The Devolution of Pakistan's Political Economy

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Introduction

In the last fifty seven years, Pakistan has gone through intense political and socioeconomic transitions.  Following the partition of the Indian Subcontinent in 1947, Pakistan has seen radical changes in political representation and economic direction on the order of once every seven to ten years.  Since her inception, Pakistan has been a land of contradictions.  Pakistan has been forced to transition from a democracy to dictatorship a number of times; she has seen periods of economic liberalization morph into pseudo-socialism.  Pakistan has seen herself anointed the darling of Western powers, and she has seen a fall from grace that left her nearly penniless.  Pakistan’s many dichotomies extend into her nuclear ambitions and her status as a third world state.  For a small third world country borne of the hopes of millions of indigent Muslims, Pakistan’s variegated history has been nothing short of remarkable.

Today, Pakistan is at a political and economic crossroads.  Although such analogies are used somewhat loosely in modern usage, the use of this device is compelling in the case of Pakistan.  Just four years ago, Pakistan was crippled with debt, was about to default on international loans, and was about to lose international credit for the importation of goods and services.  Its poverty level was at levels never been seen before; corruption was rampant, and there was no hope or end in sight.  However, since the ascension of the Musharraf dictatorship in early 2001, there has been a remarkable change in the economic apparatus in Pakistan.

For the first time in its history, Pakistan has shown recognizable macroeconomic gains, represented chiefly by growth in hard currency, foreign direct investment, substantive decreases in debt, and the accumulation of tax revenue by the federal government.  Next year, Pakistan will voluntarily eschew the employment of IMF grants and preferred rate loans, allowing it to focus its expenditures on poverty alleviation and the public sector instead of adopting IMF-mandated austerity measures.  Primary school children have been granted access to free education in one of the major provinces.  Peace with regional powers is on the horizon, if still somewhat remote. 

There is a compelling interest in understanding the evolution, or perhaps devolution, of the Pakistani economy over the last six decades.  It is convenient to forget that at one time early in her history, Pakistan was regarded as a model of economic development in Southeast Asia.  Chinese and Korean diplomats and industrialists traveled to Pakistan to discover the roots of its success.  Pakistani medical equipment and machine tool manufacturers exported their goods to Western Europe, Korea, and even the United States.  Pakistan’s canal and irrigation system was the envy of the Eastern world.  Skilled human capital was abundant and small businesses were poised to grow the newly formed Pakistan economy.  Instead, Pakistan was subject to costly errors and poor judgment.  Senseless tariffs and myopic government policies, or lack thereof, crushed the entrepreneurial spirit, and economic mismanagement helped spur the growth of an elitist state where capitalism was short circuited by graft, corruption, and uncontrolled greed by the top .1% of the country, consisting of less than 1000 families. 

The reasons are as complex as they are fascinating.  The devolution of Pakistan’s political economy was a combination of many factors; it began with an unorganized and hopelessly short-sighted leadership whose grand vision of their country was marred by their lack of understanding of their economic inheritance.   Over the next thirty years, Pakistan would be subject to economic policies that lacked anything that remotely resembled foresight.  Finally, Pakistan would see the rise of the elitist class; controlling families deeply entrenched in the socioeconomic infrastructure of the country, supported by a misguided and indifferent bureaucracy.  Cumulatively, these factors took Pakistan to the brink of ruin.

A Squandered Economic Inheritance

In 1947, the Indian Subcontinent was teetering on the precipice of independence and factional violence.   British masters were leaving in droves; Gandhi walked the streets of New Delhi with a million men and women at his side, all demanding freedom from British hegemony with swords in their hands but under the battle-banner of non-violence.   The interim British government collapsed, and Lord Mountbatten, the man tasked to bury the British Empire in India, watched helplessly as India divided on ethnic and religious lines.  Under these circumstances, Muhammad Ali Jinnah and the Muslim League clamored for an independent Muslim country. 

But Jinnah and the Muslim League were not prepared for what happened.  In the summer of 1947, Jinnah’s dream of Pakistan was realized.  As blood spilled on both sides of the border, Jinnah and the leaders of the Muslim League struggled to put together a national identity from the ashes of Partition.  The lack of preparation was evident even before 1947; in the years leading to partition, no serious scholarly research had been done on the economic viability of a potential country.  Even before the birth of Pakistan, the leadership understood the principles of Partition; that majority-Muslim states would cede to Pakistan, and Hindu-majority states would cede to India.  The greatest concentrations of Muslims in the Subcontinent were in Western Punjab and Eastern Bengal.  Nevertheless, the only guiding document to help direct the political and economic policies of a new country was a 51 page prospectus put together scant months before Partition.  There was a failure by the Muslim League to put into place a coherent and continuous industrial policy aimed at leveraging and developing already established industrial sectors.  This catastrophic failure would not be addressed until much later in the 1960s, almost 13 years after the birth of the nation.

