PAKISTAN ECONOMY LECTURE 4

End Of Ayub’s Era

Agitation against Ayub due to Inability to create jobs Accumulation of wealth in few hands

Yahya imposed martial law Elections were held Mujeeb got majority

in East and Bhutto in West Civil War Dec1971 ??

Bhutto’s Experiment with Socialism

Years 1971-1977

MAIN FEATURES

Political• Simla

Agreement• Socialistic

Approach• Strengthen ties

with other Muslim countries , China

• Constitution of 1973

Economic• Nationalizatio

n• Public

Investment• Labor Policy• Growth

Statistics• Foreign

Assistance

Policy• 5 Year Plan• Economic

Framework Order

INTRODUCTION

Pakistan had lost a whole province of 70 million, 56 percent of the total population

Left only with the four Provinces of West Pakistan

Bhutto took steps to revitalize the economy, industry and agriculture

3rd Constitution In 1972, he signed the Simla Agreement

He negotiated the return of the 90,368 prisoners of war and a peaceful settlement with India.

Major Policy Change Nationalization of Industry, insurance and banking,

educational system

ECONOMIC GROWTH

From 1970 to 77 the growth rate of economy averaged 3.8% compared to the 1960s

Reasons: Separation of the East Pakistan Poor weather conditions? And technical problems which delayed the

availability of water from Tarbela dam Oil price shock?

During Bhutto’s period, the adverse impact of higher oil prices on the balances of payments averaged about US $700 to US $800 mill annually

WHAT SAVED PAKISTAN?

Large scale inflows of foreign capital and remittances after 1973 cushioned the impact of the steep rise in the oil import bill. Debt relief was given to Pakistan , two third of the

debt payments of US $ 650 million , due in 1974-77 were wiped off.

Official Grants (aid to Pakistan from western industrial nations and multilateral banks) were resumed in 1974.

Loans from Middle East Oil Exporting Countries total $ 1.2 billion during 1974-78 on concessional terms, helped to cushion the adverse impact of oil increase.

Macroeconomic Management

FOREIGN TRADE ADJUSTMENT No major decline in Exports

Cotton and rice were sold below the international prices to East Pak in 1960’s which depressed real XR.

Real Devaluation in 1972facilitated shifts to international markets

Boom in int’l economy & commodity market increased exports

Macroeconomic Management PATTERN OF GROWTH Growth in GDP in 1973 was 7.1 and in 1974

were 3.4. Sources: Construction, public admin, defense and

service sector real investment expanded by 50% between 1972-

73 and 1976-77 and the rate of investment as per GDP recovered from a low of less than 13% to over 19% over the four year period.

Military expenditures Beginning of boom in worker’s remittances

Macroeconomic Management FINANCIAL INVESTMENT Domestic investment financed from??? Domestic savings???

External TOT, worsening fiscal situation, reduced incentives for private sector investment

Workers remittances: 4% of GDP supplemented

Macroeconomic Management EXTERNAL DEBT PROBLEM

debt service ratio to foreign exchange earnings had risen steadily from 10% on 1960-65 to nearly 20% in 1969-70.

debt service payments due in 1971-2 would have absorbed over 40% of Pakistan’s foreign exchange earnings during that year.

Assistance from Abroad: foreign assistance commitments and disbursements reached the record of average level over US $1.2 bill annually during the years 1974-5 to 1976-8.

Macroeconomic Management BUDGET DEFICITS

Explosive growth The budget deficit averaged over 8% of GDP

compare with fiscal deficits of 2-3% of GDP in the 50’s and 4-5% in the 60’s.

Inflationary financing of the budget averaged well over 3% of GDP during 1972-3 and 1976-7 while government revenue account deficit was close to 2% of GDP

Macroeconomic Management TAX POLICY

Collection from incomes and corporate tax during the 70’s did not exceed 1% of GDP.

The essential inelasticity of tax system remained intact with its heavy dependence on indirect taxes and especially certain duties.

there was only a marginal improvement in total federal and provincial tax revenues from 10.6% of GDP in 1972-73 to 11.9% in 1975-76

Macroeconomic Management INFLATIONARY PRESSURE

Fiscal deficit Imported inflation Devaluation EFFECTS???

