Pakistan’s economic performance over the past seven decades has been a mixed bag. The country, which started off virtually from scratch and was almost written off by many an analysts at the time of its inception, has bounded ahead in the face of gargantuan challenges. Today, Pakistan offers the most liberal trade and investment regime in the region. It is fully integrated into the multilateral economic and trading systems. Yet the economy continues to be beset by structural constraints, which have hobbled its dynamism. In order to appreciate the impediments faced by Pakistan on the road to economic development and prosperity, it is imperative, at the very outset, to take stock of the country’s economic predicament at the time of its birth.
Initial Economic Problems
The provinces of the British India which made up Pakistan on August 14, 1947 were for the most part underdeveloped with a scant industrial infrastructure in place. Calcutta, the capital of Bengal and Subcontinent’s largest city and industrial-cum-commercial hub, went to India. The partition scheme distributed the economic assets between the two nations in such a way that Pakistan got only 10% of the industrial enterprises, 6.5% of the industrial workforce, 5% of the electrical capacity, and 10% of the total mineral deposits.1 Pakistan’s industrial share comprised units which by and large were small and raw material based. Not surprisingly, the areas that became Pakistan were net importers of industrial goods from India at the time of independence.
As much as 90% of the population of the nascent state lived in the countryside. The largely agrarian economy was remarkably deficient in agricultural surplus, which underpins industrialization. Jute was the principal source of foreign exchange, but ironically Pakistan did not have a single jute mill, as all the units were located in the provinces that constituted the Indian Union.
Pakistan is a low riparian country and the rivers of the Indus system, which constitutes the lifeblood of the national economy, enter the country through the territory held by India. Like Kashmir, the issue of the distribution of the waters of the Indus system of rivers between the two countries is a legacy of the partition scheme. The scheme bifurcated Punjab into West (Pakistan) and East (Indian) Punjab. The important headworks of Ferozepur and Madhpur were given to India. Those headworks irrigated about 1.7 million acres of land in the West Punjab. The idea was to give the two new states joint control of the water channels. A standstill agreement was struck to preserve the status quo till March 31, 1948. However, within 24 hours of the expiry of the agreement, the Indian government cut off vital supplies to Pakistan from the two headworks. The move was unmistakably an attempt to stab at Pakistan’s fragile economy.
Economic development encompasses not only growth in the gross domestic product (GDP) but also relevant social and institutional changes by which that growth can be sustained. These changes include a considerable propensity to save, a high literacy level, improved productivity of labour and other factors of production, growth of entrepreneurship, development of credible institutions of economic governance and a value system that props up rather than holding back development efforts. In the absence of such changes in the socio-economic fabric, the growth momentum is likely to taper off.
In the first decade after independence (1947-58), the economy of Pakistan grew on average 3.1%. Despite the overall modest growth – which was encouraging in view of the initial economic problems – manufacturing grew at a healthy rate of 7.4%. During the 1960s, the growth rate more than doubled to reach 6.8%, which was underpinned by 5.1% growth in agriculture, 9.9% growth in manufacturing and 6.7% growth in services. However, the healthy growth rate could not be sustained and the next decade saw it come down to 4.8%. The nationalization policy is stated to be one of the factors which put the brakes on the economic march. While the services sector nearly maintained its robust expansion, agriculture and manufacturing growth fell to 2.4% and 5.5% respectively.
The economy regained momentum during the decade of the 1980s with overall growth of 6.5%. But as in the past, the growth rate fell to 4.6% during the 1990s as the country remained in throes of political instability as well as struggled to undergo structural economic transition. The next two decades also witnessed modest growth rates of 4.7% and 4.4% respectively. During this period, Pakistan has waged an epic struggle to ward off an existential threat posed by terrorism. The war against terror has tolled upon the national economy (we will come back to the economic costs of terrorism later).
