Faced by a near-existential threat, economies all over the world are at the pinnacle of a red alert. The novel coronavirus continues to hobble and confound the two main pillars of the global economy: demand and supply across industries and continents. Apart from China, the most affected countries reporting the highest death rates include the United States, United Kingdom, Italy, Spain, France and Germany. These countries not only contribute a large proportion to global output and trade (around 40%) but also have a significant share of manufacturing value addition coming from them.

Since half of Pakistan’s exports are to the most affected countries – the current situation poses a significant challenge to manufacturing – the second largest sector of the economy, accounting for 20% of Gross Domestic Product (GDP), and 23.67% of total employment. Although Pakistan's exports of goods and services as a percentage of GDP is only around 8.79%, with a total export earnings of US$ 23,631 million, most exporters employ a substantial number of workers in their respective businesses. Hence, a fall in exporting activities will inevitably worsen the employment crisis in Pakistan. Within manufacturing, the formal or large-scale manufacturing sector – the harbinger of the creation of better employment opportunities – has plunged by 22.95 percent on a Year-on-Year (YoY) basis  in March, 2020 owing to the closure of industries due to the lockdown (Refer to Figure 1). This, on top of an already negative growth trend in LSM, amplified the structural imbalance in the Pakistani economy. However, the government has partially lifted the lockdown and allowed export-oriented industries to resume operations, thus favoring livelihoods over lives.

Figure 1 Large Scale Manufacturing Industries Growth Rate (YOY)

In addition, Pakistan's Trade Balance recorded a deficit of US$ 2.2 billion in Apr 2020, compared with a deficit of US$ 1.5 billion in the previous month (Refer to Figure 2). Figures published by the Pakistan Bureau of Statistics (PBS) reveal a sharp contraction in exports since March 2020. Exports in April 2020 decreased to $960 million, a 54 percent reduction compared to April 2019. The viral outbreak came at a difficult time for Pakistan and could make the economic slowdown even worse for the struggling economy. However, there is a possibility of a silver lining amid the turmoil. This crisis-like situation has created business opportunities for developing countries like Pakistan, India, Bangladesh and Vietnam, especially in the manufacturing sector. For Pakistan to be able to catch the bus, it needs to revisit its export history and rethink its industrial policy for an inclusive and sustainable growth.

Figure 2 Pakistan Trade Balance (USD million)

What does Pakistan Export?

Figure 3 Pakistan Exports by Category in USD -2019 (Source)

A preliminary analysis of Pakistan’s low level of export is simple. While many countries would have dozens of categories of exports, Pakistan only has a few — most of which fit into the visual representation above (Refer to Fig 3). Pakistan’s exports are relatively unsophisticated, which, to a significant extent, implies that they are rather unresponsive to global economic growth (characterized by low-income elasticity of demand and high price elasticity of demand). Thus, Pakistan’s exports have not kept pace with global income growth.

Why is this the case?

In the early 1980s, the import substitution policy was replaced by export-led industrialization. However, this policy has miserably failed to promote exports and correct chronic foreign trade imbalances, and has instead created an import-oriented economy. Pakistan Business Council (PBC) in a report titled “Contours of a National Charter for Exports” pointed out that the “country has deindustrialized and lost its share in world exports and as an import-reliant and consumption-led economy, it has suffered from macroeconomic imbalances which have led to 22 IMF (International Monetary Fund) programs since 1958.” The report further advocated fundamental reforms to create jobs, promote value-added exports, and encourage import substitution. For this policy to bear fruits, a strong manufacturing-led export sector is required with a focus on increasing domestic efficiency while shifting its comparative advantage from primary to manufactured exports and, further, from a labor-intensive to a more capital intensive productive structure. The next plausible question is HOW!?

Improving the Economic Complexity Index of Pakistan

Pakistan’s Economic Complexity Index ranking has gone from 54 in 1980 to 94 out of 126 in 2017 with an index score of -0.86 (Refer to Figure 4). This indicator measures how knowledge intensive the export base is as well as how common the goods the country exports are. The World Bank has also given Pakistan one of the lowest rankings in the world for the share of exports in GDP, at only 8.2% in 2017. Pakistan’s neighboring countries in South Asia are doing better business. If we add up the total value of the exports of all countries in the world, Pakistan’s share has declined over time, from 0.16 percent in 2003 to 0.12 percent in 2017, according to the Pakistan Business Council.

Figure 4 Economic Complexity of Asian Tigers

An important point to note is that the conventional analysis of trade data fails to give any information about the causal-nexus that can lead to better policies. For example, firms in an industry are subjected to the same policies irrespective of their distinct performance. In order to understand their difference in productivity– we need firm-level data. Let’s take the example of the textile industry – Pakistan’s largest and most important export earner. It is important to explore this sector through the lens of innovation at the firm level with the hopes of generating insights that can be translated into action – at the firm level as well as in aid of macroeconomic policy. A relevant study in this regard by Aftab (2020), titled “Documenting firm level innovation in Punjab’s textile sector” studied 180 firms and concluded that only 39% reported to have conducted product innovation[1] (Refer to Figure 5).

