Optimal Currency AreasTheory and Evidence for an

African Single Currency

ESDS International Conference

November 2005

Paul Adams

M.Sc Development Economics

Manchester University

Objectives of Presentation

• To present my findings regarding an African Single Currency

• To highlight the importance of international datasets for this paper

• To indicate data gaps which I found whilst undertaking this research

• Re-affirm the importance of reliable data for developing countries

The Theoretical Backdrop

• Mundell (1961) and McKinnon (1963) begin the debate on the size of Optimal Currency Areas (OCAs)– Central concept of asymmetric shocks and labour

mobility• Many theoretical advancements, often from

unexpected areas of economics• Impending European Monetary Union saw a

more rigorously empirical approach to OCA theory

• See Tavlas (1993) for a thorough overview

The African Backdrop

• Single currency a political aim since 1963 when the Organisation for African Unity was founded

• Renewed emphasis since the Abuja Treaty in 1994

• Tito Mboweni, Governor of the South African Central Bank, now indicates 2021 as the target date for monetary integration

• Poor intra African trade levels – just 10% of total African trade

African Data Problems

1. Relatively large area to assess • 53 countries compared to 15 originally in EU

2. Mostly constituent of developing nations

3. More straightforward economic indicators only reliably available since the 1980’s

• Certain countries have no economic data

• More complex financial data still missing for many countries

The Way Forward

Objective1. An assessment of

regional economic communities to remove duplication

2. Investigation into the possible trade effects of monetary integration in Africa

Solution1. An ‘OCA Index’ to

predict convergence of average bilateral exchange rates within groups

2. A Gravity Model of intra-African trade

Regional Economic Communities

ECOWAS: Economic Community of West African States

COMESA: Common Market for Eastern and Southern Africa

ECCAS: Economic Community of Central African States

SADC: Southern African Development Community

AMU: United Maghreb Arab

Successive Allocation to Regional Economic Communities

Stage Country REC Chosen (Rejected)

1 Mauritius SADC (COMESA)

2 Congo, Democratic Republic ECCAS (COMESA, SADC)

3 Angola SADC (COMESA)

4 Seychelles COMESA (SADC)

5 Zambia SADC (COMESA)

6 Burundi ECCAS (COMESA)

7 Zimbabwe COMESA (SADC)

8 Malawi SADC (COMESA)

9 Rwanda ECCAS (COMESA)

Gravity Model Rationale:Things that effect trade

• Common colonial history

• Common nationality• Shared language• Geographical

distance• Geographical size• Economic Size• Population

• Island Status• Landlocked Status• Membership in

Customs Unions• Membership in

economic communities

• Common currency

The Scary Bit Or, Gravity Model Estimation

• The estimating equation:

ijtijtijt

ijtijjiijijijt

ijijijtjijitjiijt

CURTA

ComNatComColAreaAreaIslandLandREC

BordLangDPopPopYYYYX

12

11109876

543210

)ln(

ln)/ln()ln()ln(

• The simple explanation

•Countries trade for various reasons, the gravity model seeks to include as many of these as possible.

•Specifically, the variable of interest is CU: the currency union variable

•Accounting for all these variables, does membership in a single currency increase trade

Gravity Analysis: Data requirements and sources

Real Bilateral Trade International Monetary Fund Direction of Trade Statistics

Population World Bank World Development Indicators

Real GDP World Bank World Development Indicators

Other geographic and political dummies

Mostly CIA World Factbook

Estimates of the Currency Union Effect on Intra-African Trade

Pooled Panel OLS with robust Standard errors

3.27*

Time-Fixed Effects 2.93*

Rose (2000) 1.21

Rose and Glick (2002) 1.3

Masson and Patillo (2005)

1.29

Other Estimates of the Currency Union Effect

Time Series Data ProblemShort time scale

Equatorial Guinea

CFA 1985 (entry)

Guinea Bissau CFA 1997 (entry)

Madagascar CFA 1982 (exit)

Mali CFA 1984 (entry)

Conclusions

• In general, the currency union effect on intra-African trade is positive and significant

• This was robust to a number of sensitivity tests

• The point estimate is of a similar magnitude to comparable studies

• There remains the need for further investigation

Epilogue: The Search for Data

• The availability of data has been instrumental in expanding the OCA debate into more empirical areas.

• The dissemination of good data practices needs to continue in developing countries– To act as a real-time monitor– To enable detailed research which benefit from longer

and wider datasets.– PARIS21 spreading this message

• Ability of data to form a virtuous circle with development.

The Virtuous Circle

↑ Data

↑ Research

↑ Quality of Policy Decisions

↑ Growth/Development