How budget will stifle exports

Govt targets import substitution that will keep economy closed

ISLAMABAD:

While introducing the 2024-25 budget in the National Assembly, the finance minister emphasised that the key objective is to revive the reform path initiated by then prime minister Nawaz Sharif in 1990.

Perhaps many would not remember, but at the time, Nawaz Sharif had embarked on opening the economy to competition, as had been successfully done by many East Asian countries in the 1980s or earlier. However, contrary to these declarations, the budget papers highlight that the focus of this budget is on “enhancing import substitution,” which has always been synonymous with keeping the economy closed to competition through high tariffs. To illustrate the contradiction between the finance minister’s stated intentions and the actual measures, here are a few examples.

First, the budget withdraws incentives for electric and hybrid cars made available through the Electric Vehicles Policy of Pakistan 2020-25. While the rest of the world moves towards electric and hybrid vehicles for economic and environmental benefits, this budget takes the opposite approach.

This decision mirrors the PML-N government’s actions in 2015-16 when they prioritised coal-based power plants over hydroelectric ones, allocating two-thirds of the total funding to coal under CPEC. The government eventually recognised its mistake and imposed a moratorium on new coal plants, but it was too late. The current government should realise that disincentivising electric vehicles at this critical moment, when the rest of the world is moving in that direction, would be a mistake similar to the 2015 shift towards coal. Failure to embrace new technology will lead to rising oil bills and worsening pollution in major cities.

There are several other examples where proposals have been made to impose new duties to promote import substitution. These include additional duties on auto parts to encourage local production. Already, auto parts bear some of the highest tariffs. Due to these high taxes, most of the needs are met through smuggling. Further raising tariffs will only exacerbate this issue.

Another related measure is the rise in duty on iron and steel, which is a basic raw material for engineering and construction industries. These high costs disproportionately impact small and medium enterprises that cannot avail themselves of exceptions allowed under various schemes for large-scale manufacturing and exporters. Another import substitution measure is the imposition of additional duties on paper. Already considered a luxury product with the highest duty slab, paper carries a total tax burden exceeding 70%, including sales tax, additional duties, and other taxes.

These exorbitant duties and taxes have nearly decimated the printing industry, with even brochures now being printed in Dubai or Singapore. Paper, primarily used for printing books, should not be categorised as a luxury product by any stretch of imagination.

In contrast, after India rationalised tariffs on the printing industry, it experienced rapid growth. The commercial printing market in India is now estimated at $34.5 billion, and it is becoming a hub for global printing.

History has shown that import substitution does not yield successful outcomes. By the end of the 20th century, almost all countries abandoned these policies in favour of export-led growth. The sooner a country made this transition, the more successful it became. Taiwan and South Korea led the way in the 1970s, followed by China in 1979, Vietnam in 1986, and India in 1991. Unfortunately, Pakistan remains hesitant after embarking on that path in 1990, and now, in 2024, the budget document indicates a return towards import substitution policies of the last century.

The primary reason for abandoning import substitution policies is that they lead to resource misallocation by encouraging industries that are not globally competitive or efficient. Highly protected industries prefer to sell in the local market rather than improve their quality and compete internationally.

Pakistan’s focus on import substitution has resulted in its falling behind in global competitiveness and economic growth, whereas its competitors, which embraced export-led growth, have flourished.

Another perplexing decision is to introduce yet another agency to set import prices for goods. This function is already managed by the Directorate General of Customs Valuation in Karachi.

In most other countries, this human interaction has been eliminated as it was found to result in corrupt practices. In Pakistan, instead of one agency, now we will have two – one for determining import values for customs duty and another for withholding income tax.

There is already significant litigation in this area, and this will only increase it. Pakistan already has many agencies checking and rechecking imports and exports. Through this budgetary measure, we will be adding one more.

This measure clearly contradicts the finance minister’s declaration that reducing human interaction within the FBR would be the way forward to improve transparency and reduce corruption.

Overall, this budget represents a significant step backward in promoting Pakistan’s international trade, particularly its exports. The primary trade policy instrument, the customs tariff, already exhibits a substantial anti-export bias, which is further exacerbated by this year’s budget measures.

The PML-N government should acknowledge that exports have declined during each of its tenures compared to the levels when they took office. This trend is likely to repeat unless we adopt an export-led growth strategy. Without this shift, the current economic challenges are likely to persist.

Recently, two local think tanks, PIDE and PRIME, have jointly crafted an extensive roadmap to modernise tax and tariff policies. Their proposals intend to invigorate the economy and pave the way for export-driven growth. The government must evaluate these suggestions to avoid costly errors.

The writer is a member of the task force on FBR reforms. He has previously served as Pakistan’s ambassador to the WTO and FAO’s representative to the United Nations at Geneva