Devolution and regulatory changes

By Shahid Javed Burki
Monday, 25 April, 2011

FOR a country of its size and level of development, the regulatory system of Pakistan is underdeveloped. There may be a further setback if the process of devolution does not pay special attention to it, carefully distinguishing between the functions that can only be performed at the federal level from those that can be more efficiently carried out by the provinces.

This division of responsibilities will require an understanding of the initial impulses that led to the creation of the system in the first place and whether the system meets the current needs.

The system of regulation has evolved over time in response to several different compulsions. Citizenry demands, however, were seldom the main force behind regulatory changes and development. The reason for this is that Pakistan compared, say to India, took much longer to develop a representative system of government. Consequently, people’s needs were not fully reflected in the regulatory system. This is likely to change with the devolution of authority to the province under the 18th amendment.

Even at the risk of some simplification, it will be useful to identify the main pressures that have produced the current system of regulation before discussing how the system could be strained by devolution. The regulatory system can be divided into several parts. Each of these was put in place in response to different sets of imperatives.

The oldest regulatory system is managed by the provinces and regulates both the sector of agriculture as well as commerce involving agricultural produce. Laws such as the various agricultural marketing acts in the provinces are based on the 1929 legislation put on the books by the British colonial administration.

The main purpose behind them was to protect the Muslim peasantry from what were seen as the predatory behaviour of Hindu money lenders and middle-men. That reason is long gone – the nonMuslim operators in the sector of agriculture left Pakistan for India soon after the British decided to partition the sub-continent on the basis of religion – but the acts continue to regulate agricultural commerce in a way that has seriously inhibited the development of free markets.

Regulatory systems, if not kept under constant review, can attract vested interests as well rent seeking by the regulating agencies. The passage of the 18th amend ment has provided an opportunity for that review.

The second set of regulations also concern the sector of agriculture. These date back to the mid-1950s when Pakistan for the first time became a food deficit country. The government stepped in and set up mechanisms to regulate commerce in food grains and cash crops. The price of some of the commodities deemed to be essential – in particular wheat – were regulated indirectly by fixing the price at which government would acquire the surpluses for sale by the farmers.

Initially, capacity for storing wheat procured by the government was created. Later the government established its monopoly over international commerce in wheat and rice.

Trading Corporation of Pakistan is in international trade. The system has continued with the government influencing production and trade in wheat, the country’s most important crop. It announces the procurement price of wheat at the beginning of the growing season.

Banking regulation and regulation of the non-banking sector constitute the third pillar of the regulatory system. While the responsibility for overseeing commercial banks rests with the State Bank of Pakistan, non-bank institutions are regulated by a number of agencies with varying degrees of autonomy.

The regulatory system went through enormous expansion when the government headed by Prime Minister Zulfikar Ali Bhutto (1971-77) decided to expropriate large private businesses in the sectors of industry, finance and commerce.

Under Bhutto, the government also decided to improve the working conditions of the labour employed in the formal sectors of the economy. This was to be done in part by instituting laws pertaining to hiring and firing of workers, minimum wages and old-age pensions, and health care.

The pension systems to which both the workers and the employers contribute have accumulated large financial assets which are tapped by the federal government for the purpose of raising general revenue. The ownership of these funds will be a contentious issue as the process of devolution proceeds.

A number of laws concerning labour welfare have accumulated on the books. The attempt to consolidate them into one piece of legislation has not advanced because of the indifference of the provinces. This is one area where devolution might bring rationality into governance but there is also the danger that it might lead to fragmenting the labour market with adverse economic consequences.

The corporate sector was poorly regulated for decades. It was only in the early 1990s with the privatisation of the industrial and other assets nationalised in the 1970s, that the need arose for regulating enterprises in the private sector.

In this context, two agencies were established. The Security and Exchange Commission, established in 1997, regulates the entry and exit of private enterprises from the economic system while the Competition Commission, as the name suggests, ensures that companies operate in a competitive environment. These regulating agencies will continue to function at the federal level even after the process of devolution has worked its course.

In the public utilities sector, it is only for the enterprises involved in various aspects of electricity – generation, transmission and distribution – that a regulatory framework has been established. However, since these enterprises remain in public domain, the state continues to intervene.

Initially, the National Electric Power Regulatory Authority, established as a part of the reform effort launched in 1992, was mandated, among other things, to fix tariffs for various types of consumers. It has been only partially successful in this area. The government continues to intervene, one reason why what is called “circular debt” has become such a major fiscal problem.

It is in the area of delivery of social services that the regulatory system will come under stress as result of devolution. There is already considerable uncertainty as to the locus of responsibility with respect to the functions the federal government has performed in the sectors of education and health. The Higher Education Commission has the responsibility for developing curriculums for institutions operating in the sector.

The decision by the Implementation Commission to devolve the HEC has been challenged in the Supreme Court which has instructed that the process initiated as a part of the devolution should be put on hold pending further review. Similarly the decision to devolve the ministry of health may affect the various drug laws on the books as well as the country’s international obligations for controlling the spread of various diseases.

Pakistan is also committed to the various Millennium Development Goals. It is not clear how this commitment will be met if all the functions of the health ministry are devolved to the provinces. For the moment the provinces are reviewing the various laws and regulations for which they will have the responsibility under the 18th amendment.

Environment is another area that is likely to be affected by devolution. Although there is a ministry responsible for the sector and although there are laws and regulations administered by the provinces to regulate the environmental aspects of industrial production and commercial operations, protection of environment has not received the attention it deserves. There is a real danger that this function of the government may suffer from further neglect as result of devolution.

It would appear that the impact on the nascent regulatory system of devolution has not been fully appreciated by those who are responsible for implementing the process. One likely consequence is that in some areas, particularly in the area of delivery of social services, there may be some set back as the provinces begin to reflect on their own regulatory requirements in developing their system. In several cases, federal competence and ability must be maintained to ensure that there is a regulatory framework to enforce standards across the country.

Imbalances in global economic order

By Shahid Javed Burki
Monday, 09 May, 2011


UNLESS a significant reform of the economy is undertaken and the current trends are reversed, Pakistan’s dependence on external finance will increase with time.

