Escape the low level balance trap

KARACHI:

Economic conditions, as depicted by various statistics, have started to improve as certainty in the political environment has improved in recent months, leading up to the general election in February 2024.

Recent export figures, released by the Pakistan Bureau of Statistics (PBS), show an upward trend. Exports since October 2023 have crossed the $2.5 billion mark every month.

That’s significant given that they’ve been hovering below that mark for several months, especially after touching nearly $3 billion in early 2022.

Pakistan’s economy has faced significant challenges as its growth, imports as well as industrial production slowed down in 2022 and 2023.

Although the recurring balance of payments crisis is the driving factor behind the economy’s persistently dismal performance, the slowdown is also affecting supply chains, commodity availability and prices.

Pakistan has not only experienced commodity shortages in many sectors but also the highest levels of inflation in its history. As the country is about to receive its final installment from the IMF under the current program and prepares to enter another program, it must adopt policies that ensure that balance of payments crises become less frequent.

As a result, the economy will not only thrive but the country will be able to break the habit of approaching the IMF for bailouts every few years.

A balance of payments crisis is usually a result of mismanagement of foreign exchange reserves, as a lack of inflows leads to a plunge to levels that create uncertainty in the exchange rate. Low reserves often lead to speculation in the foreign exchange market, increasing the risk of currency devaluation.

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To build reserves, Pakistan has three non-debt-creating avenues, namely exports, remittances and foreign direct investment (FDI).

While FDI has been negligible, dollar inflows through remittances and exports are relatively significant. Pakistan has fared well in terms of inward remittances, being the second largest recipient in South Asia in absolute value and as a percentage of gross domestic product (GDP).

According to recent World Bank estimates, remittance inflow to Pakistan was nearly $30 billion in 2022, or 8% of GDP.

However, Pakistan performed poorly in exports. Its exports were at 10.5% of GDP in 2022, slightly more than half the average of 20.5% reported for the South Asian region.

Several sub-Saharan African countries, due to their poorer levels of development and geographic location, report a higher value of exports as a percentage of GDP.

Although the China-Pakistan Economic Corridor (CPEC) has often been portrayed as a project that will improve trade connectivity with the rest of the region and the world, the export performance speaks volumes about the challenge policymakers face to make economic conditions more sustainable and less dependent on the IMF.

Several experts set thresholds and benchmarks for export performance. The World Bank believes that exports are $60 billion below their potential, while other experts have proposed methods and proposals to boost exports beyond $100 billion.

According to trade statistics provided by the International Trade Center, Pakistan exported goods worth $11 billion in 2003, while Vietnam and Chile had exports of $20 billion.

In 2022, Vietnam exported goods worth $370 billion, Chile exported goods worth $102 billion, while Pakistan reported meager shipments of $31 billion.

Vietnam’s exports increased more than 18 times, Chile’s exports increased more than five times, but Pakistan’s exports increased less than three times.

Both Chile and Vietnam reported significant growth in their economic performance as their growth levels soared over the past 20 years.

Their policy-makers have created an environment that has helped develop the capabilities of their businesses and the capabilities of their human resources, introducing a competitive business environment that encourages rather than discourages international trade activities. This is missing from the economic policy landscape in Pakistan.

According to the tariff profile available on the World Bank’s World Integrated Trade Solution, Pakistan had eight tariff agreements in 2021 and reported weighted average tariff rates of more than 9%.

In comparison, Chile had 76 tariff agreements and a weighted average tariff rate of 0.76%, while Vietnam had 20 tariff agreements and a weighted tariff rate of 1.17%.

The high level of protection afforded to the targeted sectors in Pakistan demonstrates its lack of integration into global and regional markets. Better integration is needed to boost exports.

On the other hand, Pakistan lacks measures that improve the quality of Pakistani products, as producers often neglect the needs to protect the safety and interests of consumers.

The global market has shifted towards addressing consumer needs, as products must conform to pre-defined quality and production standards and procedures. The policy landscape needs to address the lack of non-tariff measures.

In addition, Pakistan faces challenges as it is unable to exploit its large unskilled labor force and improve its manufacturing capabilities to boost exports.

With a population of about 250 million, Pakistan has abundant labor resources to produce labor-intensive exportable goods. However, with the evolution of labor-saving technologies that help reduce costs for even the most intensive work methods, it is necessary to upgrade not only production capabilities but also workforce capabilities.

Increasing productivity levels will increase the likelihood of firms participating in international trade activities. This includes not only making additional capital investments but also investing in human capital capabilities through vocational training and skills development programmes.

Pakistan will boost its exports only if the producers realize the importance of providing the best possible products at the most efficient prices.

Unfortunately, the current incentive structure includes government intervention, which is not only focused on large subsidies for exporters but also on the growing demand from lobbies to reduce their energy costs. Little attention is paid to additional investments in facilities and infrastructure.

In addition, the government offers protection to inefficient producers in the domestic market, which leads to a bias against exports and prevents exporters from meeting the needs of consumers in the world market, as high profit margins are often guaranteed in the domestic market.

The current incentive structure suggests that firms prefer low-value, low-risk transactions rather than competing for a larger share in more competitive markets.

In essence, policymakers must move to revise the strategies that have led to a low-level equilibrium that lacks innovation and pro-competitive forces. It is imperative to devise a strategic framework that enforces a dynamic change in the business environment, encouraging participation in international trade activities.

The author is Assistant Professor of Economics and Research Fellow at CBER, Institute of Business Administration, Karachi

Published in The Express Tribune, March 18, 2024
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