05
July

Pakistan’s Defence Budget Myth or Reality

pak def2Strong economy and strong defence are considered to be the two pillars of the state. A strong economy can ensure strong defence; it will enhance country's power and hence make its defence even stronger. According to Paul Kennedy, a nation's military strength rests on its economic strength and military strength is nothing but power and power is defined as the ability of a country to influence the behaviour of other countries in accordance with its aims and objectives. Power can lead to prosperity and prosperity may generate more power.  According to Robert McNamara (former US Secretary of Defence and President of the World Bank) security means development and without development there is no security. Just as peace favours development, development ultimately favours peace. But peace cannot be bought, rather it is earned through diplomacy and military might.

It is equally true that economic backwardness generates violence, social conflicts and political turmoil. A strong economy, therefore, also ensures political and social stability, which, in turn, makes the economy even stronger. The moral of the story is that a strong economy is sine qua non for strong defence and not the other way around. The former Soviet Union provides a classic example of this fact. While Soviet real GDP growth continued to decelerate from an average of 7.1 per cent per annum in the 1950s to 2.7 per cent during the 1980s, its defence spending continued to rise from 9.0 per cent of GDP to 15.4 per cent during the same period. Soviet economy was not in a position to sustain such a large defence spending and eventually it collapsed as a country. It is also argued that the two wars (Iraq and Afghanistan) that the United States fought since 2001/02 contributed immensely in weakening US economy over the last one decade. It is for this reason that the government should give greater attention to economy with a view to sustaining strong defence.pak def3

Pakistan's defence budget remained under severe scrutiny, within and outside the country for decades. Every one interpreted Pakistan's defence budget from his/her own perspective and interest, often not based on facts and figures. They criticized vehemently the defence budget of Pakistan solely for political reasons by distorting the facts. Mark Twain once remarked, “Get your facts first, and then you can distort them as much as you please.” At times, those who were critical to Pakistan's defence budget, lost rationality. Those who presented facts were dubbed as agents of the “Establishment”. In this article, I intend to analyze Pakistan's defence budget by presenting facts, as facts speak themselves.

Certain myths have been created by the critiques about the defence budget of Pakistan. These include: i) that 80 per cent of Pakistan's budget is being consumed by Pakistan Armed Forces, ii) that defence budget is the single largest component of Pakistan's budget, and iii) that defence budget is rising at a much faster pace than other critical expenditures. Is this a myth or a reality? This article intends to answer these queries by presenting facts.

What Determines a Country's Defence Budget?

A country's defence spending depends on a combination of different factors that include:

•           War or the perceived risk of war.

•           Security environment, such as:

                                    military expenditure incurred by neighbours.

            the momentum of the regional arms race.

            attitude of the neighbours (friendly or hostile).

            geo-strategic considerations.

•           Armed conflict and policies to contribute to multilateral peacekeeping operations.

•           Availability of economic resources.

pak def4Pakistan is in the midst of war on terror since 2001; a war which has cost the nation dearly in terms of men and material, and finances. The invasion of the United States in Afghanistan after the shocking event of the 9/11 opened up a new frontier (western front) for Pakistan to guard its national security. Pakistan continued to witness the rise in violent extremism and terrorism which has caused large-scale human suffering. The country has lost over 50000 civilians and security forces personnel beside a cumulative loss of over $100 billion in the last 13 years (Source: Pakistan Economic Survey 2013-14, Government of Pakistan). This has been the longest unconventional war that the country has fought thus far. The war is still continuing with greater intensity and dimension. It is quite natural that a country allocates relatively more financial resources to defence during the war periods and relatively less during the peace time. For example, the United States spent $1.5 trillion as war supplement cumulatively over the last 13 years over and above of its normal national defence budget which is about 4 per cent of GDP (Source: Growth in US Defence Spending Since 2001, US Department of Defence FY 2014 Budget Request, April 2013). As long as Pakistan continues to face unconventional war, the defence and security related expenditure may continue to rise. Did Pakistan's defence continuation of receiving adequate resources commensurate with evolving threat? The answer will be provided shortly.

