PAKISTAN’S ECONOMIC PROSPECTS – CHALLENGES AND OPPORTUNITIES
ISHRAT HUSAIN
A paper presented at the Seminar on “Pakistan – China Relations in the 21st Century” held at Beijing on March 18, 2010.
It is indeed great honour and pleasure for me to be addressing this august gathering in China. As a student of the Chinese economy for the least 30 years I am a great admirer of the people and leadership of this country for the unparalleled success they have achieved. Very few countries in history have been able to transform their economies on a scale and at a speed that has been exhibited by China. I wish my own country Pakistan could learn a few lessons from this great country and apply some of those for its own development. The topic that has been assigned to me today focuses on the challenges and opportunities facing Pakistan’s economic prospects.
Brief Overview of Pakistan's Economy since 1947
Let me begin by giving you a brief overview as to how the structure of this economy has evolved since its independence. In 1947, Pakistan had 30 million people with per capita income of $100. Agriculture accounted for almost 50 percent of economic output with hardly any manufacturing, as all industries were located in India. Therefore, it was unable to feed 30 million people and was dependent on PL-480 imports from the U.S.A. From thereon, Pakistan has come a long way. Today with 170 million people, our per capita income in 2008 was $1000 which was ten times more than the 1947 level. Pakistan is the third largest exporter of rice in the world and produces enough food grains to feed its people. Pakistan is one of the leading cotton producers and one of the five major textile producing countries in the world. Agriculture now accounts for 20% of our national income, and 40 percent of the country’s labor force is engaged in agriculture as compared to 70-75 percent sixty years ago. This implies that productivity per acre of land has increased in this period. Within agriculture there has been a significant change. Livestock, dairy, mutton, beef, poultry and similar other products form almost one half of total agriculture output. Pakistan produces third largest quantity of milk in the world. So this shift within the sector has resulted in the reduced importance of major crops which only account for 36 percent of agriculture value added and minor crops, fisheries, orchards, fruits and vegetables another 14 percent. Manufacturing and industry now account for 25 percent of the income. Please recall that there was not even a single industrial unit worth its name at the time of independence. Services sector has been the most dynamic sector that generates 50 percent of national income and employs about the same proportion of the labor force. But where we have failed is that we have not lived up to our potential. In 1969, Pakistan exports of manufactured goods were higher than the combined exports of Indonesia, Malaysia, Philippines and Thailand. In 1960’s Korea emulated Pakistan in its five years planning process. The tragedy is that even a country such as Vietnam which was completely devastated by the war has now overtaken Pakistan. Ten years ago, India which was way behind Pakistan (till 1990’s) is now way ahead.
Pakistan has achieved 5 percent average annual growth rate during the last 60 years of its existence, with much higher growth in the 1960s, 1980s and early 2000s. During 2002-07 Pakistan’s economy grew at 7 percent annually; poverty and unemployment were reduced, external indebtedness was lowered, international financial markets were accessed and Pakistan attracted sizeable foreign direct investment. But the last three years have been quite difficult for the economy. It all started with the oil and commodity price shocks of 2007 that were not managed prudently. The transition to the democratically elected government was also not easy and the economy got off the track.
For the last 16 months Pakistan has successfully pursued a macro-economic stabilization program with the assistance of the IMF. The results that were envisaged – a reduction in current and fiscal deficits, decline in government borrowing from the Central Bank, bringing inflation down, accumulating foreign exchange reserves, stopping flight of capital and maintaining a realistic exchange rate – have more or less been achieved. The Government has taken some tough decisions such as curtailing many of the untargeted subsidies and introduced social safety net for the poor in form of a Cash transfer scheme. However, in this process the country has incurred external debt that has raised the Public Debt - GDP ratio, sacrificed public sector investment for infrastructure and human development and raised overall interest rate structure. The dependence on external bilateral and multilateral agencies has increased sharply and the degrees of freedom available to economic managers have been curtailed significantly. Going ahead Pakistan’s main imperative today is how to resume the journey to high growth trajectory that was disrupted three years ago. We face at least eight challenges that have to be overcome in order to resume this journey.