Pakistan started off by embarking on import substitution industrialization strategy, which then was the prevailing norm among developing economies. The idea was to produce manufactures from the raw materials, such as jute and cotton, which were relatively abundant, and develop consumer goods industry through tariff protection and quantitative trade restrictions. Imports were allowed on the basis of a positive list, that is, only those items that were on the list could be imported. After contraction during the 1950s, both exports and imports grew considerably, 13.6% and 9.3% respectively, during the 1960s. The separation of East Pakistan, which accounted for nearly half of Pakistan's total exports, deprived the country of a valuable source of foreign exchange. All the same, exports maintained their growth momentum during the 1970s mainly because of devaluation of the rupee. During the 1980s, the country began to liberalize its trade regime. It was the first economy in the region to do so. The positive list for imports was replaced with a negative list. Only the products that were placed on the negative list could not be imported. A flexible exchange rate system was also put in place. During this period, exports and imports growth deaccelerated to 8.5% and 4.4% respectively.
Source: Pakistan Economic Survey (various issues)
Trade liberalization went full steam ahead during the 1990s as Pakistan became a founding member of the World Trade Organization (WTO) with effect from January 1, 1995. Import tariffs were scaled down and import licensing terminated, meaning that the importers did not need the government’s authorization to place orders overseas. The import substitution gave space to export-led growth strategy. However, due to supply-side constraints, exports registered a modest growth of 5.6%, while a weak domestic demand brought import growth down to 3.2%. The next decade saw acceleration in both export (9.9%) and import growth (13.7%). During the current decade, however, export and import growth have fallen to 4.2% and 7.6% respectively. The global recession which set in in 2008 together with volatility of international commodity prices lie at the bottom of much of the deceleration in foreign trade.
Like most other non-oil producing developing countries, Pakistan has persistently run trade deficit. The country has to import great gobs of oil, capital equipment and raw materials, which are essential for economic growth. At the other end of the scale, hemmed in by a narrow manufacturing base and low value addition, exports find it difficult to keep pace with imports. In 2017, Pakistan ran $35.56 billion trade deficit compared with $120.50 billion for India, $6.52 billion for Bangladesh, and $9.57 billion for Sri Lanka. When an economy imports more goods and services than it exports, it becomes a net importer of financial capital.
Like most other developing economies, fiscal deficit has been a norm in Pakistan. In the 1960s, the average fiscal deficit made up 2.1% of the GDP, which more than doubled to reach 5.3% in the 1970s and further to 7.1% during the 1980s. During the 1990s, fiscal deficit came down marginally to 6.9% before falling significantly to 4.6% during the 2000s. During the current decade on average 6.2% fiscal deficit has been recorded.3 In 2017, Pakistan’s fiscal deficit was 4.5% of the GDP compared with India’s 6.5%, Bangladesh’s 4.9% and Sri Lanka’s 4.8%.4
Fiscal deficit can be overcome, or narrowed, either by cutting back on public expenditure or racking up revenue. In Pakistan, more than 75% of the total public spending is accounted for by autonomous expenditure, which has to be incurred regardless of the state of the economy. The single largest item on public spending list is debt servicing, which represents autonomous expenditure. The major roadblock to narrowing fiscal deficit is on the revenue side: persisting lack of a tax culture along with the inability to widen the tax net (only 1.21 million taxpayers as per FBR Tax Directory 2016). Tax-GDP ratio in Pakistan is less than 12%. To these, we may add the menace of militancy, which is eating up a big chunk of public resources, and the loss-making public sector enterprises (PSEs), whose shake-up has turned out to be a sticking point.
Economic Cost of War on Terror
In the war on terror, no other nation has sacrificed as tremendously in terms of both men and materials as Pakistanis have done. The nation’s incessant and intrepid campaign against the militancy has, inter alia, tested the resilience of the economy. Between 2001-02 and 2017-18, the direct and indirect economic cost of the war on terror has teetered on the edge of $127 billion, which accounts for nearly 40% of Pakistan’s present GDP of $319 billion.
The cost includes destruction of physical infrastructure; compensation paid to the victims of the acts of terrorism; rise in security related expenditure at the expense of developmental spending; fall in economic output, revenue, investment and exports; loss of jobs; businesses’ shutdown and increased cost of doing business. Starting 2001-02 (FY02), the economic cost of the war against terror kept on going at a gallop and peaked at $23.77 billion in 2010-11. Since FY15, the cost has been on a downward trajectory; and ratcheted down to $2.07 billion during 2017-18 (July-February). The decrease in cost can easily be set down to full-scale counter-militancy operations Zarb-e-Azb, Khyber I-IV and Radd-ul-Fasaad. The significant improvement in security situation will give impetus to economic growth.
