Luận Văn Bank Restructuring And Bank Efficiency The Case Of Vietnam
Www.moip.gov.pk ip final_report_revised_aug_13_2011
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. 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. Table of Contents
List of Tables ............................................................................................................................................... vii
List of Figures ............................................................................................................................................... ix
List of Boxes ................................................................................................................................................ xii
Acronyms and Abbreviations ......................................................................................................................xiii
Acknowledgements .................................................................................................................................... xv
.
Executive Summary ..................................................................................................................................... vi
x
1 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. 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. 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
7. List of Tables
Chapter 2
Table 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. 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. List of Figures
Chapter 2
Figure 2‐1: Association between Manufacturing Value Added (MVA) Growth & GDP .............................. 13
Figure 2‐2: Historic GDP growth Rate in Pakistan, 1954‐2006 (percent) ................................................... 14
Figure 2‐3: GDP Growth Rate in Pakistan, 2001‐09 (percent) .................................................................... 15
Figure 2‐4: Sectoral growth rates in Pakistan, 2001–09 (percent) ............................................................. 15
Figure 2‐5: Annualized Growth Rates of Key Sectors in Pakistan for 10 Year Periods, 1970‐2009 (percent)
.................................................................................................................................................................... 15
Figure 2‐6: Sectoral Shares in GDP of Pakistan, 1970‐2009 (percent) ........................................................ 16
Figure 2‐7: Shifts in Sectoral Shares in GDP of Pakistan, 2000‐09 (percent) .............................................. 17
Figure 2‐8: Employment Shares by Sector in Pakistan, 1980‐2009 (percent) ............................................ 18
Figure 2‐9: Performance of the Large Scale and Small Scale Manufacturing Sector in Pakistan, 1950‐2010
(%) ............................................................................................................................................................... 20
Figure 2‐10: Manufacturing Value Added in US$ (Billions), 2001 & 2007 .................................................. 21
Figure 2‐11: Total Factor Productivity by Firm Size & Firm Age, 2001‐2006 (log values) ........................... 23
Figure 2‐12: Sectoral Value Added/Worker in Pakistan, 1981‐2002 (Rs at contact prices of 1999‐2000) . 23
Figure 2‐13: Output per Worker Growth in Pakistan, 1980‐2006 (percent) .............................................. 24
Figure 2‐14: Output per Worker in Asian Economies, 1990‐2004 (assuming 1990 as base of 100) .......... 25
Figure 2‐15: Competitiveness and Performance of Pakistan’s Exports, 2000‐2007 (percent) ................... 28
Figure 2‐16: Product Concentration Index, 1974‐2008 .............................................................................. 28
Figure 2‐17: Market Diversification Index, 1971‐2008 ............................................................................... 29
Figure 2‐18: Elasticity of Pakistan’s Exports to GDP of Industrial Countries, 1985‐2007 (percent) ........... 31
Figure 2‐19: Total, Private and Public Gross Fixed Capital Formulation (GFCF) in Pakistan, 1980‐2009 (%
of GDP) ........................................................................................................................................................ 34
Figure 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 ................................................................................................................................................... 39
Figure 2‐22: Growth Rate in Real Private GFCF & Total GFCF, 2000‐2010 (%) ........................................... 40
Figure 2‐23: Share of Manufacturing Investment in Total Fixed Investment, 2000‐10 (percent) .............. 42
Figure 2‐24: FDI Investment as % of Gross Fixed Capital Formation, 1990‐2009 (percent) ....................... 44
Figure 2‐25: Sectoral Decomposition of FDI, 2004 and 2008 9percent) .................................................... 45
.
Figure 2‐26: Real GDP and Investment Growth in Pakistan, 1991‐2009 (percent) .................................... 49
Figure 2‐27: Exports, Net Factor income from Abroad and Imports, 1990-2008 (percents of GNI) .......... 52
Figure 2‐28: Inflation and Investment in Pakistan, 2001‐2010 (% p.a.) ..................................................... 55
.
