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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

Article by Shinyekwa, Isaac and Othieno, Lawrence, 2013

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The paper investigates the potential impact of the East African Community (EAC) on trade creation and diversion. The paper seeks to establish whether the EAC regional trade agreement (RTA) has diverted or created trade using an expanded(augmented)gravity model. The authors estimate static and dynamic random effects models using a panel data set from 2001 to 2011 on 70 countries that trade mainly with the EAC partner states. Results suggest that indeed the implementation of the EAC treaty has created trade, contrary to widely held views that South-South RTAs largely divert trade.

Trade CreaTion & diversion effeCTs
of The easT afriCan CommuniTy

regional Trade agreemenT:
a gravity model analysis

researCh series no. 112

isaaC shinyekwa

lawrenCe oThieno

december 2013

Trade CreaTion & diversion effeCTs
of The easT afriCan CommuniTy

regional Trade agreemenT:
a graviTy model analysis




DECEmbER 2013

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iEconomic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis


The paper investigates the potential impact of the EAC (a South-South Regional grouping) on

trade creation and diversion. The paper seeks to establish whether the EAC RTA has diverted

or created trade using an expanded (augmented) gravity model. The paper departs from the

conventional estimation approach that uses average combined trade flows as the dependent

variable which is prone to errors and uses exports. We estimate static and dynamic random

effects models using a panel data set from 2001 to 2011 on seventy countries that trade

mainly with the EAC partner states. Results suggest that indeed the implementation of the

EAC treaty has created trade contrary to widely held views that South-South RTAs largely

divert trade. There is thus evidence that the EAC, a south-south RTA has been a more trade

creating than trade diverting as espoused in the literature. The paper explains the possible

measures that have helped generate the trade underscored; formulation and implementation

of EAC medium term development strategies, removal of internal tariffs and adoption of a CET

structure. The paper further highlights that although progress has been made in other areas,

there are challenges that need to be addressed to deepen the EAC integration: persistence

of NTB; lack of a common policy with regard to partner states’ trade policies to non-partner

states; the lack of standardised customs formalities; the lack of harmonised procedures;

and different approaches to investment and export promotion. It is recommended that; the

region adopts a legally binding approach to NTBs, harmonises trade policies and standardises

documentation and procedures.

key words
Gravity model, imports, exports, intra and extra EAC,trade creation, trade diversion, trade

flows, RTA,regional integration

ii Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

Table of ConTenTs

absTraCT i

1.0 inTroduCTion 1
1.1 Intra EAC trade 2005 - 2010 2
1.2 EAC trade with the rest of the world 3
1.3 Objectives 3
1.3 Policy Relevance 4

2.0 review of liTeraTure 5

3.0 analyTiCal framework and meThods 8
3.0 Introduction 8
3.1 Finger-Keinin Index (FK) 8
3.2 The gravity model 8
3.3. The estimation procedure 11
3.4 Diagnostic tests 11
3.5 Data 12

4.0 findings 13
4.1 Introduction 13
4.2 The FK index results 13
4.3 Estimation results 14
4.4 Results in the perspective of EAC integration progress 17

5.0 ConClusion 20

referenCes 21

aPPendix a1 24
Table A1:Total intra-EAC trade, 2005-2011 (US$ million) 24

aPPendix a2 25
Table A2: The countries that are included in the study 25

ePrC researCh series 26

1Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

1.0 inTroduCTion

In the last two decades international trade has
experienced dramatic increase in Regional

Trade Agreements. At least every country

on the globe subscribes to some sort of a

bloc and substantial amount of trade in the

world takes place within such agreements.

between 1948 and 1994 there were only 124
Regional Trade Agreements notifications,

however between 1995 and 2008, there

were additional 300 notifications made. by
January 2012, about 511 RTAs, (taking goods

and services notifications separately), had

notified the GATT/WTO1. At that same date,

319 agreements were in force2. Governments

have the liberty to pursue two broad options

when seeking to liberalize trade; namely

unilateral and preferential liberalization

(Kandogan, 2005). In both instances, there are

welfare improving end points especially when

trade creation takes place. Trade liberalization

has been an important part of East Africa’s

policy agenda since the countries embarked

on liberalising their inter-state trade as

part of the regional integration process.

This is exemplified by the number of trade

initiatives, specifically economic integration

agreements that the region is involved in,

such as the East African Community (EAC), the

Common Market for East and Southern Africa

(COMESA) and South African Development

Corporation (SADC) for Tanzania3. the EAC

1 General Agreement on Tariffs and Trade/World Trade Organisa-

2 http://www.wto.org/english/tratop_e/region_e/region_e.htm
(December 3rd 2012)

3 All EAC countries belong to the African Union (AU). Kenya and
Uganda belong to the Inter-Governmental Authority on Devel-
opment (IGAD); Burundi, Kenya, Rwanda, and Uganda belong to
the Common Market for Eastern and Southern Africa (COMESA);
and Tanzania belongs to SADC. Kenya and Tanzania are also ac-
tive members of the Indian Ocean RimAssociation for Regional
Cooperation (IOR-ARC). Burundi and Rwanda similarly par-
ticipate in the Economic Community of Great Lakes Countries

is composed of five partner states; Burundi,

Kenya, Tanzania, Rwanda and Uganda4.

A number of provisions to increase the EAC
intra-trade are enshrined in the treaty leading

to the formation of the EAC. Article 75 of the

Treaty and the Customs Union (CU) Protocol

provides a number of elements including

(i) elimination of internal tariffs and other

charges of equivalent effect (ii) elimination

of non-tariff barriers; (iii) establishment of

a Common External Tariff (CET); (iv) duty

drawback, refund and remission of duties

and taxes, among others. It was anticipated

that implementation of these provisions

would increase the value and volume of trade

within the EAC. The rationale for regional
integration include among others the benefits

of trade creation, greater economies of scale

based on profitable competition, increased

investment, and improved bargaining power.

Article 25 of the EAC CU protocol highlights

the commitment of Partner States to support
export promotion schemes in the Community

for the purposes of accelerating development,

promoting and facilitating export oriented

investments, producing export competitive

goods and attracting foreign direct

investment. These and others are among the

efforts to boast intra-EAC trade.

There are conflicting views with regard to

trade diversion and creation in South-South

Regional Trade Areas (RTAs). Yeats (1998)

expresses a pessimistic view arguing that

promoting intra-regional trade has potential

4 The Treaty for the establishment of the EAC was signed on 30th
November 1999 and came into force on 7th July 2000. The EAC
Customs Union Protocol was signed on 2nd March 2004 and
came into force on 1st January 2005.

2 Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

adverse effects on member countries and

on third party countries and have a negative

effect on Africa’s industrialization and growth.

A World Bank, (2000a) report argues that

South-South RTAs generate trade diversion

especially when CETs are high and the member

states are poor.Others who hold similar views

include Park (1995), andSchiff (1997).On the

other hand Cernat (2006) argues that, South-

South RTAsare not more trade diverting than

other RTAs implying that it is case by case.

This view is supported by Elbadawi (1997)

who argues that integration in Africa is key to

generating the threshold that can trigger the

growth through complementarities. Using

a Computable General Equilibriummodel,

Evans (1998) found a net positive effect of the

Southern Africa regional integration initiative.

Buigut (2012) uses a modified gravity model

to estimate trade effects of the EAC CU on

individual member countries and concludes

that the CU has generated disproportionate

impact on intra-EAC exports and imports.

