'Pakistan: Is Foreign Aid Helping or Hindering Development?'

Harvard Business Review Case Study  
Written Analysis of the Case by Sehrish H. Khan
Presented to Prof. F. A. Fareedy (LSE)

Identification of Key Issues 

Pakistan has a strategic location in the Middle East; its border with Afghanistan provides a refuge for terrorists, possesses nuclear weapons, frontline state of the ‘war on terror’, and is a Chinese ally. Going back to the time of Pakistan’s inception, the leaders Jinnah & Liaquat Ali Khan were both urban professionals based out of Bombay, and at odds with the feudal authorities that dominated the soil.

After losing its leaders, there was a power vacuum in 1948 and 1951. Though Pakistan was founded as a secular state, it was redefined as an Islamic Republic in 1956.

Pakistan went through four spells of military rule; its first constitution was adopted in 1956 only to be suspended from 1958 through 1970 under military rule. Turbulent times prevailed when Bangladesh achieved permanent status as a separate nation after the December 1971 war between India & Pakistan. Bhutto was tried for conspiring to murder a political opponent and hanged, General Zia took over and another military dictatorship prevailed. It was during this time that aid given to Pakistan for development, was used for building illicit nuclear weapons.

The civilian rule in 1988 after Zia’s airplane crash, ineffectual governments by Nawaz Sharif and Benazir Bhutto till the late 1990s. Army Chief of Staff General Pervez Musharraf seized power in 1999. Strengthened the army’s political influence, restoring presidential powers to dismiss the prime minister and make key appointments. In 2007 Musharraf misstepped by trying to force out the Chief justice who he feared may legally challenge his efforts to retain the political power

Violent demonstrations and protests led to negotiations with Bhutto. Bhutto and Sharif came back from exile. Before the elections, on 27 December 2007 Bhutto was assassinated, her husband started a new government and became the president after Musharraf stepped down.

Economist Intelligence Unit stated Gen. Ashfaq Kayani was Pakistan’s “ultimate political arbitrator” and its “most effective institution”. During Musharraf’s tenure from 2003-2007 Pakistan’s growth averaged over 6%. External debt as a percent of gross national income including remittances declined by more than a third.

Pakistan is the 6th most populous country in the world. Jim O’Neil of Goldman Sachs saw investor-friendly policies and ease of doing business rating than many of its peers; promising foundation for future growth, and close ties with China and the oil-based Middle East.

A significant portion of its historical GDP growth is attributed to an increase in population. In 2005, 55% of the population was between 15-64 years (working age) and 42% was >15 years. 23% of women were employed, and Pakistan had one of the highest unemployment rates among the N-11. Pakistan suffered from an education deficit; only 54% of adults (age 15 or higher) were literate in 2009.

The primary school enrolment rate was 73% for boys and 57% for girls. The adult literacy rate among women is only 40% and in men 67%. Severe lack of teachers; the pupil-to-teacher ratio was among the worst in the world, at 41-1.

Government defense spending exceeded education spending. Household spending exceeded 70% of GDP, and investment averaged a relatively low 18% of GDP. Low investment rates could be explained partly by political and economic instability; suffered unpredictable inflations and erratic interest rates. Government spending stood at 21% of GDP in 2009 but only a quarter of it went to capital investments through the Public Sector Development Program

The problem would worsen unless a new generating capacity was built. A recent agreement with Iran to construct a 560-mile $7.5 billion pipeline from its vast southern gas reserves was projected to supply Pakistan with up to a billion cubic feet of gas per day by 2015

Pakistan had the highest mobile penetration rate in South Asia, at 54% of the population and 90% of its area. Large government deficits for the past 20 years aggravated the problem of low national savings. Government bond yields had ranged from 4% to 16% in the 2000s

Tax revenues lowest levels in the world, extremely narrow tax base. One key impediment to tax collection was the central government’s limited control over rural areas, many wealthy government officials paid no taxes. 1 trillion rupees ($11.7 billion). The ratio of exports and imports to GDP was a low 31%. While nations tend to trade heavily with their neighbors. Despite low labor costs, Pakistan was a net import of goods and services.

It mostly exported low-value-added goods such as textiles and rice, and imported high-value-added goods or natural resources. With several Pakistani devaluations, the rupee lost half its value between 1995 and 2002. China’s rise as the world’s leading exporter

Remittances from Pakistani workers overseas reduced the strain on its current account deficit. Saudi Arabia and the United Arab Emirates, export labor to Gulf. A government policy statement identified labor migration as a key source of future growth.

The war on terror hindered economic development, and Pakistan’s expenditures on law enforcement agencies. Heightened uncertainty slowed economic activities, unease among foreign investors, and capital flight. Massive unemployment in terror-prone regions

The war cost the Pakistani economy $8 billion a year in lost exports and foreign investment. The stock market was one of the best performing among emerging markets, floating sovereign bonds of maturities from 5-30 years in the international capital market.

