Economic transformation…….. Riaz Riazuddin
BEFORE we dwell on Pakistan’s 76-year economic transformation, it is important to review what it means in the context of countries that transformed themselves from mostly agriculture-driven to modern industrialised nations.
Nobel laureate Simon Kuznets described this long-term, complex structural transformation in terms of three simple shares of GDP of any country: agriculture, industry and services.
At the beginning of the transformation, a country’s GDP has a very large share of agriculture. As the country starts to develop, the share of industry begins to rise, that of agriculture to fall, and the share of services increases slowly. As the country moves toward greater industrialisation, industry’s share continues to increase, peaking when the country becomes highly industrialised. During this time, the share of services continues to rise, and, in advanced economies, becomes very high as the share of industry starts to go down. During this transformation, the share of agriculture continues to go down, too.
In the US, for example, this transformation is at a very advanced stage. The share of agriculture in GDP fell from 35 per cent in 1850 to 7pc in 1950 to only 0.9pc in 2016, while that of industry rose from 25pc in 1850, peaking in 1942 at 41pc.
Since then, it fell to 33.7pc in 1950 and 17.3pc in 2016. In contrast, the share of services continued to rise from 35pc in 1850 to 59.9pc in 1950 to 81.9pc in 2016.
In other words, during the process of structural transformation, which is synonymous with the reallocation of resources within the broad sectors of America’s GDP, the share of agriculture continued to fall and that of services to rise, while the share of industry rose first, reached its peak, and then started to fall, showing a humped curve in the graph. This behaviour of structural change is common to all advanced economies.
Why does the share of agriculture fall in the industrialisation process? The reason is that there is an ample surplus of labour (unemployed or underemployed) available in this sector. Since wages (and productivity) in agriculture are lower than industry, labour moves towards industry to expand its contribution to GDP.
Reduction in labour’s share improves its own productivity, as well as that of the economy overall. It also induces modernisation of agriculture. As farmers adopt newer modes of production, agricultural output continues to increase, while its share of GDP decreases.
In contrast, if industry’s share begins to stagnate or fall in the initial stages of industrialisation, it is a bad omen for the economy because industrial and manufacturing activities are highly productive and have the potential to absorb a lot of labour and reduce unemployment.
What is alarming is the behaviour of long-term change in the share of industry.
Let us now review the structural change of our economy which, of course, is incomplete, as we are still a developing country. The share of agriculture in Pakistan’s GDP was 53.2pc in FY50. Halfway through its history, it fell to 26.3pc in FY87, representing a reduction of 26.9 percentage points. During the next half of our 76 years, it reduced by only 2.3 percentage points to 24pc in FY23. This is an indication that the rate of structural transformation in our economy has slowed down considerably.
The share of the services sector has increased from 37.2pc in FY50 to 49.7pc in FY87. While it continued to increase in the next 38 years, its pace of increase went down, as it gained only 4.6 percentage points on reaching 54.3pc in FY23.
What is alarming is the behaviour of long-term change in the share of industry. It increased from 9.6pc in 1950 to 24pc in FY87, an increase of 14.4 percentage points during the first 38 years of our history. Since then, instead of registering an increase, it has gone down by 2.3 percentage points to 21.7pc in FY23. This seems like premature de-industrialisation of our economy, contrary to the experience of nations who are developing successfully.
The most important and dynamic subsector within industry is the large-scale manufacturing sector in our economy. The long-term trend in the share of manufacturing activities in GDP gives a bleak picture of our industrial transformation. The share of LSM in GDP was only 2.2pc in 1950 and touched its highest value 13.1pc in FY71. Since then, it has first stagnated around 12pc till FY08, declining to 11pc in FY23.
The process of economic and industrial transformation is not an automatic one; it is driven by economic policies and innovation. Good macroeconomic policies fuel this process, and bad policies retard or slow it down, undermining the process of economic development. Our industrial policies of nationalisation in the early 1970s played such havoc that we have still not come out of the subsequent retardation and decline in manufacturing’s share in GDP.
Bad industrial policies combined with imprudent fiscal, monetary and exchange rate policies have not only produced financial and balance-of-payments crises, they have also constrained our overall GDP from rising faster, affecting all its subsectors. The manufacturing sector acts as the engine of growth because of its high productivity compared to agriculture and services. Bad policies have taken all the steam propelling growth out of the manufacturing sector.
While premature de-industrialisation in Pakistan is not a unique phenomenon among developing countries, the extent of slowing down and retardation in the manufacturing sector is more severe compared to India. In India, the share of agriculture in GDP has fallen from about 50.6pc in FY54 to 18.3pc in 2023. The shares of industry and services have gone up from 14.5pc and 34.3pc in FY54 to 28.2pc and 53.5pc respectively in FY23. The current share of industry in India is 6.5 percentage points higher than that in Pakistan.
We need to adopt policies that expand the share of industry in GDP. We should remove inequities in taxation among three broad sectors of GDP. The relative level of taxation is much higher in industry compared to agriculture and the services sector. This does not mean that we reduce taxation in industry. Rather, we should impose direct taxes in agriculture and reduce tax avoidance in services. Prolonging the existing tax regime will continue to retard our economic transformation.
The writer is a former deputy governor of the State Bank of Pakistan.
rriazuddin@gmail.com
Courtesy Dawn, September 2nd, 2023