Figure 2‐29: Electricity Demand and Supply, 2003 – 10 (MW) ................................................................... 60
Figure 2‐30: Provision of Training to Workers ............................................................................................ 81
Figure 3‐1: Petrochemical Value Chain ..................................................................................................... 128
Figure 3‐2: Demand and Supply Gap of Steel in Pakistan ......................................................................... 133
ix
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 ................................... 264
Figure 4‐15: Relative road density of the districts of KP with Peshawar district, 1993-94 vs. 2005-06 ....... 265
Figure 4‐16: District level employment shares in Pakistan’s manufacturing sector .................................... 267
Figure 4‐17: Distribution of 3-digit Ellison-Glaeser index ......................................................................... 271
Figure 5‐1: Distribution of inequality and per capita income .................................................................... 291
Figure 5‐2: Distribution of Poverty and Per Capita Income ...................................................................... 292
Figure 5‐3: The effect of inequality on poverty in Pakistan, 1990-91 to 2005-06 ....................................... 293
xi
12. List of Boxes
Chapter 2
Box 2-1: Inward Investment Incentives Regime in Pakistan ..................................................................... 45
Box 2-2: Energy in Comparison with China and India ............................................................................. 63
Box 2-3: The Case of Gawadar ................................................................................................................... 72
Box 2-4: Cartelization & Case Studies .................................................................................................... 109
Chapter 3
Box 3-1: The Steel Industry of China ....................................................................................................... 125
Box 3-2: The Automobile Market of Malaysia ......................................................................................... 132
Box 3-3: Electronic Industry in China ..................................................................................................... 139
Box 3-4: Singapore Electronics Industry .................................................................................................. 141
Box 3-5: New Drug Filings of Some Successful Indian Pharmaceutical Companies.............................. 144
Box 3-6: Past Government Intervention in the Furniture Sector ........................................................... 189
Box 3-7: Depiction of Suha Bazar of Lahore............................................................................................ 196
Box 3-8: Italian Marble Industry ............................................................................................................... 203
xii
13. Acronyms and Abbreviations
ADR Alternative Dispute Resolution
API Active Pharmaceutical Ingredients
BOP Balance of Payments
CRO Clinical Research Organisation
DAP Diammonium Phosphate
DFID Department for International Development
EDB Engineering Development Board
EPZ Export Processing Zones
EOBI Employee Old-Age Benefit
FDI Foreign Direct Investment
FPCCI Federation of Pakistan Chambers of Commerce and Industry
GDP Gross Domestic Product
GMP Good Manufacturing Practices
IAG Industry Advisory Group
IDB Industrial Development Board
IPR Intellectual Property Rights
ITP International Trade Price
KIBOR Karachi Interbank Offer Rate
MMF Man Made Fibre
NAVTEC National Vocational & Technical Education Commission
NEQS National Environmental Quality Standards
NPO National Productivity Organisation
OEM Original Equipment Manufacturer
PEFMA Pakistan Electric Fan Manufacturers Association
PEPCO Pakistan Electric Power Company
PHADC Pakistan Hunting Arms Development Company
PIB Pakistan Investment Bond
PLDC Pakistan Leather Development Council
PPP Public Private Partnership
PSDC Pakistan Stone Development Company
PSM Pakistan Steel Mill
PSQCA Pakistan Standards & Quality Compliance authority
PSI Pre-shipment Inspections
R&D Research & Development
RFID Radio Frequency Identification
SECP Securities & Exchange Commission of Pakistan
SEZ Special Economic Zones
SME Small & Medium Enterprises
SMEDA Small & Medium Enterprise Authority
SG Safeguards
SPS Sanitary & Phytosanitary
TBS Tariff Based System
TBT Technical Barriers to Trade
TDAP Trade Development Authority of Pakistan
TEVTA Technical Education & Vocational Training Authority
TVET Technical & Vocational Education Training
UNEP United Nation Environment Programme
xiii
14. WAPDA Water & Power Development Authority
WHO World Health Organisation
WTO World Trade Organisation
xiv
15.
Acknowledgements
This study has been completed with the support of several individuals, departments and
organizations. The project would not have been possible without the facilitation and overall
guidance 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 and
support throughout the project. We would also like to thank officers from Engineering
Development Board, Small & Medium Development Enterprise (SMEDA), Technical and
Vocational Training Authority, and Chambers of Commerce & Industry across the country for
their useful ideas on industrialisation and its issues in Pakistan. We owe a debt of gratitude to
Professor Ha Joon Chang (University of Cambridge), Professor Alice Amsden (Massachusetts
Institute of Technology) and Dr. Faheem ul Islam (LUMS) for their insightful comments and ideas
in deriving the policy proposals. We thank the members of the staff of the World Bank for
providing the funding and over all support for the project. We would like to acknowledge the
research support provided by Kiran Javaid and Abubakar Memon and the editorial input received
from Shahbano Ijaz and Nadia Mukhtar. Finally we would like to thank the numerous
representatives of the private sector, especially the members of the Task Force who took time out
from their busy schedules to discuss in detail the problems of Industry and the possible solutions.
