ARAB FREE TRADE AREA: POTENTIALITIES AND EFFECTS

ARAB FREE TRADE AREA: POTENTIALITIES AND EFFECTS Jamel E. Zarrouk Arab Monetary Fund Abu Dhabi, U.A.E. BENEFITING FROM GLOBALIZATION WORKSHOP Mediterranean Development Forum September 3-6, 1998 Marrakech, Morocco

1. Introduction The year 1997 has witnessed a renewed interest in forming a regional trading bloc by the member states of the Arab League. To pursue this end, eighteen Arab states 1 approved an executive program establishing the Arab Free Trade Area (FTA), which came into effect on January 1, 1998. The Arab FTA will lead to the elimination of import duties and other barriers to trade on goods of Arab origin over a ten-year period. These developments imply that by 2008 intra-arab imports will enter each country of the region from Morocco in the west to Oman in the East and as far south as Yemen without encountering tariffs and tariff-like barriers. The recent Arab regional integration initiative is part of a more generalized regionalism, which has become one of the most powerful forces shaping the world economy today. In 1996, around 53 percent of the world trade was conducted within regional trading blocs. The most powerful bloc is the European Union (EU) followed by NAFTA. Other regional trading arrangements have been formed in the developing world; the most important are ASEAN in Asia and MERCOSUR in Latin America. Many key factors heavily conditioned the interest in regional integration agreement in the Arab region. First, many of the countries in the region have been pursuing economic reform to reduce the economic role of the public sector and have been shifting away from import-substitution to export-led industrialization strategies. As a result, there is greater scope for the region to expand intra-trade and to exploit investment opportunities for complementarity and economies of scale. Moreover, the implementation of the package of trade liberalization agreed to in the Uruguay Round continues to confront the Arab region with less-advantageous access to the markets of their key trading partners in the EU. The response to this challenge has been the European initiative to conclude a new generation of Association Agreements with the Southern Mediterranean countries. Such Association Agreements involve the creation of a regional freetrade area with the EU in year 2010. The agreements are expected to foster trade and development, and to attract foreign direct investment in the Southern Mediterranean region. However, the danger of such Association Agreements lies in creating a bilateral trade pattern which discourages (trade diversion) intra-arab regional economic ties. If all the Arab Southern Mediterranean countries do not have comparable FTAs with each other --that is if they do not conclude a single free trade area-- then the common denominator will be the EU. Foreign investors could choose to invest in the EU as being the "hub", because of the access that it offers to all Arab countries as a "spoke", if the latter maintain high intra-regional trade barriers. Therefore, minimizing the so-called "hub and spoke" effect can be a major reason to have a single free trade area among all Arab countries. Finally and not least of all, regional efforts to pursue smaller-scale regional groupings such as the successful GCC have shown their limitations. A broad and comprehensive regional trade agreement can be regarded as a more viable response to attracting foreign direct investment by 2

the "large market effect" and to exploiting the opportunities offered by the privatization programs pursued by individual Arab countries. The intent of this paper is to assess the economic potential of the recent Arab FTA to make an impact on a successful regional integration. The paper proceeds as follows. First, the Executive Program establishing the Arab FTA is presented and evaluated. Next, the potentialities and the likely effects of the Arab FTA are analyzed against a set of statistic indicators. The paper also addresses the implications with conclusions for the Association Agreements with the EU. 2. The Past Legacy of Arab Regional Integration There have been numerous previous attempts to encourage regional integration among Arab states. Examples of the first wave of Arab regionalism include the 1953 treaty to organize transit trade among Arab countries, the creation of an Arab Common Market (ACM) in 1964, which envisaged the full exemption of tariff and non-tariff between a group of countries 2. Following, the 1981 Agreement for Facilitation and Promotion of intra-arab Trade, signed by member states of the Arab League, was a declaration of intent on the signatories to negotiate the full exemption of tariffs and non-tariff measures for manufactured and semi-manufactured goods. Broadly speaking, these agreements have not translated into successful regional trading blocs. The impact of such agreements on regional trade liberalization has been extremely limited. The failure of the first wave of Arab regionalism led some countries to devote their efforts to pursuing smaller-scale regional groupings in the 1980s. Three regional groupings were founded: the Gulf Cooperation Council (GCC) established in 1981 by Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the U.A.E, the short lived Arab Cooperation Council between Egypt, Iraq, Jordan and Yemen, and the Maghreb Arab Union established by Algeria, Libya, Mauritania, Morocco, and Tunisia. The empirical evidence (Zarrouk, 1992) 3 indicates that although intratrade of these smaller scale groupings grew, this expansion was far less than that which occurred in external trade. The discouraging history of previous Arab attempts at regionalism has been attributed to economic and political factors. On the economic side, to name a few, most Arab countries with the exception of the GCC countries have implemented industrial strategy founded on importsubstitution and a large public sector. Both of these has led to high protection across industries, non-transparent pursue of trade policies and huge investments in state owned industrial enterprises and human skills unsuited to a competitive market economy. Moreover, Arab governments ended up relying on import duties as a main source of revenues and lacked the administration capacity to introduce broad-based domestic consumption taxes (Hoekman, 1995). Bureaucratic red tape to protect rents that accrue to interest groups among domestic producers, politicians and governments officials also contributed to the failed legacy of Arab regional trade arrangements. On the political side, Arab countries did not seem to have sufficient incentives to integrate. This was translated into mistrust in binding commitments for a regional liberalization scheme covering 3

