NATIONAL security rests on strong defence and a strong economy. In May, our armed forces delivered on defence. It is now time to serve the citizens and fix the economy. Tariff reform announced in Budget 2025-26 is an important step, but is highly vulnerable to attacks by powerful lobbies.

A core economic weakness is that our industry creates far fewer jobs compared to the number of people joining the workforce. A related vulnerability is that we don’t export enough and borrow heavily to plug the current account deficit.

These problems stem from low industrial productivity and the loss of international competitiveness. So, unlike Turkey and recently Vietnam, our industry cannot tap into the global market to create domestic jobs. The current industrial structure thus erodes national security, instead of strengthening it. How did we get there?

Right up to the 1990s, we were star performers. Our export-to-GDP ratio was the highest in South Asia, barring Sri Lanka, and industrialisation was progressing well.

The spending binge of the 2000s, financed by the 9/11 windfall and rupee appreciation, started to erode competitiveness. Then came the energy crisis of 2007 that further raised costs. Industry was now looking for a policy framework to address the loss of competitiveness.

The elected PPP government took over in 2008 and negotiated an IMF programme that required raising revenue. The easiest route to this was trade taxes in the shape of additional customs duties and the humongous regulatory duty. This killed two birds: the fiscal deficit was plugged and industry received gobs of protection. Instead of fixing energy and taxing the undertaxed real estate and retail/ wholesale trade, policymakers chose to distort the tariff structure and gifted industry its desired policy framework. Industry was assured profits — not via efficient production but as additional rents. A powerful government partner, the FBR, was the underwriter.

Budget 2025-26 has pushed through the needed tariff reform.

The distorted tariffs have a huge cost. Consumers pay higher prices for domestically manufactured products whose imported versions are better and cheaper. More importantly, exporters pay higher prices for imported inputs. No wonder exports stagnated. Also, such import substitution is a misnomer — since import content of the protected industry is high. Witness the balance-of-payments crunch as industry expands following a growth spurt.

Distorted tariffs give protection in three layers: customs duty (up to 20 per cent), additional customs duty (around 7pc) and, most egregiously, regulatory duty (5pc to 90pc). Together, they constitute huge and varying protection rates. Return to investment is determined not by business efficiency but by government contacts who set duty rates. This is rent-seeking, pure and simple. Competing in the global market to export goes for a six!

Budget 2025-26 has pushed through the needed tariff reform. If done right, this has the potential to reverse the course of productivity decline and stagnant exports. The reform aims to eliminate the regulatory duty and additional customs duty in five years. Moreover, the customs duty is capped at 15pc and has only four slabs. Thus in year five, we will have a simpler, competitive tariff structure, more like East Asia’s. The survival of firms will depend on their productivity, which will facilitate access to global markets.

The experience of Turkey, Vietnam and, earlier, China shows that internationally competitive tariffs have many benefits. Labour-intensive technologies are encouraged and small firms, significant contributors to exports and employment, are promoted. A strong ex-port ecosystem attr­acts foreign investment, seeking value addition by our workers. Given our low savings, foreign inv­estment in manufactured exports is critical. It will utilise our most abundant res­ource, ie, hardworking labour, and help integrate with global supply chains.

While tariff reform is necessary to reap the benefits stated above, for sustained economic growth, the State Bank must allow the exchange and interest rates to clear the market, and not manage it. We must lower energy costs and fix a tax system that currently allows many to stay out and overburdens those who are already in it. The budget has several promising tax measures. Quantitative targets and time lines, as for tariff reform, will underscore the urgency.

A human skills-centred approach worked for defence and will also work for the economy. The proposed tariff reform creates opportunities for our industry to partner with foreign investors to integrate with global supply chains. We must be vigilant against attempts to undermine reform by powerful lobbies unwilling to compete and contribute to strengthening the economy. We owe it to our citizens.

The writer is the executive director CDPR and former dean and a professor of economics at Lums.

Published in Dawn, July 9th, 2025