American International Journal of Contemporary Research

Vol. 1 No. 2; September 2011

EFFECTS OF ECONOMIC REFORMS AND OPENNESS ON STRUCTURE CONDUCT AND

PERFORMANCE OF AGRO-BASED INDUSTRIES IN PAKISTAN

Saeed Ahmed Sheikh

Saeed Ahmed
Abstract
According to the latest Census of Manufacturing Industries (CMI: 2005-06) conducted by the Federal Bureau of
Statistics (FBS), government of Pakistan; the share of agro-based industries in gross value added by the largescale manufacturing sector is almost 52.0 percent. These industries have an important role in earning foreign
exchange and creating jobs and are expected to play important role in the future development of the economy.
Cotton, sugarcane, wheat and rice are the major crops of Pakistan and are the important source of raw material
for the agro-based industries. The spillover effects of agro-based industries are expected to have important effects
on other industries in general and the agricultural sector in particular. Agro-based industries have a large
potential for growth and development because the natural endowment of the country (availability local raw
material and cheap labor) is favorable. The agro-based industries in Pakistan operate under imperfect market
conditions, earn monopoly profits; have high concentration ratios and these ratios have not changed much
overtime. During mid 1990s Pakistan implemented various reforms to achieve macroeconomic stability including
IMF supported structural adjustment program and trade liberalization policies under WTO regime. The main
focus of this paper is to analyze the effects of trade related domestic reforms and the degree of openness on the
structure, conduct and performance of agro-based industries in Pakistan. The study of structure, conduct and
performance of these industries is important for policy prescription because if concentration leads to collusion
then this suggests intervention and if concentration arises due to technological innovation then no intervention is
needed. Census of Manufacturing Industries (CMI) data from 1996 to 2006 has been used for analyzing the
effects of economic reforms and openness on structure, conduct and performance (SCP) of agro-based industries.
Eleven agro-based industries of three digit level of industrial classification have been used for this purpose. Our
analysis shows that domestic economic reforms and openness policies adopted under IMF and WTO regime in the
mid 1990s have produced some favorable effects on structure, conduct and performance of agro-based industries.

1. Introduction
At the time of independence in 1947 Pakistan had no industrial base. There were only a few simple industries like
flour and rice mills, cotton ginning factories and only two cement factories. Over the past sixty three years
Pakistan followed the policies which were heavily biased towards the industrial sector especially during the fifties
and the sixties. Private sector was supposed to play the leading role during the earlier periods of industrialization
in Pakistan. During 1950s and 1960s the industrial sector developed rapidly but generous fiscal incentives high
rates of protection, export subsidies and favorable exchange rates led to the creation of an industrial structure
which was highly inefficient both economically as well as technically. The Economic Reform Order (ERO) of
1972, issued by the government of Z. A. Bhutto, started an unprecedented nationalization of industries.
The constant fear of nationalization shook the confidence of the private sector resulting in marked decline in
investment and production. Post 1977-78 period, was that of the return of the private sector. High priority was
given to privatization process for revitalizing and restructuring the economy. The industrial policy during the
1990s remained focused on broadening and diversification of industrial base. Present industrial policy is
characterized by the continuation of privatization process and provision of support and regulatory framework for
industrialization. Pakistans economy is still agrarian in nature with 21% share in GDP and 45% share in
employment being contributed by the agricultural sector.1 Cotton, sugar cane, rice, wheat and maize are the main
crops of Pakistan. Agricultural sector provides raw material for industries like cotton textiles, food processing and
manufacturing, paper and paper products, leather and leather products etc. Economic reforms, in general, include
trade and industrial policy reforms, fiscal policy reforms, monetary policy and exchange rate policy reforms.

