The State of Domestic Commerce in Pakistan Study 2 - Effective Protection of Manufacturing Industries in Pakistan

THE STATE OF DOMESTIC COMMERCE IN PAKISTAN

STUDY 2

EFFECTIVE PROTECTION OF

MANUFACTURING INDUSTRIES IN

PAKISTAN

The Ministry of Commerce Government of Pakistan

November 2007

By

Innovative Development Strategies (Pvt.) Ltd. House No. 2, Street 44, F-8/1, Islamabad

Table Of Contents

List of Abbreviations ............................................................................................................. i Acknowledgments .............................................................................................................. iv

Executive Summary .......................................................................................................... 3 Section 1: Introduction ................................................................................................ 6 Section 2: Review of Industrial Policy in Pakistan .................................................... 8 Section 3: Structure of Nominal Protection ............................................................. 12 Section 4: Effective Protection: A Review of Theoretical and Empirical Literature ................................................................................. 19 Section 5: Methodology, Data and Results .............................................................. 24 Section 6: Interpretation of Results .......................................................................... 26 Section 7: An Assessment ........................................................................................ 29 Section 8: Recommendations ................................................................................... 33

References ............................................................................................................ 36 Annex I .................................................................................................................. 37 Annex II ................................................................................................................. 38 Annex III ................................................................................................................ 43

List of Tables Table 1.1: Growth Performance of Components of Commodity Producing Sector of GNP

(% Growth At Constant Factor Cost) .............................................................. 6 Table 3.1: Industrial Tariffs ........................................................................................... 12 Table 3.2: Distribution of Tariff Rates ............................................................................ 13 Table 3.3: Tariff Structure 2001-02a .............................................................................. 14 Table 3.4: Tariff Structure - 2004-05 ............................................................................. 16 Table 5.1: Top Ten Effectively Protected Industrial Sectors .......................................... 25 Table 5.2: Ten Least Effectively Protected Industrial Sectors ....................................... 25 Table 5.3: Top 15 Nominally Protected Industrial Sectors ............................................. 25 Table 5.4: Ten Least Nominally Protected Industrial Sectors ........................................ 25 Table 7.1: Some inputs facing exorbitant tariffs ............................................................ 31 Table 8.1: A Proposed Tariff Structure .......................................................................... 35 Table 8.2: Revenue Implications of Tariff Reform ......................................................... 35

Innovative Development Strategies (Pvt) i

List of Abbreviations

ABAD Association of Builders and Developers

ADB Asian Development Bank

ADBI Asian Development Bank Institute

APCA All Pakistan Contractors Association

ATT Afghan Trade Transit

BAF Bank AlFalah

BCI Business Competitiveness Index

BOR Board of Revenue

CAA Civil Aviation Authority

CBM Cubic meter

CBR Central Board of Revenue

CDA Capital Development Authority

CIB Credit information bureau

CMR Contract for the International Carriage of Goods by Road

CPI Corruption Perceptions Index

CPIA Country Policy and Institutional Assessment

DFID Department for International Development

DHA Defense Housing authority

EDF Export Development Fund

EIU Economist Intelligence Unit

EOS Executive Opinion Survey

EPB Export Promotion Bureau

ESCAP Economic and Social Development in Asia and the Pacific

FBS Federal Bureau of Statistics

FCL Full Container Load

FDI Foreign Direct Investment

FIAS Foreign Investment Advisory Service

Ft Foot

FY Fiscal Year

GCI Global Competitiveness Index

GCR Global Competitiveness Report

GD Goods Declaration

GDP Gross Domestic Product

GoP Government of Pakistan

GOR Government Officials Residences

GRT Gross Register Tonnage

GST General Sales Tax

HBFC Housing Building Finance Corporation

HBL Habib Bank Limited

HDR Human Development Report

HFIs Housing Finance Institutions

IFC International Finance Corporation

IFS International Financial Statistics

IMF International Monetary Fund

ISAL Informal Subdivision of Agricultural Land

ISO International Standards Organization

IT Information Technology

ITU International Telecommunications Union

http://en.wikipedia.org/wiki/Gross_Register_Tonnage

Survey Report on Domestic Commerce

Innovative Development Strategies (Pvt) ii

KBCA Karachi Building Control Authority

KDA Karachi Development Authority

KESC Karachi Electric Supply Corporation

KM(s) Kilometer(s)

KPT Karachi Port Trust

KSE Karachi Stock Exchange

LCL Less Than Container Load

LOA Length Overall

MCB Muslim Commercial Bank

MENA Middle East and North Africa

MOC Ministry of Commerce

MOD Ministry of Defense

MTDF Medium Term Development Framework

NBP National Bank of Pakistan

NCS National Conservation Strategy

NER Net Primary School Enrollment Rate

NHA National Highway Authority

NIE Newly industrialized economy

NIT National Institute of Transport

NLC National Logistics Cell

NTN National Tax Number

NTRC National Transportation Research Center

NTTFC National Trade and Transport Facilitation Committee

NWFP North West Frontier Province

PASSCO Pakistan Agricultural Storage and Services Corporation

PEC Pakistan Engineering Council

PHDEB Pakistan Horticulture Development and Export Board

PIAC Pakistan International Airlines Corporation

PIDE Pakistan Institute Of Development Economists

PIHS Pakistan Integrated Household Survey

PKR Pakistani Rupee

PQA Port Qasim Authority

PR Pakistan Railways

PREF Pakistan Real Estate Federation

PSDP Public Sector Development Program

R&D Research and Development

REER Real Effective Exchange Rate

REITs Real Estate Investment Trusts

RICS Royal Institute of Chartered Surveyors

SAI Social Accountability International

SBP State Bank of Pakistan

SKAA Sindh Katchi Abadis Authority

SME Small and Medium Enterprises

SPS Sanitary and Phytosanitary

SRO Statutory Regulation Order

Std Standard

TEP Total Factor Productivity

TEU Twenty-Foot Equivalent Units

TI Transparency International

TOR Terms of Reference


Innovative Development Strategies (Pvt) iii

TSDI Transport Sector Development Initiative

TTFP Trade and Transportation Facilitation Program

UK United Kingdom

UNDP United Nations Development Program

US United States

USA United States of America

USC Utility Stores Corporation

USD United States Dollars

WAPDA Water and Power Development Authority

WDI World Development Indicators

WEF World Economic Forum

WGI Worldwide Governance Indicators

WTO World Trade Organization

Innovative Development Strategies (Pvt) iv

Acknowledgment

The IDS team owes a debt of gratitude to the officers of the Ministry of Commerce for their

guidance, assistance and feedback during the course of this study. Our special thanks go out,

in particular, to Syed Asif Ali Shah, Secretary; Mr. Naseem Qureshi and Mr. Ashraf Khan,

Additional Secretaries; Mr. Abrar Hussian, Joint Secretary; Syed Irtiqa Zaidi, Consultant and

Mr. Qaseem Subhani, Section Officer, for sparing their precious time and efforts for the

study.

We feel a deep sense of gratitude for the Minister for Commerce. Mr. Humayun Akhtar

Khan, who took out considerable time from his busy schedule to guide us. It was his sincere

and deep conviction which enabled us to conduct and compile this detailed and

comprehensive study on Domestic Commerce of our country. His apt guidance and keen

analytical oversight were extremely helpful in finalizing the study and formulating the policy

recommendations.

This study has benefited from comments received from the following:

1. State Bank of Pakistan, Karachi.

2. Federal Board of Revenue, Government of Pakistan, Islamabad.

3. Planning and Development Division, Government of Pakistan, Islamabad.

4. Trade Development Authority, Government of Pakistan, Karachi.

5. (Management Consultants) Establishment Division, Government of Pakistan,

Islamabad.

6. Finance Division, Government of Pakistan, Islamabad.

7. Pakistan Institute of Development Economics, Islamabad.

8. NTTFC, Karachi.

9. FPCCI, Karachi.

10. Planning and Development Board, Government of Punjab, Lahore.

11. Planning and Development Board, Government of NWFP, Peshawar.

12. Planning and Development Board, Government of Sindh, Karachi.

13. Planning and Development Board, Government of Balochistan, Quetta.

14. Investment and Commerce Department, Government of Punjab, Lahore.

15. Industries, Production & Supplies Initiatives, Government of Pakistan, Islamabad.

16. National Tariff Commission, Government of Pakistan, Islamabad.

17. SMEDA, Lahore.

18. Statistics Division, Government of Pakistan, Islamabad.

Innovative Development Strategies (Pvt) 1

EFFECTIVE PROTECTION OF MANUFACTURING INDUSTRIES

IN PAKISTAN

by

DR.MUSLEH-UD-DIN DR. EJAZ GHANI TARIQ MAHMOOD DR. M. K. NIAZI


Executive Summary 1. Pakistan had adopted a policy of import substitution with objectives of self-sufficiency and protection of domestic infant industries. Manufacturing industries in Pakistan are important contributors to GDP as well as overall employment. The sector growth had peaked to 14% in 2003-04 and then declined during the following two consecutive years. Manufacturing sector is a major payer in the external trade; produces 90 percent of exports, including about 10 percent semi-manufactures, and uses about 60 percent of imports. The measures of effective protection computed earlier are no longer relevant and there is an urgent need for computing up-to-date measures of effective protection using the latest cost structure and nominal tariff rates. The present study aims to fulfill this objective.

Review of Industrial Policy in Pakistan 2. During the early years in the history of Pakistan the need to establish a diversified industrial base, to build institutions and to put into place critical infrastructure largely shaped the economic policies. After 1952 excessive protection to industry severely distorted economic incentives not only for agriculture but also within the industrial sector. During the Sixties, the government set out to improve economic management and to deal effectively with corruption and unfair practices by the private sector especially in industry and retail trade. Economic policies during the sixties continued to be heavily biased towards promoting industrial growth in Pakistan. The government maintained an over-valued exchange rate to ensure the cheap availability of capital goods and other imported inputs to the industrial sector. The government adopted a series of measures to promote exports of manufactured goods, e.g. “Export Bonus Scheme” (EBS), which subsidized manufactured goods exports through a system of bonus vouchers. 3. The decade of seventies was beset by a number of exogenous shocks like the secession of East Pakistan led to a disruption of trade relations, fourfold increase in petroleum prices, rice, cotton, and sugarcane – remained vulnerable to wide fluctuations in international commodity prices and agricultural output, especially the cotton crop, was adversely affected by flooding and pest attacks that caused significant macroeconomic instability. 4. The industrial policy during the Eighties tried to reverse the process started during Seventies. The share of the private sector in total investment increased from 41.39 per cent in 1980-81 to 44 per cent in 1989-90. The Structural Adjustment and Stabilization Programs (SAP) was started in 1988, and major changes were introduced in the industrial policy during the Nineties. The government launched a privatization program in the Nineties to enhance the role of the private sector in the economy, and to address the problem of operational inefficiency in public sector enterprises.

Structure of Nominal Protection 5. The structure of protection is defined as “a set of policies that influence the value-added at domestic prices ─ significantly influences the pattern of resource allocation and the growth and composition of industrial output. The emphasis of Pakistan’s trade policies in recent years has been on greater openness through trade liberalization with minimal tariff and non-tariff barriers and as part of this trade liberalization program the maximum rate of custom duty has been reduced to 25 percent

1 with only 5 tariff slabs. Reforms in the tariff

structure have led to a reduction in the average tariff on industrial products from 20.2% in 2001-02 to 17.63% in 2002-03. Average tariffs for fully processed products are lower than on raw materials are mineral, stone and ceramics, plastic, glass, and miscellaneous manufactured products. The government has announced several new tariff measures in the budget for fiscal 2004-05: In particular, the customs duty on the import of plant, machinery and equipment has

1 However, there are few exceptions that relate to automobiles and alcoholic beverages.



been brought down to 5%, the customs duty on import of industrial raw materials has been reduced, and the duty structure for the automotive sector has been rationalized. The average tariff rates for food products/food preparations (fully processed) and textiles (fully processed) are 24.04% and 24.31% respectively.

Effective Protection: a Review of Theoretical and Empirical Literature 6. The concept of effective protection was first developed as a tool for summarizing the

total effect of input and output tariffs on a production process. At very initial stages, the

concept was criticized on the grounds that it is inappropriate to draw general equilibrium

inferences from a measure that is essentially partial equilibrium. Corden formulated the

concept of effective protection in the following expression

gj = (tj – Σaijti)/(1 –Σ aij)

7. Corden’s formulation has been criticized on the basis of its simplicity and its being a

partial equilibrium model and an associated problem of fixed coefficients. Despite all

criticisms Corden’s formula has survived.

8. Anderson (1995) modified the definition of effective protection “the effective rate of

protection for sector j is defined here as the uniform tariff which is equivalent to the actual

differentiated tariff structure in its effect on the rents to residual claimants in sector j. This

definition applies to general as well as partial equilibrium economic structures, has obvious

relevance for political economy models and seems to correspond to the motivation for the

early effective protection literature.”

Methodology, Data and Results

9. This study uses the Corden’s formula to compute the rates of effective protection. The

formula is given by the following expression


Where

gj = effective protective rate for activity j;

tj = tariff rate on activity j;

ti = tariff rate on activity i;

aij = share of industry i in cost of the industry j.

