Pakistan's import duties are, in effect, export taxes

स्वागत है अमितिनाज रात. Welcome back to another episode of Thought Bands Things. आज की episode जो है वह मैं आपको पहले ही बता दूंगी. It's going to be in English because we have a guest who is from Uruguay and he's currently serving as a senior economist leading the trade program of the World Bank in Pakistan. We have Gonzalo Varela with us. Sir, is that the correct pronunciation? That's the correct pronunciation. Thank you so much for being part of the show. Thank you for the invitation. Okay, mister Gonzalo. I'm gonna gonna start off the conversation. We're just trying to understand how'd you how'd you end up being a senior economist for the World Bank? Like, what's the journey been?

Well, so I started studying economics with, quite a defined interest in, the challenge of development of countries, right? So how countries get to develop, how the income, so the population get to grow. And, I, well, I did a degree in Uruguay and then I moved to The UK to do a PhD, where I studied how, a particular type of uncertainty that relates to, to how the real exchange rate frequently moves and so creates, uncertainty for, for agents, how it affects, production decisions. Right. And this is something that is very important for, for development because in developing countries there's much more uncertainty. So understanding the challenges that are associated with uncertainty and the channels that link uncertainty with production decisions and therefore with output growth, and therefore with incomes and job creation is something that is quite important. So I was doing my PhD and then I got approached by the World Bank to work on a specific assignment, in Indonesia at that time. And I took a summer off from my PhD, went to Indonesia, worked on that, and got very excited about the prospect of a career in development in the World Bank. The World Bank probably is one of the, if not the best place to work in development, one of the best. And so when I had the opportunity, when I finished the PhD, I started, working for the bank first in the global trade unit. That is a unit that looks at trade issues without a specific country focus, so, you know, across the across the world. Right. And then I moved into more country specific type of engagements,

and I ended up in Pakistan actually, working on trade. Very cool, very cool. You mentioned the real exchange rate, and I feel like that is something that's really missed in Pakistan, for for for for most people. What's the difference between a real exchange rate and the exchange rate that we see? Is that isn't that the real exchange rate essentially? Well, the exchange rate,

basically is is in the case of Pakistan. The exchange rate now is at a 171 to one. What does that mean? It means that if you put $1 on the table, someone will come with a 171 rupees and we'll give you a 171 rupees for for the dollar. Right? It's basically the price of the dollar expressed in in in domestic currency. Right. Now, the the evolution of the exchange rate tells you many things. For example, it tells you, what is happening with the price of imported things. When the dollar becomes more expensive, then Imports become more expensive, become more expensive. But what the real part adds is basically, it adds how, the evolution of the, of the, of the nominal exchange rate, of that normal exchange rate I mentioned, a 171 rupees to the dollar in the case of Pakistan, how the evolution of domestic prices affect that parity. Right? So say, for example, if, if domestic prices are growing a lot. Right. Right? And also the price of the dollar, in Pakistan increases a lot, then, it may also be that the wages of people are also growing at the same rate. Right. And so import prices from the perspective of the purchasing power of Pakistanis are not changing in real terms. So they are changing in nominal terms. So you go to the shop and instead of paying, say, a 150 rupee for something that, before costed $1, now you have to pay a 171. Right. So that's a 20 rupee extra that you have to pay, but perhaps your salary also increased by 20 rupees extra, right? Right. So what... The the important thing when one looks at how exchange rates affect, real decisions, the decisions of firms to produce, or to import or export. That is affected by the real exchange rate, so by by the price of the rupee or the price of the dollar in rupees relative to what is happening with prices

in in the domestic economy. Right. And I think that's, because recently this was, like, a part of a big debate. We saw the dollars just sort of, I mean, slipping away, went up to a 175 before sort of coming back to a 171. And I know that you're you have a you have a core focus on exports and trying to understand, you know, how exports sort of help in developing, economies like Pakistan. I know that you guys recently came out with a report as well. You know, the World Bank came out with a very detailed report. Can you tell us a little bit about that report? Yes, yes.

So we just released, last Thursday actually the Pakistan development update, the fall issue for 2021. We had an issue in spring that was released in April. This is the fall issue. And this is basically a macro update that tells us a little bit of what is happening in the economy, what do we expect, what the outlook is for the economy. But it has specific focus in this case. There is a focus on reviving exports. Right. And, as I lead the trade, the trade engagement of the World Bank with Pakistan, that was a focus I work quite, quite a lot on. The re exchange rate actually is a, is a very important determinant of reviving exports. One wants so if you talk to exporters, exporters look quite closely at what is happening with, with the exchange rate because it's a crucial element in their profitability, Changes in the exchange rate make them one day profitable, another day, not profitable. They really pay attention to what is happening with that variable. Do

you think dollar getting more expensive is essentially harmful for the economy? Or is that, like, an arbitrary thing and it entirely depends on the underlying indicators?

