This study is designed to cover the political and economic history of Afghanistan. It will provide an overview of the transitions Afghanistan has gone through. In addition, it will answer to questions as to how Afghanistan’s economic position changes due to the high political influence on the economy side. What role do the international communities play in bringing back Afghanistan to a sustainable position? What economic theories will be suitable for the development of small and medium enterprises? What challenges are there to overcome before shifting into a free market economy?
This study will provide an in-depth insight on whether Market Economy is the best choice for Afghanistan and if not what are the alternatives. The research will be based on established theories, annual reports, case studies and interpretive analysis.
Afghanistan is one of the several countries where the reliable data availability is very limited. When talking about Afghanistan’s economy, one can’t separate it from its politics. Whenever one speaks of Afghanistan economic history, he has to relate it with the political history otherwise it remains incomplete. Afghanistan is landlocked yet strategically positioned in Asia where it could serve as a crossroad across Asia but in the past few decades, the country’s economic potential hasn’t taken its root. Afghanistan has been on the receiving side of equation for the past 4 decades. Afghanistan relies heavily on the external financial flows from the international communities. The rapidly changing nature and the correlation of politics and economics have led to an unstable and volatile political economy.
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Afghanistan’s demise started in the mid-18th century when it became the buffer state between the two giants, Russia and great British Empire. The great rivalry of who is going to control Afghanistan continued for decades. “The Great Game” finally comes to an end with the Anglo-Russian Convention of 1907. This declares Afghanistan as protectorate of the United Kingdom in the 20th century. When Afghanistan achieved independence from the British rule in 1919, Afghan leaders started modernizing Afghanistan in a very rapid and uneven pace which, to much extent, wasn’t going towards the right direction.
Afghanistan remained neutral in the cold war between Russian and United States, thanks to Zahir Shah but Afghanistan’s economy was mostly intertwined with the cold war. Zahir Shah imposed a controlled economy modernizing internal industrialization and providing equal education and social measures for all. At the time of the cold was, Afghanistan being neutral, the prime minister of Afghanistan Mohammad Daud Khan plead for financial assistance from both the United States (US) and Union of Soviet Socialist Republics (USSR) believing that without brisk economic growth, the country will be segregated into sever political fragments which will completely destroy the hopes of reviving an already broken country. Russia began aiding Afghanistan in 1950s. They provided financial support to build up the economic infrastructure of Afghanistan as well as substantial military assistance. The aided lasted for many years and gained the trust of the Afghan people. Looking at Russia influencing Afghanistan, US started allocating their part of the budget for Afghanistan which was later estimated to be 30% of the foreign aid Afghanistan received. 50% of the foreign aid was provided by the USSR. In late 1970, Afghanistan faced creeping crisis. Due to the drought years, the value of the currency significantly decreased. Exports decreased and imports increased by great margins. Shortages of food items were in particular, moving across borders illicitly. When Daud Khan took over the presidency, the carried on modernizing the society and establishing a more government regulated economy. He reformed the social welfare and expanded education. Being an Islamic state, I wouldn’t say it was a great reform but abolition of Purdah was one of the reforms Daud Khan brought in Afghanistan.
The government, under Daud Khan, gained tighter control of imports as well as of export industries. In 1977, the government had to intervene to lower the exchange rate as the currency appreciation had threatened to make many exports unprofitable. The fiscal system in the 1970s was small and centralized, leaving provinces with neither tax authority nor budgets. Tax revenues amounted to around 7% of GNP in 1978. Two-thirds of all taxes were on foreign trade, thus illustrating, in Rubin’s words, “the extent to which the government relied on its links to the international system as a counterweight to its inability to [govern] or transform the society as a whole”. Though improved harvests in 1972-1976 allowed for the increased adoption of higher-value cash crops, exports accounted for 15% of GNP in 1978, suggesting only modest improvement in the country’s terms of trade. By 1978 approximately 80% of the Afghan population was dependent on the rural economy and agriculture accounted for 60% of GDP (figures which remain largely consistent to the present).
With only six miles of railroads in 1933, Afghanistan’s government has continually sought international assistance in building the necessary infrastructure. A 1973 USD 200 million assistance agreement  between the USSR and Afghanistan brought oil development, trade, transport, irrigation, factories and highway construction.
Afghanistan’s Economic downfall:
The Soviet withdrawal and ensuing civil conflict between the government and various Afghan factions led to a rapid increase in money supply (as competing governments printed their own currencies), the depreciation of the Afghan currency and a resulting rise in food prices. Mujahideen forces captured Kabul in 1992, renaming the country the Islamic State of Afghanistan, and began violently competing for control of the state. As military entrepreneurs could no longer rely on external support, they were forced to increasingly rely on domestic revenues. The sale of natural gas from Afghanistan accounