Abstract

(This paper intends to figure out the factors, both of structure and policy, responsible for the stagnation of Pakistan’s exports. For doing so, a critical analysis of the structure of exports and export-oriented schemes is conducted. The export structure is analyzed in light of data of the Atlas of Economic Complexity of Harvard Growth lab and World Integrated Trade Solution (WITS) trade statistics while for the analysis of export-oriented initiatives, relevant data of FBR is used for the period 2020-21 to 2024-25. A critical evaluation of the export structure shows that exports are characterized by low complexity, low tech-content, and low value-added. Pakistan’s revealed comparative advantage (RCA) lies in goods like textile, raw hides and skins, food items, and agricultural products. Its export value index has not witnessed a sharp increase over time in comparison to those of India, Bangladesh, and Vietnam. Analysis of export-oriented schemes suggests that they are biased in favour of big exporters. Low utilization of these schemes by small and medium-sized exporters amply vindicates the said assertion. The findings of this paper suggest that anti-export bias, low productivity, and policy neglect of small and medium-sized exporters are the main factors behind the stagnation of exports. It is suggested that exemption of input goods, meant for export, from import-stage tariffs should be given through tariff code and not schedules with strings attached or sector-specific SROs. This policy shift would induce small and medium-sized exporters in particular to avail exemptions. The gradual phasing out of import tariffs to reduce anti-export bias, a well-coordinated industrial policy, prioritization of innovation and productivity, SME-based export strategy and transforming the existing natural clusters into clusters of exports, besides granting exemption of inputs through tariff code, are recommended as public policy prescriptions to meet the challenge of low exports. – Author)

1. Introduction

Exports are essential for economic development for multiple reasons. A large body of empirical literature suggests that exporting firms are more productive, pay higher wages, and employ more skilled workers (Bernard & Jenson, 1995). Empirics also suggest that exporting improves performance of firms (Park et al, 2010). Exports are an important stimulator of economic growth and trade diversification promotes economic growth through structural transformation. Export diversification also helps overcome export instability or negative shocks of the terms of trade (Hesse, 2008). The development strategy of export-led growth delivered for a number of countries like South Korea, Singapore, and Hong Kong which rode the trajectory of sustainable economic growth by integrating themselves into the global economy in the 1960s. Malaysia and Thailand also embarked on the journey of export-led growth in the 1970s, diversified their exports and decreased their export concentration in the last four to five decades. Both moved into manufacturing exports like clothing and electronics and also developed resource-based sectors.

For instance, Malaysia capitalized on its comparative advantage in palm oil and rubber while Thailand developed its agriculture and fish sectors into high value-added products. In the recent past, China and Vietnam are two other pertinent examples whose high economic growth is largely due to export diversification and structural transformation. Chile and Costa Rica in Latin America, and Tunisia and Botswana in Africa also made exports an engine of growth for their economies. Most of these economies transitioned from exports of primary products to value added and high-tech exports (UNCTAD, 2008). Diversification not only helped them to create more opportunities of employment generation and poverty reduction but also increased their resilience to external shocks by making their income more stable and predictable.

Pakistan’s case of exports is a bit elusive. When compared to countries like Vietnam, the share of exports in Pakistan’s GDP is quite low. Its exports are substantially below its potential and the contribution of exports to GDP (in percentage terms) has also decreased in the last decade or so (see Figure 1). The contribution of exports to GDP fell from 16% in 1999 to 10% in 2020. In 1990, Pakistan exported 0.19% of the global exports which fell to 0.12% by 2019.

Figure 1: Comparative Analysis of Export Performance of Pakistan (2000-2023)

According to some estimates (WB, April 2021), Pakistan should be exporting, in view of its size, level of development, location, and factor endowments, around US$ 88.1 billion worth of merchandize. Thus, Pakistan is among the countries known for huge missing exports. The opportunity cost of missing exports for Pakistan is estimated to be approximately 893,000 jobs and US$ 1.74 billion in foregone taxes.

1.1 Motivation

Stagnant exports are a daunting challenge for Pakistan. A number of countries that started their journey of development with a similar basket of goods were able to increase their export volume manifold in a period of two to three decades. On the contrary, Pakistan’s pace of growth in exports is sluggish. The contribution of exports (in percentage terms) to GDP has declined with time. This has happened despite the introduction of several export-oriented schemes like MBCO, DTRE, EOU, EPZs, and lately, EFS. So, Pakistan’s case regarding exports is curious and needs to be critically examined with regard to structure and policy to fathom what is wrong with the export structure and why public policies, embodied in export-oriented schemes, have not delivered. Some knowledge briefs, reports, and papers about the export structure of Pakistan are available, but literature on the export-oriented schemes (i.e. public policy part) with particular reference to rate of utilization, anatomy of the exporters availing these schemes etc., is scant. This paper attempts to fill this void in literature by using Customs primary data on the export promotion schemes and their users and conducting a critical evaluation of other structural and policy constraints responsible for low exports to present a comprehensive overview of the subject at hand.

1.2 Methodology

For this paper, the export structure of Pakistan has been analyzed in light of data of Atlas of Economic Complexity and WITS. Literature, in the form of reports and knowledge briefs, has also been critically evaluated to sharpen the understanding of structural and policy constraints hindering growth of exports. In addition to critical analysis of export-oriented schemes, data of over 14000 exporters (i.e. entire population), export volume, exports made under concessionary and non-concessionary regimes, and anatomy of exporters, i.e. small, medium, or big, availing export-oriented schemes have been conducted to arrive at public policy prescriptions for boosting exports. 

2. Export Structure of Pakistan

Analysis of the export mix shows that a majority of export items belong to low complexity items, such as textile, cotton,  apparel, clothing, cereals, leather, minerals, fish, fruit, nuts, plastics, etc. It seems as if Pakistan has not yet started the process of structural transformation which is considered a key source of economic growth. The process of structural transformation reallocates economic activity from low to high productivity sectors. With structural transformation, economic activities should move from agriculture and textiles to electronics and machinery manufacturing.

