The puzzle of Pakistan's poverty

Religious fundamentalism isn't the whole story.

A map of Pakistan.

Religious fundamentalism in Pakistan has undoubtedly caused immense trouble for India, but it is not the only reason for Pakistan’s economic underperformance. Everyone already knows the damage fundamentalism does, who the culprits are, and what its effects have been. Endless ink has been spilled on it—I don’t intend to repeat the same. What puzzles me is that there are other fundamentalist states far richer than Pakistan.

Broadly speaking, most Indians remain surprisingly uninformed about Pakistan’s economic resilience. Understanding it better would be valuable. With that said, let’s begin.

GDP in current US$ for India and Pakistan. Source: World Bank

India’s economy has always been been larger than Pakistan’s since the late 1950s. That gives the impression that India has been richer than Pakistan. Looking purely at the size of the economy, that’s true. The graph above charts the Gross Domestic Product (GDP) of India and Pakistan since 1960. India’s economy has consistently been about 10x that of Pakistan since the 1950s¹.

However, total GDP isn’t the right comparison. More populous economies will usually produce more output. GDP per capita is the correct metric to consider. Until 2009, India was poorer than Pakistan on a per capita basis. India truly became richer than Pakistan after 2009 and since then it hasn’t looked back. If trends continue for a decade, India will be more than twice as rich as Pakistan soon.

Pakistan’s GDP per capita as a %age of India’s GDP per capita. Source: Financial Times.

Pakistan’s GDP is about $400 billion while India’s is around $4 trillion. Since the ratio of their economies has stayed roughly constant for decades, their nominal growth rates should be similar from the 1960s onwards.

So why has India pulled ahead in GDP per capita? The reason is simple. Pakistan’s high fertility has driven population growth faster than India’s. In 1952 Pakistan had about one-tenth of India’s population; by 2025 it had grown to nearly one-seventh.

Pakistan and India’s fertility rate over the decades.

There’s a common belief that India is vastly richer than Pakistan. The notion is endlessly reinforced by the proclaiming of India as the world’s fourth-largest economy. So it comes as a surprise to see the numbers show India isn’t that far ahead. Part of the reason is media sensationalism: media outlets trip over themselves at portraying Pakistan as a failed state, exaggerating its poverty and dysfunction. The religious fundamentalism at display in the country further reinforces the belief that its economy must be dysfunctional.

Another culprit is the laziness of statistics. Simple metrics fail to capture the real gap between the two countries. A good metric to see the difference between the two countries is to use GDP at Purchasing Power Parity (PPP). Nominal GDP is useful to understand the purchasing of a country and its citizens internationally. Goods like iPhones, laptops and television sets are traded across borders and they’ll be available at similar prices across the globe. Nominal GDP per capita tells you how much stuff people could buy that’s produced and traded across borders.

But PPP is a way of measuring how much people can buy in their own country. A dollar buys much more goods and services in India than the US. Haircuts in the US are probably five times as expensive as in India. But a haircut doesn’t noticeably change because its more expensive in the US than India. You’d like to know how many such goods and services can a country’s residents afford. And that’s where the disparity among India and Pakistan rises. India’s GDP (PPP) per capita in almost twice that of Pakistan. Among other things, it means that:

1. India’s citizens can purchase a bigger basket of goods and services locally than what differences in GDP per capita would suggest.

2. India’s currency could be slightly undervalued, but Pakistan’s currency is overvalued.

3. India’s consumption is mostly supported by domestic output, whereas Pakistan’s consumption is likely being inflated by cheap imports.

India’s GDP per capita (PPP) is almost twice that of Pakistan.

By now, I hope it is clear that while Pakistan is significantly poorer than India, it isn’t that much poorer. The difference is structurally significant, but it isn’t comparable to the difference between, say, India and the US.

