The Return of Industrial Policy and Revival of Pakistan’s Economy: Possibilities of Learning, Industrial and Technology Policies

Abstract

After being among the earliest countries to embark on the East Asian path, Pakistan fell away but was still among the ten fastest growing economies of the world during 1960–90. However, the seeds for the subsequent economic and technological malaise were also sown in that period. This paper provides an overview of recent theoretical and empirical work on industrial policies – more accurately labeled learning, industrial and technology (LIT) policies – and examines their implications for Pakistan. These include a selective, more sharply focused approach than the comprehensive agendas of reforms that have become common. Substantial islands of success with industrial policies have emerged in a variety of institutional and governance settings, different from those of the original East Asian developmental states. They offer valuable lessons. Raising the abysmally low level of investment in Pakistan is a requirement as well as an outcome and an instrument of industrial policies. This argues for a revival of development finance to stimulate investment as well as to direct it towards selective targets. How to mitigate the risks of this and other instruments of industrial policy to get the risk–reward ratio right is another concern of the paper. An important target of such policies should be the technological upgrading of existing industries. There is enormous scope for doing so, with international comparisons suggesting that Pakistani manufacturing does poorly – both in terms of variance in productivity between firms within an industry as well as in introducing new technologies and products. Whilst the constraints of the politics–governance–security/terrorism nexus are beyond the scope of the paper, their salience cannot be underestimated.

Full text

The Lahore Journal of Economics
20 : SE (September 2015): pp. 31–58
The Return of Industrial Policy and Revival of Pakistan’s
Economy: Possibilities of Learning, Industrial and
Technology Policies
Akbar Noman*
Abstract
After being among the earliest countries to embark on the East Asian path,
Pakistan fell away but was still among the ten fastest growing economies of the
world during 1960–90. However, the seeds for the subsequent economic and
technological malaise were also sown in that period. This paper provides an
overview of recent theoretical and empirical work on industrial policies – more
accurately labeled learning, industrial and technology (LIT) policies – and examines
their implications for Pakistan. These include a selective, more sharply focused
approach than the comprehensive agendas of reforms that have become common.
Substantial islands of success with industrial policies have emerged in a variety of
institutional and governance settings, different from those of the original East
Asian developmental states. They offer valuable lessons. Raising the abysmally low
level of investment in Pakistan is a requirement as well as an outcome and an
instrument of industrial policies. This argues for a revival of development finance to
stimulate investment as well as to direct it towards selective targets. How to
mitigate the risks of this and other instruments of industrial policy to get the risk–
reward ratio right is another concern of the paper. An important target of such
policies should be the technological upgrading of existing industries. There is
enormous scope for doing so, with international comparisons suggesting that
Pakistani manufacturing does poorly – both in terms of variance in productivity
between firms within an industry as well as in introducing new technologies and
products. Whilst the constraints of the politics–governance–security/terrorism
nexus are beyond the scope of the paper, their salience cannot be underestimated.
Keywords: Industrial policies, learning, technology, industrialization,
development finance, Pakistan.
JEL classification: L52, L60.
* Senior Fellow, Initiative for Policy Dialogue, Columbia University, New York.

Akbar Noman
32
1. Introduction
After a long exile during which industrial policy (IP) had become
unmentionable among mainstream economists, it has again become
respectable. The literature extolling the case for IP has mushroomed in
recent years, with a spate of publications both on its theory and practice.
Justin Lin and Joe Stiglitz give the title “The Industrial Policy Revolution”
to the two volumes emerging from two conferences/roundtables
organized by the International Economic Association (see Stiglitz & Lin,
2013; Stiglitz, Lin, & Patel, 2013).
1
In the foreword to the volumes, the
then president of the association, Joseph Stiglitz, observes that “the
roundtables were convened in recognition of the fact that industrial
policy is a sort of lynchpin in the economics of development, that the
countries that have been most successful in development have
undertaken a wide variety of industrial policies and different countries
can and should learn from these experiences.”
The IP that Stiglitz and others speak of is not confined to industry,
but also pertains to other activities, particularly in which learning and
technological change are important, ranging from the information
technology (IT) sector to agriculture with the “Green Revolution” in India
and Pakistan being, arguably, a prime example of success with IP.
2
Hence,
as Noman and Stiglitz (2011, 2015) propose, they are more accurately
referred to as “learning, industrial and technology” (LIT) policies, which
would also serve to get away from the misconceptions and knee-jerk
reactions that the term “industrial policy” evokes (the terms are used
interchangeably here, given the familiarity with “industrial policy”).
Notwithstanding this revival of LIT policies, strong objections and
resistance remain from recalcitrant adherents of the neoliberal orthodoxy
that was manifested in the so-called Washington Consensus. A more
qualified and nuanced set of concerns have also been raised, revolving
around issues of governance and rent seeking, and ones that most
proponents of IP in the new literature recognize. Thus, they also focus on
mitigating the risks and getting the risks–rewards ratio right. It should be
noted that risks, failures, and governance challenges are no preserve of LIT
policies: they arise in almost all spheres, including programs of
1
Also see, for example, Chang (2002, 2013); Lin (2012, 2014); Cimoli, Dosi, and Stiglitz (2009);
Noman and Stiglitz (2011, 2015); Greenwald and Stiglitz (2006); Stiglitz and Greenwald (2014);
Mazzucato (2013); Andreoni (2015); Primi (2015), and several other works listed in the references.
2
For an elaboration, see, for example, Noman and Stiglitz (2011). Hosono (2015a) includes the
technological change that transformed vast tracts of what were once barren agricultural lands in
Brazil as one of the five cases of outstanding success with IP that he examines.

