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WEEKLY
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| Instability and the economy |
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Tuesday, November 10, 2009
Dr Ashfaque H Khan
Political instability and economic performance are inversely related. Unstable political environment reduces investment, slows economic growth and gives rise to unemployment and poverty. Poor economic performance, meanwhile, can lead to political unrest and government collapse. Unfortunately, Pakistan is currently witnessing political uncertainty of the highest order and its adverse consequences for the economy are quite visible.
Despite a peaceful election and smooth transfer of power last year, the present government failed to find its feet and continues to lurch from one crisis to another. In the beginning, the incoming government faced a serious setback when its major coalition partner left the government. It found itself clueless in addressing economic problems, external shocks in particular. For a protracted period thereafter, Pakistan had no ministers of finance, commerce, petroleum and natural resources and health. The government gave the impression of having little sense of direction and purpose.
The crisis of confidence intensified as investors and development partners started to walk away; the stock market nosedived, flight of capital set in, foreign exchange reserves plummeted and the rupee slumped in value by a third. Pakistan had no option but to return to the IMF for a bailout package in the eighth month of the government’s existence. The return to the IMF was the first casualty of political instability.
The political instability continued to intensify. The agitation for restoration of the judges added to the political tension. The judges were finally restored by the government in March, in the twelfth month of its existence. Then came the Kerry-Lugar Bill and the government had to face widespread criticism in almost every walk of life. The criticism was not against the $1.5 billion per annum aid package but against the insulting language and the conditionalities attached to the Bill. The Kerry-Lugar Bill certainly weakened the government further and added to political instability, with adverse consequences for the economy.
The National Reconciliation Ordinance added more fuel to the fire. The government faced real embarrassment when almost all its coalition partners decided not to support the government in the Parliament on the issue of the NRO. In the process, the government appears to have been further weakened and the print and electronic media are speculating about the exit of the president and some key ministers. Such speculations are poisonous to the economy.
The government itself is responsible for creating the political instability. Why political instability is bad for the economy? Because it weakens governance as the government continues to strive for its survival with the economy remaining out of the radar screen. Poor governance erodes investors’ confidence and results in lower investment, slower economic growth, rise in unemployment and poverty, which, in turn, further fuel political instability.
Slower economic growth leads to lower collection of taxes, which undermines the ability of the government to invest on people and infrastructure. Under-investment on people, along with a rise in unemployment and poverty, increase frustration and trigger political instability. It also encourages the politically weak government, constantly under the threat of losing office, to borrow extensively to undertake unnecessarily large expenditures to please pressure groups. Such policies lead to the accumulation of debt, with adverse consequences for future generations. Political instability creates uncertainty about the policies as the government hesitates to take tough economic decisions and postpones much-needed structural reforms.
Economic governance is the victim of political instability. For women and children to die in stampedes for a few kilograms of wheat, in a country which produces more wheat than its own requirements, is nothing but lack of governance. The persistence of the sugar crisis is yet another example of that. The sugar crisis is the result of the government not taking the right decisions at the right time, and of its mishandling of the supply-demand issue, on the other hand.
The nation has already paid a heavy price of political uncertainty during the last 20 months. Economic growth slowed to two percent in 2008-09 and is not likely to improve in the current fiscal year as the political instability continues to keep the economy out of focus. Unemployment and poverty are certainly on the rise. Revenue collection will once again be a victim of the political instability and the likely shortfall will be Rs100 billion in the current fiscal year. Should the ministry of finance be blamed for this shortfall? The answer is emphatically no. It is the responsibility of the government and the political leadership to create a relatively stable environment in which economic activity flourishes and tax authorities collect revenues and the government undertakes reforms in the tax system and tax administration. In the midst of the political instability, can the present government introduce value-added tax in Budget 2010-11?
While political instability affects revenue collection, it also encourages government to borrow extensively. Accordingly, the government has added $12 billion in external debt thus far and is likely to add another $7 billion by end-June 2010. External debt servicing has increased from $2.87 billion in end-June 2007 to $4.52 billion in end-June 2009. This amount is likely to increase to $6 billion in the current fiscal year. Foreign direct investment, which stood at over $8 billion in 2006-07, has plunged to $3.7 billion in 2008-09 and is likely to decline further in the current fiscal year.
We must remember that economic stability and political stability are deeply interconnected. No amount of foreign assistance will propel growth unless conditions like a stable and honest government, market-oriented and outward-looking policies, and a willingness to undertake reforms are in place. Aid that goes into poor policy environment does not work. Instead, it contributes to debt and restrains future growth.
The writer is dean and professor at NUST Business School, Islamabad. Email: ahkhan@nims.edu.pk
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ISSN 1563-9479 
