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PHASE III - BHUTTO 1972-77 Lecture 5 Hamna Ahmed BHUTTO’S EXPERIMENT WITH SOCIALISM The early 1970s were the most traumatic and turbulent years of Pakistan’s political and economic history. The political impasse resulted in the ill-considered military action in East Pakistan in March Pakistan’s military defeat, and the creation of an independent state of Bangladesh in December 1971. In West Pakistan Bhutto was brought into power by Pakistan's military and was President till 1977. Glaring Feature of Bhutto’s era: Large scale nationalization of industry, insurance and banking, extending the state control of the modern sector significantly. Took full control of country’s educational system by nationalizing private educational establishments. BHUTTO’S EXPERIMENT WITH SOCIALISM Major Issues: Dealing with economic consequences of the separation of East Pakistan The large and unexpected oil shocks in 1973 Poor agricultural performance in the same year due to adverse weather conditions, both draught and floods which caused the economic growth to slow down, inflation accelerated and macroeconomic imbalances widened. The large scale inflows of foreign capital and remittances after 1973 cushioned the impact of the steep rise in the oil import bill. Macroeconomic Management During the five years of Bhutto's government; 1973-77; Average annual growth rate of economy = 4.9% This followed the virtual stagnation of GDP at 1.7% annual growth in the transition years 1970-2. With the deteriorating economic and political relations with East Pakistan and eventual breakup of the country, the slow down of growth was inevitable. Foreign Trade Adjustment The separation of East Pakistan did not lead to a major decline in Pakistan’s exports and there were three principal reasons for this: 1. Exports of primary products from West Pakistan, such as cotton and rice which constitute of about half of the inter-wing trade in the 60s were sold below the international prices to East Pakistan because of national policies which depressed the effective real exchange rate. 2. The real devaluation of the exchange rate in May 1972 facilitated the shifts to international markets. 3. The boom in the international economy and commodity markets in 19723 increased the demand for Pakistan’s exports. Pattern of growth The major sources of growth during the period were: Construction, Public administration, Defense Service sector. Rapid growth in investment The construction boom Between 1972-73 and 1976-77: Real investment expanded by 50% Rate of investment as per GDP increased from less than 13% to over 19% over the four year period. Boom in worker remittances Expansion of the service sector Oil price shocks External payment position worsened due to rise of international oil prices at the end of 1973 because of OPEC) At the peak of oil prices in 1972, Pakistan’s oil import bill was over 6% of GDP. For Pakistan official grants and loans from Middle Eastern oil exporting countries also increased, so the financing of the enlarged deficit did not pose major problems. External debt problem Pakistan had to face rising debt servicing burden of the existing debt in the 70’s. As political crises began in 1971 and as the economy stumbled, Pakistan found itself unable to meet debt service obligations. After separation of East Pakistan 1971, debt crises deepened as the issue’s relating to Pakistan's debt liability as distinct from that of Bangladesh’s needed to be resolved. The seriousness of the problem can be judged from the fact that the debt service payments due in 1971-2 would have absorbed over 40% of Pakistan’s foreign exchange earnings during that year. The fresh assistance from abroad relatively neutralized the effect of oil increases. Foreign assistance Western industrial nations and multilateral banks resumed new assistance on substantial scale in 1974-5. This combined with assistance from OPEC countries resulted in foreign assistance commitments and disbursements reaching the record of average level over US $1.2 bill annually during the years 1974-5 to 1976-8. Aid disbursements during mid 1970s were at a level far above that reached during the Third Year Plan even after allowing for international inflation. Large foreign assistance also meant that the immediate impact of the oil shock on the balance of payments of the economy was greatly neutralized Budget deficits Government deficits which had increased in 1970-2 due to difficult economic and political conditions and military operations in East Pakistan showed further explosive growth during the Bhutto years. The budget deficit averaged over 8% of GDP compare with fiscal deficits of 2-3% of GDP in the 50’s and 4-5% in the 60’s. Government began to borrow on large scale for current expenditures. The high rising burden of defense expenditure was a root cause of fiscal imbalance. The decision to increase defense expenditure following the separation of East Pakistan was an important political decision made for the demoralized Pakistan army Tax policy The government was not able to use the tax policy as an effective instrument of resource mobilization. Initially there was quantum jump in corporate tax collections. Profits of nationalized enterprises fell off rather quickly as inefficiencies crept in and growth slowed down. Collection from incomes and corporate tax during the 70’s did not exceed 1% of GDP. The essential inelasticity of tax system remained intact with its heavy dependence on indirect taxes and especially certain duties. Inflationary Pressure The growing fiscal deficit, combined with imported inflation resulting from higher international oil prices, had serious inflationary consequences. The devaluation of May 1972; from Rs.4.76 per dollar, to Rs.11 per US dollar also contributed to price pressures, On the economic front, the rapid rise in price level quickly dissipated any gains from exchange rate adjustments and reduced the competitiveness of exports in absence of further devaluation Energy Subsidy It was the lack of suitable price adjustment in energy, which did the most harm in economic terms, through direct subsidies from the budget for energy Between 1973 and 1976, import cost of petroleum had increased by 300%. Gas prices were kept low to promote the use of an indigenous but unfortunately scarce source of energy. As a result of subsidy on energy prices, energy consumption growth remained high, incentives for increased production especially for oil and gas were not strong, and dependence on imported energy remained high. In 1970 energy consumption expanded 30% faster than growth in GNP with obvious adverse consequences for the balance of payments. Reduced income from gas and electricity sales reduced the capability of WAPDA, KESC and Sui Gas to finance expansion from internal resource Wheat Subsidy In line with the slogan; roti, kapra aur makan, a wheat subsidy was given throughout the 1970s; The wheat subsidy at 1.6% of GDP was at its highest level in 1978-79 The wheat procurement price was increased only gradually to around Rs.1 per kilo in 1975-6 from Rs.0.5 per kilo in 1969-70. The efforts to keep wheat prices relatively low provided strong incentives for raw cotton. The ratio of cotton to wheat