Challenges to Pakistans Economy - Proposed Remedies & Solutions.

Professor Dr. Shahida Wizarat

Paper presented at the pre-budget seminar organized by the Southern Regional Committee of (ICAP), at Marriott Hotel, Karachi. 10 April 2008

1. Introduction
All the serious challenges Pakistans economy is facing today like very wide budget and trade deficits, galloping inflation, increase in the level of poverty, power outages, water shortages, closure of industries, food insecurity, etc, has diverted our attention from realizing the very serious challenge that we have overcome. Since the 1950s we had a system in this country where the Ministry of Finance and all the economic ministries were headed by World Bank and IMF officials of Pakistan origin. With increase in the indebtedness of the country the situation got from bad to worse. The worst period was the decade of the 1990s when not only the economic ministries, but even prime ministers came from these institutions. During negotiations between the Government of Pakistan (GOP) and the International Financial Institutions (IFI)s it was difficult to distinguish between the GOP and the (IFI)s, for both sides comprised of IFI officials. These were very trying times for those of us who value independence and economic sovereignty of the country. I wrote several articles questioning the wisdom of a system which even after elections denied the representatives of the people to have anything to do with the ministries that dealt with the wealth and finances of the people (Wizarat 1996). So I personally feel vindicated to see representatives of the people occupying ministries of finance and economic affairs. Starting with this positive note let us now try to give some suggestions to the new government on crisis management of the economy. But before we venture into discussing specific problems and challenges let me present two broad observations. One, that it is quite acceptable for a country to deviate from its normal course during times of emergency and ultimately come back to the designated path path. For example, the United States of America states that it is committed to liberalization and globalization. Yet, in the aftermath of a crisis it imposed a 30% tariff on the import of steel. Therefore, crisis management warrants we deviate temporarily from liberalization to fix the distortion, and return to the path when things return to normal. Second, in order to retain our economic sovereignty it will be better not to resort to policy based lending. 2. Debt Management The Debt/GDP ratio needs to be borne in mind when embarking upon further lending from the IFIs. If the Debt/GDP ratio goes up to unacceptable limits, then the involvement of IFIs in Pakistans economic affairs will be back and the elevation of elected representatives to economic ministries will be a short lived phenomenon. Our experience shows that increase in debt has led to installation of governments comprising of IFI officials of Pakistan origin. Thus the very sovereignty of the country is at stake. Moreover it is in the interest of the country not to increase the ratio as this is bound to increase the burden on our future generations

The approach of the new Government in dealing with this problem appears to be in the right direction. For example, recently the Finance Minister signed a debt development swap agreement with the Italian Government for $100mn. This is a very desirable approach for it breaks the deadlock between debt and development. This way Pakistan will be able to reduce its debt burden, while at the same time bring development to the country. At a post budget seminar of the Institute of Chartered Accountants of Pakistan (ICAP) in June 1997, I presented some ideas on debt management, which were later published in the Dawn (Wizarat, 9 June 1997) wherein I had suggested that by using debt development swaps: we can kill several birds with one stone i.e provide debt relief to the country, increase the education level of the country ---- . The best part of the exercise will however be that debt servicing and expenditure on the social sector will not pose a trade-off, with both the objectives being pursued simultaneously. And it is this expenditure on the social sector which is so vital if democracy is to deliver higher levels of welfare. Similar ideas were expressed by me in my article entitled Debt Management in Pakistan published in the Dawn on 20 August 2000 (Wizarat, 2000).

3. Macro economic balance The rate of growth of the economy during the last three four years improved a bit, but was modest when compared with the rate of growth of our neighbors China and India. Another feature of the growth phenomenon that needs to be looked into is the un-sustainability of the growth rate. When the growth rate becomes a little respectable for two or three years, prices start rising and almost immediately a clamour for a tight monetary policy starts. Compare this with the Chinese experience, where the GDP grew at almost ten percent during the last two decades before prices started rising. Why do prices start rising almost as soon as the growth rate picks up? Are prices rising as a result of excess demand as a result of government borrowings from the State Bank of Pakistan (SBP)? Or are prices rising due to increase in the prices of oil, and the concomitant increase in prices of electricity, transport, etc, which this increase brings about? The two situations warrant very different approaches. If inflation is of the demand pull type then tightening the monetary policy will, through dampening demand would bring prices down. If, however, inflation is of the cost push type, then a tight monetary policy will make matters worse. And that is what has been happening in Pakistan over the last few years. Monetary policy has been used excessively to contain inflation, irrespective of whether it is of the demand pull or cost push type. Even if prices are rising due to hoarding monetary policy has been used and advocated to contain inflation. But such a tight monetary policy has resulted in reducing the rate of growth of the economy, without reducing the rate of inflation.