Military expenditure incurred by neighbours, the momentum of the regional arms race and attitude of the neighbours also determine the size of the defence spending. Prior to the United States' invasion of Afghanistan and the subsequent developments for Pakistan's security, it concentrated exclusively on its eastern border with India for its defence. The invasion of Afghanistan has changed the security environment for Pakistan altogether. In addition to looking after the eastern border, Pakistan has been spending additional resources to protect its western border with Afghanistan. Such a change in security environment must have contributed to the rise in defence spending.

Pakistan has fought three wars with India since its inception in 1947. India's defence spending is rising at a pace that puts her at the list of the top ten defence spending countries in the world. India spent $39 billion in defence and accounted for 2.4 per cent of the world's military spending in 2009. Its defence spending rose to $47.4 billion and accounted for 2.7 per cent of world military spending in 2013. India's defence spending is close to that of Japan ($ 48.6 billion) and Germany ($48.8 billion). It has indulged in arms acquisition in a much larger way as well (Stockholm International Peace Research Institute (SIPRI) Year Book 2014).

India is not only a nuclear power but is actively involved in the development of thermonuclear weapons by expanding a covert uranium enrichment plant. The newly elected government in India under the leadership of Prime Minister Narendra Modi intends to build up India's military capability by inducting more sophisticated weapons in its armoury. In so doing, the government intends to spend additional $200 billion in acquisition of sophisticated weapons (Source: Farrukh Saleem, Monthly Hilal, June 2014). Western power, in order to get their shares of pie, are rushing to India and encouraging it to go for large-scale acquisition of arms and ammunitions. Although India would justify its arms acquisition and weapons development programmes to counter China in the region (India has fought a low intensity border war with China in 1962), the fact of the matter is that these large-scale military spending on arms acquisition and weapons developments are purely directed towards Pakistan. Such developments are bound to force Pakistan to raise its defence spending to maintain a minimum deterrence viz. India.

Armed conflict and police to contribute to multilateral peacekeeping operations also determine the size of a country's defence spending. Pakistan has been the single largest contributor of armed forces to the United Nations peacekeeping operations in conflict zones in different parts of the world (See monthly Hilal, June, 2014). This may have contributed to the rise in defence spending in Pakistan.

Availability of economic resources is yet another factor that determines the size of defence spending in a country. China and India, the world's two emerging economic powers, are demonstrating a sustained increase in their military expenditure and contributing to the growth in world military spending. In addition, high and rising world market prices for fossil fuels and minerals have also enabled some countries (Russia, Saudi Arabia, Azerbaijan, Chile and Peru) to spend more on their militaries (see SIPRI Report 2006). Has availability of economic resources helped Pakistan to raise its defence spending? Or did Pakistan raise its defence spending during the periods of economic boom? This is a valid question to which I will return shortly.

Defence Spending: The Reality

Various myths pertaining to Pakistan's defence budget have been created within and outside Pakistan. What is the reality? This leads to our discussion on the factual position of Pakistan's defence spending. Table 1 and Fig.1 are enough to break the myth about Pakistan's defence budget. Pakistan's defence budget at current rupee/dollar stood at Rs. 131 billion or $ 2.24 billion in 2000-01 and increased to Rs. 630 billion or $ 6.0 billion by 2013-14 – thus exhibiting a growth of 11.9 per cent and 7.3 per cent respectively. In other words, in rupee and dollar terms, Pakistan's defence budget increased by 4.8 times and 2.7 times in the last 14 years.

Defence spending at current rupee or dollar is uninteresting. Economists around the world have measured or presented defence budget at constant rupee or constant dollar term. In so doing, they took care of inflationary build up in the country. After adjusting for price level, Pakistan's defence spending increased from Rs. 131 billion to Rs. 199 billion or has grown at the rate of 3.0 per cent per annum over the last 14 years. Similarly, in constant dollar of 2000, Pakistan's defence budget increased from $ 2.24 billion to $ 4.33 billion during the same period, thus showing a growth of 4.8 per cent per annum. More importantly, contrary to the general perception, Pakistan's defence budget did not even double in the last 14 years (see Table 1).

