The economic landscape of Pakistan in 2007 is dramatically improved from that a decade ago. In the last few years Pakistan has been experiencing  moderately high growth , and resumption of growth is a welcome change for most Pakistanis,. The present government must be given high marks for stabilizing the economy , putting it back on the road to growth and introducing many sectoral reforms. The key question, looking forward, is whether the current growth momentum can be sustained. Thrice before in its history Pakistan has attained similar growth patterns, ending in a bust phase. One must therefore ask if   history will repeat itself .  Despite the gains, macro-economic fundamentals and foundations are  on shaky grounds and dark clouds of vulnerability are showing on the horizon . The challenges are serious enough to threaten the growth sustainability in the medium  term ( and even in the short term as a result of unforeseen exogenous shocks) and the nation state in the medium-long  term. If the cycle of economic boom and bust are to be averted, it would be prudent to not only heed the lessons of history but to embark on proactive policies to avoid the pattern of the past. So what are these lessons and what mitigating actions are worthy of consideration. In this article I have attempted to briefly highlight the underlying causes of the past three boom-bust episodes, identify the current vulnerabilities and offer a few  suggestions to  overcome the looming challenges in the economic management domain.

Lessons of History

The economic boom of the  1950s was primarily spurred by jute exports to feed the Korean war. All that wealth was largely consumed,, rather than invested, and as result  the boom ended with the end of  the Korean conflict. More disturbingly the  gains mostly  benefited West Pakistan, when its origin was in the other province, thereby sowing the initial seeds of separation.

The boom of the 60s had many sound elements, but generated inequalities (perceived or real) within the two provinces and between the rich and poor . This , along with inequitous distribution of political and administrative power, contributed to the break up of Pakistan and also created  the 22 family syndrome which ultimately provided the rationale and even  strong public support for the disastrous nationalization and socialism of the 70s. . Ten years into his reign,  Ayub believed that the  growth momentum will go on for ever. Little did he realize that celebrations of the  Decade of Development would be so short lived., and that the economic and political system he built would crash.

 The last boom, of the 80s, was fueled by strong remittances, high external flows linked to Afghan war, and liberalization of the economy. But because the main driver of growth was domestic consumption, the boom  petered out with the end of the Afghan war.  It goes without saying that the personalized nature of the governance system, in the 60s and 80s,  absence of a political system which was seen as legitimate  and truly democratic , and weak adherence to rule of law  also contributed to the economic collapse  with each change of government.

 From an economic perspective, several key lessons of the past three boom-bust episodes emerge for the future conduct of economic management. These include:  the critical importance of  sharing  resources and wealth which is seen as just,  inherent  weakness of inward looking growth strategy driven by consumption, and need to proactively address regional and income/opportunity  inequalities . An important non-economic lesson, especially from the 60s,  is that when courtiers paints a rosy picture,   it is prudent that the information and numbers originating  from the official sources are  taken with a big pinch of salt by the leadership

Similar lessons also emerge from other countries. As an example, the economic history of  South  America of the last four  decades has an uncanny resemblance to our own economic history. South American countries which had  inward looking and  consumption led growth , and widening income inequalities,, faltered in a few years. More worrisome is that many such countries have embraced, in recent years,   socialist  and populists policies as a reaction to the disenchantment with growing inequalities generated by growth and the market based economic system .

Sustaining the  current growth path will require much  bolder attention to  the lessons and challenges  noted above--  Pakistan of today not only faces many of these challenges but also the present challenges have greater intensity and complexity  than those  in the past. Key areas needing  attention are discussed below.

Flawed Growth Strategy

The first and foremost macro-economic challenge is the fundamental weakness in the growth strategy, which is inward looking and mostly driven by  consumption  Other than perhaps a few continent sized economies,  most developing countries which have followed an inward looking growth strategy  had booms followed by busts. One only has to ask  how much can Pakistan  grow through expansion of telephony,  real  estate and stock market bubble,  and domestically produced white goods  and vehicles under cover of protectionist policies. In neighboring India, while domestic consumption has been an important driver of  growth, equally important  contributors have been  export and investment. India’s exports ( as % of GDP) increased from 13% in 2000 to almost 20% in 2006. Pakistan has hovered around 15-16 % during this period. India’s investment rate is around 30% while Pakistan is woefully low at 16 %. Without a rapid  increase in exports, and investments especially in export sectors,  not only growth will soon peter out , but in a few years  the country could be faced with severe balance of payment crisis  . Exports are also key to poverty reduction and employment – all cross country experiences clearly indicate that exports tend to be employment intensive. Pakistan needs an aggressive  policy , institutional and investment reform package to address export competitiveness constraints and an equally  aggressive exchange rate policy ( not that it is being suggested as an option, but under valued exchange rate regime was followed by many East Asian Tigers in their early years of export push,  and by China to this day!)  . The incentives and institutional support for exports should be so robust that each and every economic agent ends up in hot pursuit of  exports rather than selling domestically.  Export must be nurtured by leadership to become national obsession, rather than real estate development.

