Impact of Trade Liberalization on Inflation in Pakistan

Chapter # 1

INTRODUCTION

Inflation has always been a concern for the policy makers as it creates uncertainty in the economy. To maintain an overall macroeconomic stability, the magnitude of inflation has a key role to play. For a rise in inflation the contribution of various demand and supply factors plays a vibrant role. The change in the supply of necessities items and the fluctuations in the world market of oil usually causes a change in the inflation rate. The price of oil in the world market is one of the most important factor that affects the inflation pattern. Other than the oil prices there are several other factors like exchange rate of rupee against dollar, net exports, fiscal deficit, monetary policy, price control mechanism and governance system can affect the inflation trend in an economy.

Whenever the price of oil rises, it causes the prices of the commodities (that are included in the consumer basket) to go up. These possibilities provide the ground for the price level to raise i.e. causing inflation. At some stages, these factors which are responsible for rise in inflation over-shadowed the policies adopted to control it (i.e. demand and supply management by monetary policy).

To curb the negative impacts of inflation, the various trading countries have adopted the inflation targeting policies. In this globalized world, no country can achieve its macro-economic goals without trade-liberalization. Generally, in developed countries, trade-liberalization is likely to reduce the inflation rate. But in-case of Pakistan it is vice-versa.

In recent years the inflation rate in Pakistan has increased rapidly. The people highly affected by this increase in inflation are the person which falls under the category of poor and fixed-income group. This income group usually spends a larger portion of their earnings on food items. The Whole-sale Price Index (WPI) has increased by 11.5 %.

The role of savings and investment in the development and growth process is also very critical. A increase in inflation always reduces the savings, which in-return reduces the investment. This ultimately hampers the development and growth process. The intensifying and high rate of inflation in the Pakistan’s economy clearly indicates that the government’s efforts to reduce inflation have not been successful.

Pakistan initially followed commercial policies that favored import substitution, which created a highly protected environment for industrialization. Tariffs, quantitative restrictions and other non-tariff barriers were the principal policy instruments used to shield the domestic import-substituting industry. However, Pakistan gradually moved towards outward-looking strategy as it reduced drastically its import tariffs, export taxes and quantitative restrictions on trade and followed prudent exchange rate policies. As a result, the process of trade liberalization has started in the country. The extent of bias against exports has declined and the share of Pakistan’s trade in GDP has increased.

High dependence on tariffs as a source of government revenue is the major aspect that hinders trade openness process in Pakistan. In fact, the gains from trade openness would result mostly from a lowering of trade restrictions from Pakistan’s major trading partners rather than Pakistan’s own commitment to trade openness. Although concerns remain about lingering tariffs, non tariff barriers, and other protectionist practices, it is hard to deny that Pakistan economy has become more liberalized.

Pakistan exports number of commodities, which includes agricultural products and industrial products. Number of export items and total value of export is steadily rising. The quantity of exportable goods is small and its quantity is poor therefore enough foreign exchange is not earned. Pakistan exports mostly semi-manufactured goods. Due to inflation in the country the prices of our exportable items are very high so our goods face difficulties to compete in international markets.

An adequate and stable political system plays a key role in progress and strengthening of the economic system. The Pakistani military has played an influential role in mainstream politics throughout Pakistan’s history, with military presidents ruling from 1958–71, 1977–88 and from 1999–2008. In Pakistan many years of military rule have undermined the strength of democratic institution and values and this political instability is majorly leading to affect the stability of economic system. As long as these military interventions to topple the elected political and democratic governments continues, the promotion of genuine democracy, human rights, good governance, rule of the law, and reduction of poverty in Pakistan are likely to remain distant dreams.

MOTIVES OF RESEARCH

The impulse of this study is to explore the impact of trade liberalization on inflation, so that it can help the policy makers to shape different policies, to tackle the negative impacts of inflation. The core purpose of this research is to assist in formulating different economic policies to control the inflation and promote the trade. At this time general public is not being able to have their daily necessities for living because of this continues rise in price level due to the inflation.

