Economic Performance of Pakistan 2013-14: A Skeptical Analysis

Economic Performance of Pakistan 2013-14: A Skeptical Analysis
by Shahid Kardar and Imtiaz Ahmad

Policy Brief 24/2014
Institute of Public Policy
Beaconhouse National University

Pakistan’s economic performance has been lackluster since 2008. Tall claims that economy is back on track are made by the economic managers at the time of presenting 2014-15 annual budget. The recently released Pakistan Economic Survey (PES) is extolling the virtues of the government’s policies and attributing all the good numbers to the policies pursued during the last 12 months by the present government. Unsurprisingly, the same document is dismissing all the bad numbers as the outcome of the wrong policies of their predecessors.

The most emphasized number in the PES is the growth rate of GDP. It is claimed that the national output has grown by 4.14 percent compared to the last year’s 3.7 percent. Superficially, this growth is the highest achieved by Pakistan since 2008. The pride over this performance, however, is incorrect due to some underlying issues. First, the number (4.14 percent) cannot be taken without a pinch of salt. Not only that the last review by IMF has forecasted the growth rate around 3.1 percent but also due to some clear indications of data maneuvering. Consider, for instance, the fact that 2011-12 GDP growth rate was 4.4 percent and this was revised downward in this year’s economic survey (i.e. the revision takes place after two years!) to 3.7 percent. In the present age of communication this delayed revision is not understandable. If the revision was required it should be earlier than at the time of the start of FY15. It means that if this number is taken at its original value --which appears more accurate--then the present growth rate is only the second highest since 2008. In addition, it leaves one suspicious that to what extent the present growth rate of 4.14 is reliable and for how long! Again, all the investment categories in the year 2011-12 were revised upward while other major indicators were at their previous levels. It increases one’s doubts that the revision of the growth rate was actual rather than political. Thirdly, and as explained below in more detail, other macro and social indicators are not supporting the growth rate of 4.14 percent.

To begin with, investment has not grown significantly compared to its previous years’ growth rate. Especially fixed investment and total investment have changed insignificantly compared to their values in the comparable periods of last years. For example, the growth rate of public investment has decreased from 18.4 in the first nine months of last fiscal year to 17.1 percent in the comparable period of outgoing fiscal year. Similarly the growth rate of total and fixed investment has decreased by 2 percentage points each compared to their growth rates in previous year. This should be a point of concern for the government as fixed investment is the single most important determinant of long term growth rate.

It is admitted in the PES that the targets for the two major variables--tax revenues and exports-- have been missed. Despite of the fact that tripod of Tax Revenue, Investment and Exports (TIE) is the major focus of economic managers, the slippage provide them the opportunity to rethink their economic priorities.

Ironically, instead of devising an improved plan to mobilize domestic resources to decrease reliance on foreign loans, government is priding over the $2 billion debt acquired through Euro bonds as great success. There is a need to realize that it is after all a debt that Pakistan has to pay back. In fact, one can question the rationale raising the debt at 7.25 to 8.25 percent interest rates. Interest rates in the international markets near zero since the global financial crisis. Thus, the high interest rates investors choose to lend to Pakistan speak volumes about the high risk investors are attaching to Pakistan’s economic prospects, even if we account for the higher expected interest rates in the coming years. Moreover, in view of increasing share of debt servicing in the total revenues (i.e.47% of total revenues during July-march 2013/14 compared to 44% for the comparable time period last year), this debt should be interpreted as a bane rather than a boon.

In addition to the above, the failure to mobilize the targeted revenue resources means that government is unable to muster the political will required to implement the effective taxation mechanisms and thus has to take recourse to expensive international debt.

The stability in the value of Pak rupee against US dollar is hailed as another feather in the government’s cap. The ire of country’s noted economists notwithstanding, the basic principles of economics teaches us that a change in the value of a currency foreign exchange market reflect, dominantly, the interest rate and inflation differential across these countries. Thus as long as there exist a positive differential in inflation rates of Pakistan and US, ceteris paribus, Pak rupee should be depreciated against dollar to keep our exports competitive. A stable and appreciated value of rupee will only hurt our exports growth. Notably the exports growth, one of the three key targets of present government, has already missed its growth target. According to SBP the total exports in the first 10 months stood at $21.04 billion — only $497 million higher than the comparable time period last year. Considering the average exports of $2.1 billion per month over first 10 months of the current fiscal year the economy is expected to miss the export target of $26.6 billion by at least $1.36 billion.

Unlike imports, exports are more dependent on developments outside the domestic economy. Therefore, the sluggish growth in the World GDP during 2013/14 compelled most of the South Asian economies to depreciate their currencies in order to ameliorate the impact of declining world trade. Contrary to the South Asian economies Pakistan appreciated its currency despite the fact that Pakistan’s exports to EU (European Union) could gain momentum following the GSP plus status. With exports of $5.7 billion the European Union (EU) is Pakistan’s largest export destination in FY13. Such manipulation of currency could not only tumble the competitiveness of Pakistan’s exports in international market but it can also imperil the possible gains from GSP plus status granted by EU which is considered one of the major achievements during 2013/14.

