Executive Summary

1. Introduction

It is now a truism that acceleration in the global movement of capital and goods, termed conventionally 'globalisation', carries both immense opportunities and serious potential threats. Ultimately, it will be the international competitiveness of firms, in particular economies, that will determine how far opportunities are converted into lasting national benefits and how far potential threats from heightened international competition result in serious cost. There is widespread agreement that with important domestic policy changes and with the imminent end of the international textile and clothing quota regime, the economy of Pakistan is at an important crossroads. The competitiveness of the industrial sector in the new, more liberal international and domestic environment will have a critical bearing on economic prospects for the foreseeable future.

This paper aims to place the current situation of industry in the country in an international context by 'benchmarking' various indicators of national capability and performance against competitor economies and by highlighting key lessons from the experience of the successful Asian economies.

2. Understanding Industrial Competitiveness

Competitiveness means the ability to compete with firms at the international frontier of best practice. It must be recognised that it is firms that compete not nations. Firms have their own strategies for lowering cost, improving product quality and finding marketing networks. However, due to the intrinsic failure of markets in critical areas, government support for firms has in some contexts proved to be an important component of the process of attaining competitiveness.

The essence of a competitiveness strategy is to: promote in-firm learning, skill development and technological effort; improve the supply of information, skills and technology from surrounding markets and institutions; and coordinate collective learning processes that involve different firms in the same industry, or across related industries popularly known as 'clusters', geographical or activity-wise.

Firms develop their capabilities within different 'markets', using the term broadly, for example those relating to physical infrastructure, human capital, finance, technology and cluster effects. The need for a competitiveness policy arises when any of these 'markets' fails to function efficiently. The experience of the 'Tigers' of East Asia indicates that coherent and carefully crafted policies can accelerate shifts in competitiveness and promote entry into very complex and high technology activities.

However, while it is conceptually true that whenever markets fail to function effectively there is in principle a case for government intervention, recent history has shown that the capacity of different governments to intervene effectively has been very mixed. East Asian experience has been considerably more successful than elsewhere. Hence current policy advice is normally to recommend limited interventions to tackle clear and wellunderstood market failures (such as under-investment in Research and Development (R&D) or training) rather than wider-ranging systems of protection or subsidy. Further, in the context of an economy like Pakistan, support for firm-level upgrading and technical change should be essentially promotional, supporting rather than driving the initiatives of the firms themselves.

3. The Changing Nature of Competitiveness

Rapid technical change, shrinking economic distance, new forms of industrial organisation, tighter links between national value chains and widespread policy liberalisation are all altering radically the environment facing developing country enterprises. Competition now arises with great intensity from practically anywhere in the world. To compete, enterprises must use new technologies and organisational methods at best practice, and link up to global value chains.

Economic distance is shrinking, driven by technical progress in information processing, transport and communications. This means that international competition now appears quickly and intensely but also that there are many new market opportunities. Rapid technical change pervades all activities, rendering older technologies obsolete even in low wage economies. Enterprises in all countries have to use new technologies to remain viable (new 'technologies' include not just products and processes but also organisation of firms, supply chains, human resource development, technology links and so on). All countries, even developing ones, have to undertake constant technological effort to create or access, absorb and adapt new technologies. The ability to compete depends vitally on the ability to move up the technology scale in all activities, including services.

However, capabilities develop slowly, in a cumulative and pathdependent manner. Thus economies that start off on a virtuous circle of growth, competitiveness and investment in new capabilities can carry on doing better than those that are stuck in a 'low level equilibrium' and cannot muster the resources to break out. Countries can reverse these trends but only if they can mount a concerted strategy to shift the economy, its human capital and technology base, its institutions and infrastructure from a low to a high competitiveness path.

4. New Dynamics of World Markets

High technology activities have grown faster both in terms of production and trade than other manufacturing activities (and trade has grown faster than production, indicating the increasing internationalisation of industry in all economies). Not only are technology-intensive industrial activities more dynamic, they tend to offer greater potential for sustained learning and productivity increase, more spillover benefits to other activities and more scope for foreign direct investment (FDI) in integrated production systems that offer enormous export possibilities. All production and export structures are not, in other words, equal in terms of promoting industrial growth and competitiveness.

This does not mean that low technology and resource-based products should be neglected in competitiveness strategy. On the contrary, such products are the starting point for building industrial competitiveness in developing countries. The 'bottom line' of competitiveness is to upgrade technologies in all activities, building new capabilities and finding new markets and market niches. At the same time, the dynamics of world markets suggest that it is necessary to promote structural change, and nearly all countries that have maintained high rates of export growth have upgraded the technological composition of exports.

