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Slow death of manufacturing

June 27, 2014
The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.
The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

THROUGH a combination of indifference and ineptness by successive governments in the recent past, Pakistan’s manufacturing sector has been pushed into long-term decline. This unfortunate and inauspicious trend is evident in the numbers. The share of large-scale manufacturing (LSM) in GDP has declined sharply since 2000, dropping from 14.7pc of total value added to a provisional 10.9pc in 2013-14.

The most worrying aspect of this trend of “de-industrialisation”, if it can be called that, is that new investment by the private sector in large-scale manufacturing has fallen by more than half since 2007. In seven short years, the share of new investment in the LSM sector has declined from over 22pc of GDP to only 10pc. This sharp decline in new capital spending by businesses in large-scale manufacturing for the past several years portends a “weak” outlook for the sector in the years ahead, particularly as the continued opening up of the global and regional economies translates into ever-rising competitive pressures.

In fact, in a related development, Pakistan’s ranking in global competitiveness (as compiled by the World Economic Forum) has plummeted from 83rd in 2007 to 133rd in 2014, a drop of 50 places — the sharpest for any country.

While new investment in the LSM sector has virtually stalled, overall private investment in the country has also declined to record lows. For 2013-14, total investment by the private sector dropped to 8.9pc of GDP. However, this figure is inclusive of $2 billion of Eurobonds purchased by international bond investors. If this resort to dubious accounting is corrected for, fixed investment by the private sector has actually sunk to a new multi-decade low of 8.1pc of GDP in 2013-14.

Tax revenues and job-creation will be impacted by the decline in Pakistan’s manufacturing sector.

Why should the decline of the country’s manufacturing sector worry the government — or anyone else for that matter? Despite the much-trumpeted arrival of the so-called “New Economy” at the beginning of the 21st century, the “Old Economy” consisting of smokestack industries, factory floors and mass-production assembly lines remains very much a vibrant part of the global economy.

In fact, for many of the dynamic emerging economies of the world (Thailand, Malaysia, Indonesia, China among others), “manufacturing” continues to occupy a dominant share of domestic value-added and non-agriculture employment. Despite the sharp rise of commercial services on the global stage, manufactured exports provide the bulk of foreign exchange for non-oil exporting countries, with the share of manufactures in world exports amounting to 67pc.

In Pakistan’s case, the manufacturing sector provides a large proportion of government taxes, and accounts for a still-significant share of new investment, jobs, foreign direct investment (FDI), innovation, the imparting of skills and the diffusion of technology. Apart from prospects for tax collection, the rather dim outlook for large-scale manufacturing in the medium term should be a cause for worry for the government on another important front: job-creation. If industry in general, and large-scale manufacturing in particular, continue to operate at only a fraction of their installed capacity, new employment opportunities will not be created.

The principal reasons for the decline in manufacturing in Pakistan since the 1990s appear to be:

• The disturbed internal security situation

• Policy inconsistency and uncertainty

• Political uncertainty

• Exchange rate policy

• Energy crisis (especially gas)

• Unchecked smuggling and under-invoicing

• Tax policy and practice

While all the factors have played an important part, increasingly it is the resort to what I have called “predatory taxation” by the Federal Board of Revenue (FBR) that is resulting in the suffocation and slow death of the large-scale, formal manufacturing sector in Pakistan. I am reproducing what I wrote in a previous column:

“In broad terms, this is reflected by the fact that industry accounts for over 70pc of total tax collection by FBR, with agriculture’s contribution at less than 1pc. (In fact, despite all the ruckus about indirect taxation of agri-inputs, this avenue provided Rs 20.9bn, or only 0.3pc of the sector’s value added, to the exchequer in 2012-13).

“Similarly, investors on the stock market continue to be handled with kid gloves. On a capital gain of Rs 2,828bn (US$29bn) in the past 18 months, most of it accruing to a narrow circle of large investors, the stock market’s contribution to the national exchequer was an abysmal Rs588 million (around US$6m) in 2012-13 — for a tax incidence of 0.02pc.

“On the other end of the scale, according to data compiled by the World Bank, a formal business in Pakistan makes 47 different payments of tax and government levies a year, while, on average, it spends 577 hours a year in dealing with tax matters. On both counts, Pakistan is ranked amongst the highest-burden countries in the world.”

The increase in the ambit of the withholding tax regime in the recent budget puts an additional burden of responsibility on withholding agents, adding to their transaction cost. Finally, a potential new layer of complexity for large sales tax payers has been added by the setting up of provincial revenue authorities, with no clear or uniform policy on using the origin or the destination principle for determining the tax liability. Adjustments and credits for input taxes have also been affected.

The bottom-line is that rather than burdening the formal (principally manufacturing) sector, as is happening in practice, the government should strive harder to widen the tax base before it is too late. The slow-motion implosion of large-scale manufacturing is already under way, and if allowed to continue, it will have serious long-term consequences.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

Published in Dawn, June 27th, 2014