The need to study this topic is that, that we recognize our society as a consumption oriented society, the major contribution to rise in inflation is only because of the imported commodities i.e. imported inflation. If our society is able to develop liking for it’s domestically produced goods it can save much of its foreign exchange reserves and this can be helpful in correcting the balance of payment of Pakistan.

The imports and exports of a country play a very vital and significant role in the development process of any country. But this development process should not be done at the expense of higher inflation. The common observation with respect to Pakistan is that there imports are always larger than there exports. The exported items are usually in the form of raw material or unfinished goods. The installation of proper processing plants and the exports of finished commodities can open new doors for the international trade-market, which can contribute to the well-being of the society. This will in return play a large role in equalizing the balance of payment and negating the impact of imported inflation.

Pakistan is a member of the World Trade Organization, and has bilateral and multilateral trade agreements with many nations and international organizations. Fluctuating world demand for its exports, domestic political uncertainty, and the impact of inflation vagueness, all have contributed to variability in Pakistan’s trade deficit. All these mentioned factors provides a sound basis for inflationary process in any country and Pakistan is not an exemption. This motivates us to study, the impact of trade-liberalization on inflation in Pakistan. Therefore to chalk-out the policies regarding trade, poses a great challenge for the policies makers. This research will help them to identify the different policy measures to reduce the inflation.

RESEARCH QUESTION

It is believed that Trade Liberalization can play a vital role to reduce inflation from the economy. But in case of Pakistan, Trade Liberalization contributes positively to inflation i.e. it increases inflation according to our economic trends. Here in this research an attempt is made to study the link of Trade Liberalization and Inflation, by using Polity(iv)index , Imports, Exports and GDP time series data from 1972 – 2009. The basic research question arises from the discussion is that whether the inflation has a significant (positive) relationship with Trade Liberalization? The research tries to find out the answer of this question by using econometric model.

RESEARCH OBJECTIVES

The objective of this research is to analyze the role of inflation and trade liberalization in Pakistan. Therefore this research examines the impact of trade liberalization along with polity-(iv) index on inflation. Therefore a better idea about the nature of the inflation in Pakistan can be made.

CONTRIBUTION OF THE RESEARCH

The inflation and trade reforms have always remain a core issue for most of the economic debates and policy making process but no clear cut boundaries are yet being establish so that the economy of Pakistan can grow, while keeping the inflation rate as low as possible or by maintaining it to a level which is beneficial for the economy. Trade liberalization has proved to be beneficial for the developed economies but it has not contributed same fruitful results for the economy of Pakistan. This research uses the most recent data to analyze the relationship among inflation and trade openness.

RESEARCH DESIGN

First Chapter introduces the theoretical background of the topic at the same time it provides the objectives of the research. Second Chapter, provides the literature of past researches related to inflation and trade liberalization. Third Chapter deals with the methodology of the research in which the definitions of the variables, data type, source and methodology of models are elaborated. The results of these models are presented and explained in Chapter Four, along with the interpretation of the results. The Fifth Chapter, provides the conclusion of the results it also suggests different policies options to control the inflation and to improve the quantity of export.

HYPOTHESIS

Following is the hypothesis which is subjected to be verified through this research to find out whether there exist significant relationship among inflation and trade.

Ho: There is positive (significant) relationship among inflation and trade liberalization.

H1: There prevails no positive (significant) relationship among inflation and trade liberalization.

LIMITATION OF RESEARCH

This research restrict its analysis from 1972 – 2009, as a latest data available on inflation, Imports, Exports, GDP and GDP deflator from World Development Bank is available till year 2009.

CHAPTER # 2

LITERATURE REVIEW

Haneef and Batool (2006) study the relationship between inflation and openness (open economy) with reference to Pakistan. The purpose of this case-study was to test the hypothesis; with reference to Pakistan is that, in small and trading economies the inflation remains at the less alarming stage. One of the most important macroeconomic policy objectives in Pakistan is to maintain the rate of inflation that does not hurdle the economic growth of the country (like any other developing countries). For this study the annual time series data was used. The period of the study was 1973-2005. The study reveals that inflation and trade-liberalization negatively impact the domestic price growth. In Pakistan supply side factors are more important than monetary factors in the process of inflation dynamics and therefore the inflation in Pakistan is negatively influenced by trade-liberalization. This supports the hypothesis that in small and trading economies the inflation remains at the less alarming stage.