There is thus lack of conclusive evidence with

regard to trade creation and diversion. These

are pointers to the fact that the debate is

ongoing deserving more empirical evidence.

1.1 intra eaC trade 2005 - 2010

Following the implementation of the EACCU

in 2005 the value of intra-EAC trade steadi-
ly increased and more than doubled from

US$1.8 billion in 2005 to US$4.9 billion in

2011 (AppendixATable A1). This is reflected in
the share in total EAC trade which improved

from 7.8 percent to 11.4 percent (WTO,

2012), although significant differences exist

with respect to specific member states. In

spite of the growth in intra-EAC trade perfor-
mance there are impediments like poor infra-

structural services, mainly physical infrastruc-
ture (roads and rail), and high costs of energy,

resulting in high costs of doing business that

make it difficult to boost trade. Figure 1 dem-
onstrates that Kenya is the largest contributor

to intra-EAC exports (57.2 percent of the total

in 2010) and Uganda is the largest regional

importer (37 percent of intra-EAC imports in

2010). Kenya overall contributed to an aver-
age share of over 40 percent of total intra-

EAC trade and enjoyed a trade surplus with

its EAC partners during the period.

The region has undertaken a number of trade

policy measures to increase and boost in-
tra-EAC trade and trade with the rest of the

world: The Internal Tariffs (IT) along borders

of partner states have been fully removed

and the EAC CET has been fully operational-
ized. There are however challenges of over-
lapping membership of the EAC countries

to various regional arrangements which also

poses a challenge for the EAC due to differ-
ent rules of origin requirements and these

include Tanzania in SADC and the rest of the

EAC partner states in COMESA. Non-tariff

barriers (NTBs) remain a major impediment

to regional trade and these include: non-

harmonised technical standards, sanitary and

phyto-sanitary requirements, customs proce-
dures and documentation, different rules of

origin regimes and road blocks (Okumu and

Nyakori, 2010).The establishment of the Na-
tional Monitoring Committees (NMCs) in all

the EAC members to address these NTBs has

fully not yielded the anticipated results.

3Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

figure 1: Total intra-eaC trade, 2005-2010 (us$ million)

Data Source: East African Community Facts and Figures - 2012. ARUSHA, TANZANIA. EAC Secretariat, 2012

1.2 eaC trade with the rest of the world

On the other hand total EAC trade with the

rest of the world has continued to be domi-
nated by imports. This is explained by the lim-
ited stock of technology at the regional level

compelling the EAC partner states to import

high technology manufactures from the rest

of the world. The goods are mainly imported

from the European Union, United States of

America, Asia and other African countries.

According to (WTO, 2012), the value of EAC

trade with the rest of the world fell from

US$31 billion in 2008 to US$28.8 billion in

2009. This is explained by the global economic

crisis on both imports and exports. However,

when the value of trade with the rest of the

world is compared to the intra EAC – stand-
ing at only US$4.9 billion in 2011, the partner

states have a long way to go to increase their

intra-regional trade.

1.3 Objectives

As echoed in the literature, the debate

on whether south–south RtAs create or
divert trade is inconclusive. Although trade

volumes among the EAC partner states have

increased, there is limited empirical evidence

with regard to trade creation and diversion.

The paper seeks to establish whether the EAC

RTA has diverted or created trade. Specifically

the study seeks to:

1. Establish whether trade has been di-
verted as a result of the CET adopted by

the EAC;

2. Establish whether trade has been cre-
ated by the EAC regional integration;


3. Propose policy options/measure for
deepening the EAC regional trade.

4 Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

1.3 Policy relevance

This paper will provide a basis for formulating

polices that seek to deepen the EAC regional

trade. The paper will thus guide policy makers

on key interventions to deepen the regional


The rest of the paper is organised as follows:

Section II is review of the literature, Section

III gives the augmented gravity model as used

in the paper and the data sources, section

IV presents and discusses the findings and

section V makes the conclusions and policy


5Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

2.0 review of liTeraTure

Trade theories explain why countries seek

to integrate. Richadoin the classical theory

of trade argues that trade raises a country’s

potential income (welfare) compared to

autarky through specialization according to

comparative advantage. Therefore countries

shift resources to production of goods where

they efficiently produce and import goods

where they are less efficient. Since in the real

world, the existence of tariff and NTBs distorts

the final consumer price regional integration

overcomes this challenge. On the other

hand Heckscher Ohlin (O-H) model explains

international trade based on the country’s

factor endowments, that is, the relative

quantities of capital and labour available for

production. It assumes that countries have

access to the same technology. Therefore

countries with relatively large quantities

of labour will shift production to labour

intensive production and export these goods

and import capital intensive goods. there
has been renewed interest in regional trade

agreements in the past decade especially

after the Doha Round talks stalled. The debate

questions, the impact of RTAs on partner

states and third countries (see for example
World Bank 2000a; Yeats (1998; Schiff (1997;

and Park (1995). The theoretical foundation

to make such analysis is embedded in the

Viner’s (1950) seminal work which advanced

the idea of ambiguous welfare effects that

result from formation of an RTA.

When barriers are dropped, markets become

enlarged giving more efficient producers’

entry into countries where prices had

artificially been high due to the duties and

other trade barriers. This brings into play the

concepts of trade creation and diversion5.
McIntyre (2005) argues that the assessment

of the static effects of forming an effective

RTA, hinges on three important principles

from the theory of integration, namely,

allocation/efficiency, competitiveness

and complementarity: Efficiency gains of

economic integration depend on whether

the products from partner states are in direct

competition with, or complementary to each

other. This means that considerable overlap

in the range of commodities produced by

partner members is critical for determining

efficiency gains. The overlap should be

accompanied by significant differences in

production costs between members, to

ensure leverage in terms of more efficient

allocation of resources. The EAC partner states

among themselves are likely to have a narrow

range of exports of goods and services. This

typically limits the scope for efficiency gains

but does not eliminate them altogether.

Complementarity exists when partner

states of an RTA produce commodities that

do not compete, but rather complement.

Complementarity is usually characterised by

the usual trade diversion and trade creation.

The trade agreements between the North

and the South tend to complement, where

the south produces inputs and the north

5 Trade diversion occurs when a free trade area (in this case the
EAC CU) shifts (diverts) trade, away from a more efficient sup-
plier outside the EAC region, towards a less efficient supplier
within the FTA, for example Kenya, Tanzania, Burundi and Rwan-
da. This is likely to reduce Uganda’s national welfare, however
in some instances the national welfare may improve despite the
trade diversion. Trade creation occurs when a free trade area
(in this case the EAC CU) increases (creates) trade that would
not have existed otherwise without the formation of the FTA.
In this case as a result, supply will come from a more efficient
producer of the concerned product. Gains occur if higher-cost
domestic production is replaced by cheaper imports from one/
all EAC partner states. Unlike trade diversion, in all cases trade
creation raises a country’s national welfare

6 Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

produces final products owing to the limited

processing capacities of the former. Of

course perpetuating this kind of arrangement

is at the disadvantage of the south. It is

argued that because RTAs give preferential

treatment to member countries, they divert

trade from non-member, probably least-

cost suppliers to members who are high-

cost suppliers (Bhagwati and Panagariya,

1996; and Panagariya, 1998, and 1996).

