Pakistani trade liberalisation experience and the way forward

            Pakistan’s trade liberalisation reforms have received accolades from international businesses as well as multilateral financial institutions. According to a World Bank study, “Pakistan’s recent reforms have been substantial. Its trade regime is now one of the more open in South Asia. It has the lowest applied average tariff rates of the three large South Asian economies: India, Pakistan and Bangladesh. Pakistan reached this position by reducing the number of tariff band to 25 percent. Unlike Sri Lanka and Bangladesh, and indeed most countries around the world, Pakistan has not shied away from opening its agriculture sector. In addition, the government eliminated quantitative restrictions, regulatory duties and other para tariffs and several other measures that restricted trade in the past. Finally, it reduced the number of statutory regulatory orders (SROs) and the exemptions granted under these orders. Ordinary custom duties are now the principal instrumentof trade policy. Improvement in Pakistan’s incentive structure and export environment surely contributed to its strong export performance in recent years.”

            The speed with which trade liberalisation has taken place during the last decade is impressive. Maximum tariff has been reduced to 25 percent from 80 percent in 1995 with simple average applied rate of 15 percent compared to 51 percent in 1995. The average import weight tariff rate in 2006-07 was around 8 percent. The number of regulatory duties has declined significantly. Virtually all tariffs (99.3%) are ad-Valorem and resolve around only six slabs including zero. Local content requirements have been eliminated in all sectors and policies have been brought in compliance with TRIMS agreements.

            State trading has been restricted to a few selected items only and that too not on a regular basis or under monopoly conditions. All public sector corporations engaged in trading activities have been disbanded except one i.e. Trading Corporation of Pakistan (TCP). TCP intervenes selectively to cope with domestic demands of essential conditions as and when explicitly decided by the Cabinet.

            The number of concessionary notifications in tariffs (SROs) has been reduced substantially. Customs clearance system and international trade related procedures have been streamlined to bring them at par with international best practices and make them complaint with international standards and conventions.

            Export facilitation are promotion have been the main focus of export policies and export subsides, relates and refunds have been gradually phased out or circulated in scope and coverage.

            The impact of these measures can been seen in doubling of Pakistan’s exports in US dollar terms within a period of five years and the tripling of Pakistan’s merchandise imports. It would be fair to surmise that as a result of trade policy reforms, anti export bias in manufacturing, agricultures and for services has declined substantially. But relative to the countries in East Asia, Pakistan still has a long way to go.

            A study carried out by an independent research institute – the Social Policy Development Centre (SPDC) – using both partial equilibrium and the general equilibrium impact of trade liberalisation and the simulations for the future concludes that, contrary to popular beliefs and perceptions, the process of trade liberalisation in Pakistan does not appear to have had a significant adverse impact on poverty and income inequality. The results of the study indicate that trade liberalisation has, if anything, reduced poverty and inequality although only modestly so on balance. The main channels of transmission leading to this outcome are growth, productivity, investment and price stability. Foreign direct investment that has come into Pakistan does appear to increase income inequality as it is highly skill and capital intensive and does not use much of the abundant factor of production i.e. labour. This finding that FDI increased income inequality is also consistent with a recent IMF study on the impact of FDI flows to developing countries. Also, some industries do seem to have suffered from trade liberalisation but such restructurings in the transition period are a natural consequence of trade liberalisation. An interesting and highly unique insight gained from the study is that trade liberalisation has had some adjustment costs associated with it, in particular, costs related to fiscal adjustments. Had the lower government revenue collection arising from a reduction in import tariffs been fully neutralised by other modes of direct and indirect taxation and development expenditures not fallen, the impact of trade liberalisation on poverty and income inequality would have been larger. Thus, trade liberalisation policies should only be pursued in conjunction with government revenue-neutral policies.

.           What are the generalized lessons learnt from the experience of policy reform implementation undertaken in Pakistan in the current decade?

.           Although the contours of these reforms were drawn in 1991, the pace of implementation picked up only after 1999. This became possible because the period 1999-2007 was characterized by continuity of the political regime compared to the period 1990-99, during which governments were dismissed or replaced five times and fresh elections were held three times. None of the major political parties differed on the broad thrust of the economic policies or reforms to be undertaken but they remained mostly preoccupied with the issues of gaining and sustaining political power rather than implementation of economic reforms.

The first lesson I would venture to offer is thatdomestic political stability is an indispensable prerequisite for continuity and consistency of economic policies and sustained implementation of reforms. The external shocks to the economy were almost identical in their intensity and penetration in the two periods. But what distinguished the performance was the response capacity to meet those shocks.