In manufactured exports, developing countries have grown faster than industrial ones in all categories and periods since 1981. Their lead has been greatest in high technology, followed by medium technology, products. This seems to go against received wisdom: the comparative advantage of poor countries vis a vis rich ones is supposed to lie in simple technologies, not advanced ones. There are, however, good explanations for why developing country exports of technologically complex products are growing faster:

• Some developing countries, led by the mature Tiger economies of East Asia, Korea and Taipei,China, have built domestic capabilities in high technology. This accelerated development of capabilities was driven in the early stages by strong and pervasive industrial policy, with restrictions on inward FDI, protection of infant industries, allocation of credit, and promotion of local R&D and specialised skills.
• Several other countries without strong local capabilities have become major high technology exporters by plugging into integrated production systems, starting by performing relatively simple assembly. Over time, many countries have upgraded their role, moving into greater local content, design and development, regional marketing and so on. Singapore, for instance, is one of the world's leaders in advanced electronics, with impressive design capabilities and growing local linkages.
• Trans-national company (TNC) systems have also spread in some medium technology products like automobiles. Unlike electronics, these systems tend to be in proximate countries because of transport costs. The three large Latin American economies, Argentina, Brazil and Mexico, are good examples of complex medium technology exports led by the auto industry. This value chain is unlikely to spread to many other developing regions because of its enormous scale economies and high skill requirements, but it does raise the competitive profile of the developing world in sophisticated products.
• In simple categories, rates of export growth are limited both by slow expansion of trade overall and maturing of the relocation process in labour-intensive activities like textiles and clothing. Within these products, it is difficult for developing countries to upgrade to the most advanced end of the value chain because of very demanding skill, design and branding requirements. High fashion exports, for instance, remain the preserve of rich countries, as do differentiated food products.
• Growth of developing world exports of some resource-based and low technology products is held back by trade barriers, tariff escalation (higher tariffs being levied on imports of processed products than on the raw materials) and subsidies in industrialised countries.

South Asia is a weak performer in the competitiveness stakes. Its world market shares remain small and its export structure dominated by low technology and low sophistication products.

5. Pakistan: The Current Policy Environment for Manufacturing

International competitiveness requires ready access to international inputs at close to world prices and a domestic market subject to competitive pressure, among domestic producers and between them and imports. Experience in Pakistan and elsewhere suggests that highly protected domestic markets not only reduce incentive to export but also penalise the economy by allowing inefficient domestic producers to extract policyinduced rents from domestic consumers. While there is a plausible theoretical case for infant industry support of activities with strong learning effects and positive externalities, experience suggests that if such a policy is to be pursued, it should be time-bound and performance-linked.

Pakistan has liberalised its trade policies significantly over the last decade or so. At present it is one of the more open trade regimes in South Asia, although South Asia itself remains relatively protectionist by international standards. Pakistan has unilaterally reduced import tariffs so that its applied rates are often below the bound rates to which it is committed by World Trade Organization (WTO) membership. The maximum average import tariff for Pakistan was reduced from 30 per cent to 25 per cent in 2002. The simple average applied tariff of around 10 per cent in 2003 must be compared with an average of 56 per cent in 1995 and nearly 80 per cent in 1985.

Under the investment policy introduced in 1997, policies towards inward FDI to Pakistan have also become liberal by regional standards. Foreign investors are guaranteed national treatment, face low import duties on plant and equipment, and receive a first year profits tax allowance. Full foreign ownership is allowed (for all but a small number of activities) as is full repatriation of capital, dividends and profits, and there is no restriction on the level of royalty payments. Measures have also been taken to introduce an Intellectual Property Rights regime compatible with the WTO.

Pakistan is a low wage, labour surplus economy. However, firm-level comparisons suggest that while wages in Pakistan are low by international standards, they are often significantly higher than in Bangladesh and slightly higher than in India. Allowance for differences in labour and capital productivity suggests that on average Pakistan is a higher cost location than the People's Republic of China (PRC), India or Bangladesh.

It is widely acknowledged that slow growth in private investment, particularly in large-scale manufacturing, has been one of the key constraints on Pakistan's economic growth. Part of the explanation lies in the uncertain political scene, but more narrowly economic and institutional aspects of the general investment climate have also had a negative impact on investment decisions.

Until very recently, Pakistan fared relatively poorly by the criteria of the time and cost required to start up a new business. However, changes introduced in 2002 appear to have significantly improved the situation.

