Reversing the premature deindustrialization of Pakistan's economy

It is natural at the start of a new calendar year on an optimistic note. There are some reasons for this as we enter 2017. The macroeconomy has stabilised; GDP growth is on a positive trajectory; inflation is relatively low; borrowing costs are affordable; energy availability is improving; Pakistan has been rerated by Standard and Poor's; we have a surging stock market; law and order conditions in Karachi, the country's commercial hub, have improved; and there is some progress on formalising the real estate sector which can potentially unlock a large section of the hitherto undocumented economy. There are also inherent demographic and geo-political factors that continue to sustain hope. 200 million consumers; mostly young; large and growing middle class; rapid urbanisation; current low consumption base; scope to convert loose to packaged and branded goods all augur well for growth. Pakistan's strategic location at the cross roads of the Middle East, Central Asia and China and the CPEC investment in power and infrastructure are good reasons to be optimistic. Yet there are fundamental issues that Pakistan needs to contend with, if hope is to translate into a brighter and sustainable future. Indeed it would be gross negligence if Pakistan failed to cease this opportunity.
Nearly 2 million young people become of employable age annually. We risk perpetuating the cycle of violence and terrorism that has inflicted havoc on the country if we fail to find gainful employments for them. There is a global tide of protectionism and nationalism sweeping the major economies. This coupled with trade recession does not bode well for our exports, especially of manufactured goods which provides employment. Developments in the Middle East and the downturn in oil economies from where over 60% of our remittances are derived, will undoubtedly impact the balance of payments. The recent Opec move to boost crude oil price to $50+ per barrel will increase the oil-related import bill by up to 20% in the current financial year. External borrowing is already at a record high. There still remains significant room to broaden the tax base but the will to do this is weak and is likely to be tested as we approach national elections. For years we have underinvested in social development. Half of Pakistan's children still do not attend school, large number suffer from stunting, 40% of the country is largely illiterate; all reflecting in poor skills and quality of our human capital. Pakistan's ranking on the Social Development Index (SDI) lags all our neighbours in South Asia, most of whom don't fare all that well in the global ranking! On a per capita basis Sri Lanka outspends Pakistan 2:1 and leads South Asia in SDI.
There are three critical imperatives that need to be addressed urgently and with determination: creating employment; promoting value-added exports; and generating higher tax revenue from a broader base.
A strong domestic industry, leveraging scale and competitiveness off a population of 200 million can meet all three of the critical imperatives. However, manufacturing, the key employer, exporter and taxpaying sector has been undermined over the years by a liberal import regime; initially a consequence of the various "programs" that Pakistan adopted in the last 30 years and then poorly negotiated trade agreements. The problem has been accentuated by the tolerance of smuggling, under?invoicing and other forms of direct and indirect tax evasion. Why else would markets and shops notorious for smuggled items be allowed to operate so brazenly across the country? Together these have contributed to the weakening of Pakistan industry and an unfortunate and premature trend towards becoming a nation of traders. Power outages and globally uncompetitive cost of energy have also contributed to slowing the growth of the manufacturing sector to 3%. Manufacturing's share of GDP has declined from 18.5% in 2007/8 to around 13% in 2014/15. Large Scale Manufacturing, which has the greatest scale and scope to generate jobs, value?added exports and taxes has fared even worse. Partly on account of high government borrowing, partly risk?aversion of banks to SMEs and partly due to the size of the undocumented informal economy, private sector credit has halved from 29% of GDP in 2004, when it was already amongst the lowest in the world to just 15% in 2016. Private sector credit in India and Bangladesh stands at 53% and 44% respectively, whilst those of developed countries exceeds 100% of GDP. Many units have closed. All this whilst the trade deficit with the largest FTA partner, China, grew from $3 billion in 2008, when signed to over $14 billion in 2015. Since 2008, exports to China consist mainly of commodities or low value-added products. These therefore created very few jobs in Pakistan but fuel China's economy by allowing it to add value, which we should do. Imports from China outgrew exports by more than a multiple of two, undermining many in the domestic industry and reducing the government's tax revenue on account of concessionary tariffs granted. There is now recognition of the need to renegotiate the FTAs. Surprising then to find the Ministry of Commerce continuing to pursue FTAs with Turkey and Thailand whose ability to export to Pakistan is more than three times Pakistan's ability to reciprocate. Moreover their export aspiration will hurt the sectors that Pakistan has established some manufacturing capability in - autos, auto parts, chemicals, rubber and plastics. In the case of Turkey, effort should be focused on negotiating the removal of the anti-dumping and other safeguards imposed against our textiles and other sectors.
