Role Adv Agri Tech

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iii
FORMAN JOURNAL OF ECONOMIC STUDIES
Volume: 7 2011 January-December
Estimating Food Demand Elasticities in Pakistan: 1
An Application of Almost Ideal Demand System
Babar Aziz, Khalil Mudassar,
Zahid Iqbal and Ijaz Hussain
Exchange Rate Exposure on the Automotive Industry: 25
Evidence from USA and Japan
Zeresh Mall, Saqib Jafarey,
Shabib Haider Syed and Ijaz Hussain
Rice Policy Reforms of the European Union and its 55
Impact on Rice Exports from Pakistan
Mohammad Aslam
Modeling Demand for Money in Pakistan: An ARDL Approach 75
Muhammad Asad, Shabib Haider Syed
and Ijaz Hussain
Role of Advance Agri-Technologies in Reducing the Rural 89
Poverty in Central Punjab, Pakistan
Hazoor Muhammad Sabir
and Safdar Hussain Tahir
Factors Influencing Student Achievement Scores: 99
Public vs. Private Schools
Shahnaz Rashid
Book Review 117
DEPARTMENT OF ECONOMICS
FORMAN CHRISTIAN COLLEGE (A CHARTERED UNIVERSITY)
FEROZEPUR ROAD, LAHORE, PAKISTAN
Vol. 7, 2011 (JanuaryDecember) pp. 1-24
Estimating Food Demand Elasticities in Pakistan:
An Application of Almost Ideal Demand System
Babar Aziz, Khalil Mudassar, Zahid Iqbal and Ijaz Hussain
1
Abstract
The main focus of the study is to estimate the rural-urban income and own
price elasticities across a range of consumption quintiles. The Linear
Approximate Almost Ideal Demand System (LAAIDS) is used to estimate the
parameters of aggregate food commodity groups. Due to the specific features
of the data, spatial variations in regional prices are estimated and used as
proxies for food prices (i.e. unit values) by using household survey data.
Regarding household specific elasticity estimates, households exhibit
increasing consumption of vegetables, fruits, milk and meats with higher
income. The expenditure elasticities are larger in rural areas compared to
urban areas and expenditures on most food groups increase at a decreasing
rate as income increases. Expenditure elasticities for all food groups were
positive and less than one, except for fruits, meats, and milk that have been
identified as luxuries. Cereals tend to have the lowest expenditure elasticity of
demand. The uncompensated own-price elasticities of demand for all food
groups are negative and their absolute amounts are lower than unity i.e.
demand reacts in-elastically to own-price changes, except for meats (elastic).
According to the values of the cross-price elasticities and on the level of all
selected food groups, only substitution relationships are observed. The high
price elasticities of demand for many food items stress the importance of food
price changes for households, and their reactions should be taken into
account in the development of comprehensive agricultural and food policies in
Pakistan.
Keywords: Consumer demand analysis; PIHS data; LAAIDS; price and
expenditure elasticities
JEL classification: D01, D12, C31
1
The authors are Associate Professor of Economics at Forman Christian College (A
Chartered University) Lahore, Assistant Professors of Economics at Government SE College
Bahawalpur, Forman Christian College (A Chartered University) Lahore and Gomal
University D. I. Khan, respectively.
Babar, Khalil, Zahid and Ijaz
2
I. Introduction
Demand elasticities for a particular country provide valuable
information for policy analysts in understanding the pattern of growth of the
national food consumption. Specific country elasticities are influenced by both
the level of income attained and the quantities of food that are currently eaten
by the consumer. Estimation of complete demand functions is incredibly
useful not only in obtaining price elasticities, but also in getting reliable
estimates of expenditure (income) elasticities. The measurement of these
elasticities is required for the design of many different policies; for example,
intelligent policy design for indirect taxation and subsidies requires
knowledge of these elasticities for taxable commodities and, in addition, in the
projections for future food consumption
2
.
Such knowledge would normally be obtained by the analysis of time-
series data on demand for commodities, prices, and incomes. For Pakistan as
well as for many developing countries, there is typically rather few time-series
data from which price elasticities can be inferred. As a result of this limitation
and with the available cross-sectional data resulting from extensive surveys on
household expenditures, most studies in Pakistan concentrated on the
estimation of expenditure elasticities (Engel relationship) and overlooked the
price elasticities.
As the estimation of complete demand functions is incredibly useful
not only in obtaining price elasticities, but also in getting reliable estimates of
expenditure (income) elasticities, so towards this end the study lays out the
estimated rural-urban income and own price elasticities, across a range of
consumption quintiles, of aggregated food groups. Section II addresses the
issue that how price elasticities could be estimated from cross sectional data?
Section III is specified for model specification of LAAIDS, for the estimation
of complete demand system along with the description of income and price
elasticity formulas. Section IV highlights the adopted estimation technique
along with description of the variables. The empirical findings are reported in
section V. Concluding remarks are presented in section VI along with policy
implications for Pakistan.
2
See e.g. Deaton (1986, 1987, 1988), for a meticulous discussion.
Food Demand Elasticities in Pakistan
3
II. Price Elasticities from HIES data
Deaton (1987) developed a methodology by using household survey
data to detect the spatial variation in prices and to estimate the price
elasticities by comparing spatial price variation to spatial demand patterns.
The household surveys contain information on the spatial distribution of
prices, and thus, by recovering this information in a useful form, there is a
potential for estimating the impact of prices on quantity demanded. Since
prices for food products are not provided by the survey, the ratio of
expenditure to purchased quantity can be used as a proxy for prices. These
prices should be corrected before being incorporated into the demand system
according to the causes of cross-sectional price variations.
Prais and Houthakker (1955, 1971) identify price variation due to
region, price discrimination, services purchased with the commodity, seasonal
effects, and quality differences caused by heterogeneous commodity
aggregates. When the structure of demand is relatively constant, price
variation can be attributed to changed supply conditions and can be used to
identify commodity demand curves. In order to interpret correctly the effects
of prices in the analysis of household budget data, the causes of cross-
sectional price variations must be identified and only supply related price
variations should be used to estimate the demand functions.
In the survey data used by Deaton, there are variations in the cross-
sectional price data due to region, household characteristics (male, female, age
groups), seasonal effects, aggregation of the commodities, etc. Similar data for
the survey data used by Deaton are available for a wide range of developing
countries so that the technique should have wide applicability.
Keeping in line with the methodology of Deaton nine aggregated food
commodity groups were chosen for the analysis of this study: cereals (CR),
pulses (PL), fruits (FR), edible oils and fats (EOF), sugar and gur (SG), meats
(MT), vegetables (VG), tea, coffee and soft drinks (TCS), and milk and milk
products (MMP). Each of selected food group is not a homogeneous good but
consists of a number of components. For example, in the data it is possible to
separate the cereals group into wheat, rice, and maize, but a category such as
rice does not encompass different kinds of rice, some of which are more
expensive than others. This food-grouping is to reduce the total number of
parameters in the model and then estimation demand system more
4
manageable
3
. Each food group includes those commodities that have the same
nutritional value and their prices are very likely to move in tandem and hence
there would be no serious aggregation problem.
The variation in food group prices is due to differences in consumed
items in each group and the variation in prices of each item across provinces.
The latter is due to regional market conditions. Therefore, the price of each
food group is computed as a weighted average of prices on specific items. The
price obtained is effectively a value and quantity ratio, which is called a unit
value by Deaton (1988) and consequently could be used as a proxy of prices.
This unit value as defined by Deaton is used in this study after the name of
unit value of the aggregated commodity.
Using unit values as price proxies, as in this study, brings about
another specific concern. Unit values are not only affected by the actual prices
consumers face, but also by the composition of the commodity group. When
separate goods are aggregated into a single commodity group, this leads to
variations in the average price, i.e. unit value of the aggregated commodity,
changing with the quantities of the goods of which it is composed. This means
that quality choice in this context is not only a question of differentiated goods
but also quality choice is reflected in the quantity shares of the component
goods.
The published data of the Pakistans HIES is aggregated at eight rural-
urban regions across four provinces. The ratio of expenditure to quantity, the
cost of the purchase, gives the cost of the commodities for four provinces.
This information can be used as a proxy for the prices after calculating the
unit value of the aggregated commodity. Given, for example, different
cereals costs, and then, there will be spatial variation in the costs of this food
group across the regions. This variation can be used to obtain the price
information, which is missing in the household survey data. Thus, a complete
demand system can be estimated, and price and expenditure (income)
elasticities can be calculated as a result.
So, in continuation of the previous discussion and keeping in mind the
specific features of the data, the study has made use of spatial variation in
regional prices estimated using household survey data. The estimated spatial
variation in regional prices, as per methodology suggested by Deaton, is used
as proxies for food prices. They are incorporated into the complete food
3
See for instance Abdulai (2002, 2003); and Abdulai and Aubert (2004).
5
demand analysis, i.e. LAAIDS after calculating the unit value of the
aggregated commodity, to measure own and cross price elasticities for an
assortment of food groups.
III. The LAAIDS
The LAAIDS has been chosen as the basic model for the complete
demand system estimation in this study due to its flexible functional form and
nimbleness in estimation. In a short and snappy way the demand function of
LAAIDS in budget share form can be expressed as:
*
ln ln
ic i ij jc i c c
j
w p px P
(1)
Where the commodities 1, , 9 i and the consumption quintile 1, , 5 c .
ic
w is the budget share of good i in the respective consumption quintile c ,
jc
p is the price of good j in the respective quintile,
c
x is households total
food expenditure in the specific quintile c .
*
c
P is the stones price index, and
i
,
i
, and
ij
are the parameters that need to be estimated.
The demand elasticities are calculated as functions of the estimated
parameters, and they have standard implications. The specific form of
expenditure elasticity (
i
), which measures sensitivity of demand in response
to changes in consumption expenditure, is as:
1
i i i
w (2)
The uncompensated (Marshallian) own-price elasticity (
ii
) and cross-price
elasticity (
ij
) measure how a change in the price of one product affects the
demand of this product and other products with the total expenditure and other
prices held constant. The specific form of uncompensated own and cross price
elasticities is as, respectively:
1
ii ii i i
w (3)

ij ii i i j i
w w w (4)
The compensated (Hicksian) price elasticities own and cross (
*
ii
and
*
ij
),
which measures the price effects on the demand assuming the real expenditure
*
c c
x P is constant, is described as:

