Balancing Trade and Competition in Pakistan (Article)

High tariff rates have increased the overall cost of production in Pakistan, and the domestic prices of many products have become much higher than the international market prices. Reducing import tariffs will reduce not only the domestic prices but will also increase the export competitiveness of the country because many imported products are complementary intermediate inputs in various exporting industries. Further, it will allow the country to take advantage of the augmented technology in the new imported products, which will help add new products to its export portfolio. Hence, we eliminate the import tariffs of the 10 major import items of Pakistan such as cooking oil from Indonesia; textiles, chemicals, basic metals, machinery, and electrical equipment from China; mining, coke and petroleum from the United Arab Emirates; and mining coke and chemicals from the Kingdom of Saudi Arabia. Our simulation results show that eliminating the import tariff reduces domestic production in most of these sectors. Among them, however, the mining, textile, and chemical industries still grow moderately. On the other hand, domestic production of all other sectors increases moderately indicating that access to more economic intermediate inputs allows these industries to contribute to economic growth, and the overall GDP increases by around 0.5 Percent in the country. The overall trade balance of the country improves by around US$ 338.14 million where exports of electrical equipment, mining, and machinery sectors increase by 13.5 Percent, 12.5 Percent, and 10.06 Percent, respectively.

Introduction

Pakistan faces a complex economic challenge characterised by dwindling foreign exchange reserves, a widening trade deficit, and protectionist policies aimed at shielding domestic industries. While protectionist measures like import bans and high tariffs are often implemented to support domestic industries, this paper demonstrates that such policies may be counterproductive to economic growth and competitiveness. As Najib (2022) documents, import bans often prove ineffective, leading to increased smuggling and reduced customs revenue. Similarly, trade restrictions through import tariffs can have unintended negative consequences. Shapiro (2021) illustrates how these restrictions inflate domestic prices, ultimately undermining export competitiveness and exacerbating trade balance issues.

This study is fundamentally grounded in the theory of the effective rate of protection (ERP), pioneered by Johnson (1965) and Balassa (1965). The ERP theory provides a crucial framework for understanding how tariff structures affect the entire production process, not just final goods. As Johnson (1965) demonstrates, the effective rate of protection measures the percentage increase in value added per unit in an economic activity that is made possible by the tariff structure relative to the situation in free trade. Balassa (1965) further elaborates that when import tariffs are imposed on intermediate inputs, they adversely affect domestic industries.

This theoretical framework is particularly relevant to Pakistan’s current situation, where import tariffs are heavily imposed on raw materials and intermediate inputs for domestic industries. The ERP theory suggests that such a tariff structure is counterproductive: while nominal tariffs might appear to protect domestic industries, the effective rate of protection can be negative when input tariffs are high relative to output tariffs. This creates what Johnson terms a “negative value-added at world prices,” effectively reducing the international competitiveness of domestic industries rather than enhancing it.

Building on the ERP theoretical framework, this study addresses a critical gap in the literature regarding the impact of trade liberalisation on Pakistan’s economic performance. While previous studies have examined various aspects of Pakistan’s trade policy, few have provided a comprehensive analysis of how reduced import tariffs could affect both sector-specific outcomes and broader economic indicators. The primary objective of this research is to quantify the economic impacts of trade liberalisation through targeted reduction of import tariffs on key sectors. Specifically, this study aims to:

1. Evaluate the sector-specific effects of import tariff elimination on domestic production, prices, and trade flows.
2. Assess the implications for government revenue and overall economic welfare.
3. Analyse the redistribution of factors of production across sectors.
4. Develop policy recommendations for a phased approach to trade liberalisation.

The problem of stagnant exports is particularly acute in Pakistan’s case, with the country heavily dependent on textiles and a narrow range of export markets. This concentration mirrors Chile’s historical dependence on copper exports, as documented by Lebdioui (2019). However, Chile’s successful diversification through trade liberalisation (1973-1990) provides valuable lessons for Pakistan’s current situation.

Drawing from the ERP theory, our analysis shows that Pakistan’s current tariff structure, which heavily taxes intermediate inputs, creates a cascade of inefficiencies throughout the production chain. As Balassa’s work suggests, this not only increases production costs but also distorts resource allocation, leading to reduced international competitiveness. This paper demonstrates how reforming this structure through targeted liberalisation can enhance both productive efficiency and export competitiveness.

Our analysis focuses on Pakistan’s major trading partners, including China, United Arab Emirates, USA, Indonesia, and Saudi Arabia, examining ten key import categories including cooking oil, textiles, chemicals, basic metals, machinery, and electrical equipment. The study employs a multi-regional computable general equilibrium (CGE) model using the latest available data from the Global Trade Analysis Project (GTAP) version 11 database, covering 65 sectors across 151 countries/regions.

The study’s methodological contribution lies in its innovative application of a multi-regional CGE model to Pakistan’s specific context. Unlike previous research that often relies on partial equilibrium analysis or simplified general equilibrium models, this study employs a sophisticated modeling framework that captures both direct and indirect effects of trade policy changes across multiple sectors and regions. This approach allows for a more nuanced understanding of the complex interactions between trade policy, domestic production, factor markets, and overall economic performance.

The problem of stagnant exports is particularly acute in Pakistan’s case, with the country heavily dependent on textiles and a narrow range of export markets including Germany, USA, UK, and China (Zeshan, 2022c). This concentration mirrors Chile’s historical dependence on copper exports, as documented by Lebdioui (2019). However, Chile’s successful diversification through trade liberalisation (1973-1990) provides valuable lessons for Pakistan’s current situation.

International trade can serve as a crucial mechanism for bridging productivity gaps between nations, Van Ark, et al. (2008) find that trade enables Europe to adopt advanced technologies from the U.S. due to increased exposure to innovative goods and services. By importing high-tech products, European firms gain access to new technologies and best practices, improving their productivity over time. Ethier’s (1982) seminal work demonstrates how imports can drive long-run prosperity by enhancing firm productivity through access to diverse intermediate goods. Furthermore, as Krugman (1979) argues, the imperfect substitutability of imported and domestic inputs creates productivity-enhancing synergies.

This paper’s key proposition is that trade liberalisation through reduced import tariffs can provide Pakistan access to affordable intermediate goods, final products, and capital equipment. The current high import tariffs (approximately 12 percent) distort market incentives (Asif, et al. 2022), diverting resources from competitive export sectors to less efficient domestic industries. By analysing China’s experience, where lower import tariffs and import promotion led to increased innovation and competitiveness (Tian & Yu, 2019), this study provides valuable insights for Pakistan’s trade policy reform.

The remainder of this paper is organised as follows: Section 2 reviews mainstream literature whereas Section 3 examines the structure and sources of imports in Pakistan. Section 4 presents the modeling framework, while Section 5 details the simulation design and database. Section 6 discusses the simulation results, Section 7 provides a discussion on potential pitfalls, and finally, Section 8 concludes the study and suggests key policy implications.