This is interpreted as an impediment to

multilateral trade liberalization and as such

trade diversion dominates trade creation. In

instances where the rest of the world is the

least cost supplier and faces constant costs,

an RTA with the supplier who faces increasing

costs diverts trade and the liberalizing

country forfeits tariff revenue (Robinson et
al., 1999). In contrast, when the RTA partner
is the supplier facing constant costs, there are

benefits from the price reduction in addition

to tariff revenue from the countries excluded

from the RTA. However, as Panagariya (1996)

argues, usually the rest of the world, not the

RTA partner, faces constant costs while RTA

members face increasing costs. Therefore

given such a scenario, whereas trade creation

will take place for some commodities, for the

goods coming from a partner with increasing

costs — trade diversion will dominate the


De meloet al., (1993) instead present a mild
view arguing that integration both creates

and diverts trade. Likewise, De Rosa (1998)

provides a balanced view of the theoretical

models which demonstrate both trade

creation and diversion in a situation where

an RTA is formed either with a partner facing

constant or increasing cost. He presents the

Meade model where both international and

domestic relative prices have a possibility to

adjust in a general equilibrium framework. In

this framework a country entering a regional

trade agreement and increases its imports

from all sources, improves its welfare. He

goes further to propose that to prevent trade

diversion, RTA member countries should

reduce trade barriers with non-member

countries as they do for members. Others

have used theoretical models (CGE) to analyse

RTA impact given their advantage of being

economy-wide and multi-sectoral models

(see for example, Brown 1993; Francois and

Shiells, 1994; Shinyekwa and Mawejje, 2013).

It is evident in the literature that theoretical

models give an ambiguous picture with regard

to the net impact of an RTA on trade creation

and trade diversion. Robinson et al.,(1999)
suggest that the impact depends on the

export capacity of the partner country and

whether the partner country faces constant
costs. Panagariya (1998) argues that an RTA

can be net trade-creating in one sector and

net trade-diverting in another sector. What is

common in these studies is that they analyse

macro-economic, welfare and sectoral

impacts and very limited analysis on trade

creation and diversion.

The literature on RTA using gravity models

dwells more on determinants of trade and

less on trade creation and diversion. Zarzoz

and Lehmann (2003) apply a gravity model

to assess Mercosur-European Union trade

and the trade potential following trade

agreements between the two blocs and

establish that belonging to either bloc fosters

trade. Yeats (1998) established that intra-

Mercosur trade between 1979 and 1994

increased and in some cases very dramatically.

Laaserand Schrader (2006) analyse the Baltic

trade flows and establish a strong trade

link between Estonia, Lativia, Lithuania

7Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

and the European Union (EU) suggesting

trade creation following their joining the

EU common market. Foroutan and Pritchett

(1993) looks at intra-trade in Sub Saharan

African using gravity model and concludes

that despite the proliferation of RTA in Sub

Saharan African there is very limited intra-

trade suggesting limited trade creation. Cernat

(2001) assesses regional trade arrangement

in South-South RtA6 and establishes that
contrary to the feared negative impacts they

are not more trade diverting than other RTAs.

Buigut (2012) estimates the trade effect of

the EAC customs union on each individual

member and concludes that the customs

union has generated disproportionate

impact of intra bloc exports and imports for

individual members. However, this study does

not analyse the trade diversion and creation

impact of the EAC.

There are extreme studies that have painted

a rather pessimistic picture of RTAs especially

in developing countries (South-South).

They base their argument on the similarity
of resource endowment of the partner

members which in their view makes it hard

for them to increase intra-regional trade.

Naya and Plumber (1991) reported the

failureof the Association of Southeast Asia

Nations (ASEAN) after a decade to increase

intra-bloc trade above its level of 15 percent

to 20 percent of total trade. According to

World Bank (2000a) South–South RTAs are

non-edifying as they generate trade diversion

which reduces welfare in circumstances when

tariffs are high instead of reaping economic

benefits like increase in intra-trade. Yeats

(1998) argues that intra-regional trade has a

potential to create adverse effects especially


on third party member countries among Sub-

Saharan Africa and concludes that intra-trade

is likely not to make an important impact on

the partner countries and may negatively

impact Africa’s industrialization. Schiff

(1997) is rather more radical about RTAs in

the South since, as he argues,RTAs between

small countries increase the likelihood of

partners switching from cheaper imports

from low cost third party members to higher

cost partner members. This is best explained

by Park (1995) and Derosa (1998) who argue

that when the intra-regional trade shares are

small in total trade, there are more chances

of trading blocs diverting trade. The evidence

is thus inconclusive requiring further work.

8 Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

3.0 Introduction

This section presents the analytical framework

and the different methods applied in the

analysis. We start with the Finger-Kreinin

Index, proceed to give a theoretical foundation

for the gravity model and then the modelling

of the augmented gravity model. The section

then details the estimation procedure, the

diagnostics tests and then concludes with

data sources

3.1 finger-keinin index (fk)

The FK index provides a measure of the

similarity of the trade pattern of any pair

of countries. The analysis is based on the

FK index (Finger and Kreinin, 1979) in the

Trade Sift Software with data from WITS-

UNCTAD COMTRADE7. It reveals the degree

of similarity between the export structures

or production between two countries. It

also shows whether there are any significant
changes in the trade structures among the

countries in a given economic bloc or bilateral

arrangement. It is a useful analytical index in

the context of a regional trade agreement

with regard to the likely impact on the partner

countries of the agreement, and the likely

impact on the excluded country or countries.

It thus, provides a useful benchmark in

examining the issues of trade creation and

trade diversion. It is also useful in conducting

a Trade Tracker analysis as it may help to

identify key competitor countries in particular

sectors or across a range of products. the Fk
by destination is:

7 WITS is World Integrated Trade Solutions, -UNCTAD is United Na-
tions Conference on Trade and Development and COMTRADE is
Commodity Trade


Where, and represent the two source
countries and j the destination country.

while refers to the trade flow in product
k; X to the total trade flow. Therefore,
is the share of product k in country i’s total
exports to the destination partner j. Likewise,

the share of product k in the comparator
country’s total exports.

The FK results range between 0 and 1. Thus,

when the result is 0, it would imply that the

two countries’ export structure is completely

divergent. The products that country iexports
are not traded between the two countries.

To the contrary, if the result is 1, the two

structures are identical. In that case, both

countries export similar products and with the

same intensity though they may differ in size.

Likewise, if two countries’ export products are

similar, trade creation is more likely to occur

since both countries can choose to import

from the more efficient supplier. On the

other hand, if they are different, preferential

agreement could lead to trade diversion.

3.2 The gravity model

The application of the gravity model to assess

and analyse international trade flows was

first applied in the 1960s. Since then, gravity

models have been widely used. Early studies

using gravity models (Tinbergen, 1962;

Poyhonen, 1963; and Linnemann, 1966)

were ad hoc, and lacked solid theoretical
foundations. The application of gravity

models to economic interchange and trade

was in the past criticised as lacking basis and

3. analyTiCal framework and meThods

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

foundation from trade theory (Matyaset al.
2000). It was argued that the model lacked

the ingredients of the prominent models of

international trade that included the Ricardian

model, (differences in technology) and the

Heckscher-Ohlin (HO) model (differences in

factor endowments) as the basis for trade

(UNCTAD and WTO, 2012). This view has

so far been reconsidered owing to more

enlightening empirical work and details as

reviewed in Shinyekwa and Othieno (2013).

