Industrial policy, out of sequence

Industrial policy is back in vogue, and now the very institution that for 30 years has been telling us how bad it is has turned 180 degrees. The World Bank’s new flagship report, Industrial Policy for Development, admits that bank policy on industrial policy has not aged well, according to Chief Economist Indermit Gill, who said it now has the practical value of a floppy disk. It might seem like vindication for a nation such as Pakistan, which has always been looking for a policy lever that would enable the country to bring about sustained growth. It is not. Carefully read, the report isn’t about the need for activist intervention but about calibrating ambition with state capacity, and on that measure, Pakistan is far short. The report recommends that feasibility of industrial-policy instruments should be considered when selecting them. Governments should start by ensuring institutions and public inputs – industrial parks, quality infrastructure, market access support, and industry-relevant skills – that are low cost in terms of fiscal and administrative requirements, and address market failures first. Only then, when state capacities and fiscal resources are strengthened, should governments lean towards more ambitious instruments like tariffs, subsidies and other targeted incentives, which involve more intense monitoring and the ability to correct policy errors. The report concludes that what governments can realistically do depends on three factors: administrative bandwidth, market size at home and fiscal space. By this ladder, Pakistan has been moving upwards from the top down. For some 7, 589 customs tariff lines, approximately 7, 476 have an additional customs duty, in addition to the already high customs duties and often regulatory duties. Federal tax expenditure, the income foregone due to exemptions and concessions, totaled approximately Rs2. 35 trillion in the past fiscal year, which is about one-sixth of the total tax target and almost double the federation’s spend on subsidies. Circular debt for the power sector alone was more than Rs1. 6 trillion in June and it absorbs over Rs1 trillion in subsidy every year. It is not a “light touch” state. One of the costlier industrial-policy regimes in the developing world. And it is being run by a state that, on the Bank’s own measures, lacks two of the three things the costly tools require. The Government Effectiveness score in Pakistan lags behind in the bottom one-third of countries. It is a country that has a federal tax-to-GDP ratio locked at around 10%, far below the 14% that the finance ministry itself considers to be the minimum for sustainable growth. Such a stretched government simply does not have the bandwidth to police the incentives it provides, nor does it have the fiscal space to support incentives that don’t work. The results are reflected in the factory data. Manufacturing overall accounts for less than 12% of GDP; on the manufacturing side, the expansion of large-scale manufacturing has reversed for the third consecutive year. Spend some time delving into the numbers, and the diagnosis becomes obvious. The biggest contributor on the upside was automobiles (+40%), while internationally oriented industries like chemicals, steel and electrical equipment experienced large declines. The most protected activity in the economy is booming as competitive manufacturing contracts. The instruments do not help in building competitiveness. They are working to secure incumbency. Here, he sees three failures coming together. The first is an upside-down tool hierarchy with the most expensive ones at the top, and the cheaper public ones at the bottom, ones that would do more. The second, and the most hurtful, is that it is without conditionality. Where capable agencies, protected from lobbies, can track performance and shut down failures, the Bank is insistent incentives can work. Incentives are given to Pakistan without any conditions or reviews. Interestingly, even the government’s National Tariff Policy acknowledges that its policy of additional and regulatory duties has become unfair, opaque and susceptible to elite capture. Tax exemptions have become entrenched as ongoing entitlements. The third failure is financial. In a budget that is mostly spent on debt service, each rupee that is used for an open-ended subsidy is one less rupee for schools, laboratories and roads that cost less and provide more. All this is not a reason to abandon industrial policy. It claims to be correctly ordered. The correction would start with 5 moves. Implement the tariff rationalisation already agreed to in the National Tariff Policy and safeguard the timeframe against the lobbies that have made every effort to reverse this so far. Implement measurable conditions on all export, employment and productivity based exemptions and subsidies, and review prior to renewal. Reallocate part of the income currently allocated for giving away into cluster specific quality infrastructure and skills. Bring together the diffused discretion of the FBR, the Engineering Development Board etc. in one professional and insulated agency with the ability to produce. And discipline the target list, supporting a small number of activities that are built on current assets and capabilities, not a wish list of 13 sectors. The countries that got this right – from the export contingent support of South Korea, to the disciplined investment agency of Costa Rica and the focused automotive bet of Morocco – share one aspect. They matched their means with their tools. Instruments and ambition have never been the issues in Pakistan. It’s because the instruments are not in order. More industrial policy will only add to costs until the order is corrected. The article does not necessarily reflect the opinion of Business Recorder or its owners.

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