The tax to GDP ratio has declined to the point at which the government is now dependent on foreign loans even to finance current expenditure. What this implies is that policymakers have to pursue foreign relations with an eye on what is expected of them by the countries and development agencies which provide needed cash.

Given this dependence, one would expect that Islamabad would seek admission into forums where important decisions concerning economic relations among large countries get to be taken. That, unfortunately, is not the case. Islamabad has done a poor job of advancing its case for inclusion in these deliberative bodies. Two of them are particularly important – the groups known as the BRICS and the G20.

BRICS as a group owes its existence to a study done by Goldman Sachs, the American investment bank, some years ago. The aim of the study was to see how the structure of the global economy was changing by the rapid growth of some of the large emerging markets. The researchers focused on the four largest and concluded that the center of gravity of the global economy would move away from the Atlantic to the Pacific.The acronym BRICS originally stood for Brazil, Russia, India and China. “S” was added to indicate that it was a plurality of countries that were represented by the acronym. Recently, however, South Africa was added to give the grouping a regional balance. BRICS now stand for five countries.

The BRICS as a group lacks balance. Two of its five countries have more than a billion people each; China has a population of 1.396 billion while India has 1.294 billion people. South Africa has the smallest population of the five with only 51.7 million. If the size of the population was the criterion, Pakistan with close to 180 million should be a member. Russia with 138 million has a smaller population than Pakistan and Brazil with 203 million people is slightly more populous than Pakistan.

In terms gross national income, four of the five BRICS have trillion dollar economies – China with a GNI of $5.095 trillion is the largest, followed by Brazil with $1.632 trillion, India with $1.527 trillion, and Russia with $1.289 trillion The size of the South African economy, is not much smaller than that of Pakistan’s. In other words, Pakistan could have been admitted into the group but for the poor reputation it currently enjoys in the international community. The reputation suffered a further blow with the discovery of Osama bin Laden in a safe house in Abbottabad. The same is true for the G20 which also excludes Pakistan.

The group held a summit at the resort town of Sanya in China’s Hainan province on April 14 and issued a wide-ranging communiqué. Keeping in mind the concern of rich countries that the global economy was not in balance with China and some East Asian countries running large trade surpluses while America and Europe were faced with corresponding deficits, the BRICS asked that the international community should work together to increase production capacity, strengthen producer-consumer dialogue to balance supply and demand while increasing support to developing countries.

It said that the governing structure of the international financial systems should reflect changes in the world economy and increase the voice and representation of emerging economies as well as developing countries. This demand was made at a critical time as the IMF begins the search for a new person to lead the institution since the current incumbent is contemplating to run for the French presidency. Among the people being talked about to lead the Fund is Montek Ahluwahlia of India who has worked in senior positions at the World Bank as well as the IMF and is currently the deputy chairman of India’s powerful Planning Commission.

The Sanya summit reached beyond economic matters and reflected on the situation in the Middle East and North Africa. The communiqué expressed a deep concern about the developments in the two regions and said that the use of force should be avoided in resolving turbulence. Both China and Russia had abstained when the United Nations Security Council passed the resolution that authorised action against the Libyan regime of Muammar Gaddafi. Two of the five BRICS members – Brazil and India – aspired to become perma nent members of the Security Council. With this in view the summit reaffirmed the need for a comprehensive reform of the U.N. including its Security Council to make it more effective, efficient and representative. This was needed to better deal with current global challenges.

The leaders at the summit devoted most of their time to financial and monetary issues. They welcomed the discussion of the role of the special drawing rights, the virtual currency used by the International Monetary Fund., in the international monetary system. It expressed the wish that the basket of currencies used to determine the value of the SDR should now have larger weight of the currencies of the major emerging countries. There was a hint that the BRICS leaders were urging a move away from the American dollar as the international reserve currency. The summit also called for further international financial regulatory oversight, strengthening policy coordination and promoting sound development of global financial markets and banking systems.

A couple of days after the Sanya summit, the G20 finance ministers and governors of the central bank met in Washington. They decided to authorise the IMF to bring to the attention of the international community countries that had drifted away from the path of sound economic and financial. Nations will be evaluated on their government debt (large in the case of Pakistan), private savings (low in the case of Pakistan), trade balance (for the moment acceptable in Pakistan’s case) and flow of investment (low in the case of Pakistan).

Over the coming months IMF officials will seek to determine which countries are in some basic way out of balance with the rest of the world – consumption out of whack with output (as is the case in Pakistan), or savings levels from the amount of investment (once again as is the case in Pakistan).

“We have the framework and we have the process by which policies can be scrutinised”, Christine Lagarde, the French finance minister and leader of the G20 finance ministers this year said in a news conference in Washington. Between now and next G20 meeting in October at the time of the annual conference of the World Bank and IMF, analysis will be done on which large economies have imbalances.

While Pakistan may not make it to the first list of countries to be looked at, it will come under the microscope soon after , perhaps at the time the country is heading for another set of elections. While it has been possible to dodge the pressure of the IMF to introduce serious structural changes in the economy, international opprobrium may be harder to deal with. This will be the case in particular when those who will point a critical finger at Pakistan will also include China, now the largest single benefactor of Islamabad.

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Some easing of the energy bind

By Shahid Javed Burki
Monday, 16 May, 2011

PAKISTAN’S economy comes under a great deal of stress whenever the international price of oil increases.The economy’s vulnerability to oil prices would be less severe, if these prices did not fluctuate as much as they have done in the past several years.

The fluctuations are the result of the way the markets read the supply and demand situations. The prices increase sharply whenever there is fear that supplies may be disrupted. There was great apprehension, for instance, that the explosion on the streets of the Middle East could reach Saudi Arabia and Kuwait. There was also considerable apprehension about the way the Japanese government was likely to react to the accident that disabled one of its nuclear plants. Each Japanese pronouncement produced a jump in the price.

The latest indication that Japan is likely to give a lower priority to nuclear energy rather than let its share increase from 30 per cent of total supply to as much as 50 per cent over a couple of decades caused another spike in the price of oil.

