Strong investment, both in private and public sectors, is critical for sustaining growth and reducing poverty. While private investment is the key driver of economic activity, public investment for human resource and infrastructure development is also essential for enhancing productivity and competitiveness.
As compared to many emerging economies, Pakistan has suffered from a relatively low level and quality of public spending, resulting in social and infrastructure deficit. On the one hand, given large outlays on debt service and defence, resource availability for human and infrastructure development has remained constricted, while on the other, inefficient use of public resources and rampant malpractices have led to sub-optimal outcomes.
The main challenge, therefore, is to create additional fiscal space, reorient public expenditure priorities, and enhance the effectiveness of public spending. This article seeks to undertake a review of public expenditure trends, issues and reforms. The table below gives the ratio of key public expenditure aggregates to GDP since 1980. It shows that total public expenditure averaged around 25 per cent of GDP for most part of the 1980s and early 1990s but has declined since 1993-94 (22.2 per cent during 1995-2000) to the level of 17.9 per cent during 2000-07.
Current expenditure increased from 14.5 of GDP in 1977-7 8 to 17.6 per cent during the1980s to 19.4 per cent during the 1990s but declined to an average level of 14.6 per cent during 2000-07.
Development expenditure scaled down from 8.7 per cent of GDP in 1977-78 to 7.3 per cent during the 1980s to 5.8 per cent during 1990-95 to 3.6 per cent during 1995-2000 (average of 4.7 per cent during the 1990s) to 3.3 per cent during 2000-07. It has, however, doubled since 2000-01 from a level of 2.1 of GDP to 4.2 per cent in 2000-07.
Defence expenditure declined from 6.5 per cent of GDP during the 1980s to 5.6 per cent during the 1990s to 3.2 per cent during 2000-07. Debt service increased from 3.8 per cent of GDP during the 1980s to 6.8 per cent during the 1990s but declined to 4.5 per cent during 2000-07. Defence and debt service together accounted for 10.13 per cent of GDP during the 1980s, 12.4 during the 1990s and 7.7 per cent during 2000-07.
Until 1994-95, defence expenditure remained the largest single item of current expenditure, but has been surpassed by interest payments since 1995-96. The recent reduction in interest payments has provided additional fiscal space – defined as non-defence and non-interest expenditure – for social sector and development spending. The fiscal space has increased from 8.4 of GDP in 2000-01 to 12.1 per cent in 2006-07.
Pakistan has gone through a virtuous cycle of policy reforms and good outcomes in recent years, characterised by high growth, reduced poverty and improved human development indicators. What makes this achievement even more remarkable is that a prudent fiscal stance has been maintained, marked by substantial reduction in fiscal deficit and public debt as well as acceleration of the privatisation process.
Although the track record of fiscal prudence in recent years is quite impressive, there is a need for careful handling of the emerging fiscal risks. These include a widening of the current account deficit, build-up of quasi-fiscal deficits with public sector entities and massive planned outlays on infrastructure projects. All these developments will in due course test the limits of fiscal sustainability.
In the context of the financial losses of state-owned enterprises, the power sector requires special focus. Specific measures such as raising the average tariff, strengthening bill collection, and reducing technical losses would improve performance in the short-run, although fundamental energy sector reforms are required. The cost of public borrowing should be further reduced through prudent debt management. These measures are necessary for enlarging the resource envelope for productive public expenditures.
A major structural measure adopted by the government is rule-based fiscal policy as a means to ensure prolonged commitment to financial discipline. The Fiscal Responsibility and Debt Limitation Act 2005 prescribes ceilings for fiscal deficit and borrowing, floors on social sector and poverty-related expenditures, and other measures of financial disclosure and transparency.
There is no doubt that discretionary fiscal policy can achieve the same outcomes as fiscal rules and should in theory be superior as it allows greater flexibility. However, that is not always the case in practice as discretionary fiscal policy has an inherent deficit bias. In essence, this law provides for parliamentary oversight of major indicators of fiscal performance and adjustments in line with new ground realities can always be made with the approval of the Parliament.
Another major area where significant progress has been made is privatisation. This has not only helped contain the financial losses incurred by inefficient public sector enterprises but also reflects the new thinking about the role of the state. It is increasingly felt that governments should pull out of commercial and industrial operations and focus on their role as enabler, facilitator and regulator. In line with this governance paradigm, there is a need to further accelerate the privatisation process and at the same time strengthen the regulatory framework that enables the government to effectively intervene in case of market failure.
Creation of adequate fiscal space is a necessary but not sufficient condition of ensuring the desired outcomes. There is a need for reorienting public expenditure priorities to enhance allocative efficiency. The focus on human development, which is the corner-stone of the knowledge economy, should continue through increased allocations for education and health, incentive programmes to stimulate demand for education and building public-private partnerships in remote and under-served area. Enhancement of agricultural productivity through accelerated development of water resources should also receive the highest priority.
The adoption of Poverty Reduction Strategy Paper (PRSP) and Medium-Term Development Framework (MTDF) have helped align sectoral allocations with development priorities. Building on the progress achieved thus far and the lessons learnt through pilots on Medium-Term Budgetary Framework (MTBF), serious and diligent work is required to graduate from a single-year incremental budgeting to a medium-term performance-related framework, based upon sector strategies and hard budget constraints, integration of current and development expenditure, and balance between creation of new public assets and maintenance of the existing ones.
While all this is necessary to maximise the development impact of public expenditure, the major thrust of reform should be on increasing efficiency in the use of public resources. The effectiveness of public expenditure is quite low as compared to other emerging economies. Cross-country experience shows that additional resource availability can in fact lead to waste and misuse if absorptive capacity and institutional mechanisms for effective implementation are absent or weak.
The main challenge facing expenditure reform, therefore, is institutional development through improved governance, implementation capacity, financial management, and accountability at all levels. There are serious issues in public sector management. However, strategic interventions through civil service reform, focused on merit-based selection processes, improving the incentives structure and transparent accountability, would be necessary to effect a change.