            Economic policy makers have to make tough choices and trade-offs and select ingredients of different policy options to meet the objectives they have set for the economy. These policies affect the economy as a whole in a beneficial manner over time but hurt many groups or individuals in the process. For example, the objective of aggregate GDP growth may be attained but the initial benefits of this growth may be captured by those who already own capital, land and financial assets, those who run their own businesses or those who are already employed. Thus, the consequences of this policy will affect various segments and classes of population in an uneven manner. It is the responsibility of the policy makers to inform the political leadership and communicate to the public at large as to what particular mix of instruments they are planning to use, what will be the intensity, magnitude and duration of this particular mix and what the consequences are likely to be. A neglect to communicate creates its own momentum of uncertainty that hardly helps the reform process.

The second lesson is that an effective communication strategy to inform the general public about the rationale and the consequences of the policies adopted is absolutely essential.

.           Even if an effective communication strategy is put in place, there is another reason as to why the impact of apparently benign looking policy reforms is not felt by a large number of target population i.e. due to lack of coordination among different implementing agencies within the government. The turf battles, the silo-like vertical decision making process, the concealing of vital information and data from each other, the sense of one-upmanship, and the feigned attempts to please the bosses at the expense of other competing ministries are in fact a kiss of death for both policy formulation as well as implementation. The subsequent blame game and pass-the-buck syndrome for the failures due to this lack of coordination and internal inconsistencies are hardly acceptable to the public-at-large or the political bosses themselves. Every ministry or organisation responsible for the policies ends up appearing in a bad light.

.           It is hardly realised by those engaged in these bureaucratic turf battles and clash of egos that in actual fact, it is the policy mix rather than stand-alone, isolated or uncoordinated policies that make the difference. The right policy mix requires timely cooperation, synchronisation and collaboration among various ministries and agencies. Confrontational and adversarial attitudes are counter productive and would invariably result in poor policy formulation and even greater disasters during policy implementation. The expected benefits of policy reforms are thus dissipated creating further disenchantment and disillusion in the country.

The third lesson is that bureaucratic in fighting among the government ministries and agencies and turf battles are inimical to favorable outcomes of policy reforms as even well thought out and formulated policies are implemented unevenly and in a haphazard manner. Coordination and harmony among various implementing agencies is critical to success.

.           The choice of the appropriate policy instruments would differ according to the objective assigned by the politicians. In a low inflationary low growth that characterised Pakistan in the period 1999-2002, liberal monetary policy produced the desired results. Growth picked up, unemployment rate dropped, poverty began to decline but inflationary pressures intensified. The policy makers therefore had to change gears and pursue a contractionary monetary policy in the post-2004 period. The consequences of these reforms and the set of winners and losers under each of these two sub-periods of reforms were different. In the post-2004 era, the fixed income groups and the poor suffered much due to high inflation rates. As monetary policy was tightened, nominal interest rates also shot up arousing the wrath of the business community which was the main beneficiary of the earlier liberal monetary policy regime. This simultaneous hue and cry by the losers from both ends of the spectrum began to raise doubts about the efficacy of reforms themselves. Rising international oil, food and commodity prices did not help the situation but in fact, made it worse. The political fall out of such hue and cry could be potentially disastrous for the sustainability of reforms. Dealing with the losers in a responsive manner is critical at implementation stage.

The fourth lesson is that policy objectives do not remain static and as domestic and external conditions change the policy objectives have to be modified. The losers under one set of policies can become the winners under a different set but they remain muted. So, there are no permanent winners or losers under varying economic policy environment. 

.           In Pakistan, which is a federation of four provinces in which one province enjoys absolute majority of the population, the macro economic policy reforms such as trade liberalisation, financial sector restructuring, exchange rate policy and taxation reforms can be readily carried out by the Federal Government. But the second generation reforms where state institutions are involved in delivering public goods and services cannot succeed unless the provincial and local governments are in sync with the Federal Government. There are many instances where the Federal Government has encouraged investment in infrastructure or social sectors in the backward districts of the country but the lack of cooperation by the local government functionaries has not allowed such investment to materialise. Law and order, security of property and lives, enforcement of contracts, labor laws, land allocation etc. are functions that are absolutely crucial for an investor to do business successfully. But all these functions fall under the purview of the provincial and local governments and the Federal Government cannot do very much except exhortation. The Devolution Reforms of 2001 which transferred some of the functions from the provincial governments to district governments have met fierce resistance in their actual implementation by the politicians as well as the bureaucrats. Consensus building among all affected stakeholders, striking compromises and safeguarding the interests of all those adversely affected by the reforms may slow down the pace but would lay the foundations for institutions that can deliver the results on a sustained basis.

