NS3041

1
The Afghan Economy I History and Key Issues

• NS3041
• October 2008
  
• Dr. Robert E. Looney
• relooney_at_nps.edu

2
Outline I

• Introduction
• Importance of Understanding the Afghani Economy
• The Pre-2001 Economy
• General Characteristics of the Pre-war Economy
• Effects of the Soviet Occupation
• Developments in the Post-Soviet Period
• Destruction Caused by the Conflict
• Changes Brought on by the Taliban
• The Post-2001 Economy -- Overview
• Economy after the Fall of the Taliban
• Economic Consequences of Conflict
• Break

3
Outline II

• Economic Strategy Considerations
• Key Development Objectives and Priorities
• Development Obstacles and Strengths
• Building on Economic Positives
• Economic Performance
• Difficulties in Evaluating Performance
• Recent Macroeconomic Performance
• Growth
• Inflation
• Agriculture
• Recent Sector Trends

4
Outline III

• Macroeconomic Assessment
• Unemployment
• Poverty
• The Working Poor
• The Budget
• Fiscal Vulnerability
• Debt
• Afghani Opinions
• Break

5
Outline IV

• Policy Assessment
• Economic Management
• Development Management
• Sector Policies and Performance
• Governance Issues
• Problems of Corruption
• Over-all Assessment
• Difficulties in Evaluating Progress to Date
• The Future Key Variables

6
Introduction

• Understanding Afghanistan's economy is central
  to
• Explaining the staying power of the Taliban
• Designing efficient reconstruction strategies
• Identifying projects and investments at the local
  level
• Creating the foundation for a viable
  self-sustaining economy
• Incorporating the countrys diverse populations
  into a modern nation-state
• Economic factors, like access to jobs and a
  better quality of life are vitally important, and
  will most likely become more so, in determining
  the outcome of the current conflict and the
  countrys overall future.

7
The Pre-Soviet Economy

• Before the Soviet invasion in 1979, Afghanistan's
  economy was largely based on rural subsistence,
  with a small, urban sector that was dependent on
  the state
• About 85 of the population belonged to the rural
  subsistence economy
• As late as 1972, the cash economy accounted for
  less than half of GDP
• Government expenditure constituted less than 10
  of GDP, and foreign aid accounted for over 40 of
  the budget in the 1960s
• When aid declined, it was replaced by exports of
  natural gas from northern Afghanistan to the
  Soviet Union
• The private sector was largely confined to trade
• The urban sector relied on government
  redistribution, and the government controlled
  most urban employment

8
Period of Soviet Occupation

• During the Soviet occupation, from 1979 to 1989
• The rural economy was destroyed as the
  counterinsurgency battled Soviet forces
• Food production fell by one-half to two-thirds.
• Afghanis became increasingly dependent on
  humanitarian aid for subsistence
• As traditional elites lost of their control over
  resources, their power and ability to provide
  protection weakened
• Large numbers of Afghanis were displaced
• Forced urbanization occurred as many fled to
  Afghan cities.
• Millions of mainly rural refugees out-migrated to
  camps and cities in Pakistan and Iran, and
  refugee-warrior communities arose
• Together, these factors led to the development of
  a culture of dependency

9
The Post-Soviet Period I

• After the Soviet withdrawal, the commanders
  became Afghanistan's main economic actors
• The commanders were essentially warlords drawn
  from a new elite that benefitted from U.S.,
  Pakistani and Saudi support
• As Soviet revenues declined, the commanders
  pursued economic strategies to increase their
  power, wealth and autonomy
• They established bazaars and provided local
  security to traders in return for tribute
• They also sought external aid which, in turn,
  increased resources under their control
• The war-related destruction of agriculture
  created tremendous incentives for shadow-economy
  activities, like consumer goods smuggling and
  opium growing
• A fragmentation of the country as Afghan regions
  integrated into neighboring foreign markets,
  rather than into a national market

10
The Post-Soviet Period II

• To counter the commanders' power, the government
  embarked on a program of national reconciliation
  that greatly increased government expenditures
• The program enlarged local security forces
• It offered subsidies to defecting commanders
• The program's end-result was to greatly increase
  the population's dependence on the state
• Government expenditures increased despite a
  decline in Soviet aid and a fall in gas revenues
  created by poor maintenance and the exodus of
  Soviet technicians.
• The government financed the resulting deficit by
  printing money
• From 1987-1992, the money supply increased by 45
  per year
• The result was rapid inflation.