The Return of Industrial Policy and Revival of Pakistan’s Economy
33
liberalization and privatization that also can be – and have been – captured
and give rise to enormous rents.
In Pakistan, too, there has been a revival of the case for IP,
especially at the Lahore School of Economics, with a number of recent
articles on the topic in the Lahore Journal of Economics (see, for example,
Amjad, 2006; Haque, 2014; Burki, 2008; McCartney, 2014; Rahim, 2012). The
particularities of Pakistan today that will have a vital bearing on whether
and to what degree these and the economic policy proposals advanced in
this paper will be effective or desirable will depend crucially on the politics
that undergirds economic management.
Pakistan can be characterized as a “conflicted state”, referring not
only to the challenges of armed conflict and the battle against terrorism,
but also to the priorities of policymakers. These refer to both conflicting
priorities in economic policies and to the tension between economic and
noneconomic objectives. One such type of conflict is that manifested in the
form of rent seeking: some rents are more inimical to economic progress
than others, and some can be good for economic growth.
3
Some such
conflicts are inevitable in all societies, but a modicum of consensus or
coherence and consistency is essential for sustained success in the sphere of
economics. What is involved in seeking and arriving at such a consensus is
beyond the scope of this paper. However, it is premised on a sufficient
resolution of these different types of conflicts to allow adequate
implementation of at least the less challenging – in politico-institutional
terms – of its recommendations.
The theoretical case for LIT policies has been bolstered and
nuanced in recent years by two factors: (i) the focus on externalities in
learning and in discovery, which Stiglitz and Greenwald (2014) and
Hausmann and Rodrik (2002), respectively, have emphasized; and (ii) the
importance of economic structure, which has long been recognized (see
Ocampo & Ros, 2011), but revived recently notably in Lin’s “New
Structural Economics” (2012) and in Ocampo’s writings (see, for example,
Ocampo, Rada, & Taylor, 2009). These considerations strengthen the case
that Noman and Stiglitz (2011, 2015) make for using LIT rather than IP to
more accurately capture what such policies should be about.
3
Rents are pervasive in all economies and related corruption not uncommon. However, some rents
may be good for economic growth and transformation, with dynamic gains outweighing static
losses, such as those associated with industrial polices in success cases – including, notably, in the
East Asian stars. Patents are another notable example of the recognition that some forms of rents
can benefit economic and technological progress. The challenge is to direct rents toward productive
and transformational activities rather than, say, to real estate overseas.

Akbar Noman
34
One implication of the new or renewed emphasis on learning and
structure is that it underlines the importance of manufacturing and the IT
revolution. Indeed, Greenwald and Stiglitz (2006) make a case for general
protection of the manufacturing sector in low-income developing countries
on the grounds that it is likely to be more learning-intensive than other
sectors that predominate at early stages of development. Since industries
vary in their learning intensities, this also constitutes a basis and a criterion
for LIT policies targeted at particular industries or activities.
As noted above, this recent literature strengthening the theoretical
underpinnings of LIT policies is not unmindful of their pitfalls. The issues
of design and implementation challenges are widely acknowledged,
particularly in the often messy and weak institutional and governance
contexts of developing countries such as Pakistan. There is no gainsaying
that the choice of instruments and scope of LIT policies should depend on
the competencies and priorities that underlie governance. Often, the
mitigation of the risks of state capture and rent seeking calls for broad-
based “horizontal” policies (such as undervalued exchange rates or
technical training) or very narrowly focused, carefully circumscribed
“vertical” policies pertaining to obvious low-hanging fruits, i.e., measures
with low risks relative to rewards. It should also be noted that there are
many examples of failed attempts at IP but it is difficult to parse the
causes of the failures. They were often the result of inappropriate
macroeconomic management or poor governance. Moreover, as noted
above, risks and governance challenges arise in all spheres of economic
management, not just LIT policies.
In addition to these conceptual and theoretical elaborations, a
number of empirical studies have emerged in recent years. One strand,
notably the work of Chang (2002, 2013), emphasizes the vital role LIT
policies played in the historical experience of the now developed countries.
He shows that this was the case, not just for those that caught up with the
most advanced economies in the 19th and 20th centuries, but also the
original advanced economy, the UK, where the industrial revolution was
born. Earlier, Gerschenkron (1962) had shown the importance of the state
with IP-style interventions in European industrialization.
The second strand of recent empirical work goes beyond the focus
on the original four East Asian “tigers” (Korea, Taiwan, Singapore, and
Hong Kong) – as analyzed notably in the classic works of Amsden (1989)
and Wade (1990) – to examine cases of success elsewhere (e.g., Brazil,
Ethiopia, Bangladesh, Chile, China, Thailand, and Mauritius). Earlier, the
World Bank’s (1993) study of the “East Asian miracle” was a notable

The Return of Industrial Policy and Revival of Pakistan’s Economy
35
exercise in extending the analysis beyond the four tigers plus Japan to
include Indonesia, Malaysia, and Thailand among the “miracle”
economies of the region. But, in its final version, the study goes to great
lengths to underplay the role of IP. At times, it seems to verge on making
the seemingly astonishing claim, first, that the East Asian “miracle”
happened not because of, but despite, IP – astonishing, especially in the
light of very detailed and careful research that shows otherwise,
including notably Amsden (1989, 2001) and Wade (1990). Second, that, if
and to the extent IP did not have a negative impact in the eight countries
the report examines, other countries should not try to emulate them
because they lack the allegedly unique institutional and political economy
setting of the East Asian “miracle” countries, which allowed rapid
development to coexist with IP.
The more recent set of empirical studies – as well as, arguably, the
aforementioned World Bank study, notwithstanding its protestations –
bring out the heterogeneity of conditions and circumstances in which IP
can work, as also recognized by the report of the Growth/Spence
Commission (Commission on Growth and Development, 2008). The
degrees and nature of success with LIT policies (as well as details of policy
design) also vary with several cases of sectoral or subsectoral success with
substantial overall economic impact, as distinct from the full-fledged, wide-
ranging, and more systematic LIT policies of the classic East Asian kind
(see, for example, Oqubay, 2015; Hosono, 2015; Abebe & Schaefer, 2015;
Andreoni, in press; Shimada, in press; Chandra, 2013; Narrainen, 2013).
There are potentially important lessons for Pakistan in these partial
but significant successes in taking the next steps to revive LIT policies. This
is illustrated by McCartney’s (2014) focus on the lessons for Pakistan’s
textile industry from Bangladesh’s garment export performance. More
broadly, there are lessons to be learned from such (substantial) islands of
success in countries with varying degrees of complex political
circumstances at some distance from the (somewhat idealized) full-fledged
“development states” of East Asia: Japan, Korea, Taiwan, and Singapore.
4
In this context, there is a great deal to be said for moving away
from the wide-ranging, almost all-encompassing reform programs that
have been proposed both in some Government of Pakistan publications
and in many reports of international and outside agencies, as McCartney
(2014) emphasizes. Such long lists of reforms became common in many
4
Bangladesh, with its highly polarized, personality-driven, dysfunctional politics is a particularly
striking example of how an island of success can emerge in problematic governance settings.