Saeed Ahmed Sheikh is former Dean, Faculty of Administrative Sciences, Azad Jammu & Kashmir University,
Muzaffarabad, Pakistan. Saeed Ahmed is Senior Research Fellow, Department of Electronics, Quaid-e-Azam
University, Islamabad, Pakistan.
1
Pakistan Economic Survey 2009-10, Finance Division, Economic Advisors Wing, Government of Pakistan, Chapter
2, p. 13.
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For the present study by economic reforms we mean specifically the trade and industrial policy reforms. The
literature on trade liberalization differentiates between static and dynamic gains from trade policy reforms. It is
generally acknowledged that the magnitude of the static gains is fairly low. Static gains arise when misallocation
of resources under protection and import substitution is corrected and resources shift from inefficient to efficient
sectors. The dynamic or long-term gains accrue due to correction of anti competition, anti export bias of
protectionism. Increased levels of competition are believed to generate innovative activity and productivity gains
across all sectors. The main objective of this study is to analyze the effects of economic reforms and openness on
structure-conduct-performance of a panel of eleven agro-based industries in Pakistan. Agro-based industries have
an important place in the large-scale manufacturing sector of Pakistan. These industries are the main source of
employment and foreign exchange earnings. The share of agro-based industries in large-scale manufacturing
output at constant prices of 1999-2000 is more than fifty percent (textiles 25.6%, food products 15.3%, wearing
apparel 3.9%, ginning pressing and bailing 3.2%, paper and paper products 2.7% and tobacco 2.2%).2
Trade liberalization is believed to promote exports and productivity through innovations and technological
changes associated with foreign trade. Through exposure to external markets industrial efficiency can be
increased by abolishing monopoly profits, increasing capacity utilization and allowing optimal resource allocation
in the economy. The theory of industrial organization has recognized the role of international trade in the
determination of imperfect competition and industrial efficiency. The argument is that international trade
variables can have an impact on productivity, profitability and exports by introducing changes in the structural
characteristics of the economy. Kim (2000), Weiss (1992), Krishna and Mitra (1993) and Tybout and Westbroke
(1995) have found some support in favor of the hypothesis that trade opening has a positive impact on
manufacturing sectors total factor productivity growth. Goldar and Aggarwall (2005), Weiss (1992) and Weiss
and Jayanthakumaran (1994) tested the reform induced price cost margins (PCM) and obtained some support in
favor of their hypotheses that in more open economies the ability of the domestic firms to hold price above the
average cost is reduced. Section-2 of the study is devoted to a brief review of literature; Section-3 is devoted to
methodology and econometric specification, results obtained are discussed in Section-4 and section-5 concludes.

2. Economic reforms openness and price cost margins: a brief review of literature
It is a well known fact that protection reduces efficiency and absence of foreign competition allows domestic
firms to enjoy monopoly power and earn excess profits. Literature on the study of the effects of policy reforms on
productivity and efficiency of industries in different developing countries of Asia, Africa and Latin America has
provided mixed results. Some Researchers have found significant positive effects of trade and industrial policy
reforms and openness on industrial productivity and efficiency while some others have found positive and
significant effects of protectionist policies. Some of the researchers have found that industrial policy reforms and
openness have significantly reduced the Price Cost Margins in the industrial sectors of many developing
countries.
Hadad, de Melo and Horton (1996) using 3 digit industry data for the period from 1984 to 1989 studied the impact
of import penetration on market power in Morocco and found that there was a negative association between price
cost margins (PCM) and imports. They found that a one point increase in import penetration would reduce PCM
ratio by 0.20 points. Foroutan (1996) studied the impact of trade liberalization on Turkeys 3 digit industries and
found a week negative relationship between imports growth and price cost margins. He found that for privately
owned industries one point increase in import share would reduce PCM by 0.002. For public sector industries this
relationship was found to be insignificant.
Empirical research has extensively examined the effects of trade liberalization and industrial policy reforms on
growth, productivity and efficiency at cross country, industry and firm level. The country-level research consists
of cross-section before and after reforms studies (Greenaway et al, 1997) and with and without reforms studies
(Mosley et al. 1991) as well as country specific time-series analysis (Greenaway and Spasford, 1994). Many of
these studies suggest that the effects of trade liberalization on growth are ambiguous and complex. Some
countries show an improvement in growth as well as other indicators such as investment, others show a marked
deterioration. Greenaway et al. (2001) using panel data and alternative measures of liberalization suggest a Jcurve type effect of liberalization on GDP growth.
2

Census of Manufacturing Industries (2005-06), Federal Bureau of Statistics, Government of Pakistan.