Well, the price of the dollar affects many things. I cannot possibly answer that question with a single answer. So for example, the, when the dollar gets more expensive, exporters get happier, right? Because their costs are mainly in rupees. Right. But their, the price they get, so their profits are mostly associated with... The revenues are associated with the price of the dollar. So they get more rupees per dollar, they can pay the salaries of their workers and keep a larger share. The profits increase when the dollar... When the currency depreciates, right? When the dollar becomes more expensive. So for exporters, a depreciated rupee is good news. Okay. As long as domestic prices don't grow too much, right? Because remember, it's real that matters. Right. But but the story doesn't end there, right? So the the the evolution of exchange rate also determines, for example, the burden of the debt of a country. Right. The country has an important portion of that debt denominated in dollars. So Pakistan, for example, is is is a country that get gets most of its revenues in in rupees because tax the tax base is in rupees. Right. But if it has to serve a lot of the debt, in dollars, then it will have a mismatch of currencies there. Your income, is in rupee, but part of your outflows are in dollar. So in that respect, a dollar increases the burden of... Increases the price of the dollar, increases the burden of the debt. There's also an impact that a depreciation of the, rupee has on inflation because, of course, it affects import prices, and through import prices, it affects the prices of many things. Right. So Particularly like energy, for example, because that's everything that we're importing, right? Food prices. Right. The price of any tradable good, of any good that is traded or could potentially be traded, is going to be affected by the, by the exchange rate. And so if, if you have, you know, a rapid depreciation, then that's going to translate to some extent into what is happening with inflation. So that affects the purchasing power of people that have fixed incomes, right? Affects negatively the purchasing power of people that have a salary that is fixed and won't change, very frequently. Right. So as you see, the, the exchange rate has very different impacts on different variables. So it's, it's difficult to, to tell, you know, overall whether it's What, a burden lemak or what we know from evidence, from, you know, from empirical evidence that looks at developing countries is that typically, not always, but typically, a depreciation of the re exchange rate is going to be in the long term good for growth. Right. So there's a paper, written by Danny Roderick that is a leading, economic... Development economist from Turkey actually, but lives in The US and works in Harvard. That actually shows how countries that have a relatively depreciated currency for long periods are countries that typically are going to end up growing faster in developing countries, right? Focusing on developing countries. And why is that? Because a depreciated currency makes more resources be allocated into tradable sectors, into exportable sectors, because it increases the profitability of exports, and so the export sector expands in the economy, consumption shrinks. So you tilt the growth model to a model in which exports play a larger role than consumption in explaining growth. Right. And the export sector tends to be more dynamic, and therefore you end up growing faster. So this an empirical regularity that Roderick unveiled in this paper in 2008, and I think it holds, it may also hold in, for the case of Pakistan, right? It's it's sort of a push to get more firms looking at the external sector, external markets, rather than looking inwards, with associated long term gains on productivity, right? Firms when they look more outwards than inwards, they end up learning more. Right. Their efficiency increases, and so in the long term they create more and better jobs,

wages increase. It's it's it's tends to be good news for for the So just to just to sort of put put that into context, my understanding, what you're essentially saying is that if, for example, if a country is come if if a company is looking to invest in Pakistan, stable in exchange rate, they will most likely be investing in a inward, sort of business where they're saying, you know, we're creating products for the consumers within the country, and they're gonna going to consume it, and we can take the profits out. If the money is being depreciated, the numbers would not make that much sense for them to be selling in PKR and then taking the profits out. They would rather invest in areas which would be export driven because that is all dollar denominated. Is that correct? Well, let's put it this way. If

the if an economy has an artificially high exchange rate, so a relatively appreciated rupee. Right. Yeah? Artificially held, right, by some intervention of a central bank. Right. It's likely that the type of investment it attracts is in non trade, in the non tradable sector because the tradable sector is not very profitable in that economy. Right? Because it's more profitable to import things rather than to produce them at home. Right. Yeah? So then the type of investment you're going to get is an investment focusing on the non tradable sector. If instead you have a more depreciated currency, you're likely to attract the type of investment that will focus on producing Producing things, right. Producing things at home and selling them at home or abroad. Right. Because that's going to be more profitable. Right. That tends to be associated with faster productivity growth. Right? I'm not saying that depreciated currencies are good for everyone because they are not good for everyone. There are, for, for consumers, you know, they're, on a fixed income, their incomes shrink. For, governments that have debt in foreign currency, their burden increases. But in the long term, for allocating resources, it's something that we'll tend to allocate resources into tradables, particularly into the export sector, which tends to be associated with faster growth. Makes sense.

