Pakistan; Challenges In Political Economic Development

Pakistan; Challenges in Political-Economic Development ICEA Feb 13 th 2007 Professor Paul E M Reynolds LONDON Tel + 44 20 874 86788 Mob & SMS + 44 7974 188087 E mails [email_address] [email_address]

Pakistan, showing NWFP, FATA & Northern Areas

Why is Pakistan important ?
Strategic geo-political & transport bridge Mid-East and India & China
165-170m pop – More people in Pakistan than in Russia
Potential for Kashmir flare-up – risk of big impact on world growth
Border region with Afghanistan
- Cross border raids, and question of Tribal Areas and Pashtun nationalism ?
- Relationship with NATO/US military activity
Role in ‘War on Terror’ and Deobandi ideology (‘Talibs’ = ‘Students’)
Many internal factors that create risks of political instability
Nuclear armed state – and advanced delivery systems
Borders with Iran, Afghanistan, India, China, close Gulf States, C Asia
Important Diaspora – especially in the UK (and UK troops on its border !)
URGENCY: Presidential & National Assembly Elections Oct 2007
– unclear how political events will pan out

Pakistan; Challenges in Political-Economic Development Macro, micro & political conclusions. Needing to ‘break out of gridlock’, government is in a difficult position
Macroeconomic improvements good - but slow reforms in government , in regulation and within the ‘ real economy’ retard investment & growth rates, hinder exports and undermine fiscal/structural sustainability of growth
Flow of FDI inflows now under threat, diaspora remittances up, but insufficient ‘real economy’ investment opportunities as final destination – consumer imports sucked in, savings rates low
Full-speed reforms across government needed, but gridlocked due to political uncertainty - helps the ‘reform resistance’ & ‘project silos’. Key decentralisation suffers from ‘unintended consequences’….
BUT …. political reform gridlocked by constitutional-political structures and the President’s need to please too many masters
Role of Tribal border (Afghan) areas and relationship with ‘The West’ is critical for political and economic reform

Economic performance Economy stabilised & growth path established 9.7% 4% 1990s 2.5% 3.1% 2001/2 Inflation (Av.) GDP growth WB/IMF 6.5% est 7% tgt 6.6% 8.6% 7.5% 4.7% 6.5%? 7.9% 9.3% 4.6% 3.1% 2006/7 2005/6 2004/5 2003/4 2002/3

Fragility of economic progress
Public debt declined from 97% of GDP annual average 1990s - to 75.3% by 2002-3 & 56% 2005-6
Annual fiscal deficits fell from an average (excl grants) of 6.4% of GDP, last 5 years of last decade, to 4.4% first 5 years of this decade (3.7% 2006-7 est.)
Average trade policy tariffs at ‘normal LDC’ levels after WTO memb. in 2001
BUT………………BUT…………..
Industry still less than 20% of GDP
2005/06 investment at 16.5% of GDP - too low for sustainable growth (World Bank - 27%+ required)
Growing current account deficit - driven by a widening trade gap as import growth outstrips export expansion - from 1.4% of GDP to 4% of GDP in 2005/6 – putting pressure on FX reserves
IMF says (2007) need to align demand & output growth (Privatisation-related FDI and internal borrowing one-offs) – But GoP points to import price-hikes as one-off (To be continued…..)
IMF ‘imperative’ - Higher savings and poverty reduction
IMF REMEDIES. Improve the investment climate, financial market reform, tax reform, improvements in public service delivery, and trade liberalization

Economic growth context Trade & fiscal imbalances reduced…but…
Yr. to 2006 FDI up to $3.5bn (1/2 from telecoms). Investment from Gulf states.
Remittances $4.2bn in 2005/6 - biggest ever
Banking & electricity distribution privatisation ‘successful’
‘ Poverty fell 10% 2001 – 2006’ (WB)
Cost of borrowing relatively low…..good GCC demand for Pakistani Govt paper
BUT………………………………………………
But…. trade deficit $10bn and growing
FDI effects of privatisation slowing
Big increase in MTDB , up 52% 2006/7 despite quality-of-investment problems
Low national saving’s rate, 17 percent of GDP, due to fiscal deficits and negative interest rates
4% of GDP spent on the military , possibly much higher, pressure on deficit
Only 28% of population is in the ‘workforce’, 32% of pop below poverty line
1m Afghan refugees + ‘Trouble in Tribal Areas’

Real-economy problems requiring political will to challenge the interests of the bureaucracy & ‘crony capital’ across federal, provincial, & local government
Institutional complexity and bureaucratic turf problems
Legislation, regulation, ‘overenthusiastic regulation’ – some resistance to reforms
Govt. ‘Project culture’, weak systemic reform focus (‘policy silos’)
EXAMPLE 1. Contract enforcement
EXAMPLE 2. Admin barriers and ‘cost of doing business’
Result – domestic investment opportunities, & ‘bottom up’ domestic growth, both dampened = inflationary pressure, monetary growth, import growth, pressure on FX reserves ?

