Reduce Poverty and Inequality?

DOES REGIONAL INTEGRATION

REDUCE POVERTY AND INEQUALITY?

THE CASE OF AFRICA REGIONAL ECONOMIC COMMUNITIES[1]

Gaston GOHOU, ISE, Ph.D.

Senior Economist

CESS Institute

225-3055 boulevard Wilfrid-Hamel, Quebec G1P 4C6, Qc, Canada

Ph: (1) 418914 2120, Fax: (1) 418914 3530

email:

and

Issouf SOUMARÉ, Ph.D.

Full Professor

Managing Director, Laboratory for Financial Engineering

Department of Finance, Insurance and Real Estate

Faculty of Business Administration

Laval University

Quebec (Quebec), Canada G1V 0A6

Tel: 418-656-2131, Fax: 418-656-2624

Email:

This version: August 2013

DOES REGIONAL INTEGRATION

REDUCE POVERTY AND INEQUALITY?

THE CASE OF AFRICA REGIONAL ECONOMIC COMMUNITIES

Abstract

The paper focuses on the ten Regional Economic Communities (REC) in Africa to assess the poverty and inequality reduction of being a member. Poverty effect within the REC is analyzed through the catch up effect of poorer countries in a regional group toward the richer ones (-convergence). Income inequality is assessed through the dispersion of income among the members (-convergence). Preliminary results show that SADC, CEMAC, EAC and WAEMU experience -convergence, while only WAEMU and SACU experience -convergence. WAEMU is then the only region where the two convergence effects occur: (i) the poor member countries catch up the rich ones; and (ii) income inequality decreases. The paper draws some policy implication from these findings.

JEL classification code: O11, O18, O40, R11

Keywords:regional integration, -convergence, -convergence, economic growth, poverty reduction, welfare, income distribution, Gini coefficient, income equality.

1Introduction

Why group of countries decide to enter into a regional integration scheme? The theory of Regional Integration states that every country should be a winner within a region. Poorer countries in the group should be lifted to a better welfare and richer countries will also improve their economic position with an access to a larger market. This paper answersthe following research question: Does Regional Integration reduce poverty and inequality among its member countries in Africa? In other words, the paper investigates if being a member of a Region Economic Community reducespoverty and income inequality among the member countries.

Poverty reduction is proxy with the -convergenceconcept. Indeed,-convergence determines whether or not poor countries are growing faster than richer countries.Hence, if a group of countries -converges, that means that the economic growth rates of the poorer countries are higher than that of the richer ones. Inequality, on the other hand, is analyzed with income disparity also know as the -convergence (or divergence). -convergence tests, whether or not the dispersion between per capita income levels declines over time. Furthermore, if this group of countries is a Regional Economic Community (REC), it may be the case that regional policies favor  or -convergence. Since most of the RECs main goal is to improve economic and welfare of their members, it is instrumental to assess whether members of various REC are improving their welfare and reducing income disparity among themselves.

The literature on Regional Integration (RI) and convergence has beenprolific recently. The link between Regional Integration and convergence has been assessed by several authors but results are mixed and sometime contradictory. The process of establishing a REC goes from a simple trade agreement to a Custom and/or Monetary Union (CMU) and Federal States. Empirical evidence shows that, in general, advance integrated area like Federal States or region composed by developed countries, tend to converge more than group of developing countries (Venables; 1999). For instance, Young (2008) shows that counties of the United States of America (USA) or the European Union (EU)-converge but -diverge. However, when the analysis is done for a large group of countries, not necessary member of a REC, the results are mixed depending on the methodology used and the period covered (Ghura and Hadjimichael (1996), Venables (1999), Holmes (2005), Péridy and Bagoulla (2012)).

When analyzing the impact of Regional Integration on convergence, two main shortcomings appear in the literature. First, most of the sample considered included a mixed of REC members and no member countries. Since most REC policies are aimed to support their members, mixing these two groups in a sample may create a bias. The second shortcoming concerns the period covered by these studies.Indeed, most of the studies considered the highest available period, even before the creation of the REC. Doing so creates a bias since before the creation of the REC, these countries have had different policies that may not converge toward the same steady point. The present paper is an attempt to respond to these shortcomings.

We analyze the convergence of the main African REC, including AMU, ECCAS, ECOWAS, IGAD, SADC, CEMAC, EAC, SACU, WAEMU, and WAMZ[2]. For each REC, only the founding member countries are considered to avoid survivorship bias. In addition, the analysis covers two periods: before and after the creation of the REC. This decomposition allows for a clear assessment of the REC membership impact on the convergence of its members.

