Pakistan - Role of Government in the Economy

Role of government

Policy Developments since Independence

Pakistan's economic development planning began in 1948. By 1950 a six-year plan had been drafted to guide government investment in developing the infrastructure. But the initial effort was unsystematic, partly because of inadequate staffing. More formal planning--incorporating overall targets, assessing resource availability, and assigning priorities--started in 1953 with the drafting of the First Five-Year Plan (1955-60). In practice, this plan was not implemented, however, mainly because political instability led to a neglect of economic policy, but in 1958 the government renewed its commitment to planning by establishing the Planning Commission.

The Second Five-Year Plan (1960-65) surpassed its major goals when all sectors showed substantial growth. The plan encouraged private entrepreneurs to participate in those activities in which a great deal of profit could be made, while the government acted in those sectors of the economy where private business was reluctant to operate. This mix of private enterprise and social responsibility was hailed as a model that other developing countries could follow. Pakistan's success, however, partially depended on generous infusions of foreign aid, particularly from the United States. After the 1965 Indo-Pakistani War over Kashmir, the level of foreign assistance declined. More resources than had been intended also were diverted to defense. As a result, the Third Five-Year Plan (1965-70), designed along the lines of its immediate predecessor, produced only modest growth.

When the government of Zulfiqar Ali Bhutto came to power in 1971, planning was virtually bypassed. The Fourth Five-Year Plan (1970-75) was abandoned as East Pakistan became independent Bangladesh. Under Bhutto, only annual plans were prepared, and they were largely ignored.

The Zia government accorded more importance to planning. The Fifth Five-Year Plan (1978-83) was an attempt to stabilize the economy and improve the standard of living of the poorest segment of the population. Increased defense expenditures and a flood of refugees to Pakistan after the Soviet invasion of Afghanistan in December 1979, as well as the sharp increase in international oil prices in 1979-80, drew resources away from planned investments. Nevertheless, some of the plan's goals were attained. Many of the controls on industry were liberalized or abolished, the balance of payments deficit was kept under control, and Pakistan became self-sufficient in all basic foodstuffs with the exception of edible oils. Yet the plan failed to stimulate substantial private industrial investment and to raise significantly the expenditure on rural infrastructure development.

The Sixth Five-Year Plan (1983-88) represented a significant shift toward the private sector. It was designed to tackle some of the major problems of the economy: low investment and savings ratios; low agricultural productivity; heavy reliance on imported energy; and low spending on health and education. The economy grew at the targeted average of 6.5 percent during the plan period and would have exceeded the target if it had not been for severe droughts in 1986 and 1987.

The Seventh Five-Year Plan (1988-93) provided for total public-sector spending of Rs350 billion. Of this total, 38 percent was designated for energy, 18 percent for transportation and communications, 9 percent for water, 8 percent for physical infrastructure and housing, 7 percent for education, 5 percent for industry and minerals, 4 percent for health, and 11 percent for other sectors. The plan gave much greater emphasis than before to private investment in all sectors of the economy. Total planned private investment was Rs292 billion, and the private-to- public ratio of investment was expected to rise from 42:58 in FY 1988 to 48:52 in FY 1993. It was also intended that public-sector corporations finance most of their own investment programs through profits and borrowing.

In August 1991, the government established a working group on private investment for the Eighth Five-Year Plan (1993-98). This group, which included leading industrialists, presidents of chambers of commerce, and senior civil servants, submitted its report in late 1992. However, in early 1994, the eighth plan had not yet been announced, mainly because the successive changes of government in 1993 forced ministers to focus on short-term issues. Instead, economic policy for FY 1994 was being guided by an annual plan.

Since 1947 Pakistani officials have sought a high rate of economic growth in an effort to lift the population out of poverty. Rapid industrialization was viewed as a basic necessity and as a vehicle for economic growth. For more than two decades, economic expansion was substantial, and growth of industrial output was striking. In the 1960s, the country was considered a model for other developing countries. Rapid expansion of the economy, however, did not alleviate widespread poverty. In the 1970s and 1980s, although a high rate of growth was sought, greater attention was given to income distribution. In the early 1990s, a more equitable distribution of income remained an important but elusive goal of government policy.

