Domestic resource mobilisation: a structural approach *.

Khan, Saleem M.

The Mobilisation of domestic resources and their efficient utilisation are two of the most crucial tasks in revitalising the economy of Pakistan. Historically, low saving formation and relatively higher targets of investment and economic growth made it imperative to depend on external resources. Despite heavy domestic borrowing from both private and public sectors, there still has remained an unmet resource gap that has necessitated dependence on foreign capital. (1) In recent years, the sources of foreign assistance have become scarce due to a growing shortage in world saving and growing domestic demand for budget appropriations in the western countries. If economic growth in Pakistan is to be sustained and self-generating, investment in physical and human development must be increased and mad more efficient. To meet this challenge, most of the capital will have to come from domestic sources. Hence, the focus of this paper is on harnessing domestic efforts to increase saving formation and to enhance efficiency of capital investments.

Traditionally, the government of Pakistan has relied on conventional approaches to increasing domestic saving. First, the government has been encouraging greater saving by the private sector through a package of national saving schemes and by allowing financial institutions to introduce saving incentives. Saving-schemes and saving incentives have not produced satisfying results. Table 1 shows saving and investment in selected South Asian countries. Saving in Pakistan is very low and, indeed, among the lowest even when compared with neighbouring and other developing countries. Explanations of this failure include the low levels of income and high rate of inflation in the country. (2) Moreover, the financial institutions have in general remained inefficient.

The second approach is to increase saving through taxation and incomes policies. In its taxation efforts, the government has not been able to enlarge revenues adequately from private sector incomes. This failure is due to the inelastic character of the tax system and a heavy reliance on indirect taxation, the latter causing the tax system to be inequitable.

Incomes policies have been only marginally successful. In its wage and price policies, the government adopted impelled methods of saving formation. The working population and the urban consumers have been paying for the savings in the country. (3) The public sector's contributions to domestic saving have remained negligible, mainly due to the inefficiency of state enterprises, rising defense budgets, non-development expenditure, and high inflation.

The shortcomings of traditional approaches to mobilise domestic resources and a decline in the availability of foreign assistance make it urgent to search for solutions to the problems of resource mobilisation outside the scope of conventional strategies and foreign sources. The world of economics has already entered into the age of restructuring and openness. It appears that the time is ripe for Pakistan, as well, to develop a structural change for efficient domestic resource mobilisation and free the economy from bureaucratic control. A blueprint of such an approach and its implementation targeted over a period often years is outlined in Chart 1.

With an early start on the transition of the economy from a bureaucratic toward a decentralised economic system, the pace of efficient mobilisation of domestic resources will be expected to accelerate. The resultant investments and rapid growth will enhance the rates of saving formation in the country. To analyse these issues, this paper, therefore, deals first with a general framework of structural reforms and second with efficient utilisation of resources.

I. GENERAL FRAMEWORK OF STRUCTURAL REFORMS

The dominant features of the development pattern of Pakistan so far, listed under "model" and "constraints,' in the chart, have been its long-term economic planning, direct controls, bureaucratic management, and others. Close association of the government with the development process and its management have adversely affected the sectoral balance of the economy and have led to an inefficient use of scarce resources.

These and other constraints have hampered the economy from reaching its productive potential. To revitalise the economy and broaden its potential, specific structural changes and policies are listed under "innovations/instruments" in the chart and briefly discussed below.

Structural Changes/Policy and Growth

Structural changes and policies to promote stability and growth in Pakistan should be two-fold: strategies of stabilisation in the short-run and growth policies in the long-run. Stabilisation can be achieved through fiscal and monetary policies, and growth through investment policies focusing on physical and human capital. These strategies and policies go hand in hand.

Pakistan should adopt stabilisation strategy through an active use of fiscal and monetary measures. To promote employment government should channel increased public spending into employment-oriented economic projects and provide investment incentives to businesses. To control inflation, along with fiscal measures, monetary authorities should tighten the money supply. Moreover, the State Bank of Pakistan should be made independent so that it can make monetary policy free from political influences. These monetary measures can help secure higher levels of employment and stable prices.

