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

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

PARVEZ HASAN

ARTICLE (January 15 2007): Land reforms are not a likely prospect but much more can be done to ensure land rights of tenants and to make additional land that becomes available under new irrigation schemes to the landless rather than to the privileged.Unlike the earlier periods rural poverty is now much more deeply grounded among the landless poor and non-farm households: 60 per cent of the rural poor are landless agricultural labours and non-agricultural households. For them public infrastructure and other spending is critical. It is, therefore, important to maintain the momentum of pro- poor programs and target them more closely on rural areas.A healthy agriculture growth rate o of say 4-4.5 per cent per annum remains essential for high growth rate of the economy. The expansion of agricultural productivity can help bring real prices of wheat which is so important for poor households. Agricultural diversification to higher value crops can assist in export development as well job creation. Unfortunately, the trend growth rate of agriculture since 1999-2000 has fallen to less than 3 per cent per annum compared to a rate of 4.5 per cent in the previous two decades. Unless this trend is reversed, growth and equity problems will intensify.Fiscal policy must play a role in not only in supporting public interventions to reduce poverty but also to moderate income disparities. As stressed above, the taxation system needs to fairer. The use of capital gains tax, death duties, and global income tax should be considered not only to generate more adequate revenue but also to tax those rich that escape the tax net.Last but not least, the issue of urban income disparities must be addressed through examining the access of land for the middle classes which are in growing danger of being locked out of the housing and real estate boom.CONCLUSION: Notwithstanding the strong revival of the private sector, the agenda for role of the state in Pakistan economy remains both large and challenging. No agenda can be implemented without a vision, a national consensus, and a government structure that can deliver public services on a priority basis. There has been a great deal of talk about second generation reforms but in Pakistan a lot of the basics of governance have yet to be put fully in place.ANNEX: EVOLUTION OF THE ROLE OF STATE BY MAJOR PERIODS: -- This ANNEX attempts to highlight the main developments in the role, philosophy and effectiveness of the state in respect of economic development over the last fifty years focusing on the following elements in the various political periods-- The Vision, Strategies and notions that influenced Economic Policies and state interventions in the various political periods-- Tensions with India, national security concerns and defence expenditures-- Resource Constraints, Foreign assistance and Taxation-- Attitudes and policies towards the Private sector including trade, exchange and investment control policies-- Role of planning and economic policy coordination-- Levels of public social and development spending-- Effectiveness of public expenditures, quality of public institutions and governance-- Last but not least concern with distributive justice and poverty alleviationEARLY YEARS: Policy thinking and developments in early years were shaped by four major elements-- The deterioration in the political relations with India almost at the outset and the wide perception that India was not reconciled to the creation of Pakistan required that defence be accorded precedence over all other public expenditures. Defence spending, rose quickly in the years immediately after partition. During 1948-55 defence expenditures totalled about 3.5 per cent of the then Pakistan's GDP and were more than double the development spending.-- Speedy industrialisation based on processing of domestic raw materials was the high economic priority and justified a high degree of protection partly on grounds that large industrial profits would be reinvested (as indeed they were at least in the 1950s)-- Agriculture could be neglected because food-grains self- sufficiency was taken for granted-- The state had to play a dominant role in economic development because of the large needs of infrastructure and the fact that the private sector could not be expected to play a major role in industries other than consumer goods.Even though industrialisation was formally high on the government's agenda. the policies were not consistent. Government unwittingly influenced the speed, timing, and pattern of industrialisation through its exchange rate and trade policies. The overvalued exchange rate after 1949 combined with very liberal imports of consumer goods, financed from the windfall gains export earnings generated by the Korean war related boom, were a strong discouragement to private industrial investment. However, once the foreign exchange reserves had run out in 1952, quick development of consumer goods industries, especially cotton textiles, was the only real option. For a while unlimited protection was