WTO S TRADE LIBERALIZATION AND ITS IMPLICATIONS FOR PAKISTAN COTTON ECONOMY

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1 Sarhad J. Agric. Vol.25, No.2, 2009 WTO S TRADE LIBERALIZATION AND ITS IMPLICATIONS FOR PAKISTAN COTTON ECONOMY MUHAMMAD ZULFIQAR*, SHAHNAZ A. ARIFULLAH** and ANWAR F. CHISHTI*** * Kohat University of Science and Technology, Kohat, Pakistan ** Institute of Development Studies, NWFP Agricultural University, Peshawar, Pakistan *** Department of Agricultural Economics, NWFP Agricultural University, Peshawar, Pakistan ABSTRACT This research paper on cotton economy of Pakistan distinguishes policies and interventions, their welfare effects and implications of the implementation of WTO s trade liberalization on cotton sector. The quantitative analysis of data reveals that cotton crop hanged about export tax-cum-export trade regime during and depressed price-cum-import trade regime during Welfare analysis of such policy interventions estimated higher losses to producers (Pak Rs million per year) than gains to consumers (Rs million per year) during period. In case of free trade, simulation results demonstrate greater gains to producers than losses to consumers. If world market was liberalized, supplementary gains in the range of Rs million to Rs million per year during earlier and Rs million to Rs million per year during the later period would have occurred at domestic level. Producers gains would have been higher than consumers losses in the earlier period and in contrast consumers gains would have been higher than producers losses during the later period. In light of analytical results, the following recommendations are made. (i) Government should reduce its interventions and pace of tightening down gap between domestic and international prices to carry on unless they level each other. (ii) There is a need to improve the pace of trade liberalization at domestic level in a way that world prices are permitted to prevail in domestic cotton market. (iii) Pakistan should play active role in WTO s negotiations for early implementation of WTO s trade liberalization on international level and particularly in major global economies of US, EU and other OECD countries. (iv) Government of Pakistan should steadily trim down its role in cotton and shape its role as facilitator of trade in accordance with Green Box of Agreement on Agriculture and other WTO agreements. More investment should be made in areas of research, development, out-reach and adoption of FAO/WHO s Codex Alimentarius Commission induced international quality standards. Key Words: To, Agreement on Agriculture, trade liberalization, welfare effects, policy Analysis for Pakistan cotton Citation: Zulfiqar, M., S.A. Arifullah and A.F. Chishti WTO s trade liberalization and its implications for Pakistan cotton economy. Sarhad J. Agric. 25(2): INTRODUCTION Pakistan s cotton domestic wholesale price, export/import trade price and world trade price has been reviewed to ascertain types of interventions. Government of Pakistan has espoused to regulate its cotton economy during 1985 to The data on prices (Annex Table 1) mirrors that Pakistan s domestic wholesale price (P d ) has been, on average, at US$ (Pak Rs.11246) per M. ton whereas average world trade price (P w ) stayed at US$ (Rs ) per M. ton. Though, Pakistan s average export price (P e ) was US$ (Rs ), signifying that Pakistan has taxed its export by US$ (Rs ) per M. ton during However, due to depressed domestic prices, Pakistan became an importer of cotton and it imported on average M. ton annually at average import price (P i ) of US$ (Rs ) per M. ton during The prime aim of this research is to analyze Government interventions in cotton economy, estimate welfare effects associated with such interventions and investigate implications of the WTO s Agreement of Agriculture on Pakistan s cotton economy. Methodological/Analytic Framework In order to achieve the objectives of this research, three methodologies are adopted that is: (a) analysis of prices and identification of government interventions; (b) computation of associated welfare effects in terms of changes in producer and consumer surpluses; and (c) analysis of implications of implementation of WTO s Agreement on Agriculture, which asks for trade liberalization through reduction in domestic support, import tariffs and export subsidies.

