Which way are commodities heading?

By Shahid Javed Burki
Monday, 25 Jan, 2010

RECALLING what happened to the economy in 2008-09 when a number of commodities important for the country saw their prices go through the roof, it is a good time to reflect on which way commodity markets are heading in the next few months.

Could a rise in commodity prices – the price of oil, for instance, has increased significantly in the last few months – could hurt the recovery that is taking place? Expert opinion is mixed on the question of the future of commodity prices. But one thing is clear. The way the global economy has begun to recover from the Great Recession of 2008-09 will have a profound impact on the behaviour of commodities in the later months of 2010 and in 2011.

The major difference between the recovery now underway and those that occurred after the previous recessions is that the engine of global growth is no longer the United States. This time it is China. When the United States led recoveries from recessions, it was the consumer that provided the fuel the distressed economies needed.

When the recovery begins with China it is led by investment, most of it provoked by the funding provided by the government. Private consumption is the largest single contributor to the American national product. In China it is investment. The products the American consumers demand have a very different commodity content compared to the products needed by the Chinese investors. In other words the price pressures that will appear during this period of recovery will be different from those that were felt in the previous recoveries.

Some years ago Alan Greenspan, the long-serving chairman of the Federal Reserve Bank, the American central bank, said that his country’s product was getting lighter. By that he meant that the commodity content of American output was declining while the contribution of “weightless” knowledge was increasing. This meant that when the rate of American GDP began to increase, the demand for physical commodities did not rise by as much as was the case in earlier growth spurts.

The situation is very different in emerging markets such as China and India that are now leading the way in the current recovery. The revival of the Chinese economy was helped by a large government stimulus package which was aimed at increasing the investment in physical infrastructure. To take one example: when American consumers go shopping after taking some rest during a period of recession they tend to spend money on electronic appliances that need sophisticated chips that have very little physical material embedded in them. There is not much metal content in IPhones. For devices such as these knowledge is the main component in their manufacture.

On the other hand, when the Chinese begin to spend money on building roads, railways, ports and airports as they are doing now the demand for different types of inputs goes up. Heavy machinery is needed as are cement, steel, copper and other materials that go into construction. In this recovery one will, therefore, see much greater impact on the prices of the commodities that the Chinese economy requires compared to those that the rich countries need.

Another significant change is occurring in the pattern of commodity consumption in the mature economies of the developed world comparing to those that are in the early phases of development. Input of energy per unit of output in the rich world is much lower than in the developing world. In other words, when global growth is the result mostly of the increased activity in developing countries, we can expect the demand for energy to increase more rapidly than was the case when recovery was led by industrial nations.

According to Goldman Sachs, the investment bank that coined the term “BRICS” to lump to together Brazil. Russia, India and China, these four emerging economies contributed almost 30 per cent to global growth in dollar terms between 2000 and 2007 and 45 per cent since the crisis began in 2007. This means a 50 per cent higher contribution by these four countries to global growth in the post-recovery period compared to the pre-recovery period.

There is one other reason why we should expect a significant impact on commodity prices as economic recovery takes hold this time around. Most countries that have used public policy intelligently to revive growth have ensured that the poor will not be left behind in the process. All large emerging economies, Pakistan included, have made sizeable public sector contribution to either providing increased employment opportunities to the poor or providing them with direct income support. China did the former; Pakistan the latter. India followed both approaches. The poor spend a much larger proportion of their income on food; therefore, when their incomes increase, the aggregate demand for food increases significantly. This will put pressure on food prices.

Finally, there is the matter of extensive drought this year in South Asia. Whether this is part of the changing climate pattern because of global warming is hard to say. Nevertheless, decline in the output of some of the winter crops in South Asia will have significant consequence for food prices. What are troubling for Pakistan are some of the trends relating to wheat production in the United States. Wheat is Pakistan’s staple food crop. US winter wheat plantings are likely to drop to their lowest levels in almost a century, forecast at 37.097m acres, 14 per cent down from the previous year. There is likelihood that wheat prices will rise because of the reduced plantings in America. If the drought affects the availability of water for wheat in this season, Pakistan may have to return to the world market for large purchases at a time of rising prices. This will once again put a great deal of pressure on the balance of payments.

As already indicated above, oil prices have begun to increase. They are now above $82 a barrel for February deliveries and may rise further although the OPEC has declared its intention of keeping them in the $75-80 range. Even in that range the pressure on the country’s balance of payments will be considerable.

The conclusion I would reach from this is obvious. Islamabad’s policymakers have done reasonably well in the last few months in bringing the rapid economic plunge of 2008-09 to an end. Signs of recovery have begun to appear but that is happening at a time that commodity prices have come under considerable pressure once again. If they rise sharply, the impact on the incipient recovery will be considerable.

The most important thing Islamabad can do at this time is to keep a careful watch on what happens to the international commodity markets as well what is likely to be the impact on agricultural output for the current season’s crops. If it is anticipated that domestic output will be less than expected and commodity prices seem set to rise, there may be reason to take some defensive operations in the forward markets.

Obama’s changing tone

By Shahid Javed Burki
Tuesday, 26 Jan, 2010

What has given such prominence to a string of insurgencies at this time is the fact that some non-state actors belonging to the Islamic faith have decided to challenge the West, the US in particular, by using the weapon of terrorism.

The initial response of the US to the problem was to employ force to defeat the Islamic extremists threatening its interests. This was called the ‘shock and awe’ approach that envisaged using military power against an essentially primitive enemy to obtain its submission.

This was largely the strategy followed by the administration of President George W. Bush until the final year of his tenure. Then, under the influence of Gen David Petraeus, who was responsible for developing the US counter-insurgency strategy, the Bush administration changed its course in Iraq by combining economic and political development with force to beat back the insurgents. The strategy seems to have worked. The level of violence in Iraq has subsided significantly; December 2009 was the first month since March 2003 when the US went into Iraq that the Americans did not lose a single soldier in the conflict.

