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The case for free trade in the GCC

Arabian Business

The case for free trade in the GCC

By Courtney Trenwith

28 August 2015

It has been 240 years since Scottish economist Adam Smith made the then-outrageous suggestion that nations could improve their wealth by removing tariffs on imported goods. At the time, 1776, not only did these taxes — invariably more than 40 percent on certain goods — inflate prices for consumers, they often accounted for the majority of government revenues.

Gradually — very gradually — nations have accepted they each have a competitive advantage in specific goods and services and the mercantile system has been slowly repealed in most parts of the world.

In the past 15 years, there has been an unprecedented number of free trade agreements (FTAs), both bilateral and, increasingly, among large economic blocs. In many cases, FTAs have seen trade between the parties soar, while tighter economic ties also generally has strengthened political and security relationships.

This is most evident in the European Union, which has become the world’s largest trading partner, accounting for about 16 percent of world imports and exports in 2013, giving it an enormous scale of economic advantage. Now a 28-member bloc (albeit with threats to pull out in some member countries), the EU is the world’s largest exporter of manufactured goods and services, and the biggest export market for about 80 countries.

The Association of South East Asian Nations (ASEAN) has also grown to become the seventh largest economy in the world, if considered as a single entity.

An historic deal signed in June between 26 African states, stretching from Egypt, down the East coast to South Africa, integrates three existing economic blocs, with a combined GDP of $1.3 trillion.

Meanwhile, 12 Pacific nations, including the US, are attempting to finalise a free trade deal that would bind 40 percent of the world’s economy.

However, the Middle East and North Africa (MENA) has been slow to integrate, both intra-regionally and internationally. The Greater Arab Free Trade Area (GAFTA) saw tariffs between 17 Arab states rapidly decline from an average 15 percent in 2002 to 6 percent in 2009. But it has failed to bring down trade costs.

In fact, it remains cheaper for some Arab states to trade with Europe than between themselves. Bilateral trade costs for industrial products between the Maghreb states and France, Italy and Spain is half that of trading with the GCC, Jordan, Iraq, Lebanon or Syria, according to trade policy and development expert Ben Shepherd.

The cost difference also is negligible for trade between Egypt and the rest of MENA versus parts of Europe.

The six member states of the Gulf Cooperation Council (GCC), which came into effect in 1981, are well ahead of the rest of MENA in terms of both intra-regional and international trade, however, despite its proximity, costs are still two-fifths higher than between France-Italy-Spain, according to Shepherd. And while intra-GCC trade has risen from $19.8bn to $65.4bn in 2010, it remains a small fraction of the GCC’s $1.3 trillion in total trade.

The GCC customs union, which came into force in 2003, eliminates tariffs between the six states and enforces a common 5 percent tariff on imported goods across the region. Citizens also have freedom of movement across borders and the right to employment. Unofficially, the union also has seen the states coordinate in areas such as health, education, security and knowledge.

But non-tariff barriers have inhibited greater trade between the six states. A GCC railway has been mapped out but is yet to gain much traction, while other early plans for a combined value-added tax (VAT) were put on ice until recently, when the oil price crashed. A proposal for a monetary union has been all but quashed after the UAE objected to Saudi Arabia hosting the central bank. The recent Eurozone debt crisis also has generally discouraged the notion of a common currency.

Silvia Colombo and Camilla Committeri described the GCC as a “weak integrated regional organisation” in their report ‘Need to Rethink the EU-GCC Strategic Relations’, pointing to political disagreements between member states.

Tensions between some members, particularly Qatar on the one hand, and Saudi Arabia, the UAE and Bahrain on the other, were confirmed when in March last year the latter three withdrew their ambassadors from Doha over complaints including interference in internal matters.

“…Serious obstacles have hampered closer integration, including bureaucratic and administrative inefficiencies, as well as old rivalries and a desire among smaller Gulf states to retain their autonomy. Even the countries’ wealth sometimes becomes an obstacle; with economies already growing robustly, there is less incentive to make radical changes to achieve faster growth,” Colombo and Committeri wrote in 2013.

