The author is the Director, Poverty and Social Policy Department, World Bank. The views expressed in this article are personal and do not represent those of the World Bank.

The revival of democracy in its undiluted form in 1988 had generated a sense of euphoria throughout the country. The expectations were high, hopes were rekindled for economic well being of general masses and a path to normalcy was envisioned. The situation today is nowhere close to those original expectations and there is a growing sense of resentment against the encroaching forces of privilege and patronage getting a firm hold on the economy. The authoritarian regimes devoid of legitimate political power, are, perforce, impelled to use the instruments of state power to win or maintain coalitions, build up new alliances or take coercive measures against recalcitrant individuals and groups. But why is that the democratically elected governments, brought to power by the popular mandate of a majority of the electorate, also persist in pursuing the same methods.

At least three principal reasons can be adduced to explain this behavioral pattern. First, the party in power wants to build a war chest for the next elections. Those vying for government permits, licenses, contracts, projects, purchases and imports are, in turn, asked to contribute to this war chest. It may be argued that, in absence of legally defined ways of raising campaign finance, recourse is made to this kind of financing. Second, aside from the party war chest, individual members also spend a fortune in winning the votes in their respective constituencies and would like to be reimbursed at least for the expenses incurred. The practice of allocating funds to the MNAs and the MPAs out of the development budget, initiated during the Zia regime, has not only been continued but reinforced by subsequent governments. Third, the discretionary powers of postings and transfers of government officials, sanctions of loans by the nationalized financial institutions, allotment of state and urban land, awards of contracts, permits for state enterprise products enjoying premium in the market and purchases from overseas are used strategically to return past political favors, win allegiances of key opponents, break up rival factions, or maintain partnerships within coalition governments.

The thesis of this paper is that although from a short term perspective all the above factors may appear attractive and justify economic decision making based on patronage but the medium term consequences of this policy are in fact inimical to the political survival of party in power. In other words, the economics of patronage is not only bad economics but also bad politics. Let me elaborate on this theme.

The economic consequences of decisions based on pure considerations of personal or party loyalty, partisanship, and kinship are well known, amply documented and better understood. But it is the political implications of these decisions which are seldom fully recognized. A few specific examples pertaining to our own situation will suffice to illustrate this point. Let us trace the impact on the economy of the loans that are made by the NBCs and DFIs not on the basis of the underlying viability of the project but simply

on the recommendations of political leadership. Both theory and history suggest that invariably most of these loans, unable to generate the cash flow streams required to service the debt, end up as non-performing assets. This then gets reflected in increased intermediation costs and consequently in an upward movement in the structure of lending rates well above the norm. The resulting hike in the interest rate structure and the rising wedge between deposit and lending rates will dampen demand for productive investment, divert financial savings into informal channels, increase speculative activities in the economy and lead to asset substitution. The intermediation costs are not only a function of the sheer weight of the non-performing assets in the portfolio but also of the quality of human resources in the financial institutions. If those entrusted with running these institutions are selected on the basis of their loyalty rather than professional competence , new recruitment at the entry level follows the same pattern and the number of employees with their perks and benefits is extended beyond justifiable limits the administrative cost component of the margin between deposit and lending rates peaks up reinforcing the tendency for financial disintermediation and raising the lending rates even higher making them unremunerative for productive purposes.

The more pronounced effect of the above phenomenon is the inability to tackle the budget deficit. The expanding domestic debt servicing obligations in the budget can be partially attributed to this interest rate hike caused by the non-performing assets and administrative cost components. The outstanding domestic debt obligations of the Federal Government is about Rs 800 billion. If a 3 percentage point reduction in interest rates can be effected by recovery of non-performing loans and lower administrative costs of the financial institutions, a saving of Rs 24 billion annually can be achieved. This is sufficient to reduce the budgetary deficit from 5.4 percent of GDP to an acceptable 4 percent. These lower deficits will diminish the borrowing requirements in the next period, cut down the debt service obligations and free up resources for development expenditure that, .if spent properly, will help economic growth and employment generation for the public at large.

What are the political costs and benefits of the above set of decisions? There are at least three different set of considerations that will impinge upon this calculus. First, a limited number of highly placed and connected individuals or influential persons from among the supporters of the party in power or friends of leadership will derive enormous benefits from loans granted to them. It is true that this small group of beneficiaries will remain beholden to the party and continue to support it and at the time of elections mobilize votes for the party. A few marginal constituencies may swing in their favor. But these gains are to be evaluated against the fact that this credit will not be used for productive activities, will probably be never repaid but used for ostentatious consumption. The large inflationary pressures generated by higher than optimum interest rates, stunting of productive investment and the perception that depositor funds belonging to thousands of small businesses and individuals are being misallocated for supporting ostentatious living standards of a privileged few will cause widespread resentment and dissatisfaction. A free and vocal press, not always favorably disposed towards those in power, will pick on these examples and disseminate them widely in the most sensational and at times exaggerated manner further hurting the political interests of the party and eroding its popular base. The recent history of electoral defeats of a large number of serving ministers of Junejo Cabinet in 1988, the defeat of Bhutto government in 1990 and the Nawaz government in 1993 cannot be dismissed simply in terms of the popular "conspiracy theory" rampant in the country. It is time for serious soul-searching and to concede that the general electorate of Pakistan, illiterate they may be, have become gradually more discerning and the urban electorate, in particular, exercise their right to vote fairly judiciously. The traditional sources of power in these constituencies are becoming weaker and the popular sentiment is beginning to play an important role in the determination of electoral choices. Keeping this group of vocal and articulate electorate satisfied with government policies should loom large in the calculations of political parties aspiring to capture or retain power. The drift towards religious parties witnessed recently in Algeria and Turkey, two of the most secularly minded states, is in fact a forewarning for those who neglect the aspirations of this segment of population.

