On 22 December 2001, following the defeat of the Taliban by a coalition of US and Northern Alliance forces, an interim administration under Hamid Karzai mandated from above by the Bonn peace agreement took charge of Afghanistan. Being a relatively small, landlocked and poor country that has experienced civil strife for more than two decades starting 1979, with different degrees of external involvement, Afghanistan's economy at the time of formation of the interim administration was both backward and disintegrated. With 85 per cent of its population reportedly dependent on agriculture and 53 per cent of the GDP estimated as originating in the agricultural, livestock and forestry sectors, as compared with 28 per cent in light industry, 8 per cent in trade and 6 per cent in construction, the economy in 2002 was structurally in an early stage of development. Extremely rough estimates quoted by the Asian Development Bank suggest that in 2002, Afghanistan's GDP amounted to $4.4 billion, which implied a GDP per capita of an abysmally low $170 per head.

These figures, however, could exaggerate the level of backwardness implicit in the initial conditions from which Afghanistan must begin its process of reconstruction and revival. Two factors have contributed to the high 'aggregate poverty' indicated by a per capita income that is less than half of the international poverty norm of a dollar per day per head by 2001. The first is the war that led to the ouster of the Taliban. An earlier estimate, also quoted by the ADB, relating to 1989, placed Afghanistan's GDP at a much higher $6.9 billion and its per capita income at around $300. The situation could have further improved in the years following 1989, since reports indicate that at least in regions fully occupied by the Taliban, economic conditions were stable during the early and the mid-1990s. Underlying the subsequent massive contraction of the economy was the war that devastated the limited infrastructure of the country, triggered the exodus of more than 3 million refugees to Pakistan, Iran and elsewhere and displaced a large number of people within the country. This disrupted or even brought to a standstill much of the economic activity within the country. A corollary of this role of the late 1990s war in worsening economic condition is that a concerted reconstruction effort focused on quick-impact projects combined with the observed large-scale return of refugees to Afghanistan, could ensure a sharp rise in GDP and per capita income to levels in the early 1990s.

Secondly, nature too added to the woes of an already war-ravaged economy, with protracted drought conditions that began in 1999 and lasted till 2001. Again according to estimates made by the international community, in this case the World Bank, crop production was halved and livestock herds substantially depleted, making the situation in 2002 as desperate as it was. According to a March 2002 survey by the FAO, the livestock population in the country declined by 60 per cent due to the distress selling of livestock herds in the summer and autumn of 2001 triggered by the persisting conditions of drought. The crucial role of drought in worsening economic conditions is revealed by an FAO and World Food Programme estimate which states that agricultural production in 2002 rose by 82 per cent, following better rainfall conditions. However, even in that year cereal production is estimated at 4 per cent below its 1998 level. Given the importance of agriculture for employment and GDP in the economy, these figures suggest that the rough GDP estimates relating to 2002 may be exaggerating the poor state of the economy.

These real factors that perhaps exaggerate the extent of backwardness of the economy could have been compounded by statistical errors that remain uncorrected because of the temporary closure of the statistical system. It is known that GDP and revenue estimates in Afghanistan are quite unreliable given the large role of the unaccounted, underground economy in the country. Two factors contribute to the magnitude of the unaccounted segments of the economy. To start with, Afghanistan, being a landlocked country, is also a hub for trade between some of its larger neighbours. Such trade flows occur through its porous borders with Pakistan (2,450 km), Tajikistan (1,206 km), Iran (936 km), Turkmenistan (744 km), Uzbekistan (137 km) and China (76 km). Unfortunately, figures on Afghanistan's domestically directed and re-export trade are not available. A June 2000–February 2001 UNDP study, based on an investigative survey of border crossings and major trading centres, estimated that 'indigenous exports' at $130 million constituted just 10.6 per cent of total exports, while re-exports totalled $1097 million (Chart 1). Similarly, imports for domestic consumption, based on type of commodity, amounted to $396 million (33 per cent), whereas imports that were potentially for re-export totalled $806 million (Chart 2). It is to be expected that the huge volume of transit or re-export trade would sustain an economy whose activities are not fully captured in estimates of GDP tracking the real economy. The fact that much of this trade is not officially accounted for is well known, so that profits accruing to Afghan nationals from such trade (in which exports account for more than a quarter of estimated 2002 GDP) are also likely to be inadequately captured by national income figures.
Chart 1 >> Chart 2 >>

The second reason why the magnitude of the unaccounted economy is likely to be great is the historically important role of poppy cultivation and opium production in the rural Afghan economy. According to an estimate by the United Nations Office for Drug Control and Crime Prevention, land under poppy cultivation amounted to 82,171 hectares in 2000 and opium production in 2002 was 3,400 tons, which was similar to levels that prevailed in the mid-to-late 1990s. With the Taliban having imposed a ban on opium production and the Karzai government having declared a ban on poppy cultivation in 2002, it is inevitable that a large part of this activity would occur in the underground economy. The economy surrounding the cultivation of poppy, the production of opium and its trade would generate a significant income, which again will go substantially unrecorded.