2 Muhammad Zulfiqar, et al. WTO s trade liberalization and its implications for Pakistan cotton 340 Identification of Government Interventions As the core objective of this research was to analyze the effects of WTO trade liberalization, the study period ( ) was estranged into two sub-periods i.e. pre-wto ( ) and post-wto ( ). The mean values of prices for the two sub-periods were worked out, as follows. Pre-WTO period Post-WTO period ( ) ( ) Pakistan s wholesale price (P d ) US$ (Rs ) US$315.90(Rs ) World average price (P w ) US$ (Rs ) US$ (Rs ) Pakistan s trade price (P e or P i ) US$ (Rs ) US$ (Rs ) As the average domestic price (P d ) remained at US$ per M. ton against average world trade price (P w ) at US$ and Pakistan s average export trade price (P e ) at US$388.58, the policy remained in vogue in Pakistan during the pre-wto period may be termed as export tax regime (Figure 1). Whereas during post- WTO period, average domestic price (P d ) remained at US$ per M.ton against average world trade price (P w ) at US$ per M. ton and Pakistan s average import trade price (P i ) at US$ per M. ton, suggesting depressed domestic prices regime tied with importing high quality cotton on import prices (P i ) higher than world average trade price (P w ) during the post-wto study period (Figures 2). Computation of Welfare Effects Welfare effects of the prevailing situations (pre- and post-wto) measured in terms of changes in producer and consumer surpluses ( PS & CS) along with computed export tax (ET) or import cost to society (CS) were estimated for arriving at net social welfare gains or costs (NSWG/C) of the two policy regimes recognized. Pre-WTO Situation The welfare effects of export tax regime, followed during pre-wto period, can be portrayed as given in Fig. 1. D d S d P df =Rs P d =Rs a f b e d c g P e =$ P ef =$ P d =$ j h i E s E d Pakistan s Domestic Market World Market Fig. 1. Export-tax regime practiced during The associated welfare effects were captured using the following model. ) Except Pakistan s estimated free market prices (P df or P ef ) and cotton s supply S(P) and demand D(P)

3 Sarhad J. Agric. Vol.25, No.2, functions, all other abbreviations of Model 1 4 have already been elucidated. The cotton supply and demand functions estimated by Zulfiqar (2008; p.109) were adopted; these were. S(P) = S d = P d (5) D(P) = D d = P d (6) E s = P d (7) E d = P e (8) = P w (9) For arriving at Pakistan s free market export price (P ef ), export supplies (E s ) and export demand (E d ) functions were equalized, as follows. E s = E d (10a) Since P d /EXR = P e or P d = P e *EXR (where EXR is exchange rate), replacing P d in above equation, we get estimated free market export price (P ef ): P ef = US$ per M. ton (10b) Substituting worth of P ef = (obtained in 10b) in E d in equation (8), we get estimated free market export demand (E df ): E df = (P e = ) = M ton (11) equating E df (obtained in equation 11) with export supply function given in (7), we get Pakistan s estimated free market domestic price (P df ). E df = E sf (12a) P df = Pak Rs per M. ton (12b) After computing P ef and P df in equations (10b) and (12b), the pre-wto scenario s welfare effects specified in Model 1-4 were estimated, as follows. = - Rs thousand = - Rs million (13b) = Rs thousand = Rs million (14b) ET = (ghij) = (P e P d )E s (15a) = US$ thousand = Rs thousand = Rs million (15b) NSWG/C= PS + CS + ET (16a) = thousand = Rs million (16b) The export tax regime resulted on average in losses of Rs million to producers, benefits of Rs million to consumers and gains of Rs million to government treasury as export tax revenues per year during study period; the regime thus turned out with net social gain worth Rs million per year for the society as a whole. Post-WTO Situation During post-wto period, Pakistan implemented depressed price-cum-import trade regime (Fig. 2).

