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Www.moip.gov.pk ip final_report_revised_aug_13_2011

  1. 1.   INDUSTRIAL POLICY, ITS SPATIAL ASPECTS AND CLUSTER DEVELOPMENT IN PAKISTAN BY ABID A. BURKI KAMAL A. MUNIR MUSHTAQ A. KHAN M. USMAN KHAN ADEEL FAHEEM AYESHA KHALID SYED TURAB HUSSAIN LAHORE UNIVERSITY OF MANAGEMENT SCIENCES THIS VERSION: OCTOBER 18, 2010 VOLUME I: ANALYSIS REPORT TO THE INDUSTRIAL POLICY 2010 Lahore University of Management Sciences Opposite Sector U, DHA, Lahore Cantt.54792, Lahore, Pakistan. http://www.lums.edu.pk  
  2. 2.   INDUSTRIAL POLICY, ITS SPATIAL ASPECTS AND CLUSTER DEVELOPMENT IN PAKISTAN BY ABID A. BURKI KAMAL A. MUNIR MUSHTAQ A. KHAN M. USMAN KHAN ADEEL FAHEEM AYESHA KHALID SYED TURAB HUSSAIN LAHORE UNIVERSITY OF MANAGEMENT SCIENCES THIS VERSION: AUGUST 13, 2011       Lahore University of Management Sciences Opposite Sector U, DHA, Lahore Cantt.54792, Lahore, Pakistan. http://www.lums.edu.pk   ii 
  3. 3. Table of Contents  List of Tables ............................................................................................................................................... vii List of Figures ............................................................................................................................................... ix List of Boxes ................................................................................................................................................ xii Acronyms and Abbreviations ......................................................................................................................xiii Acknowledgements  .................................................................................................................................... xv  .Executive Summary .....................................................................................................................................  vi  x1  Introduction .......................................................................................................................................... 2  1.1  Raison d’être for an Industrial Policy  ........................................................................................... 4  . 1.1.1  Brief Historical Review .......................................................................................................... 5  1.1.2  Towards an Industrial Policy ................................................................................................. 7  1.2  Methodology and Structure ........................................................................................................ 10 2  Industrial Sector of Pakistan: Structure, Performance & Problems ................................................... 12  2.1  Structure & Performance of the Industrial Sector in Pakistan ................................................... 12  2.1.1  Growth Trends .................................................................................................................... 13  2.1.2  Structural Rigidity & Inadequate Transformation  .............................................................. 16  . 2.1.3  Productivity ......................................................................................................................... 21  2.1.4  Export Performance ............................................................................................................ 25  2.1.5  Summary Analysis ............................................................................................................... 32  2.2  Investment Trends in Pakistan .................................................................................................... 33  2.2.1  Aggregate Investment Trends ............................................................................................. 34  2.2.2  Regional Comparison and Pakistan’s Investment Gap ....................................................... 35  2.2.3  Widening Resource Gap between Investment & Domestic Savings  .................................. 37  . 2.2.4  Actual & Potential Total Private Investment & Domestic Savings ...................................... 38  2.2.5  Sectoral Composition of Investment .................................................................................. 40  2.2.6  Foreign Direct Investment .................................................................................................. 42  2.2.7  Sector‐wise Decomposition of FDI ...................................................................................... 44  2.3  Constraints to Investment & Manufacturing Growth in Pakistan .............................................. 46    iii 
  4. 4. 2.3.1  Macroeconomic Instability & its Impact on Investment & manufacturing ........................ 47  2.3.2  Infrastructural Constraints on Industrial Growth ............................................................... 59  2.3.3  Factor Markets Constraints on Investment & Manufacturing ............................................ 74  2.3.4  Standards, Regulation & Governance Constraints .............................................................. 96  Competitiveness & Industry Stagnation ........................................................................................... 109 3  Competitiveness of Key Industrial Sectors of Pakistan ..................................................................... 125  3.1  Primary Industrial Sector .......................................................................................................... 126  3.1.1  Chemical Industry ............................................................................................................. 126  3.1.2  Steel Industry .................................................................................................................... 133  3.1.3  Fertilizer Industry .............................................................................................................. 137  3.2  Value Added Knowledge Based Industrial Sectors ................................................................... 141  3.2.1  Auto & Farm Machinery Industry ..................................................................................... 141  3.2.2  Electronics Industry ........................................................................................................... 144  3.2.3  Pharmaceutical Industry ................................................................................................... 151  3.3  Value Added Skill & Engineering Based Sectors ....................................................................... 159  3.3.1  The SME Sector ................................................................................................................. 159  3.3.2  Fan Sector ......................................................................................................................... 161  3.3.3  Cutlery, Utensils & Hunting Equipment Sector ................................................................. 169  3.3.4  Horticulture Processing Sector ......................................................................................... 177  3.3.5  Surgical Instruments Sector .............................................................................................. 181  3.3.6  Sports Goods Sector .......................................................................................................... 186  3.3.7  Ceramics Sector  ................................................................................................................ 191  . 3.3.8  Furniture Sector ................................................................................................................ 195  3.3.9  Leather Sector ................................................................................................................... 202  3.3.10  Gems & Jewellery Sector .................................................................................................. 207  3.3.11  Marble & Granite Sector ................................................................................................... 211  3.3.12  Light Engineering Sector ................................................................................................... 219  3.3.13  Fisheries Sector ................................................................................................................. 230 4  Spatial Concentration of Economic Activity ...................................................................................... 232  4.1  Introduction .............................................................................................................................. 232  4.2  New Economic Geography and Development .......................................................................... 234    iv 
