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Stabilizing Pakistan: Boosting its Private Sector

Author: Jayshree Bajoria
April 30, 2009

Introduction

As it struggles to contain a growing insurgency, Pakistan has aroused concern that it is a failing or fracturing state. One aspect of the international community's response has been to place new focus on Pakistan's economic weaknesses. On completing his first hundred days in office, U.S. President Barack Obama acknowledged that the Pakistani government was "fragile" and lacked capacity to deliver basic services to its people, making it difficult for them to gain support of the population. "So we need to help Pakistan help Pakistanis," he said.

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The Obama administration is seeking a strong economic aid package, and joined an international donor conference in April that pledged more than $5 billion in aid and loans to Pakistan. In November 2008, the International Monetary Fund (IMF) saved the country from defaulting on international debt with a $7.6 billion loan. Yet the private sector is seen as essential to any effort to shore up the Pakistani state. Experts say special emphasis should be placed on boosting trade with Pakistan; investing in developing its energy, water, and transport infrastructure; and making economic aid programs more transparent. But an uncertain political climate and unwillingness to risk long-term investments have so far limited engagement with the private sector.

Challenges of Doing Business

Pakistan's real gross domestic product (GDP) grew at 6 percent in 2008 and GDP per capita was estimated at about $2,600. But the IMF outlook for 2009's GDP growth is just 2.5 percent. The World Bank ranks Pakistan second in the South Asian region after Maldives on its Ease of Doing Business Index for the private sector. But infrastructural constraints, corruption, weak intellectual property rights, and a feudal system of land distribution are some of the major bottlenecks preventing a more effective and vibrant private sector in the country. Increased violence in recent years has made the private sector more reluctant to invest.

"Pakistan suffers from a dearth of infrastructure in the water, irrigation, power, and transport sectors; infrastructure which is essential for sustained growth and competitiveness both in the local and international markets." – World Bank

Growing militant violence and resulting instability have been major concerns for both domestic and international investors. However, some experts believe that creation of greater economic opportunities could help curb militant violence. While there is a lack of consensus among analysts on the link between poverty and extremism, many agree that militant groups are able to exploit local grievances to recruit new members. In March, U.S. Vice President Joseph Biden said that almost 70 percent of the Taliban joined the terrorist group in Afghanistan simply because of the money offered to them. This trend must be reversed through enhancing economic opportunities for the poor, argue some experts, and in this the private sector could play an important role.

But to do that, it will have to become more competitive. The World Economic Forum's 2008-2009 Global Competitiveness Report (PDF) ranks Pakistan's economy 101 out of 134 countries. It ranks particularly low in indicators related to health, education, labor market efficiency, and technological readiness. The report lists government instability, corruption, and inefficient bureaucracy as the most problematic factors of doing business in the country.

Developing the Private Sector

Crisis Guide: Pakistan According to the Asian Development Bank (ADB), Pakistan's private sector is by far the biggest contributor to GDP and is the biggest employer in the country. A December 2008 ADB assessment (PDF) of the private sector credits Islamabad with starting, in the early 1990s, a strategy of privatization, deregulation, and good governance to promote private-sector development. Under former President Pervez Musharraf, the report says, major structural, governance, and economic reforms were undertaken to create an environment that would "encourage the private sector to become the growth engine in the economy." As a result of this process, ADB reports, currently 77 percent of the commercial banking sector, all of the textile and telecommunications sectors, and significant parts of the cement, sugar, automobile, and fertilizer sectors are privately owned. The private sector also contributes to power generation and electricity distribution.

The government has also attracted foreign direct investment through policies enacted in the last two decades that allow 100 percent ownership to foreign investors in a large number of sectors. Total foreign investment rose from $559 million in 2003 to over $8 billion in 2007, decreasing to just over $5 billion in 2008 following political turmoil in the country.

Still, while foreign investment has been on the rise, investment in the country's infrastructure remains low. A November 2007 World Bank assessment (PDF) of the country's infrastructure found: "Pakistan suffers from a dearth of infrastructure in the water, irrigation, power, and transport sectors; infrastructure which is essential for sustained growth and competitiveness both in the local and international markets." In April 2009, Ghulam Murtaza Satti, adviser to Pakistan's ministry of finance on public-private partnership, said the country required $110 billion (The Nation) over the next five years in private-sector investment to meet the infrastructure needs of its growing population, estimated at around 170 million.

Reduction in tariffs for imports of Pakistani textiles and garments is one way the United States could most help Pakistan's economy – CFR Senior Fellow Daniel Markey

Poor infrastructure in key sectors also undermines efforts to reduce poverty, say experts. The World Bank report says without adequate irrigation resources, power, and transport infrastructure, "the very sustainability of Pakistan as an independent nation may be at stake as shortages could lead to increased social discontent and disharmony amongst the federation and the provinces." Water shortages have already sparked disputes among provinces. Infrastructure challenges, power shortages in particular, discourage businesses, says Aun Rahman, Pakistan director of Acumen Fund, a nonprofit venture capital fund that uses entrepreneurial approaches to try to end global poverty. The current political and security climate also make businesses uncomfortable with making any long-term investments, he says.

There have been efforts by the government to bring foreign investment into infrastructure development. One of the biggest achievements has been the new deepwater port at Gwadar in the southwest province of Balochistan, which was funded and built by the Chinese. In 2007 PSA International of Singapore won a forty-year contract to run the port. But this, too, is threatened by domestic insurgency, separatist rebellion, and local grievances. Robert Kaplan, national correspondent for the Atlantic magazine, writes that if Gwadar languishes "it will be yet more evidence of Pakistan's failure as a nation."

