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
======================================================================
Addressing Market failure: Improving Equity
======================================================================
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
======================================================================
Regulating Monopoly: Providing social insurance
======================================================================
Utility regulation. Re-distributive pensions
Antitrust policy. Family Allowances Unemployment
Insurance
======================================================================
Overcoming Imperfect information
======================================================================
Insurance (health, life, pensions,)
Financial regulation
Activist functions
======================================================================
Coordinating private activity Asset Redistribution
======================================================================
Fostering markets
Cluster initiatives
======================================================================
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
=================================================================================================================================================
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
-------------------------------------------------------------------------------------------------------------------------------------------------
Vision Strategy High Moderate till 1965, High Very high Moderate Moderate
and priorities High afterwards
-------------------------------------------------------------------------------------------------------------------------------------------------
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
-------------------------------------------------------------------------------------------------------------------------------------------------
Degree of Economic Low Moderate Low Moderate High High
Liberalisation
-------------------------------------------------------------------------------------------------------------------------------------------------
Priority to Moderate Moderate to High Very low Moderate High Very High
Private sector
-------------------------------------------------------------------------------------------------------------------------------------------------
Level of Public Moderate High Very High Moderate but Low and Low but
economic, social Declining Declining Rising
and development
Spending
-------------------------------------------------------------------------------------------------------------------------------------------------
Effectiveness Of Moderate High Low Moderate Low Moderate
Policy Coordination.
-------------------------------------------------------------------------------------------------------------------------------------------------
Quality of Moderate Moderate Declining Declining Declining Low but
governance/ public Improving
services delivery/
effectiveness
of spending
-------------------------------------------------------------------------------------------------------------------------------------------------
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
Copyright Business Recorder, 2007
Monday, January 22, 2007
State and Pakistan economy: where have we come from? Where do we go? - II
State and Pakistan economy: where have we come from? Where do we go? - II
PARVEZ HASAN
ARTICLE (January 13 2007): Bhutto came to power in December 1971. His 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.Apart from their negative impact on private industrial development, Bhutto's policies had adverse long-term economic consequences through increase in defence establishment, nationalisation of educational institutions, a cavalier attitude towards public spending, and, last but not least, serious erosion of the capacity and authority of public sector institutions.A great deal of the responsibility for failures in basic education, which has become an important constraint on growth, can be traced back to the decision to nationalise educational institutions in 1972.From economic point of view, Zia-ul-Haq's rule (1977-88) was the least ideological and the least innovative. Fortunately for Zia-ul-Haq, the economy showed a high and sustained growth rate helped mainly by a number of special factors both domestic and external. The completion of long gestation period Tarbela Dam project in 1977 added considerably to irrigation water availability and hydel power capacity.Fertiliser and cement investments undertaken under Bhutto contributed to industrial growth. A tremendous boost to economic activity was also provided by rising worker remittances and large external assistance for Afghan Mujahedin, channelled through Pakistan. Similarly, the narcotics trade, which gathered great momentum in the 1980s, strongly supported the service sectors of the economy.Lulled by a comfortable growth rate and a balance of payments situation greatly helped by remittances and other external factors mentioned above, Zia regime did little to deal with the serious structural problems inherited from the 1960s and 1970s: the over-extension of government, the poor climate for private sector investment, heavy dependence of exports on cotton based exports, and the inelasticity of the tax system.Indeed some structural problems were intensified. Relentless growth in public spending, a major shift in the public expenditure priorities from development to defence, and consequent rise in fiscal deficits increased debt burden sharply.There is no doubt that macroeconomic imbalances were worsening and growth was slowing down after mid 1980s. Had Zia lived, he would have had to face the consequences of his neglect of some basic economic issues. As it turned out, the responsibility for sorting out the difficulties fell to a succession of weak political democratic governments which followed Zia.These governments were both ill-equipped and disinclined to deal with the multitude of structural issues that had accumulated over time, and thus the economy has had to suffer periodic economic crises in the 1990s.Notwithstanding substantial macro-economic mismanagement over decades (less visible in the 1980s than in the 1970s and 1990s), there was a gradual process of liberalisation of the economy starting in the late 1980s notably the reduction of interventions in agricultural prices, relaxation of import and investment controls and financial sector reforms.Major agreements with the IMF and the World Bank financially supported the structural reform process which was further accelerated by the removal of foreign exchange controls and stepping up of the pace of privatisation under the first Nawaz Sharif Government in 1991-92.The policy shift towards the private sector and greater reliance on market signals rather than administered prices was influenced largely by pragmatic considerations. Policy decisions to involve the private sector in energy and infrastructure development reflected a realisation going back to 1987 that the public sector funds had become a serious constraint on development.Similarly, the drain caused by losses of public sector enterprises was a major factor in the decision to hasten privatisation of industrial assets. Efficiency considerations were also behind the drive to privatise government banks and telecommunications corporations.DEFENSE SPENDING Because relations with India deteriorated early on and Kashmir dispute has continued to simmer between the two countries, high level of defence spending has remained a key feature of state policy and strong competition between defence and development has been unavoidable.The only periods in Pakistan's history when defence spending grew less rapidly than GDP were the first half of the 1960s and the second half of the 1990s. In the former period it was the large US military assistance which made a lid on military expenditures possible. In the latter period, growing financial and fiscal crises led to an actual decline in defence outlays for a few years. (See Table 4).Between 1965 and 1990 there was an almost relentless growth in defence and related spending. Real defence expenditure almost doubled between 1960-65 and 1965-70 in the wake of the 1965 war. Under Z.A. Bhutto defence outlays increased by a further 33 percent even though the size of the country and the economy had shrunk substantially.Under Zia, real defence spending increased on average by 9 percent per annum during 1977-88 while development spending rose 3 percent per annum; by 1987-88 defence spending had overtaken development spending. For 1980s as a whole, defence spending averaged 6.5 percent of GDP. Not only was this a peak but it also contributed strongly to large fiscal deficits and a rapid build up of public debt.PUBLIC V/S PRIVATE SECTOR 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 the increase in the rate of domestic capital formation, in absolute terms fixed investment in the then West Pakistan increased nearly fourfold in the 1950s.But there was a clear public sector bias. There was an almost sevenfold increase in the real level of public investment in the 1950s and the share of public investment in total investment increased from less than 40 percent to two-thirds over the decade.The Ayub era was an exceptionally successful period of economic management because it used panning institutions and processes effectively for economic policy co-ordination. The pace of economic decision-making was speeded up, implementation processes strengthened and sectoral planning substantially decentralised. But the public sector bias of the development policy of the 1950s continued and was compounded by the large availability of foreign assistance, which mainly financed public sector development.Private investment was expected to account for only 25 percent 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 economic policies virtually halted the growth of the modern private industrial sector and reinforced the anti-export bias of the industrial strategy. Large public investments in industry focused on import substitution and the reform of the exchange rate system failed to remove the large wedge between the average effective exchange rates for imports and exports.Even though the attitude towards the private sector improved during the Zia period and some privatised units were returned to the private sector, there was no attempt to tackle the overhang of major nationalisation of the Bhutto period. Even though major inefficiencies had already emerged in public sector enterprises, especially the nationalised commercial banks, not much thought was given to systemic solutions.The early 1990s saw the emergence of liberal economic policies and a fuller realisation that the private sector should be allowed to play a greater role in the economy. But structural reforms including financial sector liberalisation and privatisation did not go far enough, or remained in early stages.Only limited progress was made in privatisation in financial, telecommunications, and the energy sectors. The delay in privatising large state-owned banks was particularly costly because credit allocation decisions became more susceptible to political pressures under the democratically elected governments.Paradoxical though it may seem, some of the liberalisation measures, though sound in themselves, had the impact of diluting the urgency of macroeconomic adjustment. First, the ease of financing the foreign exchange gap through foreign currency deposits and portfolio investments became an excuse for not facing up to the unsustainability of large balance of payments deficits. Second, large receipts from privatisation were used to bolster public spending rather than to retire debt.III - PAKISTAN AT THE THRESHOLD OF 21ST CENTURY As I have argued elsewhere Pakistan as it approached the 21st century Pakistan was faced with not only a financial crisis but also an economic growth crisis because the per capita GDP growth had slowed down to 1 percent per annum during the 1990s from the average of around 3 percent per annum during 1960-85.It is too simplistic to lay the blame for Pakistan's economic and financial problems at the end of 20th century mainly at the governance and economic policy failures in the 1990s.The fundamental governance and growth problems had long roots and had their origins in: -- A level of defence spending that the country could ill afford-- Inability of the government after mid 1980s to collect enough revenues to cover current expenditures. This led to borrowing partly for current outlays including defence and thus sharp build up of public debt and rise in interest payments. Consequently, despite large fiscal deficits, social and development spending began to squeezed and began to fall as a percentage of GDP.-- A major neglect of human development outlays and quality of public education in face of rapid growth of population and rising needs for skills.-- A weak industrial and export structure, dominated by cotton based exports resulting from both from insufficient progress in education and trade policies which discouraged backward linkages, exports based on imported inputs and diversification-- Personalised rule, over centralised decision making, weakening public institutions and rule of law, increasing public corruption, and lack of accountability-- A pattern of development which resulted in sharply increasing inequalities and only slow reduction in poverty because it rewarded rent seeking, discouraged genuine entrepreneurship, did not promote labour intensive exports, and did not sufficiently tax the rich.By the end of 1990s, the growth and governance problems had become intertwined. Because growth benefits were not widely shared, the quality of public services especially education was deteriorating and the pace of poverty reduction was slowing, the tensions in the society had begun to erupt with increasing frequency in ethnic, sectarian and random violence. The deteriorating law and order situation in turn had become a constraint on investment and growth.Taking the second half of the twentieth century as a whole, however, it is the governance failures in Pakistan that stand out much more than growth disappointments. Pakistan no doubt missed major economic opportunities especially in exports of manufactured goods but its average GDP per capita growth rate of 2 percent per annum over 1950-2000 was about the average for developing countries and about the same as India's.Furthermore, Pakistan had to cope with a much higher growth rate of population of nearly 3 percent per annum over fifty years. If governance had not deteriorated so much and the strength public institutions not eroded over time, the resources mobilised through taxation would have been more adequate and the quality of public services especially education would not have declined so precipitously.Poor governance hurt the poor and low income groups especially as they depend relatively more on public services. The failure of the well intentioned Social Action Program in the 1990s which aimed at provision of basic education and health services and narrow the gaps in human development must basically be attributed to poor governance.Why did governance decline so sharply over time? This is a big question and the answer to which is essentially beyond the scope of this paper. But one can point to some basic factors. I believe the very high population growth rate complicated, both financially and managerially, the delivery of basic public services. The responsibility for weakening of the rule of law must be borne by the political leadership both military and civilian.Some argue that extra- judicial interventions by the military and disregard of the Constitution is a root cause of this problem. But in some respects Pakistan's military regimes were less arbitrary than some democratically elected leaders starting with Z.A. Bhutto.The weakening of bureaucracy, a decline in its competence, and increase in corruption is as much due to its steadily declining relative compensation as to the frequent political interventions in violation of rules and regulations.Governance was relatively good till the 1960s. The sanctity of public expenditure was well observed and there was not the cavalier attitude towards the use of public funds. Relatively new public entities such as WAPDA and PIDC had strong leadership and were quite effective because they had more operational freedom including ability to adjust prices. Later, the governments were either populist or weak and unsure and tended to postpone difficult decisions for the sake of short term gain.But purely from an economic policy viewpoint, the picture at end of 1990s had some important bright spots. By the sheer pressure on public resources defence spending did not increase much in real terms in the 1990s. The gradual liberalisation of imports and reduction of tariffs had by reducing foreign trade taxation substantially reduced the anti-export bias in policies, agricultural price distortions had become minimal, and the environment for private sector had become much friendlier.There was a clear recognition in the privatisation efforts and seeking of private investments in power generation that government had become overextended financially as well as administratively.IV - STATE AND ECONOMY