Is Trade Liberalisation Pro‐Poor in Pakistan? Evidence from Large‐Scale Manufacturing

• Author: Atif Khan Jadoon,Ambreen Sarwar
• DOI: http://doi.org/10.1111/1467-8462.12360
• Published date: 01 September 2020
• Date: 01 September 2020

The Australian Economic Review, vol. 53, no. 3, pp. 360–394 DOI: 10.1111/1467-8462.12360

Is Trade Liberalisation Pro‐Poor in Pakistan? Evidence from

Large‐Scale Manufacturing

Atif Khan Jadoon and Ambreen Sarwar*

Abstract

This article aims to analyse the impact of

industry‐level trade liberalisation (measured

through industry‐specific tariff rates) on

poverty in Pakistan. Combining data for tariff

rates with the Labour Force Survey of

Pakistan, we use quantile regression analysis

to estimate the impact of changes in tariff

rates on workers’wages (associated with the

manufacturing sector of Pakistan) that are at

different points of the income distribution.

Our findings meaningfully signal that trade

liberalisation helps to reduce poverty in the

economy. Based on these results, this study

provides policy recommendations to reap

maximum benefits from trade liberalisation.

1. Introduction

Over the course of history, human societies

worldwide have developed progressively

closer contacts. However, in the past few

decades, the pace of global integration has

increased remarkably. Unprecedented devel-

opments in modes of communication, trans-

portation and information technology, along

with increased trade, have given global

integration a new impetus. International trade

has become an inescapable reality of the

twenty‐first century, but also one that has been

increasingly politicised and contested in the

context of developing countries. Advocates of

trade liberalisation identify many of its

positive effects on resource allocation, pro-

ductivity and economic growth. There is a

widespread acceptance that in the long run,

open economies perform much better than

closed ones (Sachs et al. 1995; Siddiqui and

Kemal 2006; Akmal et al. 2007; Raihan 2008;

Manni and Afzal 2012). However, critics of

trade liberalisation fear that in the short run, it

can have adverse impacts on certain stake-

holders in the economy, especially those in

the labour force (Hanson and Harrison 1999;

Salman and Javed 2011). According to them,

even in the long run, the process of opening

up may leave some behind in poverty.

Economists around the world have repeatedly

fostered the need for developing countries to

alleviate poverty if they are to accelerate their

pace of economic growth. Therefore, it is

important to see how trade liberalisation

affects poverty in these countries. In this

* Department of Economics, University of the

Punjab, Pakistan. Corresponding author: Jadoon,

email <atifkhan_4@yahoo.com>

© 2020 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research,

Faculty of Business and Economics

Published by John Wiley & Sons Australia, Ltd

regard, the present study aims to analyse the

impact of trade liberalisation on the incidence

of poverty in Pakistan, which is probably one

of the major challenges the country is facing

today.

Pakistan's major wave of trade liberal-

isation came after the formation of the

World Trade Organization (WTO) in 1995.

Before that, Pakistan followed highly protec-

tionist, inward‐looking, import‐substitution

policies. The manufacturing sector was

heavily protected from foreign competition

in the form of quantitative restrictions on trade

such as quotas, high tariff rates and import

surcharges. Thereafter, increased trade open-

ness in Pakistan resulted in the reduction of

import taxes, promotion of exports and

increased competition for the domestic in-

dustrial sector. The average statutory tariff

rate on imports fell from 47.1 per cent in

1997–98 to 14.4 per cent in 2005–06 (World

Bank 2006). As a result, the manufacturing

sector's total imports and exports increased

from 1997–98 to 2013–14. In the wake of

trade liberalisation Pakistan also made some

significant progress in reducing its absolute

poverty levels. According to the World Bank's

Poverty Head Count Ratio (at $1.90 a day) the

proportion of the population living in poverty

fell from a staggering 62.16 per cent in 1987

to 15.92 per cent in 1996. Thereafter, poverty

started increasing and reached 28.65 per cent

in 2001. From 2001 onwards, poverty levels

started decreasing and reached 6.07 per cent

by 2013.

1

Skeptics argue that increased trade

liberalisation would adversely affect this

scenario by increasing competition, affecting

wages and causing structural unemployment

among the poor.

However, strong economic evidence sug-

gests that with proper implementation of pro‐

poor government policies, there is a huge

potential for trade liberalisation to provide

relief to the poor by increasing their wage

returns, reducing prices of basic necessi-

ties and providing them with better employ-

ment opportunities (Siddiqui and Kemal 2006;

Akmal et al. 2007).

There are various channels through which

trade liberalisation can affect poverty, that is,

through individuals, households, enterprises

(labour market) and government (Winters

2000). Since exploring all of these channels

is not within the scope of this study, the

present study only considers the changes in

the labour market that follow the implementa-

tion of trade liberalisation policies when

considering the effect of trade liberalisation

on poverty. Activities of the enterprises,

especially those related to wages and employ-

ment, play a significant role in determining

the effect of trade shocks on the poor. In

this regard, various studies have presented

contradictory views about the effects of

trade liberalisation on wages and poverty

(Milanovic 2005; Siddiqui and Kemal 2006;

Akmal et al. 2007; Salman and Javed 2011).

