Regional Integration Study of East Africa: the Case of Kenya
Working Paper No. 9
Abstract
This study evaluates the costs and benefits of the East African Community Customs Union to Kenya. In particular, the study assesses the potential impact (to Kenya) of removing tariffs on intra-EAC trade and establishing a common external tariff for the Community. This assessment is restricted to simulation of the government tariff revenue implications of the implementation of the customs unions agreement. However, the study also analyses views of stakeholders on the current or expected impacts of the EAC customs union.
Past efforts to form regional integration schemes in Africa failed because of political and economic factors, which did not favour sustainability of the schemes. However, in recent years, a new momentum of integration has emerged in the continent with the revival of the EAC in 1993 being indicative of that momentum. A number of factors explain this new emphasis on integration including: greater political will, globalisation and the attendant need to strengthen small economies and expand markets to avoid marginalisation, and the desire to achieve economic development.
Literature on Regional Integration Agreements (RIAs) indicates that RIAs can generate benefits through (i) trade creation and growth, (ii) reallocation of resources in response to changing relative prices, (iii) specialisation, (iv) economies of scale, (v) changes in efficiency owing to increased competition, (vi) increased levels of investment and growth, and (vii) through achievement of political objectives such as enhanced security, enhanced bargaining power, and provision of a “commitment mechanism” for trade and other policy reforms. However, regional integration schemes are also associated with costs that include revenue loss from elimination of trade taxes, trade diversion and concentration of industries in well-suited locations, which can lead to increased transport costs for markets in the periphery. Other costs of RIAs may include divergence of the income levels of the countries involved, potential political conflicts as a result of such divergences and loss of national sovereignty especially if integration is deep. It is generally agreed, however, that overall integration schemes are beneficial because trade creation, welfare improvement and industrial development arising from the schemes generate spillover effects which can compensate for the costs.
Kenya has undertaken substantial trade liberalisation and has made commitments towards trade integration schemes not only with the EAC partner states but also with other countries under COMESA, CBI and IGAD. All these efforts are aimed at expanding the country’s trade. Currently, agricultural products (54%) and industrial supplies and consumer goods (33.3%) dominate Kenya’s export trade. The major imports are industrial supplies (34.5%), machinery and capital equipment (32.4%) and fuel and lubricants (15.5%). The major destinations for Kenya’s exports are Europe (33% of total exports) and East Africa (28%). Trade with COMESA countries excluding East African states constitutes about 14% and shows an increasing trend. Semi-manufactured products, processed agricultural products and minerals dominate exports to EAC and COMESA. The European union is the major source of imports for Kenya (32.8% of the total) followed by the Middle East (18%). Kenya’s imports from EAC are about 1% of the total imports and comprise mainly of agricultural products. The data indicates that there is potential to expand trade within the East African states.
A major concern with respect to integration schemes is loss of trade tax revenues. For Kenya, however, the tax revenue base is broad enough to offset some of the revenue losses. In the year 1999/2000 for instance, the country collected a total of Ksh 167 billion in taxes from the following sources: import duties (17.1% of the total), excise duties (16.9%), income tax (31.1%), value added tax (27.5%), and others (9.4%). There has been a general tendency to shift towards consumption-based tax revenues. Despite this, however, tariff-based revenues still form an important component of government revenues. This partly explains the country’s reluctance to adopt a low common external tariff under the revived East African Community (EAC).
The Kenyan perspective on an EAC customs union is favourable. The removal of internal EAC trade tariffs will cost the country about US$ 58.7 million per year in potential revenue and about US$ 613,400 in actual revenue (about 0.03% of total tax revenue collections). Therefore, the removal of internal tariffs for EAC may not be a serious problem for Kenya. The major concern for the country is the level of the common external tariff (CET). Simulation results indicate that the lower the levels of CET the higher the revenue loss for the country. However, revenue loss should not be the only consideration when setting a CET, as welfare gains or losses and impact on industrial development of members of the union are also important. In fact, the level of CET is an important determinant of the likelihood and cost of trade diversion, and the likelihood of agglomeration of economic activity, with higher CETs increasing such likelihood and costs. A maximum CET close to the current average of 20% seems to be a reasonable compromise for revenue and welfare implications, and for protection of domestic industries for Kenya. Consequently, we recommend the following CET: 0% for primary goods, 5-10% for intermediate goods and 20% for final goods. This would lead to an annual loss of potential revenue of about US$ 25-50 million (or about 10-20% of annual tax revenue collections). Determination of the actual CET rate for intermediate goods requires a careful balance between revenue considerations and technology transfer, and therefore industrial development, which requires more research.
