Reviewing Pakistan’s Import Demand Function

Abstract

This paper investigates the conventional import demand function for Pakistan using time-series data sourced from the World Development Indicators for the period 1970 to 2010. Using a vector error correction model and impulse response functions, we show that, for the given period, relative prices and income lose their significance as long-run determinants of import demand. This indicates the need for additional determinants. We compare the residuals of the conventional import demand function with those of a model that includes the terms of trade and foreign exchange availability (in addition to the conventional parameters) as determinants of import demand, and find that the latter largely resolves much of what is nondeterministic in the former model. The paper also explores the peculiar trend of a falling imports-to-GDP ratio (from the 1980s to the 2000s), which is unusual for a developing country. In a subsidiary regression analysis for this period, we argue that falling net capital inflows explain this persistent fall in the imports-to-GDP ratio. The recovery thereafter, when Pakistan started catching up with other developing economies, may have been responsible for the 2008 balance-of-payments crisis.