substantial trade. Finally and not least, political differences among the Arab leaders have weighted heavily in the Arab economic relations. In contrast, recent international experience from successful regional trading arrangements e.g., EU, NAFTA, MERCOSUR) suggests that unless such arrangements are pursued among open trade regimes relative to the rest of the world they will fail to induce substantial regional trade increases. Given that Arab countries face trade liberalization, since the 1980s, there has been a move in Morocco, Tunisia, Egypt and Jordan to reform trade policy to spur improvement to efficiency and install more market- and export oriented economies. Moreover, the traditionally open economies of the GCC and major oil exporting countries have often diversified into petrochemicals and energy-intensive industries whose products were exported to both industrial and developing markets. The change in the international trading environment is expected to have significant implications for the prospects of regional and intra-regional trade. The implementation of the Uruguay Round Agreements for global liberalization is expected to create new trading opportunities for countries that are well integrated into the world economy. Arab countries having relied for a long time on preferential trade agreements to access to the markets of their key trading partners in the EU, face challenges as to less-advantageous access to these markets. Hence, various regional efforts have taken place with the E U initiative to create a free trade area with the neighboring Southern Mediterranean countries, and more recently, the Arab League launched the Arab FTA initiative. In the following summary of the Executive Program establishing such a regional trading arrangement is accompanied by its evaluation. 3. Provisions of the Executive Program The implementation of the Executive Program for the establishment of the Arab AFTA attempts to revive the 1981 Agreement for Facilitation and Promotion of Trade among the member states of the Arab League. The main shortcoming of such an agreement lies in its nature as a declaration of intent on the part of the country signatories. It had no binding terms and everything was open to negotiations. Moreover, the liberalization scheme adopted by this agreement was a productby-product approach. Negotiating countries were allowed to pick and choose some manufactured products but not others for tariff exemptions. In addition, the Agreement did not lay out a time schedule for the elimination of tariffs and trade barriers. The political barriers also worked against efficiency and mutual confidence. In contrast, the recent Executive Program to revive the 1981 Agreement came up with specific commitments with regard to tariffs and tariff-like charges, non-tariff barriers and rules of origin. Regarding tariffs, Arab countries agreed to cut customs tariffs and the tariff-like charges by 10 percent per annum, which will be totally abolished by the year 2007. The member countries agreed to bind the national tariff schedules, which were applied on 31 Dec 97. For the remaining countries that did not ratify the Agreement, the bound tariffs are those applied at the time they notify the Arab League of the ratification and endorsement of the program. Tariff-like charges 4

and additional taxes are among the main components of the program and are to be treated like normal tariffs. As far as non-tariff measures (NTBs) are concerned, member countries are developing a work program to eliminate, or at least, reduce them. To reach this goal, the negotiating committee on NTBs has agreed, first, on a common list of goods whose imports are prohibited for religious, health, environment, and national security reasons. The list is to be reviewed on a yearly basis. Second, the NTBs negotiating committee is mandated to sort out all the other NTBs applied by each member country, and then to start the negotiations for their elimination. Note that member countries will apply the reciprocity principle in case another member does not remove unjustified NTBs. Member countries are allowed to draw up a list of exceptions. Exceptions are intended to enable local industry to carry out the restructuring needed to improve their competitiveness before having to face competition from foreign imports. But the member country requesting such exceptions should provide a report showing in full the economic impact on the national economy and the duration for each requested good (listed at the 6 digit HS at least) to be excepted from the tariff and like-tariff reductions. As regards the treatment of agricultural products, the committee supervising the implementation and the follow up of the Arab FTA project has set up a seasonal schedule comprising a list of produce. Any excepted produce from the tariff and other import taxes reductions during the peak harvest season cannot last more than 7 months. Each country is allowed to include a maximum of 10 produce items for exception. Any list of produce to be excepted from tariff and like- tariff charges during the peak harvest season should not exceed a total duration of 45 months. The Arab FTA offers rules of origin for duty-free treatment. The Arab FTA value added requirement is set to be 40 percent and a method for origin calculations was drawn. This is based on the 'net cost' approach, which subtracts specified administrative expenses from the transaction price to determine the base for calculating the ratio of foreign to regional content. Management of the Arab FTA is through the Council of Ministers of member states and through an executive and follow-up permanent body. The Arab FTA, so far, has a functioning Secretariat that comes under the Economics Department of the Arab League Secretariat. This FTA Secretariat is in charge of handling the circulation of papers between the commissions and working subgroups. Finally but not least, an innovation in the Executive Program is the call for the private sector (chambers of industry and commerce in Arab countries) to monitor the implementation of the different stages of the Program.. Pursuant to this end, The Union of Arab chambers of commerce has been requested to submit to the Council of Ministers and its executive body a semi-annual report detailing the difficulties that traders encounter in dealing with the customs 5

administration and any other regulatory agencies of individual member countries. The private sector report aims at enhancing the transparency of the Arab FTA. 4. Overall Assessment of the Arab FTA The Executive Program involves for the first time commitments by Arab countries to come forward with a complete preferential scheme covering most products to be liberalized from tariff and most tariff barriers within 10 years. Although each member country is allowed to draw up a list of agricultural and manufactured import-sensitive products to be protected during a transition period, this is due to disappear in year 2008. Moreover, the Arab FTA rules of origin to qualify for duty-free treatment is an effective administrative method to simplify the Arab FTA value added test and requirement. In addition, the boosted private sector role in monitoring those problems that occurs in the implementation of the Executive Program raising them in the Arab Council of Ministers will enhance the transparency of the member countries' trade practices. Despite its attractions, the Arab FTA has shortcomings. First, The Program has allowed agricultural products which represent about 20 percent of Arab intra-trade to be outside the tariff reductions scheme during the crop/harvest seasons, which amount to a protection of those products for most of the transition period. In addition, the decision to allow exceptions even subject to the drawn guideline might lead member countries to take advantage of this loophole, thus reducing the ability of the Arab FTA to realize its full potential for regional trade expansion. Moreover, the Program did not address the impacts of several bilateral preferential schemes between Arab countries. These agreements provide partial exemptions from tariffs to a list of products drawn by the country signatory. By allowing preferential treatment to some products and denying it to other goods of national content these protocol agreements distort bilateral trade flows rather than stimulate trade between Arab countries. The implementation of such agreements might undermine the effects of total liberalization under the Arab FTA scheme. 5. Potentialities of the Arab FTA Given the recent Arab FTA, the next issue to be addressed is whether Arab intra-trade could support such initiative. This Section draws on several draft reports and background materials that has been compiled on regional integration in the MENA region by the World Bank's Research Group to analyze the level, trends and composition of Arab intra-trade. For 1997, the value of Arab intra-regional exports is estimated to have been $15.5 billion up from $8.5 billion a decade earlier. The overall increase is largely due to the expansion of nonenergy exports, in particular chemicals and clothing. However, the relative importance of intratrade in total Arab trade rose moderately during the ten year period of 1986-96, accounting from about 8.1 to 9.6 percent as measured by ((imports + exports)/2) of total trade (Table 1 & 2). There is some indication that the levels of Arab intra-trade are below normal levels. For example, 6