10. A detailed questionnaire was developed and pre-tested to collect data for the study.

However, listing of firms for sampling cold not be obtained from the Federal Bureau of Statistics.

In view of time constraints, therefore, the Dorosh et al (2006) Input-Output Table for 2000-01

updated from the Federal Bureau of Statistics Input-Output Table 1990-91 was used. The

nominal coefficients for 2006 used in this analsyis were taken from the CBR website. Average

nominal protection rate for all manufacturing industries covered in the study is 16.9%, whereas,

average effective protection rate turns out to be 27.8%. The results indicate that effective rate of

protection is quite high for leather and leather products, foot wear, transport equipment and some

textile sub-sectors. The sectors with lowest effective protection rates are jewelry (precious metal),

vegetable oils, other textile products, bakery products, and fertilizers and pesticides.

An Assessment 11. Empirical studies show that the largest productivity gains arise from reducing input

tariffs. The effect of reducing input tariffs significantly increases productivity and that this

effect is much higher than of reducing output tariffs, as a result costs of production have been

Effective Protection of Manufacturing Industries in Pakistan


decreased owing to the reduced tariffs. Foreign direct investment has started flowing in,

enhancing prospects of better technology and integration with global markets.

12. Pakistan started its tariff reforms in early 90s. The trade-to-GDP ratio has risen from close

to 26 percent in 1999-2000 to estimated 34 percent in 2005-06, Exports and imports increased by

16% p.a. and 27% p.a. respectively in the past seven years. The share of manufactured exports

also rose, reaching to 90% in 2005-06. The GDP growth also picked up in the recent past,

reaching 7.6% in the past three years 2003-06 compared with 2% in 2000-01.

13. The trade liberalization and tariff reforms have benefited consumers in several ways,

including access to a large variety of goods at cheaper rates and better quality of goods.

Poverty levels, which had been increasing until 2001-02, started decreasing with the revival

of growth. The recent PSLM shows a decrease of 10% in poverty during FY02-05, although

there are reports of more unequal income distribution.

14. Trade taxation, both on imports and exports, leads to anti-export bias because it

makes import competing activities more profitable. Anti-export bias refers to the bias

inherent in trade policies that promote some sectors to the detriment of export sectors. Anti-

export bias may arise due to several of the following reasons:

Trade taxation, both imports and exports

Tariffs on domestically produced goods

Tariffs on imported inputs used in production of exportables, and

Over-valued exchange rate.

Recommendations 15. Manufacturing sector plays a very important role in economic growth and well-being

of the country. There is an urgent need to remove protection of inputs to make these

industries more competitive. The government has taken a number of steps to improve the

business climate in the recent past, several problem areas remain. The broad contours of the

recommended reform are given below.

We suggest that the government set this as the long term objective and reduce the

effective protection to in the range of 5-10% in near future, appropriately sequenced

over say 3-5 years.

Some new activities may become necessary to promote for the development of certain

industries. that include the following: (1) incentives should be provided only for new,

“sunrise” activities, not sunset ones; (2) there should be clear benchmarks for success

or failure; (3) support must have a predetermined end (a so-called sunset clause); (4)

public support should target activities such as worker training or infrastructure

investment, rather than sectors such as electronics; (5) subsidized activities should

provide clear potential for externalities; and (6) agencies involved in these activities

should be autonomous enough to avoid capture by private interests, but should

maintain links with the private sector to maximize economy-wide gains.

Political economy considerations are very important at the design stage if reforms are

to be sustainable.

The trade reform needs to be carefully designed and to ensure the credibility.

The reform would be more credible if the price reform is accompanied by non-price

reforms, such as investments in infrastructure and human development, better access

to credit, promotion of competition, competitive exchange rate, and incentives to

adopt improved production technologies.


Section 1

Introduction

1. Manufacturing industries in Pakistan are important contributors to GDP as well as

overall employment. The last few years have witnessed an impressive growth in

manufacturing sector in Pakistan. In fact the sector recorded the fastest growth among the

commodity producing sectors (Table 1.1). The sector growth had peaked to 14% in 2003-04

and then declined during the following two consecutive years. The manufacturing sector is

very important for GDP growth because of its forward and backward linkages and large

weight.

Table 1.1: Growth Performance of Components of Commodity Producing Sector of GNP

(% Growth At Constant Factor Cost) Commodity

Producing Sector

Agriculture Mining & Quarrying

Manufacturing Construction Electricity & Gas

Distribution

1980’s 6.5 5.4 9.5 8.2 4.7 10.1

1990’s 4.6 4.4 2.7 4.8 2.6 7.4

2002-03 4.3 4.3 6.6 6.9 4 -11.7

2003-04 9.2 2.3 15.6 14 -10.7 56.8

2004-05 9.2 6.7 9.6 12.6 18.6 3.5

2005-06 4.3 2.5 3.8 8.6 9.2 -8.4

2002-06 Average

6.75 3.95 8.9 10.525 5.275 10.05

Source: Pakistan Economic Survey 2005-06

2. The manufacturing sector has certain important features. The sector is a major payer

in the external trade; produces ninety percent of exports, including about ten percent semi-

manufactures, and uses about sixty percent of imports. For example, it is relatively less

dependent on weather than agriculture; is a relatively dynamic sort of activity; and may

respond to incentive/regulatory structure more promptly than other commodity producing

activities. Due to these reasons, it would be interesting to analyze the performance of

manufacturing industries.

3. Soon after independence, Pakistan had adopted a policy of import substitution with

objectives of self-sufficiency and protection of domestic infant industries. Several protective

instruments, tariffs and non-tariff barriers such as import licensing and import ban of certain

goods, remained in common use for decades. In 1990s, forced by international circumstances

and pressure from donors, the country started to undertake economic reforms. On the one

hand the tariffs and non-tariff barriers were drastically reduced or abolished altogether. On

the other hand foreign and domestic investors were given incentives to establish industrial

units in the country. The purpose of these reform measures was to improve competitiveness

and efficiency.



4. Tariffs cause distortions in two important ways. One is that tariffs cause the real

exchange rate to appreciate, which makes exporting less cost competitive. Another is that

import tariffs raise the price of imported goods above world prices, and these price effects

spill over into the overall cost structure. Tariffs protect domestic industry and shield them

from international competition, enabling them to charge higher prices. Exporters are normally

facilitated and can buy imported inputs at world prices, still they face a higher other local

costs than do competitors in countries with lower effective protection, which constitutes a

hidden tax on exporters.

5. The manufacturing sector in Pakistan has long operated in a tight regulatory

environment characterized by controls on entry and exit, prices, credit, foreign exchange,

imports, investment etc. These measures were meant to promote resource allocation

according to national priorities, to address market failure, and to protect consumers from anti-

competitive practices. However, the heavy state control introduced various distortions in the

economic system and led to inefficiencies, red-tape and corruption, all of which stifled

private enterprises. Over the last two decades, Pakistan has significantly reformed its

regulatory framework, though still more needs to be done. In particular, the incentive

structure has to be so reformed that it promotes dynamic comparative advantage and ensures

consistency between degree of protection and fiscal incentives.

6. Barriers to trade both indirect and direct define the degree of protection that domestic

economic activity is provided. The higher the barriers the more protected the activity.

Effective protection rates seek to quantify the protection offered to local economic activity as

a result of these barriers. The measures of effective protection computed earlier are no longer

relevant and there is an urgent need for computing up-to-date measures of effective

protection using the latest cost structure and nominal tariff rates. The present study aims to

fulfill this objective.


Section 2

Review of Industrial Policy in Pakistan

7. The need to establish a diversified industrial base, to build institutions and to put into

place critical infrastructure largely shaped the economic policies during the early years in the

history of Pakistan. A key aspect of economic policy in these early years was the provision of

strong protection to industries after 1952 when serious shortages of foreign exchange

emerged. Excessive protection to industry severely distorted economic incentives not only for

agriculture but also within the industrial sector. For example, on the recommendation of the

Economic Appraisal Committee, tariffs on consumer goods were set higher than the tariffs on

intermediate and capital goods. This cascaded tariff structure obviously favored the consumer

goods industries by restricting the import of consumer goods and hampered the establishment

of capital goods and intermediate goods industries since imports of these goods were either

freely allowed or were subject to low tariffs. Furthermore, the policy regime was

characterized by an excessive reliance on economic controls in the form of administered

prices, industrial licensing, and a host of other regulations.

8. During the Sixties, the government set out to improve economic management and to

deal effectively with corruption and unfair practices by the private sector especially in

industry and retail trade. Besides introducing strict price and profit controls in the form of

administered prices and profit margins, it also dealt with the menaces of hoarding, black-

marketing, and smuggling with an iron hand. The initial impact of these measures was

favorable and the general price index registered a fall in the early months after the 1958

Martial Law. But direct controls on prices and profits weakened the incentive to expand

production. The government soon realized that the direct controls had introduced rigidities in

the system and thus hampered the growth of the manufacturing sector. Thus the government

began to dismantle the price control system and moved towards a general policy of economic

deregulation through a greater reliance on the market mechanism.

9. Economic policies during the sixties continued to be heavily biased towards

promoting industrial growth in Pakistan. The government maintained an over-valued

exchange rate to ensure the cheap availability of capital goods and other imported inputs to

the industrial sector. Also, by keeping prices of agricultural inputs at below world market

prices, it made domestic raw materials available to the industrial sector at very cheap prices.

This, together with the policy of import controls and tariffs, tax concessions such as tax

holidays, accelerated depreciation allowances, and loans at very low interest rates, markedly

accentuated the pro-industrial bias in the growth strategy. To further help its industrialization

drive, the government adopted a series of measures to promote exports of manufactured

goods. The most significant measure was the introduction of Export Bonus Scheme (EBS),



which subsidized manufactured goods exports through a system of bonus vouchers2.

Furthermore, preferential access to credit and a host of fiscal incentives were part of a policy

package meant to enhance export competitiveness. These policies not only led to robust

growth in the exports of manufactured goods, but also helped diversify the product

composition of Pakistan’s exports.

10. While protectionist policies did contribute to industrial development and growth but

had several shortcomings. In particular, protection of domestic industry through high rates of

effective protection led to inefficiencies in domestic production, prevented the country to

realize its full export potential, and contributed to a worsening of the country’s balance of

payments (mainly because of the fact that increase in machinery and raw material imports

outweighed growth in exports). The incentives provided to manufactured goods exports

during this era were partly meant to offset this anti-export bias inherent in the policy of

import substituting industrialization followed during most of the decade, barring a few years

when import regime was liberalized somewhat3.

11. The decade of seventies was beset by a number of exogenous shocks that caused

significant macroeconomic instability. Firstly, the secession of East Pakistan led to a

disruption of trade relations between the two countries and deprived West Pakistan of half of

its export market. Secondly, with a fourfold increase in petroleum prices induced by the

newly created OPEC cartel, the Seventies witnessed phenomenal increases in Pakistan’s

import bill alongside a slowdown in exports due to the recession in the world economy. This

deterioration in terms of trade led to widening resource and trade gap. Thirdly, Pakistan’s

commodity exports – rice, cotton, and sugarcane – remained vulnerable to wide fluctuations

in international commodity prices. Fourthly, agricultural output, especially the cotton crop,

was adversely affected by flooding and pest attacks.

12. In 1972, the government nationalized all private banks and insurance companies, and

a large number of manufacturing units with the stated objective of reducing the concentration

of wealth. The government’s nationalization drive is generally held responsible for the weak

performance of the large-scale manufacturing sector especially in the first half of the

Seventies. It must be emphasized, however, that the poor performance of the industrial sector

owed as much to the policy of nationalization as to the pattern of industrialization that

developed during the earlier decades. This is borne out by the fact that there were already

signs of weakening in the growth momentum of the industrial sector by the end of the Sixties.

The inefficient allocation of resources promoted through excessive protectionism eroded the

capacity to sustain high growth rates in the manufacturing sector.

13. During this period a strong small-scale industrial sector emerged which was ignored

in the early years due to the capital-intensive bias of Pakistan's industrial regimes. Small scale

industries as diverse as leather manufactures, sports goods, and surgical instruments not only

helped diversify Pakistan's industrial structure, but also created employment opportunities for

the country’s growing labor force. A combination of exogenous and policy factors were

responsible for the growth of small-scale industries. First, private investment was diverted to

small-scale industrial units as a result of nationalization policies that exclusively targeted the

large-scale manufacturing units. Second, trade union activities in large-scale manufacturing

made investment in these units less attractive, thus contributing to the growth of smaller

production units. Third, export-oriented small-scale industries such as carpets, and garments

and made-up textiles received a boost owing to devaluation of the rupee. Fourth, remittances

2 The bonus vouchers often carried a high premium in the market as import licenses were automatically

issued against the vouchers. More than 80 percent of the total export subsidies were accounted for by this scheme (Kemal: 1978).

3 To a large extent, import liberalization was made possible by the increase in foreign loans and grants. The process of import liberalization, however, had to be cut short owing to drastically reduced foreign aid inflows in the wake of the 1965 war with India.



from abroad stimulated the domestic market for consumer goods, a large proportion of which

were produced by the small-scale industry.