Whether the same strategy should be adopted in Afghanistan, the other area of insurgent activities, is a question that was debated for four months between August and November 2009 by the senior officials of the US administration including President Barack Obama.

The latter had taken office convinced that part of the problem was a widespread impression among Muslim populations around the globe that the Americans were fighting a war against Islam. Early on in his tenure he decided to address this issue head-on. In a major address aimed at the world’s Muslims and delivered before an audience in Cairo he said: “I have come here to Cairo to seek a new beginning between the United States and Muslims around the world, one based on mutual interest and respect.”

He promised that he would build bridges between his country and the world of Islam. He wanted the Muslims to recognise that the fight against those who were committing acts of terrorism was not just America’s war or the war being waged by the West, but it was also their war. He did not wish the people in his own administration to lose sight of this fact as he prepared to define a new strategy to beat back the insurgents operating from the secured havens in the mountainous regions on the border between Afghanistan and Pakistan.

Last year, Gen Stanley McChrystal, the commander of the US forces in Afghanistan, sent in a request for 40,000 additional troops to the president. The general wanted the kind of troop surge in Afghanistan that appeared to have brought relative peace in Iraq. After an intensive discussion, led by the president, it was announced that there would be 30,000 more troops for Afghanistan. But Obama also said that he would begin the process of withdrawal of the American contingent from July 2011.

All these developments have seriously affected Pakistan which had already seen a build-up in Islamic extremism. However, just as the administration had convinced itself that it had found a way and justification for combining strong military action against the extremists with a serious development effort, the situation was complicated by a Nigerian man’s attempt to blow up an American airliner on Christmas day 2009. It was revealed that he had received training in Yemen from the Al Qaeda in the Arabian Peninsula (AQAP).

Preceding this act was the attack by a Muslim doctor, a psychiatrist, on his fellow workers at Fort Hood in Texas in which 14 people were killed. It was revealed that the doctor was also in email contact with a Yemeni imam. Under pressure from his critics who were troubled by the new president’s focus not on the use of force alone but to combine force with other types of efforts, Obama seems to be shifting his ground. He has begun to use a language resembling that of his predecessor. “We are at war against Al Qaeda and we will do whatever it takes to defeat them,” he declared, after the botched bombing attempt.

Some of those who had supported Obama in his quest for the presidency are troubled by the direction the new president is taking under the pressure of events. “Even as he fights Al Qaeda and its allies, Obama needs to be Obama. He needs to continue voicing the Cairo message of outreach to the Muslim world — not as an alternative to battling extremism but as a necessary component to that fight,” wrote syndicated columnist David Ignatius recently. “We are confronting an enemy that wants us to draw deeper into battle, so that America is more isolated and unpopular. We avoid the spider’s trap by resolving the problems that matter.”

The main hypothesis to be tested by the evolving American approach is the role of economics in producing despair among certain groups of people and to persuade them to challenge the authority of the state. If this is indeed the case it will have a profound impact on the design of public policy.

A good part of the debate in the US as President Barack Obama was deciding on a strategy to fight the Islamic militants operating in the border areas of Afghanistan and Pakistan was concerned with giving more weight to economic development in winning the war against the extremists. If economic deprivation was a powerful reason for the extremists to fight the West and simultaneously the Afghan and Pakistani states then that is where the bulk of the effort has to go.

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Development options

By Shahid Javed Burki
Monday, 01 Feb, 2010

THE global economy appears to be recovering from what is now called the “Great Recession”. The recovery is led by some of the large Asian economies, most notably China and also India. The Chinese economy is estimated to have increased by 8.7 per cent in 2009 and is likely to expand by 9.5 per cent in 2010. India will probably produce an impressive rate of GDP increase in 2009-10, close to seven per cent.
Indonesia, the third largest Asian nation by population, has shaken off the economic and political blues and is also making a contribution to Asia’s recovery. Pakistan, the fourth largest country, is the sick man of Asia. Why it has done so poorly is a subject on which many (including myself) have written; what it should be doing in order to get out of the mess in which it finds itself is a question worth some thought. In this context one thing is clear. The strategy it adopts must be based on an understanding of how Asia is recovering and how that recovery should influence development thinking in Islamabad.

The Asian model of growth was based on a number of assumptions which were made when some parts of the continent began the process of economic take-off. Some of these are no longer relevant for today’s world.

The old model was founded on four pillars. One, domestic markets were too small to support large industrial sectors. This meant that markets had to be found through exports. There was almost an insatiable appetite for Asian products in the markets of the United States in particular but also Western Europe. The Asians first exported simple labour intensive products. Gradually they climbed the production ladder and began to export such sophisticated products as automobiles. Several Asian countries are now moving towards trading in knowledge-intensive output.

Two, to develop a large industrial base, the Asians needed to invest a significant proportion of their gross domestic product. They decided that domestic savings must be the source of this investment even if it meant that consumption by the present generation had to be postponed.

Three, the industrial sector must be kept competitive by maintaining an exchange rate that remained below the level the markets would set.

Four, to protect the type of crisis that hit the Asian region in 1997, countries must maintain large external accounts reserves.

None of these pillars were built to support the Pakistani economy. It was erected instead on a shaky ground. Industrialisation was prompted largely by the Indian decision taken in 1949 to impose a trade embargo on Pakistan. Consequently the satisfaction of the domestic demand remained the overriding concern but it was not large enough to support large-scale industries. There was, therefore, concentration on establishing small industries producing products for domestic consumers.

Investment was financed mostly from foreign capital flows. Most of these came in as aid and not as foreign direct investment. For the last couple of decades, the exchange rate was overvalued which kept imports cheap while reducing the ability for the country to compete with some of its Asian neighbours in the few markets that were available to sell the few products produced in excess of domestic demand. And, foreign exchange reserves were not built up to cushion the country from adverse developments outside its borders.