Akbar Noman
36
countries especially during the era of “conditionality” based on the
Washington Consensus.
5
Aside from the flaws in any specific proposals,
they attempt to pursue the best, the enemy of the good, and lead to
paralysis in the face of the overwhelming nature of the tasks.
6
This could be
said to be a lesson of reform programs: they have to be mindful of the
capacity to implement reforms and, hence, of priorities and sequencing
(see, for example, Noman & Stiglitz, 2013, 2015a).
The rest of this paper is organized as follows. Section 2 provides
an overview of Pakistan’s development experience and the context for
LIT policies. Section 3 turns to which IPs would be appropriate for
Pakistan’s economy in the light of its past and current conjecture. In
doing so, it focuses on the lessons for Pakistan from recent empirical
work on what has worked in contexts other than the classic East Asian
cases, where islands of success have emerged. These are deemed more
relevant for Pakistan today. Section 4 focuses on policies aimed at
technological upgrading in general rather than any particular area.
Section 5 is devoted to concluding comments.
2. Pakistan: Past and Present
It is ironic that Pakistan, which was among the first of the “East
Asians” emulated by Korea in the early 1960s, has now to relearn not only
from the East Asians who have left it far behind, but also lesser, albeit
significant, successes elsewhere.
Pakistan was at the forefront of export promotion, while retaining
very high levels of protection and what has been labeled an “import
substitution industrialization” strategy. In 1965, its manufactured exports
at US$ 190 million (current $) were almost double those of Korea (US$ 104
million); some 42 percent and 15 percent higher than Brazil and Mexico,
respectively; and exceeded the combined total of such exports from
Indonesia, the Philippines, Thailand, Turkey, and Malaysia. By 1985,
exports of manufactures from Pakistan, at US$ 1,731 million, were well
below all these countries’ exports (manufactures), ranging from 80 percent
of the level in Indonesia to 6 percent of that in Korea.
5
For the more general case against attempting too many reforms too quickly, especially the African
experience therewith, see Noman and Stiglitz (2015).
6
The most recent examples of such overwhelming laundry lists of reforms for Pakistan include the
World Bank (2013) and a series of papers it has published with the caveat that they reflect the
views of the authors and not necessarily of the Bank. These are Speakman, Afzal, Yuge, and Hanna
(2012); López-Calix and Touqeer (2013); and Bennmessaoud, Basim, Cholst, and López-Calix
(2013). All these are available on the World Bank website.

The Return of Industrial Policy and Revival of Pakistan’s Economy
37
Notwithstanding the exogenous shocks of the war with India in
1965 (and the associated impact on aid inflows), the 1971 war and the
break-up of the country as well as the “policy shocks” that followed in its
aftermath,
7
the growth momentum was such that, over the three decades
ending in 1990, Pakistan’s annual GDP growth rate placed it among the top
ten countries,
8
albeit in aggregate rather than per capita terms (Table 1).
This, though, was also an era where the “Green Revolution” in agriculture,
some fortuitous exogenous “shocks”, and unsustainable fiscal expansion in
the 1980s boosted Pakistan’s growth.
Table 1: The ten fastest growing economies, 1960–90
Country
Annual GDP growth rate
1960–90 (percent)
Annual CPI inflation
1960–91 (percent)
1
Republic of Korea
9.3
12.2
2
Hong Kong
8.7
7.6
3
Taiwan (China)
8.3
6.2
4
Singapore
8.0
3.6
5
Thailand
7.5
5.6
6
China
6.6
3.4
7
Japan
6.6
4.9
8
Malaysia
6.5
3.4
9
Egypt
6.2
8.3
10
Pakistan
6.1
7.8
Notes: The table excludes countries with populations of under 2 million in 1990.
Among economies with an annual GDP growth rate of at least 5 percent over the 30 years
(and populations greater than 20 million in 1990) were the following: Turkey (5.6 percent),
Kenya (5.5 percent), Brazil (5.3 percent), and Mexico (5.0 percent). India’s GDP grew at 4.4
percent during this period.
Three countries with populations of 1–2 million showed annual GDP growth rates
exceeding 6 percent during 1960–90: Oman (12.3 percent), Botswana (10.4 percent), and
Lesotho (6.4 percent). The oil sheikhdom Oman should qualify for some sort of world
record for an annual GDP growth rate of 39.7 percent during 1965–70.
Source: World Development Indicators (http://data.worldbank.org/data-catalog/world-
development-indicators).
Since 1990, Pakistan has fallen far out of the top rankings of the
GDP growth league, with a rate of around 4.4 percent a year over 1990–
2010. Figure 1 shows the ten fastest growing economies (excluding oil
exporters) and their annual growth rates during these two decades. India
7
Much of the country’s manufacturing and finance was nationalized, bringing to an end the
Korean-style “chaebols” that were, arguably, emerging then.
8
Excluding countries with populations of less than 2 million in 1990.

