State and Pakistan economy: where have we come from? Where do we go? - I

State and Pakistan economy: where have we come from? Where do we go? - I

PARVEZ HASAN

ARTICLE (January 12 2007): Slowly but surely Pakistan has undergone a sea change in its policies towards a liberal economic framework, privatisation, and private sector development since the early 1990s.In the 1990s the impact of economic liberalisation and structural reform measures on private sector development was seriously thwarted by lack of adequate stabilisation efforts, macroeconomic instability, and critical shortages of infrastructure and slow rate of privatisation.Since 2000 the restoration of strong macroeconomic fundamentals, a determined push towards privatisation and promotion of foreign investment, and a recovery in essential public investments has greatly stimulated private sector activity. There is some debate whether privatisation has been pushed too far. But by and large there appears to a consensus that private sector development, including privatisation, has as yet a long way to go in Pakistan. A high degree of faith in the market economy is also at present the dominant economic paradigm internationally.The private sector cannot prosper on a sustained basis and an equitable high growth rate cannot be achieved, however, without a strong and stable state, an effective government role in policymaking, essential public investments, and delivery of basic public services.There is not enough debate on what should be the future role of state in Pakistan's political context, its stage of development, its rather weak public institutions, over centralised government structures and a civil service that badly needs reform.This overview paper discusses how international economic thinking about the role of the state has evolved during the last half century, stresses the importance of political leadership providing a vision, examines factors that have shaped the rate interventions and policy in Pakistan over its history, reviews recent improvements, current directions, and challenges and attempts to identify priorities for the near and longer term. The purpose is to stimulate a much needed debate on a subject which is closely tied to the governance issues being discussed in this conference and deserves more attention from our political leaders.CONCEPTUAL DEBATE AND REALITY Table 1 on Functions of the State below provides a convenient theoretical starting point of the why and how of the role of government. A minimalist state focusing on defence, law and order, macroeconomic management and public health is close to the ideal of the most influential economist of the last half century, Milton Friedman who passed away recently.Friedman and kindred spirits like Friedrich von Hayek did a great deal for establishing the case for free markets and resurgence of capitalism in the second half of the 20th century. They also turned the tide against Keynesianism with its strong faith in using public policy especially fiscal policy in ensuring full employment and high level of economic activity making up for the shortcomings of the market.In fact, however, the minimalist state is rare. Even in the most conservative developed countries, state functions often go beyond the intermediate stage not only in providing social support but also in promoting key areas such as technology, energy, exports - will beyond what could be termed as external economies.In the developing economies, the state is involved in addition, with varying degrees of success, in providing goods and commercial services especially in transport and utilities. No doubt there has been some pulling back in the role and the size of Government during the last two decades.Public spending had expanded the world over after the end of Second World War. Central Government expenditures in the OECD countries grew from less than 20 percent of GDP in 1960-64 to well over 35 percent in 1990-94. In the process, the state became overextended in relation to its implementation capacities as well as financial resources in many developed as well as developing countries. Large fiscal deficits and growing volume of public indebtedness fuelled inflation as well.Privatisation moves world wide have been stimulated by several factors, the need to reduce the drain on the public resources caused by losses of state owned enterprises, to draw on the private sector resources to meet the growing needs of infrastructure, to remove the price rigidities in public sector utilities which being under political control are not often allowed the needed price adjustments in time, to invigorate management practices and technological change in public owned corporations by attracting talent which would normally not be available because of the constraints of civil service pay scales and procedures.The interesting point is, however, that notwithstanding the Thatcher and Reagan revolutions in UK and USA respectively, the collapse of communism, the end of the cold war and the cutbacks in defence spending, the level of public spending as a percentage of GDP in developed countries is, at best, only marginally lower at present than it was in the early 1990s.In the US consolidated public spending at federal, state and local level at around 36 percent of GDP currently is about the same as in late 1980s. However, it must be stressed that the industrial country governments spend much more money on transfers and subsidies than on providing the traditional public goods notably defence and law and order. So simple comparisons with