Lahore School of Economics

A distinguished seat of learning, teaching and research

A Country and an Economy in Transition

Shahid Javed Burki*

1. Introduction

The main thrust of this chapter is that Pakistan is finally in a position to move forward and set its economy not only on the path to recovery, but on a trajectory that will ensure high levels of sustainable growth. This could happen since some of structural problems that have dogged the political system since its creation seem to be nearing resolution. Since there is a close connection between political and economic developments, this advance in the former will have positive meaning for the latter. Pakistan may well be on its way to developing a new way of managing its affairs—meaning the way in which the political system is run, how the economy is managed, and how social interactions take place among different segments of the population. With the adoption of an appropriate set of public policies, it may also be possible to pull the economy out of the deep slump into which it has fallen and achieve a much higher rate of gross domestic product (GDP) growth.

This way of thinking about the future seems much too optimistic for a time that brings grim news every day—of an economy that is not able to move out of the slow growth groove in which it has been stuck since 2007; of national bankruptcy believed to be just around the corner; and of a country increasingly isolated in a world that is busy reorganizing itself. The GDP growth rate has been on a declining trend since the 1965 war with India. For the last six years, the average rate of growth has been just slightly more than 3 percent a year—only one percentage point above the estimated yearly increase in population.

An unsettled economy and one in which many people fail to respect the rule of law creates costs that are borne largely by the poorer segments of the population. This makes the situation unsustainable in the sense that the people affected by all this uncertainty—and that means the majority of the population—will begin to search for a new order that might possibly overcome the surrounding chaos. That people buffeted from many sides find themselves increasingly alienated and begin to search for some resolution in order to bring order to their lives is not a new finding. The search may at times also include resorting to violence, not against other people or segments of society but against the state.

This conclusion was reached some decades ago by several social scientists. Huntington (1968) has focused precisely on the kind of situation that Pakistan faces today. His conclusion is that a large, alienated population will destabilize the system in which they live, hoping that change will better their lives. Hirschman’s (2004) equally influential treatise on “exit, voice, and loyalty” deals with a similar situation, and analyzes the three options that people unhappy with their situation can choose from. Both, in other words, conclude that societies under immense stress must make a serious effort to transit to an order that equitably dispenses the fruits of economic advance; only then will it become durable. Is such a change taking place in Pakistan? Has the Pakistani citizenry concluded that it needs to play a role in determining how it wants to be governed?

At this time, Pakistan faces five immediate problems in the economic arena: (i) the longest downturn in its history, (ii) serious macroeconomic imbalances, (iii) a large but poorly trained human resource base that could be an asset if properly developed or a burden if ignored, (iv) the absence of consensus on how to move the economy onto a plane of higher and sustainable GDP growth, and (v) an appropriate role for the state and how it can work with the private sector to move the economy forward.

Policymakers must address these inter-related issues simultaneously. Growth needs to become the basis of a new development paradigm. At the same time, large macroeconomic imbalances must be eliminated. Progress on one front will improve the prospects on the other four. Restoring macroeconomic stability will improve the investment climate for both foreign and domestic investors. The increased confidence and recovery in growth will lay the basis both for expanded revenues and exports. However, a growth strategy must have public support without which it will be hard to implement. This will necessarily involve some sacrifices by the relatively well-to-do in society so that those who have been left behind can begin to benefit from the process of growth. This challenge, properly and immediately met, will put the country on a constructive path, first aimed at economic survival and then at reviving the highly stressed economy.

2. Economic and Social Challenges

The chapter begins by focusing on the deteriorating external finance situation, followed by the government’s persistent reliance on fiscal deficits to manage its affairs. It then assesses whether the country can be rescued by an external player or players from the brink of bankruptcy. This approach—what in finance is called “moral hazard”—has worked in the past but might not produce satisfactory results this time around. This brief discussion on the economic situation is rounded off by some speculation about the rate of economic growth in the future.

The pace at which the country has been using up its foreign exchange reserves over the last year and a half appears to signal the arrival of yet another balance of payments crisis. The reserves reached a peak of USD 18.294 billion in July 2011 but started hemorrhaging soon after. The situation was saved somewhat both by the current economic slowdown, which reduced the current balance of payments deficit, and by the release of some blocked funds by the US. In 2011/12, the deficit was USD 4.6 billion. In the first eight months of 2012/13, it stood at USD 700 million compared with USD 3.325 billion in the same eight-month period in 2011/12.

The depletion in the level of reserves has, however, continued. They stood at only USD 7.45 billion (i.e., those held by the State Bank of Pakistan) on 21 March 2013. Payments to the International Monetary Fund (IMF) in May and June 2013 will account for USD 785 million, further squeezing the State Bank’s foreign exchange holdings. The expected fall in foreign exchange reserves is likely to further weaken the rupee, which has lost 58 percent of its value against the US dollar in the last five years. The rupee’s depreciation would help exporters if they could produce products for which there was good demand in the global marketplace. With supply constraints—mostly the result of severe power shortages—the expected fall in the value of the rupee may not significantly increase the volume of exports and thus export earnings. It will, however, put some additional pressure on domestic prices.

The type of external payments crisis toward which the country seemed to be inexorably heading in the spring of 2013 has become a regular feature of the Pakistani economy. On a number of occasions—in 1996, 1999, and 2008 for instance—Pakistan was able to re-emerge from a situation of near-default and bankruptcy with the help of bilateral donors and international financial and development institutions. In 1996, China came to the country’s help with a deposit of USD 500 million paid into Pakistan’s account at the Federal Reserve Bank in New York. In 1999 and 2008, the IMF, backed on both occasions by the World Bank, helped Pakistan to avoid defaulting on external obligations.

