Short essay on the economic development in Pakistan

When Pakistan was formed in 1947, the new state had to start almost from a scratch. The areas which constituted Pakistan were mostly agrarian and backward and were dominated by a few feudal landlords. The few industries it inherited were based on either handicrafts or on processing of agro-products.

The country’s industry and trade were again largely under the ownership of Hindus and Sikhs who left the country with their capital immediately after the partition.

These communities had managed much of the commercial activity of West Pakistan. Hence their departure caused a vacuum in these critical areas. Pakistan’s initial problems were further aggravated by the influx of a vast number of refugees. It is estimated that nearly 12 million people from India migrated to Pakistan during the first three years of partition.

The partition of the sub-continent disrupted the principles of complimentarity that earlier prevailed in the region. For instance, West Pakistan traditionally produced more wheat than it consumed and had supplied the deficit areas in India. Cotton grown in West Pakistan was used in mills in Bombay and other western Indian cities. Manufactured products such as coal and sugar were in short supply in areas that constituted Pakistan and came from areas today part of India.

The division of administrative machinery, the Indian Civil Service and the Indian Police Service, was also problematic. Out of a total of 1,157 officers, only 157 joined the Civil Service of Pakistan, which became one of the most elite and privileged bureaucracies in the world. The substantial irrigation network inherited from British rule was the only redeeming feature of the new state.

Given the predominantly agrarian nature of the economy at partition, a viable irrigation system was a necessary input for the revival of the agrarian economy, given the inadequacies of other infrastructure such as roads, power, railroads, etc.

The Early Years: Quest for Survival

In the early years (1947-58), economic policy and planning in Pakistan was dominated by a small group of bureaucrats. Given the profound adverse conditions at the time of partition, the focus of the economic planning was on keeping the economy going.

The herculean task of building an economic base was left to the state sector as the private sector was too weak and lacked the capital to launch industrial development in the country. An analysis of economic policy from 1947-58 shows a series of ad hoc reactions to crises.

The Korean War of 1952, however, proved a blessing for Pakistan by causing an upsurge in demand for Pakistani exports, mostly raw jute and raw cotton, and assisting in the creation of a nascent entrepreneurial class. It was this windfall that laid the foundation of industry in Pakistan. The end of Korean boom led to a re­examination of policy that led to the rigid system of import licensing designed to manage Pakistan’s adverse balance of payment problem.

The cumbersome web of administrative and licensing control that resulted later formed the back bone of Pakistan’s import substitution strategy. Thus, the first decade after independence was essentially bureaucratic-led and assisted industrialisation. Since much of the bureaucracy was composed of urban migrants from India, it had little knowledge of or interest in agriculture and felt that manufacturing should receive far greater state patronage.

The big landlords and nawabs who enjoyed some political clout could not translate it into economic clout. While a small number of industrialists who secured high profits in the early years acquired economic clout, they did not have the political clout; they were dependent on the benevolence of the licence raj of the civil servants. With disarray in the ranks of the political groups that existed, the military stepped in to restore law and order and to promote bureaucratic capitalism that had emerged in the 1950s.

The Ayub Decade of Development

General Mohammad Ayub Khan’s military regime was characterised by controversial and paradoxical combination of the most impressive growth rates in Pakistani history, combined with large increases in income inequality, inter-regional disparities and the concentration of economic power.

During this decade, the economic indicators were extremely impressive, with GNP growth rate hovering around 6 per cent mark throughout the decade. Agriculture grew at a respectable rate of 4.1 per cent over the period, while manufacturing growth rate recorded 9.1 per cent and trade 7.3 percent.

However, statistics on income distribution, wages and human capital development present a dismal picture. The indices of income inequality worsened and the ranks of the poor increased. Wage increases did not match productivity gains as the living standards of a large majority of the population stagnated.

The centerpiece of Ayub’s economic strategy was the commitment to rapid industrialisation. Policymaking was tailored to promote industrial investment.

This system provided a plan and procedure for investment licensing and credit disposal. Furthermore, the Pakistan Industrial Development Corporation (PIDC) was formed to spearhead the industrialisation drive by providing the critically needed capital and then withdrawing in favour of the private sector, which lacked the skills or the finances to undertake very large projects. As industrial profits were more widespread, an entrepreneurial class emerged.

It was this class which provided the dynamism that had been absent during the 1950s. This class helped accelerate the rate of growth in the large scale manufacturing sector to more than 15 per cent during the decade. The Ayub decade also witnessed a series of reforms aimed at strengthening the agriculture sector. The land reforms of 1959 were designed to make a dent on the stranglehold of the dominating landlord class while at the same time encouraging capitalist agricultural development.

This was followed by the Green Revolution in mid-sixties. The Green Revolution was characterised by the introduction of high yielding varieties of rice and wheat and the mechanization and diffusion of technology aimed at boosting Pakistan’s agricultural growth.

The expansion of irrigated acreage with the installation of private tube wells, and increased use of chemical fertilizers contributed to agricultural growth. The rapid mechanisation of agriculture however led to the displacement of small farmers, thereby aggravating rural inequality.