There was, as a result, great stress on the markets and the price of oil increased to $125, doubling within a matter of a few weeks. It fell back to less than $100 when it appeared that the oil exporting countries may be able to keep at bay the rising the tide of political discontent. It has begun to increase once again as uncertainty about Tokyo’s future plans increases.

These wide swings hurt a country such as Pakistan which is dependent to such extent on imported energy to keep its economy working.

Energy prices also increase when the markets assume a significant increase in demand. This was the case when the Chinese economy was growing rapidly and its dependence on imported energy was increasing. With Germany having closed some of its nuclear plants following the accident in Japan, the demand for energy produced from conventional sources has increased. Germans are importing electricity from the Czech Republic which relies mostly on coal as the source.

In other words sharp fluctuations in the price of oil not always caused by sudden and real changes in supply and demand but by the way speculators read the market’s future.

Policymakers in Pakistan have given little attention to developing an energy policy that aims to factor in country’s own resources as well as the impact of electricity and gas tariffs on the pattern of consumption. There are several consequences of this neglect. One of the more important one is that the country has become increasingly dependent on imported fuel for generating electricity. The other is that a much larger proportion of total energy supply is consumed by households than is normally the case for countries at Pakistan’s stage of development. In Pakistan productive sectors of the economy in fact subsidise domestic consumption.

In planning for the future, it is important to take into account some of the recent developments in the sources of energy across the globe. In this context, one important development is worth noting. This is the likely exploitation of what is called “shale gas” for commercial use.

Across the world coal, oil and natural gas remain the source for more than 80 per cent of all primary energy demand. Coal is the largest source, accounting for 50 per cent of the total supply. The three largest energy markets – the United States, China and India – all depend on this source for the bulk of their supply. Nuclear power accounts for another six per cent. Renewables add another two per cent but their share is likely to increase to seven percent by 2035.

The good news for countries such as Pakistan is that some recent developments may ease the pressure on supply and thus put a lid on the rise in the price of oil and also reduce fluctuations in price.

A recent survey by the United States Energy Information Administration has had a profound impact on market sentiment by suggesting that recoverable shale gas may add significantly to the supply of natural gas. Shale is a form sedimentary rock previously considered all but worthless. The rock in fact is ossi fied mud from the beds of ancient seas. The gas trapped in it can be recovered by hydraulically fracturing the rocks that contain it.This involves blasting the rock with water, sand and chemicals to create cracks through which the gas can flow.

However, the process produces water with toxic substances and has generated significant environmental opposition to the widespread use of the technology. Companies interested in exploiting this resource are now working on containing the environmental damage this developing technology could cause.

Recent advances have made the use of this technology possible. Gas can be extracted at affordable costs. The American study estimates for the first time technically recoverable shale gas for 32 countries. The amount of potential supplies was estimated at 6,600 trillion cubic feet. This will add 40 per cent to the word’s current estimates of gas reserves. This technology is already being used in the United States; production of shale gas has increased 12-fold in the past one decade. This has dramatically altered energy prospects for the country. Not long ago, it was assumed that the United States would become a net importer of natural gas; now some companies are working on the possibility of exporting it. One company has invested large amounts of money in building a storage facility in Texas that may be put to use once pipelines have been constructed to bring the gas to the coast.

Today just three countries – Russia, Iran and Qatar – hold 54 per cent of the world’s conventional gas reserves. The Russian dominant position has meant that Moscow has been able to dictate the price of the commodity. But shale is found in many other places, including Eastern and Western Europe, India, China and Australia.

There is some likelihood that Pakistan’s Balochistan and Sindh provinces and the Punjab’s salt range may also have gas rich shale rocks. As these resources are tapped, there will be greater competition among the producers, breaking Moscow’s hold on the gas market.

Greater focus on exploiting this potentially large source of energy is that China’s dependence on imports could decline significantly. This will affect Beijing’s unrelenting drive to invest in the countries that have large surpluses of energy and also those that can play a role in providing access to Beijing to these sources of supply.

Pakistan’s location right next to the Middle East and Central Asia – currently the largest potential sources of energy for China – is one reason why Beijing plans to make large investments in developing Pakistan’s transport infrastructure. A large team of Chinese railway engineers was recently in Pakistan exploring the possibility of providing assistance for linking the post of Gwadar with western parts of China. The Chinese consider the Pakistani port as an important part of the infrastructure they would like to develop to access the areas that have large surpluses of energy.

As Nick Butler of Kings College, London wrote recently, “there will no doubt be more energy crisis headlines in 2011. However, lasting changes are unlikely to flow from political conflicts in North Africa or the nuclear sector in Japan. It is the combination of geology and technology that could transform global energy in decades to come."

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How rich are the Pakistani rich?

By Shahid Javed Burki
Published: May 15, 2011

How rich are the Pakistani rich? Incredibly so, or just what is expected in a country that has income distribution more skewed than is normal for a country at its stage of development? The questions are important since the answers to them matter for the making of public economic policy. The answers will also affect the course of political development. Some of those who are watching the explosion in the Arab streets realise that relative deprivation — a concept developed by political economists many decades ago — is playing a role in turning millions of people against the regimes that have governed them for so long. Growing income disparity and widening consumption gaps are often the source of great political alienation. The political and economic systems that give rise to them come under pressure and may — and sometimes do — collapse under the weight of political discontent. This is what we are seeing in the Middle East.

Alienation increases when the riches of the rich are seen as ill-gotten, rather that obtained through hard work and entrepreneurship. Each of the successful revolutions (Tunisia and Egypt), as well as those still unfolding (Bahrain, Libya, Yemen), in the Middle East acquired a symbol of hatred. In Tunisia, it was Leila Traboulsi, the hairdresser who became President Ben Ali’s wife and then a symbol of the extreme extravagance of the ruling family. In Egypt, it was Ahmed Ezz who was favoured by the state as he went on to acquire lucrative assets and then became a steel magnate. He had a taste for tight Italian suits and expensive neckties; he now faces trial in a white prison uniform. In Syria, it is Rami Makhlouf, first cousin and childhood friend of President Bashar alAssad and he also happens to be the country’s most powerful businessman. He used his contacts with the ruling family to acquire licenses for businesses that handed out rich rewards, including Syriatel — the country’s largest mobile phone operator. In Libya, the sons of Muammar Qaddafi have accumulated untold wealth, stashed away in bank accounts at home and abroad.