Because of these public policy failures, the country today has an economic structure that is not ready for a rapid growth of its economy. A great deal of restructuring is needed to ready it for joining other high performing Asian nations. But in order to undertake that restructuring, there will have to be the political will to bring about change. There is little evidence that such will exists at this critical time in the country’s troubled history.

The global economy is now structured very differently from what it was when other high performing Asian economies performed their “miracles”. Developed countries that provided the markets that fed the industrialisation of these states have entered a period of slow expansion.

In the coming years the fastest growing markets will be in Pakistan’s neighbourhood, not in distant Europe, not even in the more distant North America. The sources of foreign capital flows are also shifting away to the surplus economies of Asia and the Middle East and these sources will be looking for high returns on capital than Pakistan could promise in the current situation of insecurity.

There has, therefore, to be even greater reliance on domestic savings than was the case when Pakistan could trade-off its geo-political situation for official development assistance. All this calls for a very different approach to economic development. Investment must be financed mostly from domestic savings.

This will need a number of structural changes in fiscal policy. To begin with, the authorities must expand the tax base, a goal which has been on the agenda for a long time but has contin ued to elude the policymakers. The lobbies that are against such a move have succeeded in preventing appropriate action to reach the goal.

Today the country with less than 10 per cent has one of the lowest tax-toGDP ratios in the developing world. It will also mean introducing more income-elastic tax instruments. The value added tax is the most obvious of these. The VAT should have very few exemptions and should cover all sectors of the economy. Such a programme of structural change will also require considerable fiscal decentralisation so that taxes are collected by the governments that are not too distant from those who pay them. This will result in greater accountability of the government collecting taxes by the people for whom tax revenues should be mostly used.

International trade must become the driver of growth but it will have to be directed towards Asia rather than the present developed countries. This is one reason why it is so necessary to work out better economic relations with India and to take greater advantage of the proximity of China, now the world’s most dynamic economy. Pakistan needs both a China strategy and an India strategy. In both cases an effort should be made to develop strong strategic linkages between Pakistan’s private sector and those in China and India. A strategic relationship implies division of work between the producers in Pakistan and those in the two neighbuoring countries. Pakistan could, for instance, become a supplier of parts and components to the rapidly developing automobile industries in China and India.

By opening the Pakistani territory more freely to transit trade to and from China and India, the country would be able to significantly change the structure of its economy. Modern services would become considerably more important contributors to the country gross domestic product than, for instance, large scale manufacturing. This has been a contentious issue.

Many in Pakistan believe that by giving transiting rights to India for trading with Afghanistan and Central Asia – perhaps also with China and the Middle East – the country will be taking its hands off the one lever it can use to influence policy making in New Delhi. I have always found that argument difficult to buy. In fact, there would be greater leverage if Pakistan were to become the hub of trade between India and the countries to the north.

Given the rapid changes occurring in the global economy of which Pakistan must attempt to become a larger player, the country must carefully reflect on the strategy it must put in place to catch up with the rest of Asia.

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Our population problem

By Shahid Javed Burki
Tuesday, 02 Feb, 2010

IN the 1960s President Ayub Khan made population growth a major policy concern for his development-minded administration. However, since then policymakers have not given the subject of population the attention it deserves.

That is unfortunate since the dynamics associated with population growth varies according to the location of people, the patterns of migration and differences among various areas. It has had a profound impact on the way the country has developed — and not just economically.

Demography has also had a profound impact on Pakistan’s political and economic development. Today I will look at some of the broad trends in Pakistan over the past six decades, look at the way population trends are shaping globally, and see how these world trends relate to Pakistan.

When Pakistan became independent in 1947 its population was estimated at 32 million. Sixty-three years later it has increased 5.3 times to 170 million. This implies an average annual rate of growth of 2.74 per cent, one of the highest in the world. The government claims that the rate of increase has been declining in recent years and is now below two per cent, possibly no more than 1.8 per cent a year.

In 1947, only 10 per cent of the population lived in urban areas; today the figure is about 50 per cent. This means that the size of the urban population has increased 26.5 times, again one of the highest rates of growth — 5.4 per cent a year. About a third of the urban population resides in two large cities, Karachi and Lahore. As is the case with the rest of the developing world, the rate of increase in the populations of large cities in Pakistan will also decline while those of the secondary and tertiary cities will increase.

This brings me to the question of global trends. It is useful to reflect on these in order to comprehend the challenges Pakistan’s policymakers face and will do so in the future as they begin to focus on the impact of demography.

The UN’s population division now projects that world population growth will almost come to a standstill by 2050. At that time the global population will stabilise at 9.15 billion compared to the present 6.83 billion. This levelling in the rate of increase was not anticipated a couple of decades ago. In the 1980s, for instance, demographers worried about what they had begun to call the population bomb. The bomb did not explode in most parts of the developing world. That said, there is now a new worry — the distribution worldwide of the anticipated growth. The new generation of demographers has now begun to point to some population trends that could produce a great deal of economic, political and social instability.

Almost the entire growth in the world population of 2.32 billion will occur in the developing world. By the middle of this century the share of today’s rich countries will decline to only 12 per cent of the total, five percentage points lower than was the case at the beginning of the century. It is not always recognised that this is a significant reversal of past tends. At the start of the 18th century, Europe accounted for 20 per cent of the world’s population.

The advent of the industrial revolution in Britain resulted in an explosion of its population as health and sanitation facilities improved and the rates of mortality declined. In 1913, on the eve of the First World War, Europe had a population larger than that of China at that time. By that time the proportion of Europe in the context of the global population had increased to 33 per cent of the total. However, the continent was getting too crowded. There were serious food shortages in some parts; Ireland suffered what came to be known as the potato famine. In migration, the Europeans found a solution to their population problem. There was a massive movement of people to North America and Australia.

There will be other significant changes in the distribution of the population. Not only will today’s developed countries have a significantly lower proportion of the total population, their populations will also be much older and the proportion of non-working to working populations will increase considerably. Will the burden of looking after older people fall mostly on the young or will the state step in to help? If it is the latter, how will the state pay for the care of the poor? These have already become important policy issues in developed countries.