What should the new government do to contain inflation? First, it needs to determine whether prices are rising as a result of demand pull factors or cost push factors. If prices are rising due to demand pull factors then tightening the monetary policy will be an appropriate policy. But if prices are rising due to cost push factors then we need to identify the factors that are pushing up prices and find alternatives to these. The excessive use of monetary policy to fix up every problem in the economy is hurting the economy. Monopolies and cartels have played a major role in restricting output and escalating prices in Pakistan. Most of the members of cartels are ministers and other influentials. It thus took several years for the Government to convert the Monopoly Control Authority (MCA) into Competition Commission. The new Government needs to make it effective, formulate a Competition Policy and enforce it. The Competition Policy is the appropriate policy to deal with the problems of monopolies, hoarding, excessive profit margins, etc. My own research (Wizarat, 2003) shows that several industries have very high concentration ratios and Herfindahl Indices. And when there is collusion between these firms it produces a monopoly situation, with the concomitant reduction of output and increase in profit margins. The Competition Commission needs to compute Concentration Ratios and Herfindahl Indices in each industry and determine the acceptable levels for each industry. And if the concentration level in any industry exceeds the acceptable level, then the Commission should ensure that through promotion of competition, the industries are made to conform to desirable behavior and conduct. Budget Deficit The budget deficit for the first six months of FY 07-08 was 3.6% of the GDP and the likely figure for the 12 month period is expected in the range of 6% of the GDP. Most of this was on account of increase in development expenditure in the run up to elections, energy related subsidies and the inability of the government to increase and diversify the tax base. First let us see how this deficit can be curtailed. First on measures to curtail the expenditure. Here the approach of the new government appears correct. The Prime Ministers decision to reduce the expenditure on the Prime Ministers house by 40 % is a step in the right direction. Similar steps to reduce non development expenditure on other federal and provincial ministries and civil administration, along with the Finance Ministers statement of looking into possibility of reducing the defense budget are steps in the right direction. These need to be supplemented with resolve on the part of the Government to curtail borrowing from the State Bank of Pakistan. This will not only reduce the budget deficit, but also ensure that the demand pull is not the major contributor to soaring of prices. Tightening of the monetary policy will no longer be required and appropriate policies that deal with cost push inflation will take care of the problem. On the revenue side, the government will have to tap new sources to generate receipts in order to bridge the gap. New sources for generating tax revenues should be those sectors of the economy where profits have

