In South Asia, Pakistan’s lagging labour productivity is a deep policymaking failure

A recently published work titled "Stick-in-the-Mud," by the Economic Advisory Group (EAG), an independent think tank, vividly illustrates the sluggish growth in labor productivity in Pakistan over the past three decades. This poor performance becomes strikingly apparent when compared to peer countries in South Asia and other Asian economies that have rapidly transformed, and significantly improved citizens' standards of living.

Dr. Ahmed Pirzada, an economist from Bristol University, and his colleagues note that, between 1990 and 2018, Pakistan's labor productivity increased by only 45%, implying an average annual growth rate of a mere 1.33%. In contrast, other South Asian economies experienced more than a doubling of labor productivity. Specifically, Bangladesh and India saw increases of 191% and 263%, respectively, while China's labor productivity surged over eight times during the same period, with average annual growth rates of 3.88%, 4.72%, and 8.12% for the respective countries.

The substantially higher productivity growth among peer group countries relative to Pakistan has resulted in these countries seeing a significant shift of the workforce away from agriculture towards manufacturing and services. Such a shift has been conspicuously absent in Pakistan. While the share of the agricultural sector in employment decreased by about 10% from the 1990s to the present, this contrasts starkly with a 40-percentage point decrease in Vietnam and China and a 20-30 percentage point decrease in countries like Bangladesh, India, Thailand, Indonesia, Turkey, and Sri Lanka over the same period.

Pakistan has also witnessed a stagnant composition in its trade basket over the last three decades, both in terms of exports and imports. This data shows that the overall structure of the economy has undergone limited transformation and that too at a sluggish pace compared to other rapidly growing developing countries.

Powerful families in Pakistan have lobbied for trade protection measures during crises, protecting their economic interests even when market forces signal the inadequacy of the prevailing economic structure.

Javed Hassan

The critical question then arises: what has hindered transformation in Pakistan? Pirzada et al. indicate that the low and declining capital-output ratio is a major contributory factor. They note that “the capital-output ratio has decreased from a peak of 3 at the end of the 1970s to only 1.61 in 2018. In contrast, for the regional economies, the ratio has either increased or remained stable during this period.” This may be attributed to relatively low levels of capital investment in productive capacity by the private sector, exacerbated by the failure to sufficiently enhance human capital given the low level of investment in public goods.

On the scale of the human capital index, data shows that while the level of human capital has increased in Pakistan, it has continued to remain significantly below that of regional economies for the period under consideration. Growth in labor productivity in developing countries comes from the accumulation of physical and human capital, and in both, Pakistan has lagged behind other fast-growing developing countries.

Moreover, for meaningful transformation to occur, economic resources must shift from less productive to more productive activities. However, in Pakistan, economic policies have acted to disincentivize such reallocation. Businesses continue to thrive without investing in productivity enhancement or global competitiveness, as state policies perpetuate them through a combination of protection and subsidies. Unlike in other countries, the cycle of business closures and the emergence of more productive enterprises is notably absent in Pakistan, preventing economic resources from shifting to innovative and globally competitive businesses. In the wake of trade and financial sector liberalization in the 80s and 90s, business closures that should have been unavoidable through price signalling were kept going through fiscal and monetary packages. This policy of perpetuating zombie firms continues to date.

Referencing a large body of academic research, Pirzada et al. suggest that policymakers promote counterproductive policies due to the influence of individuals or groups associated with the ruling elite. Examples from the literature demonstrate how powerful families in Pakistan have lobbied for trade protection measures during crises, protecting their economic interests even when market forces signal the inadequacy of the prevailing economic structure. This persistence of policies that fail to deliver for the masses suggests a deeper issue within the policymaking process, influenced by power dynamics between the governing classes, vested with the power to shape policies to their advantage, and the public who have limited agency to shape their destiny.

In a paper on political transitions, Acemoglu and Robinson (1999) propose a framework shedding light on the relationship between policies benefiting ruling elites and the prevalence of non-democratic institutions. In societies with large gaps between elites and the masses, transitioning from non-democratic to democratic institutions is costly for elites, as it shifts economic resources away from them. The marginalized poor can contest power through political upheaval, potentially forcing elites to democratize. This framework emphasizes that the challenge of resource misallocation in Pakistan is not merely a technical or administrative issue but is deeply intertwined with power relations between ruling elites and the disenfranchised masses.

– Javed Hassan has worked in senior executive positions both in the profit and non-profit sector in Pakistan and internationally. He’s an investment banker by training.