Growth and Structure of the Economy

By 1985 Afghanistan had developed little, in that it still relied on traditional agriculture as the mainstay of its economy, while modern industry contributed a relatively small portion of national output. Despite the relatively low level of development, there had been major changes in the previous 60 years, resulting in new industries and new links between formerly autonomous economic units and regions. In the 1930s, when economic modernization began, most Afghans were engaged in the cultivation of small plots of land or tending orchards. Traditional and primitive farming methods provided the population with a subsistence standard of living. In addition, many nomadic peoples raised livestock as they moved between summer grazing pastures in the highlands and winter feeding grounds in the lowlands (see Mixed Subsistence Patterns, ch. 2). The subsistence level of existence in the villages and the constraining geography discouraged trade between villages. Nomads were the sole trading partners of the isolated mountain people. What trade there was within and between villages was conducted by barter, with wheat and sheep often the media of exchange. Commercial money was virtually unknown to the majority of Afghans outside of the towns. In the towns there were some small﷓scale handicrafts, such as rugs and sheepskin coats. Two currencies, the afghani and the Kabuli, both silver coins, circulated among urban merchants in the town bazaars. Transport of goods was almost always by camel, donkey, or horse, for there were few roads and none for yearround travel. Electricity was nowhere to be found.

In the 1920s several wealthy merchants invested their profits in a handful of small﷓scale industrial complexes to produce soap, leather goods, and seed oils for local consumption. The growth of industry was led by an entrepreneur, Majid Zabuli, and his Bank-i-Melli (National Bank), the country's first bank, which was established in 1932. Zabuli found a clever solution to the Islamic prohibition against interest on loans that had hindered the establishment of banking in the country. His bank made interest-free loans, but the borrower was obliged to buy a stamp to be attached to each repayment receipt, thereby giving the bank a profit rather than interest. Bank-i-Melli became a center for capital accumulation and acted as an investment bank. The bank was given currency issue rights, and paper money was introduced in 1938. Funds from the bank flowed mainly into northern Afghanistan and spurred the creation of most of the prewar industrial development in Pol-e Khomri, Konduz, and Kabul. Bank-i-Melli was also an integral part of the expansion of trade in the 1930s, for it granted loans to traders and set up joint stock companies to engage in trade. Companies were established for the export of wool, skins from karakul sheep, and cotton. The cotton industry was a major recipient of Bank-i-Melli investment. The bank financed the draining of swampy, malaria-infested lands in the north and their cultivation with cotton. It also financed the construction of a ginning plant and a pressing mill in Konduz. 

Bank-i-Melli and the major industrial concerns operated under a government monopoly concession called a sherkat. Under the sherkat system the government could control 40 to 45 percent of each firm's capital, although it rarely invested so much. Private interests usually invested all the capital and owned 55 to 60 percent of the company. The system controlled production and safeguarded the invested capital while guaranteeing good profits for the investors. Many members of the royal family and high government officials held blocks of stock in the various sherkat, so that government cooperation was assured. The country's elite made large profits from the arrangement. The sherkat system greatly contributed to industrialization because most profits were reinvested in the expansion of facilities or in the development of new industries.

