Guns, babies and trade deals

The last time I left Pakistan was after my mentor, Mahbub ul Haq, passed away suddenly at the turn of the last century. Pakistan was a much more hopeful country then. In the wake of the 1998 nuclear tests and the war on terror that would soon follow, we could not have known at the time that our long international isolation was only just beginning. Looking back, it is now painfully clear that the beginning of the 21st century marked the beginning of a long stagnation in Pakistan, only briefly interrupted by a couple of false dawns fueled by US largesse after 9/11 and Chinese bounty at the beginning of CPEC. Truth be told, Pakistan has been lost at sea in the last quarter of a century. It did not have to be this way.

At the turn of the century, Pakistan was some way ahead of its regional peers. At $531, our per capita income was 20 percent higher than India’s and almost a third higher than in Bangladesh. Today, our per capita income is only two thirds of theirs, as our average economic growth rate has crashed to a little over 4 percent while theirs has soared above 6 percent, even as our population growth rate has been twice as high.

The proximate causes of our underperformance over the last quarter century are well known: exports and investment in Pakistan have been stagnant at 10 and 15 percent of GDP, respectively, less than half that in India and Bangladesh. Our neighbour’s virtuous streak owes much to brave and opportunistic policy decisions. In the mid 1990s, after a painful IMF program, India deregulated its economy and unleashed its private sector despite considerable opposition. Since the early 2000s, Bangladesh has taken full advantage of the trade privileges bestowed by its LDC status to corner the market in textiles and export its way to middle income.

Meanwhile, Pakistan has fallen behind. At the risk of over-simplification, I would argue that the seeds of Pakistan’s economic stagnation over the last quarter century were mainly sown by three major forces. All of them were the result of bad policy choices and their macroeconomic consequences are so severe and lasting that they dwarf other failings. While India and Bangladesh were busy putting things during this period, we chose to get make them worse. This resulted in historic opportunities for development being wasted, powerful demographic headwinds being allowed to entrench and extreme foreign competition being inflicted on a manufacturing industry that was ill-equipped to withstand it. With apologies to Jared Diamond, I would characterize these unforgiving forces of stagnation as stemming from guns, babies and trade deals.

First, the guns part of the story. We had a golden chance to achieve economic take-off after the generous debt restructuring of 2001, courtesy geopolitical tailwinds from our participation in the war on terror. While the damaging economic effects that this participation had on security and business sentiment have been much discussed, the one aspect that is less dwelt upon is that it also opened the floodgates of US largesse, enabling aid to flow into the country like there was no tomorrow and giving us generous amounts of foreign exchange. During 2001-3, this aid allowed us to run an average current account surplus of nearly 4 percent of GDP, the largest in our history. But instead of using this new-found fiscal space and foreign exchange to enact difficult structural reforms to boost investment and grow exports, we wasted it on promoting consumption and running huge fiscal deficits of around 5 percent of GDP after 2001. We have not been able to restore fiscal discipline or meaningfully reduce military spending since. As a result, after falling from 72 percent of GDP in 2001 to only 47 percent by 2007, general government debt has bounced back with a vengeance to almost 80 percent. All the fiscal space that the debt restructuring had opened up has been wasted and we are now once again staring into the abyss, having to choose between contentious debt restructuring or endless austerity.

Second, the babies come marching in. In 1960, each woman in Pakistan and Bangladesh was giving birth 7 babies. This is commonly known as the “fertility rate”. In India, she was producing a bit less, at 6. By the mid 1990s, both India and Bangladesh were down to 3.5, while Pak was still at 6. Today, at around 4, Pakistan’s fertility rate today is twice what is needed to keep the population constant and close to that in Afghanistan. It is also twice that of India and Bangladesh, despite similar levels of development. As a result of our inability to reduce the fertility rate, our population grows by a whopping 5 million each year while theirs is more or less constant. Years of high fertility, together with rising life expectancy, have translated into a very high “age dependency ratio” in Pakistan. This ratio is the number of very young (less than 15) and very old people (over 65) expressed as a percentage of the working age population (15-64). This ratio matters because the very young and the very old tend to consume more and save less, and they often have to be taken care of by the working age population. Therefore, a high age dependency ratio tends to pull down savings and hence investment, while pushing up consumption and imports.

This results in pressure on the current account. Today, Pakistan’s age dependency ratio is 70 percent. In India and Bangladesh, it is less than 50 percent. Since 2005, Bangladesh has run a current account deficit of almost 0, India 1.5 percent of GDP and Pakistan 3 percent. Running large current account deficits that you cannot finance inevitably results in painful economic crises and a need to turn to the IMF for a bail out. It turn outs that in Pakistan’s case, demographics are a major explanation.

And third, bad trade deals have been a major contributor to our lost quarter century. In the mid 2000s, Pakistan signed generous free trade agreements (FTAs) with Sri Lanka, China and Malaysia. In the five years before these FTAs, our exports averaged 14 percent of GDP and imports 15 percent. So they were roughly balanced. Since then, our exports have fallen to 11 percent of GDP, while our imports have jumped to 18-20 percent. This is a large cause of the persistently large current account deficits that have dogged us in recent years. By contrast, since the early 2000s, India has seen its exports double from 13 to 25 percent of GDP on the back of IT and Bangladesh has increased them from 13 to 20 percent of GDP, benefiting from GSP and LDC status for its textile exports. Both countries, like the Asian tigers before them, have been much more thoughtful in signing FTAs than we have been. In particular, they have been careful not to subject their domestic companies to extreme foreign competition before they are ready. As a result, they have had more success than us in preventing a hollowing out of manufacturing jobs while ensuring a much more balanced pattern of trade that prevents large current account deficits and preserves valuable foreign exchange reserves.

So there you have it. The lost decades of development that we have experienced since the turn of the century are to a large extent rooted in the complete capitulation of our policymakers to the malleable forces of guns, babies and lop-sided trade deals. India and Bangladesh did not succumb to these temptations. We did, and are now living with the disastrous consequences. These three cardinal policy mistakes are holding a whole generation hostage. We must immediately set out to rectify them.

As we look to chart our way out of our latest economic crisis, our chequered past offers lessons in what not to repeat. If we do manage to get relief on our external debt again, we must put it to good use this time by living within our means and reorganizing our economy towards savings, investment and exports. If we are able to re-negotiate out trade (and IPP) deals, we must do so in a way that allows our producers to compete and for the two-way benefits from trade that classical economic theory predicts to be fully realized. And finally, we must arrest our demographic descent into chaos through higher female literacy, greater investment in the skills of our workforce, and more aggressive family planning programs. The fate of the next generation is in the balance. Despondency is all around. There is no more time left to waste.

(The writer tweets at @MURTAZAHSYED)

Murtaza Syed is the former deputy governor of the State Bank Of Pakistan.