Prof. Abid A. Burki
Prof. Kamal A. Munir
Dr. Mushtaq A. Khan
M. Usman Khan, CFA IMC
Adeel Faheem
Ayesha Khalid
Dr. Syed Turab Hussain (Focal Person)
xv
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 of
comprehensive analysis of Pakistan’s industrialization - economic geography,
manufacturing sector aimed at deriving
covering issues such as inter and intra
policy recommendations for Industrial
provincial inequalities in infrastructural
growth and development. The report is
structured to provide a three tiered analysis provision and its resultant impact on
of Pakistan’s industry. income inequality, poverty and industrial
The first tier is a macro level analysis of cluster formation. The analysis in this
industrial structure and performance which section uses the Census of Manufacturing
helps identify the major constraints Industries (CMI) disaggregated data set and
hampering structural change in the rigorous econometric and statistical
country. The policy recommendations techniques to come up with both indexes
derived from this section are the broader or measuring industrial concentration and the
horizontal interventions required for factors which significantly affect cluster
industrial 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 Problems
through a firm/sector level analysis. The
main obstacles in increasing firm The first tier - macro level analysis
competitiveness and sectoral growth are analyses the structure/performance of the
investigated through both a value chain industrial sector using various macro and
industry specific indicators across time and
and a stakeholder analysis. This
in comparison to other countries. The
methodological approach helps divulge the primary focus in this section is on
necessary vertical or sector level policy macroeconomic management and
interventions. There are a total of twenty performance with respect to industrial
four sectors covered in this analysis ranging sector growth. The section highlights the
from important ancillary industries, fact that although over the last four decades
Pakistan has experienced over five percent
knowledge based industries to the major
average GDP growth rate, these episodes of
small and medium scale export based
high growth rates were mostly consumption
industrial sectors. driven leading to frequent ‘boom’ and ‘bust
cycles. The fact that industry has not been
xvi
17. the main engine of Pakistan’s growth has countries such as Korea and Taiwan, the
led to on average a low and variable growth secular fall in investment is shown to be the
rate. key factor behind an overall sluggish growth
The macro analysis also reveals that the
in GDP.
structural change in Pakistan has been
skewed towards a shift from agriculture to Following the discussion on industrial
services with manufacturing growth performance and investment trends, the
remaining fairly stagnant. It shows that broader impediments resulting in the
Pakistan’s manufacturing sector is largely systemic stagnation of industrial growth
concentrated in a few industrial products and investments are highlighted in this
with relatively less value addition compared section. Constraints related to factor
to countries within the region. With a markets, infrastructure provision, lack of
narrow manufacturing base and a macroeconomic stability, regulatory
concentration in low technology and low environment, and security/negative
value-added products whose share in the perception of Pakistan, are brought to the
world market is decreasing, the prospects of forefront. This is done by using the
industrial growth remain uncertain. repository of existing evidence on the above
Pakistan’s economy was built around textile mentioned constraints such as the cost of
and its current base is still concentrated in doing business data collected by World
textiles. Cotton textile production is the Bank and other similar studies. The
most important of Pakistan's industries, analysis is used to inform policy which by
accounting for about 19 percent of large- removing cross-cutting bottlenecks would
scale industrial employment and about 60 facilitate the overarching growth of the
percent 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 are
the report looks at the over time trend of
summarized below.
investment in the country relative to
regional economies. Investment in large In terms of macroeconomic stability the
scale 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 – is
consequence of both periodic stressed. The importance of prudent fiscal
macroeconomic instability and an and monetary policy is underscored albeit
investment climate which has been with a recommendation to lower the
persistently poor. As increased investment nominal interest rate which has been a
or capital accumulation is a necessary major factor in stifling investment and
condition for growth, substantiated by the manufacturing growth recently. Emphasis is
experience of the newly industrialized also put on the need to coordinate trade
xvii
18. policy with industrial policy. Effective use computerized clearance system. Finally, the
of Non-Tariff Barriers NTBs and creation importance of Gawadar as a potential vent
of a Science Park is also suggested as for future growth is emphasized with
mechanisms to protect and facilitate the suggestions to harness this potential
growth 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 put
given to resolve the energy crisis – which by forward to create industrial estates and
far has proven to be the most binding agro-processing zones at the identified ‘hot
constraint to industrial growth and spots’ of economic activity. The
development over the past couple of years. intervention of the government is specific
Effective 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 to
sector over both consumer and commercial international markets. Provision of hard
sector is stressed. Captive power generation and soft infrastructure and common
in industrial estates and special economic effluent treatment plants in the industrial
zones 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, land
towards more efficient/cost effective
and credit, are also dealt with and
sources, such as wind, hydel and solar
appropriate polices are derived to tackle
energy. The need for the development of
some of these. Various mechanisms are
localized machinery for hydel, thermal and
suggested to improve Labor skills and
coal 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 a
with the country’s logistical infrastructure Skill based wage subsidy scheme are
there are specific recommendations given proposed to provide incentives to
to upgrade it. For example, major businesses to invest in worker training. In
restructuring of the railways and new terms of credit markets, the rationing of
investments in freight services are small businesses is shown to be one of the
suggested. To reduce transportation and major constraints to their growth. Policies
trucking costs the building of Logistical such as credit guarantee schemes and
Parks near industrial estates is promotion of venture capital funds are
recommended. The importance of an discussed as possible mechanisms to
Automated Customs Clearance system is address the credit market failures arising
highlighted in Ports and it is suggested to from asymmetry in information. In case of
maintain and improve the existing land markets, the need for achieving
xviii
19. security of property rights by expediting the government interventions to knowledge
computerization of land records is based and technology intensive sectors
underscored. falling under the ambit of WTO rules and
regulations.