  5. 5. 4.3  Mapping Measures of Regional and Spatial Inequality ............................................................ 237  4.3.1  Regional Spatial Distribution of Population and Density .................................................. 237  4.3.2  Measuring Regional Poverty and Income Inequality ........................................................ 243  4.3.3  Spatial Disparities in Social Infrastructure ........................................................................ 253  4.3.4  Market Access and Spatial Inequality in Road Infrastructure ........................................... 260  4.3.5  Agglomeration of Manufacturing Industries in Pakistan .................................................. 265  4.3.6  Localization versus Urbanization Externalities ................................................................. 274 5  Poverty Impacts of Public Investments and Causes of Industry Agglomerations  ............................ 278  . 5.1  Introduction .............................................................................................................................. 278  5.2  Are Regional Infrastructure Disparities Influencing Incidence of Poverty? .............................. 278  5.2.1  Background ....................................................................................................................... 278  5.2.2  The causes of poverty in Pakistan ..................................................................................... 279  5.2.3  Methodology and data  ..................................................................................................... 281  . 5.2.4  The basic regressions ........................................................................................................ 283  5.2.5  The effect of spatial inequality in social infrastructure on rural poverty ......................... 285  5.2.6  Spatial inequality in road infrastructure and rural poverty .............................................. 288  5.2.7  Does high inequality cause high poverty in Pakistan? ...................................................... 290  5.2.8  Method of Analysis ........................................................................................................... 293  5.2.9  Social infrastructure and poverty: How inequality affects poverty? ................................ 294  5.2.10  Road infrastructure and poverty: Does inequality matter? .............................................. 296  5.3  What Factors Cause Agglomeration of Manufacturing Industries?  ......................................... 298  . 5.3.1  Background ....................................................................................................................... 298  5.3.2  Explaining agglomeration  ................................................................................................. 299  . 5.4  Nature of Scale Economies and Patterns of Industry Agglomeration ...................................... 303  5.4.1  Background ....................................................................................................................... 303  5.4.2  Empirical specification ...................................................................................................... 303  5.4.3  Empirical results ................................................................................................................ 304  5.5  Compendium of Policy Notes  ................................................................................................... 307  . 5.5.1  Policy for pro poor infrastructure investment .................................................................. 307  5.5.2  Location policy for industrial development ...................................................................... 309  5.5.3  Agglomeration economies, scale externalities and growth of firms ................................ 311    v 
  6. 6. References ................................................................................................................................................ 312    vi 
  7. 7. List of Tables   Chapter 2Table 2‐1: Distribution of workforce by formal/informal sectors and by gender in Pakistan, 1999‐2008 (%) ............................................................................................................................................................... 18 Table 2‐2: Average Product Shares in the Manufacturing Sector of Pakistan, 1970‐90 (percent) ............. 19 Table 2‐3: Growth Accounting in Pakistan by Decades, 1961‐2005 (percent) ........................................... 22 Table 2‐4: Growth Accounting in Asia, 1961‐2005 (percent) ..................................................................... 22 Table 2‐5: Annual Labor Productivity Growth, 1990‐2006 (percent) ......................................................... 24 Table 2‐6: Country Export Shares Relative to Total World Exports, 1970‐2008 (percent) ......................... 25 Table 2‐7: Revealed Comparative Advantage and PRODY in Textiles, 2008/09 ......................................... 26 Table 2‐8: Technological Level of Pakistani and World Exports, 1998‐2008 (percent) .............................. 30 Table 2‐9: Comparisons of Savings and Investments, 1994‐2009 (% of GDP) ............................................ 38 Table 2‐10: Inward FDI Performance Index, 2003‐08 ................................................................................. 43 Table 2‐11: Regional Comparison of FDI, 1990‐2000 ................................................................................. 43 Table 2‐12: Harbison‐Myer Skills Indicators ............................................................................................... 76 Table 2‐13: Data on Enforcing Contracts .................................................................................................. 102 Table 2‐14: individual Tax, Corporate Tax and Tax Revenue Comparisons, 2007‐2009 (% of GDP) ........ 105 Table 2‐15: Pakistan’s Global Competitiveness Index Ratings, 2003‐2010 .............................................. 111 Table 2‐16: Malmquist Index of Sector Means, 1998‐2007 ...................................................................... 113 Table 3‐1: Demand for Petrochemical Products ....................................................................................... 129 Table 3‐2: Import of Basic Chemicals in Pakistan (Million US$) ............................................................... 129 Table 3‐3: Foreign Direct Investment in the Electronics Industry, 2002‐2009  (US$ Million) .................. 147 Table 3‐4: Fan Industry Characteristics ..................................................................................................... 162 Table 3‐5: Cutlery and Steel Ornaments Industry Characteristics ............................................................ 169 Table 3‐6: Surgical Industry Characteristics .............................................................................................. 182 Table 3‐7: Sports Goods Industry Characteristics ..................................................................................... 187 Table 3‐8: Pakistan Ceramics Industry ...................................................................................................... 192 Table 3‐9: Leather Industry Characteristics .............................................................................................. 203 Table 3‐10: Marble and Granite Reserves in Pakistan .............................................................................. 212 Table 4‐1: Population Density by Area...................................................................................................... 238 Table 4‐2: List of poverty studies and their methods ...................................... Error! Bookmark not defined. Table 4‐3: Poverty estimates for the 1990s reported by previous studies .................................................... 244 Table 4‐4: Inflation-adjusted poverty lines per adult equivalent per day used for poverty estimates .......... 245 Table 4‐5: Regional poverty in Pakistan, 1990-91 to 2005-06 .................................................................... 246 Table 4‐6: Changes in Gini inequality in Pakistan and urban and rural areas .......................................... 250 Table 4‐7: Changes in Gini inequality by provinces .................................................................................. 252    vii 
  8. 8. Table 4‐8: District level variables used in principal component analysis ....... Error! Bookmark not defined. Table 4‐9: Principal component rotated factor loadings ............................... Error! Bookmark not defined. Table 4‐10: Most and least developed districts based on rankings from principal component post‐primary school system and hospital index  ............................................................................................... 255  .Table 4‐11: Change in concentration by Gini index in Punajab ..................... Error! Bookmark not defined. Table 4‐12: Agglomeration of 3‐digit manufacturing industries in Pakistan, 2005‐06 ............................. 270 Table 4‐13: Geographic concentration of 3‐digit industries in Punjab, 1995‐96 – 2005‐06  .................... 273  .Table 4‐14: Mean values of industrial concentration measures overtime ............................................... 274 Table 4‐15: Localisation versus urbanization externalities in Punjab, 1995‐96 to 2005‐06 ..................... 276 Table 5‐1: Incidence of poverty by household characteristics, 2005‐06 .................................................. 280 Table 5‐2: Distribution of Rural Sample by Household Survey ................................................................. 282 Table 5‐3: Definition of variables used in the Probit Regressions ................. Error! Bookmark not defined. Table 5‐4: Effects of household and individual characteristics on rural poverty in Pakistan, basic results .................................................................................................................................................................. 284 Table 5‐5: Marginal effects of the impact of education and health infrastructure on rural poverty ....... 287 Table 5‐6: Summary Statistics of Punjab’s Data ............................................ Error! Bookmark not defined. Table 5‐7: Post‐primary school system and poverty under different inequality regimes ........................ 295 Table 5‐8: Road density and poverty under different inequality and polarization regimes  .................... 297  .Table 5‐9: Descriptive statistics for agglomeration regression ................................................................ 300 Table 5‐10: Pearson’s correlation ............................................................................................................. 301 Table 5‐11: OLS specification for agglomeration regression .................................................................... 302 Table 5‐12; Scale Externalities and Productivity in Manufacturing Industries in Punjab, 1995‐96 – 2005‐06 .............................................................................................................................................................. 305    viii 