Foreign trade grew markedly in volume in the 1930s. The country's principal export was karakul pelts, which were auctioned in London. Fruits were exported to British India, and cotton was sent to the Soviet Union. The cotton exports had grown rapidly in the wake of the economic disorder in Soviet Central Asia after the Russian revolution. When the government began a major development policy under King Muhammad Nadir Shah to improve irrigation and communications and to explore the country's natural resources, it was understood that foreign assistance would be absolutely necessary. Afghanistan imported machinery and foreign expertise from Europe and Japan. Seeking to maintain neutrality between Britain and the Soviet Union, Afghanistan developed close economic relations with Germany. Germany provided 150 advisers, as well as financial credit to assist in the establishment of the cotton and sugar industries. The Germans built a hydroelectric plant at Wardak, which still operated in 1985. Through German offices, Afghanistan found European markets for its exports of fruits and skins. Faced with a persistent trade deficit, the Afghan government sought to boost exports while holding the level of imports to a manageable level.
Economic ties with the Soviet Union were of special concern to Nadir Shah and his son Zahir Shah. During the reign of King Amanullah, trade had grown rapidly with the Soviet Union, and by 1932 it accounted for a third of Afghanistan's total trade. Apprehensive of Soviet intentions, the government introduced controls on trade with the Soviet Union and refused permission for the Soviets to open a trade office in Kabul. As a result of government efforts, the value of exchanges with the Soviet Union remained constant until the 1950s. Afghanistan
thus avoided economic integration with the Soviet Union, though with a high degree of trade dependence.
The Afghan economy, to the extent that it could be considered a national system, experienced only moderate growth during the decade before World War II. The agriculture sector grew slightly, and industrial growth, though rapid, represented just a small part of the total economy. The slow rate of growth and development was halted by the advent of the war. Development projects with Germany came to an end and, under British and Soviet pressure, German expatriates were forced to leave the country. Karakul exports declined drastically, but other Afghan exports rose to record levels because the country could sell all the foodstuffs available to the Allied forces in British India. There was, however, little to import in return because of the interdiction of the flow of goods from Europe. The government accumulated a large surplus of British pounds sterling and United States dollars, but its development efforts could not resume until the war ended.

The economy resumed its slow growth after the war, but its structure began to change, especially under the administration of Mohammad Daoud Khan from 1953 to 1963 (see Daoud as Prime Minister, 1953﷓63, ch. 1). Before Daoud, the economy was oriented around the private sector, and the government assisted private entrepreneurs and organizations, such as Bank-i-Melli, with credit infusions and monopoly concessions. When Daoud came to power, he was dissatisfied with the slow rate of industrial growth, which he blamed on the private sector's lack of funding and its poor technical and management capabilities. Observing the economic successes in Soviet Central Asia, India, and Turkey, the new prime minister decided that direct state intervention was necessary to hasten economic growth. Daoud discarded the old approach to economic development through a partnership of the private sector and the royal family and turned toward a state-managed economic system.

The key element in Daoud's etatist policies was the supervision of the country's development through centrally administered plans. The government had drawn up development plans as early as 1930, but the first plan formally adopted by the government was the Five Year Development Plan (FYDP) of 1956﷓61. Two more five﷓year plans followed, and the idea took hold that the government in Kabul was responsible for the country's economic progress. From the beginning, however, Afghan development planning was hindered by a series of innate constraints that limited its effectiveness. The administrative and technical capabilities of the government were minimal. The government created the Ministry of Planning in 1956, but personnel deficiencies prevented the ministry from playing a constructive role in the planning process. The fiveyear plans reflected the wishes of the different ministries but did not attempt to lay down foundations for overall economic policies. The plans provided no priorities nor did they give detailed descriptions of the ways stated targets would be achieved. They were, in fact, mere lists of projects designed to solicit foreign aid. These projects were marked by an absence of cost﷓benefit analysis. The Ministry of Planning did not perform individual project evaluations, nor did it require any other ministry to do so. Many of the project schedules were hopelessly unrealistic, and the cost projections were only rough estimations. The ministry could not supervise ongoing projects, and it was unable to coordinate projects sponsored by different foreign donors. The shortage of technical manpower also forced Afghanistan to rely on the efforts of foreign advisers in drawing up the plans. The first plan, for example, was largely prepared by Soviet advisers. The projects in the various plans were poorly formulated, in part because their foreign designers were ignorant of the Afghan environment.

Afghanistan's low level of fiscal effort also weakened its development plans. Government funding for projects was always lacking because tax collections were so poor. Agriculture, the economy's largest sector, was slightly taxed. Land and livestock taxes had been set as fixed sums long before and were not revised, despite inflation. In 1926 these taxes constituted 63 percent of government revenue but by 1972 made up just 1 percent. Collecting taxes was no simple matter, and in many regions taxes were not collected at all, either because of corruption or because of poor administration capabilities. In 1959, for instance, when the government insisted that rural landowners in Qandahar pay their land taxes, there were antigovernment riots, and the taxes remained unpaid. The government was left with only taxes on exports and imports, and domestic revenue grew far more slowly than did development expenditures. Despite the government's sizable budget deficits, inflation after the war remained moderate, in large part because of the subsistence level of living for most of the population.

