Pakistan's economy - II

Lessons of experience
Positive policy actions The above brief economic history narrative suggests several points. Political leaders, both civil and military, have had a major impact on the course of economic and social development.
On the positive side, the emphasis on infrastructure development in the early years, the rapid development of textile industry in the mid 1950s initially under heavy protection, the sharp acceleration of growth in the Ayub era through unmatched rise in investment especially in the water and power sectors through large foreign aid and effective planning and policy co-ordination, Nawaz Sharif's major initiatives for liberalisation of the economy in early 1990s, and Pervez Musharraf's strong push for both stabilisation and growth in first half of his rule have been important elements in whatever economic success Pakistan has achieved. The 1950s and the 1960s were also periods of institution building including public enterprises that worked.
EARLY POLICY MISTAKES However, the list of these policy mistakes made and missed opportunities over several decades is long and vital to understanding why Pakistan has not been able to achieve sustainable high growth. The decision in September 1949 not to follow the devaluation of Pound Sterling and Indian rupee, in the final analysis on the ground that it would make Pakistan look good in relation to India, was costly because it led to a trade deadlock with India and sharp eventual reduction in trade with the big neighbour - though it yielded some benefits in import substitution such as fruit production.
Next, huge foreign exchange windfall, several billion dollars' worth in to-days prices, from the Korean War boom that increased prices of jute and cotton was frittered away in eighteen months in a totally unsustainable liberalisation of imports - under a regime of overvalued exchange rate. The fact that imported cloth became cheaper than in India for a while was a source of great pride for the citizens as well as the populist politicians. On the other extreme, large import of luxury automobiles with low import duties under an overvalued exchange rate was an indulgence for the emerging elite, both civil and military.
These early policy mistakes clearly point to the two fundamental drivers of policy that have continued to shape economic development in Pakistan for most of its history: tensions with India real or perceived need to maintain a high level of defence spending.
Because the relations with India deteriorated early after independence especially on the issue of Kashmir, a strong defence capability was a top priority even under successive civilian governments in early years. It is to the credit of Ayub Khan that he gave very high priority in early years of his rule to economic development by containing military spending partly because military assistance obviated the need to spend money on arms and equipment. However, hubris and the miscalculation that resulted in the 1965 war with India led to a sharp increase in military spending particular as US military assistance disappeared. After a military defeat and the separation of East Pakistan real defence expenditures were increased under Bhutto and sharply further under Ziaul Haq. Because of the hangover of debt, real defence expenditures did not increase in the 1990s but neither did other public spending.
High spending on defence has been a constraining factor on social and economic development almost throughout Pakistan's history. The problem has been compounded by the fact that after mid 1980s government revenue expenditures in most years have not covered current expenditures including defence necessitating government borrowing for non- development expenditures. Another way of putting to it would be that the governments have desired strong defence but have not been able to raise commensurate tax revenue.
Several other factors and policies that have also affected economic outcomes adversely are (1) High population growth (2) Neglect of Education (3) Persistent failure to exploit tremendous opportunities offered by rapidly growing international trade in manufactured goods (4) Low savings rate and thus inability to translate large foreign aid inflows into a high and sustainable level of investment and growth, and (5) Last but not least, an almost steady decline in governance over decades which is reflected in serious institutional decline, weakening of public services, and slow reduction poverty incidence.
HIGH RATE OF POPULATION GROWTH Pakistan's population is six fold larger than at independence in 1947. Pakistan's high growth rate of population of 3 percent per annum for over three decades seriously affected the level and sustainability of growth in per capita income. At the same time, high population growth has contributed to an abysmal record on social and human development and persistence of poverty at a high level despite an agricultural sector that performed reasonably well for long periods. Of course, low level of tax revenues, high level of spending on defence, and poor governance of the large public education sector are also responsible for the low level of human development in Pakistan. But if population growth rate had been only half a percent lower per annum over Pakistan's history, its population would be 25 percent lower than it is today. I believe the political, economic, and social landscape would then have been vastly different and the deep divisions in the society would have not reached the magnitude that they have today.
Population control policies of 1960s and 1970s did not succeed because of excessive focus on provision of contraceptives. During Zia's rule the policy towards limiting family size were at best ambivalent. This represents a sharp contrast to the effective policy success in Bangladesh which focused on reducing desired family size through women's education and social mobilisation.
NEGLECT OF EDUCATION The makings of a disaster in education have been a slow process. Progress in education was not bad over 1950-65. From the beginning high targets for universal education were set. But then there were two major setbacks. First, as noted earlier, after the 1965 war with India, the sharp increase in defence spending, reduction in foreign aid flows, and the urgent need for increasing food grains production dealt a blow to the allocations for the social sectors. Second, Bhutto's nationalisation of educational institutions in 1972 put Pakistan on a path of ever weakening effectiveness of public sector education expenditures. Third, the allocations for education remained low in the Zia period despite the Iqra tax. More attention has been given to social sectors including education during the last two decades but the results have been mixed because of poor governance and re-emergence of serious financial constraints.