*
1
ii ii i i
w w (5)
6

*
ij ij i j
w w (6)
Also, the compensated price elasticity can be derived easily by using
i
,
ii
,
and
ij
, and the following relation:
*
ij ij i j
w (7)
In particular, the sign of the calculated
*
ij
indicates the substitutability or
complementarily between the destinations under consideration.
Using the LAAIDS model to estimate the two-stage budgeting demand
function presents several advantages. Probably the most important is that it is
a flexible functional form. The LAAIDS substitution pattern implies an
unconstrained pattern of conditional cross-price across products within sub-
segments. This is an advantage, because competition is probably higher
among differentiated products within sub-groups. Another important
advantage of the LAAIDS model is the perfect aggregation over consumers,
without requiring linear Engle curves. This is very important in studies of
aggregate data. Finally, the demand function derived from this model crosses
the price axis, avoiding the presence of virtual prices.
IV. Data and Estimation Procedure
Data for this study is obtained from the Federal Bureau of Statistics
(FBS) for the year of 2007-08. FBS provided an electronic copy of the data
sets for four provinces aggregated into five consumption percentiles. The cost
indices of the bundles of the aggregated food commodities are calculated from
the given data set. The expenditure data are pooled across the four provinces
and five consumption percentiles in each province in the study. It is assumed
that cost indices of the bundles of the food commodities are only different
across the provinces and for each consumption quintile, but not within the
province according to Deatons methodology. In simple words it is assumed
that households at different consumption percentiles have the same cost
indices for the aggregated food commodities within the same province. The
cost indices of these commodities in each Province are used as proxies for
prices and hence enabled us to estimate income and price elasticities across
these defined consumption quintiles.
No regional elasticities (rural and urban) are estimated keeping in line
with the assumption of no variation in the unit values within the same region.
Our study includes nine aggregated food commodity groups, as defined
7
earlier. The prices for these commodity aggregates will be proxied by the cost
of these commodity aggregates in each province across the quintiles.
A system of share equations based on first equation and subject to the
restrictions (adding-up, homogeneity, and symmetry) is estimated using
Iterative Seemingly Unrelated Regression (ISUR) method of Zellner. This
method is equivalent to Full Information Maximum Likelihood (FIML)
estimation. The adding-up property of demand causes the error covariance
matrix of system to be singular, so one of the expenditure share equations is
dropped from the system to avoid singularity problems. The estimates are
invariant of which equation is deleted from the system. Homogeneity is
maintained by normalizing all of the prices (proxied by the aggregate cost
figures) by the price of others group (OT). The coefficients pertaining to the
expenditure share equation of others aggregate (OT), which is dropped from
the system in the estimation stage, are obtained by using the adding-up
property. Symmetry is imposed during the estimation of the system of
equations. Now, we present the results of our estimation. The above models
are initially estimated for the whole sample of households, regardless of their
income and consumption levels. Later, households are split according to
consumption quintiles, and the models are estimated for each group.
V. Model Results
The above model in first equation was initially estimated for the whole
sample of households, regardless of their respective consumption quintiles.
Later, households were split according to their consumption patterns, and the
models were estimated for each group. Following Green and Alston (1990,
1991), we assume that the preference structure is such that, in the first stage,
consumers choose how to spend their income among groups of products, such
as food, housing, transportation, health services, education, etc. In the second
stage, the level of expenditure in each group, as determined in the first stage,
is allocated to the commodities in that group.
The empirical results for the specified model for demand functions
(LAAIDS) illustrate that all estimated coefficients agree with a priori
theoretical expectations. As a result of 2
nd
stage of the two-stage budgeting
process the estimates of the structural parameters for food groups of the
LAAIDS model for the whole sample of households are shown in Table 1.
Following the same line of action, the parameters of LAAIDS for 1
st
quintiles
(low income households) and 5
th
quintiles (high income households) quintiles
are reported in Table 2 and 3 respectively. The equation for milk and milk
8
products was excluded to avoid singularity, but its coefficients were later
recovered with the use of the homogeneity property. The parameters estimates
satisfy the adding-up restriction. Overall, it can also be seen from the
estimated results that a reasonable number of coefficients of the explanatory
variables are significant. Out of eighty one coefficients we have twenty five
ij
's with significant t-statistics.
However of interest to researchers and policy makers is the knowledge
concerning elasticities of demand for food. According to value of the
expenditure elasticities, the selected food groups are classified as inferior
goods (
i
<0), necessities (0 <
i
<1), or luxuries (
i
> 1). Demand for a
specific commodity is defined as price inelastic (elastic), if the absolute value
of its own-price elasticity is lower than unity (larger than unity).
Pairs of commodities are denoted as substitutes or complements if
their compensated cross-price elasticities are positive or negative,
respectively. Compensated elasticities indicate the change in demand for a
commodity due to a price variation, when the real expenditure change caused
by this price variation is compensated by an expenditure variation so that
utility is kept constant. Using formulae given in equation (2) to (6) the
expenditure, uncompensated and compensated price elasticities, respectively,
are presented in Tables 4 through 12. The calculated elasticities and the
relative order of magnitude among them are reasonable as compared with
those values one would expect given heuristic considerations.
5.1. Expenditure elasticities
Table 4 displays the expenditure consumption (income) and own-price
elasticities for the food sub groups for the whole sample. Generally, the
expenditure elasticities for selected food groups in Pakistan are relatively
high. This can be explained by the economic situation in Pakistan. Many
households, especially the poor, face tight budgetary constraints and all of the
selected food commodity groups are considered as very important items
because they fulfill fundamental needs of people.
It can be seen from the Table 4 that expenditure and own-price elasticities are
of expected sign. The income (expenditure) elasticities for all food groups are
positive and less than one (0 <
i
< 1), except for fruits, meats, and milk and
milk products, indicating that food groups are normal and necessary goods,
and there are no inferior products. For pulses, the expenditure elasticity
9
Table: 1. Parameter Estimates of LAAIDS for Total Sample and for Aggregated Food Groups
Food
Groups
i
1 i
2 i
3 i
4 i
5 i
6 i
7 i
8 i
9 i
2
R
0.423 -0.078 0.060 0.103 -0.178 0.194 -0.201 0.087 -0.102 -0.063 -0.030 0.798 Cereal
(CR)
1.419 -1.709* 0.128 1.227 -2.134** 1.698* -2.957** 1.065 -2.745** -0.535 -1.046
0.048 -0.015 0.003 0.084 0.023 0.006 -0.069 0.006 -0.010 0.102 0.007 0.820 Pulses
(PL)
0.507 -1.000 0.254 3.132*** 0.879 0.152 -3.230*** 0.238 0.900 2.714 0.755
-0.039 0.009 -0.005 -0.020 0.008 0.066 -0.020 -0.015 0.001 0.006 0.011 0.793 Fruits
(FR)
-0.987 1.603* -0.743 -1.733* 0.699 4.256*** -2.257** -1.414 0.046 0.417 3.055***
-0.066 -0.007 0.020 0.011 -0.020 0.029 -0.007 -0.002 0.001 0.070 0.005 0.839 Edible Oil
& Fats
(EOF)
-1.269 -0.895 2.441** 0.806 -1.358 1.478 0.565 -0.163 0.029 3.378*** 0.862
0.235 -0.022 -0.017 0.023 -0.003 -0.032 0.020 -0.002 0.013 -0.067 0.006 0.802 Sugar
(SG)
3.392*** -1.770* -1.490 1.048 -0.190 -1.096 1.090 -0.143 1.259 -2.120** 0.799
0.176 0.099 -0.045 -0.069 0.086 -0.023 0.041 0.015 0.029 -0.089 0.008 0.789 Meats
(MT)
0.586 2.170** -0.970 -0.801 1.029 -0.207 0.598 0.177 0.760 -0.742 0.285
0.091 -0.011 0.036 0.037 -0.043 -0.154 0.120 -0.060 0.022 0.162 -0.023 0.756 Vegetables
(VG)
0.478 -0.385 1.187 0.686 -0.799 -2.094** 2.724 -1.145 0.913 2.110 -1.206
0.132 -0.008 0.002 0.006 0.045 0.036 -0.026 -0.032 -0.001 0.007 -0.009 0.812 Tea,
Coffee &
Soft
Drinks
(TCS)
2.487** 0.915 0.282 0.412 2.990** 1.700* -2.193** -2.207** -0.063 0.327 -1.877*
0.149 0.033 -0.056 -0.170 0.074 -0.121 0.141 -0.002 0.060 -0.129 0.022 0.836 Milk &
Milk
Products
(MMP)
0.941 1.399 -2.315** -3.774*** 1.660 -1.987* 3.912*** -0.057 3.015*** -2.020** 1.380
Note: 2
nd
line of each group describes the t-values, in smaller font size. * * * Indicates significant at one percent
level of significance, * * Indicates significant at five percent level of significance and * Indicates significant at ten
percent level of significance.
10
Table: 2. Parameter Estimates of LAAIDS for Quintile 1
st
and for Aggregated Food Groups
Food
Groups
i
1 i
2 i
3 i
4 i
5 i
6 i
7 i
8 i
9 i
2
R
0.396 -0.073 0.056 0.097 -0.167 0.182 -0.188 0.082 -0.096 -0.059 -0.028 0.789 Cereal
(CR)
1.326 -1.597* 0.119 1.147 -1.995* 1.588* -2.765** 0.995 -2.566** -0.500 -0.978
0.045 -0.014 0.003 0.078 0.021 0.005 -0.064 0.005 -0.010 0.096 0.006 0.845 Pulses
(PL)
0.474 -0.935 0.238 2.928** 0.821 0.142 -3.020*** 0.223 0.842 2.537**8 0.706
-0.037 0.009 -0.004 -0.018 0.008 0.061 -0.018 -0.014 0.001 0.005 0.011 0.812 Fruits
(FR)
-0.922 1.498 -0.694 -1.620* 0.654 3.978*** -2.110** -1.322 0.043 0.390 2.856**
-0.061 -0.006 0.018 0.011 -0.018 0.027 -0.006 -0.002 0.001 0.066 0.004 0.862 Edible Oil
& Fats
(EOF)
-1.187 -0.836 2.282** 0.754 -1.270 1.381 0.528 -0.153 0.027 3.158*** 0.806
0.219 -0.020 -0.016 0.021 -0.003 -0.030 0.018 -0.002 0.012 -0.062 0.005 0.798 Sugar
(SG)
3.171*** -1.654* -1.393 0.979 -0.177 -1.024 1.019 -0.133 1.177 -1.982* 0.747
0.164 0.092 -0.042 -0.064 0.081 -0.021 0.039 0.014 0.027 -0.083 0.008 0.789 Meats
(MT)
0.548 2.028** -0.907 -0.749 0.962 -0.193 0.559 0.166 0.711 -0.693 0.267
0.085 -0.011 0.033 0.034 -0.040 -0.144 0.112 -0.056 0.020 0.152 -0.021 0.776 Vegetables
(VG)
0.447 -0.360 1.109 0.642 -0.747 -1.957* 2.547** -1.071 0.854 1.973* -1.128
0.124 -0.008 0.002 0.005 0.042 0.033 -0.025 -0.030 -0.001 0.006 -0.009 0.750 Tea,
Coffee &
Soft
Drinks
(TCS)
2.325** 0.856 0.263 0.385 2.795** 1.589* -2.050** --2.063** -0.059 0.305 -1.754*
0.140 0.031 -0.053 -0.159 0.069 -0.113 0.132 -0.002 0.056 -0.120 0.020 0.861 Milk &
Milk
Products
(MMP)
0.879 1.308 --2.16** -3.5*** 1.552* -1.857* 3.657*** -0.054 2.818** -1.889* 1.290
Note: 2
nd
level of significance, * * Indicates significant at five percent level of significance and * Indicates significant
at ten percent level of significance.
11
Table: 3. Parameter Estimates of LAAIDS for Quintile 5
th
and for Aggregated Food Groups
Food
Groups
i
1 i
2 i
3 i
4 i
5 i
6 i
7 i
8 i
9 i
2
R
0.444 -0.082 0.063 0.109 -0.187 0.204 -0.211 0.092 -0.107 -0.066 -0.031 0.876 Cereal
(CR)
1.490 -1.795* 0.134 1.289 -2.241** 1.784* -3.106*** 1.118 -2.883** -0.562 -1.099
0.051 -0.016 0.004 0.088 0.024 0.006 -0.072 0.006 -0.011 0.107 0.007 0.875 Pulses
(PL)
0.533 -1.051 0.267 3.290*** 0.923 0.159 -3.392*** 0.250 0.946 2.850** 0.793
-0.041 0.010 -0.005 -0.021 0.008 0.069 -0.021 -0.016 0.001 0.006 0.012 0.773 Fruits
(FR)
-1.036 1.683* -0.780 -1.820* 0.734 4.470*** -2.371** -1.485 0.048 0.438 3.209***
-0.069 -0.007 0.021 0.012 -0.021 0.030 -0.007 -0.002 0.001 0.074 0.005 0.824 Edible Oil
& Fats
(EOF)
-1.333 -0.940 2.564** 0.847 -1.426 1.552* 0.593 -0.171 0.030 3.548*** 0.906
0.246 -0.023 -0.018 0.024 -0.004 -0.034 0.021 -0.002 0.013 -0.070 0.006 0.817 Sugar
(SG)
3.563*** -1.859* -1.565* 1.100 -0.199 -1.151 1.145 -0.150 1.322 -2.227** 0.839
0.185 0.104 -0.047 -0.072 0.091 -0.024 0.043 0.016 0.030 -0.093 0.008 0.797 Meats
(MT)
0.616 2.279** -1.019 -0.842 1.081 -0.217 0.628 0.186 0.798 -0.779 0.299
0.095 -0.012 0.037 0.039 -0.045 -0.162 0.126 -0.063 0.023 0.170 -0.024 0.740 Vegetables
(VG)
0.502 -0.405 1.246 0.721 -0.839 -2.199** 2.861** -1.203 0.959 2.216** -1.267
0.139 -0.008 0.002 0.006 0.047 0.037 -0.028 -0.034 -0.001 0.007 -0.010 0.744 Tea,
Coffee &
Soft
Drinks
(TCS)
2.612** 0.961 0.296 0.432 3.140*** 1.785* -2.303** -2.317** -0.066 0.343 -1.971*
0.157 0.035 -0.059 -0.179 0.077 -0.127 0.149 -0.002 0.063 -0.135 0.023 0.864 Milk &
Milk
Products
(MMP)
0.988 1.470 -2.431** -3.963*** 1.744* -2.087** 4.108*** -0.060 3.166*** -2.122** 1.449
Note: 2
nd
level of significance, * * Indicates significant at five percent level of significance and * Indicates significant at ten
percent level of significance.
12
amounts to 0.871 and for vegetables and sugar and gur it amounts to 0.764
and 0.664, respectively. The food groups such as fruits, meats, and milk and
its products have expenditure elasticities larger than unity (
i
>1) which
identifies them as luxuries. It is expected that these food groups will
experience an increase in demand when consumers income increases in
tandem with the overall economic growth of the country. However, if real
income of households further decreases, in relative terms, less expenditures
will be allocated to these food commodities. This result indicates that as
households expenditures increase and households diversify their diets, they
tend to increase their consumption of non-staple foods rather than staple
foods.
Table: 4. Expenditure (Income) and Marshallian Own-price
Elasticities for Total Sample
Food group Expenditure Own-price
Cereals 0.541 -0.582
Pulses 0.871 -0.238
Fruit 1.327 -0.745
Edible oils and fats 0.821 -0.247
Sugar and gur 0.664 -0.672
Meats 1.222 -1.053
Vegetables 0.764 -0.290
Tea, coffee and soft drinks 0.833 -0.839
Milk and milk products 1.209 -0.898
Another interesting finding is that cereals tend to have the lowest expenditure
elasticity of demand. The consumption of this group is relatively little affected
by income changes and has already occupied a special position in the
Pakistanis diet, as it is a staple food among the population.
The LAAIDS model permits the calculation of elasticities for different
consumption quintiles, so in addition, expenditure elasticities has also been
surged out for the poor and rich households of Pakistan (i.e. for 1
st
and 5
th
quintile) 1
st
quintile refers to the poor group and 5
th
quintile is meant for the
upper class having high rate of consumption expenditure share. It is observed
that income elasticities for almost all of the included groups are higher for
lower class and lower for the rich class. Its as per the theoretical
consideration that income elasticities move down ward as income increases
and vice versa. So for poor high income elasticity is expected and the results
of Table 5 confirm it. Among the food groups fruits; meats; tea, coffee and
soft drinks; and milk and milk products with elasticities greater then one
13
seems to have a luxurious nature for the poor. In addition to these groups
pulses; edible oils and fats; and vegetables with the expenditure elasticity
close to one also conforming their existence very close to the luxurious items.
Elasticities for 1
st
Quintile
Food group Expenditure Own-
price
Cereals 0.653 -0.694
Pulses 0.878 -0.245
Fruit 1.436 -0.854
Meats 1.350 -1.181
Table 6 demonstrates the expenditure and own price elasticities for the upper
class (i.e. the consumers belonging to 5
th
quintile). All the observed
expenditure elasticities are of
Elasticities for 5
th
Quintile
Food group Expenditure Own-price
Cereals 0.429 -0.470
Pulses 0.864 -0.231
Fruit 1.218 -0.636
Meats 1.094 -0.925
reasonable magnitude. The magnitude of the expenditure elasticities for this
upper class, as per theoretical consideration and prior assumption, is low as
compared to the poor class. Three groups reflect the tendency of being the
luxury items like fruits, meats, and milk and milk products with expenditure
elasticities 1.218, 1.094, and 1.114 respectively. No group reveals the status of
Giffen commodity.
14
Cereal group for both of the income classes shows a behavior of basic
need for the people. The expenditure elasticity of this group is lower as
compared to all other included groups in both of the cases. It is overall 0.541,
and 0.653 for 1
st
quintile and 0.429 for 5
th
quintile. As a basic need cereal
group is les elastic towards the change in income as it has a certain fixed
proportion in the expenditure of the households.
5.2. Uncompensated own-price elasticities
Uncompensated own-price elasticities of demand for all food groups
are negative and consistent with the a priori expectation. The absolute
amounts of these elasticities for all food groups are lower than unity except
for meats in total sample of households as displayed in Table 4. The demand
reacts in-elastically to own price changes. An exception is meat where the
elasticity amounts to -1.053 (elastic) thus price changes affect the demand for
meat in a greater extent as compared to the other included groups.
The uncompensated own-price elasticities for most the selected food
groups, such as pulses, edible oils and fats, and vegetables are much lower
than the total expenditure elasticities, implying that responsiveness of demand
to own price changes of these aggregates is much lower than to variations in
total expenditure. The largest absolute value of uncompensated own-price
elasticity is calculated for the meats group (i.e. -1.053). This implies that
demand reacts elastically to changes in the prices of these products. The own
price elasticities are lowest for pulses (-0.238), edible oils and fats (-0.247),
and cereals (-0.582) where demand reacts least to price changes.
Having a look on Table 5, it is observed that meats; tea, coffee and soft
drinks, and milk groups showed a high elastic attitude towards the change in
own price, having own price elasticities -1.181, -1.081 and -0.993
respectively. While, on the other hand, pulses and edible oil groups depict a
low magnitude of own price elasticities in absolute terms i.e. -0.245 and -
0.367, respectively.
Table 6 reveals the information about the uncompensated own price
elasticities for the rich class (5
th
quintile). No own price elasticity is found
here, which have a magnitude greater than one in absolute terms. However,
meat, and milk and milk products groups, with elasticities -0.925 and -0.803,
respectively, reflect highly responsive towards the change in own price as
compared to the other items pertaining to this aggregate food groups. On the
15
other side edible oil and fats, and pulses showed a very in-elastic behavior
with elasticity magnitudes -0.127 and -0.231, respectively.
5.3. Compensated own-price elasticities
As predicted by demand theory, the compensated own-price
elasticities are negative for all commodities (see table 8). For all commodity
groups, they are lower in absolute terms than the uncompensated ones.
Especially for vegetables, meats, and milk and milk product group, the
compensated own-price elasticities are much smaller in absolute terms than
the uncompensated ones, suggesting that a rise or fall in the price of the
respective commodities would have considerable real expenditure effects.
5.4. Cross-price elasticities
The values of the cross-price elasticities are smaller - in absolute terms
- than those of the expenditure or own-price elasticities. This holds true for
uncompensated and compensated cross-price elasticities (see, Tables 7 and 8).
The cross-price elasticities characterize pairs of goods as substitutes or
complements. On the level of all selected food commodity groups, there are
only substitution relationships and no complementary ones. As a matter of
fact, in Pakistan, many diets are based on a single food with small amounts
from plant or animal products. They lack dietary diversity. The fact that all
food groups showed a substitution relation
4
may be one reason explaining the
lack of diversity in the Pakistanis diet. It is important that a number of
different food sources be consumed and efforts should be made to encourage a
wide variety of foods to improve the nutritional quality of the Pakistanis diet
and health of the population. Dietary diversity is one of the most important
ways to ensure a balance of nutrients for people of all ages. However, one
would have expected a complementary relationship for cereal products with
vegetable products, where in Pakistan, cereal products are frequently
consumed jointly with vegetables (especially potatoes). This might result from
aggregation decisions of the composite commodities.
5.5. Results by consumption quintiles
The LAAIDS model permits the calculation of elasticities for different
consumption quintiles groups and HIES data materialized this happening. In
order to do so, income and price elasticities for two extreme quintiles (1
st
and
5
th
) are estimated. It is obvious from table 5 to 6 and table 9 to 12 that poor
4
In order to observe the cross price relationships among the food items, a more detailed
breakup of each food group (up to the individual commodity level) is needed.
16
people belonging to quintile 1
st
exhibit higher income elasticities for fruits,
meats, milk and soft drinks groups as compared to the higher income groups
(e.g. households belonging to 5
th
quintile). In other words, an increase in
income of poor households will lead to higher expenditure on these
commodity groups.
Table: 7. Uncompensated (Marshallian) Price Elasticities
5
for Total Sample
Group
6
CR PL FR EOF SG MT VG TCS MMP
CR -0.582 0.396 0.363 0.366 0.376 0.529 0.384 0.369 0.419
PL 0.768 -0.238 0.753 0.754 0.757 0.799 0.759 0.755 0.768
FR 0.279 0.295 -0.745 0.316 0.309 0.200 0.303 0.314 0.281
EOF 0.773 0.764 0.751 -0.247 0.757 0.816 0.760 0.754 0.772
SG 0.359 0.343 0.319 0.321 -0.672 0.441 0.334 0.323 0.357
MT 0.001 0.011 0.027 0.025 0.020 -1.053 0.017 0.024 0.001
VG 0.114 0.111 0.108 0.108 0.109 0.127 -0.290 0.108 0.114
TCS 0.179 0.171 0.159 0.160 0.164 0.219 0.167 -0.839 0.178
MMP 0.100 0.111 0.126 0.124 0.120 0.050 0.116 0.123 -0.898
Table: 8. Compensated (Hicksian) Price Elasticities
7
for Total Sample
Group CR PL FR EOF SG MT VG TCS MMP
CR -0.502 0.449 0.377 0.385 0.406 0.739 0.423 0.390 0.492
PL 0.897 -0.153 0.777 0.786 0.847 1.097 0.817 0.802 0.891
FR 0.474 0.425 -0.710 0.361 0.382 0.715 0.399 0.366 0.368
EOF 0.894 0.845 0.773 -0.219 0.802 1.135 0.819 0.786 0.888
SG 0.456 0.407 0.336 0.344 -0.695 0.695 0.382 0.349 0.450
MT 0.180 0.131 0.059 0.067 0.088 -0.579 0.105 0.072 0.174
VG 0.165 0.145 0.116 0.120 0.128 0.261 -0.265 0.122 0.162
TCS 0.302 0.253 0.181 0.189 0.210 0.544 0.227 -0.806 0.296
MMP 0.278 0.229 0.157 0.165 0.186 0.519 0.203 0.170 -0.728
5
Uncompensated (Marshallian) own-price elasticities are written in bold letters.
6
cereals (CR), pulses (PL), fruits (FR), edible oils and fats (EOF), sugar and gur (SG), meats
(MT), vegetables (VG), tea, coffee and soft drinks (TCS), and milk and milk products
(MMP).
7
Compensated (Marshallian) own-price elasticities are written in bold letters.
17
8
for 1
st
Quintile
Group
9
CR -0.694 0.284 0.251 0.254 0.264 0.417 0.272 0.257 0.307
PL 0.761 -0.245 0.746 0.747 0.750 0.792 0.752 0.748 0.761
FR 0.170 0.186 -0.854 0.207 0.200 0.091 0.194 0.205 0.172
EOF 0.653 0.644 0.631 -0.367 0.637 0.696 0.640 0.634 0.652
SG 0.302 0.286 0.262 0.264 -0.729 0.384 0.277 0.266 0.300
MT -0.127 -0.117 -0.101 -0.103 -0.108 -1.181 -0.111 -0.104 -0.127
VG 0.550 -0.456 0.535 0.536 0.539 0.581 0.541 0.537 0.550
TCS -0.063 -0.071 -0.083 -0.082 -0.078 -0.023 -0.075 -1.081 -0.064
MMP 0.005 0.016 0.031 0.029 0.025 -0.045 0.021 0.028 -0.993
10
for 1
st
Quintile
CR -0.614 0.337 0.265 0.273 0.294 0.627 0.311 0.278 0.380
PL 0.890 -0.160 0.770 0.779 0.840 1.090 0.810 0.795 0.884
FR 0.365 0.316 -0.819 0.252 0.273 0.606 0.290 0.257 0.259
EOF 0.774 0.725 0.653 -0.339 0.682 1.015 0.699 0.666 0.768
SG 0.399 0.350 0.279 0.287 -0.752 0.638 0.325 0.292 0.393
MT 0.052 0.003 -0.069 -0.061 -0.040 -0.707 -0.023 -0.056 0.046
VG 0.679 -0.371 0.559 0.568 0.629 0.879 0.599 0.584 0.673
TCS 0.060 0.011 -0.061 -0.053 -0.032 0.302 -0.015 -1.048 0.054
MMP 0.183 0.134 0.062 0.070 0.091 0.424 0.108 0.075 -0.823
8
9
(MMP).
10
18
11
for 5
th
Quintile
Group
12
CR -0.470 0.508 0.475 0.478 0.488 0.641 0.496 0.481 0.531
PL 0.775 -0.231 0.760 0.761 0.764 0.806 0.766 0.762 0.775
FR 0.388 0.404 -0.636 0.425 0.418 0.309 0.412 0.423 0.390
EOF 0.893 0.884 0.871 -0.127 0.877 0.936 0.880 0.874 0.892
SG 0.416 0.400 0.376 0.378 -0.615 0.498 0.391 0.380 0.414
MT 0.129 0.139 0.155 0.153 0.148 -0.925 0.145 0.152 0.129
VG 0.223 0.220 0.217 0.217 0.218 0.236 -0.181 0.217 0.223
TCS 0.421 0.413 0.401 0.402 0.406 0.461 0.409 -0.597 0.420
MMP 0.195 0.206 0.221 0.219 0.215 0.145 0.211 0.218 -0.803
13
for 5
th
Quintile
CR -0.390 0.561 0.489 0.497 0.518 0.851 0.535 0.502 0.604
PL 0.904 -0.146 0.784 0.793 0.854 1.104 0.824 0.809 0.898
FR 0.583 0.534 -0.601 0.470 0.491 0.824 0.508 0.475 0.477
EOF 1.014 0.965 0.893 -0.099 0.922 1.255 0.939 0.906 1.008
SG 0.513 0.464 0.393 0.401 -0.638 0.752 0.439 0.406 0.507
MT 0.308 0.259 0.187 0.195 0.216 -0.451 0.233 0.200 0.302
VG 0.274 0.254 0.225 0.229 0.237 0.370 -0.156 0.231 0.271
TCS 0.544 0.495 0.423 0.431 0.452 0.786 0.469 -0.564 0.538
MMP 0.373 0.324 0.252 0.260 0.281 0.614 0.298 0.265 -0.633
VI. Conclusion and Policy Recommendations
Lack of dietary diversity is a particular problem among the people in
Pakistan, because their diets are predominantly based on starchy staples with
little animal products and few fresh fruits and vegetables. It is observed that
the major sources of calories and proteins in Pakistan are plant products with
small amounts from animal products as a concentrated source of essential
protein that are of high quality and highly digestible. In addition, the diets in
Pakistan are low in fat intake, since of all basic foodstuffs, fat is one of the
11
12
(MMP).
13
19
most expensive. Therefore, in Pakistan, the consumers are still suffering from
malnutrition and unbalanced essential nutrients like caloric value, proteins,
and fat content. Also, there is a marked difference between rural and urban
areas in food consumption patterns.
It is explored that the expenditure and price elasticities for selected
food groups are relatively high in Pakistan. As expected, the estimation results
show that expenditure elasticities for all food groups are positive and less than
one, except for fruits, meats, and milk; indicating that the selected food groups
are necessities. For food groups such as fruits, meats, and milk having
expenditure elasticities larger than unity, identifying them as luxuries, it is
expected that these food groups will experience an increase in demand when
consumers income increases in tandem with the overall economic growth of
the country.
Another interesting finding is that cereals tend to have the lowest
expenditure elasticity of demand. This indicates that cereals have already
occupied a special position in the Pakistans diet, as it is the staple food of the
population. Uncompensated own-price elasticities of demand for all food
groups are negative and consistent with the theoretical expectation. The
absolute amounts of these elasticities for all commodity groups are lower than
unity and so the demand reacts in elastically to own price changes, except for
meats amounting to -1.053 (elastic). The uncompensated own-price elasticities
(in absolute value) for most food groups, such as pulses, oils and fats, and
vegetables than the total expenditure elasticities, implying that food demand
reacts more elastically to expenditure changes than to own price changes. The
elasticities are lowest (in absolute value) for vegetables (-0.290), oils & fats (-
0.247), and cereals (-0.582) where demand reacts least to price changes.
For all commodity groups, the compensated own-price elasticities are
lower - in absolute terms - than the uncompensated ones, suggesting that a rise
or fall in the price of the respective commodities would have considerable real
expenditure effects. According to the values of cross-price elasticities and on
the level of all selected food commodity groups, only substitution
relationships are observed. Many diets in Pakistan are based on a single of
food with small amounts from vegetables or animal products and lack dietary
diversity in the diet, which supports this result. However, one would have
expected a complementary relationship for cereal products with vegetables,
because in Pakistan, cereal products are frequently consumed jointly with
20
vegetables (especially potatoes). This might result from aggregation decisions
of the composite commodities.
The findings of the empirical analysis of price and expenditure
(income) elasticities for the selected food groups could be used in the
projections for future food consumption. Pakistan is expected to be getting
farther and farther away from being self-sufficient in its food production. This
holds true particularly for food items exhibiting high expenditure elasticities
such as livestock products. The high price elasticities of demand for many
food items stress the importance of food price changes for Pakistani
households, and their reactions should be taken into account in the
development of comprehensive agricultural and food policies in order to avoid
unattended effects harming consumers.
Due to the strong influence of diets on health, adequate food
consumption is an important public health concern. In Pakistan, diets are
traditionally overly rich in calories due to high consumption of cereal products
and comparatively low consumption of healthy food such as fruits and
livestock products. It is important, therefore, that efforts undertaken to
encourage consumption of a wide variety of foods to improve the nutritional
quality of the diet and health of the population. Considering the relatively high
expenditure elasticities of demand for fruits and livestock products of all
households, income increases would exert a positive influence on the intake of
micronutrients that are delivered by fruits and livestock products. The results
of this study suggest that income oriented policies are important to achieve
better nutrition and reduce the problem of unbalanced diets in Pakistan. In
addition, complementing policies are necessary.
Since Pakistan has a high income inequality, it is expected that income
and price-elasticities are different between the richest and the poorest. The
results supported this expectation, indicating that income-elasticities are
higher for the poorest for all staple food. Moreover, own-price elasticities are
higher for the poorest households in the case of cereals and pulses, the most
consumed staple food commodities in Pakistan. These results are an important
step forward in understanding household consumption habits in Pakistan, and
highlight the consumption differences between poor and rich in the country.
The elasticities calculated in this study are powerful instruments in helping
policymakers in devising policies targeted at poor people.
Food subsidies can be better targeted to the poor people by subsidizing
food items and distributing in villages and rural neighborhoods where the poor
21
are known to be concentrated. The total annual food subsidy resources could
be allocated to each region according to its contribution to total poverty. The
subsidy system should re-establish subsidies on some of the healthy foods like
red meat and fish because these items are a relatively concentrated source of
essential protein of high quality and highly digestible. The best way for
Pakistan to improve its food distribution system is that the food subsidy
system should be changed from the commodities form to a cash subsidy
provided only to low-income households and reduces the benefits to the non-
needy.
Increase in animal production must be focused, particularly small
ruminants and fisheries, aiming at increasing the per capita consumption of
animal protein in its various forms by means of raising productivity of
domestic cattle of buffalo, cow and sheep using improved genetic techniques;
and by introducing high-yield genetics as a means to increase milking rate,
meats and eggs production. Increasing the quantities of animal products is
expected to have an effect on the prices as a whole and as a result may benefit
consumers. Decrease per capita consumption of cereals through redistribution
of flour uses, raising the standard of living of the population and changing
food consumption patterns.
It is important that a number of different food sources be consumed
and efforts should be made to encourage a wide variety of foods to improve
the nutritional quality of the Pakistanis diet and health of the population.
Dietary diversity is one of the most important ways to ensure a balance of
nutrients for people of all ages. The results of this study suggest that income
oriented policies are important to achieve better nutrition and reduce the
problem of unbalanced diets in Pakistan.
22
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Exchange Rate Exposure on the Automotive Industry:
Evidence from USA and Japan
Zeresh Mall, Saqib Jafarey, Shabib Haider Syed and Ijaz Hussain
1
Abstract
This study analyses the impact of exchange rate shocks on firm value as well
as on the portfolio of automotive firms from U.S and Japan over a time period
of 1999-2007. The effect of intra industry competition on the relation between
exchange rate and firm value is also incorporated. The results indicate that
Japanese firms are more exposed to the dollar than U.S firms to yen and the
exposure to yen and dollar for the U.S and Japanese firms respectively is due
to the market share of Japanese firms in the U.S while the exposure to euro
for the Japanese firms is due to the market share of German firms in Japan as
well as Japanese firms in Germany.
Keywords: Exchange rate exposure; automotive industry; USA & Japan
JEL classification: F31, G30, G39
I. Introduction
Financial theory predicts that a change in an exchange rate should
affect the value of a firm or an industry. According to Eiteman et al. (1995)
and Shapiro (1992), the exchange rate exposure is conventionally classified as
transaction exposure and economic exposure. Transaction exposure is the
effect of exchange rate changes on committed cash flows such as accounts
receivables and is short term in nature. Economic exposure is the effect that
exchange rate changes have on a firms long-term cash flows and is long term
in nature. Chow et al (1997) provide evidence that transaction exposure,
economic exposure and the interest rates changes associated with exchange
rate changes work together to determine the exchange rate exposure of stock
returns. A firm is subject to economic exposure if the firms value, as
measured by the present value of its expected future cash flows, is sensitive to
1
The authors are Lecturer at Forman Christian College (A Chartered University) Lahore,
Professor of Economics at City University London, Associate Professor at Forman Christian
College (A Chartered University) Lahore and Assistant Professor at Gomal University D. I.
Khan, respectively.
Zeresh, Saqib, Shabib and Ijaz
26
changes in exchange rates. For example, the value of an exporting firm is
likely to fall if the domestic currency appreciates, while the value of an
importing firm is likely to rise with that same appreciation. A change in
exchange rate through its effect on the costs of inputs, outputs, and substitute
goods affects the competitive position of domestic companies with no direct
international involvement relative to foreign corporations. Exchange rate
movements can affect an individual investor who owns a portfolio consisting
of securities in different currencies, multinational company (MNC) with
subsidiaries and branches in foreign locations, an exporter/importer who
concentrates on international trade and even a firm that has no direct
international activities.
It is assumed that the automotive industry is competitive and that
competition acts as a proxy for the elasticity of demand for a product therefore
competition that a firm faces in the domestic and foreign markets should be a
determinant of a firms exposure in that specific market. In this study the
impact of competition will be measured by examining the market share of
firms in U.S of Japan and Germany, in Japan the market shares of firms of
U.S and Germany and in Germany the market shares of U.S and Japan to
analyse the impact of international sales on exposure. This is consistent with
the notion that the currency exposure of a firm is a function of the export sales
and the competition faced in a specific market. Williamson (2001) results
show that domestic competition from foreign firms plays a vital role in
determining exposure.
This study will be investigating the effect of real exchange rate
changes on the value of firms in the automotive industry and the impact of
competition on exposure. Automobile manufacturers are often multinationals
as they have subsidiaries and manufacturing plants in many different
countries. Automobile industry has strong international dependence for both
production inputs and exports of finished products and is likely to be sensitive
to foreign exchange rates. The automotive industry has progressed from one
of national competition, particularly in North America, to one of international
competition, in which firms from the U.S. Japan etc export to foreign markets,
to one of global competition, in which firms produce and sell in many
countries.
Exchange Rate Exposure on the Automotive Industry: USA and Japan
27
1.2. Exchange rate exposure and firm value
A company which manages its productions or delivers its services in
more than one country with export sales and costs in home currency should
depict exchange rate exposure. The exchange rate exposure tends to change
with the competition that the industry undergoes and also with the foreign
currency position of the firms operations. If there is no competitor and the
exporter have costs in the local currency while selling in a foreign market the
cash flows will be affected by changes in exchange rates. The sensitivity of a
firms cash flows to exchange rate changes is mainly a function of elasticity of
demand for the firms product. If a firm has low elasticity of demand for the
firms product but high export sales it will face a low exposure as it can
increase prices in the local market when faced with depreciation of the local
currency and this in turn lessens the impact on the home currency cash flows.
As the number of local competitors increases in the foreign market the
sensitivity of the firms cash flows to exchange rates should increase. With the
introduction of competitors the ability to increase prices if the local currency
depreciates will be affected. Conclusively with the introduction of competitors
the sensitivity of the firms cash flows to exchange rates will also increase.
Global industries undergo structural changes. This type of industry
evolution has important implications for exposures for multinational firms and
global competitors because it has a severe impact on their competitive
makeup. If there is a firm that exports to a foreign market and does not
compete directly with firms in that market, the firm's exposure will only be a
function of its foreign currency revenues because the firm may have national
competition but little or no competition from foreign markets. If the foreign
firm then faces competition in the local market, exposure becomes a function
not only of its foreign currency revenues but also of the elasticity of its own
and its competitor's product. The firm then becomes more competitive
worldwide and therefore have to be more concerned with local competitors in
a foreign market or foreign competitors in the firm's domestic market. The
complexity of a firm's exchange rate exposure evolves as the industry
becomes more global, that is when firms begin to produce in various markets.
Firms can be exposed to exchange-rate risk through various channels. For
instance a firm with foreign sales is exposed to exchange-rate risk because the
value of foreign sales in terms of domestic currency changes when the
28
exchange rate changes. The same firm may source inputs from abroad and this
may increase or decrease its exchange rate exposure depending on whether the
imports and exports are in the same currency. Furthermore, this firm may also
have assets and liabilities abroad; this can also increase or decrease a firms
exposure. Exchange-rate exposure is not limited to exporters, importers or
multinational firms. Even a domestic firm with no foreign activities may be
exposed to exchange-rate risk, for example a local firm facing import
competition.
This paper is structured in the following manner. Section reviews
the literature available on exchange rate exposure. Section presents the
model specification and data set. Section IV describes the estimation
procedure and presents empirical results. The last section provides the
conclusion and policy implications
II. Literature Review
The theoretical exchange rate exposure literature supports the common
belief that exchange rate changes should impact firms that import from
foreign markets, export to foreign markets, or face foreign competition.
Shapiro (1975) argues that a multinational firm with export sales and
competition should exhibit exchange rate exposure and that the firms
exposure should be related to the proportion of export sales, the level of
foreign competition, and the degree of substitutability between local and
imported factors of production. Second Generation studies in contrast to First
Generation studies document exchange rate exposure as being significant. To
estimate the effect of an exchange rate shock on firm value, only those shocks
should be identified that are permanent and unanticipated.
2.1. First generation
For a set of US firms, Jorion (1990) shows insignificant exchange-rate
exposure. Over the period from 1971 to 1987 only 15 out of 287
internationally operating firms or 5.2% of the sample have a significant
exchange rate exposure at the 5 percent significance level. This occurred
because firms effectively managed their exposure which is quite similar to the
study of Bodnar and Gentry (1993). Their study tested for exchange rate
exposure at the industry level in the US, Japan and Canada and found
insignificant exposure for countries which are less open and small. Bartov and
Bodnar (1994) provide an additional justification for finding insignificant
exchange risk exposure. They suggest that firms that can respond to exchange
29
rate changes and overall international market conditions at low cost will tend
to have insignificant exchange risk exposure. Choi and Prasad (1995) examine
exchange-rate exposure of a sample of 409 multinational firms that have
foreign sales, profits and assets of at least 25 percent of their respective totals.
When they examined exchange risk exposures at the industry level by
grouping the firms into 20 portfolios they found limited support for the
importance of the exchange rate factor. This was explained by the fact that
although firms in a given industry are in the same primary line of business,
they are still heterogeneous in terms of their operational and financial
characteristics. Since industry groups include firms with positive and negative
exchange risk exposure, aggregating across such firms will result in finding an
insignificant exposure coefficient for the industry group.
2.2. Second generation
Some studies demonstrate that exchange rate movements can have an
economically significant impact on firm value. A firm is said to exhibit
exchange rate exposure if its share value is influenced by changes in currency
values. Priestley and Odegaard (2002) study uses data from the Norwegian
equity market to investigate currency exposure. The Norwegian market is
particularly well suited for such an investigation as it is an open economy and
their results provide comprehensive evidence that exchange rate exposure is
statistically significant and economically important. This study analyzes the
currency exposure of industry stock returns. They show that when measuring
currency exposure in regressions including the local stock market one has to
account for the currency exposure of the local market itself in the estimates,
account for possible regime changes by the monetary authorities in exposure
estimations and use individual currencies of the major trading partners instead
of a currency basket. When these issues are accounted for, exposure estimates
are important in both an economic and statistical sense. Ligterink and Macrae
(2006) examine the relationship between exchange-rate changes and stock
returns for a sample of Dutch firms over 19941998. They find that over 50
percent of the firms are significantly exposed to exchange-rate risk. With
respect to the determinants of exposure, they find total assets and the foreign
sales ratio to be significantly and positively related to the firms exchange-rate
exposure. In comparison with other economies in the world, the Netherlands
has a relatively open economy, which may be an explanation for the
30
prominent exchange-rate exposures for the Dutch firms. Williamson (2001)
findings show that there is significant exchange rate exposure in the
automotive industry. He finds evidence supportive of the theoretical
determinants of foreign exchange rate exposures for firms in a globally
competitive industry. His tests reveal that the ratio of foreign sales to total
sales and competition are major determinants of exchange rate exposure.
Therefore firms in the automotive industry show a significant amount of
exchange rate exposure. Dominguez and Tesar (2006), Doidge, Griffin, and
Williamson (2006), Bartram and Bodnar(2007) Priestley and Odegaard (2007)
findings are also consistent with the result that exchange rate exposure is
significant.
III. Methodology
3.1. Sample selection
This study incorporates information regarding automotive firms
headquartered in U.S.A and Japan. The automotive firms of both countries
compete in major markets and manage a large percentage of worldwide
contestable cash flows linked with the automotive industry. Contestable cash
flows involve no significant barriers to foreign competition. Japanese
Automotive industry is selected because it is one of the leading and prominent
industries of the world. The sample comprises of the big three of U.S.A and
six companies of Japan namely General Motors
2
, Ford Motor, Chrysler LLC
3
,
2
General Motors Corporation is an American automaker based in Detroit, U.S. For 77
consecutive years (1931- 2007), GM was the global sales leader. On June 1, 2009 General
Motors Corporation filed for bankruptcy under chapter 11 of the Bankruptcy Code. It is the
third largest bankruptcy filing of the world and the former General Motors Corporation is now
known as Motors Liquidation Company. Therefore, the stock price taken to compute stock
returns is of Motors Liquidation Company.
3
Chrysler Group, LLC is an American automobile manufacturer headquartered in Detroit. In
1998 German based automobile manufacturer Daimler acquired Chrysler. From 1998 to 2007
Chrysler was part of the German based Daimler Chrysler. On May 14, 2007, Daimler
Chrysler announced the sale of 80.1% of Chrysler Group to an American private equity firm.
Therefore to compute the stock returns for Chrysler I have used the stock price of Daimler as
a proxy for Chrysler. The time period for this study is eight years. As Chrysler is a significant
automaker in U.S.A. I included it in my study; excluding it from the sample would have
affected the results. Therefore, I had to truncate the time of the study to take account of
Chryslers sale.
31
Toyota Motor, Nissan Motor, Honda Motor, Suzuki Motor, Mitsubishi Motor
and Subaru Motor respectively.
3.2. Data set
The information on exchange rates and market return is taken from
DataStream International. The data on stock returns, market return and
exchange rates are with a monthly frequency. The data on stock price for U.S
firms has been taken from Bloomberg while the data for stock price of
Japanese firms is from DataStream International. The stock return is
calculated by taking the logarithmic difference between stock prices of the
current and previous month.
Stock return = (
1
ln ln
t t
P P
) this is because returns are typically taken as