Akbar Noman
38
took over as the growth leader in South Asia and all other economies in the
region had a GDP growth rate higher than that of Pakistan, with Sri Lanka
averaging 5.6 percent and Bangladesh 5.4 percent. Given that Pakistan has
the highest population growth rate in South Asia, its growth in per capita
terms lagged even further behind the other economies in the region.
Among the top ten countries of 1990–2010, in terms of GDP growth,
Ethiopia is a particularly interesting and illuminating case.
9
Under the late
Prime Minister, Meles Zenawi, it deliberately articulated and pursued
policies emulating East Asia in the mid-to-late 1990s, in particular LIT
policies. After a lackluster performance in the first half of the 1990s (when
civil war still raged and the country split up with Eritrea, becoming
independent), growth began to pick up in the late 1990s to the extent that,
during 2000–10, Ethiopia’s annual growth rate at 8.8 percent was second
only to China’s (10.7 percent) in the world. It has continued to grow at
roughly similar rates after 2010. Its industrial or LIT policies are elaborated
below and raise the question, if Ethiopia with much less of an
entrepreneurial-managerial base can do it, why can’t Pakistan and how
might its lessons be learned.
Figure 1: Annual GDP growth rates, 1990–2010 (%)
Note: The figure gives the averages of the annual growth rates in the two decades 1990–2000
and 2000–10. The three countries heavily reliant on oil exports, which were in this growth
league, are Mozambique (7.0 percent), Kuwait (6.7 percent), and Sudan (6.1 percent).
Source: World Development Indicators (http://data.worldbank.org/data-catalog/world-
development-indicators).
9
Ethiopia’s story is discussed at some length in Noman and Stiglitz (2011, 2015).
10.7
7.9 7.7 7.4 76.8 6.6 6.3 65.9
0
2
4
6
8
10
12

The Return of Industrial Policy and Revival of Pakistan’s Economy
39
Before turning to what might be done in Pakistan, it would be in
order to glance quickly back at what changed between 1960–90 and 1990–
2010 that transformed the country from among worldwide leaders in the
growth league with the fastest growing economy in South Asia to a
laggard with the slowest growing economy in the region.
Arguably, the seeds for the slowdown were sown in the 1970s with
the disruptions resulting from war and the break-up of the country,
combined with ill-conceived populist policies and nationalization. While
much of that was reversed in the 1980s, the decade was one of facile
growth
10
and one in which a different set of seeds was sown for the
subsequent slowdown (it should also be noted that the growth impetus
provided by the Green Revolution in the late 1960s and 1970s had also
begun to dissipate by the 1980s).
This 1980s set of bad seeds refers to the following phenomena. The
first was heavy domestic borrowing at very high interest rates that allowed
unsustainably expansionary fiscal policies in the 1980s and that were at the
heart of the macroeconomic crises and consequent austerity programs –
with a series of IMF bailouts – that have shackled growth since the early
1990s. Much of this fiscal stimulus was not reflected in public expenditures
of the sort that were good investments for sustained future growth.
Second, arguably, was the germination of the politics–governance–
security nexus with the deterioration in the security situation and the rise
of terrorism. Associated with this was the worsening of foreign attitudes
and business sentiments and costs of doing business. Third, another
obvious candidate among the causes for the deceleration, was the neglect
of infrastructure and human development/capital during the fiscal
consolidation required after the binge of the 1980s and attendant growing
bottlenecks, especially of electricity.
Public sector development expenditures bore much of the brunt of
attempts to cut fiscal deficits. However, even in the heyday of its growth
performance, Pakistan grossly underinvested in human development. This
underinvestment was in sharp contrast to the East Asian economies that
sustained rapid economic growth and transformation and no doubt
contributed to the reasons Pakistan was unable to do so. (Another such
important contrast was that, unlike East Asia, growth was not widely shared
10
Aside from unsustainable fiscal expansion, growth was facilitated by the expansion in domestic
demand made possible by Afghan war-related foreign-financed expenditure and (more
speculatively) increased drug smuggling. See Noman (1992).

Akbar Noman
40
in Pakistan, which resulted in political turmoil, especially the tensions that
culminated in the erstwhile East Pakistan becoming Bangladesh.)
A fourth reason, though not unrelated to the previous ones, was
the depressed level of aggregate investment. Even in its high-growth
phase, Pakistan was not much of an investor with the investment-to-GDP
ratio hovering around 20 percent during 1960–90. In recent years, it has
declined to some 15 percent. Clearly, with that sort of investment level,
no country can grow at anything approaching 6 percent a year. It is also
most unlikely to succeed in technological upgrading or more generally in
pursuing LIT policies.
That Pakistan acutely needs to do so is well documented. Several
studies document the technological quagmire surrounding the country’s
manufacturing and exports (see Amjad, 2006; Haque, 2014; Lall & Weiss,
2004; Hausmann, Hwang, & Rodrik, 2005; Kemal, 2006; World Bank, 2013;
Asian Development Bank, 2003). Thus, Pakistan does very poorly on the
assorted standard indicators of technological development: sophistication
of exports, ISO certification, patents, availability of key high-level skills,
research and development, and so on.
3. LIT Policies
This section describes the LIT policies on which Pakistan should
focus.
3.1. Investment and Development Finance
The aforementioned calls for a revival of IP in Pakistan make a
compelling case, the more so in light of the literature referred to above. The
focus here is on elaborating some important policy implications of doing so.
First and foremost is the importance of raising investment from its
abysmal level of roughly 15 percent of GDP. The second challenge is to
direct investment toward promoting industrialization and other activities
that lead to learning and technological upgrading. The first proposal
(discussed below) pertaining to finance serves both as an outcome and an
instrument of LIT policies. It is also the most challenging one and likely to
be the most controversial. The subsequent policy proposals are roughly in
descending order of challenge and controversy, ending with some
bordering on being “no-brainers”, i.e., providing opportunities of low risks
and high returns.

