Aid & Pakistan's development
Thursday, 10 July 2008

By Shahid Javed Burki

THERE is a belief among economists — a belief I happen to share — that the peaks and troughs one notices in the trajectory of growth followed by Pakistan since its birth in 1947 were induced by large flows of foreign assistance.

Up until recently, a significant share of the total amount of external capital that flowed into Pakistan came from the United States' budget and from the institutions over which Washington had considerable influence.
The international financial institutions that supported Pakistan's development — the World Bank and the Asian Development Bank — seemed to open their coffers to use by Pakistan during the periods when America was also being generous. The American generosity was linked with Pakistan's willingness to advance Washington's strategic interests in various parts of the world.
Thus in the early 1960s, when President Ayub Khan aligned Pakistan with the United States in order to help the latter contain the spread of communism in Asia, the Americans provided large amounts of military and economic assistance to Islamabad. The flow of assistance declined significantly after Pakistan's war with India in September 1965 and also when the reins of power passed into the hands of Zulfikar Ali Bhutto who sought to detach Pakistan from America.
The Russian invasion of Afghanistan and its occupation of that country for a decade — during most of the 1980s — brought Pakistan into an alliance with the United States and Saudi Arabia. Pakistan was prepared to use its territory to train warriors to fight the Soviets in Afghanistan. In return it asked for and received both military and economic support from America and its western allies as well as from Saudi Arabia.
The third period of close American — Pakistani association began right after 9/11 when Islamabad responded to Washington's pressure and became a partner in the 'war on terror'. This partnership also came with support to the economy and the military. The latest estimate for the total amount of American support during the 2002-08 period is $12bn, or $2bn a year.
Each of these three periods of close donor association with Pakistan — the 1960s, the 1980s, and the early 2000s — profoundly affected the country's economy. The most important impact was on the rate of GDP growth. Averaged over the three periods, the economy grew by more than six per cent a year, a rate of growth 50 per cent higher than the one Pakistan could have sustained on its own.
During the 1960s, this high rate of growth in GDP meant an increase of 3.5 per cent per annum in income per head of the population; in the 1980s, income per head increased at the rate of 3.8 per cent. The highest increase in per capita income occurred in the more recent period when the GDP growth averaged seven per cent and income per capita increased by 5.2 per cent a year, a record for the country.
The less apparent impact of the large amounts of donor money coming into Pakistan was to postpone some of the structural problems that have adversely affected the economy. The first was a persistent low domestic savings rate. With very low domestic savings, Pakistan could afford a rate of GDP growth not significantly higher than the rate of population increase. This meant that the problem of poverty could not be addressed.
Evidence compiled from the experience of high growth developing economies by development institutions such as the World Bank suggests that the rate of GDP growth has to be two to three times the rate of increase in population for a palpable difference to be made to poverty levels. To ensure such rates of growth overtime, Pakistan needed to increase domestic savings. Or it could rely on external flows. Since the latter often became available in large amounts, policy-makers set aside the difficult decisions they would have had to take to increase domestic savings. The most important of these was the restructuring of the tax and public expenditure systems.
The second structural problem, policy-makers have failed to address, concerns the development of the country's large human resource. Since 1947, the year of the country's birth, Pakistan has witnessed a profound demographic change. The size of the population has increased five-fold from 30 million in 1947 to an estimated 165 million in 2008. The number of people living in the urban areas has increased 12-fold, from five million to 60 million.
The median age of the population has declined continuously. Today it is only 17 years which means that nearly 83 million Pakistanis are below the age of 17 years. Such a population can either become a large burden for the country or it could become a major economic asset. What will make the difference is the interest the state takes in education and skill development and in providing basic health care.
The Pakistani state has done poorly in these three areas. Public sector expenditure on education in the early 2000s was less than 2.5 per cent of GDP. The expenditure for healthcare was even less than that. Even compared to the countries at its level of development, Pakistan spends a very small part of its GDP on research and development.
As the Indian experience has shown, a well educated and trained workforce can become not only a major asset for the economy. It can also bring about significant social changes that contribute to the modernisation of the economy and the society and their better integration into the fast changing global system. Pakistan's large and very young population can move in either of the two directions: opt for a greater play in the development and modernisation of the economy or drift towards Islamic radicalism and isolationism.
The third structural change that did not happen was the integration of the economy in the rapidly evolving global system, particularly through increased exports. No developing country has developed without emphasising the development of the export sector. Pakistan, on the other hand, has allowed its share in global trade to decline. The World Bank's latest World Development Indicators, shows that Pakistan had a share of 2.4 per cent in global population, 0.23 per cent in global output but only 0.15 per cent in global exports.
What lies in Pakistan's future? Now that the United States is developing some misgivings about Pakistan's contribution to the 'war on terrorism' there is the possibility that American aid may decline once again. Should that happen, what would be the impact on the Pakistani economy?

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