Industrialization is back on the policy agenda in Pakistan. The government is about to announce a new national industrial policy aimed at ‘reshaping and reviving’ Pakistan’s long-stagnant industrial sector. This comes amid a slew of other policies approved or in development aimed at boosting industrial and export growth, including a new National Tariff Policy, a National Electric Vehicles Policy, a Textiles and Apparel policy, and a new Energy Wheeling policy among others, as well as the launch of the second phase of CPEC (which includes industrial development as a key priority).
Jaded observers of Pakistani policymaking can be forgiven for shrugging their shoulders at these developments given the sordid history of past top-down reform attempts by successive governments that amounted to little beyond fanfare, boom-bust cycles and rapid backtracking on reform commitments at the slightest hint of sectional resistance. However, regardless of how one feels about the current government’s capabilities or legitimacy to design and implement industrial policy, it is hard to argue that this exercise is unnecessary. [restrict level=1]
Pakistan has not had anything resembling a coherent industry policy for over three decades (unless one counts the voracious rent-seeking that takes place in FBR offices for various SROs and tax exemptions as ‘industrial policy’). In this time, industry’s share of GDP has fallen from 26% (in 1996) to between 10-15% today. Large Scale Manufacturing (LSM) has remained on a steady decline for years since its brief post-COVID recovery in early 2022. Investment has shrunk to around 13% of GDP. Credit to the private sector never really recovered from its 2007 peak and now hovers around 10% of GDP. In the meantime, regional competitors like India and Bangladesh have managed to create sizable industrial bases and increase their exports per capita to multiple times that of Pakistan, while our shrinking productive capacity and low export equilibrium perpetuates balance of payments crises, IMF dependence, rupee devaluation and devastating inflationary episodes.
From the government’s recent pronouncements, it appears that there has been some awakening to the need to address Pakistan’s crisis of industrial stagnation. However, from what has been revealed about the policy so far, questions remain about whether this effort will actually address the causes of Pakistan’s deindustrialization. While many of the proposed steps – particularly actions to reduce energy tariffs, taxes and import duties – are clearly needed, there are reasons to be concerned that the policy’s design and focus could perpetuate the harmful rent-seeking equilibrium that has long characterized state-capital relations in Pakistan without bringing about the required productivity and export benefits.
So what is in the policy exactly?
While the national industrial policy has not been officially announced at the time of writing, a draft in circulation provides some insight into its design and focus. Spearheaded by SAPM on Industries and Production Haroon Akhtar Khan, the policy has been formulated through eight committees (on tariffs, taxes, energy, regulations, investor confidence, credit, firm revival and land and infrastructure), comprised of representatives of government institutions – key among them being the Ministry of Industries and Production (MoIP), Ministry of Commerce (MoC), FBR and SECP – and industry associations (such as the Pakistan Business Council, APTMA and others). The thrust of the document reflects the composition of the committees that formulated it in that it reads like a negotiated settlement balancing industry demands and FBR revenue needs.
In lieu of a detailed diagnosis of the industrial landscape, the policy briefly identifies the ‘key constraints’ to industrial growth: 1) macro-instability, 2) trade protections, 3) disproportionate tax incidence on industry, 4) ‘uncompetitive space’ (including cost of land and regulatory gaps), and 5) lack of investment (including due to lack of investment security and IP rights). To address these constraints, the policy aims to provide direction to ‘boost investment in the manufacturing sector’, ‘enhance investor confidence’ and ‘grow industrial exports’. It then lists out a wide-ranging laundry list of recommendations related to: reducing the cost of power; reducing taxes and tariffs on imported inputs; provision of viable land and infrastructure; enhancing technological skills and acquisition; reforming corporate income tax and super tax; strengthening investor protection; improving access to credit; enabling revival of sick units; intellectual property protection; regulatory streamlining; and building institutional capacity for industrial policy, among others.
However, as one reads through the document, it becomes clear that the main focus of the policy (the only recommendations for which any actionable steps are outlined) is on some key areas aimed at reducing the costs of business and incentivizing investment: tax measures, energy cost reductions, investor security, sick firm revival, tariff measures, SEZ’s and institutional strengthening.