This time, however, such help is not likely to be forthcoming. The motive for providing assistance in past crises was both economic and political. For instance, in 2008, the IMF wanted to help the country consolidate the new political order the civilian leadership was developing. It was understood in Washington by the IMF, the World Bank, and the US government that a financial crisis would hinder political progress. As discussed below, this had happened on numerous occasions in the past.

When approached informally in December 2012 by the outgoing Pakistan Peoples Party (PPP)-led government in Islamabad, the IMF made it clear that it was prepared to assist if there was clear political support from most segments of the political establishment for implementing what it called “prior actions”. This was an understandable exercise of caution on the IMF’s part since, on numerous occasions, Islamabad was unable to complete the program it had signed with the institution.

The constraint to the flow of foreign capital comes at a time of declining domestic resource generation, which has further reduced the already low rate of investment. Given the resource situation, it does not seem possible that Pakistan can lift the economy out of the continuing slump. The current economic downturn has already affected the country in several different ways, and the negative consequences are likely to become even more pronounced. With a relatively low GDP growth rate, there will likely be a palpable increase in the rate of unemployment, which will only add to the strain on Pakistan’s political and social structures.

The country has now come to rely heavily on “workers’ remittances”, which crossed USD 13 billion in 2011/12 and are likely to reach USD 15 billion in the current financial year. This flow is equivalent to about 7 percent of GDP and accounts for about one half of the current rate of GDP growth. In other words, Pakistan is in the process of making another transition—from dependence on external development assistance to finance a significant part of the needed investment to greater reliance on tapping the incomes of its own citizens. Given that these citizens do not, however, live within the country’s borders, the country has come to depend on people of Pakistani origin who live and work outside the country. Nonetheless, the flow of remittances as shown by experience is volatile, and excessive dependence on it is not prudent. The country needs another transition: to raising resources for investment primarily from within its own borders. This will require the show of political will that was in short supply during the last five years.

Before leaving the subject of economics and taking up those that also affect citizens’ lives, it is important to address some of the other factors that have resulted in deep economic malaise. This means going beyond the signs of poor performance already noted—large and unsustainable current account and fiscal deficits, sharp reductions in the flow of external development assistance, and the continuing slow rate of GDP growth—to those that also harm the economy in difficult-to-quantify aspects of economic illness.

Three such manifestations are of considerable importance: (i) the absence of a well thought-out strategy for the revival of growth—one that is more practical than the framework for economic growth proposed by the Planning Commission (see Pakistan, Planning Commission, 2011a) (discussed in Section 3); (ii) in-your-face populism; and (iii) a tolerance for corruption and malpractices. It is interesting to note how easily populism slips and slides into widespread corruption as if policies directed to aid the poor are license to collect rents to benefit oneself, and one’s family, friends, and political associates. By all accounts, the last five years of democratic rule saw Pakistan at its most corrupt while the quality of governance remained extremely poor. All this raises the obvious question: Will the establishment of a new political order succeed in addressing these problems? The answer to this is: only time will tell.

Economics is not the only area where the country has faced difficulties. During the tenure of the coalition government led by the PPP from 2008 to 2013, Pakistan had to deal with a variety of problems. The most significant of these from the perspective of economic stability and development—and also the most costly—was the rise of extremism, which has taken several forms. Groups operating from the “no-man’s land” belts bordering Afghanistan continued to defy the state’s authority and challenge US and NATO operations in Afghanistan, using sanctuaries they have created in Pakistan’s lawless tribal belt. Their activity brought America’s decade-long war in Afghanistan into Pakistan by way of attacks by “drones”.

Extremism also took the forms of sectarianism and violence against religious minorities. There were attacks by Sunni extremists on the Shia communities in the cities of Quetta and Karachi. Sunni-Shia conflict was not the only communal violence the country experienced. In March 2013, Sunni extremists resorted to large-scale arson aimed at a particularly poor Christian community living in the heart of Lahore, Punjab’s capital and after Karachi, Pakistan’s second largest city.

The rise of extremism was not the only development that set back the economy. Very serious floods, severe power shortages, acute natural gas shortages, weakening exports on account of the continuing slowdown in the main markets for the country’s merchandise, and a weak foreign exchange position combined to deal a serious blow to investor confidence.

These negative developments notwithstanding, there were some positive moves, most of them in the political arena. There cannot be a serious discussion of Pakistan’s economic future without an equally serious probe into the way its political order is evolving. For this reason, a discussion of the various transitions through which the country is passing must give considerable importance to the ongoing political transformation. There was a great deal of this in the last six years, and it appears that, after much trial and error, the country may be on the way to developing a new and durable political order.
As the chapter discusses later, the political system has evolved since March 2007 in a way to open it up to the citizenry. This is why it is necessary to date the political transition of the last few years to an earlier date (rather than to February 2008 when General Pervez Musharraf agreed to hold general elections)—namely, the chain of events that caused the country’s fourth military government to unravel. The way in which the Musharraf government slowly collapsed provides some assurance that the country will not see another military interlude.

Constitutional changes initiated by the 18th Amendment prescribed the procedure for appointing the head of the National Accountability Bureau. Through the subsequent 19th and 20th amendments, detailed procedures for the appointment of high court and Supreme Court judges were laid down, and arrangements for putting in place a caretaker government to oversee elections prescribed.

These constitutional developments and changes were an indication that, at one level, the political establishment recognized that a serious constraint needed to be imposed on the way it managed the political process. On the other hand, the establishment itself, which held the reins of power, continued to exceed the limits allowed them by the rules of business. This was particularly the case with senior-level appointments. For instance, in two cases, the ever-vigilant Supreme Court took upon itself the responsibility for correcting what it believed was the exercise of unrestrained executive authority. It took serious note of the way the government had handled the appointment of senior officials of Pakistan International Airlines, the executive director representing Pakistan on the board of the World Bank, and the chairperson of the Federal Board of Revenue.