Macroeconomic Management

EXCHANGE RATE AND TRADE POLICY The serious distortion caused by the system of multiple

exchange rates which prevailed since January 1959 were finally recognized when the government decided to devalue the rupee from Rs.4.76 per dollar, to Rs.11 per US dollar in May 1972.

The Export Bonus Scheme was also abolished at the same time.

raised export prices of the primary products sharply by a range of 30 to 80% and high export duties were introduced to mop up windfall profits.

anti exports and anti agriculture biases of policy Custom revenues as percentage of GDP increased from

2.7 in 1971-2 to 5.2% in 1973-4 and remained high during the subsequent years.

Macroeconomic Management PRICE AND SUBSIDY POLICIES Explicit subsidies in the budget constituted about

3% of GDP in 1974-5 to 1975-6 but dropped to 1.6% of GDP in 1976-7.

bulk of direct subsidy sale of wheat to consumers but fertilizer and pesticides were also sizable.

The indirect subsidies were mainly on the energy products where prices were not fully adjusted upwards, the difference being absorbed either through reduced tax revenue on petroleum products or lower rate of return on electricity production by WAPDA.

Macroeconomic Management ENERGY PRICES Import cost of ______had increased by

300% Gas prices kept low After 1973, development surcharges

were used to _________ the sale of kerosene and diesel oil.

In 1970 energy consumption expanded 30% faster than growth in GNP with obvious adverse consequences for the balance of payments.

Nationalization

Economic Reform Order issued on January 3, 1972, major industries were nationalized.

The Ministry of Production, which incorporated the Board of Industrial Management, was established to oversee industry.

Break the power of the approximately twenty elite families who had dominated the nation's economy during the Ayub Khan period.

5 Waves

Jan 1972• M

anagement and Control of 31 basic industrial units

Mar 1972• 3

2 Life Insurance Companies

Aug 1973• E

dible Oil Industry

1974• B

anks

Jul 1976• 3

000 Cotton Ginning Factories

LABOR POLICY

Speedy and just settlement of disputes

Fair share in profits Labor legislation set high minimum

wages and fringe benefits Trade unions were strengthened Participation in the management of

industry Initially only applied to firms with 10

or more workers then changed to 50

Public Investments

Share of Public investment increased from 49% in 1969-70 to 70 % in 1976-77

Public Sector development Spending: 1971-2 4.7% of GDP 1977 11.7% of GDP

Spending on Tarbela Highways Nuclear processing plants at Chashma Spending on infrastructure Spending on less developed programs

Role of Planning

Planning commission?? Abandonment of __________ Civil Service Reforms

Land Reforms

The land reforms were announced in March 1972.

The individual ceiling on land holding was reduced from 36,000 produce index(500 acres of irrigated land) to 15,000 produce index units, and further reduced to 12,000 units(150 acres of irrigated land).

New rules for the tenants were laid down and the burden of taxation was shifted to landlords.

Social Services

EDUCATION outlined an ambitious Programme of

educational development including free and universal education up to class VIII, strengthening of technical education, teacher’s welfare, improvement in the quality of education, and an educational Programme for women in

the rural areas.

Social Services

Total government expenditures on education increase from Rs.0.8 million in 1971-2 to Rs.2.8 million in 1976-7 which represented increase in real terms of around 50% over the period.

Female education at the primary level did relatively well in the Bhutto’s period as females accounted for 36% of growth in the primary school enrollment and 55% of growth in teachers during 1972-7.

Social Services

HEALTH A comprehensive health policy announced in 1972

outlined an ambitious Programme of extension of health facilities to rural areas, expansion of medical education, and shift to the production of generic drugs to avoid

the soaring prices of brand named medicines. The centre price of scheme was the Basic Health

Unit, which was to serve between 8,000 and 15,000 people as a sub unit of a larger rural health centre

As a proportion of GDP the growth in health sector was from 0.4% in 1971-2 to 0.8% in 1976-7.