  9. 9. List of Figures   Chapter 2Figure 2‐1: Association between Manufacturing Value Added (MVA) Growth & GDP .............................. 13Figure 2‐2: Historic GDP growth Rate in Pakistan, 1954‐2006 (percent) ................................................... 14Figure 2‐3: GDP Growth Rate in Pakistan, 2001‐09 (percent) .................................................................... 15Figure 2‐4: Sectoral growth rates in Pakistan, 2001–09 (percent) ............................................................. 15Figure 2‐5: Annualized Growth Rates of Key Sectors in Pakistan for 10 Year Periods, 1970‐2009 (percent) .................................................................................................................................................................... 15Figure 2‐6: Sectoral Shares in GDP of Pakistan, 1970‐2009 (percent) ........................................................ 16Figure 2‐7: Shifts in Sectoral Shares in GDP of Pakistan, 2000‐09 (percent) .............................................. 17Figure 2‐8: Employment Shares by Sector in Pakistan, 1980‐2009 (percent) ............................................ 18Figure 2‐9: Performance of the Large Scale and Small Scale Manufacturing Sector in Pakistan, 1950‐2010 (%) ............................................................................................................................................................... 20Figure 2‐10: Manufacturing Value Added in US$ (Billions), 2001 & 2007 .................................................. 21Figure 2‐11: Total Factor Productivity by Firm Size & Firm Age, 2001‐2006 (log values) ........................... 23Figure 2‐12: Sectoral Value Added/Worker in Pakistan, 1981‐2002 (Rs at contact prices of 1999‐2000) . 23Figure 2‐13: Output per Worker Growth in Pakistan, 1980‐2006 (percent) .............................................. 24Figure 2‐14: Output per Worker in Asian Economies, 1990‐2004 (assuming 1990 as base of 100) .......... 25Figure 2‐15: Competitiveness and Performance of Pakistan’s Exports, 2000‐2007 (percent) ................... 28Figure 2‐16: Product Concentration Index, 1974‐2008 .............................................................................. 28Figure 2‐17: Market Diversification Index, 1971‐2008 ............................................................................... 29Figure 2‐18: Elasticity of Pakistan’s Exports to GDP of Industrial Countries, 1985‐2007 (percent) ........... 31Figure 2‐19: Total, Private and Public Gross Fixed Capital Formulation (GFCF) in Pakistan, 1980‐2009 (% of GDP) ........................................................................................................................................................ 34Figure 2‐20: Aggregate Investment Gap of Pakistan Relative to other Countries, 1980‐2008 (percent)  .. 36 .Figure 2‐21: Long Run Indexed Real/Potential Investment Decline in Trend Rate of Private Investment, 1980‐2009 ................................................................................................................................................... 39Figure 2‐22: Growth Rate in Real Private GFCF & Total GFCF, 2000‐2010 (%) ........................................... 40Figure 2‐23: Share of Manufacturing Investment in Total Fixed Investment, 2000‐10 (percent) .............. 42Figure 2‐24: FDI Investment as % of Gross Fixed Capital Formation, 1990‐2009 (percent) ....................... 44Figure 2‐25: Sectoral Decomposition of FDI, 2004 and 2008 9percent)  .................................................... 45 .Figure 2‐26: Real GDP and Investment Growth in Pakistan, 1991‐2009 (percent) .................................... 49Figure 2‐27: Exports, Net Factor income from Abroad and Imports, 1990-2008 (percents of GNI) .......... 52Figure 2‐28: Inflation and Investment in Pakistan, 2001‐2010 (% p.a.)  ..................................................... 55 .Figure 2‐29: Electricity Demand and Supply, 2003 – 10 (MW) ................................................................... 60Figure 2‐30: Provision of Training to Workers ............................................................................................ 81Figure 3‐1: Petrochemical Value Chain ..................................................................................................... 128Figure 3‐2: Demand and Supply Gap of Steel in Pakistan ......................................................................... 133   ix 
  10. 10. Figure 3‐3: Pakistan’s Fertilizer (N.P.K) Plant Capacity & Demand (000’ tons in nutrients) ..................... 137Figure 3‐4: Pakistan’s Fertilizer Import ..................................................................................................... 138Figure 3‐5: Comparison of Pakistan’s NPK Ratio with other Countries .................................................... 139Figure 3‐6: Pakistan’s Gas Demand and Supply Balance .......................................................................... 139Figure 3‐7: Motorization Levels per 1000 persons ................................................................................... 142Figure 3‐8: Broad Comparison of Pakistan and Indian Pharmaceutical Value Chain ............................... 154Figure 3‐9: Pakistan’s Fan Exports, 2004‐2009 (US$) ............................................................................... 163Figure 3‐10: Typical Value Chain of Fan .................................................................................................... 164Figure 3‐11: Capacity Utilization over typical 12 Month Period ............................................................... 165Figure 3‐12: Average Export Price of Fans US$ ......................................................................................... 166Figure 3‐13: Pakistan’s Cutlery and Steel Ornaments Sector Exports (US$) ............................................ 171Figure 3‐14: Value Chain for a 12 Inch Dagger ......................................................................................... 173Figure 3‐15: Average Export Price of Steel Used in Making Cutlery and Ornaments, US$/Kg ................. 175Figure 3‐16: Product Split of World Exports & Pakistan Exports, 2005‐09 (US$ Million) ......................... 183Figure 3‐17: Exports of Pakistan’s Surgical Instruments Sector, 2005‐09 (US$)  ...................................... 183 .Figure 3‐18: Value Chain Breakdown of a 5.5 Inch Forceps ..................................................................... 184Figure 3‐19: Pakistani Exports of Sports Goods, 2003‐2009 (US$ Billion) ................................................ 187Figure 3‐20: Comparison of World and Pakistan’s Sporting Goods Product Split .................................... 188Figure 3‐21: Typical Value of Hand‐Stitched Export Quality Training Soccer Ball .................................... 189Figure 3‐22: Ceramics Exports for Pakistan, 2005‐2009 (US$) ................................................................. 193Figure 3‐23: Furniture Export of Pakistan, 2005‐2009 (US$) .................................................................... 197Figure 3‐24: Pakistan Export Price Comparison, 2005‐2009 (US$/Kg of Wood) ...................................... 198Figure 3‐25: Key Challenges in Pakistan’s Furniture Value Chain ............................................................. 199Figure 3‐26: Comparison of Pakistan and World Product Split ................................................................ 204Figure 3‐27: Marble & Granite Exports of Pakistan, 2005‐2009 (US$ Million) ......................................... 212Figure 3‐28: Value Chain of Marble and Granite Industry ........................................................................ 214Figure 3‐29: Traditional Quarrying Method .............................................................................................. 217Figure 3‐30: Advanced Method of Quarrying ........................................................................................... 218Figure 3‐31: Value Chain for Radiator Production .................................................................................... 225Figure 4‐1: Post‐primary school system and current population, 2005‐06 .............................................. 240Figure 4‐2: Hospital size and current population, 2005‐06 ...................................................................... 241Figure 4‐3: Value of large‐scale manufacturing production and population growth ............................... 242Figure 4‐4: Regional Poverty headcount in Pakistan, 1990-91 to 2005-06 ................................................. 247Figure 4‐5: Poverty headcount in urban Pakistan, 1990-91 to 2005-06...................................................... 248Figure 4‐6: Poverty headcount in rural Pakistan, 1990-91 to 2005-06 ....................................................... 248Figure 4‐7: Changes in inequality in Pakistan and by regions ................................................................... 251Figure 4‐8: Changes in inequality in the four provinces ............................................................................ 253Figure 4‐9: Location of districts by education and hospital index  ............................................................. 257 .Figure 4‐10: Industry clusters and development ranking of districts, 2005-06 ........................................... 258Figure 4‐11: Resource based clusters and development ranking of districts, 2005-06 ................................ 259Figure 4‐12: Spatial inequality in road density in Punjab, 2005‐06 .......................................................... 262   x 
