An Analysis of the Proposed Currency Union of the Economic Community of West African States (ECOWAS)

This thesis provides an analysis of the proposed currency union of the fifteen countries of the Economic Community of West African States (ECOWAS). The study attempts to answer the following questions: (1) is ECOWAS an optimum currency area? In other words, are ECOWAS countries good candidates for a currency union? (2) are the ECOWAS countries ready for an independent currency union? And (3) are the economic benefits to the ECOWAS countries justifiable for a currency union? To address these research questions we applied the framework of the Optimum currency area theory pioneered by Mundell (1961), McKinnon (1963) and Kenen (1969). To investigate the impact of currency union and exchange rate volatility on intra-ECOWAS trade we estimate the augmented version of the gravity model of international trade using panel data over the period 1980-2012. After controlling for zero trade we found that currency union has a negative and non-significant impact on exports and imports and negative and significant impact on total trade. Whatever trade measure we use, both before and after controlling for zero trade, there is no evidence to support the trade creation argument of currency union in the decades of WAEMU existence. We found the effect of exchange rate volatility to be negative and significant on exports, imports and total trade before controlling for zero trade but the effect on all the three trade measures becomes statistically insignificant after the control for zero trade. We carried out perturbations with different exchange rate volatility measures and found our results to be insensitive and robust in all cases. We also found that while ECOWAS countries trade extensively with the rest of the world, trade with each other is very low. With a cluster analysis methodology we found a high degree of heterogeneity in ECOWAS countries’ macroeconomic characteristics especially those that are not members of the West African Economic and Monetary Union (WAEMU). While the eight WAEMU countries clustered together, the others are in fragmented clusters indicating the degree of dissimilarity. These findings are robust even with the use of alternative agglomerative methods of merging the countries. We conclude from our findings that ECOWAS is not an optimum currency area and that the countries are not good candidates for a currency union which makes them at this stage not ready for a full-fledged currency union. The thesis provides no evidence that the level of trade within ECOWAS justifies the formation of a currency union.