WHY are our exports less than half our imports? Why are our imports more than twice our exports? I have posed these seemingly identical questions because their answers are very different. The answer to the export question is extremely complex. The answer to the import question is relatively simple. Our exports in FY22 were $32.5 billion compared to India’s $680bn. For a fair comparison, our per capita exports were $140, compared to India’s $483. Pakistan’s level of per capita exports in FY22 was achieved by India in 2006. This means that we are 17 years behind India in terms of export performance. Our concern here is with long-term performance, and not the drastic fall in exports in the current fiscal, which is due to a default-like situation triggered by balance-of-payments, fiscal and political crises.
Export performance is largely determined by manufacturing performance. Very few manufacturing establishments graduate to exporting firms. Why and how does a firm graduate to an exporting unit? A domestic manufacturing unit of towels, which makes low-quality bath towels is unlikely to become an exporter. This firm displays a low level of entrepreneurship and is hardly concerned with what quality of towels sell abroad. A more aware, dynamic entrepreneur sees the opportunity of making more profits by selling abroad and concentrates on improving the productivity of his firm and enhancing the quality of its towels. With some effort and investment in training its workers, the firm’s management practices will improve and it will ultimately succeed in exporting. With greater exports over time, the firm will continue to improve its efficiency by exporting more. This is akin to learning by exporting.
Not all domestic firms produce towels. Some manufacture more sophisticated, or complex clothing like shirts, pants, suits and jackets, which fetch more value for exporters as their prices are higher compared to towels. Both exporters and non-exporters need to import the inputs required in the production process. If these inputs are costly due to import restrictions such as duties or quotas, manufacturing and exporting costs will be higher and may out-compete our exporters in the international market. It is, therefore, important to keep import duties on intermediate inputs very low. The average level of Pakistan’s import duties is relatively higher compared to our competitors. If these are brought down, many more manufacturers may start exporting for the first time, and existing exporters will likely increase their exports.
Some of the intermediate inputs may also be manufactured at home. Reduced duties will provide more competition for local manufacturers who must then increase their productivity and quality. Under high tariffs, they will continue to produce low-quality products at relatively higher prices and constrain exports. It may seem that high import duties are good for promoting import substitution, but our 75-year history shows that protection accorded to domestic manufacturers for a long time makes them dependent on high duties. In this environment, the process of export promotion becomes very difficult and the overall productivity of manufacturing declines.
Somehow our exporters haven’t captured international markets in a meaningful way.
Most of our exports such as textiles, leather goods and rice are dependent on agriculture and can be affected by crop and livestock output. The lack of technology-based products in our exports results in low product diversification and constrains growth. The total number of exported products is also lower compared to other countries. One reason for the low technology content and lower product diversification in our exports is that Pakistan receives very little foreign direct investment. If FDI goes to manufacturer-exporters, their productivity will increase further because they will adopt new technologies and management practices which FDI brings. If FDI mainly goes into producing burgers, pizzas, coffee, and ice cream it will not increase productivity in the manufacturing sector. It will only add to the pressures on foreign exchange for profit outflows, besides promoting consumption.
Our export market diversification is also low compared to competing exporters. We export very little to places like Germany, Japan, Hong Kong, Russia and Brazil which are large importers. Somehow our exporters haven’t captured their markets in a meaningful way, indicating a lack of sufficient international marketing skills and research by exporters. This is because there’s hardly any investment in research and development in our manufacturing sector.
One obvious factor affecting manufacturing and export output is the availability of energy and its cost. Electricity and gas outages and high costs negatively impact output. Electricity costs are higher in Pakistan compared to our competitors because of structural factors such as very high transmission losses. Unfortunately, due to a low revenue-to-GDP ratio and high fiscal deficit, the government can ill afford to subsidise electricity supply to manufacturers. Higher electricity costs, together with high inflation, higher interest rates and increased terrorism and extortion risks have made the cost of doing business very high in Pakistan.
An overarching factor, over and above the factors described earlier, is the lack of macroeconomic stability, which results in frequent fiscal and balance-of-payment crises accompanied by foreign exchange shortages, large devaluations and reduced imports and exports. Crisis-driven policies lead to more painful medium-term adjustments compared to consistently prudent macroeconomic governance. An environment of low cost of doing business requires low inflation, low interest rates, prudent government borrowing, adequate revenues and a truly market-based exchange rate. This is possible only by tolerating short- to medium-term pain to benefit from consistent long-term gain. All this is in the realm of the possible.
Recent research by a World Bank economist estimates Pakistan’s export potential to be $88bn instead of the FY22 $32.5bn. An important policy to achieve this, in addition to overcoming the constraining factors described above, is to keep the exchange rate competitive. While real devaluation of 10 per cent increases exports by 4.9pc over a two-year period, real appreciation decreases exports very quickly. Hence the cost of keeping the rupee overvalued is very large in terms of lost exports. This research shows that Pakistan can substantially turn around its exports in a few years if it does not consistently get its rupee overvalued. Otherwise, our exports are likely to remain anaemic.
The writer is a former deputy governor of the State Bank of Pakistan.
Published in Dawn, June 3rd, 2023