4 Muhammad Zulfiqar, et al. WTO s trade liberalization and its implications for Pakistan cotton 342 I s D d S d P i = $ g h E s P df = Rs a b c P if = $ P a = Rs P d = Rs f e d P d = $ j i E d I d Pakistan s Domestic Market World Market Fig. 2. Depressed price regime practiced during The associated welfare effects were captured using the following model. CS = -(ghij) = -(P i P d )I d (19) NSWG/C = PS + CS + CS (20) The following supply and demand functions adjusted for the post-wto period ( ) were adopted from Zulfiqar (2008; p ). S d = P d (21) D d = P d (22) For import demand (I d ) function: I d = D d - S d (23a) = P d (23b) For import supply function (I s ), we adjust the intercept of original E d function and take inverse values, as follows. I s = P i (24a) = P w (24b) In contrast to equations (5) to (9), which represent supply and demand functions of Pakistan cotton economy for export trade regime during , equations (21) to (24) represent supply and demand functions of Pakistan cotton import trade regime for period. Since Pakistan demanded higher cotton imports, the world cotton exporters would demand high price. Mathematically, equating Pakistan s average import demand I d = thousand M ton with import supply function (I s ) and solving for import price (P i ): I s = = P i (25) P i = US$ per M. ton (26) Hence, Pakistan had imported, on average, thousand M. ton of cotton per year but it had to pay a cost, a difference of import price of US$ and domestic price of US$ per M. ton, due to import of higher quality cotton coupled with higher domestic demand induced by depressed domestic prices. Please note that for post-wto scenario, relevant import demand (I d ) and Import supply (I s ) are represented, respectively, by I d and I s in the World Market penal of Fig. 2.

5 Sarhad J. Agric. Vol.25, No.2, However, when we calculate autarky (no import/no export) situation by equating S d = D d and subsequently compute free market situation represented through free market price (P df ), we arrived at the fact that: (i) Pakistan s autarky price (P a ) estimates at Rs per M. ton and (ii) its free trade price (P df ) estimates at Rs per M. ton, which reflect the fact that Pakistan would have been an exporter of cotton if trade was liberalized and domestic prices were not kept at depressed level of Rs per M. ton. The arrow shown in the Domestic Market penal of Figure 2, passes through the intersection point of S d and D d and bifurcates the penal into two parts; lower part along with I d and I s functions represents the cotton import scenario and upper portion represents the export scenario of Pakistan cotton economy. From the level of autarky price (P a = Rs ), I d originates representing import demand and E s originates representing export supply, which along with export demand (E d ) function relates to cotton export market. As far as welfare effects are concerned, because of depressed domestic price (P d = ) relative to the free trade price (P df ) of Rs , producers hurt, facing a loss of producers surplus measuring area equal to acef while consumers benefited by enhanced consumers surplus equal to area abdf (Figure 2). It has already been mentioned that imports were made at higher prices for better quality of cotton coupled with higher domestic consumption induced by lower domestic prices. One can argue that cotton prices were kept at lower than the free trade level to benefit cotton textile producers. Hence the extra cost paid by textile producers for import of cotton is actually the cost to the society (CS). The welfare effects are therefore, summarized, as follows. = - Rs million (27b) = Rs million (28b) CS = -(ghij) = -(P i P d )I d (29a) = - Rs million (29b) SWG/C = PS + CS + CS (30a) = - Rs million (30b) Implications of WTO s Trade Liberalization Implementation in Domestic Economy WTO s Agreement on Agriculture and other WTO s agreements, particularly GATT 1994, asks for adhering to reduction of protection such as domestic support, import tariffs and export subsidies and eliminate/abolish all such protection/support policies over a specified period and introduction of liberalization (WTO website: It means that WTO in general aims at introducing and implementing free trade. Recalling the way we estimated the welfare effects of existing policy regimes in previous section, the welfare effects of existing policies were estimated comparing those with free trade situation. If government interventions were not there, free trade price P df = Rs would have prevailed instead of existing domestic price P d = Rs per metric ton during the pre-wto period (Figure 1). Thus, there would have been no losses to the producers, no gains to the consumers and no tax earnings to government treasury. Therefore, the estimates of the effects of implementation of free trade per year (during pre-wto period ) would have been as follows. PS = Rs million (31) CS = - Rs million (32) ET (export tax) = - Rs million (33) NSWG/C = - Rs million (34) Correspondingly, we would have following welfare effects of free-trade scenario for post-wto period. PS = Rs million (35) CS = - Rs million (36) CS = Rs million (37) NSWG/C = Rs million (38)