UNDER MUSHARAFF PROGRESS AND PROBLEMS So what has changed and by how much during the last seven years? Unfortunately the views on what has happened tend to be rather polarised. The government claims broad success in putting national finances on a sound footing, reviving strong growth, improving social indicators and beginning the difficult processes of improving governance and sharing of growth benefits more widely.The sceptics point to the continuance of serious issues in governance and quality of public services, narrow base of the prosperity, only modest progress in poverty reduction, and re-emergence of heavy reliance on external flows. As often the reality is more complex. There have been some fundamental changes in macroeconomic policies, attitudes towards the private sector and size and use of public resources which have revived strong growth and improved growth prospects, enhanced the priority of social sectors including higher education, and accelerated pro-poor spending.But it also remains very much an open question whether reforms so far have put the economy on a sustainable high growth path and improved the economic model and the governance structures sufficiently to ensure a more equitable growth. This section and the next explore both the progress and the challenges that remain.MACROECONOMIC MANAGEMENT: REDUCTION OF DEFICITS AND DEBT BURDEN REDUCTION The sharp turnaround in the public and external finances of Pakistan has been a singular economic policy success of recent years.No doubt the improvement in the external and domestic finances and the large build up of foreign exchange reserves has been greatly helped by developments following 9/11 and realignment of Pakistan's relationship with the United States and other Western Countries. External grants, substantial concessionary assistance, Paris Club rescheduling, payments for logistical support to the US, and somewhat better access to external markets, all contributed strongly to the remarkable build up of external reserves over the last few years.But tough stabilisation policies aimed at restoring financial discipline, shrinking fiscal deficits, great restraint on non-concessionary external borrowing, and measures to promote exports laid the basic ground work for the much increased confidence in the stability and strength of Pakistan rupee which in turn resulted in reversal of capital flight, large increase in worker remittances, and growing interest by foreign investors.The external and public debt levels have come down very sharply since 2000. Total external debt of Pakistan grew only modestly from $32.1 billion in mid 2001 to $35.7 billion in mid 2006 cushioned in part by large increase in foreign investments inflows related partly to privatisation efforts. Meanwhile, exports and worker remittances have risen sharply.As a result, external debt, as a percentage of exports of goods, services, and transfers has dropped from around 250 percent to 115 percent over the period. Furthermore, the average terms of external debt have softened considerably because of large debt relief from the Paris club, retirement of expensive debt and substantial concessionary assistance especially from IDA.This is reflected in an even sharper drop in the ratio of external debt service payments to foreign exchange earnings from 26.5 percent in FY2002 to 9 percent in FY 2006.The public debt to GDP ratio has declined from over 90 percent (on new GDP numbers) in mid 2000 to 55 percent in mid 2006. As a proportion of government revenues, Pakistan's public debt has also declined from nearly 600 percent in mid 2000 to less than 400 percent in 2005-06. Interest payments as percentage of government revenue have come down from 33 of public expenditure in late 1990s to17.5 percent in 2005-06.But it is clearly desirable to reduce debt burden further say to a total public debt to revenue ratio of less than 300 percent and interest payments to government revenue ratio of less than 15 percent from 33 of public expenditure in late 1990s to17.5 percent in 2005-06.The sharp decline in interest payments in the budget from nearly 7 per cent of GDP in FY 2000 to 3.1 percent (as well as containing defence spending as a percentage of GDP) has opened up fiscal space, defined as non-interest and non-defence spending, while at the same time making possible a reduction in fiscal deficits.The non-interest and non-defence spending increased from a low of 8.6 percent of GDP in FY 2000 to 12.2 percent of GDP in FY 2006. Public spending including the earthquake related spending has doubled over the last six years in real terms providing a strong momentum to both growth and social development.The macroeconomic management in Pakistan is being challenged once again partly because of both external shocks and too accommodative a monetary policy in FYs 2005-06.-- The almost doubling of the international oil price between 2003-05 and 2005-06 has added $3 billion or more than 2 per cent of GDP to Pakistan's petroleum imports.-- The devastating earthquake which will cost the economy $6 billion over five years but at best only one-third will be covered by truly additional grants and highly concessionary assistance. So the budget will have to suffer a negative impact of 0.5 per cent for the next few years.-- In retrospect, the private credit expansion of more than 100 per cent between mid 2003 and 2006 was clearly excessive especially in respect of consumer credit increase.Notwithstanding major economic shocks, Pakistan has been able to avoid disruption to economic growth because of adequate level of foreign exchange reserves and large foreign investment flows related partly to rapid privatisation.However, the current account balance of payments deficits, after official transfers, to $5 billion in 2005-06 and the July-October 2006 data suggest could grow to $6.0 billion or over 4 percent of GDP in 2006-07, if the recent decline in international oil price is not sustained. Meanwhile, inflation though stable at around 7-7.5 percent is stubbornly high.Maintaining of macro stability would require further strengthening the structural position of both external and internal finances not only through fiscal and monetary policy adjustments but also through export push in non-traditional exports. Just because an economic shock is exogenous does not mean it does not need a policy response particularly if it is not self-correcting.Having said that Pakistan has much greater freedom of financial options than ever before as typified by its successful long term bond placement in the international market, the continuing strong interest from foreign investors especially from the Middle East, and continued strong support from international organisations especially the World Bank and the ADB.DEFENSE SPENDING As mentioned above, high defence spending (both in real terms and as percentage of GDP), has constrained growth and development over long periods in the past not the least because there was not the national will after 1985 to mobilise enough tax resources to meet defence needs without borrowing for current government expenditures.In the second half of the 1990s real defence spending as well as all other non- interest government spending fell as interest payments on debt absorbed a steadily rising share of public expenditures. Between 1991-92 and 1999-2000, there was virtually no increase in real defence spending and it declined as a percentage of GDP from 6.3 percent in 1991-92 to 4.8 percent in 1999-2000 - much lower than the peak of 7 percent in late 1980s under Zia-ul-Haq.However, it should be noted that real non-interest non-defence public spending declined even more sharply both in absolute terms and as a percentage of GDP, from 15.2 percent in 1991-92 to 10 percent in 1999-2000. Thus the civilian expenditure was squeezed to a greater extent than military spending under the financially strapped 1990s.(See Annex Tables 1&2) The analysis of defence spending since 2000 is complicated by two facts. First, as is the custom in many countries including India, the defence pensions were moved to the civilian budget from 2000-2001 Secondly the national income figures were revised substantially upwards and a new series introduced starting with 1999-2000. This makes historical comparisons somewhat difficult.Since 2000-01, defence spending, excluding pensions, has risen in real terms roughly in line with the growth in GDP. It actually fell in the stabilisation years 2000-2002 but has increased by 23 percent during the last three years (2003-06).Currently defence spending is around 3.2 percent of GDP and appears to be lower than the level in the 1990s even after making rough adjustments for comparability of data. Three points need to be noted, however. First the defence budget is still absorbing nearly one third of government revenue. Secondly, the current military outlays are being supported partly by payments from the US government for the fight against terrorism. If and when these payments decline, down ward adjustments in spending will be needed and if not made the history of late 1960s will repeat itself.Thirdly, it is not clear that all military purchases abroad either through foreign assistance or loans are fully reflected in the budget figures. In any case, the issue of an appropriate level of defence spending ie the choice between guns and butter remains very much alive.PRIVATE SECTOR DEVELOPMENT AND PRIVATIZATION Another important success of the Musharraf regime, not unrelated to the strengthening of the financial position and increased confidence in the currency, has been the further energising of the private sector through accelerated privatisation's and improvement of investment climate. Induction of foreign investment has becoming a promising source of future growth.During the last five years, 2001-2006, direct foreign private investment has totalled $7.3 billion, rising from $500 million in 2001-02 to $3.5 billion in 2005-06. Privatisation receipts at $2.4 billion have accounted for over one-third of direct foreign investment. The privatisation sales to the foreigner have been concentrated in banking, telecommunications and thermal power while other important foreign investment flows have been in oil and gas and telecommunications.TABLE 3 ====================================================================================================
Key Fiscal Aggregates, Public and Private Investment (as percentage of GDP)
====================================================================================================
Years Public Fixed Private Fixed Consolidated Defence Non-interest Fiscal Tax
investment investment Public Spending Non -defence deficits Revenue
Spending Public Spending
1960s 8.2 8.8 NA 2.8(1960-65 NA 2.1 NA
4.0(1965-75)
1970s 10.3 5.6 21.5 5.61 14.0 5.3 13.8
1980s 9.2 7.8 24.9 6.5 14.5 7.1 13.4
1990s 7.5 9.1 24.1 5.6 11.7 6.9 14.0
1999-2000 6.0 8.4 23.6 4.9 10.5 6.6 12.9
New Revised National Account Series
1999-2000 5.6 10.4 18.7 4.02 7.8 5.4 10.7
2000-2001 5.7 10.2 17.2 3.2 8.0 4.3 10.6
2001-2002 4.2 11.3 18.8 3.4 8.0 4.3 10.9
2002-03 4.0 11.3 18.6 3.3 9.2 3.7 11.5
2003-04 4.0 10.9 16.7 3.2 10.0 2.4 11.0
2004-05 4.4 12.1 18.2 3.2 11.8 3.3 10.0
2005-06 4.8 13.6 17.7 3.2 11.3 4.2 10.4
====================================================================================================(To be continued)
Copyright Business Recorder, 2007
PARVEZ HASAN
ARTICLE (January 13 2007): Bhutto came to power in December 1971. His 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.Apart from their negative impact on private industrial development, Bhutto's policies had adverse long-term economic consequences through increase in defence establishment, nationalisation of educational institutions, a cavalier attitude towards public spending, and, last but not least, serious erosion of the capacity and authority of public sector institutions.A great deal of the responsibility for failures in basic education, which has become an important constraint on growth, can be traced back to the decision to nationalise educational institutions in 1972.From economic point of view, Zia-ul-Haq's rule (1977-88) was the least ideological and the least innovative. Fortunately for Zia-ul-Haq, the economy showed a high and sustained growth rate helped mainly by a number of special factors both domestic and external. The completion of long gestation period Tarbela Dam project in 1977 added considerably to irrigation water availability and hydel power capacity.Fertiliser and cement investments undertaken under Bhutto contributed to industrial growth. A tremendous boost to economic activity was also provided by rising worker remittances and large external assistance for Afghan Mujahedin, channelled through Pakistan. Similarly, the narcotics trade, which gathered great momentum in the 1980s, strongly supported the service sectors of the economy.Lulled by a comfortable growth rate and a balance of payments situation greatly helped by remittances and other external factors mentioned above, Zia regime did little to deal with the serious structural problems inherited from the 1960s and 1970s: the over-extension of government, the poor climate for private sector investment, heavy dependence of exports on cotton based exports, and the inelasticity of the tax system.Indeed some structural problems were intensified. Relentless growth in public spending, a major shift in the public expenditure priorities from development to defence, and consequent rise in fiscal deficits increased debt burden sharply.There is no doubt that macroeconomic imbalances were worsening and growth was slowing down after mid 1980s. Had Zia lived, he would have had to face the consequences of his neglect of some basic economic issues. As it turned out, the responsibility for sorting out the difficulties fell to a succession of weak political democratic governments which followed Zia.These governments were both ill-equipped and disinclined to deal with the multitude of structural issues that had accumulated over time, and thus the economy has had to suffer periodic economic crises in the 1990s.Notwithstanding substantial macro-economic mismanagement over decades (less visible in the 1980s than in the 1970s and 1990s), there was a gradual process of liberalisation of the economy starting in the late 1980s notably the reduction of interventions in agricultural prices, relaxation of import and investment controls and financial sector reforms.Major agreements with the IMF and the World Bank financially supported the structural reform process which was further accelerated by the removal of foreign exchange controls and stepping up of the pace of privatisation under the first Nawaz Sharif Government in 1991-92.The policy shift towards the private sector and greater reliance on market signals rather than administered prices was influenced largely by pragmatic considerations. Policy decisions to involve the private sector in energy and infrastructure development reflected a realisation going back to 1987 that the public sector funds had become a serious constraint on development.Similarly, the drain caused by losses of public sector enterprises was a major factor in the decision to hasten privatisation of industrial assets. Efficiency considerations were also behind the drive to privatise government banks and telecommunications corporations.DEFENSE SPENDING Because relations with India deteriorated early on and Kashmir dispute has continued to simmer between the two countries, high level of defence spending has remained a key feature of state policy and strong competition between defence and development has been unavoidable.The only periods in Pakistan's history when defence spending grew less rapidly than GDP were the first half of the 1960s and the second half of the 1990s. In the former period it was the large US military assistance which made a lid on military expenditures possible. In the latter period, growing financial and fiscal crises led to an actual decline in defence outlays for a few years. (See Table 4).Between 1965 and 1990 there was an almost relentless growth in defence and related spending. Real defence expenditure almost doubled between 1960-65 and 1965-70 in the wake of the 1965 war. Under Z.A. Bhutto defence outlays increased by a further 33 percent even though the size of the country and the economy had shrunk substantially.Under Zia, real defence spending increased on average by 9 percent per annum during 1977-88 while development spending rose 3 percent per annum; by 1987-88 defence spending had overtaken development spending. For 1980s as a whole, defence spending averaged 6.5 percent of GDP. Not only was this a peak but it also contributed strongly to large fiscal deficits and a rapid build up of public debt.PUBLIC V/S PRIVATE SECTOR 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 the increase in the rate of domestic capital formation, in absolute terms fixed investment in the then West Pakistan increased nearly fourfold in the 1950s.But there was a clear public sector bias. There was an almost sevenfold increase in the real level of public investment in the 1950s and the share of public investment in total investment increased from less than 40 percent to two-thirds over the decade.The Ayub era was an exceptionally successful period of economic management because it used panning institutions and processes effectively for economic policy