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Pakistan: Moving the Economy Forward

Pakistan: Moving the Economy Forward by Rashid Amjad and Shahid Javed Burki was launched at Lahore School of Economic this morning. Here is an overview of the book.

 

The central question that the contributors to this volume seek to answer is how to reverse the current prolonged period of low growth and high inflation—stagflation—that the country has experienced over the past five years, and to suggest and implement measures that would decisively move the economy onto a higher, more sustainable growth path.


 
Eight key messages emerge from the studies presented in this volume:

The first is the urgent need to revive investment, which has fallen dismally to 12.5 percent of GDP in 2011/12 from its peak of 22.5 percent in 2006/07, by improving the investment climate and removing binding constraints—especially in energy—on new domestic and foreign investment. Pakistan needs to increase its investment-to-GDP ratio to over 30 percent over the next decade if it is to generate sufficient employment to productively employ its fast-growing labor force and compete effectively with other rapidly growing developing countries. However, in the medium term, investment may continue to be constrained by resource availability and so, in the near future, a large part of the revival of growth will have to come from exploiting unused capacity and productivity gains.
 
The second is that Pakistan’s economic problems are basically structural and not just cyclical in nature. Deep economic reforms are needed to remove structural imbalances to increase efficiency and competitiveness, and to spur entrepreneurship and innovation in the economy. Undertaking these reforms will require political will and a carefully sequenced pace of critical reforms so as to ease the burden of adjustment.


The third is to overcome the binding constraints to Pakistan’s growth in order to revive the economy and ensure sustainable growth. These include overcoming the crippling energy shortage, increasing revenues to regain macroeconomic stability and reduce the current unsustainable fiscal deficit, and ensuring the availability of water to meet the needs of the agricultural economy.



 
The fourth message is to make exports a major driver of economic growth. This will mean reversing Pakistan’s past poor performance in integrating with global markets—reflected in the country’s stagnant share in global exports. It will need bold steps to create and take advantage of regional trade opportunities, including trade with India. Critical to the success of this strategy will be to improve the quality of Pakistan’s human resource, which could provide the cutting edge in a highly competitive global economy.

The fifth is that the economy has been badly mismanaged, not just in recent years, but also over a long period of time. This has considerably hampered its economic performance and reflects poor economic decision-making, uncoordinated responses, lack of implementation, rampant corruption, and poor governance.
 
The sixth is that the country must aim not only for sustained and higher growth, but also inclusive growth such that the poor and vulnerable both participate in as well as share the gains of economic growth, and that development spreads to the country’s less developed economic regions.
 
The seventh is that, after the passage of the National Finance Commission (NFC) Award and the 18th Constitutional Amendment, a much greater responsibility falls on the federating units. The provinces will now have to play a major role in economic management and improving the welfare of the people. This will require their greater participation in overall macroeconomic management as well as close coordination between the federal and provincial governments in formulating and implementing development plans.

 
The eighth message concerns the roles of the state and the private sector. Having alternated between the ascendancy of the state and private enterprise for decades, the country needs to settle into a mutually supportive relationship between these two components of the economy. The private sector should play the leading role in all economic activity but within a well-functioning regulatory environment developed by the government. The government’s primary role should be to provide social and physical infrastructure, support for cutting-edge research, and affordable social protection and safety nets for the poor.
 
Pakistan has enormous potential for high and inclusive growth if its resources are well and effectively managed. The policy recommendations emanating from this volume can play an important role in realizing this potential.

Lessons from the Past
 
Pakistan’s economic performance over the past 65 years has both confounded its critics—when the country has performed much better than expected, especially in the early years—and disappointed those who had high expectations, given its initial start and economic potential. Hasan (Chapter 2) traces Pakistan’s economic history since independence as the economy went through recurring cycles of high and low economic growth. He identifies factors responsible for these episodes under different regimes and seeks to answer the key question of “why sustained growth has been elusive.”

Hasan also makes the important observation that tensions with India, which led to three wars between the neighbors (1948, 1965, and 1971), have played an important role in determining policy choices. One example is Pakistan’s decision not to devalue its currency in 1949, which led to the cessation of trade between the two countries and the start of import-substitution industrialization that fed on the Korean boom as the price of raw materials increased dramatically. Moreover, the dispute over the division of Indus river waters remained unsettled for the first decade and a half. These tensions have meant that Pakistan had to set aside far more resources for defense than it could economically afford.

The broad lesson that he draws from Pakistan’s experience is that, while its average growth of around 5.2 percent between 1960 and 2010 can be considered respectable, it certainly does not match its potential, especially when compared with the fast-growing East Asian economies and more recently those of China and India. Pakistan’s past economic performance should not be a source of comfort because output and employment have slowed down severely over the last four years and the prospect of strong economic revival has become uncertain.

Hasan identifies the following factors that have constrained Pakistan’s growth over the years:

- High spending on defense to counter the real or perceived threat from India.
- High population growth.
- The considerable neglect of human resource development, in particular, education.
- A low savings rate and the inability to translate large foreign aid inflows into high, sustainable levels of investment and growth.
- A steady decline in governance, which has resulted in a serious institutional decline, a decline in public services, and a slow reduction in poverty incidence.
- Major missed economic opportunities.

Amjad (Chapter 3) traces the more recent growth cycle through which the economy has passed, covering the period of the Musharraf government and subsequent coalition rule from 1999/2000 to 2012/13. He argues that, despite the revival of economic growth and upturn during the Musharaff period, Pakistan’s fundamental economic structure did not change; it could not, therefore, stand up to the external global economic shocks that started in 2007/08 with unprecedented increases in oil and food grain prices, followed by the global financial meltdown and ensuing recession.