percentual return:
1 1 1
% 100( / ) 100( ) / ~(ln )
t t t t
return X X X X X X

For the second regression equation the impact of sales in each market
as shown in figure 1, 2 and 3 depict market shares in each country. The sales
figures are taken for a period of eight years (1999-2007). The information for
the market shares is taken from the Japanese Automobile Manufacturers
Association also known as JAMA and auto insight data by accessing Global
Insight. To analyze the impact of competition on exposure market shares of
firms in U.S.A, Japan and Germany are examined. The firms in Germany's
sample include Porsche, B.M.W and Daimler. Market share is evaluated by
calculating the portion of a firms sales to total sales in the particular country
and the figures are in percentage.
The firms stock return is used as a proxy for changes in firm value.
To compute the stock returns I have taken the logarithmic difference between
stock prices. A firm's stock price measures the value of its expected future
cash flows. These expected cash flows can follow many different patterns, and
the patterns can vary dramatically from firm to firm. There is a high positive
correlation between low (high) firm value and low (high) stock price. Firms
that have performed poorly (well) recently tend to have lower (higher) share
prices due to this poor performance.
Previous studies have been using the trade weighted exchange rate to
measure the extent of a firms exposure to exchange rates but this can mute
32
the effect of an exchange rate shock on firm value. Therefore in this study to
investigate a firms or a countrys automotive industry exposure individual
currencies are used as well as real exchange rates. The real exchange rate can
be defined as the nominal exchange rate that takes the inflation differentials
among the countries into account. Its importance stems from the fact that it
can be used as an indicator of competitiveness in the foreign trade of a
country. When there are nominal assets and liabilities present in the foreign
currency a firm can be exposed to the nominal exchange rate because these
assets and liabilities should be interpreted at the nominal rate. In the absence
of foreign assets or liabilities a nominal rate change which is affected by
changing price levels across countries should have no effect on the real value
of the firm. Conclusively, the exchange rate change that should affect firm
value is the real exchange rate.
The work of Dumas (1978) and Adler and Dumas (1980, 1984)
suggest that exchange rate exposure can be quantified as the sensitivity of
stock returns to exchange rate movements. According to Adler and Dumas
(1984) exchange rate exposure is the influence of exchange-rate changes on
the future cash flows of the firm. In their view firm value represents the
present value of future cash flows and exchange-rate exposure is the
sensitivity of firm value to exchange-rate changes. Under this assumption,
exposure can be determined from the elasticity of firm value with respect to
the exchange rate. He defines the exposure elasticity as the change in the
market value of the firm resulting from a unit change in the exchange rate.
With this approach the exposure elasticity of the firm can be obtained from
the coefficient on the exchange rate variable in the following regression.
Following Adler and Dumas empirical studies which have measured
exchange-rate exposure by the slope coefficient from a regression of stock
returns on exchange-rate changes we will be able to evaluate the effect of
exchange rate on firm value. To estimate the effect of exchange rate on the
firm value the following regression will be used.
m e
t mt t t
r R S (1)
where r
t
is the monthly return of a firm and portfolio, is the intercept, S
t
is
the change in real exchange rate,
e
measures the exposure of the country-
specific industry portfolio, R
mt
is the return on the country-specific market
portfolio,
m
is the market risk of firms and
t
is the error term. The exchange
33
rate exposure is tested for the specific firms as well as for the portfolio of both
Japanese and American automotive manufacturers.
The equation although very similar to Adler and Dumas (1984) is
consistent with Jorion (1990) as it includes the market factor. Market factor is
added to prevent misspecification of the model and control for
macroeconomic factors. It is seen to be a significant component of the returns
generating process. This market portfolio addition controls for market-wide
factors that represent macroeconomic effects correlated with the exchange rate
and it changes the statistical properties and distribution of the exposure
estimates. Because the market return explains a substantial amount of the
typical firms stock return variation, its inclusion in the exposure estimation
model reduces the residual variance of the regression and improves the
accuracy of the exposure estimates. The market return has the additional
feature of explicitly controlling for movements in the stock market.
It is widely accepted that, for some industries, competition between
countries is economically important and this competition is strongly affected
by exchange rate changes. Economists around the world argue that some of
the industries in their countries compete vigorously with the same industries
in other countries and that exchange rate shocks affect their competitiveness.
In the U.S. it is routinely stated that some U.S. industries compete with
Japanese industries and that an appreciation of the yen is good for these U.S.
industries and bad for the competing Japanese industries. A firms exchange
rate exposure is a function of foreign sales, the elasticity of demand in the
foreign market and the elasticity of demand in the domestic market (Marston,
1996) It is assumed that the automotive industry is competitive and that
competition acts as a proxy for the elasticity of demand for a product therefore
competition that a firm faces in the domestic and foreign markets should be a
determinant of a firms exposure in that specific market. Therefore, a firm has
more significant exposure to a particular currency not only if the firm has
substantial sales in the foreign market but also if the firm faces competition in
the same market. This also holds for the domestic market. If the firm faces
competition from foreign firms, then the firm has exposure to the currency of
that competitor. To evaluate the impact of competition on exchange rate
exposure for U.S firms the market share of Japanese and German firms in US
is analysed as well as the market share of U.S firms in Japan and Germany
34
and similarly for the Japanese firms. Germany is included as a third country
to take into account the export sales and competition encountered in a
particular market.To test the exposure of a firm to competition in the home
and foreign markets the following regression is used as follows:
1 ,t , 2 ,t , 1 , , 2 , ,
m
t mt jp us us jp dm t gr us dm t us gr t
r R y S MS y S MS S MS S MS
(2)
Where
m
is the market risk, R
mt
is the return on the countrys market,
1
and
1 are the exposure of the interaction between the exchange rate and portfolio
market share
in
which MS
A,B
represents the market share of portfolio of
country A in country , S
k,t
represents the rate of change of the real exchange
rate in currency k at time t and r
t
is the monthly return.
IV. Empirical Results
4.1. USA firms
Table 1a shows the results for the USA portfolio and US firm-specific
exchange rate exposure. A negative exchange rate coefficient corresponds to a
decrease in the firms stock returns when the home currency appreciates (as
would be the case for an exporter).The US portfolio shows an insignificant
exposure to yen and euro along with a negative sign indicating that the U.S
portfolio loses values as yen and euro depreciate relative to the dollar. At the
firm specific level it can be seen that Ford loses value as yen and euro
depreciate relative to dollar, Chrysler loses (gains) value as yen (euro)
depreciates and General Motors loses (gains) value as euro (yen) depreciate
relative to dollar. The results of the portfolio for yen/dollar are driven by
Chrysler and Ford as they both carry a negative sign while General motors
and Ford show a negative sign for the euro and therefore the negative sign of
the portfolio for euro/dollar is driven through these two.
Table: 1a. USA portfolio and firm- specific exchange rate exposure
Firm Intercept market risk yen/dollar euro/dollar Adj.R (%)
U.S. portfolio -0.0128 0.7375 -0.3191 -0.0128 14.8916
[-1.6783] [4.1255]*** [-1.0468] [-0.0418]
G.M -0.0087 1.1482 0.3626 -0.2002 23.2602
[-0.9466] [5.3110]** [0.9832] [-0.5406]
Ford Motor -0.0234 0.7961 -0.1943 -0.6380 8.2814
[-1.8881]* [2.7321]** [-0.3893] [-1.2839]
Chrysler -0.0062 0.2703 -0.6829 0.3560 1.0961
[-0.6350] [1.1748] [-1.7401]* [0.9033]
*, **, ***denotes 10%, 5% and 1% significance level.
35
The full sample results of General Motors, Ford and Chrysler reveal that they
have insignificant exposure to both yen and euro resulting in an insignificant
exposure of the portfolio. Each firm and portfolio has been tested for the
standard tests of autocorrelation, multicollinearity, misspecification and
heteroskedasticity problems and there was none present in any firm. The
adjusted R is in percentage; the highest value for General Motors and the
lowest value for Chrysler Motors.
4.2. Japanese firms
Table 1b shows the results for the Japanese portfolio and firm-specific
exchange rate exposure. The Japanese portfolio shows a negative and
significant exposure for dollar/yen while an insignificant and positive
exposure for euro/yen. This reveals that the Japanese portfolio loses value as
dollar depreciates relative to yen and gains in value as euro depreciates
relative to yen.
Table: 1b. Japanese portfolio and firm - specific exchange rate exposure
Firm Intercept market risk dollar/yen euro/yen Adj.R(%)
Japan
Portfolio
0.0013 0.6439 -0.4272 0.2118 0.3389
T- statistic [0.2621] [6.9207] [-2.4926]** [1.2302]
Toyota 0.0067 0.7371 -0.6481 0.0070 31.880
T- statistic [1.0731] [6.3463]** [-3.0294]** [0.0328]
Nissan 0.0088 0.6420 -0.3437 0.1512 11.6529
T- statistic [0.9849] [3.8567]** [-1.1208] [0.4910]
Honda 0.0050 0.5793 -0.9650 0.0195 28.4657
T- statistic [3.6276]** [4.8831]** [4.4225]** [-0.9562]
Suzuki 0.0046 0.7120 -0.6504 0.4230 25.3624
T- statistic [0.6561] [5.3897]** [-2.6728]** [1.7306]*
Mitsubishi -0.0114 1.0918 -0.1188 0.1490 11.5016
T- statistic [-0.7628] [3.9132]** [-0.2312] [0.2887]
Subaru -0.0059 0.093806 0.16895 0.5189 -0.2247
T- statistic [-0.6296] [0.5344] [0.5226] [1.5979]
36
At the firm-specific level for dollar/yen Toyota, Honda, Suzuki, Mitsubishi,
Nissan all have negative sensitivity to the dollar depicting that as dollar
depreciates there is a loss in their firm value. The sign of the sensitivity is
consistent with the previous findings. Sensitivity to the dollar is driven
primarily by Honda, Toyota and Suzuki as they have a higher percentage of
cars in the U.S compared to others and from the table it can be seen that these
three firms have negative as well as significant exposures; therefore it can be
said that the results for the Japanese portfolio for dollar/yen is driven by
Toyota, Honda and Suzuki. Subaru shows a positive and insignificant
exposure along with Mitsubishi and Nissan. At the firm specific level for euro
all the firms in the portfolio have insignificant and positive exposure. The sign
of the coefficient discloses that all the firms along with the portfolio enhance
their value as euro depreciates relative to dollar. Standard tests for
autocorrelation, multicollinearity, misspecification and heteroskedasticity
were run to check for any of the problems present. The adjusted R is in
percentage; the highest value for the Japanese portfolio and the lowest value
for Subaru.
4.3. Market shares of Japan, U.S and Germany
Before analysing the impact of competition on exchange rate exposure
market shares should be taken into consideration. Figures 2a, 2b and 2c show
that the U.S automotive market has a higher market share of Japanese firms
compared to the number of U.S firms selling in Japan while Japan has a lower
Figure: 3a. USA Automobile Market Share
37
market share in Germany than U.S firms. German market share is higher in
U.S than Japan but it has quite a significant share in its own country similar to
Japan although U.S is on the course of losing its market share in its own
country to Japan. Figure 3a, b, c present market share for U.S.A, Japan and
Germany for the years 1975-1995 therefore the change in market share over
the years can be analysed.
Figure: 3b. Japan Automobile Market Share
Figure: 3c. German Automobile Market Share
4.4. US firms and market share
In tables 2 and 3 the results for equation 2 are shown. In this equation
the market share and exchange rates are interacted. The interaction term
shows that the fluctuations in the exchange rates will affect the exposure of
firms as the market share increases. To illustrate further the relationship
38
between the explanatory variables and the dependent variable a distributed lag
model will be used which includes lagged terms of independent variables. It is
quite possible in time series models to have time playing a key role. In this
equation Y
t
is not only depending on the current value of X
t
but also on past
values of X
t
. Therefore to capture the effects of time lagged independent
variables will be used. It can be seen from table 2b that when the interactions
are lagged independently they become significant.
Table: 2a. Interaction between Market share and exchange rate
Market share and exchange rate interaction U.S Firms
Intercept -0.01093
[-1.3652]
Country-specific market risk 0.7417
[4.0928]**
Interaction-USA market share for Japanese firms and /$ -0.0219
[-0.8438]
Interaction-Japanese market share for USA firms and /$ 0.6038
[0.8175]
Interaction-German market share for USA firms and /$ -0.0487
[-0.7946]
Interaction- USA market share for German firms and /$ 0.0931
[0.5972]
*, **, ***denotes 10%, 5% and 1% significance level
From table 2a it can be inferred that the interaction between the U.S market
shares of Japanese firms with yen to dollar shows a negative sign and
similarly the interaction between German market share for U.S firms and euro
to dollar shows a negative sign although both of them are not significant. The
interaction between the Japanese market share for U.S firms and yen to dollar
as well as German market share for U.S firms and euro to dollar are both
positive and insignificant.
The results in table 2b show that the U.S portfolio exposure to the yen
is due to the share of the U.S market held by Japanese firms. North American
car makers steady loss of domestic market share has not been driven by
imports from Japan but by the success of foreign-owned automobile plants
operating in the United States. Since the 1980s, Japanese automakers such as
Toyota, Honda, Nissan and Mazda dramatically have increased their
production capacity in the United States. Therefore U.S.As real competition
39
is not Japanese factories in Japan but in California, Ohio, Kentucky etc in the
United States and when US market share for Japanese firms is lagged
separately it shows a negative as well as a significant sign which is also
similar to the previous studies.
The exposure to euro for U.S portfolio should occur due to the share of
the German market held by American firms as has been predicted in previous
studies. If we compare figure 3c with 2c it can be seen that there has been a
steady increase in Germanys market share of U.S. At its inception euro
depreciated for some time but since 2002 it has progressively appreciated
versus the dollar. This can be a rationale for American firms comprising a
steady increase in market share in Germany as their cars are comparatively
cheaper in Germany. The German share in U.S has gradually increased but is
still not very substantial; although exposure to euro for both the countries
firms is not significant.
From table 2c and 2d it can be inferred that when the interaction
between the country specific industry portfolios market shares with exchange
rate is lagged it does not reveal a significant sign suggesting that there is no
significant relationship between them and U.S firm returns. On the whole it
can be said that the U.S firms are more exposed to yen than euro which is due
to the share of Japanese firms in U.S.
4.5. Japanese firms and market share
It can be seen from table 3a that the sign for the interaction between
the U.S market share for Japanese firms and dollar to yen as well as German
market share for Japanese firms and euro to yen is positive and insignificant.
The interaction between Japanese market shares for U.S firms and German
firms with dollar and euro to yen respectively is negative while the latter one
being significant. The results however are clearer when these interactions are
lagged as shown in table 3c.
As predicted in previous studies exposure to dollar for the Japanese firms
should be due to the share of U.S market held by Japanese firms. As said
before this occurs because they constitute a very large market share of the
American market as shown in fig 1c. The rationale for this as said above is
that the market share of Japanese cars has greatly increased in the past years
and as the yen has been appreciating over the past years they are also heavily
40
exposed to the dollar. According to economic theory, a yen appreciation
detracts from the international competitiveness of Japanese automakers by
raising the relative costs and thus prices of their vehicles. When producing
autos if a company utilizes Japanese labour and other inputs whose costs are
denominated in yen; the firms yen costs of these inputs remain constant if
yen appreciates. However, the firms input costs rise in dollar terms thus
reducing the firm's international competitiveness. After lagging the interaction
it becomes significant as shown in table 3c verifying its importance.
Table: 3a. Interaction between market share and exchange rate
Market share and exchange rate interaction Japanese
firms
Intercept 0.0021
[0.3921]
Country-specific market risk 0.6375
[6.8136]**
Interaction-USA market share for Japanese firms and $/ 0.0147
[0.9896]
Interaction- German market share for Japanese firms and / 0.0701
[0.3297]
Interaction- Japanese market share for USA firms and $/ -0.8545
[-1.8503]*
Interaction-Japanese market share for German firms and / -0.0984
[-0.2500]
The exposure to euro must be due to the share held by Japanese firms in
Germany and also the share held by German firms in Japan. This is because
both the countries have small market share in both countries and exposure is
the result of market shares of both countries. The exposure to the euro is due
to the shares of both German firms in Japan and Japanese firms in Germany;
this can be seen in table 3c that these interactions are significant and verify
that both of the market shares have an impact on exposure.
The interaction of the market share of U.S firms in Japan with
dollar/yen is also significant although the market share is extremely small; this
result is different from the past studies. This might be due to the effect of the
appreciation of yen against the dollar making American products cheaper in
Japan than ever before. Therefore it is beneficial for American car industry
that can export more cars to Japan, when Japanese car manufacturers cannot
41
sell as many cars in the U.S giving Gm, ford and Chrysler a large comparative
advantage.
Similar to table 2b when the market shares are lagged separately in
table 4b for Japanese firms they turn out to be insignificant and when these
interactions are lagged along with the market share and exchange rates they
are also insignificant as depicted in table 4d.
Table: 4. North American Production by Japanese Manufacturers
Years Production
1999 2797175
2001 3061612
2002 3375453
2003 3840744
2004 3840744
2005 4080713
2006 4001639
2007 4049068
On the whole the essence of this study is that the exposure to yen for both
Japanese and U.S firms is due to the market share of Japanese firms in U.S.
According to Japanese Automobile Manufacturers Association as close to the
end of the first decade of the millennium reported that the Japanese vehicle
sales account for more than 40 percent of the U.S. auto market which has risen
by about 11 percentage points over the last five years. Their companies no
longer operate as foreign competitors but as enterprises which are fully
integrated into the American auto industry. Japanese automakers in 2007
supplied 63% of their total U.S. sales from their North American plants,
compared with less than 12% in 1986, exported about 3.4 million vehicles
from Japan to the U.S in 1986 but in 2007 this figure dropped to 2.2 million
vehicles and produced 617,000 vehicles in the U.S. in 1986, compared to
more than 3.4 million vehicles in 2007.
42
------ Japanese firms exports to USA ------ Japanese firms USA production
The graph for North American production replacing exports is shown in figure
3 and table 6 reports the North American production of Japanese firms.
Japanese firms have been making a lot of effort to produce outside of its home
market but North America has been its preferred destination as they could
reduce their exposure because of the hedging value of dollar denominated
costs.
V. Conclusion
It is a widely held belief that fluctuations in exchange rates have
important implications for financial decision making as well as the
profitability of firms. The key findings of this paper suggest that there is
exchange rate exposure present for some multinational firms in a globally
competitive industry. Using a sample of automotive firms from the U.S and
Japan there is evidence that most Japanese firms are exposed to the dollar in
comparison with euro while U.S firms show insignificant exposure to both the
currencies. At the firm - specific level, there is evidence of some firms facing
significant exposure while others facing insignificant exposure; this is
consistent with the theories of the determinants of exposure.
The structure of a firms operations as well as the competition faced
within an industry plays a key role in determining the relationship between
firm value and exchange rate exposure. As said before the currency exposure
43
of a firm is a function of its foreign sales, the cost structure of the foreign
competition as well as the degree of competition. These are incorporated in
this study by taking into consideration the market shares of firms out of their
home country and in their home country. Analysing the market shares of firms
and the competition faced by firms in each market, results represent that
domestic competition from foreign firms is a critical determinant of exposure.
This study reveals that U.S firms are greatly exposed to yen and Japanese
firms to dollar due to the presence of Japanese firms in U.S. while U.S firms
are exposed to euro because of their market share in Germany and Japanese
firms are exposed to euro because of mutual market shares.
Measuring exchange rate exposure and examining factors affecting it
are of great interest to policy makers who are keen in understanding the
impact of exchange rates on certain sectors of the economy and who are trying
to understand the relation between policies that affect exchange rates and
relative wealth affects. It also has important implications for investors who
under or overweight multinational organisations in their portfolios.
44
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46
Appendices
Table: 2b. Lagged Market Shares
U.S FIRMS U.S FIRMS
Intercept -0.1962 Intercept -0.0412
T-Stat. (-1.9153)* T-Stat (-0.6558)
Country-specific market risk 0.7369 Country-specific market risk 0.7333
T-Stat (4.3006)*** T-Stat (4.1836)***
US market share for German firms 0.0196 US market share for Japan firms 0.0008
T-Stat (1.7988) T statistic (0.4618)
Intercept 0.0343 Intercept 0.0281
T-Stat (0.7260) T-Stat (0.9319)
T-Stat (4.2791)*** T-Stat (4.1085)***
German market share for US firms -0.0021 Japan market share for US firms -0.0371
T-Stat (-1.0014) T-Stat (-1.3869)
Intercept -0.1712 Intercept -0.0852
T-Stat 9-1.5529) T-Stat (-1.2262)
T-Stat (4.3815)*** T-Stat (4.3321)***
US market share for German firms (-1) 0.071781 US market share for Japan firms (-1) -0.008019
T-Stat (1.36097) T-Stat (-2.0052)**
47
US market share for German firms (-2) 0.020693 US market share for Japan firms (-2) 0.001356
T-Stat (0.2852) T-Stat (0.3055)
US market share for German firms (-3) -0.016043 US market share for Japan firms (-3) 0.0098
T-Stat (-0.2211) T-Stat (2.2135)**
US market share for German firms (-4) -0.059826 US market share for Japan firms (-4) -0.0009
T-Stat (-1.1565) T-Stat (-0.2357)
Intercept 0.03666 Intercept 0.02001
T-Stat (0.6649) T-Stat (0.6017)
T-Stat (4.19600)*** T-Stat (4.0533)***
German market share for US firms (-1) -0.004261 Japan market share for US firms (-1) -0.1389
T-Stat (-0.56685) T-Stat (-0.690)
German market share for US firms (-2) -0.005343 Japan market share for US firms (-2) 0.047165
T-Stat (-0.48907) T-Stat (0.17321)
German market share for US firms (-3) 0.008438 Japan market share for US firms (-3) 0.02918
T-Stat (0.7209) T-Stat (0.10836)
German market share for US firms (-4) -0.00105 Japan market share for US firms (-4) 0.031677
T-Stat (-0.12466) T-Stat (0.1614)
48
Table: 2c. Lagged Market share and exchange rate interaction
U.S FIRMS U.S FIRMS
INTERCEPT -0.01225 INTERCEPT -0.012522
T- stat [-1.612026] T- stat [-1.662282]
T- stat [4.099472]*** T- stat [4.310452]***
Japan for US yen to dollar -0.104401 German for US euro to dollar -0.014791
T- stat [-0.445215] T- stat [-1.285138]
T- stat [-1.717841] T- stat [-1.593722]
T- stat [4.263989]*** T- stat [4.011542]***
US for German euro to dollar -1.285138 US for Japan yen to dollar -0.005766
T- stat [-1.206662] T- stat [-0.751301]
T- stat [-1.500879] T- stat [-1.422291]
T- stat [4.301895]*** T- stat [3.961518]***
Japan for US yen to dollar (-1) 0.085764 German for US euro to dollar (-1) 0.01677
T- stat [0.351658] T- stat [1.390599]
Japan for US yen to dollar (-2) 0.010742 German for US euro to dollar (-2) -0.005515
T- stat [0.044442] T- stat [-0.459553]
49
T- stat [1.458121] T- stat [-0.413033]
T- stat [0.328929] T- stat [-0.123878]
T- stat [-1.377296] T- stat [-1.528969]
T- stat [3.961794]*** T- stat [4.193191]***
US for German euro to dollar(-1) 0.043104 US for Japan yen to dollar (-1) 0.004483
T- stat [1.490263] T- stat [0.563966]
US for German euro to dollar (-2) -0.008939 US for Japan yen to dollar (-2) -0.000973
T- stat [-0.310015] T- stat [-0.122122]
US for German euro to dollar (-3) -0.015532 US for Japan yen to dollar (-3) 0.009625
T- stat [-0.533935] T- stat [1.218156]
US for German euro to dollar (-4) 0.003435 US for Japan yen to dollar (-4) 0.006456
T- stat [0.119363] T- stat [0.829416]
50
Table: 2d. Lagged Market share and exchange rate interaction along with exchange rate and Market share
U.S FIRMS U.S FIRMS
T stat [-0.819271] T stat [-1.564327]
T statistic [3.831474]*** T stat [4.265437]***
US for Japan yen to dollar -0.06507 US for German euro to dollar 0.108515
T stat [-0.968426] T stat [0.28968]
Yen to dollar 2.043492 Euro to dollar -1.216247
T stat [0.881351] T stat [-0.34606]
