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EURO-MEDITERRANEAN AND ARAB INTEGRATION: POLITICAL IMPLICATIONS AND TRADE POLICY RESPONSE

Gonzalo Escribano Professor of Applied Economics Universidad Nacional de Educación a Distancia (UNED), Madrid e-mail: [email protected]

The author gratefully acknowledges valuable comments on a previous draft by the participants at the Bari International Seminar organised by the “Group de Recherche International Economies de la Méditerranée et du Monde Arabe du CNRS” and the University of Bari, 22-23 september 2000. I am specially indebted with Michela Pellicani, Henri Regnault and Jean Pierre Domecq. However, the author is the only responsible for the opinions expressed here and any mistake that may remain. I would also like to thanks the Economics Department at the Florida State University, where I stayed as a Visiting Fellow when this article was concluded.

Introduction

Three main options are open for Arab countries in the Mediterranean regarding regional integration: to achieve regional integration within the All Arab Free Trade Area, to conclude agreements with the European Union in the Euro-Mediterranean Free Trade Area framework or try to combine the two strategies. Some authors conceive Euro-Mediterranean agreements as incompatible with Arab integration, while others look at them as a challenge that can foster further Arab integration. However, the analysis uses to rely on narrow economic arguments, instead of dealing with the political factors.

In this paper, we adopt a political economy approach, linking economics and politics in order to analyse 1) the likeliness of Arab countries integrating within an Euro-Mediterranean or Arab scope, or both; and 2) the trade policy responses that the Euro-mediterranean FTA may rise in the Mediterranean, as exemplified by the Maghreb countries. The paper will first analyse Euro-mediterranean and Arab regionalism and its perspectives of success, focusing on the Maghreb. Secondly, we analyse the trade liberalization process in the Maghreb countries. Then, we turn to the policy and strategic implications of regionalism for the Arab world, with special emphasis on the Maghreb and concentrating on trade policy issues. In the closing section, we conclude with some final remarks.

The challenge of re gional integration in the Mediterranean

The wave of regionalism in the Mediterranean is a relatively recent trend. Vasconcelos (1999) distinguishes between three categories of regionalism: deep integration, “open regionalism” and “virtual” integration. All of them exist in the Mediterranean. The EU is the most successful integration process in the whole world, and later integration efforts have to some extent tried to imitate its model. What it is relevant, for our purposes, is that traditionally the EU has chosen regionalism as the

path to integrate in the world economy. As Helmut Kohl once put it, for the EU “the answer to globalisation is Europeanisation”. This background has to be considered when analysing Euro-Mediterranean regionalism.

Out of the EU, the furthest reaching initiative is the proposal of a EuroMediterranean Free Trade Area. Nevertheless, within the southern shore of the Mediterranean basin, other initiatives have been launched. Abstracting from past efforts that have never been fully implemented1 (“virtual” integration), the main initiatives are the Arab Maghreb Union (AMU), the Arab Free Trade Area and a potential Free Trade Area within the eastern Mediterranean, integrating Mashrek countries with Turkey and, eventually, Israel.

In a recent work, Mattli (1999) points to the interaction of markets and political institutions to explain regionalism. Two pre-conditions are needed if regionalism is to succeed. First, the so-called demand conditions, of economic nature: there must be a strong potential for economic gain derived from economic integration, so that societies demand it. Second, the supply condition, of political nature: the political willingness to match the integration demands, which depend on the expected outcome of regionalism; as far as economic welfare increases after integration, governments maximise their possibilities of being re-elected.

In addition, following the regional ‘hegemon’ argument, the co-ordination problem (the need to match eventual divergences in national interest) asks for a regional leader acting as a catalyst, or even as a ‘paymaster’, if integration is to proceed. Nevertheless, Mattli abstracts from security and foreign policy objectives, which can constitute a rationale for regionalism. Furthermore, the political dimension of his argument underscores, as most new political economy studies do, the fact that many developing countries are non-democratic states (Meier, 1990).

If so, governments do not necessarily see welfare maximisation as the only, or even the main, way to stay in power. In this concern, when dealing with the Mediterranean, the regional leadership issue could be more relevant. In any case, the two pre-conditions can be useful insofar as it lets political and economic considerations

interact. Moreover, it can be applied to foresee the likeliness of a regional initiative succeeding.

In the next two sections, we will use the Mattli’s framework to show how political, security and cultural matters are to be taken into account for a comprehensive analysis of such initiatives and its possibilities of success. We will first tackle the NorthSouth integration efforts (vertical integration), then we turn to South-South regional initiatives (horizontal integration).

