A ‘new’ order

Aqdas AfzalAugust 11, 2019

SEVENTY-FIVE years ago, delegates from the victorious nations of
the Second World War met in Bretton Woods to design a new
economic order. This economic order, or system, was to be governed
by two new institutions: the IMF and the World Bank.
Few people know that the US delegation led by Harry Dexter White
muscled out competing ideas for the new system that sought to assign
checks on rich lending countries. Dexter’s team stalled British efforts to
set up an international clearing bank for automatically reducing
borrower countries’ deficits. The US secured a third of all votes,
guaranteeing itself the power to veto any proposal as well. Some say this
new economic order was designed to ensure America’s geopolitical
dominance.
The Bretton Woods’ delegates were ardent proponents of free trade. Free
trade’s supposed positive influence was not new thinking. Even in the
early 19th century, Adam Smith and David Ricardo extolled the virtues
of free trade and advised nations to improve their ‘comparative
advantage’. Thus, free trade between nations became one of the pillars
of the new economic order.
Free trade has been successful in lifting millions out of poverty. The
problem is that these gains are concentrated in only a few nations. For
others like Pakistan, free trade has led to persistent current account
deficits and plummeting exchange rates. The primary reason why such
nations have not been able to benefit from the economic order is the
inability to produce high-value exports. Specifically, Pakistan’s
economy has not been able to make the transition from agriculture to
even light manufacturing. Why has Pakistan failed?
Free trade gains are concentrated in only a few nations.
Standard trade and growth theories that assume that countries can
always improve their comparative advantage are of little help. Had that
been the case, Pakistan would have been able to diversify and increase
the total value of its exports; 21 per cent of its export earnings would not
come from agriculture.
‘Product-space’ scholars like Ricardo Hausmann offer a more plausible
explanation by showing there is nothing automatic about high-value
exports. They argue that a country’s export sector is connected in such a
way that a country cannot automatically move from having a
comparative advantage in textiles to having one in machinery, chemicals
or artificial intelligence, ie what a nation exports today largely
determines what it will export 10 years later unless policies encourage
economies towards high-value sectors.
Given that the present economic order is based on free trade and the fact
that Pakistan has been unable to develop comparative advantage in high-
value exports, what options are available for policymakers?
Policymakers can decide to leave the free trade economic order and
impose a stringent import control regime while implementing import-
substitution-industrialisation (ISI). Many Latin American states tried ISI
with sub-par results as inward-oriented growth is costly in a globalised
world — intermediate goods, foreign technology, foreign savings and
ideas are not available locally.
Policymakers can also decide to go the East Asian ‘Tigers’ route. East
Asian countries achieved exponential economic growth rates by
improving their comparative advantage in high-value exports within the
free trade economic order through developing good policies and
effective implementation. It should be mentioned that there was nothing
automatic in this process as the government played a key role — picking
‘winners’, credit allocation, promotion of industrial investment,
encouraging firms to upgrade technology, etc.
However, the best way forward for Pakistan is a combination of both ISI
and export-oriented industrialization policies. It should play within the
free trade arena to earn foreign exchange but then channel heavy
investment to import substitution that will actually improve its
comparative advantage. At the same time, policymakers need to pick
sectors like IT and AI and make winners out of them by establishing
world-class universities and business incubators, which will train the
next generation of Pakistani technology workers and entrepreneurs.
Compared to commodities, technology-based exports have tremendous
potential as they earn more foreign exchange and increase in demand as
incomes in our trading partners rise.
The Bretton Woods system just turned 75. Though free trade has been a
pillar of this system, it has not benefited everyone since nations like
Pakistan have failed to produce high-value exports. In order to gain from
free trade, Pakistan’s economy needs a structural shift to produce high-
value exports. To do so, policymakers need to design policies that will
tangibly assist in improving its comparative advantage. With the rise of
African economies, the window to improve Pakistan’s comparative
advantage may be closing sooner than we think. The time to act is now.
The writer teaches economics and public policy at Habib University,
Karachi.