Once again Pakistan is about to adopt an economic stabilization program under the auspices of the IMF. There is little doubt that it is necessary, given the balance of payments crisis and the danger that a collapsing exchange rate could feed off the inflation rate to result in hyper inflation. The looming prospect of default gives urgency to the need for an immediate balance of payments support by the IMF, and the associated policy package of economic contraction to address the financial crisis. However the design and scope of the program must take account of Pakistan’s geo strategic context: Pakistan is fighting a war of survival against the Al Qaeda-Taliban combine whose outcome could profoundly impact security in the region and the world. At the same time Pakistan’s fragile democratic structure through which the war is to be prosecuted is threatened by rising poverty and unemployment. In addressing these strategic issues Pakistan’s economic stabilization program must go beyond the traditional IMF programs which are simply based on acute monetary contraction.
Pakistan’s experience of economic stabilization during the 1990s is relevant at this point. The contraction undertaken was so acute that it proved counter productive to the objective of reducing the budget and balance of payments deficits: The GDP growth rate was pushed down so sharply that the twin deficits reappeared near the end of the decade as the result of low revenues. At the same time the stipulated public expenditure cut fell predominantly on development expenditure rather than the government’s unproductive expenditure, thereby removing both the stimulant to growth and cushion for the poor. Thus Pakistan got the worst of both worlds: The GDP growth rate plummeted and poverty levels soared.
Thus the lesson of the 1990s was that while a financial crisis makes economic contraction necessary, this has to be done prudently so as to minimize the adverse effect on GDP growth and the vulnerable sections of the population. What does this mean for the program design?
In undertaking an economic stabilization program two strategic considerations ought to be kept in mind: (i) The economic stabilization program must be accompanied by policy initiatives to establish the institutional framework for structural changes in Pakistan’s economy and thereby lay the basis of sustained GDP growth in the post economic stabilization phase. (ii) Since an economic contraction policy will inevitably lead to increased poverty and unemployment, therefore social protection measures must be simultaneously undertaken to provide adequate income support and employment to cushion the blow on the poor.
Let us now articulate the structural constraints to sustained growth and their institutional underpinnings in Pakistan. This will be done within the perspective of a theoretical postulate that is central to the new economics even though it has not yet entered mainstream thinking in the IMF. The New Institutional Economics pioneered by Douglass North and others, has now established, that institutions are the fundamental factor in sustained growth and the efficient functioning of markets. An institution is a set of formal rules and informal norms (values, culture and consciousness). Since rules embody incentives, therefore institutions play a crucial role in shaping production organizations at the micro level and thus determining economic performance at the macro level.
In Pakistan the institutional structure of the economy provides rents for the elite by restricting competition through the exclusion of majority of the people from the process of quality education, training, investment and the process of governance. It is this narrow base of investment and restricted competition that underlies endemic inefficiency, lack of innovation, export competitiveness and hence recurrent balance of payments crises. My research for the UNDP, National Human Development Report (2003) provides evidence to suggest that the poor have unequal access compared to the rich over markets for land, labour and capital. The institutional structures of power at the local level engender asymmetric markets for inputs and outputs which deprive the poor of almost one third of their income. Furthermore my research for the Drivers of Change Study (2008) shows that Pakistan’s institutional structure constrains both sustained growth as well as poverty reduction.
It is Pakistan’s institutional framework and the associated incentive systems which have shaped the structure of its economy. By structure I mean the design format of the economy which determines the essential features of its growth process. I had argued in 2006 (DT, May 1 and 8, 2006) that Pakistan’s high GDP growth observable at the time was not sustainable and was likely to hit a balance of payments constraint which could force a slow down. Unfortunately this indeed has come to pass.
Four structural constraints to sustained growth can be identified. First, the domestic savings rate (12 percent) is far below the target investment rate (28 percent) required to sustain a target GDP growth rate of 7 percent. This is because the institutional structure provides incentives for consumption rather than savings and investment. Second, the export growth is unable to finance the foreign exchange requirements of imports associated with a high growth trajectory. This is because the incentive systems have engendered inefficiency, lack of technological change and associated lack of international competitiveness in much of Pakistan’s textile industry. At the same time the policy framework provides disincentives for diversification towards high value added exports. Third, Pakistan’s physical infrastructure including electricity, transportation and irrigation is grossly inadequate to meet the requirements of both industry and agriculture for a high growth trajectory. Fourth, the quality and coverage of higher education and vocational training do not provide the necessary skill base for sustaining growth in the high value added sectors. Each of these structural constraints are located in an institutional framework of governance within which the process of decision making with respect to economic policy is distorted in favour of rents for the elite, rather than public welfare.
I have argued that unlike the 1990s, on this occasion the scope and design of the stabilization program must be widened to take account of two new features: First, the contraction must minimize both the time span and magnitude of its adverse effect on growth and poverty. Second, a new institutional framework must be put into place as an integral part of the stabilization program so as to lay the foundations of sustained and equitable growth in the post stabilization phase. This time Pakistan is fighting a war for survival. There is no room for mistakes on the economic front.