provided to the textile industry.The virtual ban on textile imports after August 1952 led to an almost six fold growth in production of cloth over 1952-57 bringing the country close to self-sufficiency in cotton textiles. Even though initial protection for textile industry was high its development was, by and large, in line with Pakistan's comparative advantage. By mid-1950s, the domestic prices of textiles were determined mainly by domestic competition as very few import licenses were issued for cotton textiles. This increasing competition resulted in declines in wholesale cloth prices of 20-30 per cent over 1954-6, while the general price level rose sharply. With the exchange rate adjustment in 1955 Pakistan actually began to export cotton textiles.However, the notion of a textile industry based largely on domestic raw material ie cotton greatly hurt the development of a mixed textiles industry. Because of high import duties on artificial silk yarn and polyester, Pakistan almost entirely missed on export possibilities of synthetic and mixed textiles, the fastest growing area in textiles in the 1950s and 1960s. It took decades to remove some of these distortions in trade policy. But in general also the high level of foreign trade taxation in Pakistan till recently and cascading tariffs not only provided excessive domestic protection but seriously discriminated against export development.The point is that behind the protectionist policy which carried a strong anti-exports bias was the philosophy that industrialisation based on processing of imported inputs was not real industrialisation persisted well into the early 1980s. It is also true that the concept of effective protection was not well developed at the time. And export pessimism was widely prevalent in the 1950s. Still the fact remains that examples of Korea, Taiwan, Hong Kong and Singapore that were developing a hugely successful export industries based on liberal import of raw materials were not given much attention till the 1980s.The notion that the state must be leading agent in economic development was also embedded deeply in early economic thinking. An important achievement of the 1950s was nearly four fold increase in the rate of domestic capital formation. But there was a clear public sector bias. The share of public investment increased from less than 40 per cent to two-thirds over the 1950s and in absolute terms real public grew nearly seven fold.In the First Five Year Plan (1955-60), public sector investments accounted for nearly 70 per cent of the total of the plan.THE RELATIVE NEGLECT OF THE PRIVATE SECTOR WAS JUSTIFIED ON GROUNDS OF: (i) necessity to create economic and social overheads; (ii) the reluctance of private industry to go into fields other than consumer goods; and (iii) the availability of foreign aid and loans to the public sector. That the private sector was being discouraged from investments in intermediate and capitals goods because of the exchange and trade regime was not realised. Similarly, not much thought was given to channelling some of the foreign aid resources to the private sector.Pakistan's relative neglect of its agriculture in early years was hardly unique among developing countries was compounded by two things comfortable food grains availability in the pre-partition years and the assumption that population growth was only 1.4 per cent annum. The wheat crop failures of 1952 and 1953 provided a rude awakening but the system of compulsory procurement at low prices remained in place and the availability of large food grains supplies from US under PL 480 for almost a decade from mid 1950s reinforced complacency and it was not till the mid 1960s when supply of grains under US aid became uncertain, that incentives for food production were transformed in a fundamental way.Even though GDP growth in the 1950s was modest (a little over 3 per cent per annum) terms real fixed investment increased nearly fourfold in the 1950s: domestic capital formation rising from 4.1 per cent of GDP in 1949-50 to 11.5 per cent in 1959-60. The availability of large foreign assistance, both military and economic, from the US after 1954 reduced the competition between defence and development and contributed strongly to this outcome. The downside was that about 50 per cent of the investment was financed from foreign savings, a pattern of excessive reliance on external resources that was to persist in our economic history.AYUB ERA: 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. A number of commissions, including land reform and education, were set up to review policies and make recommendations.Though, in the end, only limited progress was achieved on issues like education and land reform, economic policy-making was at the center stage in Ayub's period. His commitment to economic development was strong and clear and his approach to economic issues was essentially pragmatic. The growth rate of economy rose to 6.7 per cent in the 1960s. Indeed, GDP growth in West Pakistan was exceeded among large countries only by Korea, Thailand, and Mexico. No wonder Pakistan was often cited as a model of development in this period and, Pakistan's