Institutions responsible have overlaps & gaps in reform ‘Diagnosticitis, policy silos & analysis-paralysis ?’ New institutions to solve this problem ?
Ministry of Finance & Planning
Ministry of Industry, Prod’n & SI
Board of Investment
Ministry of Commerce
Ministry of Econ. Affairs (EAD)
Monopoly Control Authority
Housing & Works Div.
Securities & Exchange Commission
Planning Commission, 4 members
National Reconstruction Bureau
Economic Coordination Committee
Public Sector Reform Committee
Cabinet Division (3 Depts)
Economic Council
Office of the Economic Adviser
Ministry of Law & Justice
National Comm. for Govt. Reforms
Civil Service Reform Unit
Law & Justice Commission
PM’s Secretariat
Ministry of IT
Ministry of Parliamentary Affairs
Competitiveness Support Fund
4 Provinces, FATA, PATA
Trade Corridor Committee
Office of Private Public Partnerships
Federal Ministry of Tribal Areas
Ministry of Inter-Provincial Coop.

Wrong micro-economic reform tools ? ‘ Government spending versus government efforts’ Huge political will required to overcome deep-rooted systemic problems & interests – does political uncertainty prevent this ?
Financial deepening reforms (NSS, Pakistani Investment Bonds) and reforms of intermediation system (Badla) underway - will make better use of remittances & other funds, and tax admin reform has increased receipts……………
…… but these are not the core problems…..
Credit expansion is a risk, and linked to remittances
Political limitations prevent expansion of the tax base
Too much reliance on more costly but less effective growth stimulation methods
… ..Eg building business parks & giving tax breaks, rather than…
- reform of regulations that inhibit capital goods imports
- tackling ‘overenthusiastic interpretation of regulations’

Pakistan (example): Steps/time and cost of contract enforcement (Source World Bank 2006)
Case backlog - half are commercial - in the High Courts of Sindh and the Punjab number over a hundred thousand, and for the lower courts, in the millions - 40% land, 30% challenges to regulations, rest banking/employment
When cases do go forward, it takes, on average, more than 46 steps, more than a year and almost a third of the contract value to enforce a contract
System is ill-prepared for modernisation - new legal frameworks in complex areas such as foreign investment, insolvency, monopoly regulation, anti-money laundering, insider trading, and corporate governance

Real-world problems in economic development dampen investment WB value-chain study of key sectors shows major structural, institutional & regulatory problems: Shrimps, textiles, marble, processed dairy, auto parts
High transport costs, high electricity costs (outages) limiting automation, labour market rigidities (temp workers used), access to finance (collateral & informational), imports costs (multiple permissions required etc), cash flow from duty drawback & custom rebate delays, high port charges, state control of input sectors, freight sector over-regulated, opaque land leasing & security of tenure - & resultant low capacity utilisation
Fees and taxes collected by the Government represent a quarter of export costs and come from three sources: the petrol tax (1 percent of export invoice), Export Development Fund (0.25 percent of export invoice), and unofficial, speed money payments (approximately Rs 1,250 per consignment). [Poor port governance contributes].
Layers of taxes & levies to agents, the PAs, and ‘security payments’ add to costs. High tarrifs in many sectors.
Pakistan’s aggregate direct labor cost $0.75 /hour - higher than China’s $0.66 and India’s $0.40 – but productivity lower.

Resistance to pro-growth regulatory reforms ?
2004/5 World Bank project on regulatory reform ’Impact has been minimal’
2005 Better business regulations IFC. Admin barriers report not published.
2006 IFC/World Bank business regulations, pending…

Future economic reform challenges
Regulatory quality and the link to rent-seeking
Poor domestic export performance relative to expectations, and the lack of investment to overcome high costs
Capital infrastructure problems – access to debt & equity finance for export development, and absence of venture capital & ‘real sector’ investment funds
Low ‘growth productivity’ in the use of inward financing from remittances and capital repatriation
This challenge combined with industrial and labour rigidities/monopolistic markets = ‘ not enough productive places to put the money’
How to apply telecom sector’s success in attracting investment to other ‘regulatory-dependent’ sectors like electricity, water, transport and hydrocarbons.
How to address investment and economic growth inhibitors (How to support the Ministry of Law & Justice in tidying up of existing legislation and regulations)
Addressing urgent need to tackle problems created by the separate MTBF and MTDF, (eg poor use of assets, lower investment)
How to address the negative impact on domestic investment and growth arising from the domestic financing of the budget deficit.