Another area of transition is federal-provincial relations, which are still evolving after the adoption of the 18th Amendment. A number of federal responsibilities have now been devolved to the provinces. The 7th National Finance Commission Award, which preceded the adoption of the amendment, significantly increased the provinces’ financial situation. The provinces, however, having become used to handholding by the federal government, have made little effort to improve their resource base on their own.

Nonetheless, these changes should move the country toward a durable political structure, which should ensure democracy and stability. The stage has been set for providing the next set of political leaders to effectively cope with the huge problems of large macroeconomic imbalances, slow growth, and poor governance. These loom large. The government will be well served to prepare a credible strategy that addresses all three interlinked issues: stabilization, reviving growth, and improving governance.

3. Developing a Better Economic Future

This brings us to the point where serious consideration needs to be given to developing a better economic future for Pakistan. The Pakistani economy is in a state of great flux. There is consensus among those studying the economic situation that, were the present rate of economic growth of 3 to 3.5 percent to persist into the future, it would cause a great deal of political and social harm. The economy must grow at about 7 percent annually to absorb the two million workers (i.e., a rate of growth of over 3.5 percent per annum) who currently enter the labor force every year. Past large increases in population have meant that this level of increase in the workforce will continue for several years. A high rate of growth—a rate more than twice that achieved in the recent past—is, therefore, needed and must be sustained for many years into the future.

Additionally, economic expansion must occur in a way that ensures that its rewards become available to all segments of the population and to all parts of the country. Modern economists call this approach “inclusive development”. How is this doubling of the rate of growth and its equitable distribution to be achieved in a country such as Pakistan?

In what it termed the “Framework for Economic Growth”, the Pakistan government’s Planning Commission (2011) came up with what it suggested was a new theory of development for Pakistan. The commission’s work on growth started with a criticism of approaches that had been adopted in the past. It argued that the previous emphasis on investment—particularly by the public sector—had created a number of growth-retarding distortions in the economy, and that “an unintended consequence of our policies has been the stifling of internal markets, cities and communities which play a critical role in fostering productivity, innovation and entrepreneurship and ultimately promote growth, and prosperity and development” (Pakistan, Planning Commission, 2010a).

The Planning Commission has been involved in the formulation of Perspective, Medium and Annual Development Plans based on a savings driven approach when growth rates are arbitrarily set and incremental capital (investment) to output ratios are used to generate investment requirements in key sectors of the economy. Public investment across sectors is allocated according to the planners’ priorities. It is assumed that public sector development program will not crowd out private investment (Pakistan, Planning Commission, 2010a).

Having offered this criticism, the Planning Commission promised a strategy that would factor in Pakistan’s situation in 2010/11 and some developments in economic thought.

“Never has there been a more pressing need in Pakistan’s history to search for a new model” (Pakistan, Planning Commission, 2010a). The commission was of the view that, in the past, there was emphasis mostly on developing a public sector development program comprising a number of public sector projects with a significant number financed by the donor community. In developing such a model, it suggested that the country needed to move from “hard” to “soft” growth (Pakistan, Planning Commission, 2011b).

By “hard” growth, the commission meant large public sector investments in brick-and-mortar development—building roads, bridges, dams and, of course, buildings. What was needed instead was a combination of efforts that would improve the quality of governance and reduce interference by the government in the working of the private sector, encouraging greater innovation within the economy and greater focus on activities that could produce higher rates of growth with low rates of development.

Implicit in this strategy was the recognition that it would take a long time to increase the rate of investment, in particular by the public sector. To have that happen would require fundamental changes in the tax system—something for which there was little or no political appetite. Pakistan’s growing and unsustainable fiscal deficit had brought the economy close to the edge of disaster, but it had not resulted in action by the political establishment. It would also require significant changes in the way the part of the economy that was still under government control was managed. Collectively, public sector enterprises had become a big charge on the budget since most were poorly managed, even though they were still treated as institutions of “first resort” for providing employment to political associates and supporters. The status quo thus appealed to the political establishment but drained the economy.

The most important conclusion to be drawn from this approach would be that, given the harsh political realities, there not much space for adopting economic policies that would help to revive the economy. Was this why the Planning Commission chose to adopt a policy stance of least resistance? Did it believe that, since investment could not be increased to obtain a higher rate of GDP growth, economic revival should come from increasing economic efficiency? In the jargon of economics, policymakers opted to work to lower the incremental capital-output ratio, producing a high rate of growth even if there was no increase in the ratio of investment to GDP.

However, what the commission did not sufficiently recognize was that the “soft” approach would take a long time to become embedded in the structure of the economy. Following it would not help the country climb out of the low-growth trap into which it had fallen. Recognizing, albeit implicitly, that the country’s existing institutional structures and prevalent style of governance could not move the economy onto a higher growth plane, the Planning Commission’s proposed growth strategy put its faith in the private sector. This was a throwback to the approach advocated in the late 1980s and early 1990s by a number of Washington-based think-tanks and development institutions—the policies they advocated came to be known as the “Washington consensus”.

Pursuing the strategy proposed by the Planning Commission will not rescue Pakistan’s economy from its current slump. The commission’s prescriptions are valid for the long term and should become the basis for introducing the structural changes needed to make this approach a success. When Pakistan’s situation is compared to the rest of the world, an entirely new approach becomes necessary to pull the economy out of the current slump in growth, develop a political consensus on the various elements included in the approach to be adopted so that it can be sustained over a long period of time, and spread more widely the fruits of growth once that growth materializes.

4. A New Development Paradigm

This section proposes a two-step approach to economic revival. The first should be taken immediately after the elections are over, the new federal government is in office in Islamabad, and new governments have been formed in the provinces. The second should be implemented after the needed analytical work has been done and the appropriate political ground has been prepared to cover the long term.

