At the edge of an abyss

By Shahid Javed Burki
Tuesday, 04 May, 2010

Pakistan's current economic situation calls for a fundamental change in the way the economy has been managed over the last couple of decades. Much has been said and written about the mistakes made by Islamabad’s policymakers during that period.

Relatively little has been suggested about the way the economy should be pulled back from the edge of the abyss where it stands today.

Unless the government takes stock of the current situation and carefully assesses the future, there is a real possibility that we will fall behind all the countries in the region if not into the abyss itself. There is also considerable danger of social chaos if the situation people face is not urgently addressed. Thanks to an open and aggressive media, people are becoming increasingly aware of their predicament in a regional context.

That Pakistan is the South Asian ‘sick man’ today was underscored by a report released to the public by the World Bank on the eve of the institution’s spring meetings held in Washington a couple of weeks ago. The Pakistani delegation to the meeting was led by the new de facto finance minister, Dr Hafeez Sheikh. According to the report all South Asian economies with, the exception of Pakistan and Afghanistan, have pulled out of the partial slowdown caused by the Great Recession of 2008-09. Even Nepal, which has had its share of economic and political problems, is expected to do better than Pakistan in terms of economic expansion.

In the World Bank Global Monitoring Report 2010, South Asia’s GDP growth rate is expected to increase to seven per cent in 2010 and 7.4 per cent in 2011. India will lead the way in this resurgence followed by Bangladesh. India’s projected performance is particularly impressive. It will approach a GDP growth rate of nine per cent which means an increase of 7.5 per cent in the country’s per capita income. Even some of the laggard states in India are being pulled out of economic stagnation and are joining those that are performing well. Bihar, for instance, will see its economy grow by 11 per cent in 2010. It has been the slowest growing state in the Indian Union and also the poorest.

A number of factors will contribute to the pick-up in India. The most remarkable of them will be the steady increase in the domestic savings rate which will draw close to 40 per cent of GDP, the level achieved by fast-growing economies such as China. This makes India considerably less dependent on external capital than Pakistan. India will also benefit from the pick-up in international trade. Unlike its previous record, exports will become more diversified with manufacturing joining services as the sectors responsible for growth.

In the past India’s IT sector had pulled the rest of the economy towards modernisation. Now manufacturing has become another area of dynamism. The source of the impressive performance of manufacturing in international trade will be based on exports that make use of some extraordinary technological developments. A small motor car brought to the market by Tata Motors is one example of this development. Called the Nano, it is designed entirely by Indian engineers, uses mostly Indian materials and inputs and is meant to be driven on the country’s depleted roads. The car is expected to do well in other parts of the world that have a growing demand for cheap and sturdy models. Nano sells for only $3,000.

India will also continue to develop new markets for exports. China has emerged as the country’s largest trading partner, buying mostly commodities of which India has abundant supplies, China, becoming increasingly dependent on material inputs for feeding its expanding industry, is turning to India for such important inputs as coal and iron ore. The point of making these observations about this happy economic situation in India is to emphasise the important role the state can play in helping the economy to grow and for people to enjoy the fruits of development. India may have been in a more advantageous position when it, together with Pakistan, acquired independence from the British in 1947. But through the use of disciplined state action in the 1960s, Pakistan brought itself to India’s level. Not only did it close the income gap with India, for about a decade and a half, it was treated as a model of economic success. That, of course, is no longer the case.

At that time India was labouring under what was called the Hindu rate of growth, above three per cent per annum. Pakistan at that point was growing at a rate twice as high: six per cent a year. Even then Pakistan had a higher rate of population growth. In spite of that its per capita income increased at a rate 75 per cent higher than that of its neighbour. Pakistan then overtook India as South Asia’s most prosperous economy.

If we were to search for the one reason why the country has been standing at the edge of a social and economic abyss, it will have to be the failure of the establishment to provide what is loosely described as ‘good governance’. By good governance is meant a number of different things; effectiveness of the various parts of the administration to provide for people’s varied needs; effectiveness, also, of the legal system and the judiciary to provide speedy justice to the people in civil and criminal matters; and reducing the level and incidence of corruption.

Without moves such as these Pakistan will not be able to pull back from the edge of the abyss where it stands today. The passage of the 18th Amendment has set the stage for bringing about improvement in this context. One can only hope that the opportunity that has become available will not be lost as several others were missed in the past. If policymakers continue to dither, the consequences may be too grim to contemplate.

Trade troubles in the neighbourhood

By Shahid Javed Burki
Monday, 10 May, 2010

There are several things unique about Pakistan’s economic situation. One of the more positive ones is that it is the only country of a significant size that borders on two mega states, China and India.

Bhutan and Nepal also border the two countries but they have relatively small economies. The gravity model of trade popular with most economists tells us that size and distance matter in determining important trading partners. Applied to Pakistan’s case that model would have China and India as the most important origins of Pakistan’s imports and the most important destinations for its exports.

But for a variety of reasons that did not happen. Most of them were of political nature. Instead, at this time, the United States is the country’s largest trading partner. That too is for political reasons.

That notwithstanding, the dynamics of the Asian region are changing in such a way that Pakistan could be drawn into this expanding economic area and begin to benefit itself. China and India are the world’s most rapidly growing economies. In 2010, China is expected to see its GDP increase by more than 10 per cent; India by eight per cent.

Now with 1.34 billion people and with per capita income of $6,500 in purchasing parity terms, China’s GDP is estimated at $8.7 trillion. In 2010, its population is estimated at 1.17 billion and its income per capita at $3,320. This means that the size of the economy is $3.88 trillion.

One of the important recent developments in recent years is the sharp increase in trade between China and India. If some of this was to be conducted over land and if Pakistan agreed to grant transit rights to India to move its products through its territory to the countries on its borders, there would be considerable benefit available to it.

The “ifs” involved in this statement are many including the possibility that the trade between China and India would remain free of frictions. That has not been the case, particularly in recent months.

Recently, India has begun to impose restrictions on the import of telecommunications equipment from China Beijing has aggressively developed its capacity to export telecommunications equipment deeply penetrating the South Asian markets. India is not the only country. China is attempting to penetrate using technology and the products that have special significance for emerging markets.