The contribution of this paper to the literature is three folds. First, as far as we know, it is one of the first papers that focusesmainly onAfrica’s REC to assess the impact of Regional Integration on poverty and inequality of its members. Second, as we mentioned above, while most papers in the literature cover the highest period available for their sample of countries, this paper analyzes the convergence issue before and after the implementation of the REC. Finally, for consistency, this paper focuses only, for each REC, on the group of founding members to avoid survivorship biasin the data.

Preliminary results show that SADC, CEMAC, EAC and WAEMU experience -convergence, while only WAEMU and SACU experience -convergence. WAEMU is then the only region where the two convergence effects occur: (i) the poor member countries catch up the rich ones; and (ii) income inequality decreases.

This REC should have an ambitious agenda to implement regional program. The main finding of the study show that only the WAEMU is experience both convergences. This achievement is mainly due to the ambitious regional program design and being implementing. Other RECs should adapt this program in their context. As WAEMU did, the free movement of person, goods and services should be the key.The REC should then design policies to allow free movement of the two main factors of production (capital and labor). In addition, REC should investment heavily in infrastructure (road, energy,…) to allow the movement of the factor of production.

The remaining of the paper is organized as follow. Section 2provides the definition of the keyconvergence concepts and a review of the literature on convergence and Regional Integration.Section 3presents the data and some descriptive statistics. Section 4 presents the empirical model and discusses the results. Finally, section 5 concludes and formulates policy recommendations.

2. Definition and literature review

2.1. Definition of the convergence concepts

The convergence literature in the 80s focused around two notions: the -convergence and the -convergence. However in the 90s, due to the failure to show the empirical evidence of the previous notions, the conditional convergence and club convergence appears.

The -convergence or absolute convergence is defined as a catch-up process based on the fact that poor countries tend to grow faster than rich ones (Barro and Sala-i-Martin 1991). Another way to define it is that, regardless of the initial conditions, the real per capita income of the countries tends to converge to the same steady state in the long run. When the dispersion among a group of countries tends to decrease over time, one speaks of -convergence. The dispersion can be evaluated by the standard deviation of the per capita income or the logarithm of the per capita income (Barro and Sala-i-Martin; 1995).

The two concepts are related as Sala-i-Martin (1996) pointed out. If there is -convergence, i.e. a poor country is catching up a rich country;it means that the poor country has a higher growth rate than the rich one. In the long run, it implies a reduction of income dispersion between the poor country and the rich country.So a -convergence is a necessary condition for the-convergence, but -convergence can exist without -convergence.

If we consider a group of countries that are similar in their structural characteristics (technology, population growth rate, saving behavior), the convergence of their per capita income in the long run, regardless of their initial conditions is defined as the conditional convergence (Galor; 1996). In this case, the initial condition can be different but the actual structural characteristic should be the same. If in addition, we have that for the same group of countries (which have the same actual characteristics), the initial conditions were the same, then the convergence of their per capita income is defined as the club convergence. Hence, the club convergence requires that two assumptions be met: the initial conditions and the actual structural characteristics are the same; While the conditional convergence requires only that the actual structural characteristics are identical.

2.2. Regional Integration and convergence: a brief review of the literature

Regional Integration (RI) has been discussed for long time in the literature but formalized mainly around the mid 1900s. Its implementation process includes several steps from the formation of a trade bloc to the establishment of an economic and monetary union. One of the argumentsin favor of RI is that it can be trade creating when trade replaces or complements domestic production, or trade diverting when partner country production replaces trade from the rest of the world (Viner;1950).

However, RI process goes beyond trade agreements and includes for instance: (i) the provision of regional governance and knowledge sharing; (ii)the avoidance of some market and coordination failures; and (iii) the coordination of national or regional activities with positive externalities (te Velde; 2011).Since RI initial impact is to improve trade openness of member countries, several studies have analyzed the effect of trade on growth. Basically, the fastest growth is observed with opened economies and this growth is higher for countries with larger neighbours (Vamvakidis; 1998).

Nevertheless, RI may not benefit evenly all its members. For instance, when the regional agreement allows foreign investors to set up in small countries to serve the region, these small countries may benefit from RI through higher investment especially from FDI coming from out of the region (Ethier;1998). When there is not such a provision, small countries in aRECmay loose from this agreement. It is also argued that RI among developing countries can only lead to divergence of income levels of the members states while agreement among developed countries will allow convergence among its members (Venables;1999).

The analysis of convergence among countries and regions has been done extensively in the literature. An exhaustive survey of the convergence literature was done by Islam (2003). The theory of convergence originates from the growth theory debate (neoclassical and new growth theories).

A perfect example of Regional integration is a federal country like the USA. In this case, the States or counties are perfectly integrated and are good candidates to see if poorer States are catching up the richer ones. Young et al (2008) use the U.S. county-level data from 1970 to 1998 containing over 3,000 cross-sectional data and find that there is -convergence but income disparity increases in certain cases. Another level of deeper integration is the European Union. For instance, Marelli (2007) investigates the convergence of the European Union 25 countries and 250 regions within the EU from 1980 to 2005, and found that poorer countries/regions β-converge toward richer ones. In general, we observe convergence among the members of the REC.

