SEVENTY-FIVE years ago, delegates from the victorious nations of the Second World War met in Bretton Woods to design a new economic order. This economic order, or system, was to be governed by two new institutions: the IMF and the World Bank.
Few people know that the US delegation led by Harry Dexter White muscled out competing ideas for the new system that sought to assign checks on rich lending countries. Dexter’s team stalled British efforts to set up an international clearing bank for automatically reducing borrower countries’ deficits. The US secured a third of all votes, guaranteeing itself the power to veto any proposal as well. Some say this new economic order was designed to ensure America’s geopolitical dominance.
The Bretton Woods’ delegates were ardent proponents of free trade. Free trade’s supposed positive influence was not new thinking. Even in the early 19th century, Adam Smith and David Ricardo extolled the virtues of free trade and advised nations to improve their ‘comparative advantage’. Thus, free trade between nations became one of the pillars of the new economic order.
Free trade has been successful in lifting millions out of poverty. The problem is that these gains are concentrated in only a few nations. For others like Pakistan, free trade has led to persistent current account deficits and plummeting exchange rates. The primary reason why such nations have not been able to benefit from the economic order is the inability to produce high-value exports. Specifically, Pakistan’s economy has not been able to make the transition from agriculture to even light manufacturing. Why has Pakistan failed?
Free trade gains are concentrated in only a few nations.
Standard trade and growth theories that assume that countries can always improve their comparative advantage are of little help. Had that been the case, Pakistan would have been able to diversify and increase the total value of its exports; 21 per cent of its export earnings would not come from agriculture.
‘Product-space’ scholars like Ricardo Hausmann offer a more plausible explanation by showing there is nothing automatic about high-value exports. They argue that a country’s export sector is connected in such a way that a country cannot automatically move from having a comparative advantage in textiles to having one in machinery, chemicals or artificial intelligence, ie what a nation exports today largely determines what it will export 10 years later unless policies encourage economies towards high-value sectors.
Given that the present economic order is based on free trade and the fact that Pakistan has been unable to develop comparative advantage in high-value exports, what options are available for policymakers?
Policymakers can decide to leave the free trade economic order and impose a stringent import control regime while implementing import-substitution-industrialisation (ISI). Many Latin American states tried ISI with sub-par results as inward-oriented growth is costly in a globalised world — intermediate goods, foreign technology, foreign savings and ideas are not available locally.
Policymakers can also decide to go the East Asian ‘Tigers’ route. East Asian countries achieved exponential economic growth rates by improving their comparative advantage in high-value exports within the free trade economic order through developing good policies and effective implementation. It should be mentioned that there was nothing automatic in this process as the government played a key role — picking ‘winners’, credit allocation, promotion of industrial investment, encouraging firms to upgrade technology, etc.
However, the best way forward for Pakistan is a combination of both ISI and export-oriented industrialisation policies. It should play within the free trade arena to earn foreign exchange but then channel heavy investment to import substitution that will actually improve its comparative advantage. At the same time, policymakers need to pick sectors like IT and AI and make winners out of them by establishing world-class universities and business incubators, which will train the next generation of Pakistani technology workers and entrepreneurs. Compared to commodities, technology-based exports have tremendous potential as they earn more foreign exchange and increase in demand as incomes in our trading partners rise.
The Bretton Woods system just turned 75. Though free trade has been a pillar of this system, it has not benefited everyone since nations like Pakistan have failed to produce high-value exports. In order to gain from free trade, Pakistan’s economy needs a structural shift to produce high-value exports. To do so, policymakers need to design policies that will tangibly assist in improving its comparative advantage. With the rise of African economies, the window to improve Pakistan’s comparative advantage may be closing sooner than we think. The time to act is now.
The writer teaches economics and public policy at Habib University, Karachi.
Published in Dawn, August 11th, 2019