In the immediate, three aspects need to be focused on: (i) improving the quality of governance by developing a system of accountability; (ii) increasing the supply of electricity by tackling the problem of “circular debt” that has kept independent power producers (IPPs) from fully utilizing their installed capacity; and (iii) privatizing loss-making enterprises, in particular those that provide essential public services. The longer-term growth strategy should be built on the “positives” in Pakistan’s current economic situation.

The suggested approach is “new” in that it differs from previous growth strategies, in which development planning, whenever it was undertaken with some seriousness, was concerned mostly with allocating public resources between different sectors and for projects within the various sectors. The new development paradigm offered here also differs, however, from the Planning Commission’s framework for economic growth, which suggests that the government’s efforts should focus on a number of areas that were neglected in the past.

Here, this chapter offers a “new development paradigm”. Before describing the new approach to development, it provides a brief overview of Pakistan’s current economic and social situation. There are several ways of doing this, one of which is to use the data recently published by the UK-based Wealth and Well-being Legatum Institute to highlight what the country is faced with at this time. This data is presented in terms of what the institute calls the “prosperity index”, according to which eight indices are used to rank the 192 countries it studies to determine their relative position in the world. As shown in Table 4.1, Pakistan’s position is strongest when measured in terms of “entrepreneurship and opportunity”; not surprisingly, it is weakest in terms of “safety and security”.

Table 4.1: Pakistan’s position on the Legatum prosperity index

* Total number of countries = 192.
Source: Legatum prosperity index, 2012.

Another way of understanding Pakistan’s relative position is to work out the ratios of various measures for the country with respect to world averages (see Table 4.2). Pakistan accounts for 2 percent of the world’s population. This share will increase since the country’s birth and fertility rates are 24 percent and 21 percent higher, respectively, than the global average. Life expectancy at 94 percent of the global average compares relatively well with the rest of the world. The country’s GDP per capita is only 18 percent of the global average. What is surprising is the country’s relatively sound situation with respect to the various satisfaction indices—the degree of overall satisfaction is close to the world average. For female participation in the national legislature, Pakistan scores 13 percent above the world average.
Table 4.2: Pakistan’s social and economic performance in the global context

Source: See Table 4.1.

The main conclusion to be drawn from this comparative analysis is that the country needs to do more to increase the economy’s rate of growth, improve those indicators that contribute to lowering the fertility rate, and adopt measures to improve security and public safety.

A number of elements distinguish this development approach report from that of the Planning Commission’s framework and also from previous development efforts. First, it is important to launch a national discourse on the development approach suggested here in order to gain broad acceptance of its various constituents. As discussed earlier, political and economic developments interact with one another—undertaking one while ignoring the other produces tension that ultimately kills the effort being made. This has happened repeatedly in Pakistan’s history. Even though the government that took office in 2008 and governed for five years achieved some success in constructing a new political order, it did not make a serious effort to set the economy on a growth trajectory.

Second, as already indicated, this chapter divides its proposed strategy into two parts: the immediate and the medium term. The immediate covers a period of one year, starting on 1 July 2013. The medium term is defined as a period of three years, starting on 30 June 2014 and ending three years later on 30 June 2017. This way, it is possible to clearly separate what needs to be done immediately. The aim of the proposed measures is to revive the economy by increasing investor confidence, slowing down and eventually stopping capital flight, and creating a new understanding with the private sector on the respective roles of the state and private enterprise. The immediate effort also aims to fill in the many institutional holes that currently exist in the economic system.

Third, given the enormous changes introduced by the passage of the 18th, 19th, and 20th amendments to the Constitution in the system of governance, our strategy provides for active roles for the provinces in the development of the national economy. The provincial efforts should take cognizance of their different inheritances and also the differences that exist in their capacity to undertake serous economic work. At this time, the fact that three of the four provinces are seriously troubled by various insurgencies also needs to be factored into the development strategy. Punjab is the exception.
Fourth, the medium-term strategy should focus on what the chapter has described as the “positives”. This strategy identifies and then discusses six such economic attributes, beginning with two of Pakistan’s economic inheritances that were largely ignored in previous development efforts—agriculture and skills-based small and medium industries. The strategy gives considerable importance to international trade and, in that context, the potential in the growing trade between India and Pakistan. Another positive is Pakistan’s location, which could turn the country into an important corridor for international commerce.

The proposed strategy also treats Pakistan’s large, growing, and young population as a positive, focusing on the demographic window of opportunity that has opened up and will remain open for several decades. However, this population will become an asset and not a burden only if it is properly educated and trained. The large number of highly trained and skilled women graduating from various institutions in the country is another positive, especially so since thousands have now become successful entrepreneurs in several modern sectors of the economy.

Finally, Pakistan’s large diaspora scattered over three continents is another positive. It is already making a key contribution by sending large amounts of money to the country as remittances. This particular type of foreign capital flow has helped the country remain afloat when several other types of flows have become highly constrained. However, the diaspora could play a number of other roles provided the stage is set by the development of certain necessary financial institutions.

Fifth, by focusing on the positives that have been identified, economic growth could become more “inclusive”. Widening income and regional disparities have become a source of great concern in recent years, not only in Pakistan but in a number of other emerging markets as well. The disparity is most glaring in districts in southern Punjab that have been left behind (see Institute of Public Policy, 2012) for which the neglect of agriculture is partly to blame. Incorporating the positives will help to bring in some segments of society and some regions in the country as dynamic components of a growing economy.

Sixth, the strategy suggests a compact with the private sector, which will give it an important role in moving the economy forward faster. The idea is not to pull back the state and leave a great deal of space for private enterprise; instead, both sectors—the government and private entrepreneurship—need to work in tandem and perform their respective roles.