co-ordination. The pace of economic decision-making was speeded up, implementation processes strengthened and sectoral planning substantially decentralised. But the public sector bias of the development policy of the 1950s continued and was compounded by the large availability of foreign assistance, which mainly financed public sector development.Private investment was expected to account for only 25 percent 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 economic policies virtually halted the growth of the modern private industrial sector and reinforced the anti-export bias of the industrial strategy. Large public investments in industry focused on import substitution and the reform of the exchange rate system failed to remove the large wedge between the average effective exchange rates for imports and exports.Even though the attitude towards the private sector improved during the Zia period and some privatised units were returned to the private sector, there was no attempt to tackle the overhang of major nationalisation of the Bhutto period. Even though major inefficiencies had already emerged in public sector enterprises, especially the nationalised commercial banks, not much thought was given to systemic solutions.The early 1990s saw the emergence of liberal economic policies and a fuller realisation that the private sector should be allowed to play a greater role in the economy. But structural reforms including financial sector liberalisation and privatisation did not go far enough, or remained in early stages.Only limited progress was made in privatisation in financial, telecommunications, and the energy sectors. The delay in privatising large state-owned banks was particularly costly because credit allocation decisions became more susceptible to political pressures under the democratically elected governments.Paradoxical though it may seem, some of the liberalisation measures, though sound in themselves, had the impact of diluting the urgency of macroeconomic adjustment. First, the ease of financing the foreign exchange gap through foreign currency deposits and portfolio investments became an excuse for not facing up to the unsustainability of large balance of payments deficits. Second, large receipts from privatisation were used to bolster public spending rather than to retire debt.III - PAKISTAN AT THE THRESHOLD OF 21ST CENTURY As I have argued elsewhere Pakistan as it approached the 21st century Pakistan was faced with not only a financial crisis but also an economic growth crisis because the per capita GDP growth had slowed down to 1 percent per annum during the 1990s from the average of around 3 percent per annum during 1960-85.It is too simplistic to lay the blame for Pakistan's economic and financial problems at the end of 20th century mainly at the governance and economic policy failures in the 1990s.The fundamental governance and growth problems had long roots and had their origins in: -- A level of defence spending that the country could ill afford-- Inability of the government after mid 1980s to collect enough revenues to cover current expenditures. This led to borrowing partly for current outlays including defence and thus sharp build up of public debt and rise in interest payments. Consequently, despite large fiscal deficits, social and development spending began to squeezed and began to fall as a percentage of GDP.-- A major neglect of human development outlays and quality of public education in face of rapid growth of population and rising needs for skills.-- A weak industrial and export structure, dominated by cotton based exports resulting from both from insufficient progress in education and trade policies which discouraged backward linkages, exports based on imported inputs and diversification-- Personalised rule, over centralised decision making, weakening public institutions and rule of law, increasing public corruption, and lack of accountability-- A pattern of development which resulted in sharply increasing inequalities and only slow reduction in poverty because it rewarded rent seeking, discouraged genuine entrepreneurship, did not promote labour intensive exports, and did not sufficiently tax the rich.By the end of 1990s, the growth and governance problems had become intertwined. Because growth benefits were not widely shared, the quality of public services especially education was deteriorating and the pace of poverty reduction was slowing, the tensions in the society had begun to erupt with increasing frequency in ethnic, sectarian and random violence. The deteriorating law and order situation in turn had become a constraint on investment and growth.Taking the second half of the twentieth century as a whole, however, it is the governance failures in Pakistan that stand out much more than growth disappointments. Pakistan no doubt missed major economic opportunities especially in exports of manufactured goods but its average GDP per capita growth rate of 2 percent per annum over 1950-2000 was about the average for developing countries and about the same as India's.Furthermore, Pakistan had to cope with a much higher growth rate of population of nearly 3 percent per annum over fifty years. If governance had not deteriorated so much and the strength public institutions not eroded over time, the resources mobilised through taxation would have been more adequate and the quality of public services especially education would not have declined so precipitously.Poor governance hurt the poor and low income groups especially as they depend relatively more on public services. The failure of the well intentioned Social Action Program in the 1990s which aimed at provision of basic education and health services and narrow the gaps in human development must basically be attributed to poor governance.Why did governance decline so sharply over time? This is a big question and the answer to which is essentially beyond the scope of this paper. But one can point to some basic factors. I believe the very high population growth rate complicated, both financially and managerially, the delivery of basic public services. The responsibility for weakening of the rule of law must be borne by the political leadership both military and civilian.Some argue that extra- judicial interventions by the military and disregard of the Constitution is a root cause of this problem. But in some respects Pakistan's military regimes were less arbitrary than some democratically elected leaders starting with Z.A. Bhutto.The weakening of bureaucracy, a decline in its competence, and increase in corruption is as much due to its steadily declining relative compensation as to the frequent political interventions in violation of rules and regulations.Governance was relatively good till the 1960s. The sanctity of public expenditure was well observed and there was not the cavalier attitude towards the use of public funds. Relatively new public entities such as WAPDA and PIDC had strong leadership and were quite effective because they had more operational freedom including ability to adjust prices. Later, the governments were either populist or weak and unsure and tended to postpone difficult decisions for the sake of short term gain.But purely from an economic policy viewpoint, the picture at end of 1990s had some important bright spots. By the sheer pressure on public resources defence spending did not increase much in real terms in the 1990s. The gradual liberalisation of imports and reduction of tariffs had by reducing foreign trade taxation substantially reduced the anti-export bias in policies, agricultural price distortions had become minimal, and the environment for private sector had become much friendlier.There was a clear recognition in the privatisation efforts and seeking of private investments in power generation that government had become overextended financially as well as administratively.IV - STATE AND ECONOMY UNDER MUSHARAFF PROGRESS AND PROBLEMS So what has changed and by how much during the last seven years? Unfortunately the views on what has happened tend to be rather polarised. The government claims broad success in putting national finances on a sound footing, reviving strong growth, improving social indicators and beginning the difficult processes of improving governance and sharing of growth benefits more widely.The sceptics point to the continuance of serious issues in governance and quality of public services, narrow base of the prosperity, only modest progress in poverty reduction, and re-emergence of heavy reliance on external flows. As often the reality is more complex. There have been some fundamental changes in macroeconomic policies, attitudes towards the private sector and size and use of public resources which have revived strong growth and improved growth prospects, enhanced the priority of social sectors including higher education, and accelerated pro-poor spending.But it also remains very much an open question whether reforms so far have put the economy on a sustainable high growth path and improved the economic model and the governance structures sufficiently to ensure a more equitable growth. This section and the next explore both the progress and the challenges that remain.MACROECONOMIC MANAGEMENT: REDUCTION OF DEFICITS AND DEBT BURDEN REDUCTION The sharp turnaround in the public and external finances of Pakistan has been a singular economic policy success of recent years.No doubt the improvement in the external and domestic finances and the large build up of foreign exchange reserves has been greatly helped by developments following 9/11 and realignment of Pakistan's relationship with the United States and other Western Countries. External grants, substantial concessionary assistance, Paris Club rescheduling, payments for logistical support to the US, and somewhat better access to external markets, all contributed strongly to the remarkable build up of external reserves over the last few years.But tough stabilisation policies aimed at restoring financial discipline, shrinking fiscal deficits, great restraint on non-concessionary external borrowing, and measures to promote exports laid the basic ground work for the much increased confidence in the stability and strength of Pakistan rupee which in turn resulted in reversal of capital flight, large increase in worker remittances, and growing interest by foreign investors.The external and public debt levels have come down very sharply since 2000. Total external debt of Pakistan grew only modestly from $32.1 billion in mid 2001 to $35.7 billion in mid 2006 cushioned in part by large increase in foreign investments inflows related partly to privatisation efforts. Meanwhile, exports and worker remittances have risen sharply.As a result, external debt, as a percentage of exports of goods, services, and transfers has dropped from around 250 percent to 115 percent over the period. Furthermore, the average terms of external debt have softened considerably because of large debt relief from the Paris club, retirement of expensive debt and substantial concessionary assistance especially from IDA.This is reflected in an even sharper drop in the ratio of external debt service payments to foreign exchange earnings from 26.5 percent in FY2002 to 9 percent in FY 2006.The public debt to GDP ratio has declined from over 90 percent (on new GDP numbers) in mid 2000 to 55 percent in mid 2006. As a proportion of government revenues, Pakistan's public debt has also declined from nearly 600 percent in mid 2000 to less than 400 percent in 2005-06. Interest payments as percentage of government revenue have come down from 33 of public expenditure in late 1990s to17.5 percent in 2005-06.But it is clearly desirable to reduce debt burden further say to a total public debt to revenue ratio of less than 300 percent and interest payments to government revenue ratio of less than 15 percent from 33 of public expenditure in late 1990s to17.5 percent in 2005-06.The sharp decline in interest payments in the budget from nearly 7 per cent of GDP in FY 2000 to 3.1 percent (as well as containing defence spending as a percentage of GDP) has opened up fiscal space, defined as non-interest and non-defence spending, while at the same time making possible a reduction in fiscal deficits.The non-interest and non-defence spending increased from a low of 8.6 percent of GDP in FY 2000 to 12.2 percent of GDP in FY 2006. Public spending including the earthquake related spending has doubled over the last six years in real terms providing a strong momentum to both growth and social development.The macroeconomic management in Pakistan is being challenged once again partly because of both external shocks and too accommodative a monetary policy in FYs 2005-06.-- The almost doubling of the international oil price between 2003-05 and 2005-06 has added $3 billion or more than 2 per cent of GDP to Pakistan's petroleum imports.-- The devastating earthquake which will cost the economy $6 billion over five years but at best only one-third will be covered by truly additional grants and highly concessionary assistance. So the budget will have to suffer a negative impact of 0.5 per cent for the next few years.-- In retrospect, the private credit expansion of more than 100 per cent between mid 2003 and 2006 was clearly excessive especially in respect of consumer credit increase.Notwithstanding major economic shocks, Pakistan has been able to avoid disruption to economic growth because of adequate level of foreign exchange reserves and large foreign investment flows related partly to rapid privatisation.However, the current account balance of payments deficits, after official transfers, to $5 billion in 2005-06 and the July-October 2006 data suggest could grow to $6.0 billion or over 4 percent of GDP in 2006-07, if the recent decline in international oil price is not sustained. Meanwhile, inflation though stable at around 7-7.5 percent is stubbornly high.Maintaining of macro stability would require further strengthening the structural position of both external and internal finances not only through fiscal and monetary policy adjustments but also through export push in non-traditional exports. Just because an economic shock is exogenous does not mean it does not need a policy response particularly if it is not self-correcting.Having said that Pakistan has much greater freedom of financial options than ever before as typified by its successful long term bond placement in the international market, the continuing strong interest from foreign investors especially from the Middle East, and continued strong support from international organisations especially the World Bank and the ADB.DEFENSE SPENDING As mentioned above, high defence spending (both in real terms and as percentage of GDP), has constrained growth and development over long periods in the past not the least because there was not the national will after 1985 to mobilise enough tax resources to meet defence needs without borrowing for current government expenditures.In the second half of the 1990s real defence spending as well as all other non- interest government spending fell as interest payments on debt absorbed a steadily rising share of public expenditures. Between 1991-92 and 1999-2000, there was virtually no increase in real defence spending and it declined as a percentage of GDP from 6.3 percent in 1991-92 to 4.8 percent in 1999-2000 - much lower than the peak of 7 percent in late 1980s under Zia-ul-Haq.However, it should be noted that real non-interest non-defence public spending declined even more sharply both in absolute terms and as a percentage of GDP, from 15.2 percent in 1991-92 to 10 percent in 1999-2000. Thus the civilian expenditure was squeezed to a greater extent than military spending under the financially strapped 1990s.(See Annex Tables 1&2) The analysis of defence spending since 2000 is complicated by two facts. First, as is the custom in many countries including India, the defence pensions were moved to the civilian budget from 2000-2001 Secondly the national income figures were revised substantially upwards and a new series introduced starting with 1999-2000. This makes historical comparisons somewhat difficult.Since 2000-01, defence spending, excluding pensions, has risen in real terms roughly in line with the growth in GDP. It actually fell in the stabilisation years 2000-2002 but has increased by 23 percent during the last three years (2003-06).Currently defence spending is around 3.2 percent of GDP and appears to be lower than the level in the 1990s even after making rough adjustments for comparability of data. Three points need to be noted, however. First the defence budget is still absorbing nearly one third of government revenue. Secondly, the current military outlays are being supported partly by payments from the US government for the fight against terrorism. If and when these payments decline, down ward adjustments in spending will be needed and if not made the history of late 1960s will repeat itself.Thirdly, it is not clear that all military purchases abroad either through foreign assistance or loans are fully reflected in the budget figures. In any case, the issue of an appropriate level of defence spending ie the choice between guns and butter remains very much alive.PRIVATE SECTOR DEVELOPMENT AND PRIVATIZATION Another important success of the Musharraf regime, not unrelated to the strengthening of the financial position and increased confidence in the currency, has been the further energising of the private sector through accelerated privatisation's and improvement of investment climate. Induction of foreign investment has becoming a promising source of future growth.During the last five years, 2001-2006, direct foreign private investment has totalled $7.3 billion, rising from $500 million in 2001-02 to $3.5 billion in 2005-06. Privatisation receipts at $2.4 billion have accounted for over one-third of direct foreign investment. The privatisation sales to the foreigner have been concentrated in banking, telecommunications and thermal power while other important foreign investment flows have been in oil and gas and telecommunications.TABLE 3 ====================================================================================================