The partition scheme distributed the economic assets between the two nations in such a way that Pakistan got only 10% of the industrial enterprises, 6.5% of the industrial workforce, 5% of the electrical capacity, and 10% of the total mineral deposits.
The foregoing brings out that Pakistan’s economic journey has been on a roller coaster. A sound growth rate in the 1960s and the 1980s was followed by a slump in the 1970s and the 1990s. One of the capital reasons for the inconsistent economic performance is that despite high growth rates the concomitant socio-economic changes have not come about on the desired scale.
Capital formation or investment is regarded as the engine of growth and development. The source of investment is savings. In Pakistan, because of low per capita income coupled with a high cultural propensity to consume – the demonstration effect as it is called – the level of domestic savings has fallen well below the desired one. Low savings have made for lower level of investment. During the 1970s and 1980s, the domestic savings on average accounted for 7.4% and 7.7% of the GDP respectively, which scaled up to 14% during the 1990s and 14.6% during the 2000s. During the current decade, the average domestic savings-GDP ratio has fallen to 9.3%.
By the same token, during the 1970s and the 1980s, the total investment on average accounted for 17.7% and 18.7% of the GDP respectively, which marginally came down to 18.3% during the 1990s before rising one percentage point to reach 18.4% during the 2000s. During the current decade, average investment-GDP ratio has fallen to 15.4%. It is obvious that the level of investment has always exceeded that of domestic savings. The difference has been met through external borrowing, which has resulted in accumulation of debt.
Entrepreneurship, which has been the principal driver of development all over the world, entails the willingness to take risk, innovate and venture into new products, processes, or new ways of doing business. The corporate culture of Pakistan is, however, short on entrepreneurship. Most businesses are family owned; they prefer to tread the beaten track with regard to both the management style and the product mix that they offer, and look to the government for special packages. Lack of entrepreneurship is one powerful factor behind Pakistan’s continuous reliance on relatively low value added products for earning export revenue.
Over past seven decades, the economy has gone through many crises and on each occasion it rebounded. On the whole, the numbers, which take into account only the formal sector, grossly underestimate the resilience of the economy.
A vital condition for entrepreneurial growth is the presence of a supportive social climate or institutions. As institutional economists put it, economic activity is socially embedded and dependent on supportive institutions. In a word, institutions provide a predictable, fair and supportive environment for economic growth. Pakistan is deficient in strong institutions of economic governance, which in part accounts for such economic issues as revenue slippages, cartelization, and rather seedy contract enforcement.
Development is above all a cultural problem. Capital formation is a necessary ingredient of development. But no economy has made significant strides by simply building factories or upgrading the infrastructure. In the course of development, the biggest challenge that a society faces is to evolve the values and attitudes that anchor the efforts for economic turnaround: prizing material progress and prosperity as a goal worth pursuing, work ethic, rational-cum-empirical mode of thinking, preference for a small family, and woman empowerment, to name only a few.
At present, the Pakistan economy is racked by a host of problems: trade and fiscal deficits, domestic and foreign debt, low value addition, and a relatively high cost of doing business. Such problems have caused many to get in a stew about the fate of the economy. By all accounts, these deficits are a cause for concern and a way must be found to get around them. At the same time, the doomsday scenarios are also up the spout. Over past seven decades, the economy has gone through many crises and on each occasion it rebounded. On the whole, the numbers, which take into account only the formal sector, grossly underestimate the resilience of the economy. As in the rest of the world, Pakistan has a substantial informal, unregistered, undocumented and unregulated sector – the exact size will always remain a matter of conjecture. The informal sector is a significant source of output and thus income and job creation. A big challenge for policymakers is to formalize the informal sector. Likewise, the multi-billion China-Pakistan Economic Corridor (CPEC) will go a long way in effecting economic revival through infrastructure development, shoring up energy supply and sprouting overall economic activity.
If Pakistan can become a nuclear state – a feat which only a handful of countries have accomplished – there’s no reason it cannot graduate to an economic powerhouse. Overcoming the structural and cultural constraints that have undercut the efforts for an economic turnaround to come to fruition is what the doctor ordered.
The writer is a frequent contributer to national print media on issues of politics and economy.
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