Possible Sino-Pak Economic Integration and the Impact of Chinese Productivity Shock on Pakistan’s Economy

Abstract

The recent wave of globalization boosted by the innovations in the information technology is making the world smaller, more symbiotic, and unpredictable. It is expected that in the near future no individual country will remain isolated. Economic integration reduces the trade barriers and facilitates bilateral trade by the reduction of taxes and duties on the tradable products and on services. In this study, the possible Sino-Pak economic integration and its implications for the economy of Pakistan is examined. China Pakistan Economic Corridor (CPEC) is one of such projects that will connect Pakistan not only with China but also with the Central Asia and many other important trading countries. The New Keynesian two-country Dynamic Scholastic General Equilibrium (DSGE) framework is developed for Pakistan and China to examine the effect of Chinese productivity shock on macroeconomic aggregates of both countries. The counter factual analysis is based on different degrees of trade openness and alternative monetary policy scenarios chosen by Pakistan. The study confirms that a positive productivity shock in China though beneficial for Chinese economy would have an adverse impact on Pakistan as comparative advantage will tilt in favour of China. Secondly, the impact of shock will prolong as the degree of trade openness increases in Pakistan. However, the adverse impact could be mitigated if the monetary authority in Pakistan opts for a strict inflation targeting monetary stance.