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Old Tuesday, February 24, 2009
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Post How to fix the economy

How to fix the economy

By Shahid Javed Burki

THAT the country is faced with a serious economic crisis is recognised by the current group of policymakers. It is not certain whether they realise how serious the situation is and what could be its consequences.

Pakistanís 165 million people of which one-half are under the age of 17 and about 40 per cent live in urban areas are becoming restive because of the deprivation caused by the severe economic downturn.

Security will not return to Pakistan unless the economy is put on a sustainable growth path. That will need considerable work on the part of the government and also help from the community of donors willing to come to Pakistanís aid. At this time Pakistanís economy is faced with numerous problems, most of which are a consequence of poor public policy decisions in the past.

The gross domestic product in 2009 is not likely to increase by more than two to 2.5 per cent. With the population growing at 1.5 per cent a year this rate of growth will certainly mean increase in the incidence of poverty to about 40 per cent of the population. This means that 65 million people will be living in absolute poverty by the end of this year, an increase of 15 million. Many of these will be in the urban areas and many in the parts of the country where Islamic extremists are trying to establish their control.

Urban unemployment will also increase sharply especially in large metropolitan areas such as Karachi, Lahore, Rawalpindi-Islamabad and Peshawar. These cities have absorbed a lot of surplus labour from the countryside in the past couple of decades. They have also been the favoured destination of refugees from Afghanistan. Unless jobs are provided to the urban unemployed and incomes are transferred to the urban poor, these developments will lead to restiveness among the urban youth and attract them to extremist causes. What are the options available to the state in these circumstances?

There are several. Of these I will briefly mention four, one immediate and the remaining having an impact over the medium and long term. The government needs to provide cash transfers, targeted subsidies and temporary employment to the unemployed in both urban and rural areas. For all of these there are examples available from several countries around the globe that have successfully implemented such programmes during periods of economic stress.

Several Latin American countries have created temporary employment opportunities when economic crises increased unemployment levels. The countries in the Middle East have achieved impressive levels of social development by spending three to four per cent of GDP on social safety nets during periods of economic stagnation. Pakistan needs to make a comparable level of commitment to these kinds of activities.

Second, government expenditure needs to be significantly restructured in favour of larger amounts of spending on education and primary healthcare. This redirection of public expenditure would require additional government revenues as well as changes in the direction of government spending. The size of the federal government needs to be reduced, non-development public expenditure will need to be drastically curtailed, duplication will have to be eliminated between federal and provincial spending, defence expenditure will need to be reduced.

Third, Pakistan needs to get off the roller-coaster it has been on ever since its birth, with the economy growing at a respectable rate whenever there were large flows of American assistance to the country (in the 1960s, the 1980s, and the early 2000s) and slowing down when the flow of funds from Washington declined.

This reliance on external finance was the consequence of the inability of the country to raise the needed resources from the domestic economy. This has to change. A shift would entail a significant restructuring of the tax system by the expansion of its base and by bringing in all sectors of the economy, including agriculture, into the tax net. The aim should be to double the tax-to-GDP ratio from the current pitifully low 10 per cent.

Fourth, the government needs to focus on developing the sectors and lines of products that could help increase export earnings. Pakistan has not benefited from the process of globalisation that led to a much higher increase in international trade compared to growth in the size of the combined international product. Export-led strategies have helped many Asian countries see sustained economic expansion for decades.

Pakistan will also need to trade more with its neighbours, in particular India and China. It is one of three countries (the other two are the relatively small nations of Bhutan and Nepal) that border on these billion-plus-people countries with dynamic economies. Rather than have the United States as the main trading partner, that position, as suggested by the gravity model of trade, should be occupied by India and China. Restoring trading relations with India should also help to reduce regional tensions.

These structural changes would need not only the full attention of Islamabad. They would also require a considerable amount of additional external resources at least for the next half a decade. This is where the United States enters the picture. It could provide leadership to a group of donors to fund a large programme of structural change (say $50bn to $60bn over the next five years) with one half to be provided by the donors and the remaining by Pakistan. The donor contribution should be front-loaded with Pakistan picking up the bulk of the expenditure at the programmeís tail-end.

How Pakistan will provide funding should be made clear at the very start of the planning process. This will require a major overhaul of the tax structure. The donors should also carefully monitor the implementation of the programme by creating a consortium chaired either by the World Bank or USAID.

Ten to 12 donors interested in associating themselves in this exercise may contribute to the establishment of a group tasked with helping Pakistan develop a plan for the use of the funds made available by the donors as well as overseeing the implementation of the programme. Funding should start only after Islamabad has prepared a medium-term programme of structural reform and sustained development including some of the elements suggested above in this brief article.
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