Pakistani papers of late are reporting tensions within the cotton value chain, i.e., between raw cotton producers, yarn producers and the value added garment producers.
Thus, the yarn producers demand export taxes on raw cotton so that they can procure cheap cotton as domestic supply increases. They argue since they are able to earn more foreign exchange than cotton exporters their demands are justified. Meanwhile, cotton farmers, particularly if they have clout with the government as our large farm estates do are adept at protecting their economic interests.
Similarly, the garment producers want an export tax on yarn exports in order to get cheaper yarn as input for their garment production. This method, they argue, is in national interest as it allows them to earn more foreign exchange. This article provides a way of thinking about such policy to get beyond the cacophony of shrill demands, protests and confusion.
How does one decide what is the national interest on economic issues? The decision could admittedly be a very complex one, especially in a heterogeneous society given separate interests of provinces, districts, industries, ethnic groups and classes to name just some of the key players. However, one does need to make this concept operational since it seems sensible to make policy to further the national interest.
I make the self-evident assumption that the national interest in this case since it is issue specific is what contributes most towards economic development. Economic development is defined here as economic diversification and technological upgrading.
Technological upgrading here means moving towards activities that allow for increasing returns which represent real wealth creation and learning without which the economy remains backward. Given the definitions of national interest and economic development above, there emerges a policy hierarchy.
Primary production like cotton is a constant returns activity and provides little learning potential to move up the value chain. Similarly, while yarn production does represent a move to becoming an industry, in the hierarchy of value added activities it remains low. At first sight, it appears then that the administration has made the right decision: The cabinet committee of textiles decided to cap yarn exports at 650 million kilogrammes (kg) per month.
However, the decision is multifaceted since not only does it need to be right but the implementation mechanisms also need to be right. Let us consider the conflict between yarn and garment producers. While higher value-added-increasing-returns activities need to be encouraged, the wrong mechanism can do more harm than good.
Capping exports is a very blunt instrument for two reasons. First, it creates perverse incentives for yarn exporters to engage in ‘illegal activities’ to bypass the ban. Second, it provides a blanket incentive to garment producers if the policy really is successful.
Suppose yarn prices do fall; do all garment producers really deserve this subsidy? The best mechanism to provide an incentive to garment producers is one that provides it only to those who truly deserve it.
In this case, good performance can be defined through demonstrating export growth. Thus, one could argue that only those garment producers who can document that their exports increase are worthy of getting an input subsidy. However, export growth should not be based on getting an input at below the world market price.
To be continued.
Shahrukh Rafi Khan is a professor of economics at Mount Holyoke College, US