Specifically, the works of Anderson (1979),

Bergstrand (1990), Deardorff (1998), and

Feenstra, et al,(1998) have since resolved this
problem providing relevant trade theories.

The debate now as explained by Baldwin and

Taglioni (2006) is on the errors that different

specifications of the gravity model face in

the literature. The three errors are the gold,

silver and bronze medal errors. Respectively

they refer to the multilateral resistance terms

which are always omitted and yet they are

correlated with trade costs, averaging the

reciprocal trade flows8, and inappropriate

deflation of trade flows. Baldwin and Taglioni

(2006) extensively reveals the problems

and suggests how these problems can be

addressed which the current study adopts.

We use direction specific data (exports) and

not averaged bilateral trade databased on

trade theory that asserts that gravity models

hold for each and every uni-directional trade

flow. Cernat (2001) argues that using bilateral

trade flows as a dependent variable for a

given pair of countries fails to discriminate

the impact of RTA formation on exports from

non-member to RTA members and exports

8 The basic theory of the gravity equation is a modified expendi-
ture function, that is, it gives us the value of expenditure by a
country on goods produced by another country. This implies
that the gravity model explains uni-directional bilateral trade.
However, most gravity models estimated use the average of the
two-way exports between the two countries

from the RTA members to the non-member.

We use the log-linear form of the gravity

equation to estimate the trade creation

and diversion effects of the EAC RTA, using

a panel regression analysis. The gravity

equation helps to analyse the evidence of

trade diversion through ex-post analysis of

trade flows. We use the export trade flows

as the dependent variable, in log form, from

country i to country j at a given time t – 2001-
2011. The gravity equation demonstrates the

relationship between the natural logarithm

of the monetary value of trade between

two countries and the log of their respective

GDPs, a composite term measuring barriers

and incentives to trade between them.


where Xijt are exports from country i to
country j at time t. Yit and Yjt are the GDPs
at time t of country i and j, respectively9. the
distance between the two capital cities of

the two countries is defined as Dij. therefore
bilateral trade flows are dependent upon the

size of the two economies and the distance

between them. Whereas a high level of

income in the exporting country indicates

a high level of production leading to more

products for export, high level of income

in the importing country suggests higher

demand and therefore, higher imports. In this

case, both Yit and Yjt are positively correlated
with the level of bilateral exports. Yppcit+
Yppcjt are the per capital incomes at time t
of country i and j, respectively. The choice
of the per capita income is meant to reflect

the population impact that is implied in the

effective demand for commodities among

the trading partners.

9 Later in the model we will define another country k to represent
countries outside the EAC RTA

10 Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

In this case, both Yppcit+ Yppcjt are positively
correlated with the level of bilateral exports.

The coefficient for distance is expected to be

negative since distance increases transport

costs. Finally, εijis the log normally-distributed

error term. For estimation purposes, the

basic gravity model is most often used in its

log-linear form. We interpret the parameters

of the estimated equation in logarithms as

elasticities as specified in equation 3.

………...…………….................. (3)

It is also common to expand the basic gravity

model by adding other variables, which are

thought to explain the impact of various

policy issues on trade flows. Traditionally,

the augmented version of the gravity model

assessing the impact of RTAs has other dummy

variables added. Empirically, trade costs are

traditionally captured as distance between

the two countries. However, additional

variables are also used and these include

dummies for islands, landlocked countries

and common borders. According to UNCTAD

and WTO(2012) they reflect the fact that

transport costs increase with distance and

that they are higher for landlocked countries

and islands but are lower for neighbouring

countries. The coefficients for the land locked

and islands dummy variables are expected

to be negative while the common border

is positive due to proximity. Other dummy

variables are used to capture information

costs and these include common language,

adjacency or other relevant cultural features

such as colonial history. In(RERij)t denotes
the real exchange rate between Uganda and

trading partners calculated as the average of

the national currency unit of country j per US
dollar divided by the annual average of the

national currency unit of i per US dollar.

The variable of interest is the RTA,taking

two countries i and j in a common RtA (for
example Uganda and Kenya) and country k
(Zambia) that is not. If i imports more from
j and less from kfollowing integration, then
trade diversion will have taken place. On

the other hand if iimports more from j and
k, following integration, then trade creation
is said to have taken place. A number of

approaches have been proposed to model

trade creation and diversion effects of an RTA:

UNCTAD (2012) and Cernat (2001) propose

that if i and j are members of the RTA at time
t we assign them 1 and 0 otherwise (k). this
dummy is intended to capture the increase in

exports from EAC members as a result of RTA

formation. This means that Uganda, Kenya,

Tanzania, Burundi and Rwanda take the value

of 1 (also referred to as bothinEAC). Countries
out of the EAC region will take 0. The other

dummy captures trade between a member of

the EAC and trading partners outside the EAC,

which is given 1 and 0 for trade between both

countries outside the EAC. We will refer to this

dummy as oneinEAC. The dummy is intended
to approximate the change in exports from

third countries to the EAC member as a result

of formation of the EAC. In case of a decrease

in exports from more efficient third country

exporters (k), this variable is interpreted

as trade diversion. However, if there is an

increase in exports from third countries as a

result of EAC formation this dummy should

be interpreted as trade creation. Therefore

when both coefficients are positive and

significant it suggests that trade creation has

taken place. However, when the bothinEAC
is positive but oneinEACis negative it means
trade diversion has taken place. This implies

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

that the interpretation of the two dummy

variables can be done jointly. Including all

the other variables leads to the following


3.3. Theestimationprocedure

We use the Hausman test to choose between

the FE and RE models. The choice is made

by running the Hausman test where the null

hypothesis is that the preferred model is RE

versus the alternative - the FE model. It tests

whether the unique errors (ui) are correlated
with the repressors. We run a FE model and

save the estimates, then run a RE model and

save the estimates, then perform the tests.

Since the results are not significant we accept

the null hypothesis that the preferred model

is the RE. Since the RE model had the correct

specification for the trade flows, we conducted

the Breusch-PeaganLangrange Multiplier

(LM) to decide between a RE regression and

a simple OLS regression. The null hypothesis

says that the variances across entities are

zero implying that there is no significant

difference across units, that is, no panel effect

in which case OLS suffices. The results show a

very significant difference (P-value 0.0000) in
which case we reject the null hypothesis and

conclude that RE is the appropriate model

to estimate. There is strong evidence of the

significant difference across the countries and

therefore we cannot run a simple ordinary

least squares (OLS). Finally we include a lag of

exports since bilateral agreements and trade

preferences are likely to have a lag hence

the need to apply dynamic models. Dynamic

panel models are increasingly being used in

panel data estimation partly due to increase

in panel data availability and the vast array

of economic theories fronting some form

of partial adjustment of economic variables

to an equilibrium level (Harris and Matyas,

1996). These are models which include

lagged value(s) of the endogenous variable

as explanatory variables. The paper therefore

estimates a dynamic RE model in addition to

the static RE to gauge the impact of previous

trade flows on current trade flows.

3.4 Diagnostictests

We checked multi-collinearity in the model

by conducting the simple correlation test

that reveals the coefficients between the

explanatory variables. Results demonstrated

that the values of the correlation coefficients

between explanatory variables are lower

than 0.80. Studenmund (200110) argues that

below such a threshold the model is fine,

therefore we concluded that there is no

serious problem. We conducted Unit root

tests to determine a potentially co-integrated

relationship between the variables. When all

the variables are stationary, the traditional

estimation methods can be used to estimate

the relationship between the variables.

