Trade Creation and Diversion Effects of the East African Community Regional Trade Agreement: A Gravity Model Analysis

The paper investigates the potential impact of the EAC (a South-South Regional grouping) on trade creation and diversion. The paper seeks to establish whether the EAC Regional Trade Agreement has diverted or created trade using an expanded (augmented) gravity model. The paper departs from the conventional estimation approach that uses average combined trade flows as the dependent variable which is prone to errors and uses exports. We estimate static and dynamic random effects models using a panel data set from 2001 to 2011 on seventy countries that trade mainly with the EAC partner states. Results suggest that indeed the implementation of the EAC treaty has created trade contrary to widely held views that South- South RTAs largely divert trade. There is thus evidence that the EAC, a south-south RTA has been a more trade creating than trade diverting as espoused in the literature. The paper explains the possible measures that have helped generate the trade underscored; formulation and implementation of EAC medium term development strategies, removal of internal tariffs and adoption of a CET structure. The paper further highlights that although progress has been made in other areas, there are challenges that need to be addressed to deepen the EAC integration: persistence of NTB; lack of a common policy with regard to partner states’ trade policies to non-partner states; the lack of standardized customs formalities; the lack of harmonized procedures; and different approaches to investment and export promotion. It is recommended that; the region adopts a legally binding approach to NTBs, harmonizes trade policies and standardizes documentation and procedures.