US market share for Japan firms 0.001181 US market share for German firms 0.016866
T stat [0.641492] T stat [1.457969]
INTERCEPT 0.02974 INTERCEPT 0.022355
T stat [0.979347] T stat [0.443318]
T stat [3.807353]*** T stat [4.203125]***
Japan for US yen to dollar 0.748356 German for US euro to dollar -0.013569
T stat [0.804269] T stat [-0.161377]
Yen to dollar -0.998982 Euro to dollar 0.016912
T stat [-0.94727] T stat [0.008897]
Japan market share for US firms -0.038425 German market share for US firms -0.001552
T stat [-1.426969] T stat [-0.693251]
51
Table: 3b. Lagged Market shares
Japanese firms Japanese firms
INTERCEPT 0.007545 INTERCEPT -0.098229
T stat [0.356141] T stat [-0.952975]
T stat [6.281639]*** T stat [6.402478]***
Japan market share for US firms -0.004688 Japan market share for German firms 0.023118
T stat [-0.250632] T stat [0.977502]
T stat [0.707581] T stat [0.181004]
T stat [6.343567]*** T stat [6.324097]***
Germ market share for japan firms -0.005257 US market share for japan firms -0.000159
T stat [-0.671523] T stat [-0.12663]
INTERCEPT -0.035727 INTERCEPT 0.086442
T stat [-0.709693] T stat [1.241067]
T stat [5.681498]*** T stat [6.301533]***
US market share for japan firms(-1) -0.000814 German market share for japan firms(-1) -0.001124
T stat [-0.281608] T stat [-0.041507]
US market share for japan firms(-2) 0.000717 German market share for japan firms (-2) -0.01426
T stat [0.224543] T stat [-0.381328]
US market share for japan firms (-3) -0.002414 German market share for japan firms (-3) -0.029091
T stat [-0.765767] T stat [-0.779622]
US market share for japan firms (-4) 0.003605 German market share for japan firms (-4) 0.033669
52
T stat [1.259035] T stat [1.270408]
T stat [0.438119] T stat [-1.149395]
T stat [6.014752]*** T stat [6.083453]***
Japan market share for US firms (-1) -0.192649 Japan market share for German firms (-1) 0.090296
T stat [-1.453943] T stat [0.957708]
Japan market share for US firms (-2) 0.293911 Japan market share for German firms (-2) -0.112049
T stat [1.615007] T stat [-0.853198]
Jap market share for US firms (-3) -0.115032 Japan market share for German firms (-3) 0.107267
T stat [-0.632704] T stat [0.817885]
Japan market share for US firms(-4) 0.004783 Japan market share for German firms(-4) -0.05526
T stat [0.036068] T stat [-0.580162]
Table: 3c. Lagged Market share and exchange rate interaction
T stat [0.372603] T stat [0.363478]
T stat [6.701543]*** T stat [6.862232]***
US for Japan dollar to yen -0.011852 Japan for US dollar to yen -0.454803
T stat [-2.362376]** T stat [-3.017634]***
T stat [0.374069] T stat [0.335657]
53
T stat [6.569114]*** T stat [6.549483]***
German for Japan euro to yen 0.032482 Japan for German euro to yen 0.057408
T stat [1.454898] T stat [1.380317]
INTERCEPT -0.000723 INTERCEPT 0.000821
T stat [-0.136926] T stat [0.16241]
T stat [5.948503]*** T stat [5.995854]***
Japan for German euro to yen (-1) 0.039909 Japan for US dollar to yen(-1) -0.276518
T stat [0.977001] T stat [-1.739644]*
Japan for German euro to yen (-2) 0.069937 Japan for US dollar to yen (-2) -0.174619
T stat [1.707714]* T stat [-1.120061]
T stat [0.610185] T stat [-2.388688]**
T stat [1.429318] T stat [-1.45159]
INTERCEPT -4.44E-05 INTERCEPT 0.000652
T stat [-0.008486] T stat [0.126911]
T stat [6.024505]*** T stat [5.575843]***
German for Japan euro to yen (-1) 0.022311 US for Japan dollar to yen(-1) -0.010261
T stat [1.015852] T stat [-1.918668]*
German for Japan euro to yen (-2) 0.038638 US for Japan dollar to yen (-2) -0.006317
T stat [1.758912]* T stat [-1.204578]
T stat [0.594217] T stat [-1.470467]
54
T stat [1.297762] T stat [-1.901337]*
Table: 3d. Market share and exchange rate interaction along with market share and exchange rate
T stat [0.195194] T stat [0.422464]
Country- specific market risk 0.629707 Country- specific market risk 0.621992
T stat [6.819719]*** T stat [6.731103]***
US for Japan dollar to yen 0.083122 Japan for US dollar to yen -1.149336
T stat [1.894655]* T stat [-1.871998]*
Dollar to yen -3.306902 Dollar to yen 0.809189
T stat [-2.181867]** T stat [1.165601]
US market share for Japan firms -0.000162 Japan market share for US firms -0.006217
T stat [-0.134302] T stat [-0.346994]
T stat [0.300316] T stat [-0.731153]
Country- specific market risk 0.635509 Country- specific market risk 0.629027
T stat [6.399447]*** T stat [6.499003]***
German for Japan euro to yen 0.132159 Japan for German euro to yen -0.75454
T stat [0.478488] T stat [-0.714052]
Euro to yen -0.803597 Euro to yen 3.435025
T stat [-0.368709] T stat [0.763179]
German market share for US firms -0.002205 Japan market share for German firms 0.018366
T stat [-0.26404] T stat [0.759405]
Rice Policy Reforms of the European Union and
its Impact on Rice Exports fromPakistan
Mohammad Aslam
1
Abstract
The study of the import rice regime of the EU is important as it has
implications for Pakistan. The EU is a sizable importer of rice in the world in
terms of volume. Its rank as net importer of rice further improves to 4th when
considered in value terms as it is importer of high quality long grain rice.
Pakistan is a producer of high quality aromatic rice called basmati that
fetches premium price in the EU (27) and Middle East. The paper attempts an
historical review of the Rice Policy of EU and the transition through which it
has passed. Then, there is discussion of present status of the rice regime. This
is undertaken against the backdrop of the policy reforms introduced first in
1995-2000 and then post-2003 reforms. These reforms are studied with
special reference to their impact on rice exports from Pakistan. The WTO
related issues of concern such as reducing domestic support in EU, increasing
market access and changing of natural export competitiveness through grant
of export subsidies are also reviewed. Finally, conclusions of the study are
spelled out along with their policy implications. Pakistan in 2008 emerged as
the third largest exporter of rice in the world accounting for 13.8% of the
total world exports. Its share of the EU market has also been on the increase
in the recent past (around 12%). In order to sustain and further increase its
share, it requires to register and protect its basmati under GI rule, settle the
dispute regarding super basmati, press for ending quota restrictions, build
up indigenous capacity for DNA test, develop expertise for dispute resolution
and promote culture of multiple crop.
Keywords: Rice policy; EUs imports & exports; policy reforms; WTO; super
Basmati
JEL classification: F13, F19, Q17, Q18
I. Introduction
The European Union (EU) is the extension of the European Common
Market (ECM) established in 1958 under the Treaty of Rome. It had started
1
The author is Professor of Economics at Lahore School of Economics, Lahore.
Mohammad Aslam
56
with six members. Its nomenclature kept on changing with the change in the
scope and range of its activities. From the European Common Market (ECM)
to the European Economic Community (EEC) to simply the European
Community (EC) and finally to the European Union (EU) has been gradual
transition and transformation of the original organization. In the process its
membership expanded from the original six founder members and it has now
become a formidable bloc of 27 member countries of the European Continent.
The EU (27) is the largest importer and exporter of agricultural
products in the World. There is however a qualitative difference between the
nature of its agricultural imports and exports. The agricultural imports of the
EU mostly consist of basic agricultural commodities whereas its agricultural
exports mostly comprise high quality farm products.
The EU is the most important trading partner of Pakistan, accounting
for about one-fifth of its total trade in 2007. In this year, Pakistans exports to
the EU were valued at 3.4 billion while its imports were estimated at 3.8
billion, showing 0.4 billion trade deficit. Textiles and clothing by far
dominate goods exports to the EU, accounting for almost three-fourth of its
total exports.
Pakistan is also an important exporter of rice to the EU, accounting for
12% of total imports of rice of the EU in the recent past, only lagging behind
India (29%), Thailand (25%) and USA (20%). These four countries together
supplied 86% of total imports of rice of the EU. Their market share may vary
but they will remain main competitors in this market.
1.1. Problemstatement
What is the Common Agricultural Policy (ACP) of the EU? How it has
been changed and transformed over the years? What is the rice import regime
of the EU and how it has evolved over the years particularly after
establishment of the World Trade Organization (WTO)? What reforms have
been introduced and how these have impacted upon domestic production,
exports and imports of rice? What are the implications for traditional
exporters of rice to the EU and in particular how exports from Pakistan are
likely to be affected? What are the prospects for Pakistan for raising its share
of the market? What steps are needed to be taken to achieve this? These are
important questions and require investigation. The present paper is an attempt
to seek, as far as possible, answers to all the complex questions listed above.
Rice Policy Reforms of the European Union and Pakistans Exports
57
II. Rice Production in the EU (27)
The EU is a quality conscious market and Pakistan is an important
producer of high and premier quality rice called basmati. The EU also
produces rice and ranks 17
th
as a world rice producer
2
. But out of 27 member
states, only 6 countries namely Italy, Spain, Greece, Portugal, France and
Hungary are producers of rice. Italy and Spain are by far the largest producers
accounting for more than 80% of the total production. Italy is the single
largest producer accounting for more than half of the total production.
The rice producers in the EU however do not produce long-grain rice
or the indica rice. They only produce round-grain rice or the so-called
japonica rice which is almost entirely meant for domestic consumption in
rice producing countries. Most of the EU member states however are
consumers of long grain rice. Towards the close of 1980s and beginning of
1990s, long grain rice production was consciously promoted through direct
cash payments to the growers. This enabled the EU to meet 55% of its
consumption requirement of long grain rice through domestic production. This
had an adverse impact for exporters of long grain rice such as Pakistan
3
. The
EU rice consumption is divided into human consumption (85%), animal feed
(7%), industry and seed (3%) and wastage (1%). The table below gives rice
production and consumption over the last half decade.
Table: 1. Rice Production and Consumption in the EU (27)
*
Years Production Consumption
2005/06 1,731,000 2,651,000
2006/07 1,676,000 2,911,000
2007/08 1,757,000 3,185,000
2008/09 1,680,000 2,970,000
2009/10 (Nov.) 1,930,000 3,100,000
Source: USDA FAS Grain World Markets and Trade Circular Series FG 01-10
Jan.2010. *The EU membership increased to 27 after inclusion of Bulgaria and
Romania.
The production had increased by around 11.5% by 2009/10 compared to that
in 2005/06. This had happened due to a surge in global and the EU rice prices,
particularly in 2008. The rice price index of FAO which was 100 in base
period of 2002-2004, had risen to 295 in 2008, a three-fold increase. This had
2
For details see: appendix table 1 & 2
3
For Pakistans export of rice and its share see appendix table 3 & 4.
Mohammad Aslam
58
almost closed the gap between the EU and world market prices. This was also
one of the objectives of the rice sector reform. This dramatic increase in rice
price was largely attributable to market interventions by major rice producing
4
and exporting countries such as India, Vietnam and Cambodia. These
countries had imposed restrictions on exports to ease domestic price
escalation. The bad weather also played a role. The situation was further
worsened due to the high oil prices and appreciation in the price of dollar. The
narrowing down of gap between EU and world prices of rice has implications
for rice exporting countries as relative attractiveness of the EU market may
decline subject to persistence of the rice price upward trend. The domestic
consumption however increased
5
even more sharply by around 17% over
consumption in 2005/06. The net imports of the EU (27) also showed upward
trend. This is to be explained by the fact that the EU produces only the round
grain rice which is almost entirely consumed in the six rice producing
countries while the bulk of other countries consume long grain rice not
produced in the EU.
2.1. The EU (27) rice trade
The table below shows exports and imports of rice by the EU (27).
Table: 2. Rice imports and imports of the EU (27)
Years Exports Imports Net Imports
2005/06 144,000 1,221,000 1,077,000
2006/07 139,000 1,342,000 1,203,000
2007/08 157,000 1,520,000 1,363,000
2008/09 140,000 1,350,000 1,210,000
2009/10(Nov) 135,000 1,400,000 1,265,000
Source: USDA FAS Grain world markets and trade Circular Series FG 01-10 Jan.2010
The table 2 shows that net imports increased by around 17.5% in 2009/10 over
2005/06. This confirms the view that the EU (27) is an expanding market for
long grain rice exporters such as Pakistan. The EU remains a large importer in
terms of volume. Its rank as net importer of rice improves to 4
th
when
considered in value terms as it is importer of high quality expensive long grain
variety.
4
For details see appendix table 5 & 6.
5
For details see appendix table 7-9.
59
III. Historical Review of the EU Rice Policy
As noted above, the EU (27) is one of the largest rice consuming areas
of the world. This seems to offer fair prospects for exporters such as Pakistan
to expand their rice exports in this direction. But rice imports in the EU have
been traditionally conducted in accordance with the procedure laid down in
the rice policy which has now undergone many reforms with implications for
rice exporting countries.
The rice regime of the EU is however a part of the Common
Agricultural Policy (CAP) envisaging agricultural protectionism and
uniformity of price levels. The regulation 16/64 issued around mid sixties led
to establish of a common market in rice. The CAP while discarding different
protective devices operative in the member states, had provided for gradual
elimination of all tariff and non-tariff barriers in intra-community trade and
establishing a common frontier for exports originating from third countries.
The system adopted for the purpose was the price support system under which
prices regarded as fair for producers were arbitrarily fixed and imports tariffs
were imposed in an effort to control supply. The farmers were thus protected
against low-priced foreign foodstuffs and also ensured adequate return to the
farmers. The tariff imposed on the import of rice was called the variable
levy. The addition of the variable levy to the c.i.f. import price of rice was
referred to as the threshold price. The indicative price on the other hand,
was wholesale fixed at the community level and was supposed to prevail in
the area of biggest deficit. This helped farmers to plan their acreage of the
crop. The intervention price was also fixed and governments or their
relevant agencies were obliged to buy up rice offered to them. This helped in
sustaining indicative price at the desired level. The imposition of a variable
levy on imports was a foolproof mechanism to exclude all imports so long as
the local market price is below the indicative price. This meant that the EU
producers would get guaranteed price and burden of adjustment in supply and
demand in the EU would fall on foreign suppliers. This also implied that any
price reduction on the part of foreign suppliers would be of no use as it would
be absorbed by the so-called variable levy which would correspondingly go
up. Similarly any export subsidization by exporting countries would be
pointless as its effect would simply be soaked up by a parallel increase in
amount of the variable levy. The idea of the variable levy was such an
Mohammad Aslam
60
effective tool of protection that it was compared to the invention of wheel that
had revolutionized the transportation.
3.1. Impact on domestic rice production: the early period
How this impacted upon rice production in the member countries? As
stated earlier, rice production was then concentrated in Italy and France. They
only produced round grain rice which fitted well into the ecological
characteristics of the area. The consumers in the non-producing countries, on
the other hand, had preference for long grain rice which had to be imported
from third countries. The members also did not produce broken rice which
was used by the large rice processing industry of the EU. Another notable
feature of rice production was that the crop was entirely dependent on
artificial irrigation and this made it less susceptible to vagaries of nature. This
made planning and forecasting job much easier.
The result of the policy was a steady upward trend in production
particularly Italian production between 1966/67 to 1974/75. The further
expansion in rice production was however hampered by the price ratio
between rice and maize which was a competing crop of rice, expensive labor
and need for minimum level of imports of broken rice not produced in the EC
and consumer preference for long grain rice in the non-producing countries.
3.2. Intra and extra-community trade: the early period
The total imports of rice had registered an increase of nearly 36% but
Italy was the main beneficiary whose share of the market increased
remarkably from 5% of the total to about 20% by the middle of the seventies.
The share of the EC as a whole rose from 7% to 29% during the same period.
The third countries particularly USA and Egypt were the main losers.
Pakistan was effectively knocked out of this market. The rice import pattern
was also changed from import of milled rice to import of husked rice. This
was to cater to the husked rice need of a large milling industry of Germany.
The imports entirely consisted of long grain rice as there was absolutely no
production of this variety. In the later years, however, production of long
grain rice was also consciously promoted. The impact of the policy was
different on the ACP countries and OCT countries compared to third
countries. The ACP (Africa, Caribbean and Pacific) countries were the
associated countries covered by LOME Agreement 1975. The OCT referred to
the overseas territories and countries of the member states from the colonial
61
era. Both enjoyed reduced levy on their exports to the EC. This gave them
competitive edge over third countries to which group Pakistan belonged.
Thus the rice policy of EU had envisaged a unified rice market having
a single price system and a single levy on imports from third countries. The
following points of the policy were noteworthy up to the mid-seventies.
3.2.1. Maize-Rice competition for acreage: Maize was a competing crop of
rice in the original EC. Thus acreage decision of the farmers was determined
not only by price of rice but also its competing crop, maize.
3.2.2. The limiting factor of labor: The labor was scarce and expensive in
the EC and this found to be a limiting factor on further area expansion under
rice.
3.2.3. The compulsive broken rice imports: One-third of total imports of
rice comprised broken rice for industrial uses. The broken rice was not
produced in the Community.
3.2.4. The absence of long grain rice production: There was a total
absence of production of long grain rice but this has changed after deliberate
efforts at conversion to production of long grain rice. This may have been
prompted by consumer preference for such rice in the non-producing
countries.
3.2.5. The bias against milled rice imports: There was a deliberate bias
against the import of milled rice as it attracted the highest rate of the levy.
This was to ensure the interest of a large milling industry in some of the
member countries such as Germany.
3.2.6. Positive relationship between stage of processing and amount of
levy: The variable levy showed a positive relationship with the stage of
processing of rice. Thus milled rice entailed the highest rate while paddy was
subjected to the lowest rate.
3.2.7. Discriminatory enforcement of the levy: For purposes of levy, rice
exporters were categorized into third country suppliers and those members
of ACP (Africa, Caribbean and Pacific) associated under the Lome agreement
and OCT (overseas countries and territories) countries.
The ACP and OCT countries were levied at half the rate compared to the
third countries.
Mohammad Aslam
62
3.3. Reforms and present status of the rice regime
The result of the rice policy outlined above was expansion of rice
production in the EU particularly in Italy and consequent expansion in intra-
EU trade. The intervention stocks also kept on increasing and at one time had
reached 40% of the total annual consumption. Due to fixation of a high
intervention price far above the world market price, there was overproduction
and surplus production was marketed abroad through grant of huge export
subsidies.
The rice sector reform among other things had included replacement of
price support, with direct aid payments, to farmers. Initial reforms
introduced in 1995 however failed to check overproduction and intervention
stocks continued soaring.
In 1996/97, there was a fixation of maximum guaranteed area
(MGA) for rice production for the EU as a whole (433,123 hectares).This was
done to avoid excess production while at the same time allowing scope for
further expansion of rice acreage. Italy and Spain together got bulk share of
the maximum guaranteed area (79%) out of which Italys share was fixed at
55% of the total. As a consequence, rice production crossed 1995/96 pre-
reform level. Other factors also contributed. These included, among others, an
increase in per hectare yield, higher ratio of recovery of useable rice and
relative higher return of rice crop. This implied a total subsidy of Euro 251 per
ton to rice farmers. This resulted in higher production and build-up of
intervention stocks to needlessly high levels. This prompted further reforms in
2003 and in later years and aimed at reduction in production and intervention
stocks.
A package of additional reforms was proposed in 2000 but it could not
be approved and was finally abandoned. Another reforms package was
approved in 2003 and was called as the Everything but Arms (EBA) regime.
This aimed to allow duty- free and quota- free access to rice imports from
developing countries.
3.4. Main elements of 2003 rice reforms under EBA regime
3.4.1. Replacement of price support system with direct aid
payments: Rice farmers will be compensated for reduction in the rice
intervention price equivalent to 88% of the price reduction. This amounted to
an increase of direct aid payments to the farmers of 177 per tonnes.
63
3.4.2. Downward fixation of the intervention price: The intervention price
will be reduced by half so as to touch 150 per tonnes. This was expected to
bring rice price at par with world market price.
3.4.3. Fixation of a ceiling on annual purchases: The annual purchases of
rice for intervention stocks will be fixed at 75,000 tonnes per annum. This was
to reduce huge stock-piling of intervention stocks which had gone up as high
as 40% of annual consumption of the EU.
3.4.4. Introduction of the single payments schemes: The single-payment
scheme or the so-called decoupled payments will also be introduced in the
rice sector. The compensation under the SPS was subject to compliance of the
relevant EU rules concerning environment, animal welfare, food quality and
safety. The member states were allowed a transition period of 2005-07 for
implementation of the reforms.
3.4.5. Modification of the EU rice import regime: A modification of the
rice import regime of the EU was also envisaged in the reforms of 2003. The
reforms, according to an EU-funded report conducted by a French consultancy
firm Consulenti per la gestione Aziendale (COGEA), did not had any
adverse impact on EU rice production and incomes of farmers but improved
the efficiency of the system. The reforms had two negative off-shoots for
developing countries. First, these led to an erosion of the value of preferential
levies availed of by the ACP and OCT countries. Second, the position of these
countries in respect of margins of tariff preferences also deteriorated relative
to the third country suppliers. But margin of decline was more pronounced
for LDCs relative to ACP countries and OCTs. It was perhaps in this
background that a completely duty-free and quota-free access for rice from
LDCs was introduced in 2009.
3.5. The Reforms envisaged under WTO and response
The reforms revolved around three things; reducing domestic support,
allowing greater market access and phasing out export subsidies.
3.5.1. Reducing domestic support: This takes the form of all the three
box definition of the domestic support policies i.e. Amber Box or
production distorting domestic policy measures; Blue Box or policy
measures replacing price support with direct cash payments in order to limit
production and Green Box or domestic support policies isolated from the
level of production or prices. The negotiation on reducing domestic support to
rice sector assumes special relevance for the EU as it has a high level of
Mohammad Aslam
64
assistance programs. The policy of direct cash payments falling under blue
box category is even more operative in the EU. The EU after 1995 have
reduced price support and instead instituted the system of direct cash
payments. The domestic policies falling under green box category are also
rampant in the EU.
The main issues to be sorted out in difficult negotiations under WTO
relate to: a) evolving criteria for designating the EU countries in line with the
three box definition; b) the permissible limit of use of the domestic support
policies under de minimis provision of the WTO; c) the time-framework or the
speed of implementation.
3.5.2. Increasing market access: The domestic markets in the EU are
protected from international competition by imposing high duties or so-called
variable levies, import ban or import quotas. The ad-valorem tariffs on rice
have already been reduced from 99% in 1994 to 57% by the end of stipulated
implementation period. The tariff escalation is a special feature of rice trade
involving the EU. This is done to safeguard milling industry in the EU.
The preferential access is also granted to some countries to the
detriment of others under the Cotonou Agreement i.e. the Everything-but-
Arms initiative of the EU. The ensuing negotiations under WTO for better
market access are expected to centre on expansion of minimum access
quotas or reduction in bound tariffs.
3.5.3. Changing natural export competitiveness: The EU still uses export
subsidies to maintain and bolster its rice sales abroad. The EU however does
so within the WTO ceiling of 133,000 tons in milled equivalent.
According to one assessment, complete liberalization at the Global
level i.e. an absence of domestic support, export subsidies and trade barriers
was found to increase prices up to a maximum of 14% and world rice trade to