11
Rise of the Taliban

• The rise of the Taliban was facilitated by
• Years of war that devastated communities and
  institutions and destroyed much of Afghanistans
  social capital -- trust
• The prevalence of predatory economic activities
  that reflected the fragmentation of social and
  economic power
• The relatively limited number of organized
  groups.
• Among the best-organized groups were the rural
  religious ulama, who continued to teach or study
  in madrasas largely funded by Pakistanis and
  Saudis
• Links among madrasa students and teachers
  provided an effective form of social capital
• Shared madrasa experience superseded tribal
  affiliations
• Religious linkages provided the impetus to
  overcome warlordism and corruption
• External aid from Pakistan and Saudi Arabia
  (until June 1998) provided the Taliban with
  training, technology (weapons) and financial
  support

12
The Economy under the Taliban

• The Taliban economy was a war economy comprised
  largely of the transit trade, the drug trade, the
  gem trade, and the businesses that serviced them
• Foreign exchange earned by exports financed
  Afghanistans imports of arms as well as food and
  other necessities.
• The Taliban controlled the transit trade
• The transit trade involved the smuggling of duty
  free goods from Dubai to Pakistan
• At 2.5 billion in 1997, it accounted for half of
  Afghanistans GDP.
• In the north, Massoud controlled the gem trade
• Opium production and trade expanded in regions
  controlled by both sides.
• In 1999 the Taliban areas produced 97 of
  Afghanistans poppies.

13
The Economy in 2001 Overview

• In 2001, Afghanistan had what can best be
  described as a "survival economy"
• The economy was devastated from more than 20
  years of war, during which the Soviet occupation
  giving way to warlord conflicts and, then, to the
  rise of the Taliban
• Over a million had died in a country of 26
  million, and the number of disabled was
  proportionally among the worlds highest
• The long period of conflict destroyed most of the
  country's limited pre-war economic institutions
  resulting in abject poverty
• Economic stagnation, accompanied by severe
  fluctuations, resulted in little or no growth in
  real GDP from the late 1970s
• Illicit and conflict-related economic activities
  and behavior patterns were entrenched.
• Afghanistan was the leading producer of opium,
  controlling 75 of world production in 1999.

14
Economic Consequences of Conflict I

• As a result of warfare and state collapse,
  Afghanistans economy is largely dominated by the
  informal sector
• The informal sector makes up 80-90 of total GDP,
  when opium is included
• The informal economy encompasses a wide spectrum
  of activities, from those that are fully legal to
  some that are illicit in they way they are
  conducted to others which are outright illegal.
• Not only is the informal sector dominant in
  agriculture, but it is also very important in
  mining, manufacturing, construction, trade and
  infrastructure
• The large informal sector reflects the lack of
  basic rule of law and the poor investment climate
  that resulted from state erosion and loss of
  capacity
• Infrastructural and financial constraints, as
  well as insecurity, contribute to the size of the
  informal economy

15
Estimates of the Informal Economy
16
Economic Consequences of Conflict II

• The informal sector is dynamic and plays an
  important role in absorbing excess labor but it
  does not provide a solid foundation for future
  economic growth and employment generation.
• It is not conducive to technological
  modernization and improved productivity
• Incentives to invest in training are limited
• The size of business enterprises tends to be
  severely constrained
• Sustained export generation is hard to achieve
  because of the difficulty in meeting quality
  standards, getting around non-tariff barriers,
  obtaining insurance, etc.
• The learning-by-doing associated with formal
  sector activities does not occur, nor is there
  strong demand for modern business services

17
Economic Consequences of Conflict III

• Education levels are extremely low due to the
  conflict and underinvestment in education.
• Only 28.1 percent of Afghans are literate.
• Many classified as literate can read and write
  only at the second or third grade level.
• The majority of teachers in Afghanistan have
  educational levels equivalent to ninth-to-twelfth
  grade in the United States.
• Although more than 3,500 schools have been
  established, only 40 percent of students have
  actual buildings in which to meet.
• Thousands of communities have no easy access to
  schools, causing parents to send their children
  to madrasas in Pakistan, where Islamic
  fundamentalism is a focus.
• Approximately 30,000 to 40,000 students graduate
  from high school every year, but only one-third
  are admitted to universities due to a lack of
  university capacity.