Zakaria (2008) study the association among trade-liberalization and inflation in Pakistan by using the annual time-series data for the period 1947 to 2007 and by applying the regression analysis. The data is taken from International Financial Statistics and Pakistan Economic Survey. Domestic price level of Pakistan is affected by the external shocks due to its openness to the foreign trade. The increase in the level of country’s development and a shift from fixed to floating exchange rate regime, increases the inflation rate .The results of the study shows that inflation in Pakistan is positively and significantly effected by trade-liberalization. Exchange rate and foreign inflation rate have considerable positive affect on domestic inflation rate.

Thorvaldur (1998) studies the linkages between exports, inflation and economic growth. The study was conducted on 160 (of the 209) countries, covering the period from 1985-1994.The data source was the World Bank Atlas, 1996.The purpose of the study was to use the cross-sectional data for the purpose of identifying the important and significant determinants of economic growth and the exports. the outcome of the study illustrates that, the high inflation have a tendency to be associated with low exports in proportion to GDP and will also cause the slow growth in a large group of countries at all income levels.

Ahortor and Adenutsi (2009) study the case of developing economies which are largely import dependent to explain the relationship among economic growth, inflation and capital accumulation. The study covers the period from 1970 to 2006.The result shows low investment/GDP ratio in these developing economies, and therefore low growth rates leading to high rates of inflation. There exists cointegrating relationships between capital accumulation and economic growth. In the long run, inflation and economic growth reduces the capital accumulation. The capital accumulation is positively effected by large money supply and import-dependency ratio (in the long-run). In the context of economic growth, inflation and capital accumulation affects it negatively. In the long run ,  economic growth is positively effected by import-dependency ratio and broad supply of money. The existence of any past imbalances in the economic growth, inflation and capital accumulation as a short run phenomenon will take a longer time to be corrected.

Tan (2004) examines the inflation rate and its behavior by incorporating the time series data of WPI and CPI. The purpose was to focus the attention towards the phenomena that how the terms of trade are effected by inflation caused by the exports and imports. The behavioral change in the terms of trade is then related to the long term behavior of the import and export price inflation series. This study was conducted on eleven economies (United States, Spain, Singapore, Hong Kong, Japan, South- Korea, Taiwan, Belgium, Brazil, Finland, Mexico). The data used was monthly NBTT (net barter terms of trade). The analysis of study shows that the terms of trade of the trading economies are largely effected by the imported inflation.

Aleem, Hyder and Masood (2007) tries to identify the main determinants of inflationary trends in Pakistan. According to the study the main determinants of inflation in 2005-06 that explains 8 percent inflation in that period of 2005-2006 were future forecast regarding the inflationary trend. The terms and conditions of credit services offered by the private sector. The increase in the prices of imported goods (i.e. imported inflation.). The role of Fiscal policy in inflation was minimal in-contrast to the role of direct taxes. As an important measure to control the price-hike and inflationary situation in the economy, direct taxes hold a significant position in the Pakistan’s economy.

Gulzar and Feng (2006) tries to explore the causes that can effect the volume of exportable items of Pakistan’s goods and services. The sale of local goods and services abroad  contributes to the economic development of a country, provides foreign exchange income, helpful in correcting the imperfections present in the  balance of payments, it can reduce poverty and unemployment in the country by generating new and advance  opportunities and possibilities of employment, increases the interaction between other economies of the world. For this study the data covering the period from 1972-2005 was used. The main factors which affect the exports of Pakistan are the rate of commodities and manufacturing sector growth. The rate of growth at which the agriculture sector grows. The level of the local saving rate. The rate of inflation in the economy. The amount of aggregate spending. The volume of gross national product (GNP) and the level of school enrollments. All these above mentioned factors effects the Pakistan’s exports volume. The export and percentage change in the volume of agriculture growth rate, manufacturing sector growth rate, CPI inflation rate, domestic saving, and per capita GNP are positively correlated. The exports and school enrollment, commodities producing sector growth rate, and percentage change in the amount of total consumption are negatively correlated.