Less than 60 percent of Pakistan's adult population is literate. The situation is worse for women with less than 40 percent of adult females are literate. Despite rapid progress in increasing primary enrolments across the region and gender, only two out of every three children aged 5-9 years were enrolled in primary school, and only two-thirds of those who enroll actually complete Grade V. Currently public educational expenditures are only 2 percent of GDP. In almost all these respects Pakistan compares unfavourably with India and Bangladesh.
MISSING EXPORT OPPORTUNITIES An important long- term economic story is that Pakistan has continued to fall behind other developing countries in export development and has not exploited tremendous opportunities for exports offered by international developments. Stimulated by growth in world income, liberalisation of trade, reduction of tariffs, and technological changes reducing transport costs and improving information flows, the world trade has grown at a much faster pace than world output since the 1960s. The leading edge of this expansion has been the growth in world manufactured goods exports which have increased steadily from less than $200 billion in 1970 to the peak of $11.5 trillion in 2011, showing an average annual growth of 10 percent. While the nature of international trade in manufactures has changed quite significantly from finished goods to intermediate products or components, the growth trend was sustained till 2008. However, there was a fairly sharp decline in 2009 due to the deep international recession but there was a quick recovery in 2010 and in 2011 the earlier peak was exceeded.
The biggest economic story of recent times is the rise of China in substantial part due to its spectacular success in expanding exports. Chinese manufactured exports have risen nearly two hundred fold over the last three decades and their share in world trade has grown from less than 1 percent to 15 percent over 1980-2010. But other major developing countries have also increased their share in world manufactured exports from 7 percent to 22 percent over the period. In contrast Pakistan's share has improved only marginally from 0.12 percent to 0.16 percent and probably is lower now than it was in 1970.
In 1980 Pakistan was still substantially ahead of Turkey and Indonesia in the level of its manufactured exports and had about a quarter of Indian exports, though it had already fallen behind Malaysia, Philippines and Mexico in the 1970s. But thirty years later Pakistan's manufactured exports are less than 30 percent of Indonesia's level and only 18 percent of Turkey's. India's exports are now 8-9 times larger while Vietnam a new comer to the field has manufactured exports three times that of Pakistan.
The following table which provides a comparison on the basis of total exports of goods and services presents clear evidence of how far Pakistan has fallen in orienting its economy to exports, virtually the engine of global growth. China and most other East Asian countries are in a class by themselves but traditionally inward looking economies like India, Turkey, and Bangladesh have increased their export orientation remarkably in the last thirty years. In 1980 India had an export to GDP ratio (6 percent) half that of Pakistan (12 percent) but now its ratio at 23 percent far exceeds that of Pakistan. Even Bangladesh has moved ahead in this respect.
Why has Pakistan fallen so far behind in the export field? There are several reasons that are rooted in past policies and attitudes towards exports. First, export growth has never been a central pillar of development strategy a la Korea, Malaysia, and China. Second, exports were not as profitable as sales in the domestic markets which were heavily protected for a long period. The anti- export bias in policy was reinforced by an industrial strategy that favoured manufacturing based on processing of domestic raw materials. Export development based on imported inputs was strongly discriminated against by generally high duties on imports. Finally, the spurts of export growth that materialised in 1960s and 1980s were to a substantial extent artificially supported by indirect subsidies to the textile sector that kept the domestic price of cotton well below the international price and thus encouraged relatively low value-added textile exports notably cotton yarn.
Over time many of the distortions in trade policy acting against exports have been removed or reduced. The export taxation of cotton was phased out at the end of 1980s. Import tariffs have been gradually reduced and imports greatly liberalised.
Why the liberalisation of trade in Pakistan, which has gone farther than countries like India, not resulted in major gains in exports? One explanation is that Pakistan's real exchange rate periodically became overvalued, for example, after mid 1990s and again after 2004-05. Also, some of the consequences of past policies including neglect of human capital development, insufficient investment in infrastructure, and excessive attention to textiles are still with us and are reflected not only in the relatively low level of our manufactured exports but also in the structure of these exports.
Among large developing countries Pakistan has the least diversified pattern of manufactured exports with the exception of Bangladesh. More than 75 percent of Pakistan's manufactured goods exports consist of textiles and clothing compared with less than 12 percent for developing countries as a group and 6.5 percent for world as a whole. While Pakistan is a major exporter of textiles and clothing, accounting for nearly 2 percent of world exports, its exports of manufactured goods other than textiles and clothing are very small. At $4.5 billion in 2011 they were only 0.04 percent of world manufactured goods exports. For comparison, Vietnam a relative new exporter had other manufactured goods exports ten times that of Pakistan in 2011.