Ignoring the potential areas for rapid reconstruction of war-damaged assets, the effect of prolonged drought and the important role of unrecorded economy tends to exaggerate the poor initial conditions, which are then attributed solely to the long years of conflict. This is not to say that the two-decade-long war had no serious consequences. To start with, it did have damaging effects on the infrastructure of the country, created by the historically important role of foreign aid in the country because of its strategic and transit trade importance, making agriculture more climate dependent, fragmenting the economy by damaging the transportation and communications infrastructure and generating bottlenecks in sectors like energy. Secondly, by driving out large sections of the population and emasculating the state it undermined the institutions of state including the central bank, the financial system, tax collection and customs machinery, the statistical apparatus, the civil service, and the law and order and judicial system. Finally, it undermined the ability of the state to collect a share of the surplus being generated within the economy to finance the expenditures necessary to take on crucial governance and development responsibilities.

With regard to the last of these effects, we must recall that local revenue in Afghanistan comes from its taxes on trade, much of which occurs by land across the borders with its neighbours. A major problem being faced by the current government in Kabul is to get provincial governors (still referred to as warlords by many) to part with a reasonable share of the revenue thus garnered. Even though a meeting in May saw twelve governors signing an agreement to do so, and one of them delivered $20 million immediately thereafter, it is unclear how much of the revenue will finally accrue to the central government.

Once these features of the Afghan economy are understood and the unwarranted hopelessness deriving from perceptions of near-complete devastation and penury is set aside, the direction of the aid-supported reconstruction effort and its likely consequences can be easily deduced. There are three pillars on which that effort should rest: (i) restoration of the infrastructure with initial focus on quick-impact projects that can yield substantial benefits in a short period; (ii) restoration of the institutions of state and the powers of those institutions so that the state can mobilize the revenues and undertake crucial developmental expenditures, which only it can pursue since low per capita income levels imply inadequate incentives for private investment in many areas; and (iii) restoration of the 'economic space' within which the new state can pursue a national development agenda.

A range of specific initiatives can be identified within this overall framework. To begin with, a greater degree of security and an end to periodic local conflict must be ensured. This must build on the intense and easily observed desire of the Afghan people for peace and the opportunity to get on with their lives and must be secured only by an international, UN-mandated force that is seen as a source of support and not an instrument of occupation. Second, the damaged and destroyed infrastructure must be immediately reconstructed, with a large proportion of aid diverted for the purpose, so that the economy is reintegrated and rendered functional.

Third, the ability of the state to mobilize resources needed to finance crucial developmental responsibilities must be restored for which an appropriate monitoring, tax collection and revenue sharing system must be worked out. Given the fact that Iran and Pakistan account for a substantial share of Afghanistan's trade, and trade revenues constitute a large share of the total, the initial task should not be too difficult. But over time, it would be necessary to widen the tax base and obtain resources from internal direct and indirect taxation, especially the former.

Fourth, it would be necessary to rebuild the financial system with a two-fold purpose: that of mobilizing household savings and of channelizing those savings to priority areas, using mechanisms such as directed credit and differential interest rates. This implies that an overemphasis on microfinance and any neglect of the task of creating a well-regulated formal banking system would be misplaced. Fifth, the rural infrastructure needed to restore dynamism to agriculture, reduce dependence on rainfall for irrigation and encourage growth of non-agricultural activities needs to be created by the state.

Finally, Afghanistan needs to move out of being a mere transit hub for trade between its neighbours and must seek to develop activities that add value to imported inputs to produce outputs for export and benefit to a greater extent from its crucial role in regional trade. The problem with the transit trade is not that it adversely affects the balance of payments. The field survey-based estimates quoted above show that though there was a small deficit in terms of the indigenously directed and originating trade, Afghanistan did not suffer from a trade imbalance that needed significant external financing. The real difficulty is that unregulated growth of such trade creates disincentives for investment aimed at increasing domestic employment and value-added through processing and production activities within Afghanistan.

Is this the direction in which the ostensibly UN-coordinated reconstruction effort is heading to? Expectations were high when, soon after the Bonn agreement that signalled peace, a meeting of donors in Tokyo in January 2000 pledged to deliver sums, estimated at an aggregate of $4.5 billion within a thirty-month period, to kick-start the reconstruction effort. But a visit to Kabul, the capital city, close to a year-and-a-half thereafter suggests that the process of reconstruction has been slow. The inadequacy of the reconstruction effort is puzzling also because the limited and scattered information on aid flows does suggest that inflows have been significant even if not massive.