6 Muhammad Zulfiqar, et al. WTO s trade liberalization and its implications for Pakistan cotton 344 Implementation of WTO Trade Liberalization in International Markets Implementation of Agreement on Agriculture and other WTO agreements would have created similar trade liberalization effects in other member countries of the WTO. Resultantly world prices would rise as indicated in a number of research studies. ICAC (2002) and Summer (2003) estimated 50% and 12.6% rise in cotton prices while Tokarick (2003) and Poonyth et al. (2004) estimated 2.8% and 3.1% 4.8% increase. Similar findings have been captured by FAO (2005), Anderson, Martin and Mensbrugghe (2006) and Zulfiqar (2008). From the above findings, it becomes evident that trade liberalization would increase the world prices of cotton. We, therefore, assume a range from 5 to 20 percent rise in world price (P w ) for cotton and examine their effects on Pakistan s domestic economy. The estimation of a 5 percent increase in P w of cotton crop is provided in detail in the following paragraphs while results of other estimates are provided in table 1. Pre-WTO Scenario Being an exporter of cotton, Pakistan s domestic economy would receive the effect of world enhanced price (P w ) through Pakistan s cotton export demand function given in equation (9); hence, putting 5 percentenhanced value of P w in the said equation: E d = (P w = ) (39a) = thousand M. tons (39b) Equating E d = with E s given in (7) and solving for P d E d = E s (40a) = P d P d = Rs. per M. ton (40b) Substituting P d = in (5 & 6) and solving for S d and D d S d = P d (41a) = thousand M. tons (41b) D d = P d (42a) = thousand M. tons (42b) As estimated in (39) and (40), 5%-enhanced P w would help increase Pakistan s cotton domestic price P d from its existing original level of P d0 = Rs to new level of P df = Rs The associated welfare effect changes would be, as follows. = Rs million (43b) = - Rs million (44b) NSWG/C = PS + PS (45a) = Rs million (45b) Post-WTO Scenario As Pakistan became a net-importing cotton country during post-wto period, in such a situation, 5 percent-enhanced world price would encourage exporters to make available greater volumes of export supply (I s ; equation 24), which would further cause Pakistan domestic price (P d ) to decline (via equation 23) from the existing level of P d0 = Rs to new level of P df = Rs ; the associated welfare effects would be measured, as follows. = - Rs million (46b) = Rs million (47b) NSWG/C = PS + PS (48a) = Rs million (48b)

7 Sarhad J. Agric. Vol.25, No.2, Table I Changes in social welfare ( PS, CS and NSG/C) due to changes in world prices of cotton Scenarios (Percent Pre-WTO period (Rs. In million) Post-WTO period (Rs. in million) Change in PS CS NSG/C PS CS NSG/C Prices) 5 percent (-) (-) percent (-) (-) percent (-) (-) percent (-) (-) The estimated welfare effects reported in Table I, suggests substantial effect on net social welfare that turned out to be positive. Producers gains were higher than consumers losses during pre-wto period and consumers benefits are higher than producers losses during post-wto scenario. RESULTS AND DISCUSSION Domestic cotton price (US$ per M.ton) has been at much lower level than the world average price (US$ per M.ton), as a result cotton producers suffered losses in their producer surpluses by Rs million per year, while on other hand the low prices helped consumers to gain Rs million per year in their consumer surpluses during pre-wto period, in Pakistan. The government treasury got Rs million per year as export tax. The society, as a whole, earned net social benefit of Rs million per year due mainly to export tax earnings to the government treasury. Cotton average domestic price remained at US$ per M.ton against world average price at US$ per M.ton during post-wto period; Thus, cotton producers experienced losses amounting to Rs million per year and consumers benefitted by Rs million per year. Imports were made at higher prices for better quality of cotton coupled with higher domestic consumption relative to low production induced by lower domestic prices; this cost worth Rs million per year. The society, as a whole, faced net social loss of Rs million per year. The government interventions in Pakistan cotton economy caused net social welfare gain during pre-wto period and net social welfare cost during post-wto period; these gains and costs taken place when export tax and import quality-cost associated with such interventions during the two periods were accounted. However, such tax earnings or costs hide what actually happened to the welfare of producers and consumers. If trade was liberalized, taxes and costs would no longer remain and producers and consumers surpluses would be considered for evaluation of the welfare effects. Thus, if welfare effects of existing policies to producers and consumers are compared, then losses to producers surpluses had been greater than benefits in consumers surplus during both pre- and post-wto periods. If trade liberalization was introduced in the domestic economy, it would have incurred greater gains to cotton producers (worth Rs million and Rs million per annum during pre- and post-wto, respectively) than losses to consumers (worth Rs million and Rs million per annum). While trade liberalization at world cotton markets 1, would have benefited Pakistan s cotton economy during both pre- and post-wto periods; net social gains would have been in the range of Rs million to Rs million per year during pre-wto period and Rs million to Rs million per year during the post-wto period. However, producers gains would have been higher than consumers losses in pre-wto period and consumers gains would have been higher than producers losses during post-wto period.

