The Impact of Tariff Reforms on Income Distribution in Pakistan: A CGE-based Analysis

Like most developing countries, Pakistan has undertaken drastic economic policy reforms since the mid-1980s. Under these structural reforms there is a general shift away from quantitative restrictions and price controls towards liberalisation and privatisation. The empirical studies1 analysing the impact of the reforms report mixed results. Economy wide framework like Computable General Equilibrium (CGE), based on the social accounting matrix, is well suited to analysing the effect of these structural reforms. The CGE models are developed to capture the medium to long-run effects through which adjustment programmes affect income distribution. These models are often used to evaluate the effects of trade and tax policies on income distribution in developing countries. There are three interacting channels through which these adjustment policies affect income distribution, viz., the relative price effect, the asset price effect and the shift in portfolio. However, in this study, we are analysing the effect of changes in relative prices only. The first and more easily quantifiable channel is through analysis of the impact of changes in production prices following changes in tariff. For a given shock in the above mentioned policy variables, the medium to long-run distributional impact of the resulting structural adjustment is determined by the extent of relative price rigidities (fixed real wages, or mark up pricing), the extent of factor mobility (supply elasticity’s) and difference in consumption pattern across socio-economic groups. Difference in assumptions and closure rule play a very important role in market adjustment mechanism in developing countries. Simulation exercises show that assumptions about the macro economic closure and behavioural parameters matter a great deal in determining the productive and distributive effects of a shock and a country’s adjustment to the shock.