Pakistan’s industrial revival requires deep structural reform
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Pakistan is stuck in a trend of declining productivity growth, and with that, the sustainable GDP growth rate has also fallen from around 6.5 percent per annum in the 1980s to 4.6 percent in the 1990s, and for the last two decades at around 4 percent. In terms of per capita GDP, which is a better reflection of the improvement in the standard of living of the people than gross GDP growth, IMF’s World Economic Outlook (October 2020) shows that since 2000, Pakistan’s real per capita growth has averaged around 2 percent per annum which lags the South Asian average of 4.7 percent by 2.7 percent.
The International Labor Organization (ILO), in 2019, estimated that Pakistan’s productivity, which serves as a measure of output per person, grew at an annual rate of 1.4 percent from 2000 to 2019, compared to India’s 5.3 percent and China’s 7.0 percent. Pakistan’s labor force’s productivity over the last two decades has increased at roughly one-fourth the pace of India’s and one-fifth the pace of China’s during this time.
Pakistan’s productivity problem is exacerbated by a low-savings and low-investment trap which feeds into the anaemic productivity growth thereby creating a vicious cycle. Looking at the World Bank data for gross domestic savings rate in 2020, Pakistan’s 8.35 percent compares unfavorably with the global average of 25.2 percent, the South Asian average of 25.8 percent, and China’s 44 percent. The low savings rate reduces the availability of investible funds; low investments make growth unsustainable; the low growth creates low domestic savings. Besides the low rate of domestic saving, a large proportion of savings is directed toward real estate thereby diverting capital away from productivity-enhancing sectors of the economy.
The state has effectively created an industrial landscape that can be compared to a heroin addict that needs ever larger doses to barely function effectively.
Javed Hassan
In the absence of adequate domestic savings to tap into, the investment gap is filled through either international borrowings or foreign direct investment (FDI). The limited foreign investment that is directed into the manufacturing sector is primarily market-seeking rather than efficiency-seeking. In other words, the investment seeks to exploit Pakistan’s protected domestic markets rather than provide competitiveness to export-oriented sectors and enhance the production capacity of import-substituting industries. The underlying reason for this is Pakistan’s relative lack of attractiveness in terms of labor productivity and other input costs compared to its competitors.
The crux of the problem is the relentless and ever-increasing allocation of resources to some of the most inefficient and globally uncompetitive industries. The bulk of private sector investment is almost entirely incentivized to capture rental income provided by the state. With the exception of a few sectors such as knowledge-based services primarily related to information, computers and telecommunication (ICT), most other major sectors are reliant on the state providing tariff protection, direct subsidy or sovereign guaranteed returns.
There is little incentive to improve productive capabilities and as industries invest more into globally less competitive industries, they become increasingly more dependent on state largesse to survive. Consequently, the state has effectively created an industrial landscape that can be compared to a heroin addict that needs ever larger doses to barely function effectively. Despite several IMF structural adjustment programs, there appears no urgency to eliminate the addiction. Consequently, the country has to borrow more from other countries to keep this addiction going.
The episodes of higher GDP growth have inevitably been fueled by consumption, serviced by borrowing from external resources while domestic production capacity was constrained by structural weaknesses and excess demand is filled through imports, resulting in the widening of the trade imbalance. The borrowing binge boosts demand and GDP growth, and imports burgeon to build up external imbalances, which eventually results in financial crises and economic slowdowns. The chronic boom-and-bust cycle of fast growth followed by a slump is a pattern that has been often repeated in Pakistan, and resultantly, the country has had to turn to the IMF on 13 separate occasions for bailout packages.
Whenever the Pakistani economy shows signs of stabilizing, the focus, once again, turns to growth. It is therefore important to emphasize that not all growth is equally beneficial, and the policy choices that yield the most immediate short-term growth do not necessarily prepare the ground for sustained economic and social progress. Savings and investment, which enables improved productivity, greater specialization and global integration, are the true engines of economic growth. Increased consumption should be the fruit of such growth, and cannot be the cause of it.
There needs to be an ecosystem that compels businesses to, constantly improve efficiency, adopt and adapt to new technologies in order to enhance profitability. Periodical increases in the minimum wage, as a political instrument, have to be avoided, and rather linked to the reality of economic developments such as improvements in productivity. Doing so will make Pakistan a cost-effective and more attractive investment destination than its competitors.
- Javed Hassan is Chairman Economic Advisory Group (EAG). He’s an investment banker by training and has worked in senior executive positions both in the profit and non-profit sector internationally. Twitter: @javedhassan