Key Fiscal Aggregates, Public and Private Investment (as percentage of GDP)
====================================================================================================
Years Public Fixed Private Fixed Consolidated Defence Non-interest Fiscal Tax
investment investment Public Spending Non -defence deficits Revenue
Spending Public Spending
1960s 8.2 8.8 NA 2.8(1960-65 NA 2.1 NA
4.0(1965-75)
1970s 10.3 5.6 21.5 5.61 14.0 5.3 13.8
1980s 9.2 7.8 24.9 6.5 14.5 7.1 13.4
1990s 7.5 9.1 24.1 5.6 11.7 6.9 14.0
1999-2000 6.0 8.4 23.6 4.9 10.5 6.6 12.9
New Revised National Account Series
1999-2000 5.6 10.4 18.7 4.02 7.8 5.4 10.7
2000-2001 5.7 10.2 17.2 3.2 8.0 4.3 10.6
2001-2002 4.2 11.3 18.8 3.4 8.0 4.3 10.9
2002-03 4.0 11.3 18.6 3.3 9.2 3.7 11.5
2003-04 4.0 10.9 16.7 3.2 10.0 2.4 11.0
2004-05 4.4 12.1 18.2 3.2 11.8 3.3 10.0
2005-06 4.8 13.6 17.7 3.2 11.3 4.2 10.4
====================================================================================================(To be continued)
Copyright Business Recorder, 2007
State and Pakistan economy: Where have we come from? Where do we go? - III
State and Pakistan economy: Where have we come from? Where do we go? - III
PARVEZ HASAN
ARTICLE (January 14 2007): The opening up of the financial and telecommunications sectors partly with the help of foreign sectors is transforming and modernising the economy in a fundamental fashion.The growth in cellular phones in Pakistan has been nothing short of phenomenal and the competition in the telecommunications sectors has pushed down prices very sharply, essentially reducing the cost of information and doing business.The liberalisation, privatisation and reforms of the financial system, a process that was started in the 1990, are providing a strong base for healthy private sector development. The largely publicly owned banking system was greatly misused by vested interests both to earn economic rents and thwart genuine entrepreneurial activity.In a very short time, the control of the banking system has moved into private hands. More than 80 per cent of the bank deposits are now with the privately owned banks. Under the leadership of the State bank of Pakistan, corporate governance in the private sector banks has improved, their capital base strengthened and the problem of non-performing loans largely resolved.After taking into account the provisioning for bad loans, the ratio of net non-performing loans to net advances has come down to around 5 per cent. Above all, the prudential regulatory capacity of the central bank has been greatly enhanced and its autonomy increased.Financial reforms have improved resource allocation by making lending follow sound economic and financial criteria. It has also improved governance by closing avenues for corrupt practices and political influence paddling.There is also evidence of financial deepening as the ratio of monetary assets to GDP has risen from 40 to 44 percent over the last five years after having been stagnant for a long period. The increased financial intermediation also generally augurs well for economic efficiency.There is also broad evidence that investment climate for the private sector is improving and the cost of doing business is going down. According to the World Bank, Pakistan was one of the top reformers in terms of doing business in 2004. It ranked 60th out of 154 countries in 2006 (India was 116th) and 74th out of 175 countries in 2007.However, employing workers, paying taxes, and enforcing contracts remained relatively very weak areas according to the 2007 survey. According to World economic Forum Global Competitiveness Reports, Pakistan's ranking improved from 75th out of 102 in 2003 to 66th out of 116 in 2005. However, Malaysia, Thailand, India, China, and Turkey were substantially ahead of Pakistan in rankings.The growing importance of private sector in Pakistan is also evident from its share in fixed investment. The share of private investment which exceeded 50 per cent of the total only in the 1990s is now approaching 75 per cent.(Table below) It is also important to note that public investment that was practically stagnant during 1997-2002 has grown strongly during the last few years. Furthermore, even though public investment as a percentage of GDP declined moderately from 5.6 per cent in 1999-2000 to 4.8 per cent in 2005-06, the composition of public investment has changed dramatically in recent years. While investment in public enterprises has dropped in absolute terms, public development outlays have grown strongly over 2001-06.This trend which is likely to continue means that public investment is increasingly concentrated in infrastructure areas which do not pose direction competition to the private sector, indeed facilitate private sector development. So not only has the share of private sector in investment increased but there are growing complementarities between private and public investment.STILL THERE ARE THREE MAJOR PROBLEM AREAS First in the power sector, which is largely in public hands, the inefficiencies and frequent breakdowns in supplies not only increase the costs for the private sector by requiring alternative generating capacity but also result in large losses for public entities which are a significant drain on public resources. It is not clear that largest scale privatisation of WAPDA's energy corporations is a quick and fully feasible answer at least in the short run.Secondly, though much progress has been made the private sector still looks too much to the government for solving its competitiveness problems by seeking tax, credit and other concessions. Rs 50 billion package demanded recently by the textile industry to cope with competitive pressures in the post MFA era is a case in point.The government on its part has not been able to resist the urge to control prices as inflationary pressures reemerged and the consumers complained. Rent seeking behaviour has not entirely disappeared and genuine entrepreneurship is still hampered though medium and small industries are faring better than before.Third, while the large foreign investment flows are providing a more balanced source of external finance, the bulk of foreign investments are taking place in areas like energy, telecomm, financial and other services which do not contribute directly to export development.Since, as discussed below, export growth remains critical for Pakistan's development a lop- sided pattern of foreign investment could prove costly in the long run.In other areas where state interventions required improvement, resource mobilisation, distribution of growth benefits, human development, and last but not least governance, progress has been more mixed.TAXATION The structure of taxation has improved, the burden of several taxes has been reduced, the move away from reliance in foreign trade taxation has continued, and serious efforts are under way to improve tax administration. It is too early to say, however, whether improvements undertaken or proposed would result in an elastic system of taxation which will automatically capture a reasonable share of GDP growth as government revenues.Also, the tax system is regressive because the rich and the well do not pay sufficient taxes and the individual income tax receipts remain very small. Finally, the present tax to GDP ratio at 10.4 per cent remains very low both in relation to needs and international norms. It should be stressed, however, that the stagnation in the tax to GDP ratio, indeed a small decline compared to 1990s, is due entirely to the liberalisation measures which have reduced import duties.It has been estimated that if the import tax reductions had not occurred and if sales tax had not been increased in partial compensation, the government revenues would have been about 11 per cent higher than otherwise in FY 2005.INCOME DISTRIBUTION, POVERTY, AND EMPLOYMENT The revival of strong growth, and doubling of real public spending over the last six years, after the stagnation of a decade, has expanded employment, resulted in some increase in real wages, and reduced poverty incidence. The extent of reduction in poverty incidence over 2001-05 is a matter of some debate but there is little disagreement that poverty has declined in recent years.This is hardly surprising considering especially the strong agricultural growth in 2004-05. The more interesting question is why has poverty reduction not shown a clear downward trend since 1990.Obviously greater progress in poverty alleviation would have been possible but for the inherent inequalities promoted by the existing power and asset structures, a tax system that does not generate sufficient revenue to fund poverty programs adequately and a labour market that has yet to fully exploit opportunities offered by labour intensive exports.Rural poverty and growing differences in income between rural and urban areas are a matter of growing concern. According to government numbers, the rural poverty incidence in 2004-05 was at 28 per cent was almost double the rate of urban poverty. Surely the high incidence of rural poverty in a bumper crop year cannot be the basis of much satisfaction.Government pro- poor spending, though still low, has increased in recent years to 4.5 per cent of GDP as fiscal space has opened up and progress on some rural programs such as rural electrification and girls' education is impressive. Increased pace of social spending has improved gross enrolment ratios and reduced gender differences.But net primary enrolment rate of 60 percent in 2004-05 means that 40 per cent of the primary school cohort were not in school. The overall education spending is still less than 2 per cent of GDP and quality and governance issues in public education remain huge. At the same time, the government must be given credit for turning its urgent attention to higher education and skills gap and developing cogent plans.Reducing poverty incidence and increasing the access of the poor to basic public services in the rural areas is, however, only one dimension of Pakistan's distribution problems which are reflected in growing income inequalities and regional differences.It seems that the current high growth is deepening inequalities more dramatically than was the case in the earlier high growth periods of 1960s and 1980s because the growth of incomes of the relatively well to do is being fuelled greatly by extraordinary booms in the real estate and stock market.There is not even a modest capture of the windfall profits because of a total absence of capital gains taxation. USA, even after the tax cuts of recent years, has a 15 per cent capital gains tax rate. More generally the income taxation of the well to do has yet to become effective.As mentioned above, the economic rents in the private sector have not disappeared. Though it is difficult to quantify the impact of this factor, it does exacerbate income disparities.Containing of income and consumption disparities as well as steady reduction in poverty especially rural poverty needs to be built in more explicitly as an integral part of the future economic strategy because clearly the issue of the distribution of growth benefits has assumed more urgency with economic liberalisation and greater role for the private sector.The distribution problems have distinct dimensions in rural and urban areas, with poverty being much more of a problem in rural areas and growing income disparities much more of a problem in urban areas. In rural areas the share of consumption of the highest quintile to the lowest quintile was only two only 2.2 in 2004-05 and had changed little since 2000-01.But as mentioned above, rural poverty is widespread and nearly 80 per cent of Pakistan's poor live rural areas. In contrast urban areas account for little over 20 per cent of the poor. But in urban areas consumption disparities are huge and growing. In 2004-05 the share of consumption of the highest quintile to the lowest quintile in urban areas was over 12 times and had grown from 10.4 in a short period of four years.Some of the ways in which Pakistan's policy approaches to the twin issues of poverty and income distribution might be strengthened are discussed in the next section.GOVERNANCE Governance is a very broad area which encompasses the delivery and effectiveness of all public services. Here again the record of last several years is very mixed.The opening of fiscal space has certainly made possible a very sharp expansion in public spending on economic and social development including more adequate pay for the civil servants. But the quality of many services including law and order and justice including enforcement of property rights remains extremely problematic.Still it appears surprising, that the perceptions about widespread corruption have not improved. The Transparency International's Corruption Perception Index (on a scale of 0 (worst0) to 10 (best)) for Pakistan stood at 2.2 in 2006 compared to 2.3 in 2001. Pakistan is now ranked 142 out of 163 as against 79 out of 91 in 2001.Is corruption in Pakistan worse than Nigeria and so much worse than China and India who with a score of 3.3 are ranked 70? In any case, Pakistan's bad score seems a little difficult to reconcile with the absence of major financial scandals linked to the top layers of government. Still perceptions matter and Pakistan's corruption problems appears to be compounded by image problems.The lack of definite progress on governance issues shows, on the one hand, the intractability of issues of institution building and lags in obtaining visible results as shown by the tax administration reform.The biggest achievement of the Musharraf Government has been the creation of a political structure consisting of 6400 new indirectly elected governments with significant participation of women. The devolution to Nazim as an elected head of district government could prove to be a revolutionary change provided other political interest do not undercut the reforms, the initiative is properly funded and is fully supported by measures to enhance local governments' capacities.The biggest disappointment is the stalling of the civil service reform. While merit now plays a greater role in recruitment and promotion, and there is an important initiatives to upgrade skills of civil servants through foreign training, the restructuring of processes and incentives to attract the best and the brightest to the top layers of governments at all levels of government are lacking.Civil service reform must go hand in hand with effective devolution and should include much improved compensation at higher levels as well more competition for these positions including hiring from the private sector.There are examples both from Pakistan's past and recent history that strong, effective, and independent public institutions can be created through autonomy, proper selection of top management and professional staff, and adequate pay.V - LOOKING AHEAD Pakistan's development and modernisation have suffered in the past either because there was not a very clear vision of the future or there were conflicting views about national identity and priorities.One hopes that that main political parties and the military leadership have learnt their lesson from history and would strive to unite the country around a broad emerging consensus about future directions. This consensus must have both economic and non-economic dimensions because social and political shocks can easily derail the economy.Some of the elements of the non-economic consensus that appear to be falling in place are: -- Need for an enlightened moderation in which narrow interpretations of Islam are not allowed to drive the societal and state agenda-- Resolution of conflicts with India, containment of military establishment and gradual reduction of defence spending as a percentage of GDP and public spending-- A determined attempt to reduce the centralisation of decision making by empowering the provinces in the spirit of the federation, hopefully making possible effective devolution of authority and resources to local governments.Decisive progress on the non economic issues is a necessary but perhaps not a sufficient condition for releasing the creative energies of the country to meet its aspiration of high growth rates to match those that are being achieved by China and India.For that a better articulation of an economic vision is necessary which encompasses concern with growth as well as broadening of the growth benefits, reducing income, regional, gender disparities, and modernisation of attitudes towards work and thrift.The