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SENSITIVE SIPDIS

E.O. 12958: N/A TAGS: ECON, ETRD, EFIN, EAGR, EINV, ENRG, PREL,PK SUBJ: U.S.-PAKISTAN FREE TRADE AGREEMENT: A POTENTIAL GAME CHANGER

1. (SBU) Summary and Introduction: President Zardari, Prime Minister Gilani and Finance Minister Tarin, like many Pakistanis before them, have pleaded with the USG for “trade, not aid.” A Free Trade Agreement (FTA) with Pakistan holds substantial opportunity for the Pakistani economy, with small, but positive, implications for the U.S. economy. However, the economic benefits of any potential FTA depend on the inclusion of Pakistan's primary export: textile goods, primarily in cotton.

2. (SBU) Our initial research conducted by Deloitte indicates that an FTA that includes textiles would result in over 1.4 million new jobs in Pakistan, including in impoverished regions of Southern Punjab and Northern Sindh where militant recruitment is high. It would double Pakistani exports to the United States, but would have little to no impact on total U.S imports. Increased textile imports from Pakistan would merely supplant imports from other countries. Based upon recent experiences of other countries having bilateral trade agreements with the United States, the multiplier effects in terms of employment, investment, and innovation in Pakistan would spur rapid growth across the country. Foreign direct investment (FDI) could potentially double and Pakistan's GDP growth would be bumped up by 1.5 percent each year.

3. (SBU) An FTA would also serve our broader interests in the region. A U.S.-Pakistan FTA would encourage other countries in South Asia, including possibly India, to engage with Pakistan on trade and investment matters to benefit from Pakistan's access to the U.S. market. It would also encourage Pakistan to conclude the Afghanistan Pakistan Transit Trade Agreement.

4. (SBU) Embassy recommends Washington agencies analyze the potential benefits of a free trade area with Pakistan. We are mindful of the U.S. domestic constraints, the pending free trade areas with other countries, and the lack of trade promotion authority. But given Pakistan's enormous national security importance to the United States - and Pakistan's role in our eventual success in Afghanistan - we believe an FTA with Pakistan is worthy of serious consideration. The FTA would reduce the burden on our own foreign assistance budget (currently $3.5 billion a year) and improve the U.S. image in Pakistan. The Reconstruction Opportunity Zones (ROZs) have languished in Congress for almost three years and have always had serious limitations in product and geographic coverage. We believe it is time to move to something more far-reaching and sustainable. End summary and introduction.

Pakistan's Current Trade with the United States --------------------------------------------- --

5. (SBU) The United States is Pakistan's top export market, accounting for approximately 18.8 percent of Pakistan's total exports in FY 2008-2009. Pakistan's exports to the U.S. reached $3.6 billion in 2008-2009, with textiles representing 84 percent of that total. Exports to the United States are primarily in cotton-based textiles (home textiles and apparel including knit shirts, denim trousers and socks) which account for over 90 percent of Pakistan's textile exports. Tariff levels applied by the United States to these top 61 export items range to as high as 23.5 percent.

6. (SBU) The top ten U.S. imports from Pakistan for 2008 (value and applied tariff rate in parenthesis) are: 1) Cotton terry towels, excluding dish towels ($282 million, 9.1 percent); 2) Cotton sheets, printed ($207 million, 6.7 percent); 3) Men's and boy's cotton knit shirts ($160 million, 19.7 percent); 4) Men's or boys' cotton socks ($138 million, 13.5 percent); 5) Men's and boy's cotton pullovers ($126 million, 16.5 percent); 6) Cotton terry towels, including dish towels ($115 million, 9.1 percent); 7) Cotton sheets, not printed ($109 million, 6.7 percent); 8) Men's cotton denim trousers ($63 million, 16.6 percent); 9) Men's and boy's cotton overcoat ($74 million, 15.9 percent) and 10) Cotton bed linen knit or crocheted ($64 million, 6 percent). All the products are cotton-based.

7. (SBU) Other products that could benefit from an FTA include leather, surgical tools, carpets, gems and jewellery, sporting goods, cutlery and marble. Some of these goods are currently benefiting from zero tariffs as part of the U.S. General System of Preference (GSP) initiative, which will expire on December 31, 2010.

