Chronic Importer Syndrome of Pakistan- Are Trade Agreements a Cure?

Abstract

To capitalize on trade opportunities across national borders, countries enter into various kind of trade agreements standing on the core principle of greater market with no or minimum trade barriers. There is no denying the fact that trade liberalization offers tremendous economic benefits, but not necessarily for all and all the time. It may depend on the institutional structure and governance of a country. As an example, this paper attempts to explore the impact of PTAs on the bilateral trade of Pakistan. To this end, this paper estimates the export and import demand functions for Pakistan using an ARDL with Pool Mean Group and data from 1992 to 2016 involving a panel of ten trade agreements. Analysis reveals that signed PTAs have a significant positive impact on imports of Pakistan, but not on exports. Pakistan’s growing trade deficit with China is already a question mark over the efficacy of FTA between the two countries.

Keywords: exports, imports, preferential trade agreement, free trade agreement, Pakistan

Subject classification codes: F14, F15, O24

1.     Introduction

International trade is the lifeline for global economy. And for the trade to thrive across borders and promote global welfare, trade liberalization with minimum or no trade barriers is the prerequisite. According to most studies, with technological advancements in transportation and communications, the volume of global trade has increased a great deal. The lowered cost of transport and communications has allowed for the integration of markets around the world (Mohammed and Williamson, 2004). One mode to benefit from increased global trade and reduce the costs of trading is to enter into Preferential Trade Agreements (PTA) with a bilateral trade partner or a group of countries. For instance, Arvis et al. (2013) empirically showed that regional trade agreements, among other things, are a key determinant in reducing overall costs. However, the prime benefit of trade agreements is the increased trade amongst the signatories.

In an effort to gain greater market access, Pakistan has signed PTAs with different countries like Iran, Indonesia, Sri Lanka, SAFTA (with Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, and Sri Lanka), China, Malaysia, and Mauritius , with several other in the pipeline. However, despite these efforts, Pakistan’s exports have increased only from US $ 12.58 billion in 2004 to US $ 22.09 billion in 2015. Whereas our competitors have increased their export shares in Billions of US Dollars during the same period as follows: India from $75.90 to $264.38, China from $593.32 to $2273.47, Bangladesh from $8.27 to $31.73, and Viet Nam from $26.48 to $162.01.Alarmingly, the share of Pakistan’s exports fell in relation to world’s exports, as depicted in figure 1.

If individual agreements are taken into account, e.g. a PTA between China and Pakistan, the overall trade volume has grown by more than 100% (Irshad, 2015). However, the composition of trade shows a tilted balance in favor of China with a relatively rapid growth in imports compared to exports, leading to a growing trade deficit. Therefore, one may ask if such trade agreements have been adding to Pakistan’s economic woes on external account balance. Figure 2 shows the export to import ratio of Pakistan.

******* Figure 1 and Figure 2 *******

An important implication of free trade agreements is exports diversification, both in terms of products as well as destinations. In case of Pakistan, however, trade agreements do not appear to have served this purpose as exports and imports are flowing towards a few trade partners and are concentrated in a few selected commodities. Table 1 presents the trade share of its PTA partners in its exports and imports and rank of FTA/PTA partners in terms of share in exports and imports for the year 2016. It is important to note that, except for China, none of the other countries that have signed an FTA/PTA agreement with Pakistan are in its top 15 trading countries except SAFTA which is shown as sum of trade with all the signatories. Pakistani imports also follow a similar trend for FTAs/PTAs, apart from China, Indonesia, and SAFTA.

******* Table 1 *******

Table 1 raises a question on the mode of selection of individual PTA partners. On similar grounds the composition of category-wise top 5 exports and imports are placed at Table 2. At present, the textile and clothing exports of Pakistan accounted for almost 60.42 % of total exports in 2016 (UN COMTRADE). While the second in line is vegetables, which accounts for 13.48% of the total exports. Pakistan earned revenue of $ 12.40 Billion from textile exports in 2016. The gap between the first two commodities itself shows Pakistan’s export concentration towards textile. On the other hand, 53.35% of total imports are high valued products in the form of Machinery and electrical goods, fuels, and chemicals, which amounts to almost $ 25.07 Billion. So, Pakistan runs trade deficit right at the start when its major exports which are 60% of the total exports does not generate enough revenue to finance even few of the imports which are only 53.35% of the total imports. Pakistan’s major imports are more than twice in value to its major exports.

