Exporting for innovation and profitability

Pakistan’s innovation landscape presents a grim picture. Pakistan ranked 88th globally and 7th regionally in the Global Innovation Index 2023. While India ranked 40th globally and 1st in the region, this stark contrast underscores the urgent need for transformative strategies and concerted efforts to propel Pakistan’s innovation ecosystem into a new era of growth and competitiveness.

The primacy of innovation in development cannot be denied. Innovation and technological change are fundamental causes of growth. They increase productivity and efficiency, evolve products to capture new markets, and can lead to advances in sustainability by decreasing negative externalities. Technological advancement also tends to have spillover effects, as advancements in production processes, knowledge, and capital are adaptable across industries.

So, how does innovation occur?

In developing countries, innovation is predominantly driven by exports due to two major factors. Firstly, because exporters have access to larger markets which drives economies of scale. In order to fulfill the demands of both domestic and international consumers, exporting firms must increase their productivity through both increased inputs but more so through gains in efficiency. The selection pressure between firms to fulfill demand allows resources to be allocated to efficient firms as less efficient ones become uncompetitive and leave the market.

However, this does not happen in Pakistan as the inefficient, unproductive, and uncompetitive firms are subsidized and protected by the government. For instance, a plant owing to heavy protection in the form of import duties and anti-dumping duties on purified terephthalic acid (PTA) and polyester staple fiber (PSF), is purportedly still using 30-year-old outdated technology and it neither innovates nor exits the market. This situation forces exporters to purchase PTA and PSF at inflated prices, disincentivizing the production of Man-Made Fiber (MMF). Consequently, MMF-based exports struggle to expand and remain uncompetitive in international markets.

Secondly, trade creates knowledge spillovers both directly and indirectly. Direct benefits occur from the learning of new technologies and methods, while indirect benefits arise from reverse engineering advanced imports. There is also a process of ‘learning by exporting,’ which states that export behavior has a direct and positive impact on firm-level innovation and productivity. Firms engaging in trade develop minute innovations, learn the dynamics of new markets, and expand networks in the global value chain, which all lead to faster and greater knowledge spillovers.

According to trade statistics provided by the International Trade Centre, Pakistan exported goods worth $11 billion in 2003 while Vietnam and Chile had exports of $20 billion. In 2022, Vietnam exported goods worth $370 billion, Chile exported $102 billion while Pakistan exported a meagre $31 billion. In 2022, Pakistan’s exports accounted for only 10.5% of GDP, whereas the South Asian average stood at 20.5%. One of the major reasons for Pakistan’s low exports is its closed economy.

This correlation between international market exposure and innovation is particularly evident in Pakistan’s textile sector, the country’s largest exporting sector. According to Wadho & Chaudhry 2016, firms whose main market is the Middle East, has an innovation rate of 100%, followed by the USA (91%) and Europe (80%). On the other hand, firms whose main market is the local market has an innovation rate of 41%. This further highlights the structural weaknesses in the economy that impedes the growth of domestic industry which is vital for economic growth.

Furthermore, Pakistan’s Global Innovation Index 2023 rankings show room for improvement when compared to regional leaders India and Vietnam, highlighting opportunities for enhancing the innovation ecosystem to boost investments and sustainable growth (Figure 1).

In assessing innovation, various indicators are used, such as patent applications, R&D expenditure, scientific and journal article publications, and gross fixed capital formation. A comparative analysis of patent applications illustrates the gap between Pakistan and India. In 2022, for instance, Indian residents filed 26,267 patent applications, while Pakistan saw only 426. Despite Pakistan’s high rate of change in patent applications over the last decade, with a 273% increase (surpassing Vietnam’s 248% and India’s 196%), the country has yet to leverage potential effectively. This underscores the need for Pakistan to foster a more conducive environment for innovation, aligning with global standards and practices to realise its full potential.

This need for a conducive environment is further illustrated by the decline in non-resident patent applications in Pakistan, which dropped by 42% over the past decade. In stark contrast, India, Bangladesh, and Vietnam witnessed increases of 14%, 35%, and 128%, respectively. This divergence indicates that Pakistan’s innovation landscape might be perceived less favourably by foreign investors and innovators, potentially due to inadequate regulatory and legal frameworks that impede innovation and investment.

Regarding research and development (R&D) spending, Pakistan allocated only 0.16% of its GDP to R&D in 2021, a decrease from the 0.32% spent a decade earlier in 2011. This reduction contrasts with the broader trend in South Asia; as per the World Bank’s Enterprise Surveys, only 2.3% of firms in Pakistan invest in R&D, which is significantly lower than the South Asian average of 12.5% (Figure 3). This low investment level in R&D starkly limits the country’s innovative capabilities and growth prospects in the competitive global market.

These challenges in investment and innovation translate into credit crunch for the domestic industry. This situation is particularly complex when considering the state of Pakistani SMEs, which constitute 90% of all businesses and employ 30% of the labor force. Despite their significant presence, these SMEs face substantial growth barriers, primarily due to limited access to credit. The World Bank’s Enterprise Surveys reveal that 40.9% of firms in Pakistan are fully credit constrained, and 15.2% are partially constrained. These figures are alarmingly higher than the South Asian averages of 17.1% and 17.7%, respectively. Furthermore, only a mere 2.1% of local businesses in Pakistan had a bank loan or line of credit, compared to 23.7% in the region. The lack of financial support for Pakistani SMEs hampers their ability to innovate and expand, hindering the country’s economic development.

In conclusion, Pakistan’s potential for growth and innovation is substantial yet underutilized. Addressing the challenges of regulatory hurdles, limited investment in R&D, and the constraints faced by SMEs are crucial steps towards unleashing this potential. By focusing on strengthening domestic industries, improving the business environment, and investing in innovation, Pakistan can not only enhance its global competitiveness but also create a robust foundation for sustainable economic growth.

Moreover, removing barriers hindering the export sector is vital to remedying the current innovation dearth. This underscores the importance of adopting an export-led paradigm to drive economic growth. An export-led paradigm shift coupled with a focus on domestic industry development will not only boost exports but also enhance innovation capacity, driving sustainable economic growth in the long term.

The overarching message is clear: export-led growth is not just a solution for Pakistan’s balance of payments crisis and economic expansion but also a catalyst for amplifying innovation. To achieve this, exporters must be insulated from

distortionary interventions, unfavorable tax regimes, and other inefficiencies that impede sectoral growth and divert resources via transaction costs.

Copyright Business Recorder, 2024