Tax measures: The rationale for tax cuts is simple enough – the disproportionately high tax burden on the manufacturing sector (which accounts for only 13% of GDP but over 60% of total tax revenue) limits formalization, stifles cost competitiveness and limits the entry of newcomers, while also making FDI in the sector unattractive in comparison to the rest of South Asia. The main tax measures proposed (subject to IMF approval as per FBR’s comments) are a reduction in corporate income tax from 29% to 26% over three years and gradual reduction and eventual abolition of the Super Tax (currently up to 10% of marginal income above Rs. 300m for multiple industries) over five years. In addition, the policy proposes a new Drawback of Local Taxes and Levies (DLTL) scheme by the Ministry of Commerce as an export incentive.
Energy cost reductions: While the policy does not offer a roadmap for energy cost reduction, the key steps proposed include the removal of the cross-subsidy from industrial tariffs and abolition of peak rates by the Power Division and removal of cross subsidy from industrial gas prices by the Petroleum Division. In addition, the document refers to the implementation of the new Energy Wheeling Policy, which allows industrial consumers to buy energy directly from captive power plants via a streamlined open access mechanism, with special rates just above the marginal cost for high-tech green field sectors such as EV, batteries, and data centers.
Investor protection measures: Investor protection measures are clearly a priority and are discussed in some detail. The policy recommends a host of proposals to eliminate ‘undue harassment’ of industries and the private sector, including amendments to the SECP Act 1997 for mandatory SECP approval prior to LEA action, empowering the PM to act to safeguard investments, simplification of audit and oversight procedures, and safeguards against arrests of company personnel by LEAs without prior regulator opinion. It also proposes legislative amendments to the Corporate Rehabilitation Act to develop a concrete legal regime for bankruptcy and insolvency to improve investors’ confidence about investment recovery and restructuring of firms in case of failure. An amendment is also proposed to the Protection of Economic Reforms Act (PERA 2016) to bar retrospective withdrawals of fiscal incentives (e.g., subsidies or tax breaks) where ‘investment steps have already been taken’ and prescribe a maximum limit of ten years for retention of records by companies of relevance to those fiscal incentives.
Firm revival: A significant amount of space is devoted to firm revival or what the policy refers to as revival of ‘sick industrial units’ to reactivate idle capacity and create jobs and local value chains. The policy proposes the establishment of an SBP-led framework for the revival and debt resolution of ‘distressed industrial units’ (in manufacturing, agribusiness, logistics, energy and services) that enables banks to consider revival-linked credit schemes with principal and interest rate reductions and provision of fresh working capital, and corporate restructuring companies (CRCs) to acquire non-performing loans and oversee firm recovery. In addition, the policy proposes the establishment of a National Industrial Revival Commission (NIRC) to oversee the firm revival policy and provide monitoring, statistical and governance support.
Tariff reform: Perhaps the most potentially significant aspect of the government’s industrial reform effort is something that is not explicitly part of the industrial policy itself – the new National Tariff Policy 2025-30, which aims to liberalize and rationalize import tariffs. While the industrial policy references and affirms the new Tariff policy, the latter was developed out of a parallel long-running tariff reform advocacy led by Pakistan’s former WTO rep, Dr Manzoor Ahmad, and economists like IGC Director Dr Ijaz Nabi among others.
Pakistan has long had a skewed tariff regime – with the region’s highest average tariffs and high import duty cascading – that has disincentivized an export orientation among domestic firms. High duties on intermediate and finished goods have both diminished the cost competitiveness of local producers faced with high input duties and created an incentive for local manufacturers to produce goods solely for domestic markets behind tariff walls.
The new tariff policy aims to address this problem through three key measures: a) a simplification of the tariff regime to four slabs (0%, 5%, 10% and 15%), a gradual elimination of additional customs duty (ACD) and regulatory duties (RD) over five years, a reduction in customs duties (CD) to a maximum of 15% over five years, and a phasing out of the distortionary Fifth Schedule of exemptions over five years. The policy aims to route all future tariff change requests through a Tariff Policy Board, which could limit the discretionary abuse of SROs to serve special interests. Overall, the policy targets a reduction in Pakistan’s simple average tariff rate from the current 20% to 9.5% in five years.