For Pakistan, the largest contribution to export growth comes from low complexity products like textile made ups, apparel, knitwear, etc. Pakistan’s exports are concentrated in low value addition and dominated by labor-intensive light manufacturing. In 1986, the sophistication of its export basket was higher than that of Vietnam but in the last three decades or so, its export basket has not shown any improvement while Vietnam has moved upwards on the ladder of sophistication. Diversification of exports, both in terms of new products and destinations, is low. The technological content of exports is low. The share of high-tech exports in case of Pakistan hovers around 2%. On the contrary, high-tech exports of India, Vietnam, and Malaysia constitute around 10%, 40% and 50% respectively of their total exports.

Generally, countries whose exports are more complex than expected for their income level grow comparatively faster, as research from the Growth Lab of Harvard suggests. A mix of a country’s products is a predictor of subsequent patterns of diversification, economic growth, and distribution of income, as the ability of an economy to generate and distribute income has a strong correlation with the mix of products a country is able to produce and export (Hartman et al, 2017). Some researchers developed an indicator EXPY which measures productivity level associated with the export basket of a country and their findings are that countries producing high-productivity goods grow faster than countries producing low-productivity goods. Simply put, countries are what they export (Hausmann et al, 2007). Economic growth is driven by diversification into more complex export products. According to Harvard Atlas of economic complexity, Pakistan has added 22 new products since 2008 and these products contributed $7 in income per capita in 2023. Interestingly, the addition of new products is highly correlated with an increase in per capita income. Pakistan has diversified into 15 new products in the last 15 years, however, because of the volume, the contribution to economic growth is low (see Table 1).

Table 1: Addition of New Export Products (2008-2023)

An analysis of export competitiveness, measured on the basis of  revealed comparative advantage (RCA), shows that Pakistan does not enjoy RCA in more sophisticated products like capital goods and machinery and transport equipment. Its RCA is restricted to textiles and clothing, consumer goods, food products, agricultural raw materials, ores and metals, minerals, etc. In other words, Pakistan’s comparative advantage is in primary or low-value added products and when it comes to comparatively more sophisticated goods, Pakistan does not enjoy comparative advantage as evident from the RCA analysis over time (see Table 2). Pakistan has not witnessed any big change in its comparative advantage since decades. It is exporting traditional, low value-added products. Moreover, its RCA has declined even in non-sophisticated products like hides, skins, and intermediate goods.

Table 2: Revealed Comparative Advantage over Time

It is also interesting to note that the number of export products at 6-digit level has declined in the case of Pakistan. In 2007, its export products were around 3200. This witnessed a gradual decline in the following years. Since 2015, the number of export products is hovering around 2800 (see Figure 2).

Figure 2: Year-Wise Pakistan Export Products

If we trace Pakistan’s export value trajectory back from 1988 and compare it with some other countries like Bangladesh, India, and Vietnam, it emerges that Pakistan’s import value index has not seen a sharp increase like those of the said countries. Ready-made garments constitute over 80% of Bangladesh’s exports mainly due to preferential access to European markets and availability of cheap labour. Vietnam has emerged as a star in terms of exports and structural transformation of its economy. The export trajectory of Pakistan and Vietnam was almost similar but in the last two decades, their paths diverged drastically. Vietnam moved to technology-oriented and high-value added products (see Figure 3). Over 45% of its export basket consists of information technology-driven products. Vietnam’s success story is primarily due to structural transformation of the economy involving sectoral reallocation from agriculture to high productivity sectors. It has also benefited from the demographic dividend—the 15-64 age bracket increased from 55% in the mid-eighties to over 70% of its population in the past one decade or so (Tarp et al, 2017).

Figure 3: Export Value Index

The import-export product ratio shows that Pakistan’s number of imported products is more than its exports despite its avowed policy of import substitution since its inception. The ratio is high, both for India and Pakistan (see Figure 4). In case of Vietnam, it witnessed a persistent decrease in this ratio. The point being emphasized here is not that imports are essentially bad. Imports are needed for increasing exports. Empirical evidence suggests that the long run elasticity of exports with respect to imports in case of Pakistan is about 37%, though effect appears with a lag. The contribution of raw materials and capital goods respectively is 24 and 16% respectively (Sadia Badar, 2006). High import to export ratio suggests that the policy of import substitution industrialization (ISI) has not delivered and the issue of balance of payments is due to low exports. And this issue would persist unless exports are substantially increased.

Figure 4: Import-Export Product Ratio (2003-2022)

Pakistan, like other countries, adopted various export-oriented schemes within the constraints imposed by WTO rules which included duty drawback and rebates, duty-free import of input goods and machinery, export processing zones, etc. These policies, however, do not seem to have delivered on the promise of export promotion. The ensuing section is an attempt to critically analyze the export-oriented schemes of Pakistan.

3. Export-oriented Schemes

3.1 Duty drawback Scheme

Under this scheme, duties and taxes paid on importation of any goods used for manufacturing of output goods meant for export are repaid as drawback once the goods have been exported. Duty drawback is available for a number of products like textile products, leather, sports goods, footwear, engineering, metal products, etc. under various SROs. The duty drawback scheme differs from exemption schemes in the sense that under such schemes duty and taxes are charged at the time of import and are refunded subsequently. The government normally prefers the duty drawback scheme over exemption schemes due to the possibility of diversion of non-duty paid material into the local market. The exporters, on the other hand, prefer exemption schemes due to cash-flow advantages. Generally, both schemes prevail concurrently. The drawback scheme, which is administratively simple, is applied in case of new or occasional exporters who do not have a track record of their business practices. The exemption scheme, on the other hand, is considered a better option for reputed manufacturers who regularly export a specified minimum percentage of their production. However, in both the schemes, technical calculations called rate of yield, are required for determining the ratio of imported material used in per unit of output agreed between the manufacturer and Customs.