The Muslim League knew next to nothing about the industry or human capital they would inherit, and this would prove costly indeed.  No one had identified regional economies or manufacturers; at Partition, there were established industries around railroad and rail car manufacturing, electric fan manufacturing, canal engineering, machine tool manufacturing, cement plants, and surgical instrument manufacturing.  Pakistani engineers reverse engineered cinema cameras and diesel engines, developing fledgling industries around these durable goods, most of which were exported around the world.   Diesel engine manufacturing faded into oblivion in the late seventies, a victim of under-capitalization and regressed technology.  The industrial mineral content of the countryside had not been assessed, and would not be for decades to come, for no apparent reason.  Pakistani leadership not only failed to enhance these fledgling industries; they failed even to identify these industries as potential sources of export quality goods, depriving itself of badly needed income. 

Skilled and semiskilled labor was plentiful in Pakistan immediately following partition.  Across Asia, there was not another country with greater experience in canal engineering and development.  China, India, and the Middle East at this time desperately needed expertise in this field.  Tool manufacturers were plentiful; in fact, the Chinese Prime Minister visited Lahore’s vast tool manufacturing hub in the 1950s and wished that China too had such a diverse and comprehensive tool manufacturing industry.  Precision tools were exported throughout the world.  Pakistan was a leader in road building as well; at Partition, the road network in Pakistan was one of the best in the third world, and it had been managed and built by Pakistani managers and laborers.  Nevertheless, none of these skills was identified by the Pakistani government as potential sources of export labor. 

It becomes clear that at Partition, Pakistan’s lack of leadership, vision, and even rudimentary assessments of natural and manufacturing resources contributed significantly to the underutilization of its industries and human capital.  Pakistan’s industries kept themselves afloat after the partition without any help or direction from the national government and only through the creative entrepreneurial spirit that guided these small businessmen was Pakistan able to sustain some sort of encumbered growth during the first decade of its existence.  In the 1950s, Pakistan’s growth rate was approximately 3.1%.  Banking and financial services were virtually unheard of; the government had no process or ability to assist with the mechanization of industry or provide capitalization to heavy industry for upgrades.  Over the next few decades, Pakistan’s impressive economic inheritance would be almost totally squandered.

Decades of Flawed Economic Policies

Under these abysmal circumstances did the people of Pakistan witness the birth of their nation.  However, it should be noted that the primary function of the federal government in 1947 was compelled by the situation on the ground.  Partition in 1947 witnessed the largest single human migration in history; millions of people moved across the border in both directions, often with bloody consequences.  Pakistan was a country of refugees; the driving impetus at this time was feeding the hungry.  Consequently, the government began a series of ad-hoc reactions to crises, and this would be a model that they would not be able to escape from for the next decade.  This reactive model would also set the stage for a series of economic policy blunders that would leave Pakistan in shambles in the years and decades to follow.

The 1950s were witness to two major policy blunders that would have far-reaching effects for Pakistan’s economy.  The first of these was the collapse of the canal system.    In 1947, almost 38,000 miles of canals and systems of barrages were bequeathed to Pakistan, which irrigated some 14 million acres of previously uncultivated land.  This system ensured that Punjab – the granary of Pakistan and India – would have a viable irrigation network for the agricultural production process, which at that time comprised 53% of the economy.  Until the early 1950s, Pakistan was a food exporting country, with Wheat and sugarcane exports headed to Egypt and the Middle East.  However, six years after partition, Pakistan began importing wheat from the United States.  At first, misfortune was blamed; evidently, food growing land had been plagued with waterlogging and salinity.

In fact, the British had become aware of waterlogging and salinity as far back as the 1930s, and had adjusted their canal development processes to mitigate the problems associated with rapid canal growth and the subsequent runoff water associated with it.  However, after Partition, the Pakistani government mentally switched off the alarm bells and continued with business as usual.  Canal growth continued without due consideration for the rising water table or the slow salinization process that resulted from it.  Even as recently as the 1980s, some 40,000 hectares of land were being rendered unarable due to waterlogging and salinization.  Only in the late 1960s did the government take notice, and that notice was only at the behest of U.S. consultants.  Even today, a lack of political will exacerbates irrigation system redevelopment, and Pakistan’s approach to solving her problems has been haphazard and tactical at best.

