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) PMESA, AAIBF Griffith Business School GRIFFITH UNIVERSITY Submitted in fulfilment of the requirements of the degree of Doctor of Philosophy 2006 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 i ACRONYMS AND ABBREVIATIONS ADB Asian Development Bank AL ATC CPI Awami League Agreement on Textiles and Clothing Central Board of Revenue Constant Elasticity of Substitution Constant Elasticity of Transformation Computable General Equilibrium Cost, Insurance and freight Census of Manufacturing Industries Consumer Price Index CV Coefficient of Variation PIDC DFID Department for International Development Export Bonus Scheme Economic Revival Program European Union Equivalent Variation PIDE CBR CES CET CGE cif CMI EBS ERP EU EV FBS FDI F-G-T Federal Bureau of Statistics Foreign Direct Investment Head Count, Poverty Gap and Severity Ratios FKIs Foreign Capital Inflows fob Free on Board FSP Food Support Program GATT General Agreement on Tariffs and Trade GTAP Global Trade Analysis Project HAR Header Array HIES Household Integrated Economic Survey IMF International Monetary Fund I-O Input-Output IRSA Indus River System Authority LES Linear Expenditure System MFA Multi-Fibre Arrangement MFN Most Favoured Nation MHDC Mahbub ul Haq Human Development Centre MIMAP Micro Impact of Macroeconomic Adjustment Policies MMRF Monash Multi-Regional Forecasting MoF Ministry of Finance MRES NGOs NTBs MONASH-regional equation system Non-Government Organisations Non-Tariff Barriers NWFP OGL ORES North West Frontier Province Open General Licence ORANI-Regional Equation System PICIC PSTC REER RES Pakistan Industrial Credit and Investment Corporation Pakistan Industrial Development Corporation Pakistan Institute of Development Economics Pakistan Industrial Finance Corporation Pakistan Poverty Alleviation Fund Public Sector Enterprises Pakistan Standard Industrial Classification Pakistan Standard Trade Classification Real Effective Exchange Rate Regional Equation Systems Rs SAM SAPs SBP Rupees Social Accounting Matrix Structural Adjustment Programs State Bank of Pakistan SPS SROs SSA Sanitary and Phytosanitary Special Regulatory Orders Systematic Sensitivity Analysis TBT TERM TRIM UR US WTO Technical Barriers to Trade The Enormous Regional Model Trade Related Investment Measure Uruguay Round United States World Trade Organisation PIFC PPAF PSEs PSIC ii 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 iii 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 iv 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: 1.2: 1.3: 1.4: 1.5: BACKGROUND MOTIVATION PURPOSE SPECIFIC RESEARCH OBJECTIVES OUTLINE OF STUDY CHAPTER 2: POLITICAL SETUPS, TRADE REGIMES AND REGIONAL DISPARITIES 2.1: INTRODUCTION 2.2: ANALYTICAL REVIEW OF TRADE POLICIES UNDER DIFFERENT POLITICAL REGIMES 2.2.1: Bureaucracy-Led Ad-hoc Trade Policies—1947-52 2.2.2: Bureaucracy-Led Highly Protected Trade Regime—1952-59 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 v 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: 4.4.4.2: 4.4.4.3: 4.4.4.4: 4.4.4.5: 4.4.4.6: Direct Demands by each Region 112 Demand for Margin 113 Determining Regional Share Variables 114 Three Constraints 115 Regional Wage Bills and Matrix of Contributions .116 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 vi 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 vii 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 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 viii in the long-run) and also because they have been subjected to high import-competition following the tariff cuts With respect to the industry employment growth in the short-run, employment grows (contracts) in association with the output growth (contraction) However, the intensity of the employment growth (contraction) remains higher than the output growth (contraction) This occurs because while capital is held fixed, labour is assumed variable in the short-run; and the production function of PAKREG implies a declining marginal product of labour The implication is when output of an industry increases/decreases with capital held fixed, labour and thus the ratio of labour to capital must increase/decrease by more than output As a result, 13 industries with a negligible output growth in the short-run—and, hence, considered as industries with unchanged output—show a noticeable change in employment Therefore, employment increases in 23 industries, remains almost unchanged in industries and declines in 28 industries Nevertheless, the relative positions of the winning, unaffected and losing industries remain almost the same in terms of the output and employment growth In the long-run, a substantial increase in the cost of labour (which is assumed fixed in the long-run) relative to the cost of capital (which is held mobile) causes substitution of capital for labour Consequently, only 13 industries record an increase in employment These 13 industries comprise the export industries with the best output performance in the long-run, services industries, non-export manufacturing industries and agricultural industry Employment remains unchanged in industries and 45 industries experience a reduction in