The performance on the human development front is the easiest and most desired way of understanding the nature of economic growth. On this front the economy is decelerating or at least remains unimproved. Thus expenditures on education are stagnant at 2 percent of GDP the same level they had in 2009. More depressingly, we are now spending lesser share of our GDP on health as we used to do in 1980s or even during tumultuous 1990s: 0.4 percent compared to 0.8 and 0.7 percent, respectively in 80s and 90s. This should be disquieting given the fact that population is the greatest resource Pakistan has and continue to be so for many years to come.
The rate of unemployment in Pakistan is continuously on the rise. In 2009-10 it was 5.6 percent and climb to 6.2 in 2012-13 and remains unchanged in the outgoing fiscal year. Superficially, it means that we have experienced a jobless growth this year. However, and more worryingly, one cannot admit such a low rate of unemployment given the visible levels of high youth unemployment all around. On the other hand, it also makes mockery of the claims of high, broad based and inclusive growth by the finance minister.

The literacy rates both at national and provincial levels are unbelievable. The net primary enrollment ratio, the basic indicator of human development, is hovering around 55 percent for the last 10 years. This explains volumes about the priorities of our economic managers vis a vis the future of the country. Since 2010 the growth rate has not changed, even by official estimates, from 56 to 57 percent.
The percentage of population living below poverty line as given in PES is 12.4 percent which is surprisingly low. On the one hand there is an increase in unemployment and while on the other

the percentage of people living below poverty is decreasing. More surprisingly, the growth rate of agricultural sector has squeezed but rural poverty has decreased despite of the fact that around 45 percent of the rural population is employed in agriculture. These are clear discrepancies in need of explanations.

Comparing development and non-development expenditures in per capita terms is instructive. Compared to last year military expenditures in per capita terms has increased from Rs. 3411 to Rs. 3901 while the total development spending (mentioned as pro-poor spending in the PES) has decreased from Rs. 11000 per person to Rs. 10668 per person. It should also be noted that military expenditures for the last 5 years are constant as percentage of GDP for Pakistan (which should be interpreted as increasing given the fact that national pie is getting bigger each year) while the military expenditures for other countries are decreasing for example India and SriLanka. The share of military expenditures in GDP is shown to be constant by locating pensions of military personnels and categories of security related expenditures in other government expenditures heads.

In sum, the overall state of the economic landscape in Pakistan has not changed significantly during the last one year. Admittedly, the time period of one year is insufficient to solve the economic malaise that plagued our economy. However, the government should paint a realistic picture of the economy rather than manipulating the key indicators. It could demand credit for crafting out a well thought out plan, if it were so. But it appears that government was unable to come out with any such plan and most of the policies are devised and implemented in a ham fisted way. In coming years, we can only hope that government will not repeat the mistakes of its first year in office.

Human Development

                                                         
Human development is the most important breakthroughs in the 1970s in the development economics. From 1970s and onwards the broader meanings of development at the conceptual level was recognized but there was no way to quantify it. Between 70s and 90s numbers of attempts were made by development professionals, one of the concept was physical quality of life index (PQLI) which was developed in the late 70s.

                GDP or GNP per capita was defining items, and all the countries had national accounts which allow very neat kind of analysis. But it does not capture the social or human side of development. In 1989 when Mehbub-ul-haq joined UNDP he worked with a number of people and came up with Human Development Index (HDI). Human Development Index although more complex than GDP per capita measure, it brought together four indicators. First measure in Human Development Index is life expectancy at birth (how many children die out of 1000), second is literacy (they added combined enrollment of primary tertiary and higher education), finally GDP per capita at Purchasing power parity.  Index was divided into three categories, high human development index (between 0.8 and 1), medium human development index (between 0.5 and o.8), and low human development index (below 0.5).

This was remarkable categorization because if put with the per capita income is divorce, in some countries the per capita income is high and human development index is low and in some other countries it was the reverse, so these two measures together show where the country is heading. Within three to four years, when measures like per capita income proved weak and in some cases misleading measure,  starting from 1990s it led to very interesting debate because it was regarded as major conceptual breakthrough in understanding and measuring development. Then country after country started measuring country level human index.
 

                The preseason why economies were experiencing the deteriorating levels of developing despite increase in per capita income was the fundamental flaw the public policies. The poorly designed interventions accrue substantial benefits to the non deserving groups. Furthermore there was no balance between targeted and across the board policies. As Mehbub ul haq suggested the well structured across the board policies are likely to be appropriate where incomes are low but distribution is good. In countries with higher income and good growth but skewed income distribution, targeted interventions that favor the poor are necessary to supplement across the board policies.

