Tariff Reforms: A necessary first step, needs to be complemented with institutional reforms
The Economic Advisory Group (EAG) strongly supports the tariff reforms, which the government plans to implement over the coming years. According to some proposals under consideration, the simple average tariff rate, which includes regulatory duties and advanced customs duties, is expected to fall from close to 20% currently to less than 10% over the next five years. Research shows that Pakistan’s economic landscape is dominated by sectors which are protected from international competition, thus making these reforms important for the country’s future.
EAG, a group of independent economists, has long emphasized the need for greater integration with the rest of the world through tariff liberalisation, becoming part of trading blocs, and strengthening domestic regulatory regimes. Pakistan’s tariff structure not only imposes high costs on industries that rely on imported inputs but also prevents resources from moving from firms that cannot compete with the rest of the world to firms that can. This restricts Pakistan’s export potential and encourages businesses to compete for protection instead of focusing on innovation. Tariff liberalisation is an important step towards addressing these challenges.
The increased dependence on tariffs as a source of revenue for the government presents a further challenge. In 2023, trade-related taxes accounted for more than 40% of total tax revenue collected by the government – more than eight times that of the global average of 5%. In short, our trade policy has been held hostage by the twin impulses of protectionism and revenue extraction.
While the importance of tariff liberalisation cannot be overstated, we emphasize that the success of these reforms will also depend on providing the institutional environment and macroeconomic stability in which production of more complex, high value-added goods can take place. Researchers Nathan Nunn and Daniel Trefler show that countries with strong institutions are more likely to undertake production of more complex, high value-added goods, whereas countries with weak institutions remain stuck in the production of low value-added goods. Differences in institutional quality may also be important for understanding why trade liberalisation succeeded in East Asia but showed mixed results in Africa and Latin America.
With this in mind, EAG emphasizes additional measures which are critical for the success of tariff reforms:
- Improve institutional quality to ensure that both domestic and international businesses can engage in long-term partnerships and implement complex production processes, necessary for transforming the economy towards high value-added production.
- A market-based exchange rate regime must be upheld to allow currency movements to absorb trade pressures. Exchange rate management should not be used to suppress import growth artificially.
- Positive real interest rates are essential to restrain excessive consumption-driven import demand as tariffs are reduced.
- A level playing field for domestic producers should be ensured by rationalizing indirect taxes such as GST and FED, so that domestic manufacturing is not placed at a disadvantage relative to imports.
- Policy credibility and consistency are paramount. Without clear communication and political ownership, businesses will delay investment decisions, and the reform process risks reversal.
These measures should be part of a policy package that includes responsible fiscal and monetary coordination, and institutional constraints which give a credible signal that these reforms will not be rolled back. We urge policymakers to treat tariff reform as the starting point of a longer-term transition to a globally integrated economy. Postponing this transition would only deepen the stagnation we’ve seen in recent years—and leave us further behind our regional competitors.
For further information, contact EAG Chair, Dr Aadil Nakhoda at anakhoda@iba.edu.pk
The Economic Advisory Group is an independent platform of individuals drawn from economics, policy and the private sector. It was formed in January 2021, under the auspices of PRIME Institute, an independent think tank, which serves as its secretariat.
Chair: Aadil Nakhoda, IBA Karachi
Members:
Ahmed Jamal Pirzada, Bristol University
Ali Salman, PRIME Institute
Mueen Batlay, Think Build Scale Pvt Ltd
Muhammad Adil Mansoor, Business Recorder
Muhammad Ashraf Khan, Retired Federal Secretary
Najma Pirzada, The Life Sciences Division
Sajid Amin Javed, SDPI
Samir Ahmed, LUMS
Vaqar Ahmed, SDPI