Is industrial policy passe for Pakistan?

By S. M. Naseem

Pakistan's manufacturing sector holds the key to whether the country will succeed in regaining the lost ground in the extremely competitive race for development in emerging Asia.

If the country had continued the pace of manufacturing growth it started out with in the first two decades of development when it averaged over 12 per cent per annum, it would easily have entered the ranks of tiger economies by now. But the neglect of many structural factors, especially land reforms and education, prevented it from maintaining the momentum of those early decades.

Political developments, both domestic and external, also conspired to slow down the rate of growth of manufacturing and impede the structural transformation from an agrarian to an industrial economy.

Without such a transformation, it would not be possible for the country to achieve the growth rate that is necessary for it to attain the place it aspires for in the highly competitive economic race in Asia.

Pakistan's industrial sector remains a relatively small part of the total economy. The share of manufacturing in GDP has risen by less than 30 per cent since 1968, while it has increased by 280 per cent in case of Malaysia, 170 per cent in case of Thailand and 120 per cent in case of Korea.

It is significant that in the case of South East Asian countries, including Asia, which had in the past depended largely on the production and export of primary products have dramatically shifted their production structure and export basket in favour of manufacturing and non-traditional exports.

In the case of Pakistan, however, primary products and exports based on them, principally, cotton and its manufactured products, still have the dominant share. Bangladesh in South Asia is the most successful story of transformation from its dependence on jute and jute products, which now account for less than 10 per cent of its export proceeds, to garments and knitwear, which account for about 60 per cent of its export earnings.

A similar example is that of Taiwan where the government decided to dismantle the production and processing of sugar, a traditional industry which had fallen on hard times due to international competition.

Instead, the government launched an investment programme of $65 million to develop a world-class orchid industry, which would absorb those growing and producing sugar.

There is considerable inter-country statistical evidence to suggest that countries which diversify their industries grow richer than those which don't. According to one such study published in 2003, there is a U-shaped relationship between industrial concentration and per capita incomes. What this means is that as countries diversify their income increases until the point when they have found their real comparative advantage in a few specialized activities.

Achieving specialization at too early a stage and ossifying the country's comparative advantage in a few industries is detrimental to its growth. On the other hand, countries with high income levels, such as the United States, can afford to remain specialized in a relatively few industries with large economies of scale.

The acquisition of mastery over a broad range of products, rather than concentrating on a few products which it has become accustomed to exporting, seems to be the proper strategy for long-term growth.

Such diversification does not have to be random, but should result from a systematic study of world demand for new goods and the country's ability to produce them at competitive prices. This is where industrial policy can a play a critical role.

Most instance of "productive diversification" are the result of concerted government action and of private-public collaboration. In the Taiwanese example quoted above, for instance, the government provided infrastructure, including a genetics laboratory, quarantine site and power and transportation facilities, besides giving subsidized credit for green houses to produce orchids.

The bane of Pakistan's manufacturing sector is the lack of diversification, epitomized by its heavy dependence on cotton and cotton textiles. This is largely due to the continued influence of large cotton growers and textile mill owners exercise in the politics and decision-making of the country.

Pakistan's policy makers have not been able to think out of the box because of these pressures, despite the falling share of the country in world textile exports and continued infusion of resources, including bank credit and other facilities.

According to the State Bank of Pakistan's figures for July-December 2004, the textile sector which has always been pampered by government policies in the past, continued to get the lion's share of credit, increasing its credit off-take by 25.4 per cent to Rs95.4 billion; it constituted 39 per cent of the total credit off-take and 75 per cent of the total credit utilized by the manufacturing sector. If a serious study of domestic resource costs was made, the textile sector would rank high among the most socially costly industries in Pakistan.

The policy response to this situation is not necessarily to disinvest from the sector but to make it more efficient and to discourage its further expansion. It should be required to use its own savings to undertake the expansion rather than gobbling a huge chunk of commercial bank credit which could be deployed to encourage more dynamic emerging industries, as well as agriculture and rural industries.

What is needed, therefore, is a recourse to industrial policy which was successfully adopted by many East Asian countries to transform their economies through industrialization.

In recent years, especially, since the 1997 East Asian crisis, industrial policy is being termed as passé and is being blamed as one of the culprits of that crisis, although there is no credible evidence to support it. The neo-liberal endorsement of that miracle is restricted to market liberalization, deregulation and privatization.