******* Table 2 *******

The severity of trade imbalance lies in the fact that Pakistan’s major exports (60% of total export) fall short by almost double in value compared to the value of major imports. Moreover, there has been almost no improvement in this situation despite the agreements are in place. This situation provides sufficient ground to analyze the impact of trade liberalization measures exports and imports of Pakistan. Extensive research has been done on Pakistan’s trade with different countries. However, there is a dearth of literature that examine the impact of PTA/FTA on the exports and imports of Pakistan separately. Using a panel of ten countries with which Pakistan has signed an FTA/PTA, this paper explores this relation.

Rest of the study is organized as follows: section 2 briefly summarizes the relevant literature, section 3 presents the methodology, section 4 & 5 discusses the data and results respectively, while section 6 summarizes and concludes the study.

2.     LiteratureReview

Globalization have benefited all, especially developed economies, mainly by fostering cross border trade ties (Savrul and Incekara, 2015) and improving access to skills and new technology (Arora and Gambardella, 2005, Bresnahan and Gambardella, 2004, Florida, 2002). The basic need for trade arises when a country either has an excess of a certain good or service, or when it lacks the ability to meet its own requirements. Access to knowledge and new technologies increases with trade, especially when a country starts trading goods and services with technologically advanced partners. This might be due to two main reasons: higher product standards defined by advanced economies and the spill over of technology through foreign direct investment (FDI) from advanced economies. According to Mukherjee (2008), manufacturing firms favor countries with cheap labor. He further states that if a country sends FDI in return for cheap labor and reduces the costs associated with trade (transport cost and not tariff cost) then the receiving country’s welfare increases.

To maximize trade benefits, countries enter into preferential trade agreements to ensure sustainable export growth and access to cheaper sources of imports. In pursuit of a vast market for its products, Pakistan has signed PTAs with different countries. However, trade statistics tell a disappointing story compared to what was expected because of trade openness. There must be some inherent issue for a country like Pakistan which enters in a trade agreement but does not benefit from it. Implementation gap of an agreement can be one of the issues, which could be linked with weak rule of law, poor infrastructure, low domestic capacity and institutional design. Gray (2014) asks this fundamental question in the following fashion:

‘If domestic capacity is low, no institutional design— no matter how ambitious or legalized—can make states do what they are fundamentally unable to accomplish at the domestic level. If that is the case, why, then do states sign on to these commitments? Are they unaware of their own capacity limitations? Do they sign these agreements in the hope that they will spur reform, and then end up disappointed? Is it simply an empty promise that they have no intention of carrying out? The incentives that drive heads of states to sign overly ambitious agreements deserve extensive further study.’

Pakistan’s literature concerning trade suggests that the total trade in Pakistan has increased over time. According toIqbal et al. (2010), Pakistan’s trade has increased by 23 times since the 1980s and the FDI inflow has also increased by around 13 times. Some even argue that Pakistan’s trade potential has not been fully tapped due to multiple issues. For instance, Mohmand and Wang (2013) claim that Pakistan has an immense amount of trade potential but due to political and social tensions with neighboring countries, its trade volume with them is very low. India is a good example of this, where the country can be a good trading partner; however, due to the on-going territorial and water disputes that is not the case.

This study focuses on trade between Pakistan and its PTA trading partners where total trade volume has improved significantly, but imports have grown rapidly than exports, resulting in a continuous trade. Thus, the growing volume of imports and suppressed exports growth following various PTA is a source of concern and the main motivation for this research. As highlighted earlier in section 1, Pakistan FTA/PTA partner countries, except China, are not the ones where exports and imports are concentrated. Therefore, a study is warranted where the impact of these PTAs may be explored on the export and import demand functions separately.