I'm just gonna, you know, quickly sort of, get your comment on the the exchange rate in the past decade if you've seen the data in Pakistan. So it's been very random. Right? We were at 65 for the longest time, and, suddenly, we went from 65 to a 100. Then we were at a 100 for the longest time, and then suddenly we went from a 100 to a 150, and then from a 150. Slowly and steadily, we've, you know, raised our way through the through 270. And based on the understanding of the real exchange rate, can you tell us a little bit about what what's been going on over the last decade or so, in terms of the the way that the the the the currency has sort of evolved?

Right. So you you probably can break this this period. Right? The last ten years, you can break it in two, and you could say, well, what was happening before 2018, twin when there was a substantial depreciation? A move to a to a competitively priced Right. Currency. Right? So the State Bank, Pakistan moved to a regime in which we can say that we have a a float or a managed float, right? But basically, it's a It's like a free market sort of a It's sort of a free market, right? In which, there may or may not be interventions to control volatility of changes.

But essentially

demand and supply and, you know. Exactly. Right. Exactly. Before then, there was, let's say the exchange rate was preserved at a certain level, the nominal. And because prices kept on growing, what happened was that the real exchange rate, right, that takes into account not only the nominal but also the prices, ended up appreciating. So that means that imports became cheaper gradually and exports became, more, more difficult to, to compete internationally, right? Because domestic costs for exporters were growing, but whatever whooping they were getting for the dollar they exported, they were not changing. They were sort of fixed. Right? Right. So what that did was it eroded, to a large extent, the capacity of the export sector in Pakistan. So if you look at what happened with the export orientation of the country as a whole, right? So we moved from having about 16% of GDP explained by exports in 2000, to have today less than 10% explained by exports. And to a large extent or to a substantial extent, that decline, has been encouraged, right, by an appreciation exchange rate during three, four, five years, quite sustained that it ordered the profitability of the export sector and turned the economy more into a, consumption based it's cheaper, it was cheaper to buy imported products, and it was less convenient to export. That that element, so that the fact that that that the export sector lost competitiveness for for a long period of time had long term implications. And and I can tell you a little bit more why I'm saying this. There is a lot of discussion, and I I see it in the press a lot. And I come from a country, and and from a region. In Latin America, the exporters pay a lot of attention to exchange rate. They are constantly talking about exchange rates, and, and newspapers are constantly... The exchange rate is something that is in the, in the newspapers all the time. Right. And when I came here, I kept hearing, exports in Pakistan are not sensitive to, to the exchange rate. So a depreciation of the rupee is not gonna do anything, particularly when I was coming at the beginning in 2017, that I was coming on on on short assignments. And there was this discussion, should they, should, you know, should they let the the the currency freely float? Right. And they'll say, you know, the the the experts are not going to react. Experts are insensitive to to exchange rates. So one of the things I I did when I moved in here and I I had a little bit more time to look at these things in detail, was okay, let's let's look at the data and see what what is happening. And what we unveiled in a in a paper that actually I can I can then share share with you the the the reference so you can you can add it? One thing that we saw is, in the long term, Pakistani exports are sensitive to the exchange rate just like everywhere else in the world. Right. Just like Econ 101 tells us. A 1% depreciation of the rupee, in real terms, increases exports by half a percentage point. A 1% appreciation in real terms of the rupee decreases exports by 0.5%.

And and and that's like...