Planning Commission is now working on a Vision 2030 paper. The approach paper has many good and important ideas but the longer- term economic vision needs to focus more clearly on some problem areas which have severely hampered Pakistan's development.The following goals need special attention: -- Rapid export expansion-- An elastic tax system which mobilises, at all levels of government, at least 15 per cent of the increment of GDP-- Major decentralisation of public services and accountability closer to the people-- Compact with the private sector which guarantees a liberal economic framework but requires in return proper payment of taxes and abiding by the regulatory framework-- Narrowing of gaps in incomes and access to public services that exist among households, regions and districts and between genders.The policy goals are interlinked and would reinforce each other. Rapid export expansion is necessary for sustaining high growth which must remain a central element in reducing poverty.A more effective tax system would generate the revenues necessary for expanding and improving public services and help narrowing income and regional differences. But an effective tax system would not take root unless governance improves and there is ability to tax at local and provincial governments as well and there is a better understanding with the private sector.EXPORT DEVELOPMENT Despite early promise, export growth has lagged in Pakistan. Even after the substantial export expansion of the last few years, the ratio of exports to GDP remains at 13 per cent very much below the range of 30-50 per cent of GDP in the successful East Asian economies.Even India has a greater export orientation (around 21 per cent of GDP), thanks to its IT exports, than Pakistan Failure of Pakistan to develop a large and diversified base of exports is one of the fundamental factors why it has not matched the growth and poverty reduction performance of not only the first generation of Asian tigers, South Korea, Hong Kong and Singapore but also relative late comers to the field, Thailand, Malaysia and above all China.The relatively slow growth in manufactured exports in Pakistan is highlighted by the continued very heavy reliance on cotton based exports and the failure to enter new lines of production, synthetic textiles in the 1950s, electronics in the 1970s and 1980s and information technology exports in the 1990s.Future development strategy needs to emphasise exports sufficiently and help remove, the trade policy distortions that remain. Special policy support might be needed to diversifying the export base and to develop information technology exports. Recent weakness in exports is particularly worrisome.The Planning Commission is not particularly shy in indicating export targets for 2030. It suggests raising the share of Pakistan's export in world exports from 0.2 at present to say 1 per cent over the next twenty five years.Not an impossible goal but one that will require an average real growth of 12 per cent per annum, raising Pakistan's exports from $16 billion to $270 billion, assuming the world trade grows only 5 per cent per annum.Policies and programs are not in place to achieve these ambitious targets. Diversification of exports should be a key goal. Miscellaneous manufactured goods where Pakistan has little world presence and high value agriculture products are the most promising areas.The vehicles for aggressive export development could include economic zones, targeted foreign private investment in technology and export intensive areas and major breakthrough in exports to China. Right now the large negative trade balance with China is clearly hurting industry as well as the overall balance of payments position.REVENUE MOBILIZATION AND SIZE OF GOVERNMENT Improvements in governance and further economic reforms will depend critically on management of public service personnel. But I doubt that improved governance, better delivery of public services, and a vibrant civil service can be delivered without expanding the base of government revenues.The over extension of government terms of its functions should not obscure the woeful inadequacy of its financial capacity. In Pakistan non-interest non -defence public spending, a key indicator of the size of government is only a little over 11 per cent of GDP, much lower than almost all developing countries.(See Table 4 above)Raising tax revenue is both a moral and a practical imperative. One cannot run an effective government, however circumscribed its functions, on a shoestring. But the expansion in real spending in support of social and economic development must focus on de-centralised programs supporting the important devolution initiative which remains seriously under funded. Taxation effort and authority also need to be devolved in parallel.DISTRIBUTION OF GROWTH BENEFITS Sustained growth and political stability do require a better distribution of growth benefits than in the past. Income distribution issues are not peculiar to Pakistan. Even rapidly growing economies like China have major income distribution issues notably growing rural and urban income gaps and widening regional disparities.Some of these issues arise from structural factors like concentration of labour force in agriculture and rural areas while non-rural economy grows much faster. In the long-run only increased education and out - migration from rural areas can provide a durable solution of rural poverty in Pakistan. But much more can and should be done in the medium term to alleviate both rural and urban poverty and to contain income disparities.First, the rather obvious but sometimes overlooked point, the trend in population growth would remain a major determinant of poverty. The demographic transition has begun but must be strongly reinforced by policy actions. Fertility rates have declined but still remain high.The desired family size in Pakistan is still four children compared to 2 in Bangladesh. Since rural fertility rates are much higher in rural areas, the present efforts to increase the levels of female education must be combined with making family planning services available widely and cheaply.TABLE 4 ===============================================================
Non-Interest and Non-Defence Expenditure for Selected Countries
---------------------------------------------------------------
(Percent of GDP)
---------------------------------------------------------------
1990 1995 2000
Argentina 9.0 13.2 12.7
Bangladesh 15.1 12.6 11.8
Chile 16.2 17.4 21.1
Egypt 20.4 24.3 19.4
India 21.0 17.8 19.8
Indonesia 14.7 12.1 13.0
Malaysia 20.5 15.9 17.5
Nepal NA 14.3 13.8
Pakistan 14.5 11.7 10.3
Philippines 11.2 12.9 14.3
Sri Lanka 20.9 19.3 15.9
Thailand 9.8 13.2 15.5
Turkey 12.2 17.3 22.2
===============================================================Source: World Bank, Pakistan Public Expenditure Management, 2004.(To be continued)
Copyright Business Recorder, 2007
PARVEZ HASAN
ARTICLE (January 14 2007): The opening up of the financial and telecommunications sectors partly with the help of foreign sectors is transforming and modernising the economy in a fundamental fashion.The growth in cellular phones in Pakistan has been nothing short of phenomenal and the competition in the telecommunications sectors has pushed down prices very sharply, essentially reducing the cost of information and doing business.The liberalisation, privatisation and reforms of the financial system, a process that was started in the 1990, are providing a strong base for healthy private sector development. The largely publicly owned banking system was greatly misused by vested interests both to earn economic rents and thwart genuine entrepreneurial activity.In a very short time, the control of the banking system has moved into private hands. More than 80 per cent of the bank deposits are now with the privately owned banks. Under the leadership of the State bank of Pakistan, corporate governance in the private sector banks has improved, their capital base strengthened and the problem of non-performing loans largely resolved.After taking into account the provisioning for bad loans, the ratio of net non-performing loans to net advances has come down to around 5 per cent. Above all, the prudential regulatory capacity of the central bank has been greatly enhanced and its autonomy increased.Financial reforms have improved resource allocation by making lending follow sound economic and financial criteria. It has also improved governance by closing avenues for corrupt practices and political influence paddling.There is also evidence of financial deepening as the ratio of monetary assets to GDP has risen from 40 to 44 percent over the last five years after having been stagnant for a long period. The increased financial intermediation also generally augurs well for economic efficiency.There is also broad evidence that investment climate for the private sector is improving and the cost of doing business is going down. According to the World Bank, Pakistan was one of the top reformers in terms of doing business in 2004. It ranked 60th out of 154 countries in 2006 (India was 116th) and 74th out of 175 countries in 2007.However, employing workers, paying taxes, and enforcing contracts remained relatively very weak areas according to the 2007 survey. According to World economic Forum Global Competitiveness Reports, Pakistan's ranking improved from 75th out of 102 in 2003 to 66th out of 116 in 2005. However, Malaysia, Thailand, India, China, and Turkey were substantially ahead of Pakistan in rankings.The growing importance of private sector in Pakistan is also evident from its share in fixed investment. The share of private investment which exceeded 50 per cent of the total only in the 1990s is now approaching 75 per cent.(Table below) It is also important to note that public investment that was practically stagnant during 1997-2002 has grown strongly during the last few years. Furthermore, even though public investment as a percentage of GDP declined moderately from 5.6 per cent in 1999-2000 to 4.8 per cent in 2005-06, the composition of public investment has changed dramatically in recent years. While investment in public enterprises has dropped in absolute terms, public development outlays have grown strongly over 2001-06.This trend which is likely to continue means that public investment is increasingly concentrated in infrastructure areas which do not pose direction competition to the private sector, indeed facilitate private sector development. So not only has the share of private sector in investment increased but there are growing complementarities between private and public investment.STILL THERE ARE THREE MAJOR PROBLEM AREAS First in the power sector, which is largely in public hands, the inefficiencies and frequent breakdowns in supplies not only increase the costs for the private sector by requiring alternative generating capacity but also result in large losses for public entities which are a significant drain on public resources. It is not clear that largest scale privatisation of WAPDA's energy corporations is a quick and fully feasible answer at least in the short run.Secondly, though much progress has been made the private sector still looks too much to the government for solving its competitiveness problems by seeking tax, credit and other concessions. Rs 50 billion package demanded recently by the textile industry to cope with competitive pressures in the post MFA era is a case in point.The government on its part has not been able to resist the urge to control prices as inflationary pressures reemerged and the consumers complained. Rent seeking behaviour has not entirely disappeared and genuine entrepreneurship is still hampered though medium and small industries are faring better than before.Third, while the large foreign investment flows are providing a more balanced source of external finance, the bulk of foreign investments are taking place in areas like energy, telecomm, financial and other services which do not contribute directly to export development.Since, as discussed below, export growth remains critical for Pakistan's development a lop- sided pattern of foreign investment could prove costly in the long run.In other areas where state interventions required improvement, resource mobilisation, distribution of growth benefits, human development, and last but not least governance, progress has been more mixed.TAXATION The structure of taxation has improved, the burden of several taxes has been reduced, the move away from reliance in foreign trade taxation has continued, and serious efforts are under way to improve tax administration. It is too early to say, however, whether improvements undertaken or proposed would result in an elastic system of taxation which will automatically capture a reasonable share of GDP growth as government revenues.Also, the tax system is regressive because the rich and the well do not pay sufficient taxes and the individual income tax receipts remain very small. Finally, the present tax to GDP ratio at 10.4 per cent remains very low both in relation to needs and international norms. It should be stressed, however, that the stagnation in the tax to GDP ratio, indeed a small decline compared to 1990s, is due entirely to the liberalisation measures which have reduced import duties.It has been estimated that if the import tax reductions had not occurred and if sales tax had not been increased in partial compensation, the government revenues would have been about 11 per cent higher than otherwise in FY 2005.INCOME DISTRIBUTION, POVERTY, AND EMPLOYMENT The revival of strong growth, and doubling of real public spending over the last six years, after the stagnation of a decade, has expanded employment, resulted in some increase in real wages, and reduced poverty incidence. The extent of reduction in poverty incidence over 2001-05 is a matter of some debate but there is little disagreement that poverty has declined in recent years.This is hardly surprising considering especially the strong agricultural growth in 2004-05. The more interesting question is why has poverty reduction not shown a clear downward trend since 1990.Obviously greater progress in poverty alleviation would have been possible but for the inherent inequalities promoted by the existing power and asset structures, a tax system that does not generate sufficient revenue to fund poverty programs adequately and a labour market that has yet to fully exploit opportunities offered by labour intensive exports.Rural poverty and growing differences in income between rural and urban areas are a matter of growing concern. According to government numbers, the rural poverty incidence in 2004-05 was at 28 per cent was almost double the rate of urban poverty. Surely the high incidence of rural poverty in a bumper crop year cannot be the basis of much satisfaction.Government pro- poor spending, though still low, has increased in recent years to 4.5 per cent of GDP as fiscal space has opened up and progress on some rural programs such as rural electrification and girls' education is impressive. Increased pace of social spending has improved gross enrolment ratios and reduced gender differences.But net primary enrolment rate of 60 percent in 2004-05 means that 40 per cent of the primary school cohort were not in school. The overall education spending is still less than 2 per cent of GDP and quality and governance issues in public education remain huge. At the same time, the government must be given credit for turning its urgent attention to higher education and skills gap and developing cogent plans.Reducing poverty incidence and increasing the access of the poor to basic public services in the rural areas is, however, only one dimension of Pakistan's distribution problems which are reflected in growing income inequalities and regional differences.It seems that the current high growth is deepening inequalities more dramatically than was the case in the earlier high growth periods of 1960s and 1980s because the growth of incomes of the relatively well to do is being fuelled greatly by extraordinary booms in the real estate and stock market.There is not even a modest capture of the windfall profits because of a total absence of capital gains taxation. USA, even after the tax cuts of recent years, has a 15 per cent capital gains tax rate. More generally the income taxation of the well to do has yet to become effective.As mentioned above, the economic rents in the private sector have not disappeared. Though it is difficult to quantify the impact of this factor, it does exacerbate income disparities.Containing of income and consumption disparities as well as steady reduction in poverty especially rural poverty needs to be built in more explicitly as an integral part of the future economic strategy because clearly the issue of the distribution of growth benefits has assumed more urgency with economic liberalisation and greater role for the private sector.The distribution problems have distinct dimensions in rural and urban areas, with poverty being much more of a problem in rural areas and growing income disparities much more of a problem in urban areas. In rural areas the share of consumption of the highest quintile to the lowest quintile was only two only 2.2 in 2004-05 and had changed little since 2000-01.But as mentioned above, rural poverty is widespread and nearly 