3.     Data and Methodology

To start the investigation, this paper begins with the analysis of the basic import and export functions. The export and import performance of a country may be expected to depend primarily on competitiveness (measured as the price of a country’s exports and imports relative to the foreign price of related goods expressed in a common currency) and the level of ‘world’ demand which determines shifts in the demand curve for a country’s goods. If the price and income elasticities of demand are assumed constant the export and import functions can be written as:

where X_t is the level of exports while M_t is the level of imports at time t; A is a constant; P_d/P_f is relative domestic and foreign prices measured in a common currency; W is the level of ‘world’ income; g (< 0) is the price elasticity of demand for exports, and e (> 0) is the income elasticity of demand for exports.

For this study Panel Auto Regressive Distributed Lag (ARDL) Model has been used, presented by Pesaran et al. (2001). The ARDL model will be further estimated based on the Pool Mean Group to investigate long and short run association between variables. Here, the Pooled Mean Group is used in place of other estimators, such as three stage least squares (3SLS) and the general method of moments (GMM) because it is an intermediate estimator that combines pooling and averaging. It also has many advantages compared to OLS and DOLS. Due to the robustness in the presence of both endogeneity and non-stationarity, pool mean group is a better technique as opposed to fixed effect estimators.ARDL has three advantages over the traditional cointegration methods. Firstly, it does not require all the variables to be integrated of same order. It can be applied to variables if all are stationary at I(0), or I(1) or fractionally integrated. Secondly, it gives good estimates even if the sample size is very small.

Since the objective is to see the effect of free and preferential trade agreements on both the imports and exports of Pakistan, two separate panel equations for imports and exports are established for a Panel of countries with which Pakistan has Preferential Trade Agreements. For imports, the following equation has been estimated:

where the subscripts i and t stand for country and time respectively. Imports are taken as import per capita, DummyPTA is dummy variable representing effective date of implementation of PTA, DummySAFTA is dummy included for South Asian Free Trade Agreement (SAFTA), Xrate is the real effective exchange rate of Pakistan, FDI is also taken as log of FDI, TOT is terms of trade, and GDP is Pakistan’s growth of GDP per capita.

In our model, we expect Dummy variables to be positive and statistically significant. Considering the widening trade deficit of Pakistan, we have hypothesized that signing these agreements would have increased the imports. For the control variables, we expect a negative sign of GDP, positive for Exchange Rate, FDI and negative for Terms of Trade.

To see the impact of trade agreements on exports, the following model has been estimated:

where exports are taken as a percentage of Pakistan’s GDP, DummyPTA is dummy variable for representing effective date of implementation of PTA, DummySAFTA is dummy for South Asian Free Trade Agreement (SAFTA),GDP is taken as growth of GDP, exchange rate is taken as the real effective exchange rate of trade partners of Pakistan included in this study, terms of trade is in log form, and FDI is also taken as log of FDI.

In the context of our study, we expect the dummy variables to have a negative or statistically insignificant effect on the exports of Pakistan, because, despite these trade agreements, the overall exports of Pakistan have not increased very significantly. Moreover, as has been discussed in the previous sections, Pakistan’s exports are not concentrated with its PTA signatories; in fact, most of them are not even in the top 20 of export destinations, except China, and SAFTA. For the rest of the control variables, we expect positive significant signs with GDP of trade partner, their Exchange Rate, FDI, and terms of trade.

The data for these variables from the year 1992-2016 for Pakistan and PTA signatory countries have been collected from different sources including World Bank’s World Development Indicators (WDI), State Bank of Pakistan, Handbook of Pakistan’s Economy, UN-COMTRADE Portal and Bruegel Datasets.