By the middle of the century more than half the global population will live in towns and cities. Most of the increase in urban populations will take place in the large- and medium-sized cities in the developing world. Even at this time these cities are proving hard to manage. Neither they nor the states in which they are located have the means to provide some of the essential services people need. In many of them security is a major concern. Today some 90 per cent of global homicides are committed in the urban areas of the developing world.

There will also be significant demographic shifts within the developing world. Populations in Muslim countries will increase much more rapidly than in other parts. As Jack A. Goldstein says in his article, ‘The new population bomb’, in a recent issue of Foreign Affairs, “most of the world’s expected population will increasingly be concentrated in today’s poorest, youngest and most heavily Muslim countries which have lack of quality education, capital and employment opportunities”. He probably had Pakistan in mind when he wrote that sentence. But the option of migration is increasingly less available to the crowded Muslim world as was the case for the Europeans 100 years ago.

This then is the context in which we should look at our demographic situation. We are engaged in a race: either develop the economy rapidly so that opportunities are created for the young or fumble with the economy and let the youth turn increasingly towards extremism.

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Global economy after the Great Recession

By Shahid Javed Burki
Monday, 08 Feb, 2010

MOST large economies posted respectable growth numbers for the fourth quarter of 2009. The United States saw its GDP increase by 5.4 per cent on annualised basis in the quarter ending December 31, 2009. The increase was much more than expected by most experts.
The Chinese economy expanded by 10.7 per cent, again more than anticipated. Even European economies have begun to show some signs of life. What is now called the Great Recession seems finally over, having taken a heavy economic toll across the globe. In what shape has it left behind the global economy?

Perhaps the greatest consequence is on the conceptual front. The previous consensus on how to manage economies, global as well as national, was wrong. It was called The Washington Consensus. There was the assumption that the best way to take care of the world economy was to leave it alone. This is what was meant by “globalisation”. The enormous increase in global output and trade over the previous 30 years was the result of removing barriers to trade and capital flows. This was also the period that saw the largest reduction in the levels of global poverty even though it may have increased the income gap between poor and rich nations.

There are, in fact, three consequences of the Great Recession of which all policy makers, no matter where they are located, should be mindful. One, while the world is linked by different types of flows – capital, trade and that of people – these links need to be tended. This is particularly the case in the sector of finance where most large firms operate across national borders.

Two, private initiative is important and what is loosely described as “capitalism” should be the guiding philosophy for all nations, developed and developing. That notwithstanding, activities of private operators in the economy should be kept under constant observation so that they don’t do social harm.

Three, the world is being reshaped with the centre of economic activity moving from the Atlantic to the Pacific. This will have enormous implications for all world economies.

The collapse of financial and capital markets all over the world after the demise of Lehman Brothers in the United States showed that governments could not stand by and let the markets take care of themselves. They had to intervene. The recently published biography of Hank Paulson, the US Secretary of Treasury at that time, reveals how close the world economy was in September 2008 to a total meltdown.

Led by the United States, governments intervened massively in both developed and developing countries. Washington provided tens of billions dollars each to several financial institutions that were near collapse. That help kept institutions such as Citibank, Bank of America, and Goldman Sachs afloat. The governments also realised that much of what John Keynes, the British economist, had said about macroeconomic management and the role of the state was correct. The United States and China launched stimulus programmes that had no historical peace-time precedence in terms of their size.The IMF was given additional resources to help the countries in acute distress. Pakistan was among the countries that were assisted.

It is also now recognised that the state has to play a much larger role in managing the domestic economy and the assumption that financial markets are selfcorrecting was deeply flawed. Under Alan Greenspan, who served for nearly two decades as chairman of the US Federal Reserve, the American central bank, the belief that even regulation could be left to the markets had become popular not only in the Anglo-Saxon world. It was also the basis of economic policy making in Islamabad during the period of President Pervez Musharraf. Islamabad under Musharraf left the private sector mostly alone. Even the regulatory agencies that had the power to watch over the private sector were defanged. The Competition Commission, although led by a strong chairman, was not encouraged to prevent monopolistic behaviour by large firms. The result was that significant shares of the market were captured by a few producers manufacturing some critical commodities.

The Great Recession seems to have quickened the pace at which global output was being distributed across the globe. China is expected to overtake Japan as the world’s second largest economy. It has already become the world’s largest trading nation. It is now the world’s largest market for automobiles. That the centre of gravity of the global economy was moving from the Atlantic to the Pacific seemed a far-fetched assumption a few years ago. It has become a reality.

In the next one decade, almost twothirds of the increase in world output will come from the emerging economies. Not too long ago, policy makers in the developing world – including those from Pakistan – focused on their relations with the rich western nations to ensure that they had adequate availability of financial resources and access to the markets of rich countries in order to promote domestic economic development. Pakistan has spent a great deal of time and effort in cultivating the United States as a supplier of much needed external capital flows. It has also sought to improve access to the markets in the United States to improve its export earnings. That strategy has to be rethought.

The Great Recession, therefore, has left the global economy in a very different shape from the one that existed before it took hold. Those policy makers who have sharp instincts will be able to draw for their countries the benefits that these changes can provide. Islamabad needs to do at least three things. It must develop a strategy to strengthen the institutions of economic management. There has been weakening of the state over many decades. That has to be arrested. This will involve movement on several fronts: civil service reform, redesign of the fiscal system, reform of the regulatory system, greater autonomy to the provinces. These are some of the areas that need immediate and thoughtful attention.

What will be more difficult for Islamabad is to ensure that it would not be completely left out of the emerging international system of global economic management. At this time, Pakistan has no presence in G20; a very weak voice in the boards of the IMF and the World Bank; little say in matters such as international trade, international migration and climate change; weak links with the more rapidly growing economies of Asia. All these subjects are of great importance for the country but they are being left largely unmanaged.

