IMPACT OF TRADE LIBERALIZATION AND INSTITUTIONS ON ECONOMIC GROWTH: A TIME SERIES ANALYSIS FOR PAKISTAN

Abstract

To examine the connections between quality of institutions, trade liberalization, and economic growth was the key point of this study. This trio has emerged as a new avenue of research in Economics. To enhance the economic growth of a country improved quality of institutions is considered the key determinant. The existing theoretical and empirical research on this issue depicts that improved quality of institutions is important to collect the payback from the occurrence of free trade. This new avenue of research has not been explored so far in the case of Pakistan at aggregated and sectoral levels (i.e. agriculture, industry and services sectors). This gap in the literature motivated the researcher to conduct this empirical study for Pakistan. To achieve the above cited objectives of the study, time series datasets over the time period of 1984-2013, in annual frequency were utilized. The Cobb- Douglas production function has been augmented by the author, and employed to probe the impact of the, quality of institutions, trade liberalization, and financial development on economic growth. To check the stationarity of the data not only Augmented Dickey -Fuller (ADF), but also Phillips and Perron (PP) unit root tests have been applied. The most recently developed combined cointegration technique by Bayer and Hanck (2013) has been used to check the cointegration among the variables. Being a better technique than earlier approaches, it added to the quality of research. Long run empirical results have been obtained by applying the Ordinary Least Square Method (OLS), whereas, for short run empirical results, Error Correction Method (ECM) has been used. Moreover, the direction of causality among the variables has also been examined by employing the Vector Error Correction Method (VECM) Granger causality technique. In this study four null hypotheses have been tested. The empirical results rejected all the null hypotheses, for the aggregate and disaggregated economic analysis of Pakistan. The empirical evidences supported that trade liberalization, and the quality of institution is inevitable for economic growth; because they exert positive and significant impact on the economic growth of Pakistan. Trade liberalization exerts positive and significant impact on the growth of industrial, and services sectors of Pakistan but negatively contribute to the agricultural sector. It may be so because many developing countries are alike and export the same. Moreover, agricultural trade of Pakistan still faces many problems at international level. One of these is health hazard, as its fruits crops like Mango and Oranges cannot be exported to Europe, Japan and other countries due to hygienic reasons and sanitary rules of WTO. Besides this, larger trade openness is a test for agriculture sector for some of the developing x economies like Pakistan, because the growth of agricultural sector diminishes when these countries are open ups to the global markets (Mourao, 2015). The quality of institutions positively contributes to the economic growth of the industrial and agricultural sectors, but is insignificant for services sector. It is important to learn that institutional development is still far away to reap significant benefits of trade liberalization. No wonder, the quality of institutions of Pakistan is still weak mainly for rules and regulations. Financial development is positively and significantly related to economic growth, and, is in line with substantial development in the financial market in Pakistan. The research has also pointed out the direction of economic growth. The empirical results of VECM model suggest that trade liberalization and financial development enhances the economic growth in Granger sense. Financial development and quality of institutions cause trade liberalization in Granger sense. This study is a forerunner in investigating the relationship between trade liberalization, quality of institutions, and economic growth at aggregated and disaggregated levels for Pakistan. This study has some additional noteworthy contributions. For example, it has constructed a composite index for quality of institutions after the normalization treatment of all the variables of institutional quality to capture their combined effect on economic growth, and its use in estimation to draw the inferences from empirical evidences. To portray the more reliable results of cointegration Bayer and Hanck (2013) technique of cointegration has been used. On the basis of above empirical findings, it may be concluded that trade liberalization and the quality of institutions are inevitable for economic growth of Pakistan because they exert positive and significant impact on the economic growth of the country not only at aggregated level but also at sectoral levels. It is a new contribution to the literature in Pakistani context. Moreover, to enhance the economic growth of a country, policy makers should pay more attention to strengthen its institutions as this is an area that requires further improvement. Developing countries have weak institutions which could be a cause of slow growth and being not fully integrated with the rest of the world. It is in line with the Kruger‟s views that domestic environment needs to be improved to fully benefit from trade liberalization. This can be done by improving the law and order situation through good governance and by creating a competitive environment in the country. Agricultural and industrial policies should integrate with the trade policy as xi one factor to endorse the trade of these sectors at home and overseas. To reap the benefits of trade reforms, Pakistan should pay attention to develop political and economic institutions because without strengthening these institutions, the desired sustainable development cannot be achieved. The positive coefficients of trade liberalization and the quality of institutions should draw immediate attention of the policy makers of Pakistan not only to focus at aggregate level but also at sectoral levels. Hence, better quality and well-functioning of the institutions is a pre-requisite to boost the foreign sector and to achieve higher rate of economic growth of Pakistan.