CHALLENGES TO PAKISTAN’S ECONOMY
a. Low Domestic Savings
Out of every hundred rupees of our national income, 85 rupees are consumed and only 15 rupees are saved, which means that the amount of money which is available to invest for economic growth and development is too inadequate in relation to the country’s needs. In order to grow by 6 percent annually at least 24-25 percent investment rate is required. Consequently, the desired saving rate should be 25 percent. India’s saving rate has jumped from 15-20 percent to 35 percent. China’s saving rate is 50 percent and household consumption accounts for only 36 percent of national income. Pakistan will have to at least double the national savings rate otherwise either the dependence on external sources will intensify or growth rates will remain low.
b. Low Export Growth
Pakistan’s exports of merchandise goods are stuck at US $20 billion for past several years. This is equivalent to less than five days of exports of China. Services exports are even more insignificant. Pakistan has a free trade agreement with China but does not yet figure in the global supply chain of Chinese imports. Other Asian countries have integrated themselves in this chain and are benefiting from the dynamic demand for goods by the world’s largest exporting nation. Pakistan should strive to capture at least 1 percent of Chinese market. The lower is the gap between the export earnings and expenditure on imports – and that can be achieved only by expanding the exports ---the reliance on external sources would be reduced.
c. Fiscal Deficits Are High
Pakistan’s government captures only 15 percent of national income leaving 85 percent in the hands of the private sector. This meager amount is to be spent on defence, debt servicing, internal security, development on education, health, general administration, etc. Out of every rupee of income received by a Pakistani on average, tax paid is only 9 paisas and 91 paisas remain with the individual. In 2007-08, Pakistan’s fiscal deficit was more than 7 percent which means its income or revenues were only 13 percent of GDP whereas, expenditures were 20 percent. Therefore, fiscal deficits have to be financed either by borrowing from external sources for from the State Bank of Pakistan. The financing provided by the State Bank of Pakistan is perilous because it creates high inflation in the economy, which is injurious to the middle class, those earning fixed wages and salaries, and the poor. The double digit inflation rates in Pakistan have historically been rare and the tolerance threshold for inflation beyond 7 to 8 percent is low. Debt / GDP ratio was reduced gradually between 1999/2000 and 2007/08 and brought down from 100 percent to 50 percent, --average for emerging economies. However, during the last two years, it has moved up to 58 percent and may reach 60 percent.
d. Lagging Social Indicators
A country such as Pakistan that should have had social indicators i.e. literacy, infant mortality, fertility rates, access to water supply, primary enrolment ratios comparable to the Asian countries is lagging way behind. Even Tajikistan, which is a very poor country, has better literacy rate and primary enrolment ratios than Pakistan. Gender disparities are quite significant and low female participation in the labor force is preventing the country from reaching its peak capacity. If we had literacy rate of 100 percent instead of 55 percent then in 2009-10 our per capita income would have been $2000 rather than $1000. Instead of 30 million middle class in Pakistan we would have had 60-70 million middle class people; and poverty would have been reduced to 15-20 percent. The link between high social indicators and economic development is now very well established and documented.
e. Energy and Water Shortages
A more recent problem that is slowing down the economy is persistence of energy and water shortages. It is not only that the generaion capacity of existing power plants is not enough or that we do not have enough water. The inefficiencies of public utility companies, the exceptionally high Transmission and Distribution losses, the non-payment of electricity dues and the circular debt problem have exacerbated the situation. Government of Pakistan out of its own limited resources is paying 200 billion rupees ($2.5 billion) every year as subsidies to power companies. We have silting of our dams, but not a single new large storage reservoir has been constructed since Tarbela in 1974. Water course losses of about 20-25 percent are depleting the water availability at farm level. Even after these losses, the water is inequitably distributed. As a result the productivity of the poor farmer is only one third of that of the large holders. If water was equitably distributed and the small farmer got his due share, the productivity gains will translate into additional income for the poor ( in turn reducing the incidence of rural poverty) and generating surplus food grains, cotton and fruits and vegetables that can add to export earnings of Pakistan. The impact of rising purchasing power in the rural areas would also be beneficial for domestic manufacturing industry which is facing deficiency in demand.