There is a detailed discussion on
strengthening governance to stimulate Competitiveness of Key Industrial
investment and manufacturing growth in Sectors of Pakistan
the country. It is noted that businesses
spend too much time and money dealing The second section of the industrial
with 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 and
Also, uncertainty about the security sectors within the country. This section
situation acts as a deterrent to outside comprises analyses of both large and small
investors from seeking business manufacturing sectors. In both cases, the
partnerships in Pakistan. The judicial competitiveness of each sector is assessed
system works slowly and the sanctity of and policy options are proposed to enhance
contracts and of land rights can be opaque. it. This is done by conducting in depth
Policy proposals addressing these consultative sessions with sector
governance 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-chain
in this section is the creation of a full scale analysis supplemented by a broader
Science Park to promote knowledge based industry assessment that contextualized
industries in the country The Science Park value-addition achieved in a particular
will have formal operational links with chain. This methodology helps identify
universities and research centers. It will those factors which inhibit value addition
have the necessary infrastructure to and result in relegation of firms to the
facilitate R&D, manufacturing, marketing lower rungs of the global value chain. The
and branding – covering thus the entire reasons behind the lack of value addition
product cycle. The Park would not only and competitiveness is identified with
provide 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 the
initiative would attract professionals, government. This broader analysis provides
businessmen and scientists which would to insights that became the basis for vertical
an extent reverse brain drain facilitating the policy interventions that are both strategic
technological up-gradation of industry. The and emergent.
Science Park would also allow government
policy coordination and targeted
xix
20. We are able to cover all major large scale improve governance structure of the Steel
sectors, key SME export sectors and light Mill and triple its capacity over the next five
engineering sectors. This coverage includes years and make investments to enable the
primary/ancillary industry such as Steel, Steel Mill to manufacture high grade steel.
Chemical and Fertilizer. We include We also propose that government should
knowledge based sectors such as Auto, use the existing iron ore deposits of
Electronics and Pharmaceutical including Pakistan to its full benefit.
Bio-Chemical. And finally, we look at
In this section we also analyze few of the
eighteen 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 believe
and some feed in directly into the local
gaps exist in the global value chain and
markets. The sectors in this category among
there is room for Pakistan to augment its
others include, Surgical Instruments, Sports
strategic comparative advantage to
Goods, Fans, Cutlery, Agro-food, Leather,
competitive advantage. We argue that such
Furniture, Marble and Granite, Gems &
opportunities mainly exist in knowledge
Jewllery and Light Engineering Sector.
based industries such as Auto, Electronics
We argue that the inclusion of primary and Pharmaceuticals. While analyzing the
sectors is necessary as almost all the value auto sector we find that the past policies
added industry depends for their inputs on were heavily influenced by MNCs and the
these sectors. For example, leather tanning interests of the local industry were highly
requires the use of 101 chemicals, out of compromised. We present evidence that in
which around 98 are currently being periods the deletion policy was followed,
imported. This not only adds more to the significant growth of local industry
costs but also results in shortages. Similarly, resulted, however, since the introduction of
the pharmaceutical sector is entirely Trade Related Intellectual Property Rights
dependent on imported chemicals. We (TRIPs) there has been no indigenization or
recommend that if Pakistan is to move growth of the local auto industry. The
more towards value addition then licensing regimes of international
government will have to invest in building collaborators especially in the tractor
the chemical industry in the country. One industry are prohibitive. They limit the
such recommendation is to set up a Naphta permission of sales, especially in value
cracking facility. Moreover, steel is an input added export markets. We recommend
into almost all the value added industries. ways by which government can promote
It is surprising to see that even with a large outward FDI and assist the tractor
local demand for steel the Steel Mill of manufacturers, for example, to acquire
Pakistan is running in significant deficits. international brands. The deletion program
We recommend to the government to
xx
21. is also strongly supported, in fact, deletion knowledge intensive industries we
should 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 attract
afford not to develop competencies in
investment into the bio-technology
electronics. Electronics pervade almost all
industry.