If implemented as designed, this could have a significant impact. According to estimates by the Global Trade Analysis Project (GTAP), these tariff measures alone are projected to increase Pakistan’s exports by 10-14% and revenue by 6-7%, along with a host of other expected knock-on effects.
Access to credit: To address the longstanding issue of low credit to the private sector, the policy proposes increased utilization of the State Bank’s Export Finance Scheme (EFS), requirements for banks to justify loan refusals and consider lowering rates, lending incentives like reducing capital adequacy risk weighting for medium firms, issuance of sectoral bonds to provide a framework for long-term financing, reinsurance support for EXIM bank and improved access to digital gateways. However, no steps are outlined for carrying out any of these recommendations.
The policy does lay out some actionable taxation and regulatory measures for building Pakistan’s venture capital eco-system including: granting statutory pass-through status to licensed VC Funds (revoked by FBR in 2021); changes to the FE manual to address repatriation friction for VC equity at entry and exit points; and creating a ‘Fund of Funds’ to finance new Fund managers focused on various asset classes in Pakistan (along the lines of MSMEDA in Egypt and ISSF in Jordan).
Institutional capacity: The policy aims to enhance institutional capabilities for industrial governance, including through the establishment of a Support Cell and a Strategic Planning Cell at the MoiP to oversee industrial policy, SOE restructuring, privatization, and land titling issues, among others. Further, a government-backed guarantee facility has been proposed to institutionalize enforceable guarantees for industrial and infrastructure projects.
Land and infrastructure: The discussion of land and infrastructure provision in the policy is mostly centered on SEZs. Recommendations include the establishment of a ‘One-stop Service’ at SEZs that combines corporate registration, taxation, customs, visas, environmental regulations and energy with legally delegated autonomy of operations. The policy also recommends a national land bank and harmonization of zoning laws across cities but does not lay out any steps to achieve these outcomes.
Table 1 summarizes the key priority areas, actions and outcomes in the industrial policy. Other recommendations that are included in the policy but without any related actions laid out include review of VAT and WH-Tax on imported inputs, enhancing technology acquisition, strengthening intellectual property rights protection, enhancing domestic certification capacity and policy coordination.
Problems of design
On their own, many of the proposals in the industrial policy are eminently reasonable and if appropriately implemented, could go some distance in improving cost competitiveness, investment and export orientation in the industrial sector. However, the policy at times reads more like a prescriptive wish list of parallel proposals rather than a robust evidence-based and sequenced planning framework for industrial revival.
To begin with, there is no attempt at a detailed diagnosis (or even citation of existing evidence) on the roots of Pakistan’s industrial crisis. For instance, the policy does not examine the failure of past policies of import substitution and export promotion to engender manufacturing growth. It does not discuss issues like structural trends in the post-94 financial system that hinder credit access, distortions in land policies that limit supply of affordable industrial land nor the vast gulf in female labor force participation that separates Pakistan from manufacturing success stories like Vietnam and Bangladesh.
The policy does not examine the current industrial structure of the country, in terms of its sectoral composition, clusters, evolving comparative advantages, sectoral economies of scale, or supply chain gaps (nor are any references made to ongoing sectoral policy processes on EVs, textiles and others). There is no attempt to understand the key technological and capability gaps that are keeping Pakistani industries stuck in a low-value primary and intermediary goods equilibrium and preventing them from moving up value chains. Some ongoing debates of obvious relevance to GVC integration and productive capacity, such as development of indigenous minerals processing capacity, do not find mention. There is also no attempt made to place the policy in the context of the seismic disruptions in international trade underway and how to navigate the challenges and explore new opportunities and markets for Pakistani manufacturers under the circumstances. The lack of any attention to these questions is reflected in the lack of any targeted sectoral interventions outlined in the policy.
It is also unclear how policy success will be measured – no modeling or feasibility is provided for any intervention, and no theory of change or framework is outlined for achievement of the policy objectives. No quantifiable targets or measurable indicators have been established to measure overall policy success.