There's a there's a study and there's a paper on that. There's a paper on that, yes. Very interesting. And we have it in our PDU, also in our Pakistan development update. But the interesting thing happens when in the short term so, as I said before, in the long term, this relationship is out there. It happens. Exchange rates and exports are linked. In the short term, what happens is something different, is that exports fall very fast when the exchange rate appreciates. So when the rupee becomes stronger against the dollar, right? Then it's cheaper to import, it's more costly to export. Then exports react very fast to that. So exporters lose markets, right? They lose global buyers because they are not competitive anymore. Reaction? Quite fast. Right. But when the exchange rate depreciates, right? The of exports is lower. Right. Right? So, why is that? And and we hear a lot about the, oh, there's no export surplus in Pakistan. So we looked at we looked into this, and we found three things that, that are quite interesting. The first one is the exports of what we call, in economics, homogenous goods react fast, react quickly. But the exports of differentiated goods don't. What is a homogenous good? A homogenous good is, say, for example, rice, is wheat. Right. It is traded in an organized market, right? With a reference price. So we know what the international price for basmati rice is. Exporters of basmati rice want to go and sell it. There's an organized market. It's relatively straightforward. Do many things to be able to export successfully, of course, but the rice is the basmati rice is clearly defined what we're talking about. Same with wheat. Mangos perhaps, Right. So those ones, exchange rate depreciates, they export more. Right. Differentiated goods are goods that are not so standard, right? So it could be, for example, this cup. Right. This cup is a differentiated good. In some countries, this cup, needs to be bigger than this. So the Americans like to drink in big cups, perhaps the Europeans like smaller cups. They may like a different color than this one or they may like, the the the this handle here to be somewhere else, right? So you need to tailor the product to the needs of the client. Right. So that means that if your opportunity to export improves because now the rupee is depreciated so low aside you're profitable, it's not that you start selling these mugs anywhere you want. You need to go find a client, discuss with your client how is it that their clients are going to like this mug, and tailor the product to their preferences. Decide how you're gonna price this. It's not like rice, there's a fixed price, right? And all of that takes time and effort. Right? Takes, what we call market intelligence, and getting that market intelligence takes money. Right. Yeah? So exporters need to get this market intelligence, need to invest in that, and so their, their capacity to react to an improvement in relative prices, in this case a depreciation exchange rate, is going to be slower. They're going to take longer. The second thing we find in this analysis is something that you're going to say this is obvious. It is. That is, if you don't get credit, you won't be able to expand. So the rupee depreciates, all of a sudden your export product's more profitable. But you don't have the money to invest. You can't invest. You can't buy the machinery you need to scale up. Right. Right? And so if you don't have credit, you won't be able to scale up. But, know, as the personal trainer say, no, no pain, no gain. In this case, it's no credit, no gain. Right? Right. If you don't get credit, no gain. So that's why we see that sectors that have access to credit react much faster. Right. Sectors that don't, don't react fast. And the third thing is related to the fact that, Pakistani exporters are quite small in the international picture. So let me give you a a number. What we see is that on average, a firm, an exporter of Pakistan, exports in a year $1,400,000 on average. An exporter of Bangladesh exports about $3,800,000. So that gives us an idea that exporters out of Pakistan are small. Right. If you do a a more thorough, analysis, a comparison, you see that Pakistani exporters are at the bottom of the distribution in terms of size. And so what happens when you're small? What happens, what happens when you're small is that you have global buyers that are going to have power to bargain with you. Yeah? Right. And these global buyers are larger. And so when they see that the rupee depreciates, they see, oh, that means that this exporter is making more profit, so I'm going to take some of these profits. If the market was competitive and everyone was the same size, they couldn't do that because the Pakistan exporter would say, I'll choose another global buyer, right? I don't want you But to take some of my because the market is not that competitive, global buyers are large and not many, and Pakistani exporters are more and smaller, then the global buyer takes some of these profits, eats some of these, profits away. It's called, in in economics, it's called pricing to market. So the global buyer prices whatever they are paying for the input in different markets at different prices, right? Depending on the conditions. So these three things, the fact that you need to pay for information to be able to market your products, the fact that you need credit to expand, and the fact that you're small and so they eat up some of the profits that the, that the depreciation gives you determines that exports of Pakistan react slowly to depreciations and fast to appreciations. And this is why people say, oh, Pakistani exports won't grow with a depreciation. They will, but very slowly. Will take time. Will take time. Right.

In this same breath, and you you talked a lot about, you know, import led economy or or consumption economy where, you know, the rupee was essentially made to be stable, and and so import was essentially subsidized or or made more competitive. Right? When we look at Pakistan, we every every single time, almost every year, we're looking at a balance of payment crisis. We're looking at, you know, some sort of, like, a trade deficit. We're looking at much, much more much, much higher imports versus the amount, you know, amount amount of, products that we're exporting, essentially. Why is it so important for for that for for the exports to and and and imports to have parity, essentially? Or or rather, is it important to begin with? Like, is it is it okay for a country? I mean, when you look at The US, they also have a balance of payment crisis or, or have, like, a huge, you know, debt to to manage. So why is it that Pakistan or a country like Pakistan seems to have to go to, like, some sort of, like, a creditor every few years and and and try to bail out the economy.

When you when you study economics, the first thing you need to be able to do to pass the the the exams and and get the degree is to learn to answer any question with it depends. Right. So is it good to, is it good to run a, a trade deficit or a trade surplus or to have a balanced trade? It depends. Right. So that's, that's... The short answer is it depends. So say for example, if you're a young economy that is growing fast. Right. It's receiving a lot of foreign direct investment. It's very likely that you're importing a lot of capital equipment, machinery. Right. Right? You're building domestic capacity, and so you're running a trade deficit. Right? So you're importing more than what you're exporting, and that gap is financed because you're receiving all this foreign direct investment. Right. Or it's financed because investors look at this economy that is growing so fast, and it's looking so good that they decide to buy bonds of this, of this country and, you know, finance that, that, that difference. So in that case, that trade deficit is actually, if anything, is a sign of a healthy economy, right? In a country in which what you see is that investment is not very high, and and and most of, of these imports are explained by high consumption patterns. Then perhaps that trade deficit is a little bit more, complicated to sustain in the sense of, it's more difficult to get investors to to pay for that deficit. At the end of the day, what the trade deficit is showing is that, that that there is more demand for dollars than there is supply of dollars, right? Because the demand for dollars comes from the importers that want to buy imports and supply of dollars from the exporters that get the dollars, right, when they sell. Right. And someone needs to give you that difference. Right. Right? So if you have someone that is willing to give you that difference in a way that is sustainable in the wrong, long run for the economy, say, foreign direct investment, right? It's associated with faster growth in the future, then you're happy with that. If instead it's difficult to get these dollars, or these dollars come at a really high, interest rate, for example, then that trade deficit is a little bit more problematic. So I, I don't want to say much about The U. S. Trade deficit, but one thing that, that we know is that The U. S. Economy is among the, is the largest economy in the world, and so it, it gives a little bit of, of confidence to investors, right, that, It can sustain this amount of debt. We'll sustain that amount of debt, right? Let's say Australia is in our, in our case, yeah, It has run an endemic trade deficit, but investors are happy to continue investing in Australia. Right?