4.     Results and Discussion

4.1.   Import Demand Function

The results for Import demand function are presented in Table 3 below.All the variables have expected signs except GDP in the long run and exchange rate in both long and short run, which are also insignificant. Foreign direct investment has a positive significant effect on imports which is mainly due to the imports of raw materials funded by FDI. DUMMYPTA is positively significant in short and long run showing that imports have increased because of the free and preferential trade agreements. GDP seems to be significant in the short run with a negative sign which shows the substitution effect, i.e. more produced domestically would reduce imports. Terms of trade is negatively significant which means that weaker terms of trade reduce imports, which although has a very small coefficient. The error correction term is positively significant which means that the model is moving away from the equilibrium (Engle and Granger, 1987).

******* Table 3 *******

The results presented above coincide with stylized facts of trade statistics of Pakistan. To put the discussion into context, Pakistan’s trade statistics with China, Indonesia, and Malaysia before and after signing the trade agreements are noted in Appendix A from Table A.1 to A.3.

As shown in Table A.1 Pakistan’s total textiles imports from China for the years 2001-2004 before the agreement stood at 140 Million Dollars, but after the agreement became operational Pakistan imported 1.5 Billion Dollars’ worth of textiles in the years 2007-2010. For the same years, imports of telecommunication products and general electric machinery were 235 and 217 Million Dollars which rose to 2.5 Billion Dollars and 1.3 Billion Dollars for the years 2007-2010. Pakistan has provided very high tariff concession, and, in most cases, Pakistan has agreed to reduce tariffs to zero on many of the above-mentioned imports.

Similarly, Pakistan provided access to Indonesian imports under the preferential trade agreement (Tables A.2). For the years 2008-2011 (before the agreement became operational) Pakistan imported a total 872 Million Dollars’ worth of fixed vegetable oils and fats. After the agreement in the years 2012-2016 Pakistan imported 4.9 Billion Dollars’ worth of fixed vegetable oils and fats. For the same period before the agreement Pakistan imports of vegetables, fruits and textile from Indonesia were equal to 420 Million Dollars which rose to around 644 Million Dollars for the period 2012-2016.

Table A.3 shows imports from Malaysia which have increased after the trade agreement took place. As mentioned earlier Pakistan has provided access to Malaysian edible oil which has increased significantly after the trade agreement. The volume of fixed vegetable oils and fats imports from Malaysia for the years 2001-2004 was worth 1.5 Billion Dollars. But after the trade agreement became operational, the volume of imports of such oils increased to 4.6 Billion Dollars in the years 2007-2010. Similarly, For the same periods as mentioned above, imports of artificial resins and plastic materials rose from just 53 Million Dollars to over 217 Million Dollars.

4.2 Exports Demand Function

The result for export equation is presented in Table 4 below. All the variables appear with expected signs in Long and Short run except DUMMYPTA and Terms of Trade in both long and short run, and GDP and dummy SAFTA in short which are insignificant. Our variables of interest namely; DUMMYPTA and DUMMYSAFTA have no significant effect on exports of Pakistan. This means that the trade agreements have no effect on the exports which is not favorable for any country. Free and preferential trade agreements should play a role in increasing the exports of a country by securing good market access through these agreements which seems to be lacking in the case of Pakistan.

GDP (Foreign GDP) has a positive significant relation with exports in the long run. This means that when foreign countries GDP increases, Pakistan’s exports also increase to those countries. Foreign exchange rate also has a positive significant relation with exports which means that when foreign exchange rate increases so their purchasing power improves thus increasing our exports to that country. When FDI increases it increases the production which leads to increase in exports. Terms of trade is insignificant in the long run. In the short run all the variables are insignificant except FDI which is positively significant. Error correction term is positive which means that the model is moving away from the equilibrium (Engle and Granger, 1987).

******* Table 4 *******

Again, just like in imports case we have presented certain stylized facts based on important export statistics in Appendix B Tables B.1 to B.3 for Mauritius, India, and Indonesia so that the results of Table 4 can have meaningful explanation.

