Free Trade Agreements: A Welfare Analysis for Pakistan
Author: Khurram Shahzad

The welfare gains that may be derived from free trade agreements (FTAs) include enhanced trade volumes, improved terms of trade and economies of scale that eventually benefit the consumers and the producers of the countries that are parties to such agreements. The net welfare gains from FTAs depend on the amount of trade creation (welfare gains) and the trade diversion (welfare loss). Our study analyses the welfare implications of bilateral FTAs of Pakistan with three countries, namely, Sri Lanka (PSFTA), China (PCFTA) and Malaysia (PMFTA). We extend the welfare analysis to the manufacturing and agriculture sectors to obtain meaningful evidence with regards to sector level welfare. The evidence on sector and industry level analysis is intended to guide and aid the formulation of trade policy, which may ensure net welfare gains for the country as we undertake and sign the FTAs. The execution of the agenda entails a series of objectives that involves the use of an array of methodologies and estimation techniques. These include the application of the Gravity model, the Viner model and the Lloyd and Maclaren model, to study the welfare gains of the FTAs, based on trade creation and trade diversion; and also to calculate the welfare changes of trading agreements based on the prices and quantities of products, respectively. The empirical model of Magee (2016) has been used to quantify trade creation and diversion from the sectoral (manufacturing and agricultural) and industry level trade. The evidence from Poisson Pseudo Maximum Likelihood method suggests the existence of net welfare gains from all the FTAs undertaken since the signing of PCFTA, causing significant trade creation from the manufacturing sector worth USD 76.84 million. However, trade creation from PSFTA is worth USD 0.15 million only. PMFTA has produced negative trade creation, amounting to USD 0.56 million. PCFTA has made a positive change in trade of 793 product groups and an adverse change in trade of 240 product groups all because of the agreement. PMFTA has caused a positive change in the trade of 131 product groups and an adverse change in the trade of 117 product groups. The negative change outweighs the positive change resulting in an adverse net change. Despite the improved terms of trade with Malaysia, Pakistan saw an adverse net change in trade volume. Overall, Pakistan gains from these FTAs, as none of the FTAs caused a welfare loss since we did not find any trade diversion. Findings are robust at the sectoral, industry and product level. The estimates from the counterfactual analysis, based on the Lloyd and Maclaren model, confirm that trade volume would be lower, and terms of trade would be unfavourable in the absence of the FTAs. The results are robust in all three FTAs. Based on the product group level analysis, we conclude that the countries with a high concentration of exports and imports do not gain much from the FTAs. It is necessary for Pakistan to diversify trade to reap the fruits of the FTAs fully. We find that the consumers in Pakistan gain from these FTAs because of the reduction in the prices of several import products after the preclusion of tariff; and so, the import demand for the products available in the particular FTA is enhanced. ii The consumer gains from PSFTA and PMFTA are not that significant. The producers, however, are worse off due to the high competition because of the trade liberalisation brought about by the FTAs. The availability of a variety of goods available at cheaper rates causes lower local production. However, we conclude that overall the producers have gained from these FTAs. The estimates show that the FTAs have increased Pakistan’s industry-level imports by USD 52.97 million, meaning there has been trade creation. The Chinese and Malaysian FTAs account for trade creation worth USD 27.69 million and USD 24.73 million, respectively. Out of the three PSFTA has not shown an impressive trade performance. The exports to Sri Lanka have increased sluggishly, and at the same time, the imports have decreased. Alarmingly, the FTA partner countries do not import from Pakistan in proportion to their expanding economic abilities. Our study contributes to the literature multi-fold. It is a novel study, as it assesses the welfare implications of Pakistan’s FTAs, using trade data from aggregated to product level. Further, we use the empirical model of Magee (2016), developed very recently, to calculate trade creation and trade diversion as introduced by Viner (1950). We also use the most recent historical data for estimations. It is so far the most extensive dataset used for welfare analysis in Pakistan. We not only make conclusions based on aggregate data, but also quantify the trade volume and terms of trade gain using counterfactual analysis. We also augment the Magee (2016) model by incorporating individual dummies for each of the FTA and by working out the model for sectoral level trade. We use Poisson Pseudo Maximum Likelihood Method to solve issues of heteroskedasticity, zero trade values and log-linearity of the gravity equation, which is still unattended by Ordinary Least Squares. Importantly, we control the estimates for macroeconomic and structural changes going beyond the simple gravity equation. Overall, our study uses efficient analytical frameworks and estimation techniques to gauge the welfare implications and to better analyse the agreements, in the context of the product groups, industry and sectoral level trade. Finally, based on the findings of our study, we recommend different policy measures to increase the welfare gains from these agreements. We recommend re-negotiating the currently active FTAs to address the concerns of producers and other stakeholders. The FTAs increase consumer surplus on the cost of a reduction in producer surplus, hence, trade policy needs to focus on increasing the producer surplus. There is a dire need to grant tariff concession from either side on the top trading products, along with high trade potential products. The re-negotiation of the FTAs requires us to focus onan export promotion policy that would convince the FTA partners to enhance their imports from Pakistan. The excessive cost of doing business and the payment of high taxes need to be eroded to encourage the local producer and the business community to take part in export promotion activities. The exports from Pakistan need diversification from a few products to a wide range of products along with an active search for different markets. As required of the concerned departments, they should launch an awareness campaign for the producers to inform them about the concessions these agreements offer them. Supervisor:- Dr Sajid Amin Javed Co-Supervisor:- Dr Attiya Yasmin Javid

Meta Data

Supervisor: Sajid Amin Javed
Cosupervisor: Dr Attiya Yasmin Javid

Related Thesis​