But more recent changes, notably the oil price fall from more than $100 per barrel mid-2014 to as low as $39 in late August, could make a closer GCC union more urgent as each of the six states try to recover their billions of dollars in revenue losses.

IHS Middle East and India vice president Sanjay Sharma says regional blocs are the latest trend in international economics, as globalisation plateaus. The percentage of trade to global GDP before 2003 was less than 20 percent, peaking at 25 percent in 2008 and 2010, but it has since stagnated.

“[Economists] think globalisation has reached saturation point. That is a concern for the GCC producers who are increasing their exports,” Sharma says.

As the GCC works to diversify its exports, Asian countries are edging in on the region’s traditional export markets by signing bilateral FTAs that eliminate or significantly reduce import tariffs and therefore erode previous cost advantages, Sharma says.

“As a bloc, [the GCC states] probably under-appreciate the importance of free trade,” Sharma says. “They can push their product into any market they like [based on the cost advantage] but that is becoming more and more difficult with these [economic blocs].”

The FTA trend has been set essentially by Asian countries, led by Singapore (20 FTAs in operation and 15-20 more in negotiation or signed), India (ten in existence and at least 22 in negotiation) and South Korea (ten in existence and at least 20 in negotiation).

With a comparatively higher production cost, these countries have been strategically using FTAs to price-out more competitive exporters, Sharma says.

“The FTAs are very important for them to compete in those export markets,” he says. “If you look at the way the market works, for example, South Korea has an FTA with Turkey, which is a big petrochemical market for the GCC. But since South Korea has an FTA, the Korean producers have an advantage in exporting products to Turkey. The GCC, even if it has a better cash-cost position can’t set their own prices in that market.

“[The GCC states] have got into a comfort zone that their cost position is so good… but they lose when FTAs [are signed] with other countries. They thought they’d be able to divert from market to another market; that’s fine in the short term but in the long term, if globalisation is stagnating, that will be a concern.

“I think it’s time for them to seriously think about [negotiating more FTAs].”

The GCC has few FTAs as a bloc, of which Singapore has arguably been the most lucrative.

The third-richest country in the world per capita, Singapore has positioned itself as a gateway to Asia and has one of the most open markets globally; it’s almost-blanket zero tariff policy is marred by only a 1.4 percent duty on agricultural products.

The GCC-Singapore FTA, which came into effect in September 2013, lowers tariffs on Singapore-made goods and refined oil products, and grants GCC nationals preferential treatment in sectors such as the law, engineering and retail.

Faisal Tabbaa, deputy managing partner of Saudi-based law firm Dhabaan & Partners, says the pact already has induced “some very interesting numbers”.

“More than QR900m [$247m] from Singaporean businesses [have been invested] in Qatar [and] there was $9.2bn in trade with the UAE in the first three quarters of 2013. It’s great. So the Singapore FTA is definitely a good one, and it’s a win-win,” Tabbaa says.

The GCC also has been in talks to establish free trade zones with the European Union, Japan, China, India, Pakistan, Turkey, Australia, New Zealand, Korea, Brazil, Argentina, Uruguay and Paraguay. Some have reached more advanced stages than others, while a handful presently seem almost unattainable.

Potentially worth $64bn in collective annual GDP, a free trade deal with the EU, under discussion since 1990, was unilaterally taken off the negotiating table by the GCC in 2008, as the global economic crisis hit. It was reported at the time that the GCC was unhappy with European demands for the deal to include human rights issues, on the grounds it was an attempt to interfere in domestic policies that had nothing to do with economic cooperation.

EU-GCC relations are mostly driven by Europe’s energy needs — biofuels remain the most traded product between the two regions — and the Gulf’s access to technology and knowledge, according to Colombo and Committeri.

As the world economy pivots further towards Asia, the GCC’s bargaining power with Europe is likely to strengthen, due to its geographical position.