the developed countries and developing counties cannot be made.Some argue that the massive intellectual and rhetorical libertarian assault on the welfare state launched in the United States from 1970 onwards by the libertarians including Milton Friedman has been finally defeated. They cite the rejection in the past decade by the US public of every element of the libertarian counter-revolution, school vouchers, privatisation of social security, individual health accounts, abandoning minimum wages and the abolition of the estate tax.It is thus speculated that the 'libertarian moment has passed. It will not come again and its defeat as a force in US politics will change the definition of the right, left and centre, not only in the US but also , the world.'Be as it may, for developing countries like Pakistan the welfare state at best, is only a distant dream. For these countries the real challenges are to provide the minimal functions of the state effectively while promoting sustainable and equitable growth.STATE AND ECONOMIC DEVELOPMENT: IMPORTANCE OF VISION Accepting the paradigm that reliance on markets is greatly desirable and should be encouraged as a matter of public policy, the role of state can, nonetheless, be pivotal in economic development.The classification of state functions given in Table above, though wide ranging, does not capture some of the dynamic elements of state's contribution to economic development nor does it deal with the issues of effective government. The issues of resources available to the state and the basic choice between guns and butter, as constraints, are also not addressed.In my view, even with a strong commitment to the markets, four areas of state intervention can significantly influence the growth path of an economy.-- a vision or a lack thereof for the future of the country and its strategic directions by the state, as embodied in the political leadership and the elites-- The burden of defence on national resources and the balance between development and defence-- Quality of governance and effectiveness of delivery of basic public services such as law and order, property rights, education and health, infrastructure.-- Resource mobilisation through taxation, borrowing, and foreign assistance.-- The last three points are rather obvious but the first one needs some elaboration.The spectacular failure of communism to deliver on its promise of material advancement and social justice in the Soviet Union and Eastern Europe is the most extreme example of unsuccessful state interventions and philosophy. The sad experience of the former Soviet Union suggests that even a combination of high rates of investment and high level of human resource development can fail to deliver sustained growth if the economic signals are distorted, competition is absent, and incentives for efficiency, productivity improvements and technological change do not exist. Soviet Union experience also points to the danger of excessive preoccupation with defence spending.But in a sharp contrast to the Soviet model, vision, philosophy and strategic directions set by the state have, in combination with reliance on market forces, played a very positive role the in some of the most successful cases of development during the last quarter century.South Korea, Singapore, Taiwan, China, Thailand, Malaysia, and more recently India have all strongly benefited from positive directions provided by a reformed or reforming state.In Korea manufactured exports were almost negligible in early 1960s and saving and investment and balance of payments gaps were huge. Park Chung. He who assumed the leadership in 1961, put his trust in export development and export led growth became almost a religion in Korea during the 1960s and the 1970s.Exports trends were monitored monthly by a high level meeting chaired by the President and attended both by high economic officials and leading exporters with a view to co-ordinate policy and to do trouble shooting. As a result of this almost single-minded focus, manufactured exports from Korea which were a modest $100 million even in 1965 grew quickly to $600 million by 1970 and had already exceeded $10 billion mark by 1980. Total exports from Korea were $288 billion in 2005.The Korean export drive would not have been quite so successful if in early 1970s the Korean Planning Board had not, again under the direction of President Park, drawn up an ambitious plan to diversify and deepen the export and industrial structures. Till that time the Korean exports were heavily concentrated in labour intensive manufactured goods such as textiles: textiles, clothing, footwear and wigs accounted for nearly 70 percent of manufactured goods exports in 1970.Recognising that relatively low skill intensive manufactured exports will be losing their comparative advantage as real wages had started to rise sharply, the political leadership launched a long term plan in 1973 to develop more skill and capital intensive heavy industries including steel and shipbuilding as well as electronics, the new growth pole in international trade. Apparently, the impulse for shipbuilding came directly from President Park personally who wanted to emulate and ultimately challenge Japan's dominant place in world shipbuilding at the time.He felt that Korea's location, climate and educated and disciplined labour force could all eventually match Japanese's competitive edge. He had to actively encourage private entrepreneurs like Hyundai Group to take the risks in a field totally new to them. But he had the foresight