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The phoenix that never rises: what’s holding back Pakistan’s economy?

Pakistan’s recent election has further eroded trust between citizens and the state. The economy continues to fall behind its Asian neighbours, with low rates of productivity growth and an unsustainably high burden of external debt. There are no signs these challenges will be addressed any time soon.

Pakistan today is a melting pot of crises. The events leading up to this year’s elections and what followed has only increased the mistrust between the people and the state. Further, the expansion in the role of the military in both politics and the economy – through the subversion of the constitution and suppression of political freedoms – leaves the country ill-prepared to address the many challenges that it faces.

What are the main economic challenges facing Pakistan’s new government?

Over the last three decades, Pakistan has experienced one of the world’s lowest growth rates in labour productivity – a measure of goods and services produced by workers in a given time, and a key indicator of economic performance and living standards.

The country is also mired in a debt trap, with significant amounts of policy-makers’ time spent securing short-term rollovers of external debt year after year. The damaging effects of repeated bailouts from external partners are at their peak – what economists refer to as ‘moral hazard’, whereby the government has few incentives to reduce its exposure to risk as it does not bear all of the costs.

What’s more, the erosion of trust between the people and state institutions continues to exacerbate an already precarious situation. This took root almost immediately after Pakistan was born in 1947, due to frequent military takeovers, their implicit or explicit validation by the courts and subsequent suppression of social and political freedoms.

To borrow from Kenneth Arrow, a Nobel laureate in economic sciences, ‘It can be plausibly argued that much of the economic backwardness in the world can be explained by the lack of mutual confidence’ (Arrow, 1972).

It may seem that Pakistan has finally hit rock bottom with nowhere to go but up, except that the ‘rock’ keeps sinking.

What’s happening with labour productivity?

Pakistan’s average annual growth in labour productivity between 1990 and 2018 has been as low as 1.33%, according to data from the Economic Transformation Database, ETD (Pirzada et al, 2024). In stark contrast, labour productivity has grown at an average annual rate of 3.88% in Bangladesh, 4.72% in India and 8.12% in China.

Part of labour productivity growth in an economy is due to workers moving from less productive sectors to more productive sectors. In the case of Pakistan, if we only consider the growth in labour productivity due to improvements within sectors, the average annual growth falls to the abysmally low level of only 0.73% (using the same analysis as Timmer et al, 2015, and de Vries et al, 2015). The comparable annual within-sector labour productivity growth rates for Bangladesh, India and China are, respectively, 2.11%, 3.38% and 5.90%.

Figure 1: Change in labour productivity in Pakistan, 1990-2018

Source: Economic Transformation Database, release February 2021

The picture appears even bleaker when looking at labour productivity changes across sectors over the same period. Unlike its South Asian peers, labour productivity in Pakistan has either fallen or stayed the same across six of the 12 sectors in the ETD database over the past three decades – namely, mining, utilities, transport, real estate, construction and trade.

A closer look at the data shows that the small amount of growth that we do see is in non-tradable manufacturing and services sectors, which generally have limited potential to deliver high growth in the future.

Figure 2: Growth in labour productivity in Pakistan by sector, 1990-2018

Source: Economic Transformation Database, release Feburaury 2021

This poor performance in terms of improving labour productivity is closely tied to Pakistan’s inability or, perhaps, unwillingness to benefit from the wave of globalisation that has helped many developing economies to sustain high growth in recent decades. Research shows how ‘exclusion of a country from trade reduces productivity growth, with large long-term effects’ (Alvarez et al, 2013).

Figure 3 uses data from the Asian Development Bank’s Multiregional Input-Output (MRIO) database to plot a standard measure of trade openness and a measure of participation in global value chains for 62 countries. We make a distinction between export and non-export sectors, where export sectors are defined as those that account for at least 10% of a country’s exports. Pakistan does poorly on both measures of trade integration.

Figure 3: Pakistan’s participation in global value chains and trade openness

Source: Asian Development Bank’s Multiregional Input-Output (MRIO) database

An unsustainable external debt servicing burden

Failure to undertake the necessary reforms to improve labour productivity has resulted in policy-makers relying on external debt to deliver brief periods of prosperity in Pakistan.

Yet excessive reliance on external partners to sustain growth has led the country into a debt trap. According to data shared by the State Bank of Pakistan, as of January 2024, Pakistan’s external debt servicing burden for the next 12 months equals almost $29 billion.

That is almost 45% of the country’s expected dollar income – in other words, income from exports and remittances. This is up from 12% in 2011 and it is one of the highest debt burdens in the world.

Figure 4: Pakistan’s external debt servicing burden

Source: State Bank of Pakistan

The last time that Pakistan was in a comparable situation was in the years from 1998 to 2001, when the external debt servicing burden as a percentage of the country’s dollar income had increased to 40%.

Economic growth only returned after the massive debt restructuring that happened once Pakistan decided to join the United States in its war in Afghanistan. In the following two decades, while the economy did experience several episodes of high growth, these proved unsustainable and left the country with similar levels of debt burden from which it had escaped around 20 years earlier.

Pakistan’s journey back into the debt trap matches closely with what has been dubbed ‘the paradox of debt’, where ‘heavily indebted poor countries (HIPCs) became heavily indebted after two decades of debt relief efforts’ (Easterly, 2002).

