The State of Domestic Commerce in Pakistan Study 2 - Effective Protection of Manufacturing Industries in Pakistan

THE STATE OF DOMESTIC COMMERCE IN
PAKISTAN

STUDY 2

EFFECTIVE PROTECTION OF
MANUFACTURING INDUSTRIES IN
PAKISTAN

The Ministry of Commerce
Government of Pakistan
November 2007

By
Innovative Development Strategies (Pvt.) Ltd.
House No. 2, Street 44, F-8/1, Islamabad

Table Of Contents

List of Abbreviations ............................................................................................................. i
Acknowledgments .............................................................................................................. iv

Executive Summary .......................................................................................................... 3

Section 1: Introduction ................................................................................................ 6

Section 2: Review of Industrial Policy in Pakistan .................................................... 8

Section 3: Structure of Nominal Protection ............................................................. 12

Section 4: Effective Protection: A Review of Theoretical and
Empirical Literature ................................................................................. 19
Section 5: Methodology, Data and Results .............................................................. 24

Section 6: Interpretation of Results .......................................................................... 26

Section 7: An Assessment ........................................................................................ 29

Section 8: Recommendations ................................................................................... 33

References ............................................................................................................ 36
Annex I .................................................................................................................. 37
Annex II ................................................................................................................. 38
Annex III ................................................................................................................ 43

List of Tables

Table 1.1: Growth Performance of Components of Commodity Producing Sector of GNP
(% Growth At Constant Factor Cost) .............................................................. 6
Table 3.1: Industrial Tariffs ........................................................................................... 12
Table 3.2: Distribution of Tariff Rates ............................................................................ 13
Table 3.3: Tariff Structure 2001-02
a
.............................................................................. 14
Table 3.4: Tariff Structure - 2004-05 ............................................................................. 16
Table 5.1: Top Ten Effectively Protected Industrial Sectors .......................................... 25
Table 5.2: Ten Least Effectively Protected Industrial Sectors ....................................... 25
Table 5.3: Top 15 Nominally Protected Industrial Sectors ............................................. 25
Table 5.4: Ten Least Nominally Protected Industrial Sectors ........................................ 25
Table 7.1: Some inputs facing exorbitant tariffs ............................................................ 31
Table 8.1: A Proposed Tariff Structure .......................................................................... 35
Table 8.2: Revenue Implications of Tariff Reform ......................................................... 35

Innovative Development Strategies (Pvt)
i
List of Abbreviations

ABAD Association of Builders and Developers
ADB Asian Development Bank
ADBI Asian Development Bank Institute
APCA All Pakistan Contractors Association
ATT Afghan Trade Transit
BAF Bank AlFalah
BCI Business Competitiveness Index
BOR Board of Revenue
CAA Civil Aviation Authority
CBM Cubic meter
CBR Central Board of Revenue
CDA Capital Development Authority
CIB Credit information bureau
CMR Contract for the International Carriage of Goods by Road
CPI Corruption Perceptions Index
CPIA Country Policy and Institutional Assessment
DFID Department for International Development
DHA Defense Housing authority
EDF Export Development Fund
EIU Economist Intelligence Unit
EOS Executive Opinion Survey
EPB Export Promotion Bureau
ESCAP Economic and Social Development in Asia and the Pacific
FBS Federal Bureau of Statistics
FCL Full Container Load
FDI Foreign Direct Investment
FIAS Foreign Investment Advisory Service
Ft Foot
FY Fiscal Year
GCI Global Competitiveness Index
GCR Global Competitiveness Report
GD Goods Declaration
GDP Gross Domestic Product
GoP Government of Pakistan
GOR Government Officials Residences
GRT Gross Register Tonnage
GST General Sales Tax
HBFC Housing Building Finance Corporation
HBL Habib Bank Limited
HDR Human Development Report
HFIs Housing Finance Institutions
IFC International Finance Corporation
IFS International Financial Statistics
IMF International Monetary Fund
ISAL Informal Subdivision of Agricultural Land
ISO International Standards Organization
IT Information Technology
ITU International Telecommunications Union
Survey Report on Domestic Commerce

Innovative Development Strategies (Pvt) ii
KBCA Karachi Building Control Authority
KDA Karachi Development Authority
KESC Karachi Electric Supply Corporation
KM(s) Kilometer(s)
KPT Karachi Port Trust
KSE Karachi Stock Exchange
LCL Less Than Container Load
LOA Length Overall
MCB Muslim Commercial Bank
MENA Middle East and North Africa
MOC Ministry of Commerce
MOD Ministry of Defense
MTDF Medium Term Development Framework
NBP National Bank of Pakistan
NCS National Conservation Strategy
NER Net Primary School Enrollment Rate
NHA National Highway Authority
NIE Newly industrialized economy
NIT National Institute of Transport
NLC National Logistics Cell
NTN National Tax Number
NTRC National Transportation Research Center
NTTFC National Trade and Transport Facilitation Committee
NWFP North West Frontier Province
PASSCO Pakistan Agricultural Storage and Services Corporation
PEC Pakistan Engineering Council
PHDEB Pakistan Horticulture Development and Export Board
PIAC Pakistan International Airlines Corporation
PIDE Pakistan Institute Of Development Economists
PIHS Pakistan Integrated Household Survey
PKR Pakistani Rupee
PQA Port Qasim Authority
PR Pakistan Railways
PREF Pakistan Real Estate Federation
PSDP Public Sector Development Program
R&D Research and Development
REER Real Effective Exchange Rate
REITs Real Estate Investment Trusts
RICS Royal Institute of Chartered Surveyors
SAI Social Accountability International
SBP State Bank of Pakistan
SKAA Sindh Katchi Abadis Authority
SME Small and Medium Enterprises
SPS Sanitary and Phytosanitary
SRO Statutory Regulation Order
Std Standard
TEP Total Factor Productivity
TEU Twenty-Foot Equivalent Units
TI Transparency International
TOR Terms of Reference

Innovative Development Strategies (Pvt) iii
TSDI Transport Sector Development Initiative
TTFP Trade and Transportation Facilitation Program
UK United Kingdom
UNDP United Nations Development Program
US United States
USA United States of America
USC Utility Stores Corporation
USD United States Dollars
WAPDA Water and Power Development Authority
WDI World Development Indicators
WEF World Economic Forum
WGI Worldwide Governance Indicators
WTO World Trade Organization

Innovative Development Strategies (Pvt) iv
Acknowledgment

The IDS team owes a debt of gratitude to the officers of the Ministry of Commerce for their
guidance, assistance and feedback during the course of this study. Our special thanks go out,
in particular, to Syed Asif Ali Shah, Secretary; Mr. Naseem Qureshi and Mr. Ashraf Khan,
Additional Secretaries; Mr. Abrar Hussian, Joint Secretary; Syed Irtiqa Zaidi, Consultant and
Mr. Qaseem Subhani, Section Officer, for sparing their precious time and efforts for the
study.

We feel a deep sense of gratitude for the Minister for Commerce. Mr. Humayun Akhtar
Khan, who took out considerable time from his busy schedule to guide us. It was his sincere
and deep conviction which enabled us to conduct and compile this detailed and
comprehensive study on Domestic Commerce of our country. His apt guidance and keen
analytical oversight were extremely helpful in finalizing the study and formulating the policy
recommendations.

This study has benefited from comments received from the following:
1. State Bank of Pakistan, Karachi.
2. Federal Board of Revenue, Government of Pakistan, Islamabad.
3. Planning and Development Division, Government of Pakistan, Islamabad.
4. Trade Development Authority, Government of Pakistan, Karachi.
5. (Management Consultants) Establishment Division, Government of Pakistan,
Islamabad.
6. Finance Division, Government of Pakistan, Islamabad.
7. Pakistan Institute of Development Economics, Islamabad.
8. NTTFC, Karachi.
9. FPCCI, Karachi.
10. Planning and Development Board, Government of Punjab, Lahore.
11. Planning and Development Board, Government of NWFP, Peshawar.
12. Planning and Development Board, Government of Sindh, Karachi.
13. Planning and Development Board, Government of Balochistan, Quetta.
14. Investment and Commerce Department, Government of Punjab, Lahore.
15. Industries, Production & Supplies Initiatives, Government of Pakistan, Islamabad.
16. National Tariff Commission, Government of Pakistan, Islamabad.
17. SMEDA, Lahore.
18. Statistics Division, Government of Pakistan, Islamabad.

Innovative Development Strategies (Pvt) 1
EFFECTIVE PROTECTION OF
MANUFACTURING INDUSTRIES
IN PAKISTAN

by

DR.MUSLEH-UD-DIN
DR. EJAZ GHANI
TARIQ MAHMOOD
DR. M. K. NIAZI

Executive Summary

1. Pakistan had adopted a policy of import substitution with objectives of self-
sufficiency and protection of domestic infant industries. Manufacturing industries in Pakistan
are important contributors to GDP as well as overall employment. The sector growth had
peaked to 14% in 2003-04 and then declined during the following two consecutive years.
Manufacturing sector is a major payer in the external trade; produces 90 percent of exports,
including about 10 percent semi-manufactures, and uses about 60 percent of imports. The
measures of effective protection computed earlier are no longer relevant and there is an
urgent need for computing up-to-date measures of effective protection using the latest cost
structure and nominal tariff rates. The present study aims to fulfill this objective.

Review of Industrial Policy in Pakistan

2. During the early years in the history of Pakistan the need to establish a diversified
industrial base, to build institutions and to put into place critical infrastructure largely shaped
the economic policies. After 1952 excessive protection to industry severely distorted
economic incentives not only for agriculture but also within the industrial sector. During the
Sixties, the government set out to improve economic management and to deal effectively
with corruption and unfair practices by the private sector especially in industry and retail
trade. Economic policies during the sixties continued to be heavily biased towards promoting
industrial growth in Pakistan. The government maintained an over-valued exchange rate to
ensure the cheap availability of capital goods and other imported inputs to the industrial
sector. The government adopted a series of measures to promote exports of manufactured
goods, e.g. Export Bonus Scheme (EBS), which subsidized manufactured goods exports
through a system of bonus vouchers.
3. The decade of seventies was beset by a number of exogenous shocks like the
secession of East Pakistan led to a disruption of trade relations, fourfold increase in
petroleum prices, rice, cotton, and sugarcane remained vulnerable to wide fluctuations in
international commodity prices and agricultural output, especially the cotton crop, was
adversely affected by flooding and pest attacks that caused significant macroeconomic
instability.
4. The industrial policy during the Eighties tried to reverse the process started during
Seventies. The share of the private sector in total investment increased from 41.39 per cent in
1980-81 to 44 per cent in 1989-90. The Structural Adjustment and Stabilization Programs
(SAP) was started in 1988, and major changes were introduced in the industrial policy during
the Nineties. The government launched a privatization program in the Nineties to enhance the
role of the private sector in the economy, and to address the problem of operational
inefficiency in public sector enterprises.

Structure of Nominal Protection

5. The structure of protection is defined as a set of policies that influence the value-
added at domestic prices significantly influences the pattern of resource allocation and the
growth and composition of industrial output. The emphasis of Pakistans trade policies in
recent years has been on greater openness through trade liberalization with minimal tariff and
non-tariff barriers and as part of this trade liberalization program the maximum rate of
custom duty has been reduced to 25 percent
1
with only 5 tariff slabs. Reforms in the tariff
structure have led to a reduction in the average tariff on industrial products from 20.2% in
2001-02 to 17.63% in 2002-03. Average tariffs for fully processed products are lower than on
raw materials are mineral, stone and ceramics, plastic, glass, and miscellaneous manufactured
products. The government has announced several new tariff measures in the budget for fiscal
2004-05: In particular, the customs duty on the import of plant, machinery and equipment has

1
However, there are few exceptions that relate to automobiles and alcoholic beverages.

been brought down to 5%, the customs duty on import of industrial raw materials has been
reduced, and the duty structure for the automotive sector has been rationalized. The average
tariff rates for food products/food preparations (fully processed) and textiles (fully processed)
are 24.04% and 24.31% respectively.

Effective Protection: a Review of Theoretical and Empirical Literature

6. The concept of effective protection was first developed as a tool for summarizing the
total effect of input and output tariffs on a production process. At very initial stages, the
concept was criticized on the grounds that it is inappropriate to draw general equilibrium
inferences from a measure that is essentially partial equilibrium. Corden formulated the
concept of effective protection in the following expression
g
j
= (t
j
a
ij
t
i
)/(1 a
ij
)
7. Cordens formulation has been criticized on the basis of its simplicity and its being a
partial equilibrium model and an associated problem of fixed coefficients. Despite all
criticisms Cordens formula has survived.
8. Anderson (1995) modified the definition of effective protection the effective rate of
protection for sector j is defined here as the uniform tariff which is equivalent to the actual
differentiated tariff structure in its effect on the rents to residual claimants in sector j. This
definition applies to general as well as partial equilibrium economic structures, has obvious
relevance for political economy models and seems to correspond to the motivation for the
early effective protection literature.