pak def5Is defence spending a burden to the nation and its economy? Defence spending in relation to the size of the GDP as well as in relation to the size of the budget represents a burden to economy and budget, respectively. Table 2 and Fig. 2 clearly indicate a declining trend in defence spending. Pakistan's defence budget was 3.2 per cent of GDP in 2000-01, remained stagnant at that range until 2004-05, but declined to below 3.0 per cent of GDP in 2005-06. For the last six years, it has remained stagnant at 2.5 per cent of GDP – much lower than many developing and emerging economies. As total or consolidated size of the budget, defence spending continued to exhibit a declining trend over the last 14 years, declining from 18.3 per cent in 2000-01 to 12.1 per cent in 2013-14.

Conclusions

Contrary to the general perception created by the vested interest that “Pakistan's defence spending accounts for 80 per cent of the total budget”, the readers should know that it accounts for only 12 per cent of the budget and in fact, it was less than the subsidy provided by the government to its citizens in 2011-12 (12.8 per cent of the total budget) in the midst of war on terror. In constant dollar, the per capita defence spending increased from $16 in 2000-01 to $23 in 2013-14. It has virtually remained stagnant over the last 14 years as can be seen through Table 2 and Fig. 3.

For those who have interest in Pakistan's defence budget should know that interest payment is the single largest expenditure item of Pakistan's budget. Defence spending has remained almost one half of the interest payment over the last 14 years (See Table 3). Fiscal profligacy contributed to the persistence of large fiscal deficit, resulting in accumulation of public debt and contributing to the surge in interest payment accordingly. While defence spending was 18.3 per cent of the size of the budget in 2000-01, interest payment was almost 35 per cent. Even today, the interest payment accounted for 23 per cent of the budget as opposed to 12 per cent in the case of defence spending. Table 3 reveals that defence spending became a victim of rising public debt and concomitant rise in interest payment. As public debt rose because of the persistence of large fiscal deficit, interest payment continued to rise. To keep the budget deficit at a manageable level, the axe always fell on defence and development spending, including social sector. Interest payment alone is more than the combined spending on defence and development. It is the rising interest payment which is more worrisome than defence spending for the budget as well as for the economy. Surging interest payment has eroded fiscal space and forced the successive governments to keep allocation to defence and development at a bare minimum.

Concluding Remarks

As stated at the outset, Pakistan's defence budget has remained under severe scrutiny within and outside the country. Such scrutiny has never been based on facts. An attempt is made in this paper to present facts about the defence budget of Pakistan. The main findings of the paper are summarized as follows:

Given the size and the dimension of national security challenges that Pakistan has been facing over the last 14 years, its defence budget has never been consistent with growing national security challenges.

Defence spending as per centage of GDP and the size of the budget has been on the decline, even in the midst of war on terror, the country is fighting for the last 14 years.

Pakistan is spending 2.5 per cent of GDP, 12 per cent of the size of the budget (not 80 per cent as critiques within, and outside, the country have always been quoting to misguide the people) and $23 per person on defence  all during the war on terror.

It is the growing interest payment and not the defence spending which should worry us all. Fiscal profligacy contributed to the surge in public debt which, in turn, caused interest payment to balloon. Defence spending has been onehalf of the interest payment. Interest payment even surpassed the combined spending of defence and development.

Defence and development spending have been the major victims of ballooning interest payment.

While Pakistan's arch rival India continued its procurement drive of sophisticated weapons and emerged as top ten spenders on military in the world, Pakistan continued to spend modestly (2.5% of GDP and $23 per person) to maintain its minimum deterrence.

Encouraged by the western powers, India is spending over $47 billion on defence and intends to spend additional $200 billion in weapon acquisition in the next few years. Pakistan, on the other hand, is fighting a non-conventional war for 14 years in a row with differing intensities and continued to exhibit a declining trend in its defence budget. Even during the period of relatively stronger economy (2002-2007), its military spending continued to witness a declining trend. Therefore, the availability of resources did not increase defence spending in the case of Pakistan. The burden of defence budget continued to witness a declining trend.

