Comment on “Pakistan's Economy: Fallout of 2022 Economic Distress Magnifies the Need for Structural Reforms”

Van der Eng (2024) is a comprehensive and well-argued paper which discusses recent macroeconomic trends as well as structural aspects of Pakistan's growth and development going back six decades. In my comments, I focus only on the structural aspects since these are useful in explaining the country's recurring economic challenges. In some years, of course, exogenous factors, such as exceptional rains and floods in 2022–23, have added fuel to the fire. But the fire itself has been smoldering for a long time. van der Eng shows that Pakistan's industrial output, gross investment, public investment, and exports, measured as shares of gross domestic product (GDP), are low relative to middle-income country averages. Many of these rates were higher in earlier years and have declined and stagnated since 1990. The flip side of the low investment rate is a high consumption rate which has risen from 70% to 85% of GDP over the last 50 years or so. A high consumption rate implies a low domestic savings rate which underlies a reliance, in turn, on foreign savings. While these have come mostly in the form of concessional debt flows their servicing has, nevertheless, proved difficult. Within total consumption, the share of public consumption has risen. Since 2000, public spending has risen from 15% to 20% of GDP. While this rate is low relative to high- and middle-income economies, it has proven high in relation to revenues. Pakistan has been unable to raise domestic revenues by enough (to match public expenditure levels) to avoid recurrent fiscal deficits in the 5%–7% range. Furthermore, Pakistan's consumption pattern has also featured import-orientation sufficient to generate sustained trade deficits which, in turn, have underpinned recurring balance of payments problems. Most analyses of Pakistan's economic challenges converge to these twin deficits. Why have these persisted? Why have they not been resolved even through multiple engagements with Interntaional Monetary Fund (IMF) stabilization programs? van der Eng presents expert views suggesting political economy causes. The country has for long been dominated by an elite (political/business/bureaucratic/military) whose interests have prevailed over considerations of economic efficiency, long-run growth, and distribution. The elite has typically accepted short-term solutions to macroeconomic problems as they have arisen (such as IMF programs) but has resisted deeper structural reforms (in taxation, subsidies, and rents). I agree with this assessment. I also believe an additional element could be considered. This element is the Dutch disease impact of foreign aid and remittance inflows. Pakistan has been the recipient of significant flows of foreign aid (including grants for military purposes) since it became a frontline ally of the West in the campaign to oust Soviet forces from Afghanistan after 1979 and to oust al-Qaeda from Afghanistan after 9/11. In addition, since the 1970s, Pakistan has been the recipient of remittances as Pakistani workers streamed abroad to work in the oil-rich Gulf states after the price of oil rose following the Arab–Israeli War of 1973. These unrequited flows, while welcome for other reasons, have generally pushed the rupee toward appreciation, thereby undermining exports. They have also underwritten the public sector's tendency toward higher consumption, thereby undermining fiscal discipline. Two empirical studies provide support for such a link between remittances and the exchange rate. Makhlouf and Mughal (2013) find a statistically significant but quantitatively modest positive relationship between remittances and the real effective exchange rate, while controlling for several standard determinants of the latter. Jafarey and Nabi (2024) also find a similar relationship, reporting that a 1% rise in remittances is typically followed by a 0.05% increase in the real exchange rate within 6 months. Jafarey and Nabi (2024) also report that a rise in remittances is followed by a rise in consumption and public expenditures and a fall in exports. The Dutch disease story suggests that financial flows associated with geopolitical events, such as the Soviet invasion of Afghanistan, the oil-based transformation of the Gulf countries since the1970s, and the aftermath of 9/11, have oriented Pakistan's economy toward consumption and imports rather than investment and exports. Together with elite control, this has shaped the nature of the country's development for the past four decades or so.