China’s Zong telecom has not only entered Pakistan; it is making deep inroads into the country’s market. It has grabbed a significant share of the market and has done so at the expense of a number of foreign suppliers who have been much longer in the country. Pakistan now has one of the large mobile telephone markets in Asia with a penetration ratio higher than that achieved by India. It had 95.54 million customers in 2009 for a population then of 162 million which implies a penetration ratio of close to 60 per cent. China was very helpful in developing this industry. Zong now has 6.48 million customers. There are now discussions going for the manufacture of cheap Chinese mobile phones and personal computers in Pakistan.

While the Chinese have not been involved in the provision of services in India, they have taken a significant share in that country’s market in the equipment business. The Indian mobile industry is second only to China’s in terms of subscribers. Both have large populations and rapidly modernising economies. China has 825 million subscribers, India 584 million. The number is increasing rapidly in both countries. In March 2010, India added 20 million new subscribers to the list. This rapid expansion has put pressure on mobile operators to add network capacity as quickly as possible.

Operators in India added significantly to the network in recent years investing about $34 billion in the process. While India is developing indigenous industry to supply the equipment needed, it cannot keep up with rapidly growing demand. It has had to rely on imports, a significant part of which – about 40 per cent –comes from China, which, as in so many other things, is able to supply much more cheaply. According to one estimate China is 20 per cent cheaper than such European providers as Siemens and Nokia. But a new wrinkle has begun to cut into this trade. I will return to this issue a little later.

A number of issues have begun to affect trade relations between the two Asian giants. New Delhi has liberally used the anti-dumping measures allowed under the WTO rules to restrict many imports form China. Some of the moves were made at the urging of Indian manufacturers.

According to a recent report in International Herald Tribune, “India recently clamped down on the number of visas allotted to foreign companies, a move regarded by some as being aimed at Chinese power companies that import labourers from home to build India plants.” This is a common Chinese practice.

For instance, when it constructed a new embassy building for itself in downtown Washington, China requested and received the permission to bring in Chinese workers into the United States. This was done so that the engineers from China working on the projects could communicate with their workers.

Most Chinese engineers are monolingual; they speak only Mandarin. But the Chinese maintain that they have used mostly Indian workforce for the projects in that country. Two Chinese companies – Huwaei and ZTE Corp., both among the largest players in the world – are active in building infrastructure in India. They employ 7,000 people in India, and 85 per cent of these employees are Indians.

The wrinkle that has begun to affect the flow of telecommunications equipment to India is the latter country’s security concerns. A report titled Shadows in the Cloud, released in April by the Citizens Lab at the University of Toronto said that computer hackers in China conducted an extensive spying operations in India. It began in 2009 and was able to obtain sensitive information including documents from Ministry of Defence. This has further deteriorated trade relations between the two countries.

This affair as well as the Chinese complaints about the excessive use of the WTO dumping clause by India have soured relations but probably not dealt a serious blow. What these incidents underscore is the absence of a dispute resolution mechanism to handle issues such as these. Pakistani manufacturers also complain of Chinese practices. Some of them suggest that producers in China have copied their products and sold them at extraordinarily cheap prices, ruining their industries. But they did not press the government to go to the WTO knowing that Islamabad would not resort to that provision because of the very close relations between the two countries.

Could a regional arrangement serve this purpose. China now has the status of an observer in SAARC but that organization remains weak, unable to deal with issues concerning its full members. In fact when the Indians agreed to the establishment of SAARC they insisted that bilateral issues would remain outside its purview.

Another approach worth exploring is for the large Asian neighbours – China, India and Pakistan – is to set up a multilateral commission that could perform a number of trade related functions, not just dispute resolution. Its main focus could be trade facilitation as well as improving the physical infrastructure – roads, railways, power grids, gas pipelines – that connect or should connect these countries. Perhaps Islamabad could take the lead in taking such an initiative.

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Managing external flows

By Shahid Javed Burki
Tuesday, 11 May, 2010

FOR some time — perhaps for a very long time — Pakistan’s economy will remain dependent on external financial flows. The country cannot at this time achieve a sustainable rate of economic growth without obtaining a significant amount of money from abroad.

As several economists — the writer included — have pointed out, the country’s economy did well when money flowed from abroad. This happened during the periods of Presidents Ayub Khan, Ziaul Haq and Pervez Musharrraf. The rate of economic growth exceeded six per cent a year and serious dents were made in the levels of poverty.

For the last several years this relationship between large external capital flows and the rate of economic growth has broken down. Since 9/11 the country has received large amounts of money from abroad. Initially it had an impact on GDP. For three years the GDP increased at an average rate of seven per cent and the country seemed on its way to join other states in a rapidly growing Asia. Since then the economy has stalled. It is now clear that it will require large doses of foreign capital flows to recover. In the language of economics external capital flow for Pakistan is a necessary condition for growth but it is not enough. Many more things need to be done. Doing them will require some serious strategic thinking by Islamabad.

Continuing with the subject of foreign capital flows, it is worth pointing out that they come from several different sources each with different objectives. Balancing these is part of the strategy the government needs to develop. The flows are provided by friendly countries that have a variety of different interests they wish to pursue. They come from such development agencies as the World Bank Group and the Asian Development Bank primarily interested in promoting economic development and alleviating poverty.

The IMF on occasion becomes an important source of finance as it has for the last year and half for Pakistan. Its purpose is to provide quick money for helping countries experiencing severe economic stress. Pakistan, Iceland, Hungary and more recently Greece are some of the countries pursuing IMF programmes.

The private sector is often the source of funds. It may provide them as portfolio flows when investors pick up shares in the capital markets. The recent run-up in the Karachi Stock Exchange was helped by external portfolio flows. Capital may come as foreign direct investment when companies or individuals buy economic assets or build green-field plants.

The privatisation programme pursued vigorously by the Musharraf government brought in this kind of money. Countries such as Pakistan that have a large number of people living and working abroad normally receive large amounts of remittances. These are sent for a variety of purposes — help to family members, general charity, portfolio investment, general investment. In Pakistan’s case remittances are now the largest single source of foreign finance.