employment The worst performers are the non-export manufacturing industries, the sports goods export industry, and the highly protected cotton and textile related export industries With respect to the regional impact of the tariff cuts in the short-run, the largest region, Punjab, records the highest output growth and the second-largest region, Sindh, records the second-highest output growth, whereas the regional output contracts in the smaller regions, NWFP and Balochistan Among the four regions, Punjab is the only region with a positive regional advantage (the difference between the regional and national real GDP growth) with Sindh, NWFP and Balochistan recording negative regional advantages In the long-run, while all the four regions record significantly high positive growth in the regional output, NWFP leads the regions, Punjab and Balochistan score 266 the second-highest growth, and Sindh experiences the lowest growth Further, NWFP, Punjab and Balochistan register positive regional advantages, whereas Sindh records a negative regional advantage The regional employment growth in the short-run follows the regional output growth in the short-run, keeping the relative position of each region alike in terms of the output and employment growth Punjab records the highest employment growth, followed by Sindh, whereas NWFP and Balochistan experience a contraction in employment In addition, Punjab is the only region with the regional employment growth surpassing the national employment growth The employment growth in the long-run also follows, to some extent, the regional output growth in the long-run While NWFP experiences the highest employment growth and Balochistan and Punjab achieve the second-highest employment growth, employment falls in Sindh noticeably (by 1.30 per cent) This indicates that, in contrast to the other regions, tariff reduction can cause sustained unemployment in Sindh The observed differences in the regional output and employment growth stem from the differences in the economic structure of the four regions Punjab specialises in most agricultural industries and some export-oriented industries (most of them unrelated to cotton and textiles) On the contrary, the economy of Sindh is dominated by the highly protected non-export import-competing manufacturing industries and the majority of the highly protected cotton and textile related export industries As regards NWFP and Balochistan, the share of the agricultural sector is considerably higher than that of the manufacturing sector in both the regions All the export-oriented manufacturing industries and non-export manufacturing industries have an insignificant share in the economies of these regions Punjab’s output growth exceeds the national real GDP growth in the short-run because its major agricultural and export-oriented manufacturing industries grow faster than national real GDP Sindh experiences positive output growth because its main exportoriented manufacturing industries which are related to the highly protected cotton and textile sector grow faster than national real GDP However, its regional output growth becomes slightly lower than the national real GDP growth because all the highly protected non-export import-competing manufacturing industries that form a notable part of its economy contract or grow slower than national real GDP NWFP and 267 Balochistan become the main losers of the tariff reduction policy because the agricultural industries which constitute the considerable part of their economies contract or grow slower than national real GDP In the long-run, NWFP and Balochistan benefit from the tariff cuts because they are under-represented in about all the export industries and just about all the non-export manufacturing industries which contract or grow slower than national real GDP These benefits exceed the losses arising from the slow output growth of the main agricultural industries of these regions relative to national real GDP While the agricultural industries and some export industries (the sports goods industry and a few cotton and textile related export industries) with a significant share in Punjab’s economy grow slower than national real GDP, the output growth of Punjab becomes positive and almost equal to that of Balochistan because its other major export-oriented industries (surgical instruments, air transport, and water transport) grow faster than national real GDP and also because the region is under-represented in most highly protected cotton and textile related industries and nearly all the highly protected non-export importcompeting manufacturing industries whose output contracts or grows slower than national real GDP Sindh becomes the only region whose output growth is lower than the national real GDP growth in the long-run because it is over-represented in nearly all the highly protected non-export manufacturing industries and most of the highly protected cotton and textile related export industries which grow slower than national real GDP In the short-run, the regional employment growth moves in unison with the regional output growth The highest employment growth in Punjab in the short-run is primarily based on significantly high