He also describes the extremely poor performance of all the key economic indicators when averaged out over the period. With little growth in productivity—especially total factor productivity—there was little structural change in the economy or movement toward higher-productivity sectors.

The strength of Amjad’s chapter is that it covers in some detail issues related to economic management, including lessons from the International Monetary Fund (IMF) programs that both governments entered into soon after taking office, though for very different reasons. He also assesses the current institutional arrangements for economic decision-making and how these can be improved, including the role of the Finance Ministry in budget making and the Planning Commission in development planning and monitoring economic reforms.

Burki’s chapter (Chapter 4) is important in that it takes a broader socioeconomic–political view of where the economy is today and the challenges it faces, and then recommends policies to revive the economy as well a medium-term strategy, which, as he states, “builds on the positives in Pakistan’s current economic situation.” Burki’s basic hypothesis is that Pakistan may well be on its way to developing a new way of managing its affairs and he traces this to the political development that began after March 2007 with the lawyers’ movement and the restoration of the Chief Justice of Pakistan.

Besides the economic factors responsible for the longest downturn in Pakistan’s economic history, he identifies other important factors that have resulted in a deep economic malaise, harming the economy in ways that are not easily quantified. The most significant of these is the impact on economic stability and development, which also results in very high direct costs to the economy. Among the factors responsible is the rise of extremism, which has taken many forms including sectarianism and communal violence.

Overcoming Major Constraints

To move the economy forward, it is vital to overcome the major constraints to economic growth and to search for practical solutions, especially in the short term, to revive the economy. This section analyzes three of these major constraints: energy, revenues, and water.

An important conclusion that emerges from the chapters dealing with these issues is that poor economic management in the form of ad hoc and inconsistent policy responses has contributed greatly to the current situation. This poor economic management results from lack of technical expertise, a tendency to follow donor-driven advice without examining alternative options, rampant corruption, inter-provincial rivalries, and strong vested interests.

The Energy Crisis

Given the overwhelming impact of energy shortages, both direct and indirect, on the economy and people’s lives, several chapters in the book (including those by Hasan, Amjad, and Burki) draw attention to the problem and suggest solutions.

Malik (Chapter 5) presents a comprehensive review of how the problem arose, what factors accentuated it, and why there are no simple solutions to solving it. She then presents in some detail areas of policy action that could help ease the crisis and gradually overcome it.

The energy crisis is not manifest merely in terms of its direct impact on output and the fact that it has shaved off 1.5 to 2 percentage points of GDP growth over the last five years. It is also responsible for digging a large hole in government finances and causing the fiscal deficit resulting from untargeted subsidies on energy consumption to balloon; it has also resulted in the emergence of an unending circular debt of huge proportions (almost 3 percent of GDP).

The root causes of the problem can be traced to Pakistan’s decision during the 1990s to opt for an energy mix that involved independent power producers (IPPs) who set up oil- and gas-fired energy plants to overcome the country’s energy shortages. As the price of oil increased from around USD 15–20 a barrel to USD 100–140, these plants could only supply electricity at high prices, which had to be subsidized for fear of public reaction spilling over into street violence. Prices were not adjusted during 2004–07 till the subsidy became unsustainable; when, eventually, they were adjusted in 2008 and over the years, they were never done so in sufficient measure to overcome the cost and prices charged to consumers. The result has been a widening gap between supply and demand and between costs and prices. The prices also reflect almost 30 percent worth of losses from theft and technical factors, of which theft comprises almost 60 percent.

What, then, are some of the more short-term solutions (12 to 18 months) to the problem? Malik (Chapter 5) and Burki (Chapter 3) suggest the following measures:

- Increase output through the best use of existing capacity, which would mean diverting oil and gas from inefficient public sector thermal plants to private sector plants (IPPs), which have excess capacity and can generate electricity at a lower cost.
- Eliminate the recurring circular debt by (i) cutting down on line losses resulting from theft and then (ii) gradually increasing prices to cover costs once consumers are assured of a regular supply and that they are not paying for the inefficiency of the system, including corruption and theft.
- Shift some of the major IPP thermal power plants from oil and gas onto imported coal. This would reduce costs and also allow these large plants to work at full capacity.
- Shift the ownership of all thermal plants operating in the public sector to an entity that can sell part of its share to the private sector. This entity could also issue bonds backed by its assets in order to liquidate the accumulated circular debt.
- Encourage the provinces to invest in the development of the energy sector (which, under the 18th Amendment, they are empowered to do), with the assurance that their power supply from the national grid will not be reduced.
- Transfer the distribution companies operating in different provinces to the provinces so that they can take effective steps—backed by law enforcing agencies—to stop theft and reduce line losses.
- Develop a market for trading power in which provinces can sell and buy electricity from each other.

Medium- to long-term solutions include the following:

- Correctly price power consumption to attract private investors.
- Change the country’s currently expensive energy mix by utilizing its enormous coal supplies, especially the unexplored 185 billion tonnes of coal reserves in Thar. The shift to coal should be accompanied by measures to reduce its environmental impact.
- Build run-of-the-river hydropower projects.
- Move to alternative environment-friendly energy generating systems, including wind power, biogas, and solar energy.
- Build more major dams: start by raising resources for the construction of the Bhasha-Daimer dam and plan to build two major dams over the next decade and a half.
- Actively pursue the completion of the Iran–Pakistan gas pipeline and establish links with energy networks from Central Asia through Afghanistan.