Yeats (1995) noticed that although intra-regional trade activity may appear low, the region exports to the world about 3 percent of global exports. As such Arab countries have higher than average propensity to trade with one another, given their relatively low propensity to trade at all. As far as the contribution of the established sub-regional groupings to the trade changes is concerned, the GCC has had some positive impact on intra-regional trade, indicating that an open trade regime may be a prerequisite to effective regional trading arrangements, (Table 3). Moreover, since the eventual success or failure of a free trade arrangement may be influenced by the relative importance of intra-trade of member countries, statistics on the average share of individual Arab countries' intra-trade over the ten-year period (1986-96) were computed. This shows that five countries (Lebanon, Jordan, Iraq, Sudan and Somalia) account for more than 25 percent of their total exports, while the average share exceeds 10 percent for six others (Oman, Syria, Bahrain, Yemen, Egypt and Saudi Arabia). The corresponding imports data show that the average intra-trade share over the ten year period is reported to be 25 percent and more for four countries (Bahrain, Sudan, Oman and Jordan) and more than 10 percent for five others (Iraq, Yemen, Qatar, Morocco and Lebanon). The analysis shows that the importance of intra-trade to individual countries varies. The only countries whose intra-trade shares both of total exports and imports have been relatively significant are Jordan, Lebanon and Sudan. Part of the explanation might involve the import potentials of the neighboring GCC markets. Lebanon having a broad export base managed to sell in the GCC markets more than the other Arab countries, while Jordan relies on the GCC markets for both exports and imports. Regarding countries' contributions to Arab intra-trade, the computed shares of exports and imports of individual countries in all intra-regional exports and imports, ranked on the basis of each country's average (1985-1996) value show a high degree of concentration of intra regional exports in a few countries. Two countries (Saudi Arabia and the UAE) account for about half of all intra-regional exports and around 21 percent of imports. The overall intra-trade shares of imports are relatively less concentrated, as eight countries (Bahrain, Oman, Saudi Arabia, UAE, Morocco, Jordan, Kuwait, and Iraq) account for around three-quarter of all intra-regional imports. Another perspective on Arab intra-trade feature is to look into the matrix of the origins and destinations of this exchange. The figures reported in this matrix show that cross-border trade generally accounts for a high share of Arab intra-trade. This exchange represents more than 60 percent of exports of Bahrain, Algeria, Saudi Arabia, Libya and Tunisia. Such a high bilateral trade between countries sharing common border reflects a lack in general of functional transport and communication links within the Arab region. This issue is important since existing infrastructural and institutional constraints would limit the expected expansion in trading opportunities from the Arab FTA. Another explanation is that many Arab countries have similar export profiles that may have limited export opportunities for intra-trade (Table 4). 7

To shed some light on the broad composition of Arab intra-trade, (Table 5) provides summary statistics of the share of this exchange classified in seven basic product groups, in 1995-1997. This Table shows that mineral fuels and manufactures by materials represent the two major components of intra-arab trade although considerable variations exist among Arab countries. Mineral fuels and manufactured products are equally important accounting each for about 32 percent of all intra-arab exports. The third largest category is food and beverages such as vegetables and processed food, which accounted for around 15 percent of intra-arab exports. The fourth major category is chemical exports (e.g., organic petrochemicals such as fertilizers and inorganic chemicals such phosphatic fertilizers) accounting for an average of 9 percent of intra-arab exports. Finally, machinery and transport equipment account for less than 10 percent of intra-arab exports. As regards the composition of intra-imports, these follow similar pattern as exports since intra-exports equal intra-imports by definition. As regards the comparative profile of the intra-regional export basket and the total regional export basket of Arab countries, the data show a similar pattern underying both export baskets. However, there is a significant difference in the relative importance of petroleum products as these account for a much higher share (68 percent) in total Arab exports and more than double of that in intra-arab exports (32 percent). One conclusion suggested by the actual commodity structure of Arab intra-regional exports is that there has been increased regional trading in industrial goods, chiefly chemicals, electrical articles, machinery, clothing and textiles. However, an important consideration to take into account is whether recent trade changes are evolving along lines, which more closely match regional imports. Statistical measures, such as the "revealed" comparative advantage (RCA) index, can be employed to help assess the Arab FTA prospects. Yeats (1995) and Limam (1998) computed RCA indices for several Arab countries and found most of them have a comparative advantage in a limited range of products (e.g., energy products and chemicals). They concluded that the greatest opportunities for expanded intra-regional trade exist between energy exporting countries and the more diversified economies such as Lebanon, Syria and Egypt that have relatively high RCAs for manufactured goods and processed foodstuffs. It is important to note along with this result the shortcoming of applying the concept of revealed comparative advantage to Arab countries, this should be measured in an environment with trade regimes that have very low external trade barriers (i.e., tariffs and non-tariffs) that do not distort individual countries export profiles. Although trade barriers facing Arab countries from their main trading partners are relatively low, trade barriers in most Arab countries are high and have long reduced the ability of producers in the region to look for export opportunities within the regional markets. Hence, it is likely that the true comparative advantage of many Arab countries may lie in other export products than the computed RCAs suggest. Indeed, the trade liberalization measures embodied in the recent Executive Program establishing the Arab FTA is intended to improve intra-regional competitiveness and expand the product coverage of intra-regional exports. 8

