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
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
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
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.
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.