TRADE MODELING AND TRADE POLICY EFFECTS: THE CASE OF PAKISTAN'S COTTON TEXTILE INDUSTRY

Pakistan's textile industry is of considerable importance to the economy. It is the largest employer in the manufacturing sector and contributes over thirty percent to Pakistan's exports. This research deals with the structure of this vital industry, and analyzes the importance and contribution of prices and domestic government policies in explaining the structure and growth of textile exports. In this context two econometric models have been estimated. In the first model, known in the traditional trade literature as the perfect substitutes model, an attempt has been made to determine domestic production, and domestic demand, with exports as a residual. In the second (imperfect substitutes) model, which is the more traditional approach in the empirical literature, export supply and export demand have been determined simultaneously. Policies have been incorporated in the supply-price variables in both models. The two estimated models have been simulated, and compared, using standard statistical criteria, to determine the relevance of each model to the structure of production and exports of Pakistan's textile industry. The imperfect substitutes model yielded a better fit. The results indicate that Pakistan's textile exports are dependent on foreign demand (and domestic supply), and are not merely a residual after domestic demand has been met. This result implies a degree of export dynamism in the industry. The results of the estimations show that price elasticity of supply and demand, and income elasticity of demand are very small in the domestic market, and large in the foreign market, indicating that there is great potential for the government to divert supply away from the domestic market and towards the foreign market, using trade policies. Within this framework, numerous policy simulations have also been run to illustrate the effect of alternative government policies on the level of exports, and an attempt has been made to measure the costs imposed on public revenues due to these respective policies. The policy simulation results indicate that historical export levels would have been achieved with much less cost to the government if there had been less reliance on subsidies, and greater use of a realistic exchange rate.