Impact Of Tariff Cuts On Pakistan: A Computable General Equilirium Analysis With Particular Focus On Main Exports And Regional Disparities

ABSTRACT The history of Pakistan has been characterised by frequent military interventions in the democratic governing process, diverse economic and trade policies pursued by different a

IMPACT OF TARIFF CUTS ON PAKISTAN: A COMPUTABLE GENERAL EQUILIBRIUM ANALYSIS WITH PARTICULAR FOCUS

ON MAIN EXPORTS AND REGIONAL DISPARITIES

Muhammad Shoaib Butt

Bachelor of Arts, Graduate Diploma of Economics Master of Applied Economics (Honours)

To my mother, Amtul Hafiz (who passed away before the completion of my PhD program), and father, Nazir Ahmad Butt, who dedicated their lives to educating their children

ABSTRACT

The history of Pakistan has been characterised by frequent military interventions in the democratic governing process, diverse economic and trade policies pursued by different autocratic and democratic governments, and regional conflicts and disparities which led to the civil war of 1971 and the secession of the country’s majority wing—East Pakistan More recently, in common with other South Asian economies, Pakistan has embarked on an extensive trade liberalisation program since the late 1980s, with across-the-board tariff reductions being one of its key ingredients This study critically reviews the political economy of Pakistan and examines the likely impacts, in both the short run and long run, of the comprehensive tariff cuts on the economy as a whole, its key industries, and its main regions In doing so, it utilises a computable general equilibrium (CGE) model of the economy The study highlights the effects of the tariff cuts on the country’s major exports, and on the output and employment levels of various regions of Pakistan

The review of Pakistan’s economy reveals a possible, positive relationship between trade liberalisation and regional disparities under military regimes By contrast, under truly democratic governments, trade liberalisation has tended to be associated with reduced disparities CGE model simulations suggest that across-the-board tariff reductions increase real GDP slightly in the short run but significantly in the long run At the microeconomic level, a striking implication of the tariff cuts is a persistent slowdown, or even a decline, in cotton and textile related exports in the long run Increases in regional disparities are also likely In the short run, the gap between the rates of output growth of the largest and most developed region, Punjab, and two smaller and less developed regions—North West Frontier Province (NWFP) and Balochistan—will probably rise sharply In the long run, a sustained increase in unemployment in another smaller region, Sindh, is predicted The study recommends a number of appropriate policy responses to these likely developments,

at the national as well as regional levels of government

ACRONYMS AND ABBREVIATIONS

ADB Asian Development Bank MIMAP Micro Impact of Macroeconomic

Adjustment Policies

ATC Agreement on Textiles and

Clothing

MoF Ministry of Finance CBR Central Board of Revenue MRES MONASH-regional equation system CES Constant Elasticity of Substitution NGOs Non-Government Organisations CET Constant Elasticity of

Transformation

NTBs Non-Tariff Barriers CGE Computable General Equilibrium NWFP North West Frontier Province

cif Cost, Insurance and freight OGL Open General Licence

CMI Census of Manufacturing

Development

PIDE Pakistan Institute of Development

Economics EBS Export Bonus Scheme PIFC Pakistan Industrial Finance Corporation ERP Economic Revival Program PPAF Pakistan Poverty Alleviation Fund

EV Equivalent Variation PSIC Pakistan Standard Industrial

Classification FBS Federal Bureau of Statistics PSTC Pakistan Standard Trade Classification FDI Foreign Direct Investment REER Real Effective Exchange Rate

F-G-T Head Count, Poverty Gap and

Severity Ratios

RES Regional Equation Systems

FSP Food Support Program SAPs Structural Adjustment Programs

GATT General Agreement on Tariffs and

Trade

SBP State Bank of Pakistan GTAP Global Trade Analysis Project SPS Sanitary and Phytosanitary

HIES Household Integrated Economic

Survey

SSA Systematic Sensitivity Analysis IMF International Monetary Fund TBT Technical Barriers to Trade

IRSA Indus River System Authority TRIM Trade Related Investment Measure LES Linear Expenditure System UR Uruguay Round

MFA Multi-Fibre Arrangement US United States

MFN Most Favoured Nation WTO World Trade Organisation

MHDC Mahbub ul Haq Human

Development Centre

STATEMENT OF ORIGINALITY

I declare that the contents of this thesis have not been previously submitted for a degree or diploma in any university To the best of my knowledge and belief, this thesis contains no material previously published or written by another person except where due references have been made in the thesis

Muhammad Shoaib Butt

May 2006

ACKNOWLEDGEMENTS

I would like to express my deepest respect and most sincere gratitude to my supervisors—Professor Tom Nguyen and Associate Professor Jay Bandaralage—for their support and encouragement, both in the fulfilment of this thesis and in developing my academic interests generally Their constructive criticism and comments from the initial conception

to the end of this work are highly appreciated I am greatly indebted to their assistance and understanding in matters of non-academic concern which have helped me endure some difficult times during my study period

My thanks and appreciation also go to my brother, Shahid Nazir Butt, and Mr Aftab Ahmad, Chief Executive, Aftec (Pvt.) Limited, for their help in the data collection process

I also owe many thanks to my friend Dr Tien Pham from the University of Queensland for very productive and thought-provoking discussions on various aspects of CGE modelling

SPECIAL ACKNOWLEDGEMENTS

A very special appreciation is due to my wife, Saima, not only for her constant encouragement but also for her patience and understanding throughout my PhD studies I deeply appreciate the loneliness she endured for so long I am also very grateful for her help in compiling the massive database of the model developed in this study and proofreading various drafts of the thesis This work would not have been possible without her love and support Finally, I am indebted to my son, Uns, who cannot comprehend why his dad had no time to play with him for such a long time Hopefully, he will be able to unravel this mystery sometime in the future

TABLE OF CONTENTS

ABSTRACT I

ACRONYMS AND ABBREVIATIONS II

STATEMENT OF ORIGINALITY III

ACKNOWLEDGEMENTS IV

LIST OF BOXES IX

LIST OF CHARTS X

LIST OF FIGURES XI

LIST OF TABLES XII

CHAPTER 1: INTRODUCTION 1

1.1: BACKGROUND 1

1.2: MOTIVATION 3

1.3: PURPOSE 5

1.4: SPECIFIC RESEARCH OBJECTIVES 5

1.5: OUTLINE OF STUDY 6

CHAPTER 2: POLITICAL SETUPS, TRADE REGIMES AND REGIONAL DISPARITIES 7

2.1: INTRODUCTION 7

2.2: ANALYTICAL REVIEW OF TRADE POLICIES UNDER DIFFERENT POLITICAL REGIMES 8

2.2.1: Bureaucracy-Led Ad-hoc Trade Policies—1947-52 8

2.2.2: Bureaucracy-Led Highly Protected Trade Regime—1952-59 9

2.2.3: Partial Trade Liberalisation under First Military Government—1959-71 13

2.2.3.1: Pre-War Period—1959-65 14

2.2.3.2: Post-War Period—1965-71 16

2.2.3.3: Whole Period—1959-71 18

2.2.4: Partial Trade Liberalisation under First Democratic Government—1971-77 19

2.2.5: Gradual Trade Liberalisation under Second Military Government—1977-88 21

2.2.6: Consistent and Gradual Trade Liberalisation by Four Democratic Governments under Structural Adjustment Programs—1988-99 25

2.2.7: Vigorous Trade Liberalisation under Third Military Government—October 1999 Onwards 29

2.2.8: Trade Policy Areas Requiring Further Reform 34

2.3: RATIONALE FOR A STUDY ON IMPACT OF TARIFF CUTS ON DOMESTIC INDUSTRY WITH PARTICULAR FOCUS ON EXPORTS 35

2.4: REGIONAL DISPARITIES 37

2.4.1: Regional Disparities Leading to Secession of East Pakistan 38

2.4.2: Brief Overview of Current Regions of Pakistan 39

2.4.3: Major Regional Conflicts 41

2.4.4: Analysis of Regional Socioeconomic Conditions 43

2.4.5: Poverty Reduction Strategy of Current Military Government 49

2.5: INTERACTIONS BETWEEN POLITICAL SETUPS AND REGIONAL DISPARITIES, AND RATIONALE FOR MODELLING IMPACT OF TARIFF CUTS ON REGIONAL DISPARITIES 50

2.6: CHAPTER SUMMARY 54

CHAPTER 3: RATIONALE FOR A NEW CGE STUDY ON PAKISTAN 57

3.1: INTRODUCTION 57

3.2: JUSTIFICATION FOR USING CGE MODELLING APPROACH 57

3.2.1: CGE Models versus Econometric Models 57

3.2.2: CGE Models verses I-O Models 59

3.3: SURVEY OF CGE STUDIES ON PAKISTAN 60

3.3.1: General Characteristics of CGE Studies on Pakistan 61

3.3.2: Structural Characteristics of CGE Studies on Pakistan 63

3.3.3: Critical Review of Major CGE Studies on Pakistan 64

3.3.3.1: Absence of Focus on Impact of Trade Liberalisation on Regional Disparities 64

3.3.3.2: Poor Quality of Limited Number of Studies on Regional Issues 65

3.3.3.3: Usage of Inadequate Databases 66

3.3.3.3.1: Absence of Pakistan in GTAP Database 66

3.3.3.3.2: Absence of Import Matrix in Database of Trade Liberalisation Studies 67

3.3.3.4: Need to Use Latest I-O Table for Pakistan 68

3.3.3.5: Highly Aggregated Industry and Export Results 68

3.3.3.6: Lack of Explicit Information on Model Closures 69

3.3.3.7: Little Focus on Sensitivity Analysis 69

3.3.3.8: Repetitive Applications of a Single Model to Analyse Trade Liberalisation 69

3.3.3.9: Contradictory Results of Some Studies on Trade Liberalisation 71

3.4: SALIENT FEATURES OF PROPOSED CGE STUDY IN LIGHT OF LITERATURE REVIEW 71

3.5: CHAPTER SUMMARY 72

CHAPTER 4: STRUCTURE OF DATABASE AND MODEL 74

4.1: INTRODUCTION 74

4.2: STRUCTURE OF DATABASE OF MODEL (PAKREG) 74

4.2.1: Main Database of Core Model 75

4.2.2: Parameters Required by Core Model 77

4.2.3: Database of Regional Extension 78

4.3: THEORETICAL STRUCTURE OF CORE MODEL 78

4.3.1: Dimensions of Model 80

4.3.2: Variables 83

4.3.3: Coefficients 84

4.3.4.: Equations of Model 85

4.3.4.1: Structure of Production 86

4.3.4.2: Demands for Primary Factors 88

4.3.4.3: Demands for Intermediate Inputs 89

4.3.4.4: Top Nest of Industry Input Demands, and Industry Output 90

4.3.4.5: Demands for Investment 91

4.3.4.6: Household Demands 92

4.3.4.7: Export Demands 95

4.3.4.8: Government and Inventory Demands 95

4.3.4.9: Demands for Margin 96

4.3.4.10: Market-Clearing Equations 96

4.3.4.11: Price System 98

4.3.4.12: Indirect Taxes 99

4.3.4.13: Trade Balance and other Aggregates 99

4.3.4.14: Investment Allocation 100

4.3.4.15: Labour Market—Wage Setting Equation and Average Wage 101

4.3.4.16: Miscellaneous Equations 101

4.4: THEORETICAL STRUCTURE OF REGIONAL APPROACH OF PAKREG 103

4.4.1 Selection of Most Appropriate Regional Modelling Approach 103

4.4.1.1 Tops-Down Approach 103

4.4.1.2 Bottoms-Up Approach 106

4.4.1.3 Selection of Tops-Down Approach 108

4.4.2 Dimensions of Regional Extension of PAKREG 110

4.4.3: Variables and Coefficients 111

4.4.4: Equations of Tops-Down Regional Extension 112

4.4.4.1: Direct Demands by each Region 112

4.4.4.2: Demand for Margin 113

4.4.4.3: Determining Regional Share Variables 114

4.4.4.4: Three Constraints 115

4.4.4.5: Regional Wage Bills and Matrix of Contributions 116

4.4.4.6: Regional Advantage Matrix 116

4.5: CLOSURES OF MODEL 117

4.5.1: Short-Run Closure 118

4.5.2: Long-Run Closure 120

4.6: CHAPTER SUMMARY 122

CHAPTER 5: CONSTRUCTION OF DATABASE 124

5.1: INTRODUCTION 124

5.2: OUTLINE OF REQUIRED DATABASE 125

5.3 CONSTRUCTION OF DATABASE OF CORE MODEL 128

5.3.1: Primary Source of Database: I-O Table of Pakistan 1990-91 128

5.3.2: Systematic Construction of I-O Data Matrices 131

5.3.2.1: Construction of Import Matrix 1990-91 141

5.3.2.1.1: Reconciliation of Classifications of I-O Table 1990-91 and Import-Matrix 1983-84 141

