Pakistan is making strenuous efforts to increase its trade flows. It has automated its border clearance procedures and recently signed the WTO's Trade Facilitation Agreement (TFA). Earlier, it made some fundamental changes in its trade policy; for instance, it introduced zero-rating scheme for vital exporting sectors in 2005 and subsequently signed trade agreements with China, Sri Lanka and Malaysia. These reforms have contributed to increase in trade flows but the country has yet to see the appropriate trade response commensurate with its trade potential. This article analyses the issue of trade promotion from a micro perspective and makes some recommendations to make Pakistan a trading place.
During the last decade, the dynamics of international business have changed rapidly. Previously it was generally thought that countries engage in trade but now it is widely believed that it is the firms, not countries or industries, that conduct international business. A cursory look at the trading pattern of Pakistan's exporters indicate that most of them sell large quantities in the home market. This is because international trade is costly, particularly in Pakistan (Figure 1). Before engaging in trade, firms must incur fixed and sunk costs of production, transportation, and development of distribution network in export markets. A firm should be able to meet these costs and make substantial operating profit. These costs are incurred upfront but profits are deferred and uncertain. Therefore, these costs deter most firms from engaging in international markets.
Broadly speaking, there are three categories of trade costs along the supply chain: behind the border, at the border, and beyond the borders. Behind-the-border costs pertain to transportation of goods from factories and farms to gateway airports or seaports, as well as other barriers, such as credit constraints, and product and labour market regulations. Geographically Pakistan is a semi-landlocked country with access to seaport through the Arabian Sea only but its manufacturing and exporting activities are unevenly distributed in the hinterland. The most important component of trade costs relates to inland transportation. Owing to long internal transportation, Pakistan's geography becomes a natural non-policy barrier to trade through sea. Fortunately, the China Pakistan Economic Corridor (CPEC) project would reduce trade costs within Pakistan by significantly increasing connectivity. The CPEC will provide a network of road and railways to link remote manufacturing facilities in hinterland to seaports of Karachi and Gwadar. This improved connectivity will reduce the costs of transportation and curtail travel time. However, these behind-the-border costs are just one component of cost of doing international business.
Second important component of trade costs pertains to crossing international borders. At-the-border costs involve preparation and filing of documentation, and chasing them with customs authorities, freight forwarders and shipping agents. Pakistan has streamlined these procedures to a great extent. Reforms in customs administration and the enhanced use of information and communication technology have significantly reduced these costs. These border-related costs would drop further over time because of the ongoing reforms, especially as the implementation of the TFA sets in.However, one important component of trade costs at the border is relatively higher import tariffs, which needs rationalisation. Like many other developing countries, Pakistan obtains a substantial share of revenues from border taxes. Although the rate of customs duty has dropped substantially, the effective rate has not changed much because of many other taxes levied at the import stage. The ADB reckons that Pakistan's import taxes are highest in the region.
Relatively higher border taxes directly affect Pakistan's trade in three important ways: i) they impede the use of imported inputs as industrial raw materials for exports. As exports and imports are two sides of the same coin, a tax on imports is basically a tax on exports; ii) high import tariff shields inefficient domestic producers. Tariff rationalisation will remove this protection and foster competition, which in turn will push these inward focused firms to explore international markets, leading to an increase in exports; and iii) the reduced tariffs will improve cash flows of existing exporters and incentivise them to expand their output and diversify their products as big exporters are also big importers.
The third component of trade costs relates to market access beyond the borders. Pakistan's trade regime, which so far has been multilateral in nature, needs considerable revisiting. As multilateral trading system has not made much progress, the world stands divided in various regional trading blocs. Currently more than 700 free and preferential trading agreements (FTA/PTA) exist between WTO members and Pakistan is a member of only six such agreements. Moreover, the world is witnessing the emergence of mega trading blocs such as Trans-Pacific Partnership, and Transatlantic Trade and Investment Partnership in Asia and Europe, and the continent-wide FTA in Africa. Pakistan needs to engage in these regional and extra-regional agreements to improve the comparative advantage of its export-oriented firms. The increase in market access owing to the PTAs could incentivise more firms into exporting, and existing exporters to expand their product set. Pakistan's own FTA with China is a best example of the trade effect of these agreements. Pakistan signed FTA with China in 2007. At that time, only 1,100 firms were exporting to that market. Last year, the figure was around 2,000, raising the trade volume from $3 to $16 billion.
To facilitate exports, Pakistan needs to take a holistic approach to reduce trade costs along the supply chain. The CPEC will reduce behind-the-border trade costs but the country still needs to focus on reducing trade costs at the border by rationalising tariffs, and those beyond the borders by negotiating trade agreements. Moreover, it needs to focus on upgradation of skills which are critical to increasing production capacity, and a country can only export what it produces.
(The writer is an empirical trade economist pursuing a PhD in the University of Nottingham, UK. He can be reached at Salamat.ali@alumni.lse.ac.uk.)