Nigeria must use the ‘Commonwealth effect’ for better trade gains

Last year, the Commonwealth Secretariat invited me to join the technical review committee for a major trade report to be presented to Commonwealth leaders at the CHOGMin Malta in November 2015. The unveiling of the flagship report at the 2015 CHOGM was a key feature of that summit. Last week, the report, titled “The Commonwealth in the Unfolding Global Trade Landscape: Prospects, Priorities, Perspectives”, was presented to an audience of trade diplomats and experts in London.

In a nutshell, the Commonwealth Trade Review, as the report is also called, tells an interesting story about a phenomenon known as the “Commonwealth effect” and how it’s   positively influencing trade and investment between Commonwealth members, thereby creating a “Commonwealth trade advantage”! This is interesting because the Commonwealth is not a trading bloc. In fact, it lacks the association-wide mechanisms to promote trade between its members. It is a 53-memberstrong voluntary organisation of former British colonies, although non-British former colonies can now join, as did Mozambique, a Portuguese colony, and Rwanda, a Belgian/German colony. Commonwealth members are very diverse,and dispersed across the globe. The average distance between Commonwealth markets is 9,500 km.

But here lies the “Commonwealth effect”. Despite being an unnatural trading hub, the report notes that“when two countries are both Commonwealth members, they trade and invest significantly more with each other than they would otherwise have done”. But what factors drive the “Commonwealth effect”? Well, not exactly what you may be thinking – a common language, colonial links etc. It’s more than these factors. I will explain this phenomenon shortly, but, first, let’s consider the report’s other interesting findings.

The report’s overarching message is that the global trade landscape is fundamentally changing; significant transformations are taking place, which are mainly caused by the following factors: (1) the rapidly growing trade of developing countries, such as China, India and Brazil; (2) the increasing resort by the developed countries to bilateral and plurilateral trade regimes, such as the Trans-Pacific Partnership (TPP), the Transatlantic Trade and Investment Partnership (TTIP) and the Economic Partnership Agreements (EPAs); (3) the rise of global value chains, which involves “production sharing”, with countries specialising in producing specific parts or performing specific tasks, rather than producing final goods; and (4) the implications of climate change for countries with high export concentration in climate-sensitive sectors, such as agriculture, resource extraction, fisheries and tourism. These fundamental changes, the report notes, can influence “the sources and direction of trade, its patterns and, in turn, individual countries’ comparative and competitive advantages”.

Another interesting aspect of the report is its analysis of Commonwealth trade flows. The evidence shows that Commonwealth members, on aggregate, have an impressive performance on global exports. For instance, since 2000, the combined total global exports of goods and services of Commonwealth countries have tripled, from $1.3 trillion to $3.4 trillion in 2013. The Asian members, led by India, Malaysia and Singapore, dominate the share of developing countries in total Commonwealth trade, accounting for 80 percent. But the combined exports of the 18 Commonwealth African countries rose from $79 billion in 2000 to more than $300 billion in 2013 (about 10 percent of total Commonwealth exports). Nigeria and South Africa account for about 70 percent of Commonwealth African trade, with Nigeria’s exports growing from $21 billion in 2000 to $97 billion in 2013, while that of South Africa rose from $37 billion in 2000 to $109 billion in 2013.

Trade with developing countries, particularly China, has also grown. For instance, total Commonwealth exports to China increased from just $19 billion in 2000 to $268 billion in 2013. Among Commonwealth African states, Sierra Leone has made the most significant progress in trading with other developing countries. Its exports to non-Commonwealth developing countries rose from a meagre 7 percent in 2000 to a whopping 83 percent in 2013, while that of Nigeria rose from 28 to 44 percent and South Africa’s from 35 to 63 percent.

Of course, no surprises here! Virtually all Commonwealth African exports whether to the rest of the world or to other developing countries are commodities. As the report notes, “Lack of export diversification is a salient feature of the trade orientation of Sub-Saharan Africa”. Commonwealth African countries are also weak in services exports, with only 13 percent of their export earnings coming from services. When broken down into different African countries, however, the report shows that Nigeria has probably the lowest proportion of services exports, with just 2 percent, compared with Mauritius (54 percent), Uganda (45 percent) and Tanzania (38 percent). South Africa also has a relatively low proportion of services exports, at 13 percent.

