Trade deficit of Pakistan last 5 years that led to a debt trap

Trade deficit of Pakistan

Due to their
growing national debt and widening trade deficit, several emerging countries,
including Pakistan, have found themselves in a debt trap. These nations gave up
some of their sovereignty to their lenders since they had no choice but to use
lenders’ funds to pay their trade deficit. In order to keep emerging economies
in debt, the IMF and World Bank have both been accused of using predatory lending
practices. These practices include requiring structural adjustment programs
as a condition of loans, frequently to governments that view these loans as a
last resort, pushing for privatization, and improperly influencing central
banks. “The World Bank
and the IMF have routinely offered loans to States as a means of influencing
their policies,” the Committee for the Abolition of Illegitimate Debt
stated. The IMF has chosen which nations received loans based on geopolitical
factors rather than just economic circumstances. During the Trump presidency,
the phrase “debt-trap diplomacy” first appeared in US government
documents. The 2020 Department of State study “The Elements of the China
Challenge” is one of many U.S. official papers that mention it.

Beijing is now Islamabad’s biggest creditor, China has significantly increased
its power to influence Pakistan’s economy in recent years. Only 9.3 percent of
Pakistan’s entire public and publicly guaranteed external debt, which was
$44.35 billion in June 2013, was owed to China, according to documents made
public by the finance ministry of Pakistan. The International Monetary Fund
estimates that by April 2021, this external debt had grown to $90.12 billion,
with $24.7 billion ($27.4 percent) of Pakistan’s total external debt owed to
China (IMF). However,
China has yet to exert direct control over Pakistan’s economic decisions. The
World Bank, the Asian Development Bank (ADB), and the IMF are still the primary
decision-makers when it comes to the fiscal policies that are pursued in
Islamabad, as seen by the ongoing IMF loan program.

We must
comprehend some macroeconomic models that describe the balance of trade and
capital influx in order to comprehend the origin and causes of the debt trap.
The primary macroeconomic distinction between an open economy and a closed
economy is that an open economy does not require that a nation’s expenditure in
any given year match its output of goods and services. A nation has two
options: it can borrow from abroad to cover its surplus spending, or it can
borrow less and lend the remainder to foreigners.

Net Exports and
Trade Balance

The national
income accounts identity shows that net capital outflow always equals the trade
balance. That is,

Net Capital
Outflow = Trade Balance

S – I   =    

We will see how
this equation is derived.

To expand this
equation, we need to start with National Income Identity,

Y = C + I + G +


Y is National
output or GDP

C is total

I is Investment

G is Government

NX is Export –

To arrive at
this identity, we need to look into

This identity (Y
= C + I + G + NX
) is derived Y = Cd + Id + Gd
+ X

The first three
terms Cd + Id + Gcombine to represent
domestic spending on goods and services. Foreign spending on domestic goods and
services is the fourth term, X.

The total
amount of domestic spending on goods and services equals the sum of domestic
spending on domestic goods and services plus domestic spending on international
goods and services. Thus, total consumption C is equal to the sum of the
consumption of local products and services (Cd) and the consumption
of goods and services from other countries (Cf). The total investment I
is equal to domestic investment in goods and services plus foreign investment
in goods and services. if; and total government purchases G equal the sum of
the government’s purchases of goods and services domestically (Gd)
and abroad (Gf). Thus,

C = Cd
+ Cf also Cd = C – Cf

I = Id
+ If,  also Id = I
– If

G = Gd
+ Gf, also Gd = G – Gf

We substitute
these three equations into the identity Y = Cd + Id +
Gd + X

Y = (C – Cf)
+ (I – If) + (G – Gf) + X

We can
rearrange to obtain Y = C + I + G + X – (Cf + If + Gf)

Spending on
imports is calculated as the total of domestic purchases of foreign goods and
services (Cf + If + Gf) (IM). The national
income accounts identity can thus be written as

Y = C + I + G +
X – IM.

calculation subtracts import spending because it is part of domestic spending
(C + I + G) and because foreign-imported goods and services are not included in
a nation’s output. Net exports are defined as exports minus imports (NX = X –
IM), and the identity is

Y = C + I + G +

With some
manipulation we get,

Y – C – G = I +

Y – C – G is
national saving S, which equals the sum of private saving, Y – T – C, and
public saving, T – G, where T stands for taxes. Private Saving + Public Saving
= Y – T – C + T
G: T cancel out, Therefore, S (total national
saving) = Y – C – G

Therefore, S =
I – NX or

NX                    =     S – I

Balance   =    Net Capital Flow

This table
shows the three outcomes that an open economy can experience.