 

Figure 5 Product Innovation in Pakistani textile firms

84% of firms reported extending the range of goods and services being offered and opening new markets as the primary reason for innovating. In a way, this testified to firms’ rationality and nullified the neo-classical notion of a firm engaged in the production of a homogenous product – firms place importance on the notion of growth and are cognizant that consumer preferences evolve. Hence, firms’ decisions are demand driven rather than cost minimization (Refer to Figure 6). Now that the global and national market has contracted (demand has fallen), it is plausible and safe to say that innovation will decline. When innovation declines, economic complexity will fall further leading to more inequality. This is worrisome for Pakistan.

Figure 6 Reasons for being Innovative (Product)

The Way Forward

Pakistan needs to rethink its industrial policy with the aim of improving its economic complexity. Henceforth, we have divided our recommendations into short, medium and long-term goals.

Short-term Goals

The country is unprepared for the challenges and opportunities offered by the 4th & 5th industrial revolution. Pakistan needs to sensitize its industries to switch to new technologies, which are not only cost-effective, but are also compatible with international standards. Textile sector is one highly promising area to target that is consistent with the “latent comparative advantage[2]” approach. It has forever been overly involved in low-productivity activities producing output at or near the “lowest end of technological sophistication and demand dynamism.” Hence, it is difficult to say but it is time for Pakistan to move away from textile-centric trade and support only those textile units that are well integrated in global supply chains. Moreover, there should be a realistic assessment of sectoral efficiency for the optimal allocation of resources, incentive schemes and efforts for export promotion.

The pandemic also made it evident that the market responds to demand. When cities ran short of hand sanitizer, disinfectant and masks - the government realized that such basic items were not produced locally and were in fact imported. Since Pakistan is a major exporter of raw ethanol, an important ingredient in sanitizers and sprays, the Pakistan Council for Scientific and Industrial Research (PCSIR) was tasked to produce sanitizers and disinfectant sprays. In two months, which is barely recognized as a lag in economic terms, Pakistan was not just self-sufficient but in a position to export these products. However, this spike in export earnings is temporary and not a way forward but should be considered as solid evidence that the country can adapt and produce in response to the demands of the local economy.

Medium-Term Goals

5G mobile networks hold great promise and potential to boost digital development in Pakistan, but delays in its deployment would delay a revolutionary leap in capacity from 4G to 5G, according to the World Bank. The roll-out of 5G opportunity will not only improve industrial processes but automate factories and enhance productivity. Therefore, there is an urgent need to upgrade and develop Pakistan’s ICT infrastructure, and make it more affordable to boost its industrial capacity and digital economy.

Secondly, Pakistan’s dairy sector has a lot of potential. Despite decades of oversight by the Government and the fact that Pakistan is the fifth-largest milk producer in the world, there is little in the way of success. A few recommendations to export Pakistan’s dairy products are as follows:

●      promote exports within the region because the quality standards are at par with those in the international markets;

●      enhance animal and enterprise productivity to satisfy the domestic and international demand;

●      make cold chains an integral part of the dairy sector (to improve milk quality)

●      introduce economical small-scale processing.

Long-Term Goals

Globalization that embodies the modern world is built on a strong scientific knowledge-based economy, derived from innovation. Pakistan is the only country in the world to cut funding for research and development after 2007 from 0.67pc of GDP to 0.24pc. R&D helps examine technological advances and innovative solutions, which foster economic growth and development, making it an attractive area for policy intervention at the state level. Henceforth, Pakistan should support R&D initiatives by providing extensive funding and pave the way for state-to-state collaboration.

To reap optimal benefits it is important to connect research to production. Moreover, it must be complemented by improved collaboration and dissemination of knowledge by mutually beneficial university-research and institutes-industry linkages in Pakistan and with those in neighboring countries. As the success of R&D is contingent upon development of skilled human capital, emphasis must be on academic quality, but more importantly on skill enhancement, and more funded training programs.

Disproportionate burden of taxes on industry, misdeclaration of imports, blatant availability of smuggled goods, short-term oriented export policies, energy shortfall, high cost and generally anti-manufacturing policies and many other factors have thwarted the growth of industry. Pakistan needs a fresh industrial policy that promotes employment generation, focuses on value-added exports with a dash of import substitution to reverse the trend of deindustrialization.

[1] Product innovation is defined as the introduction of a good or service that is new to the market or is a significantly improved version of a current product.

[2] The latent comparative advantage refers to an industry in which the economy has low factor costs of production but the transaction costs are too high to be competitive in domestic and international markets