Promotion of long-run growth in Pakistan depends on effective investment policies with macroeconomic perspective, development of human resources, and trade expansion. Macroeconomic policy in the context of Pakistani problems of growth involves two fundamental decisions: how aggregate demand should be managed, and how output should be allocated between consumption and various forms of investment. Increased investment in physical capital such as equipment and machinery would significantly boost productivity growth. Regarding human resource development, investment in education, job training, and skill development will contribute to improvements in labour productivity and economic growth. The gains from structural changes/policies are summarised under "economic outcomes" and "resource mobilisation" in the chart. The restructuring of trade is necessary through establishing high value export industries and promoting regional economic integration (SAARC). (4)

Financial/Monetary Reforms

Central to the issue of domestic saving mobilisation is the state of the financial system. It is widely recognised that an efficient and well-developed financial system in a country is a prerequisite for: first, the growth and stability of an economy; second, mobilising a country's saving; and, third, channelling saving into the most productive investments. This process is, indeed, the very lifeblood of economic development and rising standards of living.

The state of the banking and financial systems in Pakistan has have been lack of public confidence, inefficient management, and low capital-risk assets ratios.

Public control of the commercial banks and political interference in their decision-making have adversely affected their performance. For instance, nationalisation of banks involvement of the authorities in credit decisions, heavy borrowing by the government at "artificially low rates," and government underwriting of "non-performing loans" have undermined public confidence, increased mismanagement, and brought capital-risk assets ratios lower to a crisis level-Table 2.

Indeed, in the light of the crisis in the financial sector, the confidence factor will become all the more important over time as the ownership of the formerly nationalised banks and financial institutions shifts to private hands. Any worthwhile package of reforms must deal with these fundamental problems.

No matter what the precise legal and institutional financial framework in a particular country, there are certain preconditions for the banking system to be able to perform its functions of mobilising and allocating savings. In Pakistan the reform package must include three fundamental elements: restoration of public confidence, efficient management of liability and assets, and maintenance of a high capital-risk asset ratio.

Restoration of public confidence is necessary because the functions banks perform entail risk, and confidence is a key to the public's decision to entrust its saving to banks. Minimising the effects of risk-taking and improvement in the performance of the commercial banks will be a big step forward in restoring public confidence. This goal can be met by instituting prudent deregulation of the banking industry on the one hand and tightening the monetary authorities' supervision of the banks on the other.

Efficient management of assets and liabilities and independent credit decision-making by the bankers are essential. Decisions regarding management of investment portfolios, for instance, and who gets credit and who does not, must be left to bank managers. However, managers should be made accountable for their decisions and should have a major stake in it-their own jobs.

A high capital-risk asset ratio is the evidence of a bank's strength and its longevity. Large capital accounts representing ownership interests serves two main objectives: first, they are a source of funding, and second, they provide a buffer for absorbing losses. Therefore, laws should be enacted to require banks to maintain a relatively high capital-risk assets ratio.

Fiscal Reforms

The fiscal system needs structural reforms on both the revenue side and the expenditure side. On the revenue side, a package of comprehensive tax reforms that addresses the issues of equity and the "elasticity" of the present tax system must be given top priority. The present narrow base for direct taxes, yielding tax revenue of about 2.0 percent of GDP, can be broadened by the elimination of about 180 income tax exemptions and by gradually phasing out numerous tax credits and area- and industry-specific tax holidays. These measures, according to the Seventh Plan document (Seventh Five-Year Plan 1988-1993), will not only increase tax receipts, but also reduce the dispersion in effective income tax rates among industries, thus improving the efficiency of resource allocation. The addition to tax revenues from these changes could amount to 1 percent of the GDP. The base for indirect taxation, which contributes revenues of about 11 percent of GDP, comprises primarily consumption taxes such as sales taxes, and excise and import duties. The coverage of sales taxes on both domestic and imported luxury and semi-luxury items must be broadened not only by withdrawing exemptions, but also by increasing specific tax rates. These measures could yield additional revenues amounting to 1 percent of GDP.

Often discussed and repeatedly recommended by the economists, an agriculture income tax awaits enactment in Pakistan. The argument that agriculture is already heavily taxed via export taxes overlooks the relief provided in the form of highly subsidised prices of farm inputs such as fertilizer, seeds, and water. An agriculture income tax or a kind of land tax is justified on economic grounds. To maintain the equity from the "incidence" of new tax, small land owners would need protection and should be exempted. This new tax can contribute about 1 percent of GDP to public revenue.

