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Do Financial Sector Activities Affect Tax Revenue in Pakistan?
Published:July - Dec 2016
By mobilizing savings, financial markets play a crucial role in economic development. Given that the literature does not fully explore the nexus between financial activities and tax revenue, this study attempts to analyze the role of financial markets in generating tax revenue in Pakistan, using time series data for the period 1975–2014. It finds that, in the long run, the number of bank branches and market capitalization have a positive and significant impact on tax revenue. While credit to the private sector has a bidirectional relationship with tax revenue, public sector credit has an insignificant impact. In the short run, only the number of bank branches and market capitalization have a significant impact on tax revenue.
KEYWORDS: Financial sector, financial liberalization, tax revenue, Pakistan.
JEL: C32, G38, H21, G1.
Since the early 1990s, Pakistan’s economy has continued to lose its earlier growth momentum, except for a brief spurt in 2002–06. This has now become cause for considerable concern and urgent policy action is needed to revive the economy and move it to a higher growth trajectory. This slowdown during a period of rapid globalization (at least till 2008) and unprecedented technological advancement has raised fundamental questions as to the growing lack of competitiveness, both at the global level as well as against cheaper and better-quality imports in the domestic economy. In addition, recurring balance-of-payments crises have forced Pakistan to frequently seek IMF assistance and resort to severe contractionary policies to restore macroeconomic stability.
KEYWORDS: Pakistan, economy, IMF, 12th annual Conference, Management of the Pakistan Economy.
The Productivity Growth–Technology–Entrepreneurship Nexus: Implications for Pakistan
Irfan ul Haque
Labor productivity growth has received scant attention in Pakistan even though it is the foundation of rising living standards and a country’s ability to compete in the world market. Productivity rises when producers invest and introduce new technologies to reduce production costs and improve the quality and range of goods produced. Competition among producers entails a constant search for areas of improvement, tapping new technologies and finding innovative ways to produce and deliver the output to consumers. This is entrepreneurship. The first part of the paper discusses productivity growth and its drivers. The second part explains the critical importance of technological progress and innovation in economic growth and the catch-up process. Entrepreneurship and how it might be stimulated in Pakistan is discussed next. The paper concludes with a few ideas on how science and technology might be promoted in Pakistan.
KEYWORDS: Labor, productivity, entrepreneurship, Pakistan.
JEL: E24, O14.
Shrinking the Variance-Covariance Matrix: Simpler is Better
Muhammad Husnain, Arshad Hassan and Eric Lamarque
Published:Jan - June 2016
This study focuses on the estimation of the covariance matrix as an input to portfolio optimization. We compare 12 covariance estimators across four categories – conventional methods, factor models, portfolios of estimators and the shrinkage approach – applied to five emerging Asian economies (India, Indonesia, Pakistan, the Philippines and Thailand). We find that, in terms of the root mean square error and risk profile of minimum variance portfolios, investors gain no additional benefit from using the more complex shrinkage covariance estimators over the simpler, equally weighted portfolio of estimators in the sample countries.
KEYWORDS: Variance-covariance matrix, mean-variance criteria, portfolio management.
JEL: G11, G15, C51, C13, C52.
Pakistan’s Productivity Performance and TFP Trends, 1980–2015: Cause for Real Concern
Rashid Amjad and Namra Awais
This paper reviews Pakistan’s productivity performance over the last 35 years (1980–2015) and identifies factors that help explain the declining trend in labor productivity and total factor productivity (TFP), both of which could have served as major drivers of productivity growth – as happened in East Asia and more recently in India. A key finding is that the maximum TFP gains and their contribution to economic growth are realized during periods of high-output growth. The lack of sustained growth and low and declining levels of investment appear to be the most important causes of the low contribution of TFP to productivity growth, which has now reached levels that should be of major concern to policymakers vis-à-vis Pakistan’s growth prospects.
Using the endogenous growth model, we examine the contribution of physical capital, human capital and TFP to labor productivity. The results suggest that, over these 35 years, the contribution of physical capital and education remains modest and there has been a declining trend in TFP growth. This shows that Pakistan’s economy has not taken full advantage of the favorable technological developments and rapid globalization of the period. We also question the view expressed in recent studies that Pakistan’s growth has been driven primarily by factor inputs, namely labor and capital, and not by TFP growth. The paper argues to the contrary that it is the lack of investment in and growth of the stock of capital embodying the most recent knowledge and technology that has inhibited TFP growth post-1990. Finally, there is an urgent need for further research to understand the dynamics of growth in services and to raise TFP in this sector as India has done post-1990.