For a country as dependent on foreign money as Pakistan is today, mobilising money from abroad and channelling it into productive purposes become important areas for government involvement and public policy. There is a need to balance foreign with domestic interests. This is not always easy as demonstrated by the different objectives being pursued by the United States, the IMF and the development banks in Pakistan. I will begin by elaborating on the US strategy towards Pakistan and how Pakistan is reacting to it.

When countries provide money they do it generally in pursuit of their strategic interests. Among the four large bilateral donors to Pakistan the interests of China, Japan, Saudi Arabia and the United States differ. Reconciling these with domestic objectives can often be tricky. We are seeing this in the case of American help to Pakistan. With the Kerry-Lugar bill having become law, Washington has attempted to bring in line its policy with Islamabad’s interest: it is committed to helping the country over a long period of time with the level of support clearly indicated for a period of five years, possibly 10. This initiative took care of the long-standing complaint by Pakistan that Washington kept it on a short leash.

Washington also accepted Pakistan’s contention that fighting terrorism will mean more than the use of force. It will also need economic development of the enormously backward areas that contain a number of terrorists. The US had come to the same conclusion as it altered its own strategy by opting for what is called the ‘counter-insurgency’ strategy. It combines force with development. In return, the US wants Pakistan to aggressively pursue the terrorists operating on and from its soil.

The United States does not wish Islamabad to distinguish among various terrorist groups by using the criterion of the damage they are inflicting on Pakistan (Tehrik-i-Taliban) or concentrating their activities outside the country (the Haqqani network operating in Afghanistan out of sanctuaries in North Waziristan). Pakistan has been prepared to battle the former but not the latter. That it makes sense for Washington not to draw distinctions between terrorist groups is illustrated by the recent case of Faisal Shahzad, an American citizen of Pakistani origin who is alleged to have attempted to set off a bomb in New York’s Times Square.

Faisal is reported to have spent some time in Pakistan in 2009. He may have been motivated to attempt to bomb Times Square by one of the terrorist groups in Pakistan. Washington, therefore, cannot be expected to distinguish among different terrorist groups. No matter which way this case develops it will have profound implications for Pakistan-US relations. Islamabad needs to carefully manage this unhealthy development. Left unattended it will hurt the American interest in the economic development of Pakistan.

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Asia and the Greek

By Shahid Javed Burki
Monday, 17 May, 2010

THERE are important lessons to be learned from the unfolding Greek tragedy. This is particularly the case for Asia that has for years looked at the process of economic integration in Europe as an interesting model to be studied for bringing about regional economic cooperation.
That said, a consensus has developed among Asian policy analysts that economic, political and social situations in Asia did not match those in Europe. Regional cooperation in Asia, therefore, had to be a much slower and deliberate process than the one pursued by Europe in the second half of the twentieth century.

The European Union evolved at a pace and in scope that could not have been possibly envisioned by its founding fathers half a century ago. The EU now has 27 countries as its members. They are of varying size and are at different levels of development.

Having given membership to so many countries, the Europeans have allowed some of the older participants in the enterprise to develop additional mechanisms for further integration. A group of 16 nations within the larger union has given up national currencies in favour of the euro, the common currency. Some of them have done away with the need for passports to cross their borders. Travelers need only one document to travel among these countries.Politics more often than economics was the reason for the race to integrate Europe. Initially it was the fear of the Soviet Union and the encroachment of Communism on the European mainland that prompted those in the western part of the continent to band together. There was considerable comfort in presenting the expansionary Soviet Union with a united front.

The EU expanded to the south and south west of the continent in order to prevent the spread of Communism. As the countries in the Iberian Peninsula and those along the Mediterranean cast off autocratic rule in favour of democratic structures, the European core felt it necessary to embrace them quickly. This would stop slippages from occurring. It was mostly for this reason that Spain, Portugal and Greece were admitted into the union. It is interesting that at this time all three are feeling extreme economic stress which was proving hard to manage because of the constraints imposed by membership in the European Union.

The EU’s expansion to the east also happened largely because of politics. As the Soviet Union collapsed and several countries in east Europe emerged from behind the Iron Curtain, the core group once again offered EU membership to secure their independence. Poland, Hungary, the Czech Republic, Slovenia and several other countries moved in as members. Poland’s inclusion was especially significant since under the Soviet Union the defense agreement among the countries in the east of the continent was known as the Warsaw pact, after the name of the country’s capital.

In hindsight the mistake the Europeans made was to marry economic objectives with political motives. While it was considered politically prudent to bring into the EU the countries on the fringes of Europe, they had to accept stringent economic conditions to obtain membership. But it turned out to be a process where policymakers did not pay much attention economic criteria. This is why the case of Athens unfolded like a classic Greek tragedy. No matter what roadblocks were erected Greece kept moving towards disaster.

The latest $1 trillion package of support is meant to prevent the worst from happening: the beginning of the unraveling of the union.

Europe’s current plight can be traced to 1981 when Greece, still recovering from the aftermath of military rule, was rushed into EU 14 years ahead of several more developed countries . Greece beat the much richer Austria, Finland and Sweden to the European stage. That was not the only lapse In January 1999, 11 countries locked their currencies – the first stage in the creation of euro, the common currency – after agreeing to a tough set of conditions. These included budget deficits that must remain below three per cent of the country’s gross domestic product; national debt must not exceed 60 per cent of GDP; and the annual rate of inflation must remain below three per cent. Countries such as Greece could not – and did not – make the grade but were still admitted.

But Athens persisted, even resorting to the cooking of its accounts. In 2002, Greece was among those that gave up their currencies to adopt the euro. When the new currency notes were being printed Yannos Papantoniou, the then Greek finance minister, implored his counterparts that the euro notes and coins that circulated in his country should also carry the wording in Greek alphabet.

