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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


RESEARCH SERIES No. 112


ISAAC SHINyEkwA
&


LAwRENCE otHIENo


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


absTraCT


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-
tion


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
(CEPGL).


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.




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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;


and


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


trade.


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


suggestions.




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


RtAs.


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


6 (AFTA, CARICOM, COMESA, ECOWAS, MERICOSUR and SADC)


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


………..1


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




9Economic Policy Research Centre - EPRC


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.


……………………………..…………….(2)


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




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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


specification:


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


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


the implementation of the EAC regional


integration.


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


html?p1=115&p2=17
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-
sues.


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


one.


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


Table2:TradeCreationandDiversionEffectsoftheEACCustomsUnion


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***
0.00332


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


magnitudes.


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


communicate.


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


effect.


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


integrationprogress


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


eliminated.


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
Ntbs.




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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


emerge:


(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.




21Economic Policy Research Centre - EPRC


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


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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


imports
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


exports


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


ePrC researCh series


Listing of Research Series published since 2007 to date. Full text format of these and earlier


Papers can be downloaded from the EPRC website at http://www.EPRC.or.ug/


series no. author(s) Title date
112 Shinyekwa Isaac & Othieno


Lawrence
Trade Creation And Diversion Effects Of
The East African Community Regional
Trade Agreement: A Gravity Model
Analysis.


December 2013


111 Mawejje Joseph &
Bategeka Lawrence


Accelerating Growth And Maintaining
Intergenerational Equity Using Oil
Resources In Uganda.


December 2013


110 Bategeka Lawrence et ; UN
Wider


Overcoming The Limits Of Institutional
Reforms In Uganda


September 2013


109 Munyambonera Ezra
Nampewo Dorothy, Adong
Annet & Mayanja Lwanga
musa


Access And Use Of Credit In Uganda:
Unlocking The Dilemma Of Financing
Small Holder Farmers.


June 2013


108 Ahaibwe Gemma & Kasirye
Ibrahim


HIV/AIDS Prevention Interventions In
Uganda: A Policy Simulation.


June 2013


107 Barungi Mildred & Kasirye
Ibrahim


Improving Girl’s Access To Secondary
Schooling
A Policy Simulation For Uganda


June 2013


106 Ahaibwe Gemma, Mbowa
Swaibu & Mayanja Lwanga
musa


Youth Engagement In Agriculture In
Uganda: Challenges And Prospects.


June 2013


105 Shinyekwa Isaac & Mawejje
Joseph


Macroeconomic And Sectoral Effects Of
The EAC Regional Integration On Uganda:
A Recursive Computable General
Equilibrium Analysis.


may 2013


104 Shinyekwa Isaac Economic And Social Upgrading In The
Mobile Telecommunications Industry:
the Case of mtN.


may 2013


103 mwaura Francis Economic And Social Upgrading In
Tourism Global Production Networks:
Findings From Uganda.


may 2013


102 Kasirye Ibrahim Constraints To Agricultural Technology
Adoption In Uganda: Evidence From The
2005/06-2009/10 Uganda National Panel
Survey.


may 2013


101 Bategeka Lawrence,
Kiiza Julius &
Kasirye Ibrahim


Institutional Constraints To Agriculture
Development In Uganda.


may 2013


100 Shinyekwa Isaac &
othieno Lawrence


Comparing The Performance Of Uganda’s
Intra-East African Community Trade And
Other Trading Blocs: A Gravity Model
Analysis.


April 2013




27Economic Policy Research Centre - EPRC


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


series no. author(s) Title date
99 Okoboi Geoffrey Kuteesa


Annette & Barungi Mildred
The Impact Of The National Agricultural
Advisory Services Program On Household
Production And Welfare In Uganda.


march 2013


98 Adong Annet, Mwaura
Francis & Okoboi Geoffrey


What Factors Determine Membership
To Farmer Groups In Uganda? Evidence
From The Uganda Census Of Agriculture
2008/9.


January 2013


97 Tukahebwa B. Geoffrey The Political Context Of Financing
Infrastructure Development In Local
Government: Lessons From Local Council
Oversight Functions In Uganda.


December 2012


96 Ssewanyana Sarah
&
Kasirye Ibrahim


Causes Of Health Inequalities In Uganda:
Evidence From The Demographic And
Health Surveys.


October 2012


95 Kasirye Ibrahim HIV/AIDS Sero-Prevalence And
Socioeconomic Status: Evidence From
Uganda.


October 2012


94 Ssewanyana Sarah and
Kasirye Ibrahim


Poverty And Inequality Dynamics In
Uganda: Insights From The Uganda
National Panel Surveys 2005/6 And
2009/10.


September 2012


93 othieno Lawrence &
Dorothy Nampewo


Opportunities And Challenges In
Uganda’s Trade In Services.


July 2012


92 Kuteesa Annette East African Regional Integration:
Challenges In Meeting The Convergence
Criteria For Monetary Union: A Survey.


June 2012


91 Mwaura Francis and
Ssekitoleko Solomon


Reviewing Uganda’s Tourism Sector For
Economic And Social Upgrading.


June 2012


90 Shinyekwa Isaac A Scoping Study Of The Mobile
Telecommunications Industry In Uganda.


June 2012


89 Mawejje Joseph
Munyambonera Ezra
Bategeka Lawrence


Uganda’s Electricity Sector Reforms And
Institutional Restructuring.


June 2012


88 Okoboi Geoffrey and
Barungi Mildred


Constraints To Fertiliser Use In Uganda:
Insights From Uganda Census Of
Agriculture 2008/09.


