Pakistan:
Foreign Aid or Band Aid?
By Dr Ahmad Faruqui
Dansville, CA
The
World Bank has stated its intent to provide foreign
aid of up to $6.5 billion to Pakistan over the
next four years. This amount, the largest single
award ever by the Bank to Pakistan, is more than
twice the amount that the Bank has provided during
the past four years. In fact, it is almost half
of the entire amount that the Bank has lent since
independence.
John Wall, the Bank’s man in Islamabad,
said the country had laid “the groundwork
for sustained economic growth and significant
poverty reduction. We will substantially ramp
up support to Pakistan and focus on the areas
that are most critical for the country’s
poor and most vulnerable.” The Bank’s
director for South Asia, Praful Patel, cautioned
that sustained growth in Pakistan is not assured,
noting that it “will require continued sound
macroeconomic management along with further improvements
in the investment climate and faster progress
in improving the quality of life for all Pakistani
citizens, especially women.”
While there is some evidence that foreign aid
equivalent to one percent of GDP that is given
to a poor but well-managed country can help in
increasing its growth rate by a sustained 0.5
percentage points, the economics profession is
divided on the long-term merits of foreign aid.
Advocates maintain that it allows nations to climb
out of poverty by overcoming the “financing
gap” between domestic savings and investment
needs. This position, argued persuasively by Jeffrey
Sachs in “The End of Poverty,” hearkens
back to Walt Rostow’s thesis in “The
Stages of Economic Growth.” Writing in 1960,
he asserted that aid could launch an economy that
would otherwise stay trapped in poverty into the
stage where it would “take off” toward
prosperity. Indeed, Rostow’s theorizing
provided the underpinning for the early work that
was carried out at General Ayub Khan’s Planning
Commission under the guidance of Harvard economists.
One of the chestnuts in development planning is
the incremental capital-output ratio. If the ratio
is 4 and the rate of domestic investment is 20
percent of GDP, then GDP will grow at 5 percent
a year. If the country wishes to grow at a faster
rate of 8 percent, it will need an investment
rate of 32 percent. Foreign aid can help bridge
some of the difference in investment rates, with
the rest coming from personal remittances (from
expatriates) and foreign direct (private) investment
(FDI).
In addition to World Bank aid, Pakistan is expected
to receive some $600 million of US aid annually,
split equally between economic and military applications.
According to the US Congressional Research Service,
Pakistan has received a total of $15 billion in
US foreign aid since independence. Between 2002-05,
it also received $3.6 billion in US aid for counter-terrorism
operations, most probably as a grant requiring
no repayment of principal or interest. Between
2001-07, Pakistan is estimated to receive $4.4
billion in US aid, of which 29 percent will be
for financing military supplies.
In the coming years, Pakistan is also likely to
get additional aid from the Asian Development
Bank, the Islamic Development Bank and other sources.
All things considered, it is likely to add $2
billion a year to its foreign debt. Just in the
past three years, foreign debt has grown by $5
billion.
How much will it cost to service the debt? That
depends on the terms of the loan. For example,
if the term is 20 years and the interest rate
is 8 percent, every billion dollars of foreign
aid will require $100 million in annual debt servicing.
Over the life of the loan, Pakistan will have
returned $2 billion to the lender. For aid to
be cost-effective, Pakistan would have to generate
productive revenues that far exceed the cost of
debt servicing. Can this be assured?
Hardly, since Pakistan received 20 “structural
adjustment” loans from the World Bank and
the IMF with the explicit requirement to lower
the budget deficit between 1980 and 1999. But
this never happened. Neither did aid eliminate
year-to-year fluctuations in the rate of economic
growth.
It is lackluster results such as these that lead
critics of foreign aid to argue that it simply
represents a waste of resources in the donor countries
and promotes dependency in the recipient country.
William Easterly lays out this position in “The
White Man’s Burden,” which builds
on arguments that he first marshaled in his 2001
book, “The Elusive Quest for Growth.”
A former Bank economist, Easterly says that despite
the disbursement of $2,300 billion of foreign
aid over the last five decades, almost half of
the world lives in poverty. Aid has even failed
to deliver a basic necessity such as mosquito
netting costing four dollars to poor families
in Africa. When aid agencies hand these out, they
are often diverted to the black market or wind
up being used as fishing nets or wedding veils.
Only rarely do they get to the recipients.
Easterly recommends that the West stop “coddling
the warlords and kleptocrats” by bestowing
them with the gift of foreign aid. At the minimum,
it needs to do a much better job of seeing what
happens once the big checks are cut.
Since independence, Pakistan has received more
than $30 billion in aid just from the Bank and
the US and billions more from other sources. Despite
this “embarrassment of riches,” it
has failed to become an Asian tiger. This is evidenced
by the continuing presence of five structural
problems in the economy. First, as the economy
grows, imports grow faster than exports, leading
to rising deficits on the current account. Second,
consumer goods rather than capital goods dominate
the growth of imports, reflecting a bias toward
consumer spending and fueling inflation. Third,
domestic investment rates remain low, thus requiring
continuing infusions of foreign aid to bridge
the non-vanishing “financing gap.”
Fourth, as growth occurs, the government begins
to rack up rising budget deficits to placate special
interest groups, most notably the military. And,
finally, despite all of Shaukat Aziz’s rhetoric
about transparency, Pakistan remains a highly
corrupt country according to Transparency International.
As Parliament debates the budget, it should ask
the government how it would use the new foreign
aid to address these endemic problems. Otherwise,
the new money will become a band aid to cloak
the ills of military rule. General Musharraf’s
regime should not be allowed to leave a painful
inheritance for future generations of Pakistanis,
by saddling them with billions in debt servicing
costs.
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