Modelling welfare effects under Pakistan–China free trade agreement

Date01 October 2018
Published date01 October 2018
Pages202-218
DOIhttps://doi.org/10.1108/JCEFTS-07-2018-0028
AuthorLubna Uzair,Ahmad Nawaz
Subject MatterEconomics,International economics
Modelling welfare ef‌fects
under PakistanChina free
trade agreement
Lubna Uzair
Hailey College of Commerce, University of the Punjab, Lahore, Pakistan, and
Ahmad Nawaz
COMSATS University Islamabad, Lahore Campus, Lahore, Pakistan
Abstract
Purpose This paper aimsto empiricallyexamine the trade creation and diversion impacts on merchandise
imports of Pakistan under the PakistanChina Free Trade Agreement (FTA). The analysis of Pakistans
preferential treatmentwith its largest trade partner as well as the most substantial exporter of the world will
help to shape trade policy, open windowsfor academic research and also gives an immense contribution in
literature.
Design/methodology/approach A disaggregated panel data on the importsof Pakistan from China
and other WTO member countriesand tariff concessions at Harmonized System (HS) two-digit level used for
the agreement period of 2006-2012. The empirical analysis takes care of bias through robust and panel-
correctedstandard errors with time, industry-specif‌ic effects andcontrolling for multilateral trade resistance.
Findings Evidence found in support of trade creation underthe PakistanChina FTA. It means overall
this agreementincreased the welfare of Pakistani consumers.
Practical implications Findings are in favour of negotiations and signing forthe next round of this
agreementand with other major trade partners like the US and Saudi Arabia.
Originality/value It is worth investigating empirically the impact of preferential trade
liberalization between Pakistan a developing country and China the largest importer of the world
explicitly, in the form of trade creation or diversion. The empirical assessment of this FTA signed with
the worlds largest exporter will not only contribute immensely to the literature but also helpin trade
policy formulation and open windows for academic research. Another unique aspect of this study is the
use of disaggregated data consisting of all goods imports along with tariff concessions at two-digit
Harmonized System (HS) code.
Keywords China, Pakistan, Trade creation, Free trade agreement, Import demand
Paper type Research paper
1. Introduction
The debate about the effects of regional trade agreement (RTA)was started about 70 years
ago when General Agreement on Tariffs and Trade (GATT) advocated liberalization as a
policy variable from 1947 to 1995 till that renovated as World Trade Organization (WTO).
One highly controversial and emerging aspect of trade liberalization among empirical
researchers is the impact assessment of free trade agreements (FTAs). Interestingly, 625
regional trade agreements were notif‌ied globally till 1 February 2016, and 238 out of these
were FTAs (WTO, 2016). That is why there has been a great debate on the assessment of
FTA by two concepts trade creation and trade diversion. An FTA, economically benef‌icial
JEL classif‌ication F14, F15, R11
JCEFTS
11,3
202
Journalof Chinese Economic and
ForeignTrade Studies
Vol.11 No. 3, 2018
pp. 202-218
© Emerald Publishing Limited
1754-4408
DOI 10.1108/JCEFTS-07-2018-0028
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1754-4408.htm
or not for partner countries, depends on the extent of trade creation and trade diversion
(Viner 1950). Because under preferential trade liberalization, a country may replace its
imports from non-members to members and the possibility of ineff‌iciency arises if the
member is a high-cost country (Plummer et al.,2010). In that case, the shift is merely a shift
from low-cost suppliers to the high-cost supplier. It is not necessary that all preferential
treatments must end up in eff‌iciency, as it depends upon the member countries, their
position in international trade and their economic structure (Muhammad and Yucer, 2009;
Panagariya, 2000). Burf‌isher (2001) claims that empirical analysis determines whether a
specif‌ic agreementis causing welfare or not.
Existing literature examines trade f‌lows of participants under regional trade
agreements and shows the impact of a trade policy change in two ways, ex ante and ex
post. In case of ex post analysis, gravity or augmented gravity equation used by Baier
and Bergstrand (2007),Carrère (2006),Ghosh and Yamarik (2004b), Glick and Rose (2002),
Herath et al. (2014),Krueger (1999),Liu and Jiao (2006) and Soloaga and Wintersb (2001).
Import demand and export supply framework was also examined by Clausing (2001) and
Susanto et al. (2007) in the case of ex post analysis of the agreement and the approach of
the gravity equation was criticized.
Based on the empirical literature, researchers were divided into two categories, one
who consider them as trade diverters who hinder growth through discrimination and
others who conclude that preferential liberalization is trade creatingand also highlight
its various determinants. For example, Krueger (1999) shows that trade is not diverting
under North America FTA (NAFTA) by considering USMexico trade pattern. Instead,
evidence of trade creation found and further showed that tariff concession was not the
only reason for that trade creation. Gauto (2012) f‌inds evidence of trade creation under
MERCOSUR in the case of Paraguay and further determines that the effect of FTA are
likely to be larger for small economies in case of agreement with a large economy. Vicard
(2011) reveals large,similarand geographically closecountries are more likely
trade-creating. Additionally, he f‌inds that level and similarity of GDPs, bilateral distance,
common border and language, colonial history and membership of GATT/WTO, are
some factors that inf‌luence the effectiveness of RTAs. Ghosh and Yamarik (2004b)
conclude that the degree of integration and period of agreement affect trade creation and
as the degree of integration increases, the extent of trade creation also increases. Clausing
(2001) highlights the importance of trade creation instead of an only increase in the volume of
trade and to highlight the signif‌icance of the use of disaggregated data instead of aggregated
data. Soloaga and Wintersb (2001) f‌ind evidence of trade diversion as well as an export
diversion in case of EU and EFTA. Due to such potential ineff‌iciencies, preferential treatments
considered the second best policy option (ADB, 2008).
On the other side, the speed at which China is expandingits network of the agreement is
striking as compared to large bodies of tradeagreement system, i.e. USA and EU. Pakistan
is the f‌irst country located in South Asia that has an FTA with China (Kataria and Naveed,
2014). The f‌irst phase of the FTAs implementation period was completed in 2012 and
further economic cooperation was enhanced through strengthening trade relations via the
construction of the Economic Corridor. In this scenario, an agreement about the
investment of $46bn signed on 20 April 2015 for the development of the EconomicCorridor
from Kashgar to Gwadar, but the impact of the FT agreement has not been determined
empirically yet (Ministryof Planning, 2016).
It is a fact that most of the countries overcome poverty and increase income by
liberalizing trade, especially East Asian or Southeast Asian economies like Singapore,
Korea, Japan, Taiwan and Hong Kong (Hoekman and Nicita, 2001). All these countries are
Modelling
welfare ef‌fects
203

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