However if the variables are non-stationary,

a test for co-integration is required. We

conducted the Levin et al. (2000)11 test
of panel unit roots that assume that the
autoregressive parameters are common

across countries. Levin, Lin and Chu (LLC)

10 Studenmund AH (2001) Using Econometrics – A Practical Guide,
San Francisco, CA, Addision Wesley Longman

11 Levin, A, Lin, C F and Chu (20020 Unit Root Tests in Panel Data:
Asymptotic and Finite Sample Properties, Journal of Economet-
rics , 108. 1-1-24

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

used a null hypothesis of a unit root that

states that the panels contain unit roots and

the alternative that the panels are stationary.

The test results indicate that all variables are

stationary (the null unit root is rejected). As

a result of this the co-integration test is not

required to estimate the model.

3.5 data

We obtained export trade data from the

COMTRADE and World Integrated Trade

Solutions (WITS) database. We included

seventy five countries12 which mainly trade

with the EAC partners based on the value of

trade that exist among them. The data for

distances were extracted from the distance

calculator website13 which is defined as

direct distance between the capital cities of

a pair of trading partners without taking into

consideration the actual routes by either

forms of transport. The GDP, per capita
income, and real exchange rate data were
taken from the World Bank Development

Indicators (WDI) of the World Bank. The data

on whether, a country is land locked or not,

is an island or not, borders a trading partner

or not and has the same official language or

not were extracted from the Centre d’Etudes

(CEPII)14 gravity dataset. The analysis is done
for the period 2001 to 2011 which covers

the implementation of the EAC regional


12 The countries are in the Appendix
13 http://www.timeanddate.com/worldclock/distanceresult.

14 CEPII make available a “square” gravity dataset for all world pairs

of countries, for the period 1948 to 2006. This dataset was gen-
erated by Keith Head, Thierry Mayer and John Ries to be used in
the following paper: HEAD, K., T. MAYER AND J. RIES(2010)

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

4.0 findings

4.1 Introduction

This section presents the results of the Fin-
ger-Kreinin Index and the estimation results

of the gravity model. This is followed by a dis-
cussion that explains why trade has been cre-
ated within the EAC and further highlights the

areas that need policy intervention to deepen

the EAC integration. Finally, a conclusion is

made underpinning the emerging policy is-

4.2 The fk index results

The result in Table 1 suggests that the trade

pattern among the EAC partner states had

limited similarity over the period 2005-2010.

The fact that the index has values closer

to zero than to one attests to this. Had the

index been around 0.5 or even higher, then

this would have suggested an even stronger

relations between the partners’ exports. This

in one way would imply that the preferential

trade agreement under the EAC customs

union has to a limited extent created trade or

no overlap in production and export bundles.

The conclusion emerging from this analysis

is that the regional engagement in the EAC

customs union has generated limited trade

creation arising from the preferential trade

liberalisation since 2005.In this case therefore,

championing deeper integration through full

implementation of a single customs territory

and clearing existing barriers to both goods

and services trade would foster trade creation

on the consumption side but also increase

complementarity of trade among the EAC

partner states.

Table 1: finger-kreinin index for uganda and eaC partners 2005-2010

reporter 1 reporter 2 2005 2006 2007 2008 2009 2010

Burundi Rwanda 0.1 0.1 0.4 0.3 0.4 0.2
Burundi Tanzania 0.1 0.1 0.1 0.2 0.2 0.1
Burundi Uganda 0.1 0.0 0.1 0.1 0.1 0.1
Burundi kenya 0.0 0.1 0.1 0.1 0.0 0.1
kenya Tanzania 0.2 0.2 0.2 0.2 0.2 0.2
kenya Uganda 0.2 0.2 0.2 0.2 0.2 0.3
kenya Rwanda 0.1 0.1 0.1 0.0 0.1 0.1
Rwanda Uganda 0.3 0.1 0.1 0.2 0.1 0.2
Rwanda Tanzania 0.1 0.1 0.1 0.1 0.2 0.1
Uganda Tanzania 0.3 0.2 0.2 0.3 0.1 0.2

Source: Calculation based on Trade Sift, 2013

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

4.3 Estimationresults

Table 2 gives the estimation results of the

impact of the EAC RTA on trade specifically

trade creation and diversion. The dependent

variable is the log of real exports of the

EAC countries and their 70 major trading

partners as illustrated in Appendix A Table

A2:The estimation of gravity model for trade

flows in the literature has been done with

limited consideration of past trade and trade

agreements on trade flows. Trade is dynamic

and any efforts undertaken to increase trade

flows like trade facilitation, signing regional

agreements and access to Generalised

System of Preferences (GSP) is likely to gain

momentum over time. In this paper the

progressive implementation of the EAC treaty

and protocols is captured by a lag of the

exports and a dummy variable breaking the

period into two (2001-2004 and 2005 - 2011)

and to achieve the former, we extend the

standard static RE gravity model to a dynamic


The ultimate purpose of this paper is to

estimate the trade creation and diversion

effects of the EAC trade agreement on

partner states. In interpreting our results

we examine the levels of significance and

coefficients of the estimations, particularly

those relating to intra and extra EAC trade
trends. In addition, other pertinent model

variables are interpreted in respect of their

impact on the EAC overall exports. The

results demonstrate the different estimations

undertaken as discussed in section 3.3. The
discussion is based on the static and dynamic

RE estimations. Overall the two models have

similar results and their explanatory power

is quite high and reasonable. The overall

R-Squared for the static RE is 0.53 and 0.56

for the dynamic RE suggesting that more

than a half of the variation in trade flows is

explained by the variables used in the model.

The Wald chi2 test(for panel models) clearly

shows that the model is a good predictor

(goodness of fit) with the probability of less

than one percent.

With the exception of the importer’s per

capita income, for all the models the

estimated coefficients present the expected

signs and magnitudes. Whereas under the

static RE, a 10 percent increase in the per

capita income of the exporters increases trade

by 2 percent, the dynamic models estimates a

1.7 percent increase in trade. The per capita

income elasticities of the importers on the

other hand are negative and extremely small

in magnitudes. The income elasticities (GDP)

are positive and highly significant clearly

demonstrating that GDP is highly correlated

with trade flows. A 10 percent increase in

GDP for the exporters leads to a 15 percent

increase (static RE) and 12 percent (dynamic)

in exports. Similarly an increase in the GDP

of the importers by 10 percent leads to 13

percent in export trade under both static

and dynamic RE models. It thus emerges as

it is conventionally established that when

countries increase their incomes they are
likely to trade more.