In many ways the incoherence of the policy design is reflective of the fragmented and clientelist way in which policymaking takes place in Pakistan. Rather than being an outcome of an autonomous and representative governing structure’s attempts to formulate strategic evidence-based interventions to achieve beneficial economic outcomes for society, the policy reads like an exercise in reducing the costs and risks of doing business of existing businesses and investors to boost their profitability while balancing against the government and IMF’s revenue needs. Institutions responsible for long-term economic planning (e.g., the Planning Commission), SOEs involved in strategic sectors like oil, gas and minerals or representatives of industrial labor appear to have not been involved in its development.
However necessary improving the cost competitiveness of and risk environment for businesses and investors (as the policy aims to do) might be, industrial policy can and must go beyond that in its design. It should address key structural and institutional barriers to Pakistan’s industrial growth and provide a clear, actionable and measurable long-term plan to overcome them. Most fundamental among them is the question of productivity.
The productivity elephant in the room
As Ricardo Hausmann and numerous other industrial economists have pointed out – industrial policy should not just be about improving firms’ profitability but improving productivity. For industrial economists like Mushtaq Khan, the very point of industry policy is to ‘support the development and adoption of technologies and capabilities that raise social productivity’. Industrial policies are required, he says, when ‘private contracting fails to organize potentially gainful investments that achieve these outcomes’. This is certainly the case for Pakistan.
Pakistan’s crisis of productivity is at the core of its industrial dysfunction. Pakistani firms have the lowest productivity growth among regional competitors, with most firms not becoming more productive as they grow older unlike in other countries, impeding growth and technology adoption. The most marked decline in firm productivity in Pakistan over time (-7.5% between 2012 and 2020) has been for family-owned firms. Excessive reliance on family for senior managerial roles by such firms (also notoriously averse to public listings) and inefficient managerial and organizational practices in general have been found in research to be the key drivers of firm productivity stagnation. A recent survey of innovation in Pakistani firms found that the largest productivity improvements came from reforms related to organizational and process innovation, consistent with results from around the world.
Yet the word productivity appears a total of two times in the industrial policy (once as an assumed outcome of reduction in super tax and once in reference to establishment of a ‘productivity fund’ which is not elaborated on in any section of the policy). The word innovation does not appear at all.
No strategy for industrialization can succeed without embedding productivity growth into its design. Successful industrial policies across the world have focused on enhancing productivity with a variety of instruments that incentivized technology adoption, capability upgradation, organizational and process innovation and learning-by-doing. Bangladesh’s experiences with partnerships between Bangladeshi and South Korean firms in the garments sector demonstrate how contracting for organizational capability and technology transfers can enable productivity growth in fiscally strained contexts.
At the policy level, this requires developing the ability to monitor and measure productivity growth across firms and sectors and linking entitlements and incentives to measurable improvements in productivity. It requires planning for productive and technological sovereignty, mapping gaps across priority sectors, enabling financing for firms seeking to enhance technology acquisition and capabilities and developing academia-industry linkages that drive applied innovation, learning and technological diffusion. In this process, new opportunities for productivity-enhancing technology transfers, such as Chinese investment in textile hubs and EVs under CPEC2.0, must be integrated into Pakistan’s industrial planning matrix.
Conditioning rents for industrial policy
Regardless of country context, a key feature of successful industrial policies around the world has been the ability of governments to condition subsidies (be it tariff protections, tax cuts or export incentives) on firm performance, exports and productivity. Pakistan has consistently failed to enforce conditions on subsidies offered to domestic forms, leading to rent capture that has stifled competitiveness and productivity.
There is every reason to fear that the current industrial policy will end up repeating the same mistakes that have led to rent capture in the past. For one, the policy’s lack of any targets or measurable indicators of performance in response suggest that payoffs will be accrued to firms regardless of effort. Further, the policy doubles down on proposals of export subsidy programs like Drawback of Local Taxes and Levies (DLTL) without examining why such programs have failed to achieve improved export performance in the past. Studies have found that instruments like DLTL have had limited export impact and only benefited a small number of ‘insider’ firms by focusing high-rated duty drawbacks on the established products of those firms while discouraging diversification by driving concentration of capital allocation towards high-rated DLTL product categories with often lower global demand. Persisting with the same incentive structure without productivity and innovation conditions is likely to lead to similar outcomes.
