Pakistan - The Political Economy of Growth, Stagnation and the State, 1951-2009

Matthew McCartney

• Publisher: Routledge
• Year: 2011
• ISBN:
  9781136709456
• Edition: 1
• Topic: Economics
• Subtopic: Economic Policy
• Index: Economics

This book provides a comprehensive reassessment of the development of the economy of Pakistan since independence to the present. It employs a rigorous statistical methodology, which has applicability to other developing economies, to define and measure episodes of growth and stagnation, and to examine how the state has contributed to each. Contesting the orthodox view that liberalisation has been an important driver of growth in Pakistan, the book places the state at the centre of economic development, rather than the market. It examines the state in relation to its economic roles in mobilising resources and promoting a productive allocation of those resources, and its political roles in managing the conflict inherent in economic development. The big conclusions for economic growth in Pakistan are that liberalisation, the market and the external world economy in fact have less influence than that of the state and conflict. Overall, the book offers analyses of the different successive approaches to promoting economic growth and development in Pakistan, relates these to medium-term economic outcomes - periods of growth and stagnation - and thereby explains how the mechanisms by which the state can better promote growth and development.

1 Introduction

The introduction first reviews some of the key theoretical and empirical ideas in this book, and then outlines the structure of the book.

Key theoretical and empirical ideas in this book

This section briefly reviews some of the key theoretical and empirical ideas in this book. These are the role of the state, political economy, development and conflict, and the book’s focus on the medium term and methodological problems with cross-country growth regressions.

The role of the state

As I write this Introduction, the Republican Party has re-taken control of the House of Representatives in the USA.¹ The result, argued many Republican candidates and voters, was driven by a desire to reclaim America from an intrusive and debt-laden government, its reach having been destructively extended during two years of Obama as President. This book argues instead that government has a crucial role in promoting economic development, particularly in the world’s poorest countries. Pakistan has had a lot of government since 1947. If in many cases, to paraphrase Ronald Reagan, government in Pakistan has clearly been one of Pakistan’s many problems, it has at other times and in other ways been instrumental in solving the profound problems of development. And if not entirely fulfilling the most optimistic aspirations at independence, it has proved those idealists who strove to create Pakistan not irredeemably impractical and misguided.

Chapter 4 provides a coherent statist political economy framework that is used as the basis of the empirical chapters, 5–9. The schools elucidating the capability of the state (the political school) and what the state could do to promote growth and development (the economic school) are too often considered separately. This book is part of a recent and welcome trend that attempts to unify the political and economic roles of the state. The state has two economic roles, to mobilise and allocate an economic surplus to those able and willing to utilise it productively, and a political role to build and maintain institutions to manage the conflicts associated with growth and development. First, the state, argues chapter 4, has a crucial role in mobilising and allocating an economic surplus. Neo-classical economics conjures up a world of developing countries beginning the transition to modern economic growth, where savers miraculously appear bearing their deposits to a pristine banking system. Profit-maximising firms compete for the privilege to acquire those deposits by scouring the economy for an optimal portfolio of investment projects. The tribe of savers and investors emerges as an act of creation much as a ‘Big Bang’. In reality, the state will play a crucial role in mobilising an economic surplus and transferring it to those willing and able to utilise it to promote economic growth. Much of the economic surplus in a developing country will be in existence, but squandered by luxuriating landlords, recycled in repressive relations of rural money-lending or finding its way overseas, as the profits perhaps of plantations are returned to shareholders in developed countries. The allocation of a surplus is a profoundly political question in a developing country. Those who can use it productively will accumulate and become the large-scale capitalists of the future. Those who hold political power at the outset of growth may be traditional landlords, with neither the capacity nor vision to utilise the economic surplus beyond dominating local politics. A strong developmental state may be required to enforce the re-allocation of property rights, and more generally the surplus from the latter to the former.

There is no sense in trying to measure the relative merits of big government versus small government. Government intervention is all but impossible to measure. Crosscountry growth regressions have often used crude proxy measures for government intervention with predictably poor results. To mobilise an economic surplus, the state could utilise subsidies (which indicate an enlarged fiscal role for the state), tax incentives (which imply a reduced fiscal role for the state) and/or policies such as labour repression that raise the profitability of private sector firms (which implies no fiscal role for the state). Such policies are complementary ways of achieving the same fiscal outcome, and hence there is no reason to assume why, for example, the ‘share of government expenditure in GDP’ should have any particular sign or significance in a cross-country growth regression.