increased in the past few years, but have not been brought within the tax net. These include agriculture and service sectors, especially oil companies, banks and financial institutions and real estate. Current Account Deficit The external account deficit has widened, and is expected to cross US$10.5 billion in FY07-08, to over 6.6% of GDP. The IFIs will I am sure offer their credits to cover the deficit. But it would be very imprudent to fill up the gap by borrowing from the IFIs. It will not only increase the indebtedness of the country, worsen the Debt/GDP ratio, with adverse implications on the politico-social structure of the country. The Government has to devise both a short term as well a long term policy to deal with the situation. In the short run the Government should scrutinize the imports of the country and temporarily halt the import of non essential consumer goods, luxuries, etc, so that oil, machinery, capital goods, which keep the wheels of industry moving are not stopped. This would be a temporary deviation from policy and not abandonment of the present policies. This has been the practice in all the countries that are faced with a crisis situation as discussed earlier by the imposition of a 30% tariff on the import of steel in the aftermath of a crisis by the United States. Other countries have also resorted to such deviations from policies in order to crisis manage their economies. The long run solution entails that the Government finds substitutes to the essential imports that are soaring the import bill. We need to switch over to the use of oil substitutes to generate power, transport lubricants, etc, and to cut down on travel cost by providing low cost housing to laborers at the work place, etc. These would result in reducing the dependence on imported oil. If the import bill is getting inflated because of import of machinery and capital goods from Europe, where due to the rise in the value of the Euro, the prices are high and increasing continuously, we need to explore other markets like the Chinese for the supply of these machineries and capital goods to us. Import substitution of these goods within the country also needs to be explored. 4. Agriculture The government needs to develop its vision for agriculture. How does it want to use agriculture for meeting the needs of the country. My vision for the agricultural sector is two fold. First, use it to make the country self sufficient in food and industrial raw material. Second, use it for providing high value added exports. Export of organic fruits and vegetables can fetch good prices in the international markets. Instead of waiting for any type of land reforms that will redistribute land to peasants, which seems quite unlikely, it will be advisable for the government to distribute fallow land to the peasants and provide bank credit to purchase inputs, manure, seeds, etc. Since this land has not been cultivated before, its yield will be good. These small farmers should be encouraged to produce food items like fruits, vegetables, rice, wheat, pulses, corn, barley, etc, both for the home market as well as for exports. This will make the country self sufficient

in food, earn foreign exchange and thus reduce the deficit, improve the environment and health of the population by making healthy food items available to the population. 5. Industry The government also needs to decide about the kind of industrial structure it should promote. Even during the 1960s when we used industrial policy very effectively, the tendency to produce a wide range of commodities and the grant of across the board fiscal incentives created imbalances. Formulating an industrial policy for the future necessitates that we evaluate our strengths and weaknesses objectively and dispassionately. Both the principles of static and dynamic comparative advantage should figure in such a policy formulation. The industrialization of the under-developed areas should initially be based on the static comparative advantage of these areas. Such industrialization can be reinforced with industry-cumarea specific fiscal incentives. This will ensure a viable industrial structure in the rural and hitherto under-developed areas. At the same time, a dynamic comparative advantage should be nurtured in selected industries at the national level. Extreme care needs to be exercised in the choice of these industries. First, these should be a select group of industries and not a multifarious lot. Second, the country must possess some strengths in these industries. Third, the income elasticity of demand for the products of these industries must be high. This is how we can construct a viable industrial structure in Pakistan. (see Wizarat 2002)

6. Water and Power Water and power scarcity are going to pose a major obstacle to the strategies suggested above. Therefore, development of water and power development projects should be given top most priority by the government. Power policy of the government should have both a short term as well a long term plan. Bridging the gap between supply and demand in the short run, when supply cannot be increased should focus on demand management and reducing transmission losses. Both Commercial and domestic consumption of power has to reflect the fact that there is a serious power crisis in the country. Ostentatious consumption of electricity has to be banned with immediate effect. Lightening of wedding halls, hotels, public buildings has to be banned. Celebration of religious and public events by lighting up buildings will have to be postponed to times when the balance between supply and demand has been restored. Till such time we will have to make do with decorating our buildings, lawns and parks with flags, buntings and balloons. Domestic consumption of electricity can also be brought down by educating the public and making them realize that it is in their own interest not to waste energy. In the long run the increase in supply should be through developing alternative sources of generating power like wind and solar energy instead of oil. This will not only be environmentally friendly, but will also restore balance in the external account. Vertically integrated industrial units producing their own power and selling it to other units also

