The anatomy of trade deficits

In the first 10 months of the outgoing financial year (FY 2017), a $19.93 billion trade deficit was registered on account of exports worth $17.91 billion and imports that amount to $37.84 billion. Trade deficit during the same period of the preceding financial year was $14.61 billion, with exports worth $18.14 billion and imports amounting to $32.75 billion. As a result, during FY 2017 (July 2016 till April 2017), trade deficit has increased by 36.41 percent compared with the previous year.

Trade deficit, along with fiscal deficit, has been a perennial feature of Pakistan’s economy – as in the case of most other net petroleum-importing developing countries. The reasons for this stem from both economic and cultural factors. These economies need to import a great deal of capital equipment and industrial raw materials to maintain or accelerate the growth momentum.

Culturally, the people living in such societies are strongly inclined towards imitating a lifestyle that is prevalent in rich countries – even though they lack the corresponding productive capacity – which encourages the import of luxury goods. On the other hand, owing to severe supply-side constraints, coupled with a relatively large population, exports can’t keep pace with imports.

It may be useful to compare Pakistan’s foreign trade performance with that of two other countries in the region over last three years. In FY 2014, Pakistan’s trade deficit was $16.59 billion (exports amounting to $25.07 billion and imports worth $41.66 billion), which went up to $17.20 billion in FY 2015 (exports worth $24.08 billion exports and imports amounting to $41.28 billion). The deficit further increased to $18.48 billion in FY 2016. The exports worth $21.97 billion while imports stood at $40.45 billion.

India registered a trade deficit worth $141.82 billion in 2014, with export amounting to $317.54 billion and imports worth $459.36 billion. The deficit came down to $126.36 billion ($264.38 billion for exports and $390.74 billion for imports) in 2015 and fell further to $96.37 billion in 2016 (exports worth $260.32 billion and imports amounting to $356.70 billion). Likewise, in the case of Sri Lanka, trade deficit stood at $7.94 billion (exports amounting to $11.29 billion and imports worth $19.24 billion) in 2014. It went up to $8.52 billion (with exports worth $10.43 billion and imports at $18.96 billion) in 2015 and rose further to $8.95 billion (exports amounting to $10.54 billion and imports worth $19.50 billion) in 2016.

It is evident that all the three countries are running an adverse trade balance and its scale is understandably relative to the size of the economy – the biggest for India and the smallest for Sri Lanka. Trade deficit has gone up for both Pakistan (11.4 percent) and Sri Lanka (12.7 percent) over last three years. But in the case of India, it has come down. Imports have come down for both Pakistan (marginally by 2.9 percent) and India (largely by 22.3 percent), with a small increase for Sri Lanka. Exports have come down for each of the three countries: 12.4 percent for Pakistan, 18 percent for India and 6.6 percent for Sri Lanka. These figures reflect a reduction in global trade from $18.9 trillion in 2014 to $15.86 trillion in 2016.

The increase in trade deficit during FY 2017 (between July 2016 and April 2017) over the corresponding period of the preceding year may be explained by looking at both imports and exports. Total imports have gone up from $32.75 billion to $37.84 billion by 15.5 percent. Category-wise, the largest increase occurred in the transport sector by 39.2 percent, followed by the petroleum group (15.5 percent), food items (18.9 percent), machinery and capital equipment (16.1 percent), textiles (7.7 percent), chemicals (4.3 percent) and metals (1.7 percent).

Likewise, the total exports have gone down slightly from $18.14 billion to $17.91 billion by 1.3 percent. Exports fell in almost all important categories: textiles (3.2 percent), food items (4.5 percent), other manufactures, such as leather, sports and surgical goods (5.8 percent), petroleum (7.6 percent) and engineering goods (17.3 percent). However, the export of chemical and pharmaceutical products went up by 4.3 percent.

It follows that the fundamental cause of the substantial growth of trade deficit is the increase in imports rather than the decrease in exports. At the same time, it is exceedingly difficult for the government to check the growth in imports for one reason or another. The import basket can be divided into three categories: essential items, such as food and petroleum products; capital equipment and raw materials necessary for economic growth; and luxury goods.

Restricting the import of the first two categories is not desirable for obvious reasons. The government can restrict the import of luxury goods by raising the customs duties. Like other developing countries, Pakistan has a considerable gap between its bound (WTO) and applied import tariffs. However, the problem is that the demand for the luxury goods comes either from the government itself or the politically powerful affluent class. As a result, restricting their imports is a difficult proposition in a political sense.

Increasing exports is the right way to narrow the trade deficit. Obstacles to export promotion are of three types: market access, the high cost of doing business and structural constraints. The focus of the government and the private sector has been on overcoming the first and second obstacles. Over the last decade, Pakistan has been on a spree to conclude preferential trading arrangements (PTAs). However, most of the PTAs have caused imports to grow at a faster pace than exports. This has driven up trade deficits with PTA partners.

Bringing down the cost of doing business includes seeking exemptions from internal and border taxes, duty drawbacks, reducing interest rates, providing electricity at subsidised rates and keeping wages from increasing. From time to time, the government declares zero-ratings for the key export-oriented sectors and thereby exempts them completely from the GST. Earlier this year, a hefty export package, in the form of duty and tax remissions, was announced by the prime minister.

Lowering the cost of doing business and securing preferential access in foreign markets is important. But without addressing the structural constraints, an appreciable increase in exports is not possible. Unfortunately, the latter has been short-shrifted by both the government and the businesses.

Pakistan has a narrow export base. It is essentially an exporter of either primary products – such as rice and fruits – or of semi-manufactured goods – such as textiles, garments and leather products. Not only are exports deficient in value addition, but they are also sold to the low-end of the market. The export basket – being agro-based – is subject to the vagaries of weather. A bad cotton crop – as was witnessed during the current year – can impact export receipts. The export profile reflects the dismal state of industrial development.

Another major structural problem is low labour productivity, mostly because human resource development has traditionally been a neglected area in Pakistan. The corporate sector works under the misconception that low wages are the key to competitiveness. Instead, what really matters is high labour productivity.

The corporate culture is markedly deficient in entrepreneurship – one of the principal drivers of economic growth and export promotion. Most of the businesses are family-owned. They believe in playing it safe and making quick profits. These businesses are averse to innovation and venturing into new areas and have little commitment to improving quality. There is a culture of quality, which must be embedded into all the key processes of an enterprise: procuring supplies, putting together the factors of production, manufacturing products, marketing and sales. Making improvement in quality must be a continuous process.

Not surprisingly, Pakistan – deficient as it is in both entrepreneurship and culture of quality – continues to be an exporter of a narrow mix of low quality, low priced products.

The writer is a freelance
countributor.

Email: hussainhzaidi@gmail.com