Another lesson we learn from the Middle East is that the poor normally don’t risk their lives by confronting those who constitute the political and economic establishment. They are too preoccupied with earning small amounts of money, needed to sustain life for them, to take time off for agitation. But the not-so-poor are different. While the poor don’t come in contact with the very rich, the not-so-poor do. They work in the kitchens of the rich and prepare their meals; they serve the rich at their dining tables, drive their children to school, tend their gardens and provide other services needed by the affluent.

But the question of how rich are the Pakistani rich, is not easy to answer since the country does not produce detailed data on household incomes and income distribution. We will, therefore, have to do with some derived measures using the information provided by the World Bank in World Development Indicators. The Bank’s data bank provides estimates of the shares in national income for various quintiles of the population for its member nations. Adjusting the estimates to reflect the deterioration in income distribution that has occurred in the last few years, it is safe to assume that some 42 per cent of the total national income is claimed by the top 20 per cent of the population. This means that 36 million people have a combined income of $75.6 billion, which translates into a per capita income of $2,100 or twice the national average. According to the Bank, 27 per cent of the national income goes to 18 million people, the 10 per cent who sit on top of the income pyramid. For them, the per capita income is $2,700.

Applying the same distribution for the top 10 per cent and top one per cent of the population as for the entire population, it would appear that the total income of the affluent 1.8 million people is $13.12 billion, or $7,300 per capita, and for the richest 180,000, it is close to $20,000. The super rich 18,000 people have a combined income of $1.31 billion or $72,700 per capita. Since the poorest 10 per cent of the population receives only four per cent of the total income, their income per head is only $400 per annum. These numbers begin to put some substance on the extent of relative deprivation in Pakistan. The richest 40,000 people in the country have combined income equal to that of the poorest 18 million people. The super rich — the 18,000 who make up 0.001 per cent of the population — earn 180 times as much as the poorest 18 million. Or, to put it in another way, the super rich earn in just two days what it takes the poor to earn in one year.

A significant part of the wealth from which the rich derive their incomes is unearned: It is either inherited or is obtained through graft and corruption, or has been built up on the basis of tax avoidance. The rich have found many ways to dodge the tax man. Some of their income comes from agriculture which, by law, cannot be taxed. Over the years, the tax code has been punctured with holes which the rich use to not pay their share to the state. In more progressive economic systems, the tax system is the main vehicle the governments have of introducing some income and wealth equality into the society. In the case of Pakistan the opposite is the case: The burden falls on the not-so-rich.

It is clear that for the ruling establishment to avoid the kind of upheaval that has struck the streets of the Middle East, ways will have to be found to cater to those the economic system is not serving well. The best way is to devise a tax structure that introduces some equality into a system that is highly unequal.

Source: How Rich

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Living without foreign assistance

By Shahid Javed Burki
Monday, 23 May, 2011

CAN Pakistan live without foreign assistance? This question has begun to be debated after a statement by Mian Shahbaz Sharif on May 12 when he said his province, the most populous and prosperous in the country, will make a serious attempt to forego foreign assistance with conditionalities.
The aim is admirable but the real question is whether it is achievable within a reasonable period of time. The only way to reflect on this issue is to take emotions out of it and build a case for or against aid by looking at the numbers.

We should begin this investigation by deciding on what should be the country’s rate of economic growth and that of its several provinces. Pakistan is doing poorly compared to its South Asian neighbours. Bangladesh --- once the much poorer part of this country which was doing much less well compared to its western wing--- has seen its economy grow at around six per cent a year in recent times. This is almost three times the current rate of economic growth in Pakistan.

Several serious Bangladeshi economists believe that they can see their country sustain a rate of growth of more than seven per cent per annum for many years.

The Indian annual growth rate has averaged 8.5 per cent over the last six years. Its ambition is to achieve double digit growth rates in two to three years and sustain them for decades. This seems feasible looking at the current trends. The rates of savings and investment are high enough to make a 10 per cent rate of increase in GDP feasible. If India achieves that rate it would have become one of Asia’s miracle economies.

Some of the empirical work done at the World Bank has shown that for a country such as Pakistan not to have an increase in the incidence of poverty, gross domestic product must grow at a rate twice the rate of increase in the work force.

Although Pakistan’s population growth rate is said to have declined to less than a two per cent a year — we will only have firm numbers once the on-going census has been carried out and its results tabulated — the rate of increase in the workforce continues to be three per cent per year. The reason why this is so much larger than the rate of increase in population is because of what demographers call “demographic inertia”. It takes times before fertility declines begin to translate into declines in the rate of increase in the workforce.

For Pakistan not to see any further increase in the already large incidence of poverty, the GDP must increase by at least six per cent annually. For a decline in the incidence of poverty, the rate of increase in the GDP must be more than six per cent a year — say seven or eight per cent. This is one reason why the Planning Commission, in setting its sights for the future, would like to see the economy expand by at least seven per cent a year. Is this feasible?

Pakistan does not have an efficient economy.There are many reasons for this. The technological base of the economy is poor; the work force is poorly trained and not well educated; supporting physical infrastructure (for instance availability of uninterrupted supply of electricity and gas) is below the level required by a growing economy; the state, mostly unwittingly, has placed many hurdles that entrepreneurs must cross; and rampant corruption increases the cost of business transactions.

My guess is that in Pakistan’s case the incremental capital ratio is of the order of four.This means that the country must invest at least four per cent of the gross do mestic product to produce one per cent increase in domestic output. For the economy to grow at between 7- 8 per cent a year, it must invest between 28 and 32 per cent of the GDP.This is more nearly twice the current rate. This could happen — other countries do it, India has surpassed this level in recent years — but it will need a great deal of effort.

According to Pakistan Economic Survey, 2009-10, the average rate of investment in the five year period between 2004 and 2008 was 18.9 per cent. It was higher in the earlier years but declined in recent times. About three quarters of the investment was financed by domestic sav ings, the remaining one-quarter was provided for by foreign savings which includes external assistance. Without foreign aid, even the low level of effort being made currently to generate growth would become difficult. To raise it to the levels needed would be virtually impossible without sizeable foreign capital flows, including foreign assistance.