14. The industrial policy during the Eighties tried to reverse the process started during

Seventies. Consequently, high priority was given to the restoration of business confidence,

which was considerably eroded in the previous decade due to the nationalization drive of the

Bhutto regime. Besides denationalization of a number of public sector enterprises, the

government provided a host of incentives to revive private investment. Moreover, the

government initiated wide ranging structural reforms that aimed at liberalizing and

deregulating the economy, and streamlining the investment licensing procedures. Though the

initial response of the private sector to the reform package was lukewarm, by the mid-

Eighties there was a pick up in private investment: the share of the private sector in total

investment increased from 41.39 per cent in 1980-81 to 44 per cent in 1989-90. Nevertheless,

the total investment failed to rise.

15. The Structural Adjustment and Stabilization Programs (SAP) was started in 1988, and

major changes were introduced in the industrial policy during the Nineties. One of the major

objectives of the industrial policy during this period was to address the structural weaknesses

of Pakistan’s industrial sector which stemmed from years of import substituting

industrialization, and the nationalization policy of the Seventies. In addition, emphasis was

also placed on improving the viability of Pakistan’s industrial sector in an increasingly

competitive international economic environment. A host of measures including fiscal

incentives, tax holidays, de-licensing of investment regimes, and reduction of tariffs on

capital goods were adopted to encourage private investment. Despite the fact that these

incentives had a favorable impact on private investment, growth in industrial output was

sluggish as compared to the previous decade, presumably reflecting a lagged effect of

investment on output growth.

16. With an objective to enhance the role of the private sector in the economy, and to

address the problem of operational inefficiency in public sector enterprises, the government

launched a privatization program in the Nineties. However, the response of the private sector

to privatization was quite weak, not least because of the fears that the government might

continue to meddle in the affairs of the privatized enterprises. Not surprisingly, therefore, the

pace of privatization was slower than planned and only 90 units in the public sector had been

privatized by 1995, while larger units such as telecommunications are still on offer. In

addition to its privatization drive, the government opened up the power sector to private

investment, which led to the setting up of power generation plants by the independent power

producers (IPPs). However, the performance of these privately financed projects was marred

by allegations of corruption and litigation between the government and the IPPs on electricity

tariffs and other issues. While the question of whether or not the independent power

producers contributed to improving the supply and distribution of power in an efficient

manner is debatable, the controversy surrounding these projects considerably eroded business

confidence in Pakistan.

17. At this point it seems appropriate to draw the attention of the reader to the special role

of public sector towards industries and the process of industrialization. As Pakistani

entrepreneurs were reluctant to invest in the non-traditional industries Pakistan Industrial

Development Corporation (PIDC) was set up in 1958 with the mandate to set up state

enterprises in the non-traditional manufacturing industries and to transfer the profit making

units to the private sector. Nevertheless, most of the manufacturing activities until 1971 were

carried out by the private sector and the role of the public sector was mainly restricted to the

provision of basic infrastructure. Beginning in 1972, a wide range of industries were

nationalized including iron, steel, basic metals, heavy engineering, motor vehicles, chemicals

and petrochemicals, cement, rice milling, flour milling, and cotton ginning. Consequently, the



number of Industrial Public Enterprises (IPEs) increased from 22 in 1972 to 55 in 1977. The

Seventies also witnessed heavy public investment in steel mills, fertilizer and cement plants,

and several sugar and textile mills. The nationalization drive accompanied by the increasing

dominance of the public sector during the Seventies severely dented business confidence

which led to a sharp reduction in private investment.

18. Though the role of the public sector has been drastically curtailed as a result of

deregulation and privatization policies initiated in the 1980s, some industries continue to be

dominated by the state owned enterprises. Some of these enterprises produce primary raw

materials and intermediate inputs and resultantly the inefficiencies of the public sector have

an adverse impact on the downstream industries. For example, the inefficiencies of Pakistan

Steel have been the major stumbling block to the engineering industries. Similarly, the

engineering industries in the public sector make the investment expensive and the otherwise

viable investments are made less profitable. All the remaining public enterprises in the

manufacturing sector should be divested with the clear understanding that the import duties

on such products would be rationalized.


Section 3

Structure of Nominal Protection

19. The structure of protection is defined as “a set of policies that influence the value-added at

domestic prices ─ significantly influences the pattern of resource allocation and the growth and

composition of industrial output.” The degree of stringency of import restrictions, including tariff

and non-tariff barriers to trade, largely determines the profitability of import substitutes and the

anti-export bias in the industrial policy. It is obvious that protection to domestic industries which

removes the distortions arising from the differential between static and dynamic comparative

advantage is welfare inducing. However, protective measures which create more distortions than

they offset, result in the lowering of welfare.

20. The emphasis of Pakistan’s trade policies in recent years has been on greater openness

through trade liberalization with minimal tariff and non-tariff barriers and the market based

exchange rate system. The ongoing trade liberalization program comprises reduction of import

tariffs, simplification and rationalization of tariff structure, and deregulation of administrative

controls including quantitative restrictions on imports. The maximum rate of custom duty has

been reduced to 25 percent4 with only 5 tariff slabs, para-tariffs have been eliminated and the

scope of the negative list has been drastically reduced over the years; imports being restricted

generally on very specific religious, health, and security considerations. Reforms in the tariff

structure have led to a reduction in the average tariff on industrial products from 20.2% in 2001-

02 to 17.63% in 2002-03 (Table 3.1). Table3.1: Industrial Tariffs

Simple Average Rates 2001-02a 2002-03

b 2004-05

b

Industrial Products 20.2 17.63 17.09

Normal Maximum Rate 30 25 25

Number of Standard Rates* 4 4 4

Source: a Trade Policies in South Asia: An Overview, Volume I: An Overview b Authors' own calculations * Currently there are 5 tariff slabs.

21. Pakistan has completely dismantled its apparatus of quantitative restrictions meeting its

obligations to the WTO, and tariffs are now the main trade policy instrument. In the medium

term, the government is committed to maintaining the liberalization process which has resulted in

the substitution of quantitative restrictions with tariff measures, reduction in the level and

disparities in tariffs, and the reduction in the anti-export bias.

22. The main aims of the trade policy reforms are: a cascaded tariff structure in an attempt to

encourage greater value addition; greater uniformity across activities at the same stage of

production; and promotion of investment by lowering the cost of machinery through reduction in

the rate of taxation of imported machinery. These reforms have resulted in a more equitable

4 However, there are few exceptions that relate to automobiles and alcoholic beverages.



incentive structure for import competing activities, reduced the bias against exporting activities as

well as distortions in the domestic price structure, and paved the way for enhancing the efficiency

of domestic manufacturing activities.

23. Table 3.2 highlights the tariff structure for the manufacturing sector for the year 2003-04,

the latest year for which a detailed tariff schedule is available. To analyze the protection structure

and the level of protection, the industrial sector has been divided into 30 broad categories each

subdivided into processed and semi-processed goods, and raw materials5. The simple average

tariff6 on all products is below 25%, which is the normal maximum tariff rate. However, for the

beverages and transport and transport equipment sectors7 the average tariffs are 78.8% and

34.49% respectively. Whereas high tariff rates on beverages are imposed to discourage the import

of alcoholic beverages, high tariff rates for transport and transport equipment sector are meant to

protect the nascent automotive sector in Pakistan.

Table 3.2: Distribution of Tariff Rates

Tariff Rate Percent of Tariff Lines in 2001-02

a

Percent of Tariff Lines in 2002-03

b

Percent of Tariff Lines in 2004-05

b

5% 10.1 17.05 25.09

10% 32.2 26.27 21.12

20% 17.2 13.91 14.54

25% 39.4 41.53 35.95 Source: a Trade Policies in South Asia: An Overview, Volume I: An Overview b Authors' own calculations

24. As part of the overall tariff reduction program, more and more tariff lines have been

brought into lower tariff slabs: tariffs on a number of processed goods have been reduced from

20% to 10%, while tariffs on raw materials and components of various kinds have been curtailed

from 10% to 5%. There is an evidence of cascading in the nominal protection structure as the

average tariffs for raw materials, semi-processed, and fully processed products are 12.16%,

13.22%, and 20.09% respectively. At a disaggregated level, all major sectors including food

processing, textiles, leather products, chemicals, and iron and steel products etc. have a cascaded

tariff structure.

25. The few exceptions for which average tariffs for fully processed products are lower than

on raw materials are mineral, stone and ceramics, plastic, glass, and miscellaneous manufactured

products8.

26. Despite the steady reduction of the top rates and the removal of zero-duty slab, tariffs in

Pakistan are still quite dispersed. The overall standard deviation is 11.80 and coefficient of

variation is 67%, whereas for the raw materials, semi-processed, and fully processed products

standard deviation and coefficient of variations are 7.31, 7.09, and 12.97; and 60%, 54%, and

65% respectively (see Table 3.1). Presently, over 40% of the tariff lines are at 5% or 10% slab,

14% at 20% and almost 40% at 25% slab (Table 3.2).

27. In an attempt to further rationalize the tariff structure, the government has announced

several new tariff measures in the budget for fiscal 2004-05. In particular, the customs duty on the

import of plant, machinery and equipment has been brought down to 5%, the customs duty on

import of industrial raw materials has been reduced, and the duty structure for the automotive

5 Of the 5268 tariff lines, 446 are classified as raw materials (1st stage of processing), 1378 as semi-

processed goods, and 3444 as fully processed products. 6 Simple average or mean tariff is the un-weighted average of the effectively applied rates for all products

subject to tariff. Simple averages are generally deemed to be better indictors of tariff protection than weighted averages, the latter being biased downward because higher tariffs discourage trade and reduce the weights applied to these tariffs.

7 These product categories include only processed goods. 8 Miscellaneous manufactured products include articles such as tools, cutlery, spoon, articles of base metal,

watches, toys etc.



sector has been rationalized.9 Notwithstanding these initiatives, the structure of protection

continues to favor consumer products as against industrial products and products that can be

classified as capital goods. For example, the average tariff rates for food products/food

preparations (fully processed) and textiles (fully processed) are 24.04% and 24.31% respectively.

On the other hand, the average tariff rate for electrical machinery is 17% and for non-

electrical/mechanical machinery it is 12.72%. A more even structure of protection will promote

competition and encourage an efficient allocation of resources, thereby benefiting all the market

participants.

28. It is instructive to draw a comparison between average tariffs and the level of dispersion

in the years 2001-02 and 2005-05. It is evident that not only the average tariffs for all product

categories (including sub-processes) have come down; the standard deviation in the tariff rates

has also been reduced. (see Table 3.3 and 3.4).

Table 3.3: Tariff Structure 2001-02

a

Product and processing Number of lines

Average Range Standard deviation

Coefficient of variation

Total

- 1st stage of processing 642 13.4 5-30 8.4 0.6

- semi-processed 1,767 17.5 5-30 9.4 0.5

- fully processed 3,068 23.6 5-250 19.2 0.8

Agriculture

- raw materials 296 14.9 5-30 8.9 0.6

Mining and quarrying

- raw materials 109 12.7 5-30 8.3 0.7

Food products


- semi-processed 60 18.2 10-30 6.8 0.4

- fully processed 249 25.0 10-30 7.4 0.3

Food manufacturing


- semi-processed 6 30.0 30-30 0.0 -

- fully processed 34 23.7 5-30 6.9 0.3

Beverages

- fully processed 24 81.9 10-200 46.1 0.6

Tobacco manufactures

- fully processed 6 30.0 30-30 0.0 -

Textiles


- semi-processed 388 25.0 5-30 7.7 0.3

- fully processed 263 29.1 10-30 3.7 0.1

Clothing

- fully processed 134 29.3 20-30 2.5 0.1

Leather products

- 1st stage of processing 1 10.0 10-10 0.0 -

- semi-processed 32 7.2 5-30 5.7 0.8

- fully processed 20 28.5 10-30 4.9 0.2

Footwear

- fully processed 17 29.4 20-30 2.4 0.1

Continued…

9 Most notably, the maximum duty on import of automobiles has been slashed from 200% to 100%; and

import duty on cars with a capacity of 1000-1300 cc has been cut to 50%.