18
Economic Consequences of Conflict IV

• Over the years Afghan conflicts have driven
  millions from the country.
• Since early 2002, nearly four million have
  voluntarily returned to Afghanistan, placing an
  added strain on resources.
• Currently there are about three million living in
  neighboring countries
• Pakistan 2,000,000
• Iran 910,000
• Other 90,000.
• Presently Iran and Pakistan are forcefully
  evicting refugees, many of whom have lived there
  for up to three decades
• With violence at record levels and basic services
  already overwhelmed, large numbers of returning
  Afghanis are creating another source of
  instability.

19
Afghan Refugees Voluntarily Repatriated
Afghan Index Tracking Variables of
Reconstruction Security in Post-9/11
Afghanistan, Brookings Institution September 23,
2008, p. 17.
20
Returning Refugees
21
Economic Consequences of Conflict V

• In sum, Afghanistans human capital has been
  severely depleted by
• Destruction (deaths and injuries).
• Displacement (flight of refugees and émigrés)
• Extremely low investment in human capital during
  the last 30 years.
• As a consequence,
• The high demand for some forms of labor does not
  seem to translate into sustained high employment
  growth, but rather into high wage rates which
  even attract skilled labor from neighboring
  countries
• The shortfall in human capital is manifested
  strikingly in Afghanistan's weak government
  capacity. Although structures and civil servants
  are in place, government effectiveness is
  limited.

22
Economic Consequences of Conflict VI

• The country also appears to have a number of
  misaligned markets in particular an overly
  strong exchange rate -- the Dutch Disease
• The exchange rate reflects large inflows of drug
  proceeds, aid, and possibly remittances, as well
  as a scarcity of literate, trained and
  professionally qualified labor
• Wages for skilled and professional labor are
  high, and unskilled wages are driven up by the
  labor-intensive opium economy
• With domestic inflation running higher than
  global inflation and the exchange rate holding
  steady against the US dollar, Afghanistans
  currency has been appreciating in real terms
• International experience suggests that chronic
  overvaluation of the exchange rate is not good
  for sustained economic growth.

23
Economic Consequences of Conflict VII

• Investment climate surveys (2005) indicate that
  the main concerns of formal sector firms are
• Access to land, electricity and finance together
  with corruption are the most important
  constraints to their activities.
• Insecurity and lack of rule of law also seen as
  major constraints deterring many investors from
  setting up formal-sector business in the first
  place.
• Weak state capacity and poor rule of law combine
  with the large informal economy to create an
  informal equilibrium
• In this equilibrium, incentives to develop formal
  sector businesses are weak and incentives to
  remain in the informal economy strong
• Breaking out of this vicious circle is a critical
  element of the overall development agenda,
  necessary for sustained growth of the formal
  sector and the associated growth in employment

24
The Informal Equilibrium
Source World Bank, Responding to Afghanistans
Development Challenge, October 2007, p. iv
25
Economic Consequences of Conflict Summary

• Deficient human capital, Dutch Disease, poor
  investment climate, opium dominance and the large
  informal sector prevent Afghanistan's economy
  from producing a sustainable gross domestic
  product with strong growth and export potential
• Past export markets have been eroded, lost, or
  have shifted to the informal sector, with its
  lower levels of quality and value
• Import substitution has been occurring to a much
  more limited extent than might have been
  expected, given the high demand for imports of
  goods that were formerly produced in Afghanistan
• Overall, Afghanistan's is a high-cost, high-risk
  economy for investment, employment and growth in
  the formal sector
• Expansion of the formal sector has been more
  limited than the overall growth of the economy
  would imply

26
Questions? -- Break

• Questions?
• Next
• Economic Strategy Considerations
• Development Objectives
• Economic Performance to Date.
• Afghani Perceptions of the Economy

27
Economic Strategy Considerations I

• Afghanistan was one of the poorest and most
  economically backward countries even before the
  Soviet invasion plunged it into decades of
  warfare
• The pre-war Afghan state had only a veneer of
  modernity
• It did not reach much beyond Kabul and a few
  other cities
• It was oriented toward keeping the peace and
  maintaining order rather than toward the economic
  and social betterment of the population
• The pre-war Afghan economy could not have served
  as a springboard for economic development
• It was largely traditional, with exports limited
  to items such as dried fruits and nuts and
  carpets.
• It lacked fiscal self-sufficiency and required
  foreign aid to finance its public investments
• Its dependence on aid rose out of a long history
  of relying on external resources, such as
  payments from British Empire, etc.