expand up to a maximum of 47%. Some models limited to policy reforms in
the EU, the United States, Japan and the Republic of Korea predicted an
increase in world prices up to a maximum of 21%. Other models
disaggregated on the basis of varieties, predicted larger price increases in
japonica rice compared to indica rice. Since indica rice producers are
located in the temperate zone where japonica rice is difficult to plant, there
is only a limited scope of a switch over to japonica production.
The Uruguay Round Agreement on agriculture had stressed greater
access to the EU market but little has changed and the market remains highly
65
restricted. In addition to levy of import duties, the EU also subsidizes
agricultural exports in order to make these more competitive in world markets.
The amount of subsidy granted is so high that the EU is responsible for almost
90% of global agricultural export subsidies.
IV. Problems and Implications for Pakistan
Asian suppliers of rice to the EU in particular Pakistan and India
supply basmati rice. This is partly due to demand for basmati by a sizable
population from both countries residing in the EU with large concentration in
the UK. The basmati literary means fragrance of a virgin and has a
geographical origin in the Kalar tract of Punjab. It is special aromatic long
grain rice with an unmatched flavor. Due to absence of any competition, it
fetches premium price in the world markets especially in the EU and the
Middle East. Due to its popularity and high price, attempts have been made in
the US to label or advertise its long grain rice as basmati. This has been
stopped for the time being and instead they were allowed to use the word
texmati by the US Patent Office in response to a joint petition by both India
and Pakistan. Now some multinationals have obtained patents on basmati
rice. The Trade-Related Intellectual Property Rights (TRIPS) agreement under
WTO may be moved for securing exclusive rights for the use of the word
basmati in terms of its GIs( geographical indications) clause. The US rice
growers and multinationals are interested in getting their rice patented as
basmati as its import was allowed massive duty abatement by the EU.
In 2004 the EU decided to withdraw duty concession on imports of
super basmati by branding it a hybrid basmati variety rather than a pure
basmati. It was going to adversely affect basmati exports to the EU as the EU
is the second most important destination after Middle Eastern countries. Also
because about three-fourth of total rice exports of Pakistan to the EU are of
super basmati variety. The EU decided to impose an import duty of 264
Euros a ton on hybrid basmati rice starting 31 March 2004 instead of the 14
Euros a ton as earlier. (The super basmati has been evolved by crossing
between basmati 370 and basmati 320). Pakistan earned about 531 US Dollars
from its rice exports to the EU of which 80% was super basmati variety. The
duty concession was however granted on the import of kernel basmati and
basmati 370, but it was only for a temporary period of three months.
Moreover the share of these varieties in total exports was relatively small. It
may be mentioned here that even before the withdrawal of this duty
concession, Pakistan was exporting basmati rice under stringent conditions
Mohammad Aslam
66
imposed by the EU such as fixing a quota ceiling and minimum price and
harsh quality control checks. The negotiations between the major stake-
holders however resulted in an agreement re-incorporating super basmati in
duty abatement list of the EU starting September 2004. Pakistan agreed to a
control system based on DNA test and to protect its basmati rice on the basis
of the so-called GIs. Moreover if its exports of rice increase to a level of
disturbance, then a normal tariff would apply.
The variable duty has also been replaced with a new system of tariff
rate quotas (TRQs). Under this basmati gets preferential access or duty free
entry into the EU but it is quota-restricted. Pakistan may benefit more if it is
allowed to export under reduced import duty but without quota restrictions.
Despite these handicaps, Pakistan in 2005 was the fourth largest exporter of
rice to the EU accounting for 12% of total imports
6
. India, Thailand and USA
were the largest exporters with EU market shares of 29%, 25% and 20%
respectively. In 2005, duties levied on import of rice into the EU are contained
in the table-3, below.
Table: 3. Duties on Import of Rice in the EU (2005)
(Euro/ton)
Rice Category Third County Third Country ACP
(duty) (tariff quota)
Rice Paddy 211 ------ 69.51
Husked Rice 42.5 88 10.54
Milled Rice 145-175 ------ 38.36
Source: http://export-help.cec.eu.int/
Among the ACP countries, Guyana and Surinam are major beneficiaries of the
EU trade preferences. Imports are made at duties which are substantially
lower compared to those levied on rice imports from third countries. The
import of husked rice is favored as lowest duties are imposed on it. This is
done for benefit of the milling industry which is quite strong in some EU
countries especially in Germany.
4.1. Major countries of origin for the EU rice imports:
Table-4 indicates that there was an impressive increase in the share of
India, Thailand, Pakistan and Guyana. This seems to have occurred at the cost
of the US and the other suppliers whose share dropped to 20% and 7%
respectively in 2005 from 32% and 40% respectively in 1995.
6
For total export of rice and production see appendix table 7 & 8.
67
Table: 4. Extra-EU Imports of the European Community
Countries Imports (million Euro) Average annual growth
1995 2005
Total 306 403 (2.6)
(100) (100)
India 40 16 (11.4)
(13) (29)
Thailand 37 99 (10.4)
(12) (25)
USA 98 82 (-1.9)
(32) (20)
Pakistan 5 48 (24.3)
(2) (12)
Guyana 3 28 (26.5)
(1) (7)
Others 123 30 (-24.4)
(40) (7)
Source: Eurostat COMEXT 20 September 2006 (S.R.4) and Figures in parenthesis are
percentages.
The growing importance of the EU market for Pakistan is evident from the
above table. Starting as minor exporter of rice to the EU market in 1995 when
it was responsible for 2% of the total imports, it emerged as the 5
th
largest
exporter accounting for 12% of the total imports by 2005.
V. Conclusions and Policy Implications
The EU market is important for basmati rice exports from Pakistan. It
is therefore imperative that Pakistan not only maintains its present share of the
EU market but also expands it. In order to do that, the following issues must
be resolved on priority.
Pakistan should immediately take steps to register its basmati at the
international level. This will foreclose any future attempt of either its main
competitors or multinationals to label their rice as basmati. India has
already done it and Pakistan should follow suit.
The government without delay should frame Geographical Indication
Law that will enable her to register basmati rice produced in Pakistan.
Other traditional products of Pakistan may also be registered under the
same law.
Mohammad Aslam
68
The EU objection of super basmati not being a pure basmati must be
permanently settled otherwise its exports will be adversely affected. The
duty concession may be withdrawn if the proposed DNA tests do not
confirm it distinctiveness.
Even super basmati must be protected and patented by Pakistan to
foreclose its use by other rice growers particularly India. The super
basmati seed had been exclusively developed by Pakistan and others must
be barred to use this.
The basmati must also be treated differently because it does not compete
with other long grain rice from either US or Thailand. Moreover it does
not threaten the livelihood of rice farmers in the EU. The duty reduction
given to basmati imports is precisely due to these factors and it must not
be curtailed.
Since duty free imports of basmati into the EU are accompanied by quota
restrictions, this dilutes the ensuing benefits to Pakistan. An effort may be
made to replace it with unlimited access accompanied by some duty
reduction.
Pakistan must build up indigenous capacity for DNA testing in
collaboration with the EU for certification of purity and quality. This
will obviate the necessity of hiring foreign experts or sending specimens
abroad for verification.
Pakistan lacks legal and technical capacity for resolution of trade disputes
under the Dispute Settlement Mechanism (DSM) provided under WTO. It
is in the long term interest of the country that such an expertise is
developed as soon as possible.
The mono-crop culture must be replaced with diverse crop strategy and
relatively more value-added exports of rice such as polished rice. This will
impart greater stability to exports and ensure more secure income to the
farmers.
69
References
Aslam Mohammad (1978). The production and trade of rice and cotton in
Pakistan with special reference to exports to the European
community, Unpublished Ph.D. Thesis submitted to the University of
Exeter, England.
-------------------------(1980). The rice policy of the European community and
prospects of rice exports from Pakistan. Pakistan Economic and Social
Review. Vol. xviii (3).
-------------------------(1982). Rice economy in the Punjab with a particular
focus on consumption Aspect. PERI, Lahore.
-------------------------(2007). World rice trade, WTO and Pakistan. Pakistan
and Gulf Economist, Vol. xxvi (20), May 14-20.
http://www.pakistantimes.net/2004/02/05/business1.htm: EU accepts
Pakistans case on Super Basmati Rice.
http://www.dailytimes.com.pk/2006/12/04: EU Team to Test Pakistani
Basmati.
http://www.blonnet/2003/07/06/stories/htm: EU Policy will not hit basmati
exports.
http://agritrade.cta.int/en/layout/set/print/content/view/full/73: Rice Sector.
http://www.fao.org: International Trade in Rice, Recent Developments and
Prospects.
http://www.fao.org: Rice Liberalization: Predicting Trade and Price Impacts
Mohammad Aslam
70
Appendices
Table: 1. Rice Production in the EU (25)
Country Production (tonnes) Share (%)
Italy 1,360,000 51.3
Spain 855,000 32.2
Greece 175,000 6.6
Portugal 146,000 5.5
France 105,000 4.0
Hungary 10,000 0.4
Total (EU) 2,651,000 100.0
Table: 2. EU Exports and Imports of Rice (1995/962009/10)
Years Exports Imports Net Imports
1995/96 149,000 491,000 342,000
1996/97 279,000 540,000 261,000
1997/98 288,000 553,000 265,000
1998/99 275,000 489,000 214,000
1999/00 214,000 519,000 305,000
2000/01 215,000 549,000 334,000
2001/02 241,000 534,000 293,000
2002/03 235,000 577,000 342,000
2003/04 276,852 768,264 491,412
2004/05 401,303 759,800 358,497
2005/06* 144,000 1,221,000 1,077,000
2006/07 139,000 1,342,000 1,203,000
2007/08 157,000 1,520,000 1,363,000
2008/09 140,000 1,350,000 1,210,000
2009/10 135,000 1,400,000 1,265,000
Source: 1) Agricultural in the European Union (annual reports)
2) USDA Grain Report No 35181(09/13/2005)
3) USDA FAS Grain World Markets and Trade circular series FG 01-10, Jan. 2010
4) * figures prior to 2005/06 are for EU (25).
71
Table 3: Pakistans Rice Exports (1995-2008)
(000 tonnes)
Years Pak. Exports World Exports Pak. Exp. as % of
world exports
1995 1592 20,800 7.6
1996 1677 19,700 8.5
1997 1982 18,818 10.5
1998 1994 27,670 7.2
1999 1838 24,941 7.4
2000 2026 22,846 8.9
2001 2417 24,414 9.9
2002 1603 27,813 5.8
2003 1958 27,550 7.1
2004 1986 27,116 7.3
2005 2350 27,716 8.5
2006 2696 31,844 8.5
2007 3000 29,663 10.1
2008 4000 28,960 13.8
Source: World Grain Situation and outlook, foreign Agriculture Service, USDA.
Table 4: Major Rice Exporters and Market Shares (2008)
(1000 tons)
Countries Exports %Share
World 28,960 100.0
Thailand 9,000 31.1
Vietnam 5,000 18.2
Pakistan 4,000 13.8
USA 3,100 10.7
India 2,500 8.6
China 1,300 4.5
Total(6) 24,900 86.0
Source: USDA
Mohammad Aslam
72
Table 5: Major Rice Importers and Market Shares (2008)
(1000 tons)
Countries imports % Share
World 26,342 100.0
Philippines 1,800 6.8
Iran 1,700 6.4
Nigeria 1,600 6.1
Saudi Arabia 1,370 5.2
Europe 1,300 4.9
Iraq 1,000 3.8
Malaysia 830 3.1
Cote dlvoire 800 3.0
South Africa 720 2.7
USA 700 2.6
Bangldesh 700 2.6
Japan 700 2.6
Total(12) 13,220 50.1
Source: USDA.
Table 6: Major Rice Producers and Shares (2008)
(1000 tons)
Countries Production % Share
World 661,811 100.0
Asia 600,541 90.7
China 193,000 29.1
India 148,365 22.4
Indonesia 57,829 8.7
Bangladesh 46,505 7.0
Vietnam 35,898 5.4
Thailand 29,394 4.4
Myanmar 17,500 2.6
Philippines 16,814 2.5
Japan 11,029 1.7
Pakistan 9,451 1.4
Total(10) 565,785 85.5
Source: The International Rice Research Institute +USDA
73
Table: 7. Rice Exports from Pakistan (1994/95-2007/08)
(Million Rupees)
Years Rice Exports Total Exports As % of total
1994/95 14026 251173 5.6
1995/96 17141 294741 5.8
1996/97 18453 325314 5.7
1997/98 24563 373160 6.6
1998/99 26825 390342 6.9
1999/00 27944 443678 6.3
2000/01 30849 539070 5.7
2001/02 27510 560947 4.9
2002/03 32433 652294 5.0
2003/04 36535 709036 5.2
2004/05 55516 854088 6.5
2005/06 68939 984841 7.0
2006/07 67935 1029312 6.6
2007-08 117270 1196638 9.8
Source: i) Pakistan Statistical Yearbook 2005.
ii) Pakistan Economic Survey 2008-09.
Table 8: Variety-wise Production and Yield of Rice in Pakistan
(000 tonnes)
Years Basmati IRRI Others
Prod. % Prod. % Prod. %
1994/95 1352 39 1927 56 168 5
1995/96 1488 38 2284 58 195 5
1996/97 1564 37 2493 59 150 4
1997/98 1439 33 2468 57 426 10
1998/99 1687 36 2593 55 393 9
1999/00 1871 36 2912 56 373 8
2000/01 1701 36 2556 53 546 11
2001/02 1999 52 1695 43 188 5
2002/03 2304 52 1942 43 232 5
2003/04 2522 52 1901 39 425 9
2004/05 2555 51 1908 38 562 11
2005/06 2920 53 2214 40 412 7
2006/07 2736 50 2238 41 465 9
2007/08 2643 48 2284 41 637 11
Source: Pakistan Statistical Yearbook 2005 and 2009
Mohammad Aslam
74
Table 9: Pakistan per Capita Availability of Rice (1995/962004/05
(000 tonnes)
Years Production Exports Seed/waste* Net Avail. Per capita
1995/96 3966 1685 238 2043 15.52
1996/97 4305 1767 258 2280 16.85
1997/98 4325 2091 260 1982 15.07
1998/99 4674 1789 280 2663 19.80
1999/00 5156 1990 309 2857 20.78
2000/01 4810 2294 289 2227 15.85
2001/02 3882 1645 233 2004 13.97
2002/03 4479 1684 269 2560 17.24
2003/04 4848 1972 291 2585 17.38
2004/05 5000 2168 300 2532 16.50
2005/06 5547 3137 333 2077 13.40
2006/07 5438 2848 326 2264 14.32
2007/08 5563 3500 334 1729 10.73
Source: Pakistan Statistical Yearbook 2005, * 6% of production on average
Modeling Demand for Money in Pakistan:
An ARDL Approach
Muhammad Asad, Shabib Haider Syed and Ijaz Hussain
1
Abstract
In this study we have estimated demand for money (M
2
) function in Pakistan,
over the period of 1980 Q1 to 2009 Q2, using ARDL method. The study
corroborate support for the hypothesis of long-run equilibrium relationship
between real money demand and a set of variables including real GDP,
inflation, rate of interest, real effective exchange rate and foreign rate of
interest. The result of F-test and negative sign of EC(-1) term, both suggest
the presence of cointegration. The results are further approved by CUSUM
and CUSUMSQ tests. The study concludes that the use of monetary policy
could be effective in Pakistan because there is a stable long-run equilibrium
relationship between money demand and the set of aforementioned variables.
Inflation has a large impact on the demand for money in Pakistan, indicating
towards the tendency of agents to hedge in physical assets.
Keywords: Demand for money; ARDL; Pakistan
JEL classification: E41, E44, E4
I. Introduction
The topic of money demand has been drawing the attention of
economists from the classical period to the present era of modern economics.
To start with the Quantity Theory of Money by Irving Fisher (1911), to
Keyness Liquidity Preference theory (1936), and Friedmans Modern
Quantity Theory of Money (1956), up till now, economists have done
considerable work on the determinants of money demand, its functional form
and appropriate methodology for estimating it. The topic of money demand is
important because money demand and supply conditions in the economy,
together contribute towards inflation, level of production and fluctuations in
the interest rate. To control these key variables, central banks alter money
supply to the economy. The effectiveness of monetary policy is associated
1
The authors are student of BS honor, Associate Professor at Department of Economics,
Forman Christian College (A Chartered University) Lahore and Assistant Professor at Gomal
University D. I. Khan, respectively.
Asad, Shabib and Ijaz
76
with the stability of money demand function in the economy. Bahmani (2008)
explains the relationship between the monetary policy effectiveness and the
demand for money by saying The Quantity Theory of Money implies that if a
change in money supply is to be transmitted to a change in price level or the
level of production, the velocity of money must be stable. Because velocity is
no more than a linear combination of money, price and output, the stability of
velocity is reduced to testing for the stability of the linear relation among the
three variables, or the demand for money. It means that an unstable money
demand function will render the use of monetary policy ineffective. This study
tries to make a comprehensive money demand function and then check for the
hypothesis that the set of selected variables are mutually cointegrated i.e. the
existence of long run equilibrium relationship. According to Bahmani-
oskooee & Bohl (2000), cointegration does not necessarily imply stability. To
check the stability of model, CUSUM and CUSUMSQ tests are performed to
the residuals of the ECM equation.
In Pakistan a host of studies have taken up this topic. One of the most
recent works is Qayyum (2005) using annual data from 1960-99. A flaw could
be the use of annual data, as Ericsson (1998) concludes, The frequency of
observation may affect both the exogeneity and cointegration. If agents
decisions occur over a shorter time period than the data frequency, dynamics
may be confounded and inferences about cointegration altered; (see Hendry
1992)
2
.
Inflation, interest rate and exchange rate usually change frequently, it
is better to consider them as of short-term nature. Moreover, there is no reason
in assuming that economic agents adjust their portfolios annually. Thus, by
taking annual data Qayyum (2005) might have missed out the short-term
fluctuations in the variables and may have the problems indicated by Ericsson
(1998). Another issue is the use of Johansen cointegration method, which does
not include short term dynamics in the estimation of long run coefficient
estimates. Bounds testing approach or autoregressive distributed lag approach,
(ARDL) developed by Pesaran et al (2001) is a better choice to test
cointegration and error correction modeling because it includes the short run
dynamics in the estimation of long run coefficient estimates (Bahmani 2008).
2
Ericsson (1998) refers Hendry (1992) for this conclusion.
Modeling Demand for Money in Pakistan
77
Bahmani (2008) supports the use of ARDL by saying that inclusion of short
run dynamics is important for the stability of money demand equation
3
.
In this paper, a remedy of these issues is taken by applying ARDL
method to quarterly data. This methodology has been used by Khan and Sajjid
(2005) for quarterly data from 1982 Q1 to 2002 Q4, but the execution of
methodology raises questions. They have selected lag order 2 for VAR
because of strong evidence of cointegration at that lag length. Which is a little
inappropriate, lag order is selected on the basis of AIC or SIC and residuals
that become serially uncorrelated. At that selected lag length further
adjustments are made on the basis of AIC to find the order for ARDL equation
and then the presence of cointegration is tested at that selected ARDL model.
Also they have not provided results of some important tests like; RESET test
for misspecification, JB-test for normality of the residuals, LM test for the
serial correlation and chi-square test for heteroscedasticity. So, it is difficult to
conclude anything about the validity of their results.
Other studies on the demand for money in Pakistan are; Ahmed and
Khan (1990), Khan and Ali (1997), Qayyum (1994-98), Tariq and Matthews
(1997), Qayyum (2001) and Khan (1994). Some other interesting works
regarding the demand for money are; Bahmani (2008) for Middle East,
Bahmani-oskooee (2002) for Korea, Hafer and Jansen (1991) for United
States, Hafer and Kutan (1994) for China, Khalid ( 1999) for Asia and Sharifi-
Renani (2007) for Iran.
The rest of the study is arranged as follows; section II presents model
specification, section III is about Data. Section IV presents Methodology.
Empirical results are given in section V and section VI provides the
conclusion.
II. Model Specification
According to economic literature, the demand for money is typically
for two reasons; (a) For transaction purpose, (b) As an asset in the portfolio
(Ericsson 1998). Some theories also highlight the speculative and
precautionary demand for money
4
. The general functional form the money
demand will be:
3
Bahmani (2008) refers to Laidler (1993) who has emphasized the importance of inclusion of
short run dynamics for the stability of the money demand equation.
4
For detail discussion on money demand theories see Laidler (1993).
78
) 1 ( ) , , , , ( F EX R Y f Lrm t =
|
|
.
|
\
|
=
t
t
P
M
Ln Lrm
All the variables except inflation ( ), M and P are in natural log. M is
money stock (M
2
), here we are using a simple sum measure rather that a
Divisia monetary aggregate because Tariq and Matthews (1997) shows that
there is little evidence for the superiority of Divisia aggregates over simple
sum aggregates in Pakistan. P is the price level, Y is the scale variable
showing the level of economic activity, is inflation, R is interest rate which
shows the opportunity cost of holding money, EX is exchange rate and F is
foreign interest rate.
Real GDP is taken as the scale variable, whereas inflation proxies the
return on physical assets, call money rate is the opportunity cost of holding
money
5
. In open economy money demand is also affected by variables like
foreign interest rate and exchange rate
6
. A proxy for foreign interest rate may
be US federal funds rate (used by Khan and Sajjid 2005) or London Interbank
Offer Rate (LIBOR) for dollar deposits. In this paper, 6-month LIBOR (UK
based) is used to account for foreign interest rate. Fed funds rate is an
inappropriate measure here, because it depicts US monetary policy stance
rather than foreign interest rate. Exchange rate is the real effective exchange
rate (REER).
Equation (1) is usually estimated in double log form
7
. The general
model will be of the form:
1 2 3 4 5 6 t t t t t t
Lrm Y R EX F o o o t o o o c = + + + + + + (2)
The coefficients of the variables in equation (2) represent the respective
elasticities. Only the coefficient of inflation represents semi-elasticity of
money demand. Inflation was not converted into natural log because of the
presence of negative inflation in some quarters.
Economic theory suggests that
2
should be positive because as the
transaction level and economic activity in the economy increases the demand
for real money balances also increases. If the magnitude of
2
is close to 0.5
5
For more on opportunity cost see Sriram (2001); Ericsson (1998); Hafer and Jansen (1991).
6
For discussion and references see Sriram (2001); Khan and Sajjid (2005).
7
See Sriram (2001); Ericsson (1998)
79
then it supports the square root law, if it is near 1 then monetarists fixed rule
is supported (Bahmani 2008). The
3
is expected to be negative because rise in
inflation will induce people to invest money, thus, the demand for money shall
fall and demand for physical assets shall increase. For
4
we expect the sign to
be negative because an increase in the opportunity cost of holding money will
decrease the demand for money. For
5
the sign could be positive or negative,
if an increase in exchange rate (i.e. depreciation of domestic currency) is
perceived by the people as an increase in their wealth (because now their
foreign currency holdings are worth more in terms of domestic currency) then
they may increase the demand for domestic currency, hence, the coefficient
will be positive. If, however, after increase in exchange rate people expect it
to rise even further (i.e. domestic currency falls further) they will convert the
holdings of domestic currency into foreign currency to protect themselves of
the loss from depreciation of domestic currency, in this case the sign of the
coefficient will be negative
8
. For
6
the sign should be negative because as the
interest rate on foreign assets increases the attractiveness on those assets
increases and people will try to have more of these high yield assets. In order
to do so they will convert their domestic money holding into foreign currency
and then invest in foreign assets, this will reduce the demand for domestic
currency and/or assets and increase the demand for foreign assets
9
.
III. Data
The study is based on quarterly data from 1980 Q1 to 2009 Q2 for
Pakistan. The quarterly data on real GDP is not available from the government
agencies. So, we have taken quarterly real GDP data from Kemal and Farooq
(2004), they have done quarterization by using direct method. The paper has
provided quarterly real GDP series from 1971Q1 to 2002Q4. For the years
after 2002 we use percentage quarterly seasonal factors of GDP provided by
Kemal and Farooq (2004) to break the annual GDP series into quarters.
Inflation is calculated from CPI. The data are collected from IFS CD-ROM
and is converted to base year of 1980-81 because the quarterly real GDP
series provided by Kemal and Farooq (2004) was in 1980 base year.
IV. Methodology
All the variables involved in this study are time series variables. Each
of these variables could be stationary I(0) or non-stationary I(1) or I(2). If
8
This is called currency substitution effect. See Khan and Sajjid (2005) for references.
9
This is called capital mobility effect. See Khan and Sajjid (2005) for reference.
80
variables are non-stationary then applying simple OLS technique could lead to
spurious regression. The suitable methodology is, to use cointegration analysis
and error correction modeling. If a set of variables is found to be cointegrated,
it means that these variables have a long run equilibrium relationship, and in
the long run, they cannot wander arbitrarily without any relation among
themselves. In this paper, we are trying to verify the hypothesis of long run
equilibrium relationship between real money demand and the fore-mentioned
variables.
The hypothesis of cointegration can be tested by using Johansen
maximum likelihood procedure or by Bounds testing approach (i.e. ARDL)
which was introduced by Pesaran et al (2001). In this paper, ARDL approach
is used for at least three reasons; (1) Pre-unit root testing is not required,
because, ARDL method can test for the presence of cointegration between a
set of variables of order I(1) or I(0) or a combination of both. (2) In ARDL
approach short-run dynamics are involved in the estimation of the long run
coefficient estimates (Bahmani 2008). (3) In ARDL method exogeneity of the
regressors is not an issue (Khan and Sajjid 2005). Our model under the ARDL
approach is as follows:
1 0 0 0 0 0
p p p p p p
t i t i i t i i t i i t i i t i i t i
i i i i i i
Lrm Lrm Y R EX F o | o t q

