Pakistan’s potential export flow: The gravity model approach

Abstract

Pakistan is facing a chronic trade deficit due to highly concentrated nature of its international trade. The exports are dependent on the few lower value added agriculture and manufacturing industries, and are directed toward few trading partners. The highly concentrated nature of exports result in higher vulnerability and dependence of the economy. Pakistan signed regional and bilateral free trade agreements for diversification of its exports and markets. These free trade agreements significantly distorted the trade balance due to relatively lower specialization level of Pakistan. The trade theories and empirical studies urge achievement of competitive specialization in diversified exports and markets. This study attempts to investigate the macroeconomic behavior of export flow and export potential of Pakistan with its bilateral trading partners employing the augmented gravity model using panel data from 40 trading partners for the period 1991-2011. The dependent variable is merchandise exports flow, which is explained by the domestic supply capacity, demand potential of trading partners, relative price level and binary variables for free trade agreements, common language and common border. The model is then used to investigate potential markets for exports by Pakistan and provides a framework for export and market diversification. The annual data for this study is available in Statistical Year Book of Pakistan, World Development Indicators and International Financial Statistics. The results show that Pakistan’s export is positively determined by its supply capacity and partner country’s demand potential as well as market size, whereas negatively determined by the geographical distance. The domestic supply capacity shows the highest possible effect. The relative price shows significant positive, but less elastic impact. The common language shows significant positive impact while common border shows negative impact. The free trade agreements of Pakistan show negative insignificant impact. The result of export potential shows that the Pakistan has higher export potential with India, Philippines, Japan, Singapore, Malaysia and Indonesia, in Asia. Morocco, Egypt and Tanzania, in Africa. New Zealand and Australia, in Oceana. Hungary, Austria, Switzerland, Finland, Norway, Denmark and Sweden, in Europe. The Europe emerged as the most potential region for Pakistan’s exports. The policy implications of this study are that Pakistan needs to develop and diversify its industries targeting market fundamentals of potential economies, and revisit its regional and bilateral free trade agreements with a view to improving the trade balance and achieving sustainable economic development.