At partition in 1947, the new government lacked the personnel, institutions, and resources to play a large role in developing the economy. Exclusive public ownership was reserved only for military armaments, generation of hydroelectric power, and manufacture and operation of railroad, telephone, telegraph, and wireless equipment--fields that were unattractive, at least in the early years of independence, to private investors. The rest of the economy was open to private-sector development, although the government used many direct and indirect measures to stimulate, guide, or retard private-sector activities.

The disruptions caused by partition, the cessation of trade with India, the strict control of imports, and the overvalued exchange rate necessitated the stimulation of private industry. Government policies afforded liberal incentives to industrialization, while public development of the infrastructure complemented private investment. Some public manufacturing plants were established by government holding companies. Manufacturing proved highly profitable, attracting increasing private investments and reinvestment of profits. Except for large government investments in the Indus irrigation system, agriculture was left largely alone, and output stagnated in the 1950s. The broad outline of government policy in the 1950s and early 1960s involved squeezing the peasants and workers to finance industrial development.

Much of the economy, and particularly industry, was eventually dominated by a small group of people, the muhajirs, who were largely traders who migrated to Pakistan's cities, especially Karachi, at partition. These refugees brought modest capital, which they initially used to start trading firms. Many of these firms moved into industry in the 1950s as a response to government policies. Largely using their own resources, they accounted for the major part of investment and ownership in manufacturing during the first two decades after independence.

By the late 1960s, there was growing popular dissatisfaction with economic conditions and considerable debate about the inequitable distribution of income, wealth, and economic power-- problems that had always plagued the country. Studies by economists in the 1960s indicated that the forty big industrial groups owned around 42 percent of the nation's industrial assets and more than 50 percent of private domestic assets. Eight of the nine major commercial banks were also controlled by these same industrial groups. Concern over the concentration of wealth was dramatically articulated in a 1968 speech by Mahbubul Haq, then chief economist of the Planning Commission. Haq claimed that Pakistan's economic growth had done little to improve the standard of living of the common person and that the "trickle- down approach to development" had only concentrated wealth in the hands of "twenty-two industrial families." He argued that the government needed to intervene in the economy to correct the natural tendency of free markets to concentrate wealth in the hands of those who already possessed substantial assets.

Although Haq exaggerated the extent of the concentration of wealth, his speech struck a chord with public opinion. In response, the government enacted piecemeal measures between 1968 and 1971 to set minimum wages, promote collective bargaining for labor, reform the tax structure toward greater equity, and rationalize salary structures. However, implementation was weak or nonexistent, and it was only when the government of Zulfiqar Ali Bhutto (father of Benazir) came to power in 1971 that there was a major shift in government policy.

Bhutto promised a new development strategy more equitable than previous policies. Yet he downplayed economic analysis and planning and relied instead on ad hoc decisions that created many inconsistencies. In May 1972, he promulgated a major act that devalued the rupee by 57 percent and abolished the multiple-exchange-rate system. This act greatly stimulated exports and indicated that the removal of price distortions could spur the economy. But devaluation also completely altered the cost and price structure for industry and affected the level and composition of industrial investment and the terms of trade between the industrial and agricultural sectors. Devaluation helped agriculture, particularly larger farms that had marketable surpluses. Mechanization increased but had the adverse side effect of displacing farm laborers and tenants, many of whom migrated to cities seeking industrial jobs.

In 1972 Bhutto's government nationalized thirty-two large manufacturing plants in eight major industries. The industries affected included iron and steel, basic metals, heavy engineering, motor vehicle and tractor assembly and manufacture, chemicals, petrochemicals, cement, and public utilities. Subsequently, domestically owned life insurance companies, privately owned banks, domestic shipping companies, and firms engaged in oil distribution, vegetable oil processing, grain milling, and cotton ginning were nationalized. The result was a drop of nearly 50 percent in private investment in large-scale manufacturing between FY 1970 and FY 1973. By FY 1978 such investments were little more than one-third (in constant prices) of those in FY 1970. Private capital fled the country or went into small-scale manufacturing and real estate. Between 1970 and 1977, industrial output slowed considerably.

