Pak-SAARC Bilateral Trade: An Application of Gravity Model

Abstract

This research study attempts to explore trade relations between Pakistan and SAARC (South Asian Association for Regional Cooperation) economies. It is a group of eight independent states including Pakistan. The study elaborates its history of formation and executive body. It depicts introduction of SAARC economies, their GDP growth rate and economic structure. Since its inception, the member countries have conducted many summits. In these summits, the member countries have signed various trade agreements. Whether these agreements enlarged the regional trade or not and what are the hurdles in the smooth flow of regional trade, all these are explained comprehensively in this study. Trade is the engine of economic growth. Achieving sustainable development and reducing poverty are the main goals of almost all developing nations. The main objective of this research study is to measure the bilateral trade flow of Pakistan with other partner countries. Moreover, in this study the major macroeconomic determinants are discussed. This panel study spreads over the period from 2003 to 2016. For empirical analysis, gravity model of trade is used. Various econometrical techniques are used to estimate bilateral trade between Pakistan and SAARC countries. The initial results of gravity model are obtained through pooled OLS, fixed effect and random effect estimators. The Hausman test results suggest that fixed effect model is suitable for estimation. Therefore, the study concentrates only on the findings of the fixed effect model. The empirical findings reveal that GDPs of both Pakistan and the partner countries have a positive impact on bilateral trade. The population or market size has a negative impact on Pakistan’s bilateral trade. As all the SAARC countries including Pakistan are populous countries and they prefer to put their commodities in the local markets to meet the requirements of their own population. This was justified on the basis of absorption effect. Similarly, distance and exchange rate also have a negative correlation with bilateral trade. The study finds that Pakistan has very low trade with India and Afghanistan despite the common border. The reasons are the military and political conflicts between Pakistan and India. However, trade is not friendly between Pakistan and Afghanistan due to terrorism. The results of this study also show that common language has a positive but insignificant impact on bilateral trade. Before short run and long run analysis, panel unit root tests are applied to check the staionarity of the variables. The empirical results are obtained through Levin Lin & Chu (LLC) and Im, Pesaran and Shin (IPS) tests. The findings of both the tests suggest that some variables are stationary at level while some are stationary at the first difference. In such a case, pooled mean groop (PMG) estimator was the best option with us. The empirical findings of the PMG model suggest that GDP and population have positive impact on Pakistan’s bilateral trade both in short run and long run. The exchange rate and distance have the usual signs that are negative. Similarly, common border has negative impact in short run while positive impact in the long run. Lastly, common (official or commercial) language is found expansionary in its effects on bilateral trade both in short run and long run. The study also attempts to calculate the trade potential of Pakistan. The findings reveal that Pakistan has high trade potential with all SAARC countries except Maldives and Afghanistan. On the basis of empirical results it is recommended that member vii countries should remove or reduce trade barriers, especially Pakistan and India should solve their historical disputes (Kashmir Issue) and abandon unnecessary tensions. In this regard fully implementation of SAFTA is necessary. Pakistan and Afghanistan can extend their trade because they are culturally very close to each other. This is possible only if peace comes in both countries. Pakistan should control high population growth rate. Similarly, Pakistan and other countries of the region should improve infrastructure to reduce transportation costs. The monetary authorities of Pakistan should focus on the exchange rate stability. It will improve the competitiveness of Pakistani currency in international market. Pakistan should also extend bilateral trade relations with other South Asian countries like Sri Lanka, Bhutan and Nepal. The empirical analysis presented in this study are not without limitations. The study has not analyzed the impact of regional trade agreements on Pakistan’s bilateral trade flows. It failed to investigate the trade creation and trade diversion effects of SAFTA membership on trade flows of Pakistan. The analysis and findings of the study are affected by the relative small number of countries and short time period of data used in the study. Of course, Pakistan’s key trading partners are more than 25 countries and these bilateral trade relationships have spanned for many years. However, limited availability of data on bilateral trade flows and other variables for all the countries for a longer period of time imposed a constraint on the sample size of the study.