28
Economic Strategy Considerations II

• Changes in the world economy since the 1970s make
  it impossible for Afghanistan simply to return to
  its pre-Soviet economy
• There are new constraints on agricultural trade,
  such as non-tariff barriers and international
  quality standards
• The communications revolution has increased
  Afghani awareness of other areas of the world
• Improvements in transportation and an
  increasingly globalized economy have dramatically
  changed the conditions of trade
• As a result, any reconstruction program must
  address underdevelopment and not simply focus on
  the restoration of the pre-conflict status quo
• Reconstruction without development risks renewed
  conflict and an escalation in terrorist
  activities

29
Economic Strategy I

• To overcome the many conflict-related problems
  built up over the years and to combat the
  insurgency, the U.S. has stressed an economic
  strategy centered on four main areas
• Embracing free market economic policy at senior
  levels of government
• Enhancing government resources
• Addressing inflation
• Implementing structural reforms
• Commitment to free markets means resisting costly
  subsidies and price controls that serve to reduce
  resources for other, more constructive
  expenditures in areas like infrastructure,
  education, and healthcare.

30
Economic Strategy II

• The U.S. and international community efforts are
  assisting the Afghan government in moving towards
  a sustainable fiscal policy capable of generating
  revenue, managing resources and operating without
  foreign financial support.
• The international community is also trying to
  enhance economic growth by modernizing the
  countrys infrastructure, particularly in the
  areas of electrical power, road construction,
  water management and agricultural development.
• Provincial Reconstruction Teams (PRTs) are key
  elements in these endeavors, ensuring that
  reconstruction and development efforts are
  coordinated at all levels and responsive to local
  needs.

31
Key Development Objectives I

• Generating productive employment, raising
  per-capita incomes and reducing poverty are key
  long-run development objectives of this strategy
• The goal is to draw large segments of the
  population into the formal economy as quickly as
  possible
• For development to succeed, the low-productivity,
  opium-based informal economy must be replaced by
  more productive, formal sector activities.
• To this end, development planners must facilitate
  a transition phase from illegality and
  informality to formal legitimacy by
• Creating an environment that enables the private
  sector to flourish
• Boosting the rural economy and assisting the
  poorest and most vulnerable
• Defining the role of the state and establishing
  government capacity
• Increasing the effectiveness of foreign aid
• Developing Afghanistan as part of a wider
  Central Asia region
• Improving competitiveness so that new exports can
  emerge to replace opium as the countrys source
  of foreign exchange.
• .

32
Key Development Objectives II

• A complementary objective is state-building
• Afghanistan cannot not achieve sustained
  development without a reasonably functional,
  effective and accountable state
• A functional state is defined as one possessing
  adequate institutions, financial resources
  (ultimately through domestic revenue mobilization
  to pay for core state functions), human capacity,
  sound processes and management, and a reasonable
  degree of integrity
• Good governance is critical. Of particular
  importance for the economy progress must be made
  in rule of law, regulation, and control of
  corruption.
• Adequate infrastructure, and improved security
  are prerequisites for sustained private
  sector-based economic growth in the formal sector
• Effective government programs will be critical
  for building Afghanistans human capital

33
Key Development Objectives III

• The economic objectives, especially poverty
  reduction will be especially difficult to achieve
  given the countrys demography and topography
• Afghanistans poor are overwhelmingly illiterate,
  tend to be located in remote areas with difficult
  topography, and have little land or other
  agricultural assets
• They tend to grow staple crops rather than
  horticultural products, suffer from very low
  health indicators, and are highly vulnerable to
  shocks as well as seasonal patterns of income
  fluctuation

34
Development Assets

• Despite its many handicaps, the country also
  possesses some notable strengths to serve as a
  foundation
• Afghanistan has an entrepreneurial population, as
  evidenced by the vibrant informal economy, which
  allowed most Afghans to survive decades of
  conflict and displacement
• The Afghan refugee population has built up of
  significant human capital
• Afghanistan maintains market-oriented and
  unrestricted private sector policy environment
  with low import tariffs, few non-tariff barriers,
  relative ease of establishing new enterprises,
  sensible laws and regulations