5. Focusing on the Immediate

This chapter takes up the subject of governance in the belief that improving it will create confidence in the economy’s future. That alone would slow down the flight of capital from the country, making more resources available for investment in the domestic economy. The Pakistani state—meaning the numerous institutions that support the working of the government and guide the public’s interaction with it—has been weakened over time. This has been the result of many factors, most notably the political rollercoaster ride Pakistan has been on ever since it became an independent state almost 66 years ago. With frequent changes in the political order, the state’s institutional structure did not have the time to develop. There is now an opportunity for the political order to develop toward a genuinely representative system of government. There is now national consensus that Pakistan should be governed by a system that gives voice to its diverse population; this implies the establishment of a durable political order.

In a real sense, improving governance must be the key element of a growth strategy. If the quality of governance had not deteriorated as much as it did in the last several years, if the strength of public institutions had not been eroded over time, and had adequate resources been mobilized through taxation to provide basic public services—especially law and order and education—the growth challenge would have been less severe. Over time, growth and governance problems have become increasingly intertwined. Because growth benefits were not widely shared, the quality of public services, especially education, deteriorated and the pace of poverty reduction fell. Consequently, there was a palpable increase in social tension, with a rising frequency in ethnic, sectarian, and random violence.

Without necessarily increasing the role of the state, governance can be improved significantly by erecting a firewall between the executive authority and its accountability mechanisms, and strengthening deterrents to prevent the abuse of power and breaking of the law. It would be fair to say that Pakistan has one of worst records in punishing wrongdoers, whether politicians, bureaucrats, businesspersons, or military leaders. Effective steps need to be taken to decentralize authority to the local government level, initially at least for the provision of social services. There is evidence from other countries that locating government closer to the public improves the sense of accountability of those responsible for providing public services. The country also needs to make serious efforts to reform the civil service and restore the independence of public institutions through autonomy, the proper selection of top management and professional staff, and adequate pay. It should encourage the development of civil society institutions at all levels of government.

Pakistan has tried several institutional mechanisms to ensure that public officials—both elected and those belonging to the various administrative services—are accountable for carrying out the duties entrusted to them. Each institution was ultimately politicized and lost the public’s confidence. Three improvements in the existing system should help restore confidence. Following the recent approach adopted in India, Pakistan too should pass a law that would allow citizens to obtain information about the actions taken by government officials and the practices followed by various ministries and departments.

Pakistan needs to draw lessons from countries where the state’s weaknesses were compensated for by the development of various institutions in the private space. Bangladesh is a notable example of a country that founded several nongovernment organizations (NGOs) to provide public services that normally fall within the state’s ambit. The same trend is in evidence in Pakistan. The void left by the state has been filled by private institutions that operate in a number of different areas.

A number of analysts have also noted that Pakistan is now one of the more “giving” societies in the world, financed by donations from citizens in the country as well as those by people living and working abroad (see, for example, Najam, 2006). These charitable organizations are doing impressive work in the education sector that could become the basis for a new approach to increasing the extent of literacy and improving the skill base of the population. Microfinance is another area where, with the active involvement of the private sector, Pakistan has outperformed even Bangladesh where this form of lending was institutionalized. It is worth noting that women have been particularly active in developing this part of finance. Mobile telephone banking is another important area of economic activity in this context.

The Pakistani state’s relations with the private sector have been through several iterations. This may be a good time to dispel the ambiguity and define a relationship in which both—the state and private entrepreneurs—will have an enduring confidence. The government could work with the private sector to add to the amount of resources that need to be committed to developing the economy and improving public welfare. Our specific suggestions can be summarized as follows:

- Issue a policy statement prepared in consultation with the private sector clearly defining the respective roles of the state and the private sector.
- Develop policy frameworks for the private sector’s involvement in education, health, and vocational training.
- Thoroughly examine the regulatory landscape with the aim of weeding out those regulations that have lost their relevance. Some of them, such as those pertaining to agricultural processing and marketing, are redundant and in place only because they have created rent-seeking for certain vested interests.
- Formulate a program for the privatization of some of the economic assets that remain under public sector control. These include Pakistan International Airlines, the National Shipping Corporation, National Logistics Cell, and Pakistan Steel Mills. Private use of the railway system, launched recently, could also be expanded. The funds generated by these sales should be put in a new fund to be called the Future Generations Fund.

Over the years, Pakistan’s energy sector has been studied from several different angles, including by the World Bank and Asian Development Bank in some detail. Both institutions have provided technical advice as well as finance for developing the sector. More recently, the energy problem has received the attention of the United States Agency for International Development. The Americans have identified the sector as one of their priority areas under the Kerry-Lugar-Berman initiative, and concentrated their efforts on the supply-side of the equation, offering assistance for several electricity generation projects. The Planning Commission was mandated to come up with a solution to ease the electricity supply shortage, which continues to cause enormous public discomfort and badly hurt the economy. Building on these analyses, the discussion below offers some ideas that could alleviate the situation in the short term as well as setting the stage for the sector’s long-term development.

It is clear from the way the sector has developed that the problems it now faces are the product of poor public policy. At no time in its history has Pakistan adopted a consistent approach to developing a sector that is critical for the economy’s health and growth. As a result, the sources used to augment the supply of electric power did not reflect the country’s comparative advantage. Each time it faced a crisis, it turned to whichever source of generation was available with little attention given to the long-term cost to the economy of the choice that was being made.

At this time, the sector faces three problems, each of which needs a different solution. To begin with, there is the problem of “circular debt”—a consequence of the type of contracts that were negotiated with IPPs to solve the crisis the country faced in the 1990s. The private entrepreneurs who entered the sector were given several guarantees, the most important of which was the commitment to purchase the power they produced at a pre-agreed price. These “take-or-pay” contracts shifted the financial burden to the Water and Power Development Authority (WAPDA) and, by default, to the government. Since the government lacked the political will to levy appropriate tariffs on the end-users, timely payments were not made to the IPPs. The circular debt became “circular” when the IPPs failed to make payments to their plants’ fuel suppliers.