Despite the revenue implications, the government and various stakeholders in the country are in favour of quick and deep integration because they expect overall benefits from such integration to outweigh the costs in the long run. With exception of the agricultural sector, other sectors of the Kenyan economy are expected to gain from the implementation of the EAC customs union according to the stakeholders interviewed.
Important policy concerns emerge from this research, including:
(i) Information regarding EAC integration and its objectives: The objectives of the EAC Treaty and in particular the creation of a customs union are not well known to all stakeholders. There is need to disseminate information regarding the objectives of the Treaty and what it entails to all stakeholders.
(ii) Speed of integration: Most stakeholders consider the speed of integration to be slow and many would like to see the removal of internal tariffs effected as soon as possible.
(iii) Implementation of those aspects of the Treaty that have been agreed upon: Stakeholders are dissatisfied with the implementation of those elements of the Treaty which have been agreed upon such as lower import tariffs (80% by Uganda and Tanzania for Kenyan products and 100% by Kenya for Ugandan and Tanzanian products). Other matters of concern include the removal of travel barriers, and reduction and harmonisation of documentation. Stakeholders complain that these have not been implemented effectively and would like them to be.
(iv) Consultations with stakeholders on major aspects concerning creation of a customs union: Most stakeholders feel left out on discussions regarding some aspects of the customs union such as the level of the common external tariff. Stakeholders should be consulted on such matters for their opinion.
(v) Revenue implications from a customs union: The loss in revenue from removal of EAC trade internal tariffs is insignificant for Kenya and should not pose a problem. However, the level of a CET has significant revenue and other implications. The established CET should be a compromise for revenue gain or loss, welfare gain or loss, appropriate protection of domestic industries for the country, and in general socio-political implications.
(vi) Losses from EAC integration other than revenues: These include conflicts with other integration schemes such as COMESA and SADC, loss of sovereignty and employment in sectors likely to lose (such as agriculture). The position of these schemes with respect to the EAC need to be clarified to stakeholders and harmonised. Fear of loss of sovereignty and employment also needs to be addressed.
(vii) Compensation mechanisms for revenue loss: Revenue implications and distribution of benefits from the EAC customs union are major concerns for government and stakeholders in the economy. For stakeholders, increased competition and therefore lower profits is the main concern. This can be dealt with through improvement of infrastructure to reduce the cost of doing business. Therefore, creation of a development fund to support development of common services for the region is a useful mechanism to consider for compensation of losers from the EAC customs union. In some cases, use of surcharges and rules of origin to protect infant industries are mechanisms that can be considered.
(viii) EAC integration strategy: Considering that the old East African Community collapsed partly because of ideological and other political differences between the heads of state, it is imperative that institutions of the current EAC deal effectively with such vulnerability. Even the current EAC treaty, however, grants excessive power to the heads of state. For instance, Article 63 empowers the heads of state to assent to or reject Bills of the East African Legislative Assembly, weakening it substantially. There is need therefore to review parts of the treaty and to secure as much political will as possible even as economic integration proceeds.
After consideration of a number of factors, EAC integration is viable but the following political, social, and economic challenges have to be addressed. First, in the economic sphere, the three countries are low-income countries although Kenya is slightly better off. Yet, we are informed by experience that RI between low-income countries tends to result in divergence rather than convergence in incomes, trade diversion rather than trade creation, and to attract “tariff jumping” foreign direct investment–factors that reduce the economic and political viability of such RIAs. Second, even though political will does not seem to be a problem for the moment, the immense power that heads of state continue to hold over the destiny of the Community is potentially disastrous. Third, lack of adequate involvement of stakeholders could also affect successful implementation of the EAC. Fourth, non-tariff barriers (such as administrative delays, lack of information at border points or delays in getting it, pre-shipment requirements, technical and standardisation requirements, and bureaucratic administration of rules of origin) are a serious bottleneck to the successful implementation of the EAC Treaty. Finally, membership to multiple RI schemes is likely to adversely affect implementation of EAC Treaty through contradictory obligations, increase in complexity that may adversely affect decision-making by the private sector and therefore affect investment, and through diversion of the energy and commitment that is required to pursue depth and width of EAC integration.
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