It is the rise of China that Pakistan must study and understand in order to draw full benefit from the fact that this rising global economic power sits right across its borders. This relationship has not been neglected; there is a constant flow of officialdom from both sides across the border. The problem, however, is that all this energy is being applied without a well thought out strategy.

To begin with Islamabad would do well to establish an inter-ministerial group tasked to oversee the development of economic relations between Pakistan and China. This group should be ideally headed by a person who has the rank of a federal minister so that its deliberations and actions are kept under review by senior politicians. I have proposed on several occasions that Pakistan needs a China strategy to benefit from the reshaping of the global economy.

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A small victory

By Shahid Javed Burki
Tuesday, 09 Feb, 2010

THE recent conference in London to chart the future course for Afghanistan produced a small victory for Pakistan. Islamabad had insisted for many years that a long-term, stable solution to the 30-year-old Afghan problem could only be found if some of those identifying themselves with the Taliban movement were accommodated within the governing structure.

This position was first advanced by Gen Pervez Musharraf and followed by the present government. The Americans, however, would not have anything to do with anybody who went under the banner of the Taliban movement. But then an interesting thing happened. The Taliban emerged as different groups, each with its own agenda.

At least three major Taliban groups emerged. The first was the group headed by Mullah Omar who had led the government the Taliban had formed in Kabul in the mid-1990s. It is widely believed that this group was led by leaders of the ‘Quetta shura’ whose main goal is said to be to bring Afghanistan under the control of the Taliban. That could happen only if the Americans were made to leave Afghanistan. The bulk of support for this group came from the many local commanders involved in various insurgencies in Afghanistan.

The second group was led initially by Jalaluddin Haqqani and is now under the control of his son Sirajuddin. The older Haqqani had been helped by the Americans, the Saudis and the Pakistanis to fight the Soviet occupation of Afghanistan. Having achieved that objective they were unable to work together to govern the liberated country, paving the way for the Taliban regime.

When the Americans moved into Afghanistan in late 2001 and pushed the Taliban out of Kabul, the Haqqani group shifted to Pakistan’s North Waziristan. It has remained there, supporting the insurgents in the areas adjoining their sanctuary in Pakistan. Since the senior Haqqani had served in Mullah Omar’s government his Taliban movement retained some contacts with the Quetta shura. But the linkages are believed not to be strong.

The third group had little to do with the insurgency in Afghanistan but wanted to bring about change in Pakistan. It was formed out of several small tribal groups and was given the name of Tehrik-i-Taliban Pakistan (TTP). Initially led by Baitullah Mehsud who was killed last year in a drone attack, the TTP quickly expanded its reach.

Last summer its affiliate in Swat took over the district and advanced into Buner. They were only a short distance away from Islamabad. It was then that the army moved to reclaim the areas, carrying out a successful operation. It followed it up with an equally successful operation in South Waziristan. Recently, newspapers carried the story that Hakimullah Mehsud, Baitullah’s successor, had died of injuries sustained in a drone attack sometime earlier.

While Pakistan drew a sharp distinction between these three groups, the Americans were of the view that all of them had to be treated the same way. They were pleased with Pakistan’s move against the TTP in Swat, Buner and South Waziristan but were unhappy that Islamabad was not anxious to go into North Waziristan against the Haqqani group or to hit the Quetta shura.

Neither of the two groups had launched attacks against Pakistan while the TTP was involved in many terrorist activities that had killed hundreds of people in various parts of Pakistan. Also, Islamabad, worried about the political vacuum that might occur once the Americans and Nato forces began the promised withdrawal from Afghanistan. It wanted a situation where it could depend on these two groups of Taliban to help establish a regime in Kabul that would be friendlier towards it than the one headed by President Hamid Karzai.

What motivated the Afghan president to dispense with his enduring antipathy towards the Taliban movement to hold out an olive branch to some of them in London?

In fact, Karzai and his associates went to London to get the support of the countries assembled there to help him win over those in the Taliban movement who were its foot soldiers for economic reasons and not out of ideological compulsions. His finance minister asked for assistance amounting to $1.2bn, with $200m dispersed immediately so that employment opportunities could be created for these people. The regime held out the assurance that this money would not be used to bribe the Taliban but for promoting development.

This, in fact, is a recognition by Karzai that an important reason for his mounting troubles was of the poor governance of Pakhtun areas, most of which border Pakistan. The president was also thinking of the time when the Americans would not be present in large numbers to prop up his administration. The time had come for him to bring under his tent those Pakhtuns who were prepared to work with him.

While the outcome of the London conference vindicates Pakistan’s long-held position, it also points to the importance of focusing on economic development as a way of countering insurgency. It is important for Pakistan to launch a massive programme for the development initially of Malakand division and South Waziristan — two areas where the army has scored impressive successes — in order to ensure that the people there remain loyal to the Pakistani state.

A well-articulated programme of economic development will have the support of the West and should not impose a heavy financial burden on Islamabad. This is a good time to start work on it.

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History’s influence on public policy

By Shahid Javed Burki
Monday, 15 Feb, 2010

ALMOST half a century ago when I was a graduate student at Harvard University, I learned why it was important to understand the influence of history on the making of public policy. I was taught then by Alexander Gerschenkron — by far the best known and widely read economic historian of our times.

He took me under his wing and instructed me how to study economic history and how to apply that study to the working of the state in the design of public policy.

According to him, the important question about the working of the state was not only to ask what needed to be done at a given point in time to improve the economic and social conditions of the citizenry. It was equally important to ask the question why certain things were done by the state in the past.

Choices the makers of public policy make at any given time are the result of their understanding of the situation they are addressing as well as the consequence of the influences under which they are working. What I learnt from the master economic historian then is as relevant today as it was when he did his pioneering work.

The problems Pakistan’s policy makers confront today are well known – in fact they have been known for a long time. The economy is in deep trouble now for many reasons. Among them the following four are particularly important.

