This article is part of a series titled “Is there a way forward for Pakistan?” Read more about the series here.
Pakistan continues to experience deep economic turmoil. Years of mismanagement by subsequent governments and political instability have contributed to the economic crisis. As I write this article, the country’s liquid foreign exchange reserves stand at an abysmally low at around US$ 4 billion, enough to cover less than a month’s imports. The Stand-by-Agreement (SBA) with the International Monetary Fund (IMF), the lender of last resort, remains stalled. The lack of progress on the IMF programme means that inflows from ‘friendly countries,’ a euphemism for China and Middle Eastern countries, especially Saudi Arabia and the United Arab Emirates (UAE), have not materialised. Subsequent governments, including the Pakistan Tehreek-e-Insaf (PTI)-led coalition and the Pakistan Muslim League-Nawaz (PML-N)-led Pakistan Democratic Movement (PDM) government, have meandered through these crises, hoping for a miracle. Limited attention has been given to the root causes of the deep structural constraints contributing to the boom-bust growth cycle affecting the country’s economy. The economic woes have been exacerbated by instability and the almost constant political engineering, which has become a hallmark of Pakistan’s political economy.
In the rest of the article below, I will highlight some of the major issues affecting Pakistan’s economy, especially manufacturing. I will follow this with some suggestions to help alleviate these problems.
Manufacturing
A substantial structural change has occurred in Pakistan’s economy over the last two decades. The services sector has emerged as the primary growth driver, while industry and agriculture have underperformed. Within the industry, growth in manufacturing has been particularly sluggish. A comparison with other large regional economies in South Asia shows that the share of manufacturing in GDP is the lowest and has been for a considerable period, showing evidence of secular stagnation. The declining share of manufacturing in the GDP has raised fears that Pakistan is going through premature de-industrialisation (Hamid & Khan, 2015; Nazeer & Rasiah, 2016).
The literature highlights several issues contributing to this dismal picture in the manufacturing sector. A strand focuses on the negative effects of rapid liberalisation and deregulation, which increased the cost of inputs, for example, electricity (Zaidi, 2005). Furthermore, the privatisation of banks increased the borrowing costs for manufacturers (ibid.). More recent empirical evidence, however, suggests that over the last two decades, while tariff barriers have come down, governments have enacted non-tariff measures and regulatory duties to protect local industries. This has meant that the overall trade protection is at the same levels as in 2001. This is especially true for politically connected firms that have benefited disproportionately over the last two decades from a mix of tariff and non-tariff measures (Malik, 2022). Malik (ibid.) argues that trade protection that is given to special interest groups, especially firms with political connections, has contributed to the anti-export bias, leading to the problems of stagnant exports, low productivity, and the perennial current account deficit.
The anti-export bias also contributes to lower productivity. Evidence suggests that there is substantial heterogeneity in productivity levels between firms that export and those that don’t (Lovo & Varela, 2020). They estimate the productivity gap to be 25 per cent. Low productivity negatively affects the ability of local firms to compete in export markets (Safdar, forthcoming) as can be evidenced by the decrease in the share of exports to GDP from 12 per cent in 2000 to 10 per cent in 2021.
Apart from the anti-export bias, the structure of manufacturing remains concentrated in low-technology areas like textiles and food processing. Pakistan failed to enter high-technology areas, unlike the more dynamic economies in East Asia and, more recently, in Southeast Asia like Vietnam. This concentration is a function of policy frameworks that have created islands of what Naseemullah (2017) identifies as rent-thick areas within manufacturing in the name of food security and import-substitution industrialisation (ISI). The sugar industry is a classic example of an industry where the country has limited comparative advantage, yet it has received generous rents and state patronage (Safdar, 2015). Similar is the case with other significant contributors to large-scale manufacturing (LSM). Cement and automobiles are also technology laggards, where local manufacturers have limited prospects of achieving global competitiveness (Safdar, forthcoming). Within manufacturing, there are a few politically connected areas where rents remain high. Based on an analysis of the return on equity (ROE) for firms listed on the stock exchange, Pasha (2018, p. 158) shows that the ROE is the highest in ISI sectors like automobiles and food. Despite the importance of textiles in Pakistan’s exports, the ROE of firms engaged in textile spinning, weaving, and textile garments is the lowest among listed companies (ibid.).