prices generally was far more favorable during the 70s than in 60s. In order to compensate farmers for wheat prices, which were well below international prices through out the 70s, the government continued to provide large direct subsidies on fertilizers and pesticides and equipment for plant protection. Wheat Subsidy Increase in fertilizer subsidies in the mid 70’s was the result of both rising fertilizer imports and exceptionally high international prices of fertilizers. Producer’s prices were kept below international level after allowing for reasonable efforts to mitigate large fluctuations; this triggered the need to maintain input prices at low level. The burden of both direct and indirect subsidies was felt ultimately on the budget and since the large budgetary deficits were financed during 70’s at the margin by borrowing from banking system, the consumer paid the price through a higher level of domestic inflation. Extending the Role of the State The structural reforms undertaken during the Bhutto period further enlarged the considerable role of the state in the economy. Public control of industry expanded considerably and banking and insurance totally nationalized, but there was also a massive expansion in public investment in infrastructure. By the end of the Bhutto period, the public sector accounted for more than 70% of the expenditure on capital formation. Public Investments The extension of the role of the public sector was not confined to nationalization and increased public sector investment in industry. There was a massive increase in other areas of public investment as the total public sector development spending increased from 4.7% of GDP in 1971-72 to 11.7% of GDP in 1976-77. The share of public investment in gross domestic fixed capital formation had grown from 49% in 1969-70 to nearly 70% in 1976-77. A number of factors contributed to the increase in public investment apart from investment in industry, including the steel mill. Public Investments A number of factors contributed to the increase in public investment apart from investment in industry, including the steel mill. Expenditure on Tar Bella Dam remained sizeable because of technical problems and partly because of the decision to increase the hydro power generation capacity of the dam. About 10% of the development spending was on Tarbella Dam and other Indus Basin works. The government increased spending on agriculture and on infrastructure on power, roads, education and health. An important motivation in quickening the pace of public investment was to spread the benefits to the people and to the less developed provinces Nationalization The government took over the management and control of thirty-one industrial units in January 1972 in ten basic industry groups including iron and steel, heavy engineering, motor vehicles, heavy chemicals and cement. In March 1972, the government over took the management and control of thirty-two life insurance companies. Cotton export and cooking oil industries were nationalized during 1973. The Pakistani banks were not nationalized till 1974. Nationalization The final wave of nationalization during the Bhutto period came in July 1976 when government unexpectedly took over about three thousand cotton ginning factories, rice and flour mills with a total turnover of Rs.14 billion and employing 3,000 persons. The nationalization of heavy industries, insurance and banking were part of the relatively well thought out actions to curb the power of 22 families, Whereas the decision to nationalize cotton export trade, edible oil industry and agro processing units were largely ad hoc, responding either to economic or political pressures. The nationalization of thirty-one units in the industrial sector in January 1972 affected less than 20% of the value added of the large scale-manufacturing sector. Labor Policy Comprehensive labor policy announced in February 1972 measures to improve the income and the bargaining position of labor. procedures for speedy and just settlement of disputes, a fair share in profits and participation in the management of industry, bounces, and better housing, health and education facilities. This extended the benefits of reforms to another 1.2 mill workers but elicited a strong negative reaction from the large number of small businesses which became a subject to a whole new set of regulations. The new labor policy added about 12% to the cost of labor and thus met resistance even by the managers of state enterprises. Labor policy combined with uncertainty about the attitude of the government towards the private sector acted as a strong disincentive to further investment in large-scale industry in the private sector Social Services - Education New educational policy- March 1972, Outlined an ambitious program of educational development including: Free and universal education up to class VIII, Strengthening of technical education An educational program for women in the rural areas. The immediate focus was the nationalization of private educational institutions. Take over of private educational institutions adversely affected the development of basic education as well as the quality of education. Social Services - Education Only about one third of the education expenditures were directed at the primary level. Total government expenditures on education increased from Rs.0.8 million in 1971-2 to Rs.2.8 million in 19767 which represented an increase in real terms of around 50% over the period. Female education at the primary level did relatively well in the Bhutto’s period as females accounted for 36% of growth in the primary school enrollment and 55% of growth in teachers during 1972-7. Social Services - Health Health policy - 1972 Extension of health facilities to rural areas Expansion of medical education Shift to the production of generic drugs to avoid the soaring prices of brand named medicines. The central piece of the scheme was the Basic Health Unit, which was to serve between 8000 and 15000 people as a sub unit of a larger rural health center. In northern areas of Pakistan people were trained as health guards who were to provide basic medical facilities. As a proportion of GDP the growth in health sector was from 0.4% in 1971-2 to 0.8% in 1976-7. Number of basic health units increased from 249 in 1971 to 786 in 1977 and the number of rural health centers increased from 87 to 256 over the period and 1900 health guards were trained. Reaching the poor Food, clothing and shelter for the poor were a key slogan of the founders of the PPP and it was this platform which had brought Bhutto to power. Large parts of Bhutto’s economic and social program labor policy, educational reform, sharp expansion in public development spending, credit policies for small farmers and businessmen were aimed at improving the lots of the poor. While there was a defined reduction in absolute poverty after 1971-72 a good deal of it was concentrated in the period after 1976. Between 1976-79 worker remittances, a major source of poverty reduction increased from US $ 562 million to US $ 1749 million. Slow economic growth, high level of inflation and not very effective social policies and spending frustrated distribution goals even though they were pursued quite aggressively.