Moving to new industrial policy

The debate on premature de-industrialisation in developing economies hinges on the premise that open trade, elimination of protective tariffs and withdrawal of subsidies are harmful for local industries.

In the case of auto policy, the proponents of this debate devised import substitution policies, which led to the deletion programme. Thus, while it helped local auto parts industry to develop, it gave rise to a protected auto industry, which has continued to flourish on the back of tariffs and other incentives. The government and automobile industries are the main beneficiaries as this has led to a stable flow of income for both at the cost of consumers, who have been forced to pay more for less.

Furthermore, the rising demand for cars on the back of income and improved infrastructure has created opportunities for the market to arbitrage the lag in production, resulting in the unique phenomenon of “on money”. This policy has not only caused harm to the consumers, but it has also proven to be a bad industrial policy. Pakistan has not been able to produce a single car which is competitive regionally or internationally.

As Pakistan has not achieved economies of scale, there is hardly any incentive in innovation and product development. The benchmark of economies of scale for the auto sector is 500,000 units (cars, vans and jeeps) in a year, whereas the government target was to achieve production of 350,000 units. The country’s production has barely crossed 100,000 units. Thus, the high tariffs have led to expensive assembled vehicles, suppressing demand and hence production.

This has resulted in an oligopolistic structure where some players have benefitted hand in hand with the government, which has benefitted from the high level of excise duties, which in turn has made cars more expensive. This is the double jeopardy that the country’s old industrial policy has visited upon us. As the government is revisiting the industrial policy, and in particular the automobile policy, there is an opportunity to evolve a new industrial policy.

“The past and contemporary policies have been focused on merely establishing assembly units, instead of developing manufacturing capacity, which is the real driver of growth in an economy; consequently, the inflow of FDI has been limited compared to profits earned and repatriated out of the country,” observed recently the independent Economic Advisory Group.

The timing is critical. Pakistan is stuck at a low level of exports and there is no way to jump on this ladder while relying on the existing product mix, which has been maintained for the last 20 odd years. Pakistan’s commodity basket including textile, rice, leather, etc is highly unlikely to help achieve the ambitious export targets. While the country may see a gradual rise in total exports, thanks to IT services, the manufactured exports will not be contributing to this rise. Thus, we may be seeing de-industrialisation even more rapidly.

Government measures are only contributing to the de-industrialisation. In the context of the upcoming auto policy, the decrease in tariffs on completely knocked down (CKD) kits, as envisaged in the Finance Bill 2021, which will be imported into the country and then assembled, in reality, discourages the domestic auto parts makers because imported items are being subsidised against domestic production. This implies that relative profits will be higher in the assembly business as compared to the auto parts manufacturing business, which will gradually reduce the linkage between the auto assemblers and the domestic auto parts makers.

In the context of expected foreign direct investment (FDI) in the telecom sector, if mobile phones are assembled without value addition arising from some intrinsic latent advantage but only as a result of some fiscal incentive, then the industry will remain dependent on protection from the government and manufacturing will not become a profitable avenue for companies. Such investment will be market-seeking instead of efficiency-seeking.

The new mobile phone manufacturing policy is also regressive as tariffs are more than 70% on lower-end mobiles and hover around 40% on higher-end phones. The policy also fails to incentivise the inflow of new technology and latest devices to the country as consumers will be paying higher prices for old-generation phones just to enable companies to set up assembly units in the country.

What needs to be done?

As envisioned in the Vision for Economic Transformation, Pakistan needs to alter the existing incentive structure dramatically.

As a corollary, we propose a new industrial policy. The main parameters of the new industrial policy should be open trade, universal reduction of tariffs instead of selective reduction, integration with the global value chains, export orientation, value addition, product development and innovation. The government should play an active role through the new industrial policy.

It should use its democratic power to counter the influence of powerful lobbies and ill-informed bureaucrats. An incremental approach will not work and will only provide more time for protective lobbies as well as arbitragedriven investors to maximise profits at the cost of the country’s manufacturing capability and consumer choice, which is the ultimate arbiter of market.

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