Methodology, Data and Results

9. This study uses the Cordens formula to compute the rates of effective protection. The
formula is given by the following expression
g
j
= (t
j
a
ij
t
i
)/(1 a
ij
)
Where
g
j
= effective protective rate for activity j;
t
j
= tariff rate on activity j;
t
i
= tariff rate on activity i;
a
ij
= share of industry i in cost of the industry j.
10. A detailed questionnaire was developed and pre-tested to collect data for the study.
However, listing of firms for sampling cold not be obtained from the Federal Bureau of Statistics.
In view of time constraints, therefore, the Dorosh et al (2006) Input-Output Table for 2000-01
updated from the Federal Bureau of Statistics Input-Output Table 1990-91 was used. The
nominal coefficients for 2006 used in this analsyis were taken from the CBR website. Average
nominal protection rate for all manufacturing industries covered in the study is 16.9%, whereas,
average effective protection rate turns out to be 27.8%. The results indicate that effective rate of
protection is quite high for leather and leather products, foot wear, transport equipment and some
textile sub-sectors. The sectors with lowest effective protection rates are jewelry (precious metal),
vegetable oils, other textile products, bakery products, and fertilizers and pesticides.

An Assessment

11. Empirical studies show that the largest productivity gains arise from reducing input
tariffs. The effect of reducing input tariffs significantly increases productivity and that this
effect is much higher than of reducing output tariffs, as a result costs of production have been
Effective Protection of Manufacturing Industries in Pakistan
decreased owing to the reduced tariffs. Foreign direct investment has started flowing in,
enhancing prospects of better technology and integration with global markets.
12. Pakistan started its tariff reforms in early 90s. The trade-to-GDP ratio has risen from close
to 26 percent in 1999-2000 to estimated 34 percent in 2005-06, Exports and imports increased by
16% p.a. and 27% p.a. respectively in the past seven years. The share of manufactured exports
also rose, reaching to 90% in 2005-06. The GDP growth also picked up in the recent past,
reaching 7.6% in the past three years 2003-06 compared with 2% in 2000-01.
13. The trade liberalization and tariff reforms have benefited consumers in several ways,
including access to a large variety of goods at cheaper rates and better quality of goods.
Poverty levels, which had been increasing until 2001-02, started decreasing with the revival
of growth. The recent PSLM shows a decrease of 10% in poverty during FY02-05, although
there are reports of more unequal income distribution.
14. Trade taxation, both on imports and exports, leads to anti-export bias because it
makes import competing activities more profitable. Anti-export bias refers to the bias
inherent in trade policies that promote some sectors to the detriment of export sectors. Anti-
export bias may arise due to several of the following reasons:
Trade taxation, both imports and exports
Tariffs on domestically produced goods
Tariffs on imported inputs used in production of exportables, and
Over-valued exchange rate.

Recommendations

15. Manufacturing sector plays a very important role in economic growth and well-being
of the country. There is an urgent need to remove protection of inputs to make these
industries more competitive. The government has taken a number of steps to improve the
business climate in the recent past, several problem areas remain. The broad contours of the
recommended reform are given below.
We suggest that the government set this as the long term objective and reduce the
effective protection to in the range of 5-10% in near future, appropriately sequenced
over say 3-5 years.
Some new activities may become necessary to promote for the development of certain
industries. that include the following: (1) incentives should be provided only for new,
sunrise activities, not sunset ones; (2) there should be clear benchmarks for success
or failure; (3) support must have a predetermined end (a so-called sunset clause); (4)
public support should target activities such as worker training or infrastructure
investment, rather than sectors such as electronics; (5) subsidized activities should
provide clear potential for externalities; and (6) agencies involved in these activities
should be autonomous enough to avoid capture by private interests, but should
maintain links with the private sector to maximize economy-wide gains.
Political economy considerations are very important at the design stage if reforms are
to be sustainable.
The trade reform needs to be carefully designed and to ensure the credibility.
The reform would be more credible if the price reform is accompanied by non-price
reforms, such as investments in infrastructure and human development, better access
to credit, promotion of competition, competitive exchange rate, and incentives to
adopt improved production technologies.


Section 1
Introduction

1. Manufacturing industries in Pakistan are important contributors to GDP as well as
overall employment. The last few years have witnessed an impressive growth in
manufacturing sector in Pakistan. In fact the sector recorded the fastest growth among the
commodity producing sectors (Table 1.1). The sector growth had peaked to 14% in 2003-04
and then declined during the following two consecutive years. The manufacturing sector is
very important for GDP growth because of its forward and backward linkages and large
weight.

Table 1.1: Growth Performance of Components of Commodity Producing Sector of GNP
(% Growth At Constant Factor Cost)
Commodity
Producing
Sector
Agriculture Mining &
Quarrying
Manufacturing Construction Electricity &
Gas
Distribution
1980s 6.5 5.4 9.5 8.2 4.7 10.1
1990s 4.6 4.4 2.7 4.8 2.6 7.4
2002-03 4.3 4.3 6.6 6.9 4 -11.7
2003-04 9.2 2.3 15.6 14 -10.7 56.8
2004-05 9.2 6.7 9.6 12.6 18.6 3.5
2005-06 4.3 2.5 3.8 8.6 9.2 -8.4
2002-06
Average
6.75 3.95 8.9 10.525 5.275 10.05
Source: Pakistan Economic Survey 2005-06

2. The manufacturing sector has certain important features. The sector is a major payer
in the external trade; produces ninety percent of exports, including about ten percent semi-
manufactures, and uses about sixty percent of imports. For example, it is relatively less
dependent on weather than agriculture; is a relatively dynamic sort of activity; and may
respond to incentive/regulatory structure more promptly than other commodity producing
activities. Due to these reasons, it would be interesting to analyze the performance of
manufacturing industries.
3. Soon after independence, Pakistan had adopted a policy of import substitution with
objectives of self-sufficiency and protection of domestic infant industries. Several protective
instruments, tariffs and non-tariff barriers such as import licensing and import ban of certain
goods, remained in common use for decades. In 1990s, forced by international circumstances
and pressure from donors, the country started to undertake economic reforms. On the one
hand the tariffs and non-tariff barriers were drastically reduced or abolished altogether. On
the other hand foreign and domestic investors were given incentives to establish industrial
units in the country. The purpose of these reform measures was to improve competitiveness
and efficiency.
4. Tariffs cause distortions in two important ways. One is that tariffs cause the real
exchange rate to appreciate, which makes exporting less cost competitive. Another is that
import tariffs raise the price of imported goods above world prices, and these price effects
spill over into the overall cost structure. Tariffs protect domestic industry and shield them
from international competition, enabling them to charge higher prices. Exporters are normally
facilitated and can buy imported inputs at world prices, still they face a higher other local
costs than do competitors in countries with lower effective protection, which constitutes a
hidden tax on exporters.
5. The manufacturing sector in Pakistan has long operated in a tight regulatory
environment characterized by controls on entry and exit, prices, credit, foreign exchange,
imports, investment etc. These measures were meant to promote resource allocation
according to national priorities, to address market failure, and to protect consumers from anti-
competitive practices. However, the heavy state control introduced various distortions in the
economic system and led to inefficiencies, red-tape and corruption, all of which stifled
private enterprises. Over the last two decades, Pakistan has significantly reformed its
regulatory framework, though still more needs to be done. In particular, the incentive
structure has to be so reformed that it promotes dynamic comparative advantage and ensures
consistency between degree of protection and fiscal incentives.
6. Barriers to trade both indirect and direct define the degree of protection that domestic
economic activity is provided. The higher the barriers the more protected the activity.
Effective protection rates seek to quantify the protection offered to local economic activity as
a result of these barriers. The measures of effective protection computed earlier are no longer
relevant and there is an urgent need for computing up-to-date measures of effective
protection using the latest cost structure and nominal tariff rates. The present study aims to
fulfill this objective.


Section 2
Review of Industrial Policy in
Pakistan

7. The need to establish a diversified industrial base, to build institutions and to put into
place critical infrastructure largely shaped the economic policies during the early years in the
history of Pakistan. A key aspect of economic policy in these early years was the provision of
strong protection to industries after 1952 when serious shortages of foreign exchange
emerged. Excessive protection to industry severely distorted economic incentives not only for
agriculture but also within the industrial sector. For example, on the recommendation of the
Economic Appraisal Committee, tariffs on consumer goods were set higher than the tariffs on
intermediate and capital goods. This cascaded tariff structure obviously favored the consumer
goods industries by restricting the import of consumer goods and hampered the establishment
of capital goods and intermediate goods industries since imports of these goods were either
freely allowed or were subject to low tariffs. Furthermore, the policy regime was
characterized by an excessive reliance on economic controls in the form of administered
prices, industrial licensing, and a host of other regulations.
8. During the Sixties, the government set out to improve economic management and to
deal effectively with corruption and unfair practices by the private sector especially in
industry and retail trade. Besides introducing strict price and profit controls in the form of
administered prices and profit margins, it also dealt with the menaces of hoarding, black-
marketing, and smuggling with an iron hand. The initial impact of these measures was
favorable and the general price index registered a fall in the early months after the 1958
Martial Law. But direct controls on prices and profits weakened the incentive to expand
production. The government soon realized that the direct controls had introduced rigidities in
the system and thus hampered the growth of the manufacturing sector. Thus the government
began to dismantle the price control system and moved towards a general policy of economic
deregulation through a greater reliance on the market mechanism.
9. Economic policies during the sixties continued to be heavily biased towards
promoting industrial growth in Pakistan. The government maintained an over-valued
exchange rate to ensure the cheap availability of capital goods and other imported inputs to
the industrial sector. Also, by keeping prices of agricultural inputs at below world market
prices, it made domestic raw materials available to the industrial sector at very cheap prices.
This, together with the policy of import controls and tariffs, tax concessions such as tax
holidays, accelerated depreciation allowances, and loans at very low interest rates, markedly
accentuated the pro-industrial bias in the growth strategy. To further help its industrialization
drive, the government adopted a series of measures to promote exports of manufactured
goods. The most significant measure was the introduction of Export Bonus Scheme (EBS),
which subsidized manufactured goods exports through a system of bonus vouchers
2
.
Furthermore, preferential access to credit and a host of fiscal incentives were part of a policy
package meant to enhance export competitiveness. These policies not only led to robust
growth in the exports of manufactured goods, but also helped diversify the product
composition of Pakistans exports.
10. While protectionist policies did contribute to industrial development and growth but
had several shortcomings. In particular, protection of domestic industry through high rates of
effective protection led to inefficiencies in domestic production, prevented the country to
realize its full export potential, and contributed to a worsening of the countrys balance of
payments (mainly because of the fact that increase in machinery and raw material imports
outweighed growth in exports). The incentives provided to manufactured goods exports
during this era were partly meant to offset this anti-export bias inherent in the policy of
import substituting industrialization followed during most of the decade, barring a few years
when import regime was liberalized somewhat
3
.
11. The decade of seventies was beset by a number of exogenous shocks that caused
significant macroeconomic instability. Firstly, the secession of East Pakistan led to a
disruption of trade relations between the two countries and deprived West Pakistan of half of
its export market. Secondly, with a fourfold increase in petroleum prices induced by the
newly created OPEC cartel, the Seventies witnessed phenomenal increases in Pakistans
import bill alongside a slowdown in exports due to the recession in the world economy. This
deterioration in terms of trade led to widening resource and trade gap. Thirdly, Pakistans
commodity exports rice, cotton, and sugarcane remained vulnerable to wide fluctuations
in international commodity prices. Fourthly, agricultural output, especially the cotton crop,
was adversely affected by flooding and pest attacks.
12. In 1972, the government nationalized all private banks and insurance companies, and
a large number of manufacturing units with the stated objective of reducing the concentration
of wealth. The governments nationalization drive is generally held responsible for the weak
performance of the large-scale manufacturing sector especially in the first half of the
Seventies. It must be emphasized, however, that the poor performance of the industrial sector
owed as much to the policy of nationalization as to the pattern of industrialization that
developed during the earlier decades. This is borne out by the fact that there were already
signs of weakening in the growth momentum of the industrial sector by the end of the Sixties.
The inefficient allocation of resources promoted through excessive protectionism eroded the
capacity to sustain high growth rates in the manufacturing sector.
13. During this period a strong small-scale industrial sector emerged which was ignored
in the early years due to the capital-intensive bias of Pakistan's industrial regimes. Small scale
industries as diverse as leather manufactures, sports goods, and surgical instruments not only
helped diversify Pakistan's industrial structure, but also created employment opportunities for
the countrys growing labor force. A combination of exogenous and policy factors were
responsible for the growth of small-scale industries. First, private investment was diverted to
small-scale industrial units as a result of nationalization policies that exclusively targeted the
large-scale manufacturing units. Second, trade union activities in large-scale manufacturing
made investment in these units less attractive, thus contributing to the growth of smaller
production units. Third, export-oriented small-scale industries such as carpets, and garments
and made-up textiles received a boost owing to devaluation of the rupee. Fourth, remittances

2 The bonus vouchers often carried a high premium in the market as import licenses were automatically
issued against the vouchers. More than 80 percent of the total export subsidies were accounted for by this
scheme (Kemal: 1978).
3 To a large extent, import liberalization was made possible by the increase in foreign loans and grants. The
process of import liberalization, however, had to be cut short owing to drastically reduced foreign aid inflows
in the wake of the 1965 war with India.