Macro-Stability: Raising Revenues and Reducing the Fiscal Deficit

If crippling energy shortages is the first of the major constraints to economic revival and sustained growth, then the second is the rising unsustainable fiscal deficit as government expenditures outstrip revenues. Without a determined effort to raise the currently very low revenue levels in terms of current expenditures, macroeconomic stability will remain elusive. Of course, raising taxes must be accompanied by cutting down sharply on wasteful expenditures; the government must demonstrate that these resources are being efficiently used and reflected in improved public services, including the security and law and order situation.

This critical issue is analyzed in a number of chapters, but Pasha and Pasha (Chapter 7) present a detailed account of the existing system of tax collection in Pakistan, and the path that tax reforms must take if tax revenues are to increase from the current dismal level of less than 10 percent of GDP to around 15 percent over the next few years. Most manifestos issued by the mainstream political parties have endorsed this or similar goals.

The package of tax reforms that Pasha and Pasha identify has a focus on direct taxes, which would result in an increase in tax yields but also make the tax system more progressive. The measures suggested to achieve this include levying an effective agricultural income tax; reintroducing the wealth tax; instituting a minimum tax on turnover; targeting tax exemptions; rationalizing tax rates; developing the property tax; and providing incentives for taxpayers to file returns.

In the domain of indirect taxes, the authors propose introducing a broad-based integrated VAT and bringing into the tax net major services currently not covered by the sales tax. They also propose rationalizing the statutory tariff rates into essentially three slabs of 5 percent, 15 percent and 25 percent, and simultaneously withdrawing most of the statutory rules and orders (SROs), except those pertaining to trade agreements.

Finally, the authors are of the view—shared by many—that radical changes are needed in the Federal Board of Revenue to make it more efficient and effective.

The Critical Role of Tax Reforms in Making Devolution Work
In Chapter 8, Ahmad examines whether the major reforms undertaken through the 7th NFC Award and the 18th Constitutional Amendment will work effectively and ensure higher living standards for all people in all four provinces. In this context, he also examines in detail the downward slide in Pakistan’s tax-to-GDP ratio and argues that, unless effective measures are taken to raise revenues, any structural shifts involving significant decentralization to the provincial governments are “of little more consequence than shifting deck chairs on the Titanic.”
 
Examining the recent history of tax reforms in Pakistan, he points out that the government’s approach to the IMF in 2008 was predicated on tax reforms. He argues that the failure of tax reforms has seriously jeopardized both the NFC award and the 18th Amendment. Indeed, as he starkly puts it, “without the tax reforms, the NFC award is just a mirage in the desert.”

Ahmad points out that the greatest shortcoming of the decentralization process in developing countries—and this must also apply to Pakistan—is the lack of attention given to adequate own-source revenues at the subnational level. He details China’s successful reforms undertaken during 1993/94 from which Pakistan could learn. An important recommendation he makes is that provinces and districts should be provided flexibility in generating their own-source revenues.

Water: Maintaining and Harnessing the Indus Basin Irrigation System

Pakistan, it is rightly said, is the gift of the Indus and, as Chaudhry states in Chapter 9, “Pakistan’s Indus Basin irrigation system is the strong heart of the country’s economy.” The chapter provides an historical overview paying tribute to the British irrigation engineers who created the original system (1847–1947) and the Pakistani irrigation engineers and institutions (particularly the Water and Power Development Authority and provincial irrigation departments) who have added new dams and barrages, built new link and branch canals, and maintained the world’s most complex and extensive irrigation system.

A critical concern is whether adequate policy measures have been taken and investments made to increase surface water storage in line with rising demand and to rehabilitate the Indus irrigation system. Chaudhry provides details of the important projects that have been built in the last decade, largely financed by the Government of Pakistan, including (i) the Mangla dam raising project, which added 2.9 MAF to its existing capacity of 6 MAF; (ii) the Greater Thal Canal project in Punjab, which created a new culturable command area (CCA) of 1.5 million acres; (iii) the Kachi Canal project for Balochistan, covering Dera Bugti, Naseerbad, and Thal Magsi, and creating a CCA of 0.71 million acres; and (iv) the Rainee Canal project area in Sindh, covering Ghotki, Khairpur, and Sukkur, and creating a new CCA of 0.41 million acres. In addition, an irrigation system rehabilitation project started in Sindh is now nearing completion.

The author highlights the fact that, with the exception of a few barrage irrigation projects, the World Bank has provided no funds for such projects and its focus since 1997 has been solely on institutional development and in the long term to encourage the privatization of the irrigation system. (This is very similar to the World Bank’s early decision since 1987 not to lend for energy development and focus on the privatization of the energy sector instead.)

Excluding climate change requirements, Chaudhry estimates that Pakistan optimally requires about 22 MAF of storage on the Indus—its present storage capacity is about 8 MAF at Tarbela and an additional 6 MAF if the construction of Basha-Daimler goes as planned at an estimated cost of USD 8 billion. He therefore recommends building additional storage capacity in the form of two dams on the Indus to deal with the present situation. While the Asian Development Bank has indicated support for Basha-Daimler, the World Bank has recently shown interest in funding a hydroelectric project at Dasu downstream of Basha-Daimer and upstream of Tarbela. Chaudhry also draws attention to the increasing pressure on the Indus Water Agreement signed in 1960 as the Indian Punjab runs out of groundwater and India continues to build barrages on the rivers that were allocated to Pakistan under this agreement.

