World wide quotas on imports of textiles and clothing ended on December 31, 2004. Since textiles, apparel, and related products account for nearly three-quarters of Pakistan's exports , this has raised concerns about how the country's export sector will fare after the demise of the quota system.

Unconstrained by quotas, will Pakistan make inroads and increase its world market share of textile-related exports? Or will competitors such as China and India, which also stand to benefit potentially from the post-quota environment, gobble up Pakistan's existing market share?

Major industrial countries introduced quotas on imports of textile-related products from developing countries in 1974 under the Multi-Fibre Agreement (MFA). In 1995, the MFA was replaced by the Agreement on Textiles and Clothing (ATC), which called for a phase-out of the quantitative restrictions in several stages over a ten-year period.

At each stage the goods that became quota-free were incorporated into WTO rules, which disallow quantitative restrictions. Not surprisingly, importing countries chose first to integrate goods whose quota utilization rates were low. Thus, in practice, the bulk of the liberalization was back loaded and would not have occurred until January 1, 2005.

Economic theory provides a useful starting point for analyzing the impact of quota removals. Quantitative restrictions distort the allocation of resources and, therefore, removal of these restrictions should lead to efficiency gains that would lower world output prices, benefiting consumers all over the world.

Among the producers, there will be losers and gainers-producers in developing countries that can produce these textile goods relatively cheaply, and whose quotas are fully utilized, should gain at the expense of producers in industrial countries and those developing countries where the quotas are non-binding.

A key factor is the relative positions of those countries that face binding quotas, which again depends on how competitive they are relative to one another in terms of price and quality.

Theory thus suggests that Pakistani consumers would gain, but one needs to delve a little deeper into the real world to determine the likely fate of producers and exporters.

The first relevant question is: has Pakistan been able to fully utilize its past quotas? Several studies suggest an affirmative answer. For example, a 2004 WTO working paper lists Pakistan as having the highest percentage of binding quotas.

Pakistan is also generally included in the list of countries that have high effective taxes on exports implied by all the quantitative restrictions. Thus, Pakistan's textile exports may have been substantially constrained by the existence of quotas, creating a potential for some gains in the post-quota environment.

The next relevant question is: how have Pakistan's textile exports responded to the gradual phasing out of quotas under the ATC since 1995? The answer should contain some hint about future performance, notwithstanding the fact that the bulk of the effects of the quota liberalization are probably yet to be realized.

Data indicates that China has been a big gainer under the ATC, with its world market share of textile exports going up from about 121/2 per cent in 1995 to nearly 20 per cent in 2003.

India and Turkey are also among those countries that have made a significant gain in world market share. It is potentially encouraging for Pakistan that these gains in the shares of China and such countries as India and Turkey, have not come at the expense of Pakistan's share, which has gone up-albeit only a little-from 3.8 per cent in 1995 to 4.2 per cent in 2003.

Rather, they have come at the expense of industrial countries such as Japan and some EU and East Asian countries. The story is broadly similar for the world's leading clothing exporters, although Pakistan is not as big a player in clothing to begin with.

The fact that Pakistan has not lost market share to countries like China and India with the modest quota relaxations under the ATC augurs well, potentially, for the future of Pakistani exports.

But this brings us back to the key question: will Pakistan be able to match them in competitiveness in the new environment where the quotas have been eliminated completely? On this front, according to research published in the Social Policy and Development Centre (SPDC)'s 2004 Annual Review of Social Development in Pakistan, the news does not appear to be so good.

A country can enhance its competitiveness by reducing the costs of producing a unit of output. Unit costs, in turn, can fall by input prices rising slower than output prices (so that less is spent in generating a given amount of revenue) and/or by gains in productivity (so that increasingly more output can be produced for any given amount of inputs).

Policy instruments can also influence competitiveness. For example, keeping the exchange rate relatively depreciated makes a country's exports relatively cheaper in international markets for any given local price that producers are receiving.

Also, lower import tariffs and lower government surcharges decrease the effective cost of inputs. Let's first consider the historical behaviour of input prices relative to the overall price level in the economy, as measured by the GDP deflator.

Between 1974 and 2003, the price increases of some key inputs in Pakistan's manufacturing sector have well outpaced the increases in the general price level. Specifically, while the GDP deflator increased 13-fold over this period, wages increased 15-fold, the prices of machinery and transport increased 20-fold, and energy prices increased a staggering 40-fold.

SPDC's research study also computes composite input price indices for two categories of inputs: factor inputs (labour and capital) and non-factor inputs (all other inputs).

The recent trends are worrisome-between 1999 and 2003, the composite factor and non-factor input price indices rose about 21/2 per cent and nearly five per cent respectively, whereas the export output price actually fell 11/2 percent!

Have the gains in productivity more than offset the erosion of profitability due to input prices rising faster than export output prices? One widely used measure of productivity is total factor productivity (TFP), measuring the extent to which we get more output for any given levels of labour and capital.

According to estimates in the SPDC study, TFP did rise about 21/2 per cent per annum over the period 1974-2003. However, considering various sub-periods, the trend in TFP growth has been slightly downward, although the 1999-2003 period shows some pick up relative to the 5-year period immediately preceding it.

To get a fuller picture, a measure of "net productivity" can be used, which incorporates the effects of both factor input prices and productivity changes on competitiveness. Net productivity is defined as the gain in productivity over and above that necessary to offset the negative effects on profitability of the extent to which input prices rose faster than the export output price.

Over the period 1974-2003, the situation seems fairly satisfactory, with net productivity increasing by about 11/2 per cent per year. However, this is largely because of a large positive gain in the 1994-98 period owing to a rise in export prices (caused by both a rise in the world price of our exports as well as a massive depreciation of the rupee), rather than a check in factor input price increases or unusually strong productivity gains.

More telling is the 1999-2003 period, during which there was a significant net loss of productivity of 21/2 percent per annum. In other words, the excess of factor input price increases over export price increases during this period (4 per cent per annum) has exceeded productivity growth (11/2 per cent per annum) by about 21/2 percentage points.

This paints a rather pessimistic picture about the recent trend of the external competitiveness of Pakistan's manufacturing sector. One edge Pakistan does have over competitors is a relatively lower import content of inputs in textiles because of its indigenous production of cotton.

Thus, it is better positioned to use exchange rate depreciation as a tool to try and stay competitive; if competitors have a higher import content of inputs, the greater is the extent to which any exchange rate depreciation by them would simultaneously drive up the effective prices of imported inputs and negate the gains in competitiveness.

It is, of course, debatable whether Pakistan's exchange rate policy should cater primarily to the textile sector. Exchange rate depreciation is a double-edged sword: while benefiting exporters, it will drive up prices of imported goods for Pakistani consumers as well, contributing to inflation; and in other sectors primarily producing goods for domestic markets, Pakistan does import a much larger fraction of inputs such as machinery and raw materials, making these sectors vulnerable to a more depreciated value of the rupee.

To sum up, the post-textiles quota environment presents a potential opportunity for Pakistan's export sector. In order to realize the inherent potential, however, and compete with the likes of China and India-which also stand to gain from quota-free textile trade-Pakistan's manufacturing sector needs to become substantially more efficient.

This can be achieved through enhanced productivity and lower costs of production, including possibly through policy measures such as lower energy surcharges.

Without the requisite gains in efficiency, the fate of Pakistan's textile sector will likely depend upon transient fortuitous factors, such as an unusually good cotton crop.