AN ECONOMIC CRISIS STATE?

The Pakistan economy was a trend-setter in Asia up to the 1960s. It has steadily deteriorated and has lurched from one financial crisis to the next.

At the heart of the problem has been the poor management of public finances and deep-seated unresolved structural issues in the economy that bad management and poor governance has exacerbated.

The consequences of this secular decline in economic governance are:

• macroeconomic instability
• high inflation
• poor public services
• criminal neglect of the social sectors
• widespread corruption
• crippling power outages
• growing unemployment
• deepening poverty and a deteriorating debt profile.

The Early Years

In Ayub Khan’s era, Pakistan was a ‘model of development’ and ‘aid-effectiveness’. Ayub Khan was deeply interested in economic development.

He placed the Planning Commission under the President’s Secretariat and himself became the Chairman.

The Planning Commission was staffed with some of Pakistan’s best and brightest economic minds. It was ably supported by a number of fine economists from the former East Pakistan who worked in the Pakistan Institute of Development Economics, as well as economists and policy analysts from the Harvard Advisory Group.

Ayub Khan listened to their advice and often deferred to their judgment over the views of the mighty ICS/CSP.

Pakistan’s Second Five-Year Plan came to be widely regarded as the best produced in Pakistan and the developing world. It was not only well-crafted and technically sound but embodied targets and objectives that were realistically ambitious.

The report on the Evaluation of the Second Five-Year Plan showed that most plan targets had been met or exceeded both in the macroeconomic field and with respect to projects and programs bearing testimony to the fundamental soundness and realism of the plan.

Pakistan was also blessed with other fine institutions led by persons of great integrity and competence: PIA, WAPDA, the Railways, PICIC, IDBP, the State Bank, the ICS/CSP, and so on.

All these institutions operated at high levels of efficiency and in the case of commercial entities were profitable. The economy grew at a steady pace with some sectors such as manufacturing racing ahead at double-digits. Inflation remained tame with agricultural productivity boosted by the fruits of the Green Revolution. The domestic and external deficits were kept in check.

At the time, the economy was closed and tightly controlled and rationing of some food items and especially foreign exchange was commonplace. Yet there was no evidence of price pressures suggesting that the underlying balance between demand and supply was being maintained. Even exports performed well despite the clumsy and opaque ‘Bonus Voucher Scheme’ with its multiple exchange rates.

Foreign aid, at that time mostly in the form of outright grants and PL-480 grain shipments paid for in rupee counterpart funds and thus non-external debt-creating, fuelled much of the growth.

By supplementing domestic savings, aid allowed Pakistan to invest more than might have otherwise been possible with domestic resources alone. Importantly, the aid was well spent in building social and physical infrastructure, in particular large hydro-power dams in the context of the Indus Basin Treaty which was brokered by the World Bank.

The investment to incremental capital-output ratio, a good summary measure of capital efficiency, was low and produced high real growth rates per unit of capital invested. Plan projects and programs were well-prepared using the ‘best-practice’ techniques of project appraisal and analysis of the time. Monitoring of projects was rigorous and conducted on-site; project cost over-runs and delays were minimal; project benefits were delivered as promised; corruption was not spoken of and Plan guidelines were respected and Plan discipline enforced.

The external environment was exceptionally benign. The global economy was in the midst of an unprecedented period of expansion which started at the end of World War II with world trade growing at a healthy pace, markets relatively open, and little global inflation. Thus the economy experienced few of the shocks that could derail its steady upward trajectory and challenge policy-makers.

Ayub Khan was a victim of economic success. The revelation by none other than the Chief Economist of the Planning Commission—his most beloved institution which he headed—that twenty-two families controlled 70 per cent of manufacturing and 90 per cent of banking and insurance business in the country jolted his regime to its foundations.

It was a supreme irony that Ayub Khan was following the growth philosophy as espoused by the Chief Economist of the Planning Commission in his Cambridge PhD thesis turned book, ‘The Strategy of Economic Planning’. Growth philosophy argued that in the initial stages of economic development some concentration of income and wealth in a few hands was necessary and appropriate to stimulate ‘animal spirits’ and foster the conditions for rapid growth.

Considerations of equity and income distribution could be tackled at a later stage of development. The reaction to the revelation of concentration of wealth in a few hands was hostile and swift. Pakistan’s industrialists came to be called ‘Robber Barons’ who had earned monopolistic profits behind high walls of protection, subsidies and government patronage.