A further analysis of the evolving regional exchange is to determine the dynamic products that have different production features than traditional exports. An attempt was made to identify the (100) most dynamic broad products that recorded the highest compound annual growth rates in intra-trade of six Arab countries, namely, Egypt, Jordan, Lebanon, Morocco, Saudi Arabia and Tunisia. These countries have detailed intra-trade data for 99 key products, classified by Chapter of the Harmonized System available for the period 1993-1996. Moreover, they are relatively diversified exporting countries, and Saudi Arabia is the most important regional market for nonoil exports and imports. (Table 6) shows that out of the six countries, Saudi Arabia originates 31 of these dynamic products, followed by Jordan (24), then Tunisia (19), then Egypt and Morocco (12) and Lebanon (4). The composition of the dynamic products reveals two important observations. First, almost half (in terms of numeric value) of the products are manufactures by materials. This raises the opportunities for expanded trade in processing activities. Those products with high growth rates will become an important source of the region's export earning, and will reduce the dependency on energy products. Second, another key import group foods and feeds accounts for (40) percent of the most dynamic intra-arab export products. This also shows the existing trade opportunities for these goods to find export niches in the regional market and to help the region to overcome food security problems. Machinery and transport equipment accounts for less than 10 percent of the most dynamic export products of the selected countries. Another perspective on the feasibility of the Arab FTA is to examine the potential for further specialization and intra-industry trade of Arab countries. Theoretical analyses and empirical studies show that a high level of intra-industry trade plays an important positive role on regional arrangements, by assisting member countries to integrate more fully into global and regional markets and to speed up developing countries industrialization and growth. Havrylyshyn and Kunzel (1997) computed intra-industry (IIT) index for Arab countries' regional trade in the 1990s. They found IIT index for Arab countries are lower than for those countries which recently established regional trade arrangements such as NAFTA, APEC, and especially, MERCOSUR (which has similar per capita income). Nevertheless, the computed data for Arab countries show a significant sign of rapidly increasing level of intra-industry trade from a decade ago. Moreover, the authors found that intra-industry trade levels are higher for trade among Arab countries (i.e., regional trade) and with other developing countries than with the EU. This leads the authors to suggest that free trade agreements between Arab countries and the EU should be enforced by a regional free trade agreement such as the Arab FTA. In short, intra-industry trade could be an important vehicle for promoting and supporting the Arab FTA, as suggested by the aforementioned empirical findings. 6. The Likely Effects of the Arab FTA The standard customs union theory (Viner, 1950) predicts that elimination of tariffs implied by an FTA would lead to two familiar effects. First, trade creation would take place among FTA members, in a way similar to increases in the quantity of imported goods because they are 9

cheaper. However, trade usually depends also on both the supply and demand conditions. For example, high tariff reductions on products with low import-demand elasticities may lead to a smaller trade expansion than low tariff reductions on products with high import-demand elasticities. Second, trade diversion results from a shift of imports from relatively low cost foreign producers non-members of the FTA to high cost producers of tariff exemptions. Trade diversion is considered a discriminatory measure against non-member countries, which may lead to a reduced economic welfare that outweighs the gains from trade creation, especially, if the exchange of tariff exemptions was accompanied by the imposition of new high tariff barriers against relatively low-cost non-members. In the case in which trade diversion is high and even higher than the trade creation, there will be a loss of efficiency increasing the likelihood that losses from the trade preference will exceed gains. However, it is possible that an FTA both creates and diverts trade, and that such a trade diverting FTA can improve economic welfare if it leads to decline in producer and consumer prices. Put in another way, because tariffs are eliminated, the price to an FTA member A's consumers may well be lower on the products newly imported from member B, even though B's costs of production are higher than those of the non-member C, the previous supplier. The resulted pattern of consumption may be less distorted, and this beneficial effect may well be sufficient to compensate for the higher costs of production of member B vis-à-vis the nonmembers. The previous discussion of the effects of FTAs shows that any attempt to quantify such effects are subject to numerous assumptions to take into account as well as elasticity measures which are not available for Arab countries. Moreover, the trade creation and diversion concepts are static in nature, and there are dynamic gains associated with the flow of new investment, improved productivity and low transaction cost. These benefits are believed to outweigh the net loss in static welfare, on condition that investors do not locate in the hub (e.g., EU) rather than the spoke (e.g., Arab countries), because firms in the hub have duty free access to "spoke" countries. Such likely investment diversion might diminish if all "spoke" countries cooperate and eliminate tariff and other trade barriers facing each other's trade. This paper does not attempt to assess quantitatively such effects but rather explores the potential economic implications of Arab FTA, namely, the effects of tariff cuts as well as the welfare effects for Arab producers and consumers. Then it discusses the link with both the Association Agreements with the EU. Tariffs Effects The Arab FTA is a standard preferential trade agreement that involves the elimination of tariffs as well as a reduction of administrative and other NTBs on intra-arab trade in merchandise. Since tariff levels and tariff-like charges in the Arab region are significantly higher than those applied in countries that pursue a more outward oriented economic strategy, liberalization of Arab countries' trade barriers could have a significant trade creation effect (Hoekman, 1995). Since most Arab countries apply escalating import duties (Zarrouk, 1992), intra-arab exports face higher tariffs than primary products. This tariff escalation makes the effective rate of protection 10