The six major conclusions of this chapter are that Pakistan should focus on (i) creating additional surface storage; (ii) preserving surface water, particularly by lining canals; (iii) controlling groundwater and salinity by discouraging excessive tubewell use; (iv) encouraging general efficiency of irrigation water use through better pricing policies and improved land management techniques; (v) enhancing yields through improved farm practices; and (vi) fully meeting the environmental concerns of the Indus delta, river system, and wetlands.

Increasing Exports: A New Driver of Economic Growth
A major thrust of this volume is that, unless Pakistan is able to increase its currently stagnant share of exports in GDP (around 10 percent) and its share of exports in world trade (around 0.15 percent), it will be very difficult for the country to generate either sustainable or higher economic growth. Pakistan’s poor performance in integrating with and taking advantage of the fast pace of globalization prior to the financial crisis is brought out in a number of chapters (Hasan, Chapter 2; Amjad, Chapter 3) but Ahmed, Hamid, and Mahmud (Chapter 6) focus on measures to increase overall exports.
Pakistan’s exports have been dominated by the textiles and garments sector since the 1960s, but in the last decade, their combined share has fallen from about 75 percent of total exports in 2000/01 to 55 percent in 2010. On the other hand, the SME sector’s exports have increased steadily, with the bulk of SME units operating in industrial clusters around Karachi, Lahore, and the Sialkot–Gujrat–Gujranwala triangle in central Punjab. The cement sector has also performed better.
 
Hamid et al. identify textiles, garments, and SME exports as the key potential export drivers in the manufacturing sector in the medium term. They argue that cement exports have been mainly to Afghanistan and these may taper off with the withdrawal of US forces in 2014 and downturn in coalition civilian aid, though it is possible they may increase if India reduces its nontariff barriers (NTBs) against Pakistan’s cement exports. For textiles, they hope that the possibility of Pakistan being given GSP-plus status by the European Union from 2014 will offset weakening demand in the latter.

In the case of garments, the authors point to opportunities that are coming up as China (with current exports of USD 130 billion in 2010) moves from low-end manufactures to higher value-added products. In the case of SME exports, they identify sports goods, surgical instruments, fans, and automobile parts as the ideal export drivers in the medium to long term.

In the agriculture sector, they identify cotton as a potential driver based on a 50 to 80 percent increase in cotton production in the last five to seven years as a result of using BT cottonseed; this, in turn, could increase cotton exports by over USD 3 billion per annum and, if converted into textile products, a multiple of this amount. They also identify high-value nontraditional agricultural exports that include fruits and vegetables, and halal meat and meat preparations as having considerable potential. Finally the authors point to the large potential that lies in emulating India by expanding knowledge-based exports, including information and communication technology, as well as entertainment and health services. In fact, in some IT areas, Pakistan is doing better than India: some of its firms are in “product development”—an area in which India is relatively weak.

As a strong proponent of increasing the export-orientation of the Pakistan economy, Hasan (Chapter 2) argues that the pessimism some observers have expressed about future globalization is not justified, and that even despite the slowdown in international trade, “Pakistan can hope to gain a market share provided it follows policies that strengthen competitiveness, diversify the product mix, and move up the value chain.” Some specific policies he suggests, complementing those mentioned earlier, include:

- Instituting an exchange rate that would fully reflect the differential between movements in Pakistani prices and the international price level. Here, it is important to note that the large and increasing share of remittances does in fact raise the real effective exchange rate relative to what it would be based on the current account balance; to some extent, this does make it more difficult for Pakistani exporters to compete in global markets.
- Promoting foreign investment through joint public and private sector initiatives in textiles, clothing, and other promising export sectors from countries such as the Republic of Korea, Hong Kong, Malaysia, and Taiwan.
- An in-depth review of the free trade agreement signed with China and the establishment of a free trade zone with the country; the latter is likely to increase exports.
- Encouraging the development of export supply chains and linking these efforts to the National Trade Corridor Improvement Project.
- In the context of the Strategic Trade Policy Framework (2009–12), reducing the anti-export bias in the current incentive structure by withdrawing protection from inefficient industries, and minimizing taxation at the investment stage.
- Coordinating more closely between the commerce ministry and related ministries, including industry and textiles, as well as the Planning Commission and the provincial governments. This degree of interface is sadly missing and sorely needed.

Encouraging Regional Trade: A New Vent for Growth

In a fascinating historical discourse, Nabi (Chapter 15) traces the major drivers of economic growth: the development of canal irrigation in the later part of the 19th and early 20th centuries, the Korean War boom in the early 1990s, the start of import-substituting industrialization, the green revolution in the 1960s leading to enormous increases in the productivity of major crops (wheat and rice), overseas migration and remittance inflows in the 1980s, and finally, post-9/11, increased external assistance received as a frontline state in the war against terror.

He argues that Pakistan now needs a new driver for economic growth if it is to break out of its current prolonged economic downturn; he finds this in the country’s geographical location, which has historically served as a center of trade, commerce and finance, and education in the region. Nabi argues that Pakistan’s investment in communications infrastructure over the last 65 years and the development of a north–south trade corridor makes possible the creation of an integrated “Indus Basin market” that could open the way for east–west trade through the regions as well as spokes with Central Asia and China.