industries and competitiveness in any
industry requires knowledge of electronics Finally, in the economic activities of most
both at the level of product and process. developing regions, small and medium
Moreover, with increasing affluence a large enterprises (SMEs) play a major role and
demand has developed for electronic items Pakistan in this case is no exception. Its
such as Televisions, Computers, Washing economy is dominated by SMEs, which
machines, Air conditioners etc. Similarly, produce most of its output and employ
with the Tata Nano, India has most of its workforce.1 Specifically, SMEs
demonstrated that producing competitive constitute 90 percent of the economic
automobiles is not the sole preserve of rich, establishments and contribute 30 percent
developed 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 have
which cannot yet afford automobiles but broadly looked at around eighteen critical
will settle for slightly lower quality. SME sectors in Pakistan.
However, realizing the domestic constraints Our findings reveal that most of these
and limitations we recommend that sectors face similar issues and impeding
Pakistan should only focus on product factors to growth. One of the major issues
manufacturing and not component faced is the inadequate availability of
manufacturing. For this, product design appropriate human resource and skills. The
and development institutes will have to be existing government entities such as
established with strong linkages in national TEVTA and NAVTEC are providing class
and 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 found
Chemical is a sector with great future
that almost all industrial units in Sialkot
potential. Both India and China are fast
Small Industrial Estate had vacancies for
developing 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 SMEs
industry 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 of
markets. For development of such the GDP
xxi
22. Another major impediment is low levels design that takes place is a result of reverse
of productivity, resulting from both engineering done at the initiative of the
inadequate up-gradation of technology and factory owner. Government has funded
poor production and floor management some common facility and product
techniques. Due to high levels of illiteracy development centers, however, their
and lack of training, most of the capacity to deliver to the needs of specific
entrepreneurs’ struggle with basic costing sectors is fairly limited. Therefore, we
techniques and lean production recommend specific type of linkages that
management methods. The floor designs need to be created between SME sectors
are suboptimal resulting is high wastages of and research and development centers. We
labor time and inputs and makes it also indicate priority sectors where
impossible to capture the actual costs of government needs to immediately establish
production. Similarly, in most industries, design and research centers.
such as leather, sports, surgical, fans, cutlery
Finally, another issue facing the sectors is
the technology being used is outdated.
lack of branding and marketing. Pakistani
When combined with low scale of products are increasingly fetching lower
production all this results in significant price in international markets. Moreover, it
inefficiencies and loss of productivity. is also becoming exceeding difficult for
Hardly, any of the SME sectors employ Pakistani product to find access into newer
professional management or formal systems international markets. Given the lack of
of record keeping. We recommend that the innovation, most of the industry acts as an
Original Equipment Manufacturers OEM
National Productivity Organization of
hence branding has always been limited. In
Pakistan should play a lead role in addition, marketing has been a consistently
benchmarking the SME industrial sectors weak area limiting the growth potential of
and assist them in lean management tools firms. Finally, all of the above factors have
so as to extract the maximum results from made it extremely difficult for the sectors to
existing capacities. meet international quality standards and
compliance requirements. The
Almost all the SME sectors that were international standards on quality, health
considered face issues with innovation and & safety and environment are becoming
developing original designs and products. increasingly stricter. With their current
characteristics Pakistani products are being
This is indicative of the lack of
refused access to many markets based on
collaboration and link between sectors and non compliance to these standards. It is
university engineering departments and imperative that the government not only
product development centers. In fact there provides the hard infrastructure such as
is hardly any evidence of formal linkages laboratories and testing centers but also
between research & development centers builds the capacity of Pakistan Standards
Quality Compliance Authority (PSQCA) to
and industry. Any innovation or product
enforce domestic quality standards. This
xxii
23. will ensure mandatory compliance to some between the leading and the lagging
minimum standards which will then build districts is increasing with the passage of
capacity of the sectors to meet similar time, which should worry policy makers
standards in international markets. who are interested in bringing about spatial
equality.