from abroad stimulated the domestic market for consumer goods, a large proportion of which
were produced by the small-scale industry.
14. The industrial policy during the Eighties tried to reverse the process started during
Seventies. Consequently, high priority was given to the restoration of business confidence,
which was considerably eroded in the previous decade due to the nationalization drive of the
Bhutto regime. Besides denationalization of a number of public sector enterprises, the
government provided a host of incentives to revive private investment. Moreover, the
government initiated wide ranging structural reforms that aimed at liberalizing and
deregulating the economy, and streamlining the investment licensing procedures. Though the
initial response of the private sector to the reform package was lukewarm, by the mid-
Eighties there was a pick up in private investment: the share of the private sector in total
investment increased from 41.39 per cent in 1980-81 to 44 per cent in 1989-90. Nevertheless,
the total investment failed to rise.
15. The Structural Adjustment and Stabilization Programs (SAP) was started in 1988, and
major changes were introduced in the industrial policy during the Nineties. One of the major
objectives of the industrial policy during this period was to address the structural weaknesses
of Pakistans industrial sector which stemmed from years of import substituting
industrialization, and the nationalization policy of the Seventies. In addition, emphasis was
also placed on improving the viability of Pakistans industrial sector in an increasingly
competitive international economic environment. A host of measures including fiscal
incentives, tax holidays, de-licensing of investment regimes, and reduction of tariffs on
capital goods were adopted to encourage private investment. Despite the fact that these
incentives had a favorable impact on private investment, growth in industrial output was
sluggish as compared to the previous decade, presumably reflecting a lagged effect of
investment on output growth.
16. With an objective to enhance the role of the private sector in the economy, and to
address the problem of operational inefficiency in public sector enterprises, the government
launched a privatization program in the Nineties. However, the response of the private sector
to privatization was quite weak, not least because of the fears that the government might
continue to meddle in the affairs of the privatized enterprises. Not surprisingly, therefore, the
pace of privatization was slower than planned and only 90 units in the public sector had been
privatized by 1995, while larger units such as telecommunications are still on offer. In
addition to its privatization drive, the government opened up the power sector to private
investment, which led to the setting up of power generation plants by the independent power
producers (IPPs). However, the performance of these privately financed projects was marred
by allegations of corruption and litigation between the government and the IPPs on electricity
tariffs and other issues. While the question of whether or not the independent power
producers contributed to improving the supply and distribution of power in an efficient
manner is debatable, the controversy surrounding these projects considerably eroded business
confidence in Pakistan.
17. At this point it seems appropriate to draw the attention of the reader to the special role
of public sector towards industries and the process of industrialization. As Pakistani
entrepreneurs were reluctant to invest in the non-traditional industries Pakistan Industrial
Development Corporation (PIDC) was set up in 1958 with the mandate to set up state
enterprises in the non-traditional manufacturing industries and to transfer the profit making
units to the private sector. Nevertheless, most of the manufacturing activities until 1971 were
carried out by the private sector and the role of the public sector was mainly restricted to the
provision of basic infrastructure. Beginning in 1972, a wide range of industries were
nationalized including iron, steel, basic metals, heavy engineering, motor vehicles, chemicals
and petrochemicals, cement, rice milling, flour milling, and cotton ginning. Consequently, the
number of Industrial Public Enterprises (IPEs) increased from 22 in 1972 to 55 in 1977. The
Seventies also witnessed heavy public investment in steel mills, fertilizer and cement plants,
and several sugar and textile mills. The nationalization drive accompanied by the increasing
dominance of the public sector during the Seventies severely dented business confidence
which led to a sharp reduction in private investment.
18. Though the role of the public sector has been drastically curtailed as a result of
deregulation and privatization policies initiated in the 1980s, some industries continue to be
dominated by the state owned enterprises. Some of these enterprises produce primary raw
materials and intermediate inputs and resultantly the inefficiencies of the public sector have
an adverse impact on the downstream industries. For example, the inefficiencies of Pakistan
Steel have been the major stumbling block to the engineering industries. Similarly, the
engineering industries in the public sector make the investment expensive and the otherwise
viable investments are made less profitable. All the remaining public enterprises in the
manufacturing sector should be divested with the clear understanding that the import duties
on such products would be rationalized.


Section 3
Structure of Nominal Protection

19. The structure of protection is defined as a set of policies that influence the value-added at
domestic prices significantly influences the pattern of resource allocation and the growth and
composition of industrial output. The degree of stringency of import restrictions, including tariff
and non-tariff barriers to trade, largely determines the profitability of import substitutes and the
anti-export bias in the industrial policy. It is obvious that protection to domestic industries which
removes the distortions arising from the differential between static and dynamic comparative
advantage is welfare inducing. However, protective measures which create more distortions than
they offset, result in the lowering of welfare.
20. The emphasis of Pakistans trade policies in recent years has been on greater openness
through trade liberalization with minimal tariff and non-tariff barriers and the market based
exchange rate system. The ongoing trade liberalization program comprises reduction of import
tariffs, simplification and rationalization of tariff structure, and deregulation of administrative
controls including quantitative restrictions on imports. The maximum rate of custom duty has
been reduced to 25 percent
4
with only 5 tariff slabs, para-tariffs have been eliminated and the
scope of the negative list has been drastically reduced over the years; imports being restricted
generally on very specific religious, health, and security considerations. Reforms in the tariff
structure have led to a reduction in the average tariff on industrial products from 20.2% in 2001-
02 to 17.63% in 2002-03 (Table 3.1).

Table3.1: Industrial Tariffs
Simple Average Rates 2001-02
a
2002-03
b
2004-05
b

Industrial Products 20.2 17.63 17.09
Normal Maximum Rate 30 25 25
Number of Standard Rates* 4 4 4
Source: a Trade Policies in South Asia: An Overview, Volume I: An Overview
b Authors' own calculations
* Currently there are 5 tariff slabs.

21. Pakistan has completely dismantled its apparatus of quantitative restrictions meeting its
obligations to the WTO, and tariffs are now the main trade policy instrument. In the medium
term, the government is committed to maintaining the liberalization process which has resulted in
the substitution of quantitative restrictions with tariff measures, reduction in the level and
disparities in tariffs, and the reduction in the anti-export bias.
22. The main aims of the trade policy reforms are: a cascaded tariff structure in an attempt to
encourage greater value addition; greater uniformity across activities at the same stage of
production; and promotion of investment by lowering the cost of machinery through reduction in
the rate of taxation of imported machinery. These reforms have resulted in a more equitable

4 However, there are few exceptions that relate to automobiles and alcoholic beverages.
incentive structure for import competing activities, reduced the bias against exporting activities as
well as distortions in the domestic price structure, and paved the way for enhancing the efficiency
of domestic manufacturing activities.
23. Table 3.2 highlights the tariff structure for the manufacturing sector for the year 2003-04,
the latest year for which a detailed tariff schedule is available. To analyze the protection structure
and the level of protection, the industrial sector has been divided into 30 broad categories each
subdivided into processed and semi-processed goods, and raw materials
5
. The simple average
tariff
6
on all products is below 25%, which is the normal maximum tariff rate. However, for the
beverages and transport and transport equipment sectors
7
the average tariffs are 78.8% and
34.49% respectively. Whereas high tariff rates on beverages are imposed to discourage the import
of alcoholic beverages, high tariff rates for transport and transport equipment sector are meant to
protect the nascent automotive sector in Pakistan.

Table 3.2: Distribution of Tariff Rates
Tariff Rate Percent of Tariff
Lines in 2001-02
a

Percent of Tariff
Lines in 2002-03
b

Percent of Tariff Lines
in 2004-05
b

5% 10.1 17.05 25.09
10% 32.2 26.27 21.12
20% 17.2 13.91 14.54
25% 39.4 41.53 35.95
Source: a Trade Policies in South Asia: An Overview, Volume I: An Overview
b Authors' own calculations

24. As part of the overall tariff reduction program, more and more tariff lines have been
brought into lower tariff slabs: tariffs on a number of processed goods have been reduced from
20% to 10%, while tariffs on raw materials and components of various kinds have been curtailed
from 10% to 5%. There is an evidence of cascading in the nominal protection structure as the
average tariffs for raw materials, semi-processed, and fully processed products are 12.16%,
13.22%, and 20.09% respectively. At a disaggregated level, all major sectors including food
processing, textiles, leather products, chemicals, and iron and steel products etc. have a cascaded
tariff structure.
25. The few exceptions for which average tariffs for fully processed products are lower than
on raw materials are mineral, stone and ceramics, plastic, glass, and miscellaneous manufactured
products
8
.
26. Despite the steady reduction of the top rates and the removal of zero-duty slab, tariffs in
Pakistan are still quite dispersed. The overall standard deviation is 11.80 and coefficient of
variation is 67%, whereas for the raw materials, semi-processed, and fully processed products
standard deviation and coefficient of variations are 7.31, 7.09, and 12.97; and 60%, 54%, and
65% respectively (see Table 3.1). Presently, over 40% of the tariff lines are at 5% or 10% slab,
14% at 20% and almost 40% at 25% slab (Table 3.2).
27. In an attempt to further rationalize the tariff structure, the government has announced
several new tariff measures in the budget for fiscal 2004-05. In particular, the customs duty on the
import of plant, machinery and equipment has been brought down to 5%, the customs duty on
import of industrial raw materials has been reduced, and the duty structure for the automotive

5 Of the 5268 tariff lines, 446 are classified as raw materials (1st stage of processing), 1378 as semi -
processed goods, and 3444 as fully processed products.
6 Simple average or mean tariff is the un-weighted average of the effectively applied rates for all products
subject to tariff. Simple averages are generally deemed to be better indictors of tariff protection than
weighted averages, the latter being biased downward because higher tariffs discourage trade and reduce
the weights applied to these tariffs.
7 These product categories include only processed goods.
8 Miscellaneous manufactured products include articles such as tools, cutlery, spoon, articles of base metal,
watches, toys etc.

sector has been rationalized.
9
Notwithstanding these initiatives, the structure of protection
continues to favor consumer products as against industrial products and products that can be
classified as capital goods. For example, the average tariff rates for food products/food
preparations (fully processed) and textiles (fully processed) are 24.04% and 24.31% respectively.
On the other hand, the average tariff rate for electrical machinery is 17% and for non-
electrical/mechanical machinery it is 12.72%. A more even structure of protection will promote
competition and encourage an efficient allocation of resources, thereby benefiting all the market
participants.
28. It is instructive to draw a comparison between average tariffs and the level of dispersion
in the years 2001-02 and 2005-05. It is evident that not only the average tariffs for all product
categories (including sub-processes) have come down; the standard deviation in the tariff rates
has also been reduced. (see Table 3.3 and 3.4).

Table 3.3: Tariff Structure 2001-02
a

Product and processing Number of
lines
Average Range Standard
deviation
Coefficient of
variation
Total
- 1
st
stage of processing 642 13.4 5-30 8.4 0.6
- semi-processed 1,767 17.5 5-30 9.4 0.5
- fully processed 3,068 23.6 5-250 19.2 0.8
Agriculture
- raw materials 296 14.9 5-30 8.9 0.6
Mining and quarrying
- raw materials 109 12.7 5-30 8.3 0.7
Food products
- 1
st
- semi-processed 60 18.2 10-30 6.8 0.4
- fully processed 249 25.0 10-30 7.4 0.3
Food manufacturing
- 1
st
- semi-processed 6 30.0 30-30 0.0 -
- fully processed 34 23.7 5-30 6.9 0.3
Beverages
- fully processed 24 81.9 10-200 46.1 0.6
Tobacco manufactures
- fully processed 6 30.0 30-30 0.0 -
Textiles
- 1
st
- semi-processed 388 25.0 5-30 7.7 0.3
- fully processed 263 29.1 10-30 3.7 0.1
Clothing
- fully processed 134 29.3 20-30 2.5 0.1
Leather products
- 1
st
stage of processing 1 10.0 10-10 0.0 -
- semi-processed 32 7.2 5-30 5.7 0.8
- fully processed 20 28.5 10-30 4.9 0.2
Footwear
- fully processed 17 29.4 20-30 2.4 0.1

Continued

9 Most notably, the maximum duty on import of automobiles has been slashed from 200% to 100%; and
import duty on cars with a capacity of 1000-1300 cc has been cut to 50%.
lines
deviation
Coefficient of
variation
Wood products
- 1
st
- semi-processed 33 19.1 10-30 9.1 0.5
- fully processed 27 28.1 20-30 4.0 0.1
Furniture except metal
- fully processed 22 28.6 10-30 4.7 0.2
Paper products
- 1
st
- semi-processed 68 24.0 5-30 6.5 0.3
- fully processed 34 28.7 5-30 5.4 0.2
Printing
- fully processed 31 17.7 5-30 11.7 0.7
Industrial chemicals
- 1
st
- semi-processed 680 13.4 5-30 7.4 0.6
- fully processed 28 22.7 5-30 8.3 0.4
Other chemicals
- 1
st
- semi-processed 71 16.9 5-30 7.6 0.4
- fully processed 212 18.5 5-30 9.4 0.5
Petroleum refineries
- 1
st
- semi-processed 5 18.0 10-30 11.0 0.6
- fully processed 28 23.0 5-30 9.3 0.4
Petroleum and coal products
- 1
st
- semi-processed 6 16.7 10-30 10.3 0.6
- fully processed 2 30.0 30-30 0.0 -
Rubber products
- 1
st
- semi-processed 16 21.3 10-30 8.1 0.4
- fully processed 48 27.2 5-30 6.4 0.2
Plastic products
- fully processed 29 26.4 5-30 8.4 0.3
Pottery and china
- fully processed 16 28.1 20-30 4.0 0.1
Glass and products
- semi-processed 20 25.0 10-30 6.9 0.3
- fully processed 53 24.0 5-30 8.8 0.4
Non-metallic mineral products
- 1
st
- semi-processed 14 22.1 10-30 8.9 0.4
- fully processed 73 26.3 10-30 7.0 0.3
Iron and steel products
- 1
st
- semi-processed 199 19.3 5-30 10.1 0.5
Non-ferrous metal
- 1
st
- semi-processed 159 10.5 5-30 6.4 0.6
- fully processed 1 30.0 30-30 0.0 -
Metal products
- semi-processed 5 20.0 20-20 0.0 -
- fully processed 221 26.9 5-30 5.7 0.2

Continued

lines
deviation
Coefficient of
variation
Non-electrical machinery
- semi-processed 1 30.0 30-30 0.0 -
- fully processed 575 15.3 5-60 8.9 0.6
Electrical machinery
- fully processed 323 19.5 5-30 9.8 0.5
Transport equipment
- fully processed 169 48.0 5-250 60.8 1.3
Professional and scientific equipment
- fully processed 228 13.5 5-30 8.0 0.6
Other manufactured products
- 1
st
- semi-processed 4 25.0 10-30 10.0 0.4
- fully processed 200 22.0 5-30 8.1 0.4
Electrical energy
- fully processed 1 5.0 5-5 0.0 -
Source: Trade Policy Review: Pakistan, Report by the Secretariat. WT/TPR/S/95. World Trade Organization,
December, 2001.

