbour argument, states that the formation of free trade

areas may well hurt countries outside those areas, even without any overt increase in

protectionism. This is sometimes referred to as the innocent bystander effects.

Sodersten and Reed (1994: 342) analysis suggests that if a customs union primarily leads

to trade creation, it will lead to an increase in welfare for its members, and that if it

primarily gives rise to trade diversion, it may lead to a lowering of that welfare. In the

latter case, it will certainly lead to a lowering in the welfare of the third country (the rest

of the world). More sophisticated models suggest that there is some ambiguity in these

results, but that in general terms trade creation will be superior to trade diversion.

Economists have therefore answered the basic question (whether a customs union will

increase welfare) by identifying the factors which are likely to promote trade creation

rather than trade diversion. This is a conventional trade theory argument, but however,

some new trade theory dynamics have been added to give it a modern flavour since it is a

basic unavoidable argument.

The first group of factors is concerned with the degree of overlap between the bundles of

goods which the member countries produce before joining the union. If there is no

overlap between these bundles (as might be the case if an agricultural country joined a

15

manufacturing country) then there is no scope for trade creation but a considerable

possibility of trade diversion. On the other hand, if there is considerable overlap then

there is scope for both inter-industry and intraindustry trade creation. Conversely, the

less the overlap between the union members and the rest of the world, the lower will be

the scope for trade diversion.

The second group concerns differences in production costs between countries in

industries which they have in common. The greater the difference in costs between

member countries, the greater will be the gains which can be made from trade creation.

On the other hand, the smaller the difference in costs between the lowest-cost union

producer and the lowest-cost non-union producer, the lower will be the losses from trade

diversion.

The third group are the "tariff factors". The higher the tariffs charged before the union on

goods in which there will be trade creation, the higher will be the gains. The lower the

pre-union tariffs on goods in which there will be trade diversion, and the lower the CET

on those goods after union, the lower will be the losses from trade diversion.

The fourth factor states that the more countries there are within the customs union, the

more likely it is to be welfare increasing. The argument used for this factor is that the

more countries there are within the union, the more likely it is that the union will include

the lowest-cost producer (s) of each good, and so the less likely it is that there will be

trade diversion. The argument is not particularly convincing, one could assume that

those countries forming the union take care to select partners in such a way as to ensure

that the lowest-cost producer is within the union, or at least that there is only a small

difference in efficiency between the low-cost union producer and the lowest non-union

producer, but that does not have the status of a general principle.

16

2.4. CONCLUDING REMARKS

The impact of a tariff depends on individual countries level of economic development

and it is difficult to generalise. In terms of welfare gains, it is possible to find certain

sections of the community benefiting from tariff reduction while others lose. Secondly, a

country's welfare might improve while individuals are made worse off. The impact of

trade diversion and trade creation will thus depend on the nature of industrial strength of

respective countries in a free trade arrangement, inter-commodity substitutionability and

the consumption effects (Cooper and Massel, 1965).

Economists are divided as to the desirability of regional trading blocs. It has been argued

that economic integration schemes are theoretically inferior to a global non-

discriminatory abolition of tariffs and quantitative restrictions. It is now generally agreed

that this is so but, in an imperfect world, the creation of regional trading blocs might offer

an alternative route global free trade: these blocs appear to be here to stay, and the

challenge is to ensure that they play a constructive role in the move towards the freer

global trade envisaged by the World Trade Organisation (WTO). However, there is no

consensus as to whether less developed countries should integrate among themselves or

whether closer integration with one of the strong industrial economies would be better.

But however, the new trade theory seems to be coming up with a clue as to what direction

should trade take and in what form and under what circumstances should it take place.

17

CHAPTER 3

A REVIEW OF THE SOUTHERN AFRICAN CUSTOMS UNION

3.1. THE MAIN OBJECTIVE OF SACU

The 1969 Southern African Customs Union Agreement (SACUA) defines the objective

of SACU as:

Maintaining the free interchange of goods between (member) countries and

applying the same tariffs and trade regulations to goods imported from outside

the common customs area ...on a basis designed to ensure the continued economic

development of the customs union area as a whole, and to ensure in particular

that the arrangements encourage the development of the less advanced members

of the customs union and the diversification of their economies, and afford all

parties equitable benefits arising from trade among themselves and with other

countries (SACUA, 1969 Preamble: cited in Davies, 1994).

3.2. BACKGROUND INFORMATION

The existence of the Southern African Customs Union (SACU) has given rise to a large

body of literature, the central theme of which is an evaluation of whether South Africa or

Botswana, Swaziland (BLS) and more recently Namibia emerge as net losers as a result

of the agreement. The conclusions arrived at in this debate concern not only economics

but also international relations, and are influenced by where the authors stand in the

debate. The relationship between the various countries extends back over a century. The

treaty accompanying the ACT of Union of South Africa in 1910 served until 1969. It

allocated a fixed proportion of revenue according to pre-Union trade patterns between the

member countries.

As a result of the independence of the BLS countries, a new treaty was negotiated in

1969 which substantially changed the relationship between the member countries. It

incorporated an enhancement factor much increasing the BLS countries receipts from the

revenue pool.

18

The SACU agreement was politically inspired at the outset, and the literature discussing

it reflects the highly politicised nature of this institution. Given the disparity in size and

economic development of the member countries, as well as the political costs and

benefits inherent in the agreement, SACU cannot be seen as an institution which exists

merely to facilitate trade among member countries, which is the role of a customs union

according to orthodox economic theory.

The very nature of SACU thus raises the question of the best method of examining the

costs and benefits which accrue to the five member countries. Most of the literature here

surveyed adopts an eclectic approach to the evaluation of the SACU agreement in order

to account for the economic, political and institutional factors in the costs and benefits to

member countries. A few attempts have been made to apply an orthodox economic cost-

benefit analysis of the SACU agreement. Such analyses are extremely limited as they are

confined to a calculation of the price-raising effects of the common external tariffs and

quotas within SACU and whether these are offset by payment of SACU revenue to the

BLNS countries by South Africa. These authors admit that political and institutional

costs and benefits of the SACU agreement may well prove to be more important (Leith,

1992: 1021).

Given the nature of SACU and the fact that the costs and benefits which arise from it are

political, institutional and economic (many of which are not quantifiable), one may by

necessity also adopt an eclectic methodology to provide a balanced analysis of these

quantifiable and non-quantifiable costs and benefits. The discussion of the future of

SACU is highly conjectural, given the changing and uncertain political and institutional

framework within which its reform is likely to occur. The approach followed in this

study consists of a review and assessment of the various analyses of the costs and

benefits of SACU. Within SACU there have been two types of studies of costs and

benefits: first, studies conducted by individual BLNS countries evaluating their own costs

and benefits of SACU membership in relation to South Africa; second, South African

studies evaluating SACU in relation to the BLNS countries collectively. A third potential

but neglected area of study is intra-BLNS relationships in SACU.

19

Unlike much of the literature on this subject, the purpose of this paper is not to construct

an argument to bolster either South African's assertion that SACU represents nothing but

a drain on its fiscus or the BLNS countries' assertion that they emerge as net losers from

the agreement. Rather, the aim in this paper is to examine SACU from the point of view

of all the member countries and ultimately to propose a restructuring of this institution in

a way which will address the concerns of all the member countries and thus resolve the

crisis with the BLNS countries in order to do justice to their concerns and to incorporate

their views on how SACU should be restructured.

There are broadly two paradigms in which analyses of SACU are rooted:

1. Consideration of the issue within the narrow confines of the costs and benefits which

accrue to the individual member countries that constitute SACU. Thus SACU is viewed

in isolation from the emergence of regional trading blocs in the industrialised countries

and also without considering the benefits of regional cooperation in southern political

interests forming the basis of the analysis:

(i) Two studies support the present South African government's contention that the

revenue transfers to BLNS are generous and should be decreased. Indeed, these studies

led the South African Department of Finance to propose giving notice to end the

agreement unless other SACU members agreed to a substantial cut in revenue

disbursements (Davies et al, 1993: 59).

McCarthy's (1985) study of the cots and benefits accruing to South Africa, premised as it

is on the narrow paradigm outlined above and speaking for the government, concludes

that "while the BLS countries will do their utmost best to exploit the SACU agreement as

a source of unconditional finance, South Africa at the opposite end seeks to protect a fair

residual as its own source of revenue, particularly in the light of persistent and increasing

budget deficits." He thus does not identify any real economic gain to South Africa,

arguing that one of the primary reasons for the continuous existence of SACU, from

South Africa's perspective, is political.

20

Similarly, the Margo Commission (1987: 361), guided by McCarthy's study, argues that

"SACU is a comprehensive programme of unconditional assistance by South Africa,

extended without reference to the usual criteria or norms applying internationally, and

without any recognition for this assistance. This assistance represents a first claim on the

two sources of tax and is therefore not subject to the normal process of priority

determination." The Commission (p362) thus concludes (like McCarthy) that "continued

membership on the present basis holds little or no economic advantage for South Africa."

In sum, both McCarthy and the Margo Commission portray SACU as a burden to South

Africa: the increased revenue transfers to the BLS countries are a drain on South Africa's

fiscus, and the only rationale for the existence of the union is political benefits which

South Africa derives from it.

(ii) A study within the narrow confines of the paradigm outlined above analyses SACU

from the point of view of Lesotho, the poorest of the five member countries, and

concludes that it has worked to the detriment of Botswana and Swaziland as well as

Lesotho. Lundahl and Petersson (1991: 95) argued that South Africa's involvement in

SACU is based on selfish political and strategic motives. It was thus in South Africa's

political and economic interests to make Lesotho economically dependent on it through

SACU's revenue transfers and the migrant labour system. This dependence in turn

impeded Lesotho's economic development.

The BLS countries on the other hand use SACU to build up the economic and political

unity of their nation states in order to decrease their dependence on international aid.

Their relationship with South Africa is therefore seen as a necessary evil but they try as

far as possible to minimise their dependent involvement with South Africa. As will be

argued, the failure of attempts to break the dependence lends some substance to this

argument.

Lesotho, and indeed Botswana and Swaziland, are thus seen as small, vulnerable

countries which are bullied by South Africa through a customs union which only impedes

21

their own development and locks them into a dependent relationship with South Africa.

In this argument Lesotho's dependence on South Africa is in a large part for employment

of the migrant labour force. The same authors, however, show that Malawi and

Mozambique account for much of South Africa's migrant labour, although they are not

members of SACU. The argument fails in that migrant labour forms no part of the

SACU agreement: it is an agreement that occurs outside of, and would occur in the

absence of, the SACU agreement.

(iii) Arguing from the point of view of the BLNS countries, studies contest McCarthy's

and the Margo Commission's findings. Instead, they argue that South Africa enjoys a

substantial economic gain from exporting to its customs union partners through the effect

on GDP growth and creation of (primarily manufacturing) employment (McFarland,

1983; Walters, 1989; Davies et al, 1993).

McFarland (1983) argued that the mistaken mainstream view that South African exports

to BLS are of limited significance underestimates the contribution of these exports to

South Africa's growth in GDP. He estimated that between 1970 and 1979 exports to

BLS contributed 13,1 percent of the increase in non-mining GDP. In the manufacturing

sector alone exports to BLS contributed 19,6 percent of the increase. Overall, GDP

growth per annum was raised from 3,11 percent to 3,51 percent, of which increased

exports to BLS contributed 11,3 percent (quoted in Walters, 1989: 48).

Walters (1989: 49) considers the likely effects on all member countries if the BLS

countries were to leave SACU: "the extent to which South African exports to BLS would

fall if BLS left SACU is unknown, but even if it were small, the remaining exports would

be subject to uncertainty over possible variations in the BLS external trade regime, which

would deter investment in South Africa. Similarly, South African investment in BLS

production would be deterred by uncertainty over the trade regime applied to imported

inputs."

22

Davies et al (1993: 38) contest the view of the South African Department of Finance that

the BLNS countries share of SACU revenue should be decreased because proposals

unilaterally to force reduction of (SACU) payments are clearly based on an analysis of

only one side of the equation. They do not take into account the importance of the

[SACU] market to South African industry, nor the effects which a potential loss of this

market may have. Nor does such an approach take account of the potential impact on

Lesotho and the knock-on effects on South Africa of substantial cuts in the revenue of a

country already severely affected by declining migrant labour employment.

Moreover, a study conducted in the 1970s gives an indication of the importance of trade

with BLNS. It found that although the combined GDP of BLS was responsible for 27

percent of new Manufacturing Value Added and around 67 000 jobs in South Africa's

manufacturing sector, these studies therefore go beyond the narrow accounting exercise

carried out by McCarthy and the Margo Commission and attempt to show what South

Africa stands to lose if the BLNS countries were to terminate their membership of

SACU.

2. Moving beyond the narrow view outlined above, there is a strand of analysis which

attempts to assess the costs and benefits of the SACU within a global context, that is

arising not only among the individual member countries but also from economic

cooperation in the region in an era dominated by the emergence of trading blocs and

common markets around the world. Economic cooperation in the Southern African

region then gives rise to a host of benefits not recognised in the individual country studies

outlined above.

Maarsdorp and Whiteside (1993: 31), the foremost proponent of this view, argues that the

prospects of large trading blocs emerging among the industrialised countries has led to a

number of responses in the Third World. In the Gulf region, the Maghreb, South

America and Indian Ocean, there are attempts to revive or expand existing or establish

new regional trading organisations to promote trade among members.

23

According to Maarsdorp (1993: 40) SACU is the only existing grouping which fulfills the

criteria for economic integration: together with the Common Monetary Area it provides

the Southern cone of the region with a degree of integration which in some respects is

deeper than that found in the European Community today. This should be a strength on

which to build.

Moreover, Maarsdorp (1993: 41) sees as a source of optimism the fact that "the prospect

of the post-apartheid era has led to SACU now being assessed more on its merits than on

polemics." Maarsdorp (p41), from this viewpoint, expressed an unparalleled optimism

about the future of SACU: "The main features of a multi-speed approach to greater

integration on Southern Africa are that SACU and CMA together could be deepened into

a common market, that there should be an ultimate merger in an economic integration

scheme between that common market and the non-SACU countries of Southern Africa,

and that Southern Africa should be treated as a distinct, coherent region on its own."

Davies et al (1993: 01) in their study on regional integration in southern Africa follow a

similar approach to that of Maarsdorp and take the argument a step further: "South

Africa's economic destiny is inextricably linked to that of the Southern African region,

and the way in which relations with the rest of the region evolve in the years ahead will

impact on the macro-economy of a democratic South Africa in a number of ways." The

study moreover defines the region as the existing Southern African Development

Community (SADC) countries plus South Africa, and thus attempts to place SACU in a

broader economic integration of the region. Davies warns that a precondition for

successful regional intergration is democratic cooperation rather than South African

dominance and imperialism.

Despite the optimism about the future of SACU which emerges from the second

paradigm, both sets of authors see SACU as an unsustainable institution. According to

Maarsdorp and Whiteside (1993: 41), an issue which should be faced is that of

downgrading SACU to a free trade area or a preferential trade area or even terminating it.

There are periodic rumours that some or other foreign consultant is recommending this

24

course of action to one or other of the BLNS countries. Davies et al (1993: 59) see this as

requiring urgent attention because "In 1992, the Finance Ministry reportedly proposed

giving notice to end the agreement unless other SACU members agreed to a substantial

cut in revenue disbursements, but was dissuaded by the Foreign Affairs Ministry. On the

other hand, there is the study supported by the Botswana Bank with a view to

withdrawing from SACU. Squeezed between these pressures, SACU is clearly now an

organisation in crisis.

It is in this crisis within SACU which this section of the study attempts to address by

examining the political, economic and industrial costs and benefits which currently

accrue to the five member countries, and how reforming SACU can enhance the benefits

to all parties and in this way eliminate the negative perception that all emerge as losers.

3.3. THE REVENUE SHARING FORMULA

3.3.1. Introduction

This sub-section sets out the technical features of the revenue-sharing formula, many of

which will be handled in the context of the two opposing views over the extent to which

payments based on the formula compensate the BLNS countries and whether South

Africa is overgenerous in its fiscal transfers to SACU member countries.

The formula evolved in three phases: upon inception of SACU in 1910, the revenue

sharing agreement took the form of fixed shares of the common revenue pool

independently of the BLS countries share of imports; when the treaty was renegotiated in

1969, an enhancement factor was introduced which aimed to compensate the BLS

countries for the negative economic effects which their membership of SACU entailed;

and in 1976 a stabilisation factor was introduced to prevent SACU revenue from the BLS

countries from fluctuating too much by keeping it within the range of 17-23 percent of

the value of the imports and excisable production of the BLS countries.