Vertical integration: the Euro-Mediterranean Free Trade Area

Historically, the Maghreb and Europe had been trading intensively for centuries. In spite of the economic slowdown of the Maghreb countries when compared with other regions, colonial ties and geographical proximity have acted as a cushion that prevented the decline of trade flows. Another important factor has been the EU trade policies’ concerning the Maghreb, subjected to a wider Mediterranean framework. Before the 1995 Barcelona Conference, the main content of EU-Maghreb relations had been commercial, with the EU granting preferential, non-reciprocal, access to most industrial goods coming from the region. This approach, however, proved to be insufficient, as far as agricultural products remained out of the preferential basket (and in this respect, things after Barcelona have not changed too much).

Moreover, even in the presence of such privileges, the industrial production from the Maghreb countries could not face competition from newly industrialised countries, in spite of their proximity or preferential treatment by the EU. The Uruguay Round further diminished the trade policy privileges given to Maghreb countries due to global substantial tariff cuts. Then, the solution turned out to be reforming the structure of the Maghreb’s industrial sectors in order to achieve increased productivity. This needed a structural reform of the whole economy, starting with economic liberalisation, strengthening the private sector at the expense of reducing the economic role of the state (including privatization), and a general shift towards the market as a mechanism for resource allocation. Trade liberalisation was not just another ingredient of the recipe,

1

This efforts, led by Nasser and the Arab League were of political, Pan-Arab, nature.

but a very important one that should create a link between international and domestic prices.

To be effective, the structural reform policy had to be complemented with macroeconomic stabilisation, impede the overvaluation of currencies and preventing it by keeping inflation under control. In 1995, when the proposal of a Euro-Mediterranean Free Trade Area was formally launched at the Barcelona Conference, the task of domestic economic restructuring had been under way in the Maghreb since the 80’s. However, there were political difficulties to keep on liberalising the Maghreb economies, and the risks of reversal and the shortcomings of the process endangered most of the reforms.

The Euro-Mediterranean Free Trade Area (EMFTA) should be placed as a pillar of a comprehensive approach dealing with security and political issues, as well as cultural dialogue. Without entering into the contents of the Declaration of Barcelona2 , It is important to highlight that the Euro-Mediterranean Free Trade Area (EMFTA) was just the economic dimension, while political and cultural dialogue were seen as complementary to the commercial and financial support measures. What are the prospects for Euro-mediterranean integration?

First, are the economic pre-conditions pointed by Mattli fulfilled for a FTA to be built between the two shores of the Mediterranean? Both parties maintain a sizeable percentage of their foreign trade with each other. However, the asymmetry stems from the fact that the EU is the main commercial partner for most southern Mediterranean countries, especially for the Maghreb countries, whilst the importance of southern Mediterranean countries as trade partners is smaller for the EU, especially for nonMediterranean EU members. In addition, the EU’s role as donor, investor and destination of migration flows from the region is also of big importance. Therefore, the economic conditions for commercial and even further economic integration seem to be matched. However, as Escribano and Trigo (1999) have argued, intra-industry trade between the EU and the southern Mediterranean, interpreted as a proxy for economic integration, lags behind that which is between the US and the Latin American countries.

Second, given that southern Mediterranean countries’ manufactures already enter freely (with minor exceptions) in the EU markets, the EMFTA offers few benefits from the demand side to these countries3 . On the contrary, the EMFTA looks to foster structural, supply-side reforms in the southern Mediterranean countries. Following the statement that some countries trade whilst others sign preferential agreements, the emphasis is now placed on improving industrial productivity and competitiveness in the southern Mediterranean countries. Given the mediocre results obtained by the demandside preferential treatment granted to Mediterranean countries, this is to be done through trade liberalisation and mise à niveau, upgrading measures, partially financed by the EU.

This argument assume that trade liberalisation will have beneficial effects on these economies. However, the studies that have been conducted to date point to small, or even negative, static effects to be expected in terms of GDP 4 . Why, then, should southern Mediterranean countries be interested in entering a FTA with the EU? The answer might lie in the non-traditional, non-static, beneficial effects of regionalism highlighted by the recent literature on the political economy of regionalism5 . In the two last sections of the paper, we will go back to the issue of the challenges that faces the economics actors from the southern Mediterranean countries concerning EMFTA, with special reference to the Maghreb case. Before doing that, we will deal with the Arab integration issue.