Table 3.4: Tariff Structure - 2004-05
Product Number
of lines
Deviation
Coefficient of
Variation
Total 5,468 17.09 5-200 12.28 0.72
1st Stage of Processing 463 10.78 5-25 7.21 0.67
Semi-processed 1,447 12.54 5-25 7.28 0.58
Fully-processed 3,558 19.77 5-200 13.52 0.68
Food Products and Food Preparations
Semi-processed 8 19.38 10-25 5.83 0.30
Fully-processed 152 23.98 5-25 2.97 0.13
Beverages
Fully Processed 24 82.5 25-200 44.04 0.53
Tobacco
Semi Processed 3 25 25-25 0.00 --
Fully Processed 7 25 25-25 0.00 --
Textiles
Semi-processed 180 12.89 5-25 7.89 0.61
Fully-processed 360 24.21 5-25 3.71 0.15
Leather, Fur skins and Products
1st Stage of Processing 20 6 5-25 4.36 0.73
Semi-processed 26 9.23 5-25 7.03 0.76
Fully-processed 36 20.56 5-25 7.79 0.38
Clothing
Fully Processed 328 24.88 5-25 1.56 0.06
Footwear
Fully Processed 31 24.84 20-25 0.88 0.04
Furniture except metal
Fully Processed 25 23 5-25 5.48 0.24
Chemical Products
Semi-processed 759 10.11 5-25 4.75 0.47
Fully-processed 63 18.25 5-25 8.03 0.44
Miscellaneous Chemical and Allied Products
Semi-processed 15 21.67 5-25 5.06 0.23
Fully-processed 15 21.33 5-25 6.70 0.31

Continued
Product Number
of lines
Deviation
Coefficient of
Variation
Pharmaceutical Products
Semi-processed 3 10 10-10 0.00 --
Fully-processed 44 12.95 5-25 5.26 0.41
Fertilizers
Semi-processed 2 5 5-5 0.00 --
Fully-processed 24 5 5-5 0.00 --
Perfumery, Cosmetic/Toiletry, Soaps etc
Semi-processed 3 10 10-10 0.00 --
Fully-processed 62 21.53 5-25 6.06 0.28
Mineral Products
Semi-processed 11 15.45 5-25 8.91 0.58
Fully-processed 70 14.57 5-25 8.36 0.57
Iron and Steel Products
Semi-processed 165 15.55 5-25 9.47 0.61
Fully-processed 143 21.64 5-35 6.17 0.28
Metal - Ferrous & Non-Ferrous Products
Semi-processed 70 11.86 5-20 5.29 0.45
Fully-processed 52 22.79 10-25 3.45 0.15
Precious Metals, Stones, Jewelry etc.
Semi-processed 38 5.39 5-10 1.35 0.25
Fully-processed 17 8.82 5-10 2.12 0.24
Articles of Stones and Ceramics etc
Semi-processed 24 21.25 5-25 6.50 0.31
Fully-processed 66 22.58 5-25 5.38 0.24
Plastic Products
Semi-processed 48 22.29 5-25 5.59 0.25
Fully-processed 30 21.33 5-25 6.70 0.31
Rubber Products
1st Stage of Processing 19 5 5-5 0.00 --
Semi-processed 29 20.17 5-25 5.17 0.26
Fully-processed 57 22.99 5-35 6.13 0.27
Glass Products
Semi-processed 19 21.58 5-25 5.39 0.25
Fully-processed 56 20.18 5-35 7.56 0.37
Wood, Wood Charcoal, Cork, Straw etc and Products
Semi-processed 17 22.35 5-25 5.72 0.26
Fully-processed 23 23.7 5-25 4.23 0.18
Paper products
Semi-processed 23 20.43 5-25 5.30 0.26
Fully-processed 113 21.81 5-25 4.66 0.21
Electrical Machinery
Fully Processed 367 16.51 5-35 8.59 0.52
Non-Electrical/Mechanical Machinery
Fully Processed 642 11.83 5-35 9.10 0.77
Transport Equipment
Fully Processed 173 38.82 5-200 33.33 0.86

Continued

Product Number
of lines
Deviation
Coefficient of
Variation
Professional and Scientific Equipment
Fully Processed 202 9.6 5-35 7.28 0.76
Printing
Fully Processed 22 10.68 5-25 7.58 0.71
Miscellaneous Manufactured Articles
1
st
Stage of Processing 3 20 20-20 0.00 --
Semi-processed 4 21.25 20-25 2.17 0.10
Fully-processed 350 18.53 5-35 7.34 0.40
Electrical Energy
Fully Processed 1 5 -- 0.00 --
Source: a Authors' own calculations

29. At a disaggregated level, dispersion in the tariff rates for raw materials and semi-
processed products has not changed from the previous year, but has considerably fallen in the
case of processed goods: the coefficient of variation for processed goods came down to 65%
in 2002-03 from 80% in 2001-02. Despite this, however, there still remains considerable
dispersion in the tariff rates. Also, consumer products continue to be protected as compared
with industrial products and capital goods. Therefore, consideration must be given to
reducing the burden of protecting domestic industry on final consumers and users of
protected goods and activities. The attainment of these objectives will improve the growth
potential of the country and increase employment opportunities.
30. To summarize, the review of the protection structure has revealed that:
i. There are some tariff peaks in the existing protection structure that need to be
reduced.
ii. The tariff structure is escalated.
iii. Tariff rates are dispersed and vary widely. Although the percent of tariff lines in 5%
slab have increased, still there are a substantial number of tariff lines that fall in
higher slabs.
iv. Consumer products enjoy higher protection than industrial and capital goods.

19

Section 4
Effective Protection: a Review of
Theoretical and Empirical Literature

31. The concept of effective protection was first developed as a tool for summarizing the
total effect of input and output tariffs on a production process. It soon became established as
a widely used device for evaluating protective structures and changes therein, especially in
developing countries. However, at very initial stages, the concept was criticized on the
grounds that it is inappropriate to draw general equilibrium inferences from a measure that is
essentially partial equilibrium. Yet, despite this critique, the measure still continues to be
widely used by academic researchers and policy-making agencies.
32. Economists have long since been aware that it is not appropriate to regard the nominal
tariff as a measure of protection. As Corden (1971) points out that the idea of compensating
tariff can be traced as early as 1882 in F.W. Taussigs work titled Tariff History of the United
States. The idea kept on surfacing in the writings of authors like J.E. Mead (Trade and
Welfare) and G.V. Haberler (The Theory of International Trade). Some pioneering work has
been done in Balassa (1965) and Soligo and Stern (1965). However the concept got a
systematic articulation in W.M. Corden (1966) and it was immediately picked by theoretical
as well as applied economists. The reason for its popularity lies in its intuitive appeal and
computational simplicity.
33. Corden formulated the concept of effective protection in the following
expression
g
j
= (t
j
a
ij
t
i
)/(1 a
ij
)
Where
g
j
t
j
t
i
a
ij
= share of i in cost of j in absence of tariffs

34. Cordens formulation has been criticized on the basis of its simplicity and its being a
partial equilibrium model and an associated problem of fixed coefficients. It is simple
because the effect of non-traded inputs is not accounted for. Its partial equilibrium nature
does not allow the impact of general equilibrium factor prices and exchange rates. (See for
example, Ethier (1977) and Bhagwati and Srinivasan (1973)).
35. Despite all criticisms Cordens formula has survived, and is still widely used even
after four decades of original presentation. In the words of Anderson (1995) "Effective
protection is the ranch house of trade policy construction ugly but apparently too useful to
disappear".

36. As a matter of fact this formula provides a standard framework for systematic analysis
of overall tariff structure. It describes very succinctly how tariffs on inputs and outputs
determine effective protection. This framework also includes at least two important empirical
phenomena, viz. negative effective protection and negative value added. These phenomena
have clearly brought into focus many situations where import substitution or export
promotion policies had distorted the market up to the level beyond rationality.
37. As pointed out earlier, Cordens formulation is based upon a partial equilibrium
framework. In a latter study (1969), Corden demonstrated that his formula holds in a model
in which there are two factors of productions, two final goods and intermediate inputs are
imported and not produced at home. This model was challenged by Anderson (1970) who
showed that Cordens formula of effective protection breaks down in the case of many-
commodities in general equilibrium framework.
38. Davis (1998) deals with the substation problem in the theory of effective protection.
The author resolves the substitution problem in three components; (i) the index problem i.e.
fixed coefficients, (ii) conceptualization problem, i.e. reparability of inputs, and (iii) The
paradox problem, i.e. due to input substitution, the direction of change in gross output may be
different from that of change in value added. The author finds that the conceptualization
problem does not affect the usefulness of effective protection analysis in the real-world
analysis. The index problem is also not likely to effect effective protections usefulness as
general equilibrium tool as long as the rates of protection remain below several hundred
percent. The paradox problem, however, is found to be potentially persistent. The author
concludes that partial equilibrium effective protection analysis is in practice a reasonable
estimator of certain short-run general equilibrium effects of protection.
39. Anderson (1995) modified the definition of effective protection to make it suitable in
a general equilibrium framework. According to his proposition the effective rate of
protection for sector j is defined here as the uniform tariff which is equivalent to the actual
differentiated tariff structure in its effect on the rents to residual claimants in sector j. This
definition applies to general as well as partial equilibrium economic structures, has obvious
relevance for political economy models and seems to correspond to the motivation for the
early effective protection literature. In a general equilibrium this definition implies a well
defined index which decomposes in three components. The component is the partial
equilibrium formula, leading to a special case where the partial equilibrium formula gives the
same sectoral ranking of effective rates of protection as the general equilibrium formula. The
decomposition makes clear how very special this case is, leading back to the necessity of
measuring the effective rate of protection in a general equilibrium model. The author
estimates effective protection measures in US agriculture, and the results show that the new
and old concepts of effective protection give very different pictures of the pattern of
protection afforded to sectors by the actual tariff structure. The author recommends
Computable General Equilibrium Models should be used to study the implications of various
national tariff structures.

Review of Some Empirical Studies
40. Kusum Das, Deb (2003), attempts to quantify tariff and non-tariff barriers in 72
Indian industries. Four measures are computed for this purpose. The first one is a measure of
tariff barriers while the remaining three are non-tariff in nature. These are:
1. Effective rate of protection
(Cordon formula has been used viz. EPR = (Tj a
ij
T
i
)/(1- a
ij
)
2. Frequency ratios
3. Input coverage ratios
4. Import penetration ratios
41. The study covers the period 1980-81 to 1994-95. This period has further been
subdivided in three sub-periods, i.e. 1980-81 to 1985-86, 1986-87 to 1990-91, and 1990-91 to
1994-95. In addition, measures for the whole period are also computed. Goods are classified
in three groups i.e. consumers goods, intermediate goods and producers goods.
42. The cost of production is obtained input-output tables 1983-84 and 1989-90. Tariff
rates are derived from Customs Tariff Working Schedule. Quantitative exceptions are taken
into account.
43. Free tariff coefficients are obtained by the formula:
a
ij
= [P
ij
*
/(1+ T
i
)] / [P
j
*
/ (1+ T
j
)]
(where * indicates domestic prices)

44. In other words domestic price are deflated by appropriate tariff rates. ERP are not
adjusted for any exchange rate overvaluation. Descriptive analysis of estimates of all tariff
and non-tariff barriers has been carried out.
Followings are the main findings of the study regarding ERP.
1. ERP levels are highest for intermediate goods.
2. ERP increased in the period 1986-87 to 1990-91 in all the three sectors.
3. ERP sharply fell in the period 1990-91 to 1994-95 in all the three sectors. The decline
is more pronounced in intermediate and consumer goods.

