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Realizing the full potential of the China-Pakistan free trade agreement

According to Dr. Manzoor Ahmad, who served as Pakistan’s ambassador to WTO, if Pakistan is to have a credible share of the $2 trillion Chinese import market, it needs to undertake serious trade policy reforms. Like the ASEAN, Pakistan needs to lower its import tariffs and get rid of its protectionist policies. Without regional integration and without becoming a part of global value chains, it is not likely that Pakistan would have any significant gains through its FTA with China.

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Several developing countries have taken advantage of their geographical proximity to larger trading nations to boost bilateral trade and thus grow their economies. After Turkey entered into a customs union with the EU, its exports to the block increased from US$11 billion in 1995 to $69 billion in 2020. Similarly, after Mexico became a part of the North American Free Trade Agreement (NAFTA), its exports to the US jumped from $42 billion in 1993 to $359 billion in 2019.

When the China-Pakistan Free Trade Agreement (CPFTA) went into effect in 2006, the expectation was that increased trade with a rising China would also be a boost for Pakistan’s economy. Over the last 15 years, the trade between the two countries did grow by 250% to $15 billion, and China became Pakistan’s top bilateral trading partner but the exports have been mostly one-sided. China’s exports to Pakistan are over six times its imports, $13 billion to $2 billion.

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This $11 billion gap accounts for 40% of Pakistan’s total trade deficit

It may be worth comparing the export performance of some other countries that signed FTAs with China at about the same time as Pakistan. An example is the ASEAN–China Free Trade Agreement (ACFTA), which was signed in 2004 but became effective in 2007 or at about the same time as CPFTA. During these 14 years, China has become the largest trade partner of ASEAN with bilateral trade of $686 billion. All ASEAN countries have witnessed immense growth not only in their imports but exports as well.

According to the World Bank data, from 2006 to 2019 Vietnam’s exports of goods to China grew from $3 billion to $41 billion; Malaysia’s from $11 billion to $33 billion and Indonesia’s from $8 billion to $27 billion. Pakistan’s exports to China amounting to $2 billion in 2019 pale in comparison.

Why has Pakistan’s export performance been so poor even after having preferential access to the vast Chinese market? Some blame Pakistan’s negotiators for not having been able to get a good deal in the first phase of FTA. They think that with the recently concluded second phase of CPFTA, where Pakistan managed to get duty-free access for almost all of its items of export, our exports would have an opportunity to grow.

However, it is not likely to happen as the average tariffs of China on manufactured products for all countries are now less than 5%. Furthermore, since China is now a member of the Regional Comprehensive Economic Partnership (RCEP) Agreement with 15 countries and has also signed FTA with many others, tariff preferences have become an insignificant factor for gaining access to the Chinese market.

If Pakistan wants to fully exploit the potential of CPFTA, it needs to radically reform its myopic trade policy. While all countries seek greater market access when they enter into FTA, they also aim to liberalize their economy to make it more competitive. Pakistan has followed an utterly mercantilist approach. It seeks tariff reductions from its bilateral FTA partner without offering any meaningful concessions in return. Since China and ASEAN entered into FTA, both sides have reduced their tariffs on each other to less than 1%.

A recent study by the World Bank showed that Pakistan’s tariffs are still twice as high as the world’s average and three times more than South-East Asia. On top of high tariffs, Pakistan also imposes other levies such as sales tax, income tax, and central excise duties on imports. The combined impact of these tariffs is that Pakistan collects almost half of its tax revenue from imports.

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On the other hand, the ASEAN countries get less than 5% from imports

High tariffs apply not only to finished consumer goods but also to several raw materials. For example, steel is a critical material used to make engineering goods. The combined impact of taxes on steel imports is at least 52%. Thus, our engineering industry finds it very difficult to compete internationally. Globally engineering goods, most parts and components, constitute 50% of exports. Pakistan has not adjusted its industrial and trade policy to capture this kind of trade. Since most of the Chinese imports consist of parts and components, Pakistan’s exports are unable to claim any significant share of such goods.

The worldwide emphasis on fragmented trade meant abandoning import substitution policies. Pakistan still enforces such outdated policies for crucial sectors. Pakistan’s auto industry is one such example. With a high level of protection, the auto industry only looks towards the domestic market.

China has made tremendous progress in producing electric vehicles. If Pakistan can adopt a more open policy for the auto sector and get rid of auto-specific SROs, it can attract considerable investment in this new technology. This would enable it to at least expand exports of auto parts and components.

Another problem with Pakistan’s trade policy is the government’s reluctance to trade within the region despite its recent declaration to shift emphasis from geopolitics to geoeconomics. Whereas most countries have an average of 40% trade within their region, Pakistan’s is less than 5%. The success of countries such as Turkey, Mexico and ASEANs is because of their trade with their neighbors, which provides them with cheaper inputs and nearby export markets. Having robust regional trade attracts foreign investment as it increases the size of the market. It would allow Chinese companies to make products in Pakistan for exporting to other South Asian countries.

Because of the US-China trade war as well as the disruption caused by the Covid pandemic, major buyers of Chinese goods are trying to diversify their sources. ASEAN nations are working on the “China plus One” strategy to seize this opportunity. They want the industries being relocated from China to come to their countries. Vietnam, Thailand and Malaysia are offering several incentives for this purpose. They have attracted most of the new FDIs of the industries moving out of China.

Pakistan has set up 22 Special Export Zones but has not been able to attract any significant industries relocating out of China. Recently it imposed a 17% sales tax on plant and machinery set up in these zones. These taxes will further discourage potential investors from relocating industries to the zones.

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To sum up, if Pakistan is to have a credible share of the $2 trillion Chinese import market, it needs to undertake serious trade policy reforms. Like the ASEAN, Pakistan needs to lower its import tariffs and get rid of its protectionist policies. Without regional integration and without becoming a part of global value chains, it is not likely that Pakistan would have any significant gains through its FTA with China.

The author has served as Pakistan’s ambassador to WTO and as FAO’s representative to the United Nations at Geneva. He can be reached at drahmadmanzoor@gmail.com.

The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of Global Village Space.

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