Chapter 2: Literature review and methodology
I. Literature review
2. Empirical literature review
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the export might not affect significantly capital formation. Additionally, as the author argued previously, the diversification of economic activity is the pre-condition to have strong-intra regional labor mobility.
These three criteria are not all the Optimal Currency Areas theory properties. The theory emerged and received the contribution of many other scholars. For instance, Ingram12 (1962) added an extra property to the OCA theory: financial integration. He claims that financial integration minimize the necessity for exchange rate correction throughout borrowing and lending respectively from surplus and to deficit countries. Additionally, the higher the degree of financial integration the more rapid is the transmission of monetary policy. Amongst the seminal contributors we can cite Fleming (1971) with his “similarity of participating countries inflation rate”, Kenen (1969) work on the necessity of fiscal transfer mechanism to facilitate adjustments to shock in currency areas, Mintz (1970), Haberler (1970) and Willet (1979) study on the importance of political integration for a currency areas, Frankel and Rose (1998) with trade and economic integration, similarity in business cycle etc. These contributions to the OCA theory are worth mentioning, but for space consideration, we will not explore them in debt.
2. Empirical literature review
Numerous researches have used the Optimal Currency Areas (OCA) theory developed by Mundell (1961) to study the feasibility and sustainability of common currency in West Africa as well as in Europe. Despite the fact that the OCA theory lays the foundation for the study of the feasibility of monetary unions, it is limited. For instance, Mongelli (2008)
12 We will talk more about Ingram and financial integration in chapter 3
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stresses the endogeneities of optimal currency areas. That is a group of countries not fulfilling at the OCA theory conditions’ for the establishment of a monetary union can become an OCA after the adoption of the single currency. The reasons advanced are the facts that the single currency by enhancing economic and financial integration will cause a business cycle synchronization.
Ndiaye and Korsu (2014) investigated the degree of nominal and real convergence among the ECOWAS countries. As for real convergence test they used the deviation of real GDP from its trend. Unit roots test and cointegration were the statistical tools used to test for convergence. They found that there is a partial convergence of exchange rate, reserve of money within ECOWAS as a whole, the WAMZ, the WAMZ plus Cape Verde as well. A partial real convergence that is convergence of business cycle was found within ECOWAS as a whole, the WAMZ, the WAMZ plus Cape Verde as well. As for WAEMU plus Cape Verde, there was a complete convergence of exchange rate. These results suggest that WAMZ and ECOWAS as a whole fulfilled the conditions to have common currency.
However, they have found no convergence of exchange rate, reserve of money, interest rate as well as on the indicator of real convergence between WAEMU and any of the non-WAMZ countries. This implies that it will not be ideal for any of the non-WAEMU countries to individually join the WAEMU monetary union. These authors recommend that the individuals’ national parliaments and ECOWAS parliament should make sure that the fiscal budget deficit convergence is fulfilled by ECOWAS member states13. Additionally, they urge the prospective ECOWAS central bank to have for ultimate goal low and stable
13 Note that they could not test for fiscal convergence in the ECOWAS region because only Sierra Leone and Nigeria had non-stationary series.
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inflation. Furthermore, as there is no convergence of interest rate among the WAMZ countries (without Nigeria) and WAMZ plus Cape Verde, they suggest that the ECOWAS countries should have a common money market and a common monetary policy rate.
Mougani (2014) assessed the current monetary coordination and financial integration within the WAMZ and the East African Community (EAC). He argues that despite the fact that East and West Africa have made progress in terms of economic integration, their economic convergence and financial integration progress have been slow. He claims that the Eurozone experience suggests that monetary cooperation and financial integration are crucial for the success of a monetary union. Therefore, the author recommends strengthening the monetary cooperation between the institutions and the member countries individual central banks of East and West African RECs. This can be done through ensuring an adequate degree of trade, reinforcing the financial system. Further, he argues that the continuous postponement of the monetary union project will diminish the credibility of these institutions and deteriorate the support of market participants and the general public. Thus, the RECs should set gradual and realistic goals.
Agyapong (2012) explores the Eurozone currency crisis and proposes some solutions for the WAMZ. His analysis suggests that the WAMZ model of introduction of single currency is similar to that of the Eurozone in the sense that the admission to the monetary union is based on the fulfilment of the preset convergence criteria. According to the author, macroeconomic mismanagement, rising government debt level, trade imbalance, loss of confidence and lack of transparency in some countries are the main causes of the Eurozone debt crisis. The author stresses that a common political and financial standing is imperative for a monetary union to be vital. Fiscal transfer is necessary – that is, strong economies
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have to support weaker economies to avoid contagious crisis. He goes further by arguing that the WAMZ should pay attention to new occurrences on the financial market that can cause crisis and in order to ensure countries transparency, a common macroeconomic estimation methodology should be imposed by the WAMZ to avoid potential currency crisis. Lastly, he asserts that the WAMZ countries should pursue similar economic and financial policies in order to ensure a smoother transition to the common state.
Masson and Pattillo (2003) aimed to find out whether or not monetary union can lead to more fiscal disciple from the part of the participating countries. Their findings both empirically and from the European Monetary Union (EMU) and WAEMU experience suggest that a regional common currency tends to increase the incentive for fiscal misconduct. They argue that in order to make the common currency project a successful one, it is important that the ECOWAS becomes an effective agency of restraint for fiscal policy. They recommend that the fiscal authorities be independent from the counties accession to the union throughout their life in the union.
The quality and the usefulness of the outcome of these previous studies are undeniable.
However, most of them focus entirely on ECOWAS, or the WAEMU or the WAMZ but not the combined Eurozone-ECOWAS. Although two studies elaborated on Eurozone debt crisis experience and have provided policy recommendations to the WAMZ, the sustainability of ECOWAS prospective single currency has not been evaluated in reference to Eurozone experience as a whole. Additionally, these two studies have not done an empirical study of the Eurozone but mostly relied on previous literature to evaluate its experience. Here, not only we have revised the literature on the Eurozone, but also we designed and estimated a model to analyze the Eurozone debt crisis. Our research is very
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innovative in the sense that we try to conciliate two Regional Economic Communities with different economic and historical backgrounds but having in common a desire to have a better monetary integration. Additionally, the majority of these studies do not provide a detailed explanation of why certain ECOWAS countries are facing particular economic issues. We believe that these details are very important in order to understand the ECOWAS issues and provide useful recommendations. Therefore, in this research paper, we have provided a background study of all the ECOWAS countries that are facing economic and financial issues and failing to meet the conditions to have a common currency.