45. Kemal, A. R., Mahmood, Zafar and Maqsood, Athar (1994) analyze the protection
structure, efficiency, and profitability of Pakistans manufacturing industries for the year
1992-93. The study is based upon a survey of 961 firms from all the provinces of the country.
The survey provided detailed information of variables like output, inputs, primary factors,
taxes, prices of imported inputs etc. In total 99 industries are covered.
46. For the purpose of computing effective protection three methods are used viz.
(i) Balassa Method, (ii) Corden Method, and (iii) Scott Method. Effective protection rates are
computed in many possible ways. This includes computation by:
By industry size (small medium and large)
By location (Punjab, Sindh, NEFP and Balochistan)
By market orientation (whether the industry is export oriented, import competing etc.)
Under different assumptions of under/over-reporting of inputs and outputs.

47. Out of 70 industries, 11 industries are found to be suffering from the problem of
negative value added, i.e. infinite protection. Another 39 industries were enjoying very high
level of protection. The number of moderately protected industries was 14. And 3 industries
suffered negative protection, viz. confectionary, bakery, and beverages. Across size, medium
industries enjoyed maximum protection and small industries received the least. Across
provinces, Balochistan enjoyed the highest protection, while Sindh came out to be least
protected. By market orientation, export-oriented industries were least protected, whereas
non-import-competing industries suffered negative protection.
48. Domestic resource cost of earning a unit of foreign exchange (for the year 1990-91) is
used as a measure of efficiency. It is found that manufacturing sector has become more
efficient over time (compared with 1980-81). Especially textile industries are found to shift
from negative value added (in 1980-81) to a high level of efficiency in 1990-91. By size,
small industrial units are found to be most efficient, and large-size industrial units are
inefficient. Province-wise, efficiency is highest in Balochistan. The authors attribute this to
the exclusion of six negative value added industries. In the remaining provinces, Sindh is
most efficient and NWFP is least. By market orientation, non-import competing goods

industries are most efficient. Authors claim that this is due to only one industry, i.e.
cigarettes, otherwise export-oriented industries are most efficient.
49. Authors observe that whereas 11 inefficient industries enjoy high level of protection,
there are also 14 efficient industries which are also highly protected, thus implying excessive
profit.
50. In order to analyze the profitability, the manufacturing industries have been classified
in six levels of profit rates. It is found that if net profit is used as the criterion, 24 industries
are making losses, 24 industries are making 20% profits, and 26 industries are making more
than 20% profits.
51. Soligo and Stern (1965) analyze Pakistans manufacturing sector. Their study covers
48 manufacturing industries. The industries are categorized as consumer goods, investment
goods, and intermediate goods. Composition of inputs and outputs is obtained from the
Census of Manufacturing Industries (1962); Inter-industries flows are taken from input-
output table prepared for the Planning Commission; tariff rates are obtained from Pakistan
Customs Tariff Manual. The results indicate that the consumer goods are more heavily
protected than intermediate or investment goods. Among consumer goods, non-essential
goods were more protected. Heavy machinery, transport goods and fertilizer are among least
protected goods.
52. Prema-Chandra Athukorala (2006) analyze the structure of protection in Vietnam
based on estimates of effective rates of protection based on the tariff schedule as at mid-2003
provided by the Ministry of Finance. Intermediate import coefficients are derived from the
Input-Output Table for 2000 prepared by the General Statistical Office (GSO). The nominal
rates used in estimation are simply the official applied tariff rates summed up at the input-
output sector level using import value weights.
53. Effective protection is conventionally estimated as a composite index for a given
sector incorporating both incentives for export- and import-competing protection. However,
author finds that in Vietnam, like many developing countries, export-promotion policies are
pursued alongside import-substitution policies. So, effective protection rates are estimated for
import-competing and export-oriented activities separately.
54. The estimates reveal a high degree of variability in ERP across industries. Some sectors
like liquor, beer and processed rice have well over 100 per cent effective protection. Protection
for 11 sectors (tea, bricks and tiles, home appliances, textiles, clothing, carpets, plastic products,
home appliances, motorcycles, bicycles, and motor vehicles) range between 50 and 88 per cent.
Remaining sectors have effective protection in the range of 0 to 50 per cent, with most of the
sectors concentrated at the lower end of the distribution. The products like as tea, coffee, rice and
wearing apparel are provided very high protection. In these sectors the country has a clear
comparative advantage
55. Effective protection rates are estimated for import-competing production for 2003,
together with the underlined input and output tariff and input coefficients. The estimated ERP for
import-competing production in all traded-goods sectors in 2003 is 25 per cent, compared to 58
per cent in 2001 and 72.2 per cent in 1997. A comparison of NRP and ERP estimates for the three
years suggests that this decline has come predominantly from an increase in input tariffs. The
NRP (on final goods) has changed only marginally over this period. The degree of dispersion of
ERP across sectors (measured by the coefficient of variation) increased from 156 per cent in 1997
to 172 per cent in 2001 and then declined to 134 per cent in 2003.
56. The counterbalancing effect of measures to redress the anti-export bias in the trade regime
(duty rebate, turnover tax concession and profit tax concession) is found to be much smaller in
magnitude compared to the price-raising impact of the existing import tariff structure.
Consequently, there is a clear anti-export bias in the incentive structure, even though the degree
of the bias has considerably declined in recent years.
57. Lewis and Guisinger (1968) in their study examine various measures of level and
structure of protection in manufacturing industries in Pakistan. Thirty-two industries are included
in the analysis, and are further sub-divided in three main groups viz. consumption goods,
intermediate goods, and investment and related goods. Adjustment has been made for non-traded
inputs and foreign exchange fluctuations. Input-output structure has been taken from 1963-64
input-output table. Tariff and indirect taxes data is taken from Lewis and Radhu (1966). Price
data are obtained from various sources including two surveys. Price differentials are also used as
a measure of protection. Authors give two main reasons for this approach; (a) some tariffs are
redundant and the tariff structure overstates the level of protection; (b) quantitative restrictions,
not tariffs, are the effective determinants of domestic prices of some goods, so that tariffs
understate the level of protection.
58. Consumer goods are found to be more protected than intermediate and investment goods.
Direct price comparison of inputs and outputs indicate a higher average protection than combined
effect of tax, exchange rate, and control system. However, level of protection in some very
important industries, such as cotton textile falls. It is found that the measured levels of protection
are quite sensitive to treatment of non-traded goods. Authors conclude that trade-restricting
policies in Pakistan have led to a set of domestic prices that diverge widely from the prices that
exist in international trade. Consequently, resource allocation may be badly out of line with what
it should be.


Section 5
Methodology, Data and Results

59. This study uses the Cordens formula to compute the rates of effective protection. The
formula is given by the following expression
g
j
= (t
j
a
ij
t
i
)/(1 a
ij
)
Where
g
j
t
j
t
i
a
ij
= share of industry i in cost of the industry j.

60. The study uses the coefficients a
ij
s from Input-Output Table updated by Dorosh et al
(2006) for the year 2001. A detailed questionnaire was developed and pre-tested. However, a
listing of firms to draw the survey sample could not be obtained from the Federal Bureau of
Statistics. Given time constraints it was, therefore, decided to use the available updated Input-
Output table. Nominal tariff rates t
i
s and t
j
s for the year 2006 are obtained from website of
Central Board of Revenue. In total 39 manufacturing sectors are covered in this study
61. Average nominal protection rate for all manufacturing industries covered in the study is
16.9%, whereas, average effective protection rate turns out to be 27.8%. Twenty three sectors
avail above average nominal protection, while effective protection for eighteen sectors happens to
be above average. The results indicate that effective rate of protection is quite high for leather and
leather products, foot wear, transport equipment and some textile sub-sectors. The sectors with
lowest effective protection rates are jewelry (precious metal), vegetable oils, other textile
products, bakery products, and fertilizers and pesticides. The complete list of effective and
nominal tariffs is given in the Appendix.
62. A direct comparison of the results of this study is not possible with earlier once due to
discrepancy among the sectors identified. However, some industries which could be found
common with those of previous studies, do provide an opportunity of comparison.
10

Vegetable oils which was previously negatively protected, still suffers from negative
protection.
Effective protection for fertilizer, pharmaceutics, and cotton yarn has changed from positive
to negative.
Leather products, carpets, garments, and footwear continue to avail positive effective
protection.

63. The top ten most protected sectors with respect to effective protection are:

10 Most of the comparison is made with the results of Kemal et .al. (1994).
Table 5.1: Top Ten Effectively Protected Industrial Sectors
S. No. Sectors EPR %
1 Leather, leather products 185.6
2 Foot wear 135.8
3 Transport equipment 106.5
4 Knitwear 69.9
5 Other manufacturing products 69.1
6 Made-up textile goods 64.4
7 Carpets 61.2
8 Cotton cloth 55.1
9 Garments 54.3
10 Other chemicals 53.7

64. The ten least protected sectors with respect to effective protection are:

Table 5.2: Ten Least Effectively Protected Industrial Sectors
S. No. Sectors EPR %
1 Jewelry (precious metal) -69.3
2 Vegetable oils etc. -64.3
3 Other textile products -21.9
4 Bakery products -20.4
5 Fertilizers and pesticides -17.3
6 Other non-electrical machinery -12.4
7 Other metal products -11.0
8 Cotton yarn -6.4
9 Pharmaceuticals -5.2
10 Surgical instruments -4.7

65. The top fifteen most protected sectors with respect to nominal protection are:

Table 5.3: Top 15 Nominally Protected Industrial Sectors
S. No. Sectors NR %
1 Transport equipment 47.0
2 Leather, leather products 25.0
3 Foot wear 25.0
4 Knitwear 25.0
5 Other manufacturing products 25.0
6 Made-up textile goods 25.0
7 Carpets 25.0
8 Garments 25.0
9 Other chemicals 25.0
10 Beverages 25.0
11 Rubber and plastic products 25.0
12 Bricks, tiles 25.0
13 Cigarettes, tobacco 25.0
14 MF: Cement 25.0
15 Cotton cloth 22.7

66. The ten least protected sectors with respect to nominal protection are:

Table 5.4: Ten Least Nominally Protected Industrial Sectors
S. No. Sectors NR %
1 Ginned cotton (lint) 5.0
2 Cotton yarn 5.0
3 Other metal products 5.0
4 Other non-electrical machinery 5.0
5 Fertilizers and pesticides 5.0
6 Bakery products 5.0
7 Other textile products 5.0
8 Vegetable oils etc. 5.0
9 Jewelry (precious metal) 5.0
10 Surgical instruments 8.1
Average 16.9


Section 6
Interpretation of Results

67. The results presented in previous pages indicate an urgent need for tariff
rationalization especially in leather, leather products, foot wear, transport equipment,
knitwear, other manufacturing products, made-up textile goods, carpets, cotton cloth and
garments. On the other hand sectors like, jewelry (precious metal), vegetable oils, etc., other
textile products, bakery products, fertilizers and pesticides, other non-electrical machinery,
other metal products, cotton yarn and pharmaceuticals are those which are least protected.
The negative sign of their effective protection measure indicates that their inputs are heavily
protected. A brief description of some of these sectors is given below.
68. Transport Equipment: The transport equipment sector has enjoyed very high
protection. While the government has initiated measures in the recently announced budget for
tariff rationalization in the auto sector, these measures need to be reinforced. Further tariff
rationalization in the auto sector would go a long way in enhancing the competitiveness of
the domestic auto industry as well as in benefiting consumers by lowering the price of
automobiles.
69. Leather, Textiles and Apparel Industries: This group of industries is the largest in
Pakistans manufacturing sector, accounting for 31.1 percent of manufacturing value added.
The group comprises textiles, wearing apparel and leather accounting for 24.0, 4.4 and 1.7
percent of manufacturing value added. However, the quality of product is at the lower end
with little value addition. It suffers from quality and standardization and resultantly the unit
values of Pakistani textiles products are way below the average international values. If
Pakistan is to become a global player, the sector needs to redefine its market and products,
improve product quality, move up the value chain, lay technological foundations, and
strengthen global business operations.
70. While the share of textiles in the value added of the manufacturing sector is 24
percent, it accounts for roughly 70 percent of the total exports. Since the textiles sector is
labor-intensive, its share in employment is as high as 46.9 percent. The labor intensity differs
across sub-sectors; cotton weaving, jute textiles and knitting mills are the most labor-
intensive
11
.
71. Textiles industry uses a range of imported inputs from cotton and steel. High tariff
protection is being provided to the domestic producers of these inputs, thereby eroding the
competitiveness of the textiles sector. Higher tariffs imposed on these sectors to protect
domestic producers seriously affect the textiles processing industries by raising their cost of
production. This problem has been compounded by various restrictions in EU and USA that
have forced the textile industry to switch to costly inputs. To ensure the availability of these

