Theory at Odds with Best Practice: The Travails of Industrial Policy

1. IntroductionThere is no other field of economics that generates more heat and controversy than industrial policy. The divergence of viewpoints on what is wrong with Pakistani industry and what ought to be done is evident among professional economists as well as policymaking circles. These differences have a long history and arise out of conflicting notions regarding industrial development and the role the government might play in promoting it. In an earlier paper, I have sought to show why industrial policy was required to promote international competitiveness and robust export growth in Pakistan (Haque, 2014). This paper takes the desirability and need for an articulated and coherent industrial policy as a premise, but goes forward in identifying the priority areas the country's policymakers should consider in designing one.2. Origins of Pakistan's ManufacturingThe rise of manufacturing is usually associated with domestic as well as international tensions. Domestically, new industry is perceived to upset the established rural-urban order, as the political balance shifts from the feudalists to the emerging class of industrialists. Internationally, existing producers react to the competition from new, emerging industrial centers with apprehension as specialization and trading patterns undergo profound changes. The emergence of new sources of manufactures is often taken as an outcome of unfair, even illegitimate, government practices involving commercial policy and currency manipulation.Such tensions were evident in 19th century England when the new class of industrialists succeeded in having the ancient Corn Laws removed, thereby ending the protection that agriculture had hitherto enjoyed. Although less well known, the American Civil War too was in part a battle over differential government protection between the industrial North and the agricultural South (Chang, 2002). Economic rivalry among European countries over the capture of markets and access to sources of raw materials often led to war. Today's persisting tensions in the world economy are, at the bottom, a contest over control of resources and markets and disputes over whether governments are playing by the "rules."Given this history, Pakistan's somewhat tortured struggle for industrial development is neither exceptional nor surprising. At the time of independence in 1947, the country's industry was rudimentary and mostly small-scale, while banking and insurance were largely in foreign hands. The initial motivation to industrialize arose out of a concern over the new nation's survival in the face of economically and militarily dominant India. Pakistan, by and large agricultural, produced jute in what was then East Pakistan and cotton in West Pakistan, while the factories processing these raw materials into manufactured products were mostly in India. Although self-sufficient in food, its agriculture too depended on rivers flowing out of the neighbor's territory. This dependency made Pakistan - certainly, in perception - fragile and vulnerable, and influenced the country's choices and actions with respect to industrial development.Commercial relations between the neighbors received a serious blow when Pakistan, by design or out of perversity (as many then maintained), chose not to devalue the Pakistani rupee in 1949 along with the British pound and other Sterling Area currencies. India was particularly annoyed because it now faced higher prices for its raw materials from Pakistan, even as it benefited from improved competitiveness. For this, Pakistan was duly punished with the suspension of imports of raw jute and cotton. This added to the imperative that the country should industrialize, and investments in jute and cotton mills began.In short, Pakistan's early industrialization was essentially reactive, not born out of a grand vision of turning the country into an industrial power, as was the case in India and many other developing and socialist countries at the time. …