Unsustainable Current Account Defict and its Inappropriate Financing

The next important challenge, directly an outcome of the flawed inward looking growth strategy, is the growing and unsustainable levels of current account deficits and the inappropriate manner in which it is being financed.. Reserves have dropped from 10 months of imports in 2000 to little over  4 months and could  go down to dangerously low levels in  two years. On the other hand , India’s reserves have mushroomed to over  one years’ worth of imports, with higher growth rates and lower inflation than Pakistan. Pakistan is  imprudently followed a policy of financing the current account deficit in any which way possible, rather than addressing the root cause of the imbalances and attempting to reduce the imbalances.. Using  remittances and foreign investments  in service sectors , portfolio investments  and GDR  issues ,  as a major source of financing current account deficits  is  a misguided and inappropriate strategy. Also at some point, in a few years, Pakistan will run out of selling public assets to generate foreign exchange. While  foreign investor’s interest in Pakistan is a good sign, for which the present leadership should be commended,  Pakistan’s FDI flows in recent years are  unbalanced.  Almost all FDI is in sectors that generate local revenues ( non-tradeable sector in economists jargon)  while the future FDI obligations ( in terms of  dividends and foreign loans) are in foreign currency. Moreover, the benefits of the FDI  foreign exchange inflows are one time,  because they are being consumed, , while the potential foreign obligations are perpetual and long term . FDI may not have a contractual payback as loans, but it is not a free lunch. In fact dividend payments on FDI are usually very high, to account for the high risks.   Pakistan needs more FDI in export manufacturing and far less in golf courses, fast food chains, speculative portfolio flows and fancy high rise buildings. East Asian Tigers had decades of FDI in export manufacturing, during their initial development phase,  which established a huge base for exports, before they went for golf courses and real estate developments.. Just like in the 80s and 90s, foreign flows are essentially financing  consumption related imports. This  foreign financed consumption binge is great, especially for the rich, but without a much higher and sustainable export and investment growth, the party would be soon over. As always the disastrous consequences of  low growth  would be borne by the poor. Given the macro vulnerabilities, the high levels of service sector FDIs is something to worry about rather than gloat about.  With any slackening of  growth  the current FDI strategy  will  haunt Pakistan, as  East Asian Tigers realized after the East Asian crisis and  as Pakistan faced in the 90s on account of the IPPs.     On the path that Pakistan is following, sooner or latter  reserve levels will become unsustainable, as in the 90s,  and the IMF will be back. Pakistan needs to aggressively reduce the imbalances through making exports the center stage of growth strategy , proactive exchange rate management , and encouraging FDI in export manufacturing and discouraging it in  service sectors which has limited contribution to poverty reduction and long term growth.   

Weak Fiscal Management

 The third area of macro vulnerability is the weak fiscal management, resulting from stagnant fiscal revenues and increasingly populist  public expenditure policy and management. While tax administration reforms are beginning to show results, tax/GDP ratio has generally remained stagnant. There is no way that Pakistan can sustain high growth and provide its citizens with decent public services, without a major increase in tax revenues.  Comprehensive and aggressive tax policy reforms are needed. Federal and provincial tax base needs to be expanded , especially to capture the enormous wealth generated in the services sectors like capital markets, real estate and retail. It is unthinkable that the club of the elite , comprising the main beneficiaries of the capital market and real estate boom, is by and large exempt from tax. Boom in neither sector has benefited Pakistan; thus the capital market performance has been dismal in raising funds for new investment,  which should be its main goal,  while the real estate boom has made housing out  of reach for most Pakistanis. Exempting these sectors from the tax net is not only regressive, but distorts  investment incentives.  Why would any one invest in export manufacturing, or any manufacturing, when he could get much higher tax free returns in the stock market or real estate ! Taxing these sectors will result in a drop in stock market index ,  which will only hurt the few hundred thousand participating in the market, and a drop in real estate  prices which will help the less affluent and middle-income.  And importantly the additional tax collected  could be used for increasing  pro-poor expenditures.