The Return of Industrial Policy and Revival of Pakistan’s Economy
41
Before turning to economic policy, there is no gainsaying that an
important impediment to raising investment in Pakistan is the country’s
security situation – as highlighted by both the private sector
representatives who spoke at the conference at the Lahore School of
Economics (at which a preliminary version of this paper was presented).
In the realm of economic policy, one implication of reviving IP in
the country that is analytically compelling, though demanding in
institutional and governance terms, is the high risk–high reward action of
establishing or reviving development finance institutions (DFIs). There is
no gainsaying that access to finance on attractive terms can both stimulate
overall investment and be used to direct it.
11
Earlier in Pakistan’s past, two
DFIs, the Pakistan Industrial Credit and Investment Corporation (PICIC)
and the Industrial Development Bank of Pakistan (IDBP), played a vital
role in creating a class of industrial capitalists-entrepreneurs and in the
rapid industrialization of the 1950s and 1960s (see Papanek, 1967; Lewis,
1970). They demonstrated the powerful impact that DFIs can have in
raising investment levels.
12
Long-term loans at moderate-to-low interest
rates can serve as one way to socialize the risks of investment – a
mechanism that played an important role in promoting not only
investments, but also savings in the “miracle” economies of East Asia,
because the powerful incentive to invest also served to enhance corporate
savings (World Bank, 1993; Stiglitz & Uy, 1996).
The case for mobilizing development financing to stimulate
investment is made the more compelling by the severe constraints on
public investment or development expenditures on account of the fiscal
position. The great difficulties Pakistan has had in raising its extremely low
tax-to-GDP ratio in the face of the compulsions for fiscal consolidation are
unlikely to be eased speedily. There is then a prima facie case for
development finance to be also directed at public-private partnerships in
the provision of public or quasi-public goods, especially in the spheres of
infrastructure and perhaps human development (though the scope for
public-private partnerships in the latter is likely to be confined to high-
level technical education).
However, this raises a number of issues revolving around
governance and the capacity to run DFIs effectively – in particular to guard
11
Burki (2008) notes the importance of appropriate finance for IP, but suggests focusing on small
and medium enterprises and on utilizing new financial instruments developed in recent years, such
as private equity and venture capital.
12
On the general case for development banks, see Griffith-Jones and Cozzi (in press).

Akbar Noman
42
against their capture by politically powerful rent-seekers. Such capture
marred the experience with nationalized commercial banks, particularly in
the 1980s and 1990s. Careful attention needs to be paid to how the risks
might be mitigated (later on, this paper provides some initial thoughts on
how to go about doing so). There is no gainsaying, however, that in the
political context – or what Mushtaq Khan calls “political settlement”
13
– of
Pakistan today, DFIs would be a bold and risky venture. Perhaps that is
why Burki (2008) refrains from proposing them whilst emphasizing the
importance of reviving development finance. At any rate, his proposals for
mobilizing new instruments such as venture capital and equity finance
deserve attention, but are unlikely to make anything like the impact that
more conventional development finance can, in raising investment.
Success in this venture is likely to be particularly contingent on
easing the political constraints that were emphasized at the outset, with
political commitment to adequate space for such technocratic measures. In
this regard, it is worth noting that one of the architects of India’s economic
reforms of the past two to three decades, Montek Singh Ahluwalia, has
emphasized the importance of political consensus, arguing that a strong
consensus on even weak or gradual reforms has served India well.
14
In designing the details of the operational procedures and policies of
the DFIs (including perhaps on insulation from “political” lending), Pakistan
could seek technical assistance or advice from successful development
banks. Whilst the experience of such banks in advanced countries – such as
Germany’s KfW or European Investment Bank – or in the full-fledged
developmental states of East Asia could provide useful lessons, the
experiences of reasonably successful development banks operating in rather
less advanced developed or developmental states are likely to be particularly
relevant. Aside from lessons from Pakistan’s own past in the heyday of
PICIC and IDBP, the most obvious candidate for such learning is probably
the Brazilian Development Bank, the BNDES. The Corporación Andina de
Fomento in the Andean region and the Development Bank of Ethiopia are
other examples of possible candidates for emulation.
Another way to mitigate risks and strengthen the ability of current
and future governments to resist political pressure would be to make the
13
Khan (2000) analyzes the political constraints that hampered the efficacy of IP in Pakistan. In his
later writings, he labels such political economy considerations “political settlements” and
elaborates on the concept.
14
More precisely, he attributes India’s success to a strong consensus on weak or gradual reforms
(see Ahluwalia, 2002).

The Return of Industrial Policy and Revival of Pakistan’s Economy
43
operations of the DFI, especially lending decisions and repayments,
transparent by publicizing them and subjecting them to outside scrutiny,
including possibly by Parliament and its Public Accounts Committee.
Another such measure could take the form of having outsiders serving in
some capacity to oversee lending decisions. These could be, for example,
representatives of multilateral development banks – who would then also
be more inclined to provide financing – or civil society representatives with
impeccable credentials. The latter could be either from domestic or
international NGOs or some combination thereof.
In any event, the sphere of operation of any DFI in Pakistan should
be carefully and narrowly circumscribed to the sort of activities we identify
later on as providing a particularly high reward-to-risk ratio or what might
be termed the “little-or-no-brainers” for LIT policies in the country.
Another option would be not an altogether new institution, at least to
begin with, but a development finance window in an existing institution.
Another crucial issue is that of the DFI’s source of funding or its
deposits/liabilities. In their prime, PICIC and IDBP relied heavily on
World Bank financing. It is highly unlikely that the Bank would reverse its
policy of cutting off such support to DFIs in the foreseeable future. Given
the state of public finances, the banking sector, and nonbank financial
institutions in Pakistan, DFI lending on an adequate scale is likely to
require external financing. Among the more promising sources of
concessional financial support, China is probably the most prominent. The
New Development Bank is also a possibility. Another option could be
providing a stake to some sovereign wealth fund such as the Malaysian
“Khazanah”, which actually provides support to LIT policies in Malaysia.
3.2. Targeting Activities in a Selective “Islands” Approach
We turn now to the less challenging and less controversial
questions of (i) what particular industries and technological upgrading to
promote, and (ii) how to go about doing so with (ideally) or without
(possibly) an effective DFI.
On choice of industry, recent proposals include Amjad’s (2006) call
for targeting IT, Rahim’s (2012) suggestion to subcontract in international
value chains, Haque’s (2014) idea of focusing on export competitiveness,
and Burki’s (2008) proposal to pick “winners” focused on small and
medium enterprises, notably agro-processing, small-scale engineering,
leather products, and IT in the Punjab. Burki also calls for analytical work

