CONVERGENCE OF MACROECONOMIC SHOCKS IN THE ECONOMIC COMMUNITY OF WEST AFRICAN STATES (ECOWAS)
Stéphane ZOURI1
April 2018
Abstract: This paper focuses on the convergence of macroeconomic shocks in West Africa given the willingness of ECOWAS heads of State to create a single currency by 2020. For this purpose, the paper uses a structural autoregressive vector model developed by Blanchard and Quah (1989) to analyze macroeconomic shocks and then determines their degree of convergence using a dynamic Kalman filter methodology. The results show, at several levels of robustness, a relatively high degree of asymmetry of supply, demand and monetary shocks. The asymmetry of supply shocks is due to the productive structure of the economies oriented mainly towards the extractive industries. The asymmetry of demand and monetary shocks is due to the absence of a common monetary policy in non-member countries of the West African Economic and Monetary Union (WAEMU). In addition, the study shows that the weak divergence of supply and demand shocks as well as the high degree of asymmetry of monetary shocks found in some studies, particularly in Bamba Ka (2013), Sarr and Waide (2015) come from the absence of relevant explanatory factors in their model.
Keywords: convergence, macroeconomic shocks, structural VAR, ECOWAS Classification JEL: C32, E32, F15, O55
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Research laboratory of Paris-Jourdan Economic Sciences-UMR8545 Department of Economics, University Paris1 Pantheon Sorbonne-Paris School of Economics Email :
[email protected] /
[email protected]
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Introduction The creation of a single currency in the ECOWAS area is an old project that is struggling to materialize. Since the creation of the institution in 1975, the setting up of a single currency has been one of its objectives. This desire is marked in 1996 with the creation of the West African Monetary Agency (WAMA) whose mission is to guide the design and operational implementation of this project. This sketch is reinforced 3 years later at a summit of ECOWAS heads of State and Government in Benin during which an integrated approach strategy is defined in order to give a boost to this project which is starting to get bogged down. This strategy, adopted in 1999, stipulates that countries not members of the franc zone must create a single monetary area that will subsequently merge with the WAEMU area by 2020 to have the single currency of ECOWAS.Thus, in 2000, 5 countries (The Gambia, Ghana, Guinea, Nigeria, Sierra Leone) not members of WAEMU defined the basis of a project for a common monetary area called WAMZ (West African Monetary Zone).In this context, the West African Monetary Institute (WAMI) was created in 2001 to help set up a single currency and a Central Bank for the WAMZ. Since that date, despite the support provided by the sub-regional institutions, this WAMZ project has not experienced a major breakthrough. A first deadline is fixed in 2003 and then postponed in 2005 and 2009.Faced with this immobilism, and taking into account the fact that the advent of the ECOWAS single monetary area is subject to the establishment of the WAMZ, the ECOWAS Council of Ministers meeting in Abidjan in September 2013 exhorts the 5 countries to make the necessary arrangements to deploy their project before the end of 2015, when the WAMZ will have to have a single currency in the same way as the WAEMU area. But in the face of the WAMZ's inability to acquire a single currency, the heads of State took measures in 2015 concerning, among other things, abandoning the two-speed approach and reducing the convergence criteria that goes from 10 to 6. ECOWAS consists of 15 countries (Benin, Burkina Faso, Côte d'Ivoire, Guinea Bissau, Mali, Niger, Senegal Togo, Cape Verde, The Gambia, Ghana, Guinea, Liberia, Nigeria, Sierra Leone), with 8 national currencies respectively (CFA franc for the first 8 countries that form WAEMU, Escudo Cape Verdean, Dalasi, Cedi, Guinean Franc, Liberian Dollar, Naira, Leone) and uses three different foreign official languages (French in Guinea and the countries of the WAEMU except in Guinea Bissau, Portuguese for Cape Verde and Guinea Bissau and English for the rest). These member countries have different monetary policies. Indeed, the WAEMU countries, Sierra Leone, Liberia and Cape Verde are concerned by the exchange rate pegging policy. The Gambia, Guinea and Nigeria opt for the policy of targeting a monetary aggregate. The inflation targeting policy is followed by Ghana. The primary sector remains the engine of the economy in West Africa. Its dependence on primary products whose prices are particularly volatile, favors a situation of structural vulnerability linked to the significant volatility of the terms of trade. This dependence on exports of mining products is increasing in recent decades. Commodity exports accounted for almost half of all exports in the region between 2010 and 2014, while they accounted for less than a quarter in the 1980s. West African countries have specialized in export of raw materials due to Chinese demand so that the economic growth of these countries depends on the economic cycle of China which has become over the years the leading trading and financial partner of Africa. 2