positive employment contributions from its export-oriented industries and the services industries, assisted by the lowest negative contribution among all the regions from the group of non-export manufacturing industries Further, Punjab is also the only region which receives a positive contribution from the agriculture sector The positive aggregate employment growth in Sindh also originates from the positive contributions made by its export-oriented industries and the services industries but the contributions from the latter industries are lower relative to Punjab In addition, Sindh receives a significantly negative contribution (relative to the rest of the regions) from the group of non-export manufacturing industries and a slightly negative contribution from the agriculture sector As a result, Sindh’s employment growth falls 268 behind the employment growth in Punjab The employment growth in NWFP and Balochistan becomes negative because of the lower employment contributions from the export-oriented manufacturing industries (relative to the other regions) and the notably high negative contributions from the agricultural sector, the non-export manufacturing industries and services industries In the long-run, the regional composition of the 13 industries with positive output growth industries (mostly the export-oriented industries unrelated to the protected cotton and textile sector, and services/local industries) and the industries with significantly negative employment growth (most non-export manufacturing industries, the export industry ‘sports goods’, and the highly protected cotton and textile related export industries) determines the regional employment growth NWFP experiences the highest employment growth, whereas Balochistan and Punjab record the second-highest employment growth By contrast, the employment growth in Sindh becomes negative, primarily due to the highest negative employment contributions it receives (relative to the other sectors in Sindh and among the four regions) from the cotton and textile related export industries and the non-export manufacturing industries The negative contributions from the export-oriented industries are out of proportion relative to the other regions because the labour share in Sindh of the highly protected cotton and textile related industries with decreased employment is the highest among all the regions In addition, the negative contributions from the non-export manufacturing industries grow to be the highest in Sindh because the labour share of these industries in Sindh is also the highest relative to the other regions Finally, the SSA of the key elasticity parameters indicates that the national and regional macroeconomic variables estimated in the short-run and long-run simulations are largely not sensitive to changes in the elasticity parameters 269 CHAPTER 7: CONCLUSION 7.1: INTRODUCTION This study has developed a CGE model of Pakistan and constructed a highly disaggregated database supporting this model The model and its database have been used to examine the short-run and long-run impacts of across-the-board tariff cuts on the economy at the national and regional levels This final chapter contains a summary of the main findings, recommends appropriate policy responses, identifies important limitations of the study and suggests avenues for future research The chapter ends with some concluding remarks 7.2: SUMMARY OF MAIN FINDINGS As set out in Chapter 1, the main purpose of the study was the estimation/quantification of the impact of comprehensive tariff reductions on the domestic industries at a highly disaggregated level, with the intention of pinpointing the losers and winners not only at the national level but also at the regional level On a more specific scale, the objectives of the study were: • to undertake a critical review of Pakistan’s trade policies and their socioeconomic outcomes under different political setups, and to identify possible interactions among the country’s political setups, trade regimes and regional disparities; • to develop a CGE model of Pakistan and construct an accurate and highly disaggregated database supporting the model; • 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 special reference to the key export industries at the national level and on relative output and employment growth at the regional level; and • to present the results in a manner that does not require extensive prior knowledge of CGE modelling, so that they can be useful for various groups of 270 concerned people, including exporters, importers, investors, industrialists, economic analysts and policy makers These objectives were pursued through the research reported in Chapters to Chapter examined trade policies and their socioeconomic outcomes under successive autocratic and democratic governments in Pakistan In doing so, a case was made for undertaking a study which could model/quantify the effects of across-the-board tariff cuts on (i) domestic industries at a highly disaggregated level and on (ii) regional disparities, in terms of output and employment growth The review of the CGE literature on Pakistan in Chapter served two purposes First, it helped to identify some important