A Pakistani call to the donors
Wednesday, 16 July 2008

By Shahid Javed Burki

FOR a variety of reasons, Pakistan's policymakers have either not fully realised where the potential of the economy lies or were forced into taking decisions that were not in the economy's long-term interest.

They did not make use of the impressive endowments of the country to develop an economy that would have grown rapidly without interruptions and could have become a vibrant part of the global system.
 
Had they promoted the development of agriculture, in particular high value-added crops; encouraged the growth of small and medium-sized industries using the skills traditionally available to the economy; invested in educating and training the country's large and young population; focused on using trade to better integrate the economy with the global system; and created a political structure that provided a voice to the diverse segments of the population, the country today would be in a happier economic, political and social situation. Instead it faces perhaps the worse economic crisis in its history.
 
While a number of structural weaknesses — low level of domestic savings, poorly developed human resources, inefficient attention given to the country's endowments, and a system of governance that did not give a voice to the people — have been present since the country's birth more than six decades ago, another structural fault line developed gradually over time. I am referring here to the system of economic governance.
 
Even under the British who ruled for 99 years — from 1848 to 1947 — there was much greater autonomy available to the provinces than is the case in modern Pakistan. Since Pakistan was managed most of the time by bureaucracies with strong command and control traditions, power has shifted to the centre. For the first 11 years, members of the civil services (in particular the Civil Service of Pakistan, the CSP) were important policymakers; since 1958, the military has governed for 32 years.
 
Both institutions believe in highly centralised systems of economic and political management. That approach left little room to the provinces even when — as was the case with the Constitution of 1973 — the political structure was built on two pillars, the central and provincial administrations.
 
The model of economic development followed in the past, particularly during the period of President Pervez Musharraf, had one other consequence. Since there was a high level of dependence on external flows, the economy plunged and went into a crisis whenever external support was reduced or withdrawn. This happened in the late 1960s and in the late 1980s and the early 1990s, when the United States reduced its support for the country.
 
The crisis that now engulfs the economy is not the result of withdrawal of official flows. It has been produced by a combination of external developments over which Pakistan's policymakers have no influence and because of the serious failures of public policy, especially over the last decade. The situation has been exacerbated by the process of transition from military rule that is currently under way. As several observers have noted, policymaking in Islamabad is adrift with nobody really in charge.
 
An analysis of the flow of official assistance to Pakistan reveals not only large transfers during the periods Pakistan was needed by the United States for strategic reasons. Also apparent from the data is a seeming association between economic stress and official capital flows. This correspondence remains even if we factor out the resources provided by the International Monetary Fund, an institution that provides assistance to countries in economic difficulties. What the capital flow data therefore suggests is that Pakistan was able to tap friendly countries during critical periods.
 
I can testify that this is the case from my own experience as finance minister in 1996-97 when I took leave of absence from the World Bank to join the caretaker administration that took office following the dismissal of the government of Prime Minister Benazir Bhutto. After I assumed office it was revealed to me that foreign reserves had declined to well below $100 million.
 
The State Bank of Pakistan, the country's central bank, did not have enough in its reserves to pay the bills that were due to such preferred creditors as the World Bank and the Asian Development Bank. Pakistan faced default. I travelled to Beijing (where I met the prime minister) and to Abu Dhabi (where I met the governor of the UAE central bank) and was able to raise close to a billion dollars, enough to pay the bills during my brief tenure in office.
 
I was able to do this not because I had any special negotiating skills. It was clear to me that several friendly governments would not allow Pakistan to go under. The Chinese and UAE decisions were similar in a way to the rescue operation launched in March 2008 by the US Federal Reserve Bank, the Fed, to rescue Bear Stearns, the investment bank, from collapsing under the weight of the debts it had built up.
 
The Fed acted to prevent contagion in the financial markets. Similar logic applies to countries in Pakistan's situation where serious economic problems could produce unpleasant social and political effects in sensitive areas such as those in which the country is located.
 
This experience of the donors launching rescue operations during periods of extreme distress has created a situation of moral hazard for Pakistan: the belief that even if the policymakers don't take corrective measures and change the structure of the economy, the country will be saved by its friends across the globe. If Pakistan is to be helped out of its present predicament, as it should be, the donors should attach some conditions to the help they are providing.
 
Given the way the situation is evolving in and around Pakistan, this may be a good moment for the community of international donors to step in vigorously with the aim of guiding the country and its citizenry towards a better and a more certain economic and political future. The donor response should be well developed, based on a strategy of economic reform and political development along with the promise of a large infusion of funds. But the donors will step in as a group only if Pakistan appeals to them for help. At the moment it seems to be approaching individual countries for assistance.
 
Such an approach is neither good for Pakistan nor for those in the world who would be willing to help the country out of a difficult situation. What is needed is a concerted, collective action based on a promise of reform by Islamabad.

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