The distinct monetary policies and lack of diversification of ECOWAS economies amplify the degree of asymmetry of macroeconomic shocks in the region. According to the theory of optimal currency areas, the asymmetries of shocks observed within a monetary union determine its sustainability. The ex-ante analysis shows that the viability of the monetary union can be challenged, if the member economies have different economic structures, if their economic cycles are not synchronized and if the market mechanisms are not sufficiently developed to curb these differences. In the perspective of the creation of a West African currency, some studies have been conducted. Most relate to the synchronization of economic shocks and the risk-sharing mechanism within this region. The majority of these works, like Houssa (2008), Tapsoba (2009) and Bamba Ka (2013), give a negative answer to the question of the economic relevance of West African monetary unions. For them, the cyclical asymmetries of the shocks, related to the difference of specialization of the countries of the area, make that the benefits of such unions do not compensate the costs inherent to this enlargement. These studies date and do not take into account the productive structure of the ECOWAS economies, which is a relevant criterion in the traditional theory of optimal currency areas but often ignored in the literature. Indeed, if the productive structure of an economy is well diversified, an adverse shock of demand on a good or a sector will have relatively insignificant repercussions than if it is the monoproduction of a country, Kenen (1969). This paper complements a scarce and less recent empirical literature on the convergence of macroeconomic shocks in ECOWAS. It is relevant given the will of ECOWAS heads of State to create a single currency by 2020. In addition, it provides avenues for improvement to reduce the degree of asymmetry of different macroeconomic shocks. It is innovative because it integrates the dependence of these countries vis-a-vis China which is at the origin of their specialization in the production of raw materials. This dependence is a double-edged sword because while many African countries benefit from China's expansion by exporting their raw materials to China, many are now suffering the backlash of the slowdown in the Chinese economy. The objective of the paper is to identify macroeconomic shocks, their degree of convergence and their evolution over time while controlling their dependence on China in order to appreciate not only the optimality of a monetary union in ECOWAS but also to suggest ways of improving the convergence of economies in the area. For this, the identification of economic shocks is done using Structural Autoregressive Vector analysis (SVAR) and the dynamic assessment of shock convergence is identified using the Kalman Filter. The study is organized around 4 parts. The first presents a review of the literature on the synchronization of economic cycles in Africa, the second introduces a brief overview of the economic context and the macroeconomic convergence essential for the analysis, the third defines the methodology used and the last presents the results of the empirical analysis.
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Literature review on the synchronization of economic cycles in Africa
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For Vaubel (1990), there is no operational method for measuring and comparing the benefits and costs of joining a country to a monetary union. Based on this observation, he concludes that there is no scientific method to rigorously characterize an optimal currency area. However, several authors attempt to evaluate the optimality of an area as a monetary union. The literature on the theory of optimal currency areas has focused, since the 1980s and 1990s, on the similarity of supply and demand shocks between the candidate countries for the formation of a monetary union. The shocks being unobservable, these works are of an empirical nature and most often use the autoregressive vector modeling. These studies begin with the work of Wyplosz (1989), Weber (1990), and Bayoumi and Eichengreen (1992) who use an SVAR developed by Blanchard and Quah (1989) to isolate demand and supply shocks that affect different countries of the Eurozone. This is followed by a series of empirical studies on the synchronization of shocks between countries belonging to a given area, particularly in Africa. Fielding and Shields (2001) show through a SVAR that product shocks are not correlated within WAEMU and the Central African Economic and Monetary Community (CEMAC). Only price shocks are somewhat convergent because of common monetary policies. Tanimoune and Plane (2005) examine the beta and the sigma convergence of the WAEMU economies according to the criteria defined by the 1999 pact. The authors find a generally favorable but insufficient evolution to guarantee the entry into the stability phase by 2006. The authors recognize that the structural weakness of intra-Community trade and political conflicts hamper convergence efforts. Buigut and Valed (2005) use SVAR models to assess the degree of symmetry of shocks in East Africa. Their results suggest that structural shocks in supply and demand are largely asymmetrical, while shock adjustment rates are similar. Celasun and Justiniano (2005) use a dynamic factor model to examine the synchronization of GDP cycles between ECOWAS countries. Their results indicate that the small economies of ECOWAS have relatively synchronized cycles. They conclude that a monetary union between subsets of countries would be preferable to a single currency for the whole of