  11. 11. Figure 4‐13: Relative road density of the districts of Punjab with Lahore district, 1992‐93 vs. 2005‐06   263 .Figure 4‐14: Spatial inequality in road density in Khyber Pakhtunkhwa, 2005‐06 ................................... 264Figure 4‐15: Relative road density of the districts of KP with Peshawar district, 1993-94 vs. 2005-06 ....... 265Figure 4‐16: District level employment shares in Pakistan’s manufacturing sector .................................... 267Figure 4‐17: Distribution of 3-digit Ellison-Glaeser index ......................................................................... 271Figure 5‐1: Distribution of inequality and per capita income .................................................................... 291Figure 5‐2: Distribution of Poverty and Per Capita Income ...................................................................... 292Figure 5‐3: The effect of inequality on poverty in Pakistan, 1990-91 to 2005-06 ....................................... 293   xi 
  12. 12. List of Boxes   Chapter 2Box 2-1: Inward Investment Incentives Regime in Pakistan ..................................................................... 45Box 2-2: Energy in Comparison with China and India ............................................................................. 63Box 2-3: The Case of Gawadar ................................................................................................................... 72Box 2-4: Cartelization & Case Studies .................................................................................................... 109Chapter 3Box 3-1: The Steel Industry of China ....................................................................................................... 125Box 3-2: The Automobile Market of Malaysia ......................................................................................... 132Box 3-3: Electronic Industry in China ..................................................................................................... 139Box 3-4: Singapore Electronics Industry .................................................................................................. 141Box 3-5: New Drug Filings of Some Successful Indian Pharmaceutical Companies.............................. 144Box 3-6: Past Government Intervention in the Furniture Sector ........................................................... 189Box 3-7: Depiction of Suha Bazar of Lahore............................................................................................ 196Box 3-8: Italian Marble Industry ............................................................................................................... 203   xii 
  13. 13. Acronyms and Abbreviations   ADR Alternative Dispute ResolutionAPI Active Pharmaceutical IngredientsBOP Balance of PaymentsCRO Clinical Research OrganisationDAP Diammonium PhosphateDFID Department for International DevelopmentEDB Engineering Development BoardEPZ Export Processing ZonesEOBI Employee Old-Age BenefitFDI Foreign Direct InvestmentFPCCI Federation of Pakistan Chambers of Commerce and IndustryGDP Gross Domestic ProductGMP Good Manufacturing PracticesIAG Industry Advisory GroupIDB Industrial Development BoardIPR Intellectual Property RightsITP International Trade PriceKIBOR Karachi Interbank Offer RateMMF Man Made FibreNAVTEC National Vocational & Technical Education CommissionNEQS National Environmental Quality StandardsNPO National Productivity OrganisationOEM Original Equipment ManufacturerPEFMA Pakistan Electric Fan Manufacturers AssociationPEPCO Pakistan Electric Power CompanyPHADC Pakistan Hunting Arms Development CompanyPIB Pakistan Investment BondPLDC Pakistan Leather Development CouncilPPP Public Private PartnershipPSDC Pakistan Stone Development CompanyPSM Pakistan Steel MillPSQCA Pakistan Standards & Quality Compliance authorityPSI Pre-shipment InspectionsR&D Research & DevelopmentRFID Radio Frequency IdentificationSECP Securities & Exchange Commission of PakistanSEZ Special Economic ZonesSME Small & Medium EnterprisesSMEDA Small & Medium Enterprise AuthoritySG SafeguardsSPS Sanitary & PhytosanitaryTBS Tariff Based SystemTBT Technical Barriers to TradeTDAP Trade Development Authority of PakistanTEVTA Technical Education & Vocational Training AuthorityTVET Technical & Vocational Education TrainingUNEP United Nation Environment Programme xiii  
  14. 14. WAPDA Water & Power Development AuthorityWHO World Health OrganisationWTO World Trade Organisation xiv  
  15. 15.  Acknowledgements This study has been completed with the support of several individuals, departments andorganizations. The project would not have been possible without the facilitation and overallguidance provided by Prof. Ijaz Nabi (Dean, LUMS). We would like to thank Ms. Shaista Sohail,Joint Secretary, Ministry of Industries and Production for providing us invaluable information andsupport throughout the project. We would also like to thank officers from EngineeringDevelopment Board, Small & Medium Development Enterprise (SMEDA), Technical andVocational Training Authority, and Chambers of Commerce & Industry across the country fortheir useful ideas on industrialisation and its issues in Pakistan. We owe a debt of gratitude toProfessor Ha Joon Chang (University of Cambridge), Professor Alice Amsden (MassachusettsInstitute of Technology) and Dr. Faheem ul Islam (LUMS) for their insightful comments and ideasin deriving the policy proposals. We thank the members of the staff of the World Bank forproviding the funding and over all support for the project. We would like to acknowledge theresearch support provided by Kiran Javaid and Abubakar Memon and the editorial input receivedfrom Shahbano Ijaz and Nadia Mukhtar. Finally we would like to thank the numerousrepresentatives of the private sector, especially the members of the Task Force who took time outfrom their busy schedules to discuss in detail the problems of Industry and the possible solutions. Prof. Abid A. BurkiProf. Kamal A. MunirDr. Mushtaq A. KhanM. Usman Khan, CFA IMCAdeel FaheemAyesha KhalidDr. Syed Turab Hussain (Focal Person) xv  
  16. 16. Executive Summary  Introduction: The third tier of analysis takes a more telescopic view of the industrial sector The Industrial Policy report constitutes a where the focus is on the spatial aspects ofcomprehensive analysis of Pakistan’s industrialization - economic geography,manufacturing sector aimed at deriving covering issues such as inter and intrapolicy recommendations for Industrial provincial inequalities in infrastructuralgrowth and development. The report isstructured to provide a three tiered analysis provision and its resultant impact onof Pakistan’s industry. income inequality, poverty and industrial The first tier is a macro level analysis of cluster formation. The analysis in thisindustrial structure and performance which section uses the Census of Manufacturinghelps identify the major constraints Industries (CMI) disaggregated data set andhampering structural change in the rigorous econometric and statisticalcountry. The policy recommendations techniques to come up with both indexesderived from this section are the broader or measuring industrial concentration and thehorizontal interventions required for factors which significantly affect clusterindustrial development spanning a wide formation or the lack of it.sphere of economic activity in the country. Industrial Sector of Pakistan: The second tier of analysis presents Structure, Performance &detailed look at the manufacturing sector Problemsthrough a firm/sector level analysis. Themain obstacles in increasing firm The first tier - macro level analysiscompetitiveness and sectoral growth are analyses the structure/performance of theinvestigated through both a value chain industrial sector using various macro and industry specific indicators across time andand a stakeholder analysis. This in comparison to other countries. Themethodological approach helps divulge the primary focus in this section is onnecessary vertical or sector level policy macroeconomic management andinterventions. There are a total of twenty performance with respect to industrialfour sectors covered in this analysis ranging sector growth. The section highlights thefrom important ancillary industries, fact that although over the last four decades Pakistan has experienced over five percentknowledge based industries to the major average GDP growth rate, these episodes ofsmall and medium scale export based high growth rates were mostly consumptionindustrial sectors. driven leading to frequent ‘boom’ and ‘bust cycles. The fact that industry has not been xvi  