Afghanistan was able to finance its development budget with foreign aid. During the 1950s and 1960s Afghanistan
received one of the highest levels of aid on a per capita basis of any country in the world. Foreign aid in the forms of commodity assistance, project aid, and technical assistance totaled nearly US$1.2 billion during the first three plans, extending from 1956 to 1972. Without this massive foreign aid the development effort would not have been possible. Foreign assistance provided 89 percent of the first FYDP expenditures, 76 percent of the second, and 72 percent of the third.

The Cold War competition between the United States and the Soviet Union provided an important stimulus for this largesse. The two superpowers were the largest suppliers of aid to Afghanistan as they competed for influence in the country. After World War II the United States government began providing aid for a massive land reclamation project in the Helmand Valley. In 1954 the Soviets gave a large loan for two grain silos and bakeries in Kabul and Pol﷓a Khomri. The Soviets also offered barter﷓trade agreements that guaranteed higher prices for Afghan exports of wool and raw cotton. In response to Soviet aid, the United States increased its own assistance levels, and aid transfers from both countries then rose into the early 1960s. By the end of 1971 the Soviet Union had given US$672 million, while the United States total amounted to US$412 million. During the two decades from 1950 to 1970, the Soviets accounted for 50 percent of Afghanistan's aid, and the United States, 30 percent. While most of the American aid was in the form of grants, Soviet aid consisted of loans to be repaid in commodities.
As a result of the superpower rivalry, Afghanistan was in a relatively comfortable financial situation during the period of the first two five-year plans. The principal constraints during that time lay in project identification and preparation and in the country's poor capacity to undertake projects without foreign technical supervision. The foreign aid flow, however, began to diminish when donors became increasingly disillusioned with the small contributions that the Afghan government gave to its development budget. This seemed to indicate a lack of commitment to the projects and plans on the part of the government. There was also growing concern about project implementation capabilities. The gross volume of aid, therefore, which had risen from US$245 million in the first plan to US$463 million in the second, fell to US$380 million in the third plan.

Afghanistan's first two development plans concentrated on the creation of transport and telecommunications infrastructure to link formerly isolated regions. The two superpowers built asphalt road nets that reflected their own strategic concerns. The United States built roads linking Afghanistan with Pakistan, whereas the Soviets built roads leading down from the north. By the end of the second plan period, Afghanistan had 1,900 kilometers of paved roads that connected all the major cities and regions of the country with Soviet and Pakistani railheads. Output of electric power increased substantially during the period as hydroelectric plants came into operation.
While infrastructure construction was the main accomplishment of the first two development plans, agricultural development proceeded far more slowly. There were two prominent regional agricultural projects, both of which suffered from poor planning and implementation. Both were, therefore, subject to constant delays and cost overruns. The largest of these, the Helmand Valley Project, was started after World War II in association with the American engineering firm Morrison-Knudsen. The Afghan government had long wanted to irrigate the southwestern desert from the Helmand River (see fig. 4). Shortcuts taken at the behest of the Afghan government, however, undercut the project's success. Against the advice of the American engineers, a number of soil and groundwater surveys were dispensed with in order to cut costs. Although the American firm finished the Arghandab and Kajaki dams and the Boghra Canal ahead of schedule, it underestimated the technical problems associated with the construction and maintenance of the irrigation canals and drainage systems. Because of serious waterlogging and soil salinity problems in the fields, agricultural production in the region declined from that of the initial years of the project. Inadequate extension services plagued settlers who were moved to land often found unsuitable for farming. In addition, the .Afghan bureaucracy proved unable to manage the system's operation or maintenance, and the project's total cost skyrocketed. By 1970 the area had attained an output of 100,000 tons of wheat annually, about 4 percent of total wheat production. The project had, however, consumed a third of the total public investment in agriculture to achieve this figure. Similar difficulties plagued the smaller, Soviet﷓backed Nangarhar Valley Project in eastern Afghanistan (see fig. 1). Dam and canal construction were to have created new irrigated lands for cultivation. Costs again soared because, well into the work, it was discovered that a large part of the project area was rocky soil. Consequently, huge quantities of topsoil had to be trucked in.