11 Labor-intensive textile products such as fabrics, made-up textiles and carpets are in the small scale
manufacturing sector which makes the overall textiles sector even more labor intensive.
inputs to textiles producers at competitive prices, it is proposed that the protection provided
to domestic producers of these inputs be gradually withdrawn, eventually to be replaced by
fiscal incentives.
72. Beverages: Various types of beverages are produced in Pakistan, including fruit
drinks and aerated water. It is the latter which accounts for more than 76 percent of total
beverages in Pakistan. The aerated beverages industry has mostly been controlled by the two
foreign brands and localization attempts have not been all that successful
12
. However, the
fruit beverages and local syrups have developed but the pace is slow. The fruit beverages
industry that has great potential and Pakistan can create a niche market for its fruit beverages.
However, the growth of export is possible with the induction of foreign direct investment and
use of the popular brands.
73. The drinking and mineral water have grown sharply in recent years mainly because of
the health consciousness mainly because of the rising hepatitis. The industry needs proper
certification and a mechanism for monitoring.
74. The government has been protecting the domestic steel industry from international
competition. This policy has adversely affected a number of downstream industries
particularly in the engineering sector. While tariffs on steel have been reduced recently, these
need to be further curtailed with a view to improving the competitiveness of the engineering
sector. Such a move would force the domestic steel producers to become more efficient.
75. With a view to improving the value added in the industry, and strengthening the
competitiveness of the textiles sector, especially in the rapidly changing global environment,
it is necessary that the country has a long-run vision of textiles sector and all the policies
must be geared towards realizing that. The long-run vision for textiles of Pakistan must be the
higher value added products through better quality and promotion of new and standardized
products and processes which are competitive in the world market
13
. The apparel sector has
not been able to exploit its potential in the international market due mainly to shortage of
skills in apparel designing and stitching. The highest value addition can only be achieved
through the development of manpower, equipped with the requisite skills to enable the
country to compete in international markets.
76. Despite the trade reforms, the trade regime remains very complex as is evident form
the EPRs, calculated from official tariffs given in the Pakistan Custom Tariff (PCT) 2006-07
as given in First Schedule. Even in the PCT, the policy-stated slabs have increased from four
to five and a number of specific and special rates are applied. The First Schedule now
consists of 16 specific tariffs for 48 line items and 12 ad valorem rates ranging from 5% to
90% for 6752 line items, viz. 90% for 29 items, 75% for 13 items, 65% for 4 items, 60% for
5 items, 50% for 21 items, 35% for 371 items, 30% for 33 items, 25% for 1409 items, 20%
for 929 items, 15% for 404 items, 10% for 872 items, and 5% for 2662 items.
77. Apart from the foregoing complexities, the tariff regime has been affected by several
changes and concessions given through SROs. Some of these changes are described below.
i). Several exemptions/reductions are given outside the first schedule on raw materials,
sub-components, components, sub-assemblies and assemblies, as are not
manufactured locally, e.g. S.R.O. 565 (I)/20060.
ii). Special exemption/ concessions are given outside the first schedule for plant,
machinery, equipment and apparatus, including capital goods, see S.R.O. 575(I)/2006.
iii). Special exemptions are admissible to NGOs, charitable institutions, hospitals, etc.
iv). Special exemption/ concessions are allowed for government/special interest group
imports, e.g. S.R.O.567 (I)/2006.

12 Recently there has been a shift in policy, and many small brands have started appearing in the market.
13 Such a transformation will have to take into cognizance the heightened global competition in textiles trade
after the phasing out of the MFA.

v). Special reduction in import duty is made for certain commodities in short supply,
S.R.O. 548(I)/2006.
vi). There are specific concessionary rates for select items, e.g. Rs 500 on telephone, see
SRO 541(I)/2006.
vii). There are exemptions for the privileged people.
viii). Special tariffs apply under SAFTA and other bilateral trading arrangements.
ix). At times, regulatory duties are imposed on export of some commodities.

78. Furthermore the trade policy is victim of overvalued exchange rate and complex trade
diplomacy pursued at bilateral, regional and multilateral levels. Besides multilateral trade
agreements under WTO, the government has negotiated/ has been negotiating PTA with
selected countries and regions which are perhaps trade diverting rather than trade expanding.


Section 7
An Assessment

79. Productivity improvements: Reducing protection has benefited the country in several
ways. As a consequence of the tariff reforms, the entire cost structure of all industrial sectors
has undergone a drastic change. Empirical studies show that the largest productivity gains
arise from reducing input tariffs. Lower output tariffs can produce productivity gains by
inducing tougher import competition whereas cheaper imported inputs can raise productivity
via learning, technology, variety, or quality effects. The effect of reducing input tariffs
significantly increases productivity and that this effect is much higher than of reducing output
tariffs.
14

80. Thus costs of production have been decreased owing to the reduced tariffs. Tariff
reductions have helped reduce costs of capital equipment and intermediate goods that are
crucial to expansion of the manufacturing and export sectors. By allowing prices to more
closely reflect production costs, trade liberalization brings about a shift of resources to sectors
of comparative advantages. Market horizons expand and it becomes more feasible to harness
technology, scale and trade economies. Investment prospects have increased with lowering of
effective protection and liberalization, benefiting employment and production including
exports. Foreign direct investment has started flowing in, enhancing prospects of better
technology and integration with global markets. Despite some progress however, the
momentum of industrial development has been slow in terms of speed, diversity,
technological adaptation and processing stages, and industrial development based on resource
endowment has been missing.
81. Tariff cuts have a negative side. One, they could lead to a reduction in output and
employment in certain sectors which face greater competition from lower-cost foreign
products. The import content of local consumption at times may exert BOP pressures. Some
export sectors may contract because of greater competition, e.g. textiles and garments.
Second, international trade taxes, customs duties, petroleum charges, etc., have been major
sources of revenues, and tariff reductions have lead to revenue losses. Hence industrial
lobbies have harped on these themes and found governments sympathetic, which has slowed
down reforms. This suggests undertaking broad-based tax reforms, broadening of domestic
taxation including taxing of income and consumption (i.e. non-distortive value-added
arrangements) and strengthening of tax administration.
82. Initially the tariff reforms were slow and were not very beneficial. Reduction in
effective tariff protection has to be sufficient and rapid enough to benefit countries with
increased opportunities. The progress has to be assessed in the context of the trade
liberalization that has occurred elsewhere. If the external competitiveness is not to be eroded,

14 See for example, Mary Amiti and Jozef Konings1, Trade Liberalization, Intermediate Inputs, and
Productivity: Evidence from Indonesia, IMF Working Paper WP/05/146, IMF Research Department, July
2005.

the country needs to liberalize trade sufficiently and quickly as in competing countries.
Otherwise, the trade liberalization may increase competition from abroad and lead to the loss
of trading share, productivity and welfare improvements. Besides, price and wage flexibility
is needed to allow resources to be used
more efficiently. Finally, the most
important component of trade
liberalization is the reduction in overall
protection which should not be offset by
other discriminatory taxes on trade
(import surcharges, withholding tax,
sales tax, other discriminatory
consumption taxes, etc.).
83. Trade and growth: Although
Pakistan started its tariff reforms in early
90s, its integration with the global
economy picked up in the recent past.
The trade-to-GDP ratio has risen from
close to 26 percent in 1999-2000 to
estimated 34 percent in 2005-06 (See Fig.1). Exports and imports increased by 16% p.a. and
27% p.a. respectively in the past seven years. The share of manufactured exports also rose,
reaching to 90% in 2005-06. The GDP growth also picked up in the recent past, reaching
7.6% in the past three years 2003-06 compared with 2% in 2000-01. Pakistans global
integration is however far form complete and the structure of trade remain weak. In
particular, export remains concentrated on few products with low value addition and direction
of trade is limited to a few countries. Besides Pakistans export performance has been much
weaker than its competitor countries.
84. Besides tariff reforms, several other structural and cyclical factors were responsible
for this change. On the domestic side, strong economic growth that triggered investment
spending also led to a massive surge in imports. On the external side, the global economy
continues its strong and broadbased expansion, growing by 4 percent, and by a much higher
rate in developing countries, in the last five years. This global expansion has facilitated a
much better market access for exports. The integration process was also partly accelerated by
the faster means of communication, internet and transport. A stronger growth at home and the
global expansion at the same time were responsible for a much sharper trade growth in
almost every part of the world. Certainly, the trade and tariff reforms are bringing about a
better global growth outcomes.
85. Consumer welfare and poverty: The trade liberalization and tariff reforms have
benefited consumers in several ways, including access to a large variety of goods at cheaper
rates and better quality of goods. Even the local goods improved in quality and price because
of enhanced competition and supply sources. Several international brand name products have
appeared in the market which is affording better consumer protection through quality
improvements and warranties. The welfare benefits were indeed enormous. Reportedly
poverty levels, which had been increasing until 2001-02, started decreasing with the revival
of growth. The recent PSLM shows a decrease of 10% in poverty during FY02-05, although
there are reports of more unequal income distribution.
86. Trade is an opportunity not a guarantee; while trade reforms can help accelerate
integration in the world economy and strengthen an effective growth strategy, they cannot
ensure its success. As noted earlier, several other policy instruments would need to be fixed,
including sound macroeconomic management, trade-related infrastructure and institutions,
and economy wide investments in human capital and physical infrastructure. The country
Figure. 7.1: Trade As Percent of GDP

Source: Pakistan Economic Survey, 2005-06
took some time in entering reforms in these areas before intensifying its links with the global
economy. There are many possible ways to open an economy, and the real challenge is to
identify which best suits their countrys political economy, institutional constraints, and
initial conditions. Here some mistakes might have been made in sequencing and speed of the
reforms. The initial worsening of poverty in late nineties is in line with the global experience,
i.e. tariff and liberalization reforms may increase poverty in the beginning. Trade reforms
were expected to increase the incomes of the unskilled in countries with a comparative
advantage in producing unskilled-labor intensive goods. Perhaps there has been only a partial
success in this area, and the country would need to ensure that the workers affected smoothly
move out of contracting (import-competing) sectors into expanding (exporting) sectors.
87. The reforms are however far form complete and need to continue to reap the full
benefits of opening up and reduction in protection. With end of IMF programs in Pakistan,
the trade liberalization has slowed down in recent years while the competing countries have
continued liberalizing. Revenues from custom duties are substantial which would need to be
made up from alternative sources, i.e. taxes on income and consumption. Pakistan has
addressing the other binding constraints to growth, including sound macroeconomic
management, trade-related infrastructure and institutions, and economy wide investments in
human capital and physical infrastructure. A substantial improvement in these areas is
possible which can go a long way to reap full benefits of removing protection. As the
economy accumulates physical and human capital, its comparative advantage would shift to
more modern, capital intensive activities, having internationally competitive advantage in a
wider range of goods and services. Inevitably trade share would rise further affecting growth
and more welfare.
88. Anti-export bias. A rather high anti export bias remains there in the trade regime
despite trade reforms. Anti-export bias refers to the bias inherent in trade policies that
promote some sectors to the detriment of export sectors. For example, if tariff peaks are
maintained on some product, say automobiles, investors would have an incentive to invest in
this sector rather than in an export sector. Anti-export bias may arise due to several of the
following reasons:
Trade taxation, both imports and exports
Tariffs on domestically produced goods
Tariffs on imported inputs used in production of exportables, and
Over-valued exchange rate.

89. Trade taxation, both on imports and exports, leads to anti-export bias because it
makes import competing activities more profitable. As for the next two reasons are
concerned, our tariff rationalization process has been slow compared with other countries of
the region. India, which started liberalization program much later than Pakistan, has brought
the maximum tariff rate to 10%, whereas we are still stuck with 25% tariff rates. This is in
addition to other non-tariff trade barriers, which in fact create infinite level of protection. Our
imported inputs still face high tariff rates. Some inputs facing exorbitant tariffs are given
below:

Table 7.1: Some inputs facing exorbitant tariffs
Items Tariff Rates
Ethyl Acetate
Articles of Packing
Polyvinyl Chloride (PVC)
Auto Parts
Concrete- Mixer Lorries
Soda in Aqueous Solution (soda lye or liquid soda)
25%
25%
25%
35%
60%
Rs.7000/MT

Optical Fiber Cables 25%
90. It is usually argued that tariffs are necessary for protection of domestic industries, and that
the negative impacts of such measures can be countered by adopting export promotion policies.
History shows that such measures do not work in the long run. Net effects happen to be a highly
distortionary tax structure, fiscal burden of export promotion measures and above all non-
competitive domestic producers. Measures like Duty Drawback Scheme and Duty and Tax
Remission for Exporters scheme have not produced the desired results. Waiting months or more
for tax refunds can take a big chunk of working capital in addition to unofficial payments
required to expedite the process. Central Board of Revenue (CBR) is also often blamed of
withholding refunds in order to meet its own revenue targets.
91. Third cause of anti-export bias is over-valued exchange rate. Inflation in Pakistan has
been about 9% for last three years, much higher than, say inflation in US. This persistent pressure
on domestic prices renders our exchange rate highly over-valued. This factor is also important in
creating an anti-export bias. Incidentally, tariff rationalization policies can also helpful in fighting
inflation. A coherent mix of fiscal, monetary and trade policies is recommended for this purpose.
92. It is instructive to pinpoint a couple of cases where the tariff structure has created anti-
export bias. First, the customs duty on packaging materials is 25 percent and on tin plate it is 10
percent. These high duties have tended to impede the exports of processed food by making these
uncompetitive in international markets, and this despite the fact that Pakistan has great potential
in this area. For example, Pakistan is the 5
th
largest producer of milk and can become an
important exporter of milk and dairy products. Yet the high duty on packaging material hinders
such exports. It is, therefore, not surprising that despite efforts to diversify the export basket,
exports remain concentrated in a few product groups.
93. Second, the textiles sector in Pakistan remains largely cotton-based, despite an increasing
trend towards synthetic and blended fabrics. Current spindles utilization for manmade fibers is
very low in Pakistan as compared with its competitors. Major reason for this is the protected
manmade fibers industry. Import duties on manmade fibers make the raw material expensive for
the spinning industry thereby making it non-competitive in yarn export market. Blended yarn sold
in the local market at higher prices compared to international prices erodes the competitive edge
of the weaving industry also. The overwhelming reliance of the textile sector on cotton makes it
vulnerable to adverse shocks in the cotton market. In order to decrease the reliance on cotton,
there is a need to encourage a shift towards manmade fibers.
94. The World Bank (Jaime de Melo) defines the anti-export bias as ratio of effective
exchange rates on imports and exports through the following formulae.