The second great policy blunder in the 1950s was Pakistan’s economic response to end of the Korean War, which had generated an upsurge in demand for Pakistani export, specifically cotton and raw jute.  The post war recession forced Pakistan to re-examine its international economic policies.  Pakistani leadership began to fear that Pakistan would face balance of payments difficulties and foreign exchange constraints.  The premise was that the balance of payments position could only be maintained in equilibrium if imports were sharply curtailed to a licensing regime.  What would begin as a series of exchange rate realignments would evolve into a cumbersome web of administrative controls and incomprehensible licensing systems that would collectively be known as Pakistan’s import-substitution industrialization (ISI) regime.  This regime would remain the backbone of Pakistan’s economic trace policy for the next decade.

The ISI regime was based on the idea that the development of a strong local industrial capacity was essential for development, and that dependence on agricultural commodities would be ruinous for the economy.  Pakistan’s ISI policy attempted to substitute domestic production in the place of imports, in an effort to reduce the foreign exchange gap.  Not only would this increase output, but it would also save foreign exchange, which has high value to developing countries.  Preferred rate loans, fiscal inducements, and preferential access to foreign exchange allocation for imports of capital goods were used as incentives to spur domestic industry growth.  This national policy was plagued by corruption, graft, and black-markets, rendering it almost completely ineffective.  In fact, future studies would prove that Pakistan’s use of ISI protectionism had in fact worsened the balance of payments; there was an increase in machinery and raw material imports that outbalanced the export performance.  This was due to Pakistan’s haphazard approach to levying tariffs and quotas, which was done without policy review or analysis.

However, one net result of ISI policies was a large transfer of resources from East Pakistan to West Pakistan, from unprotected agriculture to inefficient and protected industry.  Industrialization was encouraged in West Pakistan, and East Pakistan was left to be a raw jute exporter.  A key reason to the restricted growth of the 1950s was ISI’s anti-agricultural bias.  National output was restricted due to poor investment in agriculture, pricing policies that kept the cost of manufactured goods artificially high and the cost of raw materials artificially low, and inadequate technology transfer.  There was a net transfer of resources from East to West Pakistan, estimated to be approximately 3% of West Pakistan’s GDP.  Pakistan would pay a high price for these policies in the decades to come; in 1971, East Pakistan would declare independence as the sovereign country of Bangladesh, and Pakistan would be left with a shattered national identity.

The 1960s were witness to the ascension of Ayub Khan, a military dictator determined to take Pakistan into rapid industrialization.  His military regime was characterized by a paradoxical combination of exceptionally high growth rates and large increases in income distribution disparities. Ayub Khan’s economic policies were predicated upon the belief that economic growth would trickle down to the masses; his policies displayed a complete lack of any interest in issues around social justice, income equality, and poverty alleviation.  Ayub wanted to see an industrialized Pakistan, and his ruthless consolidation of power allowed him to institute an administrative apparatus to drive the formulation and implementation of his economic principles.  Given the scarcity of finance for investment and the poor condition of capital markets, profits were the only source of attainable industrial investment during Ayub’s reign.  The new industrialists of the 1950s, who had reaped tremendous windfalls from the ISI policies, came to his call and helped Ayub in his drive for industrialization.

Ayub instigated a series of reforms to alter the trade regime.  He introduced the Export Bonus System, which gave a premium to exporters and introduced a system of multiple exchange rates favoring manufactured exports.  He also provided preferential access to credit and fiscal incentives as a part of his policy package.  These policies would lead to the demise of the ISI regime of the 1950s.  However, the new industrialist class would see their profits continue unabated.

Although Ayub was responsible for some of Pakistan’s fastest and most sustained growth, his policies created a socioeconomic infrastructure that exacerbated the divide between the rich and the poor.  Pakistan experienced rapid growth in the 1960s; although agriculture grew at a modest 4.1%, manufacturing grew at 9.1% and trade at 7.3%.  GNP growth rates were at a sustained 6% for most of that decade.  On paper, it seemed that Pakistan was experiencing unprecedented growth.

Statistics on income distribution, wages, human capital development, and the incidence of poverty tell a different story.  Income inequalities increased substantially in the 1960s.  The number of people below the poverty line, both actual and relative, increased sharply, peaking at 40%.  The index of real wage valuation increased only 2% in a ten year period.  Living standards stagnated and even regressed for Pakistan’s poor, and Ayub’s policies failed to even address spending on critical social sectors.  However, one positive contribution he left to Pakistan was institution-building; Pakistan’s economic governance improved greatly, and the Government of Pakistan capacity for policy analysis, design, and implementation was a significant achievement.