Even once those willing and able to utilise the economic surplus for productive investment have hold of that surplus, they will be faced by severe market failures in learning. Neo-classical economics assumes that innovation takes place in advanced countries and that learning in LDCs is no more difficult than selecting the most appropriate among innovations. Neo-classical analysis of technology transfer assumes that all firms operate with full knowledge of all possible technologies, to which they have equal access through imports based on a known market price. There are assumed to be no tacit elements in the transfer, no learning costs or need to make adaptations. This book assumes that much technology is tacit and, to effectively master it, extensive experience in using it is necessary. The process of learning to reach the efficiency frontier is slow, risky, and costly. Learning by doing may imply a lengthy and unpredictable period of losses, as firms learn and adapt technology to make it more appropriate to developing country conditions. In theory, private capital markets could fund firms through the period of learning. In practice uncertainty, risk and illiquidity mean that private capital will be reluctant. This is especially relevant when economies are industrialising and undergoing profound structural changes, where past history is a poor guide to the future. The state has a vital role in both inducing and facilitating learning by the private sector. Without such state prompting, firms in developing countries may simply compete on the basis of sweated, unskilled labour, and producing simple products more cheaply. Such a low road of development may be an ideal path for a single firm, but there are likely to be collective and dynamic benefits from following a high road of competition based on learning and upgrading.

Chapter 4 provides a theoretical critique of the orthodox analysis of the role of institutions in economic development. This book takes as a starting point that economic growth is a process naturally laden with conflict, involving unprecedented changes in the pattern of property rights and income distribution. Although there is a good deal of existing literature looking at the relation between institutions (often property rights) and economic growth, this book looks at a related but as yet less-researched issue. How can institutions overcome the (negative) relationship between conflict and economic growth? This book argues that there are three generic types of institution that serve this role and enhance the autonomy of the state to pursue growth and development. The first are ‘repressive institutions’, to exclude and/or crush groups that oppose growth and industrialisation. The second are ‘integrating institutions’. An important means of securing legitimacy for a given (re-)allocation of rights may be in compensating the (potential) losers, rather than repressing them. Identifying those requiring compensation, minimising the transaction costs associated with such transfers, and minimising rent-seeking by other entities requires a state that is more ‘embedded’ than ‘autonomous’. A dominant political party may provide just such an inclusive and embedded institution. A third institution to overcome the conflict associated with economic development is ideology. Even groups excluded from development or suffering from rising levels of inequality may acquiesce in their own exclusion for ideological reasons or a belief in the development project being pursued. The empirical chapters (5–9) flesh out this theoretical perspective with the practice in Pakistan since independence.

One may reasonably wonder how the theoretical foundations of a book concerned with the role of the state have fared during the convulsions affecting the world economy and discipline of economics over the last few years. That the state should have an important role in regulating or otherwise influencing the financial sector is a key theme of this book. A successful financial system, as assessed here, is not one that maximises profits, but one that is able to direct the economic surplus to investors able and willing to invest it productively. The banking system is different: it requires deposit insurance from the state and in return needs some element of push to divert its resources to productive investment, rather than potentially more lucrative speculation and gambling. This book, though, takes a much broader perspective and argues that the state can also utilise its own budget (taxes and subsidies), influence the profitability of the private sector (labour repression), or manage inflows of foreign capital as other means to mobilise and allocate the economic surplus. To this end, the current concern with just the financial sector is too narrow.