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44
to pick “winners” by carefully assessing the opportunities in both domestic
and foreign markets.
In identifying the targets of LIT policies, one promising approach is
that proposed by Lin (2014), who argues that, “for an industrial policy to be
successful, it should target sectors that conform to the economy’s latent
comparative advantage. The latent comparative advantage refers to an
industry in which the economy has low factor costs of production but the
transaction costs are too high to be competitive in domestic and
international markets.” In answering the question, “How are governments
able to pick the sectors that are in line with the economy’s latent
comparative advantages?”, Lin says that a “short answer is to target
industries in dynamically growing countries with a similar endowment
structure and somewhat higher income.” Elsewhere, he has spoken of
“somewhat higher income” as being not much higher than roughly two or
three times the per capita income of the economy at hand.
The Lin proposal need not be the only route to identify targets for
LIT policy support, but it would be a useful starting point in Pakistan today.
Chang (2002), in particular, emphasizes that, while Lin’s “latent
comparative advantage” approach has considerable merit in mitigating the
risk of picking “losers”, it is a little too cautious and does not accord with
the experience of some countries, especially in East Asia, that also sought
and created dynamic comparative advantage in industries outside the ambit
of Lin’s “latent comparative advantage”. Perhaps one such opportunity is
provided by the development of niches in the global value chain of “green”
technology: given the critical importance of dealing with climate change,
this is going to be an area of rapidly growing global demand.
At any rate, in Pakistan there is one highly promising area to target
that is consistent with the “latent comparative advantage” approach: the
long-established textiles sector. It has remained mired in low-productivity
activities producing output at or near the lowest end of technological
sophistication and demand dynamism. Among the many calls for
upgrading Pakistan’s textiles sector is that of McCartney (2014) who seeks
to extract lessons for Pakistan from the experience of Bangladesh.
3.3. Creating Islands of Success
McCartney’s (2014) proposal accords well with the suggestion
made above for Pakistan to learn lessons from “islands” of success in a
variety of countries with varying proximities to a developmental state. This

The Return of Industrial Policy and Revival of Pakistan’s Economy
45
section elaborates on some of the examples cited in the opening section.
One highly illuminating exercise by Hosono (2015a) examines what he
labels as five “outstanding cases of success” in different countries and
sectors. These are (i) automobiles in Thailand, (ii) the “Cerrado” in Brazil
(which was transformed from a vast expanse of barren land to a place of
highly productive agriculture), (iii) the garments industry in Bangladesh
(most relevant for Pakistan), (iv) salmon fisheries in Chile, and (v)
Singapore’s upgrading of its industrial sector from a labor-intensive to a
knowledge-intensive base (least relevant for Pakistan).
15
Noman and
Stiglitz (2015b) summarize Hosono’s (2015a) work as follows:
Hosono seeks to extract insights from these rich case studies
on how the various considerations that go into the making
of industrial policy interact in practice in successful cases.
He focuses in particular on the acquisition of capabilities;
the creation of a learning society; using and altering factor
endowments to move from static to dynamic comparative
advantage; compensation for the positive externalities
generated by the costs of discovery by pioneer firms; and
the management of the pressures generated by globalization
and the ideology and interests of “free-marketers”.
Hosono’s five case studies illustrate how the general
principles of good industrial policy vary in their translations
into different contexts. But they also illustrate the mutual
causality between industrial development and economic
transformation, on the one hand and the “constant
development of capabilities and knowledge through
learning”. In the case of Singapore, in particular, Hosono
emphasizes the crucial role of “learning to learn”. These cases
also serve to bring out that reasonably good institutional
“islands” created for specific purposes, as distinct from an
overhaul of the entire institutional structure, can be highly
effective [emphasis added] … Hosono’s paper also brings out
the important role that the development of physical
infrastructure plays as an instrument of industrial policy.
Another example of the island approach, and one of particular
interest that is examined in some detail below, is that of Ethiopia. As noted
above, excluding countries with oil exports and discoveries, Ethiopia’s
15
Other examples of such case studies are Chandra (2013) and Narrainen (2013).

Akbar Noman
46
economy grew at a rate second only to China during 2000–10, and it was
second to none between 2004 and 2011, when the country’s GDP grew at
10.6 percent per year. The LIT policies that the country pursued were based
on a strong commitment from the political leadership, especially Prime
Minister Meles Zenawi, a veritable scholar who had carefully studied and
drawn the lessons of East Asian success; he passed away in 2012 but the
late Prime Minister’s policies are being continued under his successor.
There is, of course, a lag in the recognition of economic success and
Ethiopia’s is just beginning to be appreciated, especially with two recent
publications, including Oqubay (2015) and Abebe and Schaefer (2015). As
Justin Lin comments in his endorsement of Oqubay’s volume, “Ethiopia is
a development miracle in [the] making …” Be that as it may, the LIT
policies it has pursued thus far provide illuminating lessons.
Ethiopia’s IP is probably best known for its success in floriculture
and leather goods, which is what it began with, but other areas such as
textiles and garments as well as wine are also beginning to bloom. Before
turning to the better-known first two cases or “islands” on which Ethiopia
concentrated initially, it should be noted that the country is also going
beyond them to two other areas. Thus, the recently established largest of
the Turkish-owned garments and textiles factories employs some 12,000
workers and is expanding; a UK glove manufacturer has established three
factories in two years; and in 2014, a winery and vineyard resulting from
foreign investment was inaugurated (Oqubay, 2015).
Abebe and Schaefer (2015) have a narrower focus than Oqubay
(2015) – concentrating on floriculture and leather processing. These are
sectors that have developed rapidly, with a significant overall impact on
the economy. Exports of floriculture rose from a minute level of well under
US$ 1 million in 1997 to US$ 210 million in 2011. The promotion of leather
goods was a slower process and its exports, after rising gradually between
2005 and 2010, are now soaring dramatically, with a major Chinese shoe
producer, Huajian, having established a large factory in Ethiopia.
16
By 2014,
the factory had already begun to produce some 2,000 pairs of shoes per day
for designer labels and employed some 1,600 workers. Huajian is
implementing highly ambitious plans to expand its production with the
aim of generating US$ 4 billion in annual exports within a decade.
16
This resulted from a meeting that Zenawi sought with Huajian during his visit to China in 2011.