limitations of previous CGE studies on Pakistan Second, it pointed to the need to develop a new comparative-static CGE model capable of modelling the national and regional impacts of tariff cuts more adequately than was feasible previously An explanation of the theoretical structure of the CGE model (PAKREG) and its supporting database was the subject matter of Chapter The chapter also provided arguments in favour of the tops-down approach for modelling the regional results of tariff cuts The process of constructing the database of the model was documented in Chapter The (national and regional) database comprised 60 production sectors, including 14 export industries—the highest to date of all Pakistani databases of the same purpose The quality of the database was enhanced further by creating an explicit import matrix in the I-O accounting framework Finally, Chapter presented simulation results indicating short-run and long-run impacts of tariff reductions on the economy at the national and regional levels The main findings of the study are as follows • Trade liberalisation and the resultant increase in economic growth appear to have been associated with an increase in the incidence of poverty under military governments, but a decrease of such incidence under truly democratic governments While it has not been possible to subject this observation to 271 formal testing within the scope of this study, its implications are sufficiently grave to warrant further consideration as a working hypothesis • One possible explanation for the above observation is that, in Pakistan, the nature of military governments has been such that trade liberalisation under them tends to aggravate regional disparities and income inequalities by benefiting mainly the richer regions and affecting the poorer regions adversely • If the above explanation is correct, then in principle there is no reason to expect that trade liberalisation will necessarily result in increased regional disparities Indeed, it would appear from both theoretical reasoning and past experiences that, under a truly democratic government, trade liberalisation can lead to a reduction in such disparities • CGE model simulations suggest that across-the-board tariff cuts reduce domestic production costs and prices substantially This increases the competitiveness of domestic industries in the local and international markets Since overall domestic absorption is assumed fixed in the short-run, real GDP increases slightly on account of an increase in net exports In the long-run, however, the low prices and high incomes significantly increase domestic absorption and, hence, real GDP • While the fiscal position of the government deteriorates slightly in the short-run, some of this deterioration is offset in the long-run by an increase in indirect-tax revenue • At the microeconomic level, regardless of the cost structure, industries that benefit the most from the tariff cuts in the short-run are all the 14 export industries that have the capability of utilising the reduced industry costs and output prices to expand their exports and, to some extent, replace imports, and/or sell more to other industries The unsuccessful industries are highly protected import-competing non-export industries (mainly manufacturing and partly agricultural industries) serving primarily the domestic market They lose sales which go to domestic industries that will now replace their output with the 272 cheaper imported substitutes and, to a degree, to the domestic industries which contract after the tariff cuts • In the long-run, the majority of the industries record positive output growth As could be expected from economic theory, industries with the outstanding output performance are unprotected export industries that have recorded a significant reduction in the production costs and have the ability to utilise the low industry cost and output price to expand exports In contrast, industries with low or even negative output growth are largely the highly protected non-export importsubstitution manufacturing industries, the highly protected cotton and textile related export industries, and the sports goods export industry As opposed to the successful export industries, all these industries—including the cotton and textile related export industries—become uncompetitive in the domestic and/or overseas markets due to a significant escalation in the production costs (particularly the labour cost) and output prices Since Pakistan’s export base is dominated by the cotton and textile related products, a persistent slowdown, or more seriously a decline, in these exports can pose serious challenges to the economy • The industry employment growth is associated with the output growth in the short-run but the employment growth rate stays higher than the output growth rate This occurs because while capital is held fixed, labour is assumed variable in the short-run; and the production function of PAKREG implies a declining marginal product of labour The implication is when output of an industry increases/decreases with capital held fixed, labour and thus the ratio of labour to capital must increase/decrease by more than output As a result of