Wood products


- semi-processed 33 19.1 10-30 9.1 0.5

- fully processed 27 28.1 20-30 4.0 0.1

Furniture except metal

- fully processed 22 28.6 10-30 4.7 0.2

Paper products


- semi-processed 68 24.0 5-30 6.5 0.3

- fully processed 34 28.7 5-30 5.4 0.2

Printing

- fully processed 31 17.7 5-30 11.7 0.7

Industrial chemicals


- semi-processed 680 13.4 5-30 7.4 0.6

- fully processed 28 22.7 5-30 8.3 0.4

Other chemicals


- semi-processed 71 16.9 5-30 7.6 0.4

- fully processed 212 18.5 5-30 9.4 0.5

Petroleum refineries


- semi-processed 5 18.0 10-30 11.0 0.6

- fully processed 28 23.0 5-30 9.3 0.4

Petroleum and coal products


- semi-processed 6 16.7 10-30 10.3 0.6

- fully processed 2 30.0 30-30 0.0 -

Rubber products


- semi-processed 16 21.3 10-30 8.1 0.4

- fully processed 48 27.2 5-30 6.4 0.2

Plastic products

- fully processed 29 26.4 5-30 8.4 0.3

Pottery and china

- fully processed 16 28.1 20-30 4.0 0.1

Glass and products

- semi-processed 20 25.0 10-30 6.9 0.3

- fully processed 53 24.0 5-30 8.8 0.4

Non-metallic mineral products


- semi-processed 14 22.1 10-30 8.9 0.4

- fully processed 73 26.3 10-30 7.0 0.3

Iron and steel products


- semi-processed 199 19.3 5-30 10.1 0.5

Non-ferrous metal


- semi-processed 159 10.5 5-30 6.4 0.6

- fully processed 1 30.0 30-30 0.0 -

Metal products

- semi-processed 5 20.0 20-20 0.0 -

- fully processed 221 26.9 5-30 5.7 0.2

Continued…






Non-electrical machinery

- semi-processed 1 30.0 30-30 0.0 -

- fully processed 575 15.3 5-60 8.9 0.6

Electrical machinery

- fully processed 323 19.5 5-30 9.8 0.5

Transport equipment

- fully processed 169 48.0 5-250 60.8 1.3

Professional and scientific equipment

- fully processed 228 13.5 5-30 8.0 0.6

Other manufactured products


- semi-processed 4 25.0 10-30 10.0 0.4

- fully processed 200 22.0 5-30 8.1 0.4

Electrical energy

- fully processed 1 5.0 5-5 0.0 - Source: Trade Policy Review: Pakistan, Report by the Secretariat. WT/TPR/S/95. World Trade Organization,

December, 2001.

Table 3.4: Tariff Structure - 2004-05 Product Number

of lines Average Range Standard

Deviation Coefficient of

Variation

Total 5,468 17.09 5-200 12.28 0.72

1st Stage of Processing 463 10.78 5-25 7.21 0.67

Semi-processed 1,447 12.54 5-25 7.28 0.58

Fully-processed 3,558 19.77 5-200 13.52 0.68

Food Products and Food Preparations


Semi-processed 8 19.38 10-25 5.83 0.30

Fully-processed 152 23.98 5-25 2.97 0.13

Beverages

Fully Processed 24 82.5 25-200 44.04 0.53

Tobacco

Semi Processed 3 25 25-25 0.00 --

Fully Processed 7 25 25-25 0.00 --

Textiles


Semi-processed 180 12.89 5-25 7.89 0.61

Fully-processed 360 24.21 5-25 3.71 0.15

Leather, Fur skins and Products

1st Stage of Processing 20 6 5-25 4.36 0.73

Semi-processed 26 9.23 5-25 7.03 0.76

Fully-processed 36 20.56 5-25 7.79 0.38

Clothing

Fully Processed 328 24.88 5-25 1.56 0.06

Footwear

Fully Processed 31 24.84 20-25 0.88 0.04

Furniture except metal

Fully Processed 25 23 5-25 5.48 0.24

Chemical Products

Semi-processed 759 10.11 5-25 4.75 0.47

Fully-processed 63 18.25 5-25 8.03 0.44

Miscellaneous Chemical and Allied Products

Semi-processed 15 21.67 5-25 5.06 0.23

Fully-processed 15 21.33 5-25 6.70 0.31

Continued…



Product Number of lines

Average Range Standard Deviation

Coefficient of Variation

Pharmaceutical Products

Semi-processed 3 10 10-10 0.00 --

Fully-processed 44 12.95 5-25 5.26 0.41

Fertilizers

Semi-processed 2 5 5-5 0.00 --

Fully-processed 24 5 5-5 0.00 --

Perfumery, Cosmetic/Toiletry, Soaps etc


Semi-processed 3 10 10-10 0.00 --

Fully-processed 62 21.53 5-25 6.06 0.28

Mineral Products


Semi-processed 11 15.45 5-25 8.91 0.58

Fully-processed 70 14.57 5-25 8.36 0.57

Iron and Steel Products


Semi-processed 165 15.55 5-25 9.47 0.61

Fully-processed 143 21.64 5-35 6.17 0.28

Metal - Ferrous & Non-Ferrous – Products


Semi-processed 70 11.86 5-20 5.29 0.45

Fully-processed 52 22.79 10-25 3.45 0.15

Precious Metals, Stones, Jewelry etc.

Semi-processed 38 5.39 5-10 1.35 0.25

Fully-processed 17 8.82 5-10 2.12 0.24

Articles of Stones and Ceramics etc

Semi-processed 24 21.25 5-25 6.50 0.31

Fully-processed 66 22.58 5-25 5.38 0.24

Plastic Products


Semi-processed 48 22.29 5-25 5.59 0.25

Fully-processed 30 21.33 5-25 6.70 0.31

Rubber Products

1st Stage of Processing 19 5 5-5 0.00 --

Semi-processed 29 20.17 5-25 5.17 0.26

Fully-processed 57 22.99 5-35 6.13 0.27

Glass Products

Semi-processed 19 21.58 5-25 5.39 0.25

Fully-processed 56 20.18 5-35 7.56 0.37

Wood, Wood Charcoal, Cork, Straw etc and Products


Semi-processed 17 22.35 5-25 5.72 0.26

Fully-processed 23 23.7 5-25 4.23 0.18

Paper products


Semi-processed 23 20.43 5-25 5.30 0.26

Fully-processed 113 21.81 5-25 4.66 0.21

Electrical Machinery

Fully Processed 367 16.51 5-35 8.59 0.52

Non-Electrical/Mechanical Machinery

Fully Processed 642 11.83 5-35 9.10 0.77

Transport Equipment

Fully Processed 173 38.82 5-200 33.33 0.86

Continued…



Product Number of lines

Average Range Standard Deviation

Coefficient of Variation

Professional and Scientific Equipment

Fully Processed 202 9.6 5-35 7.28 0.76

Printing

Fully Processed 22 10.68 5-25 7.58 0.71

Miscellaneous Manufactured Articles

1st Stage of Processing 3 20 20-20 0.00 --

Semi-processed 4 21.25 20-25 2.17 0.10

Fully-processed 350 18.53 5-35 7.34 0.40

Electrical Energy

Fully Processed 1 5 -- 0.00 --

Source: a Authors' own calculations

29. At a disaggregated level, dispersion in the tariff rates for raw materials and semi-

processed products has not changed from the previous year, but has considerably fallen in the

case of processed goods: the coefficient of variation for processed goods came down to 65%

in 2002-03 from 80% in 2001-02. Despite this, however, there still remains considerable

dispersion in the tariff rates. Also, consumer products continue to be protected as compared

with industrial products and capital goods. Therefore, consideration must be given to

reducing the burden of protecting domestic industry on final consumers and users of

protected goods and activities. The attainment of these objectives will improve the growth

potential of the country and increase employment opportunities.

30. To summarize, the review of the protection structure has revealed that:

i. There are some tariff peaks in the existing protection structure that need to be

reduced.

ii. The tariff structure is escalated.

iii. Tariff rates are dispersed and vary widely. Although the percent of tariff lines in 5%

slab have increased, still there are a substantial number of tariff lines that fall in

higher slabs.

iv. Consumer products enjoy higher protection than industrial and capital goods.

19

Section 4

Effective Protection: a Review of Theoretical and Empirical Literature

31. The concept of effective protection was first developed as a tool for summarizing the

total effect of input and output tariffs on a production process. It soon became established as

a widely used device for evaluating protective structures and changes therein, especially in

developing countries. However, at very initial stages, the concept was criticized on the

grounds that it is inappropriate to draw general equilibrium inferences from a measure that is

essentially partial equilibrium. Yet, despite this critique, the measure still continues to be

widely used by academic researchers and policy-making agencies.

32. Economists have long since been aware that it is not appropriate to regard the nominal

tariff as a measure of protection. As Corden (1971) points out that the idea of compensating

tariff can be traced as early as 1882 in F.W. Taussig’s work titled Tariff History of the United

States. The idea kept on surfacing in the writings of authors like J.E. Mead (Trade and

Welfare) and G.V. Haberler (The Theory of International Trade). Some pioneering work has

been done in Balassa (1965) and Soligo and Stern (1965). However the concept got a

systematic articulation in W.M. Corden (1966) and it was immediately picked by theoretical

as well as applied economists. The reason for its popularity lies in its intuitive appeal and

computational simplicity.

33. Corden formulated the concept of effective protection in the following

expression


Where




aij = share of i in cost of j in absence of tariffs

34. Corden’s formulation has been criticized on the basis of its simplicity and its being a

partial equilibrium model and an associated problem of fixed coefficients. It is simple

because the effect of non-traded inputs is not accounted for. Its partial equilibrium nature

does not allow the impact of general equilibrium factor prices and exchange rates. (See for

example, Ethier (1977) and Bhagwati and Srinivasan (1973)).

35. Despite all criticisms Corden’s formula has survived, and is still widely used even

after four decades of original presentation. In the words of Anderson (1995) "Effective

protection is the ranch house of trade policy construction – ugly but apparently too useful to

disappear".



36. As a matter of fact this formula provides a standard framework for systematic analysis

of overall tariff structure. It describes very succinctly how tariffs on inputs and outputs

determine effective protection. This framework also includes at least two important empirical

phenomena, viz. negative effective protection and negative value added. These phenomena

have clearly brought into focus many situations where import substitution or export

promotion policies had distorted the market up to the level beyond rationality.

37. As pointed out earlier, Corden’s formulation is based upon a partial equilibrium

framework. In a latter study (1969), Corden demonstrated that his formula holds in a model

in which there are two factors of productions, two final goods and intermediate inputs are

imported and not produced at home. This model was challenged by Anderson (1970) who

showed that Corden’s formula of effective protection breaks down in the case of many-

commodities in general equilibrium framework.

38. Davis (1998) deals with the substation problem in the theory of effective protection.

The author resolves the substitution problem in three components; (i) the index problem i.e.

fixed coefficients, (ii) conceptualization problem, i.e. reparability of inputs, and (iii) The

paradox problem, i.e. due to input substitution, the direction of change in gross output may be

different from that of change in value added. The author finds that the conceptualization

problem does not affect the usefulness of effective protection analysis in the real-world

analysis. The index problem is also not likely to effect effective protection’s usefulness as

general equilibrium tool as long as the rates of protection remain below several hundred

percent. The paradox problem, however, is found to be potentially persistent. The author

concludes that partial equilibrium effective protection analysis is in practice a reasonable

estimator of certain short-run general equilibrium effects of protection.

39. Anderson (1995) modified the definition of effective protection to make it suitable in

a general equilibrium framework. According to his proposition “the effective rate of

protection for sector j is defined here as the uniform tariff which is equivalent to the actual

differentiated tariff structure in its effect on the rents to residual claimants in sector j. This

definition applies to general as well as partial equilibrium economic structures, has obvious

relevance for political economy models and seems to correspond to the motivation for the

early effective protection literature.” In a general equilibrium this definition implies a well

defined index which decomposes in three components. The component is the partial

equilibrium formula, leading to a special case where the partial equilibrium formula gives the

same sectoral ranking of effective rates of protection as the general equilibrium formula. The

decomposition makes clear how very special this case is, leading back to the necessity of

measuring the effective rate of protection in a general equilibrium model. The author

estimates effective protection measures in US agriculture, and the results show that the new

and old concepts of effective protection give very different pictures of the pattern of

protection afforded to sectors by the actual tariff structure. The author recommends

Computable General Equilibrium Models should be used to study the implications of various

national tariff structures.

Review of Some Empirical Studies

40. Kusum Das, Deb (2003), attempts to quantify tariff and non-tariff barriers in 72

Indian industries. Four measures are computed for this purpose. The first one is a measure of

tariff barriers while the remaining three are non-tariff in nature. These are:

1. Effective rate of protection

(Cordon formula has been used viz. EPR = (Tj – Σaij Ti)/(1- Σaij)

2. Frequency ratios

3. Input coverage ratios

4. Import penetration ratios



41. The study covers the period 1980-81 to 1994-95. This period has further been

subdivided in three sub-periods, i.e. 1980-81 to 1985-86, 1986-87 to 1990-91, and 1990-91 to

1994-95. In addition, measures for the whole period are also computed. Goods are classified

in three groups i.e. consumers goods, intermediate goods and producers goods.

42. The cost of production is obtained input-output tables 1983-84 and 1989-90. Tariff

rates are derived from Customs Tariff Working Schedule. Quantitative exceptions are taken

into account.

43. Free tariff coefficients are obtained by the formula:

aij = [Pij*/(1+ Ti)] / [Pj

*/ (1+ Tj)]

(where * indicates domestic prices)

44. In other words domestic price are deflated by appropriate tariff rates. ERP are not

adjusted for any exchange rate overvaluation. Descriptive analysis of estimates of all tariff

and non-tariff barriers has been carried out.

Followings are the main findings of the study regarding ERP.

1. ERP levels are highest for intermediate goods.

2. ERP increased in the period 1986-87 to 1990-91 in all the three sectors.

3. ERP sharply fell in the period 1990-91 to 1994-95 in all the three sectors. The decline

is more pronounced in intermediate and consumer goods.

45. Kemal, A. R., Mahmood, Zafar and Maqsood, Athar (1994) analyze the protection

structure, efficiency, and profitability of Pakistan’s manufacturing industries for the year

1992-93. The study is based upon a survey of 961 firms from all the provinces of the country.