First, the country is excessively dependent on external capital flows, having failed to raise resources from within the economy to finance needed investment. This dependence has created extreme volatility in the performance of the economy. The economy does well when foreign flows are large; it does poorly when these flows decline. This dependence has also subordinated Pakistan’s relations to the outside world to the need for financing the economy.

Second, Pakistan remains poorly integrated with the global economic system. It has failed to take advantage of the opportunities globalisation has opened up for emerging economies such as Pakistan.

Third, the country has not developed its large human resource. Pakistan today has one of the youngest populations in the world with the median age of only 18.2 years. This means that one-half of its population of 170 million is below that age. A significant proportion of the young is illiterate and, consequently, does not have the skills needed to participate in the modern sectors of the economy where wages and hence incomes are high. Being uncertain about their future, a large number of young people have been attracted to extremist causes. For many the likely economic rate of return from participation in these activities is higher from what they view is on offer from the economy.

Fourth, Pakistan has one of the most centralised systems of policy making among the countries of its size. The state is very distant from the people it must serve. One reason why the state operates in such a centralised manner is that it was dominated for a long period of time by the military which believes in a strong command and control system.

How should this situation be addressed? How should Pakistan raise more domestic resources to finance investment, get better integrated with the global economy, spend more on human development, and give more authority to the sub-national governments? In other words, the state should function very differently from the way it did in the past. This leads to the question Gerschenkron would ask: why is the Pakistani state behaving the way it does? We turn to history to answer the last question.

India and Pakistan emerged as independent states with the support of significant proportion of the populations that became the citizens of the two countries. The leaders of the two movements that created these two countries won mass backing having promised that the states they wished to create would better the lives of their citizenries. But this is where the similarity between the two movements ends.

The senior leaders of the Indian National Congress had clear ideas about the way the state should function to increase citizen’s welfare. Mahatma Gandhi believed in self -reliance and rule by the people in a highly decentralised system. Jawaharlal Nehru wanted a powerful state operating from the centre and occupying the commanding heights of the economy. Had Gandhi lived there would have been considerable tension between these two points of view.

After his assassination in January 1948, the ground was clear for Nehru to work for the realisation of his vision. The result was the “license raj” that produced the “Hindu rate of growth” for 40 years after the country achieved independence. The rate of increase in the Indian national income during this time was about 3.5 per cent a year, one half of the average for the following two decades and two-thirds of that for Pakistan during the same period.

In the case of Pakistan, once the Muslim League had created a state for the Muslims of British India, it had no idea how that state should function to increase the welfare of the citizenry. There was an ideological vacuum in so far as giving direction to the making of economic policy was concerned. This meant wide swings in the way the economy was managed.

Looking back at the way the policymakers designed economic strategies, we notice four broad trends. After the confusion that prevailed in the first decade after independence, General Ayub Khan, the first military president, was persuaded by a group of technocrats to opt for an economic strategy that focused on growth with considerable space assigned to private initiative. The result was a sharp pick up in the rate of GDP growth accompanied by an increase in regional and personal income disparities. This strategy led to the rise of the Pakistan People’s Party and the eventual separation of East Pakistan.

Under Zulfikar Ali Bhutto, the PPP implemented an economic agenda that was Nehruvian in content and scope.

The role of the state was radically changed and enhanced while the large private sector was punished through a series of nationalisations. Economic growth slowed down and the incidence of poverty increased. The turmoil that ensued bought the third military government in office that tinkered at the margin to introduce Islamic economic principles into the management of the economy.

The fourth ideological shift came with the first administration of Prime Minister Nawaz Sharif (1990-93) to occupy office. It once again placed its faith in the private sector and adopted some of the more important elements from the strategy that was known as The Washington Consensus. This approach was kept in place by the military administration headed by General Pervez Musharraf.

The return of democracy in 2008 with the PPP governing from the centre and sharing power in Sindh while the Pakistan Muslim League is ruling Punjab has created another ideological vacuum in the making of economic policy.

The role of the state remains undefined as is the strategy that needs to be followed to put the country back on a sustainable trajectory of high rates of growth. What the present rulers need to do, therefore, is to first reckon how they wish to run the economy.

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Talks based on economics

By Shahid Javed Burki
Tuesday, 16 Feb, 2010

THERE has been a significant shift in the positions of most countries involved in the current Afghan conflict. The process started with President Barack Obama’s speech on Afghanistan last December.

Another important development has been the decision by New Delhi to give up its position that it would not talk to Pakistan on the resolution of issues souring ties unless Islamabad took to task those who masterminded the terrorist attack on Mumbai in November 2008.

On Feb 4, New Delhi proposed the resumption of talks at the foreign-secretary level but did not suggest an agenda. The response from Islamabad was quick. The Foreign Office spokesman said that if India dispensed “with its traditional inflexibility there [was] a possibility of moving ahead. Pakistan has always believed that it is only through genuine and meaningful talks that Pakistan and India can resolve their disputes”.

On the same day P. Chidambaram, India’s home minister, said in New Delhi that the handler of the group that penetrated Indian defences in the 2008 Mumbai attack may have been an Indian. “When we say he could be an Indian, he could be somebody who acquired Indian characteristics. He could have been infiltrated into India and lived here long enough to acquire an Indian accent, familiarity with Indian Hindi words…,” he said.

On Feb 5, Shahid Malik, Pakistan’s high commissioner in India, met Nirupama Rao, India’s foreign secretary, to discuss the timing and content of the high-level meeting between the two countries. “All possible issues which are of concern to Pakistan or India will be discussed,” he told the press after the meeting. “Kashmir is an issue we have been raising with India at every possible opportunity and forum. Terrorism will certainly be one of the areas of discussions because we have issues relating to terrorism and this is something that affects Pakistan.”

The news that India was prepared to restart its dialogue with Pakistan, begun in 2004 but suspended in 2008 after the Mumbai terrorist attack, was received in Pakistan with a mixture of relief and triumph. Most policymakers were of the view that the position Pakistan had taken following the Mumbai carnage had been vindicated. Its neighbour had begun to recognise that there was no official Pakistani involvement in the attacks.