KEYWORDS: Growth, labour, capital, labour productivity, total factor productivity, Pakistan.
JEL: D24, O47, E01.
Costs, Capabilities, Conflict and Cash: The Problem of Technology and Sustainable Economic Growth in Pakistan
Growth in Pakistan has been surprisingly sustainable. GDP growth of 5 percent p.a. since independence and no recession since (at least) 1960 according to World Bank data represents a creditable performance when compared to all but the most successful developing countries. Pakistan has significantly transformed the structure of its economy during these same decades; in 1950 99 percent of its exports were agricultural goods and by the 1990s exports were largely manufactured goods. This very success indicates a growing constraint on sustaining growth into the future or the concern that Pakistan may be headed for a Middle Income Trap. Although there does exist scope for continued growth based on further structural changes - in particular the large number of people still employed in agriculture or the women not currently engaged in the labor force - for growth to be sustained a more intensive or productivity-oriented growth will be necessary. This paper first outlines the importance of productivity growth for sustaining GDP growth in Pakistan, then examines the historical and comparative productivity performance of Pakistan, and explores a number of case studies of successful technological change, particularly in South Asia, and finally attempts to draw some lessons for contemporary Pakistan.
KEYWORDS: Technology adoption, productivity, political economy, Pakistan.
JEL: O14, O49, Q16.
The Diversification and Sophistication of Pakistan’s Exports: The Need for Structural Transformation
Maha Khan and Uzma Afzal
While export diversification is considered to foster export growth and enhance GDP growth rates, this diversification has not translated into higher exports for Pakistan. In addition to diversification, the country must undergo a structural transformation of its exports to upgrade to a more sophisticated export basket. This entails shifting its comparative advantage from primary to manufactured exports and, further, from a labor-intensive to a more capital-intensive productive structure. In order to explain Pakistan’s paradoxical situation, this paper analyzes Pakistan’s orientation in the ‘product space’ as it affects the process and rate of structural transformation. In addition, we assess the sophistication of Pakistan’s exports based on their complexity and technological sophistication. Our analysis refutes the traditional argument that diversification leads to greater exports and faster economic development. It also shows that the bulk of the country’s productive capabilities are concentrated in the periphery of the product space, which is very weakly connected to the tightly packed industrial core. The export basket is neither complex nor technologically sophisticated, producing low-tech undifferentiated products. It seems that Pakistan is left with few nearby options for structural transformation, leaving it without a path to other, more sophisticated areas in the core of the product space. We argue that accelerating the process of structural transformation will require revisiting industrial policy, strengthening the country’s institutions and strategic collaboration between the public and private sectors.
KEYWORDS: Pakistan, structural transformation, technological sophistication, diversification, product space, growth, exports.
JEL: F1, F19, F43, O14, F10, O33.
Innovation in the Textiles Sector: A Firm-Level Analysis of Technological and Nontechnological Innovation
Waqar Wadho and Azam Chaudhry
In a knowledge-based economy, it has become increasingly important to better understand critical aspects of the innovation process such as innovation activities beyond R&D, the interaction among different actors in the market and the relevant knowledge flows. Using a sample of 431 textiles and apparel manufacturers, this paper explores the dynamics of firms’ innovation activities by analyzing their innovation behavior, the extent and types of innovation, the resources devoted to innovation, sources of knowledge spillovers, the factors hampering technological innovation and the returns to innovation for three years, 2013–15. Our results show that 56 percent of the surveyed firms introduced technological and/or nontechnological innovations, while 38 percent introduced new products, these innovations were generally incremental as the majority of innovations were new only to the firm. Furthermore, the innovation rate increases with firm size; large firms have an innovation rate of 83 percent, followed by medium firms (68 percent) and small firms (39 percent). Technologically innovative firms spent, on average, 10 percent of their turnover on innovation expenditure in 2015. Acquisition of machinery and equipment is the main innovation activity, accounting for 56 percent of innovation expenditures. Large firms consider foreign market sources (clients and suppliers) and small firms consider local market sources their key source of information and cooperation. 63 percent of technological innovators cite improving the quality of goods as their most important objective. Lack of available funds within the enterprise is the single most important cost factor hampering innovation, followed by the high cost of innovation. Our results show that 67 percent of the turnover among product innovators in 2015 resulted from product innovations that were either new to the market or new to the firm.
