Pakistan’s broken economy

Pakistan-watchers tend to focus on political and security issues. But they need to start thinking as well about the economy, the outlook for which is grim over the next several years. Some of Pakistan’s problems were spawned by the epic floods of the summer of 2010, but most have resulted from the long-standing failure of the Pakistani government to invest in its people, or from more mundane mismanagement of vital sectors, such as energy. Pakistan’s economic problems will weigh especially on the urban population, adding to the country’s political woes. It is the impact on the towns and cities – 36 percent of Pakistan’s people, but growing at 3.5 percent a year, three times the rate of the rural areas – that presents the most acute political danger.

Pakistan’s economy grew strongly between 2003 and 2007, with GDP rising between 5.8 percent or more, and reaching 9 percent in 2005. Since then, it has limped along, down to 1.2 percent in 2009 and an estimated 4.1 percent in 2010. Agriculture has had lackluster growth during most of this time, but has kept pace with the growth in rural population. Industrial growth, on the other hand, has lagged behind the growth of cities. These changes along with other factors have set up the squeeze Pakistan is now feeling.. 

Pakistan’s Finance Ministry estimates that the country’s energy shortfall cost the country 2 percentage points in GDP growth in the past fiscal year. Electricity outages, 8-12 hours a day in many places, especially urban centers, are infuriating for Pakistanis. When one adds kerosene shortages, it means that people are often without heat or cooking fuel in the coldest season. Much of the problem is the result of price controls, which leave energy providers chronically short of funds as their consumers delay paying bills that in any case are insufficient to cover costs – the "circular debt problem" one reads about in economic analyses of Pakistan. Combine this with a weak government, stagnant generating capacity, and rising international prices, and you have the makings of a disaster.

Power disruptions are crippling small businesses that are the lifeblood of Pakistan’s middle-sized towns and smaller cities. Some larger and better funded companies can partly compensate by buying diesel and gas generators, so they can switch their power supplies to avoid the different potential shortages. Others adjust their work flow so that jobs that need power get done whenever the power happens to be available. But others don’t make it. This situation is a job killer, in a country that has been losing the race between population growth and jobs.

Moreover, the energy crisis is becoming more acute. International oil prices have crossed $100 per barrel again. The government backed out of an energy price increase in 2010 when a party threatened to pull out of the coalition in protest. In late February 2011, desperate to prevent a cash flow crisis, it once again announced a 9 percent price hike; truckers in Karachi, Pakistan’s economic heartland, threatened a strike.

Additionally, Pakistan’s balance of payments is under pressure, despite booming remittances that totaled $7.3 billion in the first ten months of the fiscal year, representing Pakistan’s largest foreign exchange source. Imports are close to double the value of exports. Pakistan obtained an IMF program in late 2008 to survive that year’s balance of payments crisis. The program was suspended and the two final tranches of funding were not disbursed, because of the energy price issue referred to above. The government backed down and sacrificed IMF funding rather than lose its majority in parliament. It is now negotiating to reinstate the program, but the problem will not go away.

Pakistan also has a huge burden of internally displaced people; while most of the flood victims have returned to their home areas, people displaced by internal insurgency are still without productive employment, and many are likely to find their way into cities.

It’s not all bad news. Last year, agriculture, which employs some 60 percent of the population, grew 2 percent (this and the other figures for prior years come from the Finance Ministry’s Pakistan Economic Survey for 2010). But this year, while flood damage will retard planting in some parts of the country, disrupt irrigation, and lower crop production, elsewhere expectations are high for a good wheat crop, demonstrating the truth of the saying that in South Asia too much water can be better than too little. High international food prices will also be helpful for farmers, but will exacerbate urban-rural tensions. Rising food prices may help farmers, but consumers in Pakistan’s towns and cities are reeling from 14 percent food inflation.

Industry also gets mixed reviews. Annual reports from a number of Pakistan’s big business houses report healthy profits. Some local businesses with ambitious export plans seem to be reinvesting in their enterprises. However, the overall numbers are worrisome. Fixed investment was growing by close to 16 percent in 2006 and 2007; in 2010, it was essentially flat. Foreign direct investment took a beating in the last year, dropping 45 percent from the year before. Increasing insecurity both in Pakistan’s cities and countryside will make it tough to reverse this decline.

In sum, despite a few positive signs, the torrent of bad news is hitting Pakistan’s urban population in the heart and in the pocketbook. At the same time, Pakistan’s government faces a nasty confluence of other problems. Its track record in effective governance is poor. The governing coalitions in both the central government and that of Punjab, the largest province, are going through upheavals. The arrest of American security official Ray Davis in a murky shooting incident in Lahore sparked a major crisis with the United States, as opposition figures and Islamist activists have pressed the government to hold firm and deny him diplomatic immunity. Crime in the cities is touching many people’s lives. In two days in Lahore last month, I heard from two different friends about armed robberies and kidnappings for ransom involving their relatives.

These changes all come on top of chronic problems that have been building up for years, principally under-investment in education and health, under-financing of the government, and inadequate investment in new productive capacity.

Pakistan’s crises are usually described in political terms. But economic mismanagement and trouble in the cities helped bring down Ayub Khan’s government in the late 1960s, and these could well be the country’s Achilles heel now. The army, always a powerful political actor in Pakistan, has little understanding of economic issues and less appreciation for the political skill needed to deal with them. Despite its own substantial economic interests, it is not likely to help the government make the tough decisions needed to address the problems, especially due to the military’s interest in letting the civilian government take the heat for tough decisions.

There is no silver bullet – and certainly no American silver bullet – that can address all these problems. Simply pouring money into the government will buy only limited time, and could encourage the Pakistanis to delay making the serious effort needed to put their country on a sustainable path. The economic management issues that are at the heart of this storm can only be fixed from Pakistan. But Pakistan’s international donors need to look seriously at the kinds of support that can promote and sustain a real reform program.

One area of opportunity is in helping Pakistan’s electrical development. Pakistan’s electrical infrastructure has grown little in the past two decades. Short-term power fixes like bringing in barge-mounted generators are expensive; forcing businesses to buy generators destroys jobs and saps competitiveness. International donors need to help Pakistan build more generating capacity and update the creaky power infrastructure – and move toward electric rates that will pay for it.

The second is trade. Pakistan’s economy is heavily dependent on cotton, one of the three major crops and the principal input for half the manufacturing sector. Half of Pakistan’s exports are textiles and apparel, which face high tariffs in the United States and in other developed countries. The politics of trade are nasty in the United States, and making changes in trade policy is always more difficult than extending aid. But with all that is at stake, it is time to give Pakistan a chance to earn its way out of its crisis. We need a creative approach to liberalizing access to the U.S. market for Pakistan’s exports.

The next few years are likely to be tough no matter what happens, and Pakistan’s leaders will need steady nerves and more than a bit of luck to stay on a path toward a healthier long-term economic outlook. Its friends need to stay involved for the long haul, with funding and creativity. And their objective should be not to fix the problems of Pakistan, but to help Pakistan help itself.

Ambassador Teresita C. Schaffer is a retired U.S. diplomat who served in Pakistan in the 1970s and spent much of her career working on South Asia. Her book "How Pakistan Negotiates with the United States: Riding the Roller Coaster," co-authored with Ambassador Howard B. Schaffer, will be published in April. The Schaffers’ comments on South Asia can be found at http://southasiahand.com.