higher employment growth (relative to output growth), 13 industries with a negligible output change in the short-run show a noticeable change in employment Nevertheless, the relative positions of all the industries remain more or less the same in terms of the output and employment growth • In the long-run, a substantial increase in the cost of labour (which is held fixed in the long-run) relative to the cost of capital (which is assumed mobile) causes substitution of capital for labour Consequently, only 13 industries record an increase in employment These industries comprise largely the export 273 industries with the top output growth in the long-run and some services industries The worst performers are the highly protected non-export manufacturing industries, the highly protected cotton and textile related export industries, and the sports goods export industry • The tariff cuts seem to increase regional disparities in the short-run because the larger regions—Punjab and Sindh—record positive output growth, whereas the smaller regions—NWFP and Balochistan—experience negative output growth in response to the tariff cuts In addition, the largest region, Punjab, is the only region with a positive regional advantage (the difference between the regional and national real GDP growth) The remaining regions record negative regional advantages • In the long-run, all the four regions record significantly positive output growth While NWFP leads the regions, Punjab and Balochistan score the secondhighest growth, and Sindh experiences the lowest growth Furthermore, NWFP, Punjab and Balochistan register positive regional advantages, whereas Sindh records a negative regional advantage • The regional employment growth in the short-run is similar to the short-run regional output growth, keeping the relative position of each region alike in terms of the output and employment growth The employment growth in the long-run also follows, to some extent, the regional output growth in the longrun NWFP experiences the highest employment growth and Balochistan and Punjab record the second-highest employment growth However, a striking implication is that employment falls in Sindh noticeably (by 1.30 per cent) This indicates that, in contrast to the other regions, the tariff cuts may cause sustained unemployment in Sindh • The employment growth in Sindh becomes negative in the long-run primarily due to the highest negative employment contributions (relative to the other sectors in Sindh and also relative to the other regions) that it receives from the highly protected cotton and textile related export industries and the non-export import-substitution manufacturing industries These negative contributions are disproportionately high in Sindh because the labour shares in Sindh of the 274 cotton and textile related export industries and the non-export manufacturing industries, which record large employment reductions, are the highest relative to the other regions 7.3: POLICY IMPLICATIONS The above developments, if they eventuate, would have important policy implications In the short-run, the possible aggravation of the regional disparities in terms of the output growth between the largest region, Punjab, and the smaller regions—particularly NWFP and Balochistan—can have the potential of deteriorating further the acrimonious relationship between Punjab and the two smaller regions As regards the long-run implications, the possibility that wide-ranging tariff reductions can lead to a persistent slowdown, or even a decline, in the cotton and textile related exports (currently accounting for 60 per cent of total exports) is likely to be an issue of serious concern This implies that, unless steps are taken to increase the competitiveness of the cotton and textile related industries, the country will probably not be able to take full advantage of the increased international market access granted by the MFA phaseout Finally, the finding that tariff reductions may lead to sustained unemployment in Sindh in the long-run can stir considerable regional tension, given that unemployment (which was above per cent in 2004-05) is already one of the main challenges facing the economy In respect of policy responses to these likely developments, the output and employment contraction in NWFP and Balochistan in the short-run can be expected to be reversed through the long-run effects of tariff cuts Nevertheless, a large number of people are likely to bear significantly high transition costs in the short-run The best option would be providing short-term assistance to affected people in the two regions through a social security system and/or a government funded employment and training program However, given the budget constraints in Pakistan, it may not be possible to so unless non-development and defence expenditures are reduced and an appropriate public-sector debt management policy is implemented As a minimum, the federal government may possibly increase the share of the existing targeted assistance to the poor in these two regions, given that these regions are already receiving lower targeted assistance on a per capita basis relative to the other two regions (see Section 2.4.5) 275 The