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis


variable REStatic re dynamic

Exporter per capita income 0.209*** 0.172***
0.0132 0.0127

Importer per capita income -0.0578*** -0.0734***
0.0124 0.012

Exporter GDP 1.543*** 1.221***
0.0124 0.013

Importer GDP 1.269*** 1.274***
0.0109 0.0106

Distance -0.811*** -0.788***
0.023 0.0222

Area 0.0283** 0.0312***
0.00889 0.0086

Contingency 0.987*** 0.847***
0.101 -0.0981

Common Official language 0.843*** 0.876***
0.0481 0.0466

Common Colony -0.00526 -0.0324
0.0582 0.0563

Landlocked -0.0464 -0.0575
0.048 0.0464

Island 0.656*** 0.572***
0.0524 0.0507

Dummy Intra-EAC 6.897*** 7.018***
0.28 0.27

Dummy Extra-EAC 0.534*** 0.227**
0.0745 0.0723

Dummy Customs Union 0.569*** 0.384***
0.0346 0.0336

Real Exchange Rate -1.681*** -1.328***
0.112 0.109

Lag of exports 0.213***

Constant -42.08*** -38.84***
0.654 0.635

R squared overall 0.527 0.557
R squared between 0.976 0.99
R squared within 0.522 0.552
Number of observations 60214
Number of groups 11 11
Wald chi2(15) 67065.81 75753.27
Probability > chi2 0.0000 0.0000

Standard errors in parentheses: * p<0.05, ** p<0.01, *** p<0.00

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

The distance to the importers capital city is

highly significant and negative conforming

to theory that distance is associated

with transport and distribution costs in

international trade. As distance in kilometres

increases by 10 percent, trade reduces by

8 percent in all the models. The EAC region

exports commodities to the European

Union and other far areas which increases

transaction costs. Although the size of the

country is highly significant, the coefficient

is quite small with probably a small impact.

As the sizes of different country differ by

a margin of 10 percent, trade marginally

increases by less than 1 percent. It is not all

about the size of the country but the size of

the economy (GDP) that matters most. For

that matter small countries with advanced

technology in manufacturing, trade more

than large countries relying on commodities

for exports.

It is argued that trade agreements and

relations respond with time suggesting

that exports in the previous year impact on

exports in the current year. As expected the

lagged exports added to the list of predictor

variables (dynamic model) is statistically

significant (less than 1 percent), moreover

with the expected positive signs. This suggests

that lagged exports exert a positive and highly

significant impact on current export flows.

Increase in trade in the previous increases

trade in the current period by 2 percent and

this is agreement with growth in intra-EAC

trade discussed in the background of this

paper. In the context of the analysis, the EAC

trade agreement signed by partner states is

taking effect by generating more trade. This

is further underlined by the variable that

estimates the impact of the EAC CU. The

variable breaks the analysis in two periods:

where 2001 to 2004 is taken as the first phase

-FTA and 2005 to 2010 is taken as the second

phase –CU. The coefficient value of 0.56915
(static RE) and 0.384 (dynamic RE) translate

into 77 and 46 percent increase in trade

respectively. Implementation of the EAC CU

has thus increased intra-EAC export trade.

The results suggest that movements in the

real exchange rate affect trade flows as the

estimated coefficient is negative and highly

significant. A 10 percent appreciation in the

real exchange rate of the exporter country

reduces exports by 17 percent (static RE) and

13 percent (dynamic RE). this implies that
depreciation (devaluation) of the exporter

country likewise increase exports by similar


Trading with a neighbour with a similar border

increases chances of trade significantly. The

coefficient value of 0.98716 (static RE) and

0.847 (dynamic RE) translate into 168 and

133 percent increase in trade respectively.

The EAC is bordered by seven countries and

regional trade is not only increasing among

the partner states but also its non-member

neighbours.The dummies of common colony

and land locked are insignificant in all the

models estimates. However islands owing

to their proximity and access to trade routes

and facilities increase the amount to trade

between partner states. Being an island

increases trade by 93 percent (static RE)
and 77 percent (dynamic RE). Concerning

the official language, results suggest that

having the same official language among a

15 The model is estimated in natural logs therefore all dummy
variables are given a value of one in natural logs when the cor-
respondent condition is satisfied and a value of zero otherwise.
To obtain the percentage change the coefficients are computed
as follows: [(EXP (0.598)-1)*100} and [(EXP (0.384)-1)*100}.

16 To obtain the percentage change the coefficients are computed
as follows: [(EXP(0.987)-1)*100}

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

pair of trading partner increases trade by 140

percent (static RE) and 132 percent (dynamic
RE). The overall picture suggested by the
dummies is that exports are likely to reduce

with distance, increase with proximity, reduce

with poor access and increase with ability to


The variables of interest in the estimation

with regard to the study objective are the

dummy variables representing the Intra-

EAC and Extra-EAC trade as earlier defined.

The empirical question is whether the EAC

regional integration is creating or diverting

trade. Results reveal that the EAC regional

integration is creating trade. The coefficients

for the variable Intra-EAC is positive and

highly significant. It shows that intra-EAC

trade has significantly increased over time.

Furthermore, the variable Extra-EAC is

positive and significant showing that EAC

partner states trading with non-partners

increases trade by 68 percent (static RE) and

25 percent (dynamic RE). In other words
under the EAC agreement trade creation

effects far out way the trade diversion effects.

With regard to the research question,it is

evident that regional integration is helping to

increase intra-regional trade. The measures

undertaken to promote trade like reduction

of internal tariffs, reduction of non-tariff

barriers and adoption of a common external

tariff have yielded positive results. The

variable estimating the impact of the EAC CU

further explains and gives evidence to that


the results from this paper are partly in
agreement with the findings by Buigut

(2012). However, while the author detailed

the individual EAC country trade (imports and

exports) dynamics, this paper emphasizes

the EAC bloc’s trade creation and diversion

dynamics especially with respect to the rest

of the world. The paper departs from the

pessimism about trade diversion expressed

by World Bank (2000a); Yeats (1998); Schiff

(1997); and Park (1995) since evidently the

EAC has created more trade than diverted

it. The results are in total agreement with

De meloet al., (1993) and De Rosa (1998)
who argue that integration both creates

and diverts trade. Furthermore to prevent

trade diversion, the EAC member countries

should reduce trade barriers with non-

member countries as they do for members.

This paper did not examine the sectorial level

trade creation and diversion as suggested by

Panagariya (1998). What is important is that

the ultimate effect of trade diversion and

creation is summation of the sectoral effects.

This paper provides evidence that is in

agreement with the findings of Cernat (2001)

asserting that contrary to the feared negative

impacts of integration in South-South

RTAs,they are not more trade diverting than

other RtAs. Therefore this work complements
previous works by demonstrating the trade

creation and diversion elements.

4.4 ResultsintheperspectiveofEAC


There has been considerable effort to imple-
ment the different provisions of the EAC Trea-
ty. This has been done through the EAC’s vari-
ous medium-term development strategies.

The first Development Strategy of 1997-2000

focused on re-launching the EAC. This was

followed by the second one of 2001-2005

that focussed on enhancing the development

of the EAC Customs Union. The third one of

2006-2010 focused on the establishment of

the EAC shared Common Market. Finally, the

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

fourth and current one of 2011 to 2016 is to

ensure the implementation of the EAC Com-
mon Market and establishment of the EAC

Monetary Union. All these strategies contain

ingredients that emphasise increasing intra-

EAC regional trade.

The EAC partner states initiated a programme

to eliminate internal tariffs in 2005 and this

was achieved by January 2010. In order to ac-
count for differences in the size and structure

of their economies, EAC members adopted an

asymmetrical tariff reduction approach with

a transition period of five years. Under this

arrangement, all of Kenya’s imports from Tan-
zania and Uganda attracted zero tariffs, while

exports from Kenya to Tanzania and Uganda

were categorized into two lists. Category A

goods benefited from duty-free status within

the community, while category B products

(880 importable goods from Kenya to Tan-
zania and 443 from Kenya to Uganda) were

subject to duties until 2010 (WTO, 2012). The

principle of asymmetry aimed at strengthen-
ing the capacities of Uganda and Tanzania to

export, although the outcome is an empirical

question. There are no longer any internal

tariffs on intra-EAC trade and this successful

implementation of the programme partly ex-
plains the growth in intra-EAC regional trade

and therefore trade creation.