So, when it comes to exports particularly, and and and and with imports, we we did see I mean, we've seen the the you know, there there has been, particularly with CPAC, there was a lot of foreign direct investment coming in and machineries coming in. So there was that sort of a deficit as well. But then we also saw there was, at a time, we had a very hugely consumption led economy. And so, essentially, we were just importing stuff, and we were just going poofing in in the air, and it wasn't really producing anything in the long run for us. And so imports, I feel like, at this point in time, even people have that understanding where they're like, okay. Consumption based goods that are imported, maybe we can't afford that right now. But in terms of exports, we haven't seen a very major change over the last, I would say, two decades. You know? As a matter of fact, if anything, we've seen, you know, textile exports falling at at in certain times as well. And then it's just, like, been textile or surgical goods. Like, we've been I've growing up in this country, you know, that's all I've heard. You know? We have surgical goods or sports goods or or textile, and that's pretty much it. Some some agriculture here or there, but that's it. What has stopped considering, particularly in this region if you look at it, you know, India or Vietnam or Bangladesh, you know, countries have been doing a remarkable job, in terms of and and we've all heard China story as well, in terms of diversifying, in terms of really sort of being a part of the global economy. But with Pakistan, unfortunately, we haven't been able to see that same growth take shape. What are what are some of the major reasons, in in your opinion?

Let me mention one, or let me say let me start by saying it's self inflicted. Right? Okay. So the the the fact that export competitiveness, has has faded is is is completely self inflicted, and let me tell you why I think it's self inflicted. Basically, this country is among the most protected countries in the world. Okay. Import duties come in three different flavors. There is something called a customs duty. On top of that, there is a regulatory duty, and on top of that, there's an additional customs duty. Right. If you add them up, right, that's the total import duty. On average, they are at 20%, and that places Pakistan among the top five most protected economies in the world. Right. These high import duties are not for a specific type of product, they are across the board. So import duties are high when you look at consumer goods, particularly high, very high. But they are also high when you look at machinery equipment, and they are also high when you look at intermediates. Right? So import duties are high. It's not just that they're high, it's that their structure is particularly tilted against exports. So the the structure of import duties introduce an anti export bias. And you may be thinking, he's talking about import duties. What does this have to do with exports? I'll get there in a minute. But basically, what is the structure import duties in Pakistan? Well, Pakistan applies something that in trade is called cascading of tariffs. That is, the tariff is much higher on the final good than it is on the intermediate or raw material that you need to produce it. This is the case in most countries in the world. Most countries in the world have a cascading tariff structure. Why? Because what you want to do is you want to incentivize firms to industrialize, to produce things at home. And so you say, okay, fine, you can import the intermediates and raw materials at a relatively low tariff, yeah? But I'm going to protect you from import competition on the final good, yeah? So if you need the ceramic to produce this mug, you can import it at a low tariff. Right? But I'm going to put a high enough tariff on the mug itself so you're protected. So we call that effective protection. Protection that takes into account the tariff on the final good, but also the tariff on the intermediates you need to produce it. In terms of effective protection, Pakistan has the second highest in the world rates of effective protection. What do these do to export competitiveness? Well, it does the following. High effective protection means that you're giving me so if you're putting the effective protection, I'm the domestic firm, I have two options, right? One option is I can sell domestically, the other option is I can get all this headache of exporting. Right. You're giving me such a comfortable domestic market, protected Right. Right? From international competition that for me the option is very clear. Even if you if you didn't give me any effective protection, In general, firms are more comfortable selling at home because the home market is much more, it's easier to reach. Right? Transport costs but also cultural preferences, you know? They know what products their customers like. Right. So even if they guarantee and do anything, firms are going to prefer first to sell domestic. But with high effective protection, what happens is that for firms is a nonstarter. Of course, they're going to sell domestically. And so, exporting becomes only a residual option for firms because it's so profitable to sell in the domestic market. And there's even from a semantics point of view. Pakistan, they talk about export surplus. Yeah. So this is something I never heard elsewhere, right? So I never heard elsewhere people talking about export surplus. So I... Whenever they talk about export surplus, what is this? So I went to the dictionary. The Oxford dictionary defines export surplus as the difference between exports and imports. It's net exports. In Pakistan, doesn't mean that. In Pakistan, export surplus means whatever you produce and you don't sell domestically, right? And the domestic market doesn't absorb. That's the export surplus. It's the rest, right? It's the residual option. Right. And the fact that it's mentioned that way is consistent with a, a tariff structure, right, that is anti export. So the the high import duties are essentially and implicitly high export duties. So they are the duties are placed on are levied on imports, but their effects