According to Jurgen von Hagen, professor of economics at the University of Bonn, when Greece was admitted into the euro club, “there were clear indications that Athens was forging the data, especially data on deficits, to make their public finance more benign than it really was. But European governments did not want to pay attention. For political reasons they wanted Greece in.” It paid Greece to be in but only for a while. Membership in the Union and a currency it shared with such economic power houses as France and Germany meant that the country could borrow cheaply. It did that copiously particularly to finance the 2004 Olympic Games in Athens, the city that had first held such a competition. Now the bills have come due and the country has had to go hat in hand to Germany, France and the IMF for a massive bailout.

This story has obvious lessons for Asia which is also engaged in a complicated exercise to integrate its many economies into regional associations. Two lessons should be learned from the European experience. Regional integration should be guided by economic considerations rather than by politics. A neat arrangement that encompasses a diverse group of countries is not necessarily preferable to the one that evolves, perhaps untidily over time and on the basis of experience.

The Asians, ever pragmatic, have allowed regional associations to grow and evolve not according to some grand design but to reflect the needs of the time. Attached to the ASEAN now are number of arrangements that have allowed several countries to bind themselves with the core depending on their varied interests. This is the way to go.

This approach has worked well for East Asia. In South Asia, however, attempts at regional integration have largely stalled for political reasons. The two largest economies in the South Asia Association for Regional Cooperation, the SAARC, have so many political problems between them that they have found it difficult to push forward such efforts as the South Asia Free Trade Area, the SAFTA.

As was demonstrated recently at Thimpu, Bhutan there was so much interest in the meeting between the prime ministers of India and Pakistan on the sidelines of the SAARC summit that little attention was paid to regional matters.

In Europe politics pushed regionalism faster than it should have gone; in South Asia politics is having the opposite effect. But the fact remains that South Asia needs serious regional cooperation as much as Europe did in the immediate post Second World War period While South Asia should move in that direction in a measured way – a lesson to be learned from the European experience – it must begin the journey with serious intent.

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India & South Asia’s future

India should work towards bringing stability to its neighbourhood. It should not feel tempted to go it alone since it will be continuously distracted by instability and uncertainty.

By Shahid Javed Burki
Tuesday, 18 May, 2010

INDIA’S GDP increased at al most nine per cent a year before slowing down when the world went into the recession in 2008 09. It has picked up again with Finance Minister Pranab Mukh erjee promising in his 2010-11 budget speech an annual 10 per cent increase in GDP to be ach ieved in a couple of years.

While India is rising, it will find it dif ficult to achieve the coveted status of an economic superpower. This is for at least two reasons. One it has not found a way for the relative prosperity achieved by a quarter of the population to reach the remaining three-fourths. As Joseph Stiglitz writes in his most recent book on globalisation India is indeed shining “on the lives of some 250 million people [but] for the other 800 million people of India, the economy has not shone brightly at all.” The other reason why India has been held back from achieving its ambition is that it is an island of relative stability in a highly restive part of the world. There is an on-going conflict in Pakistan involving the rise of Islamic extremists who are challenging the writ of the state. Thousands of people have perished in the conflict to which there is no end in sight. This conflict has been seen by some as posing an existential threat to the country.

The militants and terrorists operating from within Pakistan are not only endangering the survival of the Pakistani state. They have also extended their operations beyond the country’s borders as evidenced by the Mumbai attacks in November 2008. More recently, an American citizen of Pakistani descent attempted to set off a car bomb in New York City’s Times Square.

The future of Afghanistan, not strictly an Indian neighbour, remains highly uncertain especially given the fact that US wants to begin withdrawing its troops from that country beginning next year. Nepal to India’s immediate north, re mains unsettled and in considerable turmoil. The powerful Maoists who earlier showed some willingness to work with the established groups to stabilise the country called a strike some weeks ago, paralysing the capital Kathmandu. As Manjushree Thapa, a Nepalese, wrote in an article published in May 2010, “we Nepalese are still baffled about how to be part of the modern world ... For this we are still … waiting.” Bangladesh to the east is still struggling to stand on its feet although it has made some progress since the return of democratic rule. It now has the second highest rate of GDP growth in the South Asian mainland after India.

Then there is Sri Lanka to the south, not strictly a part of the South Asian mainland but the narrow body of water that separates it from India is not wide enough for it not to cast a shadow on its neighbour.

Although the military was able to put down the long-enduring Tamil insurgency, discontent among the members of this large minority remains. That the Tamils are a large community in India complicates matters. What complicates issues further is the country’s drift towards authoritarian rule.

It is only with the little kingdom of Bhutan where the monarch has willingly surrendered most of his royal powers that India has a stable country on its borders.

Even India has had to deal with armed rebels in its midst, whose ranks are being swollen by the discontent occasioned by growing inequality. Known as the Naxalite-Maoists, this challenge to the Indian state was first thrown in the eastern village of Naxalbari. The areas in which insurgents draw their support are sometimes referred to as the ‘red corridor’. In 2006 Prime Minister Manmohan Singh called the group’s activities “the single biggest challenge ever faced by our country”. Two years later the prime minister said the country was “losing the battle against Maoist rebels.” India has enough military strength to first contain and then overcome the challenges it faces at home. Its leadership recognises that a high rate of economic growth, which the country has demonstrated the ability to achieve, will not trickle down fast enough to handle growing discontent inside its borders and among its own people.

The government is committed to helping the lagging rural sector. It was worried enough about creating new jobs for new entrants to the work force to launch an employment guarantee scheme for rural areas. It is the external challenges emanating from its immediate neigh bourhood that need to receive the attention of policymakers in New Delhi. India must lead the regional integration effort rather than be the perpetual laggard.

What then are the options available to India, by far the largest country in South Asia by virtue of the size of its population and that of its economy, to achieve the status of an economic superpower? This question has several answers. The most obvious one is to working towards bringing stability to its neighbourhood.

It should not be tempted to go it alone since it will be continuously distracted by instability and uncertainty all around its borders. But to deal with its neighbours, India will need to cast off part of its old approach and work towards a new strategy aimed at producing a working economic entity in South Asia to which it and its many neighbours are fully committed.