If we look at external accounts, the most interesting and unexpected development in recent years is the sharp rise in the level of remittances. In March this year, the flow of capital from this source increased to $1 billion. If this volume is sustained, an amount of $12 billion would be received this financial year.

It is not clear why the remittances are increasing when there is so much uncertainty concerning Pakistan’s economic future. There must also be a negative impact on the earnings of the members of the diaspora as a result of the economic slowdown in countries where these people are located. Given this, one would expect a decline in the level of remittances rather than an increase.

However, this is not to suggest that the policymakers should not seek to become self-sufficient and aim to generate domestic resources needed for financing development. But this can only happen if both the people and the ruling establishment are prepared to reduce the level of current consumption in favour of larger amount of savings. The citizenry must also be prepared to pay a larger share of its income to the government as tax.

At this time the people don’t seem to be prepared to that and the government lacks the political will to collect a larger share of national income as tax.

What is clear is that to climb out of the current economic slump and to put the economy on a trajectory of growth on which the neighbouring countries are moving, the rate of investment need to be significantly raised. The additional resources needed for that to happen will have to come from the outside. Even with a concerted effort by the government and display of political will that the present set of rulers seem to lack, the transition to a higher growth path will have to be financed from abroad.

The talk of dispensing with external capital flow will remain just that — talk by politicians — unless they can come up with a credible plan for increasing domestic savings and tax-to-GDP ratio.

This brings me back to the statement by the Chief Minister of Punjab. If he and his government are serious about reducing — if not altogether eliminating their province’s dependence on external capital flows that come in the form of assistance — they should take advantage of the enormous opportunities that have opened up as result of the adoption of the 18th amendment to the constitution.

The amended constitution has not only transferred new functions to the provinces, it has also given them the authority to mobilise resources from within their borders. Up until now, the provinces have relied on federal transfers for more than 90 per cent of their expenditures. This proportion needs to decline. Only if that were to happen, will Punjab be able to wean itself away from external crutches?

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Standing at the crossroads again

By Shahid Javed Burki
Published: May 23, 2011

‘Standing at the crossroads’ has become an overused metaphor for describing Pakistan’s economic progress over the last nearly 64 years. What is interesting about the country’s economy is that, with one possible exception, it has always managed to take the wrong turn whenever it arrived at a crossroads. We reached the first crossroads soon after the country gained independence and India, for whatever reasons, took a number of steps to cripple the Pakistani economy before it had the time to stand on its feet. It held back the release of what were called the sterling balances, owed by Britain to the dominions and colonies for the help they had provided in fighting the Second World War. It then threatened to divert irrigation water that flowed into the Pakistani part of Punjab from the canal headworks that were now located in India. It then punished Pakistan for not devaluing its currency with respect to the American dollar, as India and other members of the British Commonwealth had done. New Delhi imposed a trade embargo on Pakistan. However, Pakistan managed to find a way out of these crises by adopting a number of sound policies under the influence of some remarkable civil servants who were placed in charge of managing the economy. This was one occasion when Pakistan took the right road from the crossroads.

The second crossroads came in the late 1950s when the political establishment failed to find a solution to the problem of the ethnic divide created by the migration of eight million refugees from India to Pakistan. Under the leadership of the military that intervened for the first time in Pakistan’s history, the country abandoned democracy in favour of a highly centralised authoritarian structure. Under Field Marshal Ayub Khan, the country prospered economically but the lack of political consensus behind the model meant that it could not be sustained. The politics associated with this style of management got in the way.

The Ayubian model of economic and political management was abandoned when the country arrived at its third crossroad under a new military leader. Once again, Pakistan took the wrong road by not allowing the citizens of East Pakistan to take the reins of government that should have been in their hands given the enormous victory they had secured in the elections of 1970. The result was a civil war and the emergence of East Pakistan as the independent state of Bangladesh.

The country got stalled at another crossroads, the fourth in my list, when power was transferred to a civilian leadership from a highly discredited military establishment that had suffered a mighty defeat in East Pakistan. However, the country took the wrong economic road by bringing the state into economic management at a time when it had demonstrated its weakness in playing that role in many countries, especially across the border in India. Those who had studied the role of the state in economic management had concluded that it had an important role to play but not as the owner of economic assets. It should be a friend, guide and champion of private enterprise, not supplant it. Under Zulfikar Bhutto, the country had gone entirely in the wrong direction in terms of economic management.

The 9/11 terrorist attack on the US brought Pakistan to another crossroads. General Pervez Musharraf, now the country’s president, readily joined Washington in what was then called the ‘war on terror’ and received in return an enormous amount of military and economic aid. It has been estimated that the United States has given Pakistan more than $20 billion since 9/11, $14 billon as military aid and the remaining $6 billion as economic assistance. This aid was mostly wasted on the economic side as the country went on a consumption binge that temporarily raised the rate of GDP growth but left deep faults in the structure of the economy.

There is a great deal of wrong these days with the economic state of Pakistan. According to Parvez Hasan, a Pakistani economist who served in number of senior positions in Pakistan and at the World Bank, and has written about his experiences in a recently published memoir, “Given the multi-faceted economic and political problems, the revival of economic growth to a level that would ensure an adequate rate of job creation and some progress towards reducing the present high incidence of poverty appears an uphill task and perhaps more difficult than at time in the past. It is easy to be pessimistic about Pakistan’s future, (but) I believe that it is quite possible that in a decade Pakistan might surprise both itself and the world at large by not only surviving with its borders intact, but also turning a corner in a very significant way towards a modern, moderate, rapidly growing state.”

This means that Pakistan stands once again at another crossroads. There are many directions in which it can go but only one is the right one. That will keep the political system in the hands of the elected representatives of the people, make the military and security establishments responsible to the legislative branch of the government, make public officials responsible to special purpose institutions that will have the power to investigate and punish all those who abuse people’s trust, introduce a fiscal system that will yield enough resources to pay for most of the growth in the national product the country needs while bringing about better distribution of income and wealth and introduce tolerance and respect for all the people no matter what their faith or disposition is. Pakistan’s current policymakers must also engage the country with the world, help it to move away from isolation, into which many circumstances have thrust Pakistan, and focus on turning international trade into a major driver of economic growth. Development economics is not a discipline that trends itself to pessimism. I believe that the right path can be taken even from the most crowded and difficult-to-negotiate crossroads.

