What does structural change mean?

Structural change is defined as a shift in the relative weight of key components of

the economy's aggregate indicators, such as national product and expenditure,
exports and imports, and population and labor force.Structural transformation
involves countries shifting from low-productivity, low-wage activities to high-
productivity, high-wage activities.

Trajectory of structural change in Pakistan

During the 1970s, there was a strong emphasis on the nationalization of state-
owned enterprises in Pakistan. However, the 1980s witnessed a notable shift
towards denationalization, leading to a reduced role for public sector enterprises in
the economy. This transition coincided with the signing of two significant
agreements: first, an Extended Fund Facility (EFF) with the International Monetary
Fund in 1988, and second, a Structural Adjustment Loan (SAL) with the World
Bank in 1986. In exchange for these agreements, Pakistan focused on stabilizing
the economy and implementing structural reforms.

These reforms were aimed at several key objectives, including controlling

inflation, reducing the budget deficit by removing subsidies, improving the balance
of payments by boosting exports and curbing imports, lowering the debt-to-GDP
ratio, ceasing domestic credit provision for budgetary support, liberalizing external
trade, bolstering foreign exchange reserves, devaluing the domestic currency
against the US dollar, and restructuring the financial sector. The overarching goal
of these measures was to stimulate economic growth and decrease inflationary
pressures in the economy.

The implementation of the Economic Reform Order in 1991 marked the initiation
of a substantial reform program by the government. This encompassed liberalizing
the foreign exchange regime, dismantling investment controls, privatizing public-
sector enterprises, and incentivizing both domestic and foreign investment.

In the agricultural sector, reforms were directed towards four main areas:
enhancing water provision and efficient usage, allowing market forces to dictate
input and output prices, expanding physical infrastructure, and allocating funds for
innovation and research. These reforms had a positive impact on agricultural
output growth.

The 1990s also saw reforms in the financial sector, aiming to enhance efficiency
and foster competition. These included the liberalization of interest rates and credit
ceilings. Amendments to the Banks (Nationalization) Act of 1947 in 1997
strengthened the Central Bank's supervisory role over the financial sector. Public
sector banks underwent denationalization, and new banks were allowed to enter the
market.

Previously, monetary policy relied on direct instruments such as government-set

interest rates and credit ceilings, but financial sector reforms shifted towards
market-based monetary policy using open market operations. Additionally, the
introduction of the Islamic Banking System offered profit and loss sharing
facilities. Furthermore, Pakistan transitioned from fixed exchange rates to a
managed float regime on January 8th, 1982.

On May 28th, 1998, Pakistan became a nuclear power. In the aftermath, there were
restrictions on capital movement, foreign exchange accounts were frozen, and a
multiple exchange rate system was introduced. These measures aimed to alleviate
investors' ambiguity about Pakistan's ability to fulfill its external obligations
[Akram (2011)].

The terrorist attack on the US on the 11th of September 2001 had a significant
impact on Pakistan's macroeconomic indicators. Sanctions imposed on the country
following the nuclear explosions were lifted, and Pakistan received generous
financial assistance as a result of its alliance with Western countries in the fight
against terrorism. As a result, Pakistan's foreign exchange reserves increased
significantly.
Throughout the 2000s, more liberal, outward-oriented economic policies were
implemented with the goal of strengthening and integrating Pakistan into the global
economy. Despite their unpopularity, decisions such as imposing a sales tax,
raising oil prices, and withdrawing subsidies were made to address the escalating
budget deficit. Growth accelerated between 2002 and 2007 as a result of structural
policy reforms and improved governance.

However, domestic factors, in addition to recessionary circumstances, particularly

in Western countries due to the global financial crisis, had a significant effect on
Pakistan's growth trajectory. Economic conditions deteriorated to the point where
Pakistan struggled to meet its external obligations, prompting it to seek help from
the International Monetary Fund to avoid default [Gilal et al. (2017)]. Additional
difficulties arose from floods and security issues in the subsequent year.