80 per cent of Pakistan's poor live rural areas. In contrast urban areas account for little over 20 per cent of the poor. But in urban areas consumption disparities are huge and growing. In 2004-05 the share of consumption of the highest quintile to the lowest quintile in urban areas was over 12 times and had grown from 10.4 in a short period of four years.Some of the ways in which Pakistan's policy approaches to the twin issues of poverty and income distribution might be strengthened are discussed in the next section.GOVERNANCE Governance is a very broad area which encompasses the delivery and effectiveness of all public services. Here again the record of last several years is very mixed.The opening of fiscal space has certainly made possible a very sharp expansion in public spending on economic and social development including more adequate pay for the civil servants. But the quality of many services including law and order and justice including enforcement of property rights remains extremely problematic.Still it appears surprising, that the perceptions about widespread corruption have not improved. The Transparency International's Corruption Perception Index (on a scale of 0 (worst0) to 10 (best)) for Pakistan stood at 2.2 in 2006 compared to 2.3 in 2001. Pakistan is now ranked 142 out of 163 as against 79 out of 91 in 2001.Is corruption in Pakistan worse than Nigeria and so much worse than China and India who with a score of 3.3 are ranked 70? In any case, Pakistan's bad score seems a little difficult to reconcile with the absence of major financial scandals linked to the top layers of government. Still perceptions matter and Pakistan's corruption problems appears to be compounded by image problems.The lack of definite progress on governance issues shows, on the one hand, the intractability of issues of institution building and lags in obtaining visible results as shown by the tax administration reform.The biggest achievement of the Musharraf Government has been the creation of a political structure consisting of 6400 new indirectly elected governments with significant participation of women. The devolution to Nazim as an elected head of district government could prove to be a revolutionary change provided other political interest do not undercut the reforms, the initiative is properly funded and is fully supported by measures to enhance local governments' capacities.The biggest disappointment is the stalling of the civil service reform. While merit now plays a greater role in recruitment and promotion, and there is an important initiatives to upgrade skills of civil servants through foreign training, the restructuring of processes and incentives to attract the best and the brightest to the top layers of governments at all levels of government are lacking.Civil service reform must go hand in hand with effective devolution and should include much improved compensation at higher levels as well more competition for these positions including hiring from the private sector.There are examples both from Pakistan's past and recent history that strong, effective, and independent public institutions can be created through autonomy, proper selection of top management and professional staff, and adequate pay.V - LOOKING AHEAD Pakistan's development and modernisation have suffered in the past either because there was not a very clear vision of the future or there were conflicting views about national identity and priorities.One hopes that that main political parties and the military leadership have learnt their lesson from history and would strive to unite the country around a broad emerging consensus about future directions. This consensus must have both economic and non-economic dimensions because social and political shocks can easily derail the economy.Some of the elements of the non-economic consensus that appear to be falling in place are: -- Need for an enlightened moderation in which narrow interpretations of Islam are not allowed to drive the societal and state agenda-- Resolution of conflicts with India, containment of military establishment and gradual reduction of defence spending as a percentage of GDP and public spending-- A determined attempt to reduce the centralisation of decision making by empowering the provinces in the spirit of the federation, hopefully making possible effective devolution of authority and resources to local governments.Decisive progress on the non economic issues is a necessary but perhaps not a sufficient condition for releasing the creative energies of the country to meet its aspiration of high growth rates to match those that are being achieved by China and India.For that a better articulation of an economic vision is necessary which encompasses concern with growth as well as broadening of the growth benefits, reducing income, regional, gender disparities, and modernisation of attitudes towards work and thrift.The Planning Commission is now working on a Vision 2030 paper. The approach paper has many good and important ideas but the longer- term economic vision needs to focus more clearly on some problem areas which have severely hampered Pakistan's development.The following goals need special attention: -- Rapid export expansion-- An elastic tax system which mobilises, at all levels of government, at least 15 per cent of the increment of GDP-- Major decentralisation of public services and accountability closer to the people-- Compact with the private sector which guarantees a liberal economic framework but requires in return proper payment of taxes and abiding by the regulatory framework-- Narrowing of gaps in incomes and access to public services that exist among households, regions and districts and between genders.The policy goals are interlinked and would reinforce each other. Rapid export expansion is necessary for sustaining high growth which must remain a central element in reducing poverty.A more effective tax system would generate the revenues necessary for expanding and improving public services and help narrowing income and regional differences. But an effective tax system would not take root unless governance improves and there is ability to tax at local and provincial governments as well and there is a better understanding with the private sector.EXPORT DEVELOPMENT Despite early promise, export growth has lagged in Pakistan. Even after the substantial export expansion of the last few years, the ratio of exports to GDP remains at 13 per cent very much below the range of 30-50 per cent of GDP in the successful East Asian economies.Even India has a greater export orientation (around 21 per cent of GDP), thanks to its IT exports, than Pakistan Failure of Pakistan to develop a large and diversified base of exports is one of the fundamental factors why it has not matched the growth and poverty reduction performance of not only the first generation of Asian tigers, South Korea, Hong Kong and Singapore but also relative late comers to the field, Thailand, Malaysia and above all China.The relatively slow growth in manufactured exports in Pakistan is highlighted by the continued very heavy reliance on cotton based exports and the failure to enter new lines of production, synthetic textiles in the 1950s, electronics in the 1970s and 1980s and information technology exports in the 1990s.Future development strategy needs to emphasise exports sufficiently and help remove, the trade policy distortions that remain. Special policy support might be needed to diversifying the export base and to develop information technology exports. Recent weakness in exports is particularly worrisome.The Planning Commission is not particularly shy in indicating export targets for 2030. It suggests raising the share of Pakistan's export in world exports from 0.2 at present to say 1 per cent over the next twenty five years.Not an impossible goal but one that will require an average real growth of 12 per cent per annum, raising Pakistan's exports from $16 billion to $270 billion, assuming the world trade grows only 5 per cent per annum.Policies and programs are not in place to achieve these ambitious targets. Diversification of exports should be a key goal. Miscellaneous manufactured goods where Pakistan has little world presence and high value agriculture products are the most promising areas.The vehicles for aggressive export development could include economic zones, targeted foreign private investment in technology and export intensive areas and major breakthrough in exports to China. Right now the large negative trade balance with China is clearly hurting industry as well as the overall balance of payments position.REVENUE MOBILIZATION AND SIZE OF GOVERNMENT Improvements in governance and further economic reforms will depend critically on management of public service personnel. But I doubt that improved governance, better delivery of public services, and a vibrant civil service can be delivered without expanding the base of government revenues.The over extension of government terms of its functions should not obscure the woeful inadequacy of its financial capacity. In Pakistan non-interest non -defence public spending, a key indicator of the size of government is only a little over 11 per cent of GDP, much lower than almost all developing countries.(See Table 4 above)Raising tax revenue is both a moral and a practical imperative. One cannot run an effective government, however circumscribed its functions, on a shoestring. But the expansion in real spending in support of social and economic development must focus on de-centralised programs supporting the important devolution initiative which remains seriously under funded. Taxation effort and authority also need to be devolved in parallel.DISTRIBUTION OF GROWTH BENEFITS Sustained growth and political stability do require a better distribution of growth benefits than in the past. Income distribution issues are not peculiar to Pakistan. Even rapidly growing economies like China have major income distribution issues notably growing rural and urban income gaps and widening regional disparities.Some of these issues arise from structural factors like concentration of labour force in agriculture and rural areas while non-rural economy grows much faster. In the long-run only increased education and out - migration from rural areas can provide a durable solution of rural poverty in Pakistan. But much more can and should be done in the medium term to alleviate both rural and urban poverty and to contain income disparities.First, the rather obvious but sometimes overlooked point, the trend in population growth would remain a major determinant of poverty. The demographic transition has begun but must be strongly reinforced by policy actions. Fertility rates have declined but still remain high.The desired family size in Pakistan is still four children compared to 2 in Bangladesh. Since rural fertility rates are much higher in rural areas, the present efforts to increase the levels of female education must be combined with making family planning services available widely and cheaply.TABLE 4 ===============================================================
Non-Interest and Non-Defence Expenditure for Selected Countries
---------------------------------------------------------------
(Percent of GDP)
---------------------------------------------------------------
1990 1995 2000
Argentina 9.0 13.2 12.7
Bangladesh 15.1 12.6 11.8
Chile 16.2 17.4 21.1
Egypt 20.4 24.3 19.4
India 21.0 17.8 19.8
Indonesia 14.7 12.1 13.0
Malaysia 20.5 15.9 17.5
Nepal NA 14.3 13.8
Pakistan 14.5 11.7 10.3
Philippines 11.2 12.9 14.3
Sri Lanka 20.9 19.3 15.9
Thailand 9.8 13.2 15.5
Turkey 12.2 17.3 22.2
===============================================================Source: World Bank, Pakistan Public Expenditure Management, 2004.(To be continued)
Copyright Business Recorder, 2007
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
------------------------------------------------
Defence vs. Development
(Rs billion)
------------------------------------------------
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
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
------------------------------------------------
Defence vs. Development
(Rs billion)
------------------------------------------------
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
State and Pakistan economy: where have we come from? Where do we go? - V
State and Pakistan economy: where have we come from? Where do we go? - V
PARVEZ HASAN
ARTICLE (January 16 2007): The serious set back to the private sector, especially private industrial investment, which resulted from the waves of nationalisation and a strident labour policy was of course a major blow to some large industrial families.But Bhutto's economic policies virtually halted the growth of the modern industrial sector and reinforced the anti-export bias of the industrial strategy. Large public investments in industry focused on import substitution and the reform of the exchange rate system failed to remove the large wedge between the average effective exchange rates for imports and exports. Labour and other regulations provided strong disincentives to the growth of large-scale industry.Apart from their negative impact on private industrial development, Bhutto's, policies had adverse long-term economic consequences through increase in defence establishment, nationalisation of educational institutions, a cavalier attitude towards public spending, and, last but not least, serious erosion of the capacity and authority of public sector institutions.A great deal of the responsibility for failures in basic education, which has become an important constraint on growth, can be traced back to the decision to nationalise educational institutions in 1972. As a direct consequence of this decision, the management capacity of the government was extended, the competition for resources within the education sector deepened the urban and the higher education bias and thus the development of basic education and literacy slowed down.ZIAUL HAQ --- GROWTH WITHOUT VISION: From economic point of view, Zialul Haq's rule (1977-88) was the least ideological and the least innovative. Fortunately for Zial Haq, the economy showed a high and sustained growth rate of 6.6 per cent per annum helped mainly by a number of special factors both domestic and external. The completion of long gestation period Tarbela Dam project in 1977 added 10 million acre feet to irrigation water availability and helped sustain agricultural growth Fertiliser and cement investments undertaken under Bhutto contributed to industrial growth.A tremendous boost to economic activity was also provided by rising worker remittances which at their peak in 1982-3 totalled nearly US $3 billion, or about 10 per cent of GNP. In the first half of the l980s, large external assistance for Afghan Mujahedin, estimated at US $5 to US $7 billion, was channelled through Pakistan and it also helped the economy. Similarly, the narcotics trade, which gathered great momentum in the 1980s, strongly supported the service sectors of the economy.Lulled by a comfortable growth rate and a balance of payments situation greatly helped by remittances and other external factors mentioned above, Zia regime did little to deal with the serious structural problems inherited from the 1960s and 1970s: the over-extension of government, the poor climate for private sector investment, heavy dependence of exports on cotton based exports, and the inelasticity of the tax system.Indeed some structural problems were intensified. Relentless growth in public spending raised the share of government expenditure in GDP from the already high 23.5 per cent in 1976-7 to 27 per cent in 1987-8. Government expenditures adjusted for inflation increased nearly 150 per cent during 1977-88. Equally serious, there was a major shift in the public expenditure priorities from development to defence. Real defence spending increased on average by 9 per cent per annum during 1977-88 while development spending rose 3 per cent per annum; by 1987-8 defence spending had overtaken development spending.Since revenue growth was slow, the budget deficits had risen to a totally unsustainable level of over 8 per cent of GDP in the final years of the Zia regime. Public debt in the 1990s grew nearly fivefold in the 1980s, rising sharply both as a percentage of GDP and government revenues. The rise in the debt burden mortgaged future growth and price stability not only because of its sheer size but also because after 1985 a part of the large government borrowing was used to finance consumption expenditure.The consequences of slow growth in the public development spending while the economy was charging ahead were serious shortages of infrastructure, inadequate investment in the economic future, and lag in social development. Notwithstanding the brave declarations in the Sixth Plan, progress in critical long-term issues such as human resource development and population control was extremely inadequate.While incomes rose in rural areas and there was progress in poverty alleviation (especially due to worker remittances), the disparity in provision of basic services between rural and urban areas did not diminish and may have in some cases, such as water supply, increased. Economic policies in the Zia period did not even attempt to tackle the overhang of major nationalisation of the Bhutto