Govt’s efforts to entice FDI in automobile, telecom sectors in form of assembly units depended on incentives

ISLAMABAD   -   The Economic Advisory Group has noted that proposed automobile and mobile phone manufacturing policies are a repetition of the mistakes committed over 40 years ago in automobile industry by applauding market-seeking FDI and establishment of assembly plants, which are the lowest components of the entire value chain, least profitable, do not enable transfer of technology.

The independent EAG met to review the industrial policy and reforms being pursued by the government, especially in the automobile and telecom industries. It observed that the past and contemporary policies have been focused on merely establishing assembly units, instead of developing manufacturing capacity, which is the real driver of growth in an economy; consequently, the inflow of FDI has been limited compared to profits earned and repatriated out of the country.

Furthermore, the efforts of the government to entice FDI in the automobile and telecom sectors in the form of assembly units depended on incentives such as tariffs and subsidies. The protection provided to make these industries competitive is based on assumptions of latent comparative advantage, without any utilisation of tools such as Mill and Bastable Tests, which guide decision makers regarding the efficacy and compatibility of protection. The rationale behind protection is to provide an opportunity for subsequent research and innovation in technology to augment efficiency, which has never happened in the case of Pakistan.

The existence of market failures and externalities justify government intervention in the form of initial protection to make sectors competitive at the global level, but continuous protection does not equip industries to become efficient and leads to consumer and welfare losses due to higher prices. In fact, protection for any length of time has proved to be deadly, as lobbies have worked hard to ensure that it is never removed, so that industries stay infants forever. The globalised and value-chain based world of today requires rapid and systematic removal of protection so that a country is forced to identify and operate in its area of comparative advantage or risk being delegated to producing a miniscule share of global value addition. In the context of the upcoming auto policy, the decrease in the tariffs on CKDs, as envisaged in Finance Bill 2021-22, which will be imported into the country and then assembled, in reality, discourages domestic auto-part makers because imported items are being subsidised against domestic production. This implies that relative profits will be higher in the assembly business as compared to the auto-parts manufacturing business, which will gradually reduce the linkage between auto assemblers and domestic auto-part makers.

The auto industry has not been able to scale as the domestic market is too small due to demand being squeezed through protectionist policies. Pakistan is also not sufficiently connected to the international industrial community to enable transfer of knowledge and technology. The country has more incentives to scale domestic auto-parts rather than the assembled finished goods because the former has a higher demand due to utilisation in new and used cars.

In the context of expected FDI in the telecom sector, if mobile phones are assembled without value addition arising from some intrinsic latent advantage but only as result of some fiscal incentive, then the industry will remain dependent on protection from the government and manufacturing will not become a profitable avenue for companies. Such investment will be market-seeking instead of efficiency-seeking.

The new mobile phone manufacturing policy is regressive as tariffs are more than 70 per cent on lower-end mobiles and hover around 40 per cent on higher-end phones. The policy also fails to incentivise the inflow of new technology and latest devices to the country as consumers will be paying higher prices for old-generation phones just to enable companies to set up assembly units in the country.

The EAG has asked for comprehensive review of the upcoming policies through economic modelling is required before their implementation, to ensure consumer and overall economic welfare. The Economic Advisory Group is an informal association of individuals drawn from economics, policy and the private sector that deliberates regularly on economic developments and shares its views with the government and the public. It is supported by PRIME, an independent think tank.