Taming trade and the current account deficit

Updated 16 Jul 2018

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Source: World Bank, WITS
Source: World Bank, WITS

Pakistan’s current account deficit reached $15.8 billion in the first 11 months of 2017-18, up from $11.1bn a year before. Similarly, the deficit in trade in goods and services has also increased to the tune of $32.6bn, up from $27.3bn a year ago.

These numbers tell two things: one, we owe to the rest of the world more than the rest of the world owes us as we are consuming more than we are producing. Two, the gap is widening.

However, utmost care must be observed before drawing any policy implications since that necessitates a deeper look into our share in global exports, the nature of our business with trading partners, regional trade dynamics, detailed product analysis and the country’s openness to trade in general.

Policies should be devised to redirect resources to export-boosting sectors, such as IT-related services

This article uses data made available by the World Integrated Trade Solution (WITS) in an attempt to understand how Pakistan’s trade has evolved over the years; and India and Bangladesh as peers since institutional quality in these countries is more or less similar.

Export numbers for 2003 and 2016 show astounding differences. India grew its exports’ size to 4.38 times that of the 2003 level, Bangladesh 4.82 times whereas the size of Pakistan’s exports grew 1.72 times. This means Pakistan’s share of exports in regional as well as world exports must have shrunk over this period.

So how can we increase our market share in world exports? The answer lies in building Global Value Chains (GVC). Refer to the Global Network Chart for China for 2016. The size of a circle (or node) depends on a number called weighted-IN degree. The bigger this number is, the greater the share in China’s import. The other important measure is the thickness of the line that connects circles. The thickness is proportional to the share of individual flow on world trade in aggregate.

The size of the circle reflects a country’s role as supplier to China and thickness of the link shows importance of that value chain in world trade. Note that suppliers to China are clustered around United States and Canada, European and Central Asian countries, predominantly Germany (yellow circles), the United Arab Emirates in the Middle East (dark green), and Korea and Japan in East Asia and Pacific (light green). The South Asia region (India and Pakistan) has very few suppliers to China despite being closest to it.

Pakistan could use its proximity with China to not just increase its exports but also become an integral part of the GVC. The bigger challenge, however, is to identify potential areas where supply chains can be established.

The composition of exports and imports for years 2003 and 2016 has not changed much. The analysis of the share of Pakistan’s top-10 commodities in total imports and exports at two points shows that oil accounts for almost a quarter of our import bill something that hasn’t changed over the past one and a half decade.

Similarly, Pakistan’s top-10 exports accounted for 77 per cent of total exports in 2003-04, which compares to 76pc in 2017-18. Of these, the share is predominantly held by cotton and textile.

The competition in exports of textile and clothing is fierce with China dominating the world market. While China was not even in the picture in the 1990s, whereas Germany led the market with 24.88pc share in the world market; in 2016, China topped the market with 38pc share and Germany had a paltry 4.56pc.

Global Network Chart for China for 2016.
Global Network Chart for China for 2016.

One can argue that the German economy has developed to the level where it is focusing more on high-tech industrial goods. However, the same argument does not apply to Pakistan’s economy. It appears that the space for growth in textile has shrunk dramatically with the rise of China.

Accordingly, policies need to be devised to redirect resources in other potential export-boosting sectors, such as IT-related services. Demand for IT-related services should be high in the future. On the goods side, the country needs to identify and tap sectors in which supply lines can be established with China.

It is well established in empirical literature that gross domestic product (GDP) and openness to trade are correlated. As is evident in the scatter plot of trade openness and GDP, Pakistan does not fare well relative to other regional economies, such as India, Bangladesh or even Maldives.

In fact, the country is least open to trade in the South Asia region. This is particularly worrisome since per capita GDP has grown considerably over 1998-2007 after which it too has stagnated. However, it is important to note that the relationship between GDP and trade openness is complex and not fully understood.

If openness is good for trade, then tariffs are not because they discourage trade. The Effectively Applied Tariff (AHS) available on the WITS shows that Pakistan is doing relatively better compared to Bangladesh but not so well when it comes to India.

For 2013 specifically, the trade weighted average effective tariff imposed in Pakistan was 9.41pc compared to 6.3pc in India and 12.33pc in Bangladesh. What is more telling in this chart is the speed with which tariffs were brought down over the years in India and Bangladesh. Of the three countries, India brought down tariffs sharply followed by Bangladesh, while Pakistan did so steadily.

Pakistan needs to work diligently on two fronts. One, policies need to be devised and implemented soon to encourage exports of services. Two, the country needs to identify and tap sectors in which supply lines can be established with China. Institutional reforms would be key to achieving these policy objectives.

—The writer is a graduate of Columbia University and works at the State Bank of Pakistan’s research department.

Views expressed here are his own

Published in Dawn, The Business and Finance Weekly, July 16th, 2018