Published in The Express Tribune, May 23rd, 2011.
Standing at the crossroads again – The Express Tribune

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The Politics of Aid

By Shahid Javed Burki
Published: May 29, 2011

In a speech given recently at the Woodrow Wilson Centre in Washington, I made two points about the flow of aid to Pakistan. I said that the American assistance to the country was overestimated since some of the numbers that were discussed in the press — in particular the American press — did not differentiate between commitments and disbursements. The programme envisaged under the Kerry-Lugar bill was moving very slowly. There were several other aspects of aid-counting that had to be factored in before aggregate numbers were used.

My second point was to suggest that China had become the largest provider of aid to Pakistan and would become even larger, once the various programmes and projects that were in the planning stage were implemented. The second point drew some attention from some people in the audience. In one email, I was told that the numbers available in various documents suggest that China was nowhere near the position I had assigned the country in my comments. This reaction reflected less than full understanding of what is really meant by ‘aid’. I think this subject is important enough to be given some careful thought, especially by those in Islamabad’s official establishment who have the data to estimate the amount of total aid the country receives from various bilateral and multilateral sources.

Aid is commonly associated with what is generally called budgetary and balance of payments support. This assistance may come with policy conditions. Once they are met, the provider of aid writes a cheque, the proceeds from which can be used in any way the recipient wishes. This is the way the International Monetary Fund (IMF) aids the countries in economic distress. In Pakistan’s long history with the Fund, the country has seldom succeeded in completing what the IMF calls the “programme”. This is likely to happen once again, as the Fund is not satisfied with Pakistan’s performance and has suspended disbursements from the $11 billion plus programme it signed with Islamabad in late 2008.

The World Bank began to provide non-project assistance in the early 1980s when its introduced ‘structural adjustment lending’. The idea was to provide free money to the recipients when the needed structural adjustments were promised. Mahbubul Haq and I — both of us then worked in the Bank’s policy department — opposed this move by suggesting that this kind of money would be wasted and also develop poor habits. I believe our assessment was right. Pakistan is a good example of a county where this has been the outcome.

Aid has always been difficult to define. Several decades ago, Mahbubul Haq had the Planning Commission carry out a study in which he drew a sharp distinction between gross and net flows of aid. In determining net flows, he factored out from the total the amount that went back to the donors in various forms. Often — at least at that time — aid came to be tied to the procurement of goods and commodities being financed. Their prices could be much higher than those in the international market place. Some of the project aid came with the condition that the consulting services being provided would come from the donor, even when those skills were available from within the country receiving aid.

Haq’s work in the Planning Commission had an important impact in the sense that the members of the OECD (Organisation for Economic Co-operation and Development), the organisation of rich countries, pledged that they would not tie their aid to procurement from the countries providing it. Development agencies such as the World Bank and the Asian Development Bank insisted on the provision that the procurement from their funds would be on the basis of international competitive bidding — contracts go to the cheapest bidder.

This last provision brings me to case of China’s assistance to Pakistan. There is an impression that the Chinese assistance is more talk than substance; that the country promises more than it gives. This feeling is based on a misunderstanding of what is really meant by assistance. The Chinese are interested in giving mostly project support. It was, after all, Mao Zedong who said that it is much better teaching the needy to fish, rather than giving them fish to eat. Beijing considers budgetary support equivalent to giving fish and project assistance teaching the recipient to fish. One of the few occasions the Chinese departed from this practice was when I went to Beijing to seek their support to help us service debt we had with such ‘preferred creditors’ as the IMF and the World Bank. This was in late 1996, when I had taken leave of absence from the World Bank to manage Pakistan’s finance and development. We were then very close to bankruptcy. Telling me that they would not let Pakistan default while I was in charge, they made a deposit of $500 million in our account with the Federal Reserve System in New York. That saved the situation for us.

Today, China is by far the largest provider of project assistance to Pakistan. The financing of these projects comes mostly from Chinese sources which combine loans at commercial rates with grants. This helps to lower the cost to Pakistan in terms of both the amount of interest paid on the loan, as well as the period over which it needs to be serviced. China, as is well known, has financed the construction of several high profile projects — roads, nuclear stations, dams and railway equipment. For proper aid accounting, the terms of financing for each of these projects will need to be compared with alternative sources of supply and the difference between the two would constitute the component of aid.

If this calculation is done, it will show that an impressive amount of assistance is coming to Pakistan from China. Having some firm estimates — something the economic affairs division should be able to do — will put in perspective the amount of help Pakistan is receiving from China compared to other donors. Since our foreign policy focuses on economic relations, such an estimate will put the sources and amounts of aid the country receives in the right context.

Source: The Politics of Aid

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Foreign assistance: What should the donors do?

Donors need to recognise that there are many concerns about the way they provide assistance, how they spend the money and how they hold themselves accountable for the help they give.

By Shahid Javed Burki
Monday, 30 May, 2011

PAKISTAN’S case for receiving large amounts of foreign flows is well known. Given the low level of domestic savings and also the large gap between export earnings and payments for imports, the country needs a sizeable infusion of foreign capital.
Without it the economy will not be able to meet the two gaps: the gap between savings and investment and the gap between import bill and export earnings.

While the need is there, it still leaves open the question as to why should the donor assist especially when some of them have budgetary problems of their own. This is certainly the case with the United States which, at this time, is struggling to balance its own books and to cut down the size of its outstanding debt.

That is less so with China, Pakistan’s other large donor, which has money to spare for financing large aid programmes. Notwithstanding the donors’ own budgetary situation it is incumbent upon the recipient to give comfort to those providing support that their dollars are being put to good use.

The case for aid has usually been made on two grounds — moral and strategic. Those who favour it sometimes argue that it is essential for those who are rich to aid those who are poor. This applies to both the poor within a society as well those who have been left behind in the international economic system. In the latter case, it is sometimes argued that the process of globalisation has made it worse for some of the poor states.