are on the cherrying exports. So if, for example, just to, so when you mentioned let's let's look at the example of a mug. What you're essentially saying is that if if the government reduces the tariff on the raw material, the ceramic, and increases the tariff on the mug, it's still not going to increase the exports?

It's going to increase domestic production probably. It's going to increase the profits of the magmaker,

right? Right. But it's not necessarily going to reflect on the exports?

It will certainly not show in the exports. In fact, if anything, it will show negatively on the exports because this magmaker will receive a much higher price domestically. Because domestically, the price is going to be whatever the international price is plus the import duty on the mag. Right. Right? Because any producer abroad will not be able to penetrate the domestic market in Pakistan at a price lower than that. It's the international price plus this duty. Right. Okay? So that gives margin. That gives a lot of space for the producer domestically to sell at at that high price or a little bit below perhaps. Right? But that's sort of the the the minimum,

that that that an import an imported bank will cost. Right. And it's also going to... Essentially, going to incentivize smuggling or or or trying to evade all sorts of duties or whatever as well in my hands. That's true. It will incentivize smuggling.

But even in a world without smuggling, and and you're right, it will incentivize smuggling. But even in a world without smuggling, even if you could perfectly enforce your border controls, right? Even in that case, the high import duty creates extra profits for the domestic firm that chooses to sell domestically. And so it increases incentives to focus on the domestic market at the expense of the foreign market. Right. And this is why import duties are called import duties, but for all purposes, they are export taxes.

Right. And so if I understand this correctly, and it's a lot of things to process. But if I understand this correctly, what you're essentially saying is that we're doing we've always been doing two things very, very wrong. The right metric to give export competitiveness is actually the currency or the free float of the currency where the demand and supply will define the price of the of the currency essentially, not protecting it through tariffs. Is that correct? Because government has tried to sort of protect the local export industry, but not through, you know, letting the currency incentivize them, but rather... Yep. Tariffs only protect

the producer that chooses the domestic market. Tariffs don't protect the exporter. They actually deter their Exporter. Their incentive to export. Right? They reduce their incentive to export. What the tariff does is it impedes competition, right, impedes innovation, and makes firms focus on a protected domestic market. That's what tariffs do. Instead, you're right, a depreciated currency, again, and remember what we were discussing in the beginning. That's many other things. Right? So I'm not saying that it's, is what we want. I'm I'm just saying from the export import point of view, what a depreciated currency does is it makes imports more expensive. Right? Right. And it makes exports cheaper. Right. More competitive. So so it's more likely that a trade deficit will be, corrected with a depreciation of currency than with import duties increasing. Because the import duties increasing, yes, increase the, the import price paid at, you know, domestically, but it also introduces this anti export

bias. Right. Right? Right. Makes a lot of sense. In in your analysis, have you seen ample amounts of investment at least ever since we've sort of have, like, had, like, a free float market or or a floating exchange rate? Since since 2018, I believe. Right? Mhmm. Have you seen investment going into the to to the export sector even if, you know, like you said, it takes a while to sort of reflect? But have we seen any, you know, essentially positive early signs that could that could say, you know, maybe we might be seeing some sort of a growth in the coming years in the export sector? So most of the FDI that Pakistan receives... So if one focuses on the foreign investment, right? There's also domestic investment that is actually more

substantive, no? But if one focuses on foreign direct investment, most of the foreign direct investment focuses on on on what we call market seeking investments. So investment that looks into selling in the in the domestic market rather than using Pakistan as an export platform. Right. There are exceptions, of course. But, in fact, we're we're we're in the process of of doing analysis on this, one of the things that we see is that most FDI, is is is is in in the market seeking segments, right? Exploiting domestic rather than export, market. And so the thing is all of this is, you know, the the challenge with exporting or development in general is is is a combination of many things that interact. So, yes, you need a you need a competitively priced currency, but you also need less cascading. So you also need import duties that are lower. Right. If you keep the import duties very high, you will continue to attract FDI that is market seeking. Right. Right? That it will not use Pakistan as a platform for exporting, that it will exploit the fact that markets are very protected in Pakistan. And so it will come, set shop in Pakistan and take advantage of the high protection. So we still see that trend, that most of the investment received focuses on the domestic market rather than on building a platform for exporting.