8 Muhammad Zulfiqar, et al. WTO s trade liberalization and its implications for Pakistan cotton 346 Table II Pakistan s cotton prices for (prices per M. ton) Year Pakistan Domestic Wholesale Price World Price Pak Rs. US$ (US$) Net Export ( 000 M. ton) Pakistan trade Price (US$) Average ( ) Average ( ) Average (Overall) Source: FAO ( Statistical database) CONCLUSION AND RECOMMENDATIONS Keeping in view our analytical work and discussions thereupon, the conclusions reached and recommendations made are as follows. The narrowing down gap between domestic and world prices over the years reflects that government policy interventions have lessened during the post-wto period as compared to pre-wto period. The government should carry on tightening down the gap between domestic and international prices unless they level each other. The welfare effects of prevailing domestic policy interventions in terms of producers and consumers surpluses reflect greater losses than gains during both pre- and post-wto period. In case trade liberalization was carried out in domestic economy, producers gains would have been higher relative to losses to consumers. Thus, there is a need to improve the pace of trade liberalization at domestic level in a way that world prices are permitted to prevail in domestic cotton market. In case trade liberalization was carried out at world cotton market, the simulations conducted reflects that Pakistan s cotton economy would have been benefited due to a greater increase in producers surplus compared to decrease in the consumers surplus during pre-wto and greater increase in consumers surplus compared to decrease in the producers surplus during post-wto period. Pakistan should, therefore, play active role in WTO s negotiations for early implementation of WTO s trade liberalization on international level and particularly in major global economies of US, EU and other OECD countries. Government of Pakistan should steadily trim down its role in cotton trade and shape its role as facilitator of trade in accordance with the Green Box of Agreement on Agriculture and other WTO agreements. More investment should be made in areas of research, development, out-reach and adoption of FAO/WHO s Codex Alimentarius Commission induced international quality standards. Pakistan imports quality cotton at high prices. It should evolve good quality cotton varieties to lessen its dependence on import of expensive quality fiber.

9 Sarhad J. Agric. Vol.25, No.2, REFERENCES Anderson, K., W. Martin and D.V.D. Mensbrugghe Incidence of trade and subsidies policies on developing countries welfare, export and debt sustainability. The World Bank, Washington D.C. Daneswar, P., A. Sarris, and R. Sharma (2004). The impact of domestic and trade policies on the world cotton market. Commodities and Trade Div. FAO, Rome. FAO website: FAO The state of food and agriculture: Agricultural trade and poverty. FAO Agric. Series No.36. Food and Agric. Org. of the United Nations, Rome. Giannis, K The EU cotton policy regime and the implications of the proposed changes for producer welfare. FAO Commodity and Trade Policy Res. Working paper No. 9. Commodity and Trade Div.. Food and Agric. Org. Rome. ICAC Production and trade policies affecting the cotton industry. Int l Cotton Advisory Committee. Washington, D.C. Poonyth, D., S. Alexander, S. Ramesh and S. Shangnan The impact of domestic and trade policies on the world cotton market. FAO Commodity and Trade Policy Res. Working paper No. 8. Commodity and Trade Div. Food and Agric. Org. Rome. Tokarick, S Measuring the impact of distortions in agricultural trade in partial and general equilibrium. IMF working paper WP/03/110. Int l. Monetary Fund. Washington, D.C. William, S.E., A.K. Siddiqi, S.A. William and M.I. Muhammad Export restrictions- A study of restrictions on agricultural exports in Pakistan. Special Report No. 17, Ministry of Food, Agric. & Cooperatives and U.S. Agency for Int l Dev. Islamabad. WTO website: Zulfiqar, M WTO s trade liberalization: Implications for Pakistan s crop sector. Ph.D Dissert. Deptt. of Agric. Econ., NWFP Agric. Univ. Peshawar.

10 Muhammad Zulfiqar, et al. WTO s trade liberalization and its implications for Pakistan cotton 348