The terrorist activity by the Tehrik-i-Taliban Pakistan in 2009 was a clear indication that Pakistan was also a victim of terrorism. Hundreds died in attacks on major cities and in several small towns in the NWFP.

The fact that there was some disagreement over the content of the dialogue once it began is a good indication of the nature of the relationship between these two countries. Even relatively minor issues became contentious. India initially indicated that it only wished to discuss terrorism while Pakistan wanted to go back to the composite dialogue which covered most contentious issues that had caused so much hostility between the two South Asian neighbours.

This may be a good time to completely change the framework within which India and Pakistan have been discussing their relations ever since 2004. Then, at the sidelines of a regional summit, Gen Pervez Musharraf and Indian Prime Minister Atal Behari Vajpayee had agreed that the two countries should attempt to resolve their differences through dialogue. In the context of the history of India-Pakistan relations this was a major breakthrough.

As was always the case, Islamabad wanted to focus on the issue of Kashmir. New Delhi was in favour of discussions that covered the many reasons for continuing tensions between the two countries. These included territorial issues other than Kashmir. For a number of years India and Pakistan had been fighting over the Siachen glacier in the eastern part of the disputed territory of Kashmir. There was also a dispute over Sir Creek on the western side between the two states. The Indians suggested that movements on these issues would build confidence and ultimately lead to the resolution of more difficult problems, including Kashmir.

The two countries are now debating once again the content of the dialogue expected to be resumed in late February. According to a newspaper report, the issue of what should be the right approach to the Indian initiative was discussed at a brainstorming session at the foreign affairs’ ministry in Islamabad where some concern was expressed that unless the composite dialogue was fully restored, Pakistan should not participate in the discussions.

However, the diplomats left the final decision to the politicians who, it was said, might be able to think outside the box to find a way to depart from the entrenched positions in the two bureaucracies. The Indian position dealt with terrorism as the main focus of discussions and Pakistan’s position was that the entire relationship should be on the discussion table.

If thinking outside the box is to be encouraged my suggestion would be that Islamabad should base the dialogue on an entirely new consideration: how to bring about greater economic integration between the two countries.

The objective should be to develop a stake for India in the Pakistani economy and also in its stability. This would entail a number of things including unhindered flow of trade between the two countries, encouraging the private sectors on either side of the border to invest in each other’s economy, the opening up of the border that separates the two parts of Kashmir to trade and movement of people, and grant of transit rights to each other for trade with third countries.

As the experience of Europe shows, economic integration among states with a history of hostility towards one another is a good way of easing tensions. Taking that approach would constitute real thinking outside the box.

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Towards a new development paradigm

By Shahid Javed Burki
Monday, 22 Feb, 2010

THE current government has handled a difficult economic and financial situation. In the spring of 2008 it was clear that the country was heading towards an economic disaster. Urgent action was required and was taken by going to the IMF for resources to save the foreign exchange reserves from plunging to the point where the country would not have been able to service its external debt.

The Fund came to Islamabad’s rescue and in return for the commitment to stabilise the economy more than $11 billion were committed. This amount was to be disbursed over a period of 23 months.
The crisis passed, the decline in foreign exchange reserves was halted, the rate on inflation slowed down, the slide in the value of the shares listed on Karachi Stock Exchange stopped, and some investor confidence returned. With stability having been achieved, in which direction should the country move?

To answer this question, a group of business people, senior government officials and some representatives from the think tank community was established under my chairmanship in late 2008.. The group goes under the nomenclature of the Task Force for Private Sector Development. It has met four times and each time it has reported either to the president or the prime minister the substance of its deliberations. Its fourth meeting was held in Islamabad on February 12 and 13 and culminated with a briefing given to Prime Minister Yusuf Reza Gilani. We told the prime minister that the task force appreciated the fact that the government had decided to identify the private sector as the most important determinant of economic revival and growth.

In fact, the Planning Commission is looking to the task force to develop a policy framework that would help the private sector to contribute to the development of the economy. In the presentation made to the prime minister, a number of areas in which the government and the private sector needed to work together to achieve the desired result,. were identified.
The most important of these is the need to make the economy as self-reliant as possible. Over the last sixty years the economy has done well only when there was a large inflow of money from abroad. Self- reliance will only become possible if the government is able to raise more resources from within the economy rather than continue to rely on external capital flows.

In a presentation made to the task force, Finance Minister Shaukat Tarin pointed out that with the tax-to-GDP ratio having declined to about nine per cent, the entire development expenditure was being financed from foreign flows. Government’s revenues barely covered current, non-development expenditure.

The reason why Pakistan was doing so poorly was that the tax base was very small. This put a very heavy burden on the small number of people and entities that paid taxes. Given the narrow base, the incidence of tax on those that actually pay is very high. In view of this, the task force is recommending three things to the government. In reforming the tax structure, it should broaden the tax base. The most effective way of doing this is to move to towards a value added tax, lower the corporate rate and create a level playing field for all players in the economy.

Taxing the large enterprises in the formal sector, while allowing the small firms to escape the tax net, created a wrong set of incentives for asset owners in the private sector. This was one reason why the size distribution of the firm was skewed towards the very small firms. More than 90 per cent of industrial output was accounted for by the firms that employed less than 10 persons.

The task force has spent a fair amount of time in looking at the characteristics of the Pakistani firm. Using date available from the survey done by the World Bank in the context of its report, Investment Climate Assessment II, we concluded that the aim of industrial policy should be to increase the size of the firm, improve its technological base and make it more outward oriented. This will require the government to move on a number of fronts at the same time.

Labour laws need to be consolidated with the aim to protect the workers but at the same time reducing the visits to the firms by large number of regulators who seem more interested in collecting rents than in improving the conditions of workers. At the same the employers must have more flexibility in hiring workers and firing those that are performing poorly or have become redundant. The firms must also have ready access to land they need for their activities.