(i.e., protection accorded to local value added production) higher than the nominal rates of protection (i.e., protection to local finished products). High rates of effective protection have the following negative effects on intra-arab trade in the processed products. (1) Since the Arab FTA members are mostly low to middle income countries, they exhibit high demand in simple consumer goods. The high effective protection raises the price of final products, tends to reduce consumption, and (2) High effective protection also retards the development of processing industries to gain efficiency in a larger regional market. This view on the effects of high effective protection suggests that Arab countries, which levy relatively low import duties (such as the GCC countries), face small potential for increasing imports through the Arab FTA. However, many of the manufactured goods the GCC countries export face relatively high duties in other Arab country markets, so the potential for export expansion is high. Welfare Effects for Producers and Consumers The Arab FTA offers the opportunity to develop comparative advantage that is the opportunity to produce and sell in a broader domestic (Arab FTA) market before venturing into more intense international competition. Many Arab infant industries could develop a comparative advantage in a regional market only, that is, in the shelter of a protected market, generating social benefits along the way, for instance, the Arab GCC countries, endowed with capital resources, have acquired high-skill technology that are adapted to produce suited exportables to both developing and developed countries (e.g., petrochemicals, plastics). Little change is expected in imports of labor-intensive light manufacturing, especially, textiles and clothing, leather, footwear and furniture. These are sectors where the relatively more diversified economies have comparative advantage but are so similar that there are limited opportunities for intra-trade. However, the positive signs of rapidly increasing intra-industry trade levels in the Arab region as a result of their efforts to diversify economies might provide new channels for intra-industry cooperation even in those labor-intensive light manufacturing sectors. For instance, Arab countries have not developed so-called outward processing in intra-trade. This consists of shipping semi-finished products to another Arab country for further processing. The processed good is then exported back to the original Arab supplier/retailer or exported to developed countries (e.g., EU). In this respect, the garment industry can be a potential candidate to reduce production costs and risks associated with development of export markets. Regarding the effects on consumer's welfare, tariff reductions would expand intra-trade (this benefit is subsumed in trade creation), assuming a price elastic demand for imports. In addition, Arab consumers might start to substitute imports (i.e., trade diversion) from Arab FTA member countries' producers for imports from outside countries (mainly developed countries). With full elimination of tariffs and other trade barriers, Arab importers would experience some efficiency gains from the shift to trade with other Arab countries that are lower-cost producers. Finally, the Arab FTA would bring about tariff revenue losses, especially for countries with relatively high intra-trade share in their global trade. However, these revenue losses might be offset by tariff revenue generated from increased imports resulting from tariff reductions and lower import prices provided that other man-made trade barriers in many Arab countries are 11

removed. Most of all the extent to which new revenues will offset revenue loss will depend on the removal of remaining trade barriers facing Arab intra-trade. The Role of the Arab FTA with the European Union-Mediterranean Association Agreements Other major changes that are expected to have important implications for the trading prospects of the Arab FTA are the Association Agreements with the EU which aim at achieving free trade areas with the Southern Mediterranean countries. These Agreements consist of improved market access for industrial product exports of Arab countries. A key implication of such agreements is that, in one hand, they enable Arab signatory countries to commit themselves to a harmonization process of their domestic laws and standards with international norms - thereby making it easier for domestic producers to penetrate foreign markets. On the other hand, the EU is committed to the provision of financial assistance for the adjustment costs resulting from the free trade agreements. The expected payoff of such free trade agreements is an improvement in productivity and specialization in production and the higher value-added industrial products to the EU market. This is also a way to ensure that Arab Southern Mediterranean countries benefit from the growth and income generation effects of global liberalization. There have been counterarguments for the EU agreements which state that preferential trade liberalization is a second best option and that "locking in" policy commitments for domestic market access with the World Trade Organization (WTO) and the adoption of international standards and norms rather than the EU ones is superior. Countries take more advantage from the world markets at large than from preferential trade liberalization. Nevertheless, if one examines the learning-by-doing in export-oriented industries, in the South East Asian countries, these started generally by aligning their production standards to one major foreign market (Japan) for access before learning to adapt production to international norms. As far as Arab FTA is concerned, it is expected that the EU Association Agreements would support such a regional trading arrangement as long as Arab Mediterranean countries offer market access to each other's and in equal footing with the EU investors. Such a policy is likely to diminish investment diversion to the EU. Furthermore, the EU Association Agreement could support the Arab FTA through cumulation for rules of origin purposes for products manufactured in any of the Arab FTA members as well as the EU. This may contribute to creating backward and forward linkages between Arab countries and usher in expansion of Arab intra-industry trade (Hoekman, 1995). 12

List (1) EURO-MEDITERRANEAN FREE TRADE AGREEMENTS (SUMMARY) I. OBJECTIVES ARAB MEDITERRANEAN COUNTRIES: Tunisia, Morocco, Jordan (concluded the EU Association Agreement) 1. Reciprocal Free Trade in all Industrial products. Algeria, Egypt, Lebanon, Syria (candidates) 2. Preferential & Reciprocal Access For Agricultural Products. 3. Gradual Liberalization of Trade in Services and Capital. 4. EU Support for Integration of Mediterranean Countries. II. CONTENTS OF LIBERALIZATION IN INDUSTRIAL PRODUCTS Phase out of Tariffs and Non-Tariffs on all Imports 1. Intermediate Inputs and Capital Goods Duration 5 Years Transition (Front loaded) 2. Consumer goods (Textiles, Clothing, 12 Years Transition (Back Loaded) Leather, Apparel Footwear, Furniture) 3. Industrial Products not mentioned Immediate Liberalization in one of the above categories (upon entry into force of the Agreement) 13

