By Shahid Sattar and Sarim Karim
All theories of economic growth, from the Solow Model to the Endogenous growth theory, share one similarity – the primacy of innovation in development. Innovation and technological change are fundamental causes of growth. They increase productivity and efficiency, evolve products to capture new markets, and can lead to advances in sustainability by decreasing negative externalities. Technological advancement also tends to have spillover effects, as advancements in production processes, knowledge, and capital are adaptable across industries. Unfortunately, the state of innovation in Pakistan is dismal. The Global Innovation Index (GII) uses 80 indicators to rank innovation among countries, and Pakistan ranks 87th out of 132 countries (2022). The nation lags in its human capital development, which includes expenditure on R&D and education.
As well as infrastructural issues such as the availability of electricity, ICT access, and intellectual property protections. Another input to innovation highlighted by the World Bank is gross capital formation. Pakistan’s gross capital formation is 15% of its GDP (2021). Which is half that of India and Bangladesh, at 31% of GDP and below the Asian average of 28% of GDP. Pakistan’s market sophistication was also highlighted as lacking, with low scores given to trade promotion, diversification, and market scale. This final category is of particular importance, as market sophistication is a major driver for innovation, and unsurprisingly where Pakistan performs the poorest. There is a vast pool of literature that supports the claim that exporters innovate more than non-exporters, and by attributing more resources to increase the competitiveness of the trade sector, Pakistan can access greater gains in R&D.
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Theories on the relationship between exports and innovation are abundant
Most recently, endogenous models of growth situate the role of exports as drivers of innovation. Endogenous growth theory posits that internal factors like innovation, investment, and policy are equal if not greater determinants of prosperity than neoclassical theories assumed. In this model, trade leads to innovation due to two major factors. Firstly, exporters have access to larger markets which drives economies of scale.
In order to fulfill the demands of both domestic and international consumers, exporting firms must increase their productivity through both increased input but more so through gains in efficiency. The selection pressure between firms to fulfill demand allows resources to be allocated to efficient firms as less efficient ones become uncompetitive and leave the market. As firms achieve economies of scale, they divert more resources toward R&D spending to remain competitive in an evolving international market.
Secondly, as introduced by Coe and Helpman to the IMF in 1994, trade creates knowledge spillovers both directly and indirectly. Direct benefits occur from the learning of new technologies and methods, while indirect benefits arise from reverse engineering advanced imports. There is also a process of ‘learning by doing,’ whereby firms engaging in trade develop minute innovations, learn the dynamics of new markets, and expand networks in the global value chain, which all lead to faster and greater knowledge spillovers. To summarize, exporters tend to be bigger and better innovators. Notably, the research implies that smaller economies have more to gain in terms of innovation from trade than larger economies.
If the literature holds true, Pakistan can remedy its dearth of innovation by removing the barriers faced by its export sector. Within that sector, textiles have specifically shown significant levels of innovation and the potential for more. An empirical investigation into the nation’s economy supports these claims. A survey by the Lahore School of Economics into innovation in the textile sector in 2016 reported that textiles are a majorly innovative industry in Pakistan. Out of 431 manufacturers, 56% were involved in or had introduced innovations into the industry.
Overall Rs 25.4 billion were spent on R&D, with large firms reporting 10% of their budget directed towards R&D. These innovations were both technological as well as non-technological (e.g new management practices, logistical schemes, distribution methods). 38% of producers had introduced new products to the market, and 6 firms introduced products that were novel to the world. 31% of respondents reported new methods of manufacturing, logistics, distribution, and/or ancillary activities that supported the industry.
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The last fact displays the importance of forward and backward linkages for knowledge spillovers. The trend outlined in the study was that innovation rates grew higher up in the value chain, for instance, apparel manufacturers invested more in innovation than textile manufacturers. However, advancements in apparel manufacturing had spillover effects into ancillary industries. Simultaneously, advancements in supporting industries have high degrees of turnover at upper levels of the value chain too. Given the depth of the textile value chain in Pakistan, there exists both a trickle-down and rising tide effect for innovation in the sector.
Therefore, diversification has direct impact on innovation, as reaching advanced rungs of the value chain drives further innovation. This trend is evidenced by the propensity for collaboration reported in the textile sector. Especially among larger producers, where 72% reported cooperation with foreign clients as a source of innovation and 56% reported cooperation with local enterprises. This implies that large producers can act as linkages between medium and smaller firms in the global knowledge economy, as they can use their networks to disseminate new innovations into Pakistan. Another 39% of producers reported competition as a source of innovation. This validates the claim that opening exporters up to foreign competition incentivizes innovation.
The implementation of the Temporary Economic Refinance Facility (TERF) in 2020 saw a surge in investment. The proposed objective of this scheme was to facilitate expansion, balancing, modernization, and replacement (State Bank 2021). These goals were being met, as industries increased investments into capacity and imported machinery to replace outdated machinery. An estimated $5 billion was invested by the textile sector in 2021 via the TERF and other financing schemes.
The way forward
Recently, the TERF has been criticized for raising the import bill by increasing demand for foreign machinery. However, innovation cannot take place in a vacuum, and criticizing imports for productive capacity ignores how knowledge spillovers occur. Even if Pakistan is unable to reproduce these intermediate inputs locally, modernizing capital can lead to non-technological innovations as industries become acclimated to new machinery and processes.
Unfortunately, the textile industry continues to face exorbitant barriers that hinder R&D. Innovation takes place in spite of these barriers, and is likely to bloom without them. The same survey by Wadho and Chaudhry (2016) also surveyed textile producers about obstacles to innovation. The major obstacle reported was high costs and a lack of funds. This problem originates from exuberant energy tariffs, high import duties on cotton, and the withdrawal of zero-rating. Energy represents the highest conversion cost for textile manufacturers, and there is particular unevenness between Punjab and Sindh, where Punjab pays approximately four times the price of Sindh for energy. The cost of this innovation is embedded in the difference between Sindh’s 75% innovation rate compared to Punjab’s 45% (Wadho and Chaudhry, 2016).
The nation’s tax regime has also created an investment crisis. Producers face prolonged wait times for sales tax refunds, which paired with high-interest rates have dwindled their investment capacity. Thirdly, innovation is barred by Pakistan’s export promotion scheme’s misprioritization of incentives. Subsidies are given to established, less sophisticated products (World Bank, 2022). Similarly, import tariffs on inputs like polyester prevent the growth of a man-made fiber (MMF) industry. The MMF market is now dominating textiles at a ratio of 70:30 in favor of MMF. Therefore, failing to break into this market could render Pakistan uncompetitive in the future. Import tariffs and poorly allocated export subsidies discourage such diversification and create information asymmetries on the real demand for innovative products or new technology.
Mr. Shahid Sattar, now Executive Director & Secretary General of All Pakistan Textile Mills Association (APTMA), has previously served as a Member Planning Commission of Pakistan and an advisor to the Ministry of Finance, Ministry of Petroleum, and Ministry of Water & Power.
Sarim Karim is currently an internee researcher at APTMA, with a bachelor’s dual degree in Economics and International Relations from Hobart and William Smith Colleges.
The views expressed by the writers do not necessarily represent Global Village Space’s editorial policy.