25

The technical problems arising for South Africa and the BLNS countries from these three

phases are surveyed. Finally, the problem of time lag in SACU revenue payments from

South Africa to the BLNS countries is considered.

3.3.2. The original revenue-sharing agreement

The origins of economic integration between South Africa and the BLS countries go back

to 1891, when Basutoland (then under British rule) was included in a customs union

which had been formed in 1889 between the Cape Colony and the Orange Free State.

The customs union introduced a common external tariff and free internal trade, but

Basutoland received no additional customs revenue. In 1893 Bechuanaland joined.

When Swaziland was administered by Transvaal from 1894 to 1904, it became part of the

customs area of the Transvaal, which had in 1889 formed a free trade area with the

Orange Free State. In 1898 the customs union was extended to include Natal (Bruwer,

1923: 103).

After the Anglo-Boer war, the British administered Southern Rhodesia, the Cape, Natal,

the Transvaal and the Orange Free State (Ettinger, 1974: 103). In 1903 the previous

customs union was re-established between these five areas together with Basutoland and

Bechuanaland. Swaziland entered as a separate entity in 1904.

When the four provinces formed the union of South Africa in 1910, this replaced the

customs union and a new treaty became necessary between South Africa and the High

Commission Territories. The new treaty was signed in mid-1910, although the three

peripheral territories were not involved in negotiations because they were jointly

represented by Britain. The new customs union treaty dealt with customs revenue by

allowing the South African Treasury to collect all revenue from customs and excise

duties and pay the High Commission Territories quarterly. The distribution of these

revenues was based on the average of the financial years 1907-10, Bechuanaland,

Basutoland and Swaziland receiving revenue in proportion to their share of total duties in

the area (Lundahl & Petersson, 1991: 101). This agreement led to distribution of revenue

as shown in Table 1. A fixed share, totaling 1,31 percent of the actual collection of

26

customs and excise duties, was returned to the three minor parties. Until 1965 each

member's share under this agreement remained unchanged.

TABLE 1. DISTRIBUTION OF REVENUE IN THE 1910 CUSTOMS UNION

AGREEMENT

Country Percentage of total revenue

South Africa 98,68903

Basutoland 0,88575

Bachuanaland 0,27622

Swaziland 0,14900

Source: Ettinger (1974: 61). Reproduced in Lundahl & Petersson (1991:102).

3.3.3. The 1969 revenue-sharing formula: the enhancement factor

During the 1960s, Botswana, Lesotho and Swaziland were granted independence.

Following their persistent dissatisfaction with the 1910 customs union agreement,

renegotiation of the treaty took place in 1969. Articles 13 and 14 were incorporated to

redress BLS grievances over the pool of customs, excise, sales and additional duties

collected within the union. A principle was introduced of collecting and sharing sales

taxes, as well as all excise taxes, along the same lines as customs duties.

Article 13 states that all duties collected in the common customs area, including duties

collected in the BLS countries, shall be paid quarterly into the Consolidated Revenue

Fund of South Africa, thus in effect enabling South Africa to administer the common

revenue pool.

Article 14 dealt with the formula for determining the respective shares of Botswana,

Lesotho and Swaziland in the common revenue pool.

27

The formula can be expressed in the following way:

R=(i + p) C + E + S (1,42)

I + P Where:

R is the revenue received by Botswana, Lesotho or Swaziland.

i is the total cif value at the border of all imports into Botswana or Lesotho or

Swaziland inclusive of customs, excise and sales duties.

I is the total cif value at the border of all imports into the customs union area

inclusive of customs and sales duties.

p is the total value of dutiable goods produced and consumed in Botswana or

Lesotho or Swaziland inclusive of duties.

P is the total value of dutiable goods produced and consumed in the customs

union area inclusive of duties.

C is the total collection of customs duties within the customs union area.

E is the total collection of excise duties within the customs union area.

S is the total collection of sales duties within the customs union area.

P and p exclude any exports of domestically produced excisable and sales duty

goods that benefit from export drawbacks.

The enhancement factor of 1,42 was introduced because the BLS countries claimed that

they required compensation for four adverse effects to their economies as a result of

SACU membership:

28

increased prices due to South Africa's tariff protection of its own industries

Increased prices due to South Africa's quantitative import restrictions

loss of fiscal discretion

polarisation of economic development, with concentration in South Africa, to the

detriment of the BLS countries

In effect, the introduction of the enhancement factor meant that the BLS countries had

first claim over the revenue pool, leaving South Africa with residual. The figure of 1,42

was decided upon as enabling the BLS countries to secure an amount from the SACU

revenue pool equivalent to 20 percent of the value of their imports and excisable

production (20 percent being considered the norm for developing countries).

The most immediate effect of the new formula was a large increase in the BLS countries

receipts from the revenue pool. In Botswana, for instance, SACU revenue increased from

R3 million in 1967 to R50 million in 1975 or from about 20 percent to 50 percent of that

government's total revenue for these years (World Bank, 1992: 32). The determinants of

the different components of the formula and thus the BLS share of the common revenue

pool have attracted a great deal of attention in the literature.

There appears to be much confusion and difference of opinion about how the formula is

applied and how its components are calculated. For instance, Lundahl & Petersson

(1991: 138) interpret the formula as meaning that there is a direct link between the BLS

revenue and the duty content of their imports if the enhancement factor is excluded.

McCarthy (1985) interprets the formula to mean that it distributes revenue on the basis of

respective members shares in the value of imports and excisable production, regardless of

what the level of duties are. The average rate of duty is thus obtained by averaging the

rates on all dutiable goods, including those with a zero duty. This, for McCarthy, creates

a problem, because large changes in the numerator (C + E + S) or denominator (I + P) of

the formula could thus occur without commensurate changes in the pool of revenue.

29

Interpretation of the way in which the formula is implemented seems to depend on

whether the studies in question are attempting to show that the BLS share of SACU

revenue is too generous (McCarthy, 1985) or that BLS countries are not adequately

compensated for adverse effects of SACU membership (Lundahl & Petersson, 1991). It

is therefore useful to separate these two interpretations of the application of the revenue

sharing formula.

Proponents of the first approach are critical of the way in which the formula is

implemented for two reasons: firstly, high SACU revenue transfers are associated with

rapid growth in the numerator of the revenue-sharing formula, which represents increased

growth in South African exports to these countries (McCarthy, 1985); and secondly,

exports from South Africa to BLS are currently included in the numerator but not in the

denominator of the formula (Margo Commission, 1987: 362).

Proponents of the view that SACU revenue fails to compensate the BLS countries for the

adverse effects of their SACU membership argue that the formula works to the detriment

of the smaller countries. These criticisms of the formula occur on two levels: practical

implementation of the formula as it stands; and the way in which the formula was

constructed.

The BLS countries have criticised the practical implementation of the formula on a

number of grounds. Firstly, treatment of different types of imports is not standardised.

Secondly, statistics used to determine the BLS countries share of the common pool make

no provision for under-coverage of goods at border posts. This serves to decrease the

import component in the formula and therefore also revenue. Thirdly, these statistics

may be subject to double-counting, which will serve to distort the formula in two ways:

first, if an imported intermediate good is used in the manufacture of excise or sales duty

goods, application of the formula may lead to double counting, since imports may be

accounted for twice, second, duty-free goods may be included in the revenue-sharing

formula: since the mid 1920s South Africa has given rebates on customs and excise to the

imported inputs of exporting industries which have been refunded from the common

30

revenue pool and included in the formula. Both these factors serve to decrease the duty

yield and therefore BLS revenue (Lundahl & Petersson, 1991: 141-6).

The fourth criticism of implementation of the formula is that while the BLS share of

revenue was supposed to be based on the proportion of BLS dutiable imports and

excisable production of the common customs area, this proportion was constructed

incorrectly because customs (and other) duties that BLS paid on imports which originated

outside the union were included in the denominator of the ratio but not in the numerator,

and the effect of this anomaly was to reduce the BLS revenue share, other things being

equal (Guma, 1990: 64).

The construction of the formula has also been criticised for acting to the detriment of the

BLS countries. Lundahl & Petersson (1991: 145-6) criticise it for three reasons. Firstly,

because imports determine the amount of SACU revenue received by BLS, fluctuations

in economic activity and therefore imports will cause SACU revenue to fluctuate.

Secondly, South Africa can unilaterally change duties, introduce sales duties, or abolish

duties; thus profoundly affecting the revenue received by the BLS countries. For

example, if South Africa introduces duties on a good and the duty is below the prevailing

average duty, the average duty and thus the duty yield (C + E + S/1 + P) will decline and

so will the revenue due to the BLS countries. Thirdly, if prices of imports increase

causing a decrease in demand, the customs duties of SACU will decline.

In sum, South Africa has control over the components of the formula which determine

the BLS countries share of SACU revenue. The size of the payments to BLS is

determined by South African tax and tariff policies, over which the BLS countries have

no control, while the overall revenue of the common pool is determined by the overall

duty rate and the import performance of the BLS countries. The overall duty is in turn

determined by South Africa's trade, production and duties. Changes in these, which are

unilaterally imposed by South Africa, change the entire duty rate.

31

Guma (1990: 65) criticised the rationale of the formula because of two attributes which

were detrimental to the BLS countries. Firstly, although the formula incorporated the

principle of compensation for BLS, actual payments were based on redistribution of the

revenue pool and thus were not financed by a general fiscal transfer from South Africa.

Secondly, while it was the case that South African share of the revenue pool was

determined as a residual, this procedure also set an upper limit to BLS claims against

South Africa. Compensatory payments by South Africa could not exceed the value of the

revenue pool, even though the arguments in support of the principle of compensation

extended to a disparate set of economic activities not all of which were incorporated into

the text of the agreement.

To summarise, while the 1969 revenue-sharing formula greatly increased the BLS

countries share of SACU revenue, it has subsequently been criticised because of its

practical implementation and the way it was constructed. South Africa has criticised the

formula because it compensates the BLS countries for their exports from South Africa

and includes these in the numerator but not the denominator, to South Africa's detriment.

The BLS countries have criticised practical implementation because their share of the

common revenue pool is determined by their level of imports, which are subject to

fluctuations; the statistics which are used to determine the BLS share of the common

revenue pool make no provision for under-coverage of goods at border posts; and lack of

a clear-cut definition for the calculation of import and export figures has disadvantaged

the BLS countries because of double-counting.

Moreover, for the BLS countries the rationale of the formula is fundamentally flawed

because the size of payments to BLS is determined by South African tax and tariff

policies, over which the BLS countries have no control, while the overall duty rate is

determined by South Africa's trade, production and duties. Some of these arguments

provided the impetus for renegotiation of the revenue formula in 1976.

32

3.3.4. The 1976 formula: introduction of the stabilisation formula

As the 1969 formula was applied, it was discovered that the rate of revenue accruing to

the BLS countries tended to fluctuate around slightly less than 20 percent of the value of

their imports and excisable production. The BLS countries expressed concern about the

fluctuations in SACU revenue, which caused instability in government revenue, and also

about the possibility of an unanticipated decline in SACU revenue.

An amendment proposed in 1976 and agreed upon the following year specified that, if the

revenue calculated with the aid of the original 1969 formula was not equal to 20 percent

of the duty-inclusive value of imports and excisable production, a stabilisation factor

must be calculated. This factor equals 50 percent of the difference between the amount

corresponding to 20 percent and the amount calculated with the 1969 formula. If the

difference is positive, it is added to the latter amount. If it is negative, it is subtracted. In

this way, whatever divergence there is from the 20 percent level is halved. Finally, the

amendment specified a lower limit of 17 percent and an upper limit of 23 percent for the

stabilised value (Lundahl & Petersson, 1991: 138-9).

The introduction of the stabilisation factor in effect made the original 1,42 enhancement

factor irrelevant because the effects of changes in the overall duty rate were regulated by

the stabilisation factor. The stabilisation factor sparked off a further bout of controversy

over whether payments to the BLS countries from the common revenue pool were

generous or whether the formula acted to their detriment.

McCarthy (1985) argues that the stabilisation factor has served to increase the effective

enhancement factor above 1,42. For McCarthy this represents an indirect taxation of

South African taxpayers in order to compensate the BLS countries. Maarsdorp and

Whiteside (1993: 42) strengthens this perception when they argued that the agreement did

not provide for the possibility that SACU tariffs might be reduced in terms of the GATT

(now WTO) requirements for the liberalisation of trade and also to make exports from the

region more competitive. By reducing tariffs, South Africa has been penalised for doing

33

the right thing by a formula and stabilisation factor which, by guaranteeing a minimum

rate of revenue to BLNS, were valid only if duties were not reduced.

Guma (1990: 65-72) argues that through three perverse effects the stabilisation factor has

not worked to the benefit of the BLS countries: it alters the meaning and size of the

common revenue pool; it creates the potential for a transfer of resources from BLS to

South Africa; and it perverts the logic of compensatory payments to BLS. The meaning

and size of the revenue pool are altered by the stabilisation factor because, if South Africa

knows the maximum BLS claim can never exceed 23 percent of BLS imports and

dutiable production, South Africa gains an additional degree of freedom: how much to

pay into the pool. This has three consequences. Firstly, the meaning of the "common

revenue pool" becomes ambiguous because there are in effect two revenue pools: the

estimated amount of the revenue pool, which is defined de jure; and the sum of BLS

collections of customs, excise and sales taxes (and duties) which are paid into the

Consolidated Fund of South Africa plus whatever South Africa has to pay into the fund to

meet the BLS claim. Secondly, South Africa can legitimately avoid making payments in

excess of the residual which it should pay into the pool to meet the BLS claim. Such

avoidance is not illegal. Nor does it run counter to the spirit of the agreement. Rather,

the current arrangements give South Africa the freedom to meet its obligations to BLS in

full without recourse to a national, common revenue pool. Thirdly, BLS have no claim

on the contents of the national revenue pool. Their legitimate claims can be

accommodated by the other revenue pool (the actual collection of SACU revenue), which

might be described more appropriately as the South African compensated BLS revenue

pool (Guma, 1990: 67-8).

The 1976 arrangements can facilitate perverse resource transfers, from BLS to South

Africa, a possibility that could not have arisen under the 1969 agreement. This would

occur if the revenue owing to BLS exceeded the upper limit of 23 percent, in which case

the excess would flow from BLS to South Africa. This is because accruals to BLS are

now calculated by applying a stabilised rate of duty to BLS imports and excisable

production.

34

The stabilised rate of duty is not derived from the common revenue pool but from the

compensated revenue pool. Thus collections which are in excess of the amount required

to validate the stabilised rate of duty cannot be placed in the compensated revenue pool.

Instead, these may be transferred to South Africa through the national revenue pool. The

implication is that, if the duty content of BLS imports increases to an average level

exceeding the current maximum stabilised rate of 23 percent, a BLS transfer to South

Africa will become permanent. Furthermore, if this increase in duty content is caused by

the pattern of BLS growth, then the transfer will be a positive function of this growth

(Guma, 1990: 68).

For Guma (1990: 72), the possibility of transfer of resources from BLS to South Africa

destroys the logic of compensatory payments, for these ought to be from South Africa to

BLS in all circumstances. This is aggravated by the lack of systematic linkage between

changes in the fiscal environment caused by South Africa and the amount of

compensation paid to BLS. However, the 1969 agreement also failed to distinguish

between average and the marginal rates of compensation. Compensation should have

been systematically linked to the cause of the problem for which it was paid. The

absence of a distinction between average and marginal rates enables South Africa to

change the fiscal environment with impunity in response to her own needs.

In addition to the three perverse effects introduced by the stabilisation formula, Guma

argues that total accruals to BLS would have been greater under the 1969 agreement than

under the 1976 agreement. If the 1976 arrangements were to yield accrued revenue to

BLS equal to what would have been yielded by the 1969 arrangements, then the ratio of

the accrued shares ought to equal 1 in the formula:

Z= Sj,t[1969] = 1/Sj,t[1975]

Where Sj,t is the share of revenue for country j (j=BLS) with the formula outlined above

for 1969, and with the formula amended by the stabilisation factor of 1976. If the ratio of

accrued shares has numerical value greater than 1, then the flow of accruals generated by

35

applying the 1969 formula will be greater than that generated by applying the formula of

1976. Z will have a numerical value greater than 1 if the ratio of the value of the

common revenue pool to the tax base is 0,16197. When the ratio is greater than 0,16197,

then Z>1. This is likely to obtain as a consequence of two considerations: firstly, South

Africa and BLS agreed on a norm of 20 percent for the rate of revenue of the customs

union area. This norm represents the average effective rate of duty which is formally

defined as, and therefore identical to, the ratio of the value of the common revenue pool

to the tax base. Clearly, if the expected value of 20 percent is assumed, then the BLS

revenue share would be greater under the 1969 formula than under the 1975 formula

because 0,20 is greater than 0,16197.