Political economy

The phrase ‘political economy’ shares with ‘the state’ a prominent place in the title of this book for good reason. An ‘efficient’ allocation of the economic surplus by the state is unlikely once we consider political economy factors. The state may tax individuals and use the money to subsidise emerging capitalists, but there can be no credible contracts or enforceable commitments on which the state will then be able to raise tax from those capitalists to the benefit of the original taxpayers. Whether the state can overcome this time-inconsistency problem will ultimately be a question of political economy. Existing powerful interest groups may block the introduction of ‘efficient’ transfers because it may simultaneously affect the distribution of political power. The prospect of the state being able to tax a newly created capitalist class may even be reduced once that class has accumulated and gained added political leverage over the state and other classes in society. Efforts to overcome the market failures associated with learning may generate a need for intervention in both factor and product markets. In factor markets, deliberate government efforts to direct resources to particular activities create rents that may both induce and facilitate learning by private actors. There is no guarantee that such rents will promote learning. Rents must be allocated in a contingent manner, and be withdrawn from those firms failing to learn, or perhaps more objectively to export or reduce costs. The bureaucracy must be competent enough to allocate rents ex-ante to potentially dynamic capitalists or, ex-post, strong enough to withdraw them from failing capitalists. The relation of the state to various classes is important: in the case of capitalists to enforce discipline, and ensure that rents are contingent on desired performance. The relation of the state to other, non capitalist classes must be such that they do not mobilise and dissipate efficient rents towards non-productive areas.

Development and conflict

The analysis of conflict is extremely limited in orthodox economics. Economists have tried to quantify the economic impact of ‘armed conflict’. More generally, orthodox economics sees conflict as a consequence of state intervention. State intervention, it is argued, creates rents, and agents then engage in often-destructive rent-seeking activities to gain access to those rents. Liberalisation, according to this view, will remove politics from the economy and replace extra-economic conflict over resources with the impersonal competition of the market. The contrast is the atomistic capitalism of neoclassical economics, where labour and firms are small relative to aggregate supply and demand and act independently in response to changing market signals. This book takes as a basic assumption that economic development is a conflictual process. Economic development is concerned with shifting resources from low- to high-productivity areas. The mobility of some assets will be limited; owners will then face problems of obsolescence and unemployment. Those having sunk investments into physical capital, skills, contractual relationships, and political patronage are likely to resist change (Chang 1999). There may also be a natural political tendency to conflict in developing countries. The social and economic change associated with economic growth, such as urbanisation, increased literacy, industrialisation, and expansion of the mass media will extend political consciousness and political participation. The new elite of civil servants and teachers employed by the central government can fragment and challenge traditional sources of political authority, the secular and religious leaders of the villages, and traditional social networks based around family, class and caste. Economic development also creates newly wealthy groups that are not assimilated into the existing social order. There is no guarantee that political institutions will emerge to ensure political stability. Economic development and political stability are two independent and possibly contradictory goals.

The ability of the state to manage conflict is crucial in allowing the state to allocate rents to their most productive uses, rather than expending them in the form of political transfers to try and buy political stability. Institutions to control conflict studied in this book are ideological, repressive or inclusive. There is a general possibility that pursuing a policy of liberalisation and rolling back the state will weaken those institutions that control conflict. Reductions in subsidies, for instance, may violate a social contract that had previously kept a lid on conflict. A smaller state may be less able to support inclusive or repressive institutions. There should be no surprise, for example, that measures of corruption did not decline in India following liberalisation in the 1990s (Harriss-White and White 1996). There are other dramatic and relevant examples. In the early-1990s Russia and other transition countries were encouraged to break up their communist parties and move rapidly towards democracy in the belief that this would permit a faster pace of liberalisation (Nolan 1995). Such reforms did lead to rapid reform, but not to rapid economic growth. Subsequent scholarship focused on the perceived neglect to create in parallel those institutions argued to be necessary for the successful functioning of a market economy. The institutions included in this debate were primarily property rights and a stable, enforceable legal framework. The dramatic disintegration of those political institutions (Communist Parties) that had previously managed conflict and allocated rents according to clear and (for insiders) transparent rules has been neglected as a causal variable in the economic failure of the transition economies. The problem in Russia was not so much an increase in corruption, as the collapse of the Communist Party and the resulting fragmentation of the organisational structure of rent-seeking and subsequent rise of destructive roving ‘mafia-type’ bandits (Shleifer and Vishny 1996; Olson 2000). An even more recent example was the rapid break-up of the Baathist party’s military and security apparatus of the Iraqi state following the 2003 invasion. Iraq has mobilised massive quantities of resources via the USA, and had democratic elections. Unsurprisingly, there has been a massive increase in conflict and a complete failure to allocate those resources productively.