Overall impact of structural change measures on the Pakistan economy

Pakistan has distinguished itself among developing nations with its remarkable
economic growth and poverty reduction during its initial four decades. In the
1980s, driven by substantial expansion in the manufacturing sector, the country
achieved an impressive growth rate of 6% per annum. This surge in growth
coincided with a notable decline in the poverty rate from 46% to 18%,
accompanied by low inflation rates, and nearly doubling of per capita income
during this period.
However, in the 1990s, Pakistan experienced a deceleration in its growth rate,
averaging between 3 to 4%, while the poverty rate surged to 33% of the total
population. Table 1 offers an overview of Pakistan's macroeconomic variables over
time. Although the share of exports in GDP remained relatively stable around 16%
in the 1990s and 2000s, it dropped to just 8% in the last decade. Nevertheless,

compared to its Asian counterparts, Pakistan's pace of structural transformation has

been notably slow and lower than other countries in the region.

The service sector has emerged as the largest growing sector in Pakistan,
significantly contributing to employment compared to other sectors. It now
accounts for 54% of GDP and approximately one-third of total employment in the
country. Despite this, there is a concerning trend of declining manufacturing value
added in GDP percentage, which stood at 11% in 2021—lower than the South
Asian and lower middle-income averages.

Manufacturing remains crucial for driving economic growth, yet its share in
Pakistan's GDP has remained stagnant over the past six decades. Factors
contributing to this stagnation include low agricultural productivity, rising energy
costs, high taxes, and currency devaluation. Notably, the gains within the
manufacturing sector are concentrated in textiles, food, and beverages.

Analyzing Pakistan's export basket, the country holds a comparative advantage in

sectors like textiles, clothing, light manufacturing, fruits and vegetables, and
minerals. However, its advantage in sophisticated capital products is relatively
weak. Efforts to boost manufacturing have been hindered by stagnant productivity,
leading to less competitive exports globally.
To address these challenges, Pakistan must anticipate changes in global supply
chains and focus on developing its manufacturing sector. Shifting from
predominantly exporting raw goods to producing finished goods is essential for
enhancing competitiveness in the global market. Additionally, the country needs to
strike a balance between agricultural, manufacturing, and service sectors to ensure
sustainable and inclusive economic growth.

The export sector

In the traditional Heckscher-Ohlin model, countries export goods that align with
their relative abundance of factors of production. However, as countries develop,
their factor endowments change, leading to shifts in their specialization patterns.
New trade theory models, such as Krugman's, emphasize productivity growth
through learning by doing, diminishing the role of factor endowments in
determining comparative advantage. Real and monetary shocks, as well as
industrial policy, become significant factors influencing trade specialization.

Recent research by Hausmann et al. suggests that specialization patterns are not
solely determined by factor endowments but also influenced by idiosyncratic
elements. They argue that as countries develop, they undergo structural
transformation, reflected in changes in the sophistication, quality, and
diversification of their exports. Unlike the traditional theory, which relies solely on
changing factor endowments, Hausmann et al.'s model suggests that proactive
measures, such as industrial policy and investment in "cost discovery," are crucial
for upgrading and diversifying exports.

The mix of goods a country exports can significantly impact its economic growth,
with some products contributing more to growth than others. Therefore, exports
serve both as a tool for development and a measure of a country's success.
Government policy plays a crucial role in shaping the production structure, as
countries that focus on exporting higher-quality goods tend to perform better
economically.

Additionally, Hausmann and Rodrik highlight the specificity of countries'

capabilities in different activities, noting that countries may export certain products
while not exporting others, even if they seem similar or have similar endowments.
Understanding a country's export structure is fundamental for assessing its
potential for structural transformation and economic growth.
The analysis of Pakistan's export sector highlights several important characteristics
regarding the transformation of its economy. Despite a decrease in export
concentration over the years (with the share of the top ten exports declining from
62.8% in 1986 to 49.7% in 2004), the majority of Pakistan's top exports still
consist of textiles and apparel. This indicates a lack of diversification in the export
basket.
Furthermore, the weighted average of the per capita GDPs of countries exporting
Pakistan's top 10 exports, represented by PRODY, has decreased significantly over
time (from 5,014 in 1986 to 3,458 in 2004). This suggests that Pakistan is primarily
exporting goods that are being produced by countries with lower income levels,
indicating a lack of upward mobility in export sophistication.