= = = = = =
A = + A + A + A + A + A + A

1 1 2 1 3 1 4 1 5 1 6 1 t t t t t t t
Lrm Y R EX F o o o t o o o c

+ + + + + + +
(3)
By using this general model we can check for the presence of
cointegration by testing the joint null hypothesis that coefficients of the lagged
level terms are jointly equal to zero, against the alternative that they are not
zero. We use F-test for this purpose.
0 1 2 3 4 5 6
: 0 H o o o o o o = = = = = =
(4)
1 1 2 3 4 5 6
: 0 H o o o o o o = = = = = =
(5)
Pesaran et al (2001) have showed that here F-test is non-standard, and has new
critical values; a lower-bound critical value, if all the variables are assumed to
be I(0) and an upper-bound critical value if all the variables are considered as
I(1). Decision rule is that if the value of the F-test falls below the lower-bound
critical value, we do not reject the null, and hence, there is no cointegration. If
the value of F-test falls above the upper-bound critical value we do not accept
the null, and hence, accept that variables are cointegrated. If the value of F-
test falls between the two boundaries, the test is inconclusive. If cointegration
81
is established we can find out long run elasticities by normalizing on
1
as
follows:
3 5 6 2 4
1 1 1 1 1
1 1 1 1 1
t t t t t
L r m Y R E X F
o o o o o
t
o o o o o

= +
(6)
Another support for cointegration hypothesis comes from the negative sign of
EC term in the error correction model in equation (7). From Bahmani-oskooee
and Bohl (2000) we know that cointegration does not necessarily imply
stability. To check the stability of our model we apply CUSUM and
CUSUMSQ tests to the residuals of the ECM in equation (7).
1
1 0 0 0 0 0
p p p p p p
t i t i i t i i t i i t i i t i i t i t t
i i i i i i
Lrm Lrm Y R EX F EC o | o t q v

= = = = = =
A = + A + A + A + A + A + A + +

(7)
Whereas EC term is formed as follows:
3 5 6 2 4
1 1 1 1 1
( ) ( ) ( ) ( ) ( ) E C L r m Y R E X F
o o o o o
t
o o o o o
= + + + (8)
V. Empirical Results
As a first step in ARDL procedure, we have to decide the lag length
for the first differenced terms, because results of F-test vary depending upon
the number of lags included in the model (see Bahmani 2008). We calculate
F-statistic for equation (3) by imposing maximum of 7 lags on the first
differenced terms. First eight values of the data set are reserved for lag
formation, to ensure comparability. Table 1 shows the results of F-test at
different lag lengths. Cointegration was found for lag 1 [5% upper bound
critical value is 3.23. see Pesaran et al (2001) pp 300]. High value of F-test is
no criteria of selecting lag length.
Table 1: F-statistic for Testing Cointegration
P F
1 5.81
2 2.67
3 2.94
4 2.17
5 1.45
6
7
0.97
0.90
Upper bound 5% critical value = 3.23
82
The criterion for selecting lag length is AIC or SIC and LM test for serial
correlation. That lag length is selected for which AIC or SIC is lowest and
there is no serial correlation in the residuals. On the basis of results of AIC
and LM test we have selected lag length of 2 (see table 2). At lag length of 2
AIC is highest and there is no serial correlation in the residuals. After
selecting lag length of 2, we look for further improvements in the model and
select that order for ARDL which gives lowest AIC. Our selected model is
given in Table 3, Panel A. At this final model, we then conduct F-test and find
the variables to be cointegrated. Value of F-test is 9.05 against the 5% critical
value of 3.23.
Table 2: Statistics for Selecting the Lag Order of Money Demand Equation
P AIC SBC
2
( )
(1)
sc
_
2
( )
(4)
sc
_
1 -5.04 -4.60 0.69 8.78
***
2 -5.08 -4.49 0.07 3.17
3 -5.05 -4.32 0.5 6.89
4 -5.07 -4.18 0.05 4.94
5 -5.04 -4.01 0.006 4.39
6 -5.002 -3.82 0.0005 4.84
7 -4.91 -3.58 0.80 6.60
2
( )
(1)
sc
_ and
2
( )
(4)
sc
_ are LM statistics for testing no residual serial correlation against order
1 and 4. The symbols
*
,
**
, and
***
denote significance at 0.01, 0.05 and 0.10 respectively.
Table 3: Full-Information Estimation of Equation (3)
Panel A: Short-Run Coefficient Estimates.
Lag Order Variables
0 1 2
Lrm 0.134
(1.60)
a
0.273
(4.61)
Y 0.269
(10.41)

R -0.01
(-1.38)
EX 0.089
(1.48)
-0.123
(-2.09)
0.06
(1.16)
F
a: values in parenthesis are t-values.
83
Panel A of table 3 shows the short run elasticities, most of them are significant
showing that the variables included in the model have significant short run
impact on the demand for money. The coefficient of the EC(-1) terms is
negative and highly significant, which further strengthens the hypothesis of
presence of cointegration.
Panel B: Long-run Coefficient Estimates and Diagnostics
C Y R EX F Adj. R
2
F
a
EC
t-1
LM
b
RESET
c
-1.63
(-7.56)
*
1.59
(4.67)
-3.97
(-3.39)
-0.059
(-1.30)
0.44
(2.91)
-0.058
(-1.36)
0.754 9.05 -0.129
(-7.58)
0.96 0.53
_
2
R
= 0.75 DW= 1.87
AIC= -5.29 SIC= -5.07
2
( ) Het
_ = 11.60 (0.77) JB= 0.32 (0.84)
Notes: * Values in parenthesis are t-values.
a
The upper bound critical value of the F-statistic
at 5% level of significance is 3.61.
b
LM is the Lagrange multiplier test for serial correlation.
It has a chi-square distribution with one degree of freedom. The p-value for 0.96 is 0.32.
c
Reset is a test of functional form misspecification F-value is 0.53 with p-value of 0.43.
The panel B shows long run elasticities. Income elasticity is 1.59
which highly supports the monetarists fixed rule. It means that if the GDP
increases by one percent money demand increases by 1.59 percent. Inflation
semi-elasticity is -3.97 showing that if quarterly inflation increases by 1 unit
demand for money will be reduced by 4 percent, so meaning there by that
central bank should also reduce the supply of money to maintain the
equilibrium in the economy, because if supply remains the same and demand
is reduced this excess supply of money will cause further inflation. When
CMR increases by 1%, the demand for money also decreases by 0.06%. A 1%
increase in real effective exchange rate increases the demand for money by
0.44%. It means that depreciation of domestic currency is perceived by the
economic agents as an increase in wealth thus leading to increase in demand
of domestic currency. Foreign interest rate shows an elasticity of -0.058 which
means that as the foreign interest rate rises the demand for domestic currency
decreases. The speed of adjustment is 13 percent per quarter. Negative sign
shows that the system adjusts back towards the long run relationship. Also it
shows that about 52 percent of the disequilibrium is removed within one year.
All the results are significant and the signs are in conformity with the
economic theory. There is no serial correlation, no specification bias, no
84
hetero, and residuals are also normally distributed, as depicted by the test
results.
Stability of the short run and long run coefficients can be seen by
CUSUM and CUSUMSQ tests, Figure 1 and 2 shows CUSUM and
CUSUMSQ respectively. These tests show that our model and its coefficient
estimates are stable (see Bahmani 2008).
Figure: 1 Plot of Cumulative Sum of Recursive Residuals
- 3 0
- 2 0
- 1 0
0
1 0
2 0
3 0
8 4 8 6 8 8 9 0 9 2 9 4 9 6 9 8 0 0 0 2 0 4 0 6 0 8
C U S U M 5 % S i g n i f i c a n c e
Figure: 2 Plot of Cumulative Sum of Squares of Recursive Residuals
- 0 .2
0 .0
0 .2
0 .4
0 .6
0 .8
1 .0
1 .2
8 4 8 6 8 8 9 0 9 2 9 4 9 6 9 8 0 0 0 2 0 4 0 6 0 8
C U S U M o f S q ua r e s 5 % S i g ni fi c a nc e
85
To see how our model fits the actual values, we plot estimated Lrm and
actual Lrm (Figure 3). The figure shows that our model has performed very
well. It has captured the fluctuation and also their magnitude.
Figure: 3 Plot Showing Actual VS Fitted Values
-.04
-.02
.0 0
.0 2
.0 4
.0 6
-.08
-.04
.0 0
.0 4
.0 8
.1 2
8 2 8 4 8 6 8 8 9 0 9 2 9 4 9 6 9 8 0 0 0 2 0 4 0 6 0 8
Re si d ua l A ctua l F i tte d
VI. Conclusion
The study have used the bounds testing approach to error correction
modeling and cointegration analysis, for verifying the hypothesis of long run
equilibrium relationship between real M
2
and a set of explanatory variables
including real GDP, inflation, interest rate, real effective exchange rate and
foreign interest rate. We have found support for the hypothesis of
cointegration both by means of F-test and negative coefficient sign for EC(-1)
term. This relationship is stable in the long run, and indicates the absence of
structural change in the model. This amounts to finding a stable velocity of
money. Hence, we infer that monetary policy is effective in Pakistan for
influencing level of inflation and/or level of output (as suggested by the
quantity theory of money). Inflation semi-elasticity is very high, suggesting
that in times when inflation is high people do not prefer holding money to
protect them of the loss of purchasing power. Instead they hedge their
positions by investing in physical assets rather than monetary assets. Increase
in interest rates cause a decrease in demand for money. Increase in the real
86
effective exchange rate increase the demand for domestic currency because of
wealth effect. Foreign interest rate shows a small impact. It shows the
awareness and ability of domestic agents to mobilize their capital from
domestic to foreign assets. The negative sign also suggests that in the periods
of rising foreign interest rates domestic currency may come under pressure
because more people demand foreign currency. The speed of adjustment is
high and significant. It suggests that the mobility and lack of rigidities in the
money market, about 50 percent of the deviations from the long-run
equilibrium are removed within one year. We conclude that the major hurdle
for central bank in achieving the target M
2
levels in Pakistan is the variations
in the rate of inflation (Qayyum 2005).
87
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Role of Advance Agri-Technologies in Reducing the Rural
Poverty in Central Punjab, Pakistan
Hazoor Muhammad Sabir and Safdar Hussain Tahir
1
Abstract
The study was conducted in the Central Punjab for the year 2009-10. The
main objective was to find out some strategies to pick up small farmers from
their poverty status. For this purpose, a sample of 300 respondents was taken
from districts Jhang, Faisalabad and T.T Singh for final data collection.
Seven strategies; enhanced level of urea application to cash crops (S1), the
enhanced level of DAP to cash crops (S2), enhanced urea to cash crops plus livestock
units (S3), addition of hybrid tomato plus livestock units (S4), enhanced DAP plus
livestock units (S5) and addition of cut flowers plus livestock units (S6) were
practiced through the LP Model. The objective values obtained through LP
model with S1 to S3 strategies indicate that these have reduced the poverty
gap up to 48%, 34% and 20%, respectively. While S4 and S5 both were
successful but S5s impact was greater than S4. Through S6 the gap remained
only 3.95 percent. Thus, the strategy of addition of short duration crops like
hybrid tomato and productive live stock units were the agri-enterprises and
their combination can reduce the small farmers poverty successfully.
Keywords: Advanced agri-technologies; rural poverty; Punjab
JEL classification: Q12, Q14, Q16
1
The authors are Associate Professor at Department of Economics and Assistant Professor at
Department of Banking & Finance, GC University Faisalabad, respectively. Corresponding
Authors Email: hazoor.sabir@yahoo.com
Hazoor M. Sabir and Safdar H. Tahir
90
I. Introduction
Agriculture is a major contributor to the Punjabs economy,
accounting for roughly 28 percent of its output and providing employment to
over 40 percent of the work force. The performance of the sector is therefore
crucial to any strategy for generating higher incomes. (Punjab Economic
Report March 2005)
Successive governments in Pakistan have taken numerous policy
initiatives to alleviate poverty, yet the latter has continued to increase. The
International Fund for Agricultural Developments Rural Poverty Report 2011
says that poverty is widespread in Pakistan and is pre dominant in the rural
areas, holding that nearly 80 per cent of the countrys poor people live in
rural parts of the country.
Agriculture is the heart of the rural economy. The sector is not just a
source of food but also foreign exchange earnings and has done well in the
past few years. Nevertheless, small landholders and landless peasants, whose
work makes the country produce a surplus of grain, live in abject poverty. The
basic reason is being the unequal land distribution, particularly in Sindh.
Whether in power or out of it, it is this class that less benefits from
governmental subsidy policies, could not extension services and most
importantly, has access to water. The powerful farmers bring their entire
holding under cultivation by usurping the water rights of small farmers and
tail-enders.
Improving the lot of the rural poor would involve focusing on
increasing yields per acre, generating self-employment activities and
encouraging industrialization. There is a need to search for alternate sources
of income, preferably indigenous ones to which rural people are familiar. Of
these, the most common is livestock farming. Animal rearing is traditional in
rural societies.
Despite all these positive indicators, the livestock sector has been
neglected. Small farmers, who contribute about 80 per cent of the milk
production, have never been given a priority with successive governments.
Assistance and the extension of services have remained restricted to big
farmers.
1.1. Objectives of study
Keeping in view the presence of masses in poverty in rural areas
following were the main objectives of this study.
Advanced Agricultural Technologies and Rural Poverty in Central Punjab
91
i) To identify the proportion of poor and non poor among the small
farming community in rural areas.
ii) To identify different strategies that can help reduce the rural farmers
poverty.
iii) Based on study findings, the suggestions and recommendations to
reduce the rural poverty.
II. Review of Literature
Kemal (1995) focused on evaluation of public strategies and policies
for poverty alleviation. He explained four mechanisms to reduce poverty. First
was the introduction of new technologies and promotion of large or small
scale firms. Second, the taxation policy should be reasonable. Third, the poor
members of society should get more opportunities so that income equality
among households should be improved.
Malik (1996) used micro survey data from a Punjab village and
considered a large number of rural and household specific variables besides
land holding in an attempt to determine their role in raising levels of living of
rural masses and subsequently to alleviate rural poverty.
Ali and Tahir (1999): developed three consistent time series on rural,
urban, and total poverty that covers all Household Expenditure. They
highlighted the econometric problems in using the survey data in conjunction
with aggregate data on poverty and income to derive the conclusions. Their
study provided a conceptual framework for the analysis of growth, poverty.
They provided long-run elasticity of poverty with respect to growth and
inequality which are useful for policy purposes. They concluded that
systematic analysis of Growth has always helped in poverty reduction.
Ali and Abdullah (2002) concluded that enhanced vegetable
production and consumption in Asia can play a catalytic role in the overall
economic development by improving the nutritional status, learning
capabilities and managerial capacities of farmers, generating incomes and jobs
in both farms and non-farms sectors. It will also enhance resource use
efficiency in Agri sector.
Datt and Ravallion (2002) in their article Growth and redistribution
components of changes in poverty measures concluded that how changes in
poverty measures can be decomposed into growth and redistribution
components in Brazil and India during the 1980s. According to them the
92
redistribution alleviated poverty in India, though growth was quantitatively
more important. They further commented that improved distribution
countervailed the adverse effect of monsoon failure in the late 1980s on rural
poverty.
Chaudhry et al. (2005) conducted a study on the correlates and profile
of poverty in the areas of Cholistan in Southern Punjab. They empirically
analyzed and concluded that Cholistani land should be distributed based on
equality, improvement in livestock sector, improvement in socio-economic
and demographic variables are considered for reduction in poverty in remote
areas of Pakistan like Cholistan.
Chaudhry et al. (2006) also conducted a study on urban poverty
alleviation through good governance in southern Punjab. They identified that
good governance of economic infrastructural facilities among others will
alleviate poverty in urban areas of south Punjab based on the results of a
household survey data.
Chaudhry (2009) investigated the factors affecting rural poverty using
Logit regression modeling based on primary source of data in the project area
of Asian Development Bank. He proved that the rural poverty can be
alleviated by lowering the household size, persons per room and dependency
ratio, improving education, more female labor force participation, higher
household participation rate, improving assets and households access to
market especially in remote areas. He suggested to the government to pay
special attention to basic infrastructure and market access facilities beside
some other socio-economic and demographic variables to alleviate rural
poverty in remote areas of Pakistan.
Apata1 et al (2010) Accessed to micro-credit, education, participation
in agricultural seminars, livestock assets and extension services significantly
reduce chronic poverty among rural households in Nigeria. On the other hand,
female headed households and households located far away from local
markets have a high probability of staying below chronic poverty line.
However, gender disparities in property rights has a consequence on poverty,
as women empowerment through legal rights to property as key chronic
poverty ameliorating factors among the farming communities.
III. Methodology
The main thrust of this study was the rural area of the three districts, namely
Faisalabad, Jhang, and T.T.Singh of Central Punjab. The main idea behind the study
93
was to identify the different enterprises or some mix of them with the help of which
rural farming community income could be increased, leading to poverty reduction.
For this purpose some strategies were identified and practiced through L-P model.
Their strategies included:
i) Application of enhanced level of urea fertilizer to cash crops (S1)
ii) Application of enhanced level of DAP to cash crops. (S2)
iii) Enhanced urea to crops + Livestock units (S3)
iv) Addition of Hybrid Tomato + Livestock units (S-4)
v) Addition of cut flower + Livestock units(S-5)
vi) Enhanced DAP + Livestock units (S-6)
These were the strategies which were practiced along with the base model.
The base model was estimated through existing set up of the farmers crops and
livestock settings. For this purpose small farmer net income was estimated through
Farm budgeting Technique. Through this techniques farm gross income was
estimated by adding all the income from different sources. i.e. crops, livestock and
off farm income. Similarly farm cost of production of crops and livestock at their
farms was also estimated. The net income was estimated by deducting farm cost from
their respective gross income. After estimating the farm net income, per capital
income per annum was estimated. Then it was compared with national poverty of Rs.
1375. In this way poor were identified from non- poor class of rural community
sampled in this study.
After identifying the poor, a base model objective value estimated through
Linear Programming model, was obtained. Linear programming model approach is
the approach which is commonly used to get the maximum objective value of the
function facing some constraints. In this case the major constraints were the
availability of land, Urea, DAP, irrigation water and livestock animals.
3.1. Linear Programming Model
Mathematical Form of LP model
j
m
i
j j
n
j
j
s h y g Maximize