Pakistan needs to give more attention to its economy. A strong economy can sustain higher defence spending but not the other way around. A large slippage is bound to take place in defence spending during the current fiscal year (2014-15) owing to the largescale military operations in North Waziristan area. The government has allocated Rs. 700 billion or roughly $7.0 billion in 2014-15 budget. Given the scale and dimension of military operations and the attendant rise in expenditure, large slippages in defence spending cannot be ruled out.

In the end, I would urge the critiques within, and outside, Pakistan that if they want to criticize defence spending, their facts should be right. Unilaterally criticizing a country's defence budget would not serve any purpose. Critiques must take into consideration the various factors that determine the size of any country's defence budget. When hostile neighbours go on spending spree on weapon acquisition, it is difficult for a country to cut its defence spending. Easing of international political climate may create the potential for reduction in defence spending.

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The author is Principal & Dean at NUST School of Social Sciences & Humanities, Islamabad.

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07
July

Emerging Economic Opportunities Implications for Maritime Logistics Industry

Political changes in Pakistan in recent past have taken place with parallel strides on regional security management and general demand of the populace to move forward on economic front. Years of engagement with combat forces of foreign and far off lands in the name of war on terror, and fight against extremism, have blurred our vision and foresight on many of the aspects. Development index have been on decline and state of internal security had its own effects on the growth rate. Large foreign investments and long-term ventures have their own demands vis à vis the policy formulation and economic direction as a nation and state.

Announcement of an economic corridor between China and Pakistan linking Kasghar and Gwadar through multi-modal communication lines can be termed as a sigh of relief for a weakened economy and a long awaited step in the right direction. Government, having a probable five years to its credit and an outlook of being enterprises friendly, is en-cashing on the historic friendly relations between the two countries termed as higher than mountains and deeper than oceans. And here comes the vision and desire to link these mountains and oceans with trade goods and economic opportunities freely flowing to and fro.

This is in this backdrop that a need has arisen as a national requirement and international obligation to study the concept of economic corridors or land bridges, whatever we may call it, and analyze how the future lays ahead of us. This will not only bring in the much desired clarity in our minds about our future, but will also facilitate us to dove-tail our policies, directions and attitudes on a whole.

Changing Perspective

China may have been a distant land in historical context for many of the great nations, flourishing societies and colonial powers. But fact remains that it was there in all contexts and has had its own influences on the globe. People mentioned it in daily lives and proverbs, and fairy tales have had many of the Chinese characters. Silk route and Chinese spices have been in discussions on international and foreign affairs and none of the strategic and defence studies were complete without mentioning of lands beyond the mighty Himalayas.

Rising power of China, in the so-called uni-polar world, is changing the global dynamics of inter-state relations and economic interactions in all parts of the world. Special focus has been on the Asia being the largest and richest continent of the world in terms of area, population and natural resources, and also being in the immediate neighbourhood of China. The Cold war decades gave many of the vocabularies and terminologies of security management and economic progress, major portion of which can be termed as redundant and obsolete now, except the few like access to The Warm Waters.

A cursory look at the map of China can lure the on-looker to divide it in three equal and natural parts i.e. coastal belt, central depth and western outreach. Till to date, much of the Chinese development and investment has been along the eastern coastal region spread out from Vietnam and Cambodia in the south to Koreas and Japan in the north. This belt is dotted with small and medium to large ports and harbours with terminals. Days and nights, ships of all sizes and types pour in from all the nooks and corners of the globe to bring in the raw materials and unfinished goods for the factories and plants of China.

Coastal endeavours of China over-flowed and out-reached naturally and possibly to central region, especially the academic institutes, research centres, governmental programmes and strategic assets. High-valued and high-tech products flourished in central China with much of their logistic lines based upon much expensive aviation industry.

Having been saturated to some extent and based upon the concept of diminishing returns, China was bound to shift its developmental focus from coastal belt and central China to west China region and this shift is already over-due. Post 9/11 developments and wars blurred the picture for all players, whether large or small, and many of the countries including China could not take risks for a strategic shift in their developmental policies. Many of the programmes and plans were put in cold storage for years to come for want of the conducive socio-political and geo-economic environment.