However, there have been serious impedi-
ments to the full and smooth implementation

of the EAC CU. Over 35 NTBs have been iden-
tified by the EAC Secretariat and these re-
main a major problem to trade and business

development in the EAC (Kirk, 2010). Specifi-
cally, NTBs affecting intra-EAC trade include

non-harmonized technical regulations, sani-
tary and phytosanitarymeasures, customs

procedures and documentation, and police

road blocks (Okumu and Nyakori, 2010). The

EAC Customs Protocol compels partner states
to agree to eliminate remaining NTBs and re-
frain from imposing new ones, however, this

has yielded limited success. The EAC partner

states established NTB National Monitoring

Committees (NMCs17) to monitor progress

on their elimination. The outcome has been

rather not promising and little progress in

tackling NTBs has been made. NTBs still pose

one of the greatest challenges to increasing

trade in the EAC region. There is therefore

room to further expand intra-EAC trade when

NTBs are considerably reduced or altogether


Although a number of legal documents have

been adopted at the EAC level to fully har-
monize partner states’ trade policies against

non-partner states, challenges do still exist.

The RTA multiple memberships phenom-
enon by individual EAC countries impedes

full harmonization of policies. Consequently,

this complicates trade-related procedures in

the region and ultimately impends trade. The

existence of divergent trade policies and the

non-uniform application of regional instru-
ments by EAC partner states hinder trade led

development. The need for uniform and con-
sistently applied policies that are predictable

becomes imperative to generate investments

and trade.

The EAC Customs Union Protocol provides for

standardisation of customs formalities and

harmonization of documentation and proce-
dures by member states (WTO, 2012). The

practice shows that these have not been fully

harmonized. The EAC countries have contin-

17 NMCs reports to the EAC Sectoral Committee on Trade, Industry
and Investment, which is responsible for resolving outstanding

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

ued to use different customs systems where

Burundi, Rwanda, Tanzania, and Uganda use

ASYCUDA while Kenya uses SIMBA 2005. This

has created some difficulties in attaining a

smooth exchange of information. The solu-
tion to this has been the creation of an inter-
face of the two systems to operate under the

Revenue Authorities Digital Data Exchange

(RADDEx). However, owing to capacity limita-
tions and resistance to change, RADDEx has

been partially implemented only at some cus-
toms posts. The lack of standard customs for-
malities slow down the pace of business and

thus discourage cross border trade.

The Protocol that establishes the EAC CU

makes pertinent provision for export promo-
tion schemes, special economic zones and ex-
emption regimes in the region. In practice as

pointed out (Kirk, 2010), these schemes are

still rudimentary and applied differently by in-
dividual EAC partner states: Whereas Burundi

investment incentives include: duty free and

remission schemes; Kenya has a duty remis-
sion facility; manufacture under bond; and an

export processing zone programme. On the

other hand, Rwanda has the customs, VAT

and income tax laws and is in the process of

establishing an export processing zone. Tan-
zania has a duty draw-back scheme; export

credit guarantee scheme; various exemp-
tions and export incentives introduced by the

Board of External Trade; and an export pro-
cessing zone. Uganda’s investment incentives

include an export credit guarantee scheme;

foreign exchange liberalisation that entitles

exporters to retain 100 percent of their for-
eign exchange earnings; duty and VAT exemp-
tions on exports; duty draw back; and manu-
facturing under bond. These provisions target

increasing particularly export trade and they

are extremely useful although they have not

been harmonised.

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

5.0 ConClusion

The paper investigated the potential impact

of South to South Regional grouping on trade

creation and diversion. We used an expanded

(augmented) gravity model to estimate the

impact of the EAC treaty implementation on

trade among partner state and non-partner

states. Panel gravity models for trade are

conventionally estimated using bilateral trade

flows that generate results that are prone

to three the errors explained Baldwin and

Tagloni (2006). The paper instead adopted

export data to overcome this problem.

Using export data from 2001 to 2011 on 70

countries that trade mainly with the EAC

partner states, the study establishes that the

EAC region has indeed created trade contrary

to widely held views that South-South RTAs

largely divert trade. There is thus evidence

that the EAC, a south-south RTA has been a

more trade creating than a trade diverting

as espoused in the literature. The rest of the

gravity model variables conform to theory

and are significant.

The paper further explains the possible

measures that have helped generate the

trade underscored: There has been effort to

implement the provisions of the treaty and

protocols through development strategies.

These have emphasised among others

removing barriers to trade and enhancing the

environment to produce and export. The EAC

partner states have significantly reduced and

eliminated internal tariff barriers and set CETs

to boost trade. In spite of such success there

are glaring challenges which if adequately

addressed would further increase both intra

and extra EAC trade. The region is struggling

in a number of areas which are potential

areas for improving and increasing regional

trade. There is limited success with regard

to NTB which remain an impendent to trade

in the region. The customs formalities have

not been fully standardised and procedures

have not been harmonised. Although export

promotion schemes are provided for in the

protocol, they are implemented in different

shades lacking a common approach. There is

lack of a common policy with regard to partner

states’ trade policies to non-partner states

which complicates trade related procedures.

In light of the above results and in an effort

for the EAC partner states to formulate and

implement policy intervention to deepen

regional trade the following policy areas


(i) The region should use the identified
NTBs to implement regulatory reforms

and reduce trade restrictive measures.

This will require legally binding mecha-
nisms with sanctions for non-compli-
ance and should be stronger than the

existing NMCs;

(ii) The EAC partner states should fully har-
monise individual members trade poli-
cies applied to non-partner states; and

(iii) The EAC should expedite the process of
standardization of customs formalities

and harmonise the documentation and

procedures of member states.

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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis


Anderson, J E (1979),‘A Theoretical Foundation

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24 Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

aPPendix a1

Table a1:Total intra-eaC trade, 2005-2011 (us$ million)

2005 2006 2007 2008 2009 2010 2011

Burundi .. 61.2 79.6 84.9 86.8 89.2 267.1
kenya 59.5 76.7 188.0 181.0 162.5 256.8 302.9
Rwanda 139.8 139.8 201.9 303.3 363.5 344.6 589.3
Tanzania 175.9 220.6 110.1 425.3 316.9 295.9 378.0
Uganda 550.8 429.7 526.5 566.8 547.0 576.5 721.0
926.0 928.0 1,106.1 1,561.3 1,476.7 1,563.0 2,258.3


Burundi 27.0 15.4 10.7 14.2 16.0 24.1
kenya 831.2 641.0 830.4 1,036.6 1,169.5 1,280.0 1,544.4
Rwanda .. 36.6 45.1 43.4 93.2 50.4 70.8
Tanzania 142.0 147.4 169.4 310.5 285.0 462.7 416.8
Uganda 87.9 101.8 148.8 195.2 398.8 428.6 649.7
1,061.1 953.8 1,209.1 1,596.4 1,960.7 2,237.7 2,705.8

Total eaC trade value

Burundi .. 88.2 95.0 95.6 101.0 105.2 291.2
kenya 890.7 717.7 1,018.4 1,217.6 1,332.0 1,536.8 1,847.3
Rwanda .. 176.4 247.0 46.7 456.6 395.0 660.1
Tanzania 317.9 368.0 279.5 735.8 601.9 758.6 794.8
Uganda 638.7 531.4 675.3 762.0 945.7 1,005.1 1,370.7

