Carrots and sticks: balancing industrial policy

How might landscape have evolved if export subsidies were tied to performance metrics?

KARACHI:

A true biryani connoisseur understands that the dish’s excellence lies not only in premium rice and meat but also in the ideal mix of spices.

A delicious plate can be spoiled by either an excessive amount of spices, causing throat irritation, or insufficient seasoning, resulting in a bland dish more reminiscent of pulao than biryani.

It’s all about finding the right balance, which is a key concept not just confined to the realm of a home kitchen but also to industrial policy.

Industrial policies devised by governments play a major role in driving economic growth and development worldwide. The need for such policies arises because the market, on its own, usually cannot create the changes required to fuel development. Consequently, the government must step in and devise policies.

The problem, however, arises when a government starts picking winners and losers based on insufficient or incorrect information and then drafts policies that either give too many incentives to certain industries or impose excessive regulations on others.

If the government does not take a balanced approach, then it could hamper economic development, just like an inexperienced cook who either creates an extremely spicy or bland biryani.

Policymakers in Pakistan haven’t been successful in designing industrial policies that could stimulate economic growth, encourage innovation, attract foreign capital, enhance global competitiveness, promote export-oriented or import-substitution industries, and improve social welfare.

The policies that were designed could not find the right balance between incentives (carrots) and regulations (sticks). The government either gave too many carrots to certain sectors or beat others down with sticks.

This imbalance contributes to the country’s recurring economic challenges and the need for consistent International Monetary Fund (IMF) bailouts.

The oil refining industry is a prime example of an industry that has been bogged down by excessive regulations.

Pakistan has seen an increase in demand for petrol and diesel in recent years (notwithstanding the recent weakness driven by the economic slowdown and high pump prices), but no new oil refining plant has been established for well over a decade to meet this growing demand. This increases the country’s reliance on imports.

Oil refining is one of the most tightly regulated industries. Refiners do not even have control over product prices, which are set by the government.

For years, this import-substitution industry has been asking for business-friendly policies that could allow them to modernise and expand their plants. Even foreign investors have expressed interest in establishing new oil refining units. But the government has shown an entirely lacklustre attitude.

A new oil refining policy was reportedly developed by the Pakistan Tehreek-e-Insaf (PTI) government, but it seems to have been stuck in some governmental or bureaucratic quagmire, passing hands from one minister’s office to another committee’s meeting. As a result, the refining industry is now struggling to survive.

On the other end of the spectrum, we have the textile industry, which accounts for more than 60% of Pakistan’s exports. Unlike the oil refining industry, textile companies have received extensive support from the government.

From subsidised energy to access to low-cost financing schemes, the textile industry has benefited from numerous incentives. While this has fuelled an increase in exports, it has not driven further development in the industry to make it more competitive or superior to regional peers, nor has it significantly reduced Pakistan’s trade deficit. Rather, it seems to have made the industry heavily dependent on government handouts.

As a reminder, textile exports increased by almost 48% during the five years ending FY22 to $18.4 billion, according to data from the State Bank of Pakistan (SBP). This translates into a modest compound annual growth rate (CAGR) of 8.2%, which leaves room for further development and improvement.

It would have been beneficial if the government had conducted a thorough cost-benefit analysis to determine whether the subsidies given to the textile industry were worth it. Such an assessment could have facilitated more efficient resource allocation and maximised returns on investment.

One must consider the potential outcomes if the government had extended similar incentives to other industries, such as oil refining, mining, information technology (IT), or pharmaceuticals.

Could this have diversified the country’s export portfolio and reduced dependency on the textile sector? How might the landscape have evolved if export subsidies were closely tied to performance metrics?

Delving into these possibilities could enable policymakers to extract greater value from their strategic decisions, ultimately promoting more balanced and effective industrial policies.

Open communication and a free flow of information between the government and the private sector can form the foundation for developing effective policies that offer incentives (carrots) to areas with the greatest potential for growth and discourage harmful behaviour through regulations and penalties (sticks).

Therefore, establishing a lasting institutional mechanism that connects policymakers with the private sector is essential.

Economists like Dani Rodrik emphasise that policymakers must adopt a balanced carrot-and-stick approach to achieve development goals. Governments should neither yield to industrial bodies, creating strategies that provide excessive advantages and encourage rent-seeking behaviour, nor assume they have perfect information and dictate terms that could harm industries.

Instead, they should maintain autonomy to decide what is best for the economy and its people without succumbing to the undue influence of powerful lobbying while also considering input from the private sector and addressing their concerns.

The writer is a corporate consultant who writes on subjects of business and economy

 

Published in The Express Tribune, April 17^th, 2023.

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