Chapter 1

Introduction

In today’s world, no one can deny the importance of Globalization. International trade is that kind of trade that gives rise to the economy of the world and for the country growth plays a backbone role. International trading has become very important for every country of the world – be it big or small, developing nation or developed nation. There is a common perception in the media and also in the general public that Trade Deficits are a bad news to a country’s economy. The conventional wisdom is that these deficits are a drag on Gross Domestic Product. Surely, it is not considered positive for a country’s economy to import more than it exports. Favorable Trade balance is a major determinant of growth in any country, as surplus increases GDP and deficit reduces it. Unfortunately in Pakistan, Trade Balance has never seen a surplus over the period of time.

If a country is subjected to free trade, it means that the country is having many benefits from this trade openness. By doing trade with countries or to be a part of any trade agreement like South African Development Authority. Trade openness has positive impact on economic growth. Through trade openness, the ratio of domestic investment to GDP increases and this has been proven by many theorists. Sometimes your country may lack in many goods and services, so by trading you can get those products. Free trade means no barriers to trade like no protectionist policies which can be very favorable for the developing countries like Pakistan that is heavily dependent on some imports from outside countries. The main sources of revenues in Pakistan mainly comprises of four components. First source is revenues from taxes, direct and indirect. Second the capital receipts include external borrowings and internal borrowings. External borrowings include the debts which have been taken from abroad and internal non-bank borrowing includes unfunded debt, public debt, treasury and public receipts, revenue account surplus and the surplus generated by Public Sector Corporation. There is another source of revenue which is called aid from developed countries. Aid divided into project and non project aids.

After revenues the main expenditures of government includes debt servicing, defense and public administration, social service, law and order, provision of subsidies, grants to Azad Jammu and Kashmir, grants to railways, community services and economic services. Public sector development plan has been built which is termed as development budget. Its major coins are reserved for infrastructure plans such as water, power, transport and communication. For economic development and achievement of government’s main objectives like employment, this kind of investment is necessary. Pakistan is also offering itself to be used as a medium to trade with Middle East and Eastern countries. China has already offered Pakistan to be engaged in its railway and communication so that it can pave ways to access Arabian Sea for its tradable goods.

In the world, Pakistan’s economy is on 27th position in terms of purchasing power and on 45th position in purchasing dollar. Pakistan is mainly based on semi-industrialized economies which are textiles, food processing, chemicals, agriculture and others. The growth of Pakistan’s economy is situated on the riverside of the Indus. The urban centre of modified economy of Karachi and Punjab exist together with pronominal developed areas on the other side of country. The economy has endured in past because of the decaying of internal political contend , the fast expanding population, foreign investment and a costly running challenge with Pakistan’s neighbor, India. The government policies were upgraded by IMF, support of foreign investment and reestablished access to global markets which have produced solid macro economy’s recovery in the last decade. Significant macro-economic reforms from 2000, most notably on privatizing the banking sector which developed the economy. Pakistan’s economy is mostly based on its agricultural products. Major exports of Pakistan are from primary sectors so agriculture is the most important sector of this economy. However with increasing industrialization and globalization, changes are being brought in the economy of Pakistan and now its contribution is less than 25% of its output but still it is highly due to the employment generation sector in the economy. More than 50% of total population works in this sector.

Over the stretch of the past 30 years, Pakistan’s trade deficit has only worsened instead of improving. The element of self-reliance lacking in the mechanism of Pakistan’s economy is one major reason as to why Pakistan has to import goods mainly on heavy prices from other countries. In comparison to the heavily priced imports that mostly comprise of manufactured goods, the exports of Pakistan in the international market constitute chiefly of raw materials or semi-manufactured goods that are at a great deal cheaper and lesser in demand as compared to the market of manufactured goods. Another factor that contributes towards exacerbating Pakistan’s trade deficit is the paucity of variety in the range of Pakistani exports. The textile sector constitutes a major part of Pakistan’s exports and although the exports have increased from before, still the contribution is very little to the overall Gross National Product of the country. In particular, long-lasting trade deficit can lead to foreign debt, on which a country has to pay interests. If this debt is judged by market agents as unsustainable, currency crises can erupt. Even before that this perspective materializes; the government can be induced to dampen GDP growth.

Currently, Pakistan is facing major economic challenges as similar to above. Particularly in this research, main objective is to examine the correlation between Trade Deficit and GDP and to investigate, if Trade Balance has a favorable impact on growth while deficits decrease the Growth, considering the case of Pakistan. The relationship between growth and trade deficit has been a subject of research.

Problem Statement

To study and investigate the relationship between Trade Deficit and Growth, considering the case of Pakistan, showing that increasing trade deficits are the cause of dampening growth.

Research Hypothesis

Trade Deficits and Growth are negatively related.

Chapter 2

Literature Review

The relationship between growth and trade balance has been a subject of research, theoretical as well as empirical. Many Studies have been carried out over this topic but most of the work is focused on theoretical perspective, while only few economists analyzed the two variables empirically.

Baldwin (2005) concluded on the basis of statistical finding that increase in exports and increased growth are generally positively related. The export increase may be result of trade policy changes, other non-trade policy actions, or forces unrelated to a government’s policy actions. But at the same time it is noteworthy as pointed by the author that the export increase also may be the consequence of economic growth rather than the cause. Furthermore, the use of exports as an openness measure has the drawback of being a component of GDP, the usual measure of economic growth.

Amjad and Khan (2001) discussed the prospects of extended economic cooperation of Pakistan with the member countries of the SAARC (South Asian Association for Regional Cooperation). Amjad and Khan (2001) presented through statistical estimates, the major determinants of the region’s economic growth, where trade among the regional countries remains the major co