The duty drawback scheme, however, has not delivered the desired result for export promotion in Pakistan and at best such schemes are a source of rent-seeking for established exporters. Results of an analysis conducted suggest that export financing schemes and rebates/duty drawbacks have an insignificant impact on export promotion in the long-run (Haque and Kemal, 2007). The removal of tariffs is considered a superior policy than export subsidies in the form of duty drawbacks/rebates as export subsidies have little impact on exports (case of India) and are a costly instrument of export diversification (experience of Brazil and Mexico) (Panagariya, 2000). It is generally perceived that the duty drawback scheme was highly instrumental in promoting China’s exports. Some empirics, however, do not confirm the said proposition. The duty drawback system in China is revealed to be not significant in export promotion (Mah, 2007). There may be multiple reasons for the ineffectiveness of the duty drawback system like inefficiencies in administering the system, incentives for over-reporting of imported inputs, uncertainties of payments, and delays in reimbursements of import duties.    

3.2 Manufacturing Bond Scheme

Under this scheme the manufacturer operates within a specific bonded factory which is licensed as a manufacturing bond by the Customs.  The importer deposits a financial security with the Customs for securing the liability of duty and taxes against imported goods. This scheme is appropriate for big manufacturers-cum-exporters who have high proportion of imported dutiable inputs. The manufacturers licensed under this scheme are required to maintain records that document what has been imported along with the details of the final products. There is also a technical calculation called input-output ratio or rate of yield. It is a ratio of the imported materials used per unit of output agreed between the licensee and Customs Department and is monitored through audit. The monitoring or audit is designed to verify the percentage of the total production exported, sold in the local market and wastage occurred during the process and its disposal. The manufacturers availing this scheme require applying to Customs before they begin importation (Pre-authorization). Before granting a license, Customs undertakes physical verification of the factory premises to check the manufacturing process. The manufacturer is required to maintain records of imports and exports and files periodic returns wherein he gives an account of the transactions taking place under this scheme. The manufacturer is required to maintain and retain records of imported inputs, materials used in production, inventory, output goods produced, goods exported, contracts of sale, goods sold into the domestic market, details of waste, and anything relevant to the rate of yield.

In Pakistan, operations of manufacturing bonds are governed by Warehousing Rules 2001. A manufacturer-cum-exporter, having an export order or contract for supply of goods to a foreign country, can establish a manufacturing bond initially for a period of three years which is extendable. As per best practices, a manufacturer has to get a license before importation. No physical controls are required by Customs. The control and monitoring is through periodic returns/statements and audit. The IOCO department determines the rate of yield i.e. input-output ratio, and issues an analysis card. Up to 40 % of manufactured goods can be sold in the local market on payment of leviable duty and taxes.

3.3 Export-Oriented Units (EOU) Scheme

This scheme envisages complete exemption from duties and taxes on import of input goods, including machinery, imported into EOU under specified conditions laid down in the rules. This scheme also allows duty and tax free import of coal, diesel, gas, furnace oil, coke of coal used in the manufacturing of output goods. The input-output ratios/rate of yield are determined through analysis cards by IOCO. Exporters can engage the services of vendors as well and can supply their goods to other exporters availing schemes like EOU, manufacturing bond and duty and tax remission for export (DTRE). The manufacturers operating under this scheme can sell up to 20% of their production in the local market on payment of duty and taxes. The throughput period, i.e. period required to process the input goods imported duty-free, is specified in the rules. The licensee is required to maintain records of importation, exportation, production, and wastages that occurred during the process.

However, when it comes to practice, some interesting points emerge regarding the schemes of manufacturing bond and EOUs. The number of exporters availing these schemes is low. The percentage of exporters who cease to use these schemes is quite high. If we take the number of exporters (in percentage terms) who keep availing these schemes after acquiring a license of manufacturing bond or EOU as proxy for the survival rate of export firms, then it becomes obvious that the rate of export firms who fail to survive as exporters is as high as 12% and over 25% respectively for EOU and manufacturing bond licenses. Such a high ratio of casualty speaks of some inherent problems with these export-oriented schemes. The issue with all exemption schemes for importers and exporters is that their impact is highly skewed towards larger firms. “The top 100 firms in Pakistan accounted for roughly three quarters of duty-exempted value and only five firms accounted for about a third of that total”( World Bank, 2017).

3.4 Duty and Tax Remission for Exports (DTRE) Scheme

This scheme is based on a simple concept: no duty and taxes at the import stage and no duty drawbacks and refunds at the export stage. This facility is available for imported inputs, locally purchased tax-paid goods and taxable/excisable services, including gas, electricity, diesel, furnace oil, and coal. Theoretically, this scheme has wide coverage. Sales tax registered persons and commercial exporters can also avail this scheme. It also covers supplies made against international tender, EPZs, and projects entitled to duty and tax free inputs and supplies made by the indirect to direct exporter. During FY 2018-19, 444 DTRE approvals were granted country-wide. For a DTRE approval, a valid contract should be in hand of the exporter and the DTRE approval is granted to the extent of order in hand. So, this scheme is comparatively simpler than EOU and manufacturing bonds schemes where the licensee is required to at least export 80% and 60% respectively of the production of the factory and in case of non-availability of export orders or some uncertainty, may fail to meet the requirement of minimum threshold of production set for exports. Moreover, the DTRE scheme allows commercial exporters to purchase and export goods in the same state subject to 5% value addition. The import of goods by commercial exporters for subsequent export is, however, not allowed under the DTRE scheme.

3.5 Temporary Importation

The scheme of temporary importation entails suspension or exemption of duty and taxes against securities on import of accessories used in production of output goods meant for export. The utilization period is 18 months which is extendable in exceptional circumstances. No license or pre-authorization is required to operate under this scheme. It is perhaps the easiest scheme of duty suspension to be availed of by importers. The amount of duty and taxes is secured through post-dated cheques and as such no cost is involved. The inputs imported under the temporary importation scheme should be identifiable at the time of export. Only manufacturers-cum-exporters can avail this scheme. The scope of the scheme is limited in terms of items, covered under temporary importation, as well. 

