A Free Trade Area with the European Union:
Potential Impacts and Alternative Trade Policy Strategies for Kenya

With the European Union and the African, Caribbean and Pacific countries negotiating comprehensive Free Trade Agreements for implementation by January 2008, developing countries have raised genuine welfare concerns. Countries are concerned about budgetary and revenue losses, the erosion of their competitiveness, and the possible collapse of their industries if subjected to EU competition. Making informed decisions on strategies to adopt requires the assessment of the net benefits of the proposed FTA. This paper addresses some of these by analyzing the potential effects of the FTA on Kenya’s manufacturing sector. It specifically addresses two questions: (1) How will the proposed FTA affect Kenya’s manufacturing sector? and (2) What adjustments would Kenya need to make in implementing the EPA?

Our analysis of trade patterns suggests that imports to Kenya in ten manufacturing sub-sectors, at the 3-digit level of disaggregation, moderately respond to price changes. Thus, we suspect that tariff reductions threaten the viability of these sub-sectors through increased import competition. However, for most of the sub-sectors, the competition from EU imports under an FTA appears weak. Except for the paper and chemical products, the rest of the manufacturing sub-sectors selected in this analysis appear less vulnerable. The paper and chemicals sub-sectors would require immediate attention to best position them for the expected competition under the FTA.

We further find that market access opportunities for the EU due to tariff reductions will most likely be due to the market effect, rather than the competitive effect. The EU does not appear in a strong position to threaten the market shares of imports from the rest of the world. It is therefore likely that EU manufacturers will target the Kenyan domestic producers in their quest for market expansion. We however urge caution in interpreting these results because the manufacturing sector is larger than the 17 sub-sectors used in this analysis. Obviously, the timing of implementation and the final structure of the EPA will be critical in determining the outcomes for all the sub-sectors.

Comparing the proposed FTA regime with the WTO multilateral trade process, we find that Kenya manufacturing would be less vulnerable under the multilateral regime. Irrespective of the formula, the magnitude of tariff cuts envisaged under the WTO would be at least half those required for the FTA. In a worst-case scenario, manufacturers could expect less than 16 percent increase in import competition in most sub-sectors under the WTO. This is in comparison to an increase of between 16 and 24 percent in the case of an FTA with EU. Thus, we consider it plausible to conclude that, else equal, the multilateral system holds better prospects for Kenya’s manufacturing sector.

The results of this paper seem to present a compelling case for Kenya to continue with the multilateral trade system of the WTO instead of joining an EPA with the EU. We would however like to caution that these results are subject to serious data quality problems. Furthermore, data was only available up to 1998; hence, we could have missed possible market changes after this period. That said, our results offer useful pointers to the possible direction of Kenya’s strategy. I would recommend a more comprehensive analysis on the same lines, using better quality and recent data. However, our results also show that the manufacturing sector would require policies closely targeted to its sub-sectors rather than blanket policies. For instance, the paper and chemical products sub-sectors appear particularly vulnerable from our analysis results. Closer investigation of the sub-sectors could provide useful hints on areas for improvement. Such targeted analyses would provide better information for Kenya’s negotiators. Overall, the sub-sectors analyzed appear strong enough to compete with increases imports.