The Arab Common Market

The Custom Union as a first step to the Common Market

Since antiquity, the Arabs were traditionally traders convoying merchandise from East to West in some of the oldest trade routes in human history including Silk Road commerce, linking Asia, Africa, and Europe. At these times, the Omayyad Empire reigning from actual Pakistan to Spain began the first economic reform to build a monetary union by dismantling the numerous local money used in the empire (non-tariff barrier) and pushing the unified money “Gold Dinar” [2]and “Silver Dirham”.

Plans for the Arab Customs Union were announced at the LAS 2009 Arab Economic and Social Development Summit in Kuwait, where the Economic and Social Council of the League of the Arab States (ECOSOC) referred to the Arab leaders during the Summit a resolution that stipulates drawing a roadmap to complete, discuss and negotiate all issues that need to be addressed before the launch of the Union in 2015, with the vision of the importance of the formation of the ACU as a crucial need to increase inter-Arab trade that estimated presently at about 10 to 11 per cent.

The establishment of the ACU was planned to lead to an Arab common market by 2020, to increase inter-Arab trade and integration, and to boost trade under the Pan Arab Free Trade Agreement (PAFTA), the main goal was to ensure the ease of trade between Arab countries by removing trade barriers and restrictions, as well as barriers to the movement of goods, individuals, capital and more. This will further provide the opportunity for the establishment of an Arab Common Market (ACM) in the foreseeable future to complete the desired economic integration in the Arab region.

From general theoretical principles, as agreed by the economist Gerald Meier, in the Institute of Economic Studies [3], Customs Union might accelerate a region development mainly in the following ways:

·                     Increasing the “gains from trade”;

·                     Improving the competitivity of existing industries, by offering to local firms a larger market;

·                     Stimulating the creation of new industries.

We have demonstrated by applying econometric models from Nobel Prize-winning economists, The Gravity Model, the RCA model and the IIT Model, that the Arab Customs Union will benefit from these three forms of Payoff:

Gains from trade revealed by the Gravity model:

Table 1: Gains from trade within the ACU by countries in $ billion per year, generated by the Gravity model

KSA

Egypt

Iraq

UAE

Qatar

Kuwait

Gains of trade

(Billion USD per year)

+30 billion per year

+17 billion per year

+20 billion per year

+7.3 billion per year

+19.6 billion per year

+8.1 billion per year

Algeria

Oman

Syria

Bahrain

Sudan

Morocco

Gains of trade

(Billion USD per year)

+4 billion per year

+0.9 billion per year

+3.1 billion per year

+2.5 billion per year

+4.5 billion per year

+1.2 billion per year

Lebanon

Jordan

Tunisia

Libya

Yemen

Palestine

Gains of trade

(Billion USD per year)

+3.4 billion per year

+1.5 billion per year

+0.8 billion per year

+3.4 billion per year

+0.5 billion per year

+1.3 billion per year

Source: Consultant Gravity Calculations based on Gravity CEPII database, Trade Map, World Bank;

In assuming that Arab countries will build on GCC experience to achieve the Arab Customs Union we found out  that the impact of the Customs Union is up to 64.7 billion dollars of trade per year divided per country as above. This gain represents an increase of 60% of trade, of which  87.1% of the missed trade opportunities are confined in the Mashreq-GCC countries. These results  corroborate with those of Economists previous researches finding out  that Customs Unions increase trade flows by an average of 63% among their members[4].

 Indeed, GDP, Distance, Contiguity (common border), as predicted by the Gravity equation play a huge role in promoting trade, but economists also found out that Common Market  could dramatically improve Trade between close countries and may have a mean effect of additional  substantial increase in trade. That why GCC countries alone, benefiting from the freeing of trade and services between them attained such results. Whereas other Arab countries, missing such opportunities will never reach such results without  establishing an Arab Common Market creating  synergies with GCC counties, highly developed in financing,  Information and Communication  Technologies,   reexport and trade-related  services. While abundant labour intensive based economies such as Egypt,  Tunisia and Morocco will offer their labour surplus particularly their unemployed university diploma holders to contribute in achieving GCCs’  ambitious reform programs  to bolster the GCC’s fiscal position and diversify their  economy in a world of low oil prices.          Saudi Arabia vision 2030 is an example.

That why the freeing of the skilled labour force within the creation of the Common Market will turn the large and growing labour force and the formidable youth unemployment challenge into an asset, rather than a constraint. This will require ensuring sustained, high, and job-intensive growth, refocusing education and training to reduce skills mismatches, enhancing labour market flexibility and maintaining macroeconomic stability.

 Our analysis of the Revealed Comparative Advantage through the RCA model shows that the impact of the ACU will not only increase Arab Intra-trade dramatically, but it will also help improve the competitivity of thousands of sectors as shown in the below Table.