3.6 Export Processing Zones (EPZs) 

Export processing zones (EPZs) are established with the main objectives of industrialization and export promotion.  EPZs are legally regarded as being outside the customs territory of the country in question. Although they are treated in legal sense as a separate customs territory, they are physically located within the country implementing that scheme. There is diversity of approach to EPZ schemes. Sometimes they may comprise of an entire city. An entire or part of a port or airport area can also be declared as an EPZ. They can be developed as an industrial or technology park or as an individual factory. Whatever the form, they have a commonality that they have a secure perimeter within the zone that is under Customs control. In this sense, these zones are treated as a separate country from a Customs perspective. They are, however, not the best solution.  The overall improvement of the investment climate remains the foremost solution. EPZs work best in countries with developed infrastructure. Furthermore, EPZs may encourage exporters to import from abroad but they tend to disappoint those who expect them to bring development via backward linkages. Instead, EPZs tend to divide the economy between exporters and import-substituting firms, rendering little connection between them (Lotta Moberg, 2018). Close coordination between government and private enterprises is required for the success of EPZs. Attracting firms merely by offering advantageous tax treatment may not turn out to be a successful experience unless firms operating under EPZs are integrated with the local economy. EPZs should not be isolated from the rest of the economy, rather they should generate positive spillovers at the economy-wide level. Firms located in EPZs get favorable treatment in several ways. They are allowed unlimited access to duty-free raw material, receive tax holidays on corporate and income taxes, and they are generally sheltered from bureaucratic regulations which other firms located outside EPZs have to comply with (Rodrik, 2004).

In Pakistan, the Export Processing Zone Authority was established in 1980 with the mandate to plan, develop and operate EPZs in Pakistan. A number of incentives like duty-free import of machinery, equipment and input goods, 100% repatriation of capital and profits, no sales tax on input goods (including electricity and gas) relaxation in national import restrictions and foreign exchange regulations of Pakistan, etc., are available to the units set up in EPZs. Seven EPZs have been established so far in the country. The plots in EPZs are almost sold out but they are operating much below their potential as businesses are yet to be set up and made functional on these plots. They have not been able to trigger a structural transformation of the export sector and create backward linkages with the local economy. According to a report (Prime Institute, 2023) commissioned by EPZA, the EPZs have not shown any remarkable performance and their share in Pakistan’s total exports has remained less than 4% which is much higher in the case of other comparable countries. For example, in Bangladesh it is above 20%. According to the said report, the EPZs performance is marred due to constraints of infrastructure, regulations, and human resource.

In 2012, the government of Pakistan promulgated the SEZ Act to facilitate new enterprises. Under the said Act, seven SEZs were notified. The SEZs were to be set up by the Federal and Provincial Governments alone, in partnership with the private sector, or entirely through the private sector. Huge tax incentives have been provided to the SEZ developers like duty-free import of machinery, equipment, and material, exemption from all taxes on income for 10 years, and exemption of all imported capital goods from customs duties and taxes. Factors like inadequate clustering of industries, weak institutions, unskilled human resource due to limited vocational education, poor receptivity to modern technology, high business costs, and lack of hard and soft infrastructure have historically remained big challenges, restricting Pakistan’s industrial development (PIDE, 2020). The policies which address removal of bottlenecks and weaknesses regarding availability of and access to infrastructure and regulatory constraints and services are of primary importance. “Interventions in the form of pure economic incentives, such as pure credit liabilities, and preferential tax treatments are of second order importance” (IGC, 2011). Improving the business environment and upgradation of skills of the labour are equally important. Another important area which needs focus is to avoid real estate activities at SEZs. Industrial zones are vulnerable to real estate activities. The difficulties usually arise when the developers fail to provide the promised facilities in time. Resultantly, unwarranted real estate activities begin where investors purchase and occupy plots without starting production (PIDE, 2020). 

3.7 Export Facilitation Scheme (EFS)

In 2021, three export facilitation schemes (DTRE, MB and EOU) were unified into one scheme with the objectives of increasing ease of doing business, expansion of scope, enhancement in time limit of use and administrative ease. The EF scheme provides for remission of import duty, sales tax, FED, WHT on acquisition of raw material and machinery through import and local purchase subsequently meant for export. The input utilization period varies from one to 5 years for different categories of users. It is admissible to manufacturers for direct and indirect export, commercial exporters, and common export houses. Domestic supplies of output goods are allowed up to 20% against leviable duty and taxes on assessed value of finished goods. This scheme categorized the EFS-holders into various categories depending on their duration of being in the export business and quantum of exports (in percentage terms). The most important element of the EFS is that it freed up liquidity for the export-centric textile industry. The textile exporters that derive their revenue, particularly from their export receipts, are no longer required to wait for issuance of refunds for the settlement of GST and duty rebates with tax authorities. Access to duty-free material means that exporters now have access to a broader variety of inputs. This scheme was largely availed by the textile sector.

The large textile composite units are reaping the benefits of EFS but at the same time they are contributing to the marginalization of the local cotton industry. These textile exporters rely more on imported yarn and are not engaged with the local cotton market, thus affecting local farmers and small textile businesses. There are serious allegations of misuse of the scheme when exporters import duty-free raw material but use them for merchandize sold in the domestic market while exporting goods manufactured from locally procured inputs. Due to such alleged misuse, certain amendments in the original scheme have been made. Basically, the problem was with the design of the scheme.  The export period being fixed for up to 4-5 years amounts to supporting inefficient firms and providing room for misuse. Reduction in the reconciliation period to, say, one year can ward off the chances of such misuse.

