Protectionism vs productivity

ARTICLE: Pakistan has the world's seventh-most protected economy. The country's inward oriented trade policies have served as a substantial roadblock to integration in regional and global value chains. This is evidenced through research by the World Bank, PIDE and APTMA, and particularly through the work of senior economist Gonzalo Varela, which is drawn upon in this article. While modern day production networks rely on components of final goods being able to move with ease through multiple countries, protectionism has made this process inefficient and costly in Pakistan. Tariffs and other duties on imports ultimately serve as a tax on exports, as on intermediate inputs, these can be up to four times higher than in East Asia. Furthermore, average tariffs on final goods in Pakistan are 50 percent higher than the average for South Asia, and almost three times as high as the average for East Asia. (World Bank)

It is evident that periods of high tariffs within Pakistan led to export reduction, while low import taxes promote exports. In this context, a reduction in taxes can be observed from the following data: the first decade of the 2000s, government reduced trade taxes from 23.1% in 1999-2000 to 8.9% in 2014. This had led to gains in exports by 173%. However, this reduction was not consistent and until 2019, the tariffs increased to 11.6%, declining the exports to 9.1%. (PIDE)

As a glaring example of irrational tariff policies, the MMF tariff regime effectively prevents Pakistan from aligning its products in tandem with the rest of the world. More than 60% of world textile trade is in MMF materials, the demand for which has grown exponentially owing to the convenience it affords. However, the duty protection given to obsolete plants in Pakistan is denying the Pakistani industry any chance to compete in this booming market, internationally or domestically. As a result, our textiles sector has primarily been producing short staple fiber raw cotton while the world moves forward with a focus on synthetic fibers. This brings us to the issue of polyester staple fiber, a raw material of the industry upon which it would be unreasonable to apply any duties. Alarmingly, at present there is a 7% customs duty on the import of polyester staple fiber. This racks up the total import duties, which subsequently fall in the range of 20% including antidumping duty.

Trade policy distortions in the form of tariffs on intermediate inputs affect productivity downstream, through tougher import conditions. This phenomenon serves to increase the cost of production, and thereby hampers profitability. This results in price escalation, which increases the burden on consumers and renders products uncompetitive at the international level. Therefore, high protectionism serves as a hurdle to industrialization and needs to be addressed, in order for the the manufacturing sector to grow sustainably, create employment, and earn foreign exchange by increasing and diversifying exports.

Schemes have been put in place to allow exporters to obtain imported inputs at world prices, but these are largely ineffective. Only about 2 percent of textile and apparel exporters in Pakistan access duty suspension schemes such as the Duty and Tax Remission for Exports scheme (DTRE) and Manufacturing Under Bond (MUB) for their imported intermediates, compared to 90 percent in competitor countries such as Bangladesh. Any protection to domestic polyester plants should be given directly by the government and not at the cost of our country's economic future. Pakistan's DTRE programme is also highly inefficient, as it can take two to four months to import synthetic fibers, leading to delays and uncertainties in production that are not acceptable to global buyers. This begs the question of why all inputs to textiles are not zero-rated.

A recent article for Express Tribune by Muhammad Nadeem Sarwar, titled 'Pakistan's low productivity and the way out' emphasizes that a competition-based market economic system with unrestricted trade would be an effective means to direct scarce financial and human resources to efficient sectors, and thereby improve productivity. Implementing reforms that allow the above and further simplify entry into and exit from the market, allow for a low cost of doing business, stimulate a well-developed financial sector and a system that favors competition would be a surefire means to enhancing productivity. Both the firms as well as individuals would have to improve their productivity consistently, which ultimately improves competitiveness in the international market. This could serve to multiply exports and help the country to earn much needed foreign exchange.

Advanced machinery and technological adaptation increase the productivity of labour and thus enable them to produce better quality goods in more quantity and less time. However, our engineering sector does not produce sufficiently-advanced machinery that could help industries in automating production. We are left dependent upon imported machines, which brings us back to the conundrum of high protectionism. As a result, companies often opt to continue with outdated and inefficient technology, which ultimately hurts labour productivity and gives way to uncompetitive product pricing.

Given the large share of the population that lacks access to quality education, there is a need to improve infrastructure and accessibility, as well as to revise curriculum so that unemployment and low productivity in the labour force can be prevented. R&D support for academia and industry as well as collaborative efforts to introduce industry oriented solutions/innovations could take the economy a long way. To sum up, investment in human capital is an essential ingredient for boosting productivity. As per the International Labour Organisation (ILO) estimate for 2009-2019, China's output per person, which is a measure of labour productivity, increased by 388%, India's by 177%, and Bangladesh's by 109% while ours increased by a mere 32%.

Research by Dr. Waqar Wadho and Dr. Azam Chaudhry on 'Innovation in the Pakistani Textile and Apparel Sectors' speaks about several drivers of productivity at each level of Pakistan's business climate. Unsurprisingly, innovative firms were noted to experience higher labour productivity, productivity growth, and employment growth. Moreover, firms that are small, young and innovative experience even higher growth in both employment and sales. This should serve as a motivational force for businesses to prioritize innovation, but innovation tends to be costly. In this regard, it must be pointed out that those firms which receive R&D subsidies invest less in innovation. Engaging in knowledge creation has significant impact on product and process innovations, especially for firms performing R&D on a continuous basis.

Research has shown that productivity in Pakistan has been stagnant and aggregate gains have been mostly driven by more productive firms gaining market shares. This situation is likely to persist if timely efforts are not made to ease import conditions, rationalize tariffs, value competition and markets and modernize education in the country. It is about time the government, academia and industry linkages were strengthened in order to stimulate R&D and innovation, thereby paving the way for enhanced productivity. Policies should target and facilitate young innovative companies in order to build them up and help to modernize Pakistan's business environment. Furthermore, the focus should be shifted towards taxing profitability, as taxing before giving the chance to be productive would be akin to jumping the gun, and would kill many potential microsofts.

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Country                 Shares of Import Tariffs
                       In Total Tax Revenues (%)
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Pakistan                                      48
Malaysia                                     1.6
Turkey                                       2.4
Indonesia                                    2.6
South Korea                                  3.2
Thailand                                     3.9
China                                        3.9
India                                       12.8
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Source: World Bank

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