The new policy goes even further to embed rent-seeking in its design through its proposal to bar withdrawals of all fiscal incentives to firms retroactively. In practice, this could mean the government could be legally barred from withdrawing subsidies from firms that fail to meet productivity, export or growth targets, essentially amounting to legalized rent capture. While providing policy consistency and predictability for investors is important, that must not be conflated with unconditional subsidization of unproductive enterprises regardless of performance. Benchmarks with productivity, technology and export targets must be embedded in future contracts and investment plans.
Industrial policy and political settlements
However much policymakers and economists wish to treat industrial policy as an exclusively technical issue, there is a wealth of evidence from around the world on how political settlements – or the configuration of power between different organizations and institutions in society – is critical to the success or failure of industrial policies. In particular, the literature on political settlements and industrial policy demonstrates that the ability to condition rents to achieve industrial growth is often a function of the political settlement or distribution of power between organizations and institutions.
As economists like Peter Evans have explained, the success of East Asian industrialization was in part a function of the exceptional capability of its states to effectively manage and distribute rents by virtue of both their ‘embeddedness’ (intimate linkages and dialogue with both the private sector and the citizenry) and ‘autonomy’ (relative independence from sectional interests in its decision-making). On the other hand, if a country’s governing coalition excludes a large number of groups that do not benefit from the rents but have strong organizational capabilities, it is likely to increase the enforcement costs of industrial policy and limit its chances of achieving success without coercion.
Mushtaq Khan’s research on Pakistan’s industrialization attempts in the 60s and 70s attributes their failures to the rise of an organized intermediate entrepreneur class with strong political linkages that perceived itself as excluded from the benefits of industrialization and used its power to demand rents and protections from the ruling coalition. This resulted in increasing use of force to repress excluded factions, emergence of fractions in the ruling bloc and an eventual diminishing of the state’s ability to condition rents to big business interests.
Political settlements are crucial to understanding the problem of rent capture across multiple sectors in Pakistan. It is not difficult to see how the organizational power of certain sectional interests – such as real estate and banking – have enabled them to engage in rent seeking that perpetuate productive stagnation. The organizational power of real estate interests for instance has enabled policies that have driven up land values and disproportionately high returns that have diverted capital and savings away from disproportionately taxed industrial production. There has been a similar process of rent capture by commercial banks since bank liberalization in the 90s, whereby banks have colluded to secure windfall profits largely through risk-free government securities rather than financing productive investment in industry. Within manufacturing itself, it is in large part the organizational power of various family firms that has enabled decades of tariff-related rent capture while resisting productivity-enhancing management reforms or IPOs.
The question of political settlements is especially critical for industrial policy in the context of the current political settlement in Pakistan, comprised of what Mushtaq Khan would categorize as a ‘vulnerable authoritarian coalition’: characterized by limited popular legitimacy and strong excluded political factions, leading to limited autonomy from business and global interests and reliance on violence to maintain power. One potential implication for industrial policy is that developing the state’s ability to successfully condition rents and implement reforms that go against special interest groups will require the incorporation of excluded political factions into the ruling bloc to minimize policy resistance.
For all the shortcomings in the policy, the fact that Pakistan is finally devoting policy attention to industrialization is a welcome development that is long overdue. It is nonetheless crucial that this process is carried out with the seriousness and analytical depth that it requires, and policy designed with measurable targets and integrated pathways that enable productivity, export growth and a sustainable enhancement of productive capacity in Pakistan. Despite our unending policy and governance failures of past decades, Pakistan is once again faced with immense economic, strategic and demographic opportunities that could transform the economic fortunes of our people. We must get it right this time, not allow opaque policymaking processes and short-sighted rent-seeking to squander this opportunity and develop and implement a vision for industrial and economic prosperity for all. [/restrict]