The second problem concerns the sector’s organizational structure. For several decades, generation, transmission, and power distribution were the responsibilities of one public sector entity, i.e., WAPDA. Then, advised by the World Bank, the sector was split into several quasi-autonomous institutions, each with its own responsibility. This was done to prepare some parts of the sector—distribution in particular—for privatization. That has not happened while the advantages available because of aggregation were lost. This advice was in line with the thinking of the time, i.e., a strong belief in the private sector’s ability to do both economic and social good. That blind faith in the working of the private sector no longer exists.

The third problem relates to the sources used to generate power, which do not appropriately reflect Pakistan’s endowments. The country should have relied far more on hydropower and coal-based thermal power. According to one estimate, Pakistan could generate 100,000 MW of power using coal from the rich Thar deposits; this level of generation could be sustained for 100 years. However, the largest source used is imported oil, which accounts for 35.1 percent of total supply. Hydel power accounts for another 33.6 percent. The share of natural gas—a dwindling resource—is 27.3 percent, while that of nuclear power is 6 percent. Coal accounts for a minuscule amount—only 0.1 percent.

In order to solve both the short-term and long-term problems faced by the energy sector, the ownership of all thermal plants operating in the public sector could be shifted to an entity that can sell part of its share to the private sector. This entity would own 4,900 MW of installed capacity, and should also issue bonds backed by its assets in order to liquidate the accumulated circular debt. The private sector should be invited to participate in the development of renewable sources of energy, in particular wind and solar energy. A beginning has been made by a private group to set up a wind power-generating plant.

Under the 18th Amendment, the provinces have the authority to invest in the development of the energy sector. This could be encouraged by the assurance that the power supply to them from the national grid would not be reduced if they were to generate significant amounts of their own supply. A market for trading power should also be developed in which the provinces could buy and sell electricity to each other.

6. Determinants of Sustained Long-Term Growth

Pakistan’s agriculture, despite its large potential, continues to underperform. Agricultural growth, which averaged nearly 4 percent per annum over the 40-year period from 1960 to 2000, slowed down to around 2.5 percent in 2011/12. This occurred notwithstanding a buoyant livestock sector and sharply rising level of milk production. The availability of water (mostly surface irrigation), which trebled between 1960 and 1990, is no longer increasing. Nor has there been any major breakthrough in the primary crop yields, which remain low.

The reasons that both productivity and output have remained low are well known, but no systematic attempt has been made to incorporate them into public policy. The areas that need the state’s immediate attention are (i) increasing efficiency in the use of water, (ii) improving the use of modern technologies and basing them on Pakistan’s circumstances, (iii) changing the system of incentives in order to develop a cropping pattern that conforms to the country’s comparative advantage, (iv) modernizing agricultural marketing, and (v) increasing agricultural exports to food-deficit as well as high-income countries in the neighborhood.

Without immediate attention given to the proper use of water, Pakistan will face a serious problem in the not-too-distant future. Water availability has declined from about 5,000 cubic meters (cm) per capita in the early 1950s to less than 1,500 cm in 2010. According to 2008 data from the Food and Agriculture Organization, Pakistan ranked last in a list of 26 Asian countries in terms of water availability. The country is expected to become “water-scarce”—defined as an annual availability of below 1,000 cm—by 2035, though some experts project that this could happen as soon as 2020 (Asia Society, 2009).

Much of the decline is because of global warming. Few areas in the world are suffering as much from climate change as the Himalayas, which are estimated to be experiencing a thinning of the glacier cover by as much as a meter a year. A recent report by the International Food Policy Research Institute (2012) has reached a number of worrying conclusions based on productivity declines for most major South Asian crops. It projects that wheat yields could decline by as much as one half in the next quarter century.

Where there is water, there is corruption. This is evident both in rural and urban areas. In the countryside, powerful politicians who are also large landowners have no desire to push for a real overhaul of farming practices. In the large cities—in Karachi in particular—“water mafias” charge exorbitant amounts to supply water to parched communities. Most of the water they bring by truck is stolen from the pipes in the extensive public system. Those responsible for managing the public water supply infrastructure are paid by the mafia to look the other way.

Even more than most countries at its stage of development, Pakistan uses most of its available water for agriculture. History has a lot to do with current patterns of water use. An estimated 90 percent of the available water is used on farms, leaving only 10 percent for other purposes. Consequently, “anywhere from around 40 to 55 million Pakistanis—about a quarter to a third of the country’s total population—do not have access to safe drinking water” (Kuglelman & Hathaway, 2009).

The solutions to the water problem are as well known as the problem itself. The two important ones are worth recalling. The first is to properly price water to reflect its scarcity; the second, to better manage the vast irrigation system to reduce wastage. The two solutions should be taken together: the amount of resources generated from increased water charges could be earmarked for system maintenance. While “earmarking” is not favored by economists, it helps to create constituencies for raising additional incomes from taxation.

The proper pricing of water will also create an incentive structure that will affect the pattern of cropping and bring in new water-saving technologies. Cheap water has meant that Pakistan has allowed extensive cultivation of high water-intensive crops such as sugarcane. These need to be replaced by crops that use less water. A changed water-pricing structure should also create incentives for the farming community to start using technologies such as drip irrigation. According to Adrien Couton, a water expert who works for an NGO with experience in Pakistan,

Drip irrigation has particularly attractive characteristics. It generates massive increase in the efficiency of water use (the increase in yield as compared to conventional irrigation methods is from 20 to 100 percent while saving in water range from 40 to 70 percent). It offers much more granularity than typical infrastructure intervention since, no heavy capital investments are involved, and investments can be easily spread geographically and over time. Drip irrigation also delivers immediate benefits. Finally the system is to educate the end users about the immediacy of the water issue and the urgent need for more water efficiency (Couton, 2009).