Trade Surplus

Balanced Trade

Trade Deficit

Exports > Imports

Exports = Imports

Exports < Imports

Net Exports > 0

Net Exports = 0

Net Exports < 0

Y > C + I + G

Y = C + I + G

Y < C + I + G

Saving > Investment

Saving = Investment

Saving < Investment

Net Capital Outflow > 0

Net Capital Outflow = 0

Net Capital Outflow < 0

By definition, a debt trap is when a creditor country gives a debtor country an excessive amount of credit to get political or economic concessions later on when the debtor country is
unable to make repayments. Without going into specifics to comprehend the
intentions of Pakistan’s lenders (such as major lenders China, the IMF, KSA,
UAE, etc.), we will draw attention to the fact that the government of
Pakistan’s revenues—both tax and nontax—are not even enough to pay for debt repayment
and defense spending. As a result, borrowings are used to fund all ministries
of the Government of Pakistan (GOP), the Public Sector Development Program
(PSDP), debt repayment, and defense.

Let’s begin by reading the following table of Pakistan’s
national income in order to better grasp the jigsaw puzzle of the trade balance
and its relationship with the budget (fiscal measures) and GDP.

Components of GDP
Trade Deficit & Components of Pakistan’s GDP

trade deficit is shown by net exports, which are expanding from 2017 to 2022.

Household final
consumption expenditure

A transaction
of the national account’s usage of the income account, which represents
consumer spending, is the household’s final consumption expenditure. It comprises the money spent by residing households on personal consumption products and
services, even those offered at marginally profitable pricing. It also contains
a variety of imputed expenses, the most significant of which is typically the
imputed rent for owner-occupied housing services. In addition to people who
live in traditional homes, the household sector also includes those who reside
in communal settings like nursing homes, boarding houses, and jails.

The definition
of HFCE provided above covers both domestic and international spending by
resident households (outbound tourists) but does not include any domestic
spending by non-resident families (inbound tourists). The household final
consumption expenditure according to the domestic concept, which includes
household expenditures made on the domestic territory by residents and inbound
tourists but excludes residents’ expenditures made abroad, can be distinguished
from this national definition of consumption expenditure.

consumption expenditure of non-profit institutions serving households (NPISH)

NGOs and membership organizations make up Non-Profit Institutions
Serving Households (NPISHs). The total consumption expenditure of NPISHs is
equal to their operating expenses and is always of an individual type. For the
first time, the final consumption expenditure of NPISH was estimated separately
through the known output values in 2015–16 rebasing. Due to its non-market
nature, the output of NPISH has been estimated using data on fixed capital
consumption, employee compensation, and intermediate consumption expenditures
reported by NGOs for the base year survey and membership organizations. For
the new base estimates, the NPISH’s output from the base year, or Rs. 296.7
billion, has been considered as its final consumption expenditure, accounting
for 0.91 percent of the GDP.

final consumption expenditure + NPISH = C

government final consumption expenditure

total of employee compensation, purchases by the government of materials and
other intermediate consumption items, consumption of fixed capital, purchases
of goods and services by the government for the benefit of households, other
production taxes, and non-miscellaneous taxes on production equals the final
consumption expenditure by the government, which is equal to its cost. It is
compiled through the federal, provincial, and local government budget documents
and broken down in accordance with the classification of the functions of
government (COFOG).

government final consumption expenditure = G

Gross Fixed
Capital Formation (GFCF).

Assets can be
divided into two categories: financial (cash, stocks, etc.) and non-financial.
The capital stock of a nation is made up of physical non-financial assets that
are employed as a factor of production to produce GDP. Non-financial assets can
be broadly divided into produced assets, which arise as byproducts of
production processes, and non-produced assets, such as natural resources,
contracts, leases, and licenses, as well as goodwill and marketing assets.
Fixed assets, inventory, and valuables are the three primary categories of
generated assets. Fixed assets and inventories are both assets that are only
retained by producers for production-related purposes. Any institutional entity
may have valuables, which are primarily kept as stores of worth.

Fixed assets
that are generated and used regularly or continuously in industrial processes
for longer than a year is of interest to GFCF. The total value of a producer’s
acquisitions during the accounting period, fewer disposals of fixed assets, plus
a specific amount spent on services that raise the value of non-produced
assets, is used to calculate GFCF. GFCF can also take the form of enhancing
existing fixed assets, including structures or software, to boost their
productivity, lengthen their useful life, or both.

