Can Pakistan live without foreign assistance?

Article written by Shahid Javed Burki

Can Pakistan live without foreign assistance? This question has begun to be debated after a statement by Mian Shahbaz Sharif on May 12 when he said his province, the most populous and prosperous in the country, will make a serious attempt to forego foreign assistance with conditionalities.

The aim is admirable but the real question is whether it is achievable within a reasonable period of time. The only way to reflect on this issue is to take emotions out of it and build a case for or against aid by looking at the numbers.

We should begin this investigation by deciding on what should be the country’s rate of economic growth and that of its several provinces. Pakistan is doing poorly compared to its South Asian neighbours. Bangladesh — once the much poorer part of this country which was doing much less well compared to its western wing— has seen its economy grow at around six per cent a year in recent times. This is almost three times the current rate of economic growth in Pakistan.

Several serious Bangladeshi economists believe that they can see their country sustain a rate of growth of more than seven per cent per annum for many years.

The Indian annual growth rate has averaged 8.5 per cent over the last six years. Its ambition is to achieve double digit growth rates in two to three years and sustain them for decades. This seems feasible looking at the current trends. The rates of savings and investment are high enough to make a 10 per cent rate of increase in GDP feasible. If India achieves that rate it would have become one of Asia’s miracle economies.

Some of the empirical work done at the World Bank has shown that for a country such as Pakistan not to have an increase in the incidence of poverty, gross domestic product must grow at a rate twice the rate of increase in the work force.

Although Pakistan’s population growth rate is said to have declined to less than a two per cent a year — we will only have firm numbers once the on-going census has been carried out and its results tabulated — the rate of increase in the workforce continues to be three per cent per year. The reason why this is so much larger than the rate of increase in population is because of what demographers call “demographic inertia”. It takes times before fertility declines begin to translate into declines in the rate of increase in the workforce.

For Pakistan not to see any further increase in the already large incidence of poverty, the GDP must increase by at least six per cent annually. For a decline in the incidence of poverty, the rate of increase in the GDP must be more than six per cent a year — say seven or eight per cent. This is one reason why the Planning Commission, in setting its sights for the future, would like to see the economy expand by at least seven per cent a year. Is this feasible?

Pakistan does not have an efficient economy. There are many reasons for this. The technological base of the economy is poor; the work force is poorly trained and not well educated; supporting physical infrastructure (for instance availability of uninterrupted supply of electricity and gas) is below the level required by a growing economy; the state, mostly unwittingly, has placed many hurdles that entrepreneurs must cross; and rampant corruption increases the cost of business transactions.

My guess is that in Pakistan’s case the incremental capital ratio is of the order of four. This means that the country must invest at least four per cent of the gross domestic product to produce one per cent increase in domestic output. For the economy to grow at between 7- 8 per cent a year, it must invest between 28 and 32 per cent of the GDP. This is more nearly twice the current rate. This could happen — other countries do it, India has surpassed this level in recent years — but it will need a great deal of effort.

According to Pakistan Economic Survey, 2009-10, the average rate of investment in the five year period between 2004 and 2008 was 18.9 per cent. It was higher in the earlier years but declined in recent times. About three quarters of the investment was financed by domestic savings, the remaining one-quarter was provided for by foreign savings which includes external assistance. Without foreign aid, even the low level of effort being made currently to generate growth would become difficult. To raise it to the levels needed would be virtually impossible without sizeable foreign capital flows, including foreign assistance.

If we look at external accounts, the most interesting and unexpected development in recent years is the sharp rise in the level of remittances. In March this year, the flow of capital from this source increased to $1 billion. If this volume is sustained, an amount of $12 billion would be received this financial year. It is not clear why the remittances are increasing when there is so much uncertainty concerning Pakistan’s economic future.

There must also be a negative impact on the earnings of the members of the diaspora as a result of the economic slowdown in countries where these people are located. Given this, one would expect a decline in the level of remittances rather than an increase.

However, this is not to suggest that the policymakers should not seek to become self-sufficient and aim to generate domestic resources needed for financing development. But this can only happen if both the people and the ruling establishment are prepared to reduce the level of current consumption in favour of larger amount of savings. The citizenry must also be prepared to pay a larger share of its income to the government as tax.

At this time the people don’t seem to be prepared to that and the government lacks the political will to collect a larger share of national income as tax.

What is clear is that to climb out of the current economic slump and to put the economy on a trajectory of growth on which the neighbouring countries are moving, the rate of investment need to be significantly raised. The additional resources needed for that to happen will have to come from the outside. Even with a concerted effort by the government and display of political will that the present set of rulers seem to lack, the transition to a higher growth path will have to be financed from abroad.

The talk of dispensing with external capital flow will remain just that — talk by politicians — unless they can come up with a credible plan for increasing domestic savings and tax-to-GDP ratio. This brings me back to the statement by the Chief Minister of Punjab. If he and his government are serious about reducing — if not altogether eliminating their province’s dependence on external capital flows that come in the form of assistance — they should take advantage of the enormous opportunities that have opened up as result of the adoption of the 18th amendment to the constitution.

The amended constitution has not only transferred new functions to the provinces, it has also given them the authority to mobilise resources from within their borders. Up until now, the provinces have relied on federal transfers for more than 90 per cent of their expenditures. This proportion needs to decline. Only if that were to happen, will Punjab be able to wean itself away from external crutches?

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