Question

question 3

3.1 Explain the pros and cons of a potential single currency on the West African economies.

3.2 Explain the benefits of regional integration for the African economies.

Answer 1

1. There are 3 major problems with having a single currency apply to a large geographic area, such as all of Europe, or All of West Africa, or All of North America.

The first problem is national sovereignty. People are funny about money, and most nations want to be in control of their own money. They dont like giving up control to another country, or a collective or committee.

The second problem is trust: If everyone holds paper money issued by a central bank (or any form of money denominated in the currency of the central bank), they all have to trust the central bank (or the government that controls it) wont just start printing more money, and effectively cause inflation and make their supply of money worth less. And when I say “printing”, I mean that figuratively. Any action the central bank takes that increases the money supply can cause inflation.

The third problem is monetary policy. Any government (or even a federation of governments such as the EU or a federation of governments in West Africa) has 2 main tools it can use to encourage or dampen economic activity. Those tools are fiscal policy, and monetary policy. Fiscal policy mainly comes down to deciding how to raise money (through taxes and borrowing) and how to spend money. Fiscal policy is politically fairly hard to change because it is well understood by every voter, and everyone has an opinion. Everyone wants lower taxes, and more spending on their pet interest. In contrast, monetary policy comes down to increasing or decreasing interest rates, and many people dont really understand how that works and what it means to their life. Thus governments usually prefer to fine tune the economy through monetary policy, in the background.

Adjusting interest rates is achieved by deliberately “printing” more money, or less money. Again, “printing” money is meant figuratively. In reality, new money is introduced into the economy by selling government bonds to banks or institutional investors and getting back cash, which is then spent by the government. Actually printing new currency has little do to with it.

When a government sells a bond this increases the overall money supply because people who put money in a trustworthy bank still behave psychologically as if they have secure savings, even if the bank has turned around and bought government bonds. Thus the bank depositors “think” they are still wealthy and behave accordingly, meanwhile the government spends the cash and someone new gets it and they really do behave as if they have money, because they do!

When lots of new money is introduced to the economy, it drives down interest rates, at least initially. This causes the value of your nations currency to drop compared to other nations currency. This encourages exports and dampens imports. This is a form of economic stimulus for manufacturers and exporters inside your country.

But what is good for an exporter, is bad for an importer. A dropping currency makes imports more expensive.

Now imagine a large geographic area where some regions are booming and already have inflation, meaning too much money is chasing too few real goods. What that region needs is a cooling of its economy to limit inflation, so what is good for them is to increase interest rates, meaning to reduce (or tighten) the money supply.

But, elsewhere in this large geographic area, there are other regions that are economically depressed, and lots of people are not working, and factories are sitting idle because there are no buyers for the output. What that region needs is an increase in economic activity, so what is good for them is to decrease the interest rates, which will increase (or loosen) the money supply.

So there you have it, the larger your geographic area, the more likely you will have some areas that need stimulus, while other areas need economic constraint, limiting the flexibility and utility of monetary policy. If a central authority tries to help one area, they will hurt another.

Despite this inherent problem when using a single currency for a large area there are plenty of examples where this is done anyway, despite the disadvantages. For example the Euro in Europe, or the US Dollar and America.

In these jurisdictions, the advantages of having a single currency outweigh the disadvantages. Mitigating the disadvantages, firstly, the central banks are viewed as trustworthy, so the trust factor is addressed. Secondly, being stuck with a single inflexible monetary policy issue is tolerated because the government uses other fiscal means to address the need for economic stimulation in one region vs. another.

And this brings us to the big advantage of having a single currency: a more efficient environment for trade within the region sharing the single currency, since there is no need to convert from one currency to another for every transaction. Since each currency conversion has risk and takes some administration, a risk premium and administrative cost must be paid, which is a pure drag on internal trade. Avoiding these conversions saves money.