As shown in Table B.1, Pakistan seems to be struggling to benefit from trade agreements to maximize its exports with Mauritius. They have provided access to imports of Cereals, Textile, Vegetables and fruits but Pakistan has failed to capitalize on these concessions. Pakistan’s exports of cereals, textiles and vegetables for the years 2003-2006 (before the agreement) were worth 75 Million Dollars, 52 Million Dollars and 2 Million Dollars respectively. But after the agreement for the years 2008-2011 Exports of cereals were worth around 83 Million Dollars, textiles were worth only 35 Million Dollars and Vegetables and Fruits exports were worth 1.6 Million Dollars. Due to the access provided the export volume should have increased but as it remained the same and even declined in some cases, proves that the trade agreement has no effect on exports to Mauritius.

In Table B.3 Pakistan’s Exports to India before and after the agreement are almost the same which means the FTA has no effect on exports to India. Similarly, Pakistan’s Exports to Indonesia after the PTA have remained largely the same which is not a favorable outcome. Exports before and after the PTA with Indonesia is shown is Table B.2 which barely seem to be affected even though Pakistan was provided concession on textiles by Indonesia. Malaysia has also provided Pakistan access to textile products, but textile exports barely seems to have been affected. Although exports of textiles have increased to Sri Lanka and Bangladesh but both countries have strictly included textiles in their negative lists which mean the increased exports cannot be attributed to trade agreements and thus Pakistan is exporting to these uncompetitive markets.

5.     Conclusions

Increasing trade openness has many benefits and is an extensively praised topic in literature. It is one of the few areas in economics where most economists unanimously agree that greater trade openness leads to welfare maximization of consumers. This is because of comparative advantage, as country imports products that are cheaper abroad than domestically produced substitutes, allowing consumers to acquire these products at cheaper rates. Furthermore, there is efficient resource allocation by firms/factors that were producing those substitutes domestically, and they enter into better ventures. It is argued and has been shown empirically that firms that are engaged in exports are more productive and, more importantly, see increases in their productivity and technology ((Van Biesebroeck (2005) showcased this for a panel of exporting firms for nine African countries).

While the benefits of trade are widely accepted, its shortcomings are seldom discussed particularly the impact on actors like state governments. There can be cases like Pakistan, where due to poor governance and other infrastructural or political issues, the desired effects do not take place in the most optimal manner. Rampant corruption has also been identified as a serious problem, which is also linked to the political situation of Pakistan. In their study, Iqbal et al. (2010) emphasize that Pakistan’s governments should focus on improving the security conditions of the country. Such countries do import cheaper goods and consumer welfare is initially maximized and everyone is better off. However, on the export side, either the firms do not adapt to changes for increasing exports or they focus on the technologies and products that do not generate enough revenue relative to the cost of imported products. Due to this, the country’s welfare is reduced by running consistent deficits when they cannot gain from tariff imposition due to openness, they raise taxes and the consumer whose welfare which increased initially, decreases dramatically.

Our results show that the South Asian Free Trade Agreement (SAFTA) and other preferential trade agreements (PTA) have increased our imports and but have had no significant impact on exports, which is in line with the study of Santos‐Paulino and Thirlwall (2004), who, for a sample of 22 developing countries, showed empirically that imports increased more than exports due to trade liberalization. They concluded:

“We find that liberalization stimulated export growth but raised import growth by more, leading to a worsening of the balance of trade and payments. To the extent that this has constrained the growth of output and living standards, the findings have important implications for the sequencing and degree of liberalization”.

Pakistan, being a developing country, needs to increase its exports more than its imports to aid economic growth. For decades now, Pakistan has had a negative trade balance and the trade agreements seem to be worsening the situation further. We conclude that the trade agreements of Pakistan need to be re-evaluated urgently as they are hurting the economy rather than improving it. Furthermore, efforts must be made to address structural issues in the export sector, which had led to a limited adaption of new technologies and a stunted export base. It is necessary that the issues with exports are further studied in the context of Pakistan’s PTA, so that core issues may be highlighted for remedial measures through policy formulation. The issues might be explored through micro level quantitative or qualitative studies targeting various exporting firms of Pakistan.