Other U.S. FTAs and Their Impact --------------------------------

8. (SBU) Currently, the United States has 9 bilateral Free Trade Agreements (FTA) with Australia, Bahrain, Chile, Israel, Jordan, Morocco, Oman, Peru, Singapore, and two multilateral agreements: the Central America-Dominican Republic-United States Free Trade Agreement (CAFTA-DR) with Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua; and the North American Free Trade Agreement (NAFTA) with Canada and Mexico. FTAs with Colombia, Korea and Panama are pending.

9. (SBU) Examples of FTAs in the Middle East that include U.S. concessions on textile tariffs provide a model for an FTA with Pakistan. In the cases of Jordan, Bahrain, and Oman, the FTAs provide duty free or preferential treatment to more than 90 percent of traded products including textiles and garments. A year after the signing of its FTA in 2006, Bahrain's textile exports to the United States increased by 19.1 percent.

10. (SBU) Apart from these FTAs, the Qualifying Industrial Zone (QIZ) program is operating in Jordan (1998) and Egypt (2004). Since its establishment, the Qualifying Industrial Zones program has fostered over 800 firms in 21 Qualifying Industrial Zones, employing over 115,000 workers and exporting over $2.25 billion, including more than $1.25 billion in garments to the United States at the program's peak in 2007.

11. (SBU) The FTA and Qualifying Industrial Zones programs in Jordan bolstered reform efforts in other parts of the economy. FTA negotiations with Jordan provided the negotiating space and economic incentives that aligned Jordan's environmental regulation, intellectual property rights enforcement, and labor and work-permit requirements with international standards. In essence, the negotiations transformed the role of Jordan's government from that of an economic “manager” to a “regulator,” a key to modernizing its economy. Such liberalization brought substantial levels of foreign direct investment. Jordan's foreign and domestic investment increased by 79 percent after signing the FTA.

The Potential Impact on Pakistan's Economy ------------------------------------------

12. (SBU) Our research from Deloitte indicates that a U.S.-Pakistan FTA eliminating tariffs on textiles would more than double Pakistani exports to the United States from $3.6 to $6.5 billion. For this increased trade, the textile sector would build extra capacity and employ more workers, creating 1.4 million direct/indirect jobs in the textile sector. The spike in employment would have a ripple effect in other related sectors from cotton-growing farmers to the entire logistics chain leading to the exports of textiles. Southern Punjab and Northern Sindh, cotton-producing regions where poverty drives extremist recruitment, stand to benefit most from the textile export boost.

13. (SBU) According to Deloitte trade mapping, within two years of signing an FTA, bilateral trade between the United States and Pakistan would increase by at least 80 percent, with Pakistani imports from the U.S. growing nearly as rapidly as exports. The trade would bump up Pakistan's annual GDP growth by 1.5 percent. Moreover, industrial investment and economies of scale will boost Pakistan's overall trade with the world by 35 percent.

14. (SBU) Deloitte's preliminary investment flow analysis points to a U.S.-Pakistan trade agreement potentially doubling foreign direct investment in Pakistan. Such foreign direct investment would shift Pakistan's comparative advantage to a more diverse set of products both within the textile sector and beyond textiles. Foreign direct investment brings with it hard capital, managerial know-how, cutting-edge technology, and market savvy. Specifically, market access to and foreign direct investment from the United States would create opportunities for vertical integration between U.S. and Pakistani firms and enhance Pakistan's capabilities in new technologies, research and design.

15. (SBU) Moreover, an FTA would keep Pakistani capital in Pakistan. A number of Pakistani textile firms have moved production to Egypt, Jordan, Madagascar and Bangladesh to take advantage of lower U.S. tariffs. An FTA would reverse that trend.

16. (SBU) The negotiating process and the economic incentives from a U.S.-Pakistan FTA would forge a stronger economic and strategic partnership, anchoring Pakistan's existing economic reform commitments, and demanding further regulatory and institutional reform. The FTA would put rules and economic incentives in place that would strengthen Pakistan's export-oriented, market economy at the expense of rent-seeking economic behavior. This change should encourage job growth, promote investment, and erode the oligopolies that currently dominate a number of key economic sectors.