An empirical study by Professor Lawrence White of New York University lent credence to this proposition. Furthermore, some of the industries that had been set-up behind high protective tariff barriers were generating ’negative value-added’ when their inputs and outputs were valued at ‘world’ prices (rather than being valued at distorted domestic prices).

Factor price distortions, including an over-valued exchange rate had led to the choice of highly capital-intensive techniques of production, generating little employment per unit of capital and output. One study by an East Pakistan economist of repute calculated that factor intensity in Pakistan as measured by the capital-labour ratio was higher than in an advanced country like Japan.

There had been economic growth to be sure; but it had been distorted in terms of factor proportions and allocative inefficiencies. Most importantly, it had exacted a high price in terms of inter-personal and, more ominously, inter-wing disparities in income and 186wealth. In West Pakistan the revelation of concentration of income and wealth provided the springboard for the rise of Mr Z.A. Bhutto’s People’s Party and its socialist agenda. In East Pakistan Mujibur Rahman used the finding of concentration of wealth in a few hands, mostly belonging to families in the West, to argue that East Pakistan had been exploited and robbed of its resources and wealth through policy-induced distortions in the inter-wing terms-of-trade.

Yahya Khan took over without much economic dislocation. There were a few tough words about the concentration of wealth but the government did not do much except set up a toothless Monopoly Control Authority with an ostensible mandate to look at and punish anti- competitive behaviour. It never did amount to much. The 1971 war placed pressure on government spending and imports and the dismemberment of the country gave pragmatic argument for the nationalisation of the financial sector.

Bhutto had little patience with economic matters. His nationalisation program was a shock to the system and a grievous blow to private sector confidence that would take years to rebuild. New private sector investment came to a virtual halt.

There was much (concealed) capital flight as businessmen took their money out of the economy either before or after nationalisation and it would be many years for this capital flight to reverse itself.

The economic effects of the break-up of Pakistan were profound. It caused vast disruptions to the financial and corporate sectors that had operated on the basis of a single country. The State Bank of Pakistan had been pushing the Pakistani commercial banks into increasing lending in East Pakistan while their deposit base was almost entirely in the western wing where most, if not all of them, were headquartered. The dissolution of the country created an imbalance between assets and liabilities that left most of the banks (with the solitary exception of the National Bank) in virtual bankruptcy; the same applied to the insurance sector where the largest private insurance company—Eastern Federal—was headquartered in Dhaka and lost access to its assets while most of its liabilities to life policy- holders were resident in the western wing. Nationalisation was the only way that a total bankruptcy of the financial system was avoided, especially as this postponed any question of compensating the shareholders, depositors and policy-holders. Many observers remain convinced that nationalisations of the financial system was a negative turning-point for the economy but this was 187only a proximate cause: the real cause lay in the country’s break-up. The corporate sector suffered similar fracturing of balance-sheets since some of the more adventurous business firms (like the Adamjees) were operating in both wings and lost their investments in the eastern wing at one stroke.

To add insult to injury—and given the time lags involved in the income tax administration, many of these firms continued to be pressed for taxes on earlier years’ profits earned in the eastern wing! That the private sector survived at all in the wake of this calamity and with the additional ideological nationalisations imposed by Mr Bhutto is, some feel, nothing short of a miracle. That said, nationalisation was by and large well-received by the people who saw it as an election promise fulfilled and a means of redressing the evils of concentration of wealth and wide disparities in income. Bhutto’s boldest move on the economic front was to sharply devalue the Pakistan rupee and bring it closer to its ’equilibrium’ value. The years of clinging to an artificially appreciated rate of Rs. 4.76 per US dollar, which was propped up by tight controls on foreign exchange and which created many distortions in the economy were finally over. His government faced the challenge of the first oil-price shock and turned to the IMF for short-term financing but there was not much conditionality attached and no reforms were implemented. To be fair to Mr Bhutto, the gods were not kind to him. Each year brought a drought or a flood—negative domestic exogenous shocks— which hurt growth and caused a pick-up in inflation. Yet the economy was kept afloat and on a reasonably even keel thanks to Bhutto’s diplomatic success in securing financing from friendly Islamic countries (including $500 million from the Shah of Iran) and the Gulf, as well as an emerging new phenomenon: rising workers’ remittances which were becoming an important source of financing the external accounts.