The survey provided detailed information of variables like output, inputs, primary factors,

taxes, prices of imported inputs etc. In total 99 industries are covered.

46. For the purpose of computing effective protection three methods are used viz.

(i) Balassa Method, (ii) Corden Method, and (iii) Scott Method. Effective protection rates are

computed in many possible ways. This includes computation by:

By industry size (small medium and large)

By location (Punjab, Sindh, NEFP and Balochistan)

By market orientation (whether the industry is export oriented, import competing etc.)

Under different assumptions of under/over-reporting of inputs and outputs.

47. Out of 70 industries, 11 industries are found to be suffering from the problem of

negative value added, i.e. infinite protection. Another 39 industries were enjoying very high

level of protection. The number of moderately protected industries was 14. And 3 industries

suffered negative protection, viz. confectionary, bakery, and beverages. Across size, medium

industries enjoyed maximum protection and small industries received the least. Across

provinces, Balochistan enjoyed the highest protection, while Sindh came out to be least

protected. By market orientation, export-oriented industries were least protected, whereas

non-import-competing industries suffered negative protection.

48. Domestic resource cost of earning a unit of foreign exchange (for the year 1990-91) is

used as a measure of efficiency. It is found that manufacturing sector has become more

efficient over time (compared with 1980-81). Especially textile industries are found to shift

from negative value added (in 1980-81) to a high level of efficiency in 1990-91. By size,

small industrial units are found to be most efficient, and large-size industrial units are

inefficient. Province-wise, efficiency is highest in Balochistan. The authors attribute this to

the exclusion of six negative value added industries. In the remaining provinces, Sindh is

most efficient and NWFP is least. By market orientation, non-import competing goods



industries are most efficient. Authors claim that this is due to only one industry, i.e.

cigarettes, otherwise export-oriented industries are most efficient.

49. Authors observe that whereas 11 inefficient industries enjoy high level of protection,

there are also 14 efficient industries which are also highly protected, thus implying excessive

profit.

50. In order to analyze the profitability, the manufacturing industries have been classified

in six levels of profit rates. It is found that if net profit is used as the criterion, 24 industries

are making losses, 24 industries are making 20% profits, and 26 industries are making more

than 20% profits.

51. Soligo and Stern (1965) analyze Pakistan’s manufacturing sector. Their study covers

48 manufacturing industries. The industries are categorized as consumer goods, investment

goods, and intermediate goods. Composition of inputs and outputs is obtained from the

Census of Manufacturing Industries (1962); Inter-industries flows are taken from input-

output table prepared for the Planning Commission; tariff rates are obtained from Pakistan

Customs Tariff Manual. The results indicate that the consumer goods are more heavily

protected than intermediate or investment goods. Among consumer goods, non-essential

goods were more protected. Heavy machinery, transport goods and fertilizer are among least

protected goods.

52. Prema-Chandra Athukorala (2006) analyze the structure of protection in Vietnam

based on estimates of effective rates of protection based on the tariff schedule as at mid-2003

provided by the Ministry of Finance. Intermediate import coefficients are derived from the

Input-Output Table for 2000 prepared by the General Statistical Office (GSO). The nominal

rates used in estimation are simply the official applied tariff rates summed up at the input-

output sector level using import value weights.

53. Effective protection is conventionally estimated as a composite index for a given

sector incorporating both incentives for export- and import-competing protection. However,

author finds that in Vietnam, like many developing countries, export-promotion policies are

pursued alongside import-substitution policies. So, effective protection rates are estimated for

import-competing and export-oriented activities separately.

54. The estimates reveal a high degree of variability in ERP across industries. Some sectors

like liquor, beer and processed rice have well over 100 per cent effective protection. Protection

for 11 sectors (tea, bricks and tiles, home appliances, textiles, clothing, carpets, plastic products,

home appliances, motorcycles, bicycles, and motor vehicles) range between 50 and 88 per cent.

Remaining sectors have effective protection in the range of 0 to 50 per cent, with most of the

sectors concentrated at the lower end of the distribution. The products like as tea, coffee, rice and

wearing apparel are provided very high protection. In these sectors the country has a clear

comparative advantage

55. Effective protection rates are estimated for import-competing production for 2003,

together with the underlined input and output tariff and input coefficients. The estimated ERP for

import-competing production in all traded-goods sectors in 2003 is 25 per cent, compared to 58

per cent in 2001 and 72.2 per cent in 1997. A comparison of NRP and ERP estimates for the three

years suggests that this decline has come predominantly from an increase in input tariffs. The

NRP (on final goods) has changed only marginally over this period. The degree of dispersion of

ERP across sectors (measured by the coefficient of variation) increased from 156 per cent in 1997

to 172 per cent in 2001 and then declined to 134 per cent in 2003.

56. The counterbalancing effect of measures to redress the anti-export bias in the trade regime

(duty rebate, turnover tax concession and profit tax concession) is found to be much smaller in

magnitude compared to the price-raising impact of the existing import tariff structure.

Consequently, there is a clear anti-export bias in the incentive structure, even though the degree

of the bias has considerably declined in recent years.



57. Lewis and Guisinger (1968) in their study examine various measures of level and

structure of protection in manufacturing industries in Pakistan. Thirty-two industries are included

in the analysis, and are further sub-divided in three main groups viz. consumption goods,

intermediate goods, and investment and related goods. Adjustment has been made for non-traded

inputs and foreign exchange fluctuations. Input-output structure has been taken from 1963-64

input-output table. Tariff and indirect taxes data is taken from Lewis and Radhu (1966). Price

data are obtained from various sources including two surveys. Price differentials are also used as

a measure of protection. Authors give two main reasons for this approach; (a) some tariffs are

redundant and the tariff structure overstates the level of protection; (b) quantitative restrictions,

not tariffs, are the effective determinants of domestic prices of some goods, so that tariffs

understate the level of protection.

58. Consumer goods are found to be more protected than intermediate and investment goods.

Direct price comparison of inputs and outputs indicate a higher average protection than combined

effect of tax, exchange rate, and control system. However, level of protection in some very

important industries, such as cotton textile falls. It is found that the measured levels of protection

are quite sensitive to treatment of non-traded goods. Authors conclude that trade-restricting

policies in Pakistan have led to a set of domestic prices that diverge widely from the prices that

exist in international trade. Consequently, resource allocation may be badly out of line with what

it should be.


Section 5

Methodology, Data and Results 59. This study uses the Corden’s formula to compute the rates of effective protection. The

formula is given by the following expression


Where




aij = share of industry i in cost of the industry j.

60. The study uses the coefficients aij’s from Input-Output Table updated by Dorosh et al

(2006) for the year 2001. A detailed questionnaire was developed and pre-tested. However, a

listing of firms to draw the survey sample could not be obtained from the Federal Bureau of

Statistics. Given time constraints it was, therefore, decided to use the available updated Input-

Output table. Nominal tariff rates ti’s and tj’s for the year 2006 are obtained from website of

Central Board of Revenue. In total 39 manufacturing sectors are covered in this study

61. Average nominal protection rate for all manufacturing industries covered in the study is

16.9%, whereas, average effective protection rate turns out to be 27.8%. Twenty three sectors

avail above average nominal protection, while effective protection for eighteen sectors happens to

be above average. The results indicate that effective rate of protection is quite high for leather and

leather products, foot wear, transport equipment and some textile sub-sectors. The sectors with

lowest effective protection rates are jewelry (precious metal), vegetable oils, other textile

products, bakery products, and fertilizers and pesticides. The complete list of effective and

nominal tariffs is given in the Appendix.

62. A direct comparison of the results of this study is not possible with earlier once due to

discrepancy among the sectors identified. However, some industries which could be found

common with those of previous studies, do provide an opportunity of comparison.10

Vegetable oils which was previously negatively protected, still suffers from negative

protection.

Effective protection for fertilizer, pharmaceutics, and cotton yarn has changed from positive

to negative.

Leather products, carpets, garments, and footwear continue to avail positive effective

protection.

63. The top ten most protected sectors with respect to effective protection are:

10 Most of the comparison is made with the results of Kemal et .al. (1994).



Table 5.1: Top Ten Effectively Protected Industrial Sectors S. No. Sectors EPR %

1 Leather, leather products 185.6

2 Foot wear 135.8

3 Transport equipment 106.5

4 Knitwear 69.9

5 Other manufacturing products 69.1

6 Made-up textile goods 64.4

7 Carpets 61.2

8 Cotton cloth 55.1

9 Garments 54.3

10 Other chemicals 53.7

64. The ten least protected sectors with respect to effective protection are:

Table 5.2: Ten Least Effectively Protected Industrial Sectors S. No. Sectors EPR %

1 Jewelry (precious metal) -69.3

2 Vegetable oils etc. -64.3

3 Other textile products -21.9

4 Bakery products -20.4

5 Fertilizers and pesticides -17.3

6 Other non-electrical machinery -12.4

7 Other metal products -11.0

8 Cotton yarn -6.4

9 Pharmaceuticals -5.2

10 Surgical instruments -4.7

65. The top fifteen most protected sectors with respect to nominal protection are:

Table 5.3: Top 15 Nominally Protected Industrial Sectors S. No. Sectors NR %

1 Transport equipment 47.0

2 Leather, leather products 25.0

3 Foot wear 25.0

4 Knitwear 25.0

5 Other manufacturing products 25.0

6 Made-up textile goods 25.0

7 Carpets 25.0

8 Garments 25.0

9 Other chemicals 25.0

10 Beverages 25.0

11 Rubber and plastic products 25.0

12 Bricks, tiles 25.0

13 Cigarettes, tobacco 25.0

14 MF: Cement 25.0

15 Cotton cloth 22.7

66. The ten least protected sectors with respect to nominal protection are:

Table 5.4: Ten Least Nominally Protected Industrial Sectors S. No. Sectors NR %

1 Ginned cotton (lint) 5.0

2 Cotton yarn 5.0

3 Other metal products 5.0

4 Other non-electrical machinery 5.0

5 Fertilizers and pesticides 5.0

6 Bakery products 5.0

7 Other textile products 5.0

8 Vegetable oils etc. 5.0

9 Jewelry (precious metal) 5.0

10 Surgical instruments 8.1

Average 16.9


Section 6

Interpretation of Results 67. The results presented in previous pages indicate an urgent need for tariff

rationalization especially in leather, leather products, foot wear, transport equipment,

knitwear, other manufacturing products, made-up textile goods, carpets, cotton cloth and

garments. On the other hand sectors like, jewelry (precious metal), vegetable oils, etc., other

textile products, bakery products, fertilizers and pesticides, other non-electrical machinery,

other metal products, cotton yarn and pharmaceuticals are those which are least protected.

The negative sign of their effective protection measure indicates that their inputs are heavily

protected. A brief description of some of these sectors is given below.

68. Transport Equipment: The transport equipment sector has enjoyed very high

protection. While the government has initiated measures in the recently announced budget for

tariff rationalization in the auto sector, these measures need to be reinforced. Further tariff

rationalization in the auto sector would go a long way in enhancing the competitiveness of

the domestic auto industry as well as in benefiting consumers by lowering the price of

automobiles.

69. Leather, Textiles and Apparel Industries: This group of industries is the largest in

Pakistan’s manufacturing sector, accounting for 31.1 percent of manufacturing value added.

The group comprises textiles, wearing apparel and leather accounting for 24.0, 4.4 and 1.7

percent of manufacturing value added. However, the quality of product is at the lower end

with little value addition. It suffers from quality and standardization and resultantly the unit

values of Pakistani textiles products are way below the average international values. If

Pakistan is to become a global player, the sector needs to redefine its market and products,

improve product quality, move up the value chain, lay technological foundations, and

strengthen global business operations.

70. While the share of textiles in the value added of the manufacturing sector is 24

percent, it accounts for roughly 70 percent of the total exports. Since the textiles sector is

labor-intensive, its share in employment is as high as 46.9 percent. The labor intensity differs

across sub-sectors; cotton weaving, jute textiles and knitting mills are the most labor-

intensive11

.

71. Textiles industry uses a range of imported inputs from cotton and steel. High tariff

protection is being provided to the domestic producers of these inputs, thereby eroding the

competitiveness of the textiles sector. Higher tariffs imposed on these sectors to protect

domestic producers seriously affect the textiles processing industries by raising their cost of

production. This problem has been compounded by various restrictions in EU and USA that

have forced the textile industry to switch to costly inputs. To ensure the availability of these

11 Labor-intensive textile products such as fabrics, made-up textiles and carpets are in the small scale

manufacturing sector which makes the overall textiles sector even more labor intensive.



inputs to textiles producers at competitive prices, it is proposed that the protection provided

to domestic producers of these inputs be gradually withdrawn, eventually to be replaced by

fiscal incentives.

72. Beverages: Various types of beverages are produced in Pakistan, including fruit

drinks and aerated water. It is the latter which accounts for more than 76 percent of total

beverages in Pakistan. The aerated beverages industry has mostly been controlled by the two

foreign brands and localization attempts have not been all that successful12

. However, the

fruit beverages and local syrups have developed but the pace is slow. The fruit beverages

industry that has great potential and Pakistan can create a niche market for its fruit beverages.

However, the growth of export is possible with the induction of foreign direct investment and

use of the popular brands.