KEYWORDS: Innovation, technological, non-technological, Pakistan.
JEL: O14, O32.
Comparing Industrialization in Pakistan and the East Asian Economies
Rajah Rasiah and Nazia Nazeer
Drawing on the successful industrialization and catch-up experience of the UK, the US, Germany, France, Italy, Sweden and Japan, and later South Korea and Taiwan, we argue that industrialization is a necessary phase for normal economies to stimulate rapid economic growth and structural change. This paper compares Pakistan’s industrialization with that of selected economies in East Asia. The evidence shows that Pakistan not only has the lowest GDP per capita of this group, it has also industrialized the least. Pakistan enjoyed its highest manufacturing growth rates in the 1950s and 1960s. Thereafter, manufacturing grew slowly and unevenly until the 1990s and 2006, largely through clothing exports.
While Pakistan has faced deindustrialization since 2006, technology upgrading was never an integral part of its industrial policy. In contrast, the developmental role of the state, with a strong focus on technological catch-up and science-based education, is what propelled South Korea’s leading firms to the world’s technology frontier. Clientelist pressures compromised a similar role in Malaysia, the Philippines and Indonesia, although foreign-owned firms helped expand their manufactured exports. A structured technology upgrading framework was never part of policy planning in the Philippines, Indonesia and Thailand, while Malaysia’s technology upgrading blueprint, launched in 1991, lacked sound execution. Export manufacturing in the Philippines, Indonesia, Thailand and Malaysia through imports of cheap foreign labor has benefited from low wages and foreign direct investment. The comparison offers Pakistan an opportunity to learn from both the more successful and less successful industrializers in East Asia, that it might create the conditions for rapid economic growth and structural change.
KEYWORDS: Industrialization, deindustrialization, industrial policy, technological upgrading, Pakistan.
Correlates of Entrepreneurship in Pakistan: The Regional Dimension
Mahnoor Asif and Anum Ellahi
This study analyzes entrepreneurial ability in Pakistan through a cross-sectional comparison of provinces and districts based on data from the Global Entrepreneurship Monitor for 2010–12. The aim is twofold: to (i) identify individual and country-level factors that affect nascent and potential entrepreneurs and (ii) see how regional income levels and the degree of development affect entrepreneurship (of both the opportunity and necessity varieties), eventually contributing to innovation and economic growth. We investigate the effect of total early-stage entrepreneurial activity on entrepreneurial framework conditions at the regional level and then evaluate the impact of education, age, gender and entrepreneurial ability on potential entrepreneurs, nascent entrepreneurs and baby business owners to examine the entrepreneurial startup process.
KEYWORDS: Entrepreneurship, income, development, regional, Pakistan.
JEL: L26, O10.
Same Jeans, Same Stitch? A Comparison of Denim Production Across Three Factories in Punjab, Pakistan
Theresa Thompson Chaudhry and Mahvish Faran
In this paper, we look at denim production in three different factories in Punjab, Pakistan. We map the manufacturing process for a standard pair of denim jeans produced for an international retailer. We asked three factories of different scales and proximities to the technological frontier to stitch, finish and wash an identical pair of jeans. These firms included a large-scale exporter with established links to a major multinational brand, a medium exporter with links to regional European labels and a small producer selling primarily to the domestic market. Timing the operations ourselves, we find that the stitching time of the large-scale exporter is about one-third less than that of the medium exporter and about half the stitching time of the small firm. Of the three firms, only the large exporter pays wages based strictly on standard minute value – the time expected to complete an operation. The two smaller firms pay piece rates that reflect the market rates paid for individual operations by firms throughout the sector. Even without increases in stitching efficiency, the two smaller firms could reduce their stitching costs by 30–50 percent if they were able to switch to paying wages based on stitching times. We also calculate the labor cost savings that the two smaller firms could accrue by adopting some of the more advanced equipment used by the large exporter, along with lower piece rates. Of these, the most reasonable investment would be in better loop-making machines; the cost of equipment could be recuperated by producing 325,000–500,000 garments, which for the medium firm is four to eight months’ production at current levels. However, piece rates are entrenched and, if sticky, could reduce the incentives for firms to adopt labor-saving technologies.
KEYWORDS: readymade garments, manufacturing, Pakistan, piece rates, SMV, choice of technology.