However, due to the lack of focus on industry‐

level trade liberalisation in Pakistan, no past

study analyses the true nature of the effects of

trade liberalisation on the industrial work-

force. Most of the studies use the trade to

gross domestic product (GDP) ratio or

economy‐wide average tariff rates as mea-

sures of trade liberalisation, which have been

criticised for being flawed.

2

Moreover, the

focus of the majority of past studies (Salman

and Javed 2011; Mamoon and Murshed 2012)

is to check the impact of liberalisation on

mean wages while ignoring the symmetry of

the wages around the mean values. Individuals

with different levels of wages may not be

affected uniformly by trade liberalisation if

wages are not symmetrically distributed

around the median. Due to this lack of sound

investigation, in addition to conflict of evi-

dence in past studies, analysis of the relation-

ship between trade liberalisation and poverty

still remains a topic of interest for researchers.

To fill these research gaps, the foremost

objective of the present study is to analyse the

effect of industry‐level trade liberalisation on

workers with different wage levels in

Pakistan. Considering the effects of trade

liberalisation on wages of individuals at the

lower end of the income distribution, we

derive inferences related to poverty levels. For

the purpose of analysis, we combine micro‐

level data, obtained from the Labour Force

Survey (LFS) of Pakistan, with macro‐level

361Is Trade Liberalisation Pro-Poor in Pakistan?

© 2020 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research, Faculty of Business

and Economics

data on tariff rates for the years 1997–98,

2003–04, 2008–09 and 2013–14.

According to the basic economic principle of

comparative advantage from trade, countries

specialise in the production of goods that they

can produce at a lower opportunity cost than

other countries. Pakistan, like most other devel-

oping nations, has an abundant unskilled (poor)

labour force. Therefore, it specialises in the

production of relatively unskilled labour‐

intensive goods like footwear, sports goods,

surgical instruments and handicrafts (Kalim

2001). Economists explain the relationship

between trade and wages in the context of

neoclassical trade theory: the Heckscher‐Ohlin

(HO) model (Heckscher 1919; Ohlin 1933) of

international trade. According to the HO model,

as a country liberalises its trade, its most

abundant factor (labour in the case of developing

countries and capital in the case of developed

countries) will benefit (Burtless 1995).

A well‐established theorem of international

trade known as the Stolper‐Samuelson the-

orem, derived from the HO model, is used to

establish the link between trade openness and

wages (and in turn poverty) earned by labour

in Pakistan. The theorem suggests that as the

market for labour‐intensive products of the

developing country transcends national

boundaries, the demand for these products

will increase. So, by extension, will the

demand for unskilled workers. This will

subsequently increase the wages of those

involved in the production of these goods.

Hence, the wages of the poor in developing

countries like Pakistan would increase as a

result of increasing exports in a more liberal

trade regime.

Following trade liberalisation, changes in

the wages of workers who are at the bottom of

the income distribution can meaningfully

signal towards the poverty response of trade

liberalisation because these low wage‐earners

constitute the deprived and downtrodden in

society. An increase in the wages of relatively

poor workers as a result of trade liberalisation

can help them escape the poverty trap. Kumar

and Mishra (2008) provide empirical evidence

that large tariff cuts increase the relative

incomes of unskilled labour and help to

reduce the poverty rate and wage inequalities

in India. Since Pakistan's labour force struc-

ture is similar to that of India in being

primarily composed of unskilled labour, trade

liberalisation when combined with other

socio‐economic reforms to support the poor

can help ease the stranglehold of poverty.

The present research is based on examination

of the effect of trade liberalisation on poverty in

Pakistan. In this regard, we focus on the impact

of industry‐level tariff reduction on the wages of

workers who are at the bottom end of the income

distribution. The findings of our study suggest

that trade liberalisation is pro‐poor and benefits

the majority of low wage‐earners associated with

the manufacturing industries of Pakistan. Based

on these results, we provide some important

guidelines and policy recommendations to reap

maximum benefits from free trade.

Following on from this introduction, the

rest of the article is organised as follows. 2

presents a review of past literature on the

impact of trade liberalisation on wages and

poverty. 3 provides details about the model

and the estimation methodology being

followed in the analysis. The data set and

construction of the variables are discussed in

4. In 5, we present the empirical findings and

discuss the results. 6 concludes and presents

some important policy implications.

2. Literature Review

2.1 Theoretical Considerations

The link between trade liberalisation and

poverty is analysed with reference to the impact

oftheformeroneconomicgrowthontheone

hand and its impact on income distribution on

the other hand. The ‘trade–growth’link has

been controversial, with protagonists presenting

the view that free trade promotes economic

growth which, in turn, positively contributes to

poverty alleviation. Others have questioned the

link between open trade policies and economic

growth and economic growth and poverty

alleviation (Rodriguez and Rodrik 2001;

Dollar 2001; Dollar and Kraay 2001; Kiely

2004). Severe controversy exists in the case of

the ‘trade–income distribution’link as well.

362 The Australian Economic Review September 2020

© 2020 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research, Faculty of Business

and Economics