not to create a monopoly by involving at three Chaebols in the field.In the same way as South Korea's development strategy drew its inspiration from examples of Japan, Taiwan and Singapore, China in its historic opening to the outside world under Deng Xiaoping, drew on the example of Hong Kong starting as late as 1979.Just a couple of decades ago few could have imagined that a continental economy like China could make exports expansion its growth engine by turning large parts of its Eastern Coast into essentially free trade zones. In a generation, exports of goods and services from China have risen to $800 billion or well over 35 percent of GDP.China is the most export oriented large country in the world, its exports to GDP ratio at over 40 percent in 2005 compared with 21 percent and 11 percent in India and USA respectively.Malaysia represents a success story of a different sort but again one in which a state vision and well articulated strategy played a key role. While GDP, investment and export growth from Malaysia have all been very impressive, Malaysia's most significant achievement has been the creation of a more equitable society in a multiracial setting.In 1970, Malays constituted about 53 percent of the Peninsular Malaysian population. However, the share of Malay entities in the corporate sector assets was only 2 percent. Lifting the large number of Malays from poverty, and bringing about a more ethnically balanced ownership of assets in the society. The incidence of poverty in Malaysia was the highest among Malays (nearly two-thirds) compared to 39 percent among Indians and 26 percent among Chinese.This was largely because Malays were concentrated in rural areas where the incidence of poverty was twice as high as in urban areas. The average Malay household income in 1970 was half the level of a Chinese household.The social and racial inequities and tensions erupted in unprecedented 1969 riots that left hundreds dead. In response to this extremely volatile political situation, the government made constitutional amendments and formulated a New Economic Policy (NEP).The overriding aim of the NEP was to promote national unity by pursuing two objectives: the eradication of poverty and the restructuring of society so as to eliminate the identification of race with economic function.As a part of this policy, ambitious long term targets for Malay ownership and in the corporate sector, proportion of Malays employed in the manufacturing sector and managerial positions and Malays enrolled in the institutions of higher learning were set.Under Mahathir Mohamed who was Malaysia's Prime Minister for over two decades (1981-2003) state interventions in the Malaysian economy became even stronger. The aspirations were reflected in the National Development Policy (1991-2000) and Vision 2020 formulated in 1990.While pushing the NEP agenda, Mahathir also aimed at accelerating growth by making Malaysia into a high-tech manufacturing, financial and telecommunications hub. Very large investments in infrastructure had the objective of improving private investment and industrial projects notably Perwaja Steel and the Proton car aimed at deepening of the manufacturing sector.While the latter project were not successful and had to rescued by the private sector, the large investments in the North-South Highway, the multimedia Corridor, and large Kuala Lumpur Airport have sustained high growth and have helped to accelerate growth.The high growth and emphasis on equity has enabled Malaysia to virtually eliminate poverty, reduce the gap between Malays and Chinese and promote greater harmony in the society. Social indicators such as literacy levels and infant mortality rates have been pushed close to par with developed countries.It should be added, however, that Malaysia's remarkable progress was facilitated greatly by its initially strong natural resource endowment, a comfortable fiscal and foreign exchange position, a well paid and effective civil service, and last but not least a strong government reflecting broad based political coalition.The point of the above examples is that political will, a well conceived vision, and clear strategic directions can help both to stimulate and support the private sector as a part of an overall effort to accelerate growth and ensure equitable distribution.At the same time, as Korean example in early 1980s and less than successful Malaysian public industrial projects show, state attempts to manage precise directions of the economy are likely to fail as the economy becomes more complex and sophisticated. Still an enlightened state can help push economic growth as well as poverty alleviation particularly in the earlier stages of development.STATE AND THE ECONOMY IN PAKISTAN 1950-2000 The previous section outlines some of the ways in which state can help or hinder economic development. What has been Pakistan experience? What State directions and policies have promoted economic development? What State notions or priorities have hurt growth and social change?As could be expected, this is a long, varied and rather complex story which is best understood in the historical context of major political periods. Annex A highlights in some detail the major influences that governed the level and direction of state involvement and interventions in a chronological order.Major points are summarised in Table 2 and discussed below. The categorisation of State performance is, in the final analysis, subjective and not scientific and I realise could be challenged.VISION, STRATEGY AND PRIORITIES