5.3.2.1.2: Splitting Imports between Intermediate Usage and Final Demand 142

5.3.2.1.3: Disaggregation of Final Demand 144

5.3.2.1.4: Intermediate Usage Matrix 144

5.3.2.1.5: Refining Import Matrix Using I-O Table 1990-91 146

5.3.2.1.6: Refining Intermediate Usage of Import Matrix Using Census of Manufacturing Industries and RAS 147

5.3.2.2: Implementation of PAK.TAB to Produce I-O Matrices 148

5.3.2.2.1: Construction of Vectors of Primary Factors 148

5.3.2.2.2: Construction of Indirect Tax Matrices and Conversion of Data from Producers’ Prices to Basic Prices 149

5.3.2.2.3: Construction of Margin Matrices 149

5.3.2.2.4: Construction of Capital Formation Matrices 150

5.3.2.2.4.1: First version of capital formation matrices 150

5.3.2.2.4.2: Final version of capital formation matrices 150

5.3.2.2.5: Construction of MAKE Matrix 151

5.3.2.2.6: Construction of Remaining Matrices at Basic Prices 152

5.3.3: Elasticities and Parameters 152

5.3.3.1: Estimation of Frisch Parameter 152

5.3.3.2: Allocation of Exports to ‘Main/Individual Exports’ and ‘Collective Exports’ 153

5.3.3.3: Estimates of Elasticities 155

5.4: CONSTRUCTION OF DATABASE OF REGIONAL EXTENSION 158

5.4.1: Allocation of Commodities/Industries to National and Local Groups 159

5.4.2: Regional Industry Output Shares 160

5.4.3: Regional Industry Investment Shares 164

5.4.4: Regional Commodity Consumption Shares 165

5.4.4.1: Regional Consumption Shares Based on Original Data 165

5.4.4.2: Regional Consumption Shares Based on Proxies 166

5.4.5: Regional Commodity Export Shares 166

5.4.6: Regional Government Expenditure Shares 167

5.4.7: Regional Commodity Inventory Shares 171

5.5: CHAPTER SUMMARY 171

CHAPTER 6: APPLICATION OF MODEL 174

6.1: INTRODUCTION 174

6.2: SIMULATIONS AND CLOSURES 175

6.3: NATIONAL RESULTS 177

6.3.1: Macroeconomic Results 177

6.3.1.1: Short-Run 177

6.3.1.2: Long-Run 181

6.3.2: Industry Results 184

6.3.2.1: Impact of Tariff Cuts on Imports 186

6.3.2.1.1: Short-Run 186

6.3.2.1.2: Long-Run 192

6.3.2.2: Impact of Tariff Cuts on Domestic Industry Costs 196

6.3.2.2.1: Short-Run 196

6.3.2.2.2: Long-Run 201

6.3.2.3: Impact of Tariff Cuts on Domestic Industry Output 206

6.3.2.3.1: Short-Run 206

6.3.2.3.2: Long-Run 214

6.3.2.4: Impact of Tariff Cuts on Domestic Industry Employment 224

6.3.2.4.1: Short-Run 224

6.3.2.4.2: Long-Run 228

6.4: REGIONAL RESULTS 233

6.4.1: Macroeconomic Results—Short-Run and Long-Run 234

6.4.2: Industry Results 236

6.4.2.1: Impact of Tariff Cuts on Regional Output 236

6.4.2.1.1: Short-Run 237

6.4.2.1.1.1: Local industry output 237

6.4.2.1.1.2: Determinants of each region’s growth relative to national growth 241

6.4.2.1.2: Long-Run 245

6.4.2.1.2.1: Local industry output 245

6.4.2.1.2.2: Determinants of each region’s growth relative to national growth 248

6.4.2.2: Impact of Tariff Cuts on Regional Industry Employment 251

6.4.2.2.1: Short-Run 251

6.4.2.2.2: Long-Run 257

6.5: SYSTEMATIC SENSITIVITY ANALYSIS 260

6.6: CHAPTER SUMMARY 264

CHAPTER 7: CONCLUSION 270

7.1: INTRODUCTION 270

7.2: SUMMARY OF MAIN FINDINGS 270

7.3: POLICY IMPLICATIONS 275

7.4: OTHER POSSIBLE APPLICATIONS OF MODEL 277

7.4.1: Removal of Tariffs on Cement, Sugar, Livestock and Vegetables 277

7.4.2: Revenue-Neutral Tariff-Cuts 277

7.4.3: Structural Adjustment Programs 277

7.5: LIMITATIONS AND FUTURE RESEARCH 278

7.5.1: Linkage between Political Setups and Regional Disparities 278

7.5.2: Database of Model 278

7.5.3: Theoretical Structure of Model 279

7.6: CONCLUDING REMARKS 279

APPENDICES 281

APPENDIX 2.1: TRADE POLICIES 1947-2005: SELECTED TOPICS 281

APPENDIX 2.2: FOREIGN INVESTMENT POLICY AND PRIVATISATION PROCESS 1988-2005 282 APPENDIX 2.3: MAIN REGIONAL CONFLICTS OF PAKISTAN 284

APPENDIX 3.1: CGE STUDIES ON PAKISTAN 287

APPENDIX 4.1: VARIABLES AND COEFFICIENTS OF PAKREG 301

APPENDIX 4.2: UPDATE STATEMENTS AND FORMULAS OF PAKREG 313

APPENDIX 4.3: MISCELLANEOUS EQUATIONS IN CORE MODEL 315

APPENDIX 5.1: CONVERSION OF I-O TABLE 1990-91 FROM PURCHASERS’ TO PRODUCERS’ PRICES 317

APPENDIX 5.2: INPUT DATA FOR TABLO PROGRAM PAK.TAB (I-O TABLE 1990-91 AT PRODUCERS’ PRICES AND IMPORT MATRIX 1990-91) 322

APPENDIX 5.3: SPLITTING ‘GOVERNMENT SERVICES’ SECTOR OF IMPORT MATRIX 1983-84 INTO THREE SECTORS 344

APPENDIX 5.4: CLASSIFICATIONS AND ABBREVIATIONS 346

APPENDIX 5.5: EXPLANATION OF TABLO CODE OF PAK.TAB 354

APPENDIX 5.6: REFINEMENT OF CAPITAL FORMATION AND ASSOCIATED INDIRECT TAX AND MARGIN MATRICES 365

APPENDIX 5.7: REGIONAL INDUSTRY OUTPUT SHARES 368

APPENDIX 5.8: REGIONAL INDUSTRY INVESTMENT SHARES 372

APPENDIX 5.9: REGIONAL COMMODITY CONSUMPTION SHARES 375

APPENDIX 5.10: REGIONAL COMMODITY EXPORT SHARES 379

APPENDIX 5.11: REGIONAL GOVERNMENT EXPENDITURE SHARES 380

APPENDIX 5.12: REGIONAL INVENTORY SHARES 387

APPENDIX 6.1: DATA UNDERLYING TABLES AND CHARTS IN CHAPTER 6 390

APPENDIX 6.2: PRIMARY FACTOR DEMAND AND EMPLOYMENT IN SHORT-RUN 402

APPENDIX 6.3: ROLE OF NATIONAL INDUSTRIES IN SHAPING REGIONAL ADVANTAGES 403

REFERENCES 407

LIST OF BOXES

B OX 4.1: M AIN B LOCKS OF E QUATIONS IN C ORE M ODEL 85

B OX A2.1 A : E XPORT B ONUS S CHEME 281

B OX A2.1 B : E CONOMIC G ROWTH AND P OVERTY D URING A YUB R EGIME 281

B OX A2.2 A : F OREIGN I NVESTMENT P OLICY OF P AKISTAN 1988-2005 282

B OX A2.2 B : P RIVATISATION P OLICY OF P AKISTAN 1988-2005 283

B OX A4.1 A : C OEFFICIENTS C ALCULATED U SING ‘F ORMULA ’ S TATEMENTS IN C ORE M ODEL ( IN O RDER OF A PPEARANCE ) 307

B OX A4.1 B : C OEFFICIENTS C ALCULATED U SING ‘F ORMULA ’ S TATEMENTS IN R EGIONAL E XTENSION ( IN O RDER OF A PPEARANCE ) 312

B OX A4.2 A : U PDATE S TATEMENTS AND F ORMULAS IN C ORE M ODEL ( IN O RDER OF A PPEARANCE ) 313

B OX A4.2 B : U PDATE S TATEMENTS IN R EGIONAL E XTENSION ( IN O RDER OF A PPEARANCE ) 314

B OX A5.6 A : DAGG I NPUT F ILE TO S PLIT I MPROVED C APITAL F ORMATION M ATRICES INTO B ASIC , M ARGIN AND T AX M ATRICES 367

B OX A6.3 A : I MPACT OF N ATIONAL I NDUSTRIES ON R EGIONAL A DVANTAGES IN S HORT -R UN —B ASED ON T ABLE 6.12 IN M AIN B ODY OF S TUDY 403

B OX A6.3 B : I MPACT OF N ATIONAL I NDUSTRIES ON R EGIONAL A DVANTAGES IN L ONG -R UN —B ASED ON T ABLE 6.14 IN M AIN B ODY OF S TUDY 405

LIST OF CHARTS

C HART 2.1: S HARE OF P AKISTAN ’ S M AJOR E XPORTS IN T OTAL E XPORTS —1970-2002 33

C HART 2.2: A VERAGE A NNUAL R EAL O UTPUT G ROWTH R ATES (1981-98) 45

C HART 2.3: L ITERACY R ATES OF P OPULATION A GED 10 AND O VER 45

C HART 2.4: S CHOOLS WITH N O C LASSES BEING H ELD AS % OF T OTAL S CHOOLS IN 1998-99 45

C HART 2.5: A CCESS TO P UBLIC OR P RIVATE H EALTH F ACILITIES IN R URAL A REAS —1998-99 45

C HART 2.6: P ER C APITA D ISBURSEMENTS FROM S OCIAL S ECURITY P ROGRAMS IN 2000-01 (R S ) 49

C HART 6.1 A : I MPACT OF T ARIFF C UTS ( T 0 IMP = P 0 IMP ) ON I MPORTS ( X 0 IMP ) IN S HORT -R UN —T HREE S ECTORS OF E CONOMY 191

C HART 6.1 B : I MPACT OF T ARIFF C UTS ( T 0 IMP = P 0 IMP ) ON I MPORTS ( X 0 IMP ) IN S HORT -R UN —S ORTED BY % I NCREASE IN I MPORTS 191

C HART 6.2 A : I MPACT OF T ARIFF C UTS ( T 0 IMP = P 0 IMP ) ON I MPORTS ( X 0 IMP ) IN L ONG -R UN —T HREE S ECTORS OF E CONOMY 195

C HART 6.2 B : I MPACT OF T ARIFF C UTS ( T 0 IMP = P 0 IMP ) ON I MPORTS ( X 0 IMP ) IN L ONG -R UN —S ORTED BY % I NCREASE IN I MPORTS 195