Populist programs are creeping into the budget. The mind-boggling subsidy on power, which mostly benefits the non-poor ( most  poor don’t have access to commercial energy) , is  glaring example of  a populist  public expenditure policy. Bold steps are needed to divert this expenditure to improving human developments services to the poor.  Another worrisome example is the quality of the public sector development program ( PSDP) . While the public sector program has gone up, so has the share of  projects with questionable  economic benefits.  Public investment decision making suffers from  personalized decision making, inclusion of too many pet projects with questionable  returns, and poor quality  benefits analysis of  new projects. The PSDP’s throw forward is a whopping and unsustainable one trillion rupees .High PSDP will only contribute to growth if the underlying projects have adequate economic returns. PSDP is too much ‘brick and mortar’ centered, with inadequate ( if any )  attention to achieving development results. Efficiency and cost effectiveness of public expenditures leaves a lot to be desired.

High levels of Poverty and Growing Inequalities

A ticking time bomb is the high level of poverty and growing inequality, that have heightened social tensions which could undermine all economic gains and continue to be the breeding ground for growing alienation, terrorism and  crime . There are around 40-45 million poor and perhaps the same number close to the poverty line. Anywhere from 80-90 million are poor and/or vulnerable with limited access to decent education, health, economic opportunities and assets. While the share of people  below the poverty line  has gone down ( a statistic which, along with growth and inflation numbers,  suffers from severe credibility with people) , life for these 80-90 million has largely remained unchanged. And on top of that , high inflation in recent years is hurting them more than the better–off.   There is more national interest in stock markets and real estate developments, and much less in making sure that the poor are actually getting  greater  access to  better quality of life. There is absence of  a credible and comprehensive Poverty Reduction Strategy. The poverty strategy  and programs  are more on paper and less on ground, and by and large  tinkering on the margin in respect of impact. Therefore the present development strategy is   widely perceived as one  for the elite, of the elite and by the elite. A much more aggressive , effective and comprehensive poverty reduction strategy is  needed to ensure that these 80-90 million people have  a stake in the  market based economic system , to avoid the repetition of history, and to address the gross inequalities. Expenditures on basic education , preventive health , social safety nets and  programs to help the landless and rural poor, should be increased dramatically, while putting in place adequate financial safeguards and accountability mechanisms ( eg involvement of communities , local governments and NGOs in design and implementation )  to minimize waste and abuse. In addition programs are needed to enhance skills and poors’ access to opportunities and assets. There are huge  benefits of converting the energy of the large pool of underprivilged citizens , especially of  underdeveloped areas,  in terms of  productive work force as well as better utilization of land, which is a fixed resource.   Dramatic increase in pro-poor expenditures on the ground ( not that resulting from salary increases of teachers and counting police expenditures as pro-poor) are affordable and doable, by switching expenditures from questionable  PSDP projects , unjustified  subsidies and wasteful current expenditures. Easily at least 1 – 1.5 % of GDP could be made additionally available for pro-poor expenditures next year, by expenditure switching as noted above .

Poor “ Economics of the Federation”

Finally  there is need for a paradigm change in management of a nation threatening economic challenge.  What I call the “economics of the federation”. Inadequate and timely attention could lead to not only a bust but also break-up. Pakistan is a unique federation. No other large federation, India, USA, Brazil, Russia, etc faces  this “manufacturing defect”, where one federating unit has  disproportionate and overbearing influence ( perceived and real) . And compounding this issue is that whatever glue bonded these unit together , 60 years back,  is now coming apart at very dangerous pace, both on account of political issues and poor federal economic policies. The present government has increased resource flows to the provinces, which is a very good step. However there are a few  key policies that need a paradigm shift to strengthen the “federating glue” and overcome the historical sense of deprivation .

