Putting the Cart before the Horse? The Problem with a Currency Union for West Africa

Despite the modest success of their previous attempts at improving regional trade and integration, West African governments are considering turning ECOWAS into a monetary union and adopting a single currency managed by a single central bank.

It is a well-accepted idea that trade can promote inclusive economic growth and raise living standards. However, when compared with other regions of the world, trade has historically been very low within Africa. As such, most Africa countries have been unable to reap the economic benefits of regional trade. The opportunities for improved cross-border trade in Africa are considerable, however. A 2019 World Economic Forum report stated that, in 2017, intra-African exports accounted for 16.6 per cent of total exports, compared with 68 per cent in Europe and 59 per cent in Asia. 

Africa’s Quest for Regional Integration

Recently, African governments have made considerable efforts to improve regional trade and integration in Africa. The formation of the Africa Continental Free Trade Area (AfCFTA) in 2019 was meant to be a big leap in this direction. Beyond the AfCFTA, there are several regional economic groupings in Africa including the Economic Community of West African States (ECOWAS), the East African Economic Community (EAC), and the South African Customs Union (SACU), among others, which aim to raise living standards and promote regional integration across the continent. However, their success in fostering this integration has been fairly modest.

There are now plans of turning ECOWAS into a monetary union, which involves adopting a single currency managed by a single central bank. On the surface, such a plan would seem to make sense. One of the advantages of a currency union is that it fosters trade by reducing costs. Being in a currency union eliminates the costs associated with changing currencies and the currency risk associated with transactions involving multiple currencies. It also fosters trade by facilitating price comparisons by buyers promoting greater competition between firms which benefits consumers. Based on these two assertions, it may seem like a good idea for West Africa to enter into a currency union. But is it? To answer this question, we must consider the main theory through which we can establish the likelihood of a successful monetary union. This is the first exercise—to run the facts through the mill of the theory of the optimal currency area, developed by Robert Mundell, to see whether the plan for monetary integration survives this process. 

Mundell’s Theory of Optimal Currency

The theory of the optimal currency area concerns the conditions under which it would be beneficial for a group of countries to enter into a monetary union. The most well-known currency area is the eurozone. The eurozone crisis, which has had far-reaching implications for many countries in the monetary union, was predicted by some economists on the basis of countries in the euro area not satisfying at least one of the criteria discussed below. Paul Krugman, a Nobel prize-winning economist, in a column for the New York Times, argued that this theory was largely ignored when it came to the euro due to excessive optimism and a strong desire for greater regional integration in Europe. The crisis makes it clear that a monetary union is not a magic bullet and should not be entered into without careful consideration.

According to the optimum currency area theory, at least one of two criteria need to be satisfied for countries to constitute an optimum currency area. The first element is symmetric shocks across countries. This means that the unpredictable events that individual countries face are similar. So if, say, Nigeria, is experiencing a decline in demand for oil, other countries in West Africa are also likely to be experiencing a drop in demand for their major export commodities. When shocks are symmetric, West African countries would have chosen similar monetary policies in the absence of the single currency so it wouldn’t be a major loss to no longer have control of monetary policy, which would be delegated to a regional central bank. 

If shocks are different across countries or ‘asymmetric’, then labour mobility must be present, as this is an alternative way for countries to adjust to shocks. Labour mobility refers to the free movement of workers within the common currency area. The United States is often seen as a prime example of an optimum currency area. Although the US has one currency, the argument goes that each state could, in principle, have its own currency which it floats against the others. However, this is not the case as all states use the dollar as their currency. The first condition of symmetric shocks is not satisfied in the US. However, high labour mobility in the US makes it able to deal with shocks to different states as workers can move across borders as required. 