35
Evaluating Economic Performance

• Evaluating Afghanistans economic performance is
  difficult due to
• Lack of accurate economic data
• Historically, little effort was made to compile
  accurate economic data
• Limited manpower hindered systematic post-war
  data collection
• Large amounts of Afghanistans economic activity
  occur in the underground, or shadow, economy
• Lack of objective reporting
• Many accounts are impressionistic, rather than
  based on verified facts
• Lack of reliable surveys
• Insurgency limits fieldwork
• Many surveys suffer from systematic biases

36
Recent Macroeconomic Performance

• Growth in real GDP was estimated at 12.4 in
  2007, and is expected to ease to 8.6 in 2008,
  supported by
• Strong construction investment, much of which is
  linked to donor-led development projects
• Private consumption, which is driven in part by
  positive income effects of recent large opium
  crops
• The strong GDP may be hard to sustain due to
  difficulties in other key macro areas.
• The trade deficit will likely expand
• Inflation, currently under control as a result of
  a marked reduction in the expansion of the money
  supply, is predicted to pick up due to rising
  energy and wheat prices

37
Real GDP Growth ()
38
Inflation

• Inflation has been a problem in Afghanistan and
  impacts the economy in several ways
• Afghani exports are more expensive, while foreign
  imports are cheaper
• Inflation creates an arbitrary redistribution of
  income and injures creditors and those on fixed
  incomes, such as those pensioners
• Inflation complicates the planning process, since
  it is impossible to predict future costs
• Inflation makes it difficult to develop deep and
  efficient financial markets
• Inflation creates incentives for speculative
  investment real estate, rather than productive
  investment

39
Inflation ( per annum)
40
Broad Money Growth ()
41
Agriculture I

• Agriculture (excluding narcotics) contributes
  around 53 to GDP and employs 67 of the labor
  force
• The sector is central to Afghanistan's economy,
  and its performance strongly influences overall
  economic growth
• With most of the countrys poor living in rural
  areas and depending either directly or indirectly
  on agriculture, improved performance could have
  major impacts on poverty reduction
• Agriculture and related activities are major
  vehicles for womens participation in the economy
• Agricultural development is part of the
  governments core program for promoting the
  efficient and sustainable use of natural
  resources

42
Agriculture II

• Afghanistan's agriculture has suffered for nearly
  25 years
• The main drivers of agricultural growth and rural
  poverty reduction technology, roads,
  irrigation, education have all deteriorated as
  the result of war, lack of maintenance and a
  series of severe droughts.
• Agricultural output slowed dramatically from 2.2
  a year in the pre-conflict period 1961-78 to 0.2
  between 1978-2001.
• Cereal output declined by 2.0 between 1978 and
  2001, after growing at 1.3 per year during
  1961-1978.
• After 2001, there was a strong recovery with the
  return of normal precipitation and improved
  availability of seeds and fertilizers, but growth
  could not be sustained due to periods of severe
  drought
• A very small harvest in 2008 left small farmers
  all over central and northern Afghanistan short
  of food
• Large income differences still exist between
  licit agricultural output and land devoted to
  opium poppy

43
Sector Trends
44
Industrial Expansion
45
Service Sector Trends
46
Macroeconomic Assessment

• While macroeconomic data show that overall
  economic growth and that of several key sectors
  are up, it is unclear the extent to which the
  living standards of average Afghanis have
  improved
• The current data does not reflect
• Income distribution
• Regional and local differences
• Important sectarian and ethnic differences
• Data on government spending is also meaningless
  unless the productivity of that spending is also
  measured.

47
Unemployment

• Despite good economic growth, unemployment
  remains a major problem. Although most analysts
  estimate unemployment is high in Afghanistan,
  accurate statistical data is virtually
  non-existent.
• Defining unemployment is difficult as many
  Afghans are employed on a temporary basis in the
  informal economy or on a seasonal basis during
  the agricultural harvest.
• The CIA estimated that, as of 2005, the official
  unemployment rate in Afghanistan was 40.
• The Afghan Central Statistical Office also
  maintains an official unemployment rate of 40
  percent for 2007.
• However, other estimates are as high as 60
  percent, and unemployment could be even higher in
  some rural provinces and districts.

