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Lahore School of Economics Second Annual Conference on Management of the Pakistan Economy Concludes

Conclusion and Recommendations by Dr. Moazam Mahmood

The Rector of the Lahore School of Economics Dr. Shahid Amjad Chaudhry opened the conference, recalling a good bringing together of policy makers led by the Governor of the State Bank Dr. Ishrat Hussain, the private sector comprising bankers and industrialists, and academia in the First Cconference last year. The dialogue generated on public policy had been both intense and diverse, ranging across macro, sectoral and institutional issues, especially edifying for the student body of the School. Th Annual Confrence has been institutionalised and the tradition had also been set for the Governor of the State Bank of Pakistan to deliver the inaugural address at the Cconference.
The Macroeconomy and Policy

At this second conference the Deputy Governor of the State Bank, in the absence of the Governor delivered the inaugural address on the state of the economy. He emphasized that GDP growth was fundamentally on track although a little below the expected 7% target due to commodity sector weaknesses. The rising trend in unemployment had been reversed over ’02-04. Longer trend growth over the decade was expected at over 6%. However three macro imbalances needed to be managed while they still could be handled at their present relatively lower levels.
One, the current account had gone from a surplus of 1.9% of GDP in ’04 to a deficit of 1.4% in ’05, fortunately financed by the high capital flows. The surge in oil prices have contributed to the rise in the import bill, but so have capital and intermediate goods, and curtailing the second will affect growth.
Two, there is a widening savings investment gap, resulting from sluggish savings, financing the surge in imports from capital inflows, and the widening current account deficit.Three, inflationary pressures continue, although falling from 12% in ’05 to an expected 8% in ’06. This inflation threatens incomes, competitiveness and savings incentives. The reduction in inflationary pressures has been brought about by a tight monetary policy, although aggregate demand remains strong, private sector credit falling from 25% last year to a still substantive 18% this year.
Fiscal prudence is also needed, with fiscal deficits creeping up after several years of discipline. Revenue side risks include a nearly fifty percent dependence on import taxes, which could fall, and the volatility of non tax revenues.
The future outlook for ’06 was a growth rate of between 6.3%-6.8%, inflation between 7.7%-8.3%, a CA balance of 4.7%, while the tight monetary stance will continue, and structural rigidities addressed.
Mr. Saquib Sherani the Chief Economist of ABN AMRO Bank addressed these structural rigidities in the fiscal system. The primary fiscal rigidity of course lay in the narrow direct tax base, focused on industry for nearly 2/3rds of its revenues, and services for another quarter, while agriculture contributed only 1%. Mr. Janjua, former Deputy Governor of the State Bank pointed out that agriculture’s share of indirect taxes was enormous. Further the personal tax base was limited to 2.5 million people, with wage earners having been found to account for a half in past surveys. As a result Pakistan’s tax GDP ratio of 9% was amongst the lowest in the world. Subsequent discussion also clarified that Pakistan’s revision of its GDP upwards to $800 per capita had simultaneously lowered the tax GDP ratio.
This fiscal rigidity resulted in a fiscal overhang over the monetary policy of the SBP. The SBP was torn between the opposing objectives of price control and growth. And it was also torn between lending for government needs and non government needs, albeit that from the mid 90s onwards the non governmental sector had not been so squeezed fro credit. His policy conclusions accordingly were to reduce the fiscal tax burden on the formal sector and to reduce the fiscal domination over monetary policy.
Mr. Sartaj Aziz the former Finance Minister set the context between these three often opposed objectives of public policy, growth, price stabilization, and exchange rate stabilization. All three objectives could not be met simultaneously and had to be juggled. In Pakistan’s case he attributed the current dynamic to an exogenous shock of remittance increases from $1 billion to $billion per year due to the 9/11 effect. The excess liquidity forced banking credit for consumption to increase, which raised demand for manufacturing and led to its growth. Since growth was import intensive this led to a deficit in the current account balance. The liquidity also fuelled inflation through speculative investment in land and the stock market. To beat this exogenous impact on prices, he recommended stronger real estate taxation.
Dr. Ashfaq Hassan Khan, Economic Advisor to the Ministry of Finance on Debt Management pointed to strong gains in this macro area. He estimated Pakistan’s total financial requirements for the current year to be $6.8 billion, while total inflows amounted to $8.5 billion. This gives a comfortable BOP surplus of $1.7 billion, which would be added to the current reserves of $13 billion. He also stressed that the total debt as a % of GDP had declined from 100% in 2000 to 61% by ’05. This had resulted from a debt restructuring with the Paris Club in 2001 which postponed non ODA for 23 years and ODA for 38 years, giving a NPV reduction of 27% or $2.7 billion. The discussion pointed to some of this debt reduction being due to the re-appraisal of the GDP, which also lowered the debt.
The macro debate was rounded off with the continuation of the fiscal question, with Dr. Zubair Khan former Commerce Minister addressing the question of inter governmental resource transfers. The question of these transfers arises because of an asymmetry between revenues and expenditures. Since the federal government earns 90% of the revenues, while the provincial governments spend 25% of the revenues, this necessitates transfers from the federal to the provincial governments under the aegis of the National Finance Commission.
The allocations through the NFC had increased substantively over time. However there were always competing criteria for the awards, for instance between revenue capacity which favours the richer provinces and improving equity which favours the poorer provinces. He illustrated the differences between the provincial and federal governments through two cases. The NWFP contested earnings by WAPDA which was under independent arbitration. And Balochistan and Sindh which contested the formula for the gas development surcharge which was paid to them as the difference between well head price and cost. The provinces contested that the well head prices used did not favour them.
Sectoral Issues

