While the potential for exploiting foreign demand for Pakistan's exports exists, the supply dimension relating to competitiveness is a moot point. Competitiveness means that the goods a country places for export on the world market command an edge, in price and quality, over those produced by its competitors. Competitiveness can be enhanced with lower per unit costs, which can be attained with lower factor and non--factor input costs relative to the world export price and/or higher productivity, that is, producers have the ability to obtain higher output for a given amount of inputs.
Policy instruments such as exchange rate and, import tariff, can also affect competitiveness in important ways.
Pakistan's record in these respects does not appear to be very encouraging. To begin with, the performance of the manufacturing sector has been somewhat average since the late 1980s. Growth has been volatile and the trend growth rate has been in decline. This volatility and declining growth trend is also reflected in the case of manufactured exports.
The declining growth trend in manufacturing output appears to have reversed since 1999, but the same has not occurred for manufactured exports. An investigation into the reasons that has prevented manufactured exports from performing better is, therefore, necessary.
Two comparisons are pertinent in this respect. First, the comparison of trends in manufacturing input prices and the general price level; second, the comparison of trends in the composite factor and non-factor input price indices and the export price index. The factor and non-factor inputs are distinguished rather arbitrarily, with the former defined to include capital and labour and the rest of the input items defined as non-factor inputs.
The methodology for computing composite factor and non-factor input price indices is shown in Box ss-2. The analysis of movements in input prices and productivity has been carried out over four periods with respect to trade liberalisation.
The first period, 1974-88, is the pre-liberalisation phase and the following period from 1989 to 2003 is divided into three 5-year segments.
Conceptually, for a given level of productivity, the manufacturing sector is likely to suffer from diminished competitiveness if factor and non--factor input prices were to grow faster than (1) the general price level and (2) export prices. This appears to have been the case in Pakistan.
The examination of manufacturing input price trends relative to the general price level over the period 1974-03 shows that the rate of growth of two out of three factor input prices - machinery and transport, and wages - was higher than the general price level, as measured by the GDP deflator While the GDP deflator increased by 9.2 percent, machinery and transport prices and wages rose by about 11.6 and 10.2 percent, respectively; however, the rate on advances grew by just over one percent.
With respect to non-factor inputs, local and imported raw material price increased slightly lower or at par with the general price level increase; however, energy prices rose by 13.6 percent. On the whole, the growth in both the composite factor and non-factor input price indices was lower at 8.9 percent relative to the growth of GDP deflator at 9.2 percent.
During the most recent period, 1999-2003, while growth in the prices of machinery and transport was significantly higher than that in the general price level, the growth in composite factor input price index was lower on account of virtually zero growth in the cost of labour, and the substantial 8 percent decline in the cost of advances.
These two cost items account for nearly 40 percent of non-raw materials cost. The stagnancy in real wages since 1999 discriminates in favour of competitiveness, but does not reflect well from a poverty reduction perspective. During the same period, the composite non-factor price index showed a higher growth than the growth of overall prices, largely because of significantly higher growth in imported raw materials and energy prices.
Energy prices showed the highest growth, rising about forty-fold between 1973 and 2003, compared to a fourteen-fold rise in general prices. Except during the period 1989-93, energy prices posted a double-digit increase, growing 2.5 times faster than general prices during 1999-2003.
Given that government levies - customs duties, sales taxes and development surcharges - constitute 30-50 percent of energy costs, there does exist scope for some reduction of the energy cost burden on the industry in order to enhance cost efficiency and improve competitiveness.
The assessment of manufacturing input price trends relative to that of export prices (in local currency units) shows that, over the period 1974-03, both the composite factor and non-factor manufacturing input prices increased faster at 8.9 percent than the manufactured export prices at 7.9 percent.
For the most recent period, 1999-03, competitiveness eroded even further with factor and non-factor manufacturing input prices growing at 2.7 and 4.9 percent, respectively, and manufactured export prices declining by 1.3 percent.
The implication of the higher growth of input prices relative to the export prices is that, unless there are significant offsetting increases in productivity, profitability of Pakistan's exporters is being eroded. In this respect, total factor productivity (TFP) - measured as residual output after accounting for the contribution of factor (capital and labour) inputs to output - grew at an average of 2.4 percent over 1974-2003.
However, the trend over the sub-periods is one of decline with TFP growth falling from an annual average of 3.2 percent over 1974-88 to 2 percent over 1989-93, and to one percent over 1994-98, recovering slightly over 1999-2003 to 1.5 percent.
While competitiveness can be measured directly by unit costs, data limitations do not permit this in the case of Pakistan. Alternatively, a measure of 'net productivity' is used to incorporate the effect of changes in input prices and productivity on competitiveness. Net productivity is defined as follows: If A is the difference between factor input price and export price growth, then net productivity growth is the difference between TFP growth and A.
For the period 1974-03, the differential between factor input and export prices is 0.96 percentage points. It follows that TFP is required to grow by at least 0.96 percent to offset the factor price disadvantage to enable producers to maintain their net productivity at existing levels. Given that TFP has grown by 2.4 percent over the period, net productivity can be assumed to have remained positive.
Over the sub-periods, net productivity growth has been low - though positive - at less than one percent between 1974 and 1993, highly positive at 8.3 percent during the period 1994-98, and negative at 2.4 percent during 1999-03.
The period 1994-98 appears to have been an unusual phase: the export price increase (15.6 percent) was 7.3 percentage points higher than factor input price increase (8.3 percent). The sharp increase in the local currency export price during this period was caused by a significant 4.8 percent rise in the US dollar-denominated world price of exports combined with a large 9.6 percent depreciation of the nominal exchange rate.
Even though TFP growth was just over one percent in this period, net productivity was highly positive at 8.3 percent. The most recent period, 1999-03, was unfavourable for the competitiveness of Pakistan's manufacturing sector, with net productivity having become negative. Given that the differential between factor input and export prices is 3.9 percentage points, it follows that TFP must grow by at least 3.9 percent to offset the factor price disadvantage for producers to maintain their net productivity.
Instead, actual TFP growth increased by 1.5 percent only, leading to negative net productivity. The significance of productivity can be seen from the fact that year-to-year movements in large-scale manufacturing value added correlate very closely with movements in TFP, with the correlation coefficient being as high as 0.89.
The relationship between the input and export price differential, on the one hand, and TFP, on the other, is important from the perspective of investment and growth as well. Where increments in productivity are converted to increased profitability, the necessary incentive for such investments appears to exist.
However, where increments in productivity are consumed by increasing factor or non-factor input prices, the necessary incentive for investment in productivity enhancing measures can possibly weaken. Since productivity growth is an important factor in staying internationally competitive, it is useful to analyse the determinants of TFP growth in Pakistan in order to make policy prescriptions.
The analysis identifies critical areas of policy intervention - human capital development, new investment in advanced machinery and productive capital, international competition, economic restructuring from less productive to more productive sectors, and availability of infrastructure - as significant determinants of TFP growth towards enhancing international competitiveness.-Courtesy: Social Development in Pakistan.
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