Summary and Conclusion The paper examined the recent Arab FTA and focused on the potentialities and the effects of such a trading arrangement. In assessing the potentialities of the Arab FTA, the paper identified forces that are likely to stimulate the prospects for intra-trade expansion. First, the Executive Program agreed upon by the eighteen states of the Arab League involves for the first time commitments by Arab countries to come forward with a complete preferential scheme covering most products to be liberalized from tariff and most tariff barriers within 10 years. Such trade liberalization would enhance competitiveness of manufactured products by materials that are produced in the Arab region. Moreover, the similarities in the process of diversification of manufactured products in Arab countries, as a result of similar factor endowments (oil and oil products, and labor) suggest that the spread of manufacturing and the growing intra-industry specialization would provide a stimulus to regional intra-industry trade expansion. Moreover, since tariff levels and non-tariff barriers are significantly high for most Arab countries with the exception of the GCC, liberalization of Arab countries' trade barriers could have a significant trade creation effect, though trade diversion from other lower-cost more-efficient in sources in the region may occur. But overall, as the relatively more diversified Arab countries would seek to take advantage of the new global trading opportunities provided through WTO membership (as Arab countries are becoming members) external tariff levels will also come down leading to more trade creation. As far as linking the Arab FTA with the EU's Med. Association Agreements is concerned, further gains for market access into the EU through the Association Agreements would create incentives for Arab countries' commitments to keep their markets open to each another, in the context of the Arab FTA. Finally, for the Arab FTA to produce favorable intra-arab export trends further trade policy coordination is needed to keep pace with the increasing integration of the world economy. Such policies include harmonization of domestic policies that reduce or eliminate barriers to competition that affect foreign (i.e., Arab, EU.) suppliers, and the inclusion of services in the Arab FTA. The latter is important to overcome the lack of competition in services which put in turn, many Arab firms at disadvantage to compete on world markets. 14

References Havrylshyn O. and Kunzel, P. (1997) "Intra-Industry Trade of Arab Countries: An Indicator of Potential Competitiveness," IMF Working Paper, April 1997. Hoekman, Bernard. (1995), The WTO, The EU and The Arab World: Trade Policy Priorities and Pitfalls, Center for Economic Policy Research, Paper No. 1226 International Monetary Fund. (1995), "Jordan: Strategy for Adjustment and Growth," Occasional, Paper No. 136, Washington D. C. Krueger, Anne O. (1978), Lal, Deepak. And Rajapatirana, Sarath. (1987) Foreign trade regimes and economic development: Liberalization attempts and consequences, Ballinger Pub. Co. for NBER, Cambridge, MA. Foreign Trade Regimes and Economic Growth in Developing Countries, World Bank Res. Observer. Limam, I. & Abdalla, A. (1998) "Inter-Arab Trade and the Potential Success of Arab Free Trade Area (FTA)," a paper presented at the International Conference on "New Economic Developments and their Impact on Arab Economies," Arab Planning Institute (Kuwait), held in Tunis, 3-5 June 1998. Sachs, Jeffrey, and Warner, Andrew. (1987), Economic Reform And The Process of Global Integration, Brookings Papers on Economic Activity, Vol. I, PP. 1-118. UNCTAD. (1997), The Uruguay Round And It s Follow-Up: Building A Positive Agenda For Development. World Bank. (1996), The Uruguay Round and the Developing Economies, edited by Will Martin & L. Alan Winters, World Bank Discussion Papers No.307.. (1996), Tunisia s Global Integration and Sustainable Development, World Bank Middle East and North Africa Economic Studies.. (1996), Growing faster, Finding Jobs, Choices for Morocco, World Bank Middle East and North Africa Economic Studies.. (1995), The Uruguay Round and The Developing Economies, eds. By Will Martin, L. Alan Winters, World Bank Discussion Papers.. (1987), World development report, Oxford U. Press.. (1981), Accelerated Growth In Sub-Saharan Africa, Washington, DC. World Trade Organization (1998), Annual Report 1997. 15

. (1996), Annual Report, 1996.. (1996), Trade Policy Review: Kingdom of Morocco.. (1995), Trade Policy Review: Tunisia.. (1995), The Results of The Uruguay Round of Multilateral Trade Negotiations, The legal Texts. Yeats, Alexander. (1995) Zarrouk, Jamel. (1992) Trends and Prospects for Middle Eastern Exports, Working Paper, The World Bank. Intra-Trade: Determinants and Prospects for Expansion, in Foreign and Intra-trade Policies of the Arab Countries, Ed. By Said El-Naggar, International Monetary Fund. 1 All the 22 member states of the Arab League, except Algeria, Djibouti, the Comores Islands and Mauritania have endorsed the Agreement and have committed to the executive program. 2 Egypt, Iraq, Jordan, and Syria. Libya, Mauritania, and the P.D.R. of Yemen joined later. 3 Zarrouk computed increases in intra-trade as percent of GDP and compared them with increases in two other trade shares, external and total trade as a percent of GDP for two selected periods before and after the agreements was signed. These measures have been used as a test for the effects of trade policy on a country's trade pattern. 16