1 1
0 , 0
1 ,
1 ,
1
1

i j
j j
m
i
ij j j
i i i j
n
j
ij
s y
m i d y a y e
n j c s f y a to Subject
94
Note that we assume in our calculations steps that the program is in
standard form. However, any linear program may be transformed to standard
form and it is therefore not a limiting factor
The strategies which were practiced to boost up the net income of the
poor respondents belonging to the area of Faisalabad, Jhang & TTS were:
a. Base Model (BM) Existing cropping pattern of Crops + Livestock
objective value.
b. BM + S1 --------------------- Objective value
c. BM + S2 --------------------- Objective value
d. BM+ S3---------------------- Objective value
e. BM+ S4---------------------- Objective value
f. BM+ S5---------------------- Objective value
g. BM+ S6---------------------- Objective value
The Results obtained through such analysis helped to identify the strategy
which was the most powerful in reducing the poverty of poors class of rural
areas.
IV. Results and Discussion
The data collected through personal survey of the areas of central
Punjab was analyzed by using linear programming through Solver in Excel.
Some basic descriptive obtained through Excel were:
Table: 1. Poverty Estimation through Head Count Index
Description Faisalabad Jhang T. T. Sing Overall
Poor (%) 35 38 32 35
Non Poor (%) 65 62 68 65
The data given in table-1 demonstrated the poverty estimate made through
H.C. Index.
H.C.I = P
N/
T
P
Where P
N
= No. of the Poor identified
T
P
= Total Population (sample)
It indicates that majority of the respondents (38%) was poor in district
Jhang, in Faisalabad 35% and in District Toba Tek Singh only 32% of the
total respondents were found poor. Overall in the central Punjab 35%
respondents were poor.
95
28%
30%
32%
34%
36%
38%
P
e
r
c
e
n
t
a
g
e
Fsd Jg T.T.S
Fig: 1. Poor porportion in different districts of
Central Punjab
Respondents
The application of different strategies and their impact on their net
income of small farmers in different districts of central Punjab was practiced
and the results so drawn are depicted in the following table:
Table: 2. Threshold level of income and gap between poor
farmers income in central Punjab
Description Faisalabad Jhang T.T.Sing Overall
Total Family Size (No) 6.27 7.52 5.32 6.37
Threshold income based
on poverty level
Rs.1375/-P.M*
107385 124080 87780 105215
Existing income from
Crops+ Live Stock (Rs)
42642 47461 37526 42339
Poverty GAP -60.29 -61.75 -57.25 -59.76
*Poverty line-Estimated through trend analysis based on Poverty lines from 1998-2006,
Economic Survey of Pakistan 2009-10.
The data given in table-2 depicts the threshold level of income depending
upon their respective family structure and income being generated through
their existing crops and livestock sectors. In all the districts, about 60% gap
was formed between their threshold and existing income. To reduce this gap,
different strategies were practiced through LP model and their impact was
recorded.
96
Table: 3. LP-Model objective values through the application of
different strategies in central Punjab
Description Faisalabad Jhang T.T.Sing Overall
Base Model (Rs.) 42642 47461 37526 42339
BM + S
1
(Rs.) 55670 58470 42905 52348
BM + S
2
(Rs.) 70540 65290 52410 62747
BM + S
3
(Rs.) 85285 79992 75872 80383
BM + S
4
(Rs.) 110214 142410 90570 111398
BM + S
5
(Rs.) 108205 112640 88907 103250
BM + S
6
(Rs.) 99207 105409 86411 101058
Results given in table 3 reveal that all the strategies had positive
impact on the net income of respondents in all the districts. The BM+S
1
Scenario picked up the poor but not out of the poverty status. Similarly,
BM+S
2
also reduced the gap up.
Table: 4. Gap reduction through the application of different
poverty reducing strategies
Scenarios Faisalabad Jhang T.T.Sing Overall
Threshold 107385 124080 87780 105215
Base Model -60 -61.74 -57.24 -59.76
Scenario 1 -48 -52.57 -51.12 -50.24
Scenario 2 -34 -43.38 -40.29 -40.36
Scenario 3 -20.5 -35.53 -13.56 -23.60
Scenario 4 +0.02 14.77 3.18 5.87
Scenario 5 +0.07 -9.0 1.28 -1.86
Scenario 6 -0.07 -15.04 -1.55 -3.95
Data statistics given in table-4 show the impact of different strategies in the
improvement of income by reducing gap between threshold level of income
and farm income. Base model results revealed that almost there was a gap of
about 60% between income being earned by poor farmers and their threshold
level of income. When with the base model enhanced level of Urea was
applied to cash crops, their net income increased and consequently objective
value of function obtained through LP model also increased. It reduced the
gap up to 50% but was not satisfactory.
97
Scenario S
2
reduced the gap up to 40% and S
3
up to 23% while S4
after filling the gap picked the poor out of poverty. Similarly S5 almost filled
the gap. The whole mechanism has been elaborated in the figure below:
V. Conclusions
These study findings conclude that about more than 35% rural farmers were
poor and with addition of poverty reducing strategies they could improve their
income. The addition of hybrid tomato along with livestock to the base model
was a successful strategy in reducing the poverty of small farmers. Moreover,
addition of cut-flower was also another strategy that could pick the poor
farmers out of poverty. These findings are also consistent with Mandere et al.
(2011).
Based on study conclusions it is recommended that poor farmers
poverty could be eliminated through the maintenance of crops especially short
duration crops, like hybrid tomato along with livestock productive unit. The
cultivation of cut-flower at small farms was also another strong innovation. It
can also benefit to the farmers living in pre-urban areas.
Fig: 2. Poverty reduction gap through the application of different strategies
-70
-60
-50
-40
-30
-20
-10
0
10
20
BM S1 S2 S3 S4 S5 S6
Strategies
Percent
gap
Fsd
Jg
TTS
98
References
Agricultural Developments Rural Poverty Report 2011.
Ali, M. & Abedullah (2002). Nutritional and economic benefits of enhanced
vegetable production and consumption. J. Crop Prod, Vol. 6. pp. 145-
176.
Apata1 et al (2010). Determinants of rural poverty in Nigeria: Evidence from
small holder farmers in South-western, Nigeria. Journal of Science
and Technology Education Research, Vol. 1 (4), pp. 85-91.
Chaudhry, Imran S., Malik, S. & Ashraf, M. (2005). Poverty in Cholistan:
profile and correlates. Paper Presented at 21st Annual General Meeting
and Conference, Pakistan Society of Development Economists:
Islamabad, 19th-21st December.
Chaudhry, Imran S., Malik, S. & Imran, Asma (2006). Urban poverty and
governance: The Case of Multan City. The Pakistan Development
Review, Vol. 45 (4), pp. 819-830.
Datt et al. (1992). Growth and redistribution components of changes in
poverty measures: A decomposition analysis with application to Brazil
and India in the 1980s. Journal of Development Economics, Vol. 38
(2), pp. 275-295.
Economic Survey of Pakistan (2009-10),
http://www.geotauaisay.com/2010/06/
Kemal, A. R. (1995). Poverty alleviation in Pakistan: An evaluation of public
strategies and policies adopted for poverty alleviation. Organized by
Institute of Policy Studies: Islamabad.
Malik S. (1996). Determinants of rural poverty in Pakistan: A micro study.
The Pakistan Development Review, Vol. 35 (2), pp. 171-187.
PERI No. 29373-PAK, Punjab Economic Report towards a medium-term
development strategy, March 2005.
Mandere et al. (2011). Assessing the contribution of alternative agriculture to
poverty reduction and employment creation: A case study of sugar
beet cultivation in Kenya Nicodemus. African Journal of Agricultural
Research, Vol. 6(2), pp. 440-450.
Meer, M. Parihar (2011). Challenge of rural poverty posted April 22, 2011 by
sappk in 2011, Poor Farmers. Leave a Comment Post Source: Dawn
Newspaper.
Factors Influencing Student Achievement Scores:
Public vs. Private Schools
Shahnaz Rashid
1
Abstract
There are evidences of relationship between the performances of primary
school students achievement scores with socioeconomic status of the
household. Literature mostly point out the effect of school quality on
students achievement. Based on the existing literature, this study has
explored the effect of school choice, quality and socioeconomic status of the
household on student achievement score in case of Pakistan. Findings
indicate that choice of schooling and teachers characteristics play an
important role in student performance.
Keywords: Factors; student achievement scores; public & private schools
JEL classification: I23, I29
I. Introduction
The effect of socioeconomic factors on school performance is
substantial. Social gaps in achievement and outcomes are large. There exist
strong relationship between student performance in primary schools and
socioeconomic status. There have been numerous studies that examine the
effects of school quality on student educational achievement. However,
despite the large number of studies published over the years, there is little or
no consensus in the literature regarding the impact of various elements of
school quality on student educational achievement especially in case of
Pakistan. Measuring the student achievement score is challenging and
depended on socio-economic background as well as school quality.
Thus examining the nature of the relationship between socioeconomic
status and student achievement has always remained in discussion. There have
been many theories explaining this relationship. Students from a low-
socioeconomic status are at disadvantage in school because they lack an
academic home background, which influences their academic success at
school.
1
Author is Staff Economist/Lecturer at Applied Economics Research Centre, University of
Karachi, Pakistan.
Shahnaz Rashid
100
As far as literature in Pakistan is concerned study conducted by
Academy of Educational Planning and Management (AEPAM) in 1999,
Measuring Learning Achievement at primary level in Pakistan is the first most
comprehensive study. The study was based on a sample consisting of grade
five pupils for public schools. Standardized tests were used for science,
Mathematics and national language - Urdu. Study conducted by AEPAM is
very useful in developing an insight into some of the crucial factors affecting
learning in the government schools of Pakistan. It had examined students
scores and how various factors affect it. But still research is always there to
find out what are the factors that affect the achievement of the students.
This study also focuses on investigating the factors affecting
achievement of 5
th
grade students taking into account public and private
school differences. More specifically this study will aim to found out the
factors, which are responsible for student achievement scores along with
identifying those factors, which help a student to improve his/her grades.
Quality of education at the primary level in Pakistan is dependent upon many
factors including the teachers qualifications (both formal and professional),
availability of teaching learning materials, facilities in the school and the
socio-economic background of the students. This study aims to identify the
some of these major factors associated with the students achievement at
primary level. Empirical assessment is based on the survey data held in
Pakistan by World Bank to collect information regarding factors affecting
student achievement in 1997 the same data is used for this study.
The rest of paper is organized as follows: section II provides review of
relevant literature, section III discuses objectives of the study, section IV
generates detail methodology for the estimation purpose, section V gives
detail of the data source, estimation of the factors influencing student
achievement score in both types of school public/private and a logistic
regression for the choice of school by parents are discussed in section VI and
finally conclusions is given in section VII.
II. Review of Literature
The aim of the review is to have a better understanding regarding the
socio-economic and school factors that impact on student achievement score.
Literature shows that socio-economic status can have a significant effect upon
student achievement. Literature often hypothesized that student achievement
depends on different socio-economic background and learning abilities. For
example Sheldon (2003) provides evidence that a student who comes from a
Factors Influencing Student Achievement Scores
101
higher socio-economic status will achieve better test score than a student from
a lower socio-economic background. Likewise, students attending a school
that has a higher concentration of students from higher socio-economic
background will also achieves higher scores than students attending schools
with high concentrations of students coming from low socio-economic
background. This may be because students who attend schools that
predominantly serve low socio-economic status students are especially at risk
of poor school performance due to the lack of interest from the community
including parents.
Evidence indicates that there is a need of increased parental
involvement in childrens education at primary level. England and Australia
are the two countries with the longest history of parental involvement at the
school level. Worldwide, other countries, including, Canada and the United
States, are moving towards increase parental involvement. Becher (1984)
point out that recognition has been given to the crucial role that parents play
as well as emphasis on the rights and responsibilities of the parents to
influence childrens education. Over thirty years many research studies have
focused on parental involvement in education. Cox, Donald & Emmanuel
Jimenez, (1989) discuss that there is no evidence for Pakistan regarding the
issue under consideration due to non-availability of in-depth data.
The empirical evidence shows that parental involvement is one of the
key factors in securing higher student achievement and sustained school
performance (Harris, Chrispeels & Janet 2006). It would appear that involving
parents in schooling leads to there more engagement in teaching and learning
processes. The importance of parents educational attainments and behaviors
on childrens educational attainment has been well documented.
There are mixed evidence on the effects of school quality on student
achievement. Hanushek. (1995) had examined the effect of school quality on
student achievement by providing review of over 90 studies. He found very
mixed evidence concerning the effect of class size, teacher education, teacher
experience, teacher salary and expenditure per pupil. However, many of the
studies cited by Hanushek (1995) suffer from identification problems related
to endogenous school choice.
Paul and Hanan (1994) also reviews studies on school quality and tried
to correct endogenous school choice using the Ghana data. They examine the
effect of school quality on student achievement after correcting for the
selectivity bias using the characteristics of the schools chosen as an instrument
Shahnaz Rashid
102
for school choice. They find that teacher experience raised the student
achievement test scores. Alderman et al. (2001) in their study of schooling
choice of low-income families in urban Lahore find that private schools
catering to the urban poor charge low fees and the total educational
expenditure on all (uniform, fees and transport etc) in private schools is often
comparable to that in government schools.
Emmanuel et al. (1988) addressed both analytical issues (i.e. sample
selection bias and bias due to omitted unobserved characteristics such as
innate ability). They studied the problem of endogenous sample selection in
comparison to private and public schools. They applied Heckman (1979)
Two-Step Correction Procedure. Their work is based on less developed
countries,
2
like Tanzania, Thailand, Colombia, Dominican Republic and the
Philippines. David and Kruger (1992) analyzed the historical trend in the
United States, with the observations of schools during 1920s and 1930s; they
captured some differences in organization or level of resources that would be
more appropriate for developing countries. For more discussion see David and
Kruger (1992), Betts (1995), Heckman et al. (1994), Hanushek et al. (1996)
and Speakman & Fins Welch (1995). Finally a large and widely discussed
U.S. study in literature; Coleman et al. (1982) analyzed that private schools
are more efficient than public schools in improving the student achievement
scores.
III. Objectives of the Study
In the past many studies have been done in this context by developing
various models to assess the student achievement score. There are slight
variations in methodological approach and sample selection. The objective of
this study is to examine whether substantial differences exist in the students
achievement in both types of school private and public in Pakistan. The two
specific objective of the study are:
To find out the affect of socioeconomic background and school quality
on childrens achievements score.
To Determine the Factors influencing Choice of School.
2
They focus on improving learning achievement, particularly among the poorer countries.
103
IV. Methodology
Based on the literature study identified two types of factors that affect
the student achievement; first, school inputs and second, socioeconomic
characteristics i.e. family background. Equation 1 and 2 estimates the effect of
these two factors on student achievement score. Simple Ordinary Least Square
(OLS) Technique is used to estimate the parameters of equation 1 and 2. The
estimated parameters of these equations will show the effectiveness of school
and non-school factors on student achievement of private and government
schools respectively.
pi i
n
i
pi i
n
i
pi p i
Y X PSA
1 1
(1)
Where
PSA = Private School Student Achievement Score
X = Set of Socioeconomic Variables
Y = Set of School characteristics Variables
gi i
n
i
gi i
n
i
gi g i
Y X GSA
1 1
(2)
Where
GSA = Government School Student Achievement Score
X = Set of Socioeconomic Variables
Y = Set of School characteristics Variables
But the achievement score is also dependent on the choice of school made by
parents. There are several factors that affect the choices made by families for
their children schooling. This causes a selection bias problem. Students with
privileged family backgrounds also tend to attend private schools. It is
therefore very difficult to infer how they would do in Public schools. To
capture the selection biasness another regression model is adopted, in which, a
dummy variable indicating school choice is first regressed on the factors
influencing the decision of parents to chose schooling-public vs. private.
Choice of school is an important decision that directly affects the student
achievement. It again depends upon the socioeconomic factors, as given in
equation (3).
3
CASC
i
=
ji
n
i
i ji
n
i
i ji
y x

1 1
0
(3)
3
Alternatively equation 1 and 2 can be estimated by one equation, with a dummy variable
for Public and Private Type of schools but it may not address the endogeneity bias.
Shahnaz Rashid
104
Where
CASC = Category of School
X = Set of Socioeconomic Variable
Y = Set of School Characteristics Variable
Furthermore to capture the effect of selection of school on the overall student
achievement score, study regressed the predicted value from the choice of
school regression model on the overall student achievement score [see
equation (4)]. In other words by using the predicted values study tries to avoid
the possible endogeneity that could have generated because of the
simultaneity problem. Further to this school characteristics and socioeconomic
behavior also effect childs learning ability that again influences student
achievement. Ability depends on child own age as well as school and socio-
economic background to which child belongs. But variable age does not show
much variation, hence not included in the analysis. Predicted value from
equation 3 therefore not only indicates choice of schooling but also predict
childs learning ability as well.
SATS
i
= SC A C Y X
i
n
i
i i
n
i
i
1 1
0

(4)
Where
SATS = Student Achievement Test Score both private and
government school.
X = Set of Socio-Economic Variables
Y = Set of School Characteristics Variables
SC A C
= Estimated value from equation (3)