national and regional developments in the long-run are linked to each other.103 Accordingly, both of them require similar policy responses The federal and regional governments need to make the cotton and textile related export industries and the nonexport manufacturing industries more competitive by removing key supply constraints These constraints include complicated industrial procedures and practices, worsened by tight bureaucratic controls; bad governance and the resulting corruption; and a lack of the necessary infrastructure A removal of such restraints is likely to reduce the production costs and output prices of these industries This can help enhance their competitiveness in the domestic and international markets Having said that, the longterm growth of the country’s exports and economy is most likely to depend upon (a) diversifying the narrow export base to reduce dependency on the cotton and textile related products; and (b) finding new export markets to lessen the vulnerability to relatively minor policy changes in the existing export markets—the EU, US, and Japan The policy response directed toward increasing the competitiveness of the cotton and textile related export industries and the non-export manufacturing industries can also reduce unemployment in Sindh Nonetheless, there appears to be a compelling need for increasing public expenditure on health and education, particularly in Sindh This may increase not only the marginal product of labour but also the size of the labour force in the long-run, thus reducing the employment losses induced by the substitution of capital for labour Regrettably, there seems to be little fiscal capacity to so A concomitant or alternative policy option for reducing persistent unemployment in Sindh would be attracting FDI toward the industries in Sindh which become profitable and expand in the long-run A further expansion of these industries through FDI can help absorb some of the labour shed by the contracting or slower-growing industries However, the existence of a military government may be deterring the potential FDI inflows by imparting uncertainty about the consistency of the economic and trade policies after a sudden change in government A restoration of the democratic governing process should, at least in principle, clear out such uncertainties 103 The protected cotton and textile related export industries (which record low or negative output and export growth in the long-run) together with the non-export manufacturing industries shed labour in the long-run Since all these industries have the highest representation in Sindh, unemployment increases in Sindh in the long-run 276 In any case, highly developed state institutions based on democracy possess the inherent ability to reducing regional disparities through the mutual efforts of elected representatives from all regions Thus, it can be expected that restoration of true democracy in the country would facilitate a reduction of the regional disparities identified in this study 7.4: OTHER POSSIBLE APPLICATIONS OF MODEL Being a tops-down model, PAKREG can be used to simulate the national and regional effects of a wide range of national level policy shocks and region-specific demand shocks A few of the possible applications of the model are outlined below 7.4.1: Removal of Tariffs on Cement, Sugar, Livestock and Vegetables Pakistan has recently removed tariffs on cement, sugar, livestock and some vegetables, such as tomatoes, ginger and onions (see Section 2.2.7) This has generated an intense and passionate debate on the pros and cons of the policy However, the debate has been confined to qualitative discussions on the possible national-level impacts of the tariff removal PAKREG can be used to gain deeper insights into the quantitative impacts of the tariff elimination at the national and regional levels 7.4.2: Revenue-Neutral Tariff-Cuts It has been observed in Section 2.2.6 that trade reforms suffered a setback at the end of 1994-95 when regulatory duties and taxes were imposed to make up for the revenue shortfall because of the reduction in tariffs The model developed in this study can be used to simulate the national and regional impacts of revenue-neutral tariff cuts (a reduction in tariffs accompanied by the concomitant reduction in government spending or the increase in taxes ensuring that the pre-simulation fiscal balance is maintained) 7.4.3: Structural Adjustment Programs Successive governments in Pakistan have pursued trade liberalisation under a series of SAPs arranged with the IMF and the World Bank since 1988 (see Section 2.2.6) The SAPs sought a reduction in aggregate demand through fiscal-consolidation policies, such as restraining wages, freezing public-sector employment, cutting subsidies and reducing expenditure on development The implementation of the SAPs has given rise 277 to controversies about their ultimate impact on the economy The present model can be used to simulate the combined effect of the key trade liberalisation policies pursued under the SAPs 7.5: LIMITATIONS AND FUTURE RESEARCH It is recognised that there are at least three aspects of the present analysis where limitations exist and improvements can