High cost and poorly functioning infrastructure can clearly impede the operation of enterprises which may be efficient in terms of mastery of their own production processes. There is evidence that infrastructure, in particular in the power sector, has been a key bottleneck. Problems with lack of a reliable power supply are indicated by the relatively high proportion of power that firms in Pakistan estimate is lost on average due to power outages. In addition, there can be a lengthy waiting time for connection to the grid.

In the telecom sector there is a shortage of fixed line connections. The time taken to get a telephone connection is still high by international standards. Furthermore, waiting times for connections have increased, not fallen, over recent years. Connection costs for phone lines are also high by international standards. These constraints and high costs in telecoms are a contributory factor to relatively low internet usage among enterprises in Pakistan.

Transport has also been discussed as a potential bottleneck, particularly in relation to exports. In relation to ports, for example, there are estimates which suggest that port handling costs in Karachi and Port Qasim are higher than the regional average. These infrastructure deficiencies clearly need to be addressed to strengthen the competitiveness environment.

6. Benchmarking Pakistan's Performance

Manufacturing in Pakistan grew at a compound real annual rate of 5.5 per cent between 1980 and 2000, and its per capita GDP at 2.2 per cent. Performance was better in the 1980s than in the 1990s: manufacturing valueadded grew at 7.2 per cent per annum in the former and at 3.8 per cent in the latter (and in the 1990s growth slipped from 8.7 per cent in 1990-95 to -1.6 per cent in 1995-2000)¹. More recently the manufacturing sector has picked up again. Between FY2001 and FY2004 manufacturing value-added grew at an annual average of 8.5 per cent.²

In terms of structure, Pakistan has a very low share of medium and high technology products in both production and exports, and only a slow upgrading over time. (What little upgrading there has been has occurred in production rather than exports.) Moreover, exports are concentrated at the in this paper to gauge the product sophistication of a country's exports.

Pakistan's largest export product in FY2004 was made-up textile articles; this product is also a 'champion', in that the product is dynamic in world trade and Pakistan gained world market share during the 1990s. However, its next two largest exports (cotton fabrics and textile yarn) are stagnant in world trade; Pakistan gained world market share in the former and lost in the latter. Future growth is vulnerable to the slow growth of the market. Most apparel products are in the non-dynamic segment of trade, and Pakistan is unfortunate in being heavily dependent on these products. There is one major product, medical instruments, where Pakistan is losing market share in a dynamic product. (In fact, this is the most dynamic in the set of its top 20 exports.)

The picture for Pakistan is thus one of weak product positioning within its areas of export specialisation. Sustaining rapid export growth with this positioning - if world trade continues to follow recent patterns - would involve Pakistan in raising its market share in declining markets. Since these markets are fiercely competitive and are being liberalised, this would require massive upgrading of production capabilities, quality and marketing relative to competitors.

7. Benchmarking Pakistan's Skills and Technological Capabilities

Competitiveness today requires a strong base of human and technological resources, able to support enterprises in handling, adapting and improving new technologies, and selling the output to sophisticated and demanding global markets. By most common indicators of skill creation, Pakistan performs poorly by regional standards (themselves low relative to East Asian levels). For example, by the Harbison-Myer index, a classic index of skills based on school and university enrolments, Pakistan ranks below all other South Asian economies. Further, Pakistan's score and its relative position have deteriorated since the mid-1980s, making it the only country in Asia in which the index declined over the 1985-1997 period; however, several countries, including all in South Asia, have declined in the relative rankings.

By its nature, it is very difficult to measure technological effort in practice. It is clear from official statements that the Government of Pakistan has recognised fully the need for increasing local technological effort. However, per capita R&D spending in Pakistan is among the lowest for all countries for which data is available, and enterprise-financed R&D is negligible. Other indicators, such as number of scientists engaged in R&D per million inhabitants, number of technicians in R&D, number of scientific and technical journals per million inhabitants, and royalty and technical fees per capita, also highlight the lag that Pakistan suffers with respect to its comparators in the region.

8. Lessons From East Asia

The economies of East Asia, both the first tier newly industrialised economies or NIEs (Korea, Taipei,China, Hong Kong and Singapore) and a second tier group (Thailand, Malaysia, the Philippines and, more recently, PRC) offer a dramatic illustration of what rapid growth of manufactured exports can achieve. These economies are located at various positions on the ladder of comparative advantage, but to varying degrees they have each succeeded in diversifying out of traditional primary exports into more dynamic manufactured goods.

