Countries Can Gain from the Exchange of Goods with the Rest of the World: Pakistan

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Countries can gain from the exchange of goods with the rest of the world: Pakistan

For quite some time now academics have tried to explain not only the motivations and benefits, but also why through trade, some countries grow more quickly and wealthier than others. “The evolution of trade into the form we see today reflects three events: the collapse of feudal society, the emergence of mercantilist philosophy, and the life-cycle of the colonial systems of the European nation-states” (Czinkota, Ronkainem, Muffett, pp128 2009). The following essay will first explore some of the mainstream trade theories, such as the Heckscher-Ohlin trade theory and the Gravity model; and the time sequence in which they came about. Trade is argued to produce more gains in the form of increased overall output, than in a state of autarky; so the theories go. However, this statement will be empirically tested with the ten most important export partners for Pakistan and the accuracy of the theories evaluated all within the time-series of 2006 to 2010.

Since the fall of Mercantilism, at the start of the evolutionary path of trade was Adam Smith with his theory of absolute advantage; that countries should specialize in the production of that good in which it produces most efficiently and export it. Subsequently, David Ricardo’s theory of comparative advantage stated that the good that a country is relatively more efficient in producing should be should be specialized in and exported; in exchange for the good that it is relatively less efficient in producing which is imported. An expansion of Ricardo’s theory is the Heckscher-Ohlin theory of trade which, rather than assuming comparative advantage, explains it as it postulates that differences in labour, labour skills, physical capital, land or other factors of production across countries create productive differences that explain why trade occurs. Furthermore, a country which is labour abundant (capital abundant) should specialize in the production and export of that product which is relatively labour intensive (capital intensive) as locally abundant resources means cheaper production of a good because the price of its inputs will be cheaper. Likewise, the country should import that product whose production requires the intensive use of the country’s relatively scarce and expensive factor.

A mathematical way of determining trade patterns between countries is the Gravity model which uses such variables as: economic size, distance between them, cultural and colonial links, regional trade agreements (RTAs), exchange rates, other factors; as a full model specification:

The dependant variable is exports which correlates to gross domestic product (GDP) reflecting income, distance between countries ( - DIST) reflecting transport costs, GDP per capita (GDPPC)reflecting factor endowments; these first three are the gravity variables. Furthermore, adjacency (ADJ), language (LANG), and regional trade agreements (RTA) denoted as EU; the binary variables have a positive effect on trade.

Source: ESDS World Bank Data
After services, agriculture accounts for the largest component of GDP for Pakistan which has a GDP of $1.75 trillion and per capita: $1006 in 2010. However, this labour intensive sector supplies mainly domestic demand as only 1%-2% of this is exported between 2006 and 2009. Approximately, 80% of merchandise exports are that of capital intensive manufactured goods such as textiles, leather goods, sports goods and chemicals. Subsequently, this seems to conflict with the Heckscher-Ohlin theory as labour abundant Pakistan exports capital intensive goods. Furthermore, Pakistan imports more than 50% of manufactured goods as a percentage of merchandise imports further weakening trade theory (ESDS, World Bank Data). Pakistan; a net importer shows a degree of openness to trade as both...
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