The cultural zeitgeist that Pakistan is a poor and supposedly failed state primarily due to its religious fundamentalism. That perception is buttressed by the fact that Afghanistan is also a failed state with the Taliban currently in power. But Pakistan was pretty much neck and neck with India until about 2010. The 2008 financial crisis hit Pakistan’s exports and India pulled ahead. If the crisis had not happened, it might have taken a couple more years for India to pull ahead of Pakistan.

Furthermore, Bangladesh’s per capita GDP was almost the same as India, until student protests took out Sheikh Hasina’s government. Bangladesh has the same religious fundamentalist elements as Pakistan, though not to the same extent. There is a section in Bangladesh that’s always been hostile to the partition from Pakistan. So if Bangladesh shares the same fundamentalism as Pakistan, why isn’t it poorer? It isn’t the case that fundamentalist elements have only recently resurged. In the 1971 liberation war, Hindus were specifically targeted. The Vested Property Act confiscated the properties of those Hindus that fled to India as refugees during the war. There were various instances of violence in the 1980s and 1990s against Hindus, as retaliation for the Ram Mandir-Babri Masjid dispute. So while fundamentalism exists, Bangladeshi fundamentalists haven’t dragged down as much growth as their Pakistani counterparts.

India, Iran and Turkey GDP per capita.

Iran and Turkey are the other counter-arguments to the claim that Pakistan is poor because of religious fundamentalism. The graph from Our World In Data (OWID) shows that Iran’s GDP per capita is twice that of India. Turkey is seven times as rich as India. Both these countries have had fundamentalist movements. To be fair, the Iranian Revolution was more fundamentalist than Turkey’s election of Erdogan.

Iran was actually richer than Turkey until the 1979 revolution. Did Iran become poorer after the revolution? If so, that would indicate a particular causation. That becoming fundamentalist does cause economic underperformance. That doesn’t hold in Iran’s case though. Iran’s economy takes a sharp dive in 1976-77 and that’s reflected in the graph above. Oil revenues plunged in 1976, erasing billions of dollars of revenues and the shortfall created a budget deficit. Inflation arrived soon after which made Iran a fertile ground for revolution.

The Shah of Iran implemented an anti-profiteering drive against merchants and jailed many of them. In their desperation, they turned to a man they didn’t fully understand². The alliance between the merchants and the clergy — known as the bazaar-clergy alliance — mobilized the general public and precipitated the 1979 revolution. Iran’s economy actually stabilized after the revolution and it’s grown slowly since then.

The fact that Iran couldn’t reach the prosperity of the mid-1970s would’ve been a great indictment of fundamentalism being a death knell to economic growth. But there’s confounder here in the form of US sanctions. After 1979, the US has placed various sanctions on the Iranian economy. It’s estimated that without these sanctions, Iran’s economy could have been 20% bigger³. When the US briefly lifted sanctions from 2016-2018, Iran achieved a 7% GDP growth rate⁴.

The other set of comparison countries are the Gulf Cooperation Council (GCC) countries — Saudi Arabia, UAE, Qatar, Kuwait, Bahrain and Oman. The comparison is obviously because of the prominence of Islam as state religion. Saudi Arabia was the epicenter of religious fundamentalism with Wahhabism taking over the country. Kuwait’s parliament became dominated by MPs trying to Islamize Kuwaiti society. They were trying to push gender segregation in education, ban alcohol and limit citizenship to Muslims only.

The UAE has been the most secular of the lot. In the past decade, Saudi Arabia is reforming education to counter extremism. It has also stripped the religious police of many of its powers. Bahrain is pretty liberal, allowing alcohol and nightclubs to exist. As far as I understand, Oman is religiously conservative in some ways and liberal in others.

The important point is that many extremists still exist in these countries. Their hold over politics was strong a few decades ago, but it is waning now. Simultaneously, these countries have managed to become rich off their oil resources. They’ve also maintained stable polities without the usual instability seen in Pakistan.

Comparing these countries to Pakistan raises another important question: If these countries were able to get rid of their fundamentalists, why wasn’t Pakistan able to do the same? This is orthogonal to the question of why Pakistan is poor, but still an important question that needs to be answered.