In a nutshell, Pakistan devised several export-oriented schemes for enhancing exports, but its exports remained stagnant despite such fancy initiatives. Why is Pakistan unable to enhance its exports like Vietnam? What are the missing gaps in the export-oriented schemes? The ensuing section is devoted to the analysis of these questions.

4. Constraints of Structure and Policy: Analysis

Pakistan faces a number of challenges in unlocking its export potential. According to the World Bank, the stagnation of Pakistan’s exports can be explained by examining the incentives for exporting, support services for exporters, and underlying productivity of Pakistani firms. Pakistan’s trade policy creates anti-export bias due to its import substitution industrialization (ISI) policies pursued since its inception. The ISI policies aimed at substituting imports through high tariffs and restrictions on imports have brought severely negative implications for the promotion of exports. Such policies have created an anti-export bias which operates through input and output channels. High input prices of capital and intermediate goods (due to high tariffs) disincentives firms from using better technology and high quality inputs. This carries negative implications for productivity of the firms and quality of the produced goods. From the output side, high tariffs on finished products help generate abnormal profits in the local market.

The revenue imperative of import-tariffs creates a bias against exports besides accentuating the problems of misinvoicing and smuggling (Nasir, 2020). The argument of Laffer curve also applies to import taxes i.e. tariffs. When import taxes increase, they dampen economic activity and trade. With high import taxes, even the revenue imperative may not be served due to heightened incentives for misdeclaration of description, under-reporting of value, and bringing goods into the country through illegal routes and channels. High import duties imply higher effective rates of protection. Imposition of ACD and RD not only increases the anti-export bias of the tariff policy but also creates tariff policy uncertainty. The long-standing tariff cascading system creates a huge disparity between tariffs on raw materials and components compared with finished products, therefore, incentivizing firms to sell in the local market rather than export to foreign markets. What happens is that cascading allows firms to import input goods or cheap raw material while simultaneously giving them protection through high tariff on the goods produced from such raw material. A one percent increase in tariff of finished goods on average increases the profit of the firm producing that good by 4%.

The policy of protectionism has also got negative implications for the productivity of firms. The protectionist policies shield the local firms from foreign competition, they are, therefore, least interested to upgrade processes and technology. They have an advantage in their home market due to low transport costs, and better knowledge of consumer preferences, and due to a lack of competition from foreign firms, they are not incentivized to invest in research and development. They become rent-seekers and continue lobbying for protectionism and subsidies rather than focusing on productivity and quality. Pakistani firms do not grow more productive with time, but rather experience the opposite (see Figure 5). A 47-year-old firm is 87% as productive as a young firm of less than 10 years. Instead, in India and Mexico, the older firm is 30 to 40% more productive than the younger ones. This challenge is in part due to the limited integration of Pakistan into the global marketplace: “a certain minimum level of productivity is needed to integrate, and productivity, in turn, increases with integration” (World Bank, Oct 2021).

Figure 5: Productivity of Firms against Age Group

Protectionist policies not only have adverse implications for exports and productivity, they also affect the direction of foreign direct investment. In the case of Pakistan, FDI historically remained concentrated in protected and inward-looking sectors. The auto sector of Pakistan is a pertinent example. Moreover, the exchange rate—artificially overvalued over a long period of time—has also acted as a drain on productivity and undermined the competitiveness of exports. An artificial over-valued exchange rate has at least two adverse consequences. First, it weakens the competitiveness of exports by increasing the price of export goods. Second, it creates incentives for investment in unproductive non-tradable sectors and thus slows the process of structural transformation of the economy. 

Analysis of Pakistan’s exports over decades shows the same basket with few changes. Pakistan’s exports are still concentrated in textiles, wearing apparel, food and beverages, leather and leather products, and footwear which are low-tech and low sophisticated products. The structure of Pakistan’s economy has thus remained stagnant over time as the country’s production profile is dominated by low value goods. It is the country’s ability to absorb and master new technologies and production processes that perhaps matters more than its factor endowments in determining the comparative advantage. The trajectory of developed countries suggests that they gradually moved from primary, resource-based and low-technology to value-added high technology exports. In the case of Pakistan, it has not happened. A number of factors are responsible for low product diversification. First is the path dependence. The products which a country produces and exports today will mainly determine what it will produce tomorrow. Product space—a network in which products are like nodes connected to each other as if they are part of the same product mix—provides a useful framework to analyze possible paths for diversification. If we analyze the product space of Pakistan over the last fifty years, it emerges that Pakistan is stuck in the periphery, meaning thereby the products produced by Pakistan were mainly resource based low-tech products like cotton, fabrics, rice, textile, leather, and miscellaneous agriculture products. And even after fifty years, the product space has not witnessed any substantial change. Low structural transformation and innovation explain the stubbornness of the product space in the case of Pakistan.

Innovation is key for structural transformation of an economy. Innovation is not merely invention of new technology – it should be taken in a broader perspective. According to  Ocampo, innovation includes the following: (1) introduction of new goods and services; (2) introduction of new qualities of goods and services; (3) development of new production methods; (4) development of new marketing strategies; (5) opening up new markets; (6) discovery of new sources of raw materials; (7) establishment of new industrial structures in a given sector (Ocampo, 2005). Thus, innovation is a broad concept which includes creation of firms, creation of new production activities and sectors as well as ‘creative destruction’.  Moreover, the concept of innovation involves creation of knowledge or capacity development to apply such knowledge to production. Innovation is essential for structural change and economic development. The results of a study suggest that the size of the firm, its presence in the cluster, and management quality are the most significant determinants of innovation for manufacturing firms in Pakistan (Hamna & Mahreen, 2011). 