In 2007, and 2008 favorable conditions during Musharraf's tenure. Global food & oil prices rose in 2008, hurt the economy, per capita income stagnated and poverty rates rose. The fiscal deficit reached 7.6%

Core Problem

Lack of stability is a core issue faced by Pakistan since its inception. From military dictatorships to fledgling democratic governments; Pakistan has faced major political and economic upheavals, nearly always a consequence of interrelated issues.  

The core problem faced by American counterparts after waging the war on terror-with Pakistan being the frontline state-was the knowledge of discovering Osama Bin Laden, the terrorist and ex-CIA spy gone “rogue” responsible for 9/11 attacks on World Trade Centres- present amidst a location in Abbottabad; an area closely monitored by the Pakistani Army. Whereby even the location of Pakistani Military Academy was situated near the place where OBL was detected. 

The main issue for Americans is that it's not possible for OBL to be located in such a highly military secure area without Pakistani military intelligence knowing or in fact “protecting” the location of the terrorist. A concern for Americans is that perhaps there are large factions within the Pakistani military that are anti-American and OBL sympathizers or perhaps it was a way of gaining leverage over Americans. 

Americans thus need to decide whether they want to keep spending billions of dollars of military aid on the Pakistani military. In this scenario, it is possible that the Pakistani military might tolerate militants to help justify its own existence and give the US a good reason to keep financing its military with aid.

Since 9/11, the USA has imparted over $20 billion of military and civilian assistance to Pakistan. In the past, aid was also given during the proxy war in Afghanistan with the Soviet Union, out of which Pakistan started its nuclear program. The main problem inferred is whether America should continue spending its tax payer’s money to provide aid to Pakistan, as it has over the decades, countless times. Or should it stop aid altogether. 

Analysis & Recommendation

The USA cannot risk not giving aid to the Pakistani military especially as it's the only effective institution in the country, even with its corruption. Deeming the fact that Pakistan is a frontline state in the war against terror, with its strategic geo-political ties and the fact it's a nuclear state, possibly in an unstable environment poses a delicate situation. One that can be managed either forcibly or steadily. If the USA were to take forcible unilateral action, they would have destroyed and eliminated the nuclear warheads, droned Kahuta in order to de-nuclearize the country forcibly, for the "greater good," in order for it to never, accidentally fall into terrorist hands. A steady plan of action involves assisting the country to develop and strengthen existing military/government/civilian institutions to better equip themselves in order to function effectively.

The country's tumultuous history with regard to politics, security, terrorism, and development indicates that a new strategy must be maneuvered in order to restrain terrorism in areas in the grip of feudal landowners. The only way to do that is by strengthening existing institutions, training, equipment, and education. Free education can significantly reduce poverty-driven would-be terrorists. 

In the time of the floods, it was seen that radical Islamic groups were helping flood victims, gaining popularity and sympathy. Similarly, the US needs to avidly change the mindset of people as a proactive, development-friendly country, with its prime interest in Pakistan’s development of women, industries, and labor. If the US is to help Pakistan fight the war on terror it has no choice but to spend money on the country, as public sentiment in favor of the US is vital. Scholarships, empowering women, and educating women from rural areas will increase overall literacy and also bring positive development to Pakistan. With that being said it is incredibly important for the US to have its intelligence placed in Pakistan, especially after the Bin Laden raid. There are ISI factions that may be rogue, as in every intelligence community, and it's crucial for security to have CIA officials operating on the ground and to be aware of their Pakistani counterparts actions and where the aid is being spent. Corruption is high in Pakistan, and that much was understood by the development of the nuclear arsenal and uranium enrichment. It's in USA's best interests to keep a close watch on the military aid.

For development aid, it is far better to involve non-government organizations to help establish development projects. Since corruption runs high in the political landscape, it's far necessary to involve civilian agencies and work with those agencies in building projects for water, energy, sanitation, etc. 

As China is the giant exporter of the world and has a competitive edge over Pakistan, forgoing aid and going for trade seems unlikely as China has already fit itself in that role. Thus the US must keep providing aid to Pakistan, it cannot afford to have an unstable nuclear state on its hands that's also the frontline state of the war on terror, development of Pakistan in terms of economy, is crucial for the well-being of the state and its counterparts. 

Let’s move on to taking into account the exhibits mentioned in the case. From Exhibit 17 we can see that along with financial aid rising from economic crises, the United States has been a major aid donor to Pakistan, especially in the hour of need as well. In July 2010 Pakistan was hit by massive floods, approximately one-fifth of Pakistan's total land area was underwater. According to the Pakistani government, the floods directly affected about 20 million people, mostly by destruction of property, livelihood, and infrastructure, with a death toll of close to 2,000.

