Nobel insights

On October 14, 2024, the Royal Swedish Academy of Sciences announced the Sveriges Riksbank Prize in Economic Sciences (known more as the Nobel Prize in Economic Sciences), awarded to Daron Acemoglu, Simon Johnson, and James A Robinson for their groundbreaking studies on how institutions are formed and their impact on prosperity. Their research highlights the critical role societal institutions play in creating economic disparities among nations.

Three traditional perspectives explain differences in economic development. The Geographic Hypothesis emphasises geography and natural resources, suggesting that nations with favourable conditions develop faster. The Cultural Hypothesis attributes progress to cultural factors such as work ethic and social norms, arguing that societies valuing hard work and innovation tend to advance more. The Ignorance Hypothesis posits that differences stem from leaders' knowledge of growth fundamentals, suggesting that ineffective leadership leads to inefficient resource use and poor development outcomes.

The recent Nobel laureates’ institutional hypothesis challenges these views by asserting that the primary factor behind national prosperity differences is the nature of institutions. They explored how colonisation influenced institutional structures globally, finding that two types emerged: extractive institutions, which aimed to exploit indigenous populations, and inclusive institutions, which fostered long-term development for European settlers.

Regions with inclusive institutions experienced sustainable growth through broad participation and investment in public goods, while those with extractive institutions faced stagnation and restricted opportunities due to centralised control and elite interests. The laureates demonstrate how these institutional differences reshaped nations’ destinies, with some former poor colonies achieving prosperity and wealthier ones becoming impoverished. Extractive institutions, characterised by monopolised power and limited freedoms, hinder growth and innovation, while inclusive institutions promote economic participation and sustainable development.

When analysed through the lens of inclusive and extractive institutions, as explained by the recent Nobel laureates in economics, Pakistan has struggled to overcome its colonial legacy and its influence on state institutions, policies, and practices since independence. While some inclusive practices exist in certain areas of the political, economic, and social domains, state institutions have historically reflected the dominance of extractive structures established by the colonial regime. Consequently, the state has failed to fully leverage its potential for sustainable growth and development across various sectors, hindered by the extractive interplay of different institutions, extractive policies, resource allocation, and limited public participation in strategic institutional settings. In Pakistan, extractive political structures are dominated by a few elite families and the military, characterised by limited freedom of expression, restricted political participation, corruption, and legislation that consolidates power among the elite. The Economist Intelligence Unit's Democracy Index, which assesses the state of democracy in 165 states, classifies countries into four categories based on their scores across 60 indicators.

Since its introduction in 2006, Pakistan has consistently ranked poorly, initially scoring 3.92 under General Pervez Musharraf's regime and fluctuating between 4.13 and 4.64 from 2008 to 2022, categorising it as a ‘Hybrid Regime’. Recently, however, its score dropped to 3.25, ranking Pakistan as the third worst performer and placing it in the ‘Full Authoritarian’ category. This decline is attributed to electoral interference, government dysfunction, and repression of opposition.

To understand how political and government institutions have influenced economic and social institutions in Pakistan, we must analyse historical economic performance alongside various social indicators. Over the past seven decades, historical economic data reveals a troubling landscape marked by fragile growth, accumulating debt, inconsistent revenue collection, prolonged inflation, persistently high unemployment, currency devaluation, and chronic fiscal and trade deficits.

There has also been slow technology adoption, high interest rates, and inefficient, corrupt state-owned enterprises. These issues have constrained economic growth by limiting both domestic and foreign investments, hampering infrastructure development, and resulting in slow or fragile growth in per capita income. Furthermore, insufficient spending on education and health, alongside escalating conflicts and security concerns, has exacerbated the situation.

Data from the State Bank of Pakistan and global sources such as the World Bank indicates that from 1960 to 2023, the average tax-to-GDP ratio has fluctuated between 7.0 per cent and 13.7 per cent. Historically, government spending has consistently outstripped revenue estimates, leading to a persistent budget deficit averaging 6.5 per cent of GDP from 1960 to 2024. For instance, in FY2023-24 Pakistan faced a staggering budget deficit of Rs6.52 trillion, representing 45.09 per cent of the total budget and 6.8 per cent of GDP. Foreign direct investment has remained below 1.0 per cent of GDP, while inflation has exceeded 30 per cent on multiple occasions, further exacerbating living costs. Interest rates, fluctuating between 5.0 per cent and 22 per cent, pose additional challenges for investment and savings, and high exchange rates complicate foreign transactions. Trade data reveals that average exports comprise 11.3 per cent of GDP, while imports account for 17.6 per cent, leading to a trade deficit averaging 6.3 per cent of GDP. This imbalance has compelled Pakistan to resort to debt financing for foreign transactions and internal resource deficits, culminating in public debt equivalent to 75 per cent of GDP. The resulting debt, combined with substantial interest payments, exacerbates budgetary deficits and places further strain on the economy.

Social indicators paint a stark picture of the repercussions of these weakened political and economic institutions. The poverty rate stands at 39 per cent, with the lowest 20 per cent holding only 9.32 per cent of income compared to over 40 per cent for the top 20 per cent. The mortality rate is 138 per 1,000 live births, education spending is a mere 1.79 per cent of GDP, and health spending is 2.58 per cent. Over 23 million children remain out of school. Factors such as inadequate infrastructure, elite resource capture, insecure property rights, selective justice, discriminatory state policies, and unequal resource allocation hinder societal development, leading to increasing polarisation and conflicts rooted in political, ethnic, religious, and economic disparities.

Pakistan has accumulated a substantial stock of extractive institutions and practices over the past 77 years, resulting in below-average performance across all domains. To achieve a sustainable and growth-oriented economy, society, and political system, Pakistan needs to restructure its institutional model to be more inclusive and agile.

The writer is an assistant professor at the Air University, Aerospace & Aviation Campus, Kamra. He can be reached at: nayyar.rafique@aack.au.edu.pk