Trade policy and growth

By Shahid Javed Burki

Pakistan's economic managers, working in the administration headed by General Pervez Musharraf, promised to revive growth once the economy had recovered from the ravages inflicted on it in the 1990s. That promise was made in 1999 soon after the country's take-over by yet another military regime, the fourth in the country's history.

This writer had argued then that there was no need to adopt a sequential approach towards tackling Pakistan's enormous economic difficulties; that the goals of stabilization and growth could be pursued simultaneously. The decision to pursue stabilization ahead of growth was taken at the urging of the International Monetary Fund. While there is not much point in revisiting that old debate, it is important to determine whether the government is now prepared to go for sustained growth and whether it has adopted the right set of policies for achieving that objective.

In so far as the first question is concerned, it appears from the pronouncements of several senior officials that the decision has been taken to pursue the objective of growth. One evidence of this is Islamabad's signal to the IMF that it would not return to the organization to negotiate yet another programme. One reason for this stance towards the Fund is that Pakistan now has a large foreign exchange reserves available to it, almost equal to the amount required for financing one year's of imports.

The other reason is even more important. It appears that Islamabad is getting ready to let trade policy play a more important role in accelerating growth and alleviating poverty. In an address to the business community a few weeks ago, President Pervez Musharraf expressed the hope that Pakistan's exports would reach some $50 billion in the not too distant future.

He is looking for a four-fold increase in the value of exports, increasing from $12.5 billion to $50 billion. If this were to happen, say, over a period of ten years, that would imply a rate of growth of 15 per cent per annum. This is not an impossible target to achieve.

But achieving it would mean engineering a fundamental restructuring of the economy. To begin with it would mean that the Pakistani economy would become much more open to foreign competition than it is today.

In 2004, trade - both exports and imports - accounted for about 25 per cent of the revised gross domestic product. If Pakistan's trade increased at the rate hoped for by President Musharraf over the 2004-2015 period, if both exports and imports increased at 15 per cent a year, and if the economy grew at six per cent per annum, the share of trade in GDP would increase to 60 per cent by 2015.

This would turn Pakistan into one of the more open developing countries in the world. Before analyzing how this could be done it would be useful to revisit the debate that has gone on for decades about the impact of trade on economic growth.

There is a great deal of empirical evidence available from the works of both development economists as well as development institutions that trade must occupy a central position in any economic strategy designed to produce growth. However, focus on trade can lead to two opposing sets of policies.

According to one, an import substitution strategy is necessary at the initial stages of development to produce growth in the economy without hurting the poor. According to the other, economic openness and focus on the promotion of exports are vital ingredients of any growth strategy, even at the early stage of development.

Exponents of different positions in economic discourse can draw very different conclusions from the same set of information and data. This is also the case with the debate on trade and its contribution to growth. Both sides have mined two sets of data - the performance of a large number of developing countries over the past four decades in particular the experiences of the "miracle economies" of East Asia - to support their different points of view.

What does the record of development shows in terms of trade policy and its contribution to economic growth? Statistics don't lie but they can be arranged to produce certain favoured results. This has been done repeatedly by the economists who are convinced of the truth of what they consider to be the right relationship between trade and economic performance.

However, to find a relationship between trade and growth, one must first settle on the period to be investigated. Which was the period that saw a rapid increase in economic growth, and if this period coincided with a rapid increase in exports then a robust case could be made that trade promotes growth.

However, there is some dispute among economists as to which period in the last 40 years was that of rapid increase in economic output.

Some economists argue that the 1960s and the 1970s were the periods of rapid economic growth in the developing world. If developing countries' performance is seen in terms of the number that achieved a certain level of growth - say three per cent increase in per capita income per annum - then the two decades between 1961 and 1980 seemed to have produced better results compared to the two decades that followed. In the first period, 33 non-oil exporting countries crossed this threshold compared to only 29 in the second.

However, should good performance be interpreted by using the number of countries that crossed a certain threshold of increase in income per head of the population or should the criterion be the number of people living in rapidly growing countries compared to those that were residing in those doing relatively poorly. If the latter is used as the measure, the second period looks better than the first.