The fifth lesson is that in the case of a federation such as Pakistan, a centralised approach to design and then pushing the reforms to the provinces and lower tiers of governments for implementation does not work beyond the first generation of macro economic policy reforms. The benefits of the reforms will accrue only if proper institutions are involved at all tiers in the formulation and implementation process. 

.           How can Pakistan move ahead? I must admit that I am, by no means, fully satisfied with the trade policy reforms as much more needs to be done to liberalise further. This can be done by bringing down maximum tariff rate gradually from 25 percent to 15 percent, by reducing tariff dispersion and tariff escalation, by closing loopholes created by special exemptions, Pakistan has made a good start. But other countries have not stood still. Tariffs in Pakistan, though lowered, remain high relative to East Asia, Latin America and ECA Regions. “Remaining competitive in an integrated world economy is a very dynamic process. In the present world of globally fragmented supply chains, the production process is broken into different stages and located in whichever country has the greatest comparative advantage in that particular activity.” Tariff dispersion, tariff peaks and tariff escalation have to be rationalised so that Pakistan can participate in these supply chains according to its comparative advantage. FDI has spurred exports and integration in many countries but has bypassed Pakistan’s manufactured export production. It appears the returns on producing for domestic markets remain relative higher.

.           I must also underscore that trade policy liberalisation per se may not be sufficient and that there are other complementary policies such as improvement in the functioning of labor markets, in governance, availability of skilled and technical manpower, reliable and well functioning infrastructure facilities such as power, gas etc. that need reforms, investment and institution building. Too frequent changes in trade policy may undermine the business community’s long term decision making calculus. Therefore, while the road map and direction may be set for long term, the present ritual of Annual Trade Policy cycle can be easily dispensed with.

.           Pakistan can benefit from greater trade and economic interactions with its buoyant neighbours China and India. Although China and Pakistan have entered a Free Trade Agreement, the trading relations between India and Pakistan have suffered a lot due to the historical political tensions. Pakistan has not accorded MFN status to India and operates on the basis of a positive list of goods and commodities that can be directly traded. The Pakistani authorities insist that non-tariff barriers imposed by India in the name of phytosanitary, environmental, safety, technical health and other standards should be relaxed and not applied selectively to the disadvantage of Pakistani exporters. The more important barriers that need to be dismantled have to do with visa restrictions, trade facilitation, banking services, customs procedure harmonisation, telecommunications, trading routes and transport links among the two countries. The dismantling of these barriers will reduce the inefficiencies in the movement of goods and consequently the transaction costs of direct trading between the two countries. Despite the presence of high non-tariff barriers in India, the gains from granting MFN status to India are considerable. Pakistan will not only be able to increase its exports by capturing share in a big market, it stands to save substantially by substituting some of its imports from the rest of the world with India.

.           In fact, a study by SDPI has demonstrated that the likelihood of directing the informal trade taking place between India and Pakistan to legal channels is low under an MFN regime, as existing tariffs would more than offset the net transaction costs incurred on the informal trade routes. It would take a substantial tariff reduction and a lowering of formal transaction costs to redirect informal trade to the more direct routes.

.           A study by Taneja estimated that the informal trade between India and Pakistan was about $2 billion annually in the early 2000s. By now, this volume would have at least doubled. A State Bank of Pakistan study in 2005 estimated that on the basis of the existing pattern of Pakistan’s trade with the rest of the world and price structures, the total trade potential between Pakistan and India could be five times more than the actual trade that was taking place through formal channels. The potential exports from Pakistan to India could rise to around $2.5 billion (2004 constant prices) while the size of potential imports from India was about $2.7 billion. Allowing imports of items such as auto parts, light engineering goods, transport equipment, IT and entertainment could result in savings in Pakistan up to $900 million annually.

.           South Asia is the least integrated region in the world. Attempts for promoting regional trade through South Asia Preferential Trade Area (SAPTA) established in 1995 and South Asia Free Trade Area (SAFTA) that became operational since January 2006 have not borne much fruit. Under these arrangements, direct trade in products like steel, aluminum, textile machinery, chemical products and pharmaceuticals will benefit both India and Pakistan as it is diverted from third countries. Sri Lanka can gain by purchasing cement and shipbuilding from Pakistan and India rather than South Korea. According to some studies, the complete elimination of tariffs under SAFTA may increase the intra regional trade by 1.6 times of the existing level.

.           Studies have shown that SAPTA process has contributed very little in stimulating intra regional trade as it did not result in deep tariff cuts, the coverage of goods subject to preferential tariffs was not wide, some actively traded goods were left out from preferential tariffs and non tariff barriers were not considered for removal. As a result of this slow progress many countries have resorted to bilateral free trade agreements. India-Sri Lanka, India-Nepal, Pakistan-Sri Lanka free trade agreements have become operational.