will also increase the supply position as well as help to bring down the cost of production of domestic manufacturing. Water development projects are an absolute necessity for the agricultural development envisaged earlier. The government should try and bear the following in mind while developing water development projects. One, there are already great deal of controversies with regard to water development projects in the country. Therefore instead of creating any further controversies, it will be better to start with projects which do not arouse the passions of the people of any province. Second, it will be preferable to start off with medium to small projects. 7. Privatization The government should take an overview of the present privatization policy of the previous government. The typical neo liberal argument in favour of privatization of State Owned Enterprises (SOEs) is government failure, as most of the SOEs have been inefficient and a burden on the national exchequer. But what about institutions in the private sector that have also been failures? What to do when there is both government failure as well as market failure? There are so many such examples in Pakistan where there is both government failure as well as market failure. Take the case of the Karachi Electric Supply Corporation (KESC). Its performance was pathetic and it was a burden on the national exchequer when it was an SOE. But its performance has deteriorated when it ceased to be an SOE and became a privatized unit. It appears that there are certain features which remained constant to both the pre and post privatized KESC. Moreover, the KESC also continues to be a burden on the national exchequer. Since it was not making payments to WAPDA which prompted the City Nazim to offer them money to make these payments. The KESC is thus continuing to be a burden on the national exchequer. Its performance in terms of providing this essential service has also deteriorated significantly. We have many other such examples in higher education institutions, where there is both government failure as well as market failure? The new government needs to do some innovative thinking on how to respond to these situations. The government also needs to evolve a policy towards the privatization of strategic assets of the country. For we see that in-spite of being committed to liberalization policies, governments do protect their vital national interests. For example, when the privatization of some port services to an Arab country was going ahead, public opinion forced the US government to back track from its earlier stance and refrained from awarding the running of the port to an Arab company. 8. Poverty and Income Distribution Over the last about two decades policies have been generating poverty and the poverty alleviation programs instead of making a dent on poverty, have resulted in elitist capture. Pakistan has been converted into a country of ten millionaires and ten million baggers, with the state having to take care of the ten million

baggers. How should the government deal with poverty and income distribution issues? Provision of infrastructure, giving assets like land to agricultural peasants along with the development of a viable industrial structure will through expanding employment alleviate poverty. These could be supplemented by micro finance schemes to encourage small entrepreneurs. Distribution of income can also be improved by targeting the supply of education and health services to the poorer segments of the society. In view of the serious problems encountered in the past in the supply of these services to the population, particularly in the rural areas, totally different and innovative approaches will have to be adopted. These are not being discussed here, but can be presented in a seminar on provision of health care and education to the poor in Pakistan. Another suggestion to reduce the disparity between the wealthy and the poor is to increase the share of direct taxes in total taxes, for in the past the tax structure has become more regressive as a result of increase in the share of indirect taxes in total taxes. 9. Institutional Back up Economic research institutes in the country have to play their role by providing their input, evaluating government performance and providing policy guide lines. But these institutes are faced with a decline and/or are being used for political agendas. A public sector economic research organization has a PhD in Mass Communication as its head, another also has a head whose qualifications do not match the requirements of the research institute. Most of the research institutes in the country are under the control of a lobby that itself has political ambitions. So the chattering class of the country is controlled by a lobby which will not be very charitable to the government. Even if the government performs well, it will not be in their personal interest to admit about their good performance. Moreover, the lobby is very powerful and resourceful. So even if any institution is not within its ambit, it will not take very long to bring these under control. In such a situation, who will provide the research input to the new government? Who will evaluate the performance of the government honestly? And who will provide correct policy guidelines to the government free of any personal interest or axe to grind? In this scenario should the government establish new institutes to provide these services to the government? Or should it try to reform the existing institutes, purge them of politics, bring competent and independent leadership to the fore front? It is the latter option that will be preferable as it will avoid wastage of public resources and extend the control of the government to institutions which will be beyond reform if left any longer.

References
ABN-AMRO Bank, Economic Focus Pakistan, Islamabad, 2 April 2008. Wizarat, Shahida, The Impact of Foreign Borrowing on our Political Structure, Paper read at the Eminent Persons Group (EPG) Seminar and published in their papers and proceedings and later in the Business Recorder, 31 December, 1996 Wizarat, Shahida, A Debt Management Strategy for Pakistan, Paper read at the Institute of Chartered Accountants (ICAP) and Institute of Cost and Management Accountants (ICMA) Post Budget Seminars and later published in the Dawn, 9 June, 1997 Wizarat, Shahida, Debt Crisis and its Management, Dawn, 20 August 2000 Wizarat, Shahida, The Rise and Fall of Industrial Productivity in Pakistan Oxford University Press (OUP), Karachi: 2002 Wizarat, Shahida, Industrial Concentration and Economic Power in Pakistan: A Study of the Firms Quoted on the Karachi Stock Exchange, Pakistan Business Review, College of Business Management, April 2003, Karachi