Trade with Regional Neighbors

Hamid and Hayat (Chapter 14) carry this analysis further by pointing out that, over the last decade, there has been a fundamental change in Pakistan’s trading partners, which were earlier dominated by the West. For 2011, they show that 25.1 percent of Pakistan’s exports and 35.3 percent of its imports were from neighboring countries (the UAE, China, Afghanistan, India, and Iran) and, consequently, that this group of neighbors is now more important to Pakistan’s trade than North America and Europe. They discuss in detail the prospects of increasing trade with these five countries.

In the case of China, Hamid and Hayat trace the fast-growing trade between the two countries with China’s share in Pakistan’s total imports (which they suggest are grossly underestimated) increasing from around 5 percent in 2000 to over 15 percent in 2011. They highlight the considerable potential for increasing exports to China as it moves into higher value-added products as well as attracting investment from China toward labor-intensive employment generating industries in Pakistan. Pakistan could also seize the opportunity to accelerate development in China’s western provinces.

As far as increasing trade with Afghanistan is concerned, a positive development has been the rise in nontraditional exports (vegetables and fruits, petroleum products, cement, metal manufactures, machinery, and transport equipment), which have considerable long-term export potential. Similarly, the Central Asian Republics, including Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan, with a combined population of 61 million, offer substantial opportunities for Pakistan’s exports.

India–Pakistan Trade
Over the last few years, there has been considerable progress in removing barriers to trade between India and Pakistan. While India had granted most-favored-nation (MFN) status to Pakistan in 1996, the latter moved in 2011 from a positive to a much smaller negative list for imports from India and has in principle agreed to granting India MFN status in early 2013.
 
In a carefully crafted and well-analyzed paper, Pasha and Imran (Chapter 13) examine the prospects of India–Pakistan trade, including the level of import tariffs in the two countries and their potential impact on the volume of trade as well as NTBs. Pasha and Imran establish that the low trade complementarity between Pakistani exports and India arises primarily because Pakistan does not have a diversified export base and its two major product groups—agricultural items and textiles—also account for a significant portion of India’s total exports. They do point out, however, that if free trade were to take place between the two countries, further specialization could develop with Pakistani exporters finding “niche” markets in India. A number of Pakistani manufacturers in favor of granting MFN status to India also hold this view.

Having examined the existing tariff and subsidy regimes for agricultural products and tariffs on textiles and clothing, Pasha and Imran reach the important conclusion that, as a result of these measures, India has effectively restricted imports, which will deny access to Pakistani exporters in these two vital sectors. They strongly advocate, therefore, that Pakistan seek the withdrawal of specific duties on textiles and clothing and opt for the application of only ad-valorem duties. The study also shows that, compared to India, Pakistan operates fewer and less vigorous NTBs. These issues need serious consideration in both countries.

Overall, based on existing export patterns, Pasha and Imran project that, in the medium term, imports from India could rise to almost USD 7 billion to USD 8 billion, while Pakistan’s exports would rise to around USD 1 billion. This quantum jump in bilateral trade could result in the fear of “serious injury” to industries in Pakistan that have enjoyed high protection levels in the past. It will be necessary, therefore, to build up the capacity of the Ministry of Commerce and National Tariffs Commission to investigate such complaints and take necessary safeguards as allowed under the World Trade Organization and South Asia Free Trade Area agreement.

Other studies present much larger estimates of the increase in trade resulting from the lifting of trade restrictions between the two countries, and some believe that the quality and novelty of Pakistani products will considerably enhance their demand in Indian markets. International experience of trade between neighbors (EU, NAFTA, ASEAN) also shows that opening up trade results in major changes to the existing pattern of exports as dynamic forces are unleashed.

The other key conclusion that Pasha and Imran draw is the need for Indian exporters to move into Pakistani markets gradually even after MFN status is granted to them. This is so that a large, stark trade imbalance does not arise in their favor, which would otherwise lead to agitation by the affected parties, seriously slowing down the whole process.

Remittances and the Pakistan Diaspora
Under the overall rubric of increasing foreign exchange earnings Amjad, Arif, and Irfan (Chapter 12) analyze the remittances market in Pakistan and attempt to explain the almost tenfold increase in official remittances between 1999/2000 to 2011/12 from around USD 1.5 billion to over USD 13 billion. The share of remittances in GDP has risen to 5.5 percent and, in terms of foreign exchange earnings, they are equal to half of Pakistan’s total exports of goods and services. The main reasons for this increase in remittances is traced to: (i) a shift from unofficial (and unrecorded) channels (hawala) to official channels; (ii) an increase in the number of Pakistanis living and working abroad; and (iii) a rise in migrants’ skill levels. As to the unofficial flow of remittances, though they suggest their share has decreased over the years, the authors’ rough estimates suggest that these amounts could still be as high as USD 5 billion. Other estimates are even higher.

By analyzing in detail the functioning of the remittances market, Amjad et al. make the important observation that remittances entering Pakistan have a far great multiplier impact on the economy than remittances through unofficial channels, which normally result in movements of currency within Pakistan and within the destination country. They also make the key point that these remittances represent real demand for Pakistani rupees, which are backed by the foreign currency of those who demand Pakistani rupees. They play down the general notion that these official remittance flows represent the “whitening” of black money from Pakistan.

Based on the results of a household survey, their chapter also investigates why migrants prefer to send remittances through unofficial or hawala channels, and suggests incentives and measures (such as the Pakistan Remittance Initiative) for them to be sent through official channels.

Improving Governance, Transparency, and Accountability

An important premise of this volume is that, if Pakistan’s economy is to move forward, then the current decline—indeed rot—that has set in its public services and institutions needs to be reversed rapidly. This is extremely unfortunate though, sadly, a trend not restricted to Pakistan. As Hasan (Chapter 2) recounts, Pakistan was able to establish its economic viability and later displayed economic resilience through an outstanding and upright civil service.
 