Spatial Concentration of Economic
Activity
Poverty Impacts of Public
The most striking feature of economic Investments and Causes of Industry
activity in Pakistan is the geographic Agglomerations
concentration (clustering) and location of
factors of production in few cities, The econometric evidence shows that
including unequal spatial distribution of poverty coexists with illiteracy of household
income, poverty, education, health and heads and lack of household asset
physical infrastructure, among others. The ownership. Therefore, the government
concentration of economic activity in few emphasis on human capital accumulation
metropolitan areas symbolizes the and social and physical infrastructure
coexistence of development and development as tools for poverty reduction
underdevelopment within and between makes sense. Policies that seek universal
regions. We examine the economic access to education by increasing the
geography of Pakistan by exploring regional quantity and quality of schools and colleges
and spatial inequality and document seem to have a strong power to reduce
various mapping measures to highlight poverty. While current attention to
spatial distribution of population, regional investment in social infrastructure is clearly
poverty and income inequality, spatial appropriate, policy inattention to spatial
disparities in social infrastructure, road inequality in income is very costly,
infrastructure, and agglomeration of especially in more deprived districts. Our
manufacturing industries. We employ empirical analysis of the evolution of
different measures of concentration to gain poverty on the basis of high quality district
insight into spatial inequality (in poverty, level data on post-primary education and
incomes, road infrastructure and industrial hospital infrastructure index indicates that
concentration) as a function of different increased public sector investments on
push and pull factors that explain education and health infrastructure lead to
concentration versus dispersion of a sharp decline in poverty in all but highly
economic 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 social
infrastructure is highly concentrated in infrastructure by also promoting more
metropolitan cities, big cities and their spatial equality in the distribution of
surrounding districts while districts located income may yield higher returns.
away from these urban demand centers are The econometric results further show a
lagging behind. While we have evidence of strong negative association between road
convergence in the leading districts, the gap
density and poverty incidence. The
xxiii
24. magnitude of fall in poverty due to road from 1995-96 to 2000-01, but it drastically
density 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, we
and 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 workers
far greater than the short run effects. We
all help promote agglomeration of
conclude that income equality matters as
manufacturing industries. The
far as public investment on infrastructural
determinants of industry agglomeration
projects is concerned. The long run poverty
guide us on the causes of dense economic
alleviation potential of investment on roads
activity across spatial units, and the
almost doubles when we move from high
difficulties faced in attracting
income inequality districts to low income
manufacturing activities in remote districts.
inequality districts. Therefore, we reiterate
However, a range of policy instruments
that pubic policies that seek more regional
have already been tried in Pakistan, e.g., tax
equality in incomes are far more desirable
holidays, building infrastructure in
for pro poor growth policies.
industrial estates, free trade zones, export
This study has also examined the nature processing zones, etc. There is no evidence
of geographic concentration of on their systematic success or failure. We,
manufacturing industries in Pakistan by therefore, advise that more empirical
using the Ellison and Glaeser research need to be conducted to evaluate
concentration index. While there is little the effectiveness of past policies to
doubt that increasing returns to scale conclude under what circumstances these
associated with agglomeration externalities programs and policies are likely to succeed.
do exist at a wider scale in Pakistan, it is
Exploring the relative strengths of
much more difficult to identify factors that
localization versus urbanization economies
cause industry agglomeration. We have also
our results suggest that localization
explored how geographic concentration of
economies (within-industry externalities)
manufacturing industries emerges from the
are much more important than
dynamic process overtime and what is the
urbanization economies (inter-industry
nature of agglomeration economies. Our
spillovers), which implies that industry-
findings show that agglomeration of
specific subsidies and infrastructural
manufacturing industries is widespread in
investments are likely to yield much higher
Pakistan where only 27% of the industries
pay offs. However, productivity growth in
are not agglomerated, 35% are highly
the manufacturing sector as a whole is
agglomerated and 38% are moderately
almost stagnant since 1995-96. Therefore,
agglomerated. However, industry
policies aimed at rebuilding the industrial
concentration remained roughly constant
sector of Pakistan by adopting coherent
xxiv
25. strategies are long overdue to which we
turn to in the next chapter titled principal
recommendations.
xxv
27. 1 Introduction
The process of structural change has been a central feature in the economic growth and
development 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 of
manufactures and services increases. In other words, structural change is a gradual shift from low
productivity to high productivity activities. Along with this observable structural transformation
there is a large body of empirical literature which suggests that there is a “U” shaped relationship
between 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 primarily
determined by resource based comparative advantage. As the country becomes richer the
manufacturing base diversifies with firms producing and exporting a wider range of relatively more
sophisticated products. However, at higher levels of income, the process reverses; specialization
again increases but in high value added and technologically advanced products. Therefore
increased product diversification is an intermediate stage in the process of structural
transformation and economic development of a country.
In the context of the Pakistan economy this structural transformation has been skewed in favour
of the services sector. Since the 1970s the growth in services has outstripped that in agriculture
and industry resulting in its current 50% share in GDP. Agriculture and industry over the past
decade have contributed around 25% each to GDP with the share of agriculture declining over
time and that of industry remaining fairly stagnant. In fact, between 2008-09, in the wake of both
internal security issues and the increasingly binding energy constraint, output in the
manufacturing sector contracted by 3.3 percent with large-scale manufacturing registering a
substantial decrease in output of 7.7 percent [GoP (2009a)]. Notwithstanding the recent
contraction of overall industrial productivity and output, the industrial structure of the country
has not experienced any significant change in the course of the past thirty years. The
manufacturing base remains rigidly narrow leading to a lack of product and export diversification
which has been a major impediment to sustained economic growth and development of the
country.