Secondly, the condition for equality of the two sets of data is calculated on the basis of

the maximum value of the stabilised BLS rate of duty, 23 percent. If the actual stabilised

rate duty is less than 23 percent, then the likelihood of fulfilling the condition for Z to

exceed 1 increases (Guma, 1990: 69).

In sum, Guma contends that the BLS negotiators failed to perceive the inferiority of the

1975 arrangements, they seemed to believe that stabilising that rate of duty applied to

BLS imports was equivalent to stabilising the flow of BLS revenue from well-defined

revenue pool. By contrast, the South African negotiators seemed to comprehend the

implications of the changes proposed by BLS. They accepted the proposals in good faith

and obtained a degree of freedom which they previously had not enjoyed: how much to

contribute to the compensated revenue pool (Guma, 1990: 73).

The effect of the two-year lag in payment to BLNS has also been a matter of concern for

sometime. Both the BLNS countries and South Africa concur that the two-year lag in the

transfer of SACU revenue from South Africa to BLNS is unfair to them because the

enhancement factor is significantly depreciated by high inflation, loss of interest on

revenue accrued but not yet paid and depreciation of the exchange rate (African

Development Bank, 1993; Davies et al, 1993; Guma, 1990; Hudson, 1992; Lundahl &

36

Petersson, 1991; Maarsdorp, 1993; McCarthy, 1985; Margo Commission, 1987; Walters,

1989; World Bank, 1992).

3.4. THE BENEFITS AND LOSSES TO BOTH SOUTH AFRICA AND BLNS COUNTRIES OF THEIR SACU MEMBERSHIP

South Africa's share of SACU revenue, which is the residual of the common revenue

pool, is seen by the South African authorities as declining because revenue transfers to

the BLNS countries have been too large. South Africa's residual has declined because of

a substantial increase in growth in the BLNS countries accompanied by rapid growth in

imports; changes in South Africa's tax structure, which have caused the common revenue

pool to shrink; inclusion of Transkei, Bophuthatswana, Venda and Ciskei (TBVC) in

SACU revenue disbursements; a decline in the revenue accruing from tariffs as a result of

shifts in tariff policy; and a perceived reduction of South African imports during the

sanctions era. BLNS countries were not subjected to some of these sanctions, which

meant that their imports increased during this period.

The benefits which South Africa has derived from its relationship with the BLNS

countries are a captive market in BLNS for South African goods which are sold there for

above world prices; arising from this, the fiscal revenue from taxes on the profits of

companies that sell their goods in the protected markets of the BLNS countries; the

contribution of goods sold in BLNS markets to the growth of South Africa's GDP and

manufacturing employment; export of goods through BLS during the sanctions era; and

the protection provided to South African producers by the secret memorandum.

Analysis of different views in the literature on the extent to which revenue transfers from

South Africa to BLNS compensate them for the adverse effects of their membership in

SACU highlights the costs to BLNS of SACU membership.

The costs include the price-raising effect of SACU's common external tariffs and

common quotas; the loss of industrial development in the BLNS countries; the articles in

the 1969 SACU treaty (particularly the secret memorandum) which are onerous to BLNS

37

and serve to impede their economic development; and the general welfare losses incurred

by the BLNS countries, including the loss of revenue to BLNS because of the lag of two

years in payment and loss of fiscal discretion.

Against these drawbacks of SACU membership are weighed the benefits to BLNS, which

can only be seen by going beyond their relations with South Africa: the BLNS countries

by virtue of their SACU membership are in a decidedly better position than other

countries in the southern African region in regional trade, investment and institutional,

administrative and physical infrastructure, which SACU provides the BLNS countries.

Evidence of the importance of these benefits is that none of the original signatories has

seriously contemplated withdrawing from SACU. Indeed, a new member, Namibia,

joined the union on attaining independence.

3.5. ENVISAGED DIRECTIONS FOR SACU

This section outlines the alternatives available to SACU in the post-apartheid era. There

are broadly four possibilities. SACU could remain as it is. It could be terminated or

downgraded to a free-trade area. It could be broadened to include other southern African

countries. Or it could be restructured to deal with the concerns of all member countries.

Maintaining the status quo is not possible, and terminating or downgrading SACU would

be to the detriment of all the member countries. Broadening SACU and including other

countries is the most unrealistic possibility because South Africa could not afford to do

this. The bulk of the literature opts for restructuring SACU rather than downgrading or

terminating it.

3.5.1. Maintaining the status quo

SACU could remain as it is, but this does not appear to be possible for three reasons.

First, the pressure from WTO to reduce tariffs and eliminate quantitative restrictions has

important implications for future SACU revenue. The effects are not entirely clear,

however. If the quantity of imports remains the same after tariffs are reduced, SACU

revenue will certainly decline dramatically. On the other hand, if the elasticity of the

38

demand for imports is high in all five SACU member countries, SACU revenue may

remain at its current levels or even increase. What is clear is that, if in response to lower

tariffs and the removal of quantitative restrictions the BLNS countries import less from

South Africa, much of the rationale for the enhancement and stabilisation factors in the

revenue sharing formula will fall away. Secondly, South African government will be

hard pressed to increase social expenditure in order to redress backlogs from the past. It

will therefore not be in a position to make fiscal transfers of the size which have been

made in the past, particularly if exports to the BLNS countries decline as a result of lower

tariffs and the removal of quotas.

Thirdly, the political environment in the Southern African region has undergone

substantial changes after 27 April 1994, bringing friendlier relations between South

Africa and the rest of the region. Presumably it will be in the interests of both South

Africa and the BLNS countries to correct those aspects of the SACU agreement which

have impeded the economic development of the BLNS countries.

3.5.2. Terminating or downgrading SACU into a free-trade area

Various studies allude to the possibility of downgrading SACU to a free trade or a

preferential trade area or even terminating it. The Lundahl & Petersson (1991) study is

the only one which contemplates the demise of SACU. Observing that Lesotho is

trapped in a dependent relationship with South Africa and that a deepening of the

integration between the five SACU member countries would exacerbate Lesotho's

dependence, they argue that disintegration of the present arrangement might close the

door to extended integration dominated by South Africa. (Lundahl & Petersson, 1991:

402).

However, Lundahl & Petersson approach the issue in isolation from considerations of the

benefits which SACU provides the five countries, and the potential to increase them in

the post-apartheid era in the global and regional context. Also, if SACU revenue were to

cease flowing to the BLNS countries, it is likely that their citizens would migrate to

South Africa in even more substantial numbers than presently. This would exacerbate

39

South Africa's unemployment problem and place a bigger burden on its government and

might lead to conflict. It is clearly not in South Africa's interests for the economies of its

neighbours to be in crisis.

Despite the evidence cited for the real possibility of withdrawal or downgrading, it must

be realised that in the short term a popularly elected, democratic government will

renegotiate the SACU treaty with the BLNS countries. Feelings of most officials in

countries such as Botswana and Swaziland indicate that they are unlikely to want to

downgrade or terminate SACU. It appears that from their side rumours that some or

other foreign consultant is recommending this course of action are precisely that and

nothing more.

3.5.3. A broader and looser SACU

Davies et al (1993: 59) make the point that until recently SACU was widely heralded in

official and business circles in South Africa as the most successful integration scheme in

Africa and thus a potential model for a broader programme. After February 1990 state

officials mooted the idea of a broader and looser SACU in a programme to create a

southern African common market or economic community.

In addition, a survey conducted by Maarsdorp & Whiteside (1993: 46) suggests strong

private sector support in both Zimbabwe and Malawi for customs union membership.

There is also strong support in Malawi for transforming SACU into a common market.

There are also reports that Mozambique, Malawi and Zambia have expressed in private

an interest in joining SACU (Business Day: August 18, 1997).

However, Davies et al (1993: 61) argue that if new members were to be drawn in on this

basis at the same time as South Africa insisted on a reduction of overall payments to

other partners, given that a new member would bring in a contribution to the common

revenue pool smaller than it took out, this would imply further cuts to the BLNS

countries. Political issues would tend to militate against such an outcome: since current

members retain a veto over the admission of new members, they would be unlikely to

40

agree to a broadening of the union on these terms. Therefore, the condition for any

broadening of the union would be a willingness on South Africa's part to bear the cost of

admitting new members.

If any additional country to join the customs union, it would not be possible to do so on

the same conditions as the BLNS countries. South Africa could not afford to extend the

same revenue sharing formula to any new country, and there might have to be a two tier

arrangement, one for the original member countries (including Namibia) and the other for

any new members.

This point will be taken up in the discussion of the relation between SACU and non-

SACU countries in the southern African region. It is clear, however, that extending

SACU to include other countries on the same conditions as the BLNS countries is not

workable, and including them under different conditions is tantamount to a multi-tier

relationship, which could equally occur outside of SACU.

3.5.4. Renegotiating SACU

This subsection covers a survey of the different proposals on how SACU should be

restructured.

3.5.4 (a) Amending the existing treaty

According to Mayer and Zarenda (1994: 50), the balance of the literature proposes

amendments and changes to the SACU agreement which will attend to both BLNS and

South African concerns. These studies are useful as pinpointing aspects of the treaty

which act to the detriment of SACU member countries and thus require renegotiation

Most of the studies surveyed propose some form of restructuring of the revenue-sharing

formula. All the studies agree that the time lag should be done away with. Hudson

(1992) identifies three elements in the formula which require renegotiation: the low

stabilisation rate of 17 percent, which South Africa considers too high in view of the

41

agree to a broadening of the union on these terms. Therefore, the condition for any

broadening of the union would be a willingness on South Africa's part to bear the cost of

admitting new members.

If any additional country to join the customs union, it would not be possible to do so on

the same conditions as the BLNS countries. South Africa could not afford to extend the

same revenue sharing formula to any new country, and there might have to be a two tier

arrangement, one for the original member countries (including Namibia) and the other for

any new members.

This point will be taken up in the discussion of the relation between SACU and non-

SACU countries in the southern African region. It is clear, however, that extending

SACU to include other countries on the same conditions as the BLNS countries is not

workable, and including them under different conditions is tantamount to a multi-tier

relationship, which could equally occur outside of SACU.

3.5.4. Renegotiating SACU

This subsection covers a survey of the different proposals on how SACU should be

restructured.

3.5.4 (a) Amending the existing treaty

According to Mayer and Zarenda (1994: 50), the balance of the literature proposes

amendments and changes to the SACU agreement which will attend to both BLNS and

South African concerns. These studies are useful as pinpointing aspects of the treaty

which act to the detriment of SACU member countries and thus require renegotiation

Most of the studies surveyed propose some form of restructuring of the revenue-sharing

formula. All the studies agree that the time lag should be done away with. Hudson

(1992) identifies three elements in the formula which require renegotiation: the low

stabilisation rate of 17 percent, which South Africa considers too high in view of the

41

currently lower tariff regime for SACU; the time-lag in the BLNS countries receipt of

SACU revenue; and the trade diversion effect, which causes the BLNS countries to buy

more expensive South African products.

He recommends three changes to the revenue sharing formula which would provide a

compromise between South Africa and BLNS, leaving the annual cash payments

unchanged but changing their composition to take into account each party's point of

view. The minimum rate of revenue could be lowered in the revenue stabilisation

formula to deal with South Africa's complaint.

Secondly, the first estimate of the accrued revenue to BLNS could be improved. The

estimator should ensure that the first payment is closer to the actual amount instead of

being a gross underestimate as at present. BLNS would then receive nearly all that is

owing to them during the fiscal year in which it is owed. The second payment, which is

received two years later, would then be small. This would remove one of the main

grievances of BLNS. Thirdly, if the price-raising effect in BLNS due to having to

purchase their imports from South Africa is higher than would be judged likely by

looking at external tariffs alone (because of the effect on BLNS of the non-tariff barriers

against cheaper foreign goods), the lowering of a minimum rate of revenue in the

stabilisation formula should be sticky, that is it should be lowered slowly from its present

value of 17 percent. This would be an appropriate response to an additional major source

of concern to BLNS.

Hudson's proposals for balancing these three countervailing amendments for an

unchanged cash flow to BLNS from changed constituents would leave the substance of

SACU largely unchanged. They are superficial and do not begin to deal with the real

problems which the BLNS countries face.

For Davies et al (1933: 62) restructuring the revenue sharing formula would have to go

beyond the short-term budgetary implications for South Africa. This is because changes

in the formula would have implications not only for the budgets of the BLNS countries,

42

but also for the benefits to South Africa of access to the BLNS markets and for the need

to even out potential polarising effects. They believe that some loading in favour of the

less-developed partners would be expected to continue under a new arrangement.

Furthermore, attempts to depart from an approach in which privileged market access is

traded against revenue payments would need to be phased (in South Africa's interests as

much as of the other partners).

Maarsdorp (1993) has a similar approach to that of McCarthy (1985) and the Margo

Commission (1987). The 42 percent compensation factor and 20 percent stabilisation

factor should be revised down as there has never been any satisfactory explanation for

them (Maarsdorp, 1993: 43). However, he fails to evaluate the implications of such a

reduction and simply states that the impact of any reduction in the rate of revenue (from

20 percent to say 17 percent) could be mitigated by doing so in stages by a percentage

point a year. In addition, he argues that the inclusion of excise duties should be re-

examined to see if they can be eliminated from the revenue-sharing formula.

Walters (1989) provides a far more comprehensive analysis of the clauses in the SACU

treaty which are onerous to the BLS countries. He offers proposals for reforming these

clauses. His analysis in fact summarises many of the discussed issues, with the exception

of the revenue-sharing formula.

The PTA. Walters calls for renegotiation of the condition in the agreement that BLS

might join PTA provided that no tariff concessions were offered. South Africa would not

be detrimentally affected if this were to change. South Africa itself imposed this

restriction because it had been excluded from the PTA. Since leakage of lower-duty

goods from BLS to South Africa is restricted by article 19, the retention of BLS markets

for South African exports was not regarded by Walters as ranking high among South

Africa's policy objectives (Walters, 1989: 34-5).

Article 6. This allows BLS to levy additional tariffs for up to eight years on imports of

products of new BLS industries (that is industries that have been in existence for less than

43

eight years). Walters considers that this could be amended to increase its usefulness:

only Botswana has used it, in the production of beer, soap and wheat flour. However, the

brewing. industry was soon taken over by its main South Africa competitor, rendering the

protection almost irrelevant. The article should therefore be renegotiated as follows:

The eight-year period specified in the definition of newness should be amended to

refer to continuous production immediately prior to protection. The qualifying period

should thus not exclude new producers in industries where earlier producers were

liquidated but could perhaps have survived with infant-industry protection. This has

been accepted implicitly since Botswana was able to protect its infant manufacturer of

soap even though there had been production in Botswana in the 1960s.

If duties collected in terms of article 6 were to accrue directly to the country

concerned instead of being remitted to the revenue pool, revenue to that country

would almost certainly increase. Revenue would then also more closely reflect the

cost of living effects of the duties. This could facilitate offsetting such effects with

subsidies financed directly out of the duties collected. The argument should also

facilitate the possibility of establishing protection before commencement of

production. By assuring the investor in advance of the required level of protection

this would prevent investment from being deterred.

The definition of an industry as units producing the same product should be made

explicit to remedy the current problem of uncertainty of officials and observers

whether existing firms may seek protection for new products.

Article 11. This provides for restrictions on imports from any source for any reason other

than to protect local production from competition from goods produced elsewhere in

SACU area.

Walters argues that this article has been applied in contentious way by South Africa to

prevent circumvention of protectionist import controls. Specifically, some of the imports

44

of inputs by BLS have been blocked. There have been cases of BLS liberally allowing

more imports of inputs than South Africa and of these inputs being processed into low

cost final products and exported to South Africa. South Africa has often taken measures

to restrict such competition, arguing that this practice undermines the objectives of the

extra-union import controls and is therefore in breach of article 11. South African

producers of car components and ammonia inputs effectively lobbied for protection,

resulting in car assembly being prevented in Swaziland and fertiliser production Lesotho

being first delayed and later undermined. BLS have therefore contended that such

restrictions illegally protect South African producers.