B = ERm(1 + tm + d + pr) / ERm (1 tx + sx + rx),
Where
B>1 is the anti-export bias, i.e. bias in favor of import-substituting activities, B=1 is no
bias, and very rarely one observe B<1, i.e. the pro-export bias
ERx(m) is the exchange rate applied to exports (imports)
tm tx ,sx stand for import tariff, export tax, and export subsidy
d is prior deposit requirement for imports
pr is tariff equivalent of quotas and other NTBs
rx is preferential credit for exports

95. Using the World Banks formulae and assuming that the variables, d, pr, tx, sx and rx, are
negligible, we can equate the anti export bias with effective protection, i.e. 27.8%.
96. In sum, the tariff structure has become very complex as is evident from high EPRs and
other complexities described earlier. These complexities are distorting production structure,
leading to misallocation of resources which hampers economic growth, encourages rent seeking
and corruption. There is therefore an urgent need to reform and rationalize the tariff structure.


Section 8
Recommendations

97. Manufacturing sector plays a very important role in economic growth and well-being
of the country. Several industries still remain highly protected, such as leather, leather
products, foot wear, transport equipment, knitwear, other manufacturing products, made-up
textile goods, carpets, cotton cloth and garments. The least protected sectors include jewelry
(precious metal), vegetable oils, etc., other textile products, bakery products, fertilizers and
pesticides, other non-electrical machinery, other metal products, cotton yarn and
pharmaceuticals.
98. There is an urgent need to remove protection of inputs to make these industries more
competitive. While reducing protection is necessary, simple removal of protection from
highly protected industries is not sufficient for sustaining and improving growth and
increasing consumer welfare. Competitiveness in international market would require not only
trade and tariff liberalization but of sufficient size and speed. Besides catering for factors
constituting an enabling environment is also be required, such as removal of market
imperfections, improvement in physical and financial infrastructure, a better law and order
situation, well defined property rights, human resource development etc. .
99. While the government has taken a number of steps to improve the business climate in
the recent past, several problem areas remain. The World Bank (2003) study on investment
climate indicates that the investment in Pakistan is constrained by poor tax administration,
high tax rates, cost of and access to financing, corruption, regulatory policy uncertainty,
bureaucratic red-tapes and high prices of electricity. To create a business environment that is
conducive to industrial development, reforms are needed to reduce bureaucratic interference
through further deregulation and to improve the efficiency of various agencies including tax
and customs administration. To improve business climate, promote sustained high growth
and increase consumer welfare, the government may consider implementing the following
recommendations. The broad contours of the recommended reform are given below.
Selective trade liberalization reform that promotes export growth is ideal but is
difficult to implement. Exporters generally need to be given incentives to ensure that
selling abroad becomes attractive. This requires establishing a trade regime to offset
the anti-export bias and effectively functioning bureaucracy to implement it. Such a
proactive approach is generally not prescribed to developing countries since they lack
institutional capacity, as is the case here. Thus the usual recommendation is trade
liberalization through low, uniform tariffs and the elimination of quantitative
restrictions. Ideally, the protection level should be reduced to zero. We suggest that
the government set this as the long term objective and reduce the effective protection
to in the range of 5-10% in near future, appropriately sequenced over say 3-5 years. A
suggestive tariff structure and related revenue implications are given below.

Table 8.1: A Proposed Tariff Structure

Equivalent
tariff
Proposed tariff structure %
Description 2006-7 2007-08 2008-09 2009-10
Raw material 5.3 5 5 5
Machinery
not locally
manufactured
13.5 5 5 5
locally manufactured 26.9 10 7.5 5
Intermediate goods
not locally
manufactured
5.9 10 7.5 5
locally manufactured 11.8 15 10 5
Finished goods 44.0 20 10 5

100. An exercise at revenue implications of the foregoing tariff reforms reveals that the
revenue losses from the tariff reduction can be more than offset by reduction in smuggling
and under invoicing, reducing exemptions and concessions, and greater sales tax revenue
generated from additional imports. These results are summarized below and detailed in the
note in Annex II.

Table 8.2: Revenue Implications of Tariff Reform
Mill Rs
2006-07 2007-08 2008-09 2009-10 2007-10
Customs budget
With status quo 157,100 188,709 221,641 260,207 670,558
With reforms 157,100 125,720 106,529 86,615 318,864
Revenue loss -62,989 -115,112 -173,592 -351,694
With reforms2 along with reduction in
concessions/exemptions 157,100 160,292 155,353 142,191 457,836
Revenue recouped through
concessions/exemptions 34,572 48,824 55,576 138,972
reckoning of smug & under invoicing 9,670 18,750 25,718 54,138
With reforms with reduction in concessions
& reckoning of smug & under invoicing 157,100 169,962 174,104 167,909 511,975
Sales tax additional collection
on reform generated imports 31,120 68,275 113,602 212,996
Overall revenue loss 12,373 20,737 21,304 54,413

Some new activities may become necessary to promote for the development of certain
industries. But such promotion should be well considered and conform to a set of
design principles that include the following: (1) incentives should be provided only
for new, sunrise activities, not sunset ones; (2) there should be clear benchmarks for
success or failure; (3) support must have a predetermined end (a so-called sunset
clause); (4) public support should target activities such as worker training or
infrastructure investment, rather than sectors such as electronics; (5) subsidized
activities should provide clear potential for externalities; and (6) agencies involved in
these activities should be autonomous enough to avoid capture by private interests,
but should maintain links with the private sector to maximize economy-wide gains.
Political economy considerations are very important at the design stage if reforms are
to be sustainable. The key policy in this regards is to ensure that the costs of
adjustment arising from the reforms are borne equitably. One way to ease adjustment
costs is to ensure that safety nets are adequate to compensate losers. Particularly,

efforts should be made to improve labor market flexibility through consolidation of
labor levies, flexible wages to allow linking productivity with benefits, strengthening
of labor market information, training in the emerging skills in demand and improving
social protection. Still a more efficacious way is to design the trade reform that
minimizes adjustment costs.
To ensure credibility, the reform and its sequencing should be publicly communicated
upfront. This would ensure that economic agents are aware of them and can respond
accordingly. Public communication of reforms would also diminish the possibility of
reform reversals, boosting their credibility.
The trade reform needs to be carefully designed, sequenced and embedded in a larger
reform package designed simultaneously to boost domestic tax revenues. Thus
restructuring and strengthening of CBR is crucial for the success of reforms. Custom
related infrastructure and procedures, information flows, documentation related
regulations and distribution/collection system should be improved. Given the poor
state of governance, the frequency and duration of contact between CBR and the
businessmen should be minimized. CBR and other regulations relating to labor, health
and environment should be transparent. Regulatory uncertainty inhibits business
decisions and may be reduced by reducing the frequency of changes in the rules
affecting businesses and making all rules transparent and by removing discretion from
the administration of rules. Flaws in these areas are equivalent to very high protection.
The reform would be more credible if the price reform is accompanied by non-price
reforms, such as investments in infrastructure and human development, better access
to credit, promotion of competition, competitive exchange rate, and incentives to
adopt improved production technologies. This broad-based development strategy
would require more effective resources management, setting priorities and improving
service delivery. The strategy should emphasize private sector led growth, and the
government should restrict itself to market failures only, including providing basic
infrastructure, enabling regulation and improving governance (zero tolerance on
bribery).
References

Anderson (1970) General Equilibrium and the Effective Rate of Protection, Journal of
Political Economy, Vol. 78, no, 4, Part 1, pp 717-724
Athukorala, Prema-chandra (2006) Trade Policy Reforms and the Structure of Protection in
Vietnam The World Economy, Volume 29, Issue 2, Page 161-187, Feb 2006
Balassa, B. (1965) Tariff Protection in Industrial Countries: An Evaluation Journal of
Political Economy, 73, December, 573-94.
Bhagwati, J. and Srinivasan, T.N. (1973) The General Equilibrium Theory of Effective
Corden, W. Max (1966). The structure of a Tariff System and the Effective Protective Rate,
Journal of Political Economy, Vol (74) pp. (221-37)
Corden, W. Max (1969). Effective Protection in the General Equilibrium Model: A
Geometric Note Oxford Economic Paper Vol 21, No 2, July 1969, pp 135-41
Davis A. Graham (1998). The Substitution Problem in the Theory of Effective Protection
Review of International Economics 6 (2), pp307-320
Ethier, W.J. (1977) the Theory of Effective Protection in General Equilibrium: Effective
Rate Analogues of Nominal Rates, Canadian Journal of Economics, Vol. 10, pp. 233-
245.
Johnson, H. G. (1965) The Theory of Tariff Structure, with Special Reference to World
Trade and Development, in Johnson, H. G. and Kenen, P. B. Trade and Development,
Geneva: Librairie Droz. Reprinted in Johnson, Aspects of the Theory of Tariffs, London:
Allen and Unwin, 1971.
Kemal, A. R., Mahmood, Zafar and Maqsood, Athar (1994), Structure of Protection,
Efficiency, and Profitability, Pakistan Institute of Development Economics Islamabad.
Kemal, A.R., (1997), Effective Protection Rates A Guide to Tariff Making, The Pakistan
Development Review, Vol26(4): 775-83.
Kusum Das, Deb (2003), Quantifying Trade Barriers: Has Protection Declined Substantially
in Indian Manufacturing?, Indian Council for Research On International Economic
Relations, Working Paper no. 105.
Lewis, S. R. and Radhu, G.M. (1966), The Indirect Tax Structure and Incentives to
Domestic Manufacturing in Pakistan, July, 1966 (typescript).
Mary Amiti and Jozef Konings1, Trade Liberalization, Intermediate Inputs, and Productivity:
Evidence from Indonesia, IMF Working Paper WP/05/146, IMF Research Department,
July 2005
Protection and Resource Allocation Journal of International Economics, Vol. 3. No. 3, pp.
(259-281)
Soligo, Ronald and Stern, Joseph. J. (1965). Tariff, Protection, Import Substitution and
Investment Efficiency, Pakistan Development Review, Vol 5 no.2, pp. 249-270
World Bank, (2003), Investment Climate in Pakistan.
World Bank, Economic Growth in the 1990s: Learning from a Decade of Reform, Study on
development lessons of the 1990s, by Poverty Reduction and Economic Management
(PREM) Network, Washington 2005, Chapter 5.

Annex I

Table 1.1: Protection Rates
S.
No.
Sectors Nominal
Tariff
Rate %
Average
Tariff on
Inputs %
Value
Added
Coeff %
Effective
Protection
Rate %
1 Vegetable oils etc. 5.0 10.1 7.9 -64.3
2 Milling 10.0 8.3 24.7 6.8
3 Bakery products 5.0 9.5 22.3 -20.4
4 Sugar 10.0 5.6 32.3 13.5
5 Other food products 20.0 11.0 26.2 34.4
6 Beverages 25.0 10.3 34.3 42.9
7 Cigarettes, tobacco 25.0 7.0 52.9 34.0
8 Ginned cotton (lint) 5.0 3.1 6.1 31.1
9 Cotton yarn 5.0 7.0 31.0 -6.4
10 Cotton cloth 22.7 9.8 23.4 55.1
11 Art silk 15.0 11.7 23.0 14.4
12 Made-up textile goods 25.0 7.8 26.7 64.4
13 Knitwear 25.0 8.0 24.2 69.9
14 Carpets 25.0 8.8 26.5 61.2
15 Garments 25.0 17.2 14.4 54.3
16 Other textile products 5.0 10.3 24.1 -21.9
17 Leather, leather products 25.0 9.7 8.3 185.6
18 Foot wear 25.0 13.5 8.5 135.8
19 Wood, wooden products, furniture 20.0 10.5 40.8 23.4
20 Paper, paper products 18.0 10.6 33.2 22.4
21 Pharmaceuticals 13.3 14.4 20.9 -5.2
22 Fertilizers and pesticides 5.0 10.8 33.6 -17.3
23 Chemicals: Consumer products 19.4 15.1 17.3 24.6
24 Refined petroleum 9.7 8.6 6.7 16.7
25 Rubber and plastic products 25.0 13.9 26.9 41.3
26 Other chemicals 25.0 14.7 19.1 53.7
27 Bricks, tiles 25.0 3.7 57.4 37.2
28 MF: Cement 25.0 7.0 53.5 33.8
29 Other non-metallic mineral products 8.2 9.8 41.7 -3.9
30 Basic metal products 10.0 9.4 35.7 1.6
31 Other metal products 5.0 9.4 40.2 -11.0
32 Other non-electrical machinery 5.0 7.7 21.9 -12.4
33 Electrical equipment etc. 17.3 9.1 32.5 25.3
34 Transport equipment 47.0 24.2 21.4 106.5
35 Surgical instruments 8.1 9.0 20.9 -4.7
36 Handicrafts 22.5 11.3 34.0 32.9
37 Sports goods 16.0 11.6 16.4 27.0
38 Jewelry (precious metal) 5.0 13.6 12.4 -69.3
39 Other manufacturing products 25.0 13.6 16.5 69.1
Average 16.9 10.4 23.1 27.8

Annex II

Revenue Implications of Trade Reform

101. The Ministry of Commerce wanted to know the revenue implications of a tariff
reduction reforms under consideration of the Ministry for 2007-08, 2008-09 and 2009-10.
The Ministry supplied the recent data on rate-wise imports and collection of custom duties.
As can be seen below, some revenue losses are natural with tariff reductions, but a large part
of these losses can be recouped through phasing out exemptions and concessions (usually a
part of reforms) and diversion of smuggling into imports through regular channels and
reduction in invoicing. The effects of recouping of revenue losses through phase out of
exemptions and reduction in smuggling and under invoicing are shown distinctly.
102. Given the data, the following manipulations are performed to restructure the rate wise
imports and collection of custom duties to conform to the proposed tariff structure.
The benchmark structure of dutiable imports in 2006-07 has been created as follows.
The shares of dutiable raw material and intermediate goods imports is assumed equal
to the dutiable imports in the 10% and 15% tariffs, respectively, as given in the 2006-
07 Jul-Feb data. The share of finished goods imports has been assumed equal to the
share of consumer good in 2005-06. These assumed three shares give the remainder as
the share of dutiable machinery imports. Within machinery and intermediate goods,
50% of imports are assumed for locally manufactured machinery/goods, an
assumption which is continued in later years.
For the following the three reform years, the share of finished goods imports is
assumed to rise by 2%, 1% and 1%, respectively with the corresponding decrease
being accommodated equally in raw material, machinery and intermediate goods
imports.