Husain (Chapter 10) states that, “Most observers and analysts within and outside Pakistan firmly believe that the quality of economic governance and decision making and the capacity of the country’s key institutions have gradually deteriorated over time. Pakistan’s main problem in maintaining macroeconomic stability, sustaining economic growth, and delivering public services to the poor is weak governance and the gradual but perceptible decline in institutional capacity” (p. 285).

Husain argues that a major reason for poor economic management is that governments have operated with short-term horizons—so as to claim credit for their ostensible performance during their tenure of office—rather than according to what the long-term national interest may dictate. He identifies a number of important developments that warrant wide-reaching reforms. These include inadequate checks and balances in the existing institutional arrangements, which have been further changed by the 18th Constitutional Amendment.

The author also argues that the state’s failure to perform its functions is most glaring in terms of the government’s ability to serve its citizens. Acts of terrorism, violence, and extremism have become so frequent over the last several years that the writ of the state does not appear to exist any longer (p. 294, emphasis added).

Husain presents a proposed governance reform agenda for restructuring and revitalizing government institutions. The measures suggested include the need to reduce the discretionary authority exercised by government functionaries at all levels; this needs to be minimized and made more transparent, including through the introduction of e-governance, e.g., in land records and land titling. He also suggests that the role of the Council of Common Interests in formulating national policies after the 18th Amendment be defined more clearly and strengthened. He recommends creating incentives that would encourage competing civil servants to upgrade their skills, and instituting promotions based on past performance and potential for shouldering greater responsibilities. Finally, he emphasizes giving high priority to reforms in areas that affect people’s daily lives, such as education, health, the police, and land administration.

This is an important agenda for undertaking reforms and an implementation system should be set up to track these reforms.

Institutional Reforms: Empowering the Poor and Middle Classes
While Husain presents an agenda for reforms that would considerably improve the functioning of government, Akmal Hussain (Chapter 18) suggests a more radical approach that aims to replace the current “rent-based institutional structure and associated patron–client-based governance model” with new institutions through which equitable growth and poverty reduction are built into the structure of the economic growth process to make it sustainable.
 
Hussain critiques the neoliberal view that markets necessarily deliver efficient outcomes and are self-regulating. He does not subscribe to the neoliberal idea that incentives for innovation and growth will necessarily lead to the emergence of new entrepreneurs, which will then lead the economy into sustained growth. His basic argument is that the economic elite that now constitutes Pakistan has historically functioned within a patron–client system that has not changed radically in recent times. The institutional structure systematically generates rents for the coalition of elites that has emerged. His implicit argument, therefore, is that this rent-earning elite keeps out new entrants, and that an emphasis solely on economic reforms and the hope for well-functioning markets will fail to deliver in the presence of these entrenched vested interests.

Hussain presents a set of institutional initiatives that could help remove the structural constraints to sustained, equitable growth, and start a process of pro-poor growth. These include (i) distributing state land to the landless, (ii) removing structural constraints to SME growth and its export potential, and (iii) giving the poor a share in the ownership of large corporations (e.g., in marketing agriculture products) run by professional management.

Reviving Private Investment: Overcoming the Barriers Faced by the Pakistani firm

The strength of this volume is that it combines macro- and sectoral issues with the micro-dynamics of the Pakistan economy. Manes (Chapter 16) analyzes the critical role that the Pakistani firm must play in moving the economy forward. His analysis draws on empirical evidence gathered from a survey of firms conducted by the World Bank through its enterprise surveys in 2002 and 2007, as well as a perceptions survey of firms in 2013.

Manes draws two important conclusions when comparing responses from the 2002 and 2007 surveys on the major obstacles that firms face. First, firms perceived a major improvement in those areas of reform where the government had devoted resources and policy attention in the first half of 2000 (finance, tax administration, anticompetitive practices, labor regulations, and customs and trade regulations). Second, in 2007, the electricity supply (with 80 percent identifying this as their most constraining factor in 2007 compared to 39 percent in 2002), corruption (57 percent compared to 40 percent), macro-instability (57 compared to 34 percent), political instability (47 compared to 40 percent) and crime, theft, and disorder (32 compared to 21 percent) had all deteriorated substantially.

Manes also argues that productivity gains for firms accrue from innovation, structural change, and “creative destruction.” While Pakistan’s economy is perceived as having shown little structural change and has remained a low technology exporter, while most firms operating in Pakistan use very low levels of technology, the evidence based on the 2002 and 2007 surveys suggests that aggregate productivity in manufacturing has increased. From this he concludes that “the period was characterized by a policy-induced creative destruction, productivity increases, and competitiveness improvement.”

His major conclusions relate to improving the business environment in Pakistan and the importance of surveys (such as “Doing Business”) in identifying its deficiencies, progress in implementing reform, and organizing the private sector for collective activities. An important contribution of this study is that it analyzes the incentives and disincentives for firms to move from the informal to the formal economy; it argues that firms will only seek formality if the benefits outweigh the losses from such a shift.

Foreign Firms Operating in Pakistan: Foreign Direct Investment

The study by Hamdani (Chapter 11) analyzes foreign companies that operate in Pakistan and “assesses the potential for a more ambitious industrial strategy: private sector-led, fueled by FDI, and supported by policies and institutions that encourage technological deepening” (pp. 313–314).

