Pakistan Needs To Stop Drinking The Import Substitution Kool Aid

Pakistan Needs To Stop Drinking The Import Substitution Kool Aid
In the four decades since the start of the 1970s, East Asia & the Pacific region saw its exports-to-GDP ratio increase from 11% in 1970 to 36% just before the 2008 global financial crisis. However, what is often overlooked in the discussions of this phenomenal increase in exports is that, during the same period, these economies saw an almost similar increase in their imports as well.

This is hardly surprising. As countries specialise in areas where they have the potential to compete globally, they meet the rest of their needs by increasing imports from the international markets. The resulting gains from specialisation have helped transform East Asian economies.

Despite this global shift, Pakistan has made little progress towards embracing international competition. Even when average import tariffs have come down, dominant sectors have continued to enjoy protection from international competition by way of additional custom duties, regulatory duties, and non-tariff barriers. The 2020 World Bank study by Gonzalo Varela and his co-authors calculates that the effective rate of tariff protection enjoyed by sectors such as food products, dairy, sugar, beverages, wearing apparels, and motor vehicles and parts is north of 100%.

It is then not a surprise that the inefficiencies that forced the rest of the developing world to largely move away from import substitution policies continue to haunt Pakistan’s economy.

In his 1963 paper titled Industrialisation in Pakistan: A Case of Fractured Take Off, John Power had already noted how restricting international competition led to the state of affairs which were best described as “doing many things poorly instead of fewer things well.” Things have changed little since then.

It is important to appreciate that the import substitution policies of the 50s and the 60s were not specific to Pakistan. As the economic historian Douglas Irwin, points out, prominent development economists of the time had argued that developing countries would be better off if they restricted imports of consumption goods and, instead, used scarce foreign currency for the import of machinery. The Argentine economist Raul Prebisch, had further noted, “a reasonable measure of protection is generally indispensable for industrialization.”

However, the mounting evidence against the effectiveness of import substitution polices and the success of export promotion policies in the East Asia region in the following decades turned many of the early supporters skeptical.

The shift was so stark that several of the prominent economists writing in the 80s and 90s were grappling with the exact opposite question on why do countries have trade protection at all?

In his 1995 paper on the Political Economy of Trade Policy, Harvard’s Dani Rodrik, was particularly concerned about understanding why organised sectors and interest groups lobbied for trade protection to enrich themselves even when this was the most economically inefficient way of doing so.

In a recent paper, Adeel Malik and William Duncan document this phenomenon in the context of Pakistan. They show how at the onset of the 2013 crisis, organised sectors and businesses linked to powerful families successfully lobbied to increase trade protection in the form of non-tariff measures to protect themselves from international competition. Likewise, the 2018 crisis saw a sharp increase in import duties in sectors linked to powerful families. The 2022 crisis has proven to be no different. Pakistan’s economy is now being held hostage by the shameless rent-seeking behaviour of its economic and political elites.

To be clear, economic theory does justify temporary protection is special cases. However, in doing so, it ignores the political economy of trade policy, and further assumes that policymakers are fully informed of the trade-offs and always act in the interest of the society. In contrast, introducing elements of political economy such as lobbying efforts by interest groups and political competition changes these conclusions dramatically. It is then not a surprise that there are very few special cases where import substitution has been proven to be successful.

While the arguments advanced in defence of import substitution policies by both the interest groups and the policymakers continue to reverberate those from the 50s, Pakistan continues to pay the cost in terms of economic inefficiencies that come with these policies.

The Economic Advisory Group’s vision document notes, “a key requirement for any economy to undergo significant transformation is that economic resources must be allowed to move from less productive to more productive activities.

 In a market economy, this critically depends on whether the incentive structure is allowed to evolve such that returns from investing in more productive activities are indeed higher than those from less productive activities.

The import substitution policies, by forcing scarce resources towards activities where Pakistan cannot compete globally, prevent Pakistan from transforming itself into a globally competitive economy.

The EAG vision document warns, “Unless this issue is addressed, any desire on the part of policymakers to see the structure of the economy transform towards the production of more value-added goods and services will remain a pipedream.”

The author is the Chair of the independent Economic Advisory Group (EAG), Pakistan. He is also a Senior Lecturer in Economics at the University of Bristol and a Fellow of the Higher Education Academy, UK.