Pakistan needs to invest more in improving the technological base of the agricultural sector. The country inherited a fairly well-developed system that combined agriculture education, research, and extension. Not much was done after independence to keep the system current and expand its scope, which is one reason that agricultural productivity has fallen so far behind that of India. This is another area where a partnership with the private sector could help. The government should invite the private sector—especially that part now involved in processing and marketing agricultural products—to join hands with the government in setting up institutions devoted to research and extension.

Small and medium industrial enterprises are another area with high potential that public policy has neglected. Whenever public policymakers have turned their attention to industrialization as a driver of growth, they have tended to focus on large-scale industries. That notwithstanding, Pakistan has a long-established tradition of producing consumer manufactures as well as parts and components for larger products. Some clusters have developed in several parts of the country that specialize in different products: sports and leather goods in Sialkot, electrical appliances in the Gujranwala–Gujarat corridor, armaments in the vicinity of Peshawar, and ceramics in Hyderabad. Some of the newer developments are fashion houses in major cities such as Karachi and Lahore that design, produce, and market their products. The automobile vending industry has also developed to facilitate the production of cars and trucks. Government policy has encouraged this industry by requiring automobile manufacturers to comply with what was called the “deletion” policy—the policy to force manufacturers to progressively use domestically produced components in finished products.

There are a number of sectors in modern parts of the economy where women now make up a significant part of the workforce. These include traditional areas, such as teaching and medicine, in which educated women have been active for decades. However, more recently, as the number of highly skilled women has increased, they have begun to take positions in sectors such as banking, communications, law, and politics. They also now make up a significant proportion of the workforce in companies engaged in information technology (IT). Some IT experts estimate that tens of thousands of women are engaged in this sector in what they call “cottage businesses”: women with good computer skills work from their homes undertaking small contractual work for family members or friends who are living and working abroad. Some estimates suggest that more than USD 1 billion worth of work is carried out in these informal establishments. These are, by and large, one-person shops that receive payments through informal transactions. However, it is the entry of women in the entrepreneurial field where the real revolution is occurring.

By now, it is fully recognized that Pakistan has neglected the development of its large human resources. Most indicators point to human underdevelopment. This may be an appropriate time for some out-of-the-box thinking. In this context, a more aggressive public-private partnership in the areas of education and health is needed, giving special attention to having women make a larger contribution to the development of the economy.

A recent Financial Times article draws the world’s attention to the role the private sector is playing in delivering a variety of services to the poorer segments of the population: “At the grassroots, Pakistan is in perpetual motion, with ceaseless activity as people find affordable solutions to their basic needs. These largely hidden forces of resilience offer the best hope for the country’s future. In Pakistan, the state may be fragile but society is far stronger than many think” (Leadbeater, 2012). The article also points out the important role of private charity in helping the poor, which was evident at the time two floods hit the country in 2010 and 2011.

The private sector has done extremely well in the sphere of education. Low-cost private sector schools, charging perhaps USD 2 a week, are booming in slums and villages. Many such schools work in the homes of families whose female members have received a decent education and are prepared to put it to use to earn a living. A number of charitable organizations are active in building and managing schools in the country’s poorest areas. Each large organization follows its own business plan. To take one example, the Karachi-based Citizens Foundation has built 900 high-quality schools in the country’s poorest areas. The buildings that house these schools are modern and well designed. This is done to create community pride in the school, which is often located in a slum area. The teaching staff is entirely female, many of them graduates of the schools established by the charity. There are other models that work equally well. In other words, while the demand for education has outpaced the state’s financial and organizational capacity to meet such basic needs as education, the private sector has shown it is capable of filling the void. The state should take advantage of this.

As a practical matter, the state should come up with a program for inviting the private sector to participate in the development of the neglected sectors of education and health. To begin with, the provinces should be encouraged to privatize some of the educational facilities in the public sector that are, at best, providing indifferent education. Some of the state universities could be sold to the private sector on the condition that the new owners and operators follow the curricula developed by the state in collaboration with educationists from the private sector. In order for poor households to access private universities, the state could finance a subsidized student loan program through the banking sector. Several countries in Latin America—most notably Mexico, assisted by the World Bank—have successfully tried a similar approach. The same approach could be followed in the health sector with the provincial governments selling some district hospitals to private operators.

Helping women to become active participants in developing and modernizing the economy has to be an important part of the long-term growth strategy. Women’s assigned roles serve as drags on the economy. They affect the rate of growth in output, keeping it lower than would be if women were to participate more actively in the labor force. Economists have not factored into their analyses the role that Pakistan’s women can play in developing their country if their participation in the workforce was to increase and if their productivity was up-scaled through better education. If women figure in economic writings on Pakistan at all, it is usually to highlight how far behind they have been left in social development and how this could serve as a drag on economic growth.

There is also not enough attention paid to the fact that the real economic role of women is underestimated, particularly in terms of their participation in the workforce. Most of the work they do in their homes or the time they spend looking after household livestock is either not reported or not fully counted. In writings on Pakistan, both the negative and positive consequences of the lack of progress in improving women’s wellbeing have not been fully investigated.

Exports are another area of government neglect. Development strategies followed by various administrations in the country did not pay attention to the export sector’s potential role as a driver of growth—something the “miracle economies” of East Asia did. This neglect has resulted in reducing the share of Pakistani manufactures in world trade (Institute of Public Policy, 2008). Additionally, by focusing on exporting textiles to the West, Pakistan has not benefited from the enormous increase in size of the East Asian economies.