This could be due to factors including ‘profligate government, political instability, or interest group polarization’, which are unlikely to go away because of debt relief or continuous provision of soft loans offered on generous terms, known as concessional financing (Easterly, 2002).

More recent research shows that the debt servicing burden across several other developing economies – both large and small – has also returned to levels last seen in the early 2000s (Rogoff, 2022).

How have multilateral financing and bailouts from bilateral partners become a problem?

Several World Bank officials are on record chiding Pakistan’s elites (and rightly so) for not prioritising reforms. But an important overlooked factor is the very role of multilateral and bilateral partners in providing a steady stream of concessional financing for questionable initiatives or against dubious targets.

A Pakistani economist who has extensive experience of working with the International Monetary Fund (IMF) and national governments has long questioned the efficacy of concessional financing. Recollecting his own experience, Nadeem ul Haque wrote in 2002: ‘In one case, I recall a donor team take the easy approach of merely recording all that government had to say perceiving the ill-conceived laundry list of projects to be domestically-owned policy agenda.’

More recently, a similarly ill-conceived set of projects was funded by China under the umbrella of the China-Pakistan Economic Corridor (CPEC) – a Chinese-funded infrastructure network that is being built in Pakistan – further contributing to the debt crisis facing the country.

An extensive network of motorways and expensive energy projects with returns guaranteed in dollars were funded under the CPEC initiative in the hope that these would pay for themselves through increases in exports. As widely expected, and in absence of meaningful reforms, this has not happened.

Today, Pakistan generates 50% more electricity than what it needs in months when demand is at its peak. But the contracts require that taxpayers must pay for the generation capacity even when it is not used.

Figure 5: Electricity generation in Pakistan, 2017-23

Source: Electricity generation data are taken from the State Bank of Pakistan; data on generation capacity are taken from National Electric Power Regulatory Authority’s annual reports

As of September 2023, multilateral and bilateral debt together accounted for 86% of total external debt held by Pakistan’s government.

The country’s default risk, which peaked in 2023, has come down more recently, but only due to the collapse in economic activity that has generated enough surpluses to service interest payments. Nonetheless, the default risk remains one of the highest in the world.

Without absolving the policy-makers of their responsibility, it would be fair to say that: ‘The official lenders should then bear some of the blame for financing bad governments who pursue policies detrimental to their own citizens’ (Easterly, 2002).

The phoenix that doesn’t rise

Stefan Dercon (former chief economist at the UK’s Department for International Development, now merged with the Foreign and Commonwealth Office) describes the current situation in Pakistan as unsustainable, and he urges stakeholders to coordinate efforts towards a better outcome for the country.

As the recent elections show, an increasingly young population that has little to cheer about is demanding representation. This is particularly stark in a polity that is managed by the military and supported by the landed elites and business groups, which have gone to great lengths to protect their rents under the guise of protectionist policies and institutionalised corruption that allows the transfer of public resources such as land to government officials, including judicial and military officers.

Yet so far, the only consensus that has emerged in the relevant circles is an expansion of the role of the military in both politics and the economy, and the use of oppression to subvert democratic freedoms.

Under the guise of fast-tracking foreign direct investment, a new body – the Special Investment Facilitation Council (SIFC) – has been set up. This gives the army chief an explicit role in managing the economy.

The Economic Advisory Group (EAG), a Pakistani thinktank with which I am affiliated, has called this move ‘a wrong step at the time of [a] worsening investment climate’. The EAG has further argued that the ‘arbitrary powers given to the council will create more uncertainty for businesses planning to enter Pakistan or expand their existing operations here.’

In the last 12 months, more than 100,000 acres of public land has either been handed over to entities affiliated with the military or is in the process of being handed over in the name of ‘modernising agriculture’.

But relative to average productivity in the rest of the economy, labour productivity in the agriculture sector is one of the lowest in developing countries, including in Pakistan (Pirzada et al, 2024).

As a result, and in line with broader research in this area, Pakistan will benefit if it revisits policies that prevent resources from moving out of the agriculture sector. Yet in sharp contrast, policy-makers in Pakistan are reallocating resources to one of the least productive sectors of the economy.

Figure 6: Agriculture productivity gap (purchasing power parity 2017)

Source: Groningen Growth and Development Centre, productivity level database, 2023 release

The transfer of public land to entities affiliated with the military is equally problematic. The Competition Commission of Pakistan has already highlighted how the predominance of military-led organisations in the construction industry undermines competition. In the past, millions of acres of agriculture land had also been transferred to the military.

A Pakistani researcher, Ayesha Siddiqa, in her book, Military Inc., documents that 11.58 million acres of agriculture land was controlled by the military as of 2007. What’s more, 60% of this land was distributed to military personnel for personal use. The 11.58 million acres accounted for 12% of state-owned land at the time.

Researchers have argued that contestation of power by disenfranchised masses has the potential to lead either to democratisation or to more repression by the ‘elites’ to prevent democratisation (Acemoglu and Robinson, 1999).

As the young revolt and fight for representation in Pakistan, the outcome remains uncertain. The ashes are there, Nero fiddles, but the phoenix is yet to rise.

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Author: Ahmed Jamal Pirzada
Image: SAKhanPhotography for iStock
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