In practice, among the high growth NIEs there were substantial national variations in the way exports were promoted, with governments using a range of additional (often non-trade) measures to raise the profitability of exporting. In the current context of economies like Pakistan wishing to diversify their export structure and establish links with global value chains, this experience needs to be understood but not copied simplistically. In general, selective bureaucratic interventions in support of individual firms have had a poor track record, apart from the early experience of Korea and Taipei,China.

Further, in the South Asian context where there has been a long tradition of direct government involvement, current policy is based on withdrawal of government from direct intervention in enterprise decisions. It is a lighter form of industrial promotion - providing support, not direction, for the private sector - which is most appropriate.

An aspect of experience elsewhere which is of particular interest are the policies on skill formation and training in Singapore and policies on stimulation of and support for local technological development in Korea and Taipei,China. These experiences in first tier NIEs are clearly at a technological level well above that of Pakistan at present. Nonetheless, they serve to show what can be achieved over a relatively brief period of time with well thought out initiatives of public-private collaboration. The challenge for Pakistan will be to forge suitable alliances to foster technological capability in sectors operating at a lower technological level.

9. Conclusions

The development of industrial strategies involves five main steps. The first is a detailed assessment of the industrial sector and main sub-sectors. This involves evaluating industrial performance in domestic and export markets and the main drivers of performance (macroeconomic and policy framework, human resources, technology, FDI, finance, physical infrastructure and supporting institutions).

Where possible, evaluation should use quantitative benchmarks against selected comparators (within the region, in other developing regions that are likely to offer direct competition to Pakistan and in more advanced countries that serve as role models). We hope to have made a start in this benchmarking exercise by drawing on readily available international data and some recent work on the investment climate in Pakistan. Naturally, informed qualitative judgements require a much more in-depth knowledge of the local industrial sector than we possess.

The second stage is the development of a national 'strategic vision'. The vision should reflect the interests of all stakeholders, including the private sector, government institutions, employers' organisations, trade unions and so on. In this step, the government needs to define short and longterm industrial goals and to start planning how to strengthen or create capabilities to reach these goals. The vision should inform priorities for public expenditure.

The third stage is to design policies and programmes. The fourth is to implement these policies and programmes. The fifth is to monitor the progress of the strategy, assessing its success and adjusting it as necessary.

International experience suggests the value of setting up an industrial competitiveness agency headed at a very senior political level which can mount a strategy to cut across competing interests and coordinate the ministries concerned. For example, in the Pakistan context this might involve combining the work of the Export Promotion Bureau and the Board of Investment.

Then comes the task of allocating resources at various levels. At the highest level, it has to be decided which generic areas - education, infrastructure, finance, science and technology, and so on - have to be addressed. This needs a strategic 'vision' of what the main engines of industrial competitiveness are going to be. At the sectoral and sub-sectoral levels, the government has to decide on which activities to support, not 'picking winners' in detail but allowing winners to emerge in the sets of activities that hold most promise of long-term economic and technological growth. These activities have to be identified from clusters of inter-linked industrial activities that share strong technological externalities, use the existing base of skills and capabilities, can develop good backward linkages and face rising competition both locally and abroad. The best way to proceed is to examine closely the experience of countries that have similar endowments but have been successful in developing competitive bases. This is an art rather than a science and involves considerable benchmarking and policy analysis.

We note that there are already various initiatives in place in Pakistan concerning competitiveness and technological upgrading. As we do not presume to know the effectiveness of current measures, we would simply make a few basic points.

First, in the light of the international benchmarks noted above, adequate government support for a competitiveness strategy requires a significant commitment in terms of public investment in relevant technical and general education, as well as strengthening of public R&D activities. Some of these problems will require long-run, not short-run solutions.

Second, there are a number of weaknesses in the area of physical infrastructure, such as power. Any further measures to improve the investment climate, whether reducing bureaucratic restrictions or ensuring continued macro stability, will also help in competitiveness terms.

Third, it is at the firm level that critical competitiveness problems need to be addressed, and here the role of government is to facilitate and support. The issue is whether current plans - such as the measures to support technological upgrading and joint ventures with foreign investors through an Upgradation Fund - go far enough. In principle, support can take a range of forms, including the standard tax incentives for training and R&D expenditure, cost sharing for various consultancy services (as covered by the Upgradation Fund), a lower level version of innovation consortia and provision of finance for technology support, particularly a form of venture capital or matching grants for relatively high risk or innovative initiatives.

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