A matter that engaged the attention of the task force a great deal is the question of entry and exit of firms. Those countries that have done well in terms of developing their industrial base have made both processes less cumbersome. Pakistan is working on creating a mechanism for allowing firms to exit – to opt for bankruptcy if the condition so demands. The idea is to set up resolution trust corporations that will pick up non-performing assets, restructure them and dispose them off in the market.

We believe that a more effective and efficient way would be to develop a framework which would allow both debtors and creditors to work within a supervised institutional framework. The United States has such a system that works very well. It is called “Chapter 11 proceedings”. Something along those lines should be attempted in Pakistan.

Large firms are concerned about the non-availability of skilled workers. The educational base is poor. It does not place in the market workers with needed skills. Some of the firms that have successfully dealt with this problem have done so by training their workers themselves. This is costly and the firms believe that they should be given some incentives in this area. Some of the countries in East Asia that have done well, have allowed firms to write off some of the training expenses against taxes. However, this approach will add another subsidy to the many that various firms have been allowed over the years.

In approaching the question of accumulated subsidies, the task force has concluded that the government should produce a map that identifies, quantifies and estimates the cost to the economy of all the subsidies the private sector receives. This will help to rationalise them. We are also of the view that the government should publish in the form of a book all the SROs it has issued from time to time. These are aimed at specific industries or firms. Most of them create serious distortions in the system. The government should eliminate as many of these as possible. Such an exercise would also aim to create a level playing field for all firms.

Finally, we are of the view that the government should review all the economic laws that have accumulated on the books over time. Some of these don’t serve the purpose for which they were enacted in the first place. Their rationalisation will help to simplify the legal environment in which the firms are currently operating. Our main conclusion from this year-long exercise is that for the private sector to become a real driver of economic revival and growth the government will need to take a large number of required actions.

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Economics & rule of law

By Shahid Javed Burki
Tuesday, 23 Feb, 2010

THE main purpose of my latest visit to Pakistan this month was to chair the fourth meeting of the task force on private-sector development set up in November 2008 at the urging of President Asif Zardari.

As chairman, I was asked to present to the government ideas on how Pakistan’s private sector could be commissioned not only to revive the economy but to set it on the path of sustainable, high-level growth. It is the government’s hope that it can institute economic and social reforms to make it possible for Pakistan to attain the sort of GDP growth that has become common in Asia.

It was on the second and final day of our deliberations that Pakistan was convulsed by another crisis that had its origin in the continuing conflict between the executive and judicial branches of the government. The private-sector members of the task force commented on this development on the sidelines of our meeting. They were unanimous in their view that one of the factors standing in the way of development of the private sector was the weak legal and judicial system. They felt that it would remain weak for as long as its role was not clearly defined. This would require our political and legal systems to come to an understanding.

For some time now development economists at institutions such as the World Bank and the Asian Development Bank (ADB) have been analysing the relationship between the efficiency of the legal system and performance of the economy. Recognising the importance of a well-functioning legal and judicial system the ADB some years ago funded a large programme for judicial reform in Pakistan. The programme has not done well since it appears that it did not have the full support of the various parts of the executive.

Development economists who have explored the relationship between law and economics have reached several conclusions. Two are worth noting. The first is that a well-functioning legal system is an important contributor to economic growth and social improvement. Those who wish to invest in an economy find comfort in a well-functioning legal system. Such a system not only has institutional mechanisms for dispute resolution, it also creates an environment of certainty that assures investors that they will not be surprised by ad hoc and whimsical decisions by the executive.

Common law that is the basis of the system in Pakistan functions by recognising precedence as equally important as formal laws. In the case of Pakistan the executive has shown considerable contempt for precedence. With frequent changes in administrations and changes in ideologies, those who operate in the field of economics have had to deal with a great deal of uncertainty. That is not good for the process of economic development.

The second conclusion reached by many development economists is that legal systems based on common law are better for economic development than those that follow fixed and unchanging codes. Examples of the latter are the Napoleonic and religious codes. The former is being followed in most of Europe and Latin America. This is one reason why the Anglo-Saxon world, as well as those parts of the world that came under its influence as a result of colonial expansion, are doing better in economic development compared to those following rigid legal systems. Common law systems provide flexibility while those based on codes are less open to accommodating change.

The changes made in the legal system by the administration of Gen Ziaul Haq have created systemic confusion. The addition of the Sharia bench has added an element of codification to the common law foundations laid down by the British during their long rule in India. However, the main issue at this point is the conflict between the executive and the judiciary on the extent of independence the latter will enjoy. This matter needs to be settled in a way that while the judiciary enjoys full autonomy in its operations, it should not encroach upon the working of the executive branch.

In a recent book, The Rule of Law, Lord Tom Bingham who held three of Britain’s great judicial offices, holds that the rule of law is the “the nearest thing we are likely to approach to a universal secular religion”. He maintains that the blessings for people who live under the rule of law can be clearer than those conferred by liberal democracy or free markets. In other words, in the three-legged systems — liberal democracy, open and competitive markets and the rule of law — that have been adopted by the more successful states around the globe adherence to the rule of law must be the strongest leg.

According to Bingham the rule of law has many elements. Among these are the accessibility of the law, equality before the law, the right to a fair and speedy trial, the legal accountability of the functionaries of state, accountability also of those who sit in judgment over other people, and the ability of the system to change as society changes and develops. It is evident that most of these elements are absent from the Pakistani legal and judicial systems as they are presently constituted. It is their absence that the ambitious programme launched by the ADB was seeking to address.

Looking at the current debate from the perspective of an economist I can only hope that some good will come out of the current confrontation between the executive and the judicial branches of government. If this leads to a clear demarcation we may see the evolution of a legal system that would create some certainty for the entrepreneurs who work in the markets and for common citizens who look to the markets to provide them with the goods and services they need at competitive prices.

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