Right. You know, one of the things that particularly, you know, a lot of, commentators in Pakistan are are aiming for in the coming years, what they're saying is, you China obviously has is now going more towards high value goods. They have an aging population, and so they they need they have a smaller amount of people who can work and and a larger population that they need to sustain. And so, automatically, some of the lower value goods that they're still looking to export in in Africa, for example, in in Middle East, they can't afford to, sort of produce anymore. Like, it's it's become too expensive for them. And what they're saying is, okay. So in Pakistan, you have this huge youth population that's essentially, you know, a large part of that is jobless or at least jobless in a way that not really high value production or or in their own relative context. And they're saying, you know, maybe a lot of this industry might be able to they they might be able to move that to Pakistan, which is export focused. So we saw, I do believe there is within the Faeslabad Industrial Zone, there were a couple of these, like, ceramic, tile companies and tire companies. And and even, you know, we recently heard of, phones that were assembled in Pakistan that were eventually exported to to the Middle East. Do you think if we look at, you know, that that could actually potentially prove beneficial, for for Pakistan's economy? Do you think the the variables here do not make sense or the fundamentals don't make sense for something like this to happen?

I I I think they they they make sense to some extent. So I I think Pakistan is already gaining from these shifts that we see, in production structures in China, and it will continue to benefit, right? So I'll give you one example, what is happening with denim. So denim exports out of Pakistan are growing substantially. And if you look at, if you look at imports, for example, from The United States, and, and you look at the composition, who are the exporters? And you see that exports out of China to, The US are growing by very, like, single digits, and exports out of Pakistan to The U. S. Or Denmark were growing at 60% in the first quarter, right? Right. Of this, of this year. If you talk to Denim producers, exporters, they are telling, they are going to tell you that they're close to full capacity. And and to a large extent, this is because there has been some reorientation. Right? So global buyers that are not buying from China more because China is doing something else. So certainly, Pakistan will take advantage of of these shifts, and it should pay a lot of attention actually to these shifts. And, from an investment promotion point of view, I think the board of investment, should be looking at how is it that they're going to get all these firms to come into Pakistan and do it. But what we know, you know, when you think about development is as countries develop, they they keep adding more products into their baskets. Right? So it's not that they change and say, okay, now instead of exporting denim, I'm going to export, space rockets. No, it doesn't happen that way, right? You continue exporting denim, but you start adding things that are more sophisticated. And so I think it's also important that Pakistan looks ahead and thinks, okay, what is, what is coming? Right? What are the new sectors that are coming? And what is the infrastructure that is needed to attract investments in these sectors? And how can we bring pioneers

into into Pakistan? I think that's, so that was definitely gonna be my next question as well, and it's nice that you ended with it with that. Obviously, when you're looking at, particularly, you know, you're looking at trade, If you're looking at it in a in a Pakistani context, you're also looking at the world. Right? If I were to ask you, you know, what do you understand in terms of you've been here for two years? You've been able to see the industry, seen the infrastructure, seen, the capability, you know, what we do have locally and what we don't have maybe. And so in terms of potential, how would I put it? You know, potential opportunities for Pakistan to grow in different sectors. So beyond the textile and the and the sporting goods and the surgical, are there any new areas where we might, a decade from now, see that, oh, you know, Pakistan grew rapidly if all things go perfectly as they should? What are the opportunities in the in the overall export realm globally, that Pakistan could easily sort of like a low hanging fruit that Pakistan could benefit from? So,

look, there there's there's you can think about this in two ways. So one way is the way you you put it. What are the new sectors perhaps that that can be, coming up? And I'll get to that in a minute. But let me first twist your question around a little bit because I think it'll be interesting to think not so much, about new sectors, but what if we think about new ways of doing things? Right. The same things, but in new ways. And and I'll tell you where I'm going with this. So, for example, the the the garment sector, Pakistan has a comparative advantage, right? And it will continue having a comparative advantage, and it creates a lot of jobs. And you still want these jobs to be there, but you want them to be better paid and you want them to adapt to the new, developments that are happening. And one thing that is coming, and it's here already, but it's coming at a high, at a is, fast climate change.

With climate change a good question.

With climate change, one of the things that we see is that sectors will need to start decarbonizing to be able to be competitive. And when I say competitive is to be, demanded by clients. Right. So there there are two parts of this story. One one point is actually, you know, reducing the the pace of of climate change. That is a substantial point. The other point is a demand point. Right. Consumers more and more want products,

that That have a low carbon footprint. That have a low carbon footprint.