Focus on the medium-term and methodological problems with cross-country growth regressions

This book focuses on growth over the medium term, something neglected by much economic analysis of growth. The medium term is a longer period than either Keynesian models of stabilisation or Solow growth models imply and a shorter period than embraced, for example, by current work on the fundamental sources of economic growth over the very long term — colonialism, institutions, integration and geography. Chapter 2 makes a critique of orthodox investigations of economic growth in developing countries. First, it shows that the use of averages hides an important empirical reality of the growth process. These are the structural breaks and periods of expansion and stagnation that actually characterise growth, particularly in developing countries. The chapter notes that policy provides the most straightforward explanation for episodes of growth and stagnation and, were this true, we would expect to see that changes in growth were causally correlated with changes in policy. In practice, there are severe empirical and theoretical problems with uncovering any link from policy to growth through cross-country regressions. These include complementarity among policy variables, the relation between different theories of growth, the question of growth itself as an endogenous process, hysteresis effects, growth regressions and dynamics, and the assumption of universalism. The final section outlines an alternative model, using the case study approach to explain episodes of growth and stagnation, emphasising the role of the state, and relating it to these theoretical and empirical problems. Chapter 3 introduces the case of Pakistan since independence as the case study of economic growth for this book. The chapter uses a rigorous statistical measure of an episode of growth (or stagnation) that will be used in the rest of the book. This chapter finds that there are three episodes of growth, 1951/52 to 1958/59, 1960/61 to 1969/70 and 2003/04 to 2008/09, and two episodes of stagnation, 1970/71 to 1991/92 and 1992/93 to 2002/03.

Structure of the book

Chapter 2: A methodological critique and framework

This chapter makes a critique of orthodox investigations of economic growth in developing countries. First, it shows that the use of averages hides an important empirical reality of the growth process. These are the structural breaks and periods of expansion and stagnation that actually characterise growth. The second section notes that policy provides the most straightforward explanation for episodes of growth and stagnation and, were this true, we would expect to see that these episodes were causally correlated with changes in policy. In practice, there are severe empirical and theoretical problems with uncovering any link from policy to growth through cross-country regressions. These include complementarity among policy variables, the relation between different theories of growth, the question of growth itself as an endogenous process, hysteresis effects, growth regressions and dynamics, and the assumption of universalism. The final section outlines an alternative model, using the case study approach to explain episodes of growth and stagnation, emphasising the role of the state, and relating it to these theoretical and empirical problems.

Chapter 3: Episodes of growth and stagnation in Pakistan, 1951–2008

This chapter develops an empirical framework based on the methodological critique in Chapter 2. We use the case study of Pakistan since independence. This chapter begins by outlining the definition and rigorous statistical measure of an episode of growth or stagnation as will be used in this book. The book focuses on the very aggregate level of growth, GDP. Future work will extend this perspective to consider episodes of growth and stagnation by sector, agriculture, industry and type of service. This chapter finds there are three episodes of growth, 1951/52 to 1958/59, 1960/61 to 1969/70 and 2003/04 to 2008/09, and two episodes of stagnation, 1970/71 to 1991/92 and 1992/93 to 2002/03.

Chapter 4: Theoretical framework

This chapter critically reviews the literature on the role of the state in economic development. This falls into two schools, the economic and political. The limitations of the economic school include the limited scope of analysis, the lack of a political economy, and the importance of complementarity. Weaknesses of the political school include the limited analysis of the state’s role, the relation between different theories, and lack of dynamics. A number of efforts have emerged to integrate these two schools, which are reviewed here. The following theoretical section attempts an integration that is relevant for the empirical context outlined in Chapter 3, focusing specifically on the role of the state. The financial role of the state is in allocating the economic surplus to those able to invest productively. The production role of the st...

Table of contents

• Cover
• Halftitle
• Title
• Copyright
• Contents
• List of illustrations
• Acknowledgements
• Preface
• Abbreviations
• 1. Introduction
• 2. A methodological critique and framework
• 3. Episodes of growth and stagnation in Pakistan, 1951–2008
• 4. Theoretical framework
• 5. An episode of growth, 1951/52–1958/59
• 6. An episode of growth, 1960/61–1969/70
• 7. An episode of stagnation, 1970/71–1991/92
• 8. An episode of stagnation, 1992/93–2002/03
• 9. An episode of growth, 2003/04–2008/09
• 10. Conclusion
• Notes
• Bibliography
• Index