Hamdani points out that the dynamic private sector that took shape after independence and in the earlier years of the 1950s and 1980s attracted foreign participation. FDI was initially permitted in manufacturing, with larger investments used to form joint stock companies with local equity participation. He lists a galaxy of multinational companies that invested in Pakistan soon after independence and in the 1950s and 1960s, including Lever Brothers, the Lakson Group (in collaboration with Colgate-Palmolive), Glaxo Laboratories (today, Glaxo-Smith-Kline), Abbot Laboratories, Pfizer, KSB, Hercules Chemicals (fertilizer), Exide, and Honda motorcycles.

When private investment fell in the 1970s with the spate of nationalization carried out by the Pakistan People’s Party government, so did foreign investment. However, it picked up in the 1980s, growing at an annual average rate of 22 percent. FDI growth fell to only 8 percent in the 1990s, despite policy reforms and generous incentives. On the other hand, India emerged as a major destination for foreign investors during this period. Pakistan’s FDI inflows only picked up in 2003 and reached a peak of around USD 5 billion in 2007, after which they fell drastically. During the upturn, FDI shifted from manufacturing to services. In 2008, three industries—finance, telecommunications, and power—amounted to nearly half the FDI stock.

Hamdani points to the general failure of foreign manufacturing affiliates in Pakistan to develop an export-oriented approach in part due to the protected markets in which they operate. This is in contrast to the experience of other countries where, over time, they have graduated to becoming major players in global markets.

The author spells out policy measures needed to revive private investment, given that FDI and private investment have moved in tandem over the years. He argues that the government’s role in industry should be less of a player—with public enterprises being autonomous and self-sufficient or privatized—and more that of a referee to ensure that markets run efficiently and that laws are well administered.

A change in policy direction, together with efforts to overcome the current energy crisis, build technological capability through investment in research and development, and promote links between education and training could prepare the ground for attracting and benefiting from FDI. He believes that, were the right policy environment created, there is every reason to expect FDI of USD 10 billion annually or twice the highest level attained in the past.

Ensuring Inclusive Growth: Reducing Poverty

The merit of the study by Chaudhry, Chaudhry, Haseeb, and Afzal (Chapter 17) is that it moves beyond the income measurement of poverty (as defined by a poverty line) toward a more comprehensive analysis of what makes people “poor” and what the best way is to target poverty in Pakistan. They argue that the official poverty line based on income misses out a large share of those who should be counted among the multidimensional poor.

Their study focuses on three dimensions of poverty: income, education, and health, using the PSLM data for 2004, 2008, and 2010. In terms of the income-based poverty line (USD 1.08 per day in 2004 and USD 1.25 per day in 2008 and 2010), their results show that the number below the poverty line declined from approximately 20 percent to 16 percent between 2004 and 2010, and then increased marginally to 16.5 percent by 2010, which was not statistically significant. Urban poverty declined from 11.5 percent in 2004 to 9.2 percent in 2008 and remained approximately the same till 2010. The percentage of the rural poor fell significantly from 25 to 19 percent between 2004 and 2008, and though rural poverty increased from 19 to 20 percent, it was not statistically significant.

In terms of the second indicator of poverty—education—the study focuses on the percentage of people without primary education: their results show that there was a significant decrease in the number of people above the age of 20 without primary education between 2004 and 2008 from approximately 59 percent to 55.5 percent. Again, there was no significant decrease in the number between 2008 and 2010. The fall in the number of those below the age of 20 with primary education between 2004 and 2008 is seen both for men (44.6 percent to 40.6 percent) as well as for women (73.9 percent to 70.5 percent). However, between 2008 and 2010, there is no significant change.

The health dimension of poverty is measured by the source of clean drinking water. The study’s results show the number of those without access to drinking water; in contrast to the other two indicators, it increased from 11 to 15 percent between 2004 and 2008, and this higher level was also observed in 2010.

By using a multidimensional measure of poverty, the chapter brings out starkly the percentage of the overall population that is poor in terms of at least one criterion (income, education, or health). They estimate this at 73 percent of the overall population in 2004, which then fell to about 70 percent in 2008 and remained constant till 2010.

The chapter also examines the association between those below the poverty line, the circumstances in which they were born, and the factors determined by their own efforts. On the whole, the authors’ results imply that parents’ income and education are significant in determining whether their children, on becoming adults, will live above or below the poverty line. Their study also shows that factors such as education have a significant impact on determining a person’s income.

Provincial Economic Development: Challenges and the Way Forward
This volume makes an important contribution in its comprehensive analysis of the economic challenges that the provinces face in the wake of the 7th NFC award and the 18th Constitutional Amendment; it outlines the main elements of a development strategy for the provinces, given their own peculiar economic circumstances and challenges. Ikram (Chapter 19) draws on his recent detailed work at the provincial level and the data generated during this work to put together a comprehensive analysis of the importance of a province-level approach.
 
Ikram stresses that a key requirement to ensure better economic planning and monitor progress at the provincial level is that the Pakistan Bureau of Statistics (PBS) issue officially sanctioned figures of GDP and other macroeconomic variables for the provinces. The data used in his chapter draws on his and other earlier studies, and should be taken as broad indicators of trends and orders of magnitude and not as firm estimates.

In his comparative analysis, Ikram examines the trends in provincial GDP growth over the 11-year period 2000/01 to 2010/11. He comments on the disparities in areas such as education levels, immunization coverage, piped water supply, security, geological assets, human resources, the availability of power, and ease of doing business.