2
28. The short term revival and the long term growth of Pakistan’s economy thus hinges on both the
performance and the structural transformation of its industry. As mentioned above, in the past
year and a half the country has seen a dramatic retardation of economic activity characterized in
particular by a stagnating manufacturing sector. The current energy crisis has further eroded the
competitiveness of manufacturing resulting in a tremendous loss of income, employment and
export revenues. Given the fact that the potential of growth and development of a country is
inextricably linked to the extent of investment and industrialization the continued dismal
performance in industrial growth in Pakistan does not augur well for the future. Therefore it is
imperative to develop an industrial policy which is implementable and has the ingredients to
provide the much needed impetus to industrial growth and diversification. While focusing on the
revival and restructuring of the industry the strategy would have to be guided by the over arching
objective of achieving efficient, sustainable and equitable development.
Pakistan today has the highest population growth rate2 in the South Asian region with hordes of
unskilled entrants into the labour force every year. These adverse demographics pose a serious
challenge to effective policy making. If the industrial base of the country does not expand to
absorb this surplus labour, the bourgeoning unemployment in both urban and rural areas is likely
to have serious socio-economic and political ramifications.3 On the other hand, a growing
population has the potential to become a significant economic asset, if adequate policies are in
place to facilitate the development of a large, healthy and skilled labor force. Therefore a central
motivation and aim of the industrial policy should be to generate widespread employment and
raise income levels across the country, with the longer term aspiration of achieving convergence in
living standards in rural and urban areas. This would subsequently reduce the incidence of poverty
and lessen the widening inter and intra regional income inequality. An industrial policy, which
emphasizes domestic as well as international linkages, promotes and facilitates entrepreneurial
activity, 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. impetus to services, trade, transport and other ancillary sectors, can achieve the objective of
inclusive and broad based growth.
The formulation of the industrial policy is in accordance with the overall growth and development
priorities of the Government of Pakistan (GOP) as broadly identified by the “9-point” Plan put
forward 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 the
industrial policy being proposed here. For example, Industrial Competitiveness, Human Capital
Development, Energy, Capital Markets, Public-Private Partnership for Infrastructure and
Institutional/Administrative reform are some of the relevant areas which would be dealt with in
considerable detail in the industrial policy report.
The outcome of the industrial policy project is in the form this comprehensive report. This
particular report, constitutes the analysis on the basis of which the industrial policy has been
derived. Moreover, this report also provides a rigorous and detailed analysis of the spatial aspects
of industrialization from which specific policy briefs are drawn addressing issues of disparities in
infrastructural provision, regional inequalities and factors influencing spatial distribution and
concentration of industries. Therefore this report provides the analysis and evidence for the
policies that have been developed for industrialization in Pakistan presented as summary form in
earlier 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 broader
principles on which an industrial policy is to be based it is important to contextualize this
discussion in a historical perspective. Therefore the following section gives a brief synopsis of the
competing ideas on industrial policy in the twentieth century.
4
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 with
regard to industrial development. The nature and the extent of involvement and intervention of
the 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 high
growth rates has been on the back of an activist industrial policy. The extent of state intervention
in these economies ranged from a variety of input subsidies; tax exemptions; tariff protection to
direct public sector investments in large scale projects e.g., steel manufacturing plant in Korea and
Japan.
The post 1945 Structuralist conception of development considered capital accumulation or
industrialization as the engine of economic growth and development. For the Stucturalists an
interventionist industrial policy in conjunction with trade protectionism was imperative for the
transformation of an economy from primary low value added production to high value added
manufacturing, i.e., Import Substitution Industrialization.4 The logic of state intervention was
based on the prevalence of economies of scale (agglomeration economies) in manufactures and the
inherent coordination failure present in an under developed economy. In the absence of
complimentary investments (backward and forward linkages) and the lack of necessary industrial
infrastructure 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 away
from resource and factor based comparative advantage was viewed as next to impossible in a free
trade environment, giving credence to the infant industry argument for protection and the big
push 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. This
finding 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 as
Ragnar Nurkse (1953), Arthur Lewis (1955), Paul Baran (1957), Rosentein-Rodan (1943). In fact with the exception of
a few like Albert Hirschman, who viewed development as a more spontaneous –chaotic process, the consensus was
towards state led development strategy.