C HART 6.3 A : I MPACT OF T ARIFF C UTS ON S HORT -R UN V ARIABLE C OSTS ( P 1 VAR ) OF D OMESTIC I NDUSTRIES —T HREE S ECTORS OF E CONOMY 200

C HART 6.3 B : I MPACT OF T ARIFF C UTS ON S HORT -R UN V ARIABLE C OSTS ( P 1 VAR )—A BOVE -A VERAGE AND B ELOW -A VERAGE R EDUCTION IN C OSTS 200

C HART 6.4 A : I MPACT OF T ARIFF C UTS ON I NDEX OF P RODUCTION C OSTS IN L ONG -R UN —T HREE S ECTORS OF E CONOMY 205

C HART 6.4 B : I MPACT OF T ARIFF C UTS ON I NDEX OF P RODUCTION C OSTS IN L ONG -R UN —S ORTED BY D ECREASE IN I NDEX OF P RODUCTION C OSTS 205

C HART 6.5 A : I MPACT OF T ARIFF C UTS ON I NDUSTRY /C OMMODITY O UTPUT ( X 1 TOT / X 0 COM ) IN S HORT -R UN —T HREE S ECTORS OF E CONOMY 213

C HART 6.5 B : I MPACT OF T ARIFF C UTS ON I NDUSTRY /C OMMODITY O UTPUT ( X 1 TOT / X 0 COM ) IN S HORT -R UN —S ORTED BY % I NCREASE IN O UTPUT 213

C HART 6.6 A : I MPACT OF T ARIFF C UTS ON I NDUSTRY /C OMMODITY O UTPUT ( X 1 TOT / X 0 COM ) IN L ONG -R UN —T HREE S ECTORS OF E CONOMY 223

C HART 6.6 B : I MPACT OF T ARIFF C UTS ON I NDUSTRY /C OMMODITY O UTPUT ( X 1 TOT / X 0 COM ) IN L ONG -R UN —S ORTED BY % I NCREASE IN O UTPUT 223

C HART 6.7 A : I MPACT OF T ARIFF C UTS ON I NDUSTRY E MPLOYMENT ( EMPLOY ) IN S HORT -R UN —T HREE S ECTORS OF E CONOMY 227

C HART 6.7 B : I MPACT OF T ARIFF C UTS ON I NDUSTRY E MPLOYMENT ( EMPLOY ) IN S HORT -R UN —S ORTED BY % I NCREASE IN E MPLOYMENT 227

C HART 6.8 A : I MPACT OF T ARIFF C UTS ON I NDUSTRY E MPLOYMENT ( EMPLOY ) IN L ONG -R UN —T HREE S ECTORS OF E CONOMY 232

C HART 6.8 B : I MPACT OF T ARIFF C UTS ON I NDUSTRY E MPLOYMENT ( EMPLOY ) IN L ONG -R UN —S ORTED BY % I NCREASE IN E MPLOYMENT 232

C HART 6.9 A : R EGIONAL O UTPUT ( REGX 1 TOT ) OF L OCAL I NDUSTRIES IN S HORT -R UN —S ORTED BY I NCREASE IN N ATIONAL I NDUSTRY O UTPUT ( X 1 TOT ) 240

C HART 6.9 B : C HANGE IN R EGIONAL O UTPUT ( REGX 1 TOT ) OF L OCAL I NDUSTRIES R ELATIVE TO O UTPUT C HANGE AT N ATIONAL L EVEL IN S HORT -R UN 240

C HART 6.10 A : R EGIONAL O UTPUT ( REGX 1 TOT ) OF L OCAL I NDUSTRIES IN L ONG -R UN —S ORTED BY I NCREASE IN N ATIONAL I NDUSTRY O UTPUT ( X 1 TOT ) 247

C HART 6.10 B : C HANGE IN R EGIONAL O UTPUT ( REGX 1 TOT ) OF L OCAL I NDUSTRIES R ELATIVE TO O UTPUT C HANGE AT N ATIONAL L EVEL IN L ONG -R UN 247

C HART 6.11: C ONTRIBUTIONS TO T OTAL R EGIONAL E MPLOYMENT OF E ACH I NDUSTRY ( REGEMPLOYCON ) IN S HORT -R UN 256

C HART 6.12: C ONTRIBUTIONS TO T OTAL R EGIONAL E MPLOYMENT OF E ACH I NDUSTRY ( REGEMPLOYCON ) IN L ONG -R UN 256

LIST OF FIGURES

F IGURE 4.1 A : S TRUCTURE OF M AIN D ATABASE OF P AKREG —A BSORPTION M ATRIX 76

F IGURE 4.1 B : S TRUCTURE OF M AIN D ATABASE OF P AKREG —P RODUCTION AND I MPORT D UTY M ATRICES 76

F IGURE 4.2: S TRUCTURE OF P RODUCTION 87

F IGURE 4.3: S TRUCTURE OF I NVESTMENT D EMAND 92

F IGURE 4.4: S TRUCTURE OF H OUSEHOLD D EMAND 94

F IGURE 5.1 A : S UMMARY OF M ODEL ’ S D ATABASE 127

F IGURE 5.1 B : E XPLANATION OF S UBSCRIPTS AND S YMBOLS U SED IN F IGURE 5.1 A 127

F IGURE 5.2: C ONVERTING I-O T ABLE 1990-91 INTO S TANDARD D ATABASE OF C ORE M ODEL 133

F IGURE 5.3: M APPING OF 10 S ECTORS IN T ABLE 5.8 B TO 59 COMMODITIES IN I-O D ATABASE 170

F IGURE 6.1: M ACROECONOMIC I MPACT OF T ARIFF C UTS IN S HORT -R UN 180

F IGURE 6.2: M ACROECONOMIC I MPACT OF T ARIFF C UTS IN L ONG -R UN 180

LIST OF TABLES

T ABLE 2.1: K EY E CONOMIC AND S OCIOECONOMIC I NDICATORS OF P AKISTAN —1949 TO 2005 10

T ABLE 2.2: T ARIFF R ATES D URING 1956-60 AND 1960-64 12

T ABLE 2.3: T ARIFF R ATES FROM E ARLY 1980 S TO 2003-04 23

T ABLE 2.4: T ARIFF B INDING C OVERAGE AND A VERAGE B OUND AND A PPLIED T ARIFFS IN 2004 31

T ABLE 2.5: A REAS OF T RADE P OLICY R EQUIRING F URTHER R EFORM 35

T ABLE 2.6: P OPULATION , A REA AND P OPULATION D ENSITY (1998 C ENSUS ) 40

T ABLE 2.7: I NEQUALITY AND P OVERTY IN F OUR R EGIONS OF P AKISTAN 47

T ABLE 2.8: E CONOMIC G ROWTH AND C HANGE IN I NCIDENCE OF P OVERTY —H EAD C OUNTS 52

T ABLE 3.1: CGE M ODELS VERSUS E CONOMETRIC M ODELS 58

T ABLE 3.2: CGE M ODELS VERSUS I-O M ODELS 60

T ABLE 3.3: M AJOR S URVEYS OF CGE M ODELS 61

T ABLE 3.4: CGE M ODELS OF A USTRALIAN (ORANI) T RADITION AND US T RADITION 70

T ABLE 4.1: C OMPONENTS OF S ETS L ISTED IN E XCERPT 1 OF M AIN P ART OF PAKREG 82

T ABLE 4.2: S YNOPSIS OF R EMAINING E QUATIONS IN THE C ORE M ODEL 102

T ABLE 4.3: E LEMENTS OF S ETS IN E XCERPT 1 OF R EGIONAL E XTENSION OF PAKREG 111

T ABLE 4.4: S HORT -R UN C LOSURE FOR PAKREG 119

T ABLE 4.5: L ONG -R UN C LOSURE FOR PAKREG 121

T ABLE 5.1: A GGREGATED I-O T ABLE OF P AKISTAN 1990-91 AT P URCHASERS ’ P RICES WITH I NDIRECT A LLOCATION OF I MPORTS (R S MILLION ) 130

T ABLE 5.2 A : L AYOUT OF I NPUT D ATA FOR PAK.TAB—I-O T ABLE 1990-91 AT P RODUCERS ’ P RICES WITH D IRECT A LLOCATION OF D UTY -P AID I MPORTS I NCLUSIVE OF I NDIRECT T AXES ON THEIR S ALES 139

T ABLE 5.2 B : L AYOUT OF I NPUT D ATA FOR PAK.TAB—I MPORT M ATRIX 1990-91 (D UTY -P AID I MPORTS I NCLUSIVE OF I NDIRECT T AXES ON THEIR S ALES ) 139

T ABLE 5.3: O UTPUT S HARES OF M AJOR E CONOMIC S ECTORS IN P AKISTAN (%) 145

T ABLE 5.4: R ATIO OF E XPORTS TO O UTPUT (1990-91) IN D ESCENDING O RDER 154

T ABLE 5.5: E STIMATES OF R EQUIRED E LASTICITIES 157

T ABLE 5.6: N ATIONAL AND L OCAL C OMMODITIES /I NDUSTRIES 160

T ABLE 5.7: C ONSTRUCTION OF R EGIONAL I NDUSTRY O UTPUT S HARES 162

T ABLE 5.8 A : G OVERNMENT R EGIONAL E XPENDITURE IN 1990-91 (R S MILLION ) 168

T ABLE 5.8 B : G OVERNMENT N ATIONAL D EVELOPMENT E XPENDITURE BY S ECTOR 168

T ABLE 6.1: M ACROECONOMIC I MPACT OF T ARIFF C UTS —S HORT -R UN AND L ONG -R UN 181

T ABLE 6.2: S UMMARISED I MPACT OF T ARIFF C UTS ON I MPORTS IN S HORT -R UN 188

T ABLE 6.3: S UMMARISED I MPACT OF T ARIFF C UTS ON I MPORTS IN L ONG -R UN 193

T ABLE 6.4: S UMMARISED I MPACT OF T ARIFF C UTS ON S HORT -R UN V ARIABLE C OSTS OF D OMESTIC I NDUSTRIES 198

T ABLE 6.5: S UMMARISED I MPACT OF T ARIFF C UTS ON I NDEX OF P RODUCTION C OSTS IN L ONG -R UN 203

T ABLE 6.6: S UMMARY OF F AN D ECOMPOSITION AND S ALES D ECOMPOSITION OF I NDUSTRY /C OMMODITY O UTPUT ( X 1 TOT / X 0 COM ) IN S HORT -R UN 208

T ABLE 6.7: S UMMARY OF F AN D ECOMPOSITION AND S ALES D ECOMPOSITION OF I NDUSTRY /C OMMODITY O UTPUT ( X 1 TOT / X 0 COM ) IN L ONG -R UN 216

T ABLE 6.8: S UMMARISED I MPACT OF T ARIFF C UTS ON D OMESTIC I NDUSTRY E MPLOYMENT IN S HORT -R UN 226

T ABLE 6.9: S UMMARISED I MPACT OF T ARIFF C UTS ON D OMESTIC I NDUSTRY E MPLOYMENT IN L ONG -R UN 229

T ABLE 6.10: R EGIONAL M ACRO R ESULTS —S HORT -R UN AND L ONG -R UN 235

T ABLE 6.11: R EGIONAL O UTPUT OF L OCAL I NDUSTRIES IN S HORT -R UN —S ORTED BY I NCREASE IN O UTPUT OF C ORRESPONDING N ATIONAL I NDUSTRIES 238

T ABLE 6.12: R EGIONAL A DVANTAGE M ATRIX IN S HORT -R UN 242

T ABLE 6.13: R EGIONAL O UTPUT OF L OCAL I NDUSTRIES IN L ONG -R UN —S ORTED BY I NCREASE IN O UTPUT OF C ORRESPONDING N ATIONAL I NDUSTRIES 246