FACTS & FIGURES(1971-77)

GDP growth rate fell to 3.8 percent between 1971-77

The total government expenditure on education increased from 1.6% to 2% of GNP over 1972-77

The ratio of taxes to GNP improved to 12% in late 1970s

Rural poverty incidence fell from 54% in 1969-70 to 41% in 1979 Domestic Savings avg < 8%

Current Account Deficit average 6.5% of GDP

Inflation fell from 25 percent in FY 1972 to 6 percent in FY 1976.

Assignment

Comment on the macroeconomic policies under Bhutto’s Era. (10)

Discuss Bhutto’s experiment with socialism giving special attention to his nationalization and labor policy. (10)

PAKISTAN ECONOMY

Lecture 5

Return to 1960’s Policy

1977-1988

MAIN FEATURES

Political• 3rd Martial Law• Bhutto hanged• Islamization• Afghan War

Economic• Economic

Trends• Remittances• Investments• Trade• Foreign

Assistance

Policy• 5 Year Plans

INTRODUCTION

General Zia-ul-Haq imposed martial law in March 1977

Zia took over with the declared purpose of resolving the rift between Bhutto’s Peoples Party and the combined opposition to hold free and fare elections within 90 days.

Bhutto then charged with the murder of a political opponent was found guilty in March 1978 and hanged on 4th April 1979.

What helped Zia prolong his Rule?

Efforts to Islamize society to strengthen his political support.

Soviet occupation of Afghanistan

Zia extended the role of the army in governance through extensive use of military intelligence

Economy under Zia enjoyed a high and sustained rate of growth

GROWTH TRENDS

Growth Rates(% per annum)

  1977-83 1983-88 1977-88

Agriculture 4.2 3.5 3.9

Manufacturing 10.2 8.2 9.2

Other 8.6 7 7.9

GDP at factor cost 6.7 6.2 6.6

GNP per capita 4.4 1.9 3.3

WORKER REMITTANCES

Worker Remittances

Selected Years U.S $ in Millions As %age of GDP

1972-3 136 2.1

1976-7 578 3.8

1982-3 2886 10.1

1987-8 2013 5.2

1982-81 1848 4.1

1983-4 1445 2.3

EXPORT AND INDUSTRIAL GROWTH

Industrial growth under Zia was impressive as manufacturing sector growth over 1977-88 averaged over 9% as compared to 3.7% in 1972-77.

Large scale manufacturing grew even faster than the small scale.

Private sector investment in manufacturing grew by 9.5% per annum during 1978-83

MAIN REASONS

Large public sector investments which started in Bhutto’s resulted in major increases in steel, cement fertilizer and vehicle production

Incentives for manufactured exports were strengthened by the introduction of a flexible exchange rate policy after 1982, by increasing the standard rates of rebate of custom duty and sales tax for exports

The investment climate for the private sector was improved by providing guarantees against future nationalization, clearer demarcations of activities between the public and the private sector and additional tax concessions

EXCHANGE RATE

The rupee was devalued from Rs.9.90 per US dollar to Rs. 11.84 in 1982 and then gradually depreciated to Rs. 18 per US dollar by the end of 1988

This real devaluation assisted the overall export expansion of 7-8% per annum during the period and contributed in a significant way in reducing the relative dependence on worker remittances

By 1988 exports were more than double the level of remittances

TRADE POLICY

The industrial zone was established in the late 1970’s

Attract foreign investment Speed up flow of modern technology Provide more job opportunities Raise skill and management standards and

provide exporters a base for the production in an environment free from import duties

The results were however disappointing as exports from the zone were relatively small.

SLOW GROWTH IN INVESTMENT

The low rate of investment in the 1980’s was due to the failure to mobilize sufficient domestic resources in the public sector for development as foreign savings declined

Gross fixed capital formation as a percentage of GDP averaged about 17% during 1977-88, below the level of 17.5% in 1967-77

Insufficient attention given to longer term requirements of water, energy and transport also meant that toward the end of the 1980’s there were few large projects in the pipe line that would normally have helped the momentum of growth in 90’s.