The presentations and discussion then moved from the macro context to sectoral issues. Dr. A.R. Kemal set problems in the manufacturing sector against some of the conundrums emerging from the macro policy discussion. One macro puzzle was that while growth had recently risen to 8%, investment levels as a ratio of GDP appeared to have fallen. This is partly explained by the re-evaluation upwards of the GDP. But the same issue emerges in manufacturing with very high growth rates of 12%-18%, coinciding with falling investment levels coming down to 2.9% of GDP. While part of the problem may be an accounting one, at least part was real sector issue. The declining investment levels could be due to a number of factors including high production costs, transaction costs, policy continuity risks, skills and wages, and changes in the demand structure.Manufacturing now accounts for 18% of GDP. The high growth in manufacturing has been based very interestingly on domestic demand accounting for 75%, and exports for the remaining 25%. So the reflation of the economy through increased liquidity seen at the macro level has fed through to increased aggregate demand for manufacturing.
However there are major issues of competitiveness that the sector confronts. The Domestic Resource Cost which is one measure of protection, for the entire sector is 1.2 implying a degree of protection, though not high. Within the sector however consumer goods are very highly protected with a DRC of 6.0, while capital gods and intermediate goods are not with DRCs of 0.2 to 0.8. Therefore one policy implication that emerges is that consumer goods protection could decrease while some protection could be afforded to capital and intermediate goods. Second, Total Factor Productivity growth, which measures technical change has gone down from 3.2 to 1.5. And Pakistan’s reliance on food and textiles continues to be very high with 40% of the Value.
Added in the sector
It is this high dependence on cotton and textiles which Dr. Rashid Amjad from the ILO calls cottonomics that becomes the priority challenge to be confonted. Dr. Rashid emphasized that this was the juncture in Pakistan’s economic trajectory for it to learn to leap frog technologically from a labour intensive economy, skipping the intermediate stages of resource based and scale based activities to a knowledge based economy. A knowledge based economy being one that bases its growth not on increasing capital or land or labour inputs, but on knowledge. While the MTDF for ‘05-‘10 declares its objective to be the development of a competitive, technology driven knowledge economy, the leap required is considerable.
At present Pakistan’s exports of technologically intensive products is very low, much below India, Malaysia or Thailand. Further our enrollement in higher education to feed this technology driven economy is also commensurately low at 4%, although planned to increase to 8% by ’10. As a result Pakistan produces barely 8000 ICT professionals per year, and another 5000 graduates in ICT. Compared to thisIndia produced 1 million ICT professionals per year.The solution then lies in both increasing the supply of technology professionals, but it also implies improving conditions in the labour market. Two factors which militate against investment in HRD while on the job are the high levels of contract labour whith no affinity to the enterprise and labour mobility and security. If labout has sronger links to the enterpise through greater security, investment in their HRD will also pay off for the firm.
Local and Insitutional Development
The presentations and discussion then moved very logically from the meso sectoral level to the local level. Mr. Shahid Kardar, former Finance Minister for the Panjab made a strong plea for financial devolution from the federal and provincial levels to the local. His argument was that the current high degree of centralization had failed to anywhere near an adequate level of social services. Further while the more important services like education, health and water supply had devolved to the local level, higher levels of government imposed constraints on their financial expenditures. For instance waters supply schemes had been transferred to the LGs in Balochistan, but the budget was kep by the provincial government.
As a result LGs were constrained by three factors: their own taxes were extremely limited at 0.1% of GDP, with Pakistan much below most other comparable countries. Two, their tax base was very narrow and inelastic. Three, LGs had no incentive to increase their revenues, because this increase had t be surrendered to provincial governments.
His major policy recommendations were that agricultural income tax be transferred to the district government and property tax to the TMAs. There should be increased resources for LGs. There should be award incentives for DGs performing well. And that LGs should be protected from the imprudence of DGs.
Mr. Javiad Hsan Ali, former Secretary Establihement Division talked about a the institutional structures of the civil service. He essentially traced four periods in this service, pre 71, ’72-77, 78-99, and 2000 onwards. In the first time period the service worked well. In the second period the paradigm was vitiated. In the third period the anarchy continued by default. And in the fourth period anarachy continued by accident. The typology was meant to illustrate the growing disincentives in the paradigm for efficeincy.

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posted by S A J Shirazi @ 5/03/2006 06:15:00 PM,

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