73. The drinking and mineral water have grown sharply in recent years mainly because of

the health consciousness mainly because of the rising hepatitis. The industry needs proper

certification and a mechanism for monitoring.

74. The government has been protecting the domestic steel industry from international

competition. This policy has adversely affected a number of downstream industries

particularly in the engineering sector. While tariffs on steel have been reduced recently, these

need to be further curtailed with a view to improving the competitiveness of the engineering

sector. Such a move would force the domestic steel producers to become more efficient.

75. With a view to improving the value added in the industry, and strengthening the

competitiveness of the textiles sector, especially in the rapidly changing global environment,

it is necessary that the country has a long-run vision of textiles sector and all the policies

must be geared towards realizing that. The long-run vision for textiles of Pakistan must be the

higher value added products through better quality and promotion of new and standardized

products and processes which are competitive in the world market13

. The apparel sector has

not been able to exploit its potential in the international market due mainly to shortage of

skills in apparel designing and stitching. The highest value addition can only be achieved

through the development of manpower, equipped with the requisite skills to enable the

country to compete in international markets.

76. Despite the trade reforms, the trade regime remains very complex as is evident form

the EPRs, calculated from official tariffs given in the Pakistan Custom Tariff (PCT) 2006-07

as given in First Schedule. Even in the PCT, the policy-stated slabs have increased from four

to five and a number of specific and special rates are applied. The First Schedule now

consists of 16 specific tariffs for 48 line items and 12 ad valorem rates ranging from 5% to

90% for 6752 line items, viz. 90% for 29 items, 75% for 13 items, 65% for 4 items, 60% for

5 items, 50% for 21 items, 35% for 371 items, 30% for 33 items, 25% for 1409 items, 20%

for 929 items, 15% for 404 items, 10% for 872 items, and 5% for 2662 items.

77. Apart from the foregoing complexities, the tariff regime has been affected by several

changes and concessions given through SROs. Some of these changes are described below.

i). Several exemptions/reductions are given outside the first schedule on raw materials,

sub-components, components, sub-assemblies and assemblies, as are not

manufactured locally, e.g. S.R.O. 565 (I)/20060.

ii). Special exemption/ concessions are given outside the first schedule for plant,

machinery, equipment and apparatus, including capital goods, see S.R.O. 575(I)/2006.

iii). Special exemptions are admissible to NGOs, charitable institutions, hospitals, etc.

iv). Special exemption/ concessions are allowed for government/special interest group

imports, e.g. S.R.O.567 (I)/2006.

12 Recently there has been a shift in policy, and many small brands have started appearing in the market. 13 Such a transformation will have to take into cognizance the heightened global competition in textiles trade

after the phasing out of the MFA.



v). Special reduction in import duty is made for certain commodities in short supply,

S.R.O. 548(I)/2006.

vi). There are specific concessionary rates for select items, e.g. Rs 500 on telephone, see

SRO 541(I)/2006.

vii). There are exemptions for the privileged people.

viii). Special tariffs apply under SAFTA and other bilateral trading arrangements.

ix). At times, regulatory duties are imposed on export of some commodities.

78. Furthermore the trade policy is victim of overvalued exchange rate and complex trade

diplomacy pursued at bilateral, regional and multilateral levels. Besides multilateral trade

agreements under WTO, the government has negotiated/ has been negotiating PTA with

selected countries and regions which are perhaps trade diverting rather than trade expanding.


Section 7

An Assessment 79. Productivity improvements: Reducing protection has benefited the country in several

ways. As a consequence of the tariff reforms, the entire cost structure of all industrial sectors

has undergone a drastic change. Empirical studies show that the largest productivity gains

arise from reducing input tariffs. Lower output tariffs can produce productivity gains by

inducing tougher import competition whereas cheaper imported inputs can raise productivity

via learning, technology, variety, or quality effects. The effect of reducing input tariffs

significantly increases productivity and that this effect is much higher than of reducing output

tariffs.14

80. Thus costs of production have been decreased owing to the reduced tariffs. Tariff

reductions have helped reduce costs of capital equipment and intermediate goods that are

crucial to expansion of the manufacturing and export sectors. By allowing prices to more

closely reflect production costs, trade liberalization brings about a shift of resources to sectors

of comparative advantages. Market horizons expand and it becomes more feasible to harness

technology, scale and trade economies. Investment prospects have increased with lowering of

effective protection and liberalization, benefiting employment and production including

exports. Foreign direct investment has started flowing in, enhancing prospects of better

technology and integration with global markets. Despite some progress however, the

momentum of industrial development has been slow in terms of speed, diversity,

technological adaptation and processing stages, and industrial development based on resource

endowment has been missing.

81. Tariff cuts have a negative side. One, they could lead to a reduction in output and

employment in certain sectors which face greater competition from lower-cost foreign

products. The import content of local consumption at times may exert BOP pressures. Some

export sectors may contract because of greater competition, e.g. textiles and garments.

Second, international trade taxes, customs duties, petroleum charges, etc., have been major

sources of revenues, and tariff reductions have lead to revenue losses. Hence industrial

lobbies have harped on these themes and found governments sympathetic, which has slowed

down reforms. This suggests undertaking broad-based tax reforms, broadening of domestic

taxation including taxing of income and consumption (i.e. non-distortive value-added

arrangements) and strengthening of tax administration.

82. Initially the tariff reforms were slow and were not very beneficial. Reduction in

effective tariff protection has to be sufficient and rapid enough to benefit countries with

increased opportunities. The progress has to be assessed in the context of the trade

liberalization that has occurred elsewhere. If the external competitiveness is not to be eroded,

14 See for example, Mary Amiti and Jozef Konings1, Trade Liberalization, Intermediate Inputs, and

Productivity: Evidence from Indonesia, IMF Working Paper WP/05/146, IMF Research Department, July 2005.



the country needs to liberalize trade sufficiently and quickly as in competing countries.

Otherwise, the trade liberalization may increase competition from abroad and lead to the loss

of trading share, productivity and welfare improvements. Besides, price and wage flexibility

is needed to allow resources to be used

more efficiently. Finally, the most

important component of trade

liberalization is the reduction in overall

protection which should not be offset by

other discriminatory taxes on trade

(import surcharges, withholding tax,

sales tax, other discriminatory

consumption taxes, etc.).

83. Trade and growth: Although

Pakistan started its tariff reforms in early

90s, its integration with the global

economy picked up in the recent past.

The trade-to-GDP ratio has risen from

close to 26 percent in 1999-2000 to

estimated 34 percent in 2005-06 (See Fig.1). Exports and imports increased by 16% p.a. and

27% p.a. respectively in the past seven years. The share of manufactured exports also rose,

reaching to 90% in 2005-06. The GDP growth also picked up in the recent past, reaching

7.6% in the past three years 2003-06 compared with 2% in 2000-01. Pakistan’s global

integration is however far form complete and the structure of trade remain weak. In

particular, export remains concentrated on few products with low value addition and direction

of trade is limited to a few countries. Besides Pakistan’s export performance has been much

weaker than its competitor countries.

84. Besides tariff reforms, several other structural and cyclical factors were responsible

for this change. On the domestic side, strong economic growth that triggered investment

spending also led to a massive surge in imports. On the external side, the global economy

continues its strong and broad–based expansion, growing by 4 percent, and by a much higher

rate in developing countries, in the last five years. This global expansion has facilitated a

much better market access for exports. The integration process was also partly accelerated by

the faster means of communication, internet and transport. A stronger growth at home and the

global expansion at the same time were responsible for a much sharper trade growth in

almost every part of the world. Certainly, the trade and tariff reforms are bringing about a

better global growth outcomes.

85. Consumer welfare and poverty: The trade liberalization and tariff reforms have

benefited consumers in several ways, including access to a large variety of goods at cheaper

rates and better quality of goods. Even the local goods improved in quality and price because

of enhanced competition and supply sources. Several international brand name products have

appeared in the market which is affording better consumer protection through quality

improvements and warranties. The welfare benefits were indeed enormous. Reportedly

poverty levels, which had been increasing until 2001-02, started decreasing with the revival

of growth. The recent PSLM shows a decrease of 10% in poverty during FY02-05, although

there are reports of more unequal income distribution.

86. Trade is an opportunity not a guarantee; while trade reforms can help accelerate

integration in the world economy and strengthen an effective growth strategy, they cannot

ensure its success. As noted earlier, several other policy instruments would need to be fixed,

including sound macroeconomic management, trade-related infrastructure and institutions,

and economy wide investments in human capital and physical infrastructure. The country

Figure. 7.1: Trade As Percent of GDP

Source: Pakistan Economic Survey, 2005-06



took some time in entering reforms in these areas before intensifying its links with the global

economy. There are many possible ways to open an economy, and the real challenge is to

identify which best suits their country’s political economy, institutional constraints, and

initial conditions. Here some mistakes might have been made in sequencing and speed of the

reforms. The initial worsening of poverty in late nineties is in line with the global experience,

i.e. tariff and liberalization reforms may increase poverty in the beginning. Trade reforms

were expected to increase the incomes of the unskilled in countries with a comparative

advantage in producing unskilled-labor intensive goods. Perhaps there has been only a partial

success in this area, and the country would need to ensure that the workers affected smoothly

move out of contracting (import-competing) sectors into expanding (exporting) sectors.

87. The reforms are however far form complete and need to continue to reap the full

benefits of opening up and reduction in protection. With end of IMF programs in Pakistan,

the trade liberalization has slowed down in recent years while the competing countries have

continued liberalizing. Revenues from custom duties are substantial which would need to be

made up from alternative sources, i.e. taxes on income and consumption. Pakistan has

addressing the other binding constraints to growth, including sound macroeconomic

management, trade-related infrastructure and institutions, and economy wide investments in

human capital and physical infrastructure. A substantial improvement in these areas is

possible which can go a long way to reap full benefits of removing protection. As the

economy accumulates physical and human capital, its comparative advantage would shift to

more modern, capital intensive activities, having internationally competitive advantage in a

wider range of goods and services. Inevitably trade share would rise further affecting growth

and more welfare.

88. Anti-export bias. A rather high anti export bias remains there in the trade regime

despite trade reforms. Anti-export bias refers to the bias inherent in trade policies that

promote some sectors to the detriment of export sectors. For example, if tariff peaks are

maintained on some product, say automobiles, investors would have an incentive to invest in

this sector rather than in an export sector. Anti-export bias may arise due to several of the

following reasons:

Trade taxation, both imports and exports

Tariffs on domestically produced goods

Tariffs on imported inputs used in production of exportables, and

Over-valued exchange rate.

89. Trade taxation, both on imports and exports, leads to anti-export bias because it

makes import competing activities more profitable. As for the next two reasons are

concerned, our tariff rationalization process has been slow compared with other countries of

the region. India, which started liberalization program much later than Pakistan, has brought

the maximum tariff rate to 10%, whereas we are still stuck with 25% tariff rates. This is in

addition to other non-tariff trade barriers, which in fact create infinite level of protection. Our

imported inputs still face high tariff rates. Some inputs facing exorbitant tariffs are given

below:

Table 7.1: Some inputs facing exorbitant tariffs

Items Tariff Rates

Ethyl Acetate Articles of Packing Polyvinyl Chloride (PVC) Auto Parts Concrete- Mixer Lorries Soda in Aqueous Solution (soda lye or liquid soda)

25% 25% 25% 35% 60% Rs.7000/MT



Optical Fiber Cables 25%

90. It is usually argued that tariffs are necessary for protection of domestic industries, and that

the negative impacts of such measures can be countered by adopting export promotion policies.

History shows that such measures do not work in the long run. Net effects happen to be a highly

distortionary tax structure, fiscal burden of export promotion measures and above all non-

competitive domestic producers. Measures like Duty Drawback Scheme and Duty and Tax

Remission for Exporters scheme have not produced the desired results. Waiting months or more

for tax refunds can take a big chunk of working capital in addition to unofficial payments

required to expedite the process. Central Board of Revenue (CBR) is also often blamed of

withholding refunds in order to meet its own revenue targets.

91. Third cause of anti-export bias is over-valued exchange rate. Inflation in Pakistan has

been about 9% for last three years, much higher than, say inflation in US. This persistent pressure

on domestic prices renders our exchange rate highly over-valued. This factor is also important in

creating an anti-export bias. Incidentally, tariff rationalization policies can also helpful in fighting

inflation. A coherent mix of fiscal, monetary and trade policies is recommended for this purpose.

92. It is instructive to pinpoint a couple of cases where the tariff structure has created anti-

export bias. First, the customs duty on packaging materials is 25 percent and on tin plate it is 10

percent. These high duties have tended to impede the exports of processed food by making these

uncompetitive in international markets, and this despite the fact that Pakistan has great potential

in this area. For example, Pakistan is the 5th largest producer of milk and can become an

important exporter of milk and dairy products. Yet the high duty on packaging material hinders

such exports. It is, therefore, not surprising that despite efforts to diversify the export basket,

exports remain concentrated in a few product groups.