This is the reason federal states like the USA, and customs unions such as the EU choose to use a single currency, it reduces the cost of internal trade, among the different states using that single currency, which increases trade, which increases jobs, lowers costs, etc, etc. (At least that is the theory!)

2. Regional integration in Africa, however, can play a vital role in diversifying economies away from dependence on the export of just a few mineral products; in delivering food and energy security; in generating jobs for the increasing number of young people; and in alleviating poverty and delivering shared prosperity.

Natural resources management, particularly in the extractives industry, can make a meaningful contribution to a country’s economic growth when it leads to linkages to the broader economy. To maximize the economic benefits of extractives, the sector needs to broaden its use of non-mining goods and services and policymakers need to ensure that the sectors infrastructure needs are closely aligned with those of the country’s development plans.

In Africa, especially, mining and other companies that handle natural resources traditionally provide their own power, railways, roads, and services to run their operations. This “enclave” approach to infrastructure development is not always aligned with national infrastructure development plans.

In a continent facing massive infrastructure needs, African countries can thus miss out on opportunities to promote the shared use of infrastructure and to strengthen the linkages between extractive resources and the broader economy. Non-mining businesses like farms or food traders in sparsely populated or remote areas, for example, would benefit from shared infrastructure, since railways, roads and electricity are all needed to bring goods to markets.

Regional integration is often seen as less relevant for resource-rich countries, since demand for commodities typically comes from the global market rather than from regional demand. Regional integration in Africa, however, can play a vital role in diversifying economies away from dependence on the export of just a few mineral products; in delivering food and energy security; in generating jobs for the increasing number of young people; and in alleviating poverty and delivering shared prosperity.

The relationship between resources, regional integration and diversification is twofold.

First: Since resource deposits don’t always fit neatly inside the borders of individual countries and tend to span multiple borders (including landlocked countries), trans-boundary mining transport will need to be built to extract and transport the resources. That often has implications for regional integration. Global experience shows that the development of such infrastructure requires strong cooperation and coordination among all parties involved, along with a legal and regulatory environment that allows for the shared use along that infrastructure. Designing and building such infrastructure and a regulatory environment in a multi-country context is, however, very complex: It involves a wide range of political-economy issues that need to be addressed.

Second: Extractives can help diversify economies through linkages to the broader economy. Regional value chains in minerals and metals, for example, will create demand for services and goods that feed in to that value chain. Regional integration is essential here as well, since goods, services and people need to be able to flow seamlessly across borders to reduce costs and to help firms become competitive enough to link to these value chains. The deeper integration of regional markets through the elimination of non-tariff barriers can reduce trade and operating costs. It can also ease the constraints faced by many firms in gaining access not only to demand for their products but also to the essential services and skills that they need as to boost productivity and diversify into higher-value-added areas.

Deepening regional integration among African economies, therefore, provides both opportunities and challenges to the sound management of extractive resources and translating wealth from these resources in to diversified economies and equitable growth. Our recent report, “Breaking out of Enclaves
Leveraging Opportunities from Regional Integration in Africa to Promote Resource-Driven Diversification” explores this nexus of extractive resources, regional integration, and economic diversification.

The report looks at how regional approaches can increase the local employment and production effects of extractive-resources projects and discusses some of the regulatory, institutional, and political economy barriers facing African policymakers in achieving regional cooperation.

The analysis is based on three case studies of efforts to create trans-boundary transport corridors anchored by extractive resources: The cases include the extraction of coal in the Nacala corridor in southern Africa; proposals for the exploitation of iron ore in Guinea and Liberia; and the LAPSSET corridor in East Africa that aims to ship oil and gas from South Sudan to ports on the Indian Ocean. These case studies encompass three different sub-regions that vary in their level of regional integration. They are assessed through a framework that organizes the most important policy questions and leads to a number of concrete recommendations for national and regional policymakers.

Through our research and the recommendations provided in the report, we show that regional integration is still relevant for Africa’s resource-rich countries – and that it is more crucial than ever before for diversifying countries’ economies as the global commodity supercycle comes to an end.