Academic journal article The Lahore Journal of Economics

The Missing Economic Magic: The Failure of Trade Liberalization and Exchange Rate Devaluation in Pakistan, 1980-2012

Academic journal article The Lahore Journal of Economics

The Missing Economic Magic: The Failure of Trade Liberalization and Exchange Rate Devaluation in Pakistan, 1980-2012

Article excerpt

1. Introduction

Pakistan and India were part of that wave of economic liberalization among developing countries from the late 1980s. What Bhagwati wrote about India could equally well have referred to Pakistan, if though Pakistan always had a little less state intervention and socialism than India. He wrote that the policy framework in India had stifled efficiency and growth, so while India, like Pakistan, had long maintained a reasonable rate of investment, the former suffered from an enduring problem of low productivity. This, Bhagwati blamed on the "extensive bureaucratic control over production, investment and trade," "inward-looking trade and foreign investment policies" and the "substantial public sector." Together, the "the deadly combination of industrial licensing and controls at home with import and exchange controls externally, effectively cut off the rigors of competition from all sources and made the creation of a rentier, as against an entrepreneurial, economy more likely" (Bhagwati, 1993, p. 60).

This was essentially an optimistic view. Bhagwati did not blame poor economic performance on any deep and durable determinant of economic growth, such as geography, institutions, colonial history, or culture, but instead on bad policy. And bad policy could be replaced by correct policy, so India (like Pakistan), in the late 1980s, needed "merely an appropriate policy framework to produce the economic magic that Jawaharlal Nehru wished for his compatriots" (Bhagwati, 1993, p. 98).

This paper is about one aspect of that failure to "produce the economic magic" in Pakistan. The country liberalized its international trade substantially after the late 1980s and, contrary to some views, managed its exchange rate in an exceptionally clear-sighted and prudent manner. In response, Pakistan never experienced sustained and rapid export ledgrowth. In fact, so disappointing was the performance of exports that Pakistan's degree of integration with the world economy was little higher in 2015 than it had been in 1990.

Section 2 first examines the exciting promise, and then the lackluster performance, of trade liberalization. Section 3 establishes evidence that the exchange rate was managed in a way that should have helped a more liberalized trading regime contribute to economic growth. In Section 4, the paper explores wider evidence linking trade liberalization to economic growth, and argues that the positive relation is, at best, only a contingent one. Those contingent factors that have failed to support the positive link between trade liberalization and economic growth in Pakistan are investment, tax revenue, and upgrading/learning. Section 5 concludes the study.

2. The Promise of Trade Liberalization and Outcome in Pakistan

This section first reviews the theory and evidence that import substitution was an unsuccessful economic strategy in the 1950s to 1980s across developing countries. This evidence provided much of the theoretical and empirical rationale for trade liberalization in Pakistan and India and in many other developing countries in the late 1980s and early 1990s. We then review the economic outcome in Pakistan, showing that, despite undertaking extensive trade liberalization, the outcome was disappointing in terms of economic growth, export growth, and global integration.

2.1. The Promise

The basic trade model, structured around the impact of a tariff on a small developing country, forms the centerpiece of textbook treatments of international trade. The tariff will raise the price of imports and so, domestic consumer prices. Higher prices will encourage more domestic production (import substitution) and reduce domestic consumption. The tariff will raise revenue for the government. The first impact is redistribution from consumers (reduced consumer surplus) to producer profits and to government tax revenue. The second impact is a decline in efficiency as the lure of higher domestic prices/profits draws factors of production (land, labor, and capital) from other sectors to expand production in the now-protected sector. …

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