Since 1950s, foreign capital inflows have financed the imbalances between income and expenditure of Pakistan. On the other hand Pakistan has restrictions on imports in the form of: licensing, quota and tariffs, which has created distortions in the system leading to an inefficient use of resources. It encouraged import substitution and neglected the export sector that employs the most abundant factor of the economy ‘labour’. In this paper, we have incorporated the impact of foreign capital inflow on poverty with and without trade liberalisation. The investigations into the poverty implication of foreign capital inflows have been investigated into two different scenarios: (1) labour is homogeneous (2) labour is heterogeneous.
In the first scenario, the results suggest that the foreign capital inflows benefit capital owners in the presence of trade restrictions. Real income of only agriculture and miscellaneous group in the urban area increases, while in the rural area real income of all households increase except, production workers, who are the poorest group of households. However, in aggregate, real income of the urban households decline but real income of the rural households increase. From this we may conclude that foreign capital inflow in the presence of trade restrictions benefit more rich households.
When tariff is eliminated on machinery, and foreign capital inflow increases, gain is maximum for professionals (rich) and minimum for the production workers (poor), in terms of income. However, when trade is liberalised by reducing tariff on all imports, increase in wages is larger than the increase in returns to capital. The wage earners ‘professionals’ in urban area gain maximum. Among the households in rural areas, professional and miscellaneous show a larger increase in income. From this we can conclude that foreign capital inflow in the presence as well as in the absence of trade liberalisation benefits more the rich households in terms of income.
In the presence of foreign capital inflow with restricted trade, all households groups benefit and poverty reduce irrespective of the measures, P0, P1 or P2, except for the production workers in both, urban and rural areas. For this group the head count ratio, P0, does not show any change, but P1 and P2 indices in urban and rural areas show an increase in poverty. All the three P" measure of poverty decline more for rural households compared to urban households in aggregate. In the second simulation, all the three P" measures reduce more for urban households. This exercise show that more benefits accrues to capital owners. The third simulation with the increase in foreign savings in the presence of tariff reduction on all imports shows that poverty reduces very significantly by all measures in every group of households in the rural as well as in the urban area. A comparison of the results of the first and the third simulation shows that poverty reduction in the presence of trade liberalisation is larger than the poverty reduction in the absence of trade liberalisation. The variation in density function shows that the households move from the lower to higher income brackets in all experiments. The movement is larger among the lower income groups (200-500) compared to the movement in larger income groups. This suggests that income disparity reduces after increase of foreign savings in the country. This reduction is larger among the poor groups of households.
In the second set of experiments, we assume labour is sector specific and differentiated by sector of activity. This experiment shows how foreign capital inflow affects returns to different types of labour. Wages declined increase in import competing sectors, ‘Machinery’ and decline in ‘Textiles’ where relatively less skilled labour is employed after FKI in presence of trade restrictions. Income of rich households increases by higher percentage. In the presence tariff elimination on import of machinery income of households (professionals) increases by a larger percentage in both the rural and urban areas. Trade liberalisation through a reduction in tariffs by eighty percent on all imports, is harmful for the import-competing sectors and beneficial for export sector. This leads to reduction in wage gap between the skilled and unskilled workers. However, income of all households increases in the urban as well as in the rural area. Households related to clerks, agriculture worker and production workers gain more compared to professionals group of households. From this exercise we can conclude that FKI increase wage gap in presence of trade restrictions and reduces the gap in presence of trade liberalisation.
The results show that in the presence of trade restrictions, FKI leads to an increase in poverty by all P" measures in both areas by less than one percent in the urban as well as in the rural area. It is harmful for the poor group of households, production workers, as head count ratio increases only in this household group. In rural areas, the head count ratio increases for the professionals and the agriculture workers, who receive a larger share from capital. While, the poverty gap and severity indices, P1 and P2 respectively, increase for all groups of households in the urban and the rural areas.
In the second exercise, increase inflow of foreign capital in the presence of tariff elimination on import of capital goods benefits urban households more compared to rural households. All poverty indices decline more in the urban area. The number of households below the poverty line decline by a larger percentage in the groups of
households. In the third scenario, the inflow of foreign saving in the presence of trade liberalisation benefits urban households more in terms of head count ratio, but are of greater benefit to rural households if we measure poverty by P1 and P2. In the urban area, as relatively larger decline in percentage households below poverty line is agriculture workers and professionals. In rural areas, the least decline is in the households below the poverty line is for professionals. Contrary to this, poverty gap and severity index show the largest decline for professionals. Variation in density function for urban and rural households shows a reduction in income gap between rich and the poor households in both areas, urban as well as rural.