Trade protection that is given to special interest groups, especially firms with political connections, has contributed to the anti-export bias, Leading to the problems of stagnant exports, low productivity, and the perennial current account deficit.
On the other hand, more dynamic industries that can become globally competitive and offer opportunities for technological deepening, like pharmaceuticals and electronics, have struggled to attract investment (Safdar, forthcoming). Exports also remain concentrated in low-technology areas, and the country continues to focus on a narrow basket of goods for a substantial portion of exports. The continued dependence on textiles is an example of this concentration.
As opposed to creating value-enhancing rents similar to the East Asian experience, in the absence of performance monitoring by the state, state policies have created value-reducing rents based on patronage. The state’s ability to monitor rent distribution has become much weaker, while its ability to reallocate these rents is non-existent (Khan, 2000). This has given rise to a manufacturing sector where large parts remain dependent on continued state protection, with a limited incentive to improve productivity or competitiveness or to move up the value chain and diversify.
Elite interests & manufacturing
The incentives of the ruling elite do not gel with long-term development goals, and there is a focus on maximising short-term returns. Part of the problem is the access to substantial and recurring geopolitical rents over the last four decades. Access to these security rents, the distribution of which has been centralised, has had profound implications for the state’s capacity to implement growth-enhancing policies (Roy, 2013). The mode of unproductive rent capture worked even during periods of direct military rule. For example, during the decade-long rule of Pervez Musharraf, there was a marked increase in the demand for consumer durables and luxury goods on the back of high external inflows (Pasha, 2018). Pakistan’s elite favoured accumulation and speculation in real estate finance and energy (Naseemullah, 2017). Despite the inflows from external sources, speculation and consumption-based rents dominated while crowding out rents generated in manufacturing (ibid.; Dawani & Sayeed, 2020).
The incentives of the ruling elite do not gel with long-term development goals, and there is a focus on maximising short-term return
Given the incentive structure, the returns generated by manufacturing cannot compete with those from real estate. Furthermore, lower returns in manufacturing, especially in textiles, have meant that an increasing number of local manufacturers have diversified into real estate. Pasha (2018) argues that the taxation regime has also evolved to increase returns available to real estate developers. There is little regard for the economic and social consequences of the growing number and scale of housing societies as they expand in peripheral cities and towns that supply a substantial portion of the country’s food. Organisational interests linked to the country’s leading political and economic actors have been significant beneficiaries of this accumulation model by dispossession. This link contributes to the privileged position that real estate enjoys within Pakistan.
Real estate speculation has more profound implications for Pakistan’s manufacturing sector. The failure of numerous industrial and export processing zones in the country is also linked to their emergence as spaces of speculation and rent generation (Jamali et al., 2021). While these zones and industrial estates have been successful across countries in Asia, their contribution to exports in Pakistan remains minuscule. The limited ability of the state to enforce rules has meant that even when rules are enacted to discourage speculative behaviour, they are routinely disregarded or amended, further increasing the returns to engaging in such activities.
Can it be done without manufacturing?
Changes in the global economic structure have meant that service-led growth has emerged as a major paradigm in thinking about growth and economic development. The argument is that given advances in technology, and the changing structure of production, policymakers in countries like Pakistan that have struggled to industrialise can follow a services-led growth strategy, focusing on Information Technology (IT) and other such emerging technologies to boost growth. These slogans have enamoured Pakistani policymakers; however, Rodrik (2014) argues that while there is no denying that the role of services is growing, service-led development is unlikely to contribute to rapid growth and good jobs in the same way as manufacturing did in the past. Furthermore, structural constraints are posed by how the services sector is organised; unlike India, where higher productivity tradable services like banking and software dominate, Pakistan’s service sector is dominated by low-productivity traditional untradable services. Thus, the domestic services structure cannot support a service-led growth strategy.
