Does the Marshall-Learner Condition Hold for Pakistan? Exchange Rate Elasticity, and the Long-Run Determinants of Export Earnings

Abstract

Pakistan's external sector is characterised by persistent current account deficits, chronic exchange rate pressure, and a structurally narrow export base that has failed to keep pace with regional competitors over four decades. This study examines the short-run and long-run macroeconomic determinants of Pakistan's export earnings over the period 1976–2019, focusing on four theoretically motivated drivers: the nominal exchange rate (ER), foreign direct investment (FDI), domestic inflation (INF), and real GDP per capita growth (GDP). Annual time-series data from the World Development Indicators are analysed using the Autoregressive Distributed Lag (ARDL) bounds testing approach to cointegration (Pesaran et al., 2001), supplemented by an error correction model (ECM), pairwise Granger causality tests, and a full suite of residual diagnostics including serial correlation, heteroskedasticity, and CUSUM parameter-stability tests. The bounds test yields an F-statistic of 11.330, far exceeding the 1% upper critical bound, establishing a robust long-run cointegrating relationship. Long-run estimates show that exchange rate depreciation is the dominant driver of export earnings, with an elasticity of 1.521 — a finding consistent with the Marshall-Lerner condition holding for Pakistan over the full sample. Inflation enters positively but modestly, reflecting the nominal exchange rate transmission channel. FDI and GDP are individually insignificant in the long run, a result attributed to the sectoral concentration of FDI in Pakistan's non-tradable infrastructure and energy sectors. A novel finding is the oscillating short-run FDI dynamic — positive contemporaneously, negative at lags one and two, and positive again at lag three — consistent with an investment gestation period in which newly committed FDI initially draws in capital-goods imports before activating export capacity. The ECT coefficient of −0.388 implies adjustment toward equilibrium at approximately 39% per annum. Granger causality is bidirectional among exports, the exchange rate, FDI, and GDP, confirming the interconnected and self-reinforcing character of Pakistan's external sector. Inflation is causally exogenous to all trade variables. The findings carry direct implications for exchange rate management, FDI targeting policy, and export diversification strategy in Pakistan.