The cotton, textile and apparel industries which are critical sectors of the Pakistan
economy and important determinants of rural and urban poverty face challenges that
include instability in the world prices of cotton, liberalization of multilateral trade of
textiles and clothing, and strengthening of the currency arising from a surge in foreign
capital inflows and remittances since 2001. Using a computable general equilibrium
model (CGE) calibrated to a 2001-02 social accounting matrix (SAM) of the Pakistan
economy and linked to the 2001-02 Pakistan household income and expenditure survey,
this report conducts simulation experiments and analyzes the intersectoral and poverty
implications of: (1) an increase in foreign savings inflows into Pakistan; (2) an increase in
world prices of cotton lint and yarn, textiles, or a combination of these prices; (3) an
improvement in total factor productivity (TFP) in one or more of the cotton-related
sectors; and (4) a government production subsidy in one or more of these sectors.
Experiment (1) analyzes the effects on competitiveness, particularly for the cotton
and textile industries, through an appreciation of the real exchange rate that results from
the surge in foreign capital inflows. The results indicate that increased capital inflows
raise real investment and household income and reduce poverty, but the tradable sectors,
particularly the cotton and textile sectors, contract and incomes of rural farmers decline.
Experiment (2) analyzes an increase of world cotton and textile prices, where
historical indicators show wide cotton lint price fluctuations and cotton fabric prices
move to reflect the raw material price as well as for other reasons. Pakistani production
ii
and exports improve under positive sectoral price shocks, with greater benefits to farmers
and rural areas from an increase in cotton prices and indirect adverse intersectoral effects
between cotton and textiles as a boom in either sector appreciates the exchange rate.
The recent liberalization of the world trade of textiles and clothing affects world
prices and trade patterns of yarn, textiles and apparel. This will test Pakistan’s ability to
compete in world markets. Pakistan can best take advantage of this shift if it improves its
competitiveness through higher productivity. Experiment (3) looks at cases of higher
industry TFP in raw cotton, cotton lint and yarn, and textiles. If the improvement in TFP
occurs in all stages of production, the results indicate expansion in production and
exports, with less variation in higher incomes among household groups than in the earlier
cases. Poverty is reduced. The increase in income, as well as the reduction in poverty, is
lowered substantially if the TFP shock only occurs in one sector.
Finally, the textile-apparel industry is backed by a strong and powerful
association that lobbies for government support and subsidies. Experiment (4) analyzes
the effects of government production subsidies to the industry on the economy as a whole
and those favored by the policies. Such subsidies lead to overall welfare loses and higher
poverty, while they primarily benefit the owners of industrial capital.
Overall, the results of experiments (1) and (2) demonstrate the different effects
arising from two largely external positive shocks—the increase in foreign savings
strengthens the currency and creates a boom in the non-trade sectors versus an increase in
world cotton or textile prices which improves Pakistan’s terms of trade and generates a
boom in these sectors in particular. An inflow of foreign savings depresses traded sectors
iii
but stimulates investment and expanded non-traded goods production. Because of the
large share of the cotton-related sectors in overall exports, an export boom in these
sectors also strengthens the currency which negatively affects other tradables and the
domestic currency value of household income from of any given level of foreign
remittances. These different effects need to be understood by policymakers trying to
assess, for example, the performance of the yarn and textile sectors and its impacts on
employment and poverty under more liberalized trade rules but also in light of the capital
inflow and increasing foreign remittances. Experiments (3) and (4) are relevant to
policymakers who must direct limited domestic resources to capacity-building public
investments but face calls for more direct support from industry lobbies.