T ABLE 6.14: R EGIONAL A DVANTAGE M ATRIX IN L ONG -R UN 249

T ABLE 6.15: I NDUSTRY C ONTRIBUTIONS TO R EGIONAL E MPLOYMENT IN S HORT -R UN 253

T ABLE 6.16: I NDUSTRY C ONTRIBUTIONS TO R EGIONAL E MPLOYMENT IN L ONG -R UN 258

T ABLE 6.17: S YSTEMATIC S ENSITIVITY A NALYSIS OF K EY E LASTICITY P ARAMETERS 263

T ABLE A3.1 A : S UMMARY OF CGE S TUDIES ON P AKISTAN 287

T ABLE A4.1 A : V ARIABLES IN C ORE M ODEL ( IN A LPHABETICAL O RDER ) 301

T ABLE A4.1 B : C OEFFICIENTS IN C ORE M ODEL ( IN A LPHABETICAL O RDER ) 304

T ABLE A4.1 C : V ARIABLES IN R EGIONAL E XTENSION ( IN A LPHABETICAL O RDER ) 306

T ABLE A4.1 D : C OEFFICIENTS IN R EGIONAL E XTENSION ( IN A LPHABETICAL O RDER ) 307

T ABLE A4.3 A : R EMAINING E QUATIONS IN C ORE M ODEL 315

T ABLE A5.1 A : A GGREGATED 4-S ECTOR I-O T ABLE 1990-91 AT P URCHASERS ’ P RICES WITH D IRECT A LLOCATION OF I MPORTS PLUS I MPORT D UTIES IN THE FORM OF A R OW AS PER F IGURE 5.2: B OX 8 (R S MILLION ) 319

T ABLE A5.1 B : A GGREGATED M ARGIN ON S ALES OF C OMMODITIES TO A LL U SERS (R S MILLION ) 320

T ABLE A5.1 C : M ARGIN ON P URCHASES M ATRIX (R S MILLION ) 320

T ABLE A5.1 D : A GGREGATED 4-S ECTOR I-O T ABLE 1990-91 AT P RODUCERS ’ P RICES WITH D IRECT A LLOCATION OF I MPORTS PLUS I MPORT D UTIES IN THE FORM OF A R OW AS PER F IGURE 5.2: B OX 10 (R S MILLION ) 321

T ABLE A5.2 A : I NPUT D ATA FOR PAK.TAB—60-S ECTOR I-O T ABLE 1990-91 AT P RODUCERS ’ P RICES WITH D IRECT A LLOCATION OF D UTY -P AID I MPORTS I NCLUSIVE OF A SSOCIATED I NDIRECT T AX AS A S INGLE ROW , AS PER T ABLE 5.2 A IN C HAPTER 5 (R S MILLION ) 322

T ABLE A5.2 B : I NPUT D ATA FOR PAK.TAB—I MPORT M ATRIX 1990-91 I NCLUDING I MPORT D UTY AND I NDIRECT T AXES ON S ALES , AS

PER T ABLE 5.2 B IN C HAPTER 5 (R S MILLION ) 333

T ABLE A5.3 A : R ELEVANT E NTRIES FROM I NTERMEDIATE U SAGE AND F INAL D EMAND C OLUMNS OF 118-S ECTOR I MPORT M ATRIX 1983-84 (R S ‘000’) 344

T ABLE A5.3 B : R ELEVANT E NTRIES FROM I NTERMEDIATE U SAGE AND F INAL D EMAND C OLUMNS OF 82-S ECTOR I-O T ABLE 1990-91 (R S MILLION ) 345

T ABLE A5.3 C : S HARES OF C OMMODITY U SAGE BY 3 P UBLIC S ECTORS IN T ABLE A5.3 B (%) 345

T ABLE A5.3 D : I MPORT M ATRIX 1983-84—D ISAGGREGATION OF ‘G OVERNMENT S ERVICES ’ INTO T HREE S ECTORS (R S ‘000’) 345

T ABLE A5.4 A : C LASSIFICATION OF C OMMODITY /I NDUSTRY N AMES IN 82-S ECTOR I-O T ABLE 1990-91 346

T ABLE A5.4 B : C LASSIFICATION OF C OMMODITY /I NDUSTRY N AMES IN 120-S ECTOR I MPORT M ATRIX 1983-84 347

T ABLE A5.4 C : C ONDENSING 82-S ECTOR I-O T ABLE 1990-91 AND 120-S ECTOR I MPORT M ATRIX 1983-84 INTO 60 S ECTORS —U SING PSIC AND PSTC 348

T ABLE A5.4 D : E XPLANATION OF C ODE N AMES OF C OMMODITIES /I NDUSTRIES IN C ONDENSED 60-S ECTOR I-O T ABLE 1990-91 AND I MPORT M ATRIX 1990-91—D ATABASE OF PAKREG 350

T ABLE A5.4 E : C LASSIFICATION OF C ONSUMER G OODS AND C APITAL G OODS IN 60-S ECTOR I-O T ABLE 1990-91 AND I MPORT M ATRIX 1990-91 351

T ABLE A5.4 F : S YNCHRONISING THE C LASSIFICATIONS OF CMI 1990-91 WITH 35 M ANUFACTURING I NDUSTRIES IN 60-S ECTOR I-O T ABLE 1990-91 352

T ABLE A5.7 A : C OMPUTATION OF R EGIONAL I NDUSTRY O UTPUT S HARES OF 6 C RP O TR 368

T ABLE A5.7 B : C OMPUTATION OF R EGIONAL I NDUSTRY O UTPUT S HARES OF 7 C RP P ULS AG RAM 369

T ABLE A5.7 C : C OMPUTATION OF R EGIONAL I NDUSTRY O UTPUT S HARES OF 8 C RP O IL S EEDS 370

T ABLE A5.7 D : C OMPUTATION OF R EGIONAL I NDUSTRY O UTPUT S HARES OF 9 L IVESTOCK 370

T ABLE A5.7 E : R EGIONAL I NDUSTRY O UTPUT S HARES 371

T ABLE A5.8 A : C ONSTRUCTION OF R EGIONAL I NDUSTRY I NVESTMENT S HARES 372

T ABLE A5.8 B : R EGIONAL I NDUSTRY I NVESTMENT S HARES 374

T ABLE A5.9 A : C ONSTRUCTION OF R EGIONAL C OMMODITY C ONSUMPTION S HARES 375

T ABLE A5.9 B : R EGIONAL C ONSUMPTION S HARES OF F OUR C OMMODITIES WITH R EADILY A VAILABLE D ATA 376

T ABLE A5.9 C : P ER C APITA M ONTHLY C ONSUMPTION OF 26 C OMMODITIES IN EACH R EGION IN 1990-91 (R UPEES )—A VAILABLE IN HIES 1990-91 377

T ABLE A5.9 D : R EGIONAL P OPULATION ‘000’ 377

T ABLE A5.9 E : P ER C APITA R EGIONAL M ONTHLY C ONSUMPTION IN A GGREGATED F ORM —A VAILABLE IN HIES 1990-91 (R UPEES ) 377

T ABLE A5.9 F : R EGIONAL C OMMODITY C ONSUMPTION S HARES 378

T ABLE A5.10 A : R EGIONAL C OMMODITY E XPORT S HARES 379

T ABLE A5.11 A : C ONSTRUCTION OF R EGIONAL G OVERNMENT S HARES 380

T ABLE A5.11 B : G OVERNMENT E XPENDITURE S HARES IN L IVESTOCK (9 L IVESTOCK ) 382

T ABLE A5.11 C : A LLOCATION OF D EVELOPMENT E XPENDITURE TO 59 C OMMODITIES IN E ACH R EGION (R S MILLION ) 383

T ABLE A5.11 D : A LLOCATION OF N ON -D EVELOPMENT E XPENDITURE TO 59 C OMMODITIES IN E ACH R EGION (R S MILLION ) 384

T ABLE A5.11 E : A LLOCATION OF D EVELOPMENT PLUS N ON -D EVELOPMENT E XPENDITURE TO 59 C OMMODITIES IN E ACH R EGION (R S MILLION ) 385

T ABLE A5.11 F : R EGIONAL G OVERNMENT E XPENDITURE S HARES 386

T ABLE A5.12 A : C ONSTRUCTION OF R EGIONAL C OMMODITY I NVENTORY S HARES 387

T ABLE A5.12 B : R EGIONAL I NVENTORY S HARES 389

T ABLE A6.1 A : I MPACT OF T ARIFF C UTS ON I MPORTS IN S HORT -R UN 390

T ABLE A6.1 B : I MPACT OF T ARIFF C UTS ON I MPORTS IN L ONG -R UN 391

T ABLE A6.1 C : I MPACT OF T ARIFF C UTS ON S HORT -R UN V ARIABLE C OSTS OF D OMESTIC I NDUSTRIES 392

T ABLE A6.1 D : I MPACT OF T ARIFF C UTS ON I NDEX OF P RODUCTION C OSTS IN L ONG -R UN 393

T ABLE A6.1 E : S UMMARY OF F AN D ECOMPOSITION AND S ALES D ECOMPOSITION OF I NDUSTRY /C OMMODITY O UTPUT ( X 1 TOT / X 0 COM ) IN S HORT -R UN 394

T ABLE A6.1 F : S UMMARY OF F AN D ECOMPOSITION AND S ALES D ECOMPOSITION OF I NDUSTRY /C OMMODITY O UTPUT ( X 1 TOT / X 0 COM ) IN L ONG -R UN 395

T ABLE A6.1 G : I MPACT OF T ARIFF C UTS ON D OMESTIC I NDUSTRY E MPLOYMENT IN S HORT -R UN 396

T ABLE A6.1 H : I MPACT OF T ARIFF C UTS ON D OMESTIC I NDUSTRY E MPLOYMENT IN L ONG -R UN 397

T ABLE A6.1 I : R EGIONAL O UTPUT BY I NDUSTRY IN S HORT -R UN 398

T ABLE A6.1 J : R EGIONAL O UTPUT BY I NDUSTRY IN L ONG -R UN 399

T ABLE A6.1 K : E MPLOYMENT G ROWTH BY I NDUSTRY AND R EGION IN S HORT -R UN 400

T ABLE A6.1 L : E MPLOYMENT G ROWTH BY I NDUSTRY AND R EGION IN L ONG -R UN 401

1

CHAPTER 1: INTRODUCTION

1.1: BACKGROUND

The history of Pakistan’s political and trade regimes, and the associated regional disparities and conflicts, makes it an interesting case-study During the first 40 years after independence (1947-87) the country pursued a generally protectionist approach to international trade policy, despite trade liberalisation measures sporadically introduced

by different governments at different points in time More recently, in common with other major South Asian economies—particularly India, Bangladesh and Nepal—Pakistan has undertaken concrete and consistent steps toward trade liberalisation and global economic integration since the late 1980s.1

Successive governments in Pakistan have pursued this strategy under a series of structural adjustment programs (SAPs) arranged with the International Monetary Fund (IMF) and the World Bank since 1988 While these SAPs have encompassed many other areas of trade (and, more generally, of economic) policy, across-the-board tariff reductions have been a key ingredient As a result, the maximum tariff rate has dropped from 225 per cent in 1986-87 to 16.5 per cent in 2003-04 (see Chapter 2) The pace of trade liberalisation has accelerated considerably under the current military government, which ousted the last democratic government in October 1999

Pakistan has also actively participated in the Uruguay Round (UR) of trade negotiations, during which the textile and clothing sector, Pakistan’s main exporting sector, has featured prominently While the phasing out of textiles and clothing quotas under the Multi-Fibre Arrangement (MFA)2 on 1 January 2005 has provided Pakistan with a golden opportunity to increase market access for its major exports, heightened competition from the other main exporters of textile and clothing products (in particular, China and India) has posed serious challenges to the country’s main export industries

1 The World Bank (2004) argues that the primary motive for the trade liberalisation that has occurred in the South Asian countries was the belated recognition that they had missed out on the spectacular export-oriented economic growth that had benefited East Asian and South East Asian developing countries since the 1960s