1,847.3 1,881.7 2,315.2 2,857.7 3,437.2 3,800.7 4,964.1

Data Source: East African Community Facts and Figures - 2012. ARUSHA, TANZANIA. EAC Secretariat, 2012

25Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

aPPendix a2

Table a2: The countries that are included in the study

Argentina Hungary Portugal

Australia India Qatar
Austria Indonesia Republic of Korea
bahrain Iran (Islamic Republic of) Romania
Bangladesh Ireland Russia
Belgium Israel Rwanda
botswana Italy Saudi Arabia
Brazil Japan Singapore
Bulgaria Jordan South Africa
Burundi kenya Spain
Canada kuwait Sri Lanka
China Libya Sudan
Chinese taipei Luxembourg Swaziland
Congo malaysia Sweden
Czech Republic malawi Switzerland
Côte d’Ivoire Mauritius Thailand

DR. Congo Mozambique Turkey

Denmark Netherlands Uganda

Egypt New Zealand Ukraine

Ethiopia Nigeria United Arab Emirates
Finland Norway United Kingdom
France oman United Republic of Tanzania
Germany Pakistan United States of America
Greece Philippines Zambia
Hong Kong, China Poland Zimbabwe

26 Economic Policy Research Centre - EPRC

Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

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Trade Creation And Diversion Effects Of
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December 2013

111 Mawejje Joseph &
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Accelerating Growth And Maintaining
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110 Bategeka Lawrence et ; UN

Overcoming The Limits Of Institutional
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109 Munyambonera Ezra
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108 Ahaibwe Gemma & Kasirye

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106 Ahaibwe Gemma, Mbowa
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Youth Engagement In Agriculture In
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105 Shinyekwa Isaac & Mawejje

Macroeconomic And Sectoral Effects Of
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104 Shinyekwa Isaac Economic And Social Upgrading In The
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103 mwaura Francis Economic And Social Upgrading In
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102 Kasirye Ibrahim Constraints To Agricultural Technology
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101 Bategeka Lawrence,
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Institutional Constraints To Agriculture
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100 Shinyekwa Isaac &
othieno Lawrence

Comparing The Performance Of Uganda’s
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Trade Creation & Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

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Annette & Barungi Mildred
The Impact Of The National Agricultural
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98 Adong Annet, Mwaura
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What Factors Determine Membership
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97 Tukahebwa B. Geoffrey The Political Context Of Financing
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96 Ssewanyana Sarah
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Causes Of Health Inequalities In Uganda:
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95 Kasirye Ibrahim HIV/AIDS Sero-Prevalence And
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94 Ssewanyana Sarah and
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Poverty And Inequality Dynamics In
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93 othieno Lawrence &
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Opportunities And Challenges In
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92 Kuteesa Annette East African Regional Integration:
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91 Mwaura Francis and
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Reviewing Uganda’s Tourism Sector For
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90 Shinyekwa Isaac A Scoping Study Of The Mobile
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89 Mawejje Joseph
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Uganda’s Electricity Sector Reforms And
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88 Okoboi Geoffrey and
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Constraints To Fertiliser Use In Uganda:
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87 othieno Lawrence
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Prospects And Challenges In The
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86 Ssewanyana Sarah,
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Cost Benefit Analysis Of The Uganda
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85 Barungi Mildred

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Cost-Effectiveness Of Water
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Cost Effectiveness Of Malaria Control
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83 Buyinza Faisal Performance And Survival Of Ugandan
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82 Wokadala James, Nyende
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Public Spending In The Water Sub-Sector
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Bategeka Lawrence &
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Oil Wealth And Potential Dutch Disease
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June 2011

80 Shinyekwa Isaac & Othieno

Uganda’s Revealed Comparative
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79 othieno Lawrence &
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Trade, Revenues And Welfare Effects Of
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78 Kiiza Julius, Bategeka
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Righting Resources-Curse Wrongs In
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77 Guloba Madina, Wokadala
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Does Teaching Methods And Availability
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76 Okoboi Geoffrey,
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Economic And Institutional Efficiency
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75 Okumu Luke & Okuk J. C.

Non-Tariff Barriers In EAC Customs
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74 Kasirye Ibrahim &
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Impacts And Determinants Of Panel
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73 Twimukye Evarist,
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Sectoral And Welfare Effects Of The
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72 Okidi John
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Inflation Differentials Among Ugandan
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71 Hisali Eria Fiscal Policy Consistency And Its
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70 Ssewanyana Sarah &
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Food Security In Uganda: A Dilemma To
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69 Okoboi Geoffrey Improved Inputs Use And Productivity In

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march 2010

68 Ssewanyana Sarah &
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Gender Differences In Uganda: The Case
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may 2010

67 Ssewanyana Sarah Combating Chronic Poverty In Uganda:
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June 2010

66 Sennoga Edward & Matovu
John mary

Public Spending Composition And
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February. 2010

65 Christopher Adam The Conduct Of Monetary Policy In
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September 2009

64 Matovu John Mary,
Twimukye Evarist, Nabiddo
Winnie & Guloba Madina

Impact Of Tax Reforms On Household

may 2009

63 Sennoga Edward, Matovu
John Mary & Twimukye

Tax Evasion And Widening The Tax Base
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may 2009

62 Twimukye Evarist &
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Macroeconomic And Welfare
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may 2009

61 Matovu John & Twimukye

Increasing World Food Price: Blessing Or

may 2009

60 Sennoga Edward, Matovu
John & Twimukye Evarist

Social Cash transfers For the Poorest In

may 2009

59 Twimukye Evarist, Nabiddo
Winnie & Matovu John

Aid Allocation Effects On Growth And
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may 2009

58 Bategetka Lawrence,
Guloba Madina & Kiiza

Gender And Taxation: Analysis Of
Personal Income Tax (PIT).

April 2009

57 Ssewanyana Sarah Gender And Incidence Of Indirect
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April 2009

56 Kasirye Ibrahim & Hisali

The Socioeconomic Impact Of HIV/AIDs
On Education Outcomes In Uganda:
School Enrolment And The Schooling Gap
In 2002/03.

November 2008

55 Ssewanyana Sarah & Okidi

A Micro Simulation Of The Uganda Tax
System (UDATAX) And The Poor From
1999 to 2003.

October 2008

54 Okumu Mike, Nakajjo Alex
& Isoke Doreen

Socioeconomic Determinants of Primary
Dropout: The Logistic Model Analysis.

February. 2008

53 Akunda Bwesigye Denis An Assessment of the Casual
Relationship Between Poverty And HIV/
AIDs In Uganda.


52 Rudaheranwa Nichodemus,
Guloba Madina & Nabiddo

Costs Of Overcoming Market Entry
Constraints To Uganda’s Export-Led
Growth Strategy.

August 2007

series no. author(s) Title date
51 Kasirye Ibrahim Vulnerability And Poverty Dynamics In

Uganda, 1992-1999
August 2007

50 Sebaggala Richard Wage Determination And Gender
Discrimination In Uganda.

May 2007

49 Ainembabazi J. Herbert Landlessness Within The Vicious Cycle
Of Poverty In Ugandan Rural Farm
Household: Why And How It Is Born?

May 2007

48 Obwona Marios &
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Development Impact Of Higher
Education In Africa: The Case Of Uganda.

January 2007

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