Finance and Industrial Policy in Unsuccessful Developmental States: The Case of Pakistan

Abstract

While a large body of research indicates that state‐directed finance worked for successful East Asian developers, the dominant assumption remains that countries with a weak state capacity, where corruption is rife, should not ‘try this at home’. In this article, that narrative is questioned through a case study of the role of the financial sector in Pakistan, which is widely considered to be a successful case of financial liberalization, contrasting the role of the publicly controlled financial system in the 1970s and 1980s with that of the liberalized financial system in the 2000s. Utilizing archival firm‐level and aggregate data, historic government documents, and interviews with policy makers, financial sector employees and industrialists, it is argued that in the Pakistani case, the withdrawal of state control over the financial sector led to a deterioration of outcomes. This resulted in the allocation of credit away from the productive sectors, namely industry and agriculture, towards unproductive sectors, for speculative purposes; and in the health of the financial sector not improving as expected, with non‐performing loans and corruption remaining a problem, and banks actually becoming a greater burden on government finances. This indicates that even states with weak capacity and flawed industrial policy may be better off with some degree of public control over finance.

Pakistan

“…Financial liberalization and deregulation began in 1988 under an IMF structural adjustment program (Janjua, 2003). DFIs and policy lending were phased out, and four of the five nationalized commercial banks were privatized with only National Bank of Pakistan (NBP) left in the public sector, entry restrictions on foreign banks relaxed, and bank licensing liberalized (Naqvi, 2018). Significant changes in the regulatory framework were also made.…”

“…By the mid-2000s, the financial sector was highly liberalized and almost completely privately owned (Naqvi, 2018). The new 'outward-oriented' development strategy envisioned a financial sector that was highly profitable and internationally competitive in order to contribute to GDP, and in particular to increase financial services exports (Government of Pakistan, 2007; International Trade Centre with Government of Pakistan, 2007).…”

“…Following a period of crisis while they were being privatized, the commercial banks became extremely profitable, especially between 2004 and 2007, and again after the financial crisis (see Figure 4.2). Although real-economy lending had fallen, the banks remained profitable through heavy investments in risk-free but highyielding government bonds (Naqvi, 2018).…”

Ethiopia's developmental state: A building stability framework assessment

“…12–13). Naqvi () argues that the success of the East Asian developmental states should not necessarily amount to adopting such systems, particularly where corruption is prevalent and government capacity is not strong. In this regard, there is overlap between the experience of the developmental state, as Naqvi () suggests, and the building stability framework, in that institutions require capacity and consent to be effective.…”

Significant Determiners of Greek Debt Crisis: A Comparative Analysis with Probit and MARS Approaches

“…The integration of national and international financial markets, which started after the Second World War and gained momentum after 1990, led to the emergence of financial crisis (Selvarajan et al, 2018;Ocampo, 2018). In the period when many developed and developing countries liberalized their financial systems and made their capital account open, there were extraordinary increases in the international movement of capital from one side to the other, and the long-term financial crisis arose (Naqvi, 2018;Özbay et al, 2011;Dinçer et al, 2019f). A new and broader literature has emerged recently in this framework, emphasizing the causes and solutions of these crises in developing countries and developed countries (Jha, 2019;Dinçer, 2015).…”