Along with the new budget, Finance Minister Shaukat Aziz revealed a full-year data for the economy ending June 2001. Unfortunately, it revealed that economic growth was only 2.6%, which made it the slowest growth since 1980. Does this poor performance mean that the Musharraf government is failing? Where are the fruits of reform if growth is slower now than under the corrupt rule of Bhutto and Sharif? Does not this poor performance cast further doubt on the legitimacy of this government?
The truth is much more complicated than the headlines. In many ways, the poor overall growth is misleading. Pakistan was hit by several shocks in the last 18 months that had the effect of suppressing economic growth. The foremost has been the severe drought, which has crippled the agricultural sector. Cotton, sugarcane, and rice production all fell last year between 4 and 7%. Wheat production, that staple of the Pakistani diet, fell 12%. As agriculture makes up 25% of the economy, the direct effect of the drought was severe. Indirectly, lower farm income meant less purchasing power for industrial goods, further dampening the economy. A second major shock has been the sharp rise in crude oil prices during the last year. Oil is Pakistan’s single biggest import, and the price rise cost the country over 600 million dollars above budget. High oil prices benefit a small number of Muslim countries, but do not serve the long-term interest of most of the Muslim world, including Pakistan.
Credit conditions in the country also tightened; partly out of fear that aggressive lending by banks would lead to charges of corruption if default occurred by the borrowers. This led to a credit crunch, and reduced credit to the private sector stifled growth. Finally, the government tightened fiscal policy to comply with IMF conditions forcing the government to run smaller deficits and increase tax-collections. Independence for the central bank means better long term control of inflation, but also limited the ability of the government to manipulate credit conditions and monetary policy.
If the effects of this drought are backed out, the rest of the Pakistani economy actually grew at about 4.8%, which is not too bad a performance. But with labor force growth close to 4% annually, the economy needs to grow at 6-7% just to keep unemployment from climbing. America’s labor force only grows at about 1% a year, which is why 2.6% growth would be considered acceptable in the United States but is a failure for Pakistan.
Some have argued that the government has made a mistake of concentrating on structural reforms such as privatization, better tax collection, fiscal restraint, and investment in new industries (IT programs, the Gwadar port project) instead of pursuing aggressive pro-growth policies. These policies essentially mean easier credit, a more expansive budget deficit, more government spending on social programs, and lower interest rates. To use an analogy, this is a choice between stepping hard on the gas pedal, or spending time fixing the engine.
Shaukat Aziz and the government essentially believe that the engine of Pakistan’s economy is seriously broken, and needs extensive overhauling. The pro-growth critics contend that Pakistan just needs to step on the economic gas pedal. The problem with the latter approach is that if you stimulate a broken economy, you get very little extra growth, but you will overheat the engine, which economically results in inflation. Pakistan’s inflation rate is already relatively high at 4.7%, and poorly thought out stimulation of the economy could send that soaring above 10%. Aziz wants to retool the economy so that it will have a naturally rapid rate of growth without needing the excessive inflation-causing stimulus.
Certain sectors of the economy may be showing this to be the case. Most heartening has been the performance of the large-scale industrial sector, which has registered 7% growth in the first nine months of this fiscal year. The industrial sector is the backbone of future economic growth, and Pakistan needs to see 10% or better industrial growth every year. If the weather is more normal this coming year, growth will naturally pick up sharply. More importantly, once key reforms are institutionalized, a pro-growth policy mix will make sense. In addition, once the government establishes longer-term track record of credible fiscal and monetary policy, foreign investment will pick up. This will require a calmer political situation, both with India and internally. (Now President) Musharraf seems particularly keen on making Pakistan an attractive site for investment, and has even attacked the religious parties head on to reduce intolerance and sectarianism. These may be the most pro-growth policies of them all.