The Return of Industrial Policy and Revival of Pakistan’s Economy
47
The expansion of these two sectors alone contributed to a
significant transformation of the Ethiopian economy, whose total exports in
2012 amounted to about US$ 3 billion. This is akin to the role of garments
in Bangladesh, but the “transformation” is not confined to one sector, as
Ethiopia is pursuing more broad-based and deliberate IPs.
One of the key issues of LIT policies concerns how learning comes
about. Similar to the case of Bangladesh garments exports that Hosono
(2015a) examines – in which Korean firms initially trained many
Bangladeshi workers in Korea – Huajian is sending a significant proportion
of its local employees for training to its headquarters in China.
According to Abebe and Schaefer (2015), it was easy to pick the
floriculture and leather sectors for support as they have “production
organizations and technological intensities that suit the labor-abundant-
capital-scarce nature of the Ethiopian economy.” Both sectors benefitted
from a wide range of IP interventions. Abebe and Schaefer’s study
extricates both the similarities in policy actions as well as how policies were
tailored to the specific requirements of each sector. The common elements
in the LIT policy support to both sectors that were especially important
were (i) access to finance on fairly attractive terms through the
Development Bank of Ethiopia,
17
(ii) close government–business
consultations, and (iii) flexibility in altering forms and degrees of support.
Regarding the differences in policies towards the two sectors and
designing them to deal with sector specific challenges,
… the following are noteworthy: The leather sector was
characterized by the need to overcome coordination
failures that required several problems along the value
change to be tackled simultaneously to achieve global
competitiveness. The dominant challenges in the
floriculture sector on the other hand pertained to logistics,
land acquisition and initial capital (that needed to be
financed at terms that were not too short-term and costly
for such investments) (Noman & Stiglitz, 2015b).
In leather manufacturing, the government very actively supported
the acquisition of technological capabilities: setting up a leather training
institute whose training programs often involved foreign experts, and
17
Ethiopia is rare in Africa in still having a development bank after the wave of financial liberalization
that closed down such banks not only in Africa, but also in many other developing countries.

Akbar Noman
48
subsidizing the employment of such experts by domestic firms. The state
also provided land and semi-constructed factories as well as basic
infrastructural facilities in industrial zones. Tax and regulatory policies
used to encourage upgrading included a ban on exports of raw hides and
skins, and export taxes on minimally processed low value-added products.
For cut flowers, industrial policies were tailored to provide land at
relatively modest prices in proximity of the airport, as well as reliable
airfreight services, including the promotion of air-conditioned transport to
the airport and coordination with Ethiopian Airlines so that its flight
schedule got the flowers to overseas markets, especially Amsterdam, at the
appropriate time.
There are clearly many lessons Pakistan can learn from the carefully
selective approach with a sharp and narrow focus on particular subsectors,
probably no more than one or two to begin with. It should also be noted
that Ethiopia’s success was based on a substantial improvement in its
abysmal physical infrastructure, especially in transport, communications,
and energy. This reflected the mobilization and highly effective use of
foreign assistance, driven by clearly articulated government priorities as
part of the vision that guided its LIT policies.
3.4. Targeting Technological Upgrading
Aside from upgrading the textiles sector, a more general highly
promising, low-risk target for LIT policies in Pakistan stems from the fact
that the country exhibits one of the largest gaps between “best practice”
and “average practice” in productivity and technology, with firms within
the same industry often varyingly hugely on this count. This is among the
findings of a wide-ranging paper on innovation policy for Pakistan by
Speakman et al. (2012).
Speakman et al. demonstrate that there is substantial variation in
productivity levels between firms in the same country in a sample of
developing countries and that Pakistan is an extreme case: “Pakistan’s
variability is almost double the next comparator – the Philippines.” (The
other countries in the sample were Bangladesh, Brazil, Chile, Croatia,
India, Indonesia, Mexico, and South Africa). They also find that a “few
Pakistani firms” are highly productive and competitive, but the large
majority are not – even in the same industry. Spreading the leading firms’
technology to those that are far behind is an obvious and enormous
opportunity for LIT policies. The costs of discovery have already been