There is urgent need to have a  market based  natural resource pricing , for water and gas. The present pricing and sharing of profits/royalties is unfair to Balochistan and NWFP, and has largely benefited the energy consuming population in  Punjab and Karachi. Imagine the resource transfer to Balochistan and NWFP, over  last 40 years, if the prices were market prices – prices that Pakistan was paying for imported energy. Imagine if  Balochistan received the same price of gas as Pakistan is now willing to give to Iran, a few hundred miles away. Increasing federal grants and programs , as was belatedly done by Ayub in the 60s for East Pakistan, will not and cannot fully overcome the perceived wrong of  unfair resource pricing and sharing. A market based pricing, along with a system that distributes the  additional ‘windfall gains’ to  the province and directly to its citizens needs to be put in place. A possible bold step for distributing resources could be that  similar to one in Alsaka , where each Alaskan resident gets a check in the mail for the  annual dividend from the Alaskan oil/pipeline. Let each  resident of  Balochistan and NWFP get a “check in the mail”, with adequate safeguards to minimize abuse.

The second worrisome issue is the growing  disparities in economic and social progress between Punjab and the rest of the provinces. Punjab is galloping away, while the smaller provinces and rural Sindh  are  being left behind, both in a reality and perception..  Imagine what will happen in 10 years. It will become as untenable, as between West and East Pakistan by the 60s. Just as most East Pakistanis perceived that the streets of Karachi, Lahore and Islamabad were paved with earning of the golden fibre  from East Pakistan, similar perceptions  are being  generated and increasingly gaining  widespread appeal  within the smaller provinces. Overcoming this would require a paradigm shift in distribution of  NFC  resources, dramatically increasing the share of the provinces, in addition to special programs to address the perceived regional inequalities.

 Looming Energy and Water Crisis

Though not a lesson of history, two sectoral challenges  will choke growth –the   looming energy crisis will choke growth in the medium term, and the water crisis in the long term.  . It is unimaginable that  additional power generation capacity installation has been so slow, despite clear signs a few years back that shortages were around the corner. Pakistan is an energy importing country, and this dependency will increase over time.   The present situation  is unsustainable , where retail prices are lower than costs, where subsidy is nontargeted and where  consumers are not being prepared to accept the reality that cost of commercial energy will have to be same as that in international markets. There is no way that the economy or the budget can sustain a situation where Pakistan will be importing LNG at  $6-7 per MMCF  ( and perhaps Iranian gas at around $5-6 per MMCF) while retail tariffs are half  of that cost. Poor are being short changed in that they have to pay higher energy costs, for non-commercial energy, while the better-off are being subsidized.  The competitiveness of Pakistan’s manufactured exports  is also being hurt by the present distorted tariffs. Moreover, under the present pricing structure, it will be  difficult to attract private investors—unless they are given guarantees which makes the investment risk free.. Why would any private investor invest in a sector where the underlying financial situation is loss making.  Government needs to take the bull by its horn.  Reducing losses , improving sector management, introducing competition and customer service is overdue. In addition pricing reforms are critical to ensure that subsidies are targeted, that industrial tariffs are not used to subsidize households, and that consumers  face the real costs so that right choices are made and energy is conserved.

In respect of water, the government’s strategy has many good elements. But a fundamental missing element is absence of a water pricing and trading regime ( allowing trading of water between users and between provinces)  which reflects the scarcity value of water. The next generation of farmers will have to be educated , and accept, that water quantity is fixed while requirements are increasing, and consequently water has to, and will be, priced .  Farmers have to be informed , and appropriate incentives introduced ,  so that farmers switch out of growing water intensive crops (like sugarcane and coarse rice)  as well as flood based watering.. Pakistani farmers have to achieve water productivity similar to that in Turkey, Israel, California, etc for Pakistan to avoid a catastrophe and nation threatening internal water wars, in not to distant a future.

Needless to say, there are many other economic and non – economic factors that will also influence  the course of economic growth Critical non-economic factors  that are a necessary condition for sustained growth include : establishing of a stable and accountable democratic system; moving away from the present personalized form of governance, at all levels, to  institutionalized governance ; enforcement of rule of law and accountability without fear or favor; improving security environment and access to impartial justice; ; improving  stability, transparency  and predictability of policies;  enhancing quality and capacity of public institutions; and very importantly having a statistical system that is credible .

In conclusion, President Musharaff and his economic managers have brought Pakistan  back on the long road to progress. However it is vital that the recent success does not blindside policy makers to the serious challenges around the corner and the weak   growth foundations on which the present success is built upon. There are emerging  signs that the future is being compromised for the present.  Continued skirting of difficult, but necessary, choices is no longer an option. Bold steps, and a change in growth and development strategy, are needed to ensure that the growth is sustainable and the strategy is credibly is seen as one that is for the people, of the people , and by the people.

( The writer is a former Operations  Advisor at the World Bank)