2 The MFA was a framework for bilateral agreements or unilateral actions that established quotas limiting imports of textiles and clothing into countries whose domestic industries were facing serious damage from rapidly increasing imports Since 1995, the World Trade Organisation’s (WTO’s) Agreement on Textiles and Clothing (ATC) took over from the MFA By 1 January 2005, the sector was fully integrated into normal General Agreement on Tariffs and Trade (GATT) rules and the ACT ceased to exist (WTO, 2005) As a result, textiles and clothing quotas have come to an end, and importing countries are no longer able to discriminate between exporters

These developments in trade and economic policy have occurred against a background

of conflicts and disparities between the country’s various regions In turn, they have at times served to deepen such disparities and tension Pakistan’s military, which has directly controlled the country’s affairs for more than one-half of its post-independence history and which often retained real political power even during periods of democratic rule, has played a major role in all this.3 Military governments have tended to follow more liberal approaches to trade than democratic governments They have probably also contributed more to the regional conflicts, because regions and groups of people who were affected adversely by their policies were more likely to be denied the opportunity to voice their protests

Pakistan’s history may be unique in that the country’s majority wing—formerly East Pakistan, now Bangladesh—seceded from the nation in 1971 after a bloody war, leaving the minority wing—West Pakistan—as the sole constituent part of the new Pakistan This conflict arose because of serious interregional economic disparities (caused by biased economic and trade policies) and a denial of basic democratic rights under the West Pakistan-based military regime Even after this traumatic event, the relationships among the four regions that remain in (West) Pakistan have not been harmonious Reasons for regional friction have ranged from the distribution of economic resources—such as revenue and water—to the location of proposed dams and the expansion of garrisons

These conflicts and the associated regional disparities have been compounded by ongoing interventions on the part of the military in the democratic governing process The first democratically elected prime minister—Zulfiqar Ali Bhutto—was hanged by the military in 1978 and the two remaining democratic prime ministers—Benazir Bhutto and Nawaz Sharif—are both in exile The dominant role played by the military has hampered the development of key institutions—the legislature and judiciary—capable

of keeping the role of the executive in check

3 For the purpose of this study, the entire period—from the seizure of power by a military leader to his exit from the political

scene—will be considered to constitute a military regime, even though military administration may have been transformed into some kind of civilian rule This is in line with many studies on military rule in developing countries For example, see Zafarullah and Akhter (2001)

3

Military expenditure has always been disproportionately high in Pakistan For instance, defence expenditure is currently around 23 per cent of the federal government expenditure, or 4.5 per cent of GDP.4 (This estimate of military expenditure does not include pensions paid to retired army personnel, free allotments of valuable land, and generous subsidies provided to army staff with respect to main items of consumption.)

As a result, public expenditure on health and education has been squeezed to around

1 per cent and 1.8 per cent of GDP, respectively The conspicuous spending on the military and the government has generated resentment among the poorer sections of society against the privileged class, and has raised anger in the smaller regions against the largest region—Punjab—which has the highest representation in the armed forces

At present, Pakistan is again under military rule There is unrest in all the four regions

of the country, accompanied by a significant rise in poverty (to 40 per cent), high crime rates, and the virtual non-existence of justice As Zaidi (2000, p.437) argues:

There is a growing concern in Pakistan that the state and its institutions are on the brink of a collapse The general feeling is that the state has failed to deliver on basic issues, that it can no longer govern, administer justice, provide essential and basic social services, or collect taxes, and its only function seems to be coercive, with institutions of law and order increasingly turned not towards protecting the life and property of citizens, but against the people of Pakistan Corruption is noticeably rampant, and affects all institutions of the state The decline of state authority is so obvious that one wonders if there is any real state or government in Pakistan The general prognosis seems to be that, unless some action is taken in the immediate future, this country and society will collapse

1.2: MOTIVATION

Interest in the research underlying this study stems from a number of reasons Firstly, it

is well established in the literature that trade liberalisation can interact with economic growth, national welfare, income inequalities, poverty and regional disparities in complex ways For Pakistan, there exist a number of studies that have described key features of the country’s trade policies, and/or examined the impacts of trade liberalisation on important economic or socioeconomic variables, such as economic growth, national welfare, income inequalities and poverty.5 However, to our

4 The figures cited in this paragraph are based on the World Bank (2005), and the MoF (2005)

5 Some of the important studies are: Lewis (1969); Little et al (1970); Balassa (1971); Ahmed and Amjad, (1984); Asian

Development Bank (ADB, 1985); World Bank (1988); Guisinger and Scully, (1991); Naqvi and Khwaja (1993); Institute of

Developing Economies (1994); Sayeed (1995); WTO (1995); Khan and Mahmood (1996); DRI-McGraw Hill (1997); Khan (1997);

knowledge, no previous study has focused on modelling/quantifying the impacts on Pakistan’s industry at a highly disaggregated level The present study will make a

contribution toward filling this gap in the literature

Secondly, Pakistan’s export sector is facing major challenges The phasing out of the MFA can potentially have serious implications for the country as, unlike other major suppliers of textiles and clothing such as India and China, Pakistan has a narrow export base dominated by cotton and textile related products6 (World Trade Organisation (WTO), 2002) Government efforts directed toward diversifying the export base have remained infertile to date (Ministry of Finance (MoF), 1999 and 2005) Understandably, the existing literature in this area has concentrated on the possible impact of the quota abolition on this sector.7 To our knowledge, however, no study has

attempted to model/quantify the impact of wide-ranging tariff cuts on Pakistan’s textile and clothing exports This is another limitation of the existing literature that the present

study can help rectify

Thirdly, relations between Punjab and the three smaller regions are poor There is a sentiment in the smaller regions—Sindh, NWFP and Balochistan—as there was previously in East Pakistan, that Punjab and the Punjab-based military are exploiting the other regions’ resources and giving very little in return Despite the sensitivity and potential significance of such regional disharmonies, no existing study has to our

knowledge examined possible links between trade liberalisation and regional

The study should be of interest, not only to Pakistanis but also to advocates and opponents of trade liberalisation, analysts and observers of inter-regional issues, and all those who are interested in human and economic development generally

Ahmad (1998); Bandara and McGillivray (1998); Khan (1998); Siddiqui et al (1999); Khan and Mahmood (2000); Zaidi (2000); Anwar (2001); Kemal et al (2001); Ministry of Finance and Planning (2001); Siddiqui and Iqbal (2001); Khan (2002); Mahbub ul Haq Human Development Centre (MHDC, 2002); Siddiqui and Kemal (2002); Siddiqui and Kemal (2002a); World Bank (2002); World Bank (2002a); Kemal et al (2003); Martin et al (2004); and World Bank (2004)

6 The clothing sector is part of the cotton and textile sector

7 These are, just to name a few, Naqvi et al (1995); WTO (1995 and 2002); Nabi (1999); Zaidi (2000); Khan and Mahmood (2000); MHDC (2002); Martin et al (2004); and World Bank (2004)

8 Some studies (such as Lewis, 1969; Ahmed and Amjad, 1984; and Zaidi, 2000) have discussed the impact of Pakistan’s economic and political policies on the regional disparities but their analysis is confined to the political and economic disparities between West Pakistan and East Pakistan caused by the West Pakistan based government policies prior to the secession of East Pakistan

Moreover, these studies do not quantify systematically the impact of the trade policies on the regional disparities

1.3: PURPOSE

Given the above motivations, the main purpose of the study is the estimation/quantification of the impact of trade liberalisation (in particular, comprehensive tariff reductions) on Pakistan’s industries at a highly disaggregated level, with a view to identifying the losers and winners not only at the national level but also at the regional level At the national level, particular attention will be paid to the country’s major export industries, including the cotton and textile related industries At the regional level, emphasis will be placed on ascertaining whether trade liberalisation has contributed to the existing regional disparities in Pakistan

In addition, it is desirable to undertake a critical review of the country’s political economy, with a view to gaining insights into the interactions between political setups, trade policies, national socioeconomic outcomes, and regional disparities The review will also serve as a basis for the modelling and estimation work mentioned above

1.4: SPECIFIC RESEARCH OBJECTIVES

In light of the above purposes, the specific research objectives of the study are:

a) to review critically Pakistan’s trade policies and their socioeconomic outcomes under different political setups, and to identify possible relations among political setups, trade regimes and regional disparities in Pakistan;

b) to develop a CGE model of Pakistan and construct an accurate and highly disaggregated database capable of supporting the model;

c) to examine the short-run and long-run effects of across-the-board tariff reductions at the national and regional levels using the CGE model, with emphasis on the major export industries at the national level and on the relative output and employment growth at the regional level; and

d) to present the results in a way that does not require extensive prior knowledge of CGE modelling, so that they can be of use to various groups of interested people, including exporters, importers, investors, industrialists, economic analysts and policy makers

1.5: OUTLINE OF STUDY

The plan of the study is as follows Chapter 2 undertakes an analytical review of Pakistan’s political and trade regimes, socioeconomic indicators, and regional conflicts and disparities, and identifies apparent patterns of association among them In doing so,

it also provides a rationale for undertaking a study which can model/quantify the impacts of tariff cuts on (a) Pakistan’s industry at a highly disaggregated level and on (b) regional disparities, as measured by differential growth in regional output and employment

Chapter 3 provides a rationale for using a CGE approach to pursuing the objectives identified in the previous chapter To that end, it reviews the CGE literature on Pakistan, and also sets the context for the development of a CGE model and its database which would avoid some key shortcomings of previous CGE models of Pakistan’s economy Chapter 4 highlights the main features of the CGE model developed in this study, and its database Chapter 5 documents the process of constructing this database

Chapter 6 presents simulation results indicating short-run and long-run impacts of tariff reductions on Pakistan’s economy at the national and regional levels Chapter 7 summarises the major findings of the study, recommends appropriate policy responses, acknowledges important limitations of the study, and suggests avenues for future research

7

CHAPTER 2: POLITICAL SETUPS, TRADE REGIMES AND REGIONAL DISPARITIES

2.1: INTRODUCTION

This chapter undertakes a critical review of Pakistan’s political economy, with a view to gaining insights into the relations between political setups, trade policies, national socioeconomic outcomes, and regional disparities In doing so, it sets the context9 for modelling/quantifying the impacts of trade liberalisation on (a) the domestic industry at

a highly disaggregated level with a special reference to the main exports and on (b) regional disparities

The chapter is organised as follows Section 2.2 investigates the trade policies pursued

by various political regimes and the socioeconomic outcomes of such policies Particular attention will be paid to examining the trade liberalisation process (especially, comprehensive tariff cuts) since the late 1980s The export structure will also be explored, as the performance of the key exports (related to cotton and textiles) is of critical importance in the wake of the abolition of textiles and clothing quotas on

1 January 2005 Section 2.3 briefly reviews the foremost studies on the impact of the abolition of textiles and clothing quotas on the main exports of Pakistan The information and analysis presented in this section and the previous section lays the foundation for modelling/quantifying the impacts of tariff cuts on the domestic industry

at a highly disaggregated level, with explicit focus on the key export industries

Section 2.4 highlights the main regional conflicts, and evaluates the extent of regional disparities, especially between Punjab and the three smaller regions Section 2.5 identifies apparent patterns of association among Pakistan’s political and trade regimes, socioeconomic indicators, and regional conflicts and disparities It also makes a case for adding a regional dimension to the proposed study on the impact of tariff cuts on the domestic industries The chapter ends with some concluding remarks in Section 2.6

9 It should be noted that this chapter does not review general literature on trade liberalisation in Pakistan for two reasons Firstly, since the intended study will focus on quantifying/modelling the impacts of trade liberalisation, a comprehensive review of the relevant modelling studies will be undertaken in the next chapter Secondly, conducting a universal literature review of the studies

on trade liberalisation in Pakistan would be beyond the scope of this study This chapter also does not compare Pakistan’s trade liberalisation policies with other countries in South Asia because this information is already available in some recent studies,

particularly in MHDC (2002) and the World Bank (2004)