Vertical integration: South-South regional integration in the Mediterranean

We can distinguish between three regional initiatives within the southern shore of the Mediterranean: the Arab Maghreb Union (AMU), the Arab Free Trade Area (AFTA) and the FTA between Turkey and Israel. Some authors (Tovias, 1997) have also stressed the potentially beneficial effects of Mashrek-Israeli regionalism. As has been stressed by the literature, intra-regional trade is very low within the southern Mediterranean area. However, the trade potential of intra-MENA (Middle East and 2

On this issue, see, for instance Lorca and Escribano (1998, ch. 8 and 10). A similar asymmetry was experienced by Spain when entering EEC. 4 Rutheford, T., E .E. Rutström and D. Tarr (1994), Kebabjian, G. (1994 and 1995), Jaidi, L. (1994), Cogneau, D. and G. Tapinos (1995) and Tovias (1999). 5 Schiff and Winters (1998), Mansfield and Milner (1999) and Fernandez and Portes (1998). 3

North Africa) countries is a controversial issue, with some authors thinking about high trade potential while others are more sceptical6 .

The best developed effort in subregional integration is the Arab Maghreb Union (AMU). In the Maghreb, the question is if EMFTA causes conflict with AMU (Escribano, 2000). First, we should asses that the paralysis of AMU is mainly a political issue. The Algerian-Moroccan bilateral relations have been very difficult, due to the Western Sahara problem. Once this problem was more or less set apart from regional integration in the Maghreb, the AMU started to be more credible, even if the economic differences between countries proved too large. However, the whole design of AMU has been very ambitious and quite unrelated to reality. In the commercial area, the Maghreb countries negotiated tariff reductions on a product-by-product basis, following the practice of many developing countries’ integration efforts. This system had a poor record and intra-Maghreb trade represents a small part of the countries’ trade, as can be seen in table 1. The political difficulties increased with the closing of the MoroccanAlgerian frontier and Morocco’s refusal to take over the presidency of AMU.

Table 1: Direction of Maghreb countries trade, 1998. EXPORTS (%)

Algeria Lybia Mauritania Morocco Tunisia

Algeria 0,07 0,00 0,24 0,42

Lybia Mauritania Morocco Tunisia AMU Mashrek GCC Turkey MENA EU 0,07 0,20 0,64 0,36 1,27 0,05 0,01 5,35 6,68 62,72 0,01 0,33 2,17 2,51 1,67 0,01 4,42 8,62 81,81 0,00 0,20 0,20 0,40 0,80 0,00 0,20 1,40 62,73 2,20 0,22 0,88 3,54 1,42 1,60 0,71 7,90 58,63 3,51 0,03 0,64 4,61 0,71 0,78 0,90 8,32 79,78 IMPORTS (%)

Algeria Lybia Mauritania Morocco Tunisia

Algeria 0,18 4,30 0,91 0,49

Lybia Mauritania Morocco Tunisia AMU Mashrek GCC Turkey MENA EU 0,06 0,00 0,12 0,26 0,44 1,14 0,12 5,35 7,05 64,66 0,00 2,27 4,49 6,94 2,65 0,06 2,13 11,88 64,83 0,17 1,89 0,34 6,71 0,69 0,52 0,17 8,09 60,24 0,30 0,01 0,45 1,67 0,62 4,22 1,35 10,18 55,00 1,88 0,01 0,59 2,97 0,00 0,78 1,75 5,53 69,28

Source: IMF, Direction of Trade Statistics, 1999. Washington D.C.: IMF (*) Middle East and North Africa (MENA) countries are here considered as the sum of Maghreb, Mashrek, Israel, Turkey, Gulf Co-operation Council, Iran and Iraq.

6

See Escribano and Jordán (1999) for a survey on the literature and an approach based on gravity equations and trade intensity indices and Escribano (2000) for a more political economy oriented analysis.

Therefore, the failure of AMU does not have a great deal to do with the EuroMediterranean FTA. Moreover, the rules of origin’s cumulation within AMU is by far more generous than for eastern Mediterranean countries, so that intra-regional trade is not penalised by the Euro-Med FTA in this concern. However, the “hub-and-spoke” mechanism still represents a risk for the deepening of AMU, as far as AMU countries have not yet reach a comprehensive FTA between them, even if some bilateral agreements have recently been concluded between Tunisia and Morocco, the two countries involved in the Euro-Med FTA. More importantly, the AMU can be further fragmented by the fact that Morocco and Tunisia belong to the Euro-Med FTA, whereas Algeria, Libya and Mauritania do not. This risk calls for a new push to AMU integration efforts (Oualalou, 1996). Two strategies should be followed in order to overcome such a risk. First, the negotiations with Algeria for the establishment of a FTA with the EU need new impetus. Second, the AMU should be deepened in order to compensate for the possible trade diversion, but also political diversion effects of the agreements signed by Morocco and Tunisia.