This approach of western shift has its own implications and demands on policy formulation as well as development strategy for both China and its neighbours. While China has taken the responsibility on its own shoulders, for obvious reasons and high stakes, to educate and promote various stakeholders and players of this new Great Game, Pakistan is duty-bound for the sake of economic prosperity and social welfare of its people to undertake an appraisal and study the various demands put in by this new strategic shift.

Overland Bridges

One of the major demands of emerging economic opportunities in west China region is the establishment of linkages with the deep sea and logistic lines. Just on line with the coastal belt having parallel access to maritime cluster at sea and ashore, western China needs to havea coastline as an outlet to whole of the world, especially the energy centre of the Gulf and centres of raw materials in the East Africa. These logistic lines will act as the blood-lines and will spear-head the exponential growth and development of the least developed areas of China.

Need of a near coast for its western region has long been in the strategic plans of China and many of the outlets have been on the list of probables. Investments have been made for capacity building of these outlets including the much talked about Gwadar. Gwadar Port is ideally located on the hub of international Sea Lines of Communications (SLOCs) to act as mother port for large ships and carriers including bulk and container types. Whether its trans-shipment trade or energy transfer, sea lines emerging from connecting waters of the Arabian Sea including the Gulf, Red Sea and East Africa give their strength to the Gwadar Port, and it can righ tly claimed to be a stepping stone for any sea-linkage of the western China.

 Land bridges and economic corridors for sea linkages are not new to the maritime and economic spheres; rather this concept has handy examples in many parts of the world including Europe and North America. Thanks to the uniformity and connectivity brought in by the European Union (EU) within its member states, many of the smaller ports and maritime outlets have given way to the strategically located large ports and harbours. Much of the coastal belt and hinter-land is then dependant on coastal shipping of feeder ports and land bridges crossing over all sorts of terrains.

Maritime Logistics

Rising density and diversity of maritime traffic will have its own demands on maritime management and policy formulation. Large carriers and mother ships will be destined to Gwadar carrying cargo of all types. Coastal shipping in Arabian Sea and adjoining waters of Gulf, Red Sea and East Africa is certainly going to be re-shaped altogether. Pouring in of raw materials and un-finished products in parallel with energy sources will stretch the maritime cluster at sea and ashore and security management will also be a daunting task.

Based upon the experiences of managing a mega metropolitan on the coastline having a large port, we need to plan and develop Gwadar city on modern lines of integrated management and urban development. We need to control and mitigate the corresponding effects on maritime environment and coastal zone. While taking care of the original and local populace, we will have to welcome the new arrivals from within and outside of the country as maritime professionalism and expertise will be required in abundance and variety.

Logistic lines with their connecting arteries will be stretched in and out of Gwadar to Kasghar overland passing through a diversity of terrain vis à vis both the physical features and cultural norms. Logistic lines and their arteries, when appropriately developed, operated and managed, can themselves be a source of promoting and strengthening the much needed national cohesion of Pakistan.

Conclusions

Pakistan has long been involved and immersed in management of internal and regional security issues and now time has come to take a turn in the right direction for welfare and prosperity of its people. Opportunity of having an economic corridor for the west China region can put us on a track of economic and trade development, provided that we prove ourselves equal to the task and are able to plan and manage accordingly. We can ripe the fruits of our strategic location on the world map in the comity of nations by appropriately moving ahead with consistency in policy formulation, development of maritime cluster, building of transportation infrastructure and ensuring best practices while managing the maritime and internal security aspects in parallel.

In context of emerging economic opportunities in the west China region and development of an economic corridor from Gwadar to Kasghar, following are the areas that can be emphasized;

•                       Plan of developing the economic corridor can be a turning point in the welfare and prosperity of our nation as a whole and we should be all geared up to grasp this opportunity.

•           While China has become an economic giant with at least one third of its area in need of logistic linkages, we need to facilitate these linkages for the sake of our own growth and development.

Maritime cluster in Pakistan, both at sea and ashore, should be ready to grasp this magnanimous change while ensuring long-term sustainability of operations, especially vis à vis maritime environment and security management.

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The writer is a qualified Master Mariner (F.G) and a graduate of World Maritime University.