Recognizing the central role of agriculture in the economy, the Afghan government sought to shift emphasis in its third plan (1967-72) from infrastructure projects to smaller, more productive projects in agriculture. The redirection of resources proved practically impossible, however, because of delays in the large ongoing projects, which preempted scarce local expertise and labor as well as domestic funds. Furthermore, foreign donors did not want to start new projects while difficulties still hindered existing ones. Over half of the plan's eventual expenditures finally went to carryover projects, and achievements fell far short of targets for irrigation of new land and irrigation rehabilitation. During the first three plans, the Afghan government channeled over 70 percent of the agricultural sector's development funds into large irrigation projects. This left little funding for cheap credit to farmers for the modern inputs of the Green Revolution, such as fertilizers and improved seeds. Agricultural productivity, therefore, remained extremely low, and agricultural production limped forward.

Daoud's policies also stressed industrial development, and the public sector was made responsible for the formation and operation of national industries. The government already had some experience with public enterprises. At the turn of the century it built a munitions factory, and by the end of World War I it also owned and operated a textile plant and a shoe factory. Expanding on this theme in the 1950s, the government set up, with foreign assistance, a number of state﷓owned and state﷓operated companies that produced textiles, cement, sugar, and metal products. Public﷓sector expenditures on industry and mining increased rapidly and took nearly all available resources, both financial and physical. In addition, beginning in the 1950s the government began to acquire control of private companies. Bank-i-Melli was forced to sell majority stockholdings in some of its companies and as a result ceased investing in the economy. In the 1960s this trend accelerated as more state ventures were established, some of which were takeovers of long﷓established but ailing private enterprises. By the end of the 1960s nearly three﷓quarters of the total capital investment in large﷓scale industry was located in governmentowned factories. The government then controlled all major activities in slaughtering, grain mill products, printing, cement, power production, and mineral extraction.

By the mid-1960s these public enterprises were usually perceived as inefficient, and their production capacity was believed to be underused. After Daoud stepped down in 1963, the new government believed that the private sector could play a large role in the country's industrialization and acknowledged that the sector operated under a variety of constraints. The traditionally wealthy and powerful landowning and trading interests had previously seen a threat in the growth of a new group of industrialists and had supported those who advocated the dominance of government enterprise. The tariff policy had militated against local industry because customs duties had taxed intermediate goods to be assembled by local private industry more heavily than the imported finished goods sold by the traders. In addition, the government expended only minute proportions of its development budgets on private ventures. By the 1960s, therefore, private investors had become primarily interested in real estate and bazaar banking, where they dealt with foreign exchange and moneylending. Compounding the problem was the extremely limited state of the banking system. With government aid virtually nil and privateand institutional-venture capital lacking, most private industrialists had to rely on suppliers' credits for capital loans. The bazaar rate, usually about 24 percent or more per annum, was a last resort. The exorbitant cost of credit limited private﷓sector industry to little beyond handicrafts and small-scale industry.

In order to foster private investment in industry, the government passed the Foreign and Domestic Private Investment Law (FDPIL) in 1967. The law provided entrepreneurs a variety of incentives, including tax and tariff exemptions. The law spurred capital investment by the private sector and slightly lowered the proportion of the government's share in total industrial capital. Some 84 firms had been set up by 1973 under the law and were aimed primarily at the domestic market rather than at exports. Foreign investment in private industry remained very small: only 21 of the 108 projects approved by 1975 involved foreign capital, and the total foreign investment came to only US$5.5 million in 1973. Foreigners' hesitance stemmed from uncertainties about the government's future industrial policies and also from the high transport costs. For foreigners it was still easier to export to Afghanistan than to set up small plants for the local market. Another problem with the program was the small number of jobs created. Because private industrialists preferred imported machinery, capital﷓intensive production lines were established. Only 6,000 new jobs accompanied the investment.