period. Even though major inefficiencies had already emerged in public sector enterprises, especially the nationalised commercial banks, not much thought was given to systemic solutions.Finally, the two major policy problems inherited from the 1960s and the 1970s - the inelasticity of the tax system and the strong anti-export bias of the trade policy - actually worsened because of continued heavy dependence on foreign trade taxes. Even though government revenues rose as a percentage of GDP, the increase was entirely due to unpopular additional taxation. Without additional taxation, the tax to GDP ratio would have tended to fall.The further increase in reliance on foreign trade taxation to 43 per cent of central government tax revenues, or 6.7 per cent of GDP, continued to signal the continued heavy dependence on direct taxation and the rising taxation of imports which impeded the development of a diversified base of manufactured goods exports. Even though exports expanded faster than GDP during the Zia period, the structure of exports became even more heavily dependent on cotton-based exports. The sharp expansion in raw cotton production, in part a fortuitous technological development, was at the root of good export performance. Even if we overlook the fact that a large part of expansion in manufactured exports was based on the limited value added cotton yarn exports, Pakistan fell much behind other emerging developing country exporters notably China, Indonesia, Thailand, Malaysia, Mexico, and Turkey.The long period of political stability and sustained growth under Zia offered opportunities for tackling the difficult underlying structural issues which were not exploited. For instance, the opportunities for raising national savings and improving the balance of payments offered by the huge worker remittances and rapidly expanding economy were not seized. Instead, the government launched another round of large increases in defence spending and pre-empted an important part of private savings through large-scale non-bank borrowing. The relative roles of state and private sector in development was left to be decided largely on the basis of inertia.Weaknesses of the direct taxation collection machinery, a fundamental cause of continued heavy reliance on indirect taxation, were not addressed even though martial law extended over a period of eight and a half years. At another level, policy-makers did not learn from the mistakes of the 1960s, such as the overemphasis on growth, the neglect of the social sector, and lack of adequate attention to structural change in agriculture and large-scale industry. They were also slow to gain from the experience of East Asian countries where an 'economic miracle' had been unfolding.There is no doubt that macroeconomic imbalances were worsening and growth was slowing down after mid 1980s. Had Zia lived, he would have had to face the consequences of his neglect of some basic economic issues. As it turned out, the responsibility for sorting out the difficulties fell to a succession of weak political democratic governments which followed Zia.DEMOCRACY, STATE AND ECONOMY (1988-1999): It is well known that growth slowed down in the 1990s, inflation accelerated, the poverty incidence tended to increase and the income inequalities widened. No doubt macroeconomic management under democratic governments was poor, corruption in public spending definitely increased, and the banking system still largely in public hands was misused through political influences. However, many of the underlying factors that caused poor economic outcomes, and have led some to term the 1990s as a lost decade, had historical roots going back at least a couple of decades.Among these the build up of public debt, the structural weakness in exports, inelasticity of tax system, lack of investments in human capital as well as physical infrastructure, and generally declining quality of public institutions and governance need special mention. It is important to analyse the impact of these factors not only to understand fully the economic performance during the1990s but also to judge the extent of progress that has been made under Musharaff years to solve deep-seated economic and structural problems and the challenges that remain.The heavy burden of public debt made fiscal management extremely difficult in the1990s because growth of debt was being driven largely by interest payments. Interest payments in the budget accounted for 6.8 per cent of GDP during 1990-99 absorbing 40 per cent of government revenues. This crowded out all other public spending. There is not enough recognition of the fact that real public spending (excluding interest) declined in real terms during the 1990s even though fiscal deficits remained high at around 7 per cent of GDP. Fiscal space, that can be defined as public spending excluding interest and defence, averaged little over 10 per cent of GDP in the late 1990s compared with the average of about 15 per cent in the 1980s.3The problems caused by stagnant economic and social spending were further compounded by worsening of the effectiveness of public spending as witnessed by the failure of the well intentioned Social Action Program and the penchant for high visibility but low economic priority projects like Motorway and Tamir-I- Watan program.Notwithstanding substantial macro-economic mismanagement over decades (less visible in the 1980s than in the 1970s and 1990s) there was a gradual process of liberalisation of the economy notably the reduction of interventions in agricultural prices, relaxation of import and investment controls and financial sector reforms starting in the late 1980s.Major agreements with the IMF and the World Bank financially supported the structural reform process which was further accelerated by .the removal of foreign exchange controls and stepping up of the pace of privatisation under the first Nawaz Sharif Government in 1991-92.The policy shift toward the private sector and greater reliance on market signals rather than administered prices was influenced largely by pragmatic considerations. Policy decisions to involve the private sector in energy and infrastructure development reflected a realisation going back to 1987 that the public sector funds had become a serious constraint on development. Similarly, the drain caused by losses of public sector enterprises was a major factor in the decision to hasten privatisation of industrial assets.Efficiency considerations were also behind the drive to privatise government banks and telecommunications corporations. As mentioned above, these efforts were strongly encouraged and supported by international finance institutions such as the World Bank and were very much in line with the changed international thinking on the role of the state in the aftermath of the collapse of communism.The liberal economic policies could not, however, halt the economic decline and the deepening foreign exchange crisis. As the public confidence in the economy declined and economic distress resulting from inflation and lower manufacturing growth spread, there was a tendency to blame the economic reforms and the international financial institutions that supported them for the economic difficulties.But, in reality, reforms were often half-hearted, not effectively implemented, and were compromised by the absence of strong efforts to reduce macroeconomic imbalances and deteriorating effectiveness of resource use in the public sector and the growing abuses in the largely public sector controlled financial system.That structural reforms did not go far enough, or remained in early stages, was clear from the limited progress of privatisation in financial, telecommunications, and the energy sectors. The delay in privatising large state-owned banks was particularly costly because credit allocation decisions became more susceptible to political pressures under the democratically elected governments. In the case of newly privatised banks or new private banks, effective bank supervision and exercise of the regulatory authority of the State Bank of Pakistan were not yet fully in place. The improved liquidity position of the commercial banks following the large influx of foreign currency deposits probably also led to relaxation of credit standards.The guaranteeing of foreign exchange risk related to foreign currency deposits by the State Bank of Pakistan at a relatively small fee and allowing the use of foreign currency deposits as collateral meant that the costs and the risks of these funds to the commercial banks were relatively low. This provided further incentive for credit expansion to the private sector which was expanding rapidly following the liberalisation of investment controls and opening up of new areas of activity. That the private sector relied heavily on borrowing rather than domestic resource mobilisation is confirmed by the fact that the boom in the private sector investment was not accompanied by an increase in its savings rate.Paradoxical though it may seem, the liberalisation measures, though sound in themselves, had the impact of diluting the urgency of macroeconomic adjustment. First, the ease of financing the foreign exchange gap through foreign currency deposits and portfolio investments became an excuse for not facing up to the unsustainability of large balance of payments deficits. Second, large receipts from privatisation were used to bolster public spending rather than to retire debt.Furthermore, the balance of payments consequences of large-scale recourse to private sector energy development were not seriously addressed.The economic liberalisation and structural reform measures were necessary and had been overdue. They should have been pursued with even greater vigour and effectiveness. But they could not substitute for adequate stabilisation efforts and macroeconomic stability. Indeed, the benefits from economic liberalisation were seriously limited in the absence of reduction of macroeconomic balances.The external debt crisis that had been building up over time came to head with the explosion of nuclear devices by first India and then Pakistan in the summer of 1998. The imposition of foreign sanctions, the erosion of confidence in the Pakistan rupee, and the unfortunate decision to freeze the large resident foreign currency deposits totalling nearly $10 billion led to a technical default on foreign debt service obligations which led Pakistan to seek relief and debt reduction from the Paris club in January 1999. Even so the balance of payments position remained precarious and the burden of both external and public debt was at totally unsustainable level.CONSOLIDATED FEDERAL AND PROVINCIAL TOTAL EXPENDITURE IN 1999/00 PRICES(RS MILLION): ===========================================================================================================================
1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01
===========================================================================================================================
Total Budgetary 645,448 644,014 625,132 636,203 717,987 654,854 684,455 660,132 709,118 703,740
Expenditure
Interest 125,287 145,565 153,853 138,529 173,684 184,466 213,426 219,079 245,078 221,781
Defence 152,091 161,554 153,763 162,772 144,225 142,443 129,911 126,725 150,390 148,418
General Administration 38,963 40,963 40,548 50,958 65,318 54,786 42,002 46,606 46,584 55,758
Law & order 26,091 25,360 25,551 28,429 27,510 24,348 25,230 25,018 27,624 28,790
Education 50,420 50,365 51,673 54,883 55,944 49,820 53,380 50,755 54,002 53,965
Health and Population 15,450 15,487 16,526 18,714 19,242 16,966 17,390 17,519 20,026 18,373
Agriculture 13,244 11,939 11,446 11,194 10,997 8,717 8,676 8,608 8,520 8,528
Irrigation 21,833 24,529 23,458 27,764 28,441 18,247 19,339 17,320 17,611 16,481
Fuel and power 38,874 26,037 30,950 30,480 25,363 21,153 22,775 15,226 15,875 18,631
Transport and 24,951 35,283 32,670 25,524 22,700 18,863 19,829 21,849 23,912 20,316
Communication
Others 138,243 106,933 84,694 86,958 144,562 115,046 132,498 111,427 99,497 112,699
Memorandum items:
Total Non-Interest 520,161 498,450 471,279 497,674 544,303 470,389 471,029 441,052 464,040 481,958
Expenditure
Total Non-interest 368,069 336,896 317,516 334,902 400,078 327,945 341,117 314,328 313,650 333,540
Non-defence Expenditure
of which: Development 183,418 140,745 116,915 118,317 124,940 99,990 113,205 103,242 90,681 87,494
===========================================================================================================================
Sources: IMF, "Selected Issues and Statistical Appendix" November 9, 2002; Planning Commission and Finance Accounts of the federal and provincial governments.Note: Expenditures for Irrigation, Fuel & Power and Transport & Communication sectors include expenditures financed by the corporations (WAPDA, OGDC, PTCL and NHA) from the budgetary loans of the federal government.ANNEX TABLE 2CONSOLIDATED FEDERAL AND PROVINCIAL TOTAL EXPENDITURE8 (Percent of GDP)======================================================================================================================
1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01
======================================================================================================================
Total Budgetary 26.7 26.2 24.5 23.7 25.5 23.1 23.5 21.9 22.5 21.8
Expenditure
Interest 5.2 5.9 6.0 5.2 6.2 6.5 7.3 7.3 7.8 6.9
Defence 6.3 6.6 6.0 6.1 5.1 5.0 4.5 4.2 4.8 4.6
General Administration 1.6 1.7 1.6 1.9 2.3 1.9 1.4 1.5 1.5 1.7
Law & order 1.1 1.0 1.0 1.1 1.0 0.9 0.9 0.8 0.9 0.9
Education 2.1 2.0 2.0 2.0 2.0 1.8 1.8 1.7 1.7 1.7
Health and Population 0.6 0.6 0.6 0.7 0.7 0.6 0.6 0.6 0.6 0.6
Agriculture 0.5 0.5 0.4 0.4 0.4 0.3 0.3 0.3 0.3 0.3
Irrigation 0.9 1.0 0.9 1.0 1.0 0.6 0.7 0.6 0.6 0.5
Fuel and power 1.6 1.1 1.2 1.1 0.9 0.7 0.8 0.5 0.5 0.6
Transport and 1.0 1.4 1.3 1.0 0.8 0.7 0.7 0.7 0.8 0.6
Communication
Others 5.7 4.3 3.3 3.2 5.1 4.1 4.6 3.7 3.2 3.5
memo items:
Total Non-Interest 21.5 20.2 18.5 18.6 19.4 16.6 16.2 14.6 14.7 14.9
Expenditure
Total Non-interest 15.2 13.7 12.4 12.5 14.2 11.5 11.7 10.4 10.0 10.3
Non-defence Expenditure
of which: Development 7.6 5.7 4.6 4.4 4.4 3.5 3.9 3.4 2.9 2.7
======================================================================================================================Sources: IMF, "Selected Issues and Statistical Appendix" November 9, 2002; Planning Commission and Finance Accounts of the federal and provincial governments.Note: Expenditures for Irrigation, Fuel & Power and Transport & Communication sectors include expenditures financed by the corporations (WAPDA, OGDC, PTCL and NHA) from the budgetary loans of the federal government.(Concluded)(The writer is a former Chief Economist of the World Bank. He headed the Government of Pakistan Debt Management and Reduction Committee 2000-02.)Annex Table 1
Copyright Business Recorder, 2007
PARVEZ HASAN