Thus the legacy of the Ayub years is mixed. While the consolidation of economic management and the high growth rates were important achievements, the growing income inequality, wage stagnation, the neglect of human capital, and the growing dependence on foreign capital inflows, all pointed to the challenges that future regimes would need to face.

Bhutto’s Experiment with Socialism

In 1971 Pakistan lay traumatised by the cessation of East Pakistan and the defeat in the war with India. The end of the war marked the accession of Zulfikar Ali Bhutto, then a charismatic elected leader who encouraged a broad restructuring of the country’s industrial and agricultural sector along socialist lines.

It marked the strongest attempts today of the assertion of political authority over the country’s army and bureaucracy. It sought to rectify the social and economic imbalances that characterised the previous decade. Bhutto promised a new development strategy that was more equitable than previous policies.

One of the key decisions of the Bhutto administration upon accession to power was the devaluation of the rupee in 1972 by 57 per cent and abolition of the multiple exchange rate system.

This led to a phenomenal .surge in exports as Pakistan found new markets to replace the loss of trade with its erstwhile eastern wing. The most dramatic decision of the Bhutto regime was the nationalisation of large private manufacturing and financial institutions.

In 1972 all private banks and insurance companies and thirty-two large manufacturing plants in eight major industries were nationalised with the avowed objective of reducing the concentration of wealth and diluting the power of private industrialists. Consequently, the composition of investment changed dramatically from private to public sector. Nevertheless, nearly 80 per cent of the value added in the large scale manufacturing sector, particularly in textile and consumer goods remained in the private sector.

The outcome of nationalisation was not favourable as the large scale nationalised sector performed very sluggishly during this period owing to lack of able managers and technicians, many of whom migrated to the Middle East lured by higher salaries.

Private capital fled the country or Went into small scale manufacturing or real estate. One positive outcome of this was that the small scale manufacturing sector registered a growth rate of 10 per cent per annum in this period compared to 4.2 per cent for the large scale sub-sector. Another positive feature of industrialisation during this period was that for the first time an attempt was made to set up basic industries in steel, fertiliser and chemicals which laid the foundation for future growth that benefited subsequent regimes. Agricultural growth slowed due to a combination of exogenous and policy factors.

Firstly, climatic shocks and viral diseases affected the crops, with marked damage to cotton production. Secondly, there was an overall shortage of the critical agriculture inputs such as water and fertiliser tha were required to maintain productivity gains of the high yielding varieties. One unfavourable trend relating to Pakistan’s external sector during Bhutto years was the growing balance of payments difficulties and the consequent increase in the country’s external debt.

However, it was during these years that Bhutto’s policy contributed to rapidly increasing remittances that also helped to cushion the country’s external dependence. This is also the period of one of Pakistan’s slowest economic growth, constrained by a series of exogenous shocks, causing significant macro economic instability. Firstly, the cessation of East Pakistan after a brutal civil ^war led to a break-down in inter-wing trade. Secondly, the 1970s marked the beginning of a series of oil shocks induced by the newly formed OPEC cartel.

Thirdly, the 1970s was a period of substantial fluctuation in international prices of Pakistan’s commodity exports, making export performance highly uncertain. Finally, a combination of bad weather, flooding and pest attacks adversely affected the production of cotton, weakening the economy.

Military Government of Zia

This period coincided with the military rule of General Zia-ul-Haq, – who acceded to power with the goals of restoring political stability, liberalisation of the economy and islamisation of society.

In explicit contrast to 1970s, the 1980s was a period of reversal from public sector-led growth strategy. Destabilising exogenous shocks were absent in this period. As a result, the growth rate in GNP was over 6 percent. High rates of industrial growth were led by the coming on stream of the earlier investment made in the public sector under Bhutto, especially in heavy industries, and also by rapid expansion in domestic demand.

The Russian intervention of Afghanistan in 1979 propelled Pakistan to the forefront of international political attention. Not only did it give political legitimacy to the regime, it also set the way for substantial infusion of foreign aid and war-related assistance that together with generous inflow of remittances provided a safety value for the Pakistani economy. One of the negative effects of the Afghan war was the mushrooming of parallel and illegal economy estimated at about 20-30 per cent of the GDP.

The 1980s witnessed a surge in inflow of remittances from Pakistan, averaging about $3 billion per year for most of the decade. These remittances accounted for 10 per cent of GDP and 45 per cent of current account receipts. The flow of remittances supplemented household incomes and, financed the private sector with a pool of funds for investment.

The 1980s, however, witnessed the widening of fiscal deficits, which averaged 8 per cent of GDP in the second half of the 1980s. This had serious repercussions for public finances and macroeconomic stability in the 1990s. On the industrial front, the Zia regime began to deregulate and liberalise the economy to encourage private-sector investment.

The denationalisation of certain public sector projects, the provision of a package of fiscal incentives to the private sector, and the liberalisation of regulatory controls characterised the government’s industrial policy in the 1980’s.

During this period the continued growth of small-scale sector and the development of intermediate and capital goods industries led to the diversification of Pakistan’s industries.