Even military dominance of the economy isn’t a satisfactory answer to Pakistan’s poverty. Both Egypt and Algeria have militaries that dominate their economies. Like Pakistan, the military owns enterprises and has its own sources of revenues. Joining the military is a lucrative career.

In Egypt, the military influences cement, construction, food processing and retail sectors. Algerian military has an outsized influence in oil and gas, weapons manufacturing and procurement and banking. Yet, Egypt and Algeria are far richer than Pakistan.

Sri Lanka has had a Buddhist-Tamil civil war and yet it is richer than Pakistan. The island nation also had its Buddhist fundamentalists that tried to influence policy. So it isn’t as if religious fundamentalists hold back growth.

The Economic Freedom Index vs GDP per capita. Source: Fraser Institute.

Pakistan’s economic freedom.

Of course, there’s an unsatisfactory answer that we have. More economic freedom leads to more prosperity, and Pakistan ranks as one of the most economically repressed countries. It’s score is 49.1 and it ranks at 150 out of 184 countries. For reference, India’s score is 53 and its rank is 128⁵.

The Economic Freedom Index (EFI) basically tries to quantify how much a country gets out of the way of its own economy. It measures things like property rights, contract enforcement, regulatory burden, openness to trade and ease of doing business among others. High scores mean that governments set rules⁶ and then let markets do their thing. Low score mean that governments like to micromanage or extract rents. The index also explains why some countries with similar starting points diverge sharply. It isn’t about privatization or low taxes, but whether the rules of the game are predictable.

So why is this answer unsatisfactory? That just pushes the question one step higher. Going up the ranks of the EFI is possible through carrying out reforms. India and Pakistan inherited similar colonial structures from the British. Why was India able to coordinate an elite consensus to carry out various reforms across its independent history, but Pakistan wasn’t?

India has faced various crises over the years. I’ll list three major ones.

1. India faced its first crisis in 1957. Heavy industrialization required massive imports of capital goods while exports didn’t grow commensurately. Import bill ballooned and forex reserves were depleted. There weren’t any reforms, but the government responded by closing the economy and using import licensing.

2. The second balance of payments crisis occurred in 1966. As a result, it had to devalue its currency by 57% from INR 4.76 to INR 7.5 per dollar. That boosted exports and solved the forex crisis.

3. The 1991 balance of payments crisis is the most famous. Prime Minister PV Narasimha Rao took the opportunity to ram through the most impactful reforms in its wake. It also helped that India had taken an IMF loan and one of the conditions was pushing through the recommended IMF reforms.

These were possible only by using external conditions as a shield to carry out stealth reforms. Reforms change the structure of the economy and create new winners and losers. Elites tend to resist change because they wouldn’t want to lose the rents they collect through the current configuration.

Since 1958, Pakistan has gone through 23 IMF programs. Since 2010, Pakistan has gone through four IMF programs where it has received more than $12B. IMF programs usually come with a rider for pushing reforms through, but successive Pakistani governments have failed to implement them. The crucial question is this: if India could implement significant reforms by having to approach the IMF just once, why can’t Pakistan?

Unfortunately, I don’t think I have the complete answer to the puzzle. However, I do have two partial explanations. They don’t add up to a complete explanation, but they do help with visualizing the broader picture.

Let’s understand why reforms take place. I find the concept of stationary bandits to be illuminating here. Before the formation of states, roving bandits could plunder produce and move on to the next settlement to rob. But if a group of roving bandits decides to stay at the settlement, plundering a portion of the wealth of the group for providing security and prosperity, then it is beneficial for the robbers too. These people are called “stationary bandits” and they’re a useful lens to view modern states.

Through this lens, reforms can be understood as way to extract maximum rents over time. If productivity improves, the state generates more wealth and the bandits can extract more wealth at the same levels of taxation. If the citizenry take to protests, threatening the elites survival, reforms will be undertaken to reduce the pressure from below.