Baloch (2009) studies the impact of negative trade balance on the Economy of Pakistan. The data source was “Federal Bureau of Statistics” from this source, the data on exports, imports and balance of trade, for the year 1973-2008 was obtained. The increase in the trade imbalance stimulates the surge in inflation rate; low economic growth which negatively affects the balance of payments of Pakistan’s Economy. Foreign reserves and foreign investment is decreasing day by day. Privatization of national assets in the on going recession period at lower prices did not generate the fruit-full results and the intense borrowing from IMF has created burden on the general public in terms of high rates of taxes and increase in cost of livings. The source of trade deficit in Pakistan is largely domestic in nature and can be improved by the tools of trade policy and national budget policy. To reduce and eliminate the trade gap, the exports are required to be increased with wider base and at a larger amount. The policy should be adopted to decrease the imports and increase the exports with widen production base. The steps needed in shrinking the imports and raising the exports are: enhance the internal resources by improving system of governance, fiscal discipline and broadened tax base, well thought out plans, revitalization of the domestic industry, and by improving the agricultural growth to balance the trade.

Lin (2010) studies the association between trade openness and inflation. The data is obtained from the World Bank (World Development Indicator), the study contains the panel data of 106 countries over the period 1970-2007. Change rate in the GDP deflator is used as a measure of inflation and the share of imports as a percentage of GDP is used as a measure of trade openness. It is assumed that exchange rate regime affects the inflation. The quantile regression for the panel data is used to examine the association between trade openness and inflation and its result forecast the association between inflation and trade-liberalization to be negative. During high inflation phases, this relationship gets stronger. For high quantiles of inflation, the fixed exchange rate has considerably negative effect on inflation, but for low quantiles of inflation it has insignificantly negative effect on inflation.

Ulusoy, Cakir and Ogut (2008) study the association between inflation, productivity and trade by incorporating the case of Turkish Manufacturing Industry. The study employs the technique of “vector autoregressive (VAR)” system consisting of inflation rate, growth of labor productivity, growth of real money supply and growth of nominal wages. According to the study there exists a negative relationship between inflation and productivity. Therefore the increase in inflation causes a reduction in the productivity. The result reveals that in the Turkish economy, growth of labor productivity has a strong impact upon inflation, wages and money supply. Wages has a strong influence on a productivity growth alone. For the Turkish manufacturing industries, trade-off between inflation and productivity is a short-run phenomenon, as with growing shocks to the economy in the longer period of time productivity is statistically insignificant. To formulate the macroeconomics policies, the long- run behavior of the economy should be focused.

Rasmussen and Tetteh (2007) studies the relationship between inflation, interest rate, exchange rate and GDP for Canada (a developed country) and Ghana (a developing country) in 2007.The statistical analysis of least squares and regression models are use to examine the phenomena that how businesses and trade are effected by the inflation, the dependence of business operations on loans, and the correlation among inflation and interest rate both in Ghana and Canada. There exists a strong relationship between inflation (dependent variable) and GDP, Exchange rate and interest rate (independent variables) when the data used is lagged. In the determination of inflation, the role of national income (GDP), Exchange rate (trade) and interest rate (businesses) is vital. According to the results; High inflation has an adverse effect on business and trade. There exists a correlation between increase in inflation and an increase in interest rate in both Canada and Ghana; therefore, while adopting any monetary policies in minimizing inflation, this fact should be kept in mind. There exists a correlation between inflation and the exchange rate of the country which adversely effect the trade i.e. imports and exports. Canada has a very stable currency and this contributes positively to its imports and exports, when exchange rate regime use is floating. Ghana has an unstable currency; its imports are higher causing deficit in balance of payments, which negatively influences the currency when floating exchange rate regime is operating.