ARTICLE (January 16 2007): The serious set back to the private sector, especially private industrial investment, which resulted from the waves of nationalisation and a strident labour policy was of course a major blow to some large industrial families.But Bhutto's economic policies virtually halted the growth of the modern industrial sector and reinforced the anti-export bias of the industrial strategy. Large public investments in industry focused on import substitution and the reform of the exchange rate system failed to remove the large wedge between the average effective exchange rates for imports and exports. Labour and other regulations provided strong disincentives to the growth of large-scale industry.Apart from their negative impact on private industrial development, Bhutto's, policies had adverse long-term economic consequences through increase in defence establishment, nationalisation of educational institutions, a cavalier attitude towards public spending, and, last but not least, serious erosion of the capacity and authority of public sector institutions.A great deal of the responsibility for failures in basic education, which has become an important constraint on growth, can be traced back to the decision to nationalise educational institutions in 1972. As a direct consequence of this decision, the management capacity of the government was extended, the competition for resources within the education sector deepened the urban and the higher education bias and thus the development of basic education and literacy slowed down.ZIAUL HAQ --- GROWTH WITHOUT VISION: From economic point of view, Zialul Haq's rule (1977-88) was the least ideological and the least innovative. Fortunately for Zial Haq, the economy showed a high and sustained growth rate of 6.6 per cent per annum helped mainly by a number of special factors both domestic and external. The completion of long gestation period Tarbela Dam project in 1977 added 10 million acre feet to irrigation water availability and helped sustain agricultural growth Fertiliser and cement investments undertaken under Bhutto contributed to industrial growth.A tremendous boost to economic activity was also provided by rising worker remittances which at their peak in 1982-3 totalled nearly US $3 billion, or about 10 per cent of GNP. In the first half of the l980s, large external assistance for Afghan Mujahedin, estimated at US $5 to US $7 billion, was channelled through Pakistan and it also helped the economy. Similarly, the narcotics trade, which gathered great momentum in the 1980s, strongly supported the service sectors of the economy.Lulled by a comfortable growth rate and a balance of payments situation greatly helped by remittances and other external factors mentioned above, Zia regime did little to deal with the serious structural problems inherited from the 1960s and 1970s: the over-extension of government, the poor climate for private sector investment, heavy dependence of exports on cotton based exports, and the inelasticity of the tax system.Indeed some structural problems were intensified. Relentless growth in public spending raised the share of government expenditure in GDP from the already high 23.5 per cent in 1976-7 to 27 per cent in 1987-8. Government expenditures adjusted for inflation increased nearly 150 per cent during 1977-88. Equally serious, there was a major shift in the public expenditure priorities from development to defence. Real defence spending increased on average by 9 per cent per annum during 1977-88 while development spending rose 3 per cent per annum; by 1987-8 defence spending had overtaken development spending.Since revenue growth was slow, the budget deficits had risen to a totally unsustainable level of over 8 per cent of GDP in the final years of the Zia regime. Public debt in the 1990s grew nearly fivefold in the 1980s, rising sharply both as a percentage of GDP and government revenues. The rise in the debt burden mortgaged future growth and price stability not only because of its sheer size but also because after 1985 a part of the large government borrowing was used to finance consumption expenditure.The consequences of slow growth in the public development spending while the economy was charging ahead were serious shortages of infrastructure, inadequate investment in the economic future, and lag in social development. Notwithstanding the brave declarations in the Sixth Plan, progress in critical long-term issues such as human resource development and population control was extremely inadequate.While incomes rose in rural areas and there was progress in poverty alleviation (especially due to worker remittances), the disparity in provision of basic services between rural and urban areas did not diminish and may have in some cases, such as water supply, increased. Economic policies in the Zia period did not even attempt to tackle the overhang of major nationalisation of the Bhutto period. Even though major inefficiencies had already emerged in public sector enterprises, especially the nationalised commercial banks, not much thought was given to systemic solutions.Finally, the two major policy problems inherited from the 1960s and the 1970s - the inelasticity of the tax system and the strong anti-export bias of the trade policy - actually worsened because of continued heavy dependence on foreign trade taxes. Even though government revenues rose as a percentage of GDP, the increase was entirely due to unpopular additional taxation. Without additional taxation, the tax to GDP ratio would have tended to fall.The further increase in reliance on foreign trade taxation to 43 per cent of central government tax revenues, or 6.7 per cent of GDP, continued to signal the continued heavy dependence on direct taxation and the rising taxation of imports which impeded the development of a diversified base of manufactured goods exports. Even though exports expanded faster than GDP during the Zia period, the structure of exports became even more heavily dependent on cotton-based exports. The sharp expansion in raw cotton production, in part a fortuitous technological development, was at the root of good export performance. Even if we overlook the fact that a large part of expansion in manufactured exports was based on the limited value added cotton yarn exports, Pakistan fell much behind other emerging developing country exporters notably China, Indonesia, Thailand, Malaysia, Mexico, and Turkey.The long period of political stability and sustained growth under Zia offered opportunities for tackling the difficult underlying structural issues which were not exploited. For instance, the opportunities for raising national savings and improving the balance of payments offered by the huge worker remittances and rapidly expanding economy were not seized. Instead, the government launched another round of large increases in defence spending and pre-empted an important part of private savings through large-scale non-bank borrowing. The relative roles of state and private sector in development was left to be decided largely on the basis of inertia.Weaknesses of the direct taxation collection machinery, a fundamental cause of continued heavy reliance on indirect taxation, were not addressed even though martial law extended over a period of eight and a half years. At another level, policy-makers did not learn from the mistakes of the 1960s, such as the overemphasis on growth, the neglect of the social sector, and lack of adequate attention to structural change in agriculture and large-scale industry. They were also slow to gain from the experience of East Asian countries where an 'economic miracle' had been unfolding.There is no doubt that macroeconomic imbalances were worsening and growth was slowing down after mid 1980s. Had Zia lived, he would have had to face the consequences of his neglect of some basic economic issues. As it turned out, the responsibility for sorting out the difficulties fell to a succession of weak political democratic governments which followed Zia.DEMOCRACY, STATE AND ECONOMY (1988-1999): It is well known that growth slowed down in the 1990s, inflation accelerated, the poverty incidence tended to increase and the income inequalities widened. No doubt macroeconomic management under democratic governments was poor, corruption in public spending definitely increased, and the banking system still largely in public hands was misused through political influences. However, many of the underlying factors that caused poor economic outcomes, and have led some to term the 1990s as a lost decade, had historical roots going back at least a couple of decades.Among these the build up of public debt, the structural weakness in exports, inelasticity of tax system, lack of investments in human capital as well as physical infrastructure, and generally declining quality of public institutions and governance need special mention. It is important to analyse the impact of these factors not only to understand fully the economic performance during the1990s but also to judge the extent of progress that has been made under Musharaff years to solve deep-seated economic and structural problems and the challenges that remain.The heavy burden of public debt made fiscal management extremely difficult in the1990s because growth of debt was being driven largely by interest payments. Interest payments in the budget accounted for 6.8 per cent of GDP during 1990-99 absorbing 40 per cent of government revenues. This crowded out all other public spending. There is not enough recognition of the fact that real public spending (excluding interest) declined in real terms during the 1990s even though fiscal deficits remained high at around 7 per cent of GDP. Fiscal space, that can be defined as public spending excluding interest and defence, averaged little over 10 per cent of GDP in the late 1990s compared with the average of about 15 per cent in the 1980s.3The problems caused by stagnant economic and social spending were further compounded by worsening of the effectiveness of public spending as witnessed by the failure of the well intentioned Social Action Program and the penchant for high visibility but low economic priority projects like Motorway and Tamir-I- Watan program.Notwithstanding substantial macro-economic mismanagement over decades (less visible in the 1980s than in the 1970s and 1990s) there was a gradual process of liberalisation of the economy notably the reduction of interventions in agricultural prices, relaxation of import and investment controls and financial sector reforms starting in the late 1980s.Major agreements with the IMF and the World Bank financially supported the structural reform process which was further accelerated by .the removal of foreign exchange controls and stepping up of the pace of privatisation under the first Nawaz Sharif Government in 1991-92.The policy shift toward the private sector and greater reliance on market signals rather than administered prices was influenced largely by pragmatic considerations. Policy decisions to involve the private sector in energy and infrastructure development reflected a realisation going back to 1987 that the public sector funds had become a serious constraint on development. Similarly, the drain caused by losses of public sector enterprises was a major factor in the decision to hasten privatisation of industrial assets.Efficiency considerations were also behind the drive to privatise government banks and telecommunications corporations. As mentioned above, these efforts were strongly encouraged and supported by international finance institutions such as the World Bank and were very much in line with the changed international thinking on the role of the state in the aftermath of the collapse of communism.The liberal economic policies could not, however, halt the economic decline and the deepening foreign exchange crisis. As the public confidence in the economy declined and economic distress resulting from inflation and lower manufacturing growth spread, there was a tendency to blame the economic reforms and the international financial institutions that supported them for the economic difficulties.But, in reality, reforms were often half-hearted, not effectively implemented, and were compromised by the absence of strong efforts to reduce macroeconomic imbalances and deteriorating effectiveness of resource use in the public sector and the growing abuses in the largely public sector controlled financial system.That structural reforms did not go far enough, or remained in early stages, was clear from the limited progress of privatisation in financial, telecommunications, and the energy sectors. The delay in privatising large state-owned banks was particularly costly because credit allocation decisions became more susceptible to political pressures under the democratically elected governments. In the case of newly privatised banks or new private banks, effective bank supervision and exercise of the regulatory authority of the State Bank of Pakistan were not yet fully in place. The improved liquidity position of the commercial banks following the large influx of foreign currency deposits probably also led to relaxation of credit standards.The guaranteeing of foreign exchange risk related to foreign currency deposits by the State Bank of Pakistan at a relatively small fee and allowing the use of foreign currency deposits as collateral meant that the costs and the risks of these funds to the commercial banks were relatively low. This provided further incentive for credit expansion to the private sector which was expanding rapidly following the liberalisation of investment controls and opening up of new areas of activity. That the private sector relied heavily on borrowing rather than domestic resource mobilisation is confirmed by the fact that the boom in the private sector investment was not accompanied by an increase in its savings rate.Paradoxical though it may seem, the liberalisation measures, though sound in themselves, had the impact of diluting the urgency of macroeconomic adjustment. First, the ease of financing the foreign exchange gap through foreign currency deposits and portfolio investments became an excuse for not facing up to the unsustainability of large balance of payments deficits. Second, large receipts from privatisation were used to bolster public spending rather than to retire debt.Furthermore, the balance of payments consequences of large-scale recourse to private sector energy development were not seriously addressed.The economic liberalisation and structural reform measures were necessary and had been overdue. They should have been pursued with even greater vigour and effectiveness. But they could not substitute for adequate stabilisation efforts and macroeconomic stability. Indeed, the benefits from economic liberalisation were seriously limited in the absence of reduction of macroeconomic balances.The external debt crisis that had been building up over time came to head with the explosion of nuclear devices by first India and then Pakistan in the summer of 1998. The imposition of foreign sanctions, the erosion of confidence in the Pakistan rupee, and the unfortunate decision to freeze the large resident foreign currency deposits totalling nearly $10 billion led to a technical default on foreign debt service obligations which led Pakistan to seek relief and debt reduction from the Paris club in January 1999. Even so the balance of payments position remained precarious and the burden of both external and public debt was at totally unsustainable level.CONSOLIDATED FEDERAL AND PROVINCIAL TOTAL EXPENDITURE IN 1999/00 PRICES(RS MILLION): ===========================================================================================================================
1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01
===========================================================================================================================
Total Budgetary 645,448 644,014 625,132 636,203 717,987 654,854 684,455 660,132 709,118 703,740
Expenditure
Interest 125,287 145,565 153,853 138,529 173,684 184,466 213,426 219,079 245,078 221,781
Defence 152,091 161,554 153,763 162,772 144,225 142,443 129,911 126,725 150,390 148,418
General Administration 38,963 40,963 40,548 50,958 65,318 54,786 42,002 46,606 46,584 55,758
Law & order 26,091 25,360 25,551 28,429 27,510 24,348 25,230 25,018 27,624 28,790
Education 50,420 50,365 51,673 54,883 55,944 49,820 53,380 50,755 54,002 53,965
Health and Population 15,450 15,487 16,526 18,714 19,242 16,966 17,390 17,519 20,026 18,373
Agriculture 13,244 11,939 11,446 11,194 10,997 8,717 8,676 8,608 8,520 8,528
Irrigation 21,833 24,529 23,458 27,764 28,441 18,247 19,339 17,320 17,611 16,481
Fuel and power 38,874 26,037 30,950 30,480 25,363 21,153 22,775 15,226 15,875 18,631
Transport and 24,951 35,283 32,670 25,524 22,700 18,863 19,829 21,849 23,912 20,316
Communication
Others 138,243 106,933 84,694 86,958 144,562 115,046 132,498 111,427 99,497 112,699
Memorandum items:
Total Non-Interest 520,161 498,450 471,279 497,674 544,303 470,389 471,029 441,052 464,040 481,958
Expenditure
Total Non-interest 368,069 336,896 317,516 334,902 400,078 327,945 341,117 314,328 313,650 333,540
Non-defence Expenditure
of which: Development 183,418 140,745 116,915 118,317 124,940 99,990 113,205 103,242 90,681 87,494
===========================================================================================================================
Sources: IMF, "Selected Issues and Statistical Appendix" November 9, 2002; Planning Commission and Finance Accounts of the federal and provincial governments.Note: Expenditures for Irrigation, Fuel & Power and Transport & Communication sectors include expenditures financed by the corporations (WAPDA, OGDC, PTCL and NHA) from the budgetary loans of the federal government.ANNEX TABLE 2CONSOLIDATED FEDERAL AND PROVINCIAL TOTAL EXPENDITURE8 (Percent of GDP)======================================================================================================================
1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01
======================================================================================================================
Total Budgetary 26.7 26.2 24.5 23.7 25.5 23.1 23.5 21.9 22.5 21.8
Expenditure
Interest 5.2 5.9 6.0 5.2 6.2 6.5 7.3 7.3 7.8 6.9
Defence 6.3 6.6 6.0 6.1 5.1 5.0 4.5 4.2 4.8 4.6
General Administration 1.6 1.7 1.6 1.9 2.3 1.9 1.4 1.5 1.5 1.7
Law & order 1.1 1.0 1.0 1.1 1.0 0.9 0.9 0.8 0.9 0.9
Education 2.1 2.0 2.0 2.0 2.0 1.8 1.8 1.7 1.7 1.7
Health and Population 0.6 0.6 0.6 0.7 0.7 0.6 0.6 0.6 0.6 0.6
Agriculture 0.5 0.5 0.4 0.4 0.4 0.3 0.3 0.3 0.3 0.3
Irrigation 0.9 1.0 0.9 1.0 1.0 0.6 0.7 0.6 0.6 0.5
Fuel and power 1.6 1.1 1.2 1.1 0.9 0.7 0.8 0.5 0.5 0.6
Transport and 1.0 1.4 1.3 1.0 0.8 0.7 0.7 0.7 0.8 0.6
Communication
Others 5.7 4.3 3.3 3.2 5.1 4.1 4.6 3.7 3.2 3.5
memo items:
Total Non-Interest 21.5 20.2 18.5 18.6 19.4 16.6 16.2 14.6 14.7 14.9
Expenditure
Total Non-interest 15.2 13.7 12.4 12.5 14.2 11.5 11.7 10.4 10.0 10.3
Non-defence Expenditure
of which: Development 7.6 5.7 4.6 4.4 4.4 3.5 3.9 3.4 2.9 2.7
======================================================================================================================Sources: IMF, "Selected Issues and Statistical Appendix" November 9, 2002; Planning Commission and Finance Accounts of the federal and provincial governments.Note: Expenditures for Irrigation, Fuel & Power and Transport & Communication sectors include expenditures financed by the corporations (WAPDA, OGDC, PTCL and NHA) from the budgetary loans of the federal government.(Concluded)(The writer is a former Chief Economist of the World Bank. He headed the Government of Pakistan Debt Management and Reduction Committee 2000-02.)Annex Table 1
Copyright Business Recorder, 2007
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