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Monday, June 24, 2024

Finding Pakistan’s missing exports

World Bank trade expert argues that while Pakistan’s recent export recovery needs to be celebrated, the country is still very far from achieving its export potential. Postponing structural reforms conducive to that end have high opportunity costs in terms of long-term growth, job creation, and tax revenues.

Recently released export data for the first ten months of fiscal year 21 reveal the highest merchandise export values in history. The recovery is most remarkable given the disruptions to world trade that emerged due to the global COVID19 pandemic and were recently further exacerbated by the six-day blockade of the Suez Canal in March 2021.

Different and complementary hypotheses have been put forward to explain the circumstantial export pick up; ranging from a government response to the COVID19 pandemic that to some extent insulated the export sector from mobility restrictions to substantial and subsidized liquidity support to exporters, the maintenance of a market-based exchange rate regime that buffers external shocks, to the ingenuity of exporters in seizing opportunities arising from global buyers shifting suppliers due to COVID-triggered disruptions.

The truth of the matter is: Pakistan’s exports, 6.5 percent up or down, remain low, whether benchmarked against comparator countries in the region and beyond, or against Pakistan’s own export potential.

Pakistan’s missing exports

Start by benchmarking internationally. Today, Pakistan’s export to GDP ratio stands below 10 percent, ranking sixth globally in terms of the lowest exports/GDP ratio (see red arrow in Figure 1). A more interesting comparison, however, is that of Pakistan with its export potential.

In a recent World Bank report, we measured Pakistan’s export potential. To do so, we relied on what is known in international trade literature as a ‘gravity model of trade,’ a robust and well-tested model that presents trade between a pair of countries as directly proportional to the size of the trading partners and inversely proportional to the frictions that exist between them.

Essentially, we compared actual merchandise export levels with the potential that emerges from considering observable characteristics of Pakistan and other trading partners in terms of economic size, level of development, remoteness, trade frictions, such as distance between partners, import duties, etc., as well as and factor endowments.

Read More: Pakistan outperforms India in manpower exports

We estimate Pakistan’s export potentials at US$88.1 billion, about four times the actual level. The difference between the potential and the actual exports are what we call ‘missing (merchandise) exports’, which stand at about US$60-62 billion.

To be sure: achieving the export potential would not make Pakistan an export superstar. It would just position Pakistan closer to the middle of the distribution in exports/GDP (see green arrow in Figure 1).

If Pakistan’s exports were to grow at the same rate achieved by Vietnam in the last ten years, it would take ten years for the potential to be tapped into. If exports were to grow at the same rate as Bangladesh’s exports, it would take about 15 years to reach this potential.

Figure 1: Exports as percentage of GDP, Pakistan actual, potential, and rest of the world

Pakistan’s missing exports challenge is structural. Comparing missing exports for period 2000-2007 with those of 2010-2017 reveals that the challenge of missing exports has not changed since the turn of the century.

Export performance relative to potential (the concept of ‘missing exports’ measures) is persistent for most countries. Countries that had been outperforming their export potential at the beginning of the century have also outperformed it more recently (e.g., Vietnam).

At the same time, countries that had been under-performing before have also been under-performing more recently (e.g., Pakistan, Egypt, etc.). Only a few countries have moved from under-performing to over-performing (e.g., Mexico) or from over-performing to under-performing (e.g., Indonesia). This points to the structural yet urgent nature of the export performance agenda.

Where are Pakistan’s missing exports concentrated?

Destination-wise, untapped export potentials are mainly in familiar rather than distant destinations. China, the Russian Federation, and Central Asian Republics pose great potential for Pakistani exporters.

By combining information on three factors: (i) Pakistan’s missing exports to specific destinations, (ii) import dynamism of that destination (average import growth in the past five years), and (iii) the size of their import market (average imports in the past five years), we can identify high potential destinations for Pakistan’s exports.

Read More: Pakistan’s exports surge by 13.97% in Jul-May 2021

The top right quadrant of Figure 2 (QI) shows destinations with high potential: those with missing high exports (higher than median Pakistan’s missing exports among all destinations) and whose import markets have been expanding fast (faster than median import growth among all destinations).

The bottom right and top left quadrants (QII and QIV) show destinations with medium potential: those with missing exports below the median but high import growth (QII) or those with missing exports above the median but low import growth (QIV). Finally, the bottom left quadrant (QIII) shows destinations with low potential: missing exports below the median and low import growth.

Policy instruments to help firms reach these high potential destinations?

Yes. Take, for example, the Statutory Regulatory Order (SRO) 711(I) 2018. It provides an incentive in the form of an additional 2 percent to the standard duty drawback that an eligible Pakistani exporter can claim if it exports to an identified set of non-traditional destinations.