The concept of innovation is basically related to what the economists call ‘productive knowledge’. “Accumulating productive knowledge is difficult. For the most part, it is not available in books or on the internet. It is embedded in brains and human networks. It is tacit and hard to transmit and acquire. It comes from years of experience more than from years of schooling. Productive knowledge, therefore, cannot be learned easily like a song or poem. It requires structural changes. Just like learning a language requires changes in the structure of the brain, developing a new industry requires changes in the patterns of interaction inside an organization or society” (Hausmann et al, 2007). Tacit knowledge does not travel well and it is socially and culturally embedded. The process of acquiring tacit knowledge is neither linear nor timeless, nor is it costless (UNCTAD, 2007).

A majority of the Pakistani exporters are relatively small and tend to stay small. This is perhaps due to the frictions which do not let them grow. Pakistan initiated several schemes for the promotion of exports but they did not show much promise for small and medium-sized exporters. Entry and exit rates to exporting are very low compared to the world average. Low entry rate impliedly shows that the set of incentives for exports rewards the existing exporters rather than the innovators. Low exit rate or high survival rate also points towards the fact that incumbent exporters are the policy focus and not the innovators or new entrants. According to a World Bank report, the lackluster impact of export incentive schemes is due to the fact that such schemes tend to focus on the established firms. Regarding the duty drawback scheme, the report says: “By design, these duty drawback mechanisms reward less dynamic, less sophisticated, and incumbent firms, preserving the current export structure rather than transforming it. First, products eligible for rebates or entitled to higher rebate rates face less dynamic global demands than non-eligible ones. Second, eligible products tend to have low sophistication or complexity. Third, the schemes have a marked anti-new, pro-incumbent bias” (World Bank, Oct, 2021).

Low competition and barriers to entry into exporting is also reflective of strong economic institutions which can promote competition for enhancing efficiency and productivity. According to SPB’s Half Year 2024-25 report, insufficient competition in the economy is due to four major factors, namely: high import tariffs, prevalence of SROs benefitting few politically connected families in a non-transparent manner, prevalence of a large informal economy, and firms’ dependence on subsidies. Small and Medium-sized exporters face a number of constraints hindering their expansion or graduation to big exporters. Credit constraint being a prime example. The government being the dominant borrower crowds out credit for the private sector. Moreover, banks are biased against small and medium enterprises. “The composition of loans shows that banks mostly favor corporations that enjoy established banking relations rather than SMEs. Moreover, credit flow is mainly concentrated in working capital loans rather than fixed investment. This limits the prospects of productivity growth given the latter’s importance for capacity expansion and new technology” (SBP, 2025). 

Moreover, export promotion schemes are not SME-focused. The following stylized facts can be discerned from the analysis of the profile of the exporters and utilization of the export-oriented schemes. First, on an average, small and medium exporters export around 5% of the export value while 95% exports are made by big exporters. This pattern is consistent and has not witnessed any remarkable change in the last five years (see Table 3). Second, around one-fourth of exports are manufactured out of the inputs imported under export-oriented schemes. This ratio has however increased with the introduction and maturity of the EFS scheme. Third, the utilization of export-oriented schemes, including EFS, by small and medium exporters is low as they exported on average 0.3% of exports by availing these schemes (see Table 4).  Fourth, most of the exports, particularly by the small and medium-sized enterprises, are under the non-concessionary regime reflective of the low utilization of export-oriented incentives. Fifth, around 80% of exporters can be categorized as small and medium exporters. Their export value is low but number is quite high compared to big exporters. Sixth, around 80% of small and medium-sized exporters are not benefitting from the export-oriented schemes. On the contrary, on average 80% of the big exporters are availing such schemes.

Table 3: Export Shares of SMEs and Large Exporters

Table 4: Exports under Concessionary Regime

Table 5: Exports under Non-Concessionary Regime

Table 6: Anatomy of Exporters

Table 7: Anatomy of Exporters Availing Concessionary Regime

Table 8: Anatomy of Exporters Not Availing Concessionary Regime

Low utilization of these schemes by the small and medium importers points towards the difficulties in accessing these schemes. ways to make these schemes palatable, particularly for the small and medium-sized exporters, is lacking in the public policy discourse. No dedicated scheme is in place for them despite the fact that they are more of government help. Large exporters are already better placed to find markets, access concessionary loans, and make profits. The dividends for focusing on medium sized exporters are higher than large-sized exporters, even from the efficiency perspective. Empirical evidence in support of the said assertion comes from Tunisia’s FAMEX export promotion programme. Four years after receiving FAMEX assistance, exports of the small firms declined by 65%, exports of large firms were just 6% higher while exports of medium-sized firms grew by 57% (Cadot et al, 2015).

5. Conclusion and Public Policy Options

The limited and almost static product space of Pakistan is at least partly responsible for the stagnant and low exports. The process of structural transformation of the economy remained sluggish with the result that the composition of the export basket of Pakistan did not change. Its exports remained concentrated in a few sectors. The policy of ISI pursued by Pakistan created anti-export bias, having severe negative implications for productivity and competitiveness of firms. The design and implementation of export promotion schemes are also partly responsible for the problem of export. The schemes and incentives are focused on existing and big exporters, and do not encourage innovators and new entrants. The number of small and medium-sized exporters is quite large compared to big exporters. The challenge is their graduation to big exporter level to make them competitive in the export market. Some basic policy shifts in tariff setting and industrial policy would be required to provide them a level playing field.  The role of the government is important in creating an ecosystem for innovation to increase the competitiveness of the firms. To begin with, conversion of natural clusters of industries, spread in different regions of the country, into export hubs may help in unleashing the export potential of the country. The following areas are suggested as priority areas to put the country on the trajectory of export-oriented growth.