Walters therefore proposes that article 11 should be amended to state explicitly that such

restrictions, intended to protect input producers, are legitimate and that any member state

wishing to apply such restrictions should be required to establish this legitimacy in

advance.

Article 17. This provides for damaging increases in competition. A member state has the

right to consultations to seek a mutually acceptable solution. The only reported cases of

this article being invoked occurred when, to protect South African component producers,

Lesotho and Swaziland were prevented from television assembly (for the South African

market) using imported components subject to quantitative controls in South Africa.

Walters proposes that article 17 be amended in the following way:

> It should apply only to prevent dumping (the SACU agreement presently contains no

anti-dumping provisions).

> Since the member states are of such unequal bargaining strength, the range of

amicable solutions that may be sought by consultation should be circumscribed.

Article 15. This provides that discriminatory transport charges should not be applied to

goods from member states. The purpose of this is to prevent subsidies from having a

similar protective effect to trade barriers. However, this issue has come to the fore since

1982 when South Africa introduced subsidies to manufacturers in less-developed regions,

45

including subsidised transport cost for raw materials. Since BLS could not match these

subsidies, the incentives severely limited the potential for industrialisation in BLS,

thereby increasing polarisation in the customs union area. This issue has to some extent

been allayed by the new RIDP incentives in South Africa.

Fiscal harmonisation. The appropriate degree of fiscal harmonisation in the SACU area

remains contentious. However, none of the member states appears to have made a

comprehensive study of this issue. It should therefore be high on the agenda in any

renegotiation of the treaty.

A prerequisite for success of the reforms advocated by Walters is remedy of the historical

tendencies of unilateral restructuring by South Africa and lack of adequate consultation

with the BLNS countries.

In sum, if SACU remains a customs union and the South African government forges a

democratic and equitable relationship with the BLNS countries, the treaty could be

renegotiated to enhance the benefits and minimise the losses accruing to the five member

countries.

Maarsdorp & Whiteside (1993: 47) believe that the time lag apart, none of the BLNS

problems should be insuperable. In fact, they all relate to terms which are usually

included in customs union agreements, and should be able to be either improved upon or

included.

3.5.5. Strengthening the integration

3.5.5 (a) A common market

Lundahl & Petersson (1991), Davies et al (1993) and Maarsdorp & Whiteside (1993)

consider the possibility of restructuring SACU to increase the integration of the five

countries. The levels of integration they propose range from a common market to a fully-

fledged economic union.

46

A common market would allow for free factor mobility (labour, capital and enterprises)

among SACU member countries. The additional elements required to turn a common

market into an economic union are harmonised and integrated monetary, fiscal and

development policies.

Davies et al (1993: 61) argue that restructuring SACU should include an examination of

the possibility of deepening relations within the union. Upgrading SACU into a common

market could be a way of dealing with some of the current problems besetting the

migrant labour system.

Maarsdorp & Whiteside (1993: 45) support the idea of upgrading SACU into a common

market since between SACU and CMA already offer what is close to a common market

for South Africa, Lesotho, Swaziland and Namibia. The additional requirements for a

common market are:

➢ Freedom of capital movement (which already largely exists within the CMA). It

might be possible to persuade Botswana to join a common market, but to do so it

would have to join the CMA so that capital could be freely mobile between itself and

the other member countries. In practice funds do move fairly freely between

Botswana and SACU partly because the Pula is a convertible currency and exchange

controls have been liberalised. Since the CMA allows the smaller countries to vary

the exchange rates of their currencies against the Rand, Botswana would not be

obliged to bring the pula into line with the Rand.

➢ Freedom of labour mobility (which already obtains but mainly on a contract basis

under the migrant system). The conversion would involve permanent movements of

population. The net flows are likely to be one way from BLNS to South Africa

(especially to the major metropolitan regions). Those who could be expected to move

in the first instance include professionals attracted by higher salaries and families of

migrants already working in South Africa.

47

The survey among private sector firms in BLNS conducted by Maarsdorp shows

moderate support for conversion of SACU to a common market. Of firms asked whether

they would prefer SACU to remain as it was or to become a common market, 54,9

percent favoured a common market and 25,6 percent were uncertain which alternative

they preferred. Uncertainty was highest in Lesotho, while firms in Swaziland were

significantly more in favour of a common market than those in the other three countries.

In addition, in Malawi 63,3 percent wanted SACU to become a common market. The

benefits of being in a common market as opposed to a customs union would vary from

one country to another. Maarsdorp therefore considers the implications for each of the

five SACU member countries.

Lesotho. Maarsdorp (1993: 45) argues that Lesotho unquestionably would benefit most

from being in a closer form of integration with South Africa as it clearly cannot hope to

employ more than a small fraction of its labour force. It is the one country which would

be bound to experience a net outflow of population (as indeed was the case prior to the

introduction of border controls in 1963). He sees this as being in Lesotho's interests

because reduction of population pressure on the land would allow Lesotho to reform its

agricultural sector and increase per capita income. Some of the pressure of creating jobs

and expenditure on social services would also be reduced.

Maarsdorp (1993) recognises that Lesotho's domestic market might diminish (this would

depend on whether or not the increase in per capita income as a result of agricultural

reforms were to offset the outflow of consumers), and Lesotho would lose most of the

remittances from migrant workers, which contribute so much to the economy. This

would eventually be offset by revenue from the eventual sale of power and water to

South Africa under the Highlands Water Project.

Lundahl & Petersson (1991: 400) agree that, given the extent of labour migration from

Lesotho to South Africa, the crucial change that needs to be undertaken is the extension

of labour mobility. This would mean that migrants would be granted rights identical to

48

those of South African workers with regard to wages, security of employment,

opportunities for promotion, trade union membership, etc.

They are less optimistic than Maarsdorp about the benefits to Lesotho of a common

market: there is a risk that polarisation may increase and permanent migration result.

This would mean that the present positive linkage effects of migration for Lesotho's

economy will be lost, and with decreasing imports, customs union revenue will decline.

The problem of a scarcity of skilled labour in Lesotho will be exacerbated and this will

further reduce the capacity to absorb investment in both the private and the public sector

(Lundahl & Petersson, 1991: 401).

They conclude (p.401) that the likely result of an extended integration area, which may

follow upon a legal change of the present arrangements or be the result of changed

migration behaviour of Basotho in a post-apartheid South Africa, is to accentuate rather

than reduce the adverse pressure on Lesotho. A regional policy will then be required to

influence the geographical distribution of economic activity in the region. This policy

must be financed within the context of a regional policy for the economic union or by

other external sources, since increased migration will make it even more difficult to

increase revenue from domestic sources.

A deeper form of integration on a small economy like Lesotho's, which is already highly

dependent on South Africa, will therefore result in complex changes in the costs and

benefits of integration. Migrant workers will improve their position, but Lesotho itself

will emerge a net loser. Hence the uncertainty which firms in this country expressed in

Maarsdorp' survey is entirely warranted.

Swaziland. Maarsdorp (1993: 45) argues that Swaziland has a better resource base to

absorb its labour force, but it might also benefit from closer integration. In contrast to

Maarsdorp's finding that firms in Swaziland were significantly more in favour of a

common market than those in the other three countries, the statements from Swaziland's

49

officials in the Ministry of Finance and Development Planning suggest that this country

has no inclination to increase integration beyond a customs union.

Botswana. According to Maarsdorp, Botswana does not stand to gain much from either a

common market or an economic union because it has been the least dependent of the BLS

countries on the export of migrant labour. The response obtained from the officials in

Botswana suggest that they would be unwilling to enter into a stronger form of

integration.

Namibia. Namibia's role as a labour supplier is unclear because of doubtful statistics.

Nevertheless, Maarsdorp argues that permanent migration even on a limited scale would

relieve them of some of the problems of job creation.

South Africa. Maarsdorp argues that for South Africa a common market would be

problematic. Because of high formal sector employment, this country already faces a

considerable challenge in creating jobs and supplying its own rapidly growing population

with housing, education and health services. Also, immigration controls are being

breached with greater ease, and there is already a considerable injection of people from

Africa north of the Limpopo to South Africa.

Maarsdorp estimates that with a common market South Africa would have to cope with

an influx of perhaps 0,5 to 0,75 million low-income people. However, whether this

would be politically acceptable is questionable and some observers argue that there

would be strong political pressure on the Government to phase out foreign labour.

The addition to the South African population from permanent migration might be fairly

marginal. Maarsdorp estimates that it would be between 1 and 2 percent. This should be

weighed against the fact that total economic welfare within the common market should

be improved. If the integration was strengthened to the level of an economic union,

permanent migration could be minimised through macroeconomic fiscal harmonisation

50

and an agreement on a comprehensive multi-sectoral programme of regional development

which would ensure job-creating activities in the smaller countries.

Lundahl & Petersson (1991: 402) contest the view that the BLNS countries will stand to

gain from a common market at South Africa's expense. They argue that South Africa

will no doubt dominate any such grouping of states in Southern Africa and that South

Africa would secure access to a relatively larger market on preferential terms and secure

a monopoly or favoured position with respect to regional transportation.

In sum, Maarsdorp demonstrates an unparalleled optimism about strengthening the

integration between the five SACU member countries into a common market. This

optimism arises from viewing SACU in a global context, where stronger forms of

integration are rapidly emerging among industrialised and developing countries. Davies

et al (1993) consider a common market as a possible alternative to restructuring SACU.

In contrast, Lundahl & Petersson (1991: 402) are very pessimistic about this option: a

disintegration of the present arrangement might close the door for an extended integration

dominated by South Africa.

3.5.5 (b) Economic union

Maarsdorp advocates ultimately taking SACU to an economic union. Maarsdorp (1993:

46) believes that with a common market in place, an economic union should be a small

step because the CMA (Common Monetary Area) provides the basis: could the countries

agree on a unified currency and common central bank with interest rate policies? This

would in fact mean reverting to the situation which obtained prior to 1974, with the

exception that the BLNS would now be represented in the (preferably independent)

central bank and in policy making. The Multilateral Monetary Agreement would

presumably become redundant and the CMA would be subsumed into an economic

union.

51

The only studies which consider how to implement further integration among the present

SACU countries are those of Maarsdorp and the African Development Bank (ADB).

Maarsdorp (1993: 46) proposes a multi-speed approach in which, for example, South

Africa and Lesotho would form an economic union (SAEU); South Africa, Lesotho and

Swaziland a common market (SACM); and South Africa and the BLNS countries

together retain the customs union (SACU).

52

3.6. CONCLUDING REMARKS

Notwithstanding the fact that there appears to be an overwhelming economic domination

by South Africa in the region it must be emphasised that a balanced development strategy

for the entire region is crucial to the success of future economic development in all the

SACU countries. The perpetuation of existing inequities and the neglect of regionally

integrated development in southern Africa will affect South Africa adversely in mass

migration of labour to the core area and reduction in the size of markets for South African

produced goods. The challenge for the future is therefore to restructure the agreement in

a way that enhances benefits and minimises costs. Perpetuation of the historical

inequities in the implementation of the agreement cannot be afforded by any of the

member countries.

Any future restructuring strategy undertaken by the South African government covering

development, industrialisation, labour or trade has to take into account the effects on

other members of SACU. Equally important, it should analyse the capacity and

capability of BLNS to supply raw materials, intermediate inputs and even competing

consumer goods to South African markets. A future development strategy should attempt

to foster linkages between various economic sectors across the region as a whole. For

this programme, more democratic institutional structures should be established in key

decision-making areas and consistent consultation introduced.

The revenue sharing formula, which is central to the distribution of costs and benefits

among member countries needs to be totally reformed as urgently as possible. There is a

need for immediate reform of the 1969 agreement and its 1976 amendment. The urgency

of such renegotiation has been heightened by the changing political and economic

environment in South Africa, not to mention increased pressure on individual members

from international institutions such as the World Bank and the International Monetary

Fund. A democratically elected government is likely to be more conscious of the needs

and aspirations of countries that were sympathetic to the liberation struggle in the past. It

is hoped that the process of democratisation within South Africa will be extended to its

relations with the other countries in the southern African region.

53

CHAPTER 4

THE EUROPEAN UNION (EU)

4.1. BACKGROUND

In March 1996 the EU Council of Ministers gave the European Commission a mandate to

negotiate a free-trade agreement with South Africa. If this goes ahead it would be of

great significance not only for South Africa but also for the entire Southern African

subregion. However, success is not guaranteed.

Among the legacies that the "new South African government" has inherited from the

country's apartheid past is its isolation in global trade, and one of the lessons it is having

to learn is the brevity of foreign governments' attention span and sympathy, in trade as in

other areas. The ending of sanctions did not remove the international constraints under

which South Africa's exporters operate. Between 1960 and 1990 when South Africa was

internationally isolated, a complex network of trade agreements evolved, giving many

countries advantages in their export markets compared with some of their competitors.

Such has been the scale of these agreements in the case of the EU that only a small

proportion of its trading partners export to the EU on Most Favoured Nation (MFN)

terms (which only means non-discriminatory treatment among the parties awarded MFN

status). Most of the EU's trading partners have more preferential access to EU markets

than implicit in MFN terms.

Until July 1995 the list of the EU' s MFN trade partners included South Africa. Even

now, however, South Africa still has one foot in the MFN camp since it is treated entirely

sui generis: it is covered by the EU's generalised System of Preferences (GSP) but with

more restrictions than apply to other GSP participants. The ongoing negotiations

between the EU and South Africa are designed to rectify this anomaly, but they are taking

place under difficult circumstances. The climate is now less favourable not only than in

the apartheid era (when the critical terms of EU agreements with most of South Africa's

competitors were framed) but also than it was during the period immediately before and

54

after the change of government in Pretoria when the South African portfolio was on the

desks of prime ministers and foreign ministers. Now, the portfolio has moved to

ministers of agriculture and industry with predictable results for the tone of the EU' s

negotiation position.

The European Commission has complained that aspects of the negotiating mandate

handed down to it by the EU Council of Ministers are now so restrictive as to cast doubt

on its eventual acceptability to the World Trade Organisation (WTO). A range of

problems have been cited to account for this restrictiveness and these are reviewed below.

However, none provides a full explanation. The real reason is that the trade initiative is

in the hands of government departments which must also protect domestic producers, and

no one else sees sufficient advantage in a new trade deal with South Africa to seize the

reins.

The negotiations since June 1995 have concentrated on the form that South Africa's

bespoke trade agreement should take. There has been a general discussion between the

EU and South Africa on the principle of asymmetric liberalisation over ten to 15 years,

but no substantial progress on the details has been made. F & T Weekly (1997, August

29) states that SA seeks free trade with Europe, while including its neighbouring states in

the Southern African Development Community (SADC) in the deal.

South Africa needs to establish trade integration with the EU as it constitutes three of the

major trading partners of South Africa (Standard Bank, 1993: cited in Marabwa, 1995).

55

In 1991, the five major trading partners were:

TABLE 2

COUNTRY SA EXPORTS TO SA IMPORTS FROM TOTAL

Germany $1940 $2851 $4800

US $1769 $2146 $3915

UK $1718 $1812 $3530

Japan $1830 $1638 $3468

Italy $2586 $683 $3269

Source: Standard Bank, 1993 (Reproduced in Marabwa: 1995)

4.2. PROBLEM AREAS DELAYING THE FORGING OF A TRULY LIBERAL FREE TRADE.

There is no doubt that South Africa presents a problem for the EU, but it is not an

insuperable one if the political will were present to overcome the obstacles. Difficulties

are associated with South Africa's status, with the commodity composition of its current

exports, and with the likelihood of substantial change to these exports in the future

(Stevens, 1996).

South Africa, it has been claimed, is not a typical developing country. Certainly, the

apartheid regime was keen to establish South Africa's credentials as a developed country,

and it is also the case that South Africa's income, productive capacity and

competitiveness in some sectors distinguish it from other African countries (Stevens,

1996). But, the term developing country in EU trade parlance covers a very wide range

of countries. South Korea and Malaysia, for example, are classed as developing

countries, and it is not exactly obvious that South Africa is treated less favourably in

trade terms by the EU than Malaysia or, in some respects, South Korea.

Furthermore, most of the countries that compete with South Africa on the largest number

of products in the European market have a higher level of development as measured by

the UN Development Programme's Human Development Index (HDI) than does South

Africa. More than half of them have generally better terms of access to the European

56

market, although not necessarily on the terms in which they compete with South Africa.