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A substantial body of empirical literature has focused on the dynamic effects of trade liberalization and has
investigated the effects of trade policy and openness on total factor productivity (TFP) and efficiency at industry
level. Evidence from these studies, however, is inconclusive. Some studies find support for the view that the
efficiency levels are highest amongst the industries experiencing the largest decline in protection (Tybout et al,
1991). Several studies have found exporting firms to be more efficient than their domestically oriented
counterparts. Hadad (1993), Tybout and Westbrook (1995) and Aw and Batra (1998) have attributed this result to
the positive learning effects which accrue from contact with foreign buyers.
In the early periods of the 20th century protectionist theories became dominant and many of the developing
countries implemented industrialization policies with a very limited degree of openness. These policies had their
origins in the thinking of Raul Prebisch (1950) and Hans Singer (1950). During 1960s and 1970s a large number
of development economists advocated protectionist view based on import substitution ideas. The debt crisis in
1982 played an important role in reshaping policy views regarding development strategies. Policies based on
market orientation, tariff reduction and opening of international trade took over the inward oriented policies.
Trade and industrialization policies adopted by the countries like South Korea, Taiwan, Hong Kong and
Singapore have gradually created a formidable case for trade and industrial reforms in other developing countries
of the world. World Bank and IMF conditionality also links external financing to such reforms.
Amsden (1989) describes the Korean governments use of trade protection, export subsidies, selective credit
subsidies, export targets, public ownership of banking sector and price controls to achieve technological
capabilities and building industries that will eventually compete in world markets. She argues that a key element
in the success of government policy in Korea was that in exchange of trade protection and subsidies the
government also set stringent performance standards. Balassa (1981) has demonstrated that export-oriented
countries are better positioned to deal with external shocks than inward-oriented countries.
Rodrik (1995a) has identified the following four broad objectives of trade and industry related reforms.
1.
2.
3.
4.

Improvements in static resource allocation.

Dynamic benefits in the form of learning and growth.
Improved flexibility in face of external shocks.
Reduced rent seeking.

Economic liberalization reduces static inefficiencies which are mainly due to misallocation and waste and
enhances technological change and economic growth. Market based open economies are batter able to absorb
adverse external shocks, prevent rent-seeking behavior and other governance issues.
Wade (1990) describes governments role in the development of trade and industry in Taiwan. He calls Taiwan a
government market economy, characterized by high levels of investment, more investment in certain key
industries and exposure of many industries to international competition. He concludes that import restrictions,
entry requirements, domestic content requirements, concessional credit and fiscal incentives had played an
important role in the Taiwanese strategy. Bardhan (1990), Biddle and Milor (1992), Biggs and Levy (1990) and
Westphal (1990), all emphasize the usefulness of activist industrial policies. World Bank (1993) confirmed that
intervention was rampant in East Asian economies nonetheless found it unlikely that other developing countries
could successfully replicate this experience. Kreuger (1983), Bhagwati (1993), Meier and Steel (1989) and
Frischtak (1989) have attributed dismal export performance of many developing countries to domestic economic
policies. Balasa (1988) and Grossman and Horn (1989) have demonstrated that anti export and anti competition
policies have discouraged innovation, cost-cutting, technological capabilities and eventual growth.
Edwards (1993) reviewed a large volume of literature on trade and development policies and concluded that
cross-country aggregate data sets have little information regarding the relationship between trade policy and
growth. Romer (1992) and Helpman (1991) have emphasized the role of freer trade and supported the view that
more open economies grow faster than more restricted ones even in the long run. The study of the effects of
openness on productivity and growth has proven to be elusive and controversial. Krugman (1994) and Rodrik
(1995a) argue that the effects of openness on growth are doubtful. On the other hand, Barro and Sala-i-Martin
(1995) and Edwards (1998), among others, have demonstrated that openness has positive effects on growth and
productivity. Gains from trade are based on the concept of allocative efficiency. In a static sense protection is
costly because resources are not allocated in areas where a country has a comparative advantage.
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In a protected market dominated only by few domestic firms trade reforms increase competition but improving
the allocation of resources or curbing the excess market power generates a one time increase in growth.
Endogenous growth theories, however, suggest that trade policies also effect long-run growth rates by
accelerating the rate of technological change.3