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09
July

Insight In Chinese Economic Growth

Written By: Shah Faisal Afridi

China’s share of global GDP on Purchasing Power Parity (PPP) basis rose from 4.113% in 1990 to 14.531% in 2011 and over 16.479% in 2014. During the past 30 years, China's economy has changed from a centrally planned system that was largely closed to international trade to a more market-oriented system that has a rapidly growing private sector. A major component supporting China's rapid economic rise has been growth in exports. Chinese officials contend that China is a “socialist-market economy”. This appears to indicate that the government accepts and allows the use of free market forces in a number of areas to help grow the economy and plays a major role in the country’s economic development. Chinese leaders are serious about the economy both at home and across the world. The Chinese government knew that it must maintain a certain economic growth rate on one hand, make reforms on the other, and strike a delicate balance between the two.

Reforms have always been at the top of the government’s agenda and currently China’s focus area is domestic commerce system. China has progressed in four areas in terms of reforming the domestic commerce system. First on the basis of thorough research, it has formulated the plan for the comprehensive domestic commerce reform and mapped out the overall strategy for advancement. Secondly, relevant legislation as it was insufficient in this area before, especially in comparison with that in foreign trade. The laws and rules were developed in state: a) Merchandise Circulation Law, and rules on recycling and disassembling of end-of-life vehicles; b) Rules on pawnbroking; and, c) Rules on fair trading between retailers and suppliers. The rules have been listed on the State Council’s legislation plan for 2014.

China maintains that economies at different development phases should embrace the spirit of solidarity in difficult times, discard zero-sum practices, and join hands to meet common challenges. China teaches a lesson to the nations i.e, “To reshape the economy, it is important to institute an open, cooperative global economic and trade system.”

Open economic system is considered as the stimulus factor behind Chinese economic growth. Encouraging progress has been made in five areas in terms of modifying this system. Firstly, overhauling the foreign investment administration regime. China is revising the administration methods for overseas investment which will substantially streamline the verification procedures for setting up businesses overseas. Second, the further advancement of Shanghai Pilot Free Trade Zone. With State Council’s approval, 31 measures have been adopted for greater liberalization in the zone. Third, to create new models of processing trade and deepen reforms on administrative approval procedures, to accelerate Free Trade Agreement (FTA) strategies on the basis of FTAs with surrounding countries. Fourth, to move faster with the unification of laws governing domestic and foreign investments. Fifth, to promote other works related to building a new open economy such as advancing negotiations on environmental conservation, investment protection, government procurement and e-commerce under bilateral and multilateral frameworks in a positive and steady way.

In 2000, China initiated a new “Go Global” strategy allowing Chinese firms to invest overseas. In September 2007, China Investment Corporation (CIC) was launched with $ 200 billion fund. The key factors for this move were: to utilize massive accumulation of foreign exchange reserves and to obtain natural resources, such as oil & minerals.

In 2012, China invested in Canada, Australia and in some European countries. Singapore, Japan, South Korea, and the Philippines have also attracted bigger Chinese investment in comparison with other countries. In terms of size, oil, gas, and energy deals, China’s three energy giants, CNOOC, Sinopec, and Sinochem were the most noteworthy energy projects.

China has FTAs with ASEAN, Pakistan, Chile, Hong Kong, Macau, New Zealand, Singapore, Peru, and Costa Rica. China also has an economic co-operation framework agreement with Taiwan. China is currently in the process of negotiating FTAs with the co-operation council for the Arab States of the Gulf which include Saudi Arabia, Kuwait, the UAE, Qatar and Bahrain, Australia, Iceland, Norway, Switzerland, and the Southern African Customs Union which includes South Africa, Botswana, Lesotho, Namibia and Swaziland. In May 2012, China, Japan and South Korea agreed to begin negotiations for an FTA. China has also considered negotiating an FTA with India but has made little progress till date.

Few people in China are concerned about the projection of foreign trade in China, but it is observed by analysts that confidence of exporting enterprises is rising continuously and export situations are improving every single month. Few experts also comment that, China’s foreign trade no longer enjoys advantage, especially when it comes to price and cost. But it is evident that during the period following the promulgation of the decision of the 18th CPC Central Committee, the Chinese Government has reaffirmed that it treats all types of enterprises equal, and foreign investment policy remains unchanged. The existing environment for foreign enterprises in China is equally favourable as it was before and China still enjoys a comprehensive competitive edge, in shape of complete infrastructure, well-developed industrial support, a well-educated labour, and a trained workforce.