Global trade recession is only partly responsible for the poor performance of our exports. Textiles, which represent 60% of exports suffer from higher input costs vs. most competing countries. This disparity is significant against Bangladesh - 2.5 times higher cost for gas and steam and 2.3 times higher for labour.
Additionally, the exchange rate tool has been deployed the least to support exports. Over five years, the rupee depreciated by 19% vs. 44% in the case of India. Since 1998, Pakistan's share of world exports has declined, whilst Bangladesh's doubled and Vietnam's share grew seven?fold. A short term solution is to provide relief to exporters to offset uncompetitive input costs and exchange differential as also to neutralise India's recent subsidy to its textiles sector. The longer-term solution is to develop an integrated manufacturing and trade strategy which seeks to maximise local job creation through more value-addition to commodities for exports and one which also promotes import integration into value-added exports. Pakistan's import integration is less than 10% vs. 40%+ for countries like Vietnam and Thailand that deploy their industries to add jobs and value to convert imports into finished goods. This integrated manufacturing and trade strategy should have the buy-in from all line ministries and provinces and be overseen by a high-level body led by the Prime Minister. It cannot be left to just the Ministry of Commerce, which is unable to address manufacturing, taxation impact etc. Renegotiated and future FTAs, which is the Ministry of Commerce's domain, should in addition to managing the trade balance have three other critical KPIs - jobs, value-added exports and tax revenues.
The CPEC will no doubt be a game changer. However, one impact that we need to avoid is hurting existing industry. The concessions being granted to the CPEC-related Special Economic Zones must be limited to industries that incrementally add to Pakistan's exports and employment. If they merely displace existing jobs or exports then the zero sum result will potentially hurt the relationship between the two countries. Indeed, an integral part of CPEC should be relocating the 8-20 million jobs that will be displaced due to rising labour cost in China. As China becomes a net importer of apparel, units in Northern Pakistan could service that demand, whilst those elsewhere could meet China's export requirements to the rest of the world.
Taxing the already taxed is a short-term solution to meet deficit targets. Tax reforms foremost require political will. Also FBR, as currently configured lacks talent and technology to broaden the tax base. Instead to meet its targets, it often resorts to using discretionary powers to harass existing tax payers. This then discourages those outside the tax base from entering what they term as "the net." Pakistan's tax rates are high - 32% corporate tax (excl. WPPF and WWF) vs. 15% in Sri Lanka and 25% in Bangladesh. Its tax policies do not encourage capital formation and consolidation which are necessary for global competitiveness. Only by broadening the tax base will the government gain space to avoid resorting to knee-jerk reactions such as Super Tax, tax on reserves, bonus shares and inter-corporate dividends. There is also scope for simplification. Taxpayers in Karachi and Lahore have to contend with 47 different types of local, provincial and federal direct and indirect taxes, necessitating multiple returns to numerous bodies. A unified tax return to a central agency will ease doing business. Similarly technology can be deployed to create one-window facilities for various authorities to come together in easing business.
For the longest time, our investment incentives have been targeted at the asset-intensive manufacturing sector. We also need to encourage the Information, Communications and Technology (ICT) sector to reposition Pakistan in the digital economy and create employment, exports and tax revenue. Tax rates and policies affecting this industry are an impediment. Connectivity is the essential driver of ICT. Yet, 80% of Pakistanis do not have access to broadband, due mainly to the incidence of high taxes on devices, infrastructure and broadband use. Net result is that a large section of the population is denied access to valuable education and knowledge that is available on the web and which could improve their lives. Experience elsewhere shows that lowering the tax rate encourages the spread of broadband and that tax revenues revert over time. Tax on export of services such as software is 3-4 times the rate on export of goods. Financing of software development is hard to obtain and there are very few training facilities of world class. These together limit scale and discourage parts of ICT to enter the formal sector.
Philippines earns more from its BPO industry than Pakistan does from its entire exports! There is also a need for the government to digitise large parts of its processes and eliminate duplication. ICT is also a sector that can employ large number of women, in furtherance of gender balance. Brexit's "Take Control" and Trump's "America First" may or may not work to further UK and USA's interests. The EU, NAFTA may or may not survive in their current form. Irrespective, we need to "take control" of our destiny and put "Pakistan first". We must stop and then reverse the premature deindustrialization of Pakistan's economy. More jobs, higher value-added exports and larger tax revenues from a broader tax base can be delivered by a strong, competitive domestic industry leveraging on the large domestic market of 200 million people. That is the lens through which our political and economic leadership should shape the policy framework. The Pakistan Business Council, a think tank and business advocacy body is developing a national consensus to drive this, as also to promote a higher level of investor confidence from consistent policies.
(The writer is CEO Pakistan Business Council)