And now, the hard part: Towards a new vision for economic transformation
https://arab.news/97zjd
Over the last two and a half years, the Pakistan government has taken necessary but politically unpopular measures to stabilize the economy. These included the implementation of a market-determined exchange rate that resulted in as much as 30 percent depreciation of the Pakistan rupee against the dollar and fueled imported inflation. The public’s hardship was exacerbated by power sector tariff adjustments. The adoption of Circular Debt Reduction Plan will mean further power tariff hikes. The cabinet has also approved Public Financial Management Law to institutionalize the autonomy of the central bank and impose greater fiscal discipline on governments. Having achieved much, it now has to do the really hard part.
Pakistan’s economy remains ossified in terms of its sectoral make up, productive structures, and most importantly its resource allocation mechanism. There’s an urgent need for a sustainable growth model that discontinues the support of existing inefficient businesses and sectors, and instead promotes continuous reallocation of resources from less to more productive areas. Policy makers need to learn from the experience of East Asian economies, such as Vietnam, Thailand and the Philippines, among others, which have built on their endowment of capabilities to both diversify their industrial base and more importantly to get onto a growth path whose pace is accelerating.
As reflected in their export earnings, the aforementioned East Asian nations have moved their economic mainstay from resource based and agricultural products toward high and moderately sophisticated sectors such as electronics, chemicals, value-added textiles, and tourism. Pakistan’s production base is dominated by ubiquitous primary and intermediate goods (textile, leather, rice, etc.) rather than value-added finished products or those that are branded and earn a premium for exclusivity. The export portfolio remains concentrated to a few products, shipped out by a narrow band of exporters to a handful of markets.
In Pakistan, bad policies and market failures have prevented the evolution of existing industries and setting up of new, more complex ones. In effect, incentive structures are ‘static’ and prevent factors of production from being allocated to their most optimal use.
Javed Hassan
Over 70 percent of agri-products and 40 percent of textiles exports are primary commodities. According to Harvard Growth Lab’s study into the composition of export baskets of countries, Pakistan has added 21 new products since 2003, which have only contributed $2 per capita to the value of its exports. Thailand and Vietnam have added 34 and 48 new products, contributing $213 and $1020 per capita to the value of their exports, respectively. On the Economic Complexity Index (ECI) Pakistan ranks 99 out of 133 countries. More alarmingly, over the last decade, Pakistan’s economy has become relatively less sophisticated, declining 20 places in ranking. Thailand’s (22), Vietnam’s (52), improved 9 and 11 places respectively.
Economists, Diego Restuccia and Richard Rogerson in their paper, ‘The Causes and Costs of Misallocation’ observe that “corruption, regulation, or direct government involvement distort the allocation of resources from their most efficient use, especially in poorer economies.”
In Pakistan, bad policies and market failures have prevented the evolution of existing industries and setting up of new, more complex ones. In effect, incentive structures are ‘static’ and prevent factors of production from being allocated to their most optimal use.
Tax and trade policies shield dominant and sclerotic incumbent players from competition by innovative new entrants. The acceptance of oligopolistic practices adversely impact productivity improvement. State intervention through support prices, import restrictions, and direct and indirect subsidies, allow anti-competitive behaviors to permeate the productive structures as well as disincentivizing diffusion of frontier technologies and adoption of best practice methods. For example, in the sugar sector, the state sets support prices to incentivize farmers to grow sugar cane and then restrict its sale to only local sugar mills. The edifice of regulated production and fixed pricing at various stages of the value chain is then sustained by restricting much cheaper imports of white sugar from countries such as Brazil and India.
Rather than encouraging investment and trade to be intertwined, and tailoring growth strategy to encourage resource allocation toward manufacturing for competitive international markets, the regulatory and tariff regime is designed to preserve existing industries and business groups. It is therefore unsurprising to note that the largest industrial segments are those that are provided tariff protection and/or subsidies. Tariff protection for the profitable food-processing sector has been over 200 percent and similarly the auto sector is protected by tariff and non-tariff barriers. Textile exports growth has been primed to consistently receiving disproportionate state largesse compared to other sectors by way of finance facilities at subsidized rates, duty drawbacks and discounted energy prices.
If Pakistan is to grow sustainably and integrate with the rest of the world, distortive state interventions have to stop. It must undertake structural reforms that remove barriers incentivizing one type of activity over another, and thereby preventing resources from moving to where they can be optimally utilized. Incentive structures need to keep evolving and inefficient businesses should be allowed die out. The government’s role is to provide a level playing field that catalyzes the private sector’s self-discovery process of what are the most productive businesses rather than preserving existing structures/players, thus effectively preventing any economic transformation.
* Javed Hassan has worked in senior executive positions both in the profit and non-profit sector in Pakistan and internationally. He’s an investment banker by training.
Twitter: @javedhassan