The Return of Industrial Policy and Revival of Pakistan’s Economy
49
borne with the premier firms having established that it works in Pakistan.
Atkin et al. (2014) identify the misalignment of incentives mainly on
account of the form of labor contracts that are among the constraints to
upgrading to demonstrably profitable technologies.
In terms of policy prescriptions, Speakman et al. (2012) pay much
attention to the institutions involved in innovation policy and make a large
number of other recommendations based on 12 rather broad policy pillars.
They note that the “policy mix required … is a complex interaction of
general business-enabling environment reforms, increased
competitiveness, key infrastructure investments (mainly in ICT sector),
appropriate firm-level support and establishing dynamic relationships
between academia, firms and government.” They express some support for
subsidies for encouraging innovation, albeit in a muted fashion.
With regard to reforms of institutions, or what Speakman et al.
(2012) label the “innovation ecosystem”, they point to the multiplicity of
ineffective institutions that are mainly in the business of paying salaries to
their staff and the absence of a “nodal” agency and a coherent policy.
Consolidation and reform of this moribund institutional framework is
another obvious area for policy attention. Burki (2008) focuses in particular
on reform of the Small and Medium Enterprise Development Authority.
In this context, it may well be worthwhile to seek or enhance the
assistance of the Japan International Cooperation Agency under its program
of support for “Kaizen”, which it is expanding and implementing in several
countries, including Ethiopia (see Shimada, 2015, for its success in Ethiopia).
According to Hosono (2015b), “Kaizen is a Japanese concept which can be
translated, literally, as ‘improvement’ or ‘continuous improvement.’ It is not
easy to define kaizen in a strict sense since it corresponds to evolving
initiatives and activities in the quality and productivity area and can very
flexibly be adapted to each factory floor’s context.” Typically, Kaizen
involves very little investment, but focuses on raising the productivity of the
technology embodied in the pre-existing capital stock.
4. Concluding Comments
The recent revival of focus on the theory and practice of
industrial/LIT policy with a mushrooming literature makes a compelling
case for paying attention to how such policies can be adapted to the
circumstances of a particular country. This paper attempts to do so for
Pakistan.

Akbar Noman
50
After a quick overview of the new literature, we sketched
Pakistan’s development story, which saw the country transformed from
being among the leaders in growth and LIT policies to a laggard. A
combination of the growth momentum of the earlier period of success,
some fortuitous circumstances with opportunities for what we refer to as
“facile” growth, and expansionary fiscal policies meant that Pakistan was
among the world’s ten fastest growing economies during 1960–90, albeit at
the bottom and not in per capita terms. Its GDP per capita grew at a higher
rate than that of any other economy in South Asia during those three
decades. However, this was also a period in which the seeds of the
subsequent stagnation were sown. Poorly conceived populist policies,
including large-scale nationalizations, were mostly reversed in a relatively
short period, but the fiscal profligacy of the 1980s necessitated austerity
policies, subsequently with public investment in infrastructure bearing the
brunt and little room for the big increase in expenditures on human
development that Pakistan so badly needs.
Whilst the extent and quality of fiscal adjustment are debatable,
that the fiscal legacy of the 1990s constrained economic growth and
transformation for a prolonged period that has yet to end is not. Combined
with the germination of a politics–governance–security nexus inimical to
investment and economic progress, which became increasingly acute, these
constraints were reflected in Pakistan becoming the slowest growing
economy in South Asia during 1990–2010 with related technological
stagnation. An abysmally low investment rate of some 15 percent of GDP
both reflected and in turn contributed to the malaise.
We share the view of the broad thrust of several recent calls for the
revival of some form of IP in Pakistan as an essential element of economic
revival. A number of policy proposals are advanced in this paper, but we
noted at the outset that they are predicated on the state becoming less
conflicted. By that, we refer not only to the war on terrorism being
successfully concluded, but also to a modicum of success in achieving
some consensus or consistency regarding economic policy priorities and
resolving the conflicts between economic and noneconomic objectives.
These include those manifested in the form of rent seeking and whether
and to what extent they are good or bad for economic progress. Such
conflicts afflict all societies to varying degrees, but they are arguably
especially salient for Pakistan at this juncture.
This set of issues is often subsumed under governance, which has
been the subject of growing attention, and the emergence of an assortment

The Return of Industrial Policy and Revival of Pakistan’s Economy
51
of indicators and what has been labeled a “good governance” agenda.
While there is no denying the importance of governance, this agenda
confuses ends with means and makes the pursuit of the best the enemy of
the good. What is feasible and needed is what Khan (2011) calls “growth-
enhancing” and Chang (2012) “good-enough governance.”
Raising the very low level of investment is likely to depend
significantly on that essentially political venture. It is vital if the economy is
to break out of its technological stagnation, move to a sustainable higher
growth path, and generate adequate employment. Higher investment
levels are also, of course, essential both as an instrument and an objective
of LIT policies.
One policy action for stimulating investment would be to revive
development finance. DFIs played a crucial role in the earlier economic
success of Pakistan, but they are at high risk of capture in the light of the
subsequent experience with nationalized banks in the 1980s and 1990s. We
propose various ways of mitigating those risks, including learning from the
experience of successful DFIs in less pristine developmental states than
those of East Asia, various ways of making DFI operations transparent and
subject to outside scrutiny, and constricting lending to highly selective
activities such as technological upgrading.
Naturally, the choice of instruments and scope of LIT policies
should depend on the competencies and priorities that underlie
governance. This paper identifies the targets and forms of appropriate
LIT policies for Pakistan. In terms of targets, there are some obvious ones
such as upgrading the textiles sector and narrowing the huge gap
between best and average practice in Pakistani firms across the spectrum
of industries. There are also several other targets proposed by others that
have much merit, e.g., the IT sector and small and medium enterprises in
light engineering or becoming subcontractors in international value
chains. But the targets have to be chosen with great care, based on
analytical work. One promising way of doing so discussed above is that
of seeking to identify “latent comparative advantage” along the lines that
Justin Lin suggests.
At least as important as identifying the low-hanging fruits – with
high rewards in relation to risks – for targets of IP is the approach to
designing such policies and their scope. Instead of comprehensive or wide-
ranging LIT policies of the classic East Asian variety, this paper proposes a
highly selective approach focusing on creating “islands” of success. We

Akbar Noman
52
provide notable examples of success with such an “islands” approach,
including that of Ethiopia, which has been at the top of the world’s growth
league in this century. If Ethiopia, starting with much less of an industrial-
business class base and weak institutions (especially the bureaucracy), can
do it, why can’t Pakistan? The answer lies in Pakistan acquiring to some or
sufficient degree, the sort of vision and commitment accorded at the
highest levels of government in Ethiopia to economic priorities of the sort
reflected in its LIT policies. Once upon a time, Pakistan arguably did so.

The Return of Industrial Policy and Revival of Pakistan’s Economy
53
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