So the most important thing for the the export sector in Pakistan, the production in general, the productive sector, but the export sector in particular. Yeah. Yeah. So I was just looking at the COP twenty six, and and Enteroop has done a great job. Oh. Exactly. Oh, wow. Exactly. Right. Right. Right. Right. And and so one of the things that you want is you want the private sector and the public sector to start thinking together. How are we going to move into decarbonization? And how are we going to certify our products that we can get the higher price in international markets and so that we can avoid the, the, the carbon border, the, the carbon tax, right? The, border adjustment that will likely happen sooner or later, that developed countries will start imposing to avoid this carbon leakage, right, story. So to get higher prices, to avoid paying the carbon tax in in in export markets, the private sector needs to start thinking very they are already doing it, but but we need more of that. And so perhaps rather than thinking only about new sectors, let's also think about how the old sectors can become new sources of growth, upgrade in terms of, you know, environmental sustainability that also ends up being an upgrade in terms of the price you get. So that's one part of the story. Right. The other part of the story is more directly related to what you were asking. What are the sectors, that are upcoming? And there, one thing that sometimes, we we we sort of overlook is the the knowledge intensive services exports that come out of Pakistan that are growing very fast and that are, sometimes overlooked and and in part hidden because of problems with statistics. Right? When I say knowledge intensive services experts, I mean software developers. I mean architects or engineers that sell their products abroad. All of this was, you know, it became sort of the talk of the town with the pandemic, with the COVID-nineteen pandemic because of telework. So people in The US realized that actually they didn't need to have their supplier, you know, whenever it's next door. They could have it in Pakistan or somewhere else. Right. But if you look at the data, it was happening far before COVID, Outsourcing has been happening for farther Right? Part of So if you look at the last fifteen years, if you look at the services export bundle of Pakistan, in fiscal year, six, so in twenty fifteen-sixteen, sorry, February, exports of knowledge intensive, services were 10% of services experts. Today, they are 50% of services experts. Right? So as a sector that's growing, it's a sector that that is combining dynamism with quality upgrading. Right? And it's a sector that will continue in there. So policymakers need to look at how, a, you attract investment so that it's not just freelancers. It's great that you have a lot of freelancers, but also the big companies coming in. Right. Right? And and leveraging low labor costs and and and skills that are available in the market. That you give them the freedom to move money in and out of Pakistan. Because if you cannot move money out, you will not bring it in. Right? Right. And that's a problem, and that's why, a lot of these services experts are underreported because the money doesn't end up coming in, right? It stays in Dubai or stays in accounts elsewhere. So that's a sector that is going to be increasingly, more relevant and that it employs a lot of people in different skills levels, right? So we a lot of the outsourcing happens at relatively low skills. A lot of the outsourcing happens at really high skills, right? So that that is coming. And then the other thing that should be considered very seriously is taking advantage of the China Pakistan free trade agreement. Pakistan, doesn't have many free trade agreements or preferential trade agreements. The one that it has that is comprehensive is with China. And I think a lot of, low hanging fruit is in taking more advantage of that agreement, integrating a little bit more in a regional value chain with Chinese firms. And that will require support from the public sector also, support to firms, particularly to smaller firms, that could be taken advantage of those preferences and currently are not because they know much about the market, and, and and they could they could actually profit quite a lot. So three things. Doing things in a different way. Reducing carbon footprint, advertising it, and certifying that so that you can get a higher price, you can jump the taxes that are that are going to come very soon. Second, services, and particularly knowledge intensive services. And third, take advantage of China as a as a as a growth pole and embrace that

link. Right. Right. Gonzalo, this is extremely insightful. Thank you so much for for for sharing all of that detail. If I if I were to for the for the consumers, if they had have to check out this report, what's the easiest way to find it? So if you if you Google,

Pakistan development update 2021 reviving exports, you get to the link. Right? So we have in our in our website,

is is right there. Awesome. And and, Fazan, if you could just link that in the description below as well, I think that'd be great as well. Could just sort of give them directly. Gonzalo, thank you so much for coming in, taking the time out, you know, sharing all that insight. The economy certainly makes so much more sense to me now, on what's going on and and and what are the major things that we need to do in the coming years, particularly for a lot of young people who are watching. They don't have that they didn't have, for the longest time, that fundamental understanding. And and it's a lot of young people who are now disrupting, you know, coming up with new ideas, disrupting the way that things were done before. They just require that sort of guidance. Unfortunately, a lot of which isn't available at this point in time. But thank you so much for, you know, doing this and and sharing on the insight. Thank you for the invitation. It was a pleasure. Awesome. And for all of you guys, thank you so much for watching. If you like this episode, please do share it with your friends. For YouTube, if you like this, like the video. We're gonna have more engagement, and, you know, it's going to reach more people. For audio platforms, you can press the subscribe button, and you're going to get notifications for the, for the upcoming episodes. For Facebook users, you can join the link below of the TBD community where we share different articles, take your insight, you know, get take guest recommendations as well so you can join that. We have an easy press of jazz catch thing appearing here so you can, support the channel. We accept anything from unrepeated as much as you would like. It's a thought that counts. But anyways, this was Sayyim Mazam elasen Zedi. You are watching Thought Behind Things. Thank you so much for watching, and I'll see you in next one.