The income level of Pakistan's exports, denoted by EXPY (a proxy for export
complexity or competitiveness), has not shown the expected increase for a country
undergoing structural transformation toward faster growth. In fact, Pakistan's
export complexity index remained stagnant between 1986 and 2004, indicating a
lack of progress in exporting more sophisticated goods. This contrasts with the
trajectories of economies like China and India, which experienced significant
increases in export complexity during similar periods.

Overall, the analysis suggests that Pakistan's export sector is facing challenges in
diversification and upgrading to more sophisticated products, which are crucial for
sustained economic growth. Addressing these challenges would require strategic
policies aimed at promoting diversification, enhancing competitiveness, and
fostering innovation in the export sector.

Industrial policy as an important part of Pakistan’s development strategy

Pakistan's mission statement, as outlined by the Planning Commission, aims to

foster a knowledgeable, well-governed, enterprising, and prosperous nation
through realistic and innovative policies and programs delivered cost-effectively.
Achieving upgrades in production and export structures requires deliberate efforts,
as seen in the complex transformation of successful Asian economies. This process
involves identifying profitable products, learning new production methods, and
exploring new activities, all within an unpredictable economic environment.

Industrial policy (IP) plays a crucial role in this process, not merely as a method of
selecting winners, but as a means of coordinating public and private sector
activities to address market failures hindering structural transformation. IP
involves gathering information on externalities, constraints, and opportunities,
necessitating collaboration between sectors and institution-building across
industries, including agriculture and services.

The rationale for IP lies in the recognition that markets alone may fail to provide
sufficient incentives for the necessary economic transformation. In today's
development landscape, economic determinism is limited, and policy plays a
substantial role. Coordination of investment decisions, essential for growth,
requires mechanisms to transmit information and reduce uncertainty among
decision-makers.

While many developing countries have adopted industrial policies to accelerate

industrialization and growth, the results have been mixed, leading to controversies
regarding their effectiveness. Despite ample evidence of their role in fostering
industrialization in East Asia, consensus remains elusive on the precise conditions
under which industrial policy can significantly impact capital accumulation and
growth rates.
Rodrik (1994) highlights successful policy interventions in Korea and Taipei,China
as instrumental in accelerating transitions between patterns of specialization,
leading to economic prosperity. These interventions, including government
subsidies and coordinated investment decisions, were crucial in reallocating
resources toward modern industries. This reallocation raised the return on capital,
driving the economy into a high growth trajectory. The success of industrial policy
in these economies was attributed not only to their export orientation but also to
the substantial increase in investment rates, facilitated by government
interventions.

Pakistan can learn from these experiences by developing a comprehensive

industrial policy program that fosters cooperation between the public and private
sectors. Important considerations include identifying key private sector
stakeholders, implementing sector-specific reforms to foster competition,
managing labor reallocation, providing complementary inputs to the market,
prioritizing public spending on infrastructure and training, targeting foreign firms
for investment promotion, and addressing employment challenges.
Success in industrial policy hinges on the government's willingness to monitor
outcomes and adapt policies accordingly. Rodrik (2004) suggests that effective
institutional architecture for industrial policy includes political leadership,
coordination and deliberation councils, and mechanisms for transparency and
accountability. Crucially, all stakeholders—government, policymakers, and
entrepreneurs—must be actively involved in designing and implementing the
industrial policy program. Embedding private initiative within a framework of
public action is essential for fostering restructuring, diversification, and
technological dynamism beyond what market forces alone can achieve in
Pakistan's economy.