Regarding transitional and developping economies, the results are mixed. Mazurek (2013) analyses β and σ convergence of 14 Czech regions over the period 1995-2009 and found that the regions β-diverged and σ-diverged. Péridy and Bagoulla (2012) analyses the convergence of Middle East and North Africa (MENA) countries toward the European Union (EU) countries due to various trade agreements[3] between these two regions over the period 1960- 2004. Even if they found no evidence of income dispersion reduction, they were able to display a catch up process of MENA countries to EU countries, especially for Tunisia, Egypt, Turkey and Morocco. Finally, they found no direct impact of the regional integration process with the EU on the convergence process.

Velde (2011) analyzes nearly 100 developing countries over 1970-2004 and could not establish robust growth effects of regional integration (no convergence). However, he concluded on an indirect effect of regional integration on convergence through the fact that “trade and FDI promote growth, and because regional integration tends to increase trade and FDI, Regional Integration still has a positive impact on growth in its members through the effects of increased trade and investment on growth”. In addition, he found that initially high levels of regional income disparities will lead to greater decreases in disparities.

Table 1 below summarizes the main findings of the literature on the link between RI and convergence.

When analyzing the impact of Regional Integration on convergence, two main shortcomings appear in the literature. First, most of the samples considered includes REC members and no member countries. Since most of the REC policies are designed to support its members, adding a no member in the sample may create a bias. Indeed, the convergence theory assumes that countries converge toward a unique steady state (unconditional convergence) or multiple steady states (conditional convergence). Adding a country thatis not amember of the REC, it may converge to another steady state. Hence, if we assess the unconditional convergence, the presence of no member countries can bias the results since we may have additional steady states and we may wrongly conclude that there is no convergence. Second, in terms of study period, most studies considered the highest available period, even before the creation of the REC. Doing so, create also a bias since before the REC, these countries had different policies that may not convergence toward the same steady point. The present paper is an attempt to respond to these shortcomings in the African context.

3.The data and descriptive statistics

This paper will focus on the main REC of Africa. Our sample include five (5) Custom and/or monetary unions (CMU) and six (5) Free Trade Areas (FTA),all in Africa and covering 45 African countries. The CMU are CEMAC, EAC, SACU, WAEMU and WAMZ. The FTA includes AMU, ECCAS, ECOWAS, IGAD and SADC.[4] As stated above, two assumptions are made to avoid biases. The first assumption concerns the study periods: before and after the creation of the REC. Thus, this period of the study is not uniform across the REC. For instance, for AMU, the creation year is 1989, hence, the study periodsfor this REC will be 1960-1988 and 1989-2012. The first period will characterize the behavior of the member countries before the set-up of the AMU and the second period will capture the impact of the implementation of the REC.

The second assumption is to consider only the founding members in the analysis and remove also any founding member that left the REC. The argument behind this assumption is to ensure that countries have the same level of exposure to the REC agreements. Taking into account only the founding members will give the longest and homogenous data series. This will allow the analysis to capture the effects of different policies the REC has put in place since its creation. For example,the EAC in East Africa has currently 5 members. However, for this study, only the three founding members are considered, i.e. Kenya, Tanzania and Uganda. Rwanda and Burundi are currently members of the AEC but joined later this REC.Table 2 below presents African countries’ affiliation by regional economic community (REC). The countries that are not being considered for the analysis are highlighted. A brief description of each REC is done in Annex 1.

To measure the income level within a country, we use four measures of the country income per capita: (i) the Gross Domestic Product (GDP) per capita in US$ 2005 constant price; (ii) the GDP per capita in Purchase Power Parity (PPP); (iii) the Gross National Income (GNI) per capita in US$ 2005 constant price; (iv) the GNI per capita per capita in PPP.We denote them respectively: GDPPOPc, GDPPOPp, GNIPOPc and GNIPOPp. The data used for this paper are from the World Development Indicators (WDI) database of the World Bank.

Table 3 presents the descriptive statistics for these four income variables or all the REC and at the aggregate level. As expected, the number of observations is different for each REC depending on the number of member countries and theyears of data availability. More data are missing for the GDP per capita in PPP and for the GNI per capita. The longest data series is for the GDP per capita at 2005 US$ constant price.We observe that the income gap is large in some of the REC, which shows the unbalanced of income level among the member countries within the REC. For instance, in the AMU region, the ratio between the maximum and minimum income is about 4. In the ECOWAS region, the ratio between the highest income and the lowest is about 6 in 1975 and 12 in 2012, thus a widening of the gap.