Does Free Trade Affect Macroeconomic Variables in a Small Open Economy? A CGE Analysis for Pakistan

Abstract

This paper intends to investigate the impact of free trade on the macroeconomic variables; GDP, exports, imports, national income, public and private sector investment, the balance of trade, welfare, and income inequality - all in the case of a small open economy with special reference to Pakistan. The study uses SAM 2010-11 for the Pakistani economy, as developed by Dorosh et al. (2015), and employs a computable general equilibrium (CGE) model, in line with Lofgren et al. (2002), to analyze the implications of tariff abolition on the selected macroeconomic indicators. To explore the impact of a reduction in tariff, three experiments of a 50%, 75%, and 100% reduction are performed. Theil indices and the Hoover index are also applied to analyze the inequality. The outcomes reflect that a reduction in tariff results in improvement with regards to important macroeconomic variables, while cutting down on inequality and poverty. However, rural household groups express lesser amelioration in comparison to urban groups. Nevertheless, empirical evidence supports an overall free trade policy. Our study suggests that the process of tariff abolition or reduction gradually be implemented in order to overcome a deficit in the balance of trade.