The US government has pledged more money toward this year's flood relief efforts in Pakistan than the country's own government, according to a report this month from the Congressional Research Service.

U.S. contributory foreign assistance to Pakistan for flood relief, in cash or in kind was 18.7%. U.S. was also the top donor to Pakistan by donating $571 million without any coated terms and conditions. The same year U.S. granted $1,215 million which is 72.8% of a total grant received by Pakistan the same year. 

In Exhibit 16, Pakistan has turned to IMF multiple times for financial aid. Over the decades, IMF has funded Pakistan, which has gripped the country in a vicious cycle of loans, interest, and debt repayment. 

In 2008, Pakistan struggled to avoid seeking IMF's help when the country was on the verge of default on its sovereign debt of about $4 billion. The Pakistani government was reluctant to accept this assistance for several reasons. First, there is a history of poor relations between Pakistan and the IMF. Secondly, relations between the Pakistani government and the IMF may have been further strained by reports that IMF applied pressure on the World Bank to cancel $300 million in aid to Pakistan. Lastly, the government was concerned that the conditions IMF would impose on the country would be disastrous for Pakistan, both economically and politically. 

However, when all other avenues failed, the Pakistani government approached the IMF to bail out the country in November 2008. The government reached an agreement with the IMF for $7.6 billion to be given as loans over the next 23 months. The repayment of this loan began in 2011 and is supposed to continue till 2015.

According to a recent article in Express Tribune, “Pakistan’s debt obligations have crossed all sustainable levels as according to the State Bank of Pakistan the country’s debt and liabilities have soared to Rs15.2 trillion, equal to 68% of the total size of the economy.”

It can be easily derived from these facts that turning to IMF for financial aid have significantly hindered Pakistan to invest in development projects, as repayment of the loan is its biggest liability.

In Exhibit 15, countering terrorism as a war of attrition proved to be a major liability for Pakistan which hindered its economic development. As per IMF, Pakistan’s anti-terrorist campaign following the Sep-11, 2001 attacks in the USA strained the government budget, since expenditures on law enforcement were significantly increased, thus eroding the resources for development in attrition. Numerous development projects were delayed and cost overruns were the result.

IMF also found that heightened uncertainty slowed economic activities, and created unease amongst foreign investors, thus bringing about an investment deficit & capital flight. There was massive unemployment, especially in the terror-prone regions of the country as bombing and attrition of law and order took a toll on the socio-economic fabric. The government estimated that the war cost the Pakistani economy around $8 billion a year in lost exports, foreign investment, industrial output & tax collection. This indirect cost remained the major portion of the total cost of the “war on terror” almost 75% – 80% of the total cost.

In exhibit 14, we acknowledge that Pakistan stood at the 7^th number among the top remittance-receiving countries in 2009. It received $8,701 million in the form of remittances in 2009. During 2008-2009 22.2% of remittances received by Pakistan were from Pakistanis living in the United States, and 21.6% from the United Arab Emirates. It’s interesting to compare that 5.4% of Pakistani emigrants shared this remittance. According to a recent article in Express Tribune: ‘Overseas Pakistanis remitted $1.65 billion in the first month of the current fiscal year, which is 17.45% higher than the amount ($1.4 billion) they remitted during the same month of 2013-14.’

In exhibit 12a, we understand that during the year 2008-2009, the trade deficit was the worst as low-value-added goods were exported as textiles and rice which were the major export items. Textiles included bedwear, knitwear, and cotton fabric.

To further worsen the situation, the trade deficit was affected by the import of high-value-added goods as natural resources including minerals, chemicals, and fuel lubricants comprising more than 50% of the total import followed by end products or manufactured goods, which served 10% of the total imports.

In exhibit 11b we see that Pakistan’s eye on debt throughout the decade remains evident and total debt increased gradually from 2000-2006 and worsened in 2008 & 2009. Almost 90% of the debt comprised of long-term debt, with a moderate and consistent share of short-term debt catering to the cash deficit of the country over the decade.

In 11a we witness that because Pakistan has been engulfed by a fluctuating economy right from its very independence, the only favorable cash-in-hand figure was seen from 2001 to 2003. The situation went worse in the proceeding years with little improvement seen in 2009 & 2010. Exports and imports show consistent increase and decrease respectively through 1995 – 2010. The ratio of export and import to GDP was as low as 31% in 2010. The trade deficit was moderate in early 2003 but significantly worsened later in the decade

Financing requirements remained minimum in 2008 when other economic indicators showed healthy signs too. Currency devaluations posed more payments for imports, the rupee lost almost half of its value between 1995 & 2002. Remittances from overseas Pakistanis relieved the current account deficit considerably relative to GDP.

