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Policy Challenges For Industrial Revival
Dr.Akmal Hussain
Newspaper: Daily Times
Dated: 13TH JUNE 2002
 

Pakistan's large scale manufacturing sector (LSM) remains in the grip of the most acute and protracted crisis in Pakistan's history. The crisis lies in the sharp decline in the manufacturing growth rate on the one hand and adverse changes in its structure on the other. For example the growth rate of the LSM sector which was 0.8% per annum during the 1980s, fell to 5.5% in the 1990s, and is now growing at less than 3%. Thousands of industrial units have closed down and most of the remaining ones are operating at less than full capacity. Consider now, the adverse structural changes that have occurred during the last decade. The declining growth rate of output has been accompanied by a sharp decline in employment elasticities of manufacturing output. At the same time the efficiency of capital use in the manufacturing sector has declined. This means that for given investment rates the growth rate of output is now lower than before. Consequently, the adverse effects on output growth of the observed sharp decline of investment in the manufacturing sector has been accentuated. (Investment in the manufacturing industries declined from 4.7% of the GDP in the early 1990s to 2.7% of the GDP in the late 1990s).

Causes of Declining Growth

Given the structural weaknesses in the manufacturing sector the decline in the growth rate has occurred due to two sets of factors that emerged in the 1990s:

(1) A changed international environment characterized by: (i) Reduced availability of cheap credit to local industrialists as concessionary foreign capital flows began to dry up. (ii) A changed pattern of global demand for industrial products with a shift to higher value added, and knowledge and skill intensive, products. Pakistan's industrial structure was not positioned to respond quickly to these changed market conditions.

An erosion of the domestic framework within which investment and growth is sustained. The major factors in this regard are: (i) Sharply increased violence with the emergence of armed militant groups of religious extremists. There were frequent cases of professionals, traders and entrepreneurs being murdered and kidnapped for ransom during the 1990s. Apart from this the persistent tensions along the India Pakistan border bring war clouds with a depressing regularity. The resultant sense of insecurity of life and property are not conducive for investment. (ii) Political instability combined with frequent changes in the policy environment. (iii) Exceptionally high interest rates and shortage of credit to entrepreneurs due to high intermediation costs of banks and imprudent lending by nationalized banks on political grounds in the past. (iv) Astronomical electricity tariffs, partly due to high distribution losses by WAPDA (estimated at 25%) and partly due to an ill-advised shift into expensive thermal electricity generation units. (v) Lack of facilities for training skilled persons especially in the high skill sectors such as electronics and software development. (vi) An inadequate technological base through which industry can respond in a flexible way to changing patterns of demand. (vii) During the decade of the 1990s, there was an adverse policy environment in which the tariff structure and export incentives were distorted against entrepreneurs who were seeking to improve quality and productivity for export growth.

Policy Challenges for Industrial Revival

1. The establishment of a lasting peace with India through a just resolution of the Kashmir dispute is necessary. The return from the present war like situation to a no war no peace, status quo ex ante, would not be healthy for industrial investment either in Pakistan or for that matter in India. Apart from this, re-establishing the writ of the State within country is equally important for new investment.

2. The problem of the sharp slow down in the growth rate of manufacturing may be partly due to the deflationary policies followed under the IMF "structural adjustment program" for more than a decade. The fundamental flaw in the IMF programme of reducing domestic consumer demand, was the invalid assumption that production capacity thereby released, would be used for supplying export demand. The fact is that the manufacturing sector in Pakistan is not primarily export based and there is still considerable under utilized production capacity. This points to the policy imperative of stimulating rather than constricting consumer demand. Therefore contrary to the IMF mantra, the case for expansionary fiscal policies to revive demand may be worth examining.

3. An important factor in freeing resources for private sector investment, particularly its working capital requirements, is the reduction in government borrowing from the banking sector. Therefore to avoid crowding out credit for the private sector, the government needs to take to go ahead with the planned legislative measures to place a ceiling on its borrowing.

4. The profitability issue in the potentially dynamic sectors of industry is important for the revival of the manufacturing sector. In this context it may be pertinent to point out that the industrial structure has moved against high value added products partly due to distortions induced by the tariff structure. Therefore tariff rationalizations and resultant changes in the relative profitability of industries towards high value added products may be important for reviving industry.

5. The increase in the sales tax and the regulatory duties on raw materials and intermediate goods has made domestic manufacturing less competitive against smuggled goods, especially poor quality and cheap counterfeit goods, which are exact copies of established domestically manufactured brands. It may be useful, therefore, for the government to examine the effects of taxation on competition with smuggled and counterfeit goods. At the same time more energetic administrative measures need to be undertaken to reduce smuggling and the violation of Pakistani copyright laws by counterfeit imports.

6. Energy costs, which for many industries are a significant element in production costs, need to be reduced. Existing high electricity tariffs for industry are a significant factor in constraining both investment and export competitiveness. The electricity prices can be brought down by: (i) Accelerated production of hydro-electric power and thereby changing the composition of total power supply with respect to hydel and thermal power in favour of the former. The government has already begun to take initiatives in this direction. These need to be pursued vigorously. (ii) Reducing transmission losses by investing in improved transmission technology, and reducing theft.

7. Changes in the policy environment and sharp fluctuations in the exchange rate create increased medium term uncertainty with respect to profitability projections of existing and planned industrial projects. Therefore careful management of exchange rate stability, together with the consistency in the policy environment would be conducive to investment.

8. Foreign investment could play an important role in reviving the manufacturing sector and the overall economic growth. Attracting long term foreign investment would require, to start with, the containment of violence and religious extremism and the emergence of a more tolerant and peaceful social environment. Equally important is political stability. Apart from this, the following institutional measures would be helpful for foreign investment: (i) A sound legal system including enforceable bankruptcy laws that allow exit of poorly performing companies. (ii) Institutions that produce people with high quality modern skills not just at the executive level but also technicians at the shop floor level. (iii) Domestic capital and labour markets that function without unnecessary distortions. (iv) Strengthening transparency requirements of banks and financial institutions. Accurate and timely data should be provided by them on reserve levels, short term borrowing and exposure to interest rate and exchange rate risk.

CONCLUSION

The crisis in industry is so deep rooted now that it will take action on a number of different fronts to overcome it. Initiatives will have to be taken in the spheres of foreign policy and domestic law enforcement. Specific measures to counter the invasion of Pakistani industry by illegal counterfeit goods would have to be undertaken. At the same time, as we have argued in this article, a change is required in the mind set within which monetary and fiscal policies are conceived.

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