Pakistan has never had a very strong, coherent and clear economic vision about its future a la Korea, China, and Malaysia. But fairly distinct national agendas and notions of economic development have guided economic policies and priorities in almost all political periods.Economic strategies have evolved over time influenced not only by the personal views of the leadership, most notably Ayub Khan and Zulfiqar Ali Bhutto but also by the contemporary currents of international thinking about planning and economic development.Policy thinking and developments in early years were focused above all on four things: building defence capability, rapid industrialisation, reducing dependence on trade with India, and seeking large Scale US military and economic Assistance.With firm grip on power and relative political stability, Ayub Khan, Pakistan's first military ruler, put economic and social development high on his agenda. His commitment to economic development was strong and clear and his approach to economic issues was essentially pragmatic.The basic model of development under Ayub was based high reliance on the key relationship with the US for military and economic assistance, strong push for public sector investments especially in water and power facilitated by the Indus basin treaty with India, relaxation of foreign exchange and investment controls, and much improved availability of long term industrial credit for the private sector through PICIC and IDB.The essential parameters of the vision, however, fell apart after the 1965 War with India which led to a very sharp increase in defence spending from Pakistan's own resources as US assistance, both military and economic, came down sharply.TABLE 1 ======================================================================
Functions of the State Minimal Functions
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Addressing Market failure: Improving Equity
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Providing pure public goods: Protecting the Poor
Defence. Anti-Poverty programs
Law and order Disaster Relief
Macroeconomic management- Public health
Intermediate functions
Addressing externalities:
Basic education
Environmental protection
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Regulating Monopoly: Providing social insurance
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Utility regulation. Re-distributive pensions
Antitrust policy. Family Allowances Unemployment
Insurance
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Overcoming Imperfect information
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Insurance (health, life, pensions,)
Financial regulation
Activist functions
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Coordinating private activity Asset Redistribution
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Fostering markets
Cluster initiatives
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TABLE-2 =================================================================================================================================================
Key aspects Early Years Ayub's Era Z.A Bhutto's Ziaul Haq Period Return to Musharaff Years
of State's Rule Democracy
Role
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Vision Strategy Rapid Industrialisation, Foreign aid Public control of Largely Status Economic Debt burden,
and priorities Reducing dependence on mobilisation, Accelerating Modern Sector, Quo with very Liberalisation Reduction
trade with India, Growth, Long Term Water Nationalisation of few really nd Promotion Revival of High
and Seeking Large and Power investments, Education, and important Policy of Private Economic Growth
Scale US Military and Speedy Spread of Weakening of Initiatives sector, Relative And Accelerated
and economic Assistance Green Revolution Bureaucracy Neglect of Privatisation
Macroeconomic Induction of
Imbalances foreign Private
investment
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Vision Strategy High Moderate till 1965, High Very high Moderate Moderate
and priorities High afterwards
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Domestic Resource Moderate Moderate Moderate but Moderate but Low but with Low but with
Mobilisation with heavy with heavy improving tax improving tax
reliance on foreign reliance on structure structure
trade taxation foreign trade
taxation
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Degree of Economic Low Moderate Low Moderate High High
Liberalisation
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Priority to Moderate Moderate to High Very low Moderate High Very High
Private sector
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Level of Public Moderate High Very High Moderate but Low and Low but
economic, social Declining Declining Rising
and development
Spending
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Effectiveness Of Moderate High Low Moderate Low Moderate
Policy Coordination.
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Quality of Moderate Moderate Declining Declining Declining Low but
governance/ public Improving
services delivery/
effectiveness
of spending
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Concern with Low Low High but Low Low Low
Social Justice/ Ineffective but Improving
Poverty Reduction
=================================================================================================================================================Source: World Bank, 1997 Development Report (WDR).To be continued
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