Pakistan’s military is the stationary bandit. The military-bureaucratic complex dominates the state and the economy. Rent extraction occurs via taxation, government contracts, land and regulatory privileges. Reforms are a threat to this rent extraction. Even if the economy grows faster, elites lose control of the economy and privileges. For the military to consider reform, the population must rise and protest, threatening to make rent extraction unsustainable.

This is where Pakistan has a few things going for it. I’ll quote Atif Mian — a Pakistani-American economist — directly here:

When remittances are as large as they are for Pakistan, their macroeconomic effects cannot be ignored. First, they raise consumption and spending power faster than the economy’s own productive capacity. Second, the steady inflow of dollars tends to appreciate the rupee in real terms, which disproportionately hurts the more productive, export-oriented tradable sector. Together, these forces make the country “more expensive” than its productivity justifies — the classic pattern economists call Dutch disease.

Pakistan’s macro trends strongly suggest that these negative remittance effects have been at play. The export sector has steadily weakened as remittances have become more dominant. The exchange rate has been overvalued for long periods. And Pakistan’s investment-to-GDP ratio is strikingly low—implying an unusually high consumption-to-GDP ratio—compared with other countries at a similar income level.

Remittances as a % of GDP. Source: Our World in Data.

Pakistan’s monetary and state policy artificially props up the rupee making imports cheaper and subsidizing imports. The casualty is that exports become uncompetitive. Consequently, the share of investment in it goes down. Pakistan has among the lowest rates of investment in the subcontinent.

Investments are important because they are the stock of things that will generate wealth in the future. For a country, those are things like highways, airports and other infrastructure. For private companies, they could be things like new machines or computers or new productivity software that would help generate more revenue over multiple years. Because consumption is subsidized, the citizenry is relatively placated and doesn’t rise up in protest much. That removes an important reform impetus.

Private Investment as a % of GDP. Source: IMF.

The other explanation why Pakistan finds it easier to maintain the status quo is that it is located in a geopolitically sweet spot. It can extract geopolitical rents from the US. It’s location close to Afghanistan is strategically important and the US has used many Pakistani airbase.

During the Cold War, it received military aid and weapons. Post 9/11, during the War on Terror, it received billions in economic assistance and reimbursements for counter-terror operations. The GCC countries subsidize Pakistan with concessional financing. China-Pakistan Economic Corridor (CPEC) allows China access to the Gwadar port and that results in investments and financing on favorable terms. IMF loans also come with politically palatable conditions. The World Bank also prioritizes Pakistan’s projects due to its strategic location.

These semi-regular injections of foreign currency keep the Pakistani currency afloat, subsidize consumption and alleviate pressure to reform.

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As I said earlier, these explanations aren’t completely satisfactory. There are many states that face pressures to reform and eventually manage to build enough consensus to get them through. Inability to do that results in states violently fracturing, especially if elites cannot come to a consensus⁷. The fact that Pakistan has managed to stave off bad outcomes and has (mostly) kept up with India is astonishing.

Eventually, the piper needs to be paid. Pakistan’s exports are predominantly textiles with some agricultural and raw material exports thrown in there. That’s not enough to earn enough foreign exchange to stabilize the currency and it needs to earn more. However, depending on how geopolitically useful the US finds Pakistan, the rentier state could survive for quite some time.

My biggest fear is that if Pakistan continues to drive itself into poverty, there would be a huge refugee crisis on India’s western borders. That’s not in anyone’s interests.

1. Here’s a log scale graph that makes it easier to visualize the constant difference between the size of the Indian economy and that of Pakistan.

2. Yes, this is a Batman: The Dark Knight reference.

3. The exact figure can be found on page 67 of the linked document.

4. The exact growth rate can be found on page 67 of the linked document.

5. India’s score isn’t great, but it seems to be on the correct trend line.

6. Via pro-market and not pro-business reforms.

7. Somaliland is the most recent example. Yugoslavia is another great example.