A move in that direction is not taking place. The most important initiative in this respect is the South Asian Association for Regional Cooperation, Saarc, created a quarter of a century ago. As shown by the Bhutan summit of April 2010, there was much greater attention given to the meeting between the prime ministers of India and Pakistan on the sidelines of the summit than to the work of the summit itself.

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Shaping South Asia’s future

By Shahid Javed Burki
Monday, 24 May, 2010

In spite of the effort made over the last quarter century to bring about more meaningful economic integration of the South Asian region, not much has been achieved. Regional trade as a proportion of the total has increased a little but compared to other regions, it remains almost insignificant.

How much is the area losing out by not turning sufficient amount of political attention to integration and cooperation? One way of answering this question is to use trade as the driving force for accelerating economic development.

Using trade as the basis and historical GDP-trade elasticities for making projections, it is possible to develop some scenarios for the future. We do this purely for illustrative purposes.

The three scenarios presented here are based on assumptions about the extent of integration as well as the degree of reorientation of trade with a significantly more of it going to Asia in general and South Asia in particular.

According to the first scenario in Table 1, the countries in the region continue to focus the direction of international trade and its content on distant trading partners. We call this the base case.

For India, the United States and the European Union remain the most important markets for its exports and the most important source of its imports. The same is true for Pakistan. Even though China-India trade is likely to grow at a faster rate than overall trade, increasing Beijing’s share in New Delhi’s international trade, India does not become a partner in the China centered system of production that is taking shape.

According to this scenario, the growth of India’s GDP is sustained at the rate of seven per cent a year in the 18 year period between 2007 and 2025. This is well below the 10 per cent growth target Finance Minister Pranab Mukherjee set for the country in his budget for the year 2010-11. The size of the Indian GDP increases more than three-fold and income per capita grows 2.75 times. India’s share in the combined GDP of the region increases from 82 to 86 per cent.

Bangladesh will be the second most rapidly expanding economy according to this scenario with the rate of increase in GDP averaging six per cent a year. Nepal does the least well with the rate of growth at 4.8 per cent. Pakistan’s performance lies somewhere in between that of India and Nepal. Growing at 5.5 per cent a year, the size of its GDP increases 2.6 times but its share in South Asian total output declines from 10 per cent in 2007 to only eight per cent in 2025.

The second scenario is based on the assumption that the South Asian countries take greater cognizance of the importance of international trade as contributor to growth and also of the move in the centre of gravity of the global economy to the Pacific from the Atlantic.

What this means is that the countries of the area pay greater attention to the changing structure of the global production system. This will be largely centered on China. New Delhi’s policymakers, taking note of this, are already deeply engaged in building better economic relations with the ASEAN group of countries. They are also participating in the Asian Economic Summit, an arrangement that includes ten countries of the ASEAN region as well as Australia, China, Japan New Zealand and South Korea . This change in strategy adds to the rate of growth of all South Asian countries. India’s GDP is 12 per cent higher compared to the base case scenario but its share in the regional GDP remains the same at about 86 per cent. (See Table 2.)

The third case builds on the second by assuming that South Asia manages to develop stronger economic contacts among the countries in the area. Compared to the status quo situation in the first scenario, the combined GDP of the region is considerably larger as is income per head of the population– both by as much as 40 per cent. The incidence of poverty declines significantly and better services are provided to the citizenry. South Asia is also better integrated with the rest of Asia.

In terms of rates of growth, the largest gainer is Pakistan followed by India. Pakistan’s GDP growth according to the third scenario is 2.4 percentage points higher compared to the first while India’s is two percentage points better. In the case of Pakistan income per capita of the population in the third scenario is 52 per cent higher while that of India is 40 per cent greater.

The impact on poverty and quality of life will be pronounced if the third scenario is played out. This is for the reason that economic structures will be profoundly different in this case, particularly in the countries on India’s borders. Pakistan, for instance, will be able to develop agriculture to take advantage of the huge Indian market. This would have happened had the countries not severed their trade relations soon after gaining independence from the British rule. Then close to two-thirds of Pakistan’s imports came from India and about the same proportion of its exports went to that country. These proportions declined to about five per cent when the two countries declared a trade war in 1949 on the issue of the rate of exchange between their currencies. This is where the proportions have remained in spite of the launch of the South Asia Free Trade Area initiative in January 2004.

With the rebuilding of economic and trade contacts other sectors could also get aligned. Pakistan could become an important supplier of auto parts to the rapidly developing Indian automobile industry while India would become the main provider of iron ore to the steel industry in Pakistan. Bangladesh could get better integrated in the much larger textile sectors of the two larger economies, India and Pakistan.

However, to realise the third scenario there will have to be exercise of considerable amount of political goodwill which has been in short supply now for many decades.

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Discontent in India

By Shahid Javed Burki
Tuesday, 25 May, 2010


DISCONTENT in India has been brewing for a long time. It has now come to the surface with the rise of the Maoist rebellion in several states of central and eastern India. The rebels have inflicted very heavy damage on the security forces that are attempting to bring the insurgency under control.

A large number of people have been killed since April when the Maoists launched one of their more brazen attacks, killing 76 security personnel. They struck again recently blowing up a bus that was carrying 50 people. Of these 18 were special police officers belonging to a separate force to fight domestic terrorism. The Maoists triggered an improvised explosive device near Dantewada in Chhattisgarh India.

These attacks indicate a clear escalation in the activities of the Maoists, a movement that started decades ago among the hill tribes in the eastern state of Assam. According to government sources, there were 2,250 attacks in 2009. In the first four and half months of this year, the rebels have launched 810 attacks. In 2009, 590 people were killed by the insurgents. Their activities in 2010 have already claimed some 200 lives.

As political scientist Samuel P. Huntington wrote more than four decades ago it is almost inevitable that a society and an economy that grows fast will leave behind many segments of the population. This will manifest itself in open discontent if the country experiencing change does not have strong political and economic institutions to absorb discontent and provide relief to those who suffer from what he called “relative deprivation”.

Much of the evidence Huntington used for his seminal work came from Pakistan and some Latin American countries. When he was completing his work, the Ayub Khan era was coming to an end in Pakistan and there was a widespread feeling that large sections of the population had not benefited from the admittedly large increase in national output. This feeling was very strong in East Pakistan and also present in the western wing of the country.