Other problems causing low tax receipts are the widespread practice of tax evasion, official irregularities, and poor tax collection. An efficient and honest tax administration committed to a strict enforcement of anti-tax evasion laws and good conduct is necessary. Strengthening the collection machinery could also enhance the revenue performance of the tax system. These additional steps could raise revenues by about 1 percent of GDP.

Additional revenue potential lies in competitive functioning of state and semi-public enterprises. Reassessment of official pricing policies and evaluation of the management style of these enterprises will force them to become competitive, efficient, and profitable. Moreover, an immediate overhaul of management and appropriation of the financial "resources in these enterprises is essential. Reforms in this sector can increase public enterprise performance and add about 1 percent of GDP. A summary of saving formation from various sectors is given in Table 3.

On the expenditure side, a substantial increase in real resources for development is highly desirable. A strategy of internal shift of resource use toward investments will not only raise productivity and growth, but also will contribute to public revenues. Even modest cuts in administrative, defense, and subsidy expenditures will improve the resources position. In 1988-89, the government spend 6.6 percent of GDP on defense alone, compared to 6.3 percent on development. Fiscal reforms can have a significant impact on shifts in resource use. Freeing of resources from non-development spending can add to saving formation another 2 percent of GDP that could raise the development expenditure from 6.3 to 8.4 percent of GDP. Resource mobilisation is a necessary condition but not an adequate one. Stimulation of growth also depends on the efficient utilisation of resources.

II. EFFICIENT UTILISATION OF RESOURCES

Equal in importance to high savings and investment for rapid development is the key issue of efficient utilisation of resources, or the efficiency of investment. The efficiency of investment is generally measured by the incremental capital-output ratio (ICOR), defined as the ratio of change in capital stock to change in output: Other measures of economic efficiency in use are net investments as a percentage of GDP and the average capital-output ratio (COR). (5) These indicators are presented in the Table 4.

Over successive Five-Year Plans, despite rises in ratios of net investments to GDP from 4.0 to 15.7, net (incremental) capital-output ratio (ICOR) have gradually increased from 2.0 in 1955-60 to 3.0 in 1985-90. These numbers need to be observed carefully. Apart from the unreliable character of the statistics, the overall ICOR for the economy reflects, and hides, many complex economic facts and relationships. First, there is the issue of inevitable lag between capital investments and actual production. These lags, though, may be relatively shorter for the services sector. Due to the time lag, a rise in investment ratio must be expected to raise the ICOR for some time. Second, temporary external shocks, such as domestic repressions of a fall in the terms of trade, will result in higher ICOR. Usually, lower ICOR and COR imply greater efficiency of investment. Does this mean resources utilisation is really efficient in Pakistan, as suggested by the lower ICOR? To answer this question authoritatively, a comprehensive research study on the subject is needed. (6) However, in the absence of such information one can depend on some leads in the development economics literature to analyse the issues of efficiency.

The ICOR for the whole economy may not only change because of changes in the productivity of individual sectors or industries due to technical progress or improvements in organisation, but also because of structural changes in favour or against high-ICOR sectors or industries. All of these factors appear to have some significance in analysing the issue of efficiency of resource utilisation in Pakistan. Because of time lags, deterioration in terms of trade, and changes in the productivity of individual industries, ICOR should have been high, rather than low. Some possible explanations for consistently low ICOR figures in Pakistan may be such factors as increases in investments in service industries, sporadic market-based reforms, export promotion, and other policy initiatives aimed at enhancing competition and improving efficiency. Recent steps toward privatisation, relaxation of direct controls, an expanded role for private sector, and some evidence of shift in the sectoral composition of aggregate investment in favour of more efficient industries may eventually produce positive results. But these changes may not be adequate explanations for the low ICOR. Besides, it is desirable to supplement investments in human resources, a key factor in economic development that would go a long way to increase the productivity of resource utilisation. Hence, efficiency of investment have the potential of at least 2 percent increase in saving formation. In summary, a comprehensive programme of structural changes has the potential of raising the saving formation to approximately 17 percent of GDP-Table 3.

III. CONCLUSIONS

Pakistan is a poor country, and its development agenda includes improvements in economic and social conditions. A successful economic strategy to secure the goals of the development requires heavy investments in physical and human capital. This challenging task cannot be accomplished without concerted efforts toward domestic resource mobilisation and their efficient utilisation, a fact that underscores the need for structural reforms.