be made: the linkage between political setups and regional disparities; the database used for the empirical estimation of the model; and the specification of the theoretical structure of the model 7.5.1: Linkage between Political Setups and Regional Disparities It has been pointed out that while trade liberalisation under a military government appears to be associated with increased regional disparities, the reverse appears to be the case during the tenure of a truly democratic government However, this observed tendency has not been subjected to formal testing It would be of considerable interest to test the validity of this argument empirically—preferably through econometric analysis—not only in the context of Pakistan but also for a group of selected developing countries with democratic and military governments 7.5.2: Database of Model Along the lines of other tops-down regional CGE models, the model developed in this study was based on three sets of data: I-O data which reflected inter-industry relationships; sets of values for various elasticity parameters; and regional shares of the domestic commodities/industries As discussed in Chapter 5, the development of the database was subjected to various limitations Given the data constraints, some sets of the data had to be based on particular assumptions The database of the model can be improved by enhancement of the accuracy of the import flows to the agricultural and services industries; better allocation of land to the land using industries; improvement of the capital formation matrices; disaggregation of the single labour-occupation into multiple occupations; splitting up of the single margin commodity into several commodities; improvement of the regional export shares; and estimation of all the elasticity parameters econometrically The database should also be updated whenever the next I-O table is compiled for Pakistan Finally, efforts should be made to have this 278 database incorporated into the GTAP database so that Pakistan can be identified as a separate country 7.5.3: Theoretical Structure of Model There are certain limitations related to the structure of the present model Firstly, the model can handle only a single category of households The disaggregation of households on the basis of household income and/or residence in the urban or rural areas would have been desirable Secondly, while it has been noted in Section 2.2.8 that Pakistan has removed most of its NTBs, it is still using some NTBs and TBT to restrict imports In its present form, the model cannot estimate the impact of these NTBs and TBT unless they are converted into equivalent tariffs using some sort of approximation Thirdly, like many CGE models, money is absent from the model That is, monetary accommodation is assumed and only relative prices matter in the model The introduction of equations for the financial sector would be a major extension of the model Finally, since the model uses the tops-down regional approach, it is less capable of modelling region-specific supply effects because it contains no theory of regional variation in prices It would be useful to develop a model like TERM for Pakistan which could be used to simulate the effects of a region-specific supply shock, particularly the 2005 earthquake in NWFP The regional database supporting our model can be used as a stepping stone toward the construction of the database for the TERMtype model However, the database for a model like TERM needs to be constructed at the highest possible level of sectoral and regional detail (such as 144 sectors and 57 regions in the case of Australia) The limited number of regions (4) in our model’s database is completely inadequate for implementing a model like TERM Given the difficulties encountered in compiling the data for only the four regions, the development of the database for the TERM-style model will not be possible without a collaborative effort and sufficient funds 7.6: CONCLUDING REMARKS The CGE model and the supporting database developed in this study have been used to demonstrate their potential for policy analysis by examining the impact of the acrossthe-board tariff removal on Pakistan’s economy at the national and regional levels 279 Notably, three key findings of the tariff-cuts simulations have not been captured by any previous study, including the World Bank (2004) These are: (i) a slowdown or decline in Pakistan’s main exports in the long-run; (ii) an increase in the regional disparities between the largest region, Punjab, and two smaller regions, NWFP and Balochistan, in the short-run; and (iii) persistent unemployment in one of the smaller regions, Sindh, in the longrun Indeed, this model can be used to analyse the effects on Pakistan’s economy and its regions of a large number of simultaneous policy changes This shows how CGE models, supported by adequate databases, can provide valuable inputs to informed policy making Further research in this area is likely to be of interest to not only Pakistanis, but also to supporters and opponents of trade liberalisation, policy analysts and observers of interregional issues, and all those who are interested in human and economic development in general 280