3. Methodology
As stated earlier the main objective of the study is to analyze the effects of economic reforms and openness on
structure-conduct-performance (SCP) of a panel of eleven agro-based industries in Pakistan. Following
Ravenscraft (1983), de Melo and Urata (1984), Weiss (1992) and Tybout (1996); concentration ratio (CR), capital
output ratio (COR) will be used as independent variables with price cost margins (PCM) as dependent variable.
Unemployment rate (UR) will be used as proxy for domestic reforms and effective tariff rates (ETR) will be used
as proxy for the degree of openness. Both UR and ETR are expected to have a reducing effect on price cost
margins. The reduction in price cost margins will thus indicate an improvement in static resource allocation and
improved performance at industry level. The ultimate goal of economic reforms is to improve welfare through
improving resource allocation and removing inefficiencies. Both unemployment rate and effective tariff rates are
expected to reflect the effects of economic reforms and openness on price cost margins. An increase in
employment level and a reduction in effective tariff rates are expected to have a favorable effect on SCP of agrobased industries.
The following specification of the model using pooled time series and cross sectional data for eleven agro-based
industries will be tested for studying the effects of economic reforms and openness on structure conduct and
performance of these industries during the study period.
PCMit = 0+1CRit+ 2CORit+3URit +4ETRit + it with i = 1,,11; t = 1,...,11
Where,
PCM = price cost margins
0 = common intercept
CR= 4 firm concentration ratios
COR= industry capital output ratio
UR= unemployment rate
(ETR)= effective tariff rate
it = random error with zero mean and constant variance.
Economic reforms in developing countries like Pakistan basically include trade and tariff reforms, privatization
and deregulation reforms, financial sector and capital market reforms and tax reforms. The ultimate goal of
economic reforms is to increase the welfare of the society by improving static resource allocation and removing
inefficiencies and rent seeking behavior. Foroutan (1992) found a positive correlation between growth in import
penetration and total factor productivity growth in Turkey. He also found that import penetration was correlated
with lower price cost margins. Tybout et al. (1991) observed that total factor productivity growth was better in
industries that experienced the largest decline in protection in Chile. The purpose of our study is to investigate the
effects of domestic economic reforms and openness on the structure conduct and performance of agro-based
industries in Pakistan.
The main objective of the study is to analyze the effects of economic reforms and openness on structure-conductperformance (SCP) of a panel of eleven agro-based industries in Pakistan. Trade liberalization is believed to
promote exports and productivity through innovations and technological changes associated with foreign trade.
Through exposure to external markets industrial efficiency can be increased by abolishing monopoly profits,
increasing capacity utilization and allowing optimal resource allocation in the economy. The theory of industrial
organization has recognized the role of international trade in the determination of imperfect competition and
industrial efficiency. The argument is that international trade variables can have an impact on productivity,
profitability and exports by introducing changes in the structural characteristics of the economy. Weiss (1992),
Krishna and Mitra (1993) and Tybout and Westbroke (1995) have found some support in favor of the hypothesis
that trade opening has a positive impact on manufacturing sectors total factor productivity growth.

See, for example, Grossman and Helpman (1990), for an overview.

