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External Shocks in a Small Open Economy: A CGE-Microsimulation Analysis

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  • Vaqar Ahmed
  • Cathal O'Donoghue

    (Department of Economics, National University of Ireland, Galway)

Abstract

This paper studies the impact of changes in the external balance of a developing economy (Pakistan). We explain that the economic growth achieved during the past decade is highly dependent on the improvements in external balance. Between 2001 and 2007 Pakistan has benefited from, an increase in the inflow of remittances, foreign assistance from bilateral and multilateral sources, and a relatively stable exchange rate. This was also complimented by growth in the real sector. The GDP grew at an average of 6 percent from 2001 to 2007. During the same time period the investment to GDP ratio increased from 17 to 23 percent. After 2007 this performance came under pressure due to external price shocks. The increase in import price of petroleum, raw materials and other manufactured goods has the potential of reducing the growth performance, impacting the competitiveness of the economy and thereby threatening the gains achieved during the past years. We integrate a 33 sector CGE model with a detailed microsimulation model to study the effects of changes in foreign savings and import prices faced by Pakistan. A 50 percent increase in foreign savings leads to an increase in imports and a decrease in exports. Main sectors facing a decline in exports are textile, leather, cement and livestock. Changes in prices seem pro-poor as food and oil prices decline. Those factors of production that gain under this change are agricultural wage labor and non-agricultural unskilled wage labor. The later indicating a change in favor of urban poor. The increase in import prices of petroleum or industrial raw material leads to a reduction in exports. The prices impact the crop sector adversely. Return to land and profits to farm owners increase showing a change in favor of agricultural asset owners. Poverty and inequality increase.

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Bibliographic Info

Paper provided by National University of Ireland Galway, Department of Economics in its series Working Papers with number 0142.

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Length: 44 pages
Date of creation: 2009
Date of revision: 2009
Handle: RePEc:nig:wpaper:0142

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Related research

Keywords: Microsimulation; Computable General Equilibrium; Poverty; Inequality; Balance of Payments Algorithmic Trading; MACD;

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References

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  1. Rizwana Siddiqui & A. R. Kemal, 2006. "Remittances, Trade Liberalisation, and Poverty in Pakistan: The Role of Excluded Variables in Poverty Change Analysis," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 45(3), pages 383-415.
  2. Bernhard G. Gunter & Marc J. Cohen & Hans Lofgren, 2005. "Analysing Macro-Poverty Linkages: An Overview," Development Policy Review, Overseas Development Institute, vol. 23(3), pages 243-265, 05.
  3. Vos, Rob, 1998. "Aid Flows and "Dutch Disease" in a General Equilibrium Framework for Pakistan," Journal of Policy Modeling, Elsevier, vol. 20(1), pages 77-109, February.
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  6. Luc Savard, 2004. "Poverty and Inequality Analysis within a CGE Framework: a Comparative Analysis of the Representative Agent and Micro-Simulation Approaches," Cahiers de recherche 0412, CIRPEE.
  7. McCarthy, F Desmond & Taylor, Lance, 1980. "Macro Food Policy Planning: A General Equilibrium Model for Pakistan," The Review of Economics and Statistics, MIT Press, vol. 62(1), pages 107-21, February.
  8. Penelope Pacheco-Lopez & A. P. Thirlwall, 2007. "Trade Liberalisation and the Trade-Off Between Growth and the Balance of Payments in Latin America," International Review of Applied Economics, Taylor & Francis Journals, vol. 21(4), pages 469-490.
  9. Luiz Carlos Bresser-Pereira & Paulo Gala, 2008. "Foreign savings, insufficiency of demand, and low growth," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 30(3), pages 315-334, April.
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  11. Rob Vos & Niek De Jong, 2003. "Trade Liberalization and Poverty in Ecuador: A CGE Macro-Microsimulation Analysis," Economic Systems Research, Taylor & Francis Journals, vol. 15(2), pages 211-232.
  12. Maurizio Bussolo & Jann Lay, 2003. "Globalisation and Poverty Changes in Colombia," OECD Development Centre Working Papers 226, OECD Publishing.
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  16. Reisen, Helmut & Soto, Marcelo, 2001. "Which Types of Capital Inflows Foster Developing-Country Growth?," International Finance, Wiley Blackwell, vol. 4(1), pages 1-14, Spring.
  17. Davies, James B., 2004. "Microsimulation, CGE and Macro Modelling for Transition and Developing Economies," Working Paper Series UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).
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Cited by:
  1. Hassan, Syeda Anam & Zaman, Khalid, 2012. "Effect of oil prices on trade balance: New insights into the cointegration relationship from Pakistan," Economic Modelling, Elsevier, vol. 29(6), pages 2125-2143.

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