  17. 17. the main engine of Pakistan’s growth has countries such as Korea and Taiwan, theled to on average a low and variable growth secular fall in investment is shown to be therate. key factor behind an overall sluggish growth The macro analysis also reveals that the in GDP.structural change in Pakistan has beenskewed towards a shift from agriculture to Following the discussion on industrialservices with manufacturing growth performance and investment trends, theremaining fairly stagnant. It shows that broader impediments resulting in thePakistan’s manufacturing sector is largely systemic stagnation of industrial growthconcentrated in a few industrial products and investments are highlighted in thiswith relatively less value addition compared section. Constraints related to factorto countries within the region. With a markets, infrastructure provision, lack ofnarrow manufacturing base and a macroeconomic stability, regulatoryconcentration in low technology and low environment, and security/negativevalue-added products whose share in the perception of Pakistan, are brought to theworld market is decreasing, the prospects of forefront. This is done by using theindustrial growth remain uncertain. repository of existing evidence on the abovePakistan’s economy was built around textile mentioned constraints such as the cost ofand its current base is still concentrated in doing business data collected by Worldtextiles. Cotton textile production is the Bank and other similar studies. Themost important of Pakistans industries, analysis is used to inform policy which byaccounting for about 19 percent of large- removing cross-cutting bottlenecks wouldscale industrial employment and about 60 facilitate the overarching growth of thepercent of total exports. industrial sector. These essentially are the horizontal policy interventions required to After reviewing the characteristics and stimulate overall manufacturing growth.performance of the manufacturing sector Some of these interventions arethe report looks at the over time trend of summarized below.investment in the country relative toregional economies. Investment in large In terms of macroeconomic stability thescale manufacturing sector is shown to be need for enhancing the fiscal space –volatile with a significant recent decline as a through expansion of the tax base – isconsequence of both periodic stressed. The importance of prudent fiscalmacroeconomic instability and an and monetary policy is underscored albeitinvestment climate which has been with a recommendation to lower thepersistently poor. As increased investment nominal interest rate which has been aor capital accumulation is a necessary major factor in stifling investment andcondition for growth, substantiated by the manufacturing growth recently. Emphasis isexperience of the newly industrialized also put on the need to coordinate trade xvii  
  18. 18. policy with industrial policy. Effective use computerized clearance system. Finally, theof Non-Tariff Barriers NTBs and creation importance of Gawadar as a potential ventof a Science Park is also suggested as for future growth is emphasized withmechanisms to protect and facilitate the suggestions to harness this potentialgrowth of value added industry in the through the help of China.country. To promote the growth of existing and Specific policy recommendations are resource based industries policies are putgiven to resolve the energy crisis – which by forward to create industrial estates andfar has proven to be the most binding agro-processing zones at the identified ‘hotconstraint to industrial growth and spots’ of economic activity. Thedevelopment over the past couple of years. intervention of the government is specificEffective management of load shedding, to technology up-gradation, branding,peak load pricing and the need for improving quality standards such as phyto-preferential treatment of the industrial sanitary measures and facilitating access tosector over both consumer and commercial international markets. Provision of hardsector is stressed. Captive power generation and soft infrastructure and commonin industrial estates and special economic effluent treatment plants in the industrialzones is also recommended. It is suggested zones is also put forward.that the long term energy mix should shift The issues in factor markets, labor, landtowards more efficient/cost effective and credit, are also dealt with andsources, such as wind, hydel and solar appropriate polices are derived to tackleenergy. The need for the development of some of these. Various mechanisms arelocalized machinery for hydel, thermal and suggested to improve Labor skills andcoal based power plants is also pointed out. training. For example, specific programs After highlighting the issues and problems such as a Skill Development Fund and awith the country’s logistical infrastructure Skill based wage subsidy scheme arethere are specific recommendations given proposed to provide incentives toto upgrade it. For example, major businesses to invest in worker training. Inrestructuring of the railways and new terms of credit markets, the rationing ofinvestments in freight services are small businesses is shown to be one of thesuggested. To reduce transportation and major constraints to their growth. Policiestrucking costs the building of Logistical such as credit guarantee schemes andParks near industrial estates is promotion of venture capital funds arerecommended. The importance of an discussed as possible mechanisms toAutomated Customs Clearance system is address the credit market failures arisinghighlighted in Ports and it is suggested to from asymmetry in information. In case ofmaintain and improve the existing land markets, the need for achieving xviii  
  19. 19. security of property rights by expediting the government interventions to knowledgecomputerization of land records is based and technology intensive sectorsunderscored. falling under the ambit of WTO rules and regulations. There is a detailed discussion onstrengthening governance to stimulate Competitiveness of Key Industrialinvestment and manufacturing growth in Sectors of Pakistanthe country. It is noted that businessesspend too much time and money dealing The second section of the industrialwith bureaucratic red tape and meeting the policy report is a micro level analysis as it“informal” costs of relations with the state. focuses on the issues of selected firms andAlso, uncertainty about the security sectors within the country. This sectionsituation acts as a deterrent to outside comprises analyses of both large and smallinvestors from seeking business manufacturing sectors. In both cases, thepartnerships in Pakistan. The judicial competitiveness of each sector is assessedsystem works slowly and the sanctity of and policy options are proposed to enhancecontracts and of land rights can be opaque. it. This is done by conducting in depthPolicy proposals addressing these consultative sessions with sectorgovernance issues are also put forward. representatives, analyzing all existing literature on sector’s in Pakistan and for Finally, a strategic recommendation given some sectors through a simple value-chainin this section is the creation of a full scale analysis supplemented by a broaderScience Park to promote knowledge based industry assessment that contextualizedindustries in the country The Science Park value-addition achieved in a particularwill have formal operational links with chain. This methodology helps identifyuniversities and research centers. It will those factors which inhibit value additionhave the necessary infrastructure to and result in relegation of firms to thefacilitate R&D, manufacturing, marketing lower rungs of the global value chain. Theand branding – covering thus the entire reasons behind the lack of value additionproduct cycle. The Park would not only and competitiveness is identified withprovide incubators for scientific particular emphasis on factor conditions,innovations it will also be the production demand conditions, domestic rivalry,center for cutting edge products. This related industries and the role of theinitiative would attract professionals, government. This broader analysis providesbusinessmen and scientists which would to insights that became the basis for verticalan extent reverse brain drain facilitating the policy interventions that are both strategictechnological up-gradation of industry. The and emergent.Science Park would also allow governmentpolicy coordination and targeted xix  
  20. 20. We are able to cover all major large scale improve governance structure of the Steelsectors, key SME export sectors and light Mill and triple its capacity over the next fiveengineering sectors. This coverage includes years and make investments to enable theprimary/ancillary industry such as Steel, Steel Mill to manufacture high grade steel.Chemical and Fertilizer. We include We also propose that government shouldknowledge based sectors such as Auto, use the existing iron ore deposits ofElectronics and Pharmaceutical including Pakistan to its full benefit.Bio-Chemical. And finally, we look at In this section we also analyze few of theeighteen small and medium scale enterprise sun-rise sectors. The selection of the sun-sectors some of which are critical for export rise sectors is based on where we believeand some feed in directly into the local gaps exist in the global value chain andmarkets. The sectors in this category among there is room for Pakistan to augment itsothers include, Surgical Instruments, Sports strategic comparative advantage toGoods, Fans, Cutlery, Agro-food, Leather, competitive advantage. We argue that suchFurniture, Marble and Granite, Gems & opportunities mainly exist in knowledgeJewllery and Light Engineering Sector. based industries such as Auto, Electronics We argue that the inclusion of primary and Pharmaceuticals. While analyzing thesectors is necessary as almost all the value auto sector we find that the past policiesadded industry depends for their inputs on were heavily influenced by MNCs and thethese sectors. For example, leather tanning interests of the local industry were highlyrequires the use of 101 chemicals, out of compromised. We present evidence that inwhich around 98 are currently being periods the deletion policy was followed,imported. This not only adds more to the significant growth of local industrycosts but also results in shortages. Similarly, resulted, however, since the introduction ofthe pharmaceutical sector is entirely Trade Related Intellectual Property Rightsdependent on imported chemicals. We (TRIPs) there has been no indigenization orrecommend that if Pakistan is to move growth of the local auto industry. Themore towards value addition then licensing regimes of internationalgovernment will have to invest in building collaborators especially in the tractorthe chemical industry in the country. One industry are prohibitive. They limit thesuch recommendation is to set up a Naphta permission of sales, especially in valuecracking facility. Moreover, steel is an input added export markets. We recommendinto almost all the value added industries. ways by which government can promoteIt is surprising to see that even with a large outward FDI and assist the tractorlocal demand for steel the Steel Mill of manufacturers, for example, to acquirePakistan is running in significant deficits. international brands. The deletion programWe recommend to the government to xx  