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De Melo and Urata (1984), Weiss (1992), and Weiss and Jayanthakumaran (1994) tested the reform induced price
cost margins (PCM) and obtained some support in favor of their hypotheses that in more open economies the
ability of the domestic firms to hold price above the average cost is reduced. The theory of industrial organization
has recognized the role of policy reforms in the determination of imperfect competition and industrial efficiency.
The argument is that international trade variables can have impact on productivity, profitability and exports by
introducing changes in the structural characteristics of domestic market. Over the past two decades, a substantial
body of literature has accumulated on firm/industry level effects of openness in developing countries. It is
generally believed that trade liberalization squeezes price-cost margins among import competing firms, increases
productivity gains and efficiency gains from market-share reallocation. Empirical studies that have used
productivity growth, export growth and changes in Price Cost Margins as yard stick of performance have obtained
mixed results. Kim (2000), Krueger (1982), Edwards (1993), Balassa (1991) and Westphal (1990) have
emphasized the role of policy reforms in improving industrial growth and efficiency. Rodrick (1995 b), Wade
(1990) and Amsden (1989), on the on the other hand, have shown that interventionist policies played important
role by changing comparative advantage and were the important source of growth in developing economies.

4. Estimation and results

Both the fixed effects model (FEM) and the random effects model (REM) models were estimated using data
obtained from the census of manufacturing industries of Pakistan. Equation 4.1 shows the results obtained through
pooled least square FEM. The coefficients of unemployment rate (UR) and effective tariff rates (ETR) have
expected signs. Values in parenthesis are t-values.
PCM = 0.28 + 0.62 CR + 0.14 COR 1.48 UR 0.87 ETR
(3.74) (3.87)
(1.73)
(-2.53)
(-5.75)
R squared = 0.947
Adjusted R squared = 0-940
F statistic = 135.99
D.W statistic = 0.43

(4.1)

Equation 4.2 shows the results obtained through pooled generalized least squared (GLS) Random effects model
(REM). Both the coefficients of UR and ETR have expected signs with t-values in parenthesis.
PCM = 0.30 + 0.58 CR + 0.13 COR 1.52 UR 0.88 ETR
(3.22) (3.90)
(1.60)
(-2.59)
(-5.86)

(4.2)

R squared = 0.42
Adjusted R squared = 0.40
F statistic = 21.03
D.W statistic = 0.40
To choose among the FEM and the REM we conducted correlated Fixed/Random effects Hausman test. The test
statistic was set equal to zero, rejecting the existence of correlation between individual effects and other
regressors. Hence the random effects model provides more consistent estimators. The low value of D.W
statistics, however, is most probably due to measurement error or omission of some important explanatory
variable like exchange rate or interest rate etc.
5. CONCLUSION

Agro-based industries in Pakistan operate under imperfect market conditions, have positive price cost margins and
no remarkable change has taken place in S-C-P of agro-based industries overtime. Agro-based industries are
responsible for more than fifty percent of the total output of the large-scale manufacturing sector in Pakistan.
These industries are the main source of earning foreign exchange and employment. Cotton, Wheat, rice and
sugarcane are the main crops grown in Pakistan. Agro-based industries mostly use locally produced raw material
except vegetable ghee and cooking oil industry which currently is dependent on more than 70% of imported raw
material. Textile manufacturing is the largest agro-based industry in Pakistan, followed by food manufacturing
and processing industry. Ginning, pressing and bailing of fiber, wearing apparel, leather and leather products,
wood and wood products, paper and paper products are some other important agro-based industries in Pakistan.
The main emphasis of trade and industrial policies in Pakistan has been on improving market access,
strengthening trade related infrastructure, skill development and productivity enhancement.
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Government has offered various incentives to the private investors in the form of financial and commercial
support, R&D support and support for marketing abroad. Despite all these efforts no prominent change has taken
place in the structure-conduct-performance of agro-based industries. Under the S-C-P approach we tested the
hypothesis that domestic reforms reinforced with openness have a reducing effect on price cost margins.
Reduction in price cost margins is a manifestation of increased competitiveness reduced rent seeking and better
resource allocation. Our analysis shows a favorable effect of domestic economic reforms and openness on price
cost margins of agro-based industries in Pakistan during the study period

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