17. (SBU) A U.S.-Pakistan FTA could well have a regional economic and political impact. Pakistan's negotiations with Sri Lanka on a bilateral trade agreement have recently come to a halt. India has signed bilateral FTAs with Sri Lanka and Bangladesh, isolating Pakistan within the SAARC's regional bloc. A U.S. - Pakistan FTA will encourage other South Asian countries to sign trade and investment agreements with Pakistan to benefit from Pakistan's access to the U.S. market. It could potentially open up business avenues between Pakistan and India, promoting improved relations between the two countries. Additionally, the USG could use the carrot of the FTA to push for the signing of the Afghanistan Pakistan Transit Trade Agreement (APTTA). Impact of an

FTA on the United States -------------------------------------

18. (SBU) While the U.S. is Pakistan's largest export market at 18.8 percent, these goods represent only 0.21 percent of U.S. imports. An FTA will benefit both countries, but the relative sizes of the two economies translate into a much bigger gain for Pakistan. Nevertheless, U.S. exports to Pakistan stand to grow by over 80 percent.

19. (SBU) Historically, free trade agreements have increased U.S. economic growth and employment, while perhaps counter-intuitively, narrowing the U.S. trade deficit. In 2007, 16 percent of the overall U.S. trade deficit resulted from trade with FTA trading partners, compared to 84 percent attributed to trade with non-FTA trading partners. In 2008, this trend continued with total U.S. exports to partners growing by 8.5 percent, while imports grew by only 6 percent. The United States has enjoyed stronger economic growth, higher manufacturing output, and lower unemployment because of these trade agreements.

20. (SBU) U.S. growers of grain and cotton and producers of processed foods, chemicals, machinery and equipment (electrical and mechanical) will gain most from free trade access to the Pakistani market. The top 10 Pakistani imports in 2008 from the U.S. (with ad valorem tariff applied by Pakistan in parenthesis) in 2008 were 1) Aircrafts and parts (5 percent);2)Cotton (0 percent); 3) Wheat (10 percent); 4) Electric appliances (12.2 percent); 5) Ferrous waste and scrap (8 percent); 6) Air vacuum pumps (11.8 percent), 7) Moving/boring/scraping machinery of earth (5 percent); 8) Turbo jets and propellers, and gas turbines (5 percent) and 9) Machinery parts (5 percent); 10) Automatic data processing machines(0 percent).

21. (SBU) The relaxation of U.S. textile tariffs will have little effect on the U.S. textile industry. In 2008, Pakistan ranked seventh among textile exporters to the United States at $3.2 billion. That same year, the top exporters (with their share in parenthesis) of textile products to the United States were China (33 percent), India (5.7 percent), Mexico (5.5 percent), Vietnam (5.5 percent), Indonesia (4.5 percent), Bangladesh (3.7 percent) and Pakistan (3.2 percent). An FTA would potentially double Pakistan's share of such imports to 6 percent. Rather than increasing total U.S. textile imports, Pakistan's marginal increase would take market share from the top exporting countries. China and Bangladesh would lose the most market share, as much of their cotton and other textile inputs are currently imported from Pakistan. We believe Mexico would be least affected due to its geographic proximity to the United States and NAFTA.

22. (SBU) The highly automated and innovative segments of the U.S. textile industry, such as design, industrial fabrics, carpets, specialty yarns and textile machinery will see their exports grow and benefit from open textile trade. However, employment in the U.S.-based textile industry overall is expected to decline by 48 percent by 2018. The decline is primarily due to the move to more capital-intensive manufacturing. An FTA with Pakistan would have no discernible impact on this trend.

23. (SBU) Comment: Pakistani interlocutors - from President Zardari to Finance Minister Tarin - have pushed the case for U.S. “trade, not aid.” The announcement of our intention to negotiate an FTA would generate political capital. It would belie the common Pakistani perception that the United States is not committed to a robust, long-term relationship with Pakistan. The FTA would create jobs and economic growth in many of the regions where militants currently recruit unemployed young men. It would align Pakistan's economic regulatory structure with ours and orient Pakistan's economy to the outside world. And it would do so while bolstering the U.S. economy, providing U.S. exporters a leg up in the Pakistani market. For us to realize these political and economic gains, free trade in textiles is a must: the economic significance of their inclusion is negligible to the United States, but key for Pakistan.

24. (SBU) We are mindful of the U.S. domestic restraints to an FTA. The Reconstruction Opportunity Zones (ROZs) have languished in Congress for almost three years and still have serious limitations in product and geographic coverage. An FTA is ambitious, but given Pakistan's enormous national security importance to the United States as well as to our prospects for success in Afghanistan, it merits serious consideration. End Comment. Patterson