Trade reforms : total factor productivity and profitability of manufacturing sectors in Pakistan

Abstract

The effect of Pakistan's trade liberalization on total factor productivity and profitability is empirically investigated over a period of 15 years. Total factor productivity is measured for eight major sectors separately and TFP parameter estimates are derived for each sub sector individually. Parameters are estimated by following Levisohn & Petrin (2003) method which takes into account the simultaneity bias inherent in a particular level of total factor productivity and selection of inputs for a panel data set covering a period 1980-95. Technical efficiency is also measured for the same panel data and time period for four major sectors by stochastic production frontier time varying model, in order to complement the estimation of total factor productivity. Price cost margins are also measured for all the sectors to indicate the profitability of the sectors. In the second stage estimation total factor productivity and time varying technical efficiency estimates are related to a variety of trade related variables in the presence of sector specific variables which serve as control variables. The empirical results are mixed. A positive relationship between productivity and liberalization had been hypothesised but the evidence is not unanimously supportive of a positive relationship. Price cost margins are also empirically related to trade variables, plus some structural and sector specific variables. The results are informative about the effect that trade related policies have been exerting on the profitability of the sectors. Restrictive trade policies appear to have shaped a particular industrial structure which seems to limit the effect of trade liberalization policies on the price cost margins. The overall evidence suggests that trade liberalization reforms have no substantial effect on total factor productivity of the manufacturings ectors. This is due to the absence of enabling environment caused by non implementation of complementary reforms in education,infrastructure and competitive policies aimed at discouraging the monopoly powers. There is need for further research to conduct the same analysis with firm level data using entry and exit rates and relate the total factor productivity, turnover and trade liberalization in order to arrive at a definitive conclusion about the role of entry barriers that crept into the manufacturing industries by either deliberate policy making or through by products of trade protection.