Table 1. The Value and Share of Individual Arab Countries in Total Intra-Exports (US $ million & percent) Average Average Average Share in Arab value Growth Rate Growth Rate Intra-Exports 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1986-96 1986-96 1993-96 av. 1986-96 JORDAN 268 367 357 383 390 253 327 412 482 645 685 353 9.8 18.4 4.1 U.A.E. 783 770 973 996 1240 1307 1604 1626 1724 1673 1760 1154 8.4 2.7 13.4 BAHRAIN 660 672 249 280 224 255 254 367 358 365 510 335-2.5 11.6 3.9 TUNISIA 165 139 181 296 364 404 396 345 353 497 420 286 9.8 6.8 3.3 ALGERIA 37 76 194 174 284 210 236 182 245 244 195 171 18.0 2.3 2.0 SAUDI ARABIA 1958 2127 2212 3035 4441 4487 3868 3705 3779 4873 5660 3135 11.2 15.2 36.4 SUDAN 83 89 96 94 107 63 157 172 201 170 240 112 11.2 11.8 1.3 SYRIA 140 88 177 502 786 786 722 738 919 938 807 527 19.2 3.0 6.1 SOMALIA 54 94 70 67 59 45 63 68 85 105 65 0.7 IRAQ 420 661 723 955 652 252 409 443 417 451 518 489 2.1 5.4 5.7 OMAN 1597 1859 2341 2947 2762 120 123 136 158 169 188 141-19.3 11.3 1.6 QATAR 153 150 204 229 253 254 278 281 308 346 411 223 10.4 13.5 2.6 KUWAIT 574 676 762 795 516 56 119 296 310 311 326 401-5.5 3.3 4.7 LEBANON 253 290 377 255 215 289 333 248 289 344 461 263 6.2 23.0 3.1 LIBYA 181 165 199 47 459 421 383 351 468 516 527 290 11.3 14.5 3.4 EGYPT 180 118 249 275 270 416 523 533 510 479 497 323 10.7-2.3 3.7 MOROCCO 126 165 248 263 373 465 338 338 327 378 345 275 10.6 0.7 3.2 MAURITANIA 17 9 7 0 2 2 2 2 2 1 1 4-22.8-14.8 0.0 YEMEN 120 45 68 66 71 47 60 77 98 94 77 68-4.3 0.0 0.8 INTRA- ARAB EXPORTS 7768 8561 9688 11659 13467 10131 10193 10320 11032 12600 13627 8614 5.8 9.7 100.0 EXPORTS TO ROW 71201 82857 81701 99469 126867 117454 123703 117088 119232 135098 151914 97697 7.9 9.1 91.1 TOTAL EXPORTS 78970 91417 91388 111128 140334 127585 133897 127408 130264 147697 165541 107281 7.7 9.1 100.0 Source: Direction of Trade Statistics Tape, International Monetary Fund.

(US $ million & percent) Table 2. The Value and Share of Individual Arab Countries in Total Intra-Imports Average Average Average Share in Arab value Growth Rate Growth Rate Intra-Imports 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1986-96 1986-96 1994-96 av. 1986-96 JORDAN 576 717 716 588 666 497 678 720 759 869 1075 617 6.4 19.0 6.6 U.A.E. 503 537 578 755 947 801 859 1600 1561 1989 2250 921 16.2 20.1 9.9 BAHRAIN 1076 1361 1222 1425 1979 1816 1865 1600 1610 1798 1912 1432 5.9 9.0 15.4 TUNISIA 200 188 220 382 405 268 369 205 304 595 572 285 11.1 37.2 3.1 ALGERIA 148 166 105 189 185 195 324 296 393 401 292 218 7.0-13.8 2.3 SAUDI ARABIA 791 797 1050 1076 1100 1169 1379 1500 1427 1623 1705 1083 8.0 9.3 11.6 SUDAN 220 201 246 277 358 391 369 290 353 311 344 274 4.6-1.3 2.9 SYRIA 296 265 115 119 148 139 182 255 341 378 426 203 3.7 11.8 2.2 SOMALIA 31 36 12 28 25 10 13 39 23 25 22 0.2 IRAQ 591 604 786 1241 926 150 79 131 171 303 300 453-6.6 32.5 4.9 OMAN 492 433 514 632 730 937 1180 1344 1274 1335 1500 1214 11.8 8.5 13.0 QATAR 65 94 119 139 202 226 278 326 322 350 380 193 19.3 8.7 2.1 KUWAIT 414 606 836 815 423 87 811 789 802 951 1040 594 9.6 13.9 6.4 LEBANON 107 111 151 252 424 474 563 497 502 598 632 334 19.4 12.2 3.6 LIBYA 55 128 192 244 334 465 581 504 441 526 690 315 28.7 25.0 3.4 EGYPT 321 205 252 171 191 263 251 215 339 449 509 242 4.7 22.6 2.6 MOROCCO 415 562 542 579 1032 880 987 753 756 766 834 661 7.2 5.0 7.1 MAURITANIA 2 57 3 15 26 42 27 44 28 30 52 25 37.8 35.8 0.3 YEMEN 202 194 374 416 363 298 199 163 131 248 352 235 5.7 64.1 2.5 INTRA-ARAB IMPORTS 6505 7261 8032 9340 10462 9108 10995 11269 11536 13543 14865 9321 8.6 13.5 100.0 IMPORTS TO ROW 74864 74962 85683 86163 92747 100186 114085 112531 111720 123858 126037 88800 5.3 6.2 90.9 TOTAL IMPORTS 81369 82222 93715 95503 103209 109294 125079 123800 123256 137402 140902 97713 5.6 6.9 100.0 Source: Direction of Trade Statistics Tape, International Monetary Fund.

