Beyond trade deficit

Let me tell you the story of two countries that were at the same place two decades ago but then went on to entirely different trajectories. Both were developing countries, with annual exports worth $9-10 billion. Textiles and agriculture products accounted for bulk of their exports and both had a trade deficit of two to three billion dollars. If anything, the first country seemed somewhat better than the other and had a narrower deficit.

Fast-forward to the present day and we find that while the first country’s exports barely grew by 2.5 times, its trade deficit ballooned by 18-20 times. On the other hand, the second country grew its exports 25+ times and now enjoys a trade surplus. This is the story of Pakistan and Vietnam.

What’s really striking is that Pakistan and Vietnam’s trajectories were dissimilar not just in terms of export volumes but also in terms of economic complexity. In layman’s term, economic complexity looks at a country’s exports and provides an estimate of its underlying capabilities to produce these products. Economic Complexity Index (ECI), developed by Hidalgo and Hausmann, is a measure of how diverse a country’s exports are and how many countries produce these exports. A higher ECI score means that a country produces a variety of products with limited competition, thus giving it a competitive advantage.

In 1996, textiles, agriculture and food products accounted for 70% of Pakistan’s export base and they still do. Consequently, Pakistan’s ranking on ECI jumped only seven positions from 99 to 92 from 1996 to 2016. Pakistan’s poor rank depicts its continuing reliance on agricultural exports and low-technology labour-intensive production. In the meanwhile, Vietnam changed its export composition significantly and grew its electronics’ exports from almost nothing to 33% of its exports base, making it its largest export category. Vietnam, therefore, jumped 45 positions from 101 to 56 in the last 20 years.

Every few years, Pakistan runs into a major balance of payments crisis, driven by trade deficit. These crises compel the government to seek IMF support and take drastic measures such as rupee devaluation, subsidies on inputs, etc to give relief to existing exporters and give them a boost. With this supply of oxygen, our industries are able to breathe a little longer but the overall competitiveness keeps coming down.

Pakistan’s widening trade deficit and declining exports are often attributed to high cost of doing business and poor investment climate. But low economic complexity is another reason that has also contributed significantly to our poor export performance.

Therefore, there is no permanent way out of this growing trade deficit problem, unless we diversify our exports and venture into products that fewer countries export. We have to realise that ‘type’, rather than ‘number’ of products we export, is a more important determinant of economic prosperity. Experience suggests that countries are more likely to succeed on this agenda if they focus on products that are close to their current set of productive capabilities and then leapfrog to more sophisticated products. Doing this would require investing in knowledge building, technology upgradation, innovation and building human capital to support new technologies.

But it is easier said than done. It means taking away generous incentives from industries that keep on exporting the same products year after year, and instead diverting them to incentivise newer product categories and innovative technologies. This may also mean hurting interests of established industrial lobbies and leaving the rent-seeking industries on their own. It would also mean having a proactive industrial policy, where focus has to be placed on products and activities that have no or few supporting lobbies. In short, what we need is an industrial policy which targets increased economic complexity and innovation rather than blindly pursuing export growth through subsidising run-of-the-mill export categories.

Published in The Express Tribune, February 19^th, 2019.

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