                It was not as only conceptual breakthrough, around the human development index a major program of analytical research was started and annual human development report of very substantial kind also started which is published every year.

                UNDP gained tremendous respect in the US due to its research of human development of the world otherwise it was doing just projects. Each report has a theme for example 2003 report talks about MDGs and how to achieve those.

                Much of the world once believed that GDP as only sufficient indicator of development but concept of human development from the conceptual level came through measurement and now it has come to policy prescriptions and country level studies. This is how mehbub-ul-haq changed the world because now each country can see its picture and can adjust policies and learn from other countries experiences.

                 Nobel Laureate Amartya Sen put it correctly when he said, "This initiative in global communication…was no more than one instrument this creative man used as an essential component of his fight against deprivation and unfreedom across the world. We have to remember that Mahbub wanted to change the world – not merely to measure it.‟ ( A. K. Sen 2008) 

National Innovation Policy

Pakistan stands today at an unwieldy position in its economic history. After a decade of slow growth the challenge is to launch Pakistan on a new growth path characterized by a sustained high GDP growth of 7 to 9 percent combined with a change in the composition of growth. To ensure rapid poverty reduction requires different performance from the economy by focusing more on productivity rather than just adding factor inputs. The drivers of growth that are generally focused in Pakistan’s growth strategy are aimed at breaking the key bottlenecks, increasing the investment rate, creation of infrastructure, and opening up of the economy. What seems to be missed out in the growth strategy is the national innovation policy for the purpose of increasing total factor productivity.

The national system of innovation in which a firm is embedded matter greatly, since they strongly influence both the direction and the vigor of its own innovative activities. The main reasons why Pakistani firms have low rate of technological innovation are increasingly protectionist trade policies, little competencies in production and research, and the poor institutions of corporate governance.

Innovation is considered as one of the key ingredients in determining a country’s overall competiveness, productivity and hence economic growth. It must be essential part of growth strategy of developing countries to catch up with developed countries as it is also important for improving global competitiveness of a country. Therefore, the World Economic Forum considers innovation as one of the twelve pillars of its widely disseminated Global Competitiveness Index.

Pakistan’s position in this domain continues to deteriorate over the years. According to the Global Competitiveness Report 2013-2014, Pakistan has dropped further nine places and ranks at 133^rd out of a total of 144 countries. Given the crucial importance of innovation for competitiveness on the one hand, and Pakistan’s poor performance on the other, the innovation policy must be central to growth strategy.

Local demand opportunities and competitive pressures will not result in innovation unless firms have the competencies that enable them to respond. Corporate and national competencies in production and in research are essential. Using patents as an indicator of innovation, innovation at the national level is positively influenced by the size of the economy, foreign competition in the domestic market, public expenditure on R&D and the availability of venture capital; it is negatively influenced by the presence of a relatively large number of small and medium-sized firms, high company tax and a high level of economic prosperity [1].

Firstly, the research and development expenditures in Pakistan have always been low. Secondly, there have never been notable efforts to enhance the collaborative leaning and technological development with the help of foreign firms and networks. The model of collaborative learning and collective efficiency is not only confined to Italy, Spain and Germany, but diffused around the world – and under certain conditions, extremely effective for process and product innovation at firm level [2]. For example, Sialkot in Pakistan plays a dominant role in the world market for specialist surgical instruments made of stainless steel. From a core group of 300 small firms, supported by 1500 even smaller suppliers, 90% of production (1996) was exported and took a 20% share of the world market, second only to Germany. In another case the Sinos valley in Brazil contains around 500 small-firm manufacturers of specialist, high quality leather shoes. Between 1970 and 1990 their share of the world market rose from 0.3 to 12.5% and they now export some 70% of total production. In each case the gains are seen as resulting from close interdependence in a co-operative network. The big question is what types of collaborations are most appropriate in case of Pakistan?

Developing innovation culture necessitates establishment of supporting organizational context in which creative ideas can emerge and be effectively deployed. Building and maintaining such organizational conditions involve working with structures, work organization arrangements, training and development, reward and recognition systems and communication arrangements. Above all, the requirement is to create the environment within which a learning organization can begin to operate, with shared problem identification and solving and with the ability to capture and accumulate learning about technology and about management of the innovation process.

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[1] Faber, J., & B., A. H. (2004). Innovation capabilities of European. Research Policy, 33 , 193-207.

[2] Tidd, J., Bessant, J., & Pavitt, K. (1997). Managing Innovation : Integrating Technological, Market and Organizational Change. John Wiley & Sons, Ltd.