Fiscal decentralisation issues Pakistan is highly centralised fiscally Growth & political reform requires change Reforms started in 2001 but within existing structures
Sub-national governments in Pakistan - very low sub-national tax collection rates by international comparisons
Only 0.9 percent in GDP of revenues in 2005/6. India’s - 6.1 percent, or 7 percent based on more recent figures (World Bank 2005:xxvii)
Provinces in Pakistan are highly dependent on federal shared revenues and grants – complex system.
All provinces receive identical per capita levels of divisible pool allocations
All provinces are characterized by low own revenue mobilization, although some differences are evident across provinces.

Fiscal Decentralization in Major Developing Country Federations
Source: Figures for Pakistan are FY2005/6 budget. IMF GFS (10/2005), most recent year available, WB Reports for unavailable countries ( italics) . As share of central, state, and local government, net of onward transfers by central and stage governments. Sub-National Revenues do not include financing. *Alternative to GFS expenditure figures for Mexico using World Bank (World Bank 2004; 2004).
2.4
9.1
2.4
11.0
Malaysia
13.0
32.4
12.7
38.5
Russia
~
~15
~
19.6
Venezuela
4.5
25.5
7.4
41
Mexico *
10.5
39.0
15.3
41.7
Brazil
8.4
44.2
12.4
44.4
Argentina
6.1
18.9
18.9
56.5
South Africa
3.18
10.7
13.6
38
Nigeria
3.0
18.7
9.5
35.9
Ethiopia
6.1
33.8
10.8
49.2
India
0.9
7.0
6.3
34.2
Pakistan *
(IV)
(III)
(II)
(I)
Sub-National Own Revenues (% GDP)
Sub-National Own Revenues (% Total National Revenues)
Sub-National Expenditures (% GDP)
Sub-National Expenditures (% Total)
Federation, Developing Country

Unequal regional incomes Table 1: Key Indicators for Pakistan’s Disparate Federation Source: World Bank, UNDP 2003 Human Development Report (p. 11) 106 0.541 1.5 - 128.4 Total/Average 21 0.549 18.3% 61,563 23.7% SINDH 35 0.557 26.8% 47,131 57.4% Punjab 24 0.51 9.7% 35,211 13.8% N WFP 26 0.499 45.2% NA 5.1 % Balochistan Index %/km2 Rs. %/million Number of Local Governments Human Development Index Area GDP Per Capita (2004/5) Population Share

Complex system of Provincial financing

The status of the Tribal Areas ‘across the Durand Line’
Historical Afghan territorial claims over Pashtun NWFP, PATA, FATA, & Pashtun areas in Baluchistan
Administered by Punjab British Commissioner, then 1901 direct Delhi rule of NWFP Province - settled & FATA tribal areas separate, both as NWFP Afghan buffer zone
Separate status, continued post-independence – constitutional FATA buffer zone and tool against Pashtun nationalism on both sides of the border; not elected (A247). NWFP Governor formally represents President
Pre- & post- colonial regimes – ‘no troops deal’ with (paid) Maliks & Lungis
Frontier Crimes Regulations (1901 to today), FATA de facto constitutionally separate, Presidential control, Political Agent rule in FATA agencies ‘absolute’
President has authority over all governance & military arrangements in FATA (1973 constitution A247/5). Via primary legislation – FCR, permits detention-no-trial
PAs – (executive-judiciary-legislature) appoint own para-militaries – can fire Maliks – appoint Maliks to Jirga courts – no full appellate path or normal rights
FATA areas a channel for very large-scale US funds to Afghan mujahadeen during Soviet occupation – but govt. wary of Pashtun cross-border nationalism
1980-2000 – roots of ISI culture & skill balancing different Pashtun interests

The role of FATA in the Pakistani Political System
12 seats in the National Assembly, 8 in the Senate, elected by appointed (all male) FATA Maliks in the pay of the Presidency/military & each easily dismissed
But parliament cannot legislate on FATA, and general Pakistani laws do not fully apply in FATA
FATA parliamentarians linked to pro-Deobani groups (JUI-F)
No representation over FATA, or in NWFP legislature
Alleged tit-for-tat: support in parliament, for peace, arms/drugs trade, & Deobandi ‘freedom to act’ without political competition
Political parties & national/regional secular political groups banned in FATA Since Afghan Soviet occupation, (& huge US mujahadeen financing), pro-Deobandis groups & Maliks have grown under such political ‘cover’, and replaced ‘old school Maliks’
JUI-F – coalition partners of govt. in Balochistan !
Presidency has inherited this system – propped by ‘negotiated balance’
President’s international trump card: better to accept a complex negotiated balance than risk a Deobandi government /Pashtun state (may well be true !)