The competitiveness of China’s private enterprises is also strengthening. Since China’s WTO accession, their export growth rate has been 18.4 percentage points higher than the national average on a yearly basis. They have become the most dynamic market players with the greatest export potential achieved by cultivating a group of internationally competitive industries and businesses. China owns proprietary intellectual property rights to large-scaled complete plant equipment used in communication, power, rail transport, and enjoys conspicuous advantages in terms of price and technology.

Chinese leader, Deng Xiaoping is considered as the founder of Economic Reforms in China. It is due to his vision that Chinese Economy has become “The Economy of Scale” which means that transportation or shipping expenditures of a product are more than its cost of production. The economic reforms have transformed the Chinese economy and produced a period of spectacular growth.

China maintains that economies at different development phases should embrace the spirit of solidarity in difficult times, discard zero-sum practices, and join hands to meet common challenges. China teaches a lesson to the nations i.e, “To reshape the economy, it is important to institute an open, cooperative global economic and trade system.” The international community should continue to work towards diversity, openness and mutual benefit. Developed and emerging economies in particular should bring out their respective strengths to drive global economic growth by acting as the “double engines” of the global economy, reinforcing and benefitting each other. This way, we will definitely open up a new prospect of economic globalization.

The writer is CEO of Ruba SEZ Group and the President of Pak-China Joint Chamber of Commerce.
11
July

Rising Trade Costs Impair Trade Prospects

Written By: Dr. Zafar Mahmood

Trade costs, incurred locally and across the international borders, significantly affect international trade. Trade costs effectively form an important barrier to trade and thus impede the realization of gains from trade liberalization. Thus, any program of trade liberalization must take into account the role of trade costs. Owing to the importance of trade costs in explaining the size and direction of trade, experts are now increasingly focusing on its cost. Consequently, it has become an area of key interest within the modern stream of trade literature.


Global experience shows that countries that made concerted efforts to reduce trade costs have undoubtedly benefited, in terms of surge in their export earnings. Some of them have gained both comparative advantage and competitiveness and consequently are able to turn around their trade pattern.


One would like to ask a pertinent question, what exactly are the trade costs? They include all the costs incurred in getting goods to the final user, excluding the cost of producing the good itself. Hence, trade costs include transportation charges (both freight and time costs), policy barriers (tariffs and non-tariff barriers), information costs, contract enforcement costs, costs associated with the use of different currencies, local distribution costs (wholesale and retail) and legal and regulatory costs.


Sources of trade costs can be divided into two main categories. First category includes entirely bilateral factors of separation between the exporter and the importer, which are more dependent on factors like geographical distance, common border or sharing a common language than particular policy choices. The second category is composed of factors linked to international connectivity such as air or land or maritime transport services, tariffs and non-tariff measures, and other factors that facilitate or hinder trade.


Evidence shows that with growing multilateralism and regionalism in the world, countries have considerably reduced the tariff rates, on average less than five percent for rich countries, and with a few exceptions are on average between 10 to 20 percent for developing countries. With a drastic fall in tariffs on the one hand, there are, on the other hand, some other barriers to trade that are still hampering the trade performance. Most important amongst them are barriers relating to infrastructure and its quality.


Poor institutions and poor infrastructure distort strategic trade policy focus and objectives, not only in terms of the traditional mechanisms of tariffs and quotas but also of infrastructure and logistics, the so-called “behind the border issues.” Thus, besides the differences in economic size, technologies and factor endowments, the differences in trade costs, which act as a friction to trade, is an important reason as to why some countries trade more than others.


In an increasingly globalized and networked world, trade costs are of great importance from a trade policy perspective. This is because they act as a determinant of the pattern of bilateral trade and investment as well as of the geographical distribution of production. Moreover, they also determine a country’s ability to take part in regional and global production and supply chain networks. Many countries are eager to reap the benefits that such networks can bring, including trade and investment-linked technological spillovers and stronger employment demand in manufacturing industries. Understanding the sources of trade costs, and in particular the types of policies that can reduce such costs, is thus a key part of debate over production and supply chain networks going forward.