Economist Albert O. Hirschman, writing about the same time as Huntington, went a step further and identified what he thought were the options available to those who were not happy with their situation compared to the major beneficiaries of social and economic change. The title of his influential work, Exit, Voice and Loyalty, indicates the options he had in mind.

In a well-developed political system, those not satisfied can hope to be heard by raising their voice; if those who wield power act to redress the felt grievances, they can hope to win the loyalty of the affected population. If not, the adversely affected are likely to exit, moving into the areas that are hard to reach for the forces of the government. This is what the Maoists have done.

That the situation described by Huntington and Hirschman could lead to violence and ultimately regime change was understandable in a country such as Pakistan in the late 1960s when the political system of the times did not provide adequate space to the disaffected. ‘Exit’ was the only choice available and was exercised by the people not only against Ayub Khan but also Zulfikar Ali Bhutto a few years later.

India is different. For more than half a century it has had a political system that successfully accommodated many diverse people. Why is it then that the groups such as the Maoists have taken up arms against the Indian state? And why is the Indian state finding it so difficult to control the situation?

The answer to the first question is that the mode of development pursued in recent years by New Delhi has led to the creation of much visible wealth for one class of people while there has been little material change for the masses.

Income inequality has increased to the point that the high rates of growth of the last two decades have made little change to the incidence of poverty. The poor in the large Indian countryside have not seen much improvement in the quality of their lives.

The pursuit of growth has led to the exploitation of the areas that are rich in mineral wealth. However, adequate compensation has not been given to the people who have lived there for centuries. It is the mining of coal in some of the forested areas that has led to the rise of the Maoist movement.

In a statement issued by the Communist Party of India (Maoist), that has provided the political umbrella under which most of the dissident groups are operating, the blame was laid at the government’s door. “As long as the government refuses to see the socio-political roots of Naxalism and continue to treat it as a problem … Dantewada-type attacks will continue to take place [with] greater frequency and intensity. An all-out war has already been declared. Maoist counter-violence will take on new and deadly forms which these apologists of state terror cannot even imagine.”

The Indian state’s slow and somewhat clumsy response to the situation is somewhat reminiscent of the one initially adopted by the government in Islamabad in dealing with the Taliban movement. It was only after a great deal of damage had been done to the Pakistani economy and to the country’s reputation that the authorities developed a position that has begun to yield results.

In India there is now an intense debate in the media and among the political circles about the best approach that needs to be followed. P. Chidambaram, the home minister, is in favour of using as much force as possible and equipping the security forces fighting the rebels with helicopter gunships. Several ministers in the Manmohan Singh cabinet are in favour of using a softer touch — negotiations and development to win the Maoists to give up their fight. Which way this dispute is settled will have a tremendous bearing on India’s future.

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Remaking of the corporate world

By Shahid Javed Burki
Monday, 31 May, 2010

BY now the suggestion that the global economy is being reshaped by the process economists call “catching up” is generally accepted. There is no doubt that Asia is rising and within Asia, China has replaced Japan as the dominant economy.

The Japanese, when they dominated Asia, were really oriented towards the West; they had few contacts with the Asians, including those in their immediate neighbourhood. Initially China followed the same model, growing by exporting large amounts of cheap manufactured products to the West. But that approach has changed in the last few years. There are three reasons for this. Two of these are already in place; the third has only very recently begun to acquire salience.

The first reason is the remaking of the global production system that has reduced the emphasis on producing one product entirely by one process within firms. Instead, products are now being made by importing parts and components from many different places. The production process has been scattered to the four corners of the world; it has become globalised. The process will continue for many reasons, among them demographic changes in the developed world. Today’s industrial countries are simply running out of people to staff and manage businesses.

The second reason is the way some of the large emerging economies have dealt with the Recession of 2008-09, spending large amounts of “stimulus money” in reshaping their economies rather than simply creating jobs by pumping money into what President Barack Obama called “shovel ready” projects.

The Chinese, for instance, used the money to build infrastructure that will aid their economic transformation. A good part of this money went into improving China’s links with the countries in the neighbourhood. Among the countries China is developing links with are Vietnam, Laos, Thailand, Myanmar and Pakistan. This means that China is paying much greater attention to Asia than was done by Japan which was the second largest economy in the world before being replaced by China.

The third contributing factor to global change is the growth and geographic expansion of firms in the emerging world. Let us begin with some data before going on to discuss the impact of this development on the global economy. The “emerging firms”, to coin a phrase, have become more important in the corporate world over the last ten years.

In 2000, only 26 companies from the emerging world made it to the list of the Financial Times 500 companies. Their total capitalisation was estimated at $700 billion out of $21.3 trillion. In other words, only 5.2 per cent of the firms from the emerging world then could be classified as big and they had 3.2 per cent of the capital worth of the world’s 500 largest companies. The average size of the large emerging firm was about $27 billion as against $43 billion for the firms in the old industrial countries.

The picture since then has changed quite remarkably. There are now 199, or 23.8 per cent of the total, emerging firms listed by the Financial Times among the world’s largest. Their size has increased to $45 billion compared to $48 billion for the firms in the industrial world. In 2000, the average size of the large firms in the emerging world was 63 per cent of those in the industrial countries. Now, ten years later, they are practically of the same size.

The firms in the emerging world increased their presence in the global corporate world – and their size as well – through acquisitions and not organic growth. Again some numbers will help us to understand the trends. Three years ago, before the Great Recession pulled down the global economy, $211 billion of money spent on mergers and acquisitions flowed from the developed to the developing world. But the developing countries’ firms were also buying assets in the developed world. For every dollar that developed countries’ firms spent in M&A activity in the developing world, developing countries spent 87 cents.

In just two years, the ratios changed dramatically. In 2009, the cash-strapped corporations in the industrial world spent only $74 billion acquiring businesses in the developing world while the developing countries put in $105 billion for the same purpose.