Measuring Technology Differences Across Football Manufacturers in Sialkot
A fascinating example of the fluctuating fortunes of Pakistani exports is that of the footballs produced by a cluster of manufacturers in Sialkot. Dominated by Pakistani firms, the sector is now under heavy threat from cheaper balls produced in East Asia (particularly China). What is striking is that the technology used by most firms has not progressed significantly in the last 30 years. This raises the question of whether Pakistan is falling behind the technology frontier. Using data from a sample of firms, we map the football production process and focus on different cutting technologies to compare productivity across firms and measure the benefits of upgrading this technology across firms of different sizes. Our results show that technology upgrading comes at a cost, but is worthwhile for firms that need to produce a large volume of balls. However, the falling demand for Pakistani balls may not justify this for most small and medium firms in the sector, which make up the vast majority of firms in the cluster.
KEYWORDS: Technology, manufacturers, footballs, Sialkot, Pakistan.
Technology in the Sialkot Gloves Manufacturing Sector
This paper uses a unique sample of sports glove manufacturers from Sialkot to develop an index of technological sophistication. The data shows that total factor productivity (TFP) and total revenue productivity (TRP) cluster around their mean levels. The medium-tech and high-tech firms seem to have a higher TFP and LP than the low-tech firms. Another interesting result is that, across firms, the level of retained earnings has a negative impact on TFP and TRP.
KEYWORDS: Technology, manufacturing, gloves, Sialkot, Pakistan.
JEL: O14, L67.
Entrepreneurship and Innovation in the Digital Economy
Naved Hamid and Faizan Khalid
It is believed that Pakistan’s digital economy will follow a similar growth trajectory to India, but with a lag of about five to six years. This implies that the digital economy in Pakistan carries immense potential and is likely to see very rapid growth in the next five years or so. This paper provides an overview of Pakistan’s digital economy in terms of international players, successful local businesses and rising stars in different segments of the industry. We also evaluate the role played by incubation centers. The industry’s emerging financial landscape appears to be attracting international venture capital firms, which is surprising, given the country risk and monitoring and control issues that are usually seen as binding constraints to investment. However, these investors use models tested in Silicon Valley and in countries such as India to estimate the potential for increase in the capital valuation of digital businesses in Pakistan. This development has also started to attract local investors. As a result, we are seeing the emergence of a venture capital industry in Pakistan. Finally, we examine the policy environment in the country and find that the existing tax policies, which were designed for traditional businesses, could be a major obstacle to the growth of the digital economy. We conclude by recommending that the government review its tax policy in view of the different nature of digital businesses and adapt it accordingly.
KEYWORDS: Entrepreneurship, innovation, economy, Pakistan.
Promotion of Innovation and S&T: The Role of Finance
Saeed Ahmed and Mahmood ul Hasan Khan
Promotion of innovation and S&T enables economies to achieve sustainable economic growth. In addition, firms engaged in medium- to high-tech production tend to gain more from innovation and are, on average, more productive compared to enterprises which are limited to low-tech systems. Innovation is, in turn, inextricably linked to the availability and nature of financing. Empirical studies in developing countries reveal that bank financing and FDI can play a vital role in this regard. This paper provides an overview of: (a) the role of financing in facilitating innovation and S&T; (b) State Bank of Pakistan’s policy initiatives to make financing available, both in general, and also to specifically facilitate innovation and S&T in the country; and (c) the role of innovations in expanding access to finance in Pakistan.
KEYWORDS: Technological innovation, R&D, policy, banks.
JEL: G21, E61, O32.
Access to Finance and Agency: An Overview of the Constraints to Female-Run Enterprises
A large proportion of women in Pakistan engage in home-based production rather than wage employment in the public space to generate an income. This article provides an overview of the literature on the role of access to finance and women’s decision-making power (at the household level) on the likelihood of business creation and growth by women. The literature shows that finance has little impact on business and household outcomes; this suggests that other constraints are at play when it comes to women setting up an enterprise or making business decisions. This overview shows how self-control – risk aversion and present biasedness – can inhibit business investment. Household members may also ‘capture’ a woman’s financial resources, including business loans or savings, and put them to unproductive use. Further, social and cultural norms may dictate whether setting up an enterprise is seen as an ‘appropriate’ activity for women. Against the backdrop of several government and private initiatives to promote enterprise, exploring these issues provides us with important insights into how female-run businesses can be encouraged and supported.
KEYWORDS: Entrepreneurship, microfinance, credit constraints, household decision-making, norms.