Now, what about intra-Commonwealth trade? According to the report, the total intra-Commonwealth trade, in terms of goods and services, was $592 billion in 2013. This is projected to surpass $1 trillion by 2020. Commonwealth Asian members, led by India, Malaysia and Singapore, account for 55 percent of current intra-Commonwealth exports. Nigeria and South Africa account for 6 percent each. Interestingly, the analysis also shows that Commonwealth African countries now trade more with fellow African countries and Asian countries than they do with the three Commonwealth European countries, namely, the UK, Cyprus and Malta. For instance, in 2000, 40 percent of Commonwealth African countries’ intra-Commonwealth exports went to the three Commonwealth European countries, but this dropped significantly to 18 percent in 2013. By contrast, 45 percent of intra-Commonwealth African exports went to other African countries and 30 percent to Commonwealth Asian countries in 2013. The decline in Commonwealth African exports to the UK, Malta and Cyprus can be attributed to restrictive EU trade rules, which the three countries have to comply with as EU member states!

This is where the study becomes more fascinating. Despite the patchy performances of Commonwealth members, the report argues that there is a strong “Commonwealth effect”. This is evidenced by the fact that “when two countries are both Commonwealth members, their bilateral trade in goods and services is about 10 percent and 42 percent higher respectively, and bilateral foreign direct investment (FDI) is 10 percent higher”. What this means is that trade and investment between Nigeria and, say, Canada or India are more likely to be higher than between Nigeria and Japan or Russia. Some would dispute this, of course, but the finding is underpinned by data and econometric analysis.

So, what is the “Commonwealth effect”? Well, first, consider the “gravity model of trade”. According to this model, bilateral trade can be explained by the economic mass of both countries, captured by their combined GDP and the distance between them. But the model also includes other variables, such as sharing a common language, belonging to the same trading bloc, having a past colonial linkage, and having common administrative and legal systems.

However, after accounting for these variables, the analysis suggests that they can’t fully explain the Commonwealth trade advantage. So, there must be something additional to the variables. And that additional factor is the cause of the “Commonwealth effect”. Now, this factor, the report says, is the large Commonwealth diasporic community! This is explained using the concept of “psychic costs”. According to this concept, when firms want to expand to international markets, they typically begin in countries that are culturally similar. Where such similarity exists, the ‘psychic’ costs are low, and where it doesn’t the ‘psychic’ costs are high. And the report concludes that “the ‘psychic’ costs of international trade are lower in the Commonwealth”. This is what creates the “Commonwealth effect” and, in turn, the Commonwealth trade advantage.Puzzling? Perhaps. But don’t dismiss the combined effects of the “gravity model” and “psychic costs” on trade.

So, what are the policy implications of the finding? If there is a Commonwealth trade advantage, how can Commonwealth members leverage it? Well, the report sets out four key recommendations. First, countries should build productive and trade capacities. This must involve reducing barriers to trade, promoting private sector development and tackling supply-side bottlenecks. Second, they should improve trade logistics. For instance, the report notes that if each Commonwealth country achieves the same level of Logistics Performance Index (LPI) score as Singapore (which was 4.00 in 2014), the combined Commonwealth GDP would increase by $501 billion. Indeed, even if each country with a lower LPI score than South Africa can achieve the same score as that country (3.43 in 2014), the combined Commonwealth GDP would increase by $177 billion. Third, Commonwealth developing countries should strengthen regional integration and take advantage of preferential trade agreements with the developed countries. And, finally, they should exploit the potential of their Commonwealth diaspora “to catalyse innovation and investment and bridge into new markets.”

All of these are relevant to Nigeria, of course. We must develop the capacity to produce quality goods for exports. You can’t leverage a trade advantage if you have nothing of value to sell to the rest of world. Nigeria must also improve its trade logistics. Nigeria’s 2014 LPI score of 2.81 is very low for its ambition. We must significantly improve customs and trade facilitation. Finally, although controversial, as I argued previously, Nigeria should sign the EU-ECOWAS Economic Partnership Agreement. This would trigger and lock-in significant trade and competitiveness reforms, and enable us to do more business with the UK, a key European Commonwealth country and, of course, other EU member states. Major Commonwealth developing countries, such as India, Singapore, Malaysia and South Africa, already have, or are negotiating, a free trade agreement (FTA) with the EU. Their primary target is the UK market, and through it the wider EU. Nigeria must not be a laggard in this global race. If there is any trade advantage anywhere, we must do everything to leverage it!

 

Olu Fasan