f. Governance and Implementation Weaknesses
Pakistan inherited a strong Civil Service system built on merit, performance and result orientation. But with the passage of time the Civil Service has lost its direction. Consequentially, poor governance and weak implementation capacity have diluted the effectiveness of the state. Civil Service reforms that aim to strengthen the capacity and effectiveness of the governments at all levels have to be undertaken whereby the human resource policies, processes and accountability are aligned with tangible results. The delivery of basic services such as Education, Health Care, Water Supply, Security and Administration of justice will not reach the ordinary citizens unless these governance reforms are implemented.
g. Political Stability, Law and Order / Security
A robust and well functioning economy requires political stability, law and order and security. The Armed Forces of Pakistan deserve gratitude for what they have done in Malakand Division and South Waziristan in bringing about restoration of law and order in those areas and reestablishing the writ of the State. Pakistan, unfortunately has acquired an image of political instability, poor law and order situation and insecurity, whereby investors from all over the world hesitate in coming to Pakistan and invest. Until 2007, Pakistan was one of the favorite destinations among the international community despite the ongoing war against terrorism. A thirty year bond was over subscribed four times at a price which was only 300 basis points above the US treasury. Very few countries without investment grade rating can claim to have that kind of credibility with international fund managers. However, in the last two years time, foreign investors have not been that forthcoming because of the negative image and the growing concern for security. I must however, acknowledge that the only exception is our Chinese friends who have continued to visit, live and carry out projects.
OPPORTUNITIES/WAYS TO OVERCOME CHALLENGES
How can we overcome these challenges and problems and improve our economy? A lot has been written and talked about, but I will focus on only a few action points.
1. Increase Domestic Resource Mobilization
The reason the fiscal deficit is widening is low revenue collection. Tax-GDP ratio is only 9 percent and therefore there is a scope to widen the tax net, improve tax collection and remove various exemptions and concessions. Along with plugging the holes in State owned corporations and making them efficient the public dis-savings can thus be reduced raising the national savings rate. Agriculture incomes are exempt, professionals, retailers, wholesales, transport owners and many other services providers evade taxes by paying not at all or a small fraction of what is due. Studies indicate that with the same tax rates the tax authorities should be able to raise as much as S8 billion of additional revenues ( compared to $16 billion actual collection) by tightening enforcement and compliance, carrying out robust post assessment audits, better supervision of tax administration and plugging the loopholes .
2. Expand the Share in the World Trade
In 1990, Pakistan’s share was 0.2 percent of the world trade. After 20 years it has come down to 0.12 percent in a very buoyant world economy. World trade has been growing much faster as compared to the world output. Asian countries have captured a larger chunk of world exports and the best example is that of China that has increased its share to an impressive 8 percent. Pakistan has failed to take advantage of these opportunities and is stuck with only a few commodities – textiles, leather, rice, sports, goods and the surgical goods. We have not entered the markets for more dynamic products. All our exports are to a few markets – the U.S.A., EU and the Middle East. So this narrow export base and very limited geographical spread are not allowing us to expand our share. By improving the quality of our products, fitting in the global supply chain, investing in research and development, and diversifying towards Asian markets the prospects can improve.
3. Building of Human Capital
It is now well documented that for the countries to prosper and progress on a sustained basis there is no substitute other than building up human capital. Private Sector, Public Sector, NGOs, local communities, philanthropists, etc., all here to put their hands on deck and participate in making sure that every child goes to school, every high school graduate has some technical and vocational skill and every eligible person goes for higher or professional education. We need to invest massively in human capital to catch up with the rest of the world because the world economy is going to be a knowledge based economy. One has to acquire and assimilate the knowledge and apply in order to solve problems. Under the new paradigm of development human capital formation is more important than machinery and equipment. Pakistan can leap frog by building up the institutions, infrastructure and incentives for human capital formation that other countries have successfully demonstrated.
