April 18, 2008
How Real Were Aziz’s Reforms?
There are many critics of Musharraf and Shaukat Aziz who now insist that nothing meaningful really happened in the last eight years, and that if Nawaz had stayed in power in 1999 he and his Finance Minister Ishaq Dar would have done just as good a job.
Although it is correct that some very tentative economic reform steps were taken by both the Nawaz Sharif and Benazir Bhutto governments in the 1990’s, the overall actual impact of their policies were trivial. The record of PTCL was terrible, with only three million landlines in 1999, teledensity was among the lowest in the Third World, and there was no real cell phone service available until after the Aziz era. How long did it take from ordering to getting a working phone line from PTCL in 1999?
But overall, the problems with the 1990’s were the very slow growth rates. In poor countries the only way to reduce poverty is through rapid economic growth, and rapid economic growth almost always results in dramatic falls in poverty. Slow growth on the other hand raises poverty by raising unemployment. Remember that due to population growth and increasing female participation the labor force is growing 3-4% per year. But 3-4% economic growth won’t absorb those extra workers because productivity per worker is also rising at 3-4% per year. If the economy experiences slow growth, businesses can meet all the rising demand through increased productivity of the existing labor force, and the new workers remain unemployed. To absorb the extra labor, and thereby ensure that growth causes poverty reduction rather than unemployment, the economy has to grow 6-8% per year. That is why there was poverty reduction in this decade and the 1980’s but not the 1990’s, when growth averaged less than 4% per year.
In per capita terms, the economy in the 1990’s barely grew faster than 1% per year, which would not result in noticeably rising living standards. The sluggish economy of the 1990’s also explains why there was so little asset price increases in Pakistan. Stocks and real estate remained depressed throughout the 90’s, and the boom that occurred during Aziz was to a large extent catch-up after a decade of underperformance. Even now Pakistani stocks are cheap both by local historical standards and international metrics of Third World stocks.
So what were the main reforms of Aziz? There were three major things he did, that were not done in a meaningful way by his predecessors. First were financial changes. He made the central bank independent of the government.
This was politically a huge step, because it substantially reduced the power of the political government to control interest rates and regulation of the banking sector and moved Pakistan in line with international standards. Equally important was the rapid privatization of the banking sector. Although the government gave golden parachutes to offload bank employees in the 90’s, this did not solve the problem that the banks were malfunctioning because they were politically controlled by the government. In 1999, 90% of assets were in state-owned banks, now 80% is in private hands. The privately managed banks give loans based on business judgment, rather than political connections. This rational allocation of financial capital is the single biggest difference between the economy of the 90’s and the current situation. Non-performing loans, as a share of total assets, have plunged over the last eight years.
The second reform was relieving the debt burden on the economy. In the 90’s the political governments had absolutely no fiscal discipline. They were unwilling to tax effectively, nor could they restrain spending growth, so the result was a massive runup in debt. As the economy was so sluggish, there was very little growth in tax revenue, and the tax system was mainly based on tariffs and excise taxes.
To cover foreign exchange needs, large amounts were borrowed abroad. The end result was that by 2000, the total national debt exceeded the size of the economy, a clear marker of excessive debt burden, with interest expenses being one of the largest items in the national budget. This became such an overhang on Pakistan that the IMF basically had to try to micromanage the economy, but was continually thwarted by the politicians.
Pakistan was known in the IMF as a “one-tranche country” because it could never comply enough with an oversight program to qualify for the second tranche. After the coup it turned out that Dar was keeping two sets of accounts, and showing fudged numbers to the IMF to keep them happy.
Over the last eight years, Aziz dropped tariffs, shifted the tax burden to income and sales taxes, tripled tax revenues, and cut the debt to GDP burden to only 50%, which has created real fiscal space for the new government.
The third reform was the privatization of the economy. Sharif did carry out some minor privatizations during his first government, but I do not think that starting the process is the most difficult step. Privatizing small, politically insignificant entities, was not hard to do. The hard part is selling what is perceived as the “crown jewels”.
Throughout the 90’s, lots of lip service was paid to privatization by the PPP and PML, but very little was actually done. In an oil state, the great prize is control of oil revenues, but in Pakistan, the prize for political power was control of the massive patronage opportunities afforded by control of state-owned businesses. To privatize them meant to give up the associated patronage, which neither BB or NS were really interested in. By 1999, the PML had dropped the concept, and Dar’s budget speech makes no mention of any major effort at privatizing. At that point, much of the economy was still state-owned including telecom, banking, energy, gas, steel, airline monopoly, railroad, power, and many large industrial complexes such as fertilizer and cement plants. Even tourist hotels were being run by the government.
Aziz changed much of this in a real way, but even he could not get politically sensitive businesses sold such as PSO, Steel Mill, or PIA. There is much out there left to sell, and let’s see if this government sells any of them. But overall, Pakistan has a much less state-dominated economy now than it did in 1999.
Finally, Aziz created a stable macroeconomic foundation for future growth. Not only is the national debt now under control, but there are adequate foreign exchange reserves, strong capital markets, a more open trading system, and a stable currency. The end result is that poverty dropped from 35% to 25% of the population (52 million to 40 million people). This decade has seen the total number in poverty decline for the first time in Pakistani history (previous drops in the rate were overwhelmed by the growing population raising the total number of poor). Dar on the other hand was very much part of the ruling elite whose poor decisions made the 90’s a lost decade for most Pakistanis.
Not only did he lie to the IMF, but he and Nawaz Sharif totally manipulated the aftermath of the nuclear tests. Readers may recall that the run on forex after the test resulted in Sharif placing a freeze on all access to foreign currency accounts held by Pakistanis, but he conveniently gave exceptions to himself and his cronies, who were able to access their forex before devaluation. Dar has also engaged in certain acts that discouraged foreign investors in the 1990’s, the details of which my cousin was involved in firsthand, and left a very bad impression in his mind of the standards of ethics that Dar had.
One can pick and choose anecdotes of the 1990’s to suggest that meaningful reforms took place, but overall, the policies were abject failures, and people at that time knew it. There is no comparison between the Pak economy of 10 years ago and today.
