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Abstract
This paper investigates the conventional import demand function for Pakistan using time-series data sourced from the World Development Indicators for the period 1970 to 2010. Using a vector error correction model and impulse response functions, we show that, for the given period, relative prices and income lose their significance as long-run determinants of import demand. This indicates the need for additional determinants. We compare the residuals of the conventional import demand function with those of a model that includes the terms of trade and foreign exchange availability (in addition to the conventional parameters) as determinants of import demand, and find that the latter largely resolves much of what is nondeterministic in the former model. The paper also explores the peculiar trend of a falling imports-to-GDP ratio (from the 1980s to the 2000s), which is unusual for a developing country. In a subsidiary regression analysis for this period, we argue that falling net capital inflows explain this persistent fall in the imports-to-GDP ratio. The recovery thereafter, when Pakistan started catching up with other developing economies, may have been responsible for the 2008 balance-of-payments crisis.
Keywords: Pakistan, import demand function estimation, capital inflows, balance of payments.
JEL classification: F140.
(ProQuest: ... denotes formulae omitted.)
1. Introduction
Despite the rapid globalization of trade in recent decades, Pakistan has largely failed to maximize the benefits of this development and faces a consistent trade deficit. Figure 1 shows that the country's imports have remained volatile over time while the trade deficit almost mirrors the volume of imports as a result of stagnant exports. Import surges, which have tended to occur during boom periods, are directly linked to the rising trade deficit The main objective of this paper is to understand and explain the anomalies in Pakistan's import behavior.
After independence in 1947, Pakistan followed an import substitution industrialization policy, which overvalued the exchange rate in order to boost the domestic economy. In 1980, the policy paradigm shifted toward rigorous trade liberalization and export promotion in order to integrate Pakistan's economy with the rest of the world. These policies did not much affect the economy till the 1990s; even then, international trade has had a limited impact on the health of the economy. It has not led to any...