Thursday June 01, 2023

Towards industrial policy 2.0: Part - I

May 12, 2023

Recent developments in the Western countries have reopened the discourse on the need for an industrial policy. Pakistan, which has gone through deindustrialization in the last few decades, has to examine carefully whether it can benefit from evolving an industrial policy of a kind different from the earlier policy which we would characterize Industrial Policy 1.0. For this purpose, the discussion has to take place in its historical context.

At the time of independence, Pakistan had no large-scale manufacturing units, except for cement, few sugar refining, tea processing factories, two to three textile mills, and railway workshops. Pakistan was a substantial net importer of manufactured goods mainly from India. Large-scale manufacturing accounted for 1.4 per cent of GDP while the same ratio for India was 6.0 per cent.

As a dominant agrarian society, Pakistan did not have a strong entrepreneurial class which could have steered private-sector participation. Neither did the indigenous class have the capital available so vital for setting up industries.

At the global level, the beginning of industrial policy can be traced back to the reconstruction and rehabilitation of the European economy after World War II that led to active policy interventions, public investment and creation of new international financial organizations for providing financial aid.

The Marshall Plan executed through a $13.3 billion assistance package from the United States was a successful manifestation of this policy as it helped in the resurgence of industrialization, investment in infrastructure and recovery of European economies. Similarly, Japan went through a series of reforms under occupation forces headed by Douglas McArthur which resulted in rapid and sustained economic growth from 1945 to 1991. Unprecedented expansion of industrial production, development of the domestic market and an aggressive export policy were the pillars of Japan’s success.

As colonial structures began to unravel and new independent nations began to emerge in Asia and Africa – which were poor and underdeveloped – there was a quest for strategies to turn these economies around. Drawing upon the experience of the Marshall Plan and Japanese recovery, economists argued that growth could only be achieved through industrialization.

A declining share of agriculture in GDP and employment and an increasing share of output and employment in industry was required to achieve growth. Industry grows at a faster pace than agriculture because of economies of scale, higher capital intensity, complementarities and backward and forward linkages, and externalities that are not found in agriculture. Industry enjoys higher productivity which is crucial for growth and development.

The newly independent developing countries striving to achieve rapid growth adopted industrialization as the cornerstone of their development policy. They found intellectual support through the work of leading development economists who argued that protecting local infant industries from international competition by supplying capital, foreign exchange at subsidized prices, tariffs on imports, administrative and centralized control on allocation of key raw materials, imported inputs and foreign exchange could spearhead the drive to industrialization and thus accelerate the growth rate. This was the beginning of the era of Import Substitution Industrialization (ISI) strategy. Pakistan also fell in line and decided to implement these ideas through policy actions.

An undervalued exchange rate, administrative controls on imports – particularly consumer goods – high tariffs and non-tariffs barriers increased the domestic prices of these goods and set the terms of trade heavily in favor of industry. These state policies cumulated in the form of large profitability for the industrial sector even in comparison to the trading sector. The rate of return on industrial investment was so high that industrialists were able to recover their initial investment in one or two years. Thus, traders who had earlier made high profits and amassed surplus converted merchant capital into industrial capital by importing industrial machinery and manufacturing consumer goods. Manufacturers slowly began to displace primary commodities and the first industries to develop were jute and cotton textiles.

The second-stage import substitutions strategy (ISI) aimed at replacing the imports of intermediate goods and producer and consumer durables by domestic products. To facilitate this transition, the government set up the Pakistan Industrial Development Corporation (PIDC) whose objectives were to initiate pioneering ventures in many new areas of industry and to supplement private enterprises where the existing number of private units was not sufficient in relation to demand.

The main areas where the PIDC was to intervene were heavy engineering (including iron and steel), shipbuilding and jute products. The units that were successful were then handed over to the private sector after completion. In a large number of projects, the private sector worked closely with the PIDC in the form of joint ventures. The corporation also located its industrial units in the underdeveloped parts of Pakistan and roads, infrastructure and power projects had to be built in these areas thus giving a boost to the overall development of these areas.

Workers and management trainees were recruited and trained to operate these units. The government with the help of the World Bank set up two financial institutions – the Pakistan Industrial Credit and Investment Corporation (PICIC) and the Industrial Development Bank (IDBP) – for project financing by the private sector.

Thus the industrial policy in Pakistan during the 1950s and 1960s was spearheaded by the PIDC that provided initial investment which the private sector could not undertake on their own. These were long gestation period projects and the private entrepreneurs did not have the risk appetite to undertake such ventures, develop skilled manpower and wait several years before realizing the dividends. The results of the industrial policy were spectacular and gave credence to the views of proponents of big push and ISI strategy.

Large-scale manufacturing had a phenomenal growth rate of more than 9.0 per cent per year in the decades of the 1950s and 1960s.There was significant improvement in labour productivity as the sector demonstrated a high capacity for technological adaptation and innovation. By 1969, a World Bank study found that Pakistan’s manufactured exports were higher than those of Malaysia, Indonesia, Thailand and the Philippines. The export sector responded positively to the introduction of the export bonus scheme which gave a premium on exchange rate conversion to exporters, preferential access to credit and a series of fiscal incentives.

The share of the manufacturing sector in GDP had risen from 7.8 per cent in 1949/50 to 26 per cent in 1969/70. Large-scale manufacturing’s share had multiplied six times from 2.2 to 12.5 per cent in the same period.

The major underpinnings of Ayub Khan’s mixed economy model of which industrial policy was an essential ingredient but also it involved developing strong state institutions that guided and directed the private sector. The Planning Commission of the 1960s was a powerful, technocratic institution that guided the private and public sectors in determining the priorities, the allocation of resources and bringing consistency and coherence in sectoral policy formulation and execution and overall macroeconomic objectives. Policy consistency and continuity provided a strong signal of credibility to private investors and businesses.

However, the success of industrial policy and export performance revealed several shortcomings that had serious political consequences. Mahbubul Haq, the chief economist of the Planning Commission, voiced concern that the benefits of these policies were accruing predominantly to 22 industrial families. Such concentration of wealth and economic power in such few hands had accentuated income and regional disparities. East Pakistan – the province with the majority of the population – was completely neglected as none of the 22 families belonged to that province. Manufacturing footprint and expansion remained highly limited in the province where the majority of the population lived.

To be continued

The writer is the author of 'Governing the ungovernable'.