Pakistan’s claim for being assisted rests mostly on the need to stabilise the country and the society within it so that it does not disturb world peace. For several donors therefore the reason for assisting Pakistan is strategic. No matter what is the reason for aiding a country, two questions remain. The first is in what form should aid be provided? The second: in what way should the aid dollar be managed?

For obvious reasons, the recipients would prefer to receive straight forward cash assistance with mini mal conditions. They would like to see aid come in the form of simple budgetary support or to meet the trade gap – in other words to fill the two gaps. The latter type of assistance is given by the International Monetary Fund, the purpose for which the institution was created in the first place. However, in return for providing funds to tide over countries during periods of crises, the IMF wants them to adopt structural changes in the economy so that crises don’t keep on recurring.

Most of the non-IMF money used to come in the form of project and programme assistance. The first was relatively straight forward: assistance provided for implementing critical projects for which the intended recipient neither had the resources nor the expertise. Later, especially after the first oil-shock of the midseventies, multilateral agencies such as the World Bank and the Asian Development Bank began to provide assistance for structural reform. This was given in return for the recipients implementing deep structural reforms in the economy.

More often than not this was money given in return for good behaviour: reward for undertaking the right sets of reforms. Sometimes aid was needed to meet the shortfalls that may occur if needed structural changes were made. For instance, by opening a relatively closed econ omy, a country may see a sharp jump in imports while the export response was still not in place. This may result in increasing temporarily the balance of payments deficit which may have to be closed with the help of foreign assistance.

In the case for a country such as Pakistan there are many arguments for favouring aid to come in the form of project and programme support rather help for closing the budgetary and balance of payments gaps. The latter type of assistance creates what people in finance call a “moral hazard” situation – the tendency to take risks in the expectation that somebody will be there outside to come to the rescue when things really turn sour.

Pakistan has been through these kinds of phases many times. In 1996-97 it was rescued from bankruptcy by the Chinese who deposited $500 million dollars in the country’s account with the US Federal Reserve System. In 2001-02 after the 9/11 terrorist attack, the US came to Pakistan’s assistance by persuading other countries to join it in forgiving large proportions of debt Islamabad owed to them. In 2008, the IMF came in with a $7 billion Standby Arrangement to help stabilise the sinking rupee and fast disappearing foreign exchange reserves.

None of these large rescue pack ages induced the policymakers to change the structure of the economy. The country has failed to increase the tax-to-GDP ratio; it continues to spend wastefully, the rate of increase in consumption is higher than the rate of increase in GDP; it spends a relatively small proportion of the GDP on human development than, for instance, on defence; it continues to assist loss making enterprises in the public sector; it has made practically no effort to reduce the size of the government while increasing the efficiency of the administration; it has become exceptionally tolerant of corruption at all levels and in all branches of government. The list goes on and on. Can the donor community help change this habit of appealing for help during periods of extreme crises? The answer has to be yes.

The donors must also insist on the proper budgeting and accounting of the financial resources they provide. Pakistan has an elaborate system in place for budgeting, accounting and accountability. That notwithstanding it needs to be improved with all intergovernmental transfers kept under review. The aim should not be to create a silo within which aid money will flow but the development and reform of the entire system.

It is also necessary for the donors to recognise that there are many concerns about the way they provide assistance, how they spend the money and how they hold themselves accountable for the help they give.

These concerns will increase as more development functions are transferred to the provinces under the 18th Constitutional Amendment.The donors will need to work directly with the provincial governments. This means that all the provinces will need to create the capacity to work with the donors and coordinate their activities.

If all activities by the donors in individual provinces are first cleared with the federal authorities, it will defeat the purpose of devolution. If the donors find that some of the provinces don’t have the capacity to handle foreign assistance, should they turn to NGOs for implementing their programmes and projects? If this was done, it will hinder the development of weak governments. Devolution has added another set of questions to the proper utilisation of foreign aid.

Foreign assistance: What should the donors do?

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Where will the budget take us

By Shahid Javed Burki
Monday, 06 June, 2011

AT this difficult time in its history, Pakistan has one of the most competent teams of economic managers in place in years. They are stars from the field of finance, development, planning and investment banking.

Given the right amount of political space, they have the ability to turn around the faltering economy.

The budget they have presented for consideration to the National Assembly would do little to move the economy from the slump in which it has been wallowing now for past few years and get it moving again. They could have done a number of things by applying their collective experience. This did not happen apparently because the political bosses did not give them the freedom for manoeuvre.

The first, of course, is the country’s dismal resource situation. As has been said repeatedly, the country continues to slip in terms of collecting a reasonable amount of national income as taxes.

Today Pakistan has one of the lowest tax-to-GDP ratios in the world. It will be a bit more than nine per cent when the 2010-11 financial year finally closes. The budgetary proposals presented to the parliament by Finance Minister Hafiz Sheikh will push it up to about 10 per cent. However, given the past record, even this modest increase may not be achieved.

There are several unpleasant consequences of this. The most depressing of these is that the government does not have much left in its hands to pay for social services the poor need and deserve.

Pakistan has a dismal record of human development. Its population of some 180 million remains poorly educated and in poor health. These conditions will not improve unless the public sector spends more on education and health.

The other side of the resource coin is government’s non-development expenditure. It is widely known that there is an enormous amount of waste in the way it spends its meagre resources.

The finance minister should have addressed this issue more fully and with resolution. He also needed to lay out a credible plan for addressing waste and inefficiency in the way large public sector corporations are being managed.

Managers of most of these poorly performing entities have been appointed on the basis of their links with those in power rather than on the basis of competence. It is not surprising that they are a huge drain on the public exchequer.

The finance minister did well when he had the portfolio of privatisation in one of the administrations of the Pervez Musharraf period. He could have used that experience to lay down a strategy and a plan for handing over some of these enterprises to the private sector.

This brings us to the issue of the fiscal deficit which has been the Achilles heel of the management of the Pakistani economy. The budget, with an eye on the on-going discussions with the IMF, promises to reduce this to four per cent of GDP. Whether this will help to win the support of the Fund will depend on how that institution sees the tax effort in light of the country’s history.

