Why is Pakistan falling behind? What is the role of dismal labour productivity growth in hindering meaningful transformation? Can overallocation of resources in some sectors at the expense of others due to political economy reasons explain Pakistan’s poor economic performance? This report attempts to answers these questions through the lens of structural transformation.

The report starts with documenting the phenomenon of missing structural transformation in the case of Pakistan. Specifically, unlike regional peers, agriculture’s share in both total employment and value added has decreased by significantly less over the past several decades. Moreover, changes in the composition of both the export and the import baskets also point to limited economic transformation. We also find that the limited transformation Pakistan has undergone has been towards sectors with low productivity growth thus undermining the country’s future growth prospects. One of the key reasons behind the lack of transformation is that labour productivity in both the overall economy and the agriculture sector has increased by the least in the case of Pakistan relative to the regional economies. As a result, unlike in most other countries, there is limited incentive for labour to move from agriculture to non agricultural sector.

But what is behind the dismal increase in labour productivity? We find that, contrary to popular belief, a critical reason for this is the lack of capital deepening. In fact, capital-to-output ratio has been declining since late 1970s such that today Pakistan has one of the lowest levels of capital-to-output ratio across the list of 183 countries included in the PWT dataset. We think that high macroeconomic uncertainty due to irresponsible macroeconomic policies, including low foreign reserve buffers, are critical for understanding the persistent decline in capital-to-output ratio and, as a result, low growth in labour productivity.

The second half of the report starts with documenting differences in labour productivity across sectors. This is important since it has the potential to open doors for policymakers where reallocating resources from less productive to more productive sectors can increase overall productivity in the economy. Consistent with the rest of the literature, we find that the agriculture sector has one of the lowest labour productivity in Pakistan. Labour productivity in the agriculture sector is 47% that of the non-agriculture sector. We consider if differences in wages and production technology across the agriculture and the non-agriculture sectors can explain the difference in labour productivity between the two. However, we find that these factors cannot explain the observed differences, pointing to an overallocation of resources in the agriculture sector due to reasons which are related to government policies and market failures such as frictions in the credit markets.

Since an increase in labour productivity is critical for meaningful transformation, the report goes on to explore how an increase in integration in the Global Value Chains can help increase overall productivity in the economy. We document that the level of participation in the GVCs is one of the lowest for Pakistan. Surprisingly, and contrary to what we find for other fast-growing economies, the GVC participation in Pakistan is lower for the export sector than it is for the non-export sectors. We conclude the discussion with showing that an increase in GVC participation can go a long way towards increasing the productivity growth and, as a result, facilitate the transformation process.

The discussion in this report centres around the allocation of resources across the economy. However, we note that the challenge of resource misallocation as in the case of Pakistan is not just a challenge of technical knowledge and administrative expertise but also has power-relations between the ruling elites and the effectively disenfranchised masses at the core of it. What is considered economically inefficient could very well be maximising the economic rents for the elites. Therefore, we are unlikely to achieve meaningful progress without bringing these power-relations to the forefront of any discourse on reforms