Second, there is an additional invisible cost that is hardly recognized by the politicians. The "ripple" effect of the kind of transactions outlined above extends far beyond the direct actions of the political leaderships and permeates throughout the institution, multiplying in intensity. If I, as the head of the bank or DFI, have approved an unjustified loan at the behest of the " powers that be", why shouldn’t I do the same to oblige my own friends or ‘business associates’ or channel the funds to ‘dummy’ companies in which I and my family have holding interest. Similarly, if I have appointed 10 undeserving officers at the recommendation of the ‘higher ups’ why shouldn’t I appoint five officers of my own choice for some ’consideration’. The overall damage to the institution and the ensuing indiscipline in the financial sector is much wider than created by the initial request of the political leadership. Unfortunately, however, the entire blame accrues to the politicians while those functionaries who helped in magnifying the ripple effects continue to enjoy the benefits without bearing any costs. This mismatch between political benefits and costs does not always figure in the calculus of the politicians.

The third disadvantage of a patronage based system is that it gives rise to greater uncertainty, enhanced unpredictability and discontinuity in economic decision making. Empirical evidence from other developing countries strongly suggests that transparency, rule of law, accountability and credibility of policy making are all associated with good economic performance. A system based on "you show me the person and I will show you the law" is intrinsically hostile to the spread of the above attributes of good governance. Investors will shy away from such an environment, high risk premia will be charged and the transaction costs will rise creating loss of output and volatility in prices. The beneficiaries of the state patronage are, in all likelihood, not going to invest their " windfall gains" in the domestic economy but transfer their capital to the safe havens of the Swiss banks. The country suffers doubly--through capital flight and lower level of investment.

The above example of financial institution lending can be multiplied manifold and the consequences can be traced to arrive at broadly similar conclusions. If the appointments of Secretaries to the Government emanate from considerations other than merit it is no use for our political office holders to cry hoarse on poor implementation of government decisions, waste and inefficiency in government projects, rising rates of crime and weak detection and apprehension of criminals or indifferent delivery of services to the public at large. The energies of the government officials are concentrated mostly at keeping the small coterie of political heavyweights happy while ignoring the wider interests of the clients or the society they are supposed to serve.

Should the tax base remain fairly narrow because influential political supporters are spared the rod for evading taxes ,it is unreasonable to expect that the revenue targets will be met or budgetary deficits can be reduced on a sustained basis. The entire collection from urban property taxes in Pakistan is less than one percent of the market value of property in two posh areas of Karachi or Islamabad. Extracting more taxes from a fraction of existing tax payers in order to meet the revenue targets while providing exemptions to those who can well afford to pay these taxes will only exacerbate the plight of the fixed income salaried or wage earning group and alienate them further.

Leaving aside the widespread theft of electricity perpetuated in connivance with politically appointed functionaries the inability of WAPDA to recover the huge accounts receivable from well-connected individuals can only culminate in higher electricity tariffs. The hue and cry raised by the public at large against the recent surcharges on electric bills was both inevitable as well as understandable. The end result was further erosion of goodwill and popular support for the government party. The loss of competitiveness of Pakistani industries arising from these higher power tariffs is another story.

The unadulterated emphasis on loyalty or affiliation or allegiance or connection in public sector personnel management has deep-rooted deleterious effect on the economy in the long run too. The highly trained and well educated young men and women who can be selected on a system based on competition and fair play get disenchanted and either leave the country or are forced to accept jobs that do not make use of their expertise and skills. This is an enormous loss for a country with an already poor human development base. The signaling effect of this pernicious system of recruitment is that the younger people find it more advantageous to search for connections and sifarish rather than work hard and excel in their respective professions. Over time, the quality of public services will further deteriorate causing irreparable damage to the economy. Although this argument may not be persuasive for leaders who have a five year electoral cycle in mind but from a long run development perspective the effect of the present system of patronage is highly damaging.

It would be unrealistic and futile to expect that any political regime, once it assumes power, will do away with dispensations and favors to its supporters or desist from using discretion to build its political base. The client-patronage relationships characterizing our society, the fragility of the political system and the propensity for ever changing loyalty will never permit a complete switch from the present system of patronage to that based on pure merit and objectivity. The more pertinent but difficult question, in practical terms, is how to balance and dovetail the pressures of patronage and individual rewards with the imperatives of promoting a broad-based economic environment in which the majority of the population can benefit from growth, employment and price stability. At present, the tilt is too much on the side of patronage with adverse economic and political repercussions. There is a need to shift the balance in which the demands of the MPAs, MNAs, party officials are matched with the burgeoning demands of the population at large for security, jobs, schooling, health care, drinking water, electricity, etc.

To conclude, both major political parties should dispassionately recognize that the measures they take, while in power, to please or win the support of a limited number of individuals, however influential, may in fact turn out to be detrimental to their larger interests of political survival. The costs of the policy of appeasement of a narrow section of influentials are alienation of large segments of vocal population and far exceed the benefits. There is an inherent tension between the maximization of collective well being of the majority of the people and the well being of few select individuals. Like economics, there is no free lunch in politics too.