The Trade Potential of Pakistan: An Application of the Gravity Model

By Gul, Nazia; Yasin, Hafiz M. | The Lahore Journal of Economics, Summer 2011 | Go to article overview
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The Trade Potential of Pakistan: An Application of the Gravity Model


Gul, Nazia, Yasin, Hafiz M., The Lahore Journal of Economics


Abstract

This paper attempts to estimate Pakistan's trade potential, using the gravity model of trade. Panel data for the period 1981-2005 across 42 countries is employed in the analysis. The coefficients obtained from the model are then used to predict the country's trade potential worldwide as well as within specific trading regions. The results reveal that Pakistan's trade potential is highest with countries in the Asia-Pacific region (the Association of Southeast Asian Nations [ASEAN]), the European Union (EU), the Middle East, Latin America, and North America. Specifically, the maximum potential exists with Japan, Sri Lanka, Bangladesh, Malaysia, the Philippines, New Zealand, Norway, Sweden, Italy, and Denmark. Therefore, Pakistan should explore ways and means to further improve its trade relations with the countries concerned, and also concentrate on ASEAN, the Middle East, and the EU to increase its market share as far as possible. The volume of trade between Pakistan and other members of the South Asian Association for Regional Cooperation (SAARC) and Economic Cooperation Organization (ECO) is very low, despite the existence of significant potential. The main obstacles to this end are the political and social tensions among neighboring countries, particularly between Pakistan and India, which are the main players of SAARC. The same obstacles exist in the case of the EU and NAFTA, where Pakistani exports are adversely affected by political considerations.

Keywords: Trade potential, gravity model, Pakistan.

JEL Classification: F19, O16.

(ProQuest: ... denotes formulae omitted.)

1. Introduction

Pakistan has recently witnessed a significant increase in exports as a result of rapid improvement in the international trading environment. During 2002/03 to 2005/06, Pakistan's exports remained at 16 percent of gross domestic product (GDP) per annum, while imports remained at 29 percent of GDP on average. Pakistan has adopted an export-led growth strategy since 2000/01 and the success of this strategy obviously requires that Pakistan have greater access to international markets for its products. The government has started negotiating several bilateral and regional trade agreements with neighboring countries. However, despite the importance of regional trade and the government's serious efforts, the volume of Pakistan's trade within SAARC and ECO is not up to the mark. The primary reasons for low trade within the region are obviously the political and military tensions that have prevailed among the major players for decades, and the protectionist policies adopted by the nations concerned. If the members succeed in removing the tariff and nontariff barriers as visualized by the SAARC charter, all countries of the region, including Pakistan, will reap the benefits of intra-regional trade.

The present study attempts to estimate Pakistan's overall trade potential with its traditional partners and other important countries by using panel data estimation. Further, keeping in view the importance of the implementation of the South Asian Free Trade Agreement (SAFTA) 2006, the study analyzes the extent of SAARCs integration into the world economy in general and for Pakistan in particular. The results are expected to provide useful insights into the trading capacity of Pakistan and help identify new areas for exploration.

The paper is organized as follows. We discuss the theoretical foundations of the gravity model in the following section. Section 3 provides a general overview of the application of this model. Here, we review some important studies on trade potential and the impact of regional trading arrangements on trade flows. Section 4 presents the model and discusses the methodology, while Section 5 discusses the data used in the estimation. Section 6 presents the primary results of the gravity model and Section 7 uses the estimated values of parameters to compute the trade potential of Pakistan.

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