Ultimately, Pakistan’s unprecedented growth enriched a small but extremely powerful ruling elite.  The new industrialists and the wealthy landowners realized economic gains on a scale beyond belief during Ayub’s reign.  The rapid growth rates left Pakistan’s poor and fledgling middle class families behind; Ayub’s policies almost exclusively enriched the already-wealthy classes.    There was no trickle-down effect, as proposed by Ayub; instead, there was only an increase in frustration, in poverty, and a desire for a leader that would rectify all that was wrong in Pakistan.  Such a leader arose at the end of Ayub’s reign, and his name was Zulfikar Ali Bhutto, a self-styled socialist.

Following East Pakistan’s secession from Pakistan, the military ceded control of the government to an elected leader whose populist agenda included far-reaching nationalization of major industries and land reform.  Bhutto tried to control Pakistan’s commanding heights by nationalizing manufacturing and the financial sectors.  His objective was a transformation of the industrial sector by moving the economic focus from the development of consumer goods to one on building a capacity in basic industry.  Bhutto recapitalized the heavy industries of steel, fertilizers, and chemicals though the public sector.  The centralized economic planning introduced by the Ayub administration was replaced with a personalized but ad-hoc approach to economic policy development.

The results were dramatic.  GDP growth fell to 3%, and lack of controls drove inefficient industries into the ground. The transfer of ownership that resulted from nationalization significantly weakened industrial performance.  Another fundamental blow to the Pakistani economy was the resultant unbalancing of the balance of payments for imported and exported goods.

Bhutto attempted to institute a nationalization program similar to that of Eastern European and the Soviet Union.  However, instead of capturing all of the industries, Bhutto targeted only what he considered to be key facets of the economy.  Another failing of Bhutto was his lack of planning; whereas Eastern Europe and the Soviet Union staged the nationalization policies and created governance capacity at local levels, Bhutto tried to nationalize Pakistan overnight.  His policies did not have the vision nor the planning to support such an audacious experiment, and the result was catastrophic. 

The decade following Bhutto saw a reversal into military dictatorship, this time personified by General Zia ul-Haq.  During the 1980s, Zia became a key figure in the US-led proxy war against the Soviet Union in Afghanistan.  As IMF and World Bank funds poured into Pakistan, Zia reversed Bhutto’s nationalization policies.  Although Zia’s policies had no basis in research or policy review, they were sustained by the massive amount of money that flowed into Pakistan though US-based consortiums that had a vested interest in removing the Soviets from Afghanistan.  Zia’s policies, unsustainable as they were, laid the groundwork for macroeconomic instability that would continue to plague Pakistan.

Following Zia’s death in 1988, democracy was restored to Pakistan.  Benazir Bhutto, daughter of the populist who was eventually hung by Zia on trumped-up charges, came to power on a platform of privatization and representative democracy.  Her opposition, an industrialist by the name of Nawaz Sharif, would balk her and even replace her on a number of occasions in the 1990s, in a decade that would be remembered for nothing expect for the rampant corruption of both the party leaders.  Administrative reversals, adventurous economic initiatives, and ad-hoc policies dominated the rule of both parties; both parties used these same tools to establish economic supremacy over each other.  Bhutto eventually fled Pakistan after her government was sacked for corruption and she was accused of funneling millions of dollars into private accounts in England and Switzerland.  Her counterpart, Sharif, found himself in exile when he attempted to sack his head of the military, General Pervaz Musharraf.  All in all, Sharif saw his industrial sugar plants grow from three to dozens at the time of his exile.

Economic policy in the 1990s seemed to be pointed in the right direction; Benazir Bhutto managed to attract significant foreign direct investment during her tenure in office.  However, the implementation of the policies was inefficient, erratic, and inconsistent.  Constant changes of government compounded the problems faced by the economy.  In addition, the US had stopped providing Pakistan with foreign aid.  Economic problems were aggravated by cronyism, nepotism, and a complete disregard or the rule of law by the ruling elite.  Tariffs and duties did not apply to the privileged class, which now had grown to include the upper echelons of the military.  Estimates put black market growth at 30% of the size of the regular economy. 

Fifty years of bad public and economic policy had resulted in much suffering by the population.  From the ISI in the 1950s to the failed land reforms of Zulfikar Ali Bhutto in the 1970s, Pakistan’s teeming masses of indigents never saw their share of Jinnah’s vision.   Pakistan’s founders were blind to their economic inheritance.  Future economic policy was drafted to either serve the ruling masters, or was crafted in an ad hoc manger to address a current economic or political issue; in either case, they did not serve the public of Pakistan, and they paved the way for the deterioration of Pakistan’s economic infrastructure.  However, the devolution of the Pakistani economy was affected by one other major factor; the rise of the elitist class.

