All theories of economic growth, from the Solow Model to the Endogenous growth theory, share one similarity — the importance of innovation in development.

Technological advancement tends to have spillover effects, as advancements in production processes, knowledge and capital are adaptable across industries. Unfortunately, the state of innovation in Pakistan is dismal. The Global Innovation Index (GII) uses 80 indicators to rank innovation among countries, and Pakistan ranks 87th out of 132 countries (2022).

The nation lags in its human capital development, which includes expenditure on research & development and education as well as infrastructural issues such as availability of electricity, information communication technology access, and intellectual property protections.

Another input to innovation highlighted by the World Bank is gross capital formation. Pakistan’s gross capital formation is 15 per cent of its GDP (2021), which is half that of India and Bangladesh, at 31pc of GDP and below the Asian average of 28pc of GDP.

Pakistan’s market sophistication was also highlighted as lacking, with low scores given to trade promotion, diversification, and market scale. This final category is of particular importance, as market sophistication is a major driver for innovation, and unsurprisingly where Pakistan performs the poorest.

A vast pool of literature supports the claim that exporters innovate more than non-exporters, and by attributing more resources to increase the competitiveness of the trade sector, Pakistan can access greater gains in R&D.

Theories on the relationship between exports and innovation are abundant. Most recently, endogenous models of growth situate the role of exports as drivers of innovation.

Endogenous growth theory posits that internal factors like innovation, investment, and policy are equal, if not greater, determinants of prosperity than neoclassical theories assumed.

In this model, trade leads to innovation due to two major factors.

Firstly, exporters have access to larger markets which drives economies of scale. In order to fulfil the demands of both domestic and international consumers, exporting firms must increase their productivity through both increased input and efficiency gains.

The selection pressure between firms to fulfil demand allows resources to be allocated to efficient firms as less efficient ones become uncompetitive and leave the market. As firms achieve economies of scale, they divert more resources towards R&D spending to remain competitive in an evolving international market.

Secondly, as introduced by Coe and Helpman to the International Monetary Fund in 1994, trade creates knowledge spillovers both directly and indirectly. Direct benefits occur from learning new technologies and methods, while indirect benefits arise from reverse engineering advanced imports.

There is also a process of ‘learning by doing,’ whereby firms engaging in trade develop minute innovations, learn the dynamics of new markets, and expand networks in the global value chain, leading to faster and greater knowledge spillovers.

An empirical investigation into the nation’s economy supports these claims. A survey by the Lahore School of Economics into innovation in the textile sector in 2016 reported that textiles are a majorly innovative industry in Pakistan.

Of 431 manufacturers, 56pc were involved in or had introduced innovations. Overall, Rs25.4 billion was spent on R&D, with large firms reporting 10pc of their budget was directed towards R&D. These innovations were both technological as well as non-technological (eg new management practices, logistical schemes, distribution methods).

About 38pc of producers had introduced new products to the market, and six firms introduced novel products to the world. Roughly 31pc of the respondents reported new methods of manufacturing, logistics, distribution, and/or ancillary activities that supported the industry.

The last fact displays the importance of forward and backward linkages for knowledge spillovers. The trend outlined in the study was that innovation rates grew higher up in the value chain. For instance, apparel manufacturers invested more in innovation than textile manufacturers.

Given the depth of the textile value chain in Pakistan, there exists both a trickle-down and rising tide effect for innovation in the sector. Therefore, diversification has a direct impact on innovation, as reaching advanced rungs of the value chain drives further innovation.

The implementation of the Temporary Economic Refinance Facility (TERF) in 2020 saw a surge in investment. The proposed objective of this scheme was to facilitate expansion, balancing, modernisation, and replacement (State Bank 2021). These goals were being met as industries increased investments into capacity and imported machinery to replace outdated machinery.

An estimated $5 billion was invested by the textile sector in 2021 via the TERF and other financing schemes. Recently, the TERF has been criticised for raising the import bill by increasing demand for foreign machinery.

However, innovation cannot take place in a vacuum, and criticising imports for productive capacity ignores how knowledge spillovers occur. Even if Pakistan is unable to reproduce these intermediate inputs locally, modernising capital can lead to non-technological innovations as industries become acclimated to new machinery and processes.

Shahid Sattar is the secretary general and Sarim Karin is a research analyst at the All Pakistan Textile Mills Association.

Published in Dawn, The Business and Finance Weekly, May 1st, 2023