Even though the 1967 FDPIL led to an expansion of private industry, the public﷓sector industry continued to grow, from 23 percent of the total number of plants in 1961 to 42 percent in 1971. After Daoud returned to power in 1973, his statist policies were greatly intensified. All banks were nationalized during 1975﷓76, and the state gained control of many more industries previously held by Bank-i-Melli. By 1975 most industrial concerns were state owned. After 1973 the pace of private investment under the FDPIL slowed dramatically because of reluctance by private entrepreneurs and the slowness of the government to approve new projects. The new constitution in 1977 stated that large industries, energy, mines, and banks were all national property. The constitution also said private enterprise in small industries was to be encouraged and protected (see Daoud's Republic, 1973﷓78, ch. 1).
Despite the government focus on developing heavy industries based on local minerals and agricultural products, smallscale private industry maintained a greater role in Afghanistan's economy. This sector, which included the important handicrafts industries, continued throughout the postwar period to employ the bulk of industrial workers, contributing far more to domestic output and providing more exports than did the organized large-scale industries. The output of state-owned industries, however, which had been stagnant during dl the late 1960s, rose in the 1970s, especially in cement, coal, sugar, and vegetable oils.

By 1971, after 15 years of etatist economic policies, the record was one of only mixed success. The rate of growth of domestic output scarcely kept pace with population growth. The gross national product (GNP) per capita was Af5,062 (for value of the afghani﷓see Glossary) in 1961, compared with Af5,028 in 1971. The relatively large amount of foreign aid led to a disappointingly low rate of growth in economic production for several reasons. Above all, investment was persistently channeled toward major infrastructure projects that had long gestation periods and little direct productive output. These facilities were unable to spur rapid growth in the agricultural and industrial sectors by themselves. As domestic industrial and agricultural production stagnated, the economic benefit from the infrastructure remained minimal and resulted in underuse of the existing facilities.
Capacity utilization in the large-scale industries was, by the beginning of the 1970s, still estimated to be less than 30 percent. Modern industry had only a modest role in the economy at the beginning of the 1970s. The primitive agriculture sector was still the preponderant sector of the economy, contributing well over half of gross domestic product (GDP) and employing nearly 80 percent of the labor force. Its output grew slowly between 1956 and 1972 and then declined with the onset of a crippling drought in 1971, when wheat production fell about 20 percent. Livestock herds were also devastated. The drought caused a small drop in GNP with a concomitant decline in per capita income. The mediocre performance of the economy and the perceived slowdown in development were causes of Daoud's coup of July 1973.

After all the emphasis on infrastructure and industry during the preceding 20 years, agriculture remained the engine of the Afghan economy. During the mid-1970s it recovered from the drought with several good harvests and provided adequate food and industrial raw materials. Afghanistan finally attained food self﷓sufficiency, provided that the weather was favorable. The country's foreign exchange reserves rose as exports of cotton climbed and as food imports dropped. The country's balance of payments picture was further improved by natural gas sales and by the export of labor to the oil-rich Persian Gulf states. The afghani rose relative to other currencies during this period.
Although the situation was improved, when the People's Democratic Party of Afghanistan (PDPA) came to power in April 1978, it inherited one of the poorest countries in the world. Afghanistan was still at a very early stage of development. Traditional activities in agriculture and handicrafts still dominated an economy in which many people lived right at the subsistence level. Modern industry and mining contributed less than half of handicrafts' share of GDP. Agriculture was dependent on the weather, and productivity remained low because of the slow introduction of modern technology. The unequal distribution of land and water and the inequitable tenurial system also discouraged efforts to raise productivity. The PDPA's politics in response much resembled those of Daoud. He too had called for agrarian reform and had fostered national industry, price subsidies, and higher direct tax yields.

This page maintained by Luke Griffin and last updated on 01/14/2002 .