REFERENCES

Pakistan, Government of (n.d.) Seventh Five-Year Plan, 1988-93, A Perspective Plan, 1988-2008. Islamabad: Planning Commission.

State Bank of Pakistan (V.Y) Annual Reports, 1979-80, 1987-88, and 1990-91.

Sundrum, R. M. (1987) Growth and Income Distribution in India: Policy and Performance since Independence. London: Sage (1990), Economic Growth in Theory and Practice. London: Macmillan.

World Bank (V.Y) World Development Report 1982, 1991, 1992. New York: Oxford University Press.

* Owing to unavoidable circumstances, the discussant's comments on this paper have not been received.

(1) The domestic investment rates have been sustained above the domestic saving rates by workers' remittances, official development assistance, and multilateral and bilateral assistance. Total external debt at present is approximately $18 billion.

(2) Pakistan is a low income county and its GDP per capita is $380. Average annual rate of inflation during 1965-80 remained over 10 percent. More recently it has been somewhat lower, averaging about 7 percent per year.

(3) In the early periods, there is strong evidence that the real wages of the industrial workers had been declining due to strict labour laws. The peasants' incomes were kept low because of adverse tetras of trade against agriculture. Besides, the system of state trading corporations (which purchase farm products such as rice and cotton at relatively low prices and sell thorn in the world markets at higher prices) has helped the government in its revenue collection drives. The urban consumers, too, were paying prices above those in the world market for domestic manufactures.

(4) The trade sector in Pakistan is subject to "trade limit". The country has a narrow export base, and event after four decades of development continues exporting traditional goods. The export sector needs stractural changes to develop efficient industries with export potential, such as high value manufactures. The import policy must encourage import of capital goods, while inefficient import-substitution must be abandoned.

(5) ICOR [DELTA]k/[DELTA]y = I/[DELTA]y and net COR = 1/Y

Theoretically, ICOR seems to be a better measure of the efficiency of investment (MEC) than the net COR (average). However, the experiences of different studies can, certainly, throw more light on this ambivalence.

(6) Sundrum (1987) had studied the causes of India's high ICORs during 1950s and 1970s. The finding of his study suggests that high ICORs were due to the large portions of fixed investment in buildings, primarily residential, which did not contribute much to growth of GDP, and shifts in sectoral composition of investments toward highly capital-intensive programmes.

Saleem M. Khan is associated with the Department of Economics, Bloomsburg University, Bloomsburg, PA, USA.

Table 1

Savings and Investment Percentage of GDP

 Gross Domestic Gross Domestic
 Investment Savings

Country 1960 1980 1990 1960 1980 1990

Afghanistan 16 14 -- 13 11 --
India 17 23 23 14 20 23
Pakistan 12 18 19 5 6 12
Sri Lanka 14 36 22 9 14 15

Source: World Bank, World Development Report 1982,
1992 Oxford University Press, New York, 1982.
pp. 118-119, p. 234.

Table 2

Capital-Risk Assets Ratio-Scheduled Banks

(Billion of Rupees)

 1970 1980 1990

(1) Capital 466 1,135 11,366
(2) Risk Assets * 20,711 97,719 608,842
(3) Ratio (1)/(2) 2.30 1.20 1.7

Source: Annual Reports, State Bank of Pakistan,
1979-80, 1987-88, and 1990-91.

* Risk Assets consist of total asset minus cash
items and investment in government securities and
shares.

Table 3

Sector-wise Estimates of Potential Saving Formation

 Saving
 Formation
 (Percentage
Sector of GDP)

Market Reforms Investment 2
 Physical Capital 1
 Human Capital 2
Financial Monetary Sectors 2
Fiscal Sector
 Revenue Side
 Direct Taxation Reforms 1
 Indirect Taxation Reforms 1
 Agriculture Income Tax 1
 Efficient Tax Collection 1
State and Semi-public Enterprises 1
Expenditure-side
 Internal Shift in Resource Use 2
Efficiency of Investment (Capital) 3

Source: Staff estimate of the World Bank and
Ministry of Finance, Government of Pakistan.