In short, South Africa's problem is not that it is unusually rich to be given access on

terms better than MFN, it is that it is negotiating preferential access at a time when the

EU is not pre-disposed towards liberalisation and without strong allies within the Council

of Ministers. This latter point is important because, as recently as 1995, the EU extended

to Venezuela (a country with a higher GDP per head than South Africa) access terms that

are better than those currently available to South Africa.

South Africa is very unusual in the commodity composition of its exports to the EU.

These fall into one of two categories: those that are insensitive to trade barriers, and those

that are highly sensitive. Although the first category is overwhelmingly the larger in

terms of the value of exports, the second category is the one on which negotiations focus.

The reason for this dichotomy is that during the apartheid period exporters took plans to

ensure that their goods were as invulnerable as possible to sanctions and boycotts. For

this reason, a large proportion (probably more than 90% of the 1993 export value) are

items, often primary and processed primary commodities, that face low or zero MFN

tariffs and no significant non-tariff barriers (NTB). The remainder are concentrated on

agricultural products that are covered by the EU' s Common Agricultural Policy (CAP),

notably deciduous and citrus fruits and vine products. These are sensitive not only

because of the restrictive European trade regime, but also because South Africa's

competitors in the European market are often the non-EU Mediterranean countries that

have their own special preferences which they are energetic in defending.

One study of South Africa's exports to the EU in 1993, which analysed the top 156 items,

identified only 45 products (equivalent to some 6% of the total by value) that were of

potential interest in the current negotiations with the EU by virtue of their importance to

South Africa and the import restrictions (a tariff of more than 5% or an NTB) that they

face in the European market. Four-fifths of these were agricultural products, all of them

sensitive or semi-sensitive. The top items were fresh grapes, oranges, pears, apples,

frozen hake and two industrial products, silicon and phosphoric acid.

57

The limited number of South African exports facing tariff or non-tariff restrictions is

partly a consequence of the country's past. Not only did the apartheid regime try to avoid

exports that were vulnerable to embargoes, but it also created an economic system in

which South Africa became uncompetitive in some of the fastest growing areas of

manufacturing. The first of these legacies has disappeared, and the present regime is

attempting to correct the distortions associated with the second. If it is successful, or so

some European producers fear, the country could emerge as a substantial, highly

competitive exporter of manufacturers, processed industrial products, and a wider range

of agricultural items. It is this apparent uncertainty that seems to set South Africa apart

from countries such as Venezuela, coupled with its undoubted ability to compete at

present in highly sensitive agricultural markets.

Although the problem is real enough, the EU's currently proposed means of dealing with

it seems somewhat wayward. The logical approach would be to propose an agreement

with some form of break clause after an initial period. During the first phase, tariff

reductions might be limited to current exports (perhaps with tariff quotas on the more

sensitive items to cover against sudden surges in the volume of trade) with provision

made for the renegotiation to extend the list in the light of development in the South

African economy. However, the EU's approach appears to be different. It identifies at

the outset the products that are excluded which, of course, requires the list to cover

everything that might be exported in future and create problems.

4.3. ENVISAGED EU-SA FREE TRADE AGREEMENT AND THE WORLD TRADE ORGANISATION (WTO) REQUIREMENTS.

The intention is that the agreement with South Africa be of a form suitable for exemption

from the WTO' s MFN principles under Article XXIV which deals with customs unions

and free trade agreements. Two salient requirements of Article XXIV are that a free

trade agreement must be completed within a reasonable length of time and that duties and

other restrictive regulations of commerce... are eliminated on substantially all the trade

between the constituent territories (The General Agreement on Tariffs and Trade, 1947;

Article XXIV, Part II). The 1994 GATT Uruguay Round provides clarification of a

58

reasonable length of time by specifying that it should exceed ten years only in

exceptional cases (F & T Weekly, 29 August 1997; Stevens, 1996). This view was

reemphasised by Carim (1997) in the light of WTO's flexibility in some of its rules

application.

These requirements pose two problems for the EU-South Africa agreement. The first

concerns the meaning of "substantially all" trade. Given that the great majority (over

90%) of current South African exports to the EU enter either duty-free or with tariffs of

less than 5%, it would seem possible for an agreement that does no more than remove the

residual tariffs on these non-controversial items to meet the target of "substantially all".

But this would leave out an entire sector (agriculture) and mean almost no change in the

status quo as far as the EU import regime is concerned. The question arises whether this

would lay the agreement open to challenge in the WTO. As explained below, this is an

unanswered, and for the moment unanswerable, question but it is clearly justified.

The formal procedure for obtaining WTO approval for a free-trade agreement is that the

parties to the agreement should notify the WTO following signature and, if GATT

precedents are adhered to, this would be followed by the establishment of a working

group. Membership of the working group would be open to any country that felt it to be

in its interests to participate in the procedures. The group would produce a report that

will be adopted by consensus by the WTO.

Although, in principle, a free trade area (FTA) requires universal approval, this was

rarely achieved during the time of the GATT. As of January 1995 a total of 98

agreements had been notified under Article XXIV, but only six (of which only two are

still operative) had been explicitly acknowledged as comforming with Article XXIV. In

other words, the formal requirements for legitimisation of a FTA are high, but in the past

a failure' to achieve these has not proved to be a barrier to those countries wishing to

create one.

59

4.4. IMPLICATIONS OF THE AGREEMENT TO THIRD PARTIES (I.E. NON-PARTICIPATING ECONOMIES).

The approval procedures may nevertheless be a problem for a restrictive EU-South

African accord, and those countries facing worse access to either the EU or the South

African markets are likely to object to it. Any improvement in South Africa's absolute

access to the EU market may involve a potential deterioration in another country's

access. The developing countries most likely to have a case that their interests have been

adversely affected are Morocco, Brazil, Chile, Argentina and Thailand, as these compete

on a similar range of products.

The effect on third parties of an improvement in the EU's access to the South African

market needs to be considered (Stevens, 1996). Although South Africa has agreed to

tariff reductions under the Uruguay Round which are quite substantial for many of the

items the EU and its competitors export, there will continue to be positive MFN tariffs on

most goods and, hence, scope for an FTA to create additional advantages for EU

exporters. An analysis of the top 400 EU exports to South Africa has identified the

European industries most likely to gain from an FTA as motor vehicles, whisky,

pharmaceuticals, computer programmes, telephone apparatus, bottling machinery,

medical instruments, packing machinery, electrical appliances and aircraft parts (Stevens,

1996).

By extending reciprocal better-than-MFN treatment on EU exports to South Africa, any

such agreement would run the risk of provoking opposition from other countries that

export to that market. There is a significant overlap in the commodity composition of

South African imports from the EU and from other countries, particularly other OECD

economies. An accord that provided the EU with preferential access to the South African

market but did not extend similar treatment to the USA might be expected to provoke

opposition in Washington. This view is also being shared by Dr Greg Mills, national

director of the SA Institute of International Affairs, (cited from Business Day: August 18,

1997).

60

4.5. GENERAL OBSERVATIONS

The EU-South African negotiations provide an excellent place from which to observe the

EU's trade diplomacy in the 1990s. Although South Africa may not be the super-

competitive giant as is claimed by some EU policy-makers, its current exports are either

lightly restricted or concentrated on Common Agricultural Policy (CAP) products. In

consequence any deal that would be valuable to South Africa in the short term must

reduce EU protection on goods that are politically sensitive in Europe and for which

South Africans are competitive suppliers. As such it is difficult for the EU to paper over

illiberalism by copious concessions on non-sensitive items.

The evidence so far tends to indicate that there has been a considerable hardening in

attitude by the EU, certainly against non-reciprocal liberalisation, and possibly against

liberalisation altogether on sensitive items. Although the EU emphasis on a so-called

free-trade agreement with South Africa is placed within the context of recent trade

diplomacy, such as the conclusion of Europe Agreement with countries of central Europe

and recent negotiations with some Mediterranean countries, these are not particularly

relevant for South Africa.

There is no prospect of the agreement leading to full EU membership (as in the case of

the Europe agreements) and it does not build upon an existing foundation of wide-

ranging preferences (as with the Mediterranean negotiations). Furthermore, the claim

that a free-trade agreement would be more acceptable to the WTO remains

unsubstantiated. In the absence of any compelling positive arguments to justify the EU's

preference for a free trade agreement there must be a strong suspicion that it is largely

designed to camouflage a reluctance to liberalise market access for products of interest to

South Africa.

61

CHAPTER 5

SOUTHERN AFRICAN DEVELOPMENT COMMUNITY (SADC)

5.1. INTRODUCTION AND BACKGROUND DETAILS

SADC was established in 1992 and is a continuation of Southern African Development

Co-ordination Conference (SADCC) which comprised Angola, Botswana, Malawi,

Mozambique, Namibia, Swaziland, Tanzania, Zambia and Zimbabwe. SADCC was

formed in 1980 largely but not solely, to reduce dependence on South Africa during the

period when South Africa was viewed as a hostile destabilising force in the region

(Mayer, 1995: 08). South Africa was granted membership during the political

transitional phase. Business Day (1997, September 16) states that the Democratic

Republic of Congo (formerly Zaire) joined SADC in mid September 1997.

Presently SADC is negotiating a trade protocol which will create a preferential trade area.

SADC members agreed in September 1996, to work towards a free trade area by 2004

(Business Day: 1997, September 02). SADC embarked in the process of discouraging

bilateral trade agreements which existed between some member states in favour of

multinational ones. SADC executive staff argues that bilateral trade arrangements create

a massive amount of trade imbalances.

Carim (1997: 347) states that the South African support for regional integration in

Southern Africa rests on the view that:

its national interest demands economically and politically stable neighbours;

the region is an important market for South African manufactured exports;

South Africa will increasingly have to rely on its neighbours for water and energy

supplies;

Foreign investors, donors and multilateral institutions are linking their support to

South Africa on the willingness of the latter to play a positive role in the region

(Davies, Keet and Nkuhlu, 1993: 20).

62

The objective of promoting regional economic development and security emerges from

the view that the destiny of South Africa is intimately tied to that of its Southern African

neighbours. In essence, the South African approach to SADC negotiations:

aims at creating an asymmetrical free trade area over eight years on the basis of

sectoral agreements

recognises the need for variable speeds in dismantling barriers to trade among

individual countries in the region and among different sectors

seeks to link regional trade development to regional industrial restructuring and to

promote new investment in infrastructure and production (that is, to improve

supply capacity across the region)

recognizes the special problems faced by the least developed members of SADC

Carim (1997: 349) highlights that it is important to acknowledge that the current SADC

negotiations are occurring in the wider context of the re-negotiations of the Southern

African Customs Union Agreement (SACUA), and the negotiations between the

European Union and South Africa around the terms and conditions of a cross-continental

free trade area. The objective of re-negotiating the SACUA is to restore the integrity of

the customs union as Lesotho, Botswana, Namibia, Swaziland and South Africa

constitute a single market. This is important because South Africa's engagement in the

SADC negotiations is premised on a common SACU position.

An additional complicating factor in the SADC negotiations has been the simultaneous

free trade area negotiations between South Africa and the European Union. SADC

countries are likely to lose any preferential position they obtain in the South African

market if they have to compete on an equal basis against highly competitive and often

subsidised European Union exports.

A free trade area with the European Union will also erode the customs revenue on which

some SACU members are heavily dependent. Given this scenario, it is widely expected

that South Africa and SADC countries will bear most of the adjustment costs that a free

trade area with the European Union would imply.

63

For these reasons, South Africa has proposed an asymmetrical agreement with the

European Union. This would entail a longer phase in period for South African tariff

reductions as compared to those of the European Union. Moreover, the European Union

will be encouraged to open up a greater percentage of its market to South Africa than

South Africa is required to open up to the European Union. South Africa's objectives

also require, amongst other things, any agreement with the European Union is

synchronised with the SADC trade protocol so as not to hamper the efforts at regional

integration. This is likely to require that, in the context of clear regional growth and

development strategies for each sector, SADC partners obtain preferential access to the

South African market before it is extended to the European Union.

5.2. EMPIRICAL EVIDENCE ON THE CURRENT TRADE PATTERNS WITHIN SADC

Mayer and Thomas (1997: 337) argued that although intraregional trade is an objective of

economic integration, it should not be seen as a substitute for extraregional trade. The

two forms of trade should complement one another, and trade integration in the SADC

should aim to enhance the volume and nature of both extra and intraregional trade.

Competition among firms in the region, should, in fact, stimulate extraregional exports.

5.2.1. Extraregional trade

The nature of extraregional trade is decidedly neocolonial. Table 3 provides data on the

nature of exports from non-SACU SADC member countries and South Africa. Given the

production structure in SADC member countries, which is characterised by an

underdeveloped industrial sector, it follows that all countries in the region, including

South Africa, are heavily dependent on exports of primary agricultural and mineral

commodities, as the table illustrates.

64

Table 3: Structure of exports by SADC countries (by main categories of export products %)

Country Total exports $ millions

All foods Agricultural materials

Fuels Ores and metals

Manufa cturers

Unallocated

Angola 1 296,4 16,4 0,3 82,1 - 1,0 0,2 Malawi 417,6 90,5 3,2 - 0,1 4,8 1,4 Mozambique 101,1 65,7 4,0 0,1 12,1 17,5 0,7 South Africa 18 968,8 13,6 9,2 13,9 26,4 34,4 2,5 Tanzania 284,9 49,2 22,4 1,5 14,5 11,8 0,5 Zambia 1 347,6 3,9 1,4 0,1 83,4 11,2 0,1 Zimbabwe 1 467,6 44,1 7,3 0,7 15,9 30,9 1,1 All Sub-Saharan Africa 53 688,4 18,5 8,3 36,3 16,6 18,8 1,5 All developing Countries 708 947,0 11,4 3,3 26,0 4,2 53,9 1,2 Source: World Bank (1996) (Reproduced in Mayer and Thomas (1997)

In total, mineral exports comprise two thirds of the SADC's exports. The table shows

that only South Africa and Zimbabwe have sizeable manufacturing sectors of any

significance and in addition, their exports of manufactured goods are destined mainly for

other countries in the region. Manufactures constitute no more than 10 per cent of

exports in Africa, including Southern Africa, and most of these exports are low-value

consumer items and other light manufactures traded intraregionally among neighbouring

countries (United Nations, 1993: 64).

Table 4 provides a breakdown of primary commodity exports by country. Zimbabwe is

least dependent on primary commodities, which nevertheless account for almost 60

percent of total exports. Countries like Angola, Botswana and Malawi rely

overwhelmingly on a single commodity.

65

Table 4: Major exports of SADC countries, 1993

Country Commodities as a Primary products and % of total exports % of total exports

Angola 95,4 Oil (86%), Coffee (4%), diamonds (1,6%) Botswana 98,0 Diamonds (88,2%), copper/nickel (7,5%), beef (4,4%) Malawi 93,4 Tobacco (75,6%), sugar (6,1%) Mozambique 76,3 Fish (27%), cashew nuts, sugar, cotton Tanzania 79,3 Coffee (24,8%), cotton (22,9%), cashew nuts (1,6%),

Sisal (4,8%), Manufacturers (4,9%), Minerals (5,6%), Petroleum (n/a) Zimbabwe 56,9 Tobacco (20,2%), gold (14%), ferrochrome (9%), maize (6%) Zambia 90,0 - Copper (84%), cobalt (n/a), zinc (n/a) Namibia 95,0 Uranium (24%), diamonds (40%), base metals (n/a), beef (n/a),

mutton (n/a), lamb (n/a), hides (n/a), pelts (n/a), karakul (n/a), fish (n/a) South Africa 70,0 Precious and semi-precious metals (12,7%), base metals (12,4%),

mineral products (10,6%), chemical products (4,2%), machinery and appliances (3,5%), motor vehicles & parts (3,4%), vegetable products ( 3 %)\

Source: Oxfam (1993) (Reproduced in Mayer and Thomas, 1997)

South Africa's export profile is fairly diversified when compared with that of other

SADC countries. However, when compared with developing countries in Asia and Latin

America, South Africa performs poorly in terms of the range of products it exports.

Primary products account for around two thirds of South Africa's total exports and

manufactures for less than one sixth. Moreover, most of the latter are destined for the

regional market.

In terms of export markets, primary commodity exports are channelled mainly to markets

outside Africa, especially those of the Organisation for Economic Cooperation and

Development (OECD) (Cockcroft, 1993: 230). Table 5 provides a breakdown of the

direction of exports for individual SADC countries. Apart from Angola, whose main

trading partner is the United States, and Mozambique, where the majority of exports is

destined for developing countries-the EU is the region's largest export market, as alluded

to earlier. In contrast, Africa is only a marginal destination for exports.