4. Use of Technology
Technology is spreading like a wild fire. It was impossible to imagine even five years ago that more than half of the inhabitants of small towns and villages of Pakistan, would have access to mobile telephones or internet. 95 million Pakistanis out of 170 million have mobile phones today and are using them for banking services, information on climate/weather, agriculture extension, health, education, etc. It is a powerful tool which can improve the lot of those who have remained disadvantaged due to geographical distance and lack of physical access to services and information. Use of information / communication technology for the betterment of social and economic problems of Pakistan provides a huge untapped potential that can be exploited. A more holistic and comprehensive approach that deploys technology for poverty reduction can to be put in place.
4. Young Labor Force
Pakistan is one of the few countries which has a young labor force which can be harnessed for its own and global economy. Japan, Europe, U.S.A. and after 2050 China are going to have aging population where the ratio of old to young people is going to increase. India and Pakistan are two countries where the ratio of younger people to the older ones is going to rise. If these young men and women are tooled and equipped properly, the female labor force participation is increased, skills and knowledge are imparted to the youth, they can become the labor force for the rest of the world. This will give a big boost to Pakistan’s own economy. In 2001, worker remittances were less than a billion dollars; today they have reached almost 7-8 billion dollars. Now this can be multiplied by three or four times if more of the workers going for overseas employment are educated and skilled. If the domestic economy is unable to create adequate number of employment opportunities for those young men and women there could be social upheaval. Therefore, it is imperative to create such educational opportunities and avenues for them that train them in the kind of skills which are needed not only by the national economy but also by the international economy.
6. Devolution and Decentralization
As the population is increasing, one cannot govern Pakistan from Islamabad, Karachi, Lahore, Peshawar or Quetta. One has to devolve powers, decentralize and delegate authority, provide resources to the local / district governments so that they can take decisions at their own. Those decisions would be very much in accordance with the requirements and the needs of those communities. Decision making powers, financial resources and administrative authority should therefore be devolved to the people at the grassroots level as it would lead to much efficient allocation and utilization of resources. There must, however, be accountability of the Local Governments by the Provincial Governments and of Provincial Governments by the Federal Government but not interference or usurpation of powers. Under this scenario the same amount of resources can yield much higher growth rate. For example, if under the present centralized structure, investment rate of 24-25 percent generates 6-7 percent GDP growth under the devolution model the growth rate can rise to 8-9 percent with the same resources.
7. Income Distribution
Pakistan has income inequalities across households, rural / urban divide, gender and regions. Two of the provinces – Balochistan and NWFP – along with the Federally Administered Tribal Areas FATA (where most of the insurgency is taking place) have lagged behind Punjab – the most populated province and urban Sindh. The recent successful award of the National Finance Commission (NFC) has tilted the distribution of divisible pool towards the poorer provinces. The Parliament is debating some significant constitutional amendments that will transfer power to the Provincial and local government and give greater autonomy to them. These measures provide an excellent opportunity to invest resources in these backward areas and improve income distribution in the country. The impact on social cohesion and national integration from these measures is likely to be favorable and the trust deficit between the Federal and the Provincial Governments would be overcome.
CONCLUSION
The basic thrust of this paper is that Pakistani economy has made a substantial progress during the last sixty years but it has lagged behind other Asian countries in realizing its full potential. The current economic difficulties starting from 2007 have arisen due to a variety of internal factors and policy and management lapses. The stabilization program introduced in November 2008 with the assistance of the IMF is on track. But the main challenge facing the country is how to resume the high growth trajectory that Pakistan had achieved between 2002-2007. The constraints are formidable but the opportunities do exist both domestically as well as externally whereby this goal can be attained .But this would require some tough political decisions, better governance, peace and security in the country, and shift from dependence on foreign aid to external trade and investment. Pakistan has to shift its orientation from the West to the East in its foreign economic relations to align and benefit from the changes in the global economic balance of Power.