.           The South Asia Force Trade Area (SAFTA) has also not been able to make much headway so far. Outside the MFN status issue for India by Pakistan and the Pakistani representation about NTB barriers erected by India, customs cooperation, arbitration mechanism for resolution of disputes, avoidance of double taxation, promotion and protection of investments are some of the ancillary issues that are holding up progress. Despite reduction of average tariffs, distortions will prevail in the form of high tariffs in particular products in some countries. The list of products on negative list and lack of clarity on the removal of NTBs provides ammunition to the policy makers to use them as a tool for foot dragging. The argument that rigid factor markets in SAARC member countries make it difficult to restructure industries that will be hurt as a result of trade liberalisation does not hold much ground. If the countries are able to do so unilaterally, why should they see this as a problem for liberalisation under SAFTA.

.           I agree with the editors of the Economic and Political Weekly when they say, “It is for India to ensure that smaller members of the region have a growing stake in regionalism… This responsibility India has not taken seriously.”

.           But there are many other avenues of economic cooperation in the region besides trade which can result in a win-win situation. India’s growing global economic position can have positive spill over effects for Pakistan, Bangladesh and Sri Lanka in areas such as Information Technology Enabled Services (ITES) and Business Process Outsourcing (BPO), investment, energy and irrigation water.

.           India’s growing share in world ITES-BPO services market, Research and Development services and other knowledge based services and sub-sectors can act as a magnet for other South Asia countries. The large pool of English speaking, educated IT savvy youth available in Pakistan, Sri-Lanka and Bangladesh can supplement the Indian knowledge workers particularly at the lower end of the value chain. The shortages being felt by Indian companies and the rising wages can be offset by dipping into this large pool of employable workers. The Indian companies can train and mould them to suit their requirements and continue to obtain more outsourcing business from the advanced countries. The established brand name, the marketing prowess and the management skills in aggregation and integration available in India can be blended with the pool of trained workers in other countries to create a win-win situation. Indian workers can move to more high-end and high-skilled areas and value-added end of the production cycle. The standardised information processing packages, software platforms and programs and computer aided training kits have made this mobility possible. Pakistan has invested heavily in its tertiary education in the last six to seven years and there has been a manifold expansion in the number of institutions which can supply the manpower required by ITES-BPO companies in India for augmenting their exports. A top Tata consultancy services executive told me that he did not find much of a difference in the raw material of fresh IT graduates produced in Lahore and Bangalore. All he wanted to do was to train these young men and women in the particular mould of TCS skills and culture.

.           A SAARC investment area can provide the nexus between trade and investment and attract foreign investors to make location decisions within the region free from cross-border frictions. Large bilateral trade deficits can be financed by investment flows on the capital account. In the world where horizontal and vertical linkages in the production processes have become important and the assembly of final product from components and parts fabricated elsewhere are common place, South Asian industries will be able to meet competitive pressures if a common investment area is set up within the region.

.           Energy shortages in the two big countries of the region coexist with abundant supplies available in other countries. Nepal, Bhutan and Bangladesh can meet the energy demands of India at low costs but these projects have been talked about for long but no tangible progress has been made so far. Industrial and agricultural development in India and Pakistan would be stalled and economic growth rates slow down if hydroelectric, natural gas and renewable energy sources available within the region are not tapped. Integrated energy market within the region with a network of grids, pipelines and transmission lines will be economically feasible only if appropriate pricing, delivery and institutional arrangements are put in place. A bunch of inefficient and bankrupt electricity supply companies or boards owned and controlled by the public sector selling below the market cost of generation, transmission and distribution cannot make such market happen. The sale of these public monopolies to private sector would be even more disastrous. Only contestable market and vigilant regulatory body can make this happen.

.           India and Pakistan rely on irrigation. Both of these countries, as well as India and Bangladesh, share common river systems. The Indus Basin works in the 1960s created an acceptable division of water rights between India and Pakistan. But the population pressures have put both countries in likely water stress category. Efficiencies and equitable distribution of benefits can be achieved if the irrigation systems commanded by common rivers can be managed on a pan-territorial basis. Game playing whereby dams, reservoirs, storages, diversions are mindlessly put to stake, the claims by one party or the other is only going to further muddy the waters.

.           To conclude, let me say that the thrust of policy reforms in Pakistan has broad political support from all major parties and these are likely to continue. The only difference would be that these reforms would be accompanied by greater sensitivity and attention to the issues of poverty, employment and income and regional inequities. As the credibility of Indian policy reforms was enhanced when the BJP government continued the policies of Congress after coming to power in the late 1990s, I am sanguine that the change in the government in Pakistan in 2008 will have the same effect on long term economic prospects.