Reforms aimed at enhancing productivity can help economy grow sustainably, says World Bank

ISLAMABAD: Pakistan’s economy can grow sustainably only if the country introduces productivity-enhancing reforms that facilitate a better allocation of resources into more dynamic activities, and of talent to more productive uses, says the World Bank.

The bank in its report, “From Swimming in Sand to High and Sustainable Growth,” stated that the country’s inability to allocate all its talent and resources to the most productive uses has stunted economic growth. It presents evidence of systematic productivity stagnation across firms and farms. In manufacturing and services, most of the productivity stagnation is related to firms losing efficiency over time.

The report also shows a systematic decline in agricultural productivity, as well as a strong link between elevated temperatures and rainfall variations and productivity.

The report presents a roadmap to reduce distortions in the economy that are currently acting as a deterrent to productivity growth. Critical reforms include: harmonising direct taxes across sectors, so that more resources flow into dynamic tradable sectors like manufacturing and tradable services, instead of real estate and non-tradables; reduce the anti-export bias of trade policy by lowering import duties and reversing the anti-diversification bias of export incentives.

Distortions affect the way land and capitals are allocated. Distortions in the form of differences in direct tax rates tend to make it more profitable to invest in real estate relative to manufacturing or tradable services. And because the size of the tradable sector tends to be associated with growth, this reduces growth potential.

Within tradables, high import duties make it more profitable for firms to sell domestically rather than exporting. In Pakistan, a 10 percent import duty on a given product increases profits of selling domestically relative to exporting by 40 percent on average.

Firms that decide to embark upon export-oriented manufacturing despite these adverse incentives face a further distortion: if they want to innovate, they miss out on export subsidies. It is 80 percent more likely for a potential exporter that decides to export a traditional product (e.g., apparel) to be eligible for an export subsidy, than for one that decides to innovate and export a new product.

The distortions in place in Pakistan are to a large extent the result of powerful “insiders,” albeit limited in number, who influence the policy making process to maximize their own benefits. In agriculture, for example, these are large landowners that benefit from subsidy schemes or underpriced inputs for a narrow set of crops.

Productivity is further affected by the fact that Pakistan does not tap into all of its talent.

“Women in Pakistan have made progress in educational attainment, but this accumulated human capital is underused because of constraints they face to participate in the labor force,” said Najy Benhassine, World Bank Country Director for Pakistan.

“With only 22 percent of women employed in Pakistan, women’s labor force participation is among the lowest in the world. By closing the female employment gap relative to its peers, Pakistan can accrue GDP gains of up to 23 percent. Successful implementation of policies to address the demand- and supply-side barriers to female labor force participation, can create about 7.3 million new jobs for women.”

“Pakistan’s economy is at a critical stage. It could be a turning point where long-term structural imbalances that have prevented sustainable growth for too long ought to be addressed urgently.

The report puts forward a series of policy recommendations to achieve this in a sequenced way,” said Gonzalo J Varela, Senior Economist and co-author of the Report. “First, reduce distortions that misallocate resources and talent. Second, support growth of firms through smart interventions, rather than through blanket subsidies. Third, create a positive, dynamic loop between evidence and policymaking, strengthening feasibility analysis of publicly funded projects or programmes.”

The report urges Pakistan to maximise positive impact on businesses and productivity across the board by: reducing regulatory complexity; harmonizing the general sales tax (GST) across provinces; reforming investment laws to attract more foreign direct investment; and upgrading insolvency laws to reduce the costs of liquidating non-viable firms.

In the meantime, providing safe and affordable mobility especially for women; boosting digital connectivity and digitally enabled jobs; demonstrating the benefits of increased female labor force participation to positively shift entrenched norms; developing skills; and reducing sectoral gender bias are among the top and medium-term recommendations of the report.

“Firms in Pakistan struggle to grow large as they grow old. A young formal firm in Pakistan that has been in operation for 10 to 15 years is about the same size as a firm that has been in operation for more than 40 years. Similarly, an average Pakistani exporter is less than half the size of one in Bangladesh. This shows a lack of dynamism amongst Pakistani firms, compared to better-functioning markets, where firms either grow or exit,” said Zehra Aslam, economist and co-author of the report.

The bank recommended that first, remove distortions to improve aggregate productivity through a better allocation of resources, by focusing on: Tax policy: Widen the tax net, harmonizing tax rates across sectors, to ensure a level-playing and facilitate the reallocation of resources from non-productive non-tradables (e.g. real estate) and into more productive sectors (tradable or efficiency-enhancing non-tradables).

Further gradually reduce the anti-export bias of trade policy by reducing import duties, to facilitate the reallocation of resources, from domestic to outward-oriented activities. Expand eligibility of export subsidies to favor export growth and diversification.

Reconsider size-dependent industrial policies, to reduce incentives for firms to stay small de jure or de facto. It further recommended for gradually phase out subsidies and price support in the agriculture sector, to facilitate a market-based allocation of land, labor and equipment based on comparative advantage, and re-allocate the created fiscal space towards investment in climate-smart technologies and infrastructure for crops and livestock, and agriculture extension services and research.

Copyright Business Recorder, 2023