  21. 21. is also strongly supported, in fact, deletion knowledge intensive industries weshould occur at a much higher pace. recommend that the government should establish Science Parks and provide At this point in time, no country can attractive fiscal incentives to attractafford not to develop competencies in investment into the bio-technologyelectronics. Electronics pervade almost all industry.industries and competitiveness in anyindustry requires knowledge of electronics Finally, in the economic activities of mostboth at the level of product and process. developing regions, small and mediumMoreover, with increasing affluence a large enterprises (SMEs) play a major role anddemand has developed for electronic items Pakistan in this case is no exception. Itssuch as Televisions, Computers, Washing economy is dominated by SMEs, whichmachines, Air conditioners etc. Similarly, produce most of its output and employwith the Tata Nano, India has most of its workforce.1 Specifically, SMEsdemonstrated that producing competitive constitute 90 percent of the economicautomobiles is not the sole preserve of rich, establishments and contribute 30 percentdeveloped nations. Developing countries of GDP and 25 percent of export earnings,are just as capable of producing products and employ 78 percent of the non-that will appeal to the global segment agricultural labour force. Hence, we havewhich cannot yet afford automobiles but broadly looked at around eighteen criticalwill settle for slightly lower quality. SME sectors in Pakistan. However, realizing the domestic constraints Our findings reveal that most of theseand limitations we recommend that sectors face similar issues and impedingPakistan should only focus on product factors to growth. One of the major issuesmanufacturing and not component faced is the inadequate availability ofmanufacturing. For this, product design appropriate human resource and skills. Theand development institutes will have to be existing government entities such asestablished with strong linkages in national TEVTA and NAVTEC are providing classand international engineering universities. based skills that are not necessarily alleviating the problems faced by the Similarly, Pharmaceutical, in fact Bio- industry. During our field visits we foundChemical is a sector with great future that almost all industrial units in Sialkotpotential. Both India and China are fast Small Industrial Estate had vacancies fordeveloping capabilities to improve their only skilled workers.market shares in the bio-chemical industry.                                                             Pakistan cannot afford not to develop this 1 The data for all Pakistan indicate that SMEsindustry as there is going to be enhanced account for about 90 percent of all enterprises,demand both locally and in international employ 80 percent of the non-agricultural labor force, and account for approximately 40 percent ofmarkets. For development of such the GDP xxi  
  22. 22. Another major impediment is low levels design that takes place is a result of reverseof productivity, resulting from both engineering done at the initiative of theinadequate up-gradation of technology and factory owner. Government has fundedpoor production and floor management some common facility and producttechniques. Due to high levels of illiteracy development centers, however, theirand lack of training, most of the capacity to deliver to the needs of specificentrepreneurs’ struggle with basic costing sectors is fairly limited. Therefore, wetechniques and lean production recommend specific type of linkages thatmanagement methods. The floor designs need to be created between SME sectorsare suboptimal resulting is high wastages of and research and development centers. Welabor time and inputs and makes it also indicate priority sectors whereimpossible to capture the actual costs of government needs to immediately establishproduction. Similarly, in most industries, design and research centers.such as leather, sports, surgical, fans, cutlery Finally, another issue facing the sectors isthe technology being used is outdated. lack of branding and marketing. PakistaniWhen combined with low scale of products are increasingly fetching lowerproduction all this results in significant price in international markets. Moreover, itinefficiencies and loss of productivity. is also becoming exceeding difficult forHardly, any of the SME sectors employ Pakistani product to find access into newerprofessional management or formal systems international markets. Given the lack ofof record keeping. We recommend that the innovation, most of the industry acts as an Original Equipment Manufacturers OEMNational Productivity Organization of hence branding has always been limited. InPakistan should play a lead role in addition, marketing has been a consistentlybenchmarking the SME industrial sectors weak area limiting the growth potential ofand assist them in lean management tools firms. Finally, all of the above factors haveso as to extract the maximum results from made it extremely difficult for the sectors toexisting capacities. meet international quality standards and compliance requirements. The Almost all the SME sectors that were international standards on quality, healthconsidered face issues with innovation and & safety and environment are becomingdeveloping original designs and products. increasingly stricter. With their current characteristics Pakistani products are beingThis is indicative of the lack of refused access to many markets based oncollaboration and link between sectors and non compliance to these standards. It isuniversity engineering departments and imperative that the government not onlyproduct development centers. In fact there provides the hard infrastructure such asis hardly any evidence of formal linkages laboratories and testing centers but alsobetween research & development centers builds the capacity of Pakistan Standards Quality Compliance Authority (PSQCA) toand industry. Any innovation or product enforce domestic quality standards. This xxii  
  23. 23. will ensure mandatory compliance to some between the leading and the laggingminimum standards which will then build districts is increasing with the passage ofcapacity of the sectors to meet similar time, which should worry policy makersstandards in international markets. who are interested in bringing about spatial equality.Spatial Concentration of EconomicActivity Poverty Impacts of Public The most striking feature of economic Investments and Causes of Industryactivity in Pakistan is the geographic Agglomerationsconcentration (clustering) and location offactors of production in few cities, The econometric evidence shows thatincluding unequal spatial distribution of poverty coexists with illiteracy of householdincome, poverty, education, health and heads and lack of household assetphysical infrastructure, among others. The ownership. Therefore, the governmentconcentration of economic activity in few emphasis on human capital accumulationmetropolitan areas symbolizes the and social and physical infrastructurecoexistence of development and development as tools for poverty reductionunderdevelopment within and between makes sense. Policies that seek universalregions. We examine the economic access to education by increasing thegeography of Pakistan by exploring regional quantity and quality of schools and collegesand spatial inequality and document seem to have a strong power to reducevarious mapping measures to highlight poverty. While current attention tospatial distribution of population, regional investment in social infrastructure is clearlypoverty and income inequality, spatial appropriate, policy inattention to spatialdisparities in social infrastructure, road inequality in income is very costly,infrastructure, and agglomeration of especially in more deprived districts. Ourmanufacturing industries. We employ empirical analysis of the evolution ofdifferent measures of concentration to gain poverty on the basis of high quality districtinsight into spatial inequality (in poverty, level data on post-primary education andincomes, road infrastructure and industrial hospital infrastructure index indicates thatconcentration) as a function of different increased public sector investments onpush and pull factors that explain education and health infrastructure lead toconcentration versus dispersion of a sharp decline in poverty in all but highlyeconomic activities. unequal districts where these investments Our results suggest that investment in are not associated with a decline in poverty.social infrastructure and physical Policies that encourage investment in socialinfrastructure is highly concentrated in infrastructure by also promoting moremetropolitan cities, big cities and their spatial equality in the distribution ofsurrounding districts while districts located income may yield higher returns.away from these urban demand centers are The econometric results further show alagging behind. While we have evidence of strong negative association between roadconvergence in the leading districts, the gap density and poverty incidence. The xxiii  