This time for every dollar spent by the developed world corporations in the developing world, the developing world companies spent $1.42. As these numbers suggest, developed country firms have not given up expanding into the developing world. In fact some of the newer firms in the West have been aggressive in creating a presence in emerging markets. Microsoft has developed a large development and research centre close to Beijing while Cisco has set up its “eastern headquarter” in Bangalore.

Size begets size. It was only the very large developing countries’ firms that were engaged in acquisitions in developed countries. Some of these transactions hit newspaper headlines and rocked the developed world. When India’s Tata acquired Corus for over $110 billion, it was recalled by British newspapers that in the 19th century the grand father of the current head of the company was turned back contemptuously by the British when he sought to bid for the supply of railway track for the Indian railways. Indians, he was told, should concentrate on tilling the soil rather than venture into the complicated business of making steel products.

Those kinds of prejudices and biases are gone but other types of obstacles remain. On several occasions security concerns have been cited – in particular by the Americans – to prevent developing country firms from picking up assets. One example of this is the attempt by World Port, a Dubai-based company, to buy P&O, a firm that owned and managed a number of ports in the United States. The reason for this may have been that the acquiring firm was based in an Arab state and ports are considered to be sensitive assets. However, the Americans have been equally reluctant to let in the Chinese firms into some of the areas they consider sensitive. Washington objected to a bid by the Chinese telecom giant Huawei to buy 3Com, a US network technology company.

There is a belief that the Chinese and Indian firms that are expanding abroad are doing so to ensure a steady supply of raw material and sources of energy for their countries. That is only part of the reason. These companies are also interested in acquisitions for a number of other reasons: to get closer to the markets for some of their products and services, acquire new technologies and skills, diversify geographically. While the bulk of the acquisition activity has involved firms in large Asian countries, the Latin Americans have also begun to look outside their borders. The Brazilians in particular have become active.

For obvious reasons Pakistan has been almost totally absent from this area. It has not developed firms of the size that they can think of going abroad to look for expanding markets. Financial sector firms, in particular commercial banks, are the only corporate entities that have the wherewithal to venture outside the country’s borders. But they have decided to concentrate on developing the domestic market. The only example of some acquisition activity is Netsol, an IT company based in Lahore, that has acquired small companies in the UK and the United States to develop new markets for its products. Other IT firms may follow but firms from the older parts of the economy will stay domesticated unless they develop the size.

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Terrorism & the economy

By Shahid Javed Burki
Tuesday, 01 Jun, 2010


THE latest incident of attempted terrorism in the United States which has links with Pakistan has administered another blow to our economy. The reference here of course is to the attempt by Faisal Shahzad, a 30-year-old American citizen of Pakistani origin, who attempted to detonate a bomb in Manhattan’s Times Square.

The bomb did not go off, which is a great relief not only for the United States but also Pakistan. Had it taken its intended toll, the repercussions for Pakistan would have been grim. It would have set back the prospects for an economic recovery by years. Newspapers quoted a senior official of the Clinton administration saying the “the Times Square attempt has reminded Americans that most of the threats to the US homeland come from the Pakistan-Afghanistan border region.” Fareed Zakaria in a cover story for Newsweek described Pakistan as a terrorist supermarket.

Secretary of State Hillary Clinton told 60 Minutes, a widely watched TV news programme, that there will be “grim consequences” if damage was done by an attack that had links with Pakistan. There was pressure on President Barack Obama to act before it was too late. There could be a reduction in the quantum of aid flows to the county if a terrorist attack is seen to be connected to Pakistan.

As if to underscore the Pakistani involvement in international terrorism, an Indian court sentenced to death 22-year-old Mohammad Ajmal Kasab, the lone survivor of the deadly assault on Mumbai on Nov 27, 2008. The assault was launched by a group trained by a terrorist organisation in Pakistan. Kasab was earlier found guilty on most of the 86 charges brought against him, including murder and waging war against India. The terrorist had given a statement to the authorities saying he was trained by members of the Lashkar-i-Taiba, a Pakistani group designated as a terrorist organisation by both the United States and the United Nations.

The third reminder of terrorism’s links with Pakistan came when another US resident of Pakistani origin, David Coleman Headley, was taken into custody in Chicago for planning the Mumbai attack, prompting India, according to one analyst, “to repeat that extremists living in the territory of its neighbour are exporting militancy”. This is the link that Ahmed Rashid makes in a recent article contributed to the pages of The Washington Post where he says that North Waziristan, one of the seven tribal agencies located in the area that borders Afghanistan, has become “the hub of so many terrorist groups and so much terrorist plotting and planning that neither the CIA nor the ISI seems to have much clue as to what is going on there…. But Pakistan’s counter-terrorism strategy, which has been extensively praised by American generals, is now coming apart at the seams — all because of North Waziristan.”

What is the connection between the perception that Pakistan has become the centre of international terrorism and the country’s economic recovery? The most important link is via Pakistan’s dependence on external capital flows for its economic survival. Of the many types of flows Pakistan depends on, at least three would be seriously affected by the growing apprehension that most acts of terrorism — those that have been carried out and those that have been attempted but were thwarted — originate in Pakistan. The suggested links to Pakistan will not help with foreign private flows and continued assistance by the US government. Even remittances sent by Pakistanis living and working in the US could be affected as those sending money become extremely cautious about the possibility of being questioned by the authorities in America. What should Islamabad do to address this issue and to give the signal that it takes very seriously the use of its territory for the launch of any form of terrorist activity on foreign soil?The first thing that needs to be done is to develop a comprehensive strategy aimed at addressing the problem posed by the county’s real and perceived links with acts of terrorism. Statements by senior policymakers — and there have been many of those in recent months — indicating Pakistan’s resolve to deal with the threat of terrorism don’t constitute a strategy. A strategy has to include a number of elements: a precise definition of what constitutes a terrorist attack and what are the punishments meted out if these acts are committed; how the legal and judicial system will work to ensure that those who violate the law of the land will be expeditiously dealt with; and educating the youth about their responsibility towards the state and the citizenry.

