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| Social Development in Pakistan (SDiP) 2005-06 |
Karachi-May 20, 2006. The Social Policy and Development Centre (SPDC) today released its seventh Annual Review of Social Development in Pakistan 2005-06, titled “Trade Liberalization, Growth and Poverty.” The findings of the report were presented by Dr. Shaghil Ahmed, Acting Managing Director, SPDC at a session chaired by Mr. Sartaj Aziz, Vice Chairman, SPDC and former finance and foreign minister. The Guest of Honour was His Excellency Mr. David B. Collins, High Commissioner of Canada while Mrs. Bilquis Edhi, noted social worker, was also a special guest.
The Review picks up on one aspect of globalization – the liberalization of the external trade regime –and examines its impact on growth and poverty in Pakistan. It places the on-going worldwide debate on the interactions between greater trade liberalization, growth and poverty in the context of Pakistan. Policy implications concerning the role of the Government of Pakistan’s (GoP) in poverty alleviation are also drawn from the results.
Presenting the report, Dr. Shaghil Ahmed highlighted that the empirical results indicate that there is an important channel through which trade liberalization has a poverty-reducing effect. This is through its positive impact on investment and productivity and thereby growth.
At the same time, the results also show that there are important adjustment costs associated with trade liberalization that have, to a large extent, suppressed the benefits mentioned above. Trade liberalization resulted in a reduction in collection of custom duties and thus overall tax revenues, which impacted negatively on pro-poor development expenditures.
Future simulations using SPDC’s model of the Pakistan economy indicate nonetheless that if the process of further trade liberalization is accompanied by other appropriate policies, including pro-poor fiscal policies, then trade liberalization can help rather than hinder the national goal of poverty alleviation.
The following are the highlights of the presentation of the Review:
TRADE LIBERALIZATION IN PAKISTAN
The Report documents that substantial trade liberalization has taken place in Pakistan since the late 1980s at a pace that has been accelerating over time. Import taxes have been reduced, the Statutory Regulatory Orders (SROs) have now been mostly withdrawn and Non-Tariff Barriers (NTBs) have been largely dismantled. In particular, the average tariff rate has declined sharply from 77 percent in 1985 to about 17 percent.
This process of liberalization puts Pakistan towards the middle of a group of developing economies in Asia in terms of self-imposed restrictions on trade through both tariff and NTBs. In this group, Pakistan restricts its imports about as much as China and less than India, Malaysia, the Philippines, and Bangladesh, but more than Thailand, Turkey, Indonesia, Sri Lanka and Indonesia. However, in terms of barriers imposed by other countries on a country’s exports, Pakistan is the country allowed the least market access among the same group of developing countries in Asia and also ranks amid the highest among all countries of the world in being denied market access.
Trade, as measured by the sum of imports and exports, has accelerated as a result of the process of greater openness of the economy, especially over the past 5 years. However, trade performance relative to many other developing Asian economies has not been that impressive. While the trade-to-GDP ratio has increased 0.4 percentage points per annum in Pakistan since 1990, it has increased by 0.8 percentage points per annum in India, 1 percentage point per annum in Korea, 1.2 percentage points per annum in Bangladesh, and 3.5 percentage points per annum in Thailand, for example. The world average growth of trade as a share of GDP, at 1 percent per annum, has also been higher than that of Pakistan.
EFFECTS ON GROWTH AND POVERTY
SPDC’s Annual Review rigorously analyzes the empirical impact of trade liberalization on growth, poverty and inequality in Pakistan.
The simulations using SPDC’s model trace a hypothetical path that the economy would have followed since 1990, had import tax incidence been at its 1980s average level of about 45 percent instead of falling gradually to 9 percent as was actually observed. The results indicate that poverty and income inequality would have been higher without the trade liberalization, although only slightly so, on balance. Thus, the results are not consistent with the seemingly popular notion that greater trade openness has increased poverty in Pakistan.
Both positive and negative effects are involved in the channels of transmission. Trade liberalization has had a poverty-reducing effect through enhanced growth, productivity and investment and through price stability. But it also has entailed some costs, in particular costs related to fiscal adjustment, which have been poverty-increasing. The axe of lower tax revenues resulting from lower import taxes and control of the fiscal deficit fell on developing expenditures. Not only are such expenditures directly pro-poor, but the employment opportunities that could have been created as a consequence of these expenditures were also foregone, adversely affecting the income of the poor. With respect to income inequality, the evidence suggests that although trade liberalization by itself leads to a slight reduction in inequality, a rise in Foreign Direct Investment (FDI) appears to increase it.
Future simulations using SPDC’s model indicate that the economy can potentially gain from further trade liberalization but only if the adjustment costs are guarded against by following pro-poor fiscal policies. If average import tax incidence is further cut to 5 percent and at the same time development expenditures are raised to 5 percent of GDP, there can be sizable gains in economic growth and poverty reduction, provided that the macroeconomic stability is not compromised through large increases in the fiscal deficit. This would necessitate a rise in tax revenues and some expenditure switching. This, in turn, would require the political will to raise taxes and tap other sources of potential revenues; eliminate waste, inefficiencies and corruption in public expenditures; and reallocate these savings on appropriate development programmes such as rural infrastructure, education, health, water supply and sanitation.
EXTERNAL ENVIRONMENT SINCE SEPTEMBER 11, 2001
The Annual Review argues that external shocks arising from the events of September 11, 2001 have contributed to a relaxation of balance of payments constraints for Pakistan and played a role in the recent strong performance of the economy. Policy changes and other structural changes in the economy have also played a major role. But ignoring the importance of external shocks runs the risk of becoming complacent about the economy’s long-term prospects for growth.
The findings of the SPDC report suggest that attracting FDI; further reducing trade barriers; improving the institutions related to governance, political stability, law and order, corruption and regulation; and improving market access for Pakistani exports including through greater development of nearer export markets would significantly improve Pakistan’s export performance in the long run. Specifically, if Pakistan were to reduce its trade barriers to those of the Philippines, it could potentially increase its export-to-GDP ratio from 13 to about 18 percent. If it could match the quality of its institutions to those of Malaysia, its exports-to-GDP ratio could potentially rise to 16.3 percent. If it faced the less restrictive market access environment faced by China (and had the correspondingly higher FDI that is correlated with that), the rise in exports-to-GDP could potentially be even bigger. But FDI tends to increase income inequality which would have to be countered by other policies.
POLICY IMPLICATIONS
- Further reduction in trade barriers can enhance growth and reduce poverty in Pakistan under the right conditions.
It is important to have other pro-investment policies in place though, in order to take full advantage of this channel.
- Increases in development expenditures should be rigorously pursued in order that the adjustment costs of trade liberalization do not negate the gains from trade.
But budgeting for more development expenditures is only the first step in this process.
Delivery systems and monitoring systems of these development outlays must also be improved.
- The development expenditures should not largely be financed through increased fiscal deficits otherwise the hard-earned macroeconomic stability and credibility will be put at risk.
Some expenditure switching is required and taxes as a share of GDP need to increase, including through such measures as taxation of agricultural income and services as well as of capital gains on stock and real estate.
- Efforts to improve social safety nets and skill development and training schemes are needed to guard against the employment losses in the transition period
- For sustainability of exports, further progress in improving institutions, attracting export-oriented FDI and developing new export markets is needed as well as making a better case for improving market access in existing markers.
- Textile quota removal represents a potential opportunity, but given stiff competition from China, India and others Pakistan’s international competitiveness needs to improve to take advantage of this.
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