Trade and Commerce in the World
Senior 6 · Geography
Trade and Commerce in the World
Lesson 3 of 4
40 min
At an extraordinary summit of the African Union held in Kigali on 21 March 2018, 44 African countries signed the agreement establishing the African Continental Free Trade Area (AfCFTA). It entered into force on 30 May 2019, after enough countries had ratified it, and trading under it officially began on 1 January 2021. Its secretariat is in Accra, Ghana. Every member of the African Union except Eritrea has since signed it.
Why would 54 countries agree to cut the taxes they charge on each other's goods? The African Union points out that Africa takes only about 3% of world trade and that trade among African countries is no more than about 15% of their total trade (African Union, 2019); most of Africa's exports go to other continents as raw materials. A larger market without internal barriers is meant to change that. This lesson explains what such agreements are, how deep they can go, and what they gain and cost.
Definition
Trading bloc: a group of countries, usually neighbours, that agree to reduce or remove barriers to trade among themselves. Example: the East African Community (EAC).
Regional integration: the process by which neighbouring countries join their economies (and sometimes their politics) through shared rules, markets and institutions.
Common external tariff (CET): one set of import duties that all members of a customs union charge on goods from outside the bloc. Example: the EAC's CET bands of 0% for raw materials and capital goods, 10% for intermediate goods, and 25% (or 35% for some sensitive goods since July 2022) for finished goods.
Trade creation: new trade that appears when a bloc removes tariffs, so that a cheaper producer in a member country replaces dearer production at home.
Trade diversion: trade that shifts from a cheaper producer outside the bloc to a dearer producer inside it, only because the outsider still pays the tariff.
Economists, following Béla Balassa (1961), describe integration as a staircase. Each step keeps everything from the step below and adds something new (Figure 1).
Figure 1. The staircase of regional integration, with examples. Drawn by Ganzaa.
| Stage | What members agree | Example |
|---|---|---|
| Preferential trade area | Lower (not zero) tariffs on some goods traded among members | The Preferential Trade Area for Eastern and Southern Africa (1981), which became COMESA in 1994 |
| 1. Free trade area | No tariffs or quotas on goods traded among members; each member keeps its own tariffs on outsiders, so rules of origin are needed to stop goods entering through the member with the lowest tariff | AfCFTA; the COMESA Free Trade Area |
| 2. Customs union | Free trade inside, plus a common external tariff on goods from outside | EAC Customs Union (2005); Southern African Customs Union (SACU) |
| 3. Common market | A customs union plus free movement of labour, capital, services and the right to set up businesses | EAC Common Market Protocol (in force 2010); the EU single market (1993) |
| 4. Economic and monetary union | A common market plus shared economic policies and, often, one currency and central bank | The euro area (the euro launched in 1999); the EAC has signed a monetary union protocol (2013) |
| 5. Political federation | One government for the whole union | The final aim of the EAC; the United States is a federation of once-separate states |
Worked example 1: trade creation
Problem. Illustrative prices for one tonne of a building product delivered in Kigali: made in Rwanda, US$ 130; made in Kenya, US$ 115 before duty. Before joining a customs union, Rwanda charges 25% on all imports. After joining, imports from Kenya are duty-free. Where does a Rwandan builder buy before and after?
Solution.
Interpretation. This is trade creation: a cheaper producer inside the bloc replaces dearer home production. Builders save US$ 15 a tonne, but the Rwandan factory loses sales and must become more efficient or change products.
Worked example 2: trade diversion
Problem. Continue the example. A producer outside the bloc, in Asia, can deliver the same tonne for US$ 100 before duty. Under the customs union, outside goods pay the 25% common external tariff, but Kenyan goods pay nothing. Where does the builder buy, and what does the country lose?
Solution.
Interpretation. This is trade diversion: purchases shift from the cheapest producer in the world (US$ 100) to a dearer one inside the bloc (US$ 115) because of the tariff. Before the union the government collected US$ 25 duty a tonne on Asian imports; now it collects nothing, and the real cost of the product to the economy has risen by US$ 15. A bloc is beneficial overall only if trade creation outweighs trade diversion.
| Advantage | Explanation |
|---|---|
| A larger market | Firms can sell to the whole bloc and gain economies of scale; the EAC now joins eight countries |
| Trade creation and competition | Cheaper goods for consumers; inefficient firms must improve |
| Attraction of investment | Investors prefer to build one factory that can serve a whole region |
| Joint infrastructure | Shared corridors, railways, power lines and one-stop border posts |
| Stronger bargaining power | A bloc negotiates with the EU, China or the WTO with more weight than one small state |
| Free movement of people and skills | Workers, students and tourists move more easily, as with the EAC's cross-border use of national identity cards among some partner states |
| Peace and political cooperation | Countries bound by trade have strong reasons to settle disputes peacefully; this was a founding aim of the European Coal and Steel Community in 1951 |
Warning
Common mistakes
Tip
Memory hook: F, C, C, E, P. "Free, Customs, Common, Economic, Political": each step adds one thing: no internal tariffs, then a common outside tariff, then free movement of factors, then shared policies and currency, then one government.
TED-Ed: "What are tariffs, and how do they work?". As you watch, note who actually pays a tariff and why removing tariffs inside a bloc changes where people buy, then link it to worked examples 1 and 2.
Practice
Summary
Sources and credits
Video: "What are tariffs, and how do they work?", TED-Ed, embedded from YouTube.
Figure 1, the worked examples and the exercises were drawn and written by Ganzaa.
This lesson adapts CC BY-SA material and is shared under CC BY-SA 4.0.