International trade costs are large and vary widely across countries and sectors. These costs are, in general, higher in developing countries than developed countries. This is mainly due to the existence of substantial tariffs and non-tariff measures accompanied by poor quality infrastructure, dysfunctional transport and logistics. Trade costs affect the balance between different sectors of an economy. Splitting up these costs help identify which area needs to be focused on in terms of policy decision. For example, if no account is made of trade costs and trade policy decision is solely based on comparative advantage then all resources will be diverted towards one particular sector at the expense of other sectors; thus creating a bias against other sectors of the economy.


Pakistan’s major trading partners are China, USA, UK, Saudi Arabia, Malaysia, Japan, Germany and UAE. EU has now emerged as Pakistan’s largest trading partner. Total trade between the two amounts to about $10 billion with Pakistan’s share in EU market of about 0.09% and the share of EU in Pakistani market is 11.39%. Pakistan also has strong trade ties with Asian countries like China, UAE, Saudi Arabia, and Malaysia. Main reason behind massive trade of Pakistan with Asian countries is lower transportation costs, similarities of consumer tastes and trading priorities.


The size of Pakistan’s current trade doesn’t truly reflect its full trade potential. This is mainly because the direction of Pakistan’s foreign trade, which is trade cost dependent, has not changed much over the time. Keeping in view the trade potential of Pakistan, it is imperative for Pakistan to pay serious attention to the issue of higher trade costs. Only then it will improve its position in global supply chain networks to realize the gains from international trade.


Trade cost estimates for Pakistan show a decline over the time. That is a good omen to realize the full trade potential of the country. The agricultur related trade costs are comparatively higher than non-agricultural, mainly due to the existence of policy barriers, including high tariffs and non-tariff barriers as well as trade related measures that hinder entry of imported agricultural products in the country. It is also because the processing and storage costs of agricultural commodities are higher than such costs for manufactured goods.


Reduction in trade costs can be attributed to improvement in port infrastructure and shipment. An index reflecting shipping connectivity for Pakistan shows an improvement from 19% in 2003 to 32% in 2012. As more than 95% of total freight trade of Pakistan is sea borne; thus, an improved and efficient port infrastructure that would reduce trade costs, would definitely promote trade.
Bilateral trade costs between Pakistan and UAE are the lowest, followed by Bangladesh, Saudi Arabia, Malaysia, UK and China, while the highest is with India.


Despite significant reduction in trade costs in recent times there remains a substantial room for lowering them further. High bilateral trade costs with some of the larger trading partners in particular calls for measures to reduce trade costs between trading partners. Thus, our policymakers need to address the dynamics of higher trade costs to improve country’s absolute and relative position in global trade.


Since higher trade costs lower the competitiveness of trade firms and limit the potential benefits of trade as well as impair trade prospects; it is, therefore, imperative for policymakers to take policy actions in the following direction to reduce trade costs:


• Effectively implement the commitments made in the WTO’s trade facilitation agreement, which Pakistan has recently signed; in particular by reducing red tape at the border crossing.
• Expedite clearance of all type of goods particularly perishable goods at border crossings.
• Improve port connectivity, cargo handling and means of transportation, i.e., through roads, railways and air links.
• Non-tariff barriers must be streamlined and harmonized with international standards.
• Reduce the cost effect of longer distance on trade with partner countries by developing soft connectivity through internet, publicity campaign and electronic media.

 

The writer is a Professor of Economics at School of Social Sciences and Humanities at NUST, Islamabad.

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Evidence shows that with growing multilateralism and regionalism in the world, countries have considerably reduced the tariff rates, on average less than five percent for rich countries, and with a few exceptions are on average between 10 to 20 percent for developing countries. With a drastic fall in tariffs on the one hand, there are, on the other hand, some other barriers to trade that are still hampering the trade performance. Most important amongst them are barriers relating to infrastructure and its quality.

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