Modern Industrial Economy and Structure of 2008 Financial Crisis

The interdependence of key industries of the economy, have made the participants to realize their inter-reliance of profits, prices, sales, etc. Over time the recognition of such technological and economic interdependence has rapidly changed the meaning and function of stocks, debt, and corporate management structures. The stocks, debt, and boards of directors are part of central planning process and their use as instruments in the planning process rests with exercise of power and coercion over other important economic, social and political organizations. This is because of corporate leaders and their inherent powers to affect the planning process; can change and affect other social, economic and political organizations.

The market system has turned into a large measure, a centrally planned system. And instead of the forces of supply and demand and self interest that leads the important free market outcomes the economic planners in large economy’s units actually coordinate these market outcomes in terms of price, quantity, and resource allocation, from a system wide perspective instead of individuals’ perspective as in case of Adam Smith’s Economy. That is why the inter industry coordination and cooperation within the economy's centrally planned sector bears a closer resemblance to autarchic power than to firm or industry market power.

Veblen’s depiction of modern enterprise is also that companies depend on each other, just like a giant machine, where the processes are very interlinked to each other. Because these companies are very closely interlinked and dependent on each other; the standardization is ensured in a way that irregularity or departure from standard measurements brings fault and thus delay industrial process, it detracts from its ready usability in the nicely adjusted process into which it is to go; and a delay at any point means a more or less far-reaching and intolerable retardation of the comprehensive industrial process at large.  But Veblen does not talk about anything related to central planning in such an interlinked machine process. However, Veblen does talk about the pursuance of profits by the companies and generating high returns but he also warns that it may result in over production in the industry and thus may go against overall socially desirable outcome.

The financial crisis of 2008 are mainly rooted in the banking and financial institutions that are closely linked, while sharing the risk, through instruments like securitization . The interdependence of these institutions not only caused the profit and growth to spread over whole financial system but the risk also spread through securitization. However, corporate leader in financial system have operated in structures that led to an underestimation of risks and excessive risk taking. The regulatory framework overestimated the capacity of banks to manage risk and, as a result, underestimated the level of capital that they should hold. The corporate leadership started influencing the political environment to get bailout plans; and got their support because of attached externalities. The crisis peaked in September/October 2008 when the American authorities decided not to bail out the investment bank Lehman Brothers.

Efficient Retirement Policy

Fundamental laws of economic efficiency suggest that individuals that are more productive should work more and retire later than their less productive peers. While from practicality point of view, there must be some methods to evaluate the employment history to determine how early an employee must retire. However, in the bigger picture, the government cannot use policies contingent only on productivity and cost of retaining employees. As these policies, have wide range implications on unemployment, public expenditures and the welfare goals of the government.

Repeatedly, at least over the past few decades, there have been proposals from the bureaucracy for increasing the retirement age to 62 years from 60 but federal and provincial governments have turned down such proposals mainly because of political incentive in providing jobs to growing younger population. On the top of it, along with other stringent measures in the new budget government is reluctant to increase the salaries to appease the impact of 100 percent raise in salaries by PPP government.

As part to reform program IMF has advised government to increase the retirement age to 62 and to contain pension bills. As Pakistan’s federal expenditures on salaries and pensions is estimated about Rs 450bn, including pension expenses of about Rs. 171bn for the current financial year. The provincial pay and financial bills are much higher than the federal bill. 

“Public wage bill reforms should target the structural change that strengthen the link between pay and productivity, improve hiring process and ultimately raise efficiency in the provision of public services” said the IMF, adding that the increase in wage bill must commensurate with the provision of public services and growth.

In order to contain government expenditures, the pension component of an optimal policy should be based on the present value of lifetime retirement cost linked to the age of retirement. Such a policy may undo part of pension expenditures provided by government but at the same time, there must be careful analysis of the labour distortions and income tax distortions.

In private sector, though retirement behaviour is affected by multiple factors, the average effective age in private sector can be taken as efficient retirement age in public sector. One indicator of retirement behaviour in private sector is the average effective age at which older workers withdraw from the labour force. The effective age depends on multiple factors like old-age benefits, pensions and so on.

Average effective age of retirement versus the official age, 2007-2012

The effective age of retirement in most of these countries is well below the official age for receiving a full old-age pension. The difference between the age for receiving a full old age benefit and age of retirement can because of decrease in employees’ productivity and that create space for other productive employees.  However, Japan and Korea are notable exceptions where the effective age of retirement is close to 70 for men despite an official retirement age of 60.

The roots cause of present situation of salaries and pension expenditures lies in ever increasing number of employees in public sector, particularly that of provincial governments. The incomes of provincial governments are not increasing at rate commensurate to the increase in salaries, pensions and overall expenditures. The increase in retirement age from 60 to 62 years, though in line with the retirement age in most of the countries, would bring only momentary cut down in the salaries and pension expenditures. More distressing is the rapid increase in number of employees, wage rates and other largesse that has been characteristic of every new government that took office.