5.1 Exemptions via Tariff Code   

The burden of import-stage taxes on importing firms is very high. Imported goods are not only subject to custom duty, but around 3000 tariff lines are also subject to additional custom duty and regulatory duties. In addition, sales tax and withholding tax is also charged at the import-stage. In order to incentivize export-oriented firms, exemption of duty and taxes is granted by the government. There are two ways to grant exemption to inputs used in output goods meant for exports. The preferred mode of the public policy and law is to allow duty-free imports of input goods through an exemption SRO. Granting exemption through SRO has implications, particularly for the small and medium-sized exporters. They may not be able to avail exemptions under such SRO due to regulatory requirements or import input goods through commercial importers. The low utilization of such export-oriented schemes by small and medium-sized exporters confirms the said assertion. The better option is to grant exemption of duty and taxes to input goods through  tariff code. The input goods required for exports should be set at zero percent. Discrimination between a commercial importer and a manufacturer in case of import of such inputs hardly makes any sense. Doing so just makes the availability of input goods difficult for occasional, small and medium sized exporters. Therefore, exemption of all types of duties on input goods should be through ‘tariff code’ and not through difficult-to-use exemption schemes or SROs. It would encourage entrepreneurs to discover new products for exports, induce efficiency, and weed out rent-seekers. Moreover, to reduce anti-export bias, import-stage duty and taxes need to be reduced considerably but gradually. A long-term tariff rationalization plan would be required for phasing out import duties. In the first phase of the plan ACD and RD can be abolished. Doing so would reduce complexity of the tariff.

5.2 A Well-Coordinated Strategic Industrial Policy

The traditional theory of international trade is based on comparative advantage. The comparative advantage is, however, to be identified and is not static. For identification of latent comparative advantage, government intervention may be required. According to Hausmann and Rodrik, countries face uncertainty about the specific goods and services they enjoy comparative advantage of producing. The firms learn in which sectors it would be more convenient to specialize through a process of trial and error. Learning and discovering is costly, both in terms of efforts and resources. Moreover, private benefits would be lower than social benefits in such a process of discovery, so government intervention would be required. Exporting is associated with substantial non-recoverable upfront costs. The obvious part of entry costs into exporting are mostly knowledge-intensive expenditures required to enter into foreign markets such as the establishment of distribution networks or development of new products accustomed to the tastes of foreign consumers. The discovery of comparative advantage is an important function warranting government intervention.

Comparative advantage is neither fixed nor static. Several countries, which are now major exporting countries, defied the notion of fixed comparative advantage. They created comparative advantage in new goods and services. Had South Korea gone by its traditional comparative advantage, it would have been in all probability exporting rice, may be of some excellent varieties. It defied its comparative advantage through high value added goods like electronics. High quality differentiated goods not only bring more income but also ensure certainty and stability of such income. The trajectories and examples of developed countries suggest that the government played a vital role in coordinating business activities between different actors of the economy and was instrumental in creating an enabling environment for the private sector to increase exports. The government can facilitate the private sector in diversifying product ranges in multiple ways. The very process of identification of potential products and sectors requires a close collaboration between the government and businesses.

The government interacts with the private sector through its representative bodies like Chamber of Commerce and Industries. The constraints and problems at such fora are discussed in a more generalized way and at a high level of aggregation. Dialogue between the government and the private sector is needed at a more disaggregated level for the identification of sector-specific constraints to diversification, quality upgrade and exports. What is required is the identification of products (within sub-sectors of the sectors of the economy) and the constraints in producing and exporting such products. Efficiency raising improvements in ports, roads, and airport facilities can help reduce costs for exporters. Similarly, streamlining customs procedures, easing regulatory compliance, improving logistics, and reducing non-tariff barriers are some important areas where the government can play an important role for which it needs to create new institutional capabilities and modernize regulatory arrangements.

Industrial policy played a vital role in promoting industrialization and exports, both for the West and the Asian Tigers. Undoubtedly, the scope of the industrial policy has narrowed with the advent of WTO. At the same time, it is also a fact that industrial policy is understood and taken in a very narrow sense in our public policy as well as business circles. Our understanding of industrial policy is limited to subsidies, rebates, duty drawbacks, or provision of utilities like electricity and gas to the industrial sector at subsidized rates. The scope of the industrial policy, despite confines of WTO law, is much wider. Some of the industrial policy tools used by the East Asian countries, like South Korea and Taiwan, are as follows: “(1) coordination of complementary investments (so called  Big push); (2) coordination of competing investments  through entry regulations, investment cartels and negotiated capacity cuts; (3) policies to ensure scale economies e.g. licencing conditional upon production scale; (4) regulation on technology exports; (5)  regulation on foreign direct investment; (6)  mandatory workers’ training for firms above certain size; (7) state acting as venture capitalist; (8) export promotion (export subsidies, export loan guarantees); (9) government allocation of foreign exchange, etc.”(Chang, 2009). Just one caution—well-designed industrial policy should be time-bound, targeted, transparent, and closely monitored to foster knowledge spillovers and reduce uncertainty.

5.3 Productivity and Innovation

Knowledge creation and skills augmentation are the keys to productivity and innovation.  Knowledge can be explicit or tacit. Explicit knowledge is easy to transfer. For instance, it is easy to transfer information regarding yesterday’s temperature, the score of a cricket match, the amount of natural reserves in a country, the name of the first Mughal emperor in India, or a verse of a poet.  Such knowledge, however, hardly contributes to economic growth.

Tacit knowledge matters for productivity, innovation, and exports. The economies of developed countries that are operating on the production possibility frontier (PPF) curve can grow only through constant innovation and accumulation of tacit knowledge. The slowdown in economic growth of the developed countries would in all probability mean slowdown of the accumulation of tacit knowledge. For example, according to Professor Gordon of Northwestern University, faltering innovation is the major cause for the slowdown of economic growth in USA (Gordon, 2012). Developing countries like Pakistan are operating inside the PPF which simply mean that focus on productivity and innovation would produce disproportionately high dividends.