The managers of the economy have once again decided not to touch agriculture as a source of revenue. This means they were not able to overcome the resistance of the big farmers who have managed to get their sector exempt from income tax. The constitution does not allow federal income tax to be levied from agriculture, but Islamabad can exert pressure on the provinces to take care of this sector which accounts for over one-fifth of the national income. During my brief tenure as the de facto finance minister in 1996-97, the access of the provinces to the resources in the Divisible Pool was made conditional upon raising income tax from agriculture.

We prescribed two per cent of agricultural income as the minimum for drawing from the divisible pool. Unfortunately this was not looked at as a condition in the Seventh National Commission award announced at the end of 2009 but it could have been done retroactively in the budget. But that required political will.

The budget speech also promises to reduce the rate of inflation by half, to nine per cent in 2011-12. The assumption here is that a smaller fiscal deficit will reduce the printing of money for financing which in turn, by decreasing the supply of money, will bring down inflation.

This is not a credible position to take since the fiscal deficit not be reduced to the promised level nor the resort to the printing press will be curtailed. It is very unlikely that inflation will come down that rapidly. It is important to be honest with the citizenry.

Where will this budget take the economy over the next financial year? The answer unfortunately is not very far. It will not revive economic growth, not reduce the dependence on foreign flows, not reduce the incidence of poverty nor lessen the gap between the rich and the poor, and not help to integrate the economy with rest of the world. Something better was expected from a team of this talent and experience.

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The widening gap between the Muslim world and America

By Shahid Javed Burki
Published: June 6, 2011

US President Barack Obama seems to be the only person of any significance in Washington who seems to understand that the game has changed for his country in the Muslim world — not just in Arab countries but also in those of Islamic faith but of different ethnic origin. Among the non-Arab parts of the Muslim world, the countries where Americans are fast losing influence are Turkey, Afghanistan and Pakistan. It was lost decades ago in Iran. These four countries have a total population of 350 million, considerably more than the total for the Arab world. Why has this happened? There are several reasons for this, of these three are particularly important.

The first is the approach adopted by President Obama soon after assuming the American presidency. In a much anticipated speech delivered at Al Azhar University in Cairo on June 4, 2009 the American president said that his country’s approach to the Muslim world will be different while he was in charge of the making of foreign policy in Washington. “We meet at a time of great tension between the United States and the Muslim world — tension rooted in historical forces that go beyond any current policy debate,” he told his Cairo audience. “The relationship between Islam and the West includes centuries of coexistence and cooperation, but also conflict and religious wars. More recently, tension has been fed by colonialism that denied rights and opportunities to many Muslims, and a cold war in which Muslim-majority countries were too often treated as proxies without regard to their aspirations. Moreover, the sweeping change brought about by modernity and globalisation led many Muslims to view the West as hostile to the traditions of Islam.”

President Obama promised to change these attitudes. “I’ve come here to Cairo to seek a new beginning between the United States and Muslims around the world, one based upon the truth that America and Islam are not exclusive and need not be in competition. Instead, they overlap, and share common principles — principles of justice and progress; tolerance and dignity of all human beings.”

The second reason for the widening of the gap between the West and the Muslim world is the Arab Spring — the string of explosions that have rocked the Arab street in several countries. This has resulted in the demise of two long-serving regimes, and threatens several others. While the West – including the United States – was slow to appreciate the significance of this development, one consequence of this change has become clear. When the history of this extraordinary movement gets to be written, it will be recognised that the address by Obama in Cairo played a big role in emboldening the Arab street.

The policy towards the West in these countries will not be made by authoritarian regimes that could ignore the sentiment of the street. Strong rulers, often supported by their militaries, were able to ignore the aspirations of their people and opt for favoring the strategic positions that suited the West, in particular the United States. Egypt and Pakistan were at the forefront of these moves. Egyptian President Anwar Sadat signed a peace treaty with the state of Israel without asking for the settlement of the Palestine dispute. Pakistan, under three different military regimes, aligned itself closely with Washington, even when some of what it promised to do in return for support by America was not in its strategic interests. With the Muslim street having shown that it can mobilise quickly when the regimes in power adopt unpopular policies, it is highly unlikely that the rulers of this part of the world will have the same room for manoeuvre compared to when they operated in simpler times. The policy space in which they work has been considerably narrowed.

There is also an increase in confidence among the leaders of several countries in the Muslim world. Leading the way is Turkey, a country that had for decades attempted to become a part of the western world but is now governed by a party and an individual who are determined to follow an independent line. According to Anthony Shadid, a Pulitzer Prize-winning journalist writing for The New York Times, “there is a longstanding debate over whether Turkey has tilted east after decades of embracing the West as a Nato member and almost reflexively allied with the United States. It still nominally embraces the goal of joining the European Union, carrying out reforms mandated by the entry process that have made Turkey a far more moderate place. But sensing a decline of American power in the region, Turkish officials have become sharply more assertive in the Middle East, priding themselves on keeping open channels to virtually every party”.

Even Afghanistan, beholden to the United States for keeping an unpopular regime in power and pouring billions of dollars into the country for what is called nation-building, has become assertive. Hamid Karzai, the country’s president, has warned Nato that he will not tolerate any more air attacks on civilian targets, even if they are suspected of harbouring the enemy. Pakistan is passing through a similar reassessment of its relations with Washington, especially after the May 2 attack on Abbottabad that killed Osama bin Laden. There are many in Pakistan — perhaps a large majority — who believe that the rise of Islamic extremism has to be checked and that the people operating outside the purview of the law have to be brought under control. Terrorism cannot be tolerated as a way of forcing onto the rest the worldview of a small segment of the population who wish to follow a different way of life and have a different approach to the world outside. That said, there is a seeming consensus emerging in the country that the war against terrorism will have to be fought on Pakistan’s terms and not on terms dictated from the outside.

The narrowing of the space within which policymakers can operate in the Muslim world will have enormous consequences for the countries in the region. One result will be the widening of the gap between them and the West, unless the latter makes some fundamental adjustments of its own.

Source: Widening Gap

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