Towards industrial policy 2.0: Part - IV

Ishrat Husain
Saturday, Jun 03, 2023

The end purpose of an industrial policy for Pakistan should be to achieve competitiveness through higher productivity which brings greater profits for entrepreneurs, higher wages and better working conditions for workers, and more tax revenues for the government.Such a policy may also result in stable prices for consumers and saving in foreign exchange as exports become competitive and production of import substitutes efficient.

The following quotation by former prime minister of India VP Singh aptly captures this end goal: “What we need is growth that falls like rain on the mountain and flows down in stream to the valleys and plains below, not growth that is like snow, which sticks to the mountain tops.”Empirical research has provided evidence that most of the factors hindering GDP growth in Pakistan particularly in commodity producing sectors – agriculture and industry – are institutional or policy based requiring reforms instead of additional financial injections.

Focusing more specifically on industry, it was found that the failure to take off or stunted industrialization was due to dysfunctional markets and the excessive participation of government in productive activities. A recent PIDE study concluded that the government had a footprint of 67 per cent of the GDP. The declining growth in value added has been accompanied by falling productivity. The prerequisites for a workable industrial policy are political stability, sound macroeconomic policies and economic governance. Fiscal dominance which is crowding out private-sector credit for fixed investment and working capital has to be minimized. The growing informalization of the economy in production and trade is a manifestation of the weakness of state capacity to enforce the laws and rules and exercise its coercive power.

Therefore, a strong state apparatus is necessary under the industrial policy 2.0 to play an entirely different role ie to correct market failures, remove constraints from the way of a competitive market structure and improve allocative efficiency, eliminate policy-induced distortions and perverse incentives instead of picking winners through an elaborate system of protection and subsidies.

Highly protected domestic markets not only reduce the incentive to export but also penalize the economy by allowing inefficient producers to extract policy-induced rents from domestic consumers. Enforcement of contracts and protection of private property rights necessitate a well-functioning judicial system that adjudicates and resolves disputes expeditiously and at affordable costs for small and medium businesses.

The nature of government interventions under the industrial policy 2.0 would, therefore, be to unshackle the entrepreneurial energies of the private sector (by providing a level playing field) , and to shift from resource-based to technology-intensive products whose demand is growing at a rapid pace in both domestic and international markets. The basic thrust of the policy would be for the state to eliminate unnecessary and costly regulations and an extortive taxation system, promote research and development in productive sectors, provide skilled and trained manpower and infrastructure, and avoid distorting markets through administered prices of inputs and output.Market structures characterized by oligopoly, monopoly, collusive practices, cartelization and other defective practices have to be cleaned up. Entry barriers for newcomers as well as for scaling up the size of the operations have to be dismantled.

Industries that can export or save foreign exchange, attract foreign direct investment, generate employment, and have strong backward and forward linkages are most likely to emerge under such a policy. A lot of risks are too big to insure against privately. The state should step in such cases through public-private partnerships where the rewards to society at large are enormous.

The main ingredients of a forward looking industrial policy for Pakistan ought to be: Innovation: Rapid technical change is at the heart of the new competitive scene and innovation and productivity growth are interrelated. R&D expenditure in Pakistan was already paltry, but it has declined from 0.32 per cent of the GDP to 0.28 per cent in the last decade.

Support for scientific research and development in both private and public sectors to alter the production structure and processes in response to changing demand patterns, preferences and technology has to be given the highest attention and resources. Institutional specialization, complementarity between university and industry, patents acquisition, and stakeholder involvement would generate beneficial results.

Transition to green technology and clean energy, adaptation and mitigation of climate change risks and emerging technologies such as AI, robotics, data analytics, etc have to be the major components of an R&D programme. Financial incentives should be given to firms for in-house R&D activities that enhance their technological capabilities and enable them to implement new innovative techniques and processes. An innovation development challenge fund can be a useful instrument for this purpose.Institutions: Strengthening institutions of economic governance by devolving powers, delegating decision-making and decentralizing fiscal resources, and giving them autonomy while holding them accountable for results is essential. The state should withdraw from running businesses and allow the private sector to compete on a level playing field. The role of the state should be that of a facilitator, enabler and promoter but also that of delivering basic public goods and services in a cost effective and efficient manner.Technology parks, incubation centres, special economic zones can create clusters for exchange of knowledge, skills and provision of common services resulting in agglomeration economies. Narrower forms of specialization in fragmented production that now dominate global value chains have changed the dynamics of industrial and export activity.

Pakistan has to find niche products in the chain where it can compete. These clusters would also house quality testing labs, standards metrics compliance and extension services to SME suppliers and vendors. These clusters along with joint ventures between Pakistani and foreign firms can further reinforce the process of upgrading technologies, building new capabilities and finding new markets and market niches.

Deregulation and taxation: The formal industrial sector is overregulated and heavily taxed. About two-thirds of taxes are collected from the manufacturing sector which accounts for only 13 per cent of the GDP. The plethora of laws, rules, regulations and no objection certificates required for compliance by the federal, provincial and local governments – some overlapping – have stifled the entry of newcomers by increasing the cost of doing business and thus retarded the forces of competition. For example, the minimum tax based on turnover acts as a barrier to new entrants.

As a result Pakistan has gone through deindustrialization and the share of manufacturing in GDP has remained stagnant. Easing the regulatory burden and lowering the tax incidence on manufacturing industries (by bringing in other sectors and firms into the tax net) would allow the existing firms to expand their scale of operations and new companies to invest in activities that would become profitable. Large-scale firms tend to be more productive reflecting economies of scale. Export subsidy schemes have to be rationalized to incentivize new products, sub sectors and for penetration in new markets. One way to promote consolidation, capital formation, scaling up and expansion of the manufacturing sector is to remove tax on inter corporate dividends.

Human capital formation and skilled labour force: Despite loud claims that Pakistan has a large pool of talent, the fact is that we rank below our peers in the human capital index. Factors like one-third of children out of school, alarming learning poverty, a rising number of unemployed graduates, low female labour force participation rates, malnutrition and stunting and an acute shortage of skilled workers demanded by industries pose serious constraint to productivity growth.

Science and mathematics should be introduced early in the school curriculum and made mandatory for all middle and secondary school students. Technical and vocational training institutes should be expanded and operated by the private sector. Universities should produce more STEM graduates of employable skills. Manufacturing’s growing parts in value addition are research, design, engineering, marketing and networking. Digital economy would require a large workforce of ICT professionals.

To be continued

The writer is the author of 'Governing the ungovernable'.