2.2: ANALYTICAL REVIEW OF TRADE POLICIES UNDER DIFFERENT POLITICAL REGIMES

2.2.1: Bureaucracy-Led Ad-hoc Trade Policies—1947-52

There were no fully developed institutions at the time of Pakistan’s independence other than the imperial bureaucracy and military The standing of politicians eroded after the death of Pakistan’s founder, Mohammad Ali Jinnah, in 1948, and the assassination of his successor, Liaquat Ali Khan, shortly afterwards in an abortive coup Consequently,

in the early years of independence, the country was run by a small group of bureaucrats who were essentially responsible for formulating the policies to ensure the survival of the country (Zaidi, 2000) In the first few years of independence, the bureaucracy made trade policies mainly on an ad-hoc basis in response to international conditions

The bureaucracy pursued a liberal import policy from independence until September 1949 when the pound sterling was devalued by 31 per cent, and most currencies linked to the sterling were also devalued, including that of India (Zaidi, 2000) Pakistan, however, decided to maintain its old exchange rate and imposed some loose quantitative controls on certain imports and exports in order to manage trade with countries that had devalued At that time, Pakistan’s main exports were cotton and jute, with Pakistan being a monopoly exporter of jute Ahmed and Amjad (1984) argue that the main motivation behind the non-devaluation decision was to be able to sell raw jute (since Pakistan had no jute mills) at a higher price and to be able to import machinery and capital goods at a cheaper price

The loose quantitative controls on imports and exports were abolished within one year after the Korean War broke out in June 1950 During the Korean boom demand for Pakistan’s exports—mainly jute and cotton—increased by 109 per cent (Zaidi, 2000) Not only was there increased demand for jute and cotton, but their prices also increased appreciably, enabling Pakistan to make spectacular profits on its exports Zaidi (2000) argues that the government liberalised trade to the extent that by June 1951 around

85 per cent of the imports were virtually without licence, importable on the Open General Licence (OGL) System Under the OGL System, licences were issued for the import of a majority of commodities without formality and with no restrictions on quantity or source However, export taxes on jute and cotton were raised In addition, Pakistan maintained strict controls on foreign direct investment (FDI) For example, the

services sector was reserved for local investors and foreign investment was not allowed

in the fields of banking, insurance and commerce

As is evident from Table 2.1, the balance of trade improved substantially, averaging around 1.48 per cent of GDP per annum during 1949-52 (Henceforth, the statistics of Pakistan’s economy in Section 2.2 will refer to the annual averages during the period under discussion unless mentioned otherwise.) The ratio of exports to GDP grew to 16.77 per cent—the highest value so far (the words ‘highest’ or ‘lowest’ in Section 2.2 denote the highest or lowest values among the average annual values calculated for the seven trade regimes examined in this chapter) The ratios of imports and trade to GDP also increased enormously to 15.29 per cent and 32.06 per cent, respectively, with the latter being the second-highest during 1949-2005

The growth of large-scale manufacturing also became the highest (21.10 per cent), arguably because of Pakistan’s overvalued exchange rate, which allowed the import of machinery and capital goods at cheaper prices However, the real GDP growth remained modest (1.05 per cent) because the agriculture sector, which had the highest sectoral share in GDP in 1949-52 (53.19 per cent) contracted by 3.25 per cent In short, the decision not to devalue the currency turned out to be fruitful but primarily because

of the fortuitous international circumstances

2.2.2: Bureaucracy-Led Highly Protected Trade Regime—1952-59

The trade policies of Pakistan during 1952-59 were formulated mainly by the bureaucracy and partly by a collection of land-owing politicians During this period the policy of import substitution of consumer goods was pursued with a view to creating a highly protected environment for industrialisation Naoman (1992) considers the trade policy in 1952-59 the most extreme form of protection Throughout this period, revenue depended heavily on export taxes on agricultural products (cotton and jute) and import duties on imported manufactured goods In addition, the strict controls on FDI since the creation of Pakistan were maintained

Table 2.1: Key Economic and Socioeconomic Indicators of Pakistan—1949 to 2005 ANNUAL AVERAGES FOR

(% of merchandise exports) n/a n/a 32.47 51.89 43.70 56.92 61.69 83.04 85.17 High-technology exports

(% of manufactured exports) n/a n/a n/a n/a n/a n/a n/a 0.08 0.46 FDI, net inflows (% of GDP) n/a n/a n/a 0.12 n/a 0.08 0.28 0.85 0.84

Sectoral Shares in GDP (%)

Agriculture sector 53.19 46.93 39.68 38.88 39.28 33.19 28.19 25.56 24.89 Growth in agriculture sector share -11.78 -15.44 -2.02 -17.14 -15.50 -15.06 -9.32 -2.64 Manufacturing sector 7.75 11.42 15.04 16.04 15.54 15.58 16.86 17.26 17.29 Growth in manufacturing sector share 47.35 31.70 6.65 40.46 0.26 8.20 2.41 0.13 Remaining sectors 39.06 41.66 45.28 45.08 45.18 51.23 54.95 57.17 57.82 Growth in remaining sectors share 6.64 8.70 -0.44 8.22 13.39 7.26 4.04 1.14

External Assistance

Workers’ remittances (% of GDP) n/a n/a n/a n/a n/a 2.37 7.95 3.40 2.89 Foreign aid per capita (current $US) n/a n/a 7.92 6.90 7.41 7.73 9.67 9.04 11.22 Ratio of foreign aid to GDP, current

Indicators of Macroeconomic Stability

Overall budget balance (% of GDP) n/a n/a n/a n/a n/a -8.12 -7.07 -7.29 -4.08 Current account balance (% of GDP) n/a n/a n/a -6.70 n/a -5.03 -2.99 -3.96 2.72

Average external debt/GDP (%) n/a n/a n/a 34.89 n/a 54.34 43.13 50.37 50.90 Public and publicly guaranteed debt

service (% of exports) n/a n/a n/a n/a n/a 20.79 22.48 22.03 17.72

Year 1963-64 1965-66 1966-67 1969-70 1970-71 1979-80 1980-81 1984-85 1987-88 Proportion of poor

in Pakistan (%) 40.24 40.20 44.50 46.50 46.50 30.68 30.70 24.47 17.32 Year 1990-91 1992-93 1993-94 1996-97 1998-99 1999-00 2001-02 2004-05

Proportion of poor

in Pakistan (%) 22.11 22.40 23.60 31.00 32.60 33.50 37.00 40.00

Note: ‘n/a’ denotes ‘not available’

Source: ADB (1985); Zaidi (2000); Anwar (2001); Kemal et al (2001); Khan (2002); Arif (2003); IMF (2005); World Bank

(2005); and MoF (1970 to 2005)

The tightening of the trade regime originated from the steps taken to ameliorate the balance of payments, which had started deteriorating due to a fall in the prices of jute and cotton after the Korean boom Following the Korean boom, Pakistan’s exchange

11

rate was still higher than those of its trading partners, which had devalued in September 1949 As a result, Pakistan faced two choices: devalue or reimpose trade and foreign exchange controls As it did in 1949, Pakistan decided not to devalue and instead introduced strict quantitative restrictions, other non-tariff barriers (NTBs)—such

as foreign exchange controls and import/export licensing—and a highly differentiated tariff structure to manage the balance of payment problems and channel the inflow of subsidised imported inputs into priority areas—consumption goods industries and, to some extent, capital goods industries (Khan, 1998; and Zaidi, 2000) The government also embarked on the policy of issuing import licences largely to those importers who had imported during the 1950-52 period These importers were called ‘category holders’ and the policy was referred to as the ‘category system’

The tariff structure was aimed at increasing import substitution in the consumption and,

to a lesser degree, capital good industries through tariff escalation10 while giving some relief to consumers in relation to essential items, such as food, cloth, kerosene, matches and soap (see Table 2.2) For example, lower tariffs were levied on essential items and higher tariffs were levied on semi-luxury and luxury goods Higher tariffs were imposed on unprocessed industrial raw material, machinery and equipment and lower tariffs were levied on processed industrial raw materials and consumer durables Although the tariff escalation supported the import-substitution industries, it increased the discrimination of protective tariffs against exports In addition, the differential between the tariffs on the processed and unprocessed raw material for consumption goods (17 percentage points) was slightly higher than that for capital goods (15 percentage points) This reveals that the government placed relatively more emphasis on increasing import substitution in the consumption goods industries relative

to the capital goods industries However, Lewis (1969) argues that while the tariff structure played some role in directing resources in Pakistan, that role was a relatively minor one Direct quantitative controls and the other NTBs were the principal instruments in setting prices and incentives

The complete dominance of import substitution strategy in the first half of 1952-59 was reduced a little in the second half after the first devaluation of the rupee (by 30 per cent

10 Tariff escalation is the escalation of tariffs according to the degree of processing involved, with raw materials subject to the lowest tariffs, processed materials and components subject to higher tariffs, and final consumer goods subject to the highest rates

with respect to the pound sterling) in June 1955 and the introduction of the first export

promotion scheme in 1956 Through this scheme, exporters were entitled to be granted

import licences for certain specific items (Zaidi, 2000) Nevertheless, the trade regime

remained tight in the second half of 1952-59 (Naoman, 1992)

Many studies conclude that the direct quantitative controls on imports and, to a lesser

extent, the high tariff wall were primarily responsible for the initiation of industrialisation in general, and for the import-substituting industrialisation in particular, which took place in the 1950s and in the early 1960s (Lewis, 1969; Ahmed

and Amjad, 1984; Asian Development Bank (ADB), 1985; and Zaidi, 2000) As the

quantitative controls and high tariffs on consumer products raised their domestic prices,

it became profitable to shift into the production of these commodities domestically Hence, traders with their amassed wealth (earned during the Korean boom) converted

merchant capital into industrial capital, which set out the process of industrialisation in

Pakistan

Table 2.2: Tariff Rates During 1956-60 and 1960-64

Tariff Rate (%) Description

Source: Lewis (1969); and Zaidi (2000)

Import substitution progressed rapidly in those industries that had the highest protection

(consumption goods) and those that had cheap and ready access to domestically produced raw materials, such as cotton, jute and leather According to Zaidi (2000)

these newly established manufacturing industries replaced the competing imports and

started contributing to manufactured exports by the mid-1950s For example,

99 per cent of Pakistan’s export earnings in 1948-49 were made up of just five primary

commodities: raw jute, raw cotton, raw wool, hides and tea By 1951-52, the five main

primary commodities contributed 93 per cent of export earnings, which fell to

75 per cent by 1958-59 (Zaidi, 2000)

The performance of the manufacturing industries was reflected in the growth of scale manufacturing by 14.40 per cent—the highest growth among all major sectors of the economy—increasing the share of manufacturing in GDP from 7.75 per cent in 1949-52 to 11.42 per cent in 1952-59 (see Table 2.1) On the contrary, the share of agriculture in GDP between these two periods declined by 11.78 per cent—from 53.19 per cent to 46.93 per cent of GDP Zaidi (2000) argues that the expansion of the industrial sector took place partly at the cost of the agriculture sector For example, export taxes remained high on the two major agricultural exports—jute and cotton—and the agriculture sector supplied agricultural raw material at cheap prices and paid high prices for manufactured consumer goods in return However, we consider that the transfer of resources from the agriculture sector to the manufacturing sector was a normal phenomenon for this undeveloped country treading the path of development As

large-a result, this trend hlarge-as been large-applarge-arent throughout the history of Plarge-akistlarge-an (see Tlarge-able 2.1)

The trade deficit was confined to -0.39 per cent of GDP in 1952-59 (the lowest ratio of trade deficit to GDP so far), whereas the ratio of trade to GDP fell from 32.06 per cent

in 1949-52 to 19.64 per cent in 1952-59 (the lowest to date) due to a substantial reduction in the ratios of imports and exports to GDP in the latter period (see Table 2.1) Further, the external assistance in the form of aid was moderate in 1952-59 (2.5 per cent

of GDP) The real GDP growth increased from 1.05 per cent in 1949-52 to 4.04 per cent, primarily because of the high growth in the large-scale manufacturing sector assisted by the considerable growth in the remaining sectors of the economy

The pattern of the industrial development also resulted in a high degree of wealth concentration, for two reasons Firstly, most of the emerging industrialists were traders who had made money in the Korean boom and were already well established and well-off (Papanek, 1967) Secondly, the ‘category system’ bestowed considerable economic gains on those who were in this category as they had an almost virtual monopoly in the trade of the imported goods

2.2.3: Partial Trade Liberalisation under First Military Government—1959-71

Political wrangling between bureaucrats and the land-owing politicians and between different classes of the land-owing politicians made it easy for the military to step in and control the country in 1958 General Ayub Khan became the first head of the military government (However, the existing trade policies were not changed prior to 1959.)

