Future at stake: deindustrialization—I

Following the Information and Communications Technology (ICT) revolution of the 1990s, the international economy entered a second phase of globalization. The trend for developing countries within the GVCs (global value chains) has been to compete as suppliers within the production chain, usually at the lower value-added segments.

Developing countries engage in fierce price-based competition to gain a ‘slice of the pie’ within the textile chain. However, the GVC world has also ushered in new patterns of development. Specifically, it has changed the incentives for development from ‘deep’ industrialization to ‘shallow.’

This means that creating entire industries (deep industrialization) is no longer preferable compared to slotting into specific segments of the fragmented value chain (shallow industrialization). With this new dynamic arise two observable trends for industrialization within developing countries.

These processes are stalled industrialization and the looming threat of premature deindustrialization. This means that the social and economic gains from manufacturing-led development are exhausted earlier than precedent, leaving developing nations in a stunted growth bracket.

Pakistan has experienced only limited industrialization, with its major obstacles being resource constraints especially in energy supply, a distortive regulatory environment, and restricted export orientation. Before Pakistan can enter the virtuous cycle of industrialized development, premature deindustrialization is already a material concern.

Since 1990, Pakistan’s economy has become inward oriented, with exports’ share of GDP falling from 16% to 10% between 1990 and 2020 (World Bank, 2022). Complex and cascading import duties stifle growth, as firms lack competitive incentives to increase efficiency.

These duties also prevent better intermediate inputs from entering the economy, hindering partial factor productivity growth. Though the situation seems dire, Pakistan has the potential to reverse this pessimistic outlook.

The World Bank estimates that Pakistan ought to be able to quadruple its export value. The role of the textile sector is particularly instrumental.

Textile exports represent 60.81% of all exports, the sector recorded the largest trade surplus in 2021, and textile products (knitted and unknitted) made up Pakistan’s second and third fastest growing exports in the same year (Pakistan Bureau of Statistics, 2023).

Pakistan’s 2.6% expansion in overall exports is significantly due to textile exports. Therefore, for Pakistan to shirk the spectre of deindustrialization, export-led growth through investment in textiles guarantees the most gainful use of resources.

The general trend of deindustrialization

The phenomena of stalled industrialization and premature deindustrialization occur when the manufacturing sector begins to stagnate at lower levels of either relative employment shares, value-added shares, or per capita income shares following a peak. As this happens, the development potential of manufacturing to generate employment, growth, and investment is exhausted prematurely.

In response to a stagnant or contracting manufacturing sector, urban labour shifts to either services, or informal manufacturing. This creates a bloated service sector, which experiences depressed wages and increases income inequality between high-skilled and low-skilled labour.

Those segments of the working population that cannot find urban employment may move back to agriculture or fall into poverty.

The long-term outcome of these processes results in increased income inequality, decreased manufacturing output, and the loss of the ability to compete in export markets. These risks become especially likely given un-strategic and distorting regulatory environments.

Manufacturing output as a percentage of GDP has been falling since its peak of 15.71% in 1994, as shown in the graph below (World Bank, 2023). In the last twenty years, Pakistan has experienced meager manufacturing growth of 10.22% in 2000 to 11.91% in 2022.

Pakistan’s industrial production index growth rate has been stagnant at approximately 4.2% since 1998, with only a sharp decrease and corresponding increase during and after the COVID-19 pandemic (CEIC Data, 2022).

Moreover, GDP from manufacturing is approximately half of the GDP from agriculture, and approximately one-fifth of the GDP from services (State Bank of Pakistan, 2022).

This composition is worrying, as manufacturing is historically the engine of development due to its potential for productivity gains, capital accumulation, and value-added production.

The path to development must involve a sectoral shift from the relatively less productive agricultural sector, towards the more productive manufacturing sector. Pakistan’s shift has been incomplete, and the evidence is clear given the aforementioned shares of GDP per sector.

This untimely exhaustion of manufacturing growth has also meant the premature growth of the service sector and the informal economy.

SMEs (Small and medium-sized enterprises) and the informal economy are characterized as an ‘in-between’ sector in development literature. This refers to their low productivity, higher inequality, and limited avenues for technological change (Sumner, 2018).

While quantifying variables in the informal sector is difficult, it is estimated that SMEs and the informal sector comprise 72% of manufacturing in Pakistan (SMEDA, 2022).

World Bank observations show that firms in the formal economy only account for 13% of value-added (2022). SMEs and the informal sector also dominate employment shares.

Manufacturing SMEs and informal producers have 90.27% of shares in total manufacturing employment (SMEDA, 2022). The rise of the manufacturing SMEs, especially in textiles, takes place simultaneously with the decline of formal manufacturing.

The informal sector and SMEs are acting as a sponge for unemployed labour. However, such conditions cannot be a viable driver of industrialization. Firstly, the informal sector has limited capacity for economies of scale, due to its limitations in size, dispersed production, and lack of leverage to extract higher returns from trans-national corporations.

This results in limited investment confidence, which is evidenced by the State Bank of Pakistan’s regulations for SME financing being limited to medium-scale financing and risk management (2021). Secondly, SMEs and the informal sector are generally oriented towards the domestic market.

This can be helpful during stages of transition, where a nation intending to orient production towards exports can utilize the informal and small economy to fulfill domestic demand.

However, while Pakistan’s SMEs have a 30% share of total exports, upwards of 80% of those exports are low-value added (SMEDA, 2022). Therefore, there are limited returns especially compared to formal manufacturing.

(To be continued on Sunday)

Copyright Business Recorder, 2023