Using the predicted value from equation 3 to estimate equation 4 yields a
system of equations often term as two-stage least square (2sls) regression.
V. Data Source
Data for the study is taken from an earlier study conducted by System
(Private) limited for the World Bank. The study was conducted at national
level. Of the total sample, 586 cases of Karachi were selected for this study.
The study conducted by System (Private) Limited covers both public and
private school students studying in 5
th
grade. The student achievement score is
calculated on the basis of test of Urdu and Maths. Information is taken at
both school and household level. The objective was to estimate the factors
influencing the learning achievement of 5
th
grade.
105
VI. Estimation of Factors Influencing Student Achievement Score
Table 1 shows the results of factors effecting students achievement score in
both types of schools public and private. Both school related factors and
socio-economic background is explored. School related factors includes
teachers qualification (both academic and professional), teachers salary,
teaching experience and dummy variables showing type of school (girls, boys
or co-education) while parents characteristics include their education level
and fathers occupation. In order to explore the family educational back
ground based on gender, number of school going girls and boys are also
included in the analysis.
Among the variables representing teacher resources result shows the
significant effect of teachers salary but the effect is negative. Negative effect
of teachers salary means that higher the salary package offer the lower will
be the motivation to teach. The finding is in contrast to what earlier literature
have suggested; that is the strong positive relation between teacher salary and
student achievement. But for Pakistan it is not surprising because of the
almost non existence of evaluation system in both private and public schools.
Beside that due to political pressure in government schools it is very difficult
to lay-off nonperforming teachers. Thus raising pay is not a powerful way to
motivate teachers to apply more effort as wages can only serve as an effort for
motivating device when the threat of dismissal is credible. The effect of
academic or professional qualification and experience is also insignificant in
increasing the student achievement score.
Higher education expenditure shows significant positive impact on
private school student efficiency while the effect is significantly negative on
student learning in public school. The reason is may be because parents
invest in their children coaching/tuition if they are studying at private school.
Thus higher investment means higher human capital formation for the
children learning at private school. While in public school higher education
expenditure is not leading to the desire formation of human capital due to
provision of low quality of education in the public school.
Table: 1. Student achievement test scores for the private/public schools
Variables Private Public
Teachers Academic Qualification 0.3875 -0.2008
(0.0187)* * (0.2503)
Teachers Professional Qualification 0.3866 -0.0752
(0.3059) (0.8348)
Shahnaz Rashid
106
Teachers Salary -0.0008 -0.0006
(0.0009)* (0.0478) **
Teaching Experience (# year of he or she is Teaching) 0.0893 -0.0777
(0.1431) (0.2798)
Log Education Expenditure 3.1912 -3.4252
(0.1025) *** (0.0596) **
# School going girls -0.7106 -0.8751
(0.0918) *** (0.0559) **
# School going boys
0.5363 -0.2511
(0.2042) (0.5250)
Father Education Level
Primary -0.2698 -1.3118
(0.7498) (0.1394)
Middle 1.8958 0.7117
(0.0518) ** (0.4640)
Matric -0.2455 0.5130
(0.8322) (0.6048)
Inter -0.5152 -2.3962
(0.7259) (0.2831)
Graduate 2.4862 -0.7090
(0.0228) ** (0.5589)
Mother Education Level
Primary -0.5793 0.3570
(0.5016) (0.6692)
Middle -1.6093 -0.1591
(0.3375) (0.8856)
Matric -2.0034 0.4765
(0.2243) (0.7448)
Inter -6.7390 1.8985
(0.0008) * (0.2781)
Girls School 0.9259 0.1554
(0.3122) (0.8603)
Boys School -0.2032 -0.5832
(0.7947) (0.4064)
Dummy for Rural Areas -1.0279 -0.5398
(0.1185) (0.4102)
House hold Head Occupation
Private 1.1833 -2.3258
(0.4102) (0.1185)
Self employee 1.1216 -1.2781
(0.3903) (0.3308)
Independent 3.1931 -0.8664
(0.0543) ** (0.6471)
Professional 4.5775 _
(0.0096) * _
107
Unemployed 0.4372 -1.7110
(0.7486) (0.2706)
Constant 2.0154 30.7141
(0.7432) (0.0000) *
N 272 304
F-Stat 2.41 0.93
Prob. F 0.00 0.56
R-Square 0.16 0.085
Note: *, ** & *** shows significant at 1%, 5% or 10% level, respectively. Numbers in
parenthesis are p-values. Excluding category from mothers and fathers education level
is illiterate; from type of school variable excluding category is co-education while
from occupation status excluding category is other profession
6.1. Logistic regression for the choice of school types
The estimation of logistic regressions equation for school choice is
reported in table 2. The difference between table 1 and 2 is that table 2 also
include variables like distance to school, school fee and gender of the teacher.
The dependent variable is equal to one if choosing private school otherwise
zero. Any factor having significant effect will imply that the factor is
influencing the choice of private schooling. Study starts by exploring the
school related factors because these factors have greater influence on the
parental choice of schooling. First, teacher academic and professional
qualification, the effect is significant only for the teachers academic
qualification. Result show that parent choice of private schooling is positively
influence by the academic qualification of teachers while teachers salary has
negative influence on the parents choice. Moreover, teachers year of
experience has insignificant effect.
Table: 2. Choices of school by parents (Public/Private)
Variable Dependent Variable Private=1 Otherwise=0
Teachers Academic Qualification 0.2642
(0.0000) *
Teachers Professional Qualification 0.0486
(0.6670)
Teachers Salary -0.0005
(0.0000) *
# year of Teaching 0.0009
(0.9632)
Log Education Expenditure 1.4055
(0.0186) **
# School going girls -0.1495
(0.2277)
Shahnaz Rashid
108
# School going boys -0.1357
(0.3288)
Primary -0.2672
(0.3393)
Middle -0.5418
(0.0676) ***
Matric -0.2811
(0.3739)
Inter -0.7275
(0.1637)
Graduate -2.1661
(0.0005) *
Primary 0.0993
(0.7099)
Middle 0.6073
(0.1316)
Matric 0.3308
(0.5507)
Inter 0.6766
(0.4463)
Girls School -1.1335
(0.0001) *
Boys School -1.7359
(0.0000) *
Dummy for Rural Areas -0.5880
(0.0062) *
Private 0.2087
(0.6185)
Self employee -0.0418
(0.8997)
Independent 0.2016
(0.6949)
Professional _
_
Unemployed -0.6554
(0.0885) **
School Fee -0.0061
(0.2290)
Distance 0.0787
(0.2235)
Dummy for female teachers -0.1788
(0.3845)
Constant -4.0550
109
(0.0283) *
N 573
Wald chi2(26) 109.3
Prob > chi2 0
Pseudo R2 0.19
Note: *, ** & *** shows significant at 1%, 5% or 10% level, respectively. Numbers in
parenthesis are p-values. Excluding category from mothers and fathers education level is
illiterate; from type of school variable excluding category is co-education while from
occupation status excluding category is other profession.
Second school fee, distance to school and children being taught by female
have insignificant effect on parental choice but the overall education
expenditure shows the significant positive effect of parent choosing private
schooling for their children. The reason might be that parents choose private
schooling for their children to provide them quality education, thus their
decision is respective of what the school fee is, how much the far the school is
and who is teaching (male or female) as long as their children receiving good
education. The result also shows inverse relationship between parents living
in rural areas and choice of private school. Choosing the private schooling for
the children based on type of school implies that parents often not prefer
single sex schools as shown by the negative coefficient of both the dummies,
school for boys or girls.
Turning the discussion to socioeconomic or family background, shows
that father education negatively influence the decision of choosing private
school for their children while the mother education is positively related to the
decision although the effect of mother education is insignificant. Mothers
education attainment insignificantly related to choosing private school for
children indicate that fathers is solely responsible for the making the choice
of schooling for the children (as indicated by the significant co-efficient of
father having either middle level education or graduate). Although the effect
of fathers higher education on choosing the private school for their children is
negative but after making the decision in the overall achievement test score
the effect is positive. Finally, father occupation shows insignificant effect
while increase in the number of school going boys and girls in the household
decreases the probability of a parent choosing private school although the
effect is insignificant.
6.2. Student achievement score and choice of schooling
Table 3 shows the overall result of both types of schools including the
predicted values from the choice of school regression. The significant effect of
Shahnaz Rashid
110
some of the variables changes at aggregate level. Some variables have little or
insignificant effect while certain other factors influence the dependent
variable significantly when the data is aggregated as compared to the data
taken in sections. For example, result shows statistically significant effects of
teacher academic qualification which was insignificant in table 1 although the
effect is negative showing that overall teachers academic qualifications are
not effective in improving the student achievement scores. This may be
because in Pakistan inadequate training leads undesirable performance by the
teacher thus teacher having good qualification but inefficient training leads to
decline in the student achievement score. Education level of father shows
positive significant effect while result for mothers education levels indicates
the negative significant effect on student achievement once again confirming
that fathers have more say for taking the decision related to child schooling.
Table: 3. Overall Effect on Students Achievement Score Both Types of School
Variable Overall Score
Choosing Private School 8.6480
(0.0213) **
Teachers Academic Qualification -0.4431
(0.0433) **
Teachers Professional Qualification 0.0651
(0.8099)
Teachers Salary 0.0004
(0.3441)
# year of Teaching 0.0018
(0.9696)
Log Education Expenditure -3.3791
(0.0403) **
# School going girls -0.4058
(0.1950)
# School going boys 0.3713
(0.2272)
Primary -0.1385
(0.8313)
Middle 2.0894
(0.01) *
Matric 0.7639
(0.3239)
Inter 0.7022
(0.6073)
111
Graduate 5.2971
(0.0023) *
Primary 0.0056
(0.9928)
Middle -1.6340
(0.0770) **
Matric -1.4351
(0.1529)
Inter -3.7842
(0.0224) **
Girls School 2.4271
(0.0187) **
Boys School 3.0547
(0.0241) **
Dummy for Rural Areas 0.3049
(0.5968)
Private -0.7913
(0.4388)
Self employee 0.0973
(0.9146)
Independent 0.7407
(0.5502)
Unemployed 0.8993
(0.4122)
Constant 21.53
(0.0000) *
N 573
F-Stat 1.43
Prob. F 0.0872
R-Square 0.0545
Note: *, ** & *** shows significant at 1%, 5% or 10% level respectively.
Numbers in parenthesis are p-values. Excluding category from mothers and
fathers education level is illiterate; from type of school variable excluding
category is co-education while from occupation status excluding category is
other profession.
Result also shows that variables representing number of school going boys
and girls in a household have insignificant effect. Education expenditure
shows negative and significant impact on children achievement score.
Education expenditure was positive and significant for private school while
Shahnaz Rashid
112
negative and significant for public school in table 1. At the aggregate level the
effect might be capturing the dominant effect of public school. As in Pakistan
the number of public school is more dominant in number then private schools.
Study interpret the negative effect as higher education expenditure leads to
lower achievement may be because with limited household income the higher
the expenditure the lower will be the demand for getting education thus
student achievement score decline. Result also shows positive and significant
effect of single sex schools on the overall student achievement although the
effect was previously positive only for the girls school and negative for the
boys school.
Finally, student achievement score also influence by the choice of
school by the parents; private or public. This decision influences the
achievement score significantly. The variable capturing the selection bias is
basically the predicted probabilities of parent choosing the private school from
the logistic regression. The reason as explain earlier is to avoid the possible
endogeneity problem in the variable. In this case selecting private school for
the children by the parents found to have highly significant and positive effect
on the student achievement score.
Thus overall study confirms that student achievement scores differ
across public or private schools. The difference is because of the teachers
characteristic, socioeconomic background from which the student belong and
the choice of schooling by the parents.
VII. Conclusions
This paper has estimated the determinants of student achievement
score in both types of school - public and private, using a sample of fifth
graders. The study ran three sets of regressions: First students achievement
test score across private and public school was regressed on socioeconomic
background and some school related factors. Second logistic regression was
estimated to determine the choice of school types (public vs. private) and at
the final stage effect of choice of schooling, school related factors and
socioeconomic background of the student were used to determine the overall
student achievement score. The data for this study came from a survey held
for evaluating public and private primary schools performance in Karachi
through random sampling.
One interesting finding is that teacher characteristic such as salary is
negatively and significantly correlates with private and public school
113
performance score. Prior studies lacked access to data on teacher salaries in
Pakistan; this result is consistent with the view that raising pay is not a
powerful way to motivate teachers to apply more effort because wages can
only serve as a motivating device when the threat of dismissal is credible
which often lack in Pakistan.
As far as the effect of parents education on the student achievement
score is concerned; probability of choosing private school although negatively
influence by the fathers education but in the overall achievement score and
the private school student achievement score its effect is positive and
significant. On the basis of this study, one can conclude that highly educated
fathers may not send their children to private school but the higher education
is providing vision to invest in human capital of their children may be
providing help in getting education directly.
Shahnaz Rashid
114
References
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Measuring learning achievement of primary level in Pakistan. Ministry
of Education, Islamabad. National Study No. 135.
Alderman H., Peter F. Orazem & Elizabeth M. Paterno (2001). School quality,
school coast and the public/private school choices of low-income
household in Pakistan. The Journal of Human Resources, Vol. 36, pp.
304-326.
Becher, R. (1984). Parent involvement: A review of research and principles of
successful practices. Washington, D.C. National Institute of
Education.
Betts, Julian R. (1995). Does school quality matter? Evidence from the
National Longitudinal Survey of Youth. The Review of Economics and
Statistics, Vol. 77, pp. 231-247.
Coleman, James, Hoffer, T. & Kilgore, S. (1982). Cognitive outcomes in
public and private schools. Sociology of Education, Vol. 55, pp. 65-76.
Cox Donald & Emmanuel Jimenez (1989). The relative effectiveness of
private and public schools: Evidence from two developing countries.
Living Standards Measurement Study, Working Paper No. 60;
Washington, D.C.
David Card & Alan B. Krueger (1992). Does school quality matter? Return to
Education and the Characteristics of Public Schools in the United
States. Journal of Political Economy, Vol. 100, pp. 1-40.
Emmanuel J., Lockheed M. & Wattanawaha N. (1988). The relative efficiency
of private and public schools: The case of Thailand. World Bank
Economic Review, Vol. 2, pp.139-164.
Hanushek, Earic. (1995). Interpreting recent research on schooling in
developing countries. World Bank Research Observer, Vol. 10, pp.
227-246.
Hanushek, Earic., Steven G. Rivkin & Lori L. Taylor (1996). Aggregation and
the estimated effects of school resources. Review of Economics and
Statistics, Vol. 78, pp. 611-627.
Harris Alma, Chrispeels & Janet Hageman (2006). Improving schools and
educational systems: International perspectives. Taylor & Francis,
London.
Harris, A. & Charispeel (2006). Improving schools and educational system:
International perspectives. Taylor and Francis, London.
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Heckman, James J., Anne Layne-Farrar & Petra Todd (1994). Does measured
school quality matter? University of Chicago, Department of
Economics Processed Book Review, Title is, Does Money Matter? The
Effect of School Resources on Student Achievement and Adult Success,
pp. 192-288.
Heckmans-lee (1979). Sample selection bias as a specification error.
Econometrica, Vol. 47, pp. 153-161.
Paul G. & Hanan J. (1994). Student achievement and schooling choice in low-
income countries evidence from Ghana. Journal of Human Resources,
Vol. 29, pp. 843-864.
Sheldon, R. (2003). The changing influence of socioeconomic status on
student achievement: Recent evidence from Australia. Paper Presented
at the Annual Meeting of the American Educational Research
Association, Chicago, 21-25 April.
Speakman, R. & Fins Welch (1995). Does school make a difference? A
reassessment. Mimeo, Texas A. and M. University.
Shahnaz Rashid
116
Annex 1
Variables used and their Description
Variables Description
Teachers Academic Qualification Measures in number of schooling years
Teachers Professional Qualification Index equals 1 if a teacher is CT, 2 if teacher is PTC & 3
if teacher is Bachelor of education while 0 if have no
professional qualification
Teachers Salary Monthly Salary in Rupees
Teaching Experience Number of years he or she is teaching
Education Expenditure Monthly over all Education expenditure in Rs.
Number of School going girls and boys Number of school going children by gender
School Fee Monthly school fee in Rs.
Distance Distance to school in km
Fathers Education Level Fathers education level; illiterate primary, middle,
matric, inter & graduate
Mothers Education Level Mothers education level; illiterate primary, middle,
matric & inter
Type of school Categorical variable, boys, girls or co-education
Household Heads Occupation Occupational categories: private, self employed,
independent, professional, unemployed & others
Annex 2
Descriptive Analysis
Variables # Obs. Mean Std.
Dev.
Min Max
Teachers Academic Qualification 586 12.06 1.87 10 16
Teachers Professional Qualification 586 0.72 0.91 0 3
Education Expenditure 576 856 355 205 2646
Teachers Salary 586 2075 1232 300 5800
Teaching Experience 586 4.52 4.95 0 30
School Fee 586 30.69 20.88 1 71
Distance 586 2.21 1.56 1 8
Students Achievement Score 586 14.69 5.63 0 43
Book Review
Pakistan Economy in Retrospect
1947-2010
Dr. Mohammad Aslam
(First published 2011 by Ferozsons (Pvt.) Ltd., Lahore, PP. 232, Price: Rs. 350)
Pakistans economy, with all its positive and negative manifestations, is perhaps the
worlds most amazing yet fascinating area of study for socio-economic analysts who,
perusing the achievements of German wonder man Chancellor Ludwig Erhard,
believe in economic miracles. Pakistan, at the time of its birth in 1947, started with a
zero level of economic management, without any financial resources whatsoever, and
a truncated administrative structure. However, it not only showed resilience to survive
against heavy odds but in the process achieved, without any Marshall Plan,
spectacular results in building up a viable economic infrastructure. No doubt its
human development indices in many respects are still very low and recently
dangerous forms of extremism and terrorism have raised their heads, yet prominent
analysts like The Times journalist-cum-professor, Anatol Lieven, believe that in
spite of all this the country is moving and is in many ways surprisingly tough and
resilient as a state and a society and is also not quite as unequal as it looks from
outside. (Pakistan: A Hard Country: 2011)
The challenges which Pakistan has faced during the past five decades of its existence
are by all means unparalleled. It has absorbed undoubtedly twentieth centurys largest
influx of refugees, over 7.8 million from Indias East Punjab alone, along with
unceasing deluge of millions of uprooted migrants from Afghanistan, Central Asian
Republics, Iran and Kashmir. It experienced forcible separation of its big eastern wing
in 1971, now known as Bangladesh, which resulted in dislocation of its internal
common market. Its economy felt a heavy impact of the great Afghan resistance
against Soviet occupation of their motherland which resulted in the collapse of the
communist super power, an unbelievable development of global dimensions. Pakistan
is also incurring heavy losses of men and materials, being caught up, as a frontline
state, in the midst of post-9/11 merciless global power game.
Apart from the above external pressures, Pakistans internal economic, financial and
structural problems have been equally formidable. Starting virtually from a scratch in
1947, its economic performance during the past five decades has been spectacular in
many respects but distressing in fields which enhance human welfare and ensure
equitable growth. No doubt, in spite of initial bottlenecks, Pakistan has managed to
build up a modern comprehensive and vibrant financial and institutional framework
which has helped it to maintain growth around an average trend rate of 5.6% per
118
annum during the past sixty years or so. However, the benefits of growth have not
spread equitably. Actually, by all counts, the countrys basic deep rooted crisis
continues to be in the shape of poor management of public finances and bad and
corruption-laden governance. It is this crisis which has led to the whole spectrum of
prevailing economic meltdown, involving macroeconomic instability, high inflation,
growing unemployment, aggravating power shortages, weakening industrial structure,
crippling poverty, worsening of foreign and domestic indebtedness and poor public
services.
The foregoing cursory account of Pakistan multi-dimensional struggle and will to
survive shows how challenging it is to come to grips with writing a meaningful
economic history of this enigmatic nation. What makes the task more arduous is
Pakistans political journey through six specific epochs representing different and
somewhat diametrically opposed economic policies and planning and management
practices. One has to understand how, why, and under what conditions different
approaches were adopted with beneficial results or emerging challenges. The answer
of many such outcomes has been well narrated by Dr Aslams current research.
Dr. Mohammad Aslams book has tackled with commendable clarity all the mysteries
and achievements surrounding Pakistans economic history. Dr. Aslam is both a
professional economist and a teacher with a keen sense of research-based analysis.
Although a number of books have been written on the economy of Pakistan but they
are either storey type accounts of different developments or are confined to a
discussion of specific issues. Pakistan basically consists of one nation, one geography
and one economy. Dr. Aslam must be given full credit for combining all these aspects
in a very elegant, easy-to-read but professionally well written book.
One distinguishing feature of the book is its division of topics in two distinct but
interconnected categories, historical perspectives and macroeconomic issues. This
makes the task of understanding economic and non-economic developments easy and
harmonious. The book combines both elegance and sophistication and seamlessly
flows with statements of facts, analysis, and conclusions in a logical order.
The book under review covered twenty eight topics, consisting upon all major
economic issues, development pattern of Pakistan and new emerging contemporary
economic issues like regional inequalities, neglect of human resource, role of civil
society & NGO,s and litmus test of governance. Besides, long prevailing burning
economic issues like inflation, unemployment, poverty, governance and growth of
services sector have been analyzed in such a manner that clear conclusions are
drawn, which are helpful for policy formulation. Although, the discussion of each
topic is very brief but this precise presentation contains in-depth analysis of the issues
and empirical evidences are very strong to support the arguments. Of course, it
provides up to date picture of all major economic developments, review of
development planning, policy formulation and its implementation and as a result their
119
implications. The empirical findings are drawn mostly from secondary data, generally
taken from Pakistan Economic Survey. The outcomes are properly supported by
theoretical and logical arguments. The book clearly conveys its message and the
reader do not need any strong background in economics to understand economic
issues of Pakistan. Hardly any text book contains such a broad coverage of economic
issues of Pakistan.
Keeping in view the coverage of emerging economic issues, analytical review of
formulation and implementation of policies, as well as, their outcomes and in-depth
analyses surely make this book a unique contribution towards literature of economics.
It is the very reason that the book is equally beneficial for students of commerce,
business, economics and competitive examinations like CSS. Besides, the book can
also be used for different in house training programs related to Pakistans economy
such as professional training for foreign services, management, commerce and
planners.
Notwithstanding the above, the book is also helpful to provide foundations for M Phil
courses related to Pakistan economy. The scope of the book could be enhanced, if
brief critical literature review may have been added to the text. Although, the book
contains references but detailed list of bibliography could be more useful for readers.
Similarly, an addition of index (by authors and subject), at the end of the book will
facilitate its reading and usage.
Dr. Rafiq Ahmad Dr. M. AslamChaudhary
Professor Emeritus (Economics) Professor (Economics)
And former vice-chancellor of Forman Christian College
University of Punjab, Lahore (A Charted University)
Lahore
Forman
Journal of Economic Studies
Manuscript Submission guidelines
1. Manuscripts of Articles and book reviews shall be sent through
soft copy at email: fjes@fccollege.edu.pk
2. All manuscripts should be double spaced by allowing a margin of
1 on the right and 1 the left. (Except footnotes and inset
quotations).
3. Manuscripts are accepted on the assumption that they are original
and have not been published anywhere else.
4. The articles so far as possible may be organized into the following
sections: (a) a brief abstract, (b) introduction, (c) literature review,
(d) theoretical framework / methodology, (e) empirical findings, (f)
limitations (I) conclusions / summary and policy implications.
5. The first page of the article should contain the title of the paper,
name of the author and a footnote showing the affiliation of the
author and acknowledgements if any.
6. For the convenience and benefit of referees, detailed calculations
and derivations of the model, estimation results reported in the
study may also be submitted along with the article.
7. References at the end are to be written in alphabetical order but
not numbered and should confirm to the APA Manual of style.
8. References given in the footnotes are numbered consecutively
and their listing should also confirm to internal standardize
practice.
9. The acknowledgement of an article/Paper does not automatically
qualify it for publication. The acceptance of an article is generally
communicated after receipt of comments from the referees.
10. The contributors are solely accountable for originality of the
article; Intellectual integrity may not be compromised under any
circumstances.

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Forman Christian College (A Chartered University) was founded in 1864 by

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) this is because returns are typically taken as

= Estimated value from equation (3)

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