66

Table 5: Direction of SADC exports (1991 or most recent data) Countries World $

(millions) %

Europe

%

North America

%

Japan

%

Developing countries

%

Africa Other developing countries

Angola 3 105,4 25,1 52,6 0,1 20,8 1,5 1,4 Malawi 454,0 46,9 16,5 10,0 13,6 9,5 13,0 Mozambique 239,8 31,3 13,0 6,7 48,8 12,0 0,2 South Africa 17 052,0 55,2 12,4 10,8 15,3 6,1 6,3 Tanzania 404,0 59,4 4,5 4,5 30,7 7,1 0,9 Zambia 1 347,5 34,5 1,6 29,1 21,8 11,9 13,0 Zimbabwe 1 467,6 44,1 7,3 5,5 23,9 17,2 19,2 All Sub-Saharan 5,7 Africa 54 657,2 51,2 22,1 5,6 15,4 7,5 5,7 All developing countries 708 947,0 25,5 24,0 12,0 27,2 2,6 11,3

Source: World Bank (1995) (Reproduced in Mayer and Thomas, 1997)

According to Mayer and Thomas (1997: 340), reliable and comprehensive data on

imports are not available for SADC member countries. Table 6 below provides only a

broad overview of these countries main imports and trading partners, and should not be

seen as decisive. South Africa and to a lesser extent, Zimbabwe is a prominent source of

imports for the region.

A scrutiny of the composition of imports suggests that they are concentrated in

manufacturers and capital goods. Given the dominance of primary commodities in the

SADC regions productive base, it is not surprising that most countries in the region

(excluding South Africa) are not capable of producing a sufficient quantity of

manufactured goods for their own use and hence need to import them. Indeed,

manufactured goods account for approximately 70 percent of regional imports.

67

Table 6: Main imports and trading partners of SADC countries Country Main imports and trading partners

Angola Capital equipment, foodstuffs, vehicles/parts, textiles/clothing, medicines (United Sates, Cuba, Portugal, Brazil)

Botswana Foodstuffs, vehicles/transport equipment, textiles, petroleum (South Africa,

Switzerland, United Kingdom, United States)

Lesotho Manufactured products, live animals, machinery, transport equipment, textiles, petroleum (South Africa) Malawi Machinery, manufactured products, construction/transport equipment, petroleum (South Africa, Zimbabwe,

United Kingdom, Japan) Mauritius Not available - Mozambique Tea, tobacco, manufactured products, petroleum, machinery, (South Africa, Zimbabwe, Saudi Arabia, United

Kingdom, Portugal) Namibia Foodstuffs, vehicles, machinery, chemicals/plastics, petroleum (South Africa) South Africa Machinery, motor vehicles, textiles, chemicals, oil, scientific instruments and metals (Germany, United States,

Japan) Swaziland Manufactured products, machinery, petroleum, food products, (South Africa) Tanzania Manufactured products, machinery, petroleum, food products, (Saudi Arabia, United

Kingdom, Zimbabwe, Japan) Zambia Consumer goods, machinery, transport equipment, food, fuel (South Africa, United

Kingdom, Zimbabwe, Japan) Zimbabwe Petroleum, finished manufactured goods and equipment, machinery/transport, chemicals

(South Africa, United Kingdom, Japan, United States, Germany)

Source: Bronstein et al (1996) (Reproduced in Mayer and Thomas,I997)

Although South Africa features as an important source of imports for all SADC countries

(except Angola and Tanzania), it does not substantially alter low levels of intraregional

trade, as these countries are small importers relative to South Africa and hence relative to

SADC aggregates.

5.2.2. Intraregional trade

A lack of reliable data, coupled with the substantial amount of unrecorded trade in the

region, makes it impossible to arrive at conclusive estimations of intraregional trade

patterns. The general trends, however, conform to those found by the African

Development Bank study (ADB, 1993), and hence it may be assumed that very little has

changed since then.

While the economies of the region are relatively open, as evidenced in the foregoing

discussion of extraregional trade, the current volume of intraregional trade as a

proportion of total trade is very small and is significant only among the SACU subset of

68

countries. Non-SACU intra-SADC trade accounts for less than 4 percent of the total

trade of these countries. However, once intra-SACU trade is included, the significance of

intraregional trade increases substantially. These intraregional trade patterns reflect the

fact that while the SACU has historically provided an institutional framework to facilitate

trade, the SADC has not.

In general, intra-SADC trade is characterised by unprocessed primary commodities being

exported to South Africa and Zimbabwe, and manufactured goods and semi-processed

intermediate goods being imported from here. There is also considerable cross-border

trade in tourist and business services, mainly in favour of South Africa. These trends are

not surprising, given the lack of complementarity of the production structures of the

individual economies, and the fact that only South Africa and Zimbabwe have industrial

capabilities of any significance.

The direction and volume of trade flows in the region are dominated by South Africa. In

1995, the ratio of South Africa's exports to imports stood at 7,4:1, resulting in a massive

trade surplus for this country. It is widely held that such a surplus is unsustainable, both

within South Africa and in the rest of the region (Mayer and Thomas, 1997).

Clearly, the current situation is neither in South Africa's nor the region's long term

interests. As a result, the potential for de-industrialisation in these weaker economies is

very real, and impoverished countries do not make for strong trading partners. There is

also the strong possibility of negative economic spillovers and mass labour migration into

South Africa.

South Africa's accession to the SADC in 1994 has had profound impact on intraregional

trade patterns. Indeed, it is the only economy that is linked to all other SADC countries

in terms of trade. As South Africa is likely to play a pivotal role in endeavours to foster

trade integration in the region, trade patterns between this country and other SADC

countries warrant scrutiny.

69

5.2.3. South Africa-SADC trade

Mayer and Thomas (1997) argue that as reliable and up to date data on South Africa's

trade with the region are available, an analysis of such trade provides a reasonably

accurate account of intraregional trade. The analysis is however, obscured by the fact

that South Africa does not publish separate data on its trade with SACU countries, and

instead records SACU trade with the rest of the world. Nevertheless, a breakdown of

such data for 1993 enables the analysis of trade patterns to factor in South Africa's trade

with SACU.

In 1993, South Africa's exports to the SACU accounted for approximately 13 percent of

total exports while non-SACU SADC countries accounted for 6 per-Cent of South Africa's

total exports. In terms of imports, the volumes are considerably lower, with SACU

countries accounting for 5 percent of South Africa's total imports and non-SACU SADC

countries for a mere 2 percent (Davies, 1996: Bronstein et al, 1996).

Clearly, the existence of the SACU and the CMA, coupled with a regional structure of

production characterised by significant complementarities between South Africa and the

other SACU countries, has profoundly influenced the spatial distribution of trade in the

region in favour of SACU countries. Indeed, in 1993 South Africa's exports to SACU

countries amounted to R15 billion, which is more than its exports to either Asia or North

America.

The most salient feature of South Africa's trade with non-SACU SADC countries is the

very high ratio of exports to imports (7,4:1 in 1995), resulting in a massive trade surplus

with the region (R9.2 billion in 1995). Table 7 provides a breakdown of South Africa's

exports to individual non-SACU SADC countries. The data show that South Africa's

total exports to the region increased by 59 percent between 1994 and 1995, i.e. from 7,5

to 10,6 percent of total trade.

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Table 7: South Africa's exports to non-SACU SADC countries

Country Rank (in Africa) Exports 1995 (R)

% change from 1994

% of Africa exports

1995 1994 1995 1994

Zimbabwe 1 1 4 442 940 609 85 32,6 28,5

Mozambique 2 2 2 237 168 969 59 16,1 16,3

Zambia 3 3 1 366 769 605 18 9,8 13,4

Malawi 6 5 696 067 179 12 5,0 7,2

Mauritius 7 6 685 593 954 27 4,5 2,1

Tanzania 8 9 627 596 556 243 4,5 2,1

Angola 9 8 490 233 808 57 3,5 3,6

SADC 10 646 370 680 59 76,5 77,6

World 100 657 466 241 13 945,5 1 330,7

SADC as a % of the world 59 10,6 7,5

Africa as a % of the world 13,8 9,7

Source: Department of Trade and Industry (1996) (Reproduced in Mayer and Thomas, 1997)

Zimbabwe is South Africa's largest non-SACU SADC trading partner-exports there

showed a dramatic increase of 85 percent between 1994 and 1995. It should, however, be

noted that such trade has historically occurred in the context of a bilateral trade

arrangement between the two countries. The data reveal that apart from Zimbabwe,

Mozambique and Zambia, South Africa's exports to non-SACU SADC countries are not

very substantial.

Of great significance is the composition of South Africa's exports to non-SACU SADC

countries. Non-SACU SADC countries are the destination for the following proportions

of South Africa's total exports: one third of machinery and appliances, one quarter of

motor vehicles, 21 percent of chemical products, 39,1 percent of plastic and rubber

products, 16,9 percent of foodstuffs and beverages, and 13,8 percent of textiles and

clothing (Davies, 1996).

Indeed, many analysts have drawn attention to the striking contrasts between South

Africa's profile of exports to Southern African countries and her exports to other regions

71

of the world. Southern Africa is the only region to which South Africa's exports are

manufacturers rather than primary products. The nature of South Africa's trade with the

region is clearly related to its structure of production. In contrast to the poor trade

potential among many Southern African countries, there is a great deal of

complementarity between the South African economy and its neighbours. In some ways

the SADC countries trade with the northern countries is similar to their trade with South

Africa. The African market is clearly very important for South African manufactures.

Although a large part of South Africa's manufacturing sector is uncompetitive,

preliminary evidence suggests that the country's geographical proximity to the regional

market is an important factor in its ability to compete with third suppliers of certain

products. In particular, cheaper cost, insurance and freight plays a role. Licensing

agreements which allow South Africa to export certain products to the region, but not to

the international market, are also important.

Various studies show considerable potential for the non-SACU SADC countries to switch

supply from third countries to South Africa. The region should, however, endeavour to

avoid a kind of 'hub and spoke bilateralism', with South Africa at the centre and the

neighbouring economies in a supporting role (Cassim & Sethai, 1994). Moreover, if

increases in the volume of exports to these countries continue at the current rate without

compensatory increases in either South Africa's imports from the region or capital flows

to the region in the form of investment, the prevailing trade imbalance in the region will

be exacerbated.

Table 8 provides a breakdown of South Africa's imports from individual non-SACU

SADC countries. The data clearly illustrate that the gap between South Africa's exports

to and imports from the region has grown substantially between 1994 and 1995, imports

declined marginally. Moreover, non-SACU SADC countries share of South Africa's

imports declined both in relation to Africa (from 68,4 to 54,6 percent between 1994 and

1995) and relative to the rest of the world (from 1,9 to 1,47 percent between 1994 and

1995).

72

Table 8: South Africa's imports from non-SACU SADC countries Country Trade Rank (in Africa) Exports 1995 % change

{R} from 1994 % of Africa

exports

1995 1994 1995 1994

Zimbabwe 1 1 R 964 102 209 -6 36,5 48,7

Malawi 4 3 R203 409 558 10 7,7 8,8

Mozambique 6 5 R117 009 287 27 4,4 4,4

Zambia 8 4 R95 186 010 -8 3,6 4,9

Mauritius 10 13 R34 803 314 130 1,3 0,7

Tanzania 14 12 R15 420 760 -3 0,6 0,8

Angola 24 11 R3 487 962 -79 0,1 0,8

SADC RI 433 419 100 0 54,6 68,4

World R97 362 538 123 29 6 792,3 5 262,0

SADC as a % of the world 1,47 1,9 Africa as a % of the world 2,7 2,8

Source: Department of Trade and Industry (1996) (Reproduced in Mayer and Thomas, 1997).

South Africa's imports from Zimbabwe, Zambia and Tanzania decreased marginally

between 1994 and 1995, while imports from Angola decreased by a spectacular 79

percent during the same period. With the exception of Zimbabwe and Mauritius, the rank

(in terms of African suppliers) of all non-SACU SADC countries decreased.

The foregoing discussion of the production structure of the regional economies and their

membership of regional groupings goes a long way in explaining these trends, as does the

progress made in tariff liberalisation under structural adjustment programmes (SAPs).

Coupled with South Africa's more diversified production structure and its ability to

compete with third countries in manufacturing exports, rapid tariff liberalisation in non-

SACU SADC countries (in the context of SAPs) has allowed South Africa increased

access to these countries markets. For non-SACU SADC countries, this process has not

been balanced by either enhanced access to the South African market or a significant

increase in capital flows from South Africa.

The patterns of trade between South Africa and the rest of the region, as well as the

growing inequities in such trade, have occurred in the absence of any regional trade

73

arrangements. Until recently, cooperation among SADC member countries has taken the

form of sectoral integration and therefore has neglected trade integration. In August

1996, all member countries were signatories to a trade protocol to foster trade integration

(Mayer and Thomas, 1997). The critical issue is whether the protocol provides an

adequate framework to redress the current inequitable trade relationship in the region by

eliminating obstacles to intraregional trade.

5.3. THE SADC TRADE PROTOCOL

Mayer and Thomas (1997: 344) state that the SADC trade protocol, a framework

agreement, was adopted by heads of states at the SADC summit meeting in August 1996.

In the context of WTO rules, it may be defined as an interim agreement leading to the

establishment of a FTA. The protocol will enter into force following ratification by two

thirds of the member states. Thus far only two countries have ratified it-Mauritius and

Tanzania.

In essence, the trade protocol is designed to facilitate intraregional trade, move towards a

free trade area in Southern Africa, remove tariff and non-tariff barriers, encourage

regional banking that will facilitate access to trade credit and letters of credit, simplify

documentation and customs procedures, as well as lay the foundation for more

comprehensive agreements in the future.

The stated objectives of the trade protocol are as follows:

To further liberalise intraregional trade in goods and services on the basis of fair,

mutually equitable and beneficial trade arrangements complemented by protocols in

other areas.

To ensure efficient production within the SADC, reflecting the current and dynamic

comparative advantages of member states.

To contribute towards the improvement of the climate for domestic, cross border and

foreign investment.

To enhance the economic development, diversification and industrialisation of the

region.

74

■ To establish a free trade area in the SADC region.

Article 2 makes provision for the involvement of the business community in the

implementation of the protocol. It calls for member states to develop and implement

trade development policies in close cooperation with the private sector, to facilitate the

formation of private sector business associations and, in collaboration with the business

community, to encourage and facilitate the creation of small and medium enterprises and

promote their participation in trade. If effectively implemented, this aspect of the

protocol is to be lauded as it is the first concrete attempt to involve the private sector in

the SADC' s economic integration agenda.

The protocol sets a period of eight years for the elimination of tariff barriers and

quantitative restrictions, and calls for measures to eliminate non-tariff barriers. However,

reductions in tariffs are flexible, as evidenced by article 3:1c, which provides that

member states who believe they may or have been adversely affected by the removal of

tariff and non-tariff barriers to trade, may, upon application to the CMT (Committee of

Ministers on Trade), be granted a grace period to allow them additional time for the

elimination of such tariffs and non-tariff barriers.

The protocol precludes members from granting new subsidies that threaten to distort

competition but allows them to keep existing specific commodity subsidies. Goods in

transit will not be subject to any duties and only need to pay the 'normal rates' for any

services rendered. Competition policy is dealt with in Article 25, which exhorts member

states to implement measures within the community that prohibit unfair business

practices and promote competition in keeping with other international trade agreements,

there are anti-dumping provisions.

Infant industries can be protected temporarily. The protocol does not impose specific

restrictions on the time duration or the nature of the protection. A country may also

restrict imports if an item is being imported in such increased quantities...as to threaten

to cause serious injury to a domestic industry.

75

Sanitary and phytosanitary measures, as well as standards and technical regulations on

trade, are to be harmonised. Rules of origin are dealt with in a lengthy, complicated

annexure to the protocol. The protocol calls for trade in intellectual property, trade-

related investment measures and trade in services to fall under WTO regulations (Mayer

and Thomas, 1997).

The proposed FTA will have to conform to Article XXIV of the General Agreement on

Tariffs and Trade (WTO), which prescribes rules for the establishment of FTAs and

customs unions. Article XXIV 8b requires an FTA to eliminate duties on substantially all

trade between its members, and member states can maintain external tariffs at the same

level as before the FTA. In addition, Article XXIV 5b requires that members duties and

regulations of commerce should not be higher or more restrictive than those in existence

prior to the formation of the FTA (Kumar, 1995).