Such a strategy should be developed by a group that has a multidisciplinary background: a group that can view the phenomenon of terrorism from many different angles — economic, political, social, religious. It should have the full backing of the political classes who should be called upon to endorse the strategy, once formulated, fully and without reservations. While it is true that Pakistan has anti-terrorism laws on the books and courts to enforce them, they have done little to implement them. Terrorism has not been brought under control.

The other important move by the state is to make it clear that breaking the law of the land will not be tolerated, no matter who commits the crime. Organisations must not be allowed to operate training camps for militant activities, to collect funds for their operations, to run schools that don’t have proper accreditation and to use mosques to propagate outlandish beliefs.

Politicians normally take the path of least resistance and some of these measures may be hard to adopt and implement. But the alternative is the country’s destabilisation and further marginalisation in the global community. Pakistan is very isolated these days; further isolation would do it enormous damage.

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Budget-making in turbulent times

By Shahid Javed Burki
Monday, 07 june, 2010

PAKISTAN’s economic history has been exceptionally turbulent since it became independent more than six decades ago. There have been many ups and downs – more downs than ups – during this time. Many of them were caused by natural events, some by happenings outside the country’s borders, but most by the decisions taken by those who were responsible for the making of public economic policy.
This is probably the first time that all these contributing factors have come together to produce a perfect storm.

To help the country, navigate through this period of exceptional turbulence will need political will, a good understanding of the nature of the of the problems that need urgent solutions, an appreciation of the policies that will work and those that may do more harm than good, and a full awareness about the consequences on various segments of the population of the changes in public policy.

It is in this situation that Dr Abdul Hafiz Sheikh was called upon to become the economy’s steward. Within a few weeks of taking office he was required to prepare and present the federal budget for 2010-11.My initial judgment is that given the difficult circumstances in which he had to craft the budgetary proposals he has done reasonably well. This assessment is based on a quick reading of three documents: the budget speech, the Pakistan Economic Survey, 2009-10, and ministry of finance’s Medium-Term Budgetary Framework.

How well has the government done in putting together the budget proposals will be discussed in the national legislature in the coming days? However, before answering this question, I will discuss some of the points Dr Sheikh raised at a function organised by the Institute of Public Policy on June 1.

He said that the budget, as a result of a tradition that originated in Britain, has acquired the prominence in parliamentary systems that is somewhat misplaced in modern times. In modern economics budget is one of the many instruments of public policy used by the government to manage and guide the economy. By focusing so much attention on just one instrument of public policy, the people (and that includes the media) are taking the government off the hook during non-budget periods when changes in policy also have great significance. That is the correct position to take.

In fact, in a number of countries major economic policies are being made in the context of medium-term frameworks usually defined as three years. This way the government removes the element of surprise from such instruments of public policy as annual budgets.

People – both consumers and investors – know what to expect from government’s policies over the medium term. Annual budgets then are just a list of marginal changes the government wishes to introduce at that time given the way the economic environment may have been reshaped by some unanticipated events.

Dr Sheikh said that in developing the government’s fiscal stance he was essentially following three basic principles: first economic recovery that has begun to take shape must be protected; two, the government must remain fiscally austere and prudent; and, third, the poor must be provided the financial means as well as institutional support so that the burden of adjustment does not fall disproportionately on their shoulders. These three principles of policymaking are not well reflected in his budget, a point to which I will return in a moment.

That the recovery from the deep economic slump of the last couple of years has begun to manifest itself is the main theme of the Pakistan Economic Survey, 2009-10. The government has lowered the rate of growth estimated for 2008-09 from two to 1.2 per cent. This has the effect of reducing the base, allowing the authorities estimate a higher growth rate for the year in progress. Accordingly, for 2009-10 the government is now estimating a growth rate of 4.1 per cent in the gross domestic product. In the budget the government’s growth target is 4.5 per cent.

For the coming year, the government was faced with one big challenge: how to raise and manage the resources needed to maintain the pace of recovery which was noticeable at this time. The government had to ensure that the fiscal side of the equation was not squeezed to the point at which even the modest recovery that was in place would not be sustained.

The IMF and the World Bank have pressed for lower fiscal deficits. These, they have said, can be achieved by reducing the amount of subsidies that were allowed to various types of consumers. The institutions targeted energy subsidies for special attention. A 40 per cent increase in power tariffs was needed to bring the cost of producing energy in line with the revenue generated from its sale. Such a major change would have unhealthy conse quences; it would, to begin with, reduce the competitiveness of the economy and also hurt the lower middle classes that are already burdened by high and increasing inflation.

The other emphasis was also on resource generation by introducing a new tax instrument, the value added tax. To be successful in both areas, government needed to prepare the public more than it did.

This is one reason why the budget presented late on June 5 has not taken a clear position on resource generation, leaving the use of the VAT more fully perhaps to a later date.VAT is a powerful tax instrument. It has many positive features. It leads to better documentation of the economy, something needed to done urgently.

Given what the new finance minister had said while preparing the budget about the principles that will guide him only one has been fully observed. This pertains to the provision of more income support for the poor by the greater use of instruments such as Benazir Income Support Fund. The impression among people who have looked at the programme is that it is working reasonably well. Institutions such as the World Bank have developed mechanisms that produce better targeted delivery of resources aimed at augmenting the incomes of the poor.

However, where the budget falls short is in other two areas of public policy: how the recovery that is taking place will be sustained and how will the resources needed for it will be mobilised. There is no clear indication as to how the tax structure will be changed to broaden the tax base and increase the tax to GDP ratio. These questions have been asked and analysed in numerous reports produced by experts.

At a pre-budget panel TV discussion, a former industries minister Jehangir Tareen said he was the only big farmer who paid tax on income he gets from agricultural activities. If this claim is correct, it is a sorry reflection of the tax structure currently in place.

Also, I would have liked to see greater focus on reducing government’s non-development expenditure in which there is a great deal of waste and a fuller discussion of the drivers of growth that will produce sustainable growth. The promised fiscal deficit of four per cent can only be realised by a judicious mix of additional tax resources and cuts in expenditure.

Going back to the point Dr Sheikh made about the need to make public policy on a continuous basis, I can only hope that what he couldn’t do in the budget policy he announced on June 5, he will take up in the next few months.

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