Improving the competitivity of existing industries revealed by the RCA model:

Table 2: Number of sectors with a comparative advantage that will be improved under the ACU.

Jordan

Bahrain

Algeria

KSA

Sudan

Iraq

Oman

Qatar

Syria

Number of sectors with a comparative advantage that will be improved under the ACU

472

212

55

321

120

14

217

9

484

Kuwait

Lebanon

UAE

Egypt

Morocco

Yemen

Libya

Tunisia

Palestine

Number of sectors with a comparative advantage that will be improved under the ACU

103

654

303

749

552

260

32

748

442

Source: RCA Calculations based on

The above Table shows that the ACU  will also help improve the competitivity of thousands of sectors.  For example,  KSA may  increase its competitivity by helping 213 sectors to grow their exports to Egypt and 317 sectors to grow their exports to Iraq. In the same way, all Arab countries will see the competitivity of hundreds of sectors improved by benefiting from the economies of scale offered by the Customs Union.

The analysis of the Revealed Comparative Advantages (RCA) shows that Arab countries don’t have the same RCA profiles, and the RCA sectors for which, bilaterally, Arab countries are NOT competing with each other is near 95%.

However, it is worth noting that the positive impact of the Customs Union on developing trade, as revealed by the gravity model is high  for GCC countries whereas it is limited for Maghreb countries, particularly for Algeria Morocco and Tunisia. This is particularly due to the high cost of transportation between Maghreb and Mashreq countries.

Also, considering the population of each country, the GCC countries benefited more than Egypt, Iraq and Sudan from implementing the ACU due to their relative (to GDP) larger market dimension. 

Therefore, the cost-benefit analysis based only on the results of the gravity model calculation will not come up with a consensus between all Arab countries, highly required for establishing the CET.

Therefore, Tunisia and Morocco could not accept any losses in customs revenues occurring from establishing the CET if all ACU members  will not share the will for creating an Economic Union. As highlighted above,   the gain from implementing the Customs Union is not so motivating  for Tunisia and Morocco. The incurred ACU intra-trade is only USD billion 0.8 for Tunisia and USD billion 1.2 for Morocco. The gain on tax revenues from this increased intra-trade is by far below estimated Tunisian and Moroccan losses impacted by establishing  the CET in all scenarios not involving prerequisite negotiation with WTO contracting parties as per GATT articles XXIV and XXVIII. Scenario aligning CET line by line on minimum bound tariff for Agriculture and minimum applied tariffs for industry and Scenario aligning CET line by line on GCC’s common external tariff of 5 % will come up with important losses for substantial all countries including GCC countries. Such losses are impacting negatively their Budget Balance and the Current Account of their Balance of Payment that impede both  oil-driven  economies, focusing on curbing the negative impact of the drop of oil prices on their Budget Balance  and oil importing countries highly dependant on Tax revenues. The estimated gains from intra-trade within the next ten years coming period will never  cross the curve (reach the breakeven) of impacted losses of establishing the CET in the selected  scenarios for agriculture industrial based economies and even within the most optimistic forecasted intra trade growth of 15 % per year, impossible to reach in the prevalent current ACU environment dominant by  high trade barriers and lack of fast-track conflict settlement between PAFTA members.

The only way to reach a consensus of All Arab countries is to consider the additional gains that Intra industry trade including the food industry, would generate when implementing an Economic Union enabling Arab economic integration and diversification.

That why the Consultant calculated the IIT index for all Arabic countries   

 

The Stimulation of the creation of new industries revealed by the IIT model:

 

A comprehensive, advanced measure of Intra-Industry Trade known as Grubel–Lloyd index take this form:

Table 3, Average Grubel–Lloyd index for Arab Intra-trade that will be improved under the ACU:

Jordan

Bahrain

Algeria

KSA

Sudan

Iraq

Oman

Qatar

Syria

Average Grubel–Lloyd index

0.03

0.02

0.01

0.03

0.008

0.008

0.01

0.01

0.02

Kuwait

Lebanon

UAE

Egypt

Morocco

Yemen

Libya

Tunisia

Palestine

Average Grubel–Lloyd index

0.03

0.02

0.02

0.02

0.01

0.01

0.003

0.01

0.007

Source: Grubel–Lloyd index Calculations based on Trade Map; Grubel–Lloyd index scale from 0 to 1.

The value of the Grubel–Lloyd index indicates the degree of intra-industry trade, which reflects the demand for product diversity and the development of scale economy[5]. For Arab Intra-Trade the Highest Grubel–Lloyd index is 0.03, and the lowest is 0.008, while in an integrated economy this value averages 0.4. These values show the potential of the Arab world to gain in product diversity and economy of scales if they succeed in their economic integration, this trend is confirmed by the gravity model and the RCA model.