Fixed Capital Formation (GFCF) = I

Why Doesn’t capital flow to poor countries and why does it flow to
advance an economy like the U.S.A.?

Let’s start by understanding the balance of trade, trade deficit, and net capital
flow. As you can see in the following graph, Pakistan and the United States are
noticeably farther away from China in terms of gross capital expenditure,
household consumption expenditure, government expenditure, and net exports. The
main distinction between the United States and Pakistan is that the former
enjoys the advantage of attracting the surplus of its trading partners into its
financial assets (bonds & stocks), while the latter does not. Pakistan must
emulate China’s success by increasing exports and raising its national income
through Gross capital formation (formerly gross domestic investment). Where Gross
capital formation according to World Bank is made up of expenditures for
augmentations to the economy’s fixed assets as well as net changes in the level
of inventories. Purchasing plants, machinery, and equipment; building roads,
railways, and similar structures; and building schools, offices, hospitals,
private residences, commercial, and industrial structures are all fixed assets. Fixed assets also include land improvements (fences, ditches,
drains, and so forth). Stocks of items kept by businesses as “work in
progress” and to cover brief or unforeseen swings in production or sales
are known as inventories. Net acquisitions of valuables are also regarded as
capital formation in accordance with the 1993 SNA.

Trade deficit of Pakistan last 5 years
Trade deficit of Pakistan last 5 years

Even though the United States has a trade imbalance, the rest of
the world continues to invest in its economy. Capital has primarily come from
nations that have trade surpluses with the United States of America. In 2013,
this category comprised a number of countries like China, Nigeria, Venezuela,
and Vietnam that were far less developed than the United States. Savings
outpaced domestic capital investment in these countries. These nations were
sending money to nations like the United States, where domestic capital
investment outpaced saving.

The direction of global money flows seems paradoxical from one
angle. There, we demonstrated that the Cobb-Douglas form is a production
function that is experimentally realistic:

F (K, L) = A KαL1-α,

where K is capital, L is labor, A is a variable representing the
state of technology, and a is a parameter that determines capital’s share of
total income. For this production function, the marginal product of capital is

MPK = α A(K/L) α-1

How much additional production an additional unit of capital might
produce is shown by the marginal product of capital (MPK). A must be less than
1, since it represents the capital’s portion, hence – 1 0. Thus, a rise in K/L
results in a fall in MPK. In other words, the more capital a country possesses,
the less valuable each additional unit of capital is, all other things being
equal. According to the declining marginal product phenomenon, capital ought to
be more valuable in areas where it is scarce. For instance,

MPK = 0.5 (100) (0.5)0.5-1 = 70.71

MPK = 0.5 (100) (1)0.5-1 = 50

MPK = 0.5 (100) (1.5)0.5-1 = 40.82

MPK = 0.5 (100) (2)0.5-1 = 35.36

However, this projection appears to conflict with the global
capital movement that a trade deficit implies. It appears that capital does not
move to the countries where it should have the greatest value. We frequently
see the opposite, with capital-rich nations like the US lending to capital-poor
nations. How come? One explanation is that countries differ significantly in
ways other than just how much cash they have amassed. Poor countries have
poorer levels of production capacity in addition to lower levels of capital
accumulation per worker (measured by K/L) (represented by the variable A).

Poor countries may, for instance, have less access to cutting-edge
technology, lower levels of education (or human capital), or less effective
economic policies than rich countries. Such variations can result in reduced
output for a given level of labor and capital input; in the Cobb-Douglas production
function, this is represented by a lower value for parameter A. If so, despite
the fact that capital is scarce, capital need not be more valued in poorer

widespread piracy and frequent non-enforcement of intellectual property rights
are further factors that may prevent finance from reaching developing
countries. Governments frequently fail on their obligations, expropriation of
wealth is more widespread, and revolutions, coups, and corruption are all
considerably more rampant. Therefore, despite the fact that capital is more
valuable in developing countries, foreigners may be reluctant to put their
money there for fear of losing it. Additionally, similar incentives exist for
regional investment. If you were to live in a poor country and be fortunate
enough to have some money to invest, you could conclude that it is best to do
so in a safe nation like the United States, even though capital is worth less
there than it is in your own. Whichever of these two explanations is true, poor
countries including Pakistan must figure out how to change the situation. The
flow of international capital would probably change direction if these
countries provided the same levels of production efficiency and legal
protections as the American economy. Capital would flow to these developing
countries, and the trade deficit with the United States would turn into a trade
surplus. A shift like that would aid in the emancipation of the world’s

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