United States of Arabia?

The GCC Customs Union is now in place and could provide a big boost to regional economies. But this could be only the start, with plans for a single currency and an economic union on the table. Will the process of Gulf integration work and where might it all end?

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By  Massoud Derhally Published  January 5, 2003

|~||~||~|Creating an economic block of several nation states is not a mission to be undertaken lightly. If history teaches us anything, it is that governments, economists, business leaders and the man on the street have passionate views on the strengths and weaknesses of the process.
But change is healthy. With an increasingly competitive business environment, integrating into the world economy requires removing trade barriers, which means reducing tariffs and other hurdles placed in front of imports.

It is no small deal, therefore, that six Gulf States — already bound together into the Cooperation Council — are now attempting further integration in the form of customs unification. It is also no great surprise, that not everybody agrees that it is a good idea.
So how will things change? A recent report on Arab Competitiveness published by the World Economic Forum says countries will retain non-tariff protection measures in order to shelter key industries from competition in the region.

“Duty free access will be extended to products originating in GCC countries if 40% of the value added is from the GCC region, and if a citizen or entity from the GCC area owns 51% or more of the exporting enterprise,” the report states. This means that any product manufactured in any GCC country has to contain at least 40% local input in order to be classified as a national product, says Johnny Abedrabbo, senior economist at the National Commercial Bank, the largest bank in Saudi Arabia.

“If a car is manufactured in any GCC country, a minimum of 40% of the parts needed to manufacture this car has to be produced locally in the GCC). This car or product is classified as a national product and gets similar tax treatment when traded within the GCC area,” says Abedrabbo. The car then can be exported to any other GCC state tax exempt.

The customs union, which unifies customs tariffs between the six countries at 5% and covers more than 1,500 imported items, comes two years ahead of schedule.

It is a major step by the six member countries to realise economic integration in the Gulf region. The deal replaces a joint economic agreement signed when the GCC, an economic, political and security bloc, was established in 1981 to boost regional cooperation.
“The free movement of goods within the GCC will not only enhance economic welfare, but is essential in building an effective economic and monetary union. In addition, the customs union greatly reduces legal and administrative costs, thereby activating intra-GCC trade, which currently does not exceed 6% of those countries’ annual commercial exchange of about US $200 billion,” Abedrabbo.

With the customs union, facts on the ground will inevitably change. Once a product is charged the duty at any GCC port of entry, it can then move duty-free throughout the GCC. “The benefits of such an arrangement are a substantial reduction of trade barriers to imported products. It basically gives all GCC citizens access to the world’s best products at the best prices,” says Brad Bourland, chief economist at the Saudi American Bank (SAMBA). “It also eliminates the arbitrage opportunities whereby consumers would tend to buy from one country where the duties were lowest. Prices of imported products should now equalize in all the GCC markets.”

In simple terms, liberalising trade will create links to the international marketplace and push local producers to match the rest of the world in pricing. This should create competition, efficiency, income and productivity growth — and more jobs at home. The benefits of a customs union will come with the untangling and the removal of economic distortions caused by different tariff levels.

The recent report by the World Economic Forum, highlighted that trade among GCC countries is less than 10% and it interprets the formation of a customs union as “a strong desire to boost intra-regional trade.”

Economists and experts say increasing Arab trade – only 2% of the world’s trade — would enable Arab countries to deal on a more equal footing with the world’s giant economic blocs, such as the European Union, the GCC’s biggest trading partner, and benefit from joining the World Trade Organisation (WTO).

“This agreement would give birth to the Middle East’s biggest economic block with a GDP of nearly $320 billion in 2001, or about 45% of the combined Arab economies and as a result, should contribute to enhanced regional security,” says Johnny Abedrabbo.
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But trade negotiations with the EU have been stalled for a number of years, according to the Economist Intelligence Unit, because the EU, “wished to see the GCC adopt a single unified trade regime before concluding a bilateral accord.”

With a uniform external tariff, says one analyst in Saudi Arabia, the GCC can bargain for bilateral and multilateral trade concessions involving tariff reductions as a single block, instead of one medium-sized and five small countries.

Not only will the customs union strengthen the economic standing of states internationally, says economists, it will also increase intra-Arab trade and create jobs. “Economic studies show that low trade barriers coincide with high GDP growth rates and job creation, while countries with high trade barriers have low growth,” says Bourland at the Saudi American Bank.

Low tariffs, he says, will give consumers the incentive to buy low taxed products from local businesses and that creates jobs. Low tariffs will also, “discourage local businessmen from investing in uncompetitive local businesses whose success is dependent solely on tariff protections against competitors, and this means resources—capital, labor, energy, land, plant and equipment—are allocated more efficiently in the economy. Simply put, low tariffs give the gift of competition to the local economy,” says Bourland.d.
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But the customs union still has it share of problems. Tariff revenues will be greatly reduced for countries with relatively high tariffs like Saudi Arabia, since the uniform rate of 5% imposed is almost always lower than those in the countries with relatively higher tariffs, says an analyst in Saudi Arabia.

