Zombie annihilation: Creative destruction is necessary for Pakistan’s industrial revival

Pakistan's industrial sector is characterized by outdated technology, inefficiency, and heavy reliance on subsidies and protectionist measures. Many industries survive solely due to government support, and few would be able to compete on the global stage if these crutches were removed. This state of affairs not only stifles entrepreneurship and productivity but also perpetuates a cycle of dependence that hampers long-term growth. Economic upheaval may be necessary to catalyze industrial revival. 

Austrian political economist Joseph Schumpeter's ideas on "creative destruction" provide a conceptual framework for understanding this process. He argues that capitalism is inherently dynamic, driven by the constant churn of innovation and obsolescence. In his seminal 1939 work on business cycles, he discusses the role of economic crises in fostering restructuring, suggesting that downturns can shake up existing structures to clear the way for new entrepreneurial activities and creative innovations to emerge. Recession is not merely a destructive force but a necessary precursor to progress.

Numerous subsequent academic references provide evidence and arguments supporting the idea that recessions may facilitate creative destruction at the macroeconomic level. MIT economics professor R. J. Caballero, in his 1994 paper, argues that recessions can have a "cleansing effect" on the economy by eliminating inefficient firms and reallocating resources to more productive uses. This process of creative destruction is essential for sustaining long-term economic growth.

Effectively, Pakistan Inc. is shutting itself out of the vast opportunities offered by the global marketplace. 

Javed Hassan

History supports Schumpeterian insights. The United States and the United Kingdom in the early 1980s underwent severe recessions in the initial phases of their economic transformations, which were followed by sustained economic growth. Similarly, the "Asian Financial Crisis" of the late 1990s had a profound impact on countries like South Korea, Thailand, and Indonesia, triggering a process of creative destruction in their economies. In his 2002 book "Globalization and Its Discontents," Nobel laureate Joseph Stiglitz argues that the crisis exposed weaknesses in the financial systems of affected countries but also facilitated reforms and restructuring of many industries that promoted greater efficiency and resilience in the long run.

Pakistan’s industrial landscape is plagued by a lack of dynamism and entrepreneurial spirit – a natural consequence of operating in an ecosystem that incentivizes rent-seeking. Through import tariff protection, licensing requirements, input subsidies, concessionary financing, and regulatory control, a plethora of entry and exit barriers ensure that most of the manufacturing sector is dominated by select business groups. State intervention to shield the profitability of incumbent players not only results in artificially high prices for consumers but also creates an uncompetitive environment in which Pakistani producers are unable and unwilling to compete internationally. Effectively, Pakistan Inc. is shutting itself out of the vast opportunities offered by the global marketplace. According to the 2020 World Bank report on improving trade, Pakistan, comprising 2.6% of the global population, contributes less than 0.4% and 0.11% of the share of global GDP and exports, respectively.

Consider the automotive sector. Despite having benefited from over 50% effective rates of protection in favor of locally assembled vehicles for several decades, the sector has failed to develop state-of-the-art production capabilities or a market size necessary for economies of scale to be internationally competitive. Although policies were meant to encourage investments in capacity and technology that should have led to improved affordability and quality for consumers, the local assemblers singularly failed to do so. 

Countries specialize in different stages of supply in the global value chain (GVC), making it impossible to say where a car is manufactured. Data suggests Pakistan is likely to have a comparative advantage in manufacturing auto parts for the GVC. A policy that focuses on sub-sectors rather than favoring vehicle assemblage may be better suited toward achieving consumer welfare as well as increasing industrial capabilities and integrating with global markets. However, this would mean that sector incumbents may have to exit. This would also apply to other industries such as sugar, steel, chemicals, paper, petroleum, and textiles.

According to the Federal Board of Revenue (FBR) 2021 report “Zombie Firms in Pakistan and Tax Revenue Drag,” approximately 25% of the companies in Pakistan do not generate enough profits to cover their interest payments and only survive by repeatedly refinancing their loans. Of these, roughly 47% are in textiles, 19% in chemicals, and 10% in the cement sector. The report estimates that “roughly US$3 billion short-term bank credit flows to these firms annually,” presumably to continue their operations. 

The closure of zombie and other firms that cannot survive without state support will be painful, causing job losses and economic dislocation. However, the freeing up of resources and their reallocation to more productive businesses would also create opportunities for new entrants and innovative business models to emerge. Ultimately, embracing creative destruction requires courage and vision from policymakers, but the potential benefits – including a more competitive industrial sector, greater innovation, and higher long-term growth – make it a risk worth taking. 

– 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.

Twitter: @javedhassan