JEL: J16, D14, 012, P34, P36.
Explaining Pakistan’s Premature Deindustrialization
Nazia Nazeer and Rajah Rasiah
Recognizing that Pakistan faces premature deindustrialization, this paper seeks to explain the phenomenon. The country experienced wild swings in industrialization during the 1950s and 1960s. The period 2001–10 was characterized by fairly strong growth, followed by contractions in other periods. Pakistan’s manufacturing sector is dominated by clothing and textiles exports. Periods of manufacturing growth were associated with pro-manufacturing and import substitution policies, while slumps were characterized by deregulation and a relatively high exchange rate. The evidence shows that the relative stagnation of manufacturing (regardless of the policies implemented) can be explained by the lack of a dynamic industrial policy targeting technological catch-up and leapfrogging. Moreover, where rents were distributed in the form of incentives, there was no emphasis on monitoring and appraisal.
KEYWORDS: deindustrialization, industrial policy, technological upgrading, Pakistan.
Public Policy, Innovation and Economic Growth: An Economic and Technological Perspective on Pakistan’s Telecom Industry
Musleh Ud Din, Inayat Ullah Mangla and Muhammad Jamil
At a time of rapid technological advancements in every field, Pakistan must develop a comprehensive strategy for harnessing science and technology to promote economic growth on a sustained basis. In recent decades, successful economies have moved away from factor accumulation models of economic growth to productivity led growth that is underpinned by technological advancements and innovations. Using the endogenous growth theory as a framework of analysis, the paper will provide a macroeconomic perspective on the importance of technology and innovation for sustainable economic growth. We argue that public policy must be geared to generate robust growth by encouraging investment in research and development (R&D) and human capital. The paper will conceptualize the role of technology in the process of economic growth and identify policy areas that can be instrumental in promoting technological modernization and innovations.
The paper will also survey some illustrations from Pakistan’s telecommunication industry.
KEYWORDS: Policy, innovation, economic growth, technology, telecom, Pakistan.
JEL: O14, O32.
Innovation and Technological Upgrading in Lahore: Results From the LCCI Business Confidence Survey 2016
Mahvish Faran and Azam Chaudhry
The Lahore School of Economics and the Lahore Chamber of Commerce and Industry (LCCI) conducted a unique business confidence survey of firms in March 2015. The objective of the survey was to determine industry-specific trends as well as firms’ perceptions of general macroeconomic trends. In 2016, the Lahore School and LCCI conducted a second business confidence survey in which they asked a sample of firms about the same issues as well as their level of innovation and technological upgrading. In this paper, we focus on the results of the innovation and technology component of the 2016 survey. We perform an aggregate analysis across firms to see if they have innovated and upgraded their technology. Next, we focus on the impact of innovation on exports and domestic sales to gauge whether firms reporting higher exports had innovated more. Finally, we look at each sector (manufacturing, services and retail) in turn and analyze the levels of innovation and technological innovation in each.
KEYWORDS: Innovation, technology, macroeconomic trends, business confidence survey.
JEL: O14, O11.
Science and Technology for Raising Income: The Choice of Activities, the State and the Private Sector
Pakistan’s lack of industrial progress over decades should be cause for concern about the future. The goods the economy produces competitively are the typical goods that yield so little income that they are only exported by economies that have low wage labour. They are much the same manufactures now as during the 1960s and have been kept competitive by keeping wages down through repeated devaluation. Income per head will rise slowly, at best, if the economy does not learn how to produce goods that yield more income, and that means acquiring the up to date technical knowledge needed to be competitive from the foreign producers who produce such goods. But that is knowledge obtained through R&D and is not provided freely, least of all to would-be competitors. Pakistani firms can try to do their own R&D, but, even with public sector collaboration, they cannot catch up with the established foreign firms, which continue to do their R&D and have more money, experienced staff and facilities. The two possibilities are to attract foreign direct investment and for Pakistani firms to insert themselves into the production processes of foreign firms. Experience shows that the first, though it has worked well in several countries, can be ruled out for the present; there has been no FDI in Pakistan for making exportable manufactures. But economies like South Korea and China acquired the technical knowledge they needed through subcontracting and joint ventures with American, European and Japanese firms and moved on from there. There is no realistic alternative and task ahead is to determine what has to be done to realize it.
KEYWORDS: Science and technology, R & D, productivity, innovation, Pakistan.