However, Taabba says the experience of other MENA countries shows there is also a real prospect of increased competition from European imports under a lower tariff environment.

For example, Morocco’s trade deficit with the EU increased by more than five times between 1999 — the year before a free trade agreement came into place — and 2009, according to the World Bank. Similarly, the trade deficit with the US increased fourfold in the four years after an FTA came into force in 2005.

The GCC also is yet to seal a deal with another globally important trading partner, the US. Negotiations have not been helped by Bahrain and Oman’s unilateral agreements, in 2006 and 2009, respectively, Taabba says.

“The difference between Bahrain negotiating the FTA on its own and holding on and saying ‘no we’ll only negotiate as part of the GCC’ is it would have gotten a better deal,” he says. “Any of these countries on their own are not going to get the same kind of deal and that’s the drawback of FTA agreements in general.

“Bahrain did well but I think it could have done better. There’s power in numbers… Bahrain is the smallest of the GCC countries. If Saudi Arabia was to negotiate its own FTA with the US it probably would come out better off than Bahrain. But if you add all the other [GCC states] you’re going to come up with something even better, but it makes the deal more difficult as well. That’s why people go for free trade agreements these days and aren’t so [keen on] the World Trade Organisation because you can conclude them faster. They’re complicated but not nearly as complicated as the WTO.”

Given the difficulties associated with sealing FTAs with the larger markets of Europe and the US, as well as the increasing significance of Asian economies, it is perhaps unsurprising the GCC has been looking east for new trade deals.

As well as the FTA with Singapore, the GCC signed in 2011 a framework agreement with Malaysia, covering economic, commercial, investment and technical cooperation. Currently, two-way trade exceeds $30bn. Trade talks also have been taking place intermittently with China, Japan, South Korea, India and Pakistan.

Of those, freer trade with China and India would arguably have the greatest impact, given the growth in their economies. China is forecast to be the GCC’s largest export market by 2020, while India’s $2.1 trillion economy is as close as a three-hour flight.

However, concerns about the threat of cheap GCC imports to local petrochemicals industries have been a major stumbling block in negotiations with both Asian giants.

“The deal with China looks a bit more difficult,” Tabbaa says. “In this particular case it might not make any sense, that’s a conclusion many have come to, because of the nature of the trade between the two.”

Greater integration with other Arab states also could have significant impacts, not only on trade but employment. GAFTA has liberalised the markets of Algeria, Bahrain, Egypt, Iraq, Kuwait, Lebanon, Libya, Morocco, Oman, Palestine, Qatar, Saudi Arabia, Sudan, Syria, Tunisia, the UAE and Yemen, with the elimination of all tariffs in 2005.

However, it has had little effect. Total inter-Arab trade as a percentage of total Arab foreign trade has remained at about 10 percent a decade later, according to the United Nations Economic and Social Commission for Western Asia.

The World Bank says MENA’s intraregional exports averaged less than 8 percent of total exports between 2008-10, compared to 25 percent in ASEAN and 66 percent in the EU.

A pan-Arab customs union is due to come into effect this year, but it is not yet clear whether the deadline will be met.

Mohammed Saleh Shelwah, advisor to the UAE Minister of Economy, said in May varying rates of political and economic development of Arab states and different custom fees were major hurdles for creating the pan-Arab customs union.

The customs union is supposed to be the forerunner to an Arab Common Market, removing all restrictions on trade, residence, employment, labour, and transportation in 2021 — an idea first mooted in 1964.

Arab League assistant secretary general Mohammad Bin Ibrahim Al Tuwaijri said a year ago, he expected the Arab customs union to increase intra-Arab trade from 10 percent to 70 percent of member states’ total external trade.

World Trade Organisation director general Roberto Azevêdo said in May that “making the movement of goods across borders faster, easier and cheaper” would reduce trade costs by up to 15 percent in developing countries and deliver an annual boost to the global economy of up to $1 trillion per year.

With Gulf economies losing precious oil revenues and export diversification becoming ever more essential, trade agreements will undoubtedly require greater emphasis.