In exhibit 8, we witness that the value added per worker in agriculture by Pakistan is significantly lower in comparison to countries like Egypt or Brazil, which are performing far better than Pakistan. Perhaps it's the meager technological know-how of equipment coupled with literacy and human development that has kept Pakistan’s value added per work at the same level of production at around $900 USD.

In exhibit 7 we can study the overall GDP growth in Pakistan from 1995-2010. We see phenomenal growth between the years 2004-2007 (7.4%, 7.6%, 6.2%, and 5.7% respectively). This GDP growth was a consequence of the Musharraf era, where there was significant increases in imports and exports, change in inventories remained steady, investments grew steadily, and private consumption was lowered as was government consumption. Musharraf’s rule saw a positive growth phase in Pakistan’s history, a military dictatorship was able to impress the GDP growth, and lower expenditures than a democratic government. It was only after 2008 did the GDP fell, and that too was a consequence of the war on terror and its impact on the Pakistani economy.

In exhibit 6, we can analyze the structure of the literacy and labor participation by gender. We see a glaringly low literacy rate among women with only 40% being considered literate, and 67% of men considered literate. In comparison to China, Pakistan’s regional neighbor where 70% of the adult women consists of labor force participation, in comparison to Pakistan’s meager 23% female labor force participation. This exhibit, therefore, depicts the need for development and education, in comparison to neighboring development indicators, Pakistan scores badly when it comes to human capital development.

In exhibit 4, countries are ranked on their ease of doing business. A high ranking on the ease of doing business index means the regulatory environment is more conducive to the starting and operation of a local firm. This index averages the country's percentile rankings on 10 topics, made up of a variety of indicators, giving equal weight to each topic. The World Bank (WB) and International Finance Corporation's flagship report Ease of Doing Business Index 2010 ranked Pakistan 85 among 181 countries around the globe. Pakistan came highest in South Asia and also was ranked higher than China and Russia which were at 133. The top five countries were Singapore, New Zealand, the United States, Hong Kong, and the United Kingdom.

The Government of Pakistan has granted numerous incentives to technology companies wishing to do business in Pakistan. A combination of decade-plus tax holidays, zero duties on computer imports, government incentives for venture capital, and a variety of programmers for subsidizing technical education, are intended there.

Exhibit 3 takes into account the size of the middle class by country in 2010. Economies with a largely middle-income bracket consist of countries like Malaysia, Thailand, and China whose 60%-75% of the population earns a middle-income salary, with Malaysia being the topper for the highest upper-middle income at 14.13%. In comparison, Pakistan has a middle-income bracket of 39.5%, superior to India’s 24.6%. Pakistan shows a promising future for middle-income growth, depending largely on human capital development and business opportunities. 

Exhibit 2 shows the global population break-up of the top 10 most populated countries. World's total population is 7.18 Billion. The top 3 countries in the world constitute around 40% of world's population. approximately 4.06 billion people live in these countries, representing around 58% of the world’s population as of April 2012. 4 out of the 7 billion people live in 10 of the 196 countries, with Pakistan taking up 2.70% of the world population.

Conclusion

From the American perspective, they face the core issue of having to spend billions of USD on financial aid to Pakistan, be it military or development. What is the benefit that American taxpayers are gaining out of it? A stable nuclear power curbing extremism? Perhaps it is in the favor of the USA to initiate development projects and curb illiteracy that may result in terrorism. The best way to help any country is to aid its educational development. Therefore, human development is the best option for the Americans. 

From Pakistan’s perspective, we have seen that the US has waged proxy wars through Pakistan’s military. From the cold war to the war on terror, the US had a significant interest in Pakistan being a frontline state in the war against terror. Did that benefit Pakistan? Drone attacks caused significant civilian deaths causing resentment and ill-will. However, the Pakistani military did not mind the US making use of its resources to follow through with its ground operations. 

What is in the best interest of Pakistan, to keep accepting aid? The recommended solution:

1. Rather than receiving development aid, it is a viable option for Pakistan and USA to concentrate on trade instead. Trade is better than aid, whereby there are no strings attached to trading. 
2. Taper off aid so that current development projects keep running, and then concentrate on trade deals and human development.

What is in the best interest of the US, to keep giving aid to Pakistan? The recommended solution:

1. It is in the US’s best interest to militarily aid Pakistan, to fight terrorists around the FATA, Afghan border so that another 9/11 can be avoided.
2. It is in the best interest of the US to financially aid the empowerment and education of women in Pakistan, because women are the nucleus of the family and can raise children that are not extremist orientated, thus raising female literacy and aiding human development in Pakistan is in US’s national interest.
3. It is in US’s best interest to spend American tax payer’s money on aiding countries like Pakistan, a fledgling democracy and an unstable nuclear state, for global protection and stability.

Disclaimer

*WAC analysis is based purely on the author's personal analysis of the HBR case for academic purposes. Give due reference if using the author's analysis as a source of information.