In this context, we have a moderate trade potential between Maghreb neighbours, as shown by gravity equations (Ekholm, Torstensson and Torstensson, 1996) and trade intensity indices (Escribano and Jordan, 1999), which is more important for Algerian-Moroccan trade. The potential for economic relations would be higher if labour could freely circulate across frontiers and if transport infrastructures were made ready to withstand intra-regional trade. Therefore, the economic pre-conditions for regional integration to succeed are to some extent fulfilled. Nevertheless, the political pre-conditions are barely matched. If AMU is to deepen, the Algerian-Moroccan rivalry should first be solved by political means.

If regionalism is only barely succeeding in the western Mediterranean, the situation is much worse in political terms when moving eastwards. The Eastern Mediterranean concentrates the two major economic and political powers of the Mediterranean’s southern shore: Israel and Turkey. Turkey’s GDP almost equals Mashrek plus Maghreb’s GDP, while Israel’s GDP equals Mashrek’s one, and is slightly smaller than Maghreb’s GDP. Israel and Turkey agreed on a bilateral FTA recently. In relation to regionalism, both countries have asked to enter the EU, and both

of them have been rejected. Unlike Israel, which is not a European country and therefore not qualified to join the EU following the Treaty of Rome, Turkey has not qualified for accession on political grounds. The Turkish issue is of great importance. There are fears that the Euro-Mediterranean Partnership may discriminate against Turkey, given the high level of EU-Turkey bilateral relations.

The Israeli situation is unique from a regional perspective. Its economy has been isolated from its regional context due to the Arab boycott, therefore impeding Israel fully profiting from its high level of industrial development. Political and security factors prevent Israel attaining FTAs with its neighbours, in spite of these being considered as its “natural trade partners” on economic grounds. As Tovias (1997 and 1999) has argued, and from an economic perspective (high Arab-Israeli trade potential as measured by gravity equations and trade intensity indices), a Mashrek-Israel FTA will reap major gains for its participants. However, given the political and security context, Tovias has proposed the normalisation of Arab-Israeli trade relations as a first step.

The point we would like to stress here is that political costs for Arab countries may outweigh economic gains when fostering trade with Israel. As far as the situation has worsen dramatically in the last year, this is specially relevant for Arab countries now. Moreover, such an initiative will plausibly imply economic costs for Mashrek countries, as far as non-Mashrek Arab countries may decide to somehow retaliate against Mashrek countries breaking the boycott. In addition, many Mashrek countries host significant Palestinian populations, receive important investment flows from Arab countries in the Persian Gulf and are the origin of significant migration flows to these countries.

When dealing with regionalism among Mashrek countries and Israel, we can consider that economic pre-conditions are matched (high trade potential), but that foreign policy and security pre-conditions are not. Whatever economic benefits might be drawn from increased trade within the region, either by normalisation of trade or by further integration, these will remain on the hypothetical domain without a previous political spur of the peace process. It is difficult to envisage Syria, or even Egypt, trading freely with Israel without any significant advance in the peace process.

Therefore, it is doubtful that any progress based on economic, low-politics instruments will be effective in building confidence between participants in the peace process. The actual political circumstances simply block the mere normalisation of trade relations posed by Tovias.

If some Moroccan-Algerian political rapprochement is needed in the Maghreb to permit AMU to proceed with sub-regional integration, for Mashrek Arab countries to dismantle the boycott on Israel, substantial concessions on the part of the latter should be granted in the Peace Process. In fact, the pre-requisite to attain sub-regional integration in the southern shore of the Mediterranean is the rejection towards conducting ‘power politics’ and pursuing regional hegemony. Without such a political will, mercantilist trade policies are bound to prevail. This political will is by far more probable to emerge in the Maghreb than in the eastern Mediterranean, as far as the security threats and the political animosity are greater in the latter, due to past open conflicts. In addition, cultural and religious differences play an important role in impeding

rapprochement

between

Israel

and

Mashrek

Arab

countries.

When

considering the political (negative) externalities of conducting free trade with Israel by Arab countries, Tovias’ argument is not so straightforward. To put it in a well-known formula, the trade-off is something like trade-for-territories. If a political threshold is not attained, trade will not occur; only trade stemming from prior political normalisation might further act as a confidence building measure.