We can summarise the macro impacts of increased foreign capital as follows. The findings from the first simulation demonstrate that foreign capital increases the total demand for investment in the presence of trade restrictions. In absence of any other compensatory measure for the loss in government revenue due to tariff reduction, increase in foreign saving compensates for the decline in government revenue and investment demand falls. Increased foreign capital (resources) has an adverse impact on the export sector. Our results show that increased foreign capital in the country increase the inflow of imports. A comparison of a major exportable sector ‘Textiles’ and major import-competing sector ‘Machinery’ shows that with FKI in presence of trade restrictions import-competing sectors expand and sectors producing exportable surplus contract. From this we can conclude that foreign capital inflow leads to an inefficient use of resources in presence of trade restriction and benefit to export sector in presence of trade liberalisation.
From comparisons of poverty measure in different scenarios, we derive a number of interesting results.
! Poverty reduces more with foreign capital inflows in the presence of trade liberalisation.
! Free imports of machinery benefits urban households more.
! Foreign capital inflows in the presence of trade liberalisation benefit rural households more.
! In the presence of trade restrictions, the wage gap between skilled and unskilled labour increases.
! Foreign capital inflow in the presence of trade liberalisation benefits unskilled labour more and the wage gap reduces in this scenario.
ANNEX-1
Impact of Different Forms of Foreign $apital Inflo" on !ro"th and Povert*
Study Data Impact on Growth
Other Variables included
Studies Based on Econometric Estimation
(1) White (1994) Half aid has been used to finance imports and half for debt servicing (2) White (1996)
Evaluating the impact of pro6ect aid, Study evaluates sixty-seven projects and found that they have succeeded in range of physical benefits and economic services.
(3) Tamirisa (1998) Capital control reduces bilateral trade for developing and transition economies.
(4) Abrego (1999)
(1) Tariff removal leads to an outflow of capital and a loss of tax revenue.
(2) Free capital mobility and their taxation reduce gain from partial trade liberalisation.
Empirical Evidence for Pakistan
(5) Buffie (1985)
DFI is immiserising in a small tariff-distorted economy where capital is mobile and exports are labour intensive. This result still holds when capital and land are specific factors of export and import respectively and capital is endogenously determined. In light of Buffie’s argument, DFI’s is expected to have welfare worsening impact with restricted imports and exports are labour intensive.
(6) Vos (1993)
Foreign Assistance would generate ‘Dutch Disease’ effects and would thus be unsupportive of a structural adjustment meant to strengthen the export base and traded goods production. But loans through banks are more supportive to traded goods production.
(7) Siddiqui (1997)
(1) Multinational companies work on profit basis and are not interested in poverty and social impact of their investment.
(2) Widen wage gap which is expected to promote poverty.
(3) Technology transfer cost effective way of introducing new technology but their job generating impact is limited.
(8) Khan (1997) (1) Little support for aid effectiveness even with sectoral disaggregation.
(9) Wood (1995)
The paper argues that the main cause of the deteriorating situation of unskilled workers in developed countries has been expansion of trade with developing countries.
(10) Wood (1998) The rapid globalisation is one of the causes of increasing the gap between skilled and unskilled workers wages.
ANNEX- 2
$omputable !eneral E@uilibrium 2odel for Pakistan A. Foreign Trade Statistics
1.
&
'
+ n + n n + n + n + n n + s n 3 E0 D 0 , ) ( + (1* ) ) ( 1/( Export Supply 2. s n s n s n n s n s n s n n 3 2 D ; *( ( ( ) * + ) , 1/ ] ) 1 ( [ Import Demand3.; #+ , 0 #+ Domestic Demand for non-traded
goods 4.
&
+'
n n + n D n E n n P P D E, t n + n (1 )/ * ) / ( - *) ) -, Export Transformation (CET)
5.
&
'
n n n 2 n D n n P P D2 , ( / )-n( () /(1* ) ]-(n * Constant Elasticity of Substitution
between imports and domestic goods 6. $&3 8 e +R +R E0 8 P +R 9e' % 82 P R! R4 n 5E n FR n 52 n , * * $ * $ + 1
Equilibrium in Foreign Market