48
Poverty

• Poverty remains a significant problem for
  Afghanistan. Per capita income is about 300,
  making Afghanistan one of the poorest nations in
  the world despite recent economic growth. As of
  2007
• Approximately 50 of the Afghan population lives
  below the poverty line.
• An additional 20 percent of the population is
  concentrated close to the poverty line and is at
  risk of falling into poverty.
• The impact of rising diesel fuel prices and the
  doubling of wheat prices may be driving some of
  these families below the poverty line.
• Poverty may be even higher among rural and
  nomadic populations.

49
The Working Poor

• The existence of a large number of working poor
  in Afghanistan is a major problem.
• Low salaries place many who are employed,
  including government employees, at risk of
  falling below the poverty line.
• Poverty is also unevenly spread throughout
  Afghanistan the poverty rates of provinces vary
  from around 10 percent to more than 70 percent.
• Poverty is more severe in the northeast, central
  highlands and parts of the southeast.
• Despite a significant increase in public spending
  in key sectors to support poverty reduction,
  scarce domestic resources and limited
  international assistance result in only limited
  assistance to the poorest of the poor.

50
The Budget

• The components of the budget are the core and the
  external budget. The core budget is controlled
  by the government and can be divided into
• The core operating budget, consisting mainly of
  recurrent expenditure such as employee
  compensation, transfers, and outlays on goods and
  services and
• The core development budget which comprises
  largely donor-financed development projects and
  some recurrent costs.
• The external budget consists of direct donor
  expenditure that is approved and executed outside
  the national budget process.

51
Components of the Budget, 2007/08

• x

52
Fiscal Vulnerability

• Achieving fiscal sustainability is a critical
  element in the countrys recovery, but post-war
  reconstruction needs and a low revenue base, give
  the country little room for error
• The overall core budget deficit before grants is
  forecast by the IMF to average about 13 of GDP
  over the next five years
• Were grants to fall short of projections, in the
  absence of borrowing, an automatic contraction in
  expenditure would occur as many grants to the
  core budget are specifically linked to
  development projects
• The situation would be even more difficult if
  grants were cut to the external budget, which
  accounts for a large proportion of critical
  expenditure, including health and security
• Incurring long-term expenditure obligations is
  risky since these could rely on external support
  of indefinite length and unrealistic proportions

53
Revenue Excluding Grants ( GDP)
54
Central Government Expenditures ( GDP)
55
Central Government Fiscal Balance ( GDP)
56
External Debt Sustainability

• Afghanistans debt sustainability has improved
  significantly as a result of debt relief from its
  bilateral creditors and interim debt relief under
  the HIPC initiative
• HIPC is an agreement among official creditors
  designed to help the poorest, most heavily
  indebted countries escape from unsustainable debt
  performance targets are set as a condition for
  debt relief)
• In July 2006, Paris Club creditors agreed to
  cancel more than US10 billion of debt, thereby
  reducing Afghanistans external debt by nearly
  90.
• In July 2007 they committed to cancelling all
  remaining claims once Afghanistan reaches its
  completion point under the HIPC initiative.
• Additional interim debt relief under the HIPC
  initiative is being provided by the World Bank
• The Afghan authorities are actively pursuing debt
  relief agreements with the OPEC Fund for
  International Development (OFID) and non-Paris
  Club bilateral and commercial creditors, and
  continue to make progress meeting HIPC completion
  point targets.

57
Total External Debt ( GDP)
58
Afghani Opinions (1)

• Surveys (2007) of Afghanis find their mood is
  optimistic
• 42 think that things moving in right direction,
  while 24 think that the country is moving in the
  wrong direction 25 have mixed feelings
• Reconstruction was cited as single biggest reason
  the country was going in the right direction
  (39), followed by good security (34)
• 48 of those who think the country is moving in
  the wrong direction cited insecurity as the
  reason, followed by different aspects of bad
  governance and economy
• The largest problems facing Afghanistan were
  insecurity, unemployment, poor economy and
  corruption in that order

59
Survey Right or Wrong Direction?
Source Asia Foundation, Afghanistan in 2007, p.
11.
60
Afghani Opinions II

• Survey findings
• In 2007 49 of Afghanis thought that their
  families were more prosperous than during the
  Taliban regime, while 28 felt they were less
  prosperous
• In 2006, 54 felt they were more prosperous,
  while 26 felt less prosperous.
• Compared to two years ago, 51 said access to
  schools had improved, 43 said the health of
  family members was better, while 39 said the
  financial situation was more secure
• 80 felt the government was doing a good job
• Most of the credit in this area went to the
  education and health sectors
• Government was seen as below par in generating
  employment, reviving the economy and fighting
  corruption