The gravity model of trade suggests that Pakistan should trade more with the large countries in its immediate neighborhood—China and India. Islamabad has signed a free trade agreement with Beijing, which has led to a large increase in bilateral trade, but Pakistan now has a large negative balance with China. In order to correct this, public policy should aim to develop supply chains that will link up with China’s large industrial sector. These chains, as already indicated, should take advantage of the entrepreneurship that exists in the small and medium engineering sector.

The same approach should be followed to develop trade with India. The recent thawing in relations between the two South Asian nations should add significantly to their growth, particularly in Pakistan’s case. Burki (2011) estimates that, if India-Pakistan trade reverts to the share it had in total trade in the late 1940s and using the established elasticities, Pakistan’s rate of GDP growth could increase by 2.4 percentage points over a decade and a half. The possibilities of expanding trade with India thus need to be followed up urgently and diligently. While there may be losers and winners resulting from this trade expansion, the overall impact on Pakistan will most certainly be very positive.

Chinese manufactured exports have risen nearly two-hundredfold over the last three decades, and their share in world trade has grown from less than 1 percent to 15 percent over 1980–2010. China is not the only country to have benefitted from the expansion and restructuring of global trade. 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 is probably lower now than it was in 1970.

The ratio of the total export of goods and services to GDP also underlines Pakistan’s failure to orient its economy toward exports as the engine of global growth. There are several reasons why Pakistan has not succeeded in the export field. First, the country’s governments did not factor in international commerce as part of their development strategies. Second, Pakistan has the least diversified manufactured exports among the major developing countries because policymakers have focused excessively on its principal manufactured exports—textiles and clothing—and propped up this sector artificially for a long period by setting the domestic price of cotton well below the international price. Third, because of slow growth in productivity, insufficient investments in moving up the value chain in textiles and clothing, and lack of sufficient diversification in promising areas such as other manufactures and high valued-added agricultural products, Pakistan’s export competitiveness has suffered. Finally, political tension with its large neighbor India, which should be the country’s natural trading partner, has limited cross-border trade. Pakistan has also not availed fully the potential of its close relationship with China to promote exports: indeed, as mentioned above, it has a large trade deficit with its large neighbor.

Finally, a growth strategy should factor in the role the Pakistani expatriate community can play in the development of what was once their homeland. Migrations have been important in shaping Pakistan, in particular the country’s economy. Millions of people have crossed the country’s borders and settled in various parts of Pakistan, affecting their lives as well as those of the host population. Millions have also left the country and gone abroad, creating large communities of Pakistanis in three geographic areas.

There are large Pakistani diasporas in Europe, the Middle East, and North America; two others are in the process of being formed in Southeast Asia and Australia. While the exact number of Pakistanis living abroad is not known, there are perhaps some 8 million people of Pakistani origin who now live outside the country. This is equivalent to 4.2 percent of the Pakistani population, making it one of the larger diasporas in the world. There are 25 million Indians in the various diasporas they form across the globe. The number is large but the proportion, at just over 2 percent of India’s population, is less than half that of Pakistan.

The outward movement of Pakistanis started with mostly unskilled workers going to Britain to work in the country’s textile mills. Once Britain began to recover from the ravages of the Second World War, it did not have enough labor of its own to bring back to life the textile mills that had been closed down so that their workers could join the armed forces. The next large diaspora to be formed was in the Middle East in response to the opportunities created there in the 1970s and 1980s. Then, following the increase in the price of oil, a construction boom started in the oil-exporting countries—Pakistan was one of the main contributors to their needed labor force. The third large diaspora was formed in the US when the country, faced with a severe shortage of certain skills, allowed immigrants to enter the stressed labor market. Doctors, in particular, were in great demand. The North American Pakistani diaspora is different from the other two in that it comprises people with high skill levels. The average per capita income of this group is some 10 to 15 percent higher than the American and Canadian averages.

These three diasporas probably have a combined annual income of USD 100 billion or about half Pakistan’s GDP. They now remit about USD 15 billion or about 15 percent of their total income, most of which is by way of charitable contributions or help provided to family members needing financial support. Additional amounts should become available if the government in Pakistan could create an investor-friendly environment. Doubling this amount over a period of five to eight years should be possible as the diaspora’s asset base continues to expand. Using investments such as venture capital funds and private equity funds could channel finance into areas in which the expatriate community has considerable expertise. This additional flow could add 1 to 1.5 percentage points to the rate of GDP growth over the medium to long term.

* The author retired from the World Bank in 1999 after having served in a number of senior positions including as director of the Bank’s China operations (1987–94) and regional vice-president of its Latin America and the Caribbean office (1994–99). In 1996/97, he took leave of absence from the World Bank to join the caretaker government headed by Prime Minister Miraj Khalid, and was in charge of the ministries of finance, planning, economic development, and statistics. Since 2008, he has been a visiting senior fellow at the Institute of South Asian Studies, National University of Singapore.
This chapter draws on the author’s work on the Institute of Public Policy’s sixth annual report (State of the economy: From survival to revival) released on 7 May 2013. The author wrote the first chapter of the report titled “On the path to revival” and coauthored with Parvez Hasan, the sixth chapter, “Needed: A comprehensive development strategy for reviving growth”.
1 Samuel P. Huntington, with whom the author worked as a research associate in 1970/71, followed the trends in Pakistan in the late 1960s and the early 1970s to develop his thesis (see Huntington, 1968).
2 The author, as the de facto finance minister in the caretaker administration that oversaw the elections of 1997, negotiated this deal with Beijing.
3 Access to such information in India led to the discovery of a number of malpractices by various government agencies, including the sale of G2 mobile phone licenses and the grant of coal mining concessions to private operators.
4 These suggestions draw on the Planning Commission’s task force report on private sector development (see Pakistan, Planning Commission, 2010b). The author headed the task force, which included representatives of the private sector and eminent economists. See also Pakistan, Planning Commission (2011a).

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posted by S A J Shirazi @ 12/16/2013 12:00:00 AM,

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