The last initiative we will consider is the Arab Free Trade Area (AFTA), that can be thought of as a response to both the Euro-Mediterranean and Turkey-Israel FTA’s. The AFTA is led by the Arab League, with 18 out of its 22 members signing an agreement that provide for a reciprocal elimination of tariffs by 2008. However, little progress seems to occur, as happened with former attempts at an Arab level. The problem with AFTA is of both an economic and a political nature. Due to low trade potential (Ekholm, Torstensson and Torstensson, 1996; Escribano and Jordan, 1999; Escribano, 2000) among many Arab countries, integration might lie mainly in non-trade issues, like labour migration.

However, some authors have expressed a different perspective, being more optimistic about Arab trade prospects (Bolbol, 1999; Hadhri, 2000). Historical and

political factors also seem to prevent AFTA succeeding, so that the political preconditions are not met either (Kalaycioglu, 1996). In this respect, some authors have proposed that countries from the Gulf Cooperation Council form an FTA with Mediterranean Arab countries that have already signed association agreements with the EU, in order to set up a more realistic and modest initiative (Calleya, 1999). At present, AFTA remains in the wishful thinking, ‘virtual regionalism’ domain.

However, an Arab FTA may be build gradually by establishing bilateral FTAs between different southern Mediterranean countries. For instance, we have the FTAs signed between Israel and Turkey, Tunisia and Morocco, Tunisia and Egypt or Tunisia and Jordan. As happened with the rise of free trade in the nineteen century with the Cobden-Chevallier Treaty, the cumulation of bilateral FTAs may lead to a future multilateralization of these agreements in the southern shore of the Mediterranean. Hadhri has stressed that Moroccan-Tunisian and Egyptian-Tunisian bilateral trade has significantly grow after reaching the FTAs. This is a more realistic approach than the negative-lists one adopted by the All Arab FTA, from both political and economic perspectives. Many authors, like Sideri (2000), have point out how the inadequacy of regional infrastructures and institutions, as well as the differences in the Arab countries social and economic systems jeopardise its economic integration. But he has also called for a new impetus in Arab regional integration as a counterweight to the asymmetry of EU-Mediterranean relations. Here again, the political variable is crucial if Arab economic integration is to be developed.

Trade policy responses to regionalism in the Mediterranean: The Maghreb case.

In spite of different paces of trade policy reform, setbacks and specific country exceptions, trade liberalisation is proceeding slowly but steadily in the Maghreb countries. The trade policy reform process dates back to the 80’s, when first Morocco, then Tunisia and Algeria, became involved in structural adjustment programs supported by IMF and World Bank loans and technical assistance. This step was further reinforced by their entering into the GATT/WTO and, more recently, by the setting up of a EuroMediterranean Free Trade Area (FTA). The latter means a shift from multilateralism to (open?) regionalism and has been critized on the grounds of conventional international

trade theories. The purpose of this paragraph is to identify the political and cultural elements that can be affected by the establishment of a Euro-Mediterranean Free Trade Area (FTA). First, we shall analyse the Maghreb trade liberalisation process itself: where these countries came from, where are they now and where are they supposed to go. After doing so, we will try the implications of the two processes we are dealing with, the establishment of EMFTA and the trade liberalisation process, for each other.

Trade policy reform constitutes one of the main components of the structural adjustment programs followed in Morocco, Tunisia and Algeria since the mid 80’s. Libya still has an extremely protectionist commercial policy. Initial levels and instruments of protection varied substantially between countries. At the beginning of the 80’s, Morocco and Tunisia based their trade policies on tariffs and quota restrictions associated with exchange controls. In Algeria, State trade represented a powerful way to restrict imports, as well as extensive credit rationing for imports and administrative obstacles. Libya set an annual budget for imports that cannot be surpassed and most imports are subjected to State trade (Lorca and Escribano, 1998, ch. 5).

In Morocco and Tunisia, the main reform consisted in substituting quota restrictions and exchange controls for tariffs, then lowering them and, in Morocco, reducing the number of tariff rates. In Algeria, the main reform was to avoid State trade and reduce the incidence of licensing. However, as can be seen in table 2, the level of protection is still high. In the three countries, tariffs for intermediate goods and raw materials are lower than for final goods, resulting in high levels of effective protection.

Table 2: Trade policy instruments in the Maghreb countries, 1997 Algeria

Libya

Morocco

Tunisia

Quantitative restrictions

None

Yes

Few

Few

Maximum tariff rate

50%

100%

45%

43%

6

n.a.

7

26

17%

n.a.

15%

19,6%

Number of rates Effective tariff

Source: Abed (1998), table 2, p. 12.