61
Afghani Opinions III

• Additional survey findings
• In 2007, the biggest problems at the local level
  were identified as lack of electricity (15),
  unemployment (14), lack of water (11) and
  education (10), roads (10), security (9)
• In 2006, the biggest problems at the local level
  were unemployment (34), electricity (25), water
  (18) and poverty (18) followed by poor economy
  (17) and corruption (8)
• Perception of corruption was higher at the
  national level (74) than at the provincial (60)
  or local levels (48)
• 80 of the people thought poppy cultivation was
  wrong
• 50 of those who thought it wrong cited religion
  as the reason
• 35 cited opium addiction
• Linkages to terrorism and insecurity were cited
  by 10 or less of the population.

62
More Prosperous than under the Taliban?
Source The Asian Foundation, Afghanistan in
2007, p.37
63
More Prosperous than under the Soviets?
Source Asia Foundation, Afghanistan 2007, p. 39
64
Questions? -- Break

• Questions?
• Next
• Policy Assessments.
• Governance Issues
• Considerations as to future economic prosperity

65
Policy Assessment

• Improved policy implementation and economic
  reforms have contributed to the post-2001
  economic successes, specifically
• Economic management largely economic reforms,
  and support for the private sector
• Development management, in the form of
  development plans, aid strategies.
• Sector policies
• While progress has been impressive in some areas,
  reforms have lagged in many others. Lack of
  significant progress in the future would create
  an increasing impediment to improved and
  sustained economic expansion.

66
Economic Management I

• Trade Policy (0)
• Afghanistan's major rationalization of tariffs
  (which are low in the regional context) and few
  non-tariff barriers may face challenges from
  pressures for protection
• Trade facilitation is weak and problematic
• Export performance has been poor
• Financial Sector Policy (-)
• Reforms have resulted in several private banks
  getting started
• However, the private sector still does not have
  much access to financial services
• Limited progress has been made in restructuring
  state-owned banks

67
Economic Management II

• Private Sector Enabling Environment (-)
• Afghanistan maintains pro-private-sector policy
  environment on paper, but many obstacles exist
• The main impediments include corruption red
  tape, and lack of finance, land and electricity
• Progress in formal sector development has been
  limited.
• Policies for Economic Growth ()
• Growth policies have been fragmented and do not
  comprise an effective growth strategy
• The economy has seen double-digit economic growth
  so far, but serious questions remain about its
  sustainability and the factors that will drive
  future growth

68
Development Management I

• Development Management and Poverty Reduction ()
• Compelling government strategy documents have
  existed since 2002, but there is a need for
  prioritization, more consultations, and
  government-wide ownership
• The government is currently working on the Afghan
  National Development Strategy (ANDS) to address
  these issues.
• Government Leadership (0)
• Strong government efforts to exert leadership are
  hindered by limited capacity, poor leadership in
  some sectors and line ministries, donor practices
  and (in some cases) lack of donor buy-in
• AID Management (0)
• The government is attempting to take the lead and
  manage aid according to internationally agreed
  standards
• However, it has seen limited success in improving
  the cohesion of off-budget aid or in shifting
  large amounts of aid on-budget

69
Development Management II

• Donor Aid Practices (-)
• A minority of aid can be said to follow good
  practice
• However, most aid flows through bilateral
  channels without meaningful government leadership
• Recently, there have been signs that military
  concerns are distorting some aid
• Development Communication (--)
• There have been limited efforts and poor outcomes
  in development communication within government,
  at the political level, with civil society, with
  the public and by donors
• Expectations have been raised and were not
  well-managed

70
Sector Policies and Performance I

• Education ()
• There has been a tremendous expansion in primary
  enrollment (including girls), but there is still
  a long way to go
• Major quality issues exist at all levels of
  education
• Health ()
• A cost-effective Basic Package of Health Services
  with expanding coverage was adopted
• However, there are numerous problems with
  hospital system
• Roads ()
• Rehabilitation of Afghanistans highway system is
  nearly complete
• There has been much construction and repair of
  rural roads.
• However, this work is often done at high cost
• There are also concerns about meeting maintenance
  requirements