ECOWAS. Bénassy-Quéré and Coupet (2005) as well as Tsangarides and Qureshi (2006) demonstrate with the clustering method that the shocks of the West African states are strongly divergent. Debrun and al. (2005) reach a similar conclusion using the terms of trade correlation. Houssa (2008) applies the model of dynamic and structural factors and finds a strong heterogeneity of supply shocks in the ECOWAS area. Alagidede and al. (2011) examine the dynamics of inflation and common trends in the real GDP trajectories of the WAMZ countries. The authors use an econometric approach based on fractional integration and cointegration. Their results indicate that there is a lot of heterogeneity among WAMZ economies. Asongu (2012) analyzes real, monetary and fiscal convergence in the WAMZ and the East African Monetary Union (EAMU). The results indicate a glaring lack of convergence at several levels. Among others, the author finds that important differences remain between the economic structures and performances of the countries concerned. In addition, idiosyncratic fiscal shocks are asymmetrical due to the nonsynchronization of economic cycles. The author therefore concludes that the candidate countries for the monetary union must strengthen the harmonization of their economic policies and their institutions. Ekong and Onye (2012) use an SVAR to capture the correlation of external and monetary shocks for ECOWAS countries. Their analysis shows that ECOWAS is not an optimal currency area. Bamba Ka (2013), in order to identify the degree of asymmetry of macroeconomic shocks in an integration dynamic within ECOWAS, uses the SVAR model developed by Blanchard and Quah (1989) to analyze macroeconomic shocks, and then determines their degree of convergence using a dynamic methodology based on the Kalman 4
filter. His results show a fairly high degree of heterogeneity in both supply and demand shocks. For monetary shocks, these results showed a very high degree of shock asymmetry. The weak convergence of supply and demand shocks, however, makes it possible to envisage the constitution of a monetary union which, at first, would be composed only of a few ECOWAS countries whose economic relations are quite important. Diarra (2014) examines the beta and sigma convergence of WAEMU economies according to the criteria defined in the 1999 pact. The results indicate a divergence for the basic fiscal balance and the average annual inflation rate. Convergence towards the community targets seems more pronounced for the tax burden ratio and nuanced for the outstanding debt. Sarr and Waide (2015) analyze the dynamics of convergence of macroeconomic shocks in the WAEMU area. They use the SVAR model developed by Blanchard and Quah (1989) to analyze macroeconomic shocks and then determine their degree of convergence using a dynamic methodology based on the Kalman filter. The results of this dynamic analysis show that the degree of shocks asymmetry diminishes as institutions are born. Supply and monetary shocks are divergent and their effects fade after 5 years, while demand shocks converge. In addition, budget shocks are divergent despite the adoption of the stability pact. According to these studies, the divergence of shocks is the main cost of a West African monetary union. The economies of the region do not have strong institutions that are sufficiently developed to cope with asymmetric shocks. However, this last literature is static in its conception since it refers to the situation of the economies before the monetary integration to know if this one is opportune. It thus omits the changes in economic structures and economic policies that occur after the establishment of a monetary union. However, the contribution of Bangaké (2008) and Tapsoba (2009) makes it possible to approach this question in an endogenous context. These authors show that monetary union itself in West Africa creates structural changes that mitigate the impact of shocks in member states. With monetary integration, economic structures and policies are evolving and can reduce the disadvantages of asymmetric shocks and increase the optimality of the union.
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Stylized facts: economic context and macroeconomic convergence
Real growth in ECOWAS The real growth of the ECOWAS countries shown in table 1 reveals an economic divergence of the member countries. The period 1975-1994 is characterized by a positive average real GDP growth in the ECOWAS area with the exception of Liberia, which has a negative growth rate of 8.77%. Cape Verde is the country with the highest growth rate in the region high of the area with 5.27%. The post-devaluation period of the CFA franc marks a primacy of economic convergence as the basis for monetary management within WAEMU characterized by a control of its inflation. This contributes to the average real GDP growth of ECOWAS. The average real growth of the latter has regularly been above 5% between 1994-2014 under the impetus of the economic dynamism of Nigeria, by far the most important economy of West Africa. The year 2015 is characterized by a decline in real average GDP growth in the region due to a decline in the Nigerian economy and a country as Sierra Leone that has a negative real growth never recorded of -20.49%. Côte d'Ivoire has the highest real GDP growth rate in the region at 8.84% since 2015.
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Table 1: distribution of ECOWAS countries according to real GDP growth 1975-1993 0%