In addition, the negotiations on the exact tariff levels for different categories of goods can be difficult, as was the case during the long negotiating process in the GCC, which went on for around 15 years.

Dividing up tariff revenues generated by a uniform tariff among the member nations is also a problem. While the Economist Intelligence Unit (EIU) agrees that a customs union will boost prospects for an EU trade accord, it says there is room for improvement. “Other problems remain,” it says in a recent report, “notably the divergence between laws covering exclusive trade agency agreements in many Gulf States, and the move towards the establishment of a single import market. The management of goods such as alcohol barred in some states but permitted in others remains an obstacle to integration, as do the differing subsidy rates paid by GCC governments on a range of core goods.”

The situation is a mixed bag. Abdullah Al Zamil, senior vice president at Zamil Air Conditioners of the Zamil Group, a Saudi conglomerate, says “A Sony agent in Dubai will be able to sell a Sony product in Saudi without having to pay second hand duty and that’s going to create major upsets between agents among the Gulf because 90% of private businesses are based on agencies and that is going to mean a substantial conflict between trading houses.” How all is this is to be solved remains to be seen.

Re-exports by the UAE to other GCC countries without additional tariffs are a positive development, but they come at a price. Lost tariff revenues by Saudi Arabia and Oman, which had to lower their external tariffs from 12% and above to only 5% is one negative, says Nazem Abdalla, senior economist at the UN Economic and Social Commission for Western Asia (ESCWA). “The UAE, on the other hand, has to raise its external tariff rate on non-GCC imports to 5%, from the previous level of 4%. Its benefits may include more intra-GCC trade, including re-exports.”

Now that the customs union is in place next on the agenda is a Gulf common market, which requires a higher degree of economic integration. According to Abdalla, a common market will require member countries to remove restrictions on the “flow of factors of production among themselves to pave the way to an economic union.” An economic union, says Abdalla, is equivalent to a common market, but a common market will call on member countries to harmonize and unify their fiscal, monetary and socio-economic policies.

With five out of six GCC currencies already pegged to the US dollar and Kuwait closely tracking the US dollar, it would be a simple matter to implement a common currency, which is currently planned for by 2010. “It’s a political rather than an economic decision,” Henry Azzam, chief economist at Jordan Investment Trust Group, told BBC News Online. “All it needs is for someone at a very senior level in Saudi Arabia to take the decision to push forward.”

The European experiment is the catalyst for a unified GCC economic bloc. Member states of the GCC can draw on the lessons and difficulties that have faced their European counterparts.
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At present the European Central Bank (ECB) is conducting a study on the proposed monetary union of the Gulf Cooperation Council (GCC) states, according to news reports from the Saudi daily Arab News. Brad Bourland says that while, “tariff harmonisation is a logical first step towards a common currency, other steps, along the lines of the Euroland ‘Stability Pact’ are needed, such as agreement on guidelines for inflation, and government debt and deficits.”

But will the GCC’s members have the political will to implement a single currency? That remains to be seen. Sultan Al Suwaidi, the UAE Central Bank governor told a seminar on exchange rates in Abu Dhabi in December, “The GCC countries have agreed on achieving standard economy in 2005 and a monetary union in 2010. I am confident that we can realise those objectives on time. But the single GCC currency is not an end in itself as the ultimate goal is how to achieve concrete integration and to better exploit our economic resources.”

There are those who argue that were it not for the European Union’s refusal to enter trade negotiations, it would have taken more than the two decades it already took to arrive at a customs union.
Another important question to ask is will there be closer political union as a by-product of a trade and monetary union?

Consider the following. Arab countries reached an agreement for economic unity in March 1957, an agreement that was later ratified in 1964. Thirteen Arab countries then decided to sign another agreement to set up a common Arab market. Given that both agreements were never implemented, which isn’t particularly encouraging, there seems little to indicate that a political union may take shape.

If the GCC is to follow the European experiment it will have to set up a Gulf Central Bank, very similar to the European Central Bank, to carry out the convergence criteria that Brad Bourland mentions above, namely setting monetary policy, interest rates, managing inflation and to deal with the collection and disbursement issue that is of concern to Abdullah Al Zamil.

“Who is going to collect duty? For Saudi Arabia, customs duty represents major income. We need to first agree on the mechanics before we embark on disbursement of money or funds,” says Al Zamil.

But while Al Zamil may have his doubts, just like many European businessmen did at the advent of the European Union, he says, “The whole idea of the GCC was to create a cluster a single entity that negotiates on much bigger terms. Today, Saudi Arabia and the UAE negotiate on their own, but when countries go as the GCC to negotiate it’s going to be a whole different ball game.”— Massoud A. Derhally

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