5
31. State intervention in its various manifestations was not always successful in achieving efficient
industrialization and sustained economic growth. The experience of Latin America stands in sharp
contrast 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 protection
in the form of subsidies and tariffs was afforded to firms with a clear state objective of achieving
economies of scale in production through explicit export requirements, forced mergers and
investment licensing [Chang (2003)]. Latin America on the other hand did not have such a clear
focus in terms of achieving economies of scale or creating incentives for firms to be outward
oriented. In fact in most countries the industrial policy was essentially inward looking, focusing
more on achieving domestic self sufficiency in manufactures rather then creating future export
vents. The outward oriented industrial policy of the East Asian countries gave an opportunity to
the domestic firms to target regional and international markets allowing economies of scale and
efficiency in production. The inward orientation of Latin America, and, the shift of resources from
the larger agricultural sector, limited and stifled the source of demand for the nascent
manufacturing sector retarding its growth, efficiency and competitiveness, e.g., the Argentinean car
industry [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 that
industrial transformation has been state driven in one and market driven in the other. It is that
industrial policy has not been as concerted and coherent in Latin America as it has been in East
Asia, with the consequence that the transformation has been less deeply rooted in the former than
it is in the latter.”
The 1980s brought a major shift in development thinking. The debt crisis and the ensuing macro
economic 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 gave
support to the Neo-Liberal view which was cantered on the concept of market supremacy and trade
6
32. liberalization. Export led growth was highlighted as the main factor behind the successful
transformation of East Asia while its activist industrial policy and initial years of trade protection
were essentially overlooked. The alternative put forward was articulated by what came to be known
as the Washington Consensus. Under the neo-liberal development paradigm the role of the state
in industrial development was limited to correcting market failure and to the provision of public
goods. The rampant rent seeking, corruption and inefficiency of the governments in developing
countries brought further scepticism on the effectiveness of the role of the state in industrial and
economic development. Although, market failure or externalities gave a theoretical justification of
state intervention, economists and policy makers of the mainstream became more circumspect of
government intervention stressing the greater propensity and prevalence of government failure as
opposed 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 of
state 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 economists
on the broader role of Industrial Policy. The importance of structural transformation is realized by
all, the differences which remain are on how much or to what extent can a country deviate from its
comparative advantage. The notion of comparative advantage in neo-classical trade theory is
essentially static; it does not allow the possibility of industrial transformation given current prices
and factor endowments present in an economy. As stated earlier the central objective of industrial
policy is to diversify the industrial base and move into higher value added activity. While the
mainstream economists stress on a ‘step by step’ – gradual transition towards higher value added
production in conformity with available technology and factor resources, the heterodox stress the
importance of defying comparative advantage by taking ‘leaps’ in certain areas which are
considered strategic [see, Lin and Chang (2009)].
Given that the fundamental principle of an industrial policy is to facilitate the process of structural
transformation a possible bridge between the two perspectives on Industrial Policy could be to
focus intervention to facilitate both ‘new activity’ into the industrial sector and also help existing
7
33. firms upgrade their products and production methods. In other words the policies should
consolidate and strengthen existing comparative advantage and at the same time harness potential
or dynamic comparative advantage resulting in a diversified and internationally competitive
manufacturing and export base.
The ‘new activity’ entrepreneurs are those who either introduce a new product in the domestic
market or develop a more efficient production technology for an existing product. In fact the
formation of a potential industrial cluster is to a great extent dependent on the incentive structures
present for the first entrant or the pioneer firm in a new industry. Although the ability of the state
to ‘pick winners’ is in any case limited on account of imperfect information on future returns on
new investment opportunities, however, through strategic policy intervention the state can increase
the probability of a new entrant becoming a ‘winner’[see, Hausmann and Rodrik (2003)]. Such
strategic intervention can lead to the formation of an economically viable and vibrant cluster. The
policies 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 industrial
policy.
The facilitation a state can provide the entrepreneur is by addressing both coordination and
market failures which would otherwise impede the germination and growth of the new product or
production technique. Coordination failures might arise due to spatial impediments such as the
absence of necessary infrastructure (road network, electricity etc.) or the non-existence of critical
complimentary investments in the area. Therefore the costs of entry for a pioneer firm would
generally be far more than that of later entrants. In fact these costs would tend to decline with an
increase in the number of firms in the cluster – agglomeration economies.6 Also, greater
competition through entry of firms in the future would reduce the profits of the pioneer or ‘new
activity’ 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 diminishing
returns to investment at the level of the firm there exists increasing returns at the level of the industry (cluster). As
individual firms do no take into account the positive externality of their investment decisions they tend to under
invest. Hence private investment is socially sub-optimal – thus creating the rationale for government intervention.
8