  24. 24. magnitude of fall in poverty due to road from 1995-96 to 2000-01, but it drasticallydensity is even higher than the effect of fell by about 33% in the next five years.investment on post-primary school system Exploring the causes of agglomeration, weand hospitals. We also find that the long find that district population, road density,run effects of road density on poverty are and the pool of technically trained workersfar greater than the short run effects. We all help promote agglomeration ofconclude that income equality matters as manufacturing industries. Thefar as public investment on infrastructural determinants of industry agglomerationprojects is concerned. The long run poverty guide us on the causes of dense economicalleviation potential of investment on roads activity across spatial units, and thealmost doubles when we move from high difficulties faced in attractingincome inequality districts to low income manufacturing activities in remote districts.inequality districts. Therefore, we reiterate However, a range of policy instrumentsthat pubic policies that seek more regional have already been tried in Pakistan, e.g., taxequality in incomes are far more desirable holidays, building infrastructure infor pro poor growth policies. industrial estates, free trade zones, export This study has also examined the nature processing zones, etc. There is no evidenceof geographic concentration of on their systematic success or failure. We,manufacturing industries in Pakistan by therefore, advise that more empiricalusing the Ellison and Glaeser research need to be conducted to evaluateconcentration index. While there is little the effectiveness of past policies todoubt that increasing returns to scale conclude under what circumstances theseassociated with agglomeration externalities programs and policies are likely to succeed.do exist at a wider scale in Pakistan, it is Exploring the relative strengths ofmuch more difficult to identify factors that localization versus urbanization economiescause industry agglomeration. We have also our results suggest that localizationexplored how geographic concentration of economies (within-industry externalities)manufacturing industries emerges from the are much more important thandynamic process overtime and what is the urbanization economies (inter-industrynature of agglomeration economies. Our spillovers), which implies that industry-findings show that agglomeration of specific subsidies and infrastructuralmanufacturing industries is widespread in investments are likely to yield much higherPakistan where only 27% of the industries pay offs. However, productivity growth inare not agglomerated, 35% are highly the manufacturing sector as a whole isagglomerated and 38% are moderately almost stagnant since 1995-96. Therefore,agglomerated. However, industry policies aimed at rebuilding the industrialconcentration remained roughly constant sector of Pakistan by adopting coherent xxiv  
  25. 25. strategies are long overdue to which weturn to in the next chapter titled principalrecommendations. xxv  
  26. 26. i  
  27. 27. 1 Introduction The process of structural change has been a central feature in the economic growth anddevelopment of both the Western Economies and the Newly Industrialized Countries of the East.As an economy develops the share of agriculture in GDP inevitably declines while that ofmanufactures and services increases. In other words, structural change is a gradual shift from lowproductivity to high productivity activities. Along with this observable structural transformationthere is a large body of empirical literature which suggests that there is a “U” shaped relationshipbetween a country’s income level and its degree of product specialization or sectoral concentration[see, Klinger and Lederman (2004)]. At low income levels specialization is high and is primarilydetermined by resource based comparative advantage. As the country becomes richer themanufacturing base diversifies with firms producing and exporting a wider range of relatively moresophisticated products. However, at higher levels of income, the process reverses; specializationagain increases but in high value added and technologically advanced products. Thereforeincreased product diversification is an intermediate stage in the process of structuraltransformation and economic development of a country.In the context of the Pakistan economy this structural transformation has been skewed in favourof the services sector. Since the 1970s the growth in services has outstripped that in agricultureand industry resulting in its current 50% share in GDP. Agriculture and industry over the pastdecade have contributed around 25% each to GDP with the share of agriculture declining overtime and that of industry remaining fairly stagnant. In fact, between 2008-09, in the wake of bothinternal security issues and the increasingly binding energy constraint, output in themanufacturing sector contracted by 3.3 percent with large-scale manufacturing registering asubstantial decrease in output of 7.7 percent [GoP (2009a)]. Notwithstanding the recentcontraction of overall industrial productivity and output, the industrial structure of the countryhas not experienced any significant change in the course of the past thirty years. Themanufacturing base remains rigidly narrow leading to a lack of product and export diversificationwhich has been a major impediment to sustained economic growth and development of thecountry. 2  
  28. 28. The short term revival and the long term growth of Pakistan’s economy thus hinges on both theperformance and the structural transformation of its industry. As mentioned above, in the pastyear and a half the country has seen a dramatic retardation of economic activity characterized inparticular by a stagnating manufacturing sector. The current energy crisis has further eroded thecompetitiveness of manufacturing resulting in a tremendous loss of income, employment andexport revenues. Given the fact that the potential of growth and development of a country isinextricably linked to the extent of investment and industrialization the continued dismalperformance in industrial growth in Pakistan does not augur well for the future. Therefore it isimperative to develop an industrial policy which is implementable and has the ingredients toprovide the much needed impetus to industrial growth and diversification. While focusing on therevival and restructuring of the industry the strategy would have to be guided by the over archingobjective of achieving efficient, sustainable and equitable development.Pakistan today has the highest population growth rate2 in the South Asian region with hordes ofunskilled entrants into the labour force every year. These adverse demographics pose a seriouschallenge to effective policy making. If the industrial base of the country does not expand toabsorb this surplus labour, the bourgeoning unemployment in both urban and rural areas is likelyto have serious socio-economic and political ramifications.3 On the other hand, a growingpopulation has the potential to become a significant economic asset, if adequate policies are inplace to facilitate the development of a large, healthy and skilled labor force. Therefore a centralmotivation and aim of the industrial policy should be to generate widespread employment andraise income levels across the country, with the longer term aspiration of achieving convergence inliving standards in rural and urban areas. This would subsequently reduce the incidence of povertyand lessen the widening inter and intra regional income inequality. An industrial policy, whichemphasizes domestic as well as international linkages, promotes and facilitates entrepreneurialactivity, focuses on the development of small and medium scale industries, and provides an                                                            2 1.8% in 2007-08, [see GoP (2009a)].3 The manufacturing sector in 2007 -08 absorbed only 13% of the country’s labour force compared to 11.5% in 1999,a meager 1.5% point increase over the course of almost a decade, [GoP (2009a)]. 3  
  29. 29. impetus to services, trade, transport and other ancillary sectors, can achieve the objective ofinclusive and broad based growth.The formulation of the industrial policy is in accordance with the overall growth and developmentpriorities of the Government of Pakistan (GOP) as broadly identified by the “9-point” Plan putforward by the Planning Commission (PC) and the Prime Minister’s Economic Advisory Council(EAC) [GOP(2009a)]. In fact most of the priority areas highlighted by the Plan where ‘deep, broad-ranging, and sustained’ policy intervention is required are in sync with the objectives of theindustrial policy being proposed here. For example, Industrial Competitiveness, Human CapitalDevelopment, Energy, Capital Markets, Public-Private Partnership for Infrastructure andInstitutional/Administrative reform are some of the relevant areas which would be dealt with inconsiderable detail in the industrial policy report.The outcome of the industrial policy project is in the form this comprehensive report. Thisparticular report, constitutes the analysis on the basis of which the industrial policy has beenderived. Moreover, this report also provides a rigorous and detailed analysis of the spatial aspectsof industrialization from which specific policy briefs are drawn addressing issues of disparities ininfrastructural provision, regional inequalities and factors influencing spatial distribution andconcentration of industries. Therefore this report provides the analysis and evidence for thepolicies that have been developed for industrialization in Pakistan presented as summary form inearlier chapter titled “Principal Recommendations”.1.1 Raison d’être for an Industrial Policy In order to articulate the rationale of government intervention and hence outline the broaderprinciples on which an industrial policy is to be based it is important to contextualize thisdiscussion in a historical perspective. Therefore the following section gives a brief synopsis of thecompeting ideas on industrial policy in the twentieth century. 4  