Houck (2010) tries to explore the relationship between inflation and international trade and the ways by which inflation can influence the international trade. According to the study, modern international inflation occurs because of regular increase in energy prices, inventory speculation and intermittent raw material shortages, fiscal and monetary actions taken by different governments, non-competitive markets, rising real incomes, and people’s expectations about future inflation. The important way, by which international trade is affected by the general inflation, is its dependence on currency exchange rates. By the change in currency exchange rates, the relative prices and costs also changes which can encourage or discourage the international transactions in goods and services.

Deshpande and Shah (2010) study the relationship between Food – Price Inflation and the Changes in Terms of Trade. In Indian the method of calculating inflation is based on the Wholesale Price Index and is different from the rest of the world, which uses1993-94 as base year. According to the study food inflation is the major source of price hike in the recent past for the country. The use of whole-sale price indices while computing inflation increases the problems as retail or consumer prices are higher and changes rapidly than the whole-sale price. The association of inflation with Terms of Trade has to be recognizing from the view point of increasing price levels and the income effect. The impact of Food inflation on agriculture is positive. On non-agricultural sector it exerts a negative impact. But this does not mean that the income opportunities in agricultural sector have been increased.

Bowdler and Malik (2006) have analyzed a sample of developing and industrial countries using panel data over the period 1961-2000.They found a negative and statistically significant effect of trade liberalization on inflation volatility. They estimated this relationship by controlling for the potential endogeneity of liberalization and the average rate of inflation. The relationship between inflation and trade liberalization is more strongly marked in under developed and emerging market economies than in OECD countries. The main conclusion drawn by this study is that inflation volatility is lower in trading economies, whose trading interactions are higher than average as compared to the other countries

CHAPTER # 3

METHODOLOGY

The time series data from 1972-2009 is used to explore the relationship among inflation and trade liberalization in Pakistan. The variables included in the study are inflation, GDP, imports, exports, and polity. The latest available data on inflation, GDP, imports, exports, and polity is of fiscal year 2009; therefore for more realistic and reliable analysis this research is restricted to 1972-2009 time periods. World Bank national accounts data (OECD National Accounts data files) is the source of data for this study.

DATA SOURCE AND TYPE

The source of the data collection of inflation, GDP, imports, exports, and polity is World Bank national accounts data, and OECD National Accounts data files. Data collected for the first time is known as primary data i.e.it has not undergone any statistical procedure (raw data). The data used in this research is secondary data i.e.it is not a raw data or first handed data.

CHAPTER # 4

KEY CONCEPTS AND VARIABLES

VARIABLES

Inflation is taken as the dependent variable in this analysis and GDP, imports, polity, and exports, will appear as explanatory variables in this study.

DEFINITION OF VARIABLES

INFLATION

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services

A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.

Features of inflationary situation

(a). It is a process of continuously rising prices. Average level of prices rises.

(b). It starts when due to some reason it become impossible to satisfy the whole of demand for goods at existing prices. So prices start rising.

(c). After initial rise in prices, the buyers start anticipating further rise in prices. They buy more quantity of good in hurry. This induces further rise in prices. In this way inflation is propagated.

Causes of inflation

The one of the most cause of rising prices is excessive increase in money supply. When people have more money to spend they increase demand for goods and services. If the output does not grow at the same time, prices move up.

Inflation types

There are three main types of inflation because of three different reasons.

• Demand-pull inflation.

When inflation occurs because of the increase in the total or aggregate demand for goods and services, while supply of these goods and services does not change at the current prices, this is called demand-pull inflation. From the Historical perspective, demand-pull inflation has been the mainly common type of inflation. Most of the occasions, this is considered as the most serious type of inflation. Other types of inflation occur more readily in conjunction with demand-pull inflation. Demand-pull inflation is also called excess-demand inflation.

• Cost-push inflation.

The inflation of this type is caused because of the rising cost of production. Whenever the cost of producing goods and services rises, the prices of finished commodities is likely to raise too, this causes the inflation to start.  The important sources of rise in cost are workers’ demand for higher wages, increase in taxes and high prices of imports.

• Hyper-inflation.

This is the type of inflation in which prices are rising too fast e.g. prices may be doubling every month.