Table 1.2:
Dutiable Benchmark
Structure of dutiable imports Import share in 2006-07 2007-08 2008-09 2009-10
Raw material 10% tariff 30.8% 30.1% 29.8% 29.4%
Machinery Remainder 26.9% 26.3% 25.9% 25.6%
not locally manufactured 50% 13.5% 13.1% 13.0% 12.8%
locally manufactured 50% 13.5% 13.1% 13.0% 12.8%
Intermediate goods 15% tariff 31.4% 30.8% 30.4% 30.1%
not locally manufactured 50% 15.7% 15.4% 15.2% 15.0%
locally manufactured 50% 15.7% 15.4% 15.2% 15.0%
Finished goods FY06 10.9% 12.9% 13.9% 14.9%
Total 100.0% 100.0% 100.0% 100.0%

103. Given the structure of imports, the forecast of total imports has been prepared based
on normal growth (15% p.a.), reform generate growth
15
, additional growth due to reduction in
smuggling
16
and under invoicing
17
. The dutiable imports are then estimated by phasing out of
concessions and exemptions in the three reform years, 15%, 10% and 10%, respectively. The
dutiable imports are allocated in economic categories by applying the foregoing structure.

15 By using reductions in effective tariffs and elasticity of -.775 from an earlier study.
16 Smuggling is assumed to reduce with trade liberalization from an assumed level of 20% in 2006-07 to 10% in
2009-10.
17 Under invoicing is assumed to reduce with trade liberalization from an assumed level of 10% in 2006-07 to
5% in 2009-10.

Table 1.3
Mill Rs
Import Forecast 2005-06 act 2006-07 2007-08 2008-09 2009-10
Import growth 31% 15% 26% 24% 23%
Normal 31% 15% 15% 15% 15%
Due to reforms 3.4% 2.1% 1.4%
Lower under invoicing 3.0% 2.7% 2.4%
Lower smuggling 4.2% 4.0% 3.8%
Total imports 1,711,158 1,967,832 2,470,473 3,057,622 3,750,173
O/w normal imports 1,711,158 1,967,832 2,263,007 2,602,458 2,992,827
O/w reform related imports 207,466 455,164 757,346
O/w duty exempt % 45.5% 30.5% 20.5% 10.5%
O/w dutiable % 54.5% 69.5% 79.5% 89.5%
Dutiable imports 1,073,397 1,718,145 2,432,253 3,358,175
Raw material 330,290 517,227 724,093 988,551
Machinery 289,230 451,505 631,056 860,096
not locally manufactured 144,615 225,753 315,528 430,048
locally manufactured 144,615 225,753 315,528 430,048
Intermediate goods 337,390 528,592 740,182 1,010,765
Finished goods 116,487 220,820 336,921 498,763

104. The 2006-07 tariff structure has been recreated to conform to the proposed tariff
structure based on 2006-07 Jul-Feb revenues shares; the raw material is the 10% tariff share
in the dutiable imports, intermediate goods is the 15% tariff share, finished goods is the share
of 30%-90% tariffs, and machinery the remainder. Then, 2/3rd share of custom revenues
within machinery and intermediate goods each has been assumed to come from the not
manufactured locally categories (for want of better basis). The proposed tariffs for next three
years are given by the Ministry.

Table 1.4
Proposed tariff structure %
Description 2006-7 2007-08 2008-09 2009-10
Machinery
not locally manufactured 13.5 5 3.7 3
Intermediate goods
not locally manufactured 5.9 10 7 6

105. Given the conforming structure of tariffs and dutiable imports for the reform years,
estimation of custom revenue is a straight forward.
Table 1.5
Mill Rs
Custom Revenues 2006-07 2007-08 2008-09 2009-10
Raw material 17,480 25,861 21,723 29,657
Machinery 58,453 33,863 33,761 25,803
Intermediate goods 29,870 66,074 62,916 60,646
Finished goods 51,296 44,164 50,538 49,876
Total 157,100 169,962 168,938 165,982
Budget
Memo:

Effective rate % dutiable
imports
14.6% 9.9% 6.9% 4.9%
Effective rate % total imports 8.0% 6.9% 5.5% 4.4%

106. Indeed the proposed tariff reform is tremendous. The effective tariff rate on dutiable
imports falls from 14.6% in 2006-07 to 4.9% in 2009-10, a fall of 9.7%. The estimated
revenue losses over the three reform years after factoring in the import growth is Rs 356
billion. But a substantial part, 38.5% of the revenue loss, is recouped through phasing out of
concessions/ exemptions which are a necessary complement of these reforms. Another 15%
of revenue loss is recouped through reduction in smuggling and under invoicing. The
effective custom tariff on total imports falls by only 3.6% to 4.4%. The overall custom
revenues, budgeted at Rs 157 billion in 2006-07, rise by 5.7% to Rs 166 billion in 2009-10.

Table 1.6
Mill Rs
Revenues 2006-07 2007-08 2008-09 2009-10 2007-10
Customs
With status quo 157,100 188,709 221,641 260,207 670,558
With reforms 157,100 125,720 103,368 85,621 314,709
Revenue loss -62,989 -118,273 -174,586 -355,849
With reforms along with reduction in
reckoning of smug & under
invoicing 9,670 18,194 25,423 53,287
With reforms with reduction in
concessions
Additional sales tax collection

107. The reforms would also result in additional sales collections, which have been quantified
at the sales tax rate of 15% of the additional imports due to reforms. The calculation yield
additional sales tax revenues of Rs 213 billion in the three reform years, thereby more than
offsetting the revenue losses by Rs 47 billion over the three years.

108. Further more the tariff reform would reduce the anti-export bias and help the export
growth. The additional export growth can be estimated
18
by assuming the same reduction in anti-
export bias as in the average tariff on imports. These calculations reveal that the proposed tariff
reforms would generate 7.1% additional exports during the three year reform period.

Table 1.7
2005-06 2006-07 2007-08 2008-09 2009-10 2007-10

Export growth 8% 20% 18% 17%
Normal growth 8% 15% 15% 15%
due to reforms 4.9% 3.2% 2.2%
Reduction in anti-export bias 4.1% 2.7% 1.9%
Exports value (Mill Rs)
Normal growth 16,388 17698.932 20353.7718 23406.8376 26917.8632 70,678
Normal growth and reforms 16,388 17698.932 21220.497 25076.9163 29394.3163 75,692
Attributable to reforms 867 1,670 2,476 5,013
As % of normal trend value 4.3% 7.1% 9.2% 7.1%

109. A better alternative tariff reforms is to go for a single tariff rate in the range of 5-10%.
The foregoing tariff regime is still very complex given the institutional capacity to effectively
implement it and be able to effectively reduce the anti-export bias. Hence we suggest that the
government commit to total trade liberalization in the long term and reduce the tariff rates to a
single rate of 5% in next 3 years. This alternative would not only ensure a substantial removal of
anti-export bias, but also is a superior alternative on grounds of revenue. Thus the following
simpler tariff structure is thus recommended.

Table 1.8
Equivalent tariff Proposed tariff structure %
Description 2006-7 2007-08 2008-09 2009-10
Machinery
not locally manufactured 13.5 5 5 5
locally manufactured 26.9 10 7.5 5
Intermediate goods
not locally manufactured 5.9 10 7.5 5

110. The alternative tariff reform is marginally better on revenue considerations. The
implications on revenue and exports of this revenue structure, based on the otherwise same base
information, on existing imports, tariffs and revenue structure are given below. Marginal
improvements are noticeable in the table; the revenue loss is lower, recouping of losses is better,
and sales tax collection is higher. The overall custom revenue rises by a higher rate, 6.9%, to Rs
168 billion in 2009-10. However the biggest advantage of the alternative is in its effectiveness in
implementation and reduction of anti-export bias.

18 For this, the price elasticity of exports has been assumed at 1.183 from an earlier study.
Table 1.9
Revenues 2006-07 2007-08 2008-09 2009-10 2007-10
Customs
With status quo 157,100 188,709 221,641 260,207 670,558
With reforms 157,100 125,720 106,529 86,615 318,864
Revenue loss -62,989 -115,112 -173,592 -351,694
With reforms2 along with reduction in
Reckoning of smug & under invoicing 9,670 18,750 25,718 54,138
With reforms with reduction in concessions
Additional sales tax collection

Table 1.10
2005-06 2006-07 2007-08 2008-09 2009-10 2007-10

Export growth 8% 20% 18% 17%
Normal growth 8% 15% 15% 15%
Due to reforms 4.9% 2.9% 2.4%
Reduction in anti-export bias 4.1% 2.5% 2.0%
Exports value (Mill Rs)
Normal growth 16,388 17698.932 20353.7718 23406.83757 26917.86321 70,678
Normal growth and reforms 16,388 17698.932 21220.49704 25028.38016 29379.1683 75,628
Attributable to reforms 867 1,622 2,461 4,950
As % of normal trend value 4.3% 6.9% 9.1% 7.0%

111. To sum, tariff reduction reforms have a strong justification. Tariff reduction imply
revenue losses, but these losses can be recouped through appropriate phasing out exemptions
and concessions (usually a part of reforms) and diversion of smuggling into imports through
regular channels and reduction in under invoicing. Beside the reforms would lead to greater
imports and sales tax revenues. The foregoing exercise shoes that the revenue losses can be
more than offset. Besides tariff reductions reduce anti-export bias and help export growth. In
the longer run, production structures improve in more liberal trading environment due larger
market and specialization, more intense competition forcing efficiency and innovation, better
access to technology, and cheaper and quality inputs, which promotes growth. Consumers
benefit by getting better variety of goods and prices, which can help the poverty reduction
efforts.

Annex III

Table 1.11: Rate-Wise Value of Imports and Import Duties (Mill Rs)
(2006-07)
Dutiable Custom Effective tariff
Tariff rate Imports Share % IMPORT Share % Revenues Share % % of total M % of to Dutiable M
1 2 3 4 5 6 7 8 9
930,645 77.5% 608,557 92.9% 70,468 78.9% 7.6% 11.6%
10 452712 37.7% 201,467 30.8% 9,936 11.1% 2.2% 4.9%
15 248438 20.7% 205,798 31.4% 16,979 19.0% 6.8% 8.3%
20 44426 3.7% 35,623 5.4% 4,004 4.5% 9.0% 11.2%
25 68993 5.7% 59,150 9.0% 9,480 10.6% 13.7% 16.0%
30 61073 5.1% 54,226 8.3% 10,980 12.3% 18.0% 20.2%
35 6571 0.5% 6,517 1.0% 1,402 1.6% 21.3% 21.5%
50 10015 0.8% 7,749 1.2% 2,297 2.6% 22.9% 29.6%
60 23122 1.9% 23,085 3.5% 8,631 9.7% 37.3% 37.4%
65 3484 0.3% 3,459 0.5% 1,180 1.3% 33.9% 34.1%
75 2906 0.2% 2,891 0.4% 1,183 1.3% 40.7% 40.9%
90 5909 0.5% 5,638 0.9% 3,485 3.9% 59.0% 61.8%
2996 0.2% 2,954 0.5% 911 1.0% 30.4% 30.8%
Subtotal 1196879 99.7% 653,584 99.8% 81,716 91.5% 6.8% 12.5%
Other 3441 0.3% 1,157 0.2% 7,583 8.5% 220.4% 655.4%
G-total 1200320 100.0% 654,741 100.0% 89,299 100.0% 7.4% 13.6%

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