93. Second, the textiles sector in Pakistan remains largely cotton-based, despite an increasing

trend towards synthetic and blended fabrics. Current spindles utilization for manmade fibers is

very low in Pakistan as compared with its competitors. Major reason for this is the protected

manmade fibers industry. Import duties on manmade fibers make the raw material expensive for

the spinning industry thereby making it non-competitive in yarn export market. Blended yarn sold

in the local market at higher prices compared to international prices erodes the competitive edge

of the weaving industry also. The overwhelming reliance of the textile sector on cotton makes it

vulnerable to adverse shocks in the cotton market. In order to decrease the reliance on cotton,

there is a need to encourage a shift towards manmade fibers.

94. The World Bank (Jaime de Melo) defines the anti-export bias as ratio of effective

exchange rates on imports and exports through the following formulae.

B = ERm(1 + tm + d + pr) / ERm (1 – tx + sx + rx),

Where

B>1 is the anti-export bias, i.e. bias in favor of import-substituting activities, B=1 is no

bias, and very rarely one observe B<1, i.e. the pro-export bias

ERx(m) is the exchange rate applied to exports (imports)

tm tx ,sx stand for import tariff, export tax, and export subsidy

d is prior deposit requirement for imports

pr is tariff equivalent of quotas and other NTBs

rx is preferential credit for exports

95. Using the World Bank’s formulae and assuming that the variables, d, pr, tx, sx and rx, are

negligible, we can equate the anti export bias with effective protection, i.e. 27.8%.

96. In sum, the tariff structure has become very complex as is evident from high EPRs and

other complexities described earlier. These complexities are distorting production structure,



leading to misallocation of resources which hampers economic growth, encourages rent seeking

and corruption. There is therefore an urgent need to reform and rationalize the tariff structure.


Section 8

Recommendations

97. Manufacturing sector plays a very important role in economic growth and well-being

of the country. Several industries still remain highly protected, such as leather, leather

products, foot wear, transport equipment, knitwear, other manufacturing products, made-up

textile goods, carpets, cotton cloth and garments. The least protected sectors include jewelry

(precious metal), vegetable oils, etc., other textile products, bakery products, fertilizers and

pesticides, other non-electrical machinery, other metal products, cotton yarn and

pharmaceuticals.

98. There is an urgent need to remove protection of inputs to make these industries more

competitive. While reducing protection is necessary, simple removal of protection from

highly protected industries is not sufficient for sustaining and improving growth and

increasing consumer welfare. Competitiveness in international market would require not only

trade and tariff liberalization but of sufficient size and speed. Besides catering for factors

constituting an enabling environment is also be required, such as removal of market

imperfections, improvement in physical and financial infrastructure, a better law and order

situation, well defined property rights, human resource development etc. .

99. While the government has taken a number of steps to improve the business climate in

the recent past, several problem areas remain. The World Bank (2003) study on investment

climate indicates that the investment in Pakistan is constrained by poor tax administration,

high tax rates, cost of and access to financing, corruption, regulatory policy uncertainty,

bureaucratic red-tapes and high prices of electricity. To create a business environment that is

conducive to industrial development, reforms are needed to reduce bureaucratic interference

through further deregulation and to improve the efficiency of various agencies including tax

and customs administration. To improve business climate, promote sustained high growth

and increase consumer welfare, the government may consider implementing the following

recommendations. The broad contours of the recommended reform are given below.

Selective trade liberalization reform that promotes export growth is ideal but is

difficult to implement. Exporters generally need to be given incentives to ensure that

selling abroad becomes attractive. This requires establishing a trade regime to offset

the anti-export bias and effectively functioning bureaucracy to implement it. Such a

proactive approach is generally not prescribed to developing countries since they lack

institutional capacity, as is the case here. Thus the usual recommendation is trade

liberalization through low, uniform tariffs and the elimination of quantitative

restrictions. Ideally, the protection level should be reduced to zero. We suggest that

the government set this as the long term objective and reduce the effective protection

to in the range of 5-10% in near future, appropriately sequenced over say 3-5 years. A

suggestive tariff structure and related revenue implications are given below.



Table 8.1: A Proposed Tariff Structure

Equivalent tariff

Proposed tariff structure %

Description 2006-7 2007-08 2008-09 2009-10

Raw material 5.3 5 5 5

Machinery

not locally manufactured

13.5 5 5 5

locally manufactured 26.9 10 7.5 5

Intermediate goods

not locally manufactured

5.9 10 7.5 5

locally manufactured 11.8 15 10 5

Finished goods 44.0 20 10 5

100. An exercise at revenue implications of the foregoing tariff reforms reveals that the

revenue losses from the tariff reduction can be more than offset by reduction in smuggling

and under invoicing, reducing exemptions and concessions, and greater sales tax revenue

generated from additional imports. These results are summarized below and detailed in the

note in Annex II.

Table 8.2: Revenue Implications of Tariff Reform

Mill Rs

2006-07 2007-08 2008-09 2009-10 2007-10

Customs budget

With status quo 157,100 188,709 221,641 260,207 670,558

With reforms 157,100 125,720 106,529 86,615 318,864

Revenue loss -62,989 -115,112 -173,592 -351,694

With reforms2 along with reduction in

concessions/exemptions 157,100 160,292 155,353 142,191 457,836

Revenue recouped through

concessions/exemptions 34,572 48,824 55,576 138,972

reckoning of smug & under invoicing 9,670 18,750 25,718 54,138

With reforms with reduction in concessions

& reckoning of smug & under invoicing 157,100 169,962 174,104 167,909 511,975

Sales tax – additional collection

on reform generated imports 31,120 68,275 113,602 212,996

Overall revenue loss 12,373 20,737 21,304 54,413

Some new activities may become necessary to promote for the development of certain

industries. But such promotion should be well considered and conform to a set of

design principles that include the following: (1) incentives should be provided only

for new, “sunrise” activities, not sunset ones; (2) there should be clear benchmarks for

success or failure; (3) support must have a predetermined end (a so-called sunset

clause); (4) public support should target activities such as worker training or

infrastructure investment, rather than sectors such as electronics; (5) subsidized

activities should provide clear potential for externalities; and (6) agencies involved in

these activities should be autonomous enough to avoid capture by private interests,

but should maintain links with the private sector to maximize economy-wide gains.

Political economy considerations are very important at the design stage if reforms are

to be sustainable. The key policy in this regards is to ensure that the costs of

adjustment arising from the reforms are borne equitably. One way to ease adjustment

costs is to ensure that safety nets are adequate to compensate losers. Particularly,



efforts should be made to improve labor market flexibility through consolidation of

labor levies, flexible wages to allow linking productivity with benefits, strengthening

of labor market information, training in the emerging skills in demand and improving

social protection. Still a more efficacious way is to design the trade reform that

minimizes adjustment costs.

To ensure credibility, the reform and its sequencing should be publicly communicated

upfront. This would ensure that economic agents are aware of them and can respond

accordingly. Public communication of reforms would also diminish the possibility of

reform reversals, boosting their credibility.

The trade reform needs to be carefully designed, sequenced and embedded in a larger

reform package designed simultaneously to boost domestic tax revenues. Thus

restructuring and strengthening of CBR is crucial for the success of reforms. Custom

related infrastructure and procedures, information flows, documentation related

regulations and distribution/collection system should be improved. Given the poor

state of governance, the frequency and duration of contact between CBR and the

businessmen should be minimized. CBR and other regulations relating to labor, health

and environment should be transparent. Regulatory uncertainty inhibits business

decisions and may be reduced by reducing the frequency of changes in the rules

affecting businesses and making all rules transparent and by removing discretion from

the administration of rules. Flaws in these areas are equivalent to very high protection.

The reform would be more credible if the price reform is accompanied by non-price

reforms, such as investments in infrastructure and human development, better access

to credit, promotion of competition, competitive exchange rate, and incentives to

adopt improved production technologies. This broad-based development strategy

would require more effective resources management, setting priorities and improving

service delivery. The strategy should emphasize private sector led growth, and the

government should restrict itself to market failures only, including providing basic

infrastructure, enabling regulation and improving governance (zero tolerance on

bribery).



References Anderson (1970) “General Equilibrium and the Effective Rate of Protection”, Journal of

Political Economy, Vol. 78, no, 4, Part 1, pp 717-724

Athukorala, Prema-chandra (2006) “Trade Policy Reforms and the Structure of Protection in

Vietnam” The World Economy, Volume 29, Issue 2, Page 161-187, Feb 2006

Balassa, B. (1965) “Tariff Protection in Industrial Countries: An Evaluation” Journal of

Political Economy, 73, December, 573-94.

Bhagwati, J. and Srinivasan, T.N. (1973) ‘The General Equilibrium Theory of Effective

Corden, W. Max (1966). “The structure of a Tariff System and the Effective Protective Rate”,

Journal of Political Economy, Vol (74) pp. (221-37)

Corden, W. Max (1969). “Effective Protection in the General Equilibrium Model: A

Geometric Note” Oxford Economic Paper Vol 21, No 2, July 1969, pp 135-41

Davis A. Graham (1998). “The Substitution Problem in the Theory of Effective Protection”

Review of International Economics 6 (2), pp307-320

Ethier, W.J. (1977) ‘the Theory of Effective Protection in General Equilibrium: Effective

Rate Analogues of Nominal Rates’, Canadian Journal of Economics, Vol. 10, pp. 233-

245.

Johnson, H. G. (1965) “The Theory of Tariff Structure, with Special Reference to World

Trade and Development”, in Johnson, H. G. and Kenen, P. B. Trade and Development,

Geneva: Librairie Droz. Reprinted in Johnson, Aspects of the Theory of Tariffs, London:

Allen and Unwin, 1971.

Kemal, A. R., Mahmood, Zafar and Maqsood, Athar (1994), “Structure of Protection,

Efficiency, and Profitability”, Pakistan Institute of Development Economics Islamabad.

Kemal, A.R., (1997), “Effective Protection Rates – A Guide to Tariff Making”, The Pakistan

Development Review, Vol26(4): 775-83.

Kusum Das, Deb (2003), Quantifying Trade Barriers: Has Protection Declined Substantially

in Indian Manufacturing?”, Indian Council for Research On International Economic

Relations, Working Paper no. 105.

Lewis, S. R. and Radhu, G.M. (1966), “The Indirect Tax Structure and Incentives to

Domestic Manufacturing in Pakistan”, July, 1966 (typescript).

Mary Amiti and Jozef Konings1, Trade Liberalization, Intermediate Inputs, and Productivity:

Evidence from Indonesia, IMF Working Paper WP/05/146, IMF Research Department,

July 2005

Protection and Resource Allocation’ Journal of International Economics, Vol. 3. No. 3, pp.

(259-281)

Soligo, Ronald and Stern, Joseph. J. (1965). Tariff, Protection, Import Substitution and

Investment Efficiency”, Pakistan Development Review, Vol 5 no.2, pp. 249-270

World Bank, (2003), Investment Climate in Pakistan.

World Bank, Economic Growth in the 1990s: Learning from a Decade of Reform, Study on

development lessons of the 1990s, by Poverty Reduction and Economic Management

(PREM) Network, Washington 2005, Chapter 5.



Annex I Table 1.1: Protection Rates

S. No.

Sectors Nominal Tariff

Rate %

Average Tariff on Inputs %

Value Added

Coeff %

Effective Protection

Rate %

1 Vegetable oils etc. 5.0 10.1 7.9 -64.3

2 Milling 10.0 8.3 24.7 6.8

3 Bakery products 5.0 9.5 22.3 -20.4

4 Sugar 10.0 5.6 32.3 13.5

5 Other food products 20.0 11.0 26.2 34.4

6 Beverages 25.0 10.3 34.3 42.9

7 Cigarettes, tobacco 25.0 7.0 52.9 34.0

8 Ginned cotton (lint) 5.0 3.1 6.1 31.1

9 Cotton yarn 5.0 7.0 31.0 -6.4

10 Cotton cloth 22.7 9.8 23.4 55.1

11 Art silk 15.0 11.7 23.0 14.4

12 Made-up textile goods 25.0 7.8 26.7 64.4

13 Knitwear 25.0 8.0 24.2 69.9

14 Carpets 25.0 8.8 26.5 61.2

15 Garments 25.0 17.2 14.4 54.3

16 Other textile products 5.0 10.3 24.1 -21.9

17 Leather, leather products 25.0 9.7 8.3 185.6

18 Foot wear 25.0 13.5 8.5 135.8

19 Wood, wooden products, furniture 20.0 10.5 40.8 23.4

20 Paper, paper products 18.0 10.6 33.2 22.4

21 Pharmaceuticals 13.3 14.4 20.9 -5.2

22 Fertilizers and pesticides 5.0 10.8 33.6 -17.3

23 Chemicals: Consumer products 19.4 15.1 17.3 24.6

24 Refined petroleum 9.7 8.6 6.7 16.7

25 Rubber and plastic products 25.0 13.9 26.9 41.3

26 Other chemicals 25.0 14.7 19.1 53.7

27 Bricks, tiles 25.0 3.7 57.4 37.2

28 MF: Cement 25.0 7.0 53.5 33.8

29 Other non-metallic mineral products 8.2 9.8 41.7 -3.9

30 Basic metal products 10.0 9.4 35.7 1.6

31 Other metal products 5.0 9.4 40.2 -11.0

32 Other non-electrical machinery 5.0 7.7 21.9 -12.4

33 Electrical equipment etc. 17.3 9.1 32.5 25.3

34 Transport equipment 47.0 24.2 21.4 106.5

35 Surgical instruments 8.1 9.0 20.9 -4.7

36 Handicrafts 22.5 11.3 34.0 32.9

37 Sports goods 16.0 11.6 16.4 27.0

38 Jewelry (precious metal) 5.0 13.6 12.4 -69.3

39 Other manufacturing products 25.0 13.6 16.5 69.1

Average 16.9 10.4 23.1 27.8



Annex II

Revenue Implications of Trade Reform

101. The Ministry of Commerce wanted to know the revenue implications of a tariff

reduction reforms under consideration of the Ministry for 2007-08, 2008-09 and 2009-10.