The above tables show that the potential increase of intra-industry per couple of Arab countries selected as an example is as followings:

Egypt

KSA

+712%

Tunisia

KSA

+2427%

Tunisia

EGYPT

+1641%

Morocco

EGYPT

+2407%

 

The above table  shows the followings:

·         There is a high potential intra industry increase of 712% between Egypt and KSA if all the conditions for establishing an Arab economic union are met to reach the IIT of integrated economies; and 

·         There is a higher potential intra industry increase of 2427 % between Tunisia  and KSA and of 1641% between  Tunisia an Egypt and 2407 % between Morocco and Egypt if all the conditions for establishing an Arab economic union are met to reach the IIT of integrated economies of 0.4;

Although, the case study, attached in Annex, and based on the findings of a regional strategic study developed by the ATU ”Agadir Technical Unit”  shows the missed opportunities of developing intra-industry trade between Tunisia, Morocco, Egypt, and Jordan within the fruit and vegetable-based industries.  

The regional strategic study “Opportunities for cumulating of origin & complementarities in the agri-food sector in the member states of the Arab Mediterranean Free Trade Agreement of Agadir” includes an assessment of the impact of the main Trade Agreements concluded by Agadir countries with the WTO, EU, US, and Arabic countries -GAFTA, a trade cooperation program, an export development plan to the EU and a trade facilitation enhancing program.

The study found out that the value-added of processed agricultural products is 5 to 10 times less important in Agadir countries than in industrialised ones. Thus, there is an important room for them to widen their value chain and increase employment through enhancing trade.

Being more exporters of similar raw materials than of differentiated manufactured products, Agadir countries are in a competitive position hampering integration possibilities. They are by far more integrated within the EU Value Chains than within the regional ones.

Enhancing Trade facilitation and freeing of trade between Agadir countries and identified complementarities would enable economic integration thanks to the abundance and diversity of agricultural supply in the Agadir area.

The study identified the abundance of exotic fruits, citrus, olives frozen potatoes, fruits and vegetables and concentrated juice in Egypt, olives and citrus in Morocco and olives, citrus and dates in Tunisia.

Complementarity in the products mentioned above allows:

i)              the diversification of the production of food preparations and the optimal utilisation of the production capacity;

ii)             ii) developing economies of scale and thereby reducing production costs, and

iii)            iii) optimal valorisation of raw materials and reduction of waste.

This is likely to improve the competitiveness of Agadir countries’ exports of agri-food products, boost the investment in food preparations’ projects and hence, increase the level of integration in the food industry’s value chain.

Such example extended to the ACU and particularly GCC would enable by far more substantial gains and opportunities in developing food industries, thanks to enlarged market dimension, the availability of fruit and vegetable over the needs of the region and the very limited existing manufacturing capacity in fruit and vegetable-based industries.

It is worth noting the gain from intra-industry is by far more important for more integrated economies such as Tunisia, Morocco, and Egypt presenting more RCAs and endowed with a larger industrial basis. The creation of an Economic Union would enable to develop by 24 times the intra-industry between KSA and Tunisia and between Egypt and Tunisia.

 

However, such important gains are only possible if all the conditions for establishing an Economic Union are met.

Therefore, Tunisia and Morocco could not accept any losses in customs revenues occurring from establishing the CET if all ACU members will not share the will for creating an Economic Union. As highlighted above,  the gain from implementing the customs union is not so motivating for Tunisia and Morocco.

Selection of the Optimal Common External Tariff:

Based on the Nobel Prize economist and mathematician theory, John Nash, we used his Nash Equilibrium model to select the optimal scenario which:

§  Maximize the Gains

§  Minimize the Losses

§  Without breaking existing WTO and FTAs agreements

We can easily compute the Nash Equilibrium as a unique solution for this Optimization problem with no deviation incentive and find that the pure strategy (CET) Nash equilibrium that Maximize payoff without breaking the rules is:

Optimal Common External Tariff:

Apply Maximum Tariff for sensitive products, and for all other products Apply Tariff Bound if the Tariff Bound is greater than Weighted Tariff Elsewhere apply Weighted Tariff.

With:

-       Maximum Tariff is the maximum tariff used between the WTO Arab Countries;

-       Tariff Bound, is the minimum tariff bound between the WTO Arab Countries; and

-       Weighted Tariff is the Weighted Average Tariff between WTO Arab Countries.



[1] Source: “The Law of the Market” Yahia Ben Omar Al Andolsi, 9th Century.

[2] Islamic Coins during the Umayyad, Abbasid, Andalusian and Fatimid Dynasties, Wijdan Ali, PhD

[3] EFFECTS OF A CUSTOMS UNION ON ECONOMIC DEVELOPMENT, Gerald M. Meier

[4] Dissecting the Trade Effects of Europe’s Economic Integration Agreements, Sophie Soete, Jan Van Hove, 2017

[5] GL Index Calculation and Application in Intra-industry Trade. Ning Zheng, Wenxue Huang, and Xiaoguang Xue