Monday May 27, 2024

Towards industrial policy 2.0 -Part - II

By Ishrat Husain
May 19, 2023

The foreign exchange earnings from jute exports which originated from former East Pakistan were pre-empted for allocation to industrialists in what was then West Pakistan.

A number of observers have commented that this growing regional economic disparity where per capita income of West Pakistan overtook that of the eastern province by 1970 was one of the main reasons that led to the separation of the two wings in 1971. The slogan of 22 families controlling 66 per cent of industry and 87 per cent of the banking and insurance sector of the country strengthened the movement against the then president Ayub Khan. His authoritarian regime was without popular representation from the majority province. Civil-military officers mainly from West Pakistan controlled most of the levers of decision-making, adding further to the resentment against the Ayub regime.

The separation of East Pakistan on the grounds of the deprivation of their economic rights validated the main plank of the charismatic Z A Bhutto’s political party – the Pakistan Peoples Party (PPP) – which won the 1970 elections on the platform of Islamic socialism. It was also the time that the Soviet Union under a socialist economic system started to draw a lot of attention from policymakers and academics. They believed that control of the commanding heights of the economy with state-led industrialization would lead to a fair and just economic system.

The PPP got an ideological boost from the Soviet model and when it assumed power it gave an abrupt death knell to the industrialization strategy of the 1960s. All major industries, banks, insurance companies and educational institutions were nationalized without adequate thinking or preparation or planning. The private sector was not allowed to invest in these industries and sectors and bureaucrats were appointed to head the nationalized entities that were christened as state-owned enterprises.

With no prior training, lack of professional experience in running business enterprises, risk-aversion, and penchant for control rather than delegating powers for decision-making at the appropriate level, bureaucrats committed resources to ventures and activities that were neither economically feasible nor commercially viable. In the name of redistribution to the poor, economic growth and industrial development were sacrificed – making the poor worse-off.

The large-scale manufacturing sector recorded a growth rate of 3.0 per cent per annum compared to 9.0 per cent in the previous two decades. The balance of payments difficulties got exacerbated as imports increased four-fold and the wide gap between imports and exports was filled by external loans. The external debt problem grew rapidly in magnitude during the decade of the 1970s.

After this episodic stock of large nationalization of assets – both economic as well as human – and the experience of several other developing countries following the same route, a number of international studies empirically evaluated the Import Substitution Industrialization strategy and found it to be responsible for stifling growth impulses, worsening the balance of payments with the increase in machinery and raw material imports outweighing export performance. This regime, by turning the terms of trade in favour of domestic industry, had in-built long-term bias against manufactured exports.

In the 1990s, several important developments brought about changes in thinking about development policy. The winds of globalization that liberalized international trade, opened up financial flows, eased up transfer of technology and gradually removed barriers to international migration began to positively affect growth prospects and poverty reduction in developing countries.

The World Bank carried out a seminal study, ‘The East Asian Miracle’, documenting the factors responsible for the spectacular economic success of the countries in the East Asia region. China, which was a closed economy following the conventional socialist model, made a drastic departure and began integrating itself into the international economy and opening up the domestic markets to competitive forces. By liberalizing trade flows, attracting foreign direct investment, reducing the relative weight of state-owned enterprises (SOEs) and promoting the private sector, adopting the latest technology in production and processing, incentivizing rural households to grow agriculture commodities without government direction and empowering local governments, China was able to make unprecedented progress by raising the standard of living of their population and lifting 700 million people out of poverty.

The Washington Consensus adopted by the World Bank and IMF had interpreted the East Asian and Chinese experiences as validation of market-friendly economic policies .Other independent economists were of the view that state’s direction and guidance to the private sector in the form of an industrial policy were responsible for the desirable outcomes.

While this debate remained unsettled, the impulses of globalization over the next two decades gave impetus to the proponents of the Washington Consensus, putting the advocates of industrial policy on a back foot. The global economic conditions proved to be extremely favourable for developing and emerging economies which were able to make great economic strides fortifying the views of those advocating liberalization, privatization and deregulation and shunning protection to domestic industries – a key element of the industrial policy.

During 1990-2010, the number of persons living below the poverty line fell dramatically from two billion to 897 million, bringing down the share of poor people from 37 to 13 per cent. Real GDP of emerging and developing economies (EDEs) grew by 4.7 per cent annually on average and per capita income increased by over 70 per cent. On a population weighted basis, excluding China, the increase has been about 90 per cent. China’ per capita income multiplied 54 times since 1980 and its GDP stands next to the US today. Consequently, the relative share of EDEs in the global GDP (measured at purchasing power parity) increased to 57 per cent by 2014.

India, which was a closed economy with excessive controls of bureaucracy in the form of licences, permits, prices etc, faced a serious balance of payments crisis in 1991. As part of comprehensive and deep-rooted reforms, the government decided to open up the economy, dismantled the controls and licence raj, incentivized the private sector, and attracted foreign direct investment and technology. The results have been spectacular – India has achieved a growth rate of 6-7 per cent per annum over the last 15 years, and foreign exchange reserves have accumulated to $600 billion with a smooth transition of people from the poor to the middle class.

However, some events and factors sparked a debate over the need to resuscitate the industrial policy. These events included the Global Financial crisis of 2008 to 2009 and the financial instability widening wealth and income inequalities even in fast-growing countries such as China and India, the geopolitical tension arising from the ascendancy of China and its challenge to the United States, the pandemic of 2019 and the resulting supply chain disruption ,the impending climate change risks, commodity price-escalation, the Ukraine-Russian war, transition to renewable energy, emergence of global value chains instead of vertical integration where dependence on other countries supplies is heavy, and control on key technologies by competing countries against established ones, and anti-immigration sentiments.

The evidence for the post-2010 period is overwhelming. World trade fell by 5.0 percentage points in 2016-19 relative to GDP. Global flows of long-term investment fell by half and FDI from a peak of 5.3 per cent of Global GDP in 2007 to 2.3 per cent in 2021. In 2018-19, the net addition of immigrants was 200,000 – a decline of 70 per cent from the previous year. In 2016, the incomes of the highest one per cent of US earners were 225 per cent higher in real terms than they had been in 1979. For the middle class, the growth was 41 per cent.

To be continued

The writer is the author of ‘Governing the ungovernable’.