TRADE

The exchange of goods and services is called trade. The rationale for exchange through trade is that the ability of producing same amount of goods and services is not the same for all the producers. Some producers can produce some commodities at cheaper rate than the other. Therefore they focus their intentions on such commodities which they can produce at cheaper rate and exchange it for commodities which they can not produce at cheaper rate.

Kinds of trade

There are two kinds of trade.

1. Domestic Trade
2. International Trade

• Domestic Trade

The exchange of goods and services between various regions of the same country is called domestic trade or inter-regional trade.

• International Trade

The exchange of goods and services between different countries is called international trade.

TRADE LIBERALIZATION

It refers to a trade policy in which no restrictions are put by the government on the movement of goods and services between various countries. Thus the removal and reduction in the trade barriers, that hurdles the free flow of goods and services from one nation to another is called trade liberalization. It includes concessions in tariff (such as duties, surcharges, and export subsidies) as well as non-tariff barriers (such as licensing regulations, quotas, and arbitrary standards). Every trading country is free to export or import anything from any country of the world.

Features of Trade-liberalization

• Trade-liberalization helps the country to get those commodities which it can not produce within its geographical boundaries.
• It prevents monopolies. The local producer can not exploit the consumers because of cheap imports. In absence of trade, some local firms may create monopoly and charge very high price.
• Through this process, people of various countries come close together.
• If in a country there is an over-production of some commodity, it can be sold to other countries.
• The extents of markets are enlarged through this process of trade-liberalization.
• Trade-liberalization encourages imports of capital goods and raw material. It also helps in getting foreign capital and new technology. So it is helpful in accelerating the rate of development.

EXPORTS

The sale of domestic goods and services, produced by the country in any other foreign country is called exports. Therefore, exports refer to the sale of domestic commodities in the international markets. Thus Exports is a major component of international trade, and the macroeconomic risks and benefits of exporting are regularly discussed and disputed by economists and others.

Major exports of Pakistan

The major exports of Pakistan are:

1. Rice.
2. Fish and Fish preparation.
3. Cotton yarn.
4. Petroleum products
5. Cotton cloth.
6. Hosiery and Ready made garments.
7. Carpets.
8. Synthetic Textiles
9. Leather and Leather goods.
10. Sports and Surgical goods.

An invisible export is foreign exchange earned by providing services. Pakistan also earns foreign exchange through invisible exports and it can increase them by promotion of tourism, exporting labor or exporting software programs.

IMPORTS

The purchase of goods and services from abroad is called imports. Usually the imports consist of transactions in goods and services (sales, barter, gifts or grants) from non-residents residents to residents.

The main feature of the imports is that, it provides those goods and services to one country that it does not possess it-self or it can not produce it at cheaper rate at which the other country is producing it. Thus by importing the goods and services from the country which is producing it at cheaper rate, the importing country can save the greater amount of its natural resources from getting waste during the production process.

Major imports of Pakistan

The major imports of Pakistan are

1. Machinery.
2. Chemical and Dyes.
3. Petroleum and Petroleum products.
4. Electrical and Electronic goods.
5. Transport Equipment.
6. Tea.
7. Steel and iron products.
8. Non-Ferrous Metals and Plastic goods.
9. Edible oil.
10. Paper, Stationary, Pulses and Grains.

GDP

The gross domestic product (GDP) or gross domestic income (GDI) is a measure of a country’s overall economic output. It is the market value of all final goods and services made within the borders of a country in a year.

Features of GDP

• GDP is a money measure of total domestic product.
• Only the value of goods produced in current year is included.
• Generally the success of economic policies adopted by the government is judged by the growth rate of GDP.
• Increase in GDP is an indicator that economy is growing and expanding.

Polity (i.v) Index

This index is use to know the level of autocracy and democracy in any particular country. The autocracy is scaled from -1 to -10. The figure of -10 shows that the state is governed by the completely autocratic system. The numerical value of +10 represents that government is regulated by the completely democratic system.

