Pakistan’s moral-hazard economy
The day before Clinton arrived in Islamabad, the Friends of Democratic Pakistan met there. An earlier meeting of the group was chaired by Obama on the sidelines of the United Nations General Assembly session in New York last year. It was attended by then-Prime Minister Gordon Brown of Britain, the heads of the World Bank and the International Monetary Fund, and government ministers from several countries. At the Islamabad meeting, the FDP agreed to provide finance for Pakistan’s energy-development program, and requested proposals from the Pakistanis for the development of other sectors considered vital for the economy.
A few days before that, President Asif Ali Zardari paid his fifth visit to Beijing since taking office in August 2008 –- this one a state visit -– and received pledges of support for developing nuclear power and constructing a railway line over the Karakoram mountain range, linking the two countries. This would facilitate western China’s access to the sea, via the Pakistani port of Gwadar.
These promises and pledges underscore Islamabad’s growing dependence on foreign assistance, which is not surprising, given that Pakistan’s tax-to-GDP ratio has declined to less than 9 percent, the lowest among the 22 largest emerging economies. They also suggest the continuance of a sort of moral-hazard approach to economic management that ensures foreign help whenever the country drives itself to the edge of an abyss.
Today, Pakistan is Asia’s worst-performing economy. Its GDP growth rate of 3 percent is half that of Bangladesh and one-third that of India. And, while there is a good chance that this latest infusion of foreign money will help the country to pull out of a deep economic crisis, it will simply be history repeating itself. Pakistan does well when it receives large flows of foreign assistance, as in the 1960’s, during President Ayub Khan’s term in power, the 1980’s, when General Zia-ul-Haq ran the country, or the early 2000’s, when General Pervez Musharraf was in charge.
During these three periods of military rule, the country was able to align itself quickly with the US. In the 1960’s, America wanted Pakistan to be on its side as it sought to contain the spread of communism in Asia. In the 1980’s, the US wanted Pakistan to help it force the Soviet Union out of Afghanistan. After the terrorist attacks of September 11, 2001, the US wanted Pakistan to help end Taliban rule in Afghanistan.
Now, for the first time, the US is providing large amounts of assistance to a democratic government. Will this relationship help Pakistan get off the economic rollercoaster it has been riding for the last half-century?
To ensure that its economy’s performance is no longer dictated by the availability of foreign aid, Pakistan must undertake some fundamental restructuring. If carried out by a representative government, such economic reforms have a better chance of being sustained. On the other hand, there is no assurance that the right policies would be maintained if power once again passed to a military ruler.
The foreign governments that are currently engaging Pakistan should encourage its leaders to move forward on at least two related fronts: trade and better relations with India are crucial.
At independence more than 60 years ago, Pakistan had a larger trade-to-GDP ratio, owing in part to trade with India. That came to a sudden stop in 1949, as a result of the first of many trade wars that the two countries have fought.
Before 1949, India absorbed roughly 60% of Pakistan’s exports and accounted for 70 percent of its imports. Nowadays, India accounts for less than 5 percent of Pakistan’s total trade turnover.
This is contrary to what would be predicted by the so-called gravity model of trade, which is based on both the size of the trading partner and its distance. According to this model, China and India, not the US, should be Pakistan’s largest trading partners. Thus, Pakistan should not devote so much of its energy to improving its access to the US textile market, as it now does. Indeed, given competition from low-wage economies such as Bangladesh and Cambodia, Pakistan should abandon its focus on textiles altogether and expend much greater effort to develop its knowledge-based industries.
Another area of emphasis for donor dialogue with Pakistan is governance –- not just reducing and controlling corruption, but also bringing policymaking closer to the people. Long stretches of military rule, with its emphasis on command and control, has left policymaking in Pakistan highly centralized. More power needs to be devolved to the provinces.
Today’s democratic government has taken a step in this direction by amending Pakistan’s constitution. The country’s “friends” should encourage this effort, perhaps by requiring that the country’s provinces be given a voice in their dialogue with Zardari’s government.
Foreign donors must insist that Pakistan reform its economy in order to escape the moral hazard implied by continued dependence on aid flows. But that outcome is much more likely if democracy flourishes throughout the country.
*Shahid Javed Burki, a former Finance Minister of Pakistan and Vice President of the World Bank, is currently Chairman of the Institute of Public Policy, Lahore. © Project Syndicate, 2010