  30. 30. 1.1.1Brief Historical Review In the course of the economic development of the West and the Newly Industrialized Countries(NICs) of Asia, there is no example of a country following a completely laissez faire policy withregard to industrial development. The nature and the extent of involvement and intervention ofthe state varied across countries, with each having its particular recipe for industrial development,but in none of these was industrialization achieved through the unfettered workings of the market.The relative success of the Asian Tigers and more recently of China and India in sustaining highgrowth rates has been on the back of an activist industrial policy. The extent of state interventionin these economies ranged from a variety of input subsidies; tax exemptions; tariff protection todirect public sector investments in large scale projects e.g., steel manufacturing plant in Korea andJapan.The post 1945 Structuralist conception of development considered capital accumulation orindustrialization as the engine of economic growth and development. For the Stucturalists aninterventionist industrial policy in conjunction with trade protectionism was imperative for thetransformation of an economy from primary low value added production to high value addedmanufacturing, i.e., Import Substitution Industrialization.4 The logic of state intervention wasbased on the prevalence of economies of scale (agglomeration economies) in manufactures and theinherent coordination failure present in an under developed economy. In the absence ofcomplimentary investments (backward and forward linkages) and the lack of necessary industrialinfrastructure the costs of entry for a pioneering firm into a sector were considered exorbitant i.e.,coordination failure. Given these structural constraints, industrial development or breaking awayfrom resource and factor based comparative advantage was viewed as next to impossible in a freetrade environment, giving credence to the infant industry argument for protection and the bigpush model of large scale state planning and intervention for industrial development.5                                                            4 Hans Singer (1950) and Raul Prebisch (1950) showed a secular decline in terms of trade of poor countries. Thisfinding served as one of the critical arguments for structural change.5 Within the economics profession the proponents of a development strategy led by the state were many such asRagnar Nurkse (1953), Arthur Lewis (1955), Paul Baran (1957), Rosentein-Rodan (1943). In fact with the exception ofa few like Albert Hirschman, who viewed development as a more spontaneous –chaotic process, the consensus wastowards state led development strategy. 5  
  31. 31. State intervention in its various manifestations was not always successful in achieving efficientindustrialization and sustained economic growth. The experience of Latin America stands in sharpcontrast to that of East Asia. Although both regions pursued an activist industrial and trade policy,the outcomes achieved were significantly different. In countries like Korea and Taiwan protectionin the form of subsidies and tariffs was afforded to firms with a clear state objective of achievingeconomies of scale in production through explicit export requirements, forced mergers andinvestment licensing [Chang (2003)]. Latin America on the other hand did not have such a clearfocus in terms of achieving economies of scale or creating incentives for firms to be outwardoriented. In fact in most countries the industrial policy was essentially inward looking, focusingmore on achieving domestic self sufficiency in manufactures rather then creating future exportvents. The outward oriented industrial policy of the East Asian countries gave an opportunity tothe domestic firms to target regional and international markets allowing economies of scale andefficiency in production. The inward orientation of Latin America, and, the shift of resources fromthe larger agricultural sector, limited and stifled the source of demand for the nascentmanufacturing sector retarding its growth, efficiency and competitiveness, e.g., the Argentinean carindustry [see, Bruton (1998)].Notwithstanding some notable exceptions, such as the aircraft, steel and shoe industry of Brazil,generally the industrial transformation of Latin America was not as successful as in East Asia.According to Rodrik (2004), “the difference between East Asia and Latin America is not thatindustrial transformation has been state driven in one and market driven in the other. It is thatindustrial policy has not been as concerted and coherent in Latin America as it has been in EastAsia, with the consequence that the transformation has been less deeply rooted in the former thanit is in the latter.”The 1980s brought a major shift in development thinking. The debt crisis and the ensuing macroeconomic instability which ravaged Latin America for more than a decade was blamed on the‘villainous’ policies of state intervention and trade protection pursued by the region [Taylor(1996)]. The fact that East Asia remained unscathed from the vagaries of the debt crisis gavesupport to the Neo-Liberal view which was cantered on the concept of market supremacy and trade 6  
  32. 32. liberalization. Export led growth was highlighted as the main factor behind the successfultransformation of East Asia while its activist industrial policy and initial years of trade protectionwere essentially overlooked. The alternative put forward was articulated by what came to be knownas the Washington Consensus. Under the neo-liberal development paradigm the role of the statein industrial development was limited to correcting market failure and to the provision of publicgoods. The rampant rent seeking, corruption and inefficiency of the governments in developingcountries brought further scepticism on the effectiveness of the role of the state in industrial andeconomic development. Although, market failure or externalities gave a theoretical justification ofstate intervention, economists and policy makers of the mainstream became more circumspect ofgovernment intervention stressing the greater propensity and prevalence of government failure asopposed to market failure in developing countries.1.1.2Towards an Industrial Policy As is evident from the above historical overview of industrial policy demarcating the domain ofstate intervention in an economy has been the source of continued controversy and debate.However, there is an emerging consensus between the heterodox and the mainstream economistson the broader role of Industrial Policy. The importance of structural transformation is realized byall, the differences which remain are on how much or to what extent can a country deviate from itscomparative advantage. The notion of comparative advantage in neo-classical trade theory isessentially static; it does not allow the possibility of industrial transformation given current pricesand factor endowments present in an economy. As stated earlier the central objective of industrialpolicy is to diversify the industrial base and move into higher value added activity. While themainstream economists stress on a ‘step by step’ – gradual transition towards higher value addedproduction in conformity with available technology and factor resources, the heterodox stress theimportance of defying comparative advantage by taking ‘leaps’ in certain areas which areconsidered strategic [see, Lin and Chang (2009)].Given that the fundamental principle of an industrial policy is to facilitate the process of structuraltransformation a possible bridge between the two perspectives on Industrial Policy could be tofocus intervention to facilitate both ‘new activity’ into the industrial sector and also help existing 7  
  33. 33. firms upgrade their products and production methods. In other words the policies shouldconsolidate and strengthen existing comparative advantage and at the same time harness potentialor dynamic comparative advantage resulting in a diversified and internationally competitivemanufacturing and export base.The ‘new activity’ entrepreneurs are those who either introduce a new product in the domesticmarket or develop a more efficient production technology for an existing product. In fact theformation of a potential industrial cluster is to a great extent dependent on the incentive structurespresent for the first entrant or the pioneer firm in a new industry. Although the ability of the stateto ‘pick winners’ is in any case limited on account of imperfect information on future returns onnew investment opportunities, however, through strategic policy intervention the state can increasethe probability of a new entrant becoming a ‘winner’[see, Hausmann and Rodrik (2003)]. Suchstrategic intervention can lead to the formation of an economically viable and vibrant cluster. Thepolicies which facilitate the emergence of new clusters, especially in economically depressed areas,would result in a more equitable and inclusive growth – a broader objective of the industrialpolicy.The facilitation a state can provide the entrepreneur is by addressing both coordination andmarket failures which would otherwise impede the germination and growth of the new product orproduction technique. Coordination failures might arise due to spatial impediments such as theabsence of necessary infrastructure (road network, electricity etc.) or the non-existence of criticalcomplimentary investments in the area. Therefore the costs of entry for a pioneer firm wouldgenerally be far more than that of later entrants. In fact these costs would tend to decline with anincrease in the number of firms in the cluster – agglomeration economies.6 Also, greatercompetition through entry of firms in the future would reduce the profits of the pioneer or ‘newactivity’ firm, impeding incentives to ‘enter’ in the first instance and hence jeopardizing the                                                            6 An investment by a firm creates positive externalities (benefits) for other firms. Therefore while there are diminishingreturns to investment at the level of the firm there exists increasing returns at the level of the industry (cluster). Asindividual firms do no take into account the positive externality of their investment decisions they tend to underinvest. Hence private investment is socially sub-optimal – thus creating the rationale for government intervention. 8  

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