5.3.1. Shortcomings and pitfalls of the trade protocol

Thomas (1996) argues that as a policy framework, the trade protocol emerges as deficient

in four areas:

It fails to provide for differential treatment for least developed member states.

It emphasises tariff barriers to trade when they are not the main obstacles to

intraregional trade.

There are no provisions which address supply-side measures (in particular, the link

between trade and investment).

Provisions to foster equitable industrial development in the region are inadequate and

there are no compensatory mechanisms.

In the context of a regional grouping which comprises states at vastly disparate levels of

economic development-and where prevailing trade imbalances are unsustainable-the

trade protocol fails to provide preferential treatment for member states categorised by the

WTO as least developed countries (LDCs). It is surprising that while the GATT legal

system recognises LDCs as a special category of states, and the various agreements of the

76

Uruguay Round enshrine the right of LDCs to differential and more favourable treatment,

the trade protocol makes no allowances for special or differential treatment of member

states which have the status of LDCs.

While the preamble to the protocol states that the high-contracting parties are mindful of

the different levels of economic development of the member states of the community and

the need to share equitably the benefits of regional economic integration, this sentiment is

not incorporated in its provisions.

The right to differential and more favourable treatment as LDCs has, in fact, been

diminished by the protocol. Laying down unified equal rules amounts to treating equally

those who are unequal. The absurdity of this situation becomes clear when one

juxtaposes, for example, Mozambique and Malawi against the economies of either South

Africa or Zimbabwe.

Mayer and Thomas (1997: 347) argue that there are four areas in which the protocol has

diminished the gains made by LDCs during the Uruguay Round of the WTO in the

regional context: tariffs on agricultural goods; export subsidies; standards with respect to

technical regulations, textiles, clothing; and the elimination of tariffs. Taking away rights

granted to LDCs in terms of international trade laws in the regional context appears to be

inimical to their economic development.

Indeed, the failure to provide differential treatment of LDCs in a region as disparate as

Southern Africa is tantamount to admitting that economic development will be polarised

in the more developed member countries (South Africa and Zimbabwe) to the detriment

of their least developed regional partners. While it has been argued that labour

legislation in South Africa, coupled with lower wages in other SADC countries, may

result in labour-intensive industries relocating from the former to the latter, there is a

range of other factors (poor infrastructure, undeveloped financial markets, lack of skilled

local personnel, bureaucratic barriers to Foreign Direct investment (FDI), etc) that

mitigate against such an outcome.

77

A further flaw in the trade protocol is that its focus is on the elimination of tariff barriers

to trade. These are not, however, the primary obstacles to more intensive economic

integration in the region, for two reasons:

First, the existing schedule of tariffs applies in theory but not in practice. There are

large differentials between tariffs that are levied and those that are actually collected

because of the ineffective administration of customs at border posts-inter alia, due to

endemic misrepresentation and misclassification in bills of lading for imports.

Second, the African Development Bank study (ADB), 1993) found that it is not tariff

barriers, but non-tariff barriers that constitute the primary obstacle to enhanced

intraregional trade.

The protocol also does not go far enough in framing concrete measures to eliminate non-

tariff barriers. Article 6 of the protocol merely exhorts members to adopt policies and

implement measures to eliminate all types of non-tariff barriers and not to impose any

new ones. It is silent on specific commitments and a timetable for the tariffication of

non-tariff barriers.

The protocol's undue emphasis on tariff barriers and its failure to address the elimination

of non-tariff barriers to trade in the region are likely to frustrate its objective of removing

impediments to intraregional trade to increase such trade flows.

By focusing on the elimination of tariffs, the protocol aims to implement demand side

measures to enhance intraregional and foster industrial diversification and development

in the region. Since the key impediment to intraregional trade is the very structure of

regional economies production, the protocol should have made provisions for supply-side

measures to encourage industrial restructuring and diversification.

Although demand-side measures provide an opportunity for SADC countries to develop

industrially by enabling them to achieve economies of scale, if their ability to do so is

hindered by supply-side constraints, access to a larger market becomes meaningless.

78

One critical supply-side measure that is not adequately dealt with by the protocol is that

of investment. Given the well-established link between trade and investment, it is

surprising that the protocol fails to link the two. The prevailing low levels of domestic

and foreign investment will clearly be an impediment to a programme to develop and

diversify the region's industrial capacity, unless they are addressed at both a regional and

national level.

A further flaw in the trade protocol is its failure to adequately link trade integration to

industrial development (Mayer and Thomas, 1997: 348). The primary rationale for

regional integration in developing countries is industrial development and trade

integration is a necessary, but not sufficient, condition for such integration. In this

regard, the protocol's weaknesses lie predominantly in what it fails to pronounce upon.

First, there is the lack of concrete measures to direct a regional industrialisation

programme, particularly the failure to give meaningful recognition to the critical

relationship between trade and industrial development. Second, there is the absence of

measures to ensure the equitable spatial location of industry across the region,

particularly measures to counter industrial polarisation and/or compensate countries that

incur costs by virtue of their less developed industrial base.

5.4. WHAT WILL BE THE EFFECTS OF THE PROPOSED SADC FREE TRADE AREA ON PARTICIPATING COUNTRIES (IN THE CONTEXT OF THE NEW TRADE THEORY) ?

Cattaneo (1998: 115) states that there is a growing literature that addresses the question

of the effects of trade in an imperfectly competitive setting, which suggests the possibility

of benefits from trade significantly in excess of those associated with the conventional

gains from trade, largely because of economies of scale. This literature stresses the role

of market imperfections such as oligopoly, non-constant production costs, product

differentiation and the prospect of intra-industry specialisation, all of which are clearly

pervasive features of the real world.

79

It has been suggested that the dynamic effects of integration, namely, the possible ways

in which integration may affect the rate of growth of GNP of the participating countries,

are of considerable importance, particularly in the developing country context (Jaber,

1970-71: 256; cited in Cattaneo, 1998).

Cline (1982: 233) argues that possible benefits from economies of scale constitute one

major economic motive for integration. But however, there appears to have been no

serious attempt to incorporate the question of potential benefits from economies of scale

systematically into the debate on trade integration in southern Africa (cited in Cattaneo,

1998). Cattaneo (1998) states that it is often argued that the enlarged market in a regional

union between countries of unequal size or levels of development will, in sector where

scale economies are important, mainly benefit producers in the larger countries, who are

likely to capture the entire union market. Thus in the case of SADC, any gains from the

exploitation of regional economies of scale would be likely to accrue, to South Africa, to

the detriment of its smaller partners.

However, it appears that whether large or small countries will benefit (lose) most in terms

of increased exports (imports) is controversial. In his study of economies of scale and

economic integration in Latin America, Cattaneo (1998: 127) states that "it is the smaller

countries that stand to benefit the most to gain from regional economies of scale".

Cattaneo (1982: 127) suggests that most countries would benefit from economic

integration as a way of achieving a market size sufficient to exploit economies of scale.

However, the magnitude of these gains depends not only on the size of the domestic

market relative to minimum efficient scale, but also on the degree of excess cost caused

by producing at below optimal scale.

Cattaneo (1998: 127) calculates this excess cost by estimating the unit cost of producing

for the domestic market relative to the unit cost of producing for the regional market. He

finds that the highest excess costs occur in small countries, in products which require

large market size and which have high excess cost at low scale. Small countries therefore

stand to gain the most from production for the regional market because they incur higher

80

excess costs than the large countries by producing for their domestic markets at below

minimum efficient scale.

Cattaneo (1998: 128) indicates that although the smaller countries would potentially

stand to gain the most because of the higher excess cost of operating at below optimal

scale, the effect of increased competition from larger partners in a regional union will be

significant. The suggestion that smaller countries specialise in sectors with smaller

returns to scale thus appears to be made in an attempt to shed light on "the kinds of

intraregional trade, that could emerge to provide benefit to both groups of countries.

There may evidently, be gains from economies of scale even in these sectors since, if

scale is important at all in a given sector, research has shown that the degree of returns to

scale is very high at small scale, and then, diminishes as larger scale is reached.

Firms in larger countries can then be left to specialise in activities requiring greater scale,

so that both groups of countries may benefit from economies of scale in a larger regional

market. It is quite clear that there are benefits to be derived from the exploitation of

economies of scale in an integrated regional market. Further, it seems that it cannot be

concluded, a priori, that the enlarged market in a regional union among countries of

unequal size and levels of development will, in sectors in which scale economies are

important, mainly benefit producers in the larger countries.

With regard to SADC, it seems improbable that no actual or potential industrial

production of SADC members, in any individual sector, involves significant scale

economies. In the case of South Africa, for example, using the OECD classification of

manufacturing industries, Nordas (1996: 719) finds that as much as 70 percent of

manufacturing value added is either resource intensive (38 percent) or scale intensive (33

percent). Since the resource intensive industries also happen to be largely scale intensive,

there appears to be a significant potential to exploit economies of scale, given access to a

larger market. Nordas (1996: 730) argues that the poor productivity and growth

performance of a number of sectors in South African manufacturing industry can be

explained in part by unexhausted economies of scale due to a small and stagnant

81

domestic market. According to Nordas (1996: 729), "the scale-intensive industries in

South Africa are far from the point where economies of scale are exhausted and potential

gains from this source are substantial.

If this is the case, then the essential question is whether the demand of other SADC

countries, in sectors in which scale economies are important, is large enough to make a

significant difference to the scale at which South African plants operate when they supply

the SADC market. The answer would involve determining the size of the regional

market relative to the size required to achieve minimum efficient scale, as Behar (1991)

has done for Latin America. Estimates of the cost reduction benefits of integration could

then be obtained by estimating the unit cost of producing for the domestic market relative

to the unit cost of producing for the regional market.

For the smaller SADC countries, it may seem less likely that scale economies could be

important. However, a study by Pearson and Ingram (1980) of the welfare effects of

integration between Ghana and the Ivory Coast, based on the Corden (1972) framework,

finds that both countries receive significant gains from cost reduction, due to economies

of scale in industries which expand on union. According to Pearson and Ingram (1980:

1002), the widespread presence of under-utilised capacity in the industrial sectors of

Ghana and the Ivory Coast provides a basis for significant economies of scale. Using

individual firm data from the industrial sectors of the two countries, estimates are made

of per unit cost reductions from expanding production to serve the regional market.

These cost reduction effects are found to be significant in a number of sectors. The

overall welfare gains from integration for Ghana and the Ivory Coast are roughly 33 and

22 percent, respectively, of the value of pre-integration gross output in world prices.

About one-fifth of these gains have their source in Corden's (1972) cost reduction effects

(Pearson and Ingram, 1980: 1007).

If it is possible, as this discussion suggests, that scale economies could be important in

some sectors in both South Africa and the smaller SADC countries, an indication of

relative cost competitiveness in these in the different countries would be important in

82

determining the distribution of any gains from this source. Using a competitiveness

index based on relative labour productivity and labour costs in South Africa and the

United States (US), Nordas (1996: 725-728) finds that, in terms of this index, relatively

competitive sectors vis-à-vis the US are non-ferrous metals, iron and steel, paper and

printing, and shipbuilding, all of which are either resource-intensive (non-ferrous metals)

or scale-intensive (the remainder). The African Development Bank (1993b: 279-282)

provides some measures of the relative competitiveness of South African and

Zimbabwean industry, which suggest that Zimbabwe could compete with South Africa in

some sectors in which scale economies are likely to be significant, such as paper, iron

and steel, and foodstuffs.

Cattaneo (1998: 132) highlights that trade integration will lead to increased intra-industry

specialisation among member countries. It is argued that the inability of orthodox

customs union theory to incorporate the possibility of intra-industry trade stems from the

assumption of homogeneous products, which precludes a country from exporting and

importing the same good. Relaxation of this assumption, enabling the recognition of

product differentiation and consumer demand for variety, together with the incorporation

of scale economies, allows for the prospect of intra-industry specialisation and trade in

differentiated goods. According to Krugman (1982: 197-198), this creates the possibility

for reciprocal tariff reductions to lead to increased sales within an industry by producers

in both countries, so that a particular country may expand both its imports and exports in

a specific sector, which could in turn make trade liberalisation relatively easy to achieve.

With regard to the welfare effects of intra-industry specialisation, Cattaneo (1998: 139)

states that they can be explained, firstly, in terms of the gains from trade in differentiated

goods and, secondly, in terms of the implications of intra-industry specialisation for the

costs of adjustment to trade liberalisation.

According to Gray (1973: 27), the gains from trade in differentiated products are to be

found in the wider choice offered to consumers in the different nations, in the

possibilities of an exchange of scale economies among nations, and perhaps the most

83

important, in the exposure to foreign competition of domestic industries. The gains from

intra-industry trade arising from the availability of a greater variety of products and the

exchange of scale economies have been highlighted by Krugman (1979, 1981) and

Greenaway (1982). Further, Greenaway (1982: 51) argues that the X-efficiency gains

emphasised by Gray (1973: 27) may particularly follow increased intra-industry

exchange when autarkic or protected markets are oligopolistic or monopolistic.

Perhaps more interestingly, it has been suggested that the costs of adjustment to trade

liberalisation are likely to be less if tariff reductions lead to intra-industry rather than

inter-industry specialisation (Balassa, 1979: 267; Krugman, 1981, 1982; Greenaway,

1982: 52; Behar, 1991: 532-533). For example, Behar (1991: 533) argues that although

inter-industry specialisation may be efficient in the long run, "it necessarily produces

serious dislocation in both production and employment in the short run". On the other

hand, the adjustment process would be less disruptive with intra-industry specialisation.

There are two aspects to this view.

Firstly, it may be argued that, in the case of goods which are substitutable in production,

it will be easier for firms to switch between the production of close varieties than to

reallocate resources to another type of industry (Willmore, 1979: 201; Caves, 1981: 204;

Behar, 1991: 533). Caves (1981: 204), for example, suggests that "the growth of intra-

industry trade is attractive as a process of adjustment, because production can become

more efficient without a high concurrent cost of transferring factors of production to

different locations and lines of work".

Secondly, the distributional effects of trade liberalisation may not be so dramatic under

conditions of intra-industry specialisation. The Stolper-Samuelson theorem predicts that,

in the case of inter-industry specialisation in the conventional Heckscher-Ohlin

framework, the abundant factor gains from trade while the scarce factor loses absolutely

(Stolper and Samuelson, 1941). However, the models of Krugman (1981, 1982) show

that, in the presence of increasing returns, with products that are close but not perfect

substitutes, both productive factors may gain from trade.

84

In Krugman's (1982) model of two-way trade in the context of monopolistic competition,

the pattern of inter-industrial specialisation is determined by factor proportions, so that

the model incorporates an element of comparative advantage. However, the existence of

economies of scale and differentiated products ensures that there is also intra-industry

specialisation and trade, which does not depend on comparative advantage (Krugman,

1982: 197). Trade liberalisation then allows producers in each country to expand both

their exports and imports within an industry.

The products of each industry in Krugman's (1982) model are produced with industry

specific labour, and each country has a different endowment of sector-specific labour

supplies. A country's net export position in a given industry (that is, whether it has an

overall comparative advantage or disadvantage in that sector) depends on its relative

endowment of the industry-specific factor. However, a country will still import even

when it has a comparative advantage, and will still export when it has a comparative

disadvantage. The importance of intra-industry trade within a sector depends on the

degree of product differentiation within that sector and on the strength of comparative

advantage (Krugman, 1982: 203-204).

Krugman (1982: 203-204) argues that producers in both countries will oppose unilateral

trade liberalisation, since foreign competition will lower the return to the industry

specific factor, usually without a compensating consumption gain. However, reciprocal

tariff reductions will not only benefit producers in the country with a comparative

advantage, but may also raise the welfare of producers in the country with a comparative

disadvantage.

Since different countries produce commodities which are imperfect substitutes for one

another, the removal of trade barriers will offer consumers a wider choice. If this induces

them to spend a larger share of their income on a particular industry's products then, if

products are sufficiently differentiated and comparative advantage is weak, the return to

that industry's specific factor may increase in the country with a comparative

disadvantage.

85

Krugman (1982: 206-207) concludes that in industries where comparative advantage is

strong and product differentiation is weak, producers in the country with a comparative

disadvantage stand to lose from trade liberalisation. However, producers in both

countries will gain from mutual or bilateral trade liberalisation in an industry if neither

country has too great a comparative advantage and if products are strongly differentiated

within that industry, since it is then possible for both productive factors to gain from

trade. This suggests that the adjustment to trade liberalisation is likely to be easier when

the growth in trade is of the intra-industry type rather than the inter-industry type, which

in turn is more likely to be the case between countries with similar factor endowments.