The public sector expanded greatly under the Bhutto government. In addition to the nationalization of companies, plants were built by the government and additional public companies were created for various functions, such as the export of cotton and rice. Able managers and technicians were scarce, a situation that became worse after 1974, when many persons left to seek higher salaries in Middle East oil-producing states. Labor legislation set high minimum wages and fringe benefits, which boosted payroll costs for both public and private firms. Efficiency and profits in public-sector enterprises fell. Public industrial investment rose, surpassing private industrial investment in FY 1976.

Many of the other economic measures undertaken by the Bhutto government were largely ineffective because of the power of vested interests and the inefficiency of the civil administration. Ceilings on the size of landholdings were lowered, tenants were given greater security of tenure, and measures were enacted to tax farm income. Bhutto also supported large, but inadequately planned, long-term projects that tied up the country's development resources for long periods. The largest projects were an integrated iron and steel plant, a major highway on the west bank of the Indus River, and a highway tunnel in the mountainous north.

After 1977 the government of Mohammad Zia ul-Haq (1977-88) began a policy of greater reliance on private enterprise to achieve economic goals, and successive governments continued this policy throughout the late 1980s and early 1990s. Soon after Zia came to power, the government instituted constitutional measures to assure private investors that nationalization would occur only under limited and exceptional circumstances and with fair compensation. A demarcation of exclusive public ownership was made that excluded the private sector from only a few activities. Yet government continued to play a large economic role in the 1980s. Public-sector enterprises accounted for a significant portion of large-scale manufacturing. In FY 1991, it was estimated that these enterprises produced about 40 percent of industrial output.

Islamization of the economy was another policy innovation of the Zia government. In 1977 Zia asked a group of Islamic scholars to recommend measures for an Islamic economic system. In June 1980, the Zakat and Ushr Ordinance was promulgated. Zakat is a traditional annual levy, usually 2.5 percent, on wealth to help the needy. Ushr is a 5 percent tax on the produce of land, allowing some deductions for the costs of production, to be paid in cash by the landowner or leaseholder. Ushr replaced the former land tax levied by the provinces. Self-assessment by farmers is checked by local groups if a farmer fails to file or makes a very low estimate. Proceeds of ushr go to zakat committees to help local needy people.

The government of Prime Minister Nawaz Sharif (1990-93) introduced a program of privatization, deregulation, and economic reform aimed at reducing structural impediments to sound economic development. Top priority was given to denationalizing some 115 public industrial enterprises, abolishing the government's monopoly in the financial sector, and selling utilities to private interests. Despite resistance from officials and labor unions and criticism that the government was moving too quickly, by March 1992 control of twenty industrial units and two banks had been sold to private investors, and plans were under way to begin denationalizing several utilities. As of early 1994, proposals to end state monopolies in insurance, telecommunications, shipping, port operations, airlines, power generation, and road construction were also in various stages of implementation. Private investment no longer requires government authorization, except in sensitive industries. Investment reforms eliminated government sanction requirements, eased restrictions on repatriable direct and portfolio investment from abroad, enabled foreign firms to issue shares in enterprises in Pakistan, and authorized foreign banks to underwrite securities on the same basis as Pakistani banks.

Although the Nawaz Sharif government made considerable progress in liberalizing the economy, it failed to address the problem of a growing budget deficit, which in turn led to a loss of confidence in the government on the part of foreign aid donors. The caretaker government of July-October 1993 led by Moeen Qureshi, a former World Bank vice president, asserted that the nation was near insolvency and would require a number of measures to impose fiscal discipline. The government thus included sharp increases in utility prices, new taxes, stiffer enforcement of existing taxes, and reductions in government spending. In early 1994, the government of Benazir Bhutto, elected in October 1993, announced its intention to continue the policies of both deregulation and liberalization carried out by Nawaz Sharif and the tighter fiscal policies put in place by Qureshi. The government also said it intended to devote a greater proportion of the nation's resources to health and education, especially for women.

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