SAVINGS, INVESTMENTS AND FOREIGN AID Pakistan has received enormous amounts of foreign aid over the last half century or so. Both in per capita terms in constant dollars and as a percentage of Gross National Income the net official development assistance was at a peak in the 1960s but has continued to decline as repayments on all except grant aid have naturally continued to climb. Even so net ODA during the last decade was 1.7 percent of GDP close to 10 percent of gross fixed investment. As the following table shows relative foreign aid availability in relation to national income in Pakistan compared to that in India was fourfold in the 1980s and during the last decade the difference has grown to more than eightfold. The more important point is that aid flows are no longer significant in India for sustaining its quite high rate of investment and growth whereas Pakistan's growth and investment are in serious doldrums and the country is far from reviving sustained high growth on its own.
It would be difficult to argue that foreign aid in Pakistan has been used particularly ineffectively compared to most other developing countries. Indeed the large early aid inflows financed an extraordinary level of investment in water and power sectors in the 1960s and 1970s, partly for Indus Basin Works under the Water Treaty with India that was facilitated by the World Bank. These large investments helped sustain high agricultural growth of 4 percent per annum over 1960-2000.
The more serious problem has been that large external flows (foreign aid in the 1960 and 1970s, worker remittances in the 1980s, resident foreign currency deposits in the 1990s and direct private investment in 2003-08) reduced incentives for export development on the one hand, and on the other hand enabled policymakers to avoid difficult choices between consumption and savings. Judging from the long-term trends of gross capital formation, and the foreign savings available to finance the current account balance of payments deficits it would appear that gross national savings that averaged 14-15 percent of GDP in 1980s and first half of 1990s have shown no clear upward trend. After a brief spurt over 20 percent of GDP during 2002-4, the gross national savings have dropped almost steadily since then and touched a low level of 13 percent of GDP in FY 2012.
Apart from the relative ease in availability of external resources, other factors also help explain Pakistan's dismal savings performance. Political leadership has rarely emphasised the importance of sacrifice and savings for long-term development. Indeed the governing elite have often set high standards of conspicuous consumption. At a more basic level the low measured savings rate reflects low confidence in the future. Indeed the real savings are understated because of considerable flight of capital. The high savings rate during 2002-04 partly reflected returning capital flight as political stability seemed to be assured and investment climate improved considerably. In addition, for long periods the high population growth rate resulted in Pakistan having a dependency ratio (the ratio of dependent children to working age population) of 0.9 compared to 0.7 in India and 0.5 in China. Finally, for most years since mid 1980s, general government savings have been significantly negative (in many years as high as 3 percent of GDP) as stagnant or slowly growing tax revenues have not been able to cover government current expenditures in most years.
The low 'available' savings are reflected in persistently low level of gross fixed capital formation. After a recovery during 2005-08 from the low level reached in 2000, fixed investment as a percentage of GDP has fallen in 2012 to the lowest level in more than three decades.
Deteriorating governance, institutional decline and weakened public services
Taking Pakistan's history over the last half century, governance failures stand out even more than growth disappointments. Indeed poor governance has been even more of a problem than poor policy choices. If governance had not deteriorated so much and the strength of public institutions not eroded over time, the resources mobilised through taxation would have been more adequate and the quality of public services especially law and order and 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. Over time the growth and governance problems became increasingly intertwined. Because growth benefits were not widely shared, the quality of public services especially education was deteriorating and the pace of poverty reduction was slow, the tensions in the society began to erupt with increasing frequency in ethnic, sectarian and random violence. Now, extremely uncertain security situation has become a chief constraint on investment and growth. The biggest threat to the country and the economy now comes from the militants and Jihadists who would like to impose their narrow version of Islam. Only belatedly is there a realisation that Pakistan Taliban pose an existentialist threat to the very survival of Pakistan as modern, moderate and progressive state.
Unfortunately, the religious extremists draw some support from sections of the society that rightly perceive widespread corruption, growing income inequalities and lack of any meaningful accountability of political leadership as the very anti-thesis of Islam. The quiet sympathisers do not see, however, the dangers of an extremist theocratic authoritarian rule.
The greatest sources of public dissatisfaction are high level corruption and a governance style that does not give regard to merit and integrity in key appointments. The 2011 Transparency International Corruptions Perception Index puts Pakistan's score at 2.5 (on a scale of 0 (worst) to 10 (best)) and 137th out of 182 countries. Pakistan's score is well below India's (3.1) and lower than Bangladesh's (2.7) and very close to that of Nigeria (2.4)
Why did governance which was relatively good till the end of 1960s decline so sharply over time? In the early years the sanctity of public expenditure was well observed and there was not the cavalier attitude towards the use of public funds. The high level corruption was quite limited. It seemed that the politicians who grew up under the British Raj and were either lawyers or feudal landlords did not have their focus on accumulating fortunes. 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.