economic development efforts were beginning to be hailed as a rare success story.The basic model of development 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 came down sharply. The exchange rate became even more overvalued and the continuation of the multiple exchange rate regime deepened economic distortions. While high domestic protection to industry was continued, textile exports were heavily subsidised by indirectly taxing agriculture. This discouraged backward linkages, investments in industrial deepening and diversification of exports.The biggest impact of 1965 war was to change the priorities of public spending. The availability of substantial US military assistance in the first half of the 1960s made possible the containment of defence spending from Pakistan's own resources.Indeed real defence spending rose little over 3 per cent per annum in the five years before the 1965 war with India, substantially less than the rate of growth of the economy.It is significant that Ayub Khan, a former Commander-in-Chief of the army, kept the size of the army under strict control, even though India's defence expenditure was rising rapidly after its confrontation with China in 1962. But following the war with India in 1965, defence expenditures were given high priority and phasing out of US military assistance after 1965 put additional burden on domestic resources. Real defence expenditure almost doubled between 1960-5 and 1965-70. This took its toll on development.As Table below shows, a serious conflict between defence and development which had characterised the first half of the 1950s re-emerged after 1965. The Third Plan (1965-70) had targeted a sharp expansion in public development spending while reducing defence spending as a proportion of GDP. In fact, development spending remained at 7.1 per cent of GDP while defence expenditures rose from 2.8 per cent of GDP in 1960-5 to 4 per cent in 1965-70.It is interesting to note, however, that despite the loss of momentum of both public and private investment, the growth rate in the then West Pakistan remained high at 6.7 per cent per annum. The credit for this goes to the successful adaptation to the Green revolution, ushered by new and improved varieties of wheat and rice, effective use of planning processes and economic policy coordination mechanisms, and conservative fiscal monetary policies. Additional defence spending was financed by raising tax revenue rather than increasing budgetary deficit. The 1960s were the only period in Pakistan's fiscal history when significant public savings, ie, the excess of government revenue receipts over revenue expenditures, materialised.Despite some major economic policy failures, the Ayub era was an exceptionally successful period of economic management because it used panning institutions and processes effectively to do economic policy coordination, speeded up economic decision-making and decentralised implementation processes and authority. But the public sector bias of the development policy reflected in the First Plan continued and was perhaps compounded by the large availability of foreign assistance, which mainly financed public sector development. Private investment was expected to account for only 25 per cent of total development spending (including the Indus Basin Replacement Works and the Rural Works Programme) under the revised Second Plan. In fact, private investment in West Pakistan turned out to be higher than public investment (including the Indus Basin Works). Even so, the Third Plan (1970-75) allocations for the private sector were projected at little over one-third of the total (including Indus Basin Works).BHUTTO'S EXPERIMENT WITH SOCIALISM: Ayub's downfall in 1969 and the separation of East Pakistan brought Zulfiqar Ali Bhutto to power in December 1971. Bhutto's Pakistan People's party (PPP) had captured the imagination of the general public with the slogan of Roti, Kapara , Makan, Though Bhutto had no clear notions about socialism, he felt he had the public mandate to bring about fundamental changes in public ownership of means of production.Bhutto undertook large-scale nationalisation of industry, insurance, and banking, extending the state control of the modern sector significantly. Bhutto government also took full control of country's educational system by nationalising private educational establishments. This experiment with socialism had far-reaching and long-term consequences. Though successive governments in the next two decades attempted privatisation, large segments of banking, insurance, and industry remained with the state till the late 1990s.================================================
Table
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Defence vs. Development
(Rs billion)
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1960-5 1965-70 1965-70
Actual Planned Actual
Development spending 13.95 30.00 21.75
(7.1) (9.8) (7.1)
Defence spending 5.50 6.89 12.38
(2.8) (2.2) (4.0)
================================================Note: The figures in parenthesis are in per cent of GDP.Source: Fourth Five Year Plan, pp. 45-47.(To be continued)
Copyright Business Recorder, 2007