Challenges to Pakistan’s 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.

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1. Introduction

All the serious challenges Pakistan’s 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 Pakistan’s 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

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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.

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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 Minister’s decision to reduce the expenditure
on the Prime Minister’s 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 Minister’s 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

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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

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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-cum-
area 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.

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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

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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.

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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