Thus, in the case of increasing returns, as firms move down their average cost curves, the

average product of both factors may increase, and although the relative return to one

factor could fall, both factors may gain in absolute terms (Brown et al., 1992: 14).

It appears that the welfare benefits of intra-industry exchange lie not only in the gains

from trade in differentiated products, but also in the lower costs of adjustment to trade

expansion of the intra-industry type. More specifically, in contrast to the traditional

outcome, there may be what Simson (1987: 136) has called "an extra gain from trade",

since it is possible for both productive factors in a particular country to benefit from the

removal of trade restrictions.

Cattaneo (1998: 148) states that it may perhaps be suggested that if the factor intensities

of trade, as well as per capita income levels, are more similar among southern African

countries or among a subset of southern African countries than between these countries

and their trading partners in the rest of the world, then regional liberalisation could

provide benefits from intra-industry specialisation which may not be readily attainable

through multilateral liberalisation.

With regard to the dynamic effects of economic integration, Cattaneo (1998: 148) states

that they refer to the possible ways in which integration may influence the rate of growth

of GNP of the member countries in a regional union, in contrast to the static effects

86

which result in a once and for all welfare change. The dynamic effects have been defined

to include the possible exploitation of dynamic external economies in a larger union

market; the effect of integration on the volume and location of investment; the effect on

economic efficiency of increased competition and reduced uncertainty; and the

polarisation effect, which refers to "the cumulative worsening of the relative, or absolute,

economic position of a member country or some regions in the integrated area" (Jaber,

1970-71: 254).

According to Robson (1987: 32-33), some of these factors can only doubtfully be termed

"dynamic". Indeed, the whole issue of the dynamic effects of integration is, he argues,

fraught with difficulty, and insufficiently analysed. There is, however, a useful

distinction to be made between the effects of market enlargement due to regional

integration which result at a point in time, and those that operate continuously and

depend on the lapse of time. The latter have been termed "economies of time" by

Corden (1974: 249), and include dynamic external economies, which lower average costs

as the length of time over which the output produced increases, as well as the cumulative

changes that are part of the process of polarisation, referred to above (Robson, 1987: 32).

It has been argued that foreign direct investment (FDI) may be an essential catalyst for

the dynamic benefits of integration identified in the regional integration literature

(Blomstrom and Kokko, 1997: 12). Theoretical analysis of the possible impact of

integration on foreign investment is, however, poorly developed and inconclusive,

although some general observations can be made. Firstly, regional trade liberalisation

may have a differential impact on foreign investment by insiders and outsiders,

depending on the motivation for FDI. Intra-regional FDI flows of the tariff-jumping

variety are likely to fall with the removal of intra-area tariffs. However, if integration

leads to trade creation, then intra-regional FDI may increase in some member countries in

response to changes in the regional structure of production. This has been termed

"investment diversion" by Kindleberger (1966). The removal of intra-regional tariffs

may also result in "investment creation" (an inflow of FDI from the rest of the world), if

external suppliers lose export markets as a result of trade diversion. In the presence of

87

internal free trade, the location of new FDI into the region will depend on the

comparative advantages of the member countries. In the free trade area case specifically

where there will be internal free trade but no common external tariff, foreign investors

may move funds to countries with lower tariffs on raw materials and intermediate goods,

resulting in investment deflection (El-Agraa, 1989: 49).

Secondly, if the motive for FDI is internalisation of firm-specific intangible assets rather

than the avoidance of trade barriers, the removal of tariffs will not reduce the incentive to

engage in FDI, and may in fact stimulate overall investment flows between member

countries by facilitating the more efficient operation of multinationals across regional

borders. Although, in the case, integration seems likely to exert a positive effect on

aggregate FDI flows both into and within the region, it is possible that some member

countries will experience a reduction in investment, as FDI will tend to concentrate in

countries in which investment conditions are most favourable. The actual outcome is

ultimately an empirical question, and will depend on the degree to which trade and

investment flows are liberalised in the regional union, on the locational advantages of the

countries in question, and on the motivation for FDI. To the extent that South African

multinationals, for example, have operated in neighbouring countries like Zimbabwe to

avoid trade barriers, the formation of a SADC regional union may reduce intra-regional

FDI. However, there may be a net increase in intra-regional FDI flows of the efficiency

seeking type. It is difficult to envisage that a SADC FTA would have a significant

impact on FDI flows from outside the region, although there may be some investment

deflection. A concentration of investment in some parts of the union could exacerbate

any tendency towards polarisation within the area.

Lundahl and Petersson (1991: 197-198) argue that the formation of an integration

arrangement may permit the exploitation of dynamic external economies in a larger

regional market, thereby lowering the costs of infant industry protection during the

learning period and allowing optimum capacity to be reached in a shorter period of time.

The benefits of dynamic economies will facilitate the gradual reduction and eventual

elimination of tariffs, thereby offsetting the costs of protection and trade diversion.

88

According to Lundahl and Petersson (1991: 202), dynamic external economies may

provide a case for regional integration among countries at unequal levels of development,

since favourable spread effects may be induced from the more advanced centres to the

less developed regions and to the integrated area as a whole. However, it is widely

argued that any favourable dynamic effects from integration may be outweighed by

adverse polarisation effects for some members in a regional union among countries at

unequal levels of development (Vaitsos, 1978: 739, 746; Robson, 1987: 169-175;

Lundahl and Petersson, 1991: 202). Indeed, the issue of polarisation has been a

prominent theme in the literature on the effects of trade integration in southern Africa,

particularly with reference to the Southern African Customs Union (SACU). By contrast,

Holden (1996: 54-56), drawing on the analysis of Krugman (1991), suggests that

polarisation may not be inevitable in an integration arrangement involving South Africa

and the smaller SADC countries.

Krugman (1991: 83) examines the question of whether smaller countries should fear

economic integration "lest their industry be pulled into the inevitably larger cores of their

larger neighbours". His analysis suggests a U-shaped relationship between economic

integration (taken to be the absence of transport costs or barriers to trade) and welfare in

the peripheral areas of a regional union, so that close integration is beneficial, but a

limited move towards integration may be harmful.

This may be explained using the example of a region consisting of a "central" nation

(South Africa), in which wages and hence production costs are relatively high, but which

has access to a larger market, and a "peripheral" nation (Malawi), with low labour costs,

but poorer market access. Suppose that the location of production for an industry is

chosen simply to minimise the sum production and transport costs (Krugman, 1991: 96-

97). In terms of production costs alone, it is cheaper to produce the good in Malawi,

where wages are lower. However, it is cheaper to produce the good in one location only,

rather than in both, because of economies of scale. Further, production in South Africa

(the central nation) involves lower transport costs than production in Malawi, while

production in both countries reduces transport costs to zero.

89

When transport costs are high enough to outweigh the economies of scale benefit of

producing in one location only, production will take place in both countries. On the other

hand, if transport costs are very low, production will take place in the lower-wage

country, Malawi. However, if transport costs are at an intermediate level, they may be

low enough to make the concentration of production to reap economies of scale

worthwhile, yet still high enough to make market access outweigh production cost as a

determinant of location, so that production shifts to the higher-cost central nation, South

Africa. The relationship between transport costs and the peripheral country Malawi's

output in this industry is therefore U-shaped. This implies that if trade barriers are

substantially reduced in a regional union, peripheral low-wage countries should not lose

industry to the core; however, a partial move towards integration may induce

polarisation.

According to Krugman (1991: 84-87), therefore, polarisation of industrial activity is not

inevitable, and will depend on the size of the larger core, the level of transport costs, the

degree of economies of scale and the share of "footloose" industries. This implies that it

cannot be concluded, a priori, that the integration of South Africa with the smaller SADC

countries will result in polarisation.

90

5.5. CONCLUSION

It is unlikely that more stringent multilateral rules to govern regional arrangements will

emerge in the near future and, therefore, SADC should not encounter insurmountable

obstacles when its regional programme is notified to the WTO. A critical factor,

therefore, is how SADC presents its rationale to the WTO. In laying down the political

groundwork with its major trading partners, SADC members will need to stress not only

the potential economic benefits of the Trade Protocols but also their importance in terms

of fostering regional security. SADC will have to demonstrate that what is at stake is not

the issue of the integrity of the multilateral trading system nor is it trade liberalisation per

se, but the sustainable development and security of a region whose economies and

destinies are both interwoven and fragile. If such political and economic arguments are

presented coherently and convincingly, and if the technical and legal procedures are

followed closely, then the SADC can be relatively confident that its Trade Protocols will

be welcomed by the Members of the WTO.

Each of the economic arguments cautioning against a free trade area in the SADC region

are relatively easily addressed. As comparable evidence demonstrates, there are no a

priori economic grounds on which to suggest that trade diversion will outweigh trade

creation. Comparative evidence shows that regional schemes can help overcome the lack

of international competitiveness, even in developing regions. Moreover, given its

minuscule share of world trade, the creation of a free trade area in Southern Africa should

have a negligible impact on world trade flows and on third parties. The view that a

regional arrangement among the SADC countries will disproportionately benefit South

Africa could be tempered by outlining the complementary strategies to rehabilitate

regional infrastructure and promote balanced regional industrial development.

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CHAPTER 6 CONCLUSION

Chapter one covered the theoretical aspects of economic integration discussing both the

conventional and the modern theories. Theoretically the static effects of trade integration

mainly trade diversion and creation are easy to identify in a static framework. However,

quantitative measurements of the cost and benefits of trade integration within the

dynamics of a real world may be difficult to measure accurately. But however, this study

attempted to point out the major costs and benefits of integration under the auspices of

the new trade theory.

Chapter three analysed the pros and cons of the Southern African Customs Union

(SACU). This include the objectives of SACU, historical background where it was

evident from the study that South Africa benefited from integration (SACU) as it is tinted

with other non-economic implications which may off-set economic gains in the long

term. The section also touched on the most controversial aspect which is the revenue

sharing formula as well as the benefits and losses to both South Africa and the BLNS

countries of their SACU membership. Most importantly, the envisaged future directions

for SACU were comprehensively dealt with. Out of all the available options,

restructuring of the SACU agreement gets thumbs up from almost all of the literature

consulted.

Despite the overwhelming economic domination by South Africa in the region it must be

emphasised that a balanced development strategy for the entire region is crucial to the

success of future economic development in all the SACU countries. The perpetuation of

existing inequities and the neglect of regionally integrated development in southern

Africa will affect South Africa adversely in mass migration of labour to the core area and

reduction in the size of markets for South African produced goods. The challenge for the

future is therefore to restructure the agreement in a way that enhances benefits and

minimises costs. Perpetuation of the historical inequities in the implementation of the

agreement cannot be afforded by any of the member countries.

92

Any future restructuring strategy undertaken by the South African government covering

development, industrialisation, labour or trade has to take into account the effects on

other members of SACU. Equally important, it should analyse the capacity and

capability of BLNS to supply raw materials, intermediate inputs and even competing

consumer goods to South African markets. A future development strategy should attempt

to foster linkages between various economic sectors across the region as a whole. For

this programme, more democratic institutional structures should be established in key

decision-making areas and consistent consultation introduced.

The revenue sharing formula, which is central to the distribution of costs and benefits

among member countries needs to be totally reformed as urgently as possible:

The issue of the inclusion of TBVC in the disbursement of SACU revenue has

already been resolved by the reincorporation of these "homelands" back into South

Africa. Selected internal regional development programmes are distortive of the

economies of the peripheral countries and should not be repeated. This further

underlines the necessity for consultative and democratic decision-making.

The problem of the two-year lag in payments to BLNS will have to be resolved.

Improved border controls and more accurate and timely statistics will lead to a faster

transfer of SACU revenue. In the absence of such reforms, South Africa should

introduce compensation to the other members for interest losses, exchange risks and

inflation.

The current formula is insensitive to the different costs and benefits which accrue to

the four smaller countries as a result of their different wealth and resource

endowment. Each of the four smaller countries, by virtue of different growth

trajectories, currently experiences very different costs and benefits from their

relationship with SACU. In addition, the smaller countries, particularly Lesotho and

Swaziland, have incurred greater economic losses than Botswana and Namibia. The

perpetuation of the formula in its existing form will exacerbate these historical

inequities. Any future revision of the stabilisation factor should therefore compensate

for the weak bargaining position of Lesotho and Swaziland. This underlines the need

93

for improved collection and availability of statistics to enable policy-makers and

researchers to construct a formula on a basis that more accurately captures the

particular costs and benefits accruing to the different member countries. As perhaps

giving a better indication than the current emphasis on duties on imports and

excisable products, a formula might be devised that distributes revenue on the basis of

the net trade balance of the member countries. This will capture costs and benefits

better because clearly the higher the level of imports from other SACU countries to

any given member, the higher the costs of membership. Conversely, the more any

country exports to other SACU members, the greater the benefits.

There is a need for immediate reform of the 1969 agreement and its 1976 amendment.

The urgency of such renegotiation has been heightened by the changing political and

economic environment in South Africa, not to mention increased pressure on individual

members from international institutions such as the World Bank and the International

Monetary Fund. A democratically elected government is likely to be more conscious of

the needs and aspirations of countries that were sympathetic to the liberation struggle in

the past. It is hoped that the process of democratisation within South Africa will be

extended to its relations with other countries in the southern African region.

Chapter four highlighted the genesis of the proposed European-South Africa free trade

agreement. The problems preventing or delaying the forging of a truly liberal free trade,

most notably the argument about South Africa's classification either as a developed or

developing country, have been analysed in this section. The chapter also gave a brief

exposition of some of the requirements which must be complied with before a free trade

agreement can be concluded. The purpose was to determine if the EU-SA negotiations

are in line with those requirements. This proposed trade arrangement will obviously have

some implications to non-participating economies. Logically so, the effects to third

parties were briefly discussed and in particular, the effects to other developing countries

such as Brazil, Chile etc and the developed US. The stakeholders seem to be giving the

protocol a go ahead. After having done an analysis of most sectors to be directly affected

by this arrangement, SA feels comfortable and confident that even though there are some

94

drawbacks associated, the agreement to be reached will undoubtedly boost the South

African economy significantly.

On the other hand, the EU continues to play delaying tactics in an attempt to ensure that

the deal can also be extensively beneficial to them as well rather being a one sided

economic advantage in favour of the relatively less developed SA. Several studies

conducted on the subject conclude that the EU has more to gain inside this trade protocol

than undermining it as an economic drain to its detriment for the benefit of South Africa

and its "poor" neighbours. In sum, both parties stand to enjoy some economic benefits,

coupled with certain few losses of course.

Chapter five dealt with the developments surrounding the most talked about formation of

the free trade area in the Southern African development community. A short history of

SADC (successor of the controversial SADCC) has been revisited, but however, a larger

portion is occupied by the present free trade negotiations under SADC. Its predecessor,

SADCC, was more politically than economically inspired. This section highlighted why

it is to the benefit of South Africa to forge relations with its relatively less developed

neighbours and at the centre of this is the immigration issue.

The current extraregional and intraregional trade patterns as well as trade between SA

and the rest of the region, were both theoretically and empirically analysed. The SADC

trade protocol received a thorough attention, its perceived strongpoints and pitfalls have

been clearly exposed. Finally, an attempt was made to determine the possible effects of

the SADC FTA to members in the context of the new trade theory. Some of the major

arguments deliberated on in this chapter can be briefly summarized in the paragraphs

below.

It is usually argued that when a larger less efficient country joins a free trade area, trade is

often diverted from the rest of the world to the new partner. In addition to trade

diversion, the smaller countries in the southern African region fear that they may also

experience a form of deindustrialisation, or polarisation, as their industry is sucked into

95

the core of the larger South African economy. On the other hand, uniform external tariffs

have also been known to act as an engine of growth through the creation of dynamic

external economies. In addition, technology is diffused more rapidly throughout the

region if barriers to trade within the region are eliminated. Economic growth in the

advanced centre spills over to the peripheral areas through growth in their exports.

Improved infrastructural links decrease transport costs which are known to be particularly

high in Africa. Despite these favourable dynamic effects, the smaller countries fear that

the unfavourable polarisation effects may exceed the benefits arising from the dynamic

economies of the larger market.

One can conclude that the level of integration is important if polarisation effects are to be

avoided. If barriers to trade in the form of tariffs, quantitative restrictions and transport

costs are substantially reduced, peripheral countries where wages are lower should not

lose industry to the centre. In practical terms it may be the case that growing integration

of other African countries with South Africa is unlikely to impact adversely on these

economies.

96

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