71
Sector Policies and Performance II

• Community Development ()
• National Solidarity Program now covers most
  villages and effectively delivers small-scale
  rural infrastructure.
• However, questions remain about the institutional
  dimension, sustainability and the future role of
  the Community Development Councils.
• Social Protection ()
• Significant relief efforts and public works
  employment programs have been moderately
  successful
• However, progress has been limited in developing
  an effective, broad-based, and sustainable social
  protection strategy

72
Governance Issues

• According to the World Bank, successful economic
  development is more likely in countries that
  perform well in these 6 areas of governance
• Voice and Accountability
• Political Stability
• Government Effectiveness
• Regulatory Quality
• Rule of Law
• Control of Corruption
• Problems in some of these areas are so severe
  that some observers classify Afghanistan as a
  failed state

73
Voice and Accountability
74
Political Stability Absence of
Violence/Terrorism
75
Government Effectiveness
76
Regulatory Quality
77
Rule of Law
78
Control of Corruption
79
Corruption and the Economy

• Of the governance measures, corruption may have
  the worst economic consequences because it
• Reduces economic growth
• Worsens distribution of income
• Increases government inefficiency
• Worsens the international balance of payments
• Reduces the confidence of the Afghani people in
  their own government
• Reduces the availability of foreign loans and
  grants

80
Corruption and Conflict

• Conflict is good for corruption
• It justifies by-passing procedures
• It increases the necessity for getting things
  done, regardless of the cost
• It provides an excuse for corruption-related
  losses
• Corruption is good for conflict
• Terrorist groups finance their operations, in
  part, with proceeds from corruption
• Criminal groups that handle smuggled or stolen
  goods provide routes and safe houses for
  terrorists, IED makings, etc.
• Corruption undermines confidence in the GOA

81
Combating Corruption

• Specific measures to combat corruption include
• Establishing a merit system for the civil service
• Requiring officials to disclose outside
  activities that result in conflict of interest
• Providing a long statute of limitations for
  bribery and other corrupt acts and allowing its
  suspension when an offender has evaded
  prosecution
• Removing any obstacles posed by bank security
  laws to investigate corruption
• Establishing procedures to freeze, seize, and
  confiscate the proceeds of corrupt acts and
  permitting those injured by corrupt acts to
  initiate action for damages
• Taking adequate measures to protect those who
  witness or report corrupt acts

82
Overall Assessment

• Afghanistan has a number of economic building
  blocks
• It has an entrepreneurial population
• The refugee population has built up significant
  human capital that can be brought to bear for
  development.
• Afghanistan by and large maintains a
  market-oriented and unrestricted policy
  environment for the private sector.
• The country has made significant progress in many
  areas of economic reform and public sector
  management, although progress in governance has
  been slow and must be addressed if it is not
  become an increasing hindrance to further
  economic expansion.
• The large informal sector could be a great source
  of sustained economic development if transformed
  into formal sector activities.
• Economic growth has been high over the last six
  years, creating the high demand conducive to
  employment growth and business enterprise
  development.

83
Difficulties in Evaluating Progress

• While there are a number of positive signs for
  further economic progress are several significant
  caveats in affecting any assessment. These
  generally temper the level of optimism
• First, progress has been assessed against a
  starting point of late 2001. More meaningful
  would be to assess whether progress has been
  adequate in relation to what the country needs to
  escape the conflict trap of the 1990s and move
  forward onto a path of sustained development.
  Progress in many areas has not met much this more
  demanding standard.
• Second, progress, however real, is running far
  behind the expectations of the population,
  donors and government officials, some of whom
  classify Afghanistan as a failed state
• Third, given our knowledge of the economy, there
  are a number of critical intangibles that could
  adversely impact on further progress.

84
Possible State Failure
85
The Future Key Variables

• Many of the economic/social/political forces in
  Afghanistan are interrelated. The key to growth
  is to draw on these compatibilities and create an
  environment in which each builds on the other. To
  accomplish this
• The economic reform process needs to be deepened
  and completed.
• Major improvements in public administration and
  governance are essential
• Macroeconomic stability must be maintained with
  inflation at 10-15.
• Corruption levels must begin declining.
• As will be discussed, the role of opium in the
  economy and Afghan society must decrease
  dramatically.

86
End - The Afghani Economy I

• Questions?