In a democratic system of governance the political system is run with the consultation and all the decision are taken by taking the people in to confidence.  A fully autocratic system sharply restricts or suppresses competitive political participation. The chief executives are chosen by an elite group and exercise power with few institutionalized constraints. Control of social and economic activity is not measured here.

The impacts of traditional, separatist or revolutionary groups are also not measured here unless they affect the central governing structure.

 

CHAPTER # 5

The Model

The study uses the double-log model (with polity as dummy variable), to capture the effect of trade liberalization on inflation. For convenience natural-log of trade-liberalization and inflation series is taken.

In order to check whether the series of variables use in the study are stationary at level or not we have use the Augmented Dickey-Fuller test.

Double-log model (with polity as dummy variable)

The double-log models are also known as log-log or log-linear models. In these models both the regressand and the regressor(s) are expressed in the logarithmic form. The regression coefficient attached to the log of a regressor is interpreted as the elasticity of the regress and with respect to the regressor. Therefore in our study, the double-log model (with dummy variable) is used to identify the average elasticity of trade-liberalization with respect to inflation, so that we may know in which direction trade-liberalization (positive or negative) is effecting the inflation. This will indeed help us to make realistic policy to deal with the inflation in the economy.

ln  = β1 +β2 ln_TL + β3 Polity    (1)

Equation (1) shows the double-log model (with dummy variable), in which

ln  = natural log of inflation.

ln_TL = natural log of trade-liberalization.

Polity is a dummy variable which includes:

1 for democracy and 0 for autocracy

β2 will provide the elasticity of inflation with respect to trade-liberalization

The trade-liberalization variable is formed by adding each year imports and exports, and then dividing it by GDP of that year i.e. (imports + exports)/GDP.

Chapter # 6

ESTIMATION AND RESULT

In this chapter, the results of model are presented and explained which are discussed in the previous chapter. In order to solve the Augmented Dickey-Fuller (ADF) and double-log model (with dummy variable), the E-Views software is used.

Double-log model (with polity as dummy variable)

Before applying the double-log model, it has been first checked that whether the variables are stationary at level or not. For this purpose ADF test is used. After applying the ADF test on   “ln  and “ln_TL”, it has been found that the variables are stationary at level (see appendix).

The result below shows the output of equation (1).

Table

Variable	Coefficient	Std.Error	t-statistic	Prob.
C	4.559365	0.666460	6.841171	0.0000
ln_TL	2.573009	0.613428	4.194476	0.0002
Polity	0.700337	0.117201	5.975522	0.0000

Now, by using the data given in the table above, we will fit the regression line. The regression results are as follow:

ln  = β1 +β2 ln_TL + β3 Polity

ln  =4.559365  +2.573009 ln_TL + 0.700337  Polity

INTERPRETATION

According to the results, the elasticity of inflation with respect to trade-liberalization is about 2.57, suggesting that if the total volume of trade of goods and services (due to the trade- liberalization) , goes up by 1 percent , on average ,the inflation due to trade-liberalization goes up by about 2.57 percent. Thus inflation is very responsive to changes in volume of trade (due to the trade-liberalization) of goods and services.

The β2 is greater than “1”, shows that the elasticity of inflation with respect to trade- liberalization is elastic. Which means that for a relatively small increase in the total volume of trade of goods and services (due to the trade-liberalization), the increase in the inflation will be relatively large.

Polity (i.v) index coefficient has a positive value of 0.7, which shows that there exist a positive relationship between political regime and inflation. Thus, the results show that there exist a positive relationship between inflation, trade- liberalization and polity.

So the result of double-log model indicates the acceptance of null-hypothesis that “There  exists a positive (significant) relationship among inflation and trade liberalization”. Therefore, the relationship between the inflation and trade liberalization is positive.

 

Chapter # 7

CONCLUSION AND RECOMMENDATIONS

7.1 CONCLUSION

In this research the time series data from 1972-2009 has been used to test whether a significant (positive) relationship exist between inflation, trade liberalization and political regime in Pakistan. As it is a well-known phenomenon in economics that inflation is significantly effected by trade-liberalization and political regime in a country. The prime motive of our study is to examine the magnitude (positive or negative) of inflation and to see whether the inflation in Pakistan is affected significantly by trade-liberalization and political regime.