TAX SYSTEM

The inelasticity of the system witnessed during the 1960’s and 1970’s persisted in the 1980’s.

Substantial additional taxation undertaken in 1979-80 and 1986-87 yielded only marginal improvement in tax as GNP to tax ratio increased from nearly 12% in 1978-79 to 13.3% in 1987-88.

Direct taxes continued to account for fraction of total revenue and, the dependence on foreign trade taxes became greater.

The problem with the elasticity of the tax system was compounded by the generous use of tax holidays.

TAX SYSTEM

The level of income and corporation tax revenue at 1.6% of GDP in 1987-88 was not only low, but also had not increased over the previous decade.

Exemption of agricultural incomes from taxation was another actor in the elasticity of tax revenue.

Keeping domestic wheat, rice and cotton prices low, the government was able to benefit the urban consumer and the industrialists at the cost of the agricultural producer.

NON DEVELOPMENT SPENDING

Government expenditure had grown by from 10-11% to 27% of GDP

Defense expenditures increased from 5. to 7% of GDP over the period

Real defense spending increased by 9.2% per annum over 1977-88, real development spending increased only by 3.2% per annum.

The army was Zia’s main constituency and he made sure that he continued to enjoy its strong support.

Real Growth in Public Spending (Per cent per annum)

  1977-88 1988-97

Defence 9.2 1.6

Development 3.2 -2.8

Interest 15.8 7.9

Other 9.1 4.1

Total 8 2.8

RISING DEBT BURDEN

Interest payments had become the fastest growing element in government expenditures during 1977-88, rising from 1.9% of GDP in 1976-77 to 4.9% of GDP in 1987-88

Domestic debt increased from 20.38% of GDP in mid 1981 to 42.9% of GDP in mid 1988.

There was a much higher reliance on government borrowing from non-bank sources at relatively high interest rates of 14-15% per year

A greater reliance on non inflationary sources of financing meant that credit creation in the public sector and the overall rate of monetary expansion slowed down sharply in Zia period.

AGRICULTURE

The government price policies after 1980 improves agriculture incentives, especially for wheat.

The agricultural growth since the early 1980s also benefited from strong growth in live stock.

The livestock grew annually by 5.5% in the 80’s and further continued.

ISLAMIZATION OF ECONOMY

Islamic Economic System introduced in February 1980

Two most important measures of Islamizing the economy were The industrialization of the Zakat Introduction of interest free banking

ZAKAT

Under the Zakat Ordinance, most financial assets in the Banking system and saving instruments were made subject to 2.5% deduction annually on account of Zakat.

By 1987-88, Zakat collections deducted at source were Rs. 1.9billion and had risen further to Rs. 2.6 billion by 1988-89

Even assuming that all the benefits went to the lowest 20% income households and that the administration expenses were minimal, the Zakat donation would have augmented the income of this group by only 2%.

Zakat deduction of 2.5% per annum, from which foreign currency deposits are exempt, provides a strong disincentive to hold rupee assets

INTEREST FREE BANKING

Islamization also affected the interest rate policy. Technically all lending and deposit rates were by 1988 set on profit and loss sharing

The move to profit and loss sharing as such as did not make big difference to the process of financial deepening that is increase in share of monetary assets to GDP

AFGHAN WAR IMPLICATIONS

Strengthening of US Pak relationship

Huge amount of foreign assistance coming into Pakistan

Drug Trafficking

Emergence of Kalashnikov culture

Afghan Refugees

Mujahideen , the future Taliban's

Facts & Figures (1977-88)

Economic growth averaged 6.6% per annum The agriculture growth increased to 4% in 1977-88 from

2% in 1972-77 Pakistan’s manufactured exports increased fourfold

from US $1.3 billion 1980 to US $ 5.6 billion in 1983.

Reduction in the overall fiscal deficit to an average of less than 6% of GDP during the fiscal years 1980-83. By 1986 the deficit had aging risen of above 8% and stood at 8.5% of GDP in the final year of Zia’s rule

Primary school enrollment during 1977-88 expanded at an annual rate of only 4%, only moderately faster than the growth rate of the population.