However, the group of non-traditional destinations that Pakistani authorities made eligible for the incentive is not aligned with evidence of high export potentials. The scheme put forward by SRO 711(I) 2018 favors low-potential, distant destinations such as Uruguay, Kiribati, or Honduras, rather than focusing on high-potential partners – many in the region, with which exporters will be better positioned to increase their shipments.

missing exports
Figure 2: Export potentials: Pakistan’s missing exports by destination, import dynamism of destination, Import levels of destinations.

In addition, negotiations of preferential trade agreements with Central Asian Republics and negotiations of transit trade agreements with Afghanistan are likely to be helpful to reduce trade costs.

Sector-wise missing exports

All sectors in Pakistan show substantial missing exports except for textile and apparel, which over-exports relative to the benchmark. Given Pakistan’s structural characteristics, including factor endowments, it is estimated that Pakistan’s missing exports are primarily in manufacturing.

Within manufacturing, on machinery and equipment (sector for which Pakistan’s exports are negligible compared to potential), and to a lower extent in minerals, stone, glass, metals, and chemicals. On the other hand, textiles and apparel exports (textile exports of final products and intermediate apparel) show exports substantially above potential.

Read More: Japan approves Pakistan’s mango facility for exports: Abdul Razzak Dawood

Policy instruments to help firms diversify into sectors with untapped potential

Yes. Duty drawback schemes such as the Drawback of Local Taxes and Levies (DLTL) provide incentives to exporters of specific products in the form of a rebate, ranging from 2 to 4 percent of the export value.

By targeting specific products for the rebate, the scheme incentivizes the allocation of resources into the production and exports of those targeted products (and away from other non-targeted ones).

Yet, despite policymakers’ narrative on the importance of focusing on diversification, public policies do not follow suit. Instead, they are biased in favor of well-established sectors, exacerbating the concentration of the export basket in textiles and apparel.

For example, 80 percent of textile and apparel exported product varieties are eligible for duty drawbacks ranging from 2 to 4 percent of export values, while only 25 percent of non-textile and apparel exported product varieties are.

Take another metric: there are a total of 7,531 product varieties; Pakistani exporters could be exporting. Out of those, 4,689 are exported out of Pakistan. Twenty-seven percent of those are eligible for some sort of duty drawback. However, out of the 2,842 products that have not yet been exported out of Pakistan, only 43 of these potentially new export product varieties are eligible for a duty drawback.

Suppose an entrepreneur wants to choose whether to export a well-established product or a new one, in addition to all the challenges around innovating; in that case, she knows the odds of being supported by export incentives if she goes for established instead of new products are 18 to 1.

This anti-new bias of export incentives discourages the required innovation to diversify the export bundle. Leveling the playing field, and using public funds to support new, rather than well-established activities, is likely to help diversify into sectors with untapped potential.

Read More: Pakistan’s exports increase in double numbers in last ten months!

The cost of not ‘finding’ the missing exports…

The opportunity cost of Pakistan’s ‘missing exports’ is estimated at 893,000 export sector jobs and US$1.7 billion foregone taxes. Of the 893,000 jobs, 152,000 jobs could be created in the agriculture export sector, and 741,000 jobs could be created in the manufacturing export sector.

Some of these could be newly created; others may imply the reallocation of labor from relatively lower productivity, domestic-oriented firms, to higher productivity, export-oriented firms.

In terms of foregone tax revenue, a back-of-the-envelope calculation suggests that realizing the export potential would bring an additional US$1.7 billion in direct tax revenues. It considers Pakistan’s value-added share in gross exports and the implicit direct tax rate across sectors.

Finding the missing exports will require a strong public and private partnership. From the public policy side, preserving a market-based exchange rate regime that buffers external shocks will be crucial, as well as investing in the public goods related to connectivity, facilitating smooth border crossings (the National Single Window at Customs is a positive development in this area), and aligning export incentives to growth and diversification objectives. From the private side, risk-taking will be crucial for innovation and growth.

More fundamentally, finding the missing exports will require embarking on an unpostponable structural reform: reducing the anti-export bias of tariff policy. That is the big gap between import duties on final goods and intermediates and raw materials. Reducing import duties on raw materials and intermediates (as it was done in this year’s Budget recently presented to the parliament) is good for businesses.

It reduces their production costs and allows them to choose a wider set of technologies. But it does not incentivize exporting, all else equal, it does the opposite: it induces firms to focus on the protected domestic market.

To incentivize exporting activity, import duties on final goods, rather than on intermediates and raw materials, need to gradually fall too. Otherwise, protection will continue carrying a high opportunity cost in export-oriented jobs, tax revenues, and a higher productivity path the economy could otherwise undertake.

Gonzalo Varela is a Senior Economist in the Macroeconomics, Trade and Investment Global Practice of the World Bank. He is currently based in Islamabad, where he leads the trade program. Previously, he worked in the World Bank’s Global Trade Unit in Washington, in the Ministry of Industries of Uruguay, and in the private sector. His work focuses on how trade and investment policy affect firms’ performance. He holds a Ph.D. in Economics from Sussex.