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Published Date: Mar 1, 1999

Pakistan: The Impact of Economic Liberalisaton on Poverty (W-43)

Zafar Mahmood
1999

Introduction

Economic liberalization is viewed as having played a major role in the success of developing countries, especially in the East Asian region. It has been asserted that exports and foreign direct investment, which now account for a significant proportion of ASEAN’s GDP and investment, explain the high economic growth rate and the macroeconomic stability achieved by these countries in the last four decades or so.   These factors are also believed to have led to the infusion of new technologies and management skill, and to the consequent gains in productivity.

Almost all the developing countries have switched to a market based system—partly on their own, but mostly because of exogenous pressure by the IMF, World Bank and the World Trade Organization (WTO).  The latter added to the pressure for reforming of trade regimes. Following the trends of the world economy, Pakistan has also liberalized its economy since the 1980s to integrate it more fully with the global economy. Import-substitution industrialization (ISI) is no longer in fashion, and at any rate, it is difficult to practice as a WTO member.

The reform program that Pakistan gradually implemented during the 1980s and the early 1990s dismantled many of the components of the ISI strategy.  The extent of dependence on quantitative import controls was sharply curtailed. The exchange rate became increasingly determined by market forces and tariff rates were reduced. The discrimination against exports, relative to import substitutes, was reduced. There was also a sharp reduction in restrictions to which foreign direct investment had been subjected to in the past. The reform of trade and foreign investment was of course accompanied by many other reforms.  Notably, there was a general reduction of direct regulation of prices; a greater dependence on the market for resource allocation; and a reduction in the public ownership of the means of production in favour of the private sector, via denationalization and privatization of manufacturing units and banks.

A primary focus of the reform of the trade and investment regime, and the reform programme in general, was to promote a greater integration of the economy with the global economy. The reduction of impediments to free trade was intended to enhance the competitive strength of domestically produced goods. It was expected that the reform programme would encourage the expansion of production and export of goods and services. These could be produced at relatively low cost in terms of domestic resources. At the same time, there was a replacement of domestic production by the import of those goods and services that were costly to produce domestically. As a result, the rate of growth was expected to be higher due to the improved efficiency of resource use.  The reform strategy anticipated a further impetus to higher growth from an increased flow of foreign direct investment. Thus access to capital, technology, management and marketing skills were expected to induce economic growth.

Reforms were also expected to improve the distribution of income and reduce poverty. This would come about from the higher growth and from an increased reliance on comparative advantage that would promote specialization in labor intensive goods and services. The growth of productive employment is viewed as the most effective and efficient instrument for poverty reduction.  Of course, poverty reduction is possible only when liberalization of trade and investment accompany other complementary investments in the human development of the poorest. In this regard, though with some delay, Pakistan has pursued a comprehensive Social Action Program since 1992.

Theory notwithstanding, the Structural Adjustment Program (SAP) and the implementation of the WTO commitments have resulted in heightening of structural problems.  The inappropriate timing, phasing and sequencing of SAP have had significant adverse implications for growth, employment, poverty and income distribution. Also,  social sector expenditure as a proportion of total public expenditure fell after the adoption of the reform programme in 1988.  Finally, attempts to protect public expenditures that benefit the poor were not successful.

During the ISI period, the price of food grains was repressed so that low wages could be sustained for industry. The principal instrument used for this manipulation was a tax and/or quota on agricultural exports. Reforms have now dismantled much of these controls and have resulted in increased prices of agricultural products including food. The available evidence suggests that the effect of this on the poor has been substantial.

While foreign direct investment has helped augment gross production it has mostly been directed to capital intensive large infrastructure and energy projects. The rest of the foreign investment went into import substituting capital-intensive industries, which also did not create direct benefits for the poor.

Whereas SAP and WTO liberalization did not bring the required impetus for growth in the economy, the WTO-led new trading environment also did not provide Pakistan the agreed market access. This was mainly because of back loading of liberalization by developed countries in textile and clothing imports. The East Asian financial crisis and the global economic recession has further aggravated economic conditions. Pakistan’s exports in the last eight months have declined by about 24 percent.

With the above background the main objectives of this study are:
I.    To assess the conditions under which liberalization will contribute to  development targets in Pakistan.

II.    To provide arguments and evidence to enable the Department for International Development (DFID) to push for the best possible deal for developing countries in the new trade round.

III.    To build capacity in countries of South Asia to participate in an informed way in multilateral trade negotiations, and to help inform their decisions on the consistency, timing, phasing and sequencing of proposed liberalization commitments.

In particular, this study will focus on how consistency, timing, phasing and sequencing of proposed liberalization commitments can be undertaken in a way most likely to lead to effective poverty reduction. A central assumption through out the study is that policies cannot be undertaken in isolation. A secondary focus will therefore be on the other complementary policies which need to be in place (e.g. public investment in health and education especially for girls and women and the redistribution of assets including land reform) to ensure that the benefits of trade and investment reach the poor.

The section outline of the study is as follows: Section II examines the linkage between economic targets and trade and investment liberalization. The process of economic liberalization in Pakistan is discussed in Section III. The impact of liberalization on growth and equity in Pakistan is reported in Section IV. Finally, Section V contains a set of recommendations for the domestic economy and for future trade negotiations.