Data in table 2 has to be complemented with the incidence of further protective instruments which are difficult to measure, such State trade, administrative obstacles, marketing restrictions, transport monopolies and so on. Evidence from data suggests that Morocco is the most liberalised country in the region, followed by Tunisia, whose tariff rates are numerous. Algeria shows a moderate effective tariff and has been liberalising its trade regime quite fast since 1994, but some administrative controls remain. Libya is the most protectionist country in the region, due to the autarchic and nationalistic ideas of its leader.

In Morocco and Tunisia, at the beginning of the 90’s, trade policy reform started to lose momentum, due to economic difficulties related with drought and the economic crisis of the EU countries. Additional tariff cuts became difficult to implement and trade liberalisation stagnated. At this point, the main problem was to substitute fiscal revenue from tariffs for VAT, corporate and personal income taxes. Both countries started the tax reform in the 80’s, trying to rely on direct taxes instead of indirect ones. However, this process failed to reduce the weight of taxes on international trade within the fiscal system, as showed in table 3. In terms of GDP, the burden even increased slightly. In Algeria, the substitution of State trade and licensing by tariffs rapidly increased the tax income derived from taxes on international trade. Table 2 presents a picture of a tax system that relies heavily on tariffs, with Tunisia being the most dependent country on such revenues. It also shows the importance of taxes on international trade in the countries’ GDP.

Table 3: Taxes on international trade in the Maghreb Algeria

Morocco

Tunisia

1975

1995

1975

1995

1975

1995

As % of tax revenue

8,06

29,05

20,01

19,80

31,37

33,47

As % of GDP

3,30

3,37

4,20

5,00

7,14

8,39

Source: Abed (1998), table 5, p. 20.

The modernisation of the tax structure is as controversial as the trade liberalisation itself, both for political economy reasons: import substituting companies lobby to reverse trade liberalisation, which endanger their continuity; economic elites

oppose the transition over a tax system based on personal and corporate taxes. The importance of tariffs as a source of fiscal income is common to many developing countries, and is deeply rooted in Maghreb history. Both the Moroccan sultans and the Ottoman Empire used tariffs as their main financial source and were at the origins of European colonialism in North Africa (Wesseling, 1996). This socially regressive and economically inefficient tax structure has proven very difficult to dismantle, due to both the rigidities and shortcomings of the collecting system.

In fact, one of the main southern fears related with the Euro-Mediterranean FTA consists in the fiscal impact of trade liberalisation, as exemplified by the fiscal difficulties experienced by Tunisia in 1996 and 1997. Import duties from EU trade represents 19%, 10% and 16% of total tax revenue for Algeria, Morocco and Tunisia, respectively, and 2,2%, 2,5% and 3,2% of its GDP (average figures for 1994-96 taken from Abed – op. cit.). It is evident that the EMFTA will require strong fiscal action by the Maghreb countries in order to accelerate the reform of the tax system and improve its efficiency. Maghreb countries have asked the EU to compensate for such a loss, but the central point is its ability to implement a credible tax reform. Moreover, one wonders if increased EU financial aid in order to compensate for this loss will not postpone

the

deepening

of

tax

reform

indefinitely,

perpetuating its regressive

consequences.

Strategies to face the challenge of the EMFTA

From an economic perspective, the main issue about the EMFTA is its sustainability. There are doubts related to the risk of reversal in the trade liberalisation process at the Euro-Mediterranean level for political reasons, which in turn heavily depend on the economic results of the strategy. The fears that arise from the Euro-Med Free Trade Area are mainly related with (i) misallocation of resources and trade diversion, (ii) fiscal unsustainabilty of tariff cuts, (iii) rising unemployment associated with eventual deindustralization in the short run and (iv) rising external imbalances.

International trade theory warns about the risks of trade diversion when entering a regional trade arrangement. Therefore, “open regionalism” has been advocated to prevent trade diversion: the tariff reductions should be extended to third countries in

order to keep commercial preferences at a low level. That means that regional liberalisation should be accompanied by a certain degree of multilateral liberalisation if trade diversion, and consequently resource misallocation, is to be avoided. The question to be answered here is: how open should “open regionalism” be to avoid resource misallocation? “Open regionalism” implies an additional decrease of tariff revenue.

The difficulties that arise in the financing of existing budget deficits are another controversial issue. The optimal measure will be to substitute taxes on international trade by VAT, personal income and corporate taxes. Otherwise, fiscal imbalances will endanger the sustainability of the FTA. Financing such imbalances through EU funds can solve the problem in the short term, but this will in turn perpetuate the regressive nature of the tax structure, instead of fostering its modernisation. So, why not finance and technically assist the tax reform? If not, there will be a premium for late tax reformers and support for the status quo, which, from our perspective, is not desirable 7 .