The Rise of the Elitist State

Pakistan’s development as an elitist state goes back to pre-Partition and British policy.  In the late 1800s and early 1900s, the British rewarded cronies and favored subordinates with gifts of agricultural land.  Huge tracts of agricultural lands in Pakistan as well as India were given to beneficiaries by the British for loyalty demonstrated by keeping the hegemony of the British intact.  This particular incentive, i.e., the acquisition of wealth through winning favors rather than through hard work or innovation, formed the basis of the subsequent evolution of the Pakistani economy.

In the 1950s, import licensing as per the ISI regime provided ample opportunity for a small class of robber barons to enrich themselves and their families.  Although they laid the foundations for industrial growth in Pakistan, their role was motivated by self-aggrandizement and their economic and social contributions to the public were virtually nonexistent. 

Ayub’s decade of reforms was a turning point for the development of the elitist class.  Under Ayub’s high protectionist tariffs, the new industrialists were able to form oligopolistic market structures that had juxtaposed interests with financial and banking institutions.  In a decade, a few hundred industrialist families we able to capture almost all of the net gains of the industrialization policies, while at the same time keeping public spending and even the generation of wealth outside the industrialist families at near zero levels.  These years also saw the rise of the bureaucracy, and industrialists and landowners quickly move their own people into key positions of power.

The 1970s witnessed the first time the government went loggerheads against the bureaucratically entrenched elitist class.  Bhutto’s government miscalculated in its attempts to close the income distribution gap; in fact, Bhutto’s policies worsened it.  Instead of leveraging public capital for investment or other productive purposes, the industrialists and landowners resorted to speculation, trading, and obtaining contracts from state-run corporations.  When these corporations suffered financial losses that were financed by the exchequer, the entrenched bureaucracy allied itself with the elitist class.

By the 1980s, the elitist class had found a new way to generate its revenue.  As the US began flooding Pakistan’s financial institutions with large amounts of capital to finance the war in Afghanistan, the elites recognized them as major conduits for industrial capital flows.  The elitist class would seek loans from these financial institutions; these loans allowed the equity portion of the principle to be paid off by over-invoicing of machinery and equipment.  This, of course, had disastrous effects on industry.  The exponential growth of yarn producing machinery that produced low-value yarn shattered the industry.  In other countries, labor-intensive, high-value garment manufacture became major exports; in Pakistan, economic policy makers were held hostage by a lobby of extremely rich and powerful yarn spinners.  These industrialists processed domestically produced cotton at subsidized rates and sold them on the world market, reaping huge windfalls.

The 1990s were not better.  Although the fast and loose lending of the 1980s was over, banks had accumulated billions of dollars of bad debt.  The banking industry was brought to a standstill, and public loans to small businesses were virtually unheard of.  The entrenched bureaucracy still supported the incumbent government, irrespective of policy or platform, ensuring that whatever player came to power would be able to use economic policy to accumulate wealth. 

This is the legacy that the government of Pervaiz Musharraf inherited.  His efforts to bend the elitist class to his will has been only partially successful; only time will tell if he will be remembered as a visionary or as another Zia ul-Haq.  To date, his policies have resulted in sound macroeconomic progress, but the poor and destitute have yet to share in the generation of wealth.  However, Musharraf has attempted to bridge the gap between rich and poor through better representation of the lower classes at local levels, free education for primary school children, and a host of other reforms.  However, even Musharraf looks to the ruling elite class to provide him the resources and the mandate to carry out his mission of reforming Pakistani society and economy. 

Pakistan’s troubles began with a lack of vision and understanding by the leaders of the Muslim league during the birth of this nation. Fifty years of short-sighted economic policies compounded the plight of the common man, and helped pave the way to Pakistan’s economic ruin.  In those fifty years, a small class of robber barons and landowners seized control of the bureaucracy and were able to short-circuit almost every reform brought to the table by reformist governments, when they were not in colludes with the government itself, such as during the Ayub decade. 

Nevertheless, Pakistan has survived shock after shock to its economy, to its society, and even to its national identity.  Tomorrow’s Pakistan may be the grand vision once remembered in the hopes of its founder, Mohammad Ali Jinnah.  If a national consensus can be found, if political will can be gathered, if a strong leader can find a mandate across the broad spectrum of political and ethnic fractures that make up Pakistani society, there is a chance that Jinnah’s dream may be realized by more than just the industrialists.