It is lack of tacit knowledge, not explicit knowledge, which constrains productivity and growth. The difference in the amount of tacit knowledge explains the differences in the prosperity of nations. There are, however, constraints attached with the acquisition of tacit knowledge. First, it is costly and time-consuming. Second, firms in developed countries are more incentivized to acquire tacit knowledge due to the potential of huge profits they can earn from the introduction of technical, commercial, or organizational changes. In developing countries, search for new economic activities is generally sub-optimal due to an absence of special incentives (Ocampo, 2005). Third, imperfect tradability of technology means that a country would have to invest even for imitation of technology. The implication is that human resource development (focus on training and skills acquisition) should be an important plank of any export strategy. Empirics also suggest that business training increases business knowledge, reduces business failure, improves business practices, and optimizes financial and labour allocation decisions (Gine Mansuri, 2014). Training and experience of workers and managers of a firm are, among other things, an important factor in determining whether a firm would pursue the business of exports. For example, some empirical evidence (Claudio et al, 2021) suggests that prior experience of one worker at an exporting firm increases the probability of export market participation by 2.8%.

In order to stimulate innovation and productivity, public policy with clear positive bias in favour of applied research and skill development needs to be devised with a hierarchy of prioritization of public funding to universities and research institutions. More public funding should flow to technical education, skills development, product development, applied research, etc. According to Acemoglu & Robinson (2012), “Improvements follow from science and from entrepreneurs such as Thomas Edison, who applied science to create profitable businesses”. The proposition that all types of education contributes towards economic growth is a contentious idea.  Pritchett (2001) has shown, on the basis of cross-national data, that association between human capital, proxied by years of schooling, and economic growth is tenuous. It is human capital related to technological innovations which spurs economic growth and exports. Romer says that the ability to keep discovering new and better processes (i.e. innovation) is important. Visualizing a hypothetical situation of the Middle Ages, he writes: “A farmer who educated his children and workers at the leading institutions of the day would not have been able to increase his output per acre by very much. It is not the dissemination of old information but steady arrival of bits of software (new knowledge) that makes education even more valuable and provides new opportunities of growth” (Romer, 1994). Linkages between domestic industry, skills development, and science base in universities and research institutions are needed.

 Exports and innovation are connected. Strong export orientation triggers innovation as competing in international markets requires that technology and quality standards are met. This partly explains high innovative activities in countries that pursue export-led growth strategies. So the policy implication is that instead of import substitution, export-led growth should become the cornerstone of our public policy. Unfortunately, Pakistan’s firms cater to local demand and growth in Pakistan is primarily driven by the dynamics of the domestic economy contrary to popular belief that growth in Pakistan is dependent on external factors (Mathew, 2014). Succinctly put, challenges like rent-seeking prevalent among the local firms (manifest in their demands for protectionism, subsidies, etc.), lack of knowledge linkages and qualified personnel, sub-optimal management practices, etc. are required to be tackled through bold public policy interventions to create an ecosystem of innovation and for enhancing productivity.   

5.4 SME – Based Export Strategy

SMEs played a vital role in the phenomenal growth of countries like Taiwan and South Korea. For example, most Taiwanese firms pursued the reverse value chain strategy in labour-intensive manufacturing activities. In Pakistan, their role is also vital but their contribution to exports is low. Around 75 to 85% exporters belong to small and medium categories but their contribution to exports is not more than 5%. Around 75-80% of small and medium-sized exporters do not avail the concessionary regime of duty and taxes meant for export promotion.

Their graduation to big exporters is hindered, from the angle of both price and non-price factors. The standard economic model emphasizes the importance of prices in allocating quantities in competitive markets. Small and medium-sized exporters are, in all probability, in a disadvantageous position compared to big exporters. The non-price factors also do not favour them. They are unable to effectively undertake activities like marketing and advertisement. The scarcity of knowledge-intensive expenditures like establishment of distribution networks or development of new products as per tastes of foreign consumers also constrains their penetration into foreign markets. Quality is another area where Pakistani exports, particularly by the small and medium-sized exporters, badly lack. For example, a number of SMEs that are engaged in exports of horticulture, mangoes, kinows, and dates do not reach the highest paying markets due to the challenge of complying with internationally recognized quality standards.

Given these constraints, the role of public policy becomes highly significant for making small and medium exporters a vehicle of export promotion. Bundled services approach (like finding partners, intelligence and analysis of export market, finding distributors, contracts with internationally recognized laboratories for compliance certification, etc.) would be required for small and medium enterprises to enhance export volumes. For example, the Chilean government actively supported cherry exporters in promoting diversification of export markets beyond China and in developing small innovative techniques like production of plastic bags for regulating the air inside them to keep cherries fresh made Chile a world leader in export of high-value cherries. The result is that Chile earns over US$ 3 billion just from the exports of cherries.

5.5 Export Clusters

The role of clusters was highly significant in the economic development of countries like Taiwan and South Korea. The benefits of clusters like labour pooling, information spillover, specialization and division of labour are widely known. Clusters are also helpful in contract enforcement through informal mechanisms, particularly in countries like ours where cases of contract violations drag for years in courts due to a slow-moving judicial system. Clusters develop a type of community in a specified geographical area where the space is limited for an individual or a firm to renege on the commitments made due to social constraints. In this way, clusters help reduce what economists call ‘transactions costs’.

Another upside of the cluster approach is that cluster development does not require an ‘umbrella strategy’ at the macro or national level. An integrated approach based on a focused strategy is needed to develop a cluster. The role of the government for providing an enabling environment is, however, crucial. Support from the government, effective incentives, adequate legal framework of support, customized support system, long-term planning, and creation of specialized agencies are some of the important success factors for cluster based development (ADB, 2015). Pakistan’s development policy has remained oriented towards creation of industrial estates and export processing zones. Natural clusters remained victim of a lack of attention. Policy focus and strategies for natural clusters can be a good starting point for making them clusters of exports. Light engineering, leather and leather products, furniture, agri-processing, sports goods, arms and ammunition, horticulture, tobacco, etc. are some natural clusters that have evolved in different parts of the country over time. A dynamic process of technology-based export growth can be unleashed by targeting public infrastructure, skill training, development of common facilities, and technology investments as per needs of these clusters.

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