The Schumpeterian growth process

Dilemma continues as desire to reduce tariffs is met with resistance

KARACHI:

The National Tariff Policy 2025-2030, like previous episodes of tariff liberalisation in Pakistan, has ignited a debate between economists who support the essence of open markets and economic freedom, and specific interest groups who prefer the status quo of high tariffs and trade protection.

On the one hand, economists push for increased competition, fostering innovation and embracing productivity and efficiency gains through the upgrading of physical and human capital as the cornerstone of economic development in Pakistan. On the other hand, the specific interest groups emphasise the infant industry argument as they believe that their industries will not be able to survive the competitive pressure imposed by inflows of foreign goods.

The government considers the indirect taxes accumulated through customs duties and regulatory duties as an important source of fiscal revenues, asserting that their reduction may hurt the ability to reduce the fiscal deficit. Furthermore, with the risk of a burgeoning trade deficit remaining high, leading to a balance of payments crisis, tariff liberalisation is often put on the backburner in Pakistan.

Hence, the dilemma continues through different episodes as the desire to reduce tariffs and improve the overall competitiveness levels within the economy is met with resistance from special interest groups and policymakers, albeit with different preferences on trade protection and revenue generation.

The winners of the Nobel Memorial Prize in Economic Sciences 2025, namely Philippe Aghion, Peter Howitt, and Joel Mokyr, have emphasised the importance of innovation and human capital as determinants of economic growth. They contend that "creative destruction" can drive economic growth and raise standards of living across countries as firms achieve higher levels of technological capabilities. Their works deliver a strong and undeniable mandate for Pakistan, which has long been trapped in the dichotomy of tariffs and trade protectionist measures that serve as a legacy of inward-looking policies. It is important to focus on the key messages put forward by the prize winners – that true prosperity is unlikely to be built behind protectionist walls but rather with the help of a skilled and competitive workforce and industries. Therefore, it is essential to prioritise the development of human capital and encourage a pro-competitive business environment fostered by innovation.

Aghion and Howitt emphasised the role of innovation in ensuring that old technologies and firms using outdated methods of production eventually become obsolete. The process of "creative destruction" ensures that inefficient and poorly performing firms are replaced by more efficient firms with production processes geared towards higher growth.

Mokyr demonstrated that the increase in economic growth is due to organised creation, stressing the role of industrial enlightenment where the development of technical skills and human capital is valued. Therefore, blocking and restricting the process of creative destruction by building tariff walls and through anti-competitive interventions has diverted resources from the main engine of growth, which is the accumulation of knowledge and skills by the workforce. Without competitive pressure and the desire to innovate, investments in human capital often remain a low priority.

Pakistan has one of the highest tariff rates in the Asia-Pacific region. The weighted mean applied tariff rates on all products, as extracted from the World Bank's World Development Indicators, imposed by Pakistan are approximately five times more than Vietnam, a country which has experienced skyrocketing growth in exports and imports.

The high tariffs, apart from generating revenue for the government, shield domestic industries from foreign competition. By preventing competition from "creatively destroying" inefficient domestic firms, policymakers thwart a main engine of growth.

Pakistan has one of the lowest levels of trade as a percentage of GDP in the world. According to the World Bank's World Development Indicators, this indicator was at 27% for Pakistan in 2024, compared to over 165% for Vietnam, while Thailand and Malaysia reported values well over 100%.

The low levels of trade openness as measured by this indicator suggest restricted access to the best foreign technology, foreign investments and production practices, as well as international production networks and supply chains. The lack of conduits for knowledge diffusion kills the potential for economic growth. Pakistan has ranked low on the World Bank's Doing Business index, considerably lower than some of the major economies in the region such as India, Thailand, and Vietnam. The poor business environment is characterised by red tape and regulatory burden that prevent newer and more innovative firms from entering industries. The entry of such firms drives job growth and increases productivity in the economy.

Hence, it is crucial that the liberalisation process announced with the publication of the National Tariff Policy 2025-2030 must continue. The flow of foreign competition, mainly through imports, will either force the more established domestic firms to become productive and innovative or exit the industry. This is the Schumpeterian growth process or "creative destruction."

Outdated protectionist measures that involve deletion programmes, localisation incentives, and discretionary regulatory duties on imports must be abolished as they hinder the integration of domestic businesses into regional and global production supply chains and networks. Furthermore, it is also essential to ensure a more competitive playing field by implementing policies that support the growth of smaller and newer businesses. The monopolistic behaviour of larger and dominant firms can adversely impact productivity and job growth across several industries.

In order to achieve greater levels of innovation and provide an impetus for better accumulation of knowledge that helps achieve greater economic growth, it is essential to prioritise the training of human capital by ensuring the right mix of skills for the workforce. Establishing better linkages between universities and industries will not only create opportunities for research but also for the commercial application of ideas and innovations generated in research centres. Additionally, a thriving entrepreneurial ecosystem that allows a better exchange of ideas will be aided by the simplification of business regulations and laws on contract enforcement. In essence, the path to a more innovative and productive economy is through higher trade openness and the development of human capital. A more radical shift towards a competitive economy will positively influence the economic future of Pakistan.

THE WRITER IS THE ASSISTANT PROFESSOR OF ECONOMICS AND RESEARCH FELLOW AT CBER, INSTITUTE OF BUSINESS ADMINISTRATION, KARACHI. HE IS ALSO THE CHAIR OF THE ECONOMIC ADVISORY GROUP