The Ministry supplied the recent data on rate-wise imports and collection of custom duties.

As can be seen below, some revenue losses are natural with tariff reductions, but a large part

of these losses can be recouped through phasing out exemptions and concessions (usually a

part of reforms) and diversion of smuggling into imports through regular channels and

reduction in invoicing. The effects of recouping of revenue losses through phase out of

exemptions and reduction in smuggling and under invoicing are shown distinctly.

102. Given the data, the following manipulations are performed to restructure the rate wise

imports and collection of custom duties to conform to the proposed tariff structure.

The benchmark structure of dutiable imports in 2006-07 has been created as follows.

The shares of dutiable raw material and intermediate goods imports is assumed equal

to the dutiable imports in the 10% and 15% tariffs, respectively, as given in the 2006-

07 Jul-Feb data. The share of finished goods imports has been assumed equal to the

share of consumer good in 2005-06. These assumed three shares give the remainder as

the share of dutiable machinery imports. Within machinery and intermediate goods,

50% of imports are assumed for locally manufactured machinery/goods, an

assumption which is continued in later years.

For the following the three reform years, the share of finished goods imports is

assumed to rise by 2%, 1% and 1%, respectively with the corresponding decrease

being accommodated equally in raw material, machinery and intermediate goods

imports. Table 1.2:

Dutiable Benchmark

Structure of dutiable imports Import share in 2006-07 2007-08 2008-09 2009-10

Raw material 10% tariff 30.8% 30.1% 29.8% 29.4%

Machinery Remainder 26.9% 26.3% 25.9% 25.6% not locally manufactured 50% 13.5% 13.1% 13.0% 12.8%

locally manufactured 50% 13.5% 13.1% 13.0% 12.8%

Intermediate goods 15% tariff 31.4% 30.8% 30.4% 30.1%

not locally manufactured 50% 15.7% 15.4% 15.2% 15.0%

locally manufactured 50% 15.7% 15.4% 15.2% 15.0%

Finished goods FY06 10.9% 12.9% 13.9% 14.9%

Total 100.0% 100.0% 100.0% 100.0%

103. Given the structure of imports, the forecast of total imports has been prepared based

on normal growth (15% p.a.), reform generate growth15

, additional growth due to reduction in

smuggling16

and under invoicing17

. The dutiable imports are then estimated by phasing out of

concessions and exemptions in the three reform years, 15%, 10% and 10%, respectively. The

dutiable imports are allocated in economic categories by applying the foregoing structure.

15 By using reductions in effective tariffs and elasticity of -.775 from an earlier study. 16 Smuggling is assumed to reduce with trade liberalization from an assumed level of 20% in 2006-07 to 10% in

2009-10. 17 Under invoicing is assumed to reduce with trade liberalization from an assumed level of 10% in 2006-07 to

5% in 2009-10.



Table 1.3 Mill Rs

Import Forecast 2005-06 act 2006-07 2007-08 2008-09 2009-10

Import growth 31% 15% 26% 24% 23%

Normal 31% 15% 15% 15% 15%

Due to reforms 3.4% 2.1% 1.4%

Lower under invoicing 3.0% 2.7% 2.4%

Lower smuggling 4.2% 4.0% 3.8%

Total imports 1,711,158 1,967,832 2,470,473 3,057,622 3,750,173

O/w normal imports 1,711,158 1,967,832 2,263,007 2,602,458 2,992,827

O/w reform related imports 207,466 455,164 757,346

O/w duty exempt % 45.5% 30.5% 20.5% 10.5%

O/w dutiable % 54.5% 69.5% 79.5% 89.5%

Dutiable imports 1,073,397 1,718,145 2,432,253 3,358,175

Raw material 330,290 517,227 724,093 988,551

Machinery 289,230 451,505 631,056 860,096

not locally manufactured 144,615 225,753 315,528 430,048

locally manufactured 144,615 225,753 315,528 430,048

Intermediate goods 337,390 528,592 740,182 1,010,765



Finished goods 116,487 220,820 336,921 498,763

104. The 2006-07 tariff structure has been recreated to conform to the proposed tariff

structure based on 2006-07 Jul-Feb revenues shares; the raw material is the 10% tariff share

in the dutiable imports, intermediate goods is the 15% tariff share, finished goods is the share

of 30%-90% tariffs, and machinery the remainder. Then, 2/3rd share of custom revenues

within machinery and intermediate goods each has been assumed to come from the not

manufactured locally categories (for want of better basis). The proposed tariffs for next three

years are given by the Ministry.

Table 1.4

Proposed tariff structure %

Description 2006-7 2007-08 2008-09 2009-10


Machinery

not locally manufactured 13.5 5 3.7 3


Intermediate goods

not locally manufactured 5.9 10 7 6



105. Given the conforming structure of tariffs and dutiable imports for the reform years,

estimation of custom revenue is a straight forward.



Table 1.5 Mill Rs

Custom Revenues 2006-07 2007-08 2008-09 2009-10

Raw material 17,480 25,861 21,723 29,657

Machinery 58,453 33,863 33,761 25,803



Intermediate goods 29,870 66,074 62,916 60,646



Finished goods 51,296 44,164 50,538 49,876

Total 157,100 169,962 168,938 165,982

Budget

Memo: Effective rate % dutiable imports

14.6% 9.9% 6.9% 4.9%

Effective rate % total imports 8.0% 6.9% 5.5% 4.4%

106. Indeed the proposed tariff reform is tremendous. The effective tariff rate on dutiable

imports falls from 14.6% in 2006-07 to 4.9% in 2009-10, a fall of 9.7%. The estimated

revenue losses over the three reform years after factoring in the import growth is Rs 356

billion. But a substantial part, 38.5% of the revenue loss, is recouped through phasing out of

concessions/ exemptions which are a necessary complement of these reforms. Another 15%

of revenue loss is recouped through reduction in smuggling and under invoicing. The

effective custom tariff on total imports falls by only 3.6% to 4.4%. The overall custom

revenues, budgeted at Rs 157 billion in 2006-07, rise by 5.7% to Rs 166 billion in 2009-10.

Table 1.6 Mill Rs

Revenues 2006-07 2007-08 2008-09 2009-10 2007-10

Customs

With status quo 157,100 188,709 221,641 260,207 670,558

With reforms 157,100 125,720 103,368 85,621 314,709

Revenue loss -62,989 -118,273 -174,586 -355,849

With reforms along with reduction in




reckoning of smug & under invoicing 9,670 18,194 25,423 53,287



Additional sales tax collection



107. The reforms would also result in additional sales collections, which have been quantified

at the sales tax rate of 15% of the additional imports due to reforms. The calculation yield

additional sales tax revenues of Rs 213 billion in the three reform years, thereby more than

offsetting the revenue losses by Rs 47 billion over the three years.



108. Further more the tariff reform would reduce the anti-export bias and help the export

growth. The additional export growth can be estimated18

by assuming the same reduction in anti-

export bias as in the average tariff on imports. These calculations reveal that the proposed tariff

reforms would generate 7.1% additional exports during the three year reform period.

Table 1.7

2005-06 2006-07 2007-08 2008-09 2009-10 2007-10

Export growth 8% 20% 18% 17%

Normal growth 8% 15% 15% 15%

due to reforms 4.9% 3.2% 2.2%

Reduction in anti-export bias 4.1% 2.7% 1.9%

Exports value (Mill Rs)

Normal growth 16,388 17698.932 20353.7718 23406.8376 26917.8632 70,678

Normal growth and reforms 16,388 17698.932 21220.497 25076.9163 29394.3163 75,692

Attributable to reforms 867 1,670 2,476 5,013

As % of normal trend value 4.3% 7.1% 9.2% 7.1%

109. A better alternative tariff reforms is to go for a single tariff rate in the range of 5-10%.

The foregoing tariff regime is still very complex given the institutional capacity to effectively

implement it and be able to effectively reduce the anti-export bias. Hence we suggest that the

government commit to total trade liberalization in the long term and reduce the tariff rates to a

single rate of 5% in next 3 years. This alternative would not only ensure a substantial removal of

anti-export bias, but also is a superior alternative on grounds of revenue. Thus the following

simpler tariff structure is thus recommended. Table 1.8

Equivalent tariff Proposed tariff structure %

Description 2006-7 2007-08 2008-09 2009-10


Machinery

not locally manufactured 13.5 5 5 5

locally manufactured 26.9 10 7.5 5

Intermediate goods

not locally manufactured 5.9 10 7.5 5



110. The alternative tariff reform is marginally better on revenue considerations. The

implications on revenue and exports of this revenue structure, based on the otherwise same base

information, on existing imports, tariffs and revenue structure are given below. Marginal

improvements are noticeable in the table; the revenue loss is lower, recouping of losses is better,

and sales tax collection is higher. The overall custom revenue rises by a higher rate, 6.9%, to Rs

168 billion in 2009-10. However the biggest advantage of the alternative is in its effectiveness in

implementation and reduction of anti-export bias.

18 For this, the price elasticity of exports has been assumed at 1.183 from an earlier study.



Table 1.9

Revenues 2006-07 2007-08 2008-09 2009-10 2007-10

Customs

With status quo 157,100 188,709 221,641 260,207 670,558

With reforms 157,100 125,720 106,529 86,615 318,864

Revenue loss -62,989 -115,112 -173,592 -351,694

With reforms2 along with reduction in




Reckoning of smug & under invoicing 9,670 18,750 25,718 54,138



Additional sales tax collection



Table 1.10 2005-06 2006-07 2007-08 2008-09 2009-10 2007-10

Export growth 8% 20% 18% 17%

Normal growth 8% 15% 15% 15%

Due to reforms 4.9% 2.9% 2.4%

Reduction in anti-export bias 4.1% 2.5% 2.0%

Exports value (Mill Rs)

Normal growth 16,388 17698.932 20353.7718 23406.83757 26917.86321 70,678

Normal growth and reforms 16,388 17698.932 21220.49704 25028.38016 29379.1683 75,628

Attributable to reforms 867 1,622 2,461 4,950

As % of normal trend value 4.3% 6.9% 9.1% 7.0%

111. To sum, tariff reduction reforms have a strong justification. Tariff reduction imply

revenue losses, but these losses can be recouped through appropriate phasing out exemptions

and concessions (usually a part of reforms) and diversion of smuggling into imports through

regular channels and reduction in under invoicing. Beside the reforms would lead to greater

imports and sales tax revenues. The foregoing exercise shoes that the revenue losses can be

more than offset. Besides tariff reductions reduce anti-export bias and help export growth. In

the longer run, production structures improve in more liberal trading environment due larger

market and specialization, more intense competition forcing efficiency and innovation, better

access to technology, and cheaper and quality inputs, which promotes growth. Consumers

benefit by getting better variety of goods and prices, which can help the poverty reduction

efforts.



Annex III Table 1.11: Rate-Wise Value of Imports and Import Duties (Mill Rs)

(2006-07)

Dutiable Custom Effective tariff

Tariff rate Imports Share % IMPORT Share % Revenues Share % % of total M % of to Dutiable M

1 2 3 4 5 6 7 8 9

930,645 77.5% 608,557 92.9% 70,468 78.9% 7.6% 11.6%

10 452712 37.7% 201,467 30.8% 9,936 11.1% 2.2% 4.9%

15 248438 20.7% 205,798 31.4% 16,979 19.0% 6.8% 8.3%

20 44426 3.7% 35,623 5.4% 4,004 4.5% 9.0% 11.2%

25 68993 5.7% 59,150 9.0% 9,480 10.6% 13.7% 16.0%

30 61073 5.1% 54,226 8.3% 10,980 12.3% 18.0% 20.2%

35 6571 0.5% 6,517 1.0% 1,402 1.6% 21.3% 21.5%

50 10015 0.8% 7,749 1.2% 2,297 2.6% 22.9% 29.6%

60 23122 1.9% 23,085 3.5% 8,631 9.7% 37.3% 37.4%

65 3484 0.3% 3,459 0.5% 1,180 1.3% 33.9% 34.1%

75 2906 0.2% 2,891 0.4% 1,183 1.3% 40.7% 40.9%

90 5909 0.5% 5,638 0.9% 3,485 3.9% 59.0% 61.8%

2996 0.2% 2,954 0.5% 911 1.0% 30.4% 30.8%

Subtotal 1196879 99.7% 653,584 99.8% 81,716 91.5% 6.8% 12.5%

Other 3441 0.3% 1,157 0.2% 7,583 8.5% 220.4% 655.4%

G-total 1200320 100.0% 654,741 100.0% 89,299 100.0% 7.4% 13.6%

Economy & Finance

The State of Domestic Commerce in Pakistan Study 2 - Effective Protection of Manufacturing Industries in Pakistan