In search of productive investment

It's an established fact that investment is low in Pakistan. With low investment, the deployment of capital is in less productive sectors. The economic returns in terms of employment generation and production efficiencies are sub-optimal. The barriers to entry are large. The big boys invest in sectors where the businesses are protected from competition.

The idea of protection is to let the sectors gain efficiencies through acquiring skill set and attaining economies of scale. For that, businesses need to reinvest higher profits in days of protection to attain efficiencies through R&D and scaling. However, history suggests that most of the businesses spend on lobbying for continuation of support. The businesses keep on making higher commercial returns at the cost of consumers.

There has to be an end to oligopolistic structures. The capital has to be deployed in sectors where there are competitive and comparative advantages. The innovation has to be encouraged and banking and non-banking credit should be extended beyond name lending. The one-line solution is to open up the economy to competition. Government should not pick winners, and instead let the markets decide what to produce and what not.

There are numerous examples of rent seeking behavior in the country. One example is refinery business, where a few companies are operating on age-old technology and did not upgrade despite getting incentives for long. There is deemed duty on diesel for over 15 years and the idea was to upgrade production of higher quality white oil. The poor quality products have an adverse impact on the environment. The cost of poor air quality (especially in Lahore and surrounding areas) is to be borne by its inhabitants.

There are other issues of old technology. The government has to cross subsidize furnace oil production by giving higher margins on white oil products. Consumers have to bear the cost. These refineries never upgraded. The PM has decided to end poor quality fuel consumption in two years. The message is conveyed to refineries, and if they do not upgrade, they will have to shut down. Let's hope government does not back-peddle on it.

Renowned Economist Atif Mian, in a recent article wrote that the country's leadership must muster courage to take on the moneyed elite. He is on spot. The government is flexing its muscle on refineries. The need is to set precedence for other rent seekers. Atif mentioned that government continues to dole out subsidies to exporters without an iota of proof that these subsidies have helped increase exports.

The SBP under the leadership of Dr Reza Baqir should end this era of easy money making on subsidized credit. There are habitual (regular) borrowers of this credit. They are crowding out the potential new entrants - in new products and markets. There should be a mechanism to support efficient players. The SBP has extended the subsided facility limit by Rs 300 billion. The buzz is that the central bank is mustering courage to say no to habitual rent seekers and may entertain innovative and efficient players in traditional and new industries.

One problem is that banks discourage lending to new players or SMEs. The spread of banks is one percent, and they would rather like to continue lending to big boys. The next question is how to align banks' incentives. One way is to go for regional or small banks operating in certain geography or sectors. But there are barriers to entry. The paid up capital requirement for opening up a bank is Rs 10 billion. Regional players cannot enter. The reason for higher paid up capital is to protect depositors. That can be dealt with a deposit protection company. Will the SBP mull courage against the big banks' lobby? Will the SBP be able to bring competition in export subsidized credit?

Another industry Atif mentioned is automobile. The industry failed to innovate despite decades of protection. The SBP should produce a working paper on the extent of indigenization in the sector. How much components of so-called parts manufactured are imported? The components are bought from approved vendors - how much transfer pricing is there in it? The parts manufacturers supplying to assemblers cannot sell in spare parts market. That hinders them to attain scale. Is the economy better off by supporting auto parts manufacturers? Can they create exportable surplus?

The question is should we continue to support the cars assembling industry based on premise of job creation and foreign exchange savings. Is the country better off by opening up competition? The government has to have the courage to challenge the status quo.

The third sector Atif picked is power sector IPPs. This is probably the biggest mess this government has inherited. Does the government have the courage to renegotiate contracts with numerous IPPs inefficiently operating on guaranteed returns?

There are a few other sectors where these inefficiencies are present. One area is to discourage preemptive investment in real estate by adequately taxing the sector. The power hubs in this sector are perhaps the strongest in the country. Can leadership be able to take decisions to divert the investment from real estate and other inefficient sectors to productive avenues?