The adjustment costs of trade liberalisation need to be considered, too. International trade theories consider that in the long-run labour, as well as capital, will be reallocated towards sectors enjoying comparative advantages. Again, we found a political problem that can not be dismissed by technical jargon: how long is the long term? Perhaps longer than most people can bear without been paid and far more than politicians are willing to admit. Most industries in the southern shore of the Mediterranean are not competitive and are not prepared to face EU competition. For this reason, the final good sectors will be liberalised at the end of the transition period. However, this is only a way to postpone the problem, not a means to solve it.

On the other hand, the mise à niveau program seems insufficient to turn unproductive industries into competitive ones. Some selection is needed, namely the sectors on which the countries already have a comparative advantage and those where a comparative advantage can be built during the transition period. Here we find another problem: which are those sectors? How to select them? What are the criteria? And...who makes the selection? This leads us to another political economy problem: the elites will invariably defend that the sectors to be supported are theirs. The criteria to make the 7

For a political critique of EU aid re-orientation towards industrial restructuring and trade promotion, see Youngs (1999).

selection will be difficult to identify by economists. Furthermore, it is necessary to consider the economic interests of the donor. Will the European Commission select agriculture and agro-food industries as sectors deserving increased financial funds from the EU?

Moving on to macroeconomics, we find the risk of rising external imbalance as trade liberalisation proceeds. Ideally, the removal of import barriers will change the microeconomic

incentives,

increasing

exports

relative

profitability.

The

domestic

producers will then start to produce for the European market and its exports will compensate for the rising import bill. However, the experience of Spain and Portugal with accession to the EEC reminds us that external imbalance was exacerbated and that only foreign investment and EEC funds keep their external accounts viable in the short run. And this will not be the case, unfortunately. Access to European agricultural markets will be, once again and from an economic perspective, preferable to EU financing of the Southern Mediterranean countries’ current account imbalance. Increased immigration flows could also compensate for increased imports through workers remittances. Nevertheless, both doors remain closed at this point, due to high internal political costs in the EU.

On the political front, we should first tackle the political costs of the previous economic problems. If short run costs are too high (or not so short) social pressures can arise and trade liberalisation vis à vis the EU may be reversed or become too costly from a political point of view. In other words, the transition has to be eased making it sustainable in the ways we pointed out in the previous paragraphs. Political economy considerations become of great importance here.

Governments should keep a balance between the winners and losers of the process, while preserving social stability. This is a difficult exercise, as far as the elites will be threatened by the tax reform, foreign competition for import substituting industries and, dealing with public sector officials, processes like privatization and reform of the administration (both of them present in the adjustment programs followed by some southern Mediterranean countries). Workers from import substituting sectors and the governmental sector should be compensated through other mechanisms. If agricultural and final basic goods were to be included in the agreements at an early

stage of the transition period, it would entail cheaper first necessity goods and could possibly reduce social unrest.

Second, the Mediterranean countries willing to enter the EMFTA should adapt their laws to the acquis communautaire. From our point of view, this implies the modernisation of bureaucracies and of the whole state structure. This is a difficult task, as it means a change in mentality, a process that can proceed slowly, perhaps only with generational changes. It also means changes in the structure of power and its subsequent conflicts. How far is political will able to go to stand for the costs of such harmonisation is a difficult question to answer. It will depend on the countries and their particular circumstances over time. This modernisation of bureaucracy and State structures and institutions is one of the main benefits stemming from the EMFTA for the southern Mediterranean countries. It gives them an external alibi to carry out the reforms that they want to implement, but are subjected to internal controversy.

Implying market liberalisation, disappearance of bureaucratic controls, reduction in the corruption levels and the mitigation of its restraint effects on economic activity, trade liberalisation may have beneficial consequences on economic growth through the state modernisation. Likewise, the reform of the state may influence the foreign investment absorption capacity, which is closely related to the preceding issue, but also with cultural aspects. In the capital market circles, it is often said that investing in the southern shore of the Mediterranean needs time and patience, due to high transaction costs. The modernisation of bureaucracy will help in solving this problem.

The precedent paragraph leads us to consider the cultural issue. The background of corruption and bad governance in some countries of the region is associated with the westernised elites. In addition to that, the recent historical events, from colonisation to the Gulf War, generated between many Moslems a confidence deficit concerning European goodwill. On the northern shore, the cultural differences represent an important obstacle for potential investors. The Conference of Barcelona faces the problem by fostering a cultural dialogue that, as has been said, has not really caught on yet. In doing business, mutual trust is necessary. In signing agreements between sovereign nations, mutual respect is essential. If the Euro-Med FTA is perceived in the

southern Mediterranean countries as a new way of colonialism (economic one), on which the EU threatens to impose its own values, southern societies will reject the deal.

