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
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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
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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
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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
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