The military ruled the country until 1971 when it was forced to return to barracks after losing a war with India which led to the independence of East Pakistan—now Bangladesh

The trade regime of the Ayub government can be divided into two periods on the basis

of a war with India in September 1965 over the disputed northern territory of Kashmir While the pre-war period (1959-65) was characterised by partial trade liberalisation policies and remarkable industrial and economic growth, the post-war period (1965-71) saw the reversal of the trade liberalisation policies and a slowdown in the economic growth Since the major wars with India (in 1965 and 1971) have been waged during the tenures of the military governments in Pakistan, it can be argued that a democratic regime would have been less likely to be involved in a war with India, especially at the peak of Pakistan’s economic development, and the course of economic progress in Pakistan could have been substantially superior to the actual one

2.2.3.1: Pre-War Period—1959-65

The military government of Ayub Khan embarked on a trade liberalisation program in

1959 The trade policy during 1959-65 had four salient features: industrialising the country in collaboration with the private sector; shifting the trade policy focus away from import substitution toward promotion of manufactured exports; replacing direct controls on imports with indirect controls; and involving market forces in determining the commodity composition of imports and ownerships of import licences

At the heart of the trade liberalisation process was the Export Bonus Scheme (EBS) introduced late in 1959 In short, the EBS was a floating multiple exchange rate system, serving as an instrument to compensate exporters of selected manufactured commodities for the overvalued exchange rate and making easy the imports of critical items required

by the domestic industry, thus providing some flexibility to the import licensing system (see Box A2.1a in Appendix 2.1 for the details of the EBS) The EBS is considered to

be the key to involving the private sector in industrialisation, maintaining the momentum of growth in manufacturing, promoting the manufactured exports, liberalising imports to some extent, and replacing import-substitution based growth with export expansion in Pakistan, particularly during 1959-65 and generally during the 1960s (Lewis, 1969; ADB, 1985; and Zaidi, 2000)

The emphasis of the trade policy in 1959 also shifted from direct controls towards indirect controls on imports and on domestic prices of other goods The government began to dismantle the import controls of the 1950s, with the items importable on licences falling from 90.3 per cent in 1960-61 to 39.5 per cent in 1964-65 (Zaidi 2000)

In addition, a number of measures were taken in import licensing that made market forces more important in determining the commodity composition of imports and the distribution of ownerships of import licences

Firstly, ‘Repeat and Automatic Licensing Schemes’ were introduced in 1961, which allowed the automatic renewal of import licences for industrial raw materials and consumer goods Selection of firms for automatic renewal of import licences took into account their previous export performance (Guisinger and Scully, 1991) Secondly, the OGL system, which was introduced in June 1951, was expanded in 1961 to allow newcomers to enter the import trade, breaking the monopoly of the ‘category holders’ of the 1950s Finally, a Free List was introduced in 1962, which can be considered the most market-friendly step toward trade liberalisation (Khan, 1998) Commodities in the Free List could be imported without licences

The tariff structure continued to be used as a signalling device, as it had been in the 1950s, but the emphasis on import-substitution in the consumption good industries was extended to the consumer durable industries For example, it is evident from Table 2.2 that differentials in the tariff rate structure widened, with the rates for consumer goods and consumer durables rising much more than for other goods The tariffs on machinery and equipment remained the lowest, thus making it cheaper to import agricultural and industrial machinery while the EBS transferred subsidies to exporters of manufactured goods Nonetheless, as in the 1950s, the tariff structure continued to play

a minor role in shaping the composition of demand for imports in comparison with the other trade policies implemented during 1959-65 (Lewis, 1969; and ADB, 1985)

The impact of the trade regime on trade and industrial development was significantly positive (see Table 2.1) The ratio of trade to GDP increased from 19.64 per cent in 1952-59 to 22.03 per cent in 1959-65 primarily on account of a significantly high ratio

of imports to GDP (14.44 per cent) and partly due to a modest ratio of exports to GDP (7.59 per cent) The share of manufactured exports in merchandise exports also became 32.47 per cent According to the Institute of Developing Economies (1994), Pakistan’s

manufactured exports in 1965 were greater than those of South Korea, Turkey, Thailand and Indonesia combined

The large-scale manufacturing growth increased from 14.40 per cent in 1952-59 to 16.68 per cent in 1959-65, whereas the growth of agriculture remained modest in both the periods (3.30 per cent and 3.20 per cent, respectively) The external assistance in the form of aid also increased from 2.5 per cent of GDP in 1952-59 to 8.46 per cent of GDP Real GDP expanded in 1959-65 at a spectacular rate of 7.43 per cent—the highest in Pakistan’s history—because of the remarkable growth in exports, the large-scale manufacturing industries, and foreign aid (see Table 2.1) The share of manufacturing in GDP increased by 31.70 per cent between 1952-59 and 1959-65, while the share of agriculture in GDP declined by 15.04 per cent Despite the high economic growth, inflation remained subdued at 2.47 per cent As regards the social indicators, real GDP per capita increased by 4.53 per cent, the second-highest growth ever recorded However, the proportion of population in absolute poverty remained almost unchanged—around 40 per cent—between 1963-64 and 1965-66 (data on poverty are not available for the earlier years) In addition, as will be explained in Section 2.4.1, income inequalities between the two wings of Pakistan, that had begun to emerge in the 1950s, were accentuated during 1959-65

2.2.3.2: Post-War Period—1965-71

Two critical events in 1965 influenced the direction of Pakistan’s trade policy Foreign aid was severely curtailed after June 1965 and a war broke out between Pakistan and India in September 1965 The trade liberalisation process, which had reached a peak in 1964-65, was reversed abruptly in order to deal with the foreign exchange shortages and the high defence spending The growth of public administration and defence expenditure increased from 0.63 per cent in 1952-59 to 9.64 per cent in 1965-71—see Table 2.1 As a result, many important liberalisation policies were abandoned and many new import controls were introduced (ADB, 1985)

For example, the Free List became subject to varying and increasing degrees of administrative restrictions, which, according to the ADB (1985), negated its very purpose The number of importable items on the Free List and the number of imports under the OGL system were reduced However, the number of imports under the EBS continued to increase during 1965-71 (Ahmed and Amjad, 1984) Moreover, the FDI

While the agriculture sector registered higher growth (6.34 per cent) in the post-war period than that (3.20 per cent) in the pre-war period, the growth in large-scale manufacturing was particularly affected, decreasing from 16.88 per cent in the pre-war period to 9.92 per cent in the post-war period The real GDP growth rate declined from 7.43 per cent to 5.96 per cent during these two periods As regards the macroeconomic stability, inflation increased from 2.47 per cent in the pre-war period to 4.58 per cent in the post-war period The ratios of the current account deficit and the external debt to GDP in the post-war period stood at 6.70 per cent and 34.89 per cent, respectively (the values for the earlier years are not available)

With respect to the socioeconomic outcome, while the growth in per capita real GDP slowed from 4.53 per cent during the pre-war period to 2.94 per cent during the post-war period, the unemployment rate remained low in the post-war period—only 1.70 per cent Surprisingly, despite the real GDP growth of 5.96 per cent during 1965-71, the proportion of population in absolute poverty increased from 40.20 per cent

in 1965-66 to 46.50 per cent towards the end of the military regime in 1970-71

2.2.3.3: Whole Period—1959-71

Despite the curtailment of foreign aid, the war with India in 1965 and the consequent reversal of the trade liberalisation policy, the growth in real GDP (6.63 per cent), agriculture (4.63 per cent) and large-scale manufacturing (12.43 per cent) remained fairly high during the full term of the first military regime relative to the periods under the remaining trade regimes between 1949 and 2005 (see Table 2.1) Furthermore, in spite of the fairly high growth (6.63 per cent) during the full term of the Ayub government, the proportion of people in absolute poverty increased from around

40 per cent to 46.50 per cent

There are different opinions about the robust economic performance and the industrialisation of Pakistan’s economy during 1959-71, particularly in the pre-war period While some studies11 consider that the high economic growth was based on import substitution and that the EBS caused distortions in Pakistan’s trade and industrialisation process, some other studies12 argue that domestic demand and absorption, rather than import substitution, were the dominant reasons for growth during this period and that the EBS was an ingenious incentive for both export expansion and import promotion

Nevertheless, a large number of studies13 agree that foreign aid and the private sector involvement were the main instrument of Pakistan’s economic growth in the 1960s and that the reduction in aid and the high spending on defence in the 1965 war slowed the economic progress The ADB (1985) notes that more than 40 per cent of the imports of the government in the first half of the 1960s were financed by the foreign aid component, which increased from 2.5 per cent of GDP in the 1950s to 8.46 per cent of GDP in 1959-65 (see Table 2.1) Both industrial production and investment responded well to the liberalisation of imports But when the defence expenditure increased and foreign aid dropped, and so did economic growth and development

We consider that, by and large, the high economic growth during 1959-71 was the result

of the military government’s liberal trade policy, which increased openness of the

11 These studies are Little et al (1970); Balassa (1971); Ahmed and Amjad (1984); and Anwar (2001)

12 These studies include Lewis (1969); Sayeed (1995); Khan (1998); and Zaidi (2000)

13 For examples, see Papanek (1967); Lewis (1969); Amjad (1982); ADB (1985); Zaidi (2000); and Anwar (2001)

economy on the one hand and enhanced domestic demand by accelerating the industrialisation process significantly on the other hand, particularly in 1959-65 In addition, the introduction of the EBS was a positive step toward trade liberalisation because at that time the economy was characterised by anti-export bias (with the ratio of exports to GDP falling from 15.29 per cent in 1949-52 to 10.02 per cent in 1952-59 and

to 6.42 per cent in 1959-71) and a move toward trade neutrality without specific export incentives may not have been sufficient to increase exports In sum, Pakistan’s economy performed well under the trade policies of the first military regime but this would not have been possible without the large amount of foreign aid; and the intensity and duration of the economic growth would have been considerably higher if the military government had not been involved in the war with India

Finally, the increase in poverty despite the fairly high growth during the Ayub regime has attracted the attention of many studies (see Box A2.1b in Appendix 2.1) In a nutshell, it can be concluded that instead of redressing poverty through direct measures, the Ayub government relied on engendering economic growth with the expectation that the fruits of the high growth would trickle down from the industrialists to the poorest sections of society, which did not happen

2.2.4: Partial Trade Liberalisation under First Democratic Government—1971-77

The democratic government of Zulfiqar Ali Bhutto took over Pakistan in 1971 after its majority region—East Pakistan—had seceded and had become an independent country, Bangladesh (see Section 2.4.1 for details) Bhutto was Pakistan’s first democratically elected leader Not only was the political set-up different, Bhutto’s economic policies, based on socialism, also made a sharp break from the pro-private sector strategies of the earlier years All basic industries and financial institutions were nationalised between

1972 and 1976 These measures reduced drastically the role of the private sector in Pakistan’s economy However, quite interestingly, the new policies of the Bhutto government helped enhance trade liberalisation and reduce anti-export bias (Khan, 1998) The existing foreign investment was exempted from nationalisation and an adequate legal cover for foreign investment was provided for new foreign investment

In addition, the government took three significant measures in 1972 with respect to its trade policy: devaluation of the rupee, elimination of the EBS, and removal of the import licensing system