A 2004 study examining the costs of a monetary union in West Africa finds that although demand shocks are more or less symmetric in West Africa, supply shocks are largely asymmetric or less positively correlated, reflecting differences in commodity specialization in the region. This suggests that there may be costs associated with a monetary union. With regards to factor mobility in West Africa, the presence of a language barrier may lower the scope for migration within the region. For instance, if an English-speaking country is having bad economic times and unemployment is high, it may not be easy for workers to emigrate to neighbouring countries with better prospects where French is the lingua franca. 

Fiscal policy is another tool that economists have argued can support adjustment to shocks. Fiscal transfers to countries that have experienced adverse economic shocks, which raise unemployment, for example, can aid recovery. Such transfers are widely used in America to help struggling states. It has been argued that a lack of fiscal integration in Europe contributed to the economic woes that plagued the periphery countries following the financial crisis. The importance of such a policy should also be considered in the African context, where there is also the possibility of asymmetric shocks. 

Furthermore, before a monetary union can be considered, there are additional infrastructural and bureaucratic, trade-stifling challenges, such as poor transport infrastructure and time wasted at borders that need to be taken seriously. Such challenges had little to no relevance in the formation of the euro. If these issues are not dealt with across West Africa, however, a monetary union may have negligible effects on trade and the living standards of the population. 

Challenges to Trade

The costs of trade are not limited to tariffs and transaction costs, which a free trade area or a monetary union can address to a large extent. Other non-tariff barriers such as loss of goods being transported to another region for trade and delays due to poor roads also constitute barriers to trade. Studies have found that transport costs in Africa are the highest in the world. In addition, most parts of the continent are marked by major infrastructure deficits, in transportation, power and telecommunication.

Poor transport infrastructure in many regions of the continent is notorious for causing major bottlenecks and for stifling trade within and across country borders. A 2020 World Bank Doing Business report shows that cross-border activity on the continent is still severely hampered by bureaucratic bottlenecks. The report finds, for instance, that businesses spend close to 96 hours in complying with documentary requirements to import compared to businesses in other regions where it takes 3.4 hours. Such challenges illustrate why it has been argued that trade liberalization needs to be accompanied by a reduction in trade costs in order to be effective. 

Trade by itself may do little to reduce poverty. However, when combined with improved infrastructure, it has the potential to support poverty reduction. A joint report by the World Bank Group and the World Trade Organization, for instance, found that for trade to help in reducing poverty, it needs to be accompanied by infrastructural development. This suggests that addressing infrastructural challenges can have the added benefit of raising the standard of living of the poor, a major challenge still faced in the sub-Saharan region. 

Many studies examining ways of improving trade in Africa have echoed the need for better infrastructure and a reduction in obstacles to trade in the form of delays at borders and ports. In addition to improved infrastructure, there is also a need for trade facilitation measures, a lack of which hinders trade by reducing market access through delays and higher costs. Overall, delays at African customs are longer than in the rest of the world. Corruption at the borders is another problem that has been identified as negatively impacting trade. In addition to these challenges, there are others that also hamper trade in the region. These include low foreign investment, high input costs and a lack of competitiveness of African exports relative to those from their developed country counterparts.

The Case against a Monetary Union in West Africa

The theory of an optimal currency area does not provide unequivocal support for a monetary union in West Africa. It is also not obvious that a monetary union in the region will bring about a significant increase in living standards or regional trade by itself. As asserted in a Brookings Institute report, a monetary union in Africa cannot provide solutions to the significant development problems many countries face. Before African countries can begin a serious discussion of the prospects of a currency union, governments will need to address a range of issues; issues largely unrelated to transaction costs associated with carrying out trade in multiple currencies, and so which are unlikely to be addressed by a currency union.

In the worst-case scenario, a West African currency union may impose significant costs on some countries. The costs will be associated with the loss of monetary policy as an instrument, with little to no benefit in terms of increased trade and higher living standards. If the region wants to see progress on these fronts, the more fundamental issues of infrastructural deficiencies and bureaucratic bottlenecks that hinder intra-Africa trade need to be addressed. In this way, more ambitious plans run a much lower risk of doing more harm than good

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