However, the East Asian countries never regarded the state as a passive onlooker of market players, but exercised a positive influence on them in encouraging them to invest in industries which had high export potential and social benefit.

In the eagerness to continue the discredited Washington Consensus and the rush towards globalization, many countries are eschewing the positive lessons of the East Asian miracle.

Others are afraid of the stringent rules of WTO. But more often it is the domestic vested interests which oppose the entry of dynamic industries to compete for the country's limited resources.

The news of the demise of "old fashioned industrial policy approach", however, seems highly exaggerated. Neither is the assumption it doesn't work or that it would be harmful to the health of developing countries in the age of globalization a valid assertion. Professors Dani Rodrik of Harvard and Sanjaya Lall of Oxford have shown in recent articles that industrial policy is alive and working.

Professor Rodrik specifically asks the question "whether the practice of industrial policy remains valid under today's international rules of the game" and gives the unequivocal reply that the latter "do not bind (the countries) in a significant way". "What stands in the way of coherent industrial policy is the willingness of governments to deploy it, not their ability to do so."

While economists at the World Bank are still wary of touching industrial policy with a long pole, they are unable to deny that it did play an important role in the realization of the East Asian miracle which the bank celebrated with some fanfare over a decade ago.

However, it was argued that the East Asian economies were a special case and that the capability of "choosing winners" was not replicable by other developing economies. Whether the Bank's attitude towards industrial policy will become more negative when the hawkish Mr Wolfowitz takes over the reins of the bank in June remains to be seen.

However, there is now a better appreciation of the role of the state even among neo-liberal economists who until now restricted its legitimate role to maintenance of law and order, a sound legal system and macroeconomic management, are willing to grant it a role in providing a non-selective and functional role in the provision of such public goods as education, health and infrastructure, without excluding the private sector from such activities.

Selectivity has been at the core of the recent debate on industrial policy. In contrast to the neo-liberal argument, the structuralists have argued that learning and capacity building involve market failures which need to be remedied by government action and that the risk of such intervention leading to government failure (e.g., corruption and inefficiency in the public sector) is no more than the risk of market failure which is intended to be corrected.

Another reason for the need for undertaking industrial policy in preference to unhindered play of market forces, as pointed out by Stiglitz, stems from imperfect information and incomplete markets in most developing countries.

Although research and development investments are not needed in the early phases of industrialization, their total neglect can prove costly in the future. Even without R&D investments, success in industrialization in developing countries depends to a large extent on how enterprises manage the process of mastering, adapting and improving currently available technology through reverse engineering or other innovative ways.

They require investment in new skills, routines and technical and organizational information. Such investment is often subject to market and institutional failures requiring selective, rather than across the board, government intervention.

A counter argument against selective government intervention or industrial policy is that 'foreign direct investment' brings with it a package of technologies and export potential which obviates the need of local capability generation and deepening.

Despite this local capacity generation remains an important instrument for sustainable industrialization and becomes more important in tapping globalized systems which need stronger capabilities and more discretionary policies.

The degree of policy freedom currently available to developing countries under the new stated and unstated rules of globalization has become very limited. The space for industrial policy available to East Asia and to developed countries in their early phase of development is not available to contemporary industrializing countries.

Unless they want to become overly dependent on FDI flows to drive industrial and capability development, governments of these countries will have to carve out whatever little space still remains for them to pursue industrial policy and restructure and reinvigorate their industries for sustainable growth.

It is in this context that Pakistan needs to take effective measures to reinvigorate and diversify its ossified industrial sector. Not only does it need to provide generalized support to its industrial sector in terms of a good macroeconomic environment and infrastructure, but also needs to attend to the specific needs of industries with higher growth and export potential.

It also needs to take a close look at its present industrial structure and see which industries have reached their saturation point and which newer industries need to be encouraged and developed with some selective state support.

By prioritising and deploying support in favour of dynamic industries in terms of access to resources available, the country can achieve a higher industrial growth trajectory. To do all this, the government will have to make full use of the opportunities available to implement an intelligent industrial strategy in a competitive global economy.

[taken from http://www.dawn.com/2005/03/28/ebr2.htm]

Date/Time Page Created: 03/29/05

Date/Time Last Modified: 3/29/2005 2:30:20 PM

© 2004, Human Development Foundation. All rights reserved.
1350 Remington Road, Suite W, Schaumburg, Il. 60173
Toll Free: (800) 705-1310 | Email: info@yespakistan.com | Privacy Policy