June 2012


87 othieno Lawrence
Shinyekwa Isaac


Prospects And Challenges In The
Formation Of The COMESA-EAC And
SADC TripartiteFree Trade Area.


November 2011


86 Ssewanyana Sarah,
Okoboi Goeffrey&
Kasirye Ibrahim


Cost Benefit Analysis Of The Uganda
Post Primary Education And Training
Expansion And Improvement (PPETEI)
Project.


June 2011


85 Barungi Mildred


&Kasirye Ibrahim


Cost-Effectiveness Of Water
Interventions: The Case For Public
Stand-Posts And Bore-Holes In Reducing
Diarrhoea Among Urban Households In
Uganda.


June 2011




series no. author(s) Title date
84 Kasirye Ibrahim &


Ahaibwe Gemma


Cost Effectiveness Of Malaria Control
Programmes In Uganda: The Case Study
Of Long Lasting Insecticide Treated Nets
(LLINs) And Indoor Residual Spraying.


June 2011


83 Buyinza Faisal Performance And Survival Of Ugandan
Manufacturing Firms In The Context Of
the East African Community.


September 2011


82 Wokadala James, Nyende
Magidu, Guloba Madina &
Barungi Mildred


Public Spending In The Water Sub-Sector
In Uganda: Evidence From Program
Budget Analysis.


November 2011


81
Bategeka Lawrence &
Matovu John Mary


Oil Wealth And Potential Dutch Disease
Effects In Uganda.


June 2011


80 Shinyekwa Isaac & Othieno
Lawrence


Uganda’s Revealed Comparative
Advantage: The Evidence With The EAC
And China.


September
2011


79 othieno Lawrence &
Shinyekwa Isaac


Trade, Revenues And Welfare Effects Of
The EAC Customs Union On Uganda: An
Application Of Wits-Smart Simulation
Model.


April 2011


78 Kiiza Julius, Bategeka
Lawrence & Ssewanyana
Sarah


Righting Resources-Curse Wrongs In
Uganda: The Case Of Oil Discovery
And The Management Of Popular
Expectations.


July 2011


77 Guloba Madina, Wokadala
James & Bategeka
Lawrence


Does Teaching Methods And Availability
Of Teaching Resources Influence Pupil’s
Performance?: Evidence From Four
Districts In Uganda.


August 2011


76 Okoboi Geoffrey,
Muwanika Fred, Mugisha
Xavier & Nyende Majidu


Economic And Institutional Efficiency
Of The National Agricultural Advisory
Services’ Programme: The Case Of Iganga
District.


June 2011


75 Okumu Luke & Okuk J. C.
Nyankori


Non-Tariff Barriers In EAC Customs
Union: Implications For Trade Between
Uganda And Other EAC Countries.


December 2010


74 Kasirye Ibrahim &
Ssewanyana Sarah


Impacts And Determinants Of Panel
Survey Attrition: The Case Of Northern
Uganda Survey 2004-2008.


April 2010


73 Twimukye Evarist,
Matovu John Mary
Sebastian Levine &
Birungi Patrick


Sectoral And Welfare Effects Of The
Global Economic Crisis On Uganda: A
Recursive Dynamic CGE Analysis.


July 2010


72 Okidi John
& Nsubuga Vincent


Inflation Differentials Among Ugandan
Households: 1997 – 2007.


June 2010


71 Hisali Eria Fiscal Policy Consistency And Its
Implications For Macroeconomic
Aggregates: The Case Of Uganda.


June 2010


70 Ssewanyana Sarah &
Kasirye Ibrahim


Food Security In Uganda: A Dilemma To
Achieving The Millennium Development
Goal.


July 2010




series no. author(s) Title date
69 Okoboi Geoffrey Improved Inputs Use And Productivity In


Uganda’s Maize Sector.
march 2010


68 Ssewanyana Sarah &
Kasirye Ibrahim


Gender Differences In Uganda: The Case
For Access To Education And Health
Services.


may 2010


67 Ssewanyana Sarah Combating Chronic Poverty In Uganda:
Towards A New Strategy.


June 2010


66 Sennoga Edward & Matovu
John mary


Public Spending Composition And
Public Sector Efficiency: Implications
For Growth And Poverty Reduction In
Uganda.


February. 2010


65 Christopher Adam The Conduct Of Monetary Policy In
Uganda: An Assessment.


September 2009


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


Impact Of Tax Reforms On Household
welfare.


may 2009


63 Sennoga Edward, Matovu
John Mary & Twimukye
Evarist


Tax Evasion And Widening The Tax Base
In Uganda.


may 2009


62 Twimukye Evarist &
Matovu John


Macroeconomic And Welfare
Consequences Of High Energy Prices.


may 2009


61 Matovu John & Twimukye
Evarist


Increasing World Food Price: Blessing Or
Curse?


may 2009


60 Sennoga Edward, Matovu
John & Twimukye Evarist


Social Cash transfers For the Poorest In
Uganda.


may 2009


59 Twimukye Evarist, Nabiddo
Winnie & Matovu John


Aid Allocation Effects On Growth And
Poverty: A CGE Framework.


may 2009


58 Bategetka Lawrence,
Guloba Madina & Kiiza
Julius


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


April 2009


57 Ssewanyana Sarah Gender And Incidence Of Indirect
Taxation: Evidence From Uganda.


April 2009


56 Kasirye Ibrahim & Hisali
Eria


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
John


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.


September.
2007


52 Rudaheranwa Nichodemus,
Guloba Madina & Nabiddo
winnie


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 &
Ssewanyana Sarah


Development Impact Of Higher
Education In Africa: The Case Of Uganda.


January 2007










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