Boost in Trade

Several experts call for enhancing economic opportunities inside Pakistan through trade. The U.S. Chamber of Commerce and the U.S.-Pakistan Business Council, in a March 2009 report (PDF), call for a review of U.S. trade policy with Pakistan, a reduction in import tariffs for Pakistani textiles, and approval of pending legislation in U.S. Congress to create "reconstruction opportunity zones." These zones would aim to spur growth and create market-access opportunities for local populations in the country's turbulent border region with Afghanistan.

Reducing tariffs for imports of Pakistani textiles and garments is one way the United States could most help Pakistan's economy, says CFR Senior Fellow Daniel Markey. But "politically this is a dead letter in Washington," he adds, saying a tariff reduction would face significant opposition in Congress primarily because of concerns voiced by legislators representing textile-heavy districts. A 2001 bill to ease textile trade with Pakistan never passed. Reducing tariffs might be even more difficult in the current global economic crisis. CFR Senior Fellow Isobel Coleman says that by being closed on the trade front, the United States is punishing the same poor, rural populations in Pakistan that it is trying to help through development aid.

Haris Gazdar, a senior researcher at the Collective for Social Science Research, a Karachi-based research organization, says a boost in regional trade is essential to help fix Pakistan's economy. He says the Pakistani government should offer the private sector better trade opportunities with India, Afghanistan, and Iran. Other analysts, including Frederick Barton, co-director of the post-conflict reconstruction program at the Washington-based Center for Strategic and International Studies, also stress an enhanced trade relationship with India. If the ties between India and Pakistan grow stronger, Barton says, they would help ease Islamabad's fear of India. Pakistan currently spends over 3 percent of its GDP on its military, which includes the maintenance of a 550,000 strong army, the majority of which is focused on India.

Alternative Development Models

Pakistan, with meager government spending on social services like education and health care, ranks 139 out of 179 countries on the United Nations Development Program's 2008 Human Development Index. Experts say the private sector can help where the state has been unable to deliver, either because of inefficiency or lack of political will. CFR's Markey points to another country in South Asia, Bangladesh, where the private sector plays a huge role in providing social services. In Pakistan, too, the private sector provides some basic services such as education and health care. However, this is a small-scale initiative by some individuals, rather than a concerted effort by the country's businesses, says Markey.

To fill gaps in its delivery of social services, in 2001, the government set up the National Commission for Human Development, an autonomous agency that encourages public-private partnerships (PPP). It is also working with international organizations such as the Asian Development Bank to promote PPPs for infrastructure development. But the ADB's December 2008 report says the government still lacks an explicit public-private partnership policy; the public sector lacks the institutional capacity to prepare viable partnerships with the private sector; and financing is a major concern for such projects.

The Acumen Fund's Rahman says there is also a market opportunity for the private sector in delivery of essential services. Currently, he says, the informal sector provides a significant portion of basic services like water, housing, and education facilities. The formal private sector can provide these services with better quality and at affordable prices, he says. The private sector has played a major role in the communications and information sector. Both telecommunications and private media have boomed in Pakistan in recent years, in particular independent news organizations.

Pakistan's private sector, in partnership with domestic nongovernmental organizations, could also prove an effective partner for the international donor community to help stabilize Pakistan, say experts. CFR's Coleman says U.S. aid delivery should be revised to form greater partnerships with local communities and organizations. Such affiliations could also provide more transparency and accountability with respect to how money is allocated.

It ranks particularly low in indicators related to health, education, labor market efficiency, and technological readiness.

The United States is considering $7.5 billion in nonmilitary aid for the next five years. To make this aid more effective, Markey writes in a CFR Policy Options Paper that the United States should "begin discussions with Pakistan's government, business leaders, and civil society to identify creative new mechanisms to oversee and manage a significant portion of these funds through demand-driven block grants, a trust fund, or other widely accepted means." Here, too, public-private partnerships that can identify the projects where money should be spent and monitor how it is used could be very helpful, he says.

A clear accounting for aid to the Pakistani state is a growing concern. A bill introduced by Rep. Howard L. Berman (D-CA) in April 2009 lays down conditions for U.S. nonmilitary assistance to Pakistan, including better transparency and enhanced accountability for all assistance and reimbursements. According to Transparency International, Pakistan is one of the countries most affected by petty bribery. Its last national survey on corruption perceptions in 2006 revealed that Pakistan's government and political parties rank as the most corrupt institutions in the country.

How to Fix It

The Asian Development Bank says the country's private sector must help the public sector to develop the necessary institutional frameworks; improved infrastructure, especially in the energy sector; and high-quality education and health care delivery mechanisms. According to its recommendations, the private sector must also lead in improving technological readiness in the manufacturing and services sectors; investing more resources in research and development; and adopting international standards of corporate management and sophisticated business practices for greater efficiency and higher competitiveness.

The bigger challenge, though, will be the economic transformation of the country's restive areas along the Afghan border; the tribal region, rife with militancy, and Balochistan, which struggles with ethnic insurgency. In energy-rich Balochistan, a more equitable share of its natural resources and greater job opportunities for local populations at Gwadar, along with political reconciliation with separatist leaders, could offer opportunities for economic development.

Long-term economic prospects for the tribal areas, which are relatively isolated and have few natural resources, hinge on regional land trade links that connect markets and resources from Central to East Asia, writes Markey in an August 2008 Council Special Report. Pashtun tribesmen from the region have profited from local trucking concessions and greater trade could benefit them further. The standardization of national tariff regimes throughout the Central Asian region, as well as from Afghanistan to India, could further boost the flow of trade. Markey concedes that prospects for industrial development in the tribal areas are dim in the short- to medium-term; however, he recommends supporting new industries on the fringes of the tribal areas as the best approach to sustainable growth.

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