The African Continental Free Trade Area: What does it Imply for Your Business?

The African Continental Free Trade Area (AfCFTA) is a free trade agreement designed to reduce tariffs on goods and services and eliminate restrictions on the free movement of people and goods among African countries. It is the world’s second largest free trade area by number of member-states, after the World Trade Organization, and the largest in terms of population and geographic size. The economic significance of an agreement of this magnitude is immense, and if successfully implemented, it is likely to dramatically change business dynamics within Africa and between Africa and the world. How can African firms take advantage of the new opportunities opened by AfCFTA and maximize the benefits of this new reality – for themselves and for the continent? To address these questions, I begin by outlining what free trade agreement do and then describe the impact of these changes on the strategic options available for firms and the trade-offs among them.

Free trade agreements, like AfCFTA, reduce the cost of cross-border trade and investment among members to the agreement by lowering, and at times eliminating altogether, custom duties, tariff, and non-tariff barriers. In doing this, AfCFTA will significantly increase the potential advantages of specialization and scale, thus changing the economic rationale for strategic decisions related to proximity to markets, organization of the production, and competitive positioning. It will also affect the importance of distance and geographic proximity. While these effects are likely to be felt particularly within Africa, they will also have implications for Africa’s global integration.

Large Consumer Markets

Nearly half of African countries have a below 10million population, and fewer than 20 countries have more than 20 million people.  AfCFTA will transform a continent of 55 mostly small countries into a gigantic single market of more than 1.4bn people. This market size is only slightly below those of India and China, respectively, the world’s largest and second largest countries (with populations of 1.45billion and 1.5 billion). Low costs of crossing borders among African countries enables firms to reach out to remote consumers and reap the advantages of scale. The increase in the size of the market enhances the return on investment in human and physical capital and increases the economic rationale for developing these assets. Large-scale activity might enable some African firms to expand beyond the continent, to global markets elsewhere.

Specialized Production

Lower costs of cross-border activities change the trade-off between proximity to markets and the economics of specialization and scale. AfCFTA thus enhances the rationale for greater separation of the production and consumption to benefit from specialization aligned with comparative advantages of African countries. As well, it would increase the benefits that could be gained by disaggregating the production and increasing the fragmentation of supply chains, with low-cost trade makes it economically viable to connect separately located production facilities across the continent.

Different Competitive Dynamics

AfCFTA will change competitive patterns within countries and on the continent. By increasing the advantages of scale, AfCFTA is likely to boost the growth of larger firms and trigger consolidation. Smaller, weaker companies would need to modernize their operating routines and improve their physical and human capital to survive and succeed in the new reality. AfCFTA will also change the competitive balance between insiders and outsiders to the agreement, that is, African and non-African firms. It will give insiders considerable advantage in competition with imports from outside the continent. In parallel, it will increase the attraction of Africa for foreign firms seeking to become insiders by investing in the continent. This will increase competitive intensity and raise the bar for excellence, requiring African firms to upgrade their capabilities to succeed in the competition with foreign firms.

The Importance of Distance and Geographic Proximity

The reduction in the costs of crossing borders brought about by trade agreements magnifies the impact of transportation costs on business activity. By lowering, and at time eliminating the costs of transferring goods, services, capital, and people across borders, these AfCFTA will magnify the importance of distance and geographic proximity. This impact is of particular significance in Africa, whose vast land size – bigger than that of China, Japan, India, the US, and most of Europe combined – assigns considerable importance to geographic distance. By equalizing the costs of crossing borders across the continent, AfCFTA will increase the benefits of economic relationships within Africa’s sub-regions, accentuating the historical prevalence of these patterns.

AfCFTA will have far-reaching implications for African firms, regardless of their size, industry, and the geographic scope of their activity (whether domestic, regional, or global), albeit the impact will be felt differently. Some changes of deepened economic integration brought about by AfCFTA are already felt and more are likely to come with the progression in the implementation of AfCFTA. I highlighted the major areas in which this impact will manifest and offered insights into how it will affect African firms in their countries, on the continent, globally for some . It is essential to understand why and how these changes will happen, so that African firms can make the most of the new opportunities opened by AfCFTA and maximize its potential benefits for themselves and for Africa.

An edited version of this article was published in Business Daily on August 17^th 2022 https://www.businessdailyafrica.com/bd/opinion-analysis/columnists/how-afcfta-will-impact-african-firms-3916838

Article by Professor Lilac Nachum, Visiting Professor, Strathmore Business School

Professor of International Business, City University New York

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