During this time two populous countries - China and India - joined the league of rapidly growing economies. Whereas the population of high growth countries in 1961-80 was only 357 million, the number of people living in such countries in the second period was 2.1 billion.

Most of the countries followed restrictive trade policies in the first period when high walls of tariff and non-tariff barriers provided protection to local producers. If the developing countries did well in the first period then it would appear that they were helped by more restrictive trade policies. If they did better in the second period, then the opposite case could be made since by that time most developing countries had begun to open their economies to outside competition.

Instead of finding a relationship between growth and trade by using cross-country data, this debate could perhaps be settled by looking at the performance of a rapidly growing economy. South Korea, for obvious reasons, is a good candidate for this type of investigation. However, even South Korea's remarkable growth performance has been interpreted in two very different ways.

Dani Rodrik of Harvard University is the most articulate and persistent exponent of the import substitution approach. He maintains that countries such as South Korea forged ahead by providing protection to their infant industries. In fact, says Rodrik, the state policy in South Korea was directed initially at encouraging investment and that could only happen if those committing capital for new enterprises in the industrial sector knew that they would not be overwhelmed by foreign competition.

That would not have happened had the Koreans opened their economy at that stage and lowered barriers against trade. According to Rodrik, South Korea grew rapidly since its government "managed to engineer a significant increase in the private return to capital" by "subsidizing and coordinating investment decisions".

The fact that the share of exports in the country's gross domestic product expanded significantly in this period - from 5.3 per cent in 1961 to 33.1 per cent in 1980 - does not necessarily mean that an export oriented policy was pursued by the Koreans. Increase in the share of exports in national output was the passive result of expansion in investment.

The Koreans had to import capital equipment and raw materials to make a success of their investment-oriented approach, and to do that they needed access to external capital. This was obtained by encouraging exports. Using this as the argument, the American economist Larry Westphal arrived at the opposite conclusion from that reached by Rodrik.

According to him, "Korea's industrial performance owes a great deal to the government's promotional policies toward exports and its initiatives in targeting industries for development. If nothing else, policies towards exports created an atmosphere - rare in the Third World - in which businessmen could be certain that the economic system would respond and subsequently reward their efforts aimed at expanding and upgrading exports."

How do economists interpret the role of trade in India's economic performance? Some of them - in particular Colombia University's Jagdish Bhagwati - have compared India's experience with that of South Korea in support of their argument for economic openness. In the 40-year period between achieving independence in 1947, and the adoption by it of the first set of economic reforms in the late 1980s, India, like South Korea, also encouraged investment but it did that behind considerably higher walls of protection.

But this approach did not produce economic growth, which remained at an anaemic level of three per cent a year. India tried, in other words, to industrialize by restricting external competition. According to Arvind Panagariya, another Indian economist who has done research in this area, "by the mid-1970s, India's trade regime had become so repressive that imports (other than oil and cereals) had fallen from the already low level of seven per cent of GDP in 1957-58 to a bare three per cent in 1975-76."

What conclusion should one draw from this debate for South Asia in general and Pakistan in particular? It would appear that "the stage of development" is an important determinant of the approach a government in the developing world should adopt. At an early stage, it is appropriate to protect "infant industries" by building a reasonably high wall of tariff around them. But these industries must not be allowed to languish in this state for too long.

They should be eventually exposed to external competition in order to increase their productivity. Not allowing that to happen encourages them to produce goods that can be marketed only at home and would not have any demand outside the county's closed borders.

That was the experience of India with the products of much of the industry it established in the 40-year period after gaining independence. Indian industries became competitive in the world markets only after the reforms of the 1990s resulted in substantial reduction in tariff and non-tariff protection. In other words, South Asia's industrialization has reached the point at which it does not - in fact, should not - need a great deal of protection. Instead, it needs competition from regional as well as world players.

There is another facet to this debate that needs to be reviewed before reaching some conclusions on what is the appropriate set of policies that would promote economic growth in Pakistan. This concerns the pace at which an economy should be opened to outside competition. I will turn to this subject in a later article.

[taken from http://www.dawn.com/2004/10/26/op.htm]

Date/Time Page Created: 12/01/2004

Date/Time Last Modified: 12/1/2004 8:30:22 AM

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