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Table 1: Exports of goods and services - As percentage of GDP

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Country/Year           1960    1970    1980    2000    2008    2009    2010

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Bangladesh               NA      NA       5      14      20      19      18

China                    NA       3      11      23      35      27      30

India                     4       4       6      13      24      20      23

Indonesia                15      13      34      41      30      24      25

Pakistan                 NA       8      12      13      13      13      14

Thailand                 16      15      24      67      76      68      71

Turkey                    2       4       5      20      24      23      21

Vietnam                  NA      NA      36      55      78      68      78

                                      (1990)

Lower Middle Income      11      11      17      26      30      26      28

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Source: World Bank

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Table 2: Net Official Assistance - Country Pakistan India

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Years                                      1960s  1980s  2000s  1960s  1980s  2000s

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Per Capita Net Official Development

Assistance (ODA)                             7.7   10.2   11.1      -      -      -

In Current US dollars                        2.0    2.4    1.3      -      -      -

Net ODA as % of GNI (Gross National Income)  7.1    3.1    1.7     NA    0.8    0.2

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Source: World Bank

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Table 3: Gross Fixed Capital formation - As percentage of GDP

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Country/Year                  1960   1970   1980   2000   2008   2009   2010

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Bangladesh                      NA     NA     14     23     24     24     24

China                           NA     24     29     34     41     46     45

India                           13     14     18     23     32     32     30

Indonesia                       NA     NA     22     20     28     31     32

Pakistan                        11     14     18     16     20     17     14

Thailand                        14     24     28     22     27     24     25

Vietnam                         NA     NA     NA     28     35     35     36

Lower Middle Income Countries   NA     14     20     21     27     26     26

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Source: World Bank

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