He finds that Balochistan’s GDP growth has been far lower than that of the other three provinces (50 percent compared to 72 percent, taking the other three provinces together). It also shows considerable fluctuations, pointing to widening disparities as well as uncertainty and an increased perception of risk for new investment.

Ikram finds that Punjab stands well ahead of the others in education, immunization, and ease of doing business, but falls surprisingly behind in access to piped water. He emphasizes that the poor security situation and lack of energy emerge clearly as common factors impeding development in the case of all four provinces. These differences are accentuated when we compare Balochistan and the other provinces in terms of education, immunization, and access to piped water.

As future paths to development, Ikram‘s approach is that the provinces should exploit their natural resources and competitive advantage to the maximum. Balochistan’s strategy needs to tap its geological resources, which remain largely unexplored, as well as its 750-km-long-coastline, which provides a potential base for the development of fisheries and tourism. The strategic location of its coastline also provides considerable potential in Gwader port as well as the development of new ports.

Khyber-Pakhtunkhwa (KP), Ikram suggests, would benefit from exploiting its comparative advantage in producing hydel electricity and setting up industries based on an intensive use of these inputs. Given its distance from seaports, it should energetically pursue the possibility of exporting to neighboring Central Asia and Afghanistan.

In the context of the current situation, the author also examines the critical problem facing the Federally Administered Tribal Areas (FATA). He identifies the creation of productive and remunerative jobs as being critical to improving the situation, and believes that the task of generating 250,000 jobs is manageable, based on a strategy that could effectively tap remittances to support the growth of SMEs (as happened in Punjab in the 1980s) together with direct public works programs.

In the case of Punjab, raising agricultural productivity through efficient water usage and shifting cropping patterns toward high-value added items would be a prudent course to follow, besides promoting SME growth, improving governance, and reducing intra-provincial disparities.

Sindh needs to reorient its strategy of relying principally on Karachi as a growth center and, while maintaining the dynamism of Karachi, develop additional growth poles that relieve pressure on its infrastructure and take advantage of Sindh’s other assets that are located near urban centers. A strategy for developing its rural areas, Ikram suggests, will need to be based on improving the productivity of water by adopting more effective water management practices, encouraging the movement toward high value-added crops, developing high value-added nonfarm activities, integrating agriculture with the storage and transport sectors, strengthening the marketing system, and closely integrating rural and urban markets.

Main Conclusions

The studies in this volume will, the editors hope, assist the government that comes into power after the elections both at the federal and provincial levels, to meet public expectations, especially after its great disappointment with the performance of the previous coalition administration. Experience from other economies in stress suggests that there can be fairly rapid recovery if the quality of governance is improved and if the right set of policies is adopted. A program aimed at reviving growth should distinguish between the economy’s immediate needs and those appropriate for the medium and long term.

The analysis and policy recommendations emerging from the studies on which there is broad consensus suggest that policymakers need to focus on the following areas over the next 12 to 18 months:

1. Restoring macroeconomic stability and reviving private investment.
2. Increasing the supply of electricity by tackling the problem of “circular debt” that has kept IPPs from utilizing their installed capacity.
3. Restructuring public sector enterprises to make them profitable. Privatizing loss-making enterprises with the active participation of both management and workers is one option to consider.
4. Opening up further trade with India and granting it MFN status at the earliest.
5. Improving economic management, radically improving the quality of governance, and firmly stamping out rampant corruption.

The strong revival of growth on the lines suggested above, together with a strengthened ‘income support program’ would help reduce poverty and contribute to a fairer share of growth benefits than in the past. Much greater emphasis on job creation through the expansion of labor-intensive exports, small industry, and agriculture could dramatically transform the employment situation, especially for women and the young, educated unemployed. On the other hand, strictly controlling economic rents and corruption practices that benefit the few will improve government revenues and enable access to good-quality social services for the poor and middle classes.

Indeed, the first two elements listed above are closely linked. Restoring macroeconomic stability will mean reducing the fiscal deficit and that will require removing or drastically reducing untargeted subsidies, the bulk of which originate in the energy sector. The real challenge for the new government will be to reduce power sector losses and improve efficiency. This would provide a cushion to increases in energy prices to cover costs and, by reducing the recurring circular debt, allow energy supplies to be increased and power outages reduced.

Regaining macro-stability will also require increasing revenues, and the new government should consider introducing a VAT as soon as possible as well as bringing agriculture into the tax net and imposing GST on services in sectors that are currently not covered. The provinces should also take responsibility in areas that fall under their tax jurisdiction. As for raising private investment, first and foremost, there is a need to restore business confidence. Improving the security situation, reducing the energy gap, and improving the quality of governance together with immediate measures to stamp out corruption can go a long way in attracting new domestic and foreign investors.

Measures in the medium and long term, as suggested by the studies in this volume, coalesce around a medium-term strategy that could gradually move the economy onto a higher growth trajectory of around 8 percent. The strategy should:

1. Implement economic reforms to remove the major constraints to economic growth; this would also help unleash the major drivers of economic growth including moving toward a much higher level of investment and exports.
2. Effectively tap emerging forces that could propel the economy forward, namely the population of young, educated women and large Pakistani diaspora.
3. Invest in people by significantly increasing the resources committed for education and health.
4. Afford a much greater role to provinces in overall economic management and the formulation of development plans; and ensure better integration between the policies and plans of the provinces and those of the federal government.
5. Carry out comprehensive reforms to strengthen institutions and reduce corruption for better economic management.
6. Make a determined effort to reduce the high growth rate of population.

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posted by S A J Shirazi @ 5/30/2013 02:06:00 PM,

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