For many people from the Mediterranean, the Euro-Med FTA is a European diktat backed by the local westernised elites. When the problem stands on the clash of civilisations, cultural dialogue is the best solution, backed with a credible effort to support development and modernisation, instead of conceiving it as just a new way to assure economic control and security. Another problem, barely treated by the literature, is the absence of an entrepreneurial mentality due to the cultural influences of the region. This point requires some differentiation. From a historical point of view, the Mediterranean

is

a

commercial

space.

Notwithstanding,

the

economic

agents

differentiate such activity from entrepreneurial activity (producing goods and services). The main difference is that commercial activity is mainly sporadic and temporary, whilst entrepreneurship is continuous and permanent. The latter is based on the long run, so that eventually short run benefits should be sacrificed by long run ones.

The mentality for building on a long run basis is needed in order to establish relations and consolidate it in solid and mutual trust. The entrepreneurial partner is needed to absorb foreign investment: he knows the domestic markets, its habits and preferences, as well as the laws and administrative practices and channels. His strategy differs from the trader, whose activity is based on the short run. Those political and cultural aspects are extremely important, given the EU’s disregard towards the cultural, economic and political context of the Third Mediterranean countries. This ignorance is an obstacle to the growth of capital flows towards the region, one of the smallest in the world. The reason is the high-risk perception by the foreign investor, due to the failure to notice the realities of its markets and culture. The EU should take them into account, adopting proactive and urgent measures to increase the mutual cultural knowledge and foster entrepreneurial spirit in the Mediterranean.

Final remarks

In our view, the EMFTA can foster economic stability and political reforms in the Southern Mediterranean countries. The economic pre-conditions for EMFTA to be built are met. Nevertheless, the political pre-conditions are not. The FTA cannot be

considered as a panacea. Strong political action is needed for southern Mediterranean countries to entail political reforms. In addition to that, the Arab-Israeli conflict impedes the spillovers of increased trade acting as a trust generating measure.

We would also like to stress the need for the Barcelona Process to be conceived as open regionalism, both in economic and political terms. If not, there is the risk of the EU’s initiative furthering fragmentation of the Mediterranean’s southern shore on economic and political matters through a political and economic “hub-and-spoke” mechanism. This lead us to the regional integration perspectives within the southern shore of the Mediterranean basin.

Concerning EU’s Mediterranean initiative (as it has been formulated in the Barcelona Declaration), the EU is mainly interested in stabilising its southern border. The “democratic syllogism” is as follows: first, promoting economic development; then, democracy will arise from “spontaneous generation”. This causal relationship between development and democracy is uncertain in the Mediterranean. On the contrary, democracy

promotes

development,

equality

in

income

distribution,

education,

institution building and therefore increased social stability. But far from being a mere instrument, democracy it is also a valuable goal in itself (Sen, 1997 y 1999).

Instead of thinking in a causal way, it is perhaps better to pursue a virtuous circle on which democracy and development are mutually reinforcing. For the EU’s Mediterranean policy, this means to further look at the political reforms, perhaps by setting a premium for fast reformers. However, EMFTA implies a certain degree of modernisation for southern societies, as far as it means adopting the acquis communautaire and liberal trade policies. This in turn may foster both the State reform and an additional pressure to introduce progressive fiscal systems. The pace at which political reforms will proceed remains an open question, but we think that the EU should adopt a closer compromise regarding democracy and human rights.

Last, but not least, the EU’s economic role has to be reconsidered. The Common Agricultural Policy (CAP) remains the main obstacle towards wider access by southern Mediterranean countries to European agricultural markets, where they are competitive. However, the answer is not just a matter of liberalising, as far as CAP is a strong

element for EU’s internal political cohesion. In addition, the Euro-Mediterranean initiative’s main defendants within the EU are precisely the European Mediterranean countries, which are the most likely to be hurt by agricultural liberalisation. Some sort of Mediterranean agricultural pact should be attained if this problem is to be solved (Lorca y Escribano, 2000).

Finally, we think that the policy options by the EU should be analysed carefully. As we argued above, compensating tariff loss with increased aid flows or letting non competitive, final good sectors to be protected until the end of the transitory period are measures that could postpone the modernisation of the Maghreb countries. On the other hand, closing eyes and doors to agricultural trade and immigration flows will not solve the problem. In economic terms, opening both markets, even in a moderated and progressive way, can be less costly for the EU and more beneficial, from the economic, social and political point of view for the Maghreb countries than paying for not doing so.

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