Table 3. The Value and Share of Arab Intra-Trade by Subregional Groupings Country Group Trade Flow 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Value of Intra-Trade Intra GCC Export 4216 4777 5109 6433 6905 4762 4980 5025 5297 5781 5724 Intra AMU 281 335 470 580 959 1071 960 795 969 1067 1143 Intra ARAB 7768 8561 9688 11659 13467 10131 10193 10320 11032 12600 13627 Intra GCC Import 2570 2916 3138 3676 4000 3897 4424 5037 5246 6321 6251 Intra AMU 351 417 406 645 795 924 1228 988 1065 1180 1212 Intra ARAB 6505 7261 8033 9340 10462 9108 10995 11269 11536 13543 14865 Share of Intra-Trade in Total Exports or imports (%) Intra GCC Export 8.9 8.8 9.5 9.8 8.0 5.5 5.3 5.6 5.8 5.4 4.6 Intra AMU 1.5 1.5 2.2 2.4 2.9 3.3 3.2 3.1 3.8 3.6 3.4 Intra ARAB 9.8 9.4 10.6 10.5 9.6 7.9 7.6 8.1 8.5 8.5 8.2 Intra GCC Import 6.9 7.6 7.3 8.4 8.4 7.0 6.5 7.8 8.6 8.5 8.0 Intra AMU 1.7 2.2 1.8 2.7 2.7 3.5 4.3 3.6 3.8 3.8 4.0 Intra ARAB 8.0 8.8 8.6 9.8 10.1 8.3 8.8 9.1 9.4 9.9 10.5 Source: Direction of Trade Statistics Tape, International Monetary Fund.

Table 4. destination of Arab Countries' Intra-Trade, In DESTINATION EXPORTER JORDAN U.A.E BAHRAIN TUNISIA ALGERIA DJIBOUTI SAUDI ARABIA SUDAN SYRIA SOMALIA IRAQ OMAN PALESTINE JORDAN EXP 83.8 19.8 9.8 9.1 0.1 182.9 15.2 57.8 0.0 0.0 9.6 0.0 IMP 20.8 28.6 0.9 0.2 0.0 129.1 20.7 140.3 0.2 0.0 7.1 0.0 U.A.E EXP 49.3 117.9 18.8 54.9 15.8 320.8 16.2 21.1 75.5 0.0 185.7 0.0 IMP 95.6 123.1 4.4 0.3 2.7 743.4 7.1 36.0 25.6 0.0 0.8 0.0 BAHRAIN EXP 26.0 123.0 7.0 1.3 0.0 237.1... 0.9...... 19.3... IMP 21.8 81.4 11.4...... 1790.2... 7.9...... 5.4... TUNISIA EXP 1.3 8.9 10.4 96.2 0.0 23.1 0.0 3.1 0.0 0.0 1.3 0.0 IMP 7.3 8.2 7.7 127.2 0.0 34.6 6.2 32.6 0.0 0.0 0.1 0.0 ALGERIA EXP 3.5 0.2 0.0 100.7 0.0 0.2 0.0 2.4 0.0 1.2 0.0... IMP 7.8 10.0 4.7 71.5 0.0 22.8 0.0 32.1 0.0 0.0 0.0... DJIBOUTI EXP.................................... IMP.................................... SAUDI ARABIA EXP 113.2 1810.1 1757.3 55.5 13.9 21.9 115.1 78.0 8.3... 117.8... IMP 129.5 403.2 260.9 23.2 0.0 0.9 105.5 160.7 98.0... 61.1... SUDAN EXP 26.2 11.7 1.6 4.1 0.0 4.9 116.9 5.8 2.9 0.0 0.2 0.0 IMP 17.7 70.1 0.0 0.0 0.0 0.5 170.3 2.3 0.0 0.0 1.9 0.0 SYRIA EXP 30.3 12.1 2.4 6.8 10.9 0.0 55.4 1.3 0.0 0.0 0.0 0.0 IMP 30.9 5.3 0.7 0.4 0.0 0.0 26.1 2.8 0.1 0.0 0.0 0.0 SOMALIA EXP 0.2 16.3... 0.0...... 89.1 0.0...... 2.0... IMP... 9.3............ 25.0 0.5...... 0.5... IRAQ

EXP 459.6................................. IMP 149.2................................. OMAN EXP 4.2 606.8 8.8 3.4 0.5 0.0 65.5 2.1 8.1 0.0 0.0 0.0 IMP 3.6 1086.9 30.2 1.0 0.3 0.0 140.4 0.3 0.8 2.1 0.0 0.0 PALESTINE EXP.................................... IMP.................................... QATAR EXP 8.0 128.1 8.6 0.0...... 69.3 0.1 1.7...... 14.1... IMP 27.8 158.0 42.6 1.3...... 181.6 0.5 13.1...... 10.1... KUWAIT EXP 6.5 113.7 17.7 10.5 0.1 0.1 128.1 0.2 19.9 0.0 0.0 12.6... IMP 26.2 156.6 48.1 5.9 0.0 0.0 557.4 0.0 67.8 4.2 0.0 13.1... LEBANON EXP 49.9 238.4 11.3 1.8 1.3 0.3 139.0 2.8 70.0 0.0 0.0 6.7... IMP 35.4 27.6 4.3 7.5 2.8 0.0 112.4 15.8 307.6 0.1 0.1 2.7... LIBYA EXP 10.5 2.0... 213.4 5.1... 1.1 235.3 19.1............ IMP 13.2... 0.3 215.5 8.9... 3.1 6.4 74.1............ EGYPT EXP 44.7 44.5 2.6 24.2 15.9 0.8 122.9 21.0 55.1 0.1 0.0 2.9 8.2 IMP 15.1 24.3 1.8 19.9 2.1 0.0 290.9 20.8 15.3 0.5 0.0 0.6 0.0 MOROCCO EXP 11.1 4.7 0.3 59.3 35.5 0.1 62.1 0.0 15.6 0.0 0.0 0.2 0.0 IMP 1.6 3.3 1.4 42.2 0.0 0.0 491.4 0.0 23.2 0.0 0.0 0.0 0.0 MAURITANIA EXP 0.0...... 2.2........................... IMP 0.0 0.2... 0.6 22.0... 3.0... 0.0............ YEMEN EXP 1.1 8.7 19.3 0.0 0.2 2.3 38.3 0.1 0.2 4.0 0.0 0.2 0.0 IMP 18.3 115.0 12.3 0.6 1.4 11.9 135.7 4.8 3.8 14.6 0.0 5.5 0.0