According to our findings from this research, the inflation, trade-liberalization and political regime of Pakistan have a positive and significant relationship. From the result of our double- log model, it can be deduce that  inflation elasticity with respect to trade-liberalization is elastic which mean that relatively small increase in the total volume of trade of goods and services (due to the trade-liberalization) will bring a relatively large increase in the inflation.

The prime reason for this phenomenon is that Pakistan’s imports always overweight its exports. Therefore the expansion of international trade is contributing to the increase in inflation in Pakistan. The Pakistan’s trade pattern has experienced a structural shift in the form of lower exports and rising import bills of capital and raw material.

The exports capacity of Pakistan is limited as exportable commodities are not produced in large quantities and their quality is inferior and can not compete in international markets. Therefore only few goods are available for exports.

Pakistan needs to diversify its exports not only in terms of commodities but also in terms of markets. Heavy concentration of exports in few commodities and few markets can lead to export instability.

In contrast to exports, the volume of Pakistan’s importable commodities is very large. Since Pakistan is a developing nation and it can not fulfill all its economic requirements of raw material and other capital goods by its internal sources, therefore its imports are always larger than its exports. Consequently the overall effect of trade- liberalization on inflation is positive. The impact of political regime on the inflation is also positive.

7.2 RECOMMENDATIONS

In our study ‘the impact of Trade Liberalization on Inflation’, we have concluded some recommendation / suggestions, which can be beneficial for minimizing this impact and have positive impact on the economy. These recommendations are majorly related to enhancing exports and improving imports structure, which can improve the magnitude of trade liberalization and maintaining inflation at a level which effects positively to the economy.

These recommendations are:

• Trade Policies made by Governments must ensure that these policies will lead to correcting the balance of payment and this can be done by effective trade policies of exports, which can help in curbing the rising trend of Inflation.
• Increase in inflation increases the cost of living; therefore the inflation must not be allowed to increase rapidly by imposing effective inflationary checks.
• The effective policy of removal of technological backwardness and use of new modern technology must be adopted. This would certainly leads to the increase in quality and quantity of commodities and there supply at the cheaper rates.
• The mal-practice of hoarding must be discouraged, so that the ample provision of necessities at cheaper rates can be made realistic.
• Improper economic policies can leads to the increasing inflationary trend in an economy. Therefore while formulating macro-economic policies for development and growth a care should be taken to avoid the level of inflation that can be destructive for the economy.

• The policies and plan of activities should be designed in such a manner that it seek to earn the sufficient amount of foreign exchange by boosting the exports and reducing the imports.
• Through inventions and innovation in agriculture and industrial sector, Pakistan can excel at a rate that can leads to higher growth and development without hurting the poor sections of the society, which are effected greatly by the inflation.

• Assistance in marketing for exporters through trade promotion activities and increasing market access.

• Banning the imports of luxury items can be a measure in reducing the excessive volume of imports.
• Establishing import substitution industries to produce substitutes of imports.
• Pakistan usually exports the un-finished or semi-manufactured goods, which does not bring enough foreign exchange and profits for the nation and the exporters. Therefore only finished goods should be exported.
• The existence of proper infrastructure in the form of roads, telecommunication, sea-ports, railway-lines and air-ports increases the trade relations with the rest of the trading countries many folds. Therefore, the proper provision of this infrastructure, which connects the country with the rest of the world should be provided and maintained according to the international standards.
• To enhance the exports, the export industries must be provided with facilities such as tax concessions and cheaper loans etc.
• Efficiency and productivity of the labor force can be enhanced through technical education and development training. So that rising demand of the society can be matched without increasing the inflation in the country.
• A major reason for lower productivity of Pakistan’s labor force is the disturbed political atmosphere and irresponsible behavior of our political leaders in industrial policies. The political leaders must bring reforms and maintain consistency in their industrial policies specially.
• To control inflation in the long run, all those measures which increase supply of goods are helpful. Slowing the rate of growth of population has also a healthy effect and this is specially needed in-case of Pakistan.