Foreign trade debate

Published November 23, 2023
The writer is a former finance minister.
The writer is a former finance minister.

THERE is a debate in Pakistan on the foreign trade strategy we should pursue: export promotion, or import substitution? In much of the world, especially Southeast Asia, the debate has been won by export promotion to spectacular effect. We, however, are still confused, trying to carry out the best of both strategies and ending up with the worst of both.

Import substitution is a strategy that seeks to substitute imported goods with domestic production. Take, for example, cars. In the 1980s, our government, while keeping higher duties on imported cars, reduced duties on components such as engines, transmissions, windshields, etc, so that firms that assembled cars here could get a domestic market protected from foreign competition through this duty differential.

This tariff protection, paid by consumers through higher prices, was justified by the argument that this was an ‘infant industry’ and the small local market didn’t allow companies to quickly reach the production scale needed for global competitiveness.

Three decades later, infant-industry protection continues, we have excellent local cars from several international brands but they remain expensive and the market remains small. Both customs duty on parts — which is quite high — and domestic protection through prohibitively high duties on foreign cars, have kept prices high. Moreover, the auto market and firms remain small and therefore inefficient and uncompetitive.

There are, of course, certain advantages to the import substitution model. We have now developed a vibrant engineering and vendor industry, the auto industry provides many jobs, we save foreign exchange compared to importing built-up cars and collect considerable taxes.

The downside is that we still have to import a lot of auto components and we have almost no exports from this sector, so it is still a drain on our foreign exchange reserves. If every industry were like that, substituting imports but exporting nothing, we’d have no dollars to pay for the raw materials for any industry.

How do we get our exports to finally increase?

I have given the example of cars but the effect of protecting markets from competition is the same, whether it’s air conditioners, shampoos, candies, or any other good.

By imposing tariffs to protect manufacturers catering to domestic consumers, we let companies remain small and inefficient and not able to export their wares. This is an important reason why Pakistan has such low exports.

Export promotion, on the other hand, is a strategy that makes manufacturers better off selling to foreign customers than local ones. This is done through policies that favour exporters with cheap credit, lower taxes, etc.

East Asian countries have used this strategy to achieve impressive growth, but even though Pakistan has also offered many of the same incentives, we have not been able to increase exports.

The reason is that by pursuing both these stra­tegies simultaneously, we just end up increasing the cost of doing business for all manufacturers, which renders our industry neither competitive in exports nor in substituting imports.

Of course, this isn’t the only factor holding back exports; there are others as well. For instance: non-reliable and expensive provision of energy; periodically overvalued rupee; and law and order issues that prevent foreign buyers from visiting Pakistan. But here I want to discuss how, by pursuing both import substitution and export promotion simultaneously, we mess things up.

Consider a zipper manufacturer that has to import various metals, say at five per cent duty, to produce zippers. He will typically go to the government and request that it impose a 15pc duty on the imports of zippers so he can compete with larger foreign manufacturers.

Even assuming that the Pakistani zipper has no quality issues and is available in all varieties, our garment exporters will quickly run to the government and say they can’t afford to buy the more expensive Pakistani zippers or pay 15pc duty on imported zippers as they have to compete in the international market.

So the government allows them to import duty-free imported zippers that are then re-exported as part of a garment. As a result, Pakistani exporters still have to buy imported zippers and pay for freight (and hence be at a disadvantage to their international competitors) while the local zipper manufacturer will remain small and inefficient. Rather than win-win, we end up with lose-lose.

Our Ministry of Commerce over the years has tried to have an export promotion strategy, but the problem is that more than half of our tax revenues come from the ports — in the shape of customs duty, sales tax and withholding tax. And much of the remaining sales tax is also collected because the government knows who has imported raw materials and therefore those manufacturers have to pay sales tax on goods.

So our entire tax system depends on us collecting taxes from imports and therefore the import substitution strategy is not pursued because we want to but because we have to.

So, how do we get our exports to finally increase? While our textile industry has done well in spite of mills having to import cotton, not getting gas (in Punjab) and buying expensive land and water (Karachi), textile cannot be the only industry that exports.

We must diversify. We have, over the years, given a lot of benefits to exporters, such as cheap loans. And yet, we have seen these incentives not result in increased exports. (One recent World Bank study has confirmed that export refinancing has had little effect on increasing exports). What we need now is tough love.

We need to convert the 10pc supertax on all companies to those that have zero exports and reduce that tax to zero as companies increase their share of exports.

Similarly, we need concerted moral suasion on our large business houses to get into non-textile export businesses and only allow new factories that generate at least 25pc of their sales from exports.

Finally, there should be a policy, for a few years, of ‘eat what you hunt’ with foreign exchange, whereby industries that are large importers and have a protected domestic market should be asked to, over time, generate at least an equal amount of exports. In short, we need to relentlessly focus on exports, whether in agriculture or industry.

The writer is a former finance minister.

Published in Dawn, November 23rd, 2023

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