Complex governance: a simplification Difficult to reform FATAs (Mostly Pashtun). 3m pop. on Pakistan side. 7 ‘Agencies’. PATAs North West Frontier Province Settled areas ‘Districts’ Presidency Government Prime Minister. Cabinet. Donors. FATA Development Authority 7 Political Agents Naib-tehsildar (Exec, judiciary, legislature) SAFRON Funding. Donor projects . Balochistan Maliks Lungis Prov’l FATA Secretariat Agency Councils Inter-Tribal Jirga PEACE AGREEMENT

Reform and/or Resolution Military interventions – part of the solution or part of the problem ?
Parliament can normalise rights and court system (FCR was removed from NWFP and Balochistan)
Supreme Court can strike down FCR as unconstitutional
FATA could become part of PATA under NWFP
But instead…
2000/1 NRB Devolution Plan excluded FAA
Provisional Agency Councils appointed by tribal Jirgas
Military action continues , (but seen as ‘demonstration effects to USA’ – counterproductive ?) (ICG Dec 2006)

Can economic growth address political issues in Tribal areas ? Will reform strengthen or weaken the government ?
Per capita income $500. 60% below poverty line.
97% female illiteracy (male 71%).
But….
Need to demonstrate success against foreign fighters etc
Buying of permits and ‘rent-seeking’ will decline
Decline of 20 year old arms & drug trade - & military %s
(army allows vibrant trade & doesn’t require ‘permits’)
Pashtun nationalists & Deobandis may turn on govt.
Parliamentary support would be lost
NWFP JUI-F and Balochistan support may be lost

The near impossible task of serving many masters. Is the outcome a kind of political gridlock ? Foreign fighters ? Presidency Head of State Govt. Ministries I.S.I. Donors & foreign NGOs Drug & arms traders Domestic elite, landowners, govt. influencers, & ‘crony capitalism’ Deobanis & Pashtun Nationalists USA Tribal Elders Local NGOs, pro-democracy groups The view from the Presidency ? Military, Governors, & PAs

‘ Show me something’ Reform versus ‘uncovering’ foreign fighters Foreign fighters ? Presidency Head of State Govt. Ministries I.S.I. Donors & foreign NGOs Drug & arms traders Domestic elite, landowners, govt. influencers, & ‘crony capitalism’ Deobanis & Pashtun Nationalists USA ‘ War on Terror’ issues Tribal Elders Local NGOs, pro-democracy groups Military, Governors, & PAs Info flow Info barrier

The Inter-Jirga Peace Agreement Why did they fight, why did they agree ? A counterproductive brutal search for foreign militants ?
LOW-LEVEL WAR
June 2002 - US pressure – troops to capture MO, OBL etc
March 2004 – search for foreign militants ‘Tribes refused’
(‘failed’ – Former ISI General ICG 2006)
Govt. ‘sued for peace’ June 2004
Nov 204 agreement – amnesty, cash, BUT hand over foreign militants, & stop cross-border attacks
Feb/March 2005, 6-point peace plan with JUI-F over South Waziristan
Escalation - heavy casualties in March 2006 battles
Effectiveness of ‘official’ institutions declines
Military pressure on the President
New (military) NWFP Governor May 2006
North Waziristan Ceasefire June 2006 signed with JUI-F and Deobandis/Pashtun nationalists
North Waziristan Peace agreement with Deobandis Sept 2006
Oct 2006 ‘Cross border raids on UK & US troops up’ (Gen Jones NATO)
Foreign militants found are few – and mostly 20-year settlers from the anti-Soviet war (Tajiks, Uzbeks)

The Sept 2006 Peace Agreement
GoP to halt all ground & air attacks
GoP to release prisoners
Checkpoints removed
Financial compensation of combatants for losses
Tribal privileges and ‘salaries’ restored
GoP to return weapons and allow open carrying of weapons
Foreign-born militants to respect local laws
Cross-border trade (legal & ‘illegal’) restored
Combatants to halt all cross-border attacks
Return to official institutions – no parallel bodies
GoP troops relocated
Joint 10-member Council to oversee Agreement

Conclusions
Good quality macroeconomic management in Pakistan under difficult conditions – but risks from microeconomic realities
Deep-rooted problems in ‘real economy’ reforms and reform within government.
Political barriers to real-economy reforms are tenacious – strong political will needed domestically & internationally
Chain of causality ? Economic reform enables political reform or vice versa ? Symptoms of gridlock on both.
Military demonstration effects for the USA & NATO, may be counterproductive. (How to break the ‘information barrier’ ?)
Political reliance on Tribals & ISI (Deobandis indirectly) is an accidental Western creation.
International support for political reform, especially in Tribal areas, needed to untangle gridlock and accelerate economic reform.

Pakistan; Challenges In Political Economic Development

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