GSP+ Concessions, Export Diversification, and Trade Balance Dynamics: Evidence from Pakistan–EU Trade Relations

Abstract

This paper examines the Pakistan–European Union (EU) trade relationship, with a particular focus on how the Generalized System of Preferences Plus (GSP+) concessions and greater export diversification can help reduce Pakistan’s trade deficit, which continues to threaten its export sector. The analysis is grounded in classical trade theories, with particular attention to comparative advantage and the effects of trade creation. The empirical findings indicate that the GSP+ status plays a significant role in narrowing the trade deficit between Pakistan and the EU in both the short and long term. The real effective exchange rate also shows a statistically significant association with a worsening trade balance, explaining that currency appreciation tends to increase the deficit. While foreign direct investment inflows do not have a statistically significant short-run impact on the trade balance, their effect becomes positively significant in the long run, indicating a delayed but beneficial influence on export performance. An unexpected finding is the negative long-run effect of EU GDP on Pakistan’s trade balance, which points to structural weaknesses in Pakistan’s export capacity. The highly robust error correction term confirms the existence of a stable long-run relationship and indicates a rapid adjustment process. These results underscore the importance of strategically leveraging GSP+ concessions through targeted export diversification, maintaining a competitive exchange rate, and ensuring a stable environment for long-term FDI to sustainably reduce the trade deficit.

Keywords: GSP+ Concessions, Trade Balance, Export Diversification, Pakistan–EU Trade Relations