Moving beyond Structural constraints
The above analysis highlights some structural weaknesses affecting Pakistan’s manufacturing sector. Structural weaknesses have been exacerbated by a short-term time horizon which has worsened unproductive rent-seeking. A growth model predicated on speculation, especially in real estate, further contributes to Pakistan’s deep-rooted economic problems. The growth model is deeply entrenched in Pakistan’s political economy. Those who gain from this economic model are unlikely to support any changes which could negatively affect their rents, even in the short run.
The road ahead is tough; however, the following suggestions could help put the country on a more sustainable growth plane:
- Despite the initial promise, the China-Pakistan Economic Corridor has had a limited impact on Pakistan’s manufacturing sector. Despite assertions that CPEC will be a game changer, there is limited evidence of industrial relocation to Pakistan. Given the incentive structure, most Chinese investment has flowed towards rent-thick areas like power generation rather than manufacturing. In Vietnam, on the other hand, in 2018, 61 per cent of Chinese investment was in the manufacturing sector (Safdar, forthcoming). Foreign investment in manufacturing, especially textiles as the largest export-earning sector, remains dismally low. The challenge for policymakers is to alter the incentive structure to attract Chinese investment in manufacturing. There are fears regarding the impact on local manufacturers; however, in the absence of interest by local firms, inducing Chinese manufacturing investment needs to be a policy priority. This inducement must be accompanied by phased performance and local sourcing guarantees to build backward linkages.
- Linked to the above point is the operationalisation of the Special Economic Zones (SEZs). The Chinese routinely highlight the importance of SEZs in their development. While policymakers continue to observe that the next phase of CPEC is based on industrial development, the lack of seriousness can be gauged from the fact that none of the prioritised SEZs is ready. Work on Dhabeji, which is located next to the port in Karachi, is in the early stages, and the SEZ is unlikely to begin operations in the short run. Given this situation, there is a need to expedite work on the SEZs and attract private Chinese capital. Given the scale of investment by the Chinese in CPEC, the Central Chinese government could play a role in inducing some Chinese firms to relocate their operations to Pakistan.
- The incentive structure, which is predicated on short-term speculative returns, must change. This is vital to attract capital towards manufacturing, especially those sectors that can generate exports and become globally competitive. Changing the incentive structure is extremely difficult given Pakistan’s prevailing political settlement and the privileged position that the real estate sector enjoys within that settlement. A broad-based coalition with backing from the country’s most powerful organisation is required to alter this incentive structure. Given their organisational interests, this is easier said than done.
- Within manufacturing, there is an urgent need to channelise learning rents to more dynamic industries. Given the political linkages of firms that have access to these rents, getting industries to forego these rents in the absence of a coalition of actors is unlikely to be successful.
The writer is a Post-Doctoral researcher at the East Asia Center and the Department of Politics,
University of Virginia. His research explores the political and economic implications of China’s
rise for countries that are part of the Belt & Road Initiative. He holds an MPhil and PhD in
Development Studies from the Department of Politics & International Studies, University of
Cambridge.
 with the International Monetary Fund (IMF), the lender of last resort, remains stalled. The lack of progress on the IMF programme means that inflows from ‘friendly countries,’ a euphemism for China and Middle Eastern countries, especially Saudi Arabia and the United Arab Emirates (UAE), have not materialised. Subsequent governments, including the Pakistan Tehreek-e-Insaf (PTI)-led coalition and the Pakistan Muslim League-Nawaz (PML-N)-led Pakistan Democratic Movement (PDM) government, have meandered through these crises, hoping for a miracle. Limited attention has been given to the root causes of the deep structural constraints contributing to the boom-bust growth cycle affecting the country’s economy. The economic woes have been exacerbated by instability and the almost constant political engineering, which has become a hallmark of Pakistan’s political economy. ){kind=link}