The 1980s also witnessed significant structural change for Pakistan’s agriculture with deregulation of markets and production. Policies to revamp agricultural] sector included the deregulation of the sugar, pesticide and fertilizer industries, the removal of monopoly power of the Rice and Cotton Export Corporations, and the removal of bans on the private sector’s import of edible oils. As subsidies on pesticides and fertilizers were removed, the price system became more market oriented.

Overall, this was a period of substantial macroeconomic stability and revival of private investment. However; but the burgeoning trade and budget deficits did not bode well for economy in the subsequent period.

A military government was installed for the fourth time when on October 12, 1999 when in a military coup, General Parvez Musharraf, Chief of Army Staff, took over the country’s administration.

The economy of Pakistan was in total chaos when the military regime took over power. The country was heavily dependent on foreign loans to meet deficit repayment obligation, with 56 per cent of the budget going towards debt servicing. The total external debt was US $39 billion, and foreign exchange reserves were a mere $1.45 billion.

Tax collections had plummeted, while fiscal deficit had risen to 6.45 per cent of GDP in 2000.

Pakistan’s GDP slumped to mere 2.2 per cent and 3.4 per cent in fiscal years 2000-01 and 2001-02 respectively. These growth rates were the lowest in Pakistan’s recorded history.

The above indicated weaknesses notwithstanding, the military regime has been able to reduce the fiscal deficit to 5.6 per cent of GDP compared to 6.1 per cent of the 1990s. As much as 40 per cent of this reduction in deficit was achieved by drastic curtailment of public investment.

The performance of agriculture in the first two years of the new millennium was most dismal. Agriculture recorded negative growth of 2.64 per cent and 0.07 per cent in the first two fiscal years. The main reason for this poor performance was shortage of irrigated water caused by severe drought conditions. Since Musharraf’s takeover, Pakistan was in increasing danger of defaulting on its foreign debt.

But then came September 11, 2001 terrorist attack on the United States which made Pakistan a frontline state supporting the US war against the Taliban and Al-Qaida movement.

The US pledged over one billion US dollars in aid and the Paris Club creditors restructured and rescheduled much of Pakistan’s external debt. The US further lifted all economic sanctions that it had imposed against Pakistan for conducting nuclear tests in mid-1998. The fiscal year 2002-03 has witnessed a sharp recovery in economic growth accompanied by equally impressive performance of agriculture and large-scale manufacturing. While the travails of water shortages persisted, the extent of water shortage was less detrimental. The production of major crops recorded substantial recovery. The overall manufacturing sector also grew by 7.7 percent.

Return of Democracy and Structural Adjustments: 1988-98

The death of General Zia in 1988, democratic institutions were restored. Between August 1988 and August 1997, Pakistan had four general elections with both Benazir Bhutto and Nawaz Sharif being returned to power twice. None of the elected governments were able to complete their full term.

The excessive non-bank borrowing by the government in the 1980s to finance budget deficit left a legacy of debt and debt servicing in the 1990s with total interest payments amounting to one-third of total expenditures. The persistent high deficit/GDP ratio which averaged 6.8% per cent during the 1990s was beginning to take its toll on the economy.

Not only were the deficits large compared to other developing countries, the inflexibility in expenditure reduction imposed by domestic debt servicing obligations and defence outlays did not permit much room for manoeuvre to reduce the current expenditures. While there was a fundamental consensus on basic economic policies among the major political parties, the Pakistan People’s Party and the Muslim League, there was lack of continuity of programs and policies.

Administrative ad hocism and policy reversals failed to cash in the advantages of this economic policy consensus. Instead, each group of the two rival political contenders used these mechanisms to establish political power and supremacy. During this period a number of reforms were introduced in the trade sector.

In the 1990s a series of policies were introduced that reduced the items under Negative List, abolished industrial licensing, and simplified procedures for foreign investor. Furthermore, a generous package of incentives was given to exporters. A package of policies was introduced in 1990 to encourage deregulation, liberalisation and privatisation of industry.

Further, a combination of fiscal incentives-tax holidays, de-licensing of investments regimes, and reduction of tariffs on capital goods were meant to encourage the flow of private investment. However, owing to financial repression and lack of transparency, the response of the private sector to privatisation has been halting and hesitant. Agricultural performance during the 1990s was missed. Heavy flooding and pest attacks during 1991 and 1993 reduced cotton output and exposed the vulnerability of the Pakistani economy to its dependence on the vagaries of the weather and a single cash crop.

In sum, Pakistan’s economic growth decelerated in the 1990s for a variety of reasons, including worsening of macroeconomic environment, serious lapses in implementation of stabilisation policies and structural reforms, adverse law and order situation, inconsistent policies and poor governance. As against an average growth rate of 6.1 per cent in the 1980s, the real GDP growth rate slowed to an average of 4.9 per cent in the first half, and 4.0 per cent in the second half of the 1990s.

The external sector and particularly the management of debt put the economy under serve pressure. The cumulative imbalances of fiscal and current accounts combined with the decay of key institutions and poor governance have neutralised the liberal economic policy regime.