Table 4

Percentage of GDP

 First Second Third Fourth
 Plan Plan Plan Plan
 55-60 61-65 65-70 73-78

Gross
Investment 9.0 11.9 15.8 19.8

Net
Investment 4.0 7.7 11.1 14.1

Depreciation 5.0 4.2 4.7 5.7

GDP
(Growth Rate) 3.1 6.8 6.7 5.0

Net Capital-
Output Ratio 2.0 2.1 2.5 2.7

 Fifth Sixth Seventh
 Plan Plan Plan
 78-83 83-88 88-93

Gross
Investment 22.2 23.5 18.5

Net
Investment 15.5 15.7 --

Depreciation 6.7 7.8 --

GDP
(Growth Rate) 6.5 6.6 6.5

Net Capital-
Output Ratio 3.0 2.6 2.8

Source: Planning Commission, various planning
documents, Government of Pakistan.

Chart 1

Domestic Resource Mobilisation: A Structural Approach

 New Strategy and its
 Outcomes

Models/Sectors Constraints Innovations/Instruments

1. Development/ Regime of direct Economic/Pricing
 Growth Model controls, bureaucratic reforms: socially
 managements desirable pattern
 imbulanced growth; of growth; investments
 dismal/unproductive in human development
 relationship between and manufacturing
 the economy and sectors
 society
2. Market Sectors

 Agriculture Feudal structure Land ownership rights
 of land ownership; on the basis of
 market imper- cultivation only;
 fections; poor pricing reforms;
 crop and water introduction of
 management advanced methods for
 crop and water
 management

 Industry Regulations; state Price and regulatory
 control/protection; reforms; open
 slow expansion in competition; a
 manufacturing vigorous investment
 capacity; industrial strategy for capital
 power and goods industries
 concentration

3. Government State ownership/ Selective privatisation;
 Sectors: control; bureaucratic corporate management;
 State management; gradual withdrawal of
 Enterprises/ subsidies; revenue subsidies; opening up
 Semi-public leakages state companies to
 Enterprises competition

4. Fiscal System: Inequitable and Fundamental reforms in
 Revenue Regime inelastic tax tax system; introduction
 system; narrow of agricultural income
 tax base; tax tax; broad general
 loopholes; poor sales tax; better tax
 tax collection collection

 Expenditure Unrestricted growth Cap on non-development
 Regime of non-development expenditure; internal
 expenditures; high shift in resource use
 defense spending; in favour of development
 inefficient budget expenditures
 allocations
5. Monetary/ Credit controls; Central bank
 Financial tight regulatory independence; flexible
 Systems environment; credit control system;
 underdeveloped regulatory reforms;
 capital markets computer-inspired
 technological changes

6. External Narrow export base; Expansion and
 Sectors: quality control diversification in
 Trade problems; non- high value exports;
 essential imports; quality control;
 in-efficient import- emphasis on capital
 substitution goods imports;
 selective sectors
 for imports
 substitution

7. External Perpetual cycle Emphasis on productive
 Assistance of dependency; credit; external
 questionable borrowing as a "last
 type and quality; resort"; borrowing
 conditionality primarily to finance
 development projects

 Resource-
 Economic Outcomes Mobilisation

1. Development/ Efficient allocation Efficient saving
 Growth Model and utilisation of formation
 resources; robust and
 people-oriented
 economic growth;
 higher productivity
 and creativity gains

2. Market Sectors

 Agriculture A modern and highly Agriculture--a
 productive agricultural surplus
 sector, higher farm producing
 output/ incomes; food sector
 self-sufficiency/
 exports

 Industry Rigorous competition; Enhanced
 industrial efficiency; industry-wide
 increase in output, saving
 income and investments

3. Government Efficiency gains; Enhanced revenue
 Sectors: profitability; balanced generation
 State sectoral development
 Enterprises/
 Semi-public
 Enterprises

4. Fiscal System: Equitable and efficient Improved revenue
 Revenue Regime tax system; progress performance
 toward balanced budget

 Expenditure Marked reduction in Saving formation
 Regime budget deficit; in public spending;
 increased allocations increased
 for development resources for
 expenditure development

5. Monetary/ Improved management Greater saving by
 Financial and increased private sector
 Systems competition; efficient
 banking system and
 financial markets

6. External Better export Enhanced potential for
 Sectors: performance; improved trading surplus;
 Trade balance of payment, increase in foreign
 competitive trading exchange reserves
 position in world
 markets

7. External Promotion of domestic Saving in debt-servicing
 Assistance reliance on investment charges, potential for
 needs; cap on growth in foreign exchange
 foreign debt; early saving
 termination of aid