In May 1972, the rupee was devalued by 57 per cent, from 4.74 rupees per one US dollar to 11 rupees per one US dollar, which appreciated to 9.90 rupees per one US dollar after the US dollar was devalued in February 1973—a rate that remained fixed for about 8 years (Zaidi, 2000).14 Since the EBS of the 1960s was meant to compensate exporters of selected manufactured goods from the overvaluation of the rupee during the Ayub regime, the May 1972 devaluation of the rupee was accompanied by the elimination of the EBS The decision to eliminate the scheme was a movement from a multiple exchange system toward more uniform effective exchange rates for exports The third important measure was to cut down the restrictive licensing system in 1972 There were six separate import lists, which were reduced to two: a Free List of items, which, in principle could enter the country without restriction; and a Tied List of items importable only from tied aid or barter sources Except for a few items reserved for industrial users, all registered importers could obtain licences for any number of import items In addition, a concessionary credit facility for exporters was introduced Through this facility, the rate of interest charged by commercial banks on export credits was lower than the normal bank lending rate

Trade increased in the Bhutto era in response to these trade liberalisation measures The ratios of imports, exports and trade to GDP in 1971-77 became 10.61 per cent, 16.19 per cent and 26.80 per cent respectively (the corresponding values in 1959-71 were 6.42 per cent, 11.57 per cent and 17.98 per cent) The share of manufactured exports in merchandise export also rose to 56.92 per cent from 43.70 per cent in 1959-71 In contrast, FDI fell from 0.12 per cent of GDP in 1965-7115 to 0.08 per cent

of GDP under the Bhutto government, primarily due to the nationalisation of the domestic industries The performance of the economy as a whole remained somewhat modest during this period The large-scale manufacturing and agriculture sectors grew

at the rates of only 1.70 per cent and 2.38 per cent in comparison with the corresponding growth rates of 12.43 per cent and 4.63 per cent in 1959-71 In contrast, small-scale manufacturing escalated to 7.28 per cent, the highest growth rate recorded

so far The external assistance in the form of workers’ remittances (2.37 per cent of GDP) and foreign aid (5.03 per cent of GDP) also provided some support to the

14 Since Table 2.1 shows the average exchange rate per annum during different trade regimes, the exchange rates in the table slightly differ from these exchange rates

15 Where the values encompassing the whole period of the first military regime (1959-71) are not available, the values pertinent to the 1965-71 period have been used to compare them with the corresponding values under the Bhutto government

In relation to the socioeconomic performance, the growth in per capita real GDP fell from 3.66 per cent in 1959-71 to merely 0.37 per cent The unemployment rate remained low (2.03 per cent) but was higher than that (1.70 per cent) of 1965-71 However, the proportion of population in absolute poverty, which had climbed to 46.50 per cent at the end of the military rule, declined considerably to 30.78 per cent in 1979-80 This indicates that the steps taken by the socialist democratic to reduce the concentration of wealth, such as the nationalisation of the domestic economy, reduced poverty significantly Moreover, Zaidi (2000) argues that the poor performance in most areas of the economy was also the consequence of the 1973 oil price crisis and the resulting world recession, immense natural disasters—such as massive floods in 1973 and 1976-77—and huge failure of cotton crops in 1974-75 at a time when international cotton prices had risen

2.2.5: Gradual Trade Liberalisation under Second Military Government—

1977-88

In July 1977, the Bhutto government was overthrown by the second military government The new dictator—General Zia-ul-Haq—ruled Pakistan from 1977 to August 1988, the longest rule ever by a single individual in Pakistan’s history In contrast to the Bhutto government’s policy of nationalisation, the Zia government restricted the role of the public sector to consolidating the existing enterprises in 1978 and further investment in the public sector was strictly restricted (Khan, 1997) The Zia government also began a series of steps to liberalise trade but the process was slow and

did not gather momentum until 1983.16 In 1982, the government removed the fixed peg

of the rupee to the US dollar by introducing a managed float of the currency, which is considered by many studies the most important and far reaching economic decision taken by the Zia government.17 As a result, the rupee was devalued by 38.5 per cent between 1982-83 and 1987-88, reducing the anti-export bias in the economy

Between 1980 and 1983, around 100 commodity categories were added to the Free List Late in 1983, the Free and Tied Lists of the importable items were replaced by a Negative List, which explicitly listed banned and restricted imports, and a Restricted List, products on which were importable only through designated importers In addition, export-led industrialisation was mentioned for the first time as a policy goal in

1983 and emphasis was placed on the broadening of manufactured exports towards higher value-added items To encourage exports, manufactured exports were given rebates (a duty drawback system and compensatory export rebates, which were abolished in May 1986), and exporters were given import facilities, income tax concessions, and finance at concessionary rates

In 1983, many NTBs (in particular, quantitative restriction) were replaced by tariffs, which was a significant step toward trade liberalisation since quantitative restrictions had been a more important source of protection than tariffs in Pakistan (ADB, 1985) However, the reduction in the NTBs was accompanied by the introduction of a

5 per cent import surcharge and another 5 per cent Iqra (education) surcharge During 1983-86, tariffs on some non-competing machinery and inputs to the engineering industry were reduced or removed Nevertheless, the most comprehensive tariff reform was undertaken in 1987 (Khan, 1998a) The maximum tariff rate was reduced from

225 per cent to 125 per cent, excluding automobiles and alcoholic beverages which continue to carry tariffs up to 250 per cent (see Table 2.3) The number of tariff slabs was reduced from 17 to 10 A uniform 12.5 per cent sales tax replaced previous rates that varied across commodities These changes reduced the economy-wide unweighted average tariff rate from around 77 per cent in the early 1980s to around 69 per cent in 1987-88

16 The World Bank (1988) argues that Pakistan’s import regime reached its most restrictive stage in 1980 when about 41 per cent of the domestic value added was protected by import bans and another 22 per cent by various forms of import restrictions By 1986, the equivalent percentages were merely 29 per cent and 3.7 per cent, respectively

17 These studies are: ADB (1985); Naqvi and Khwaja (1993); Institute of Developing Economies (1994); Sayeed (1995); Khan (1998); and Zaidi (2000)

Some export-enhancing measures were also introduced in 1987, such as opening up of

rice and cotton exports to the private sector, and liberalisation of imports of some raw

materials and intermediate inputs of export industries (Khan, 1998) The government

also set up an export processing zone in Karachi with a view to encouraging FDI in

export oriented industries The concessions and facilities included duty free import and

export of goods and tax exemptions (Khan, 1997) The government also embarked on a

privatisation/denationalisation program during the late 1980s However, the

privatisation of industrial and financial institutions was extremely slow and the public

sector enterprises (PSEs) continued to play a major role during the Zia government

(Mahbub ul Haq Human Development Centre (MHDC), 2002)

Table 2.3: Tariff Rates from Early 1980s to 2003-04

Tariff Rate Year

*Excludes automobiles and alcoholic beverages which continue to carry tariffs up to 250 per cent

Note: ‘n/a’ means ‘not available’

Source: Ahmad (1998); Syed (1999); WTO (2002 and 2006); Kemal et al (2001); Central Board of Revenue (CBR, 1996); Khan

(1998); World Bank (2004); and MoF (2005)

Notwithstanding the significant trade reform introduced in the 1980s, the trade regime

still remained protected by 1988—the year that brought an end to Zia’s era, when he

died in an air crash in August 1988 For example, the World Bank (1988) concludes

that the trade regime that existed then still seemed to be biased in favour of

import-substituting production; and domestic markets were insulated from foreign competition

through NTBs and high tariffs Similarly, Khan (1998) argues that anti-export bias

increased significantly after the trade policies introduced in June 1987 but the reduction

in the bias achieved through tariff cuts was more than offset by the imposition of import

surcharges, and the elimination of the compensatory rebates in May 1986

The anti-export bias during the Zia government was reflected in the real effective exchange rate (REER) which remained substantially higher (176.71, with the base year 1999-2000) than that in the subsequent periods (see Table 2.1) Consequently, the trade

to GDP ratio in 1977-88 (29.65 per cent) became slightly higher than that in 1971-77 (26.80 per cent) but largely on account of an increase in the ratio of imports to GDP (19.35 per cent) rather than an increase in the ratio of exports to GDP (10.30 per cent) The ratio of trade deficit to GDP also became the highest (9.05 per cent) between 1949 and 2005 Nonetheless, the share of manufactured imports in merchandise continued to increase but at a lower pace—from 56.92 per cent in 1971-71 to 61.69 per cent in 1977-78 FDI also increased to 0.28 per cent of GDP from 0.08 per cent of GDP in the Bhutto era

While the growth in large-scale manufacturing regained the momentum lost in the Bhutto era—increasing from 1.70 per cent in 1971-77 to 9.00 per cent in 1977-88—the growth in small-scale manufacturing increased marginally—from 7.28 per cent to 8.40 per cent The growth in the agriculture sector in 1977-88 (3.88 per cent) also became somewhat higher than that in 1971-77 (2.38 per cent) Workers’ remittances increased substantially from 2.37 per cent of GDP in 1971-77 to 7.95 per cent of GDP

in 1977-88, mainly because of increased employment of the Pakistani workers in Middle East Per capita foreign aid also increased from $US7.73 to $US9.67, primarily because of the role of the Zia government in the Afghanistan war Consequently, the real GDP growth increased from 4.12 per cent during the Bhutto rule to 6.86 per cent under the Zia government Budget deficit and current account deficit also improved slightly, declining from 8.12 per cent and 5.03 per cent of GDP in 1971-77 to 7.07 per cent and 2.99 per cent of GDP in 1977-88, respectively Inflation was controlled to some extent, falling from 15.52 per cent in 1971-77 to 7.04 per cent The ratio of external debt to GDP also dropped from 54.34 per cent in 1971-77 to 43.13 per cent, mainly due to debt write-offs after the involvement of the Zia government in the Afghanistan war

The socioeconomic indicators show substantial improvement during the Zia era Per capita real GDP increased by 3.94 per cent—the second-highest up till now The unemployment rate, however, increased from 2.03 per cent in 1971-77 to 3.57 per cent The most striking feature of the Zia government was the reduction in poverty, with the proportion of population living in absolute poverty falling from 30.68 per cent in

25

1979-80 to 17.32 per cent in 1987-88 It can be argued that the high economic growth and the reduction in poverty would not have been possible without the high remittances from Pakistani workers abroad and the increased foreign aid to Pakistan But this argument cannot explain the poverty rise during the first military regime (1959-71) which was also bestowed by huge foreign aid and characterised by high real GDP growth This indicates that, as opposed to the policies of the first military government which led to the concentration of wealth (see Section 2.2.3 for details), the policies of the second military government were devised in such a way that the fruits of growth reached the poorest sections of society.18

2.2.6: Consistent and Gradual Trade Liberalisation by Four Democratic

Governments under Structural Adjustment Programs—1988-99

The post-Zia period opened up a different age in Pakistan’s history, both politically and economically There was a return to democracy when elections were held in Pakistan

on 28 May 1988 after an interval of 11 years Three democratically elected governments, the last one elected in February 1997, followed this elected government Unfortunately, none of the democratic governments was able to complete its full term The first three democratic governments were dismissed (two of them on corruption charges) by the then presidents, who had attained the power to dissolve parliament and sack government on account of an amendment to the constitution of Pakistan made by the Zia government Nevertheless, irrespective of how these governments were structured, the military remained the real source of political power (Khan, 2004) As soon as the head of the last democratic government endeavoured to reduce the domination of the military, he was ousted by the current military government of General Pervaiz Musharraf on 12 October 1999

Despite the frequent replacements of the governments, a great deal of continuity is apparent in the economic policy and trade policies of Pakistan since September 1988 The consistency in economic management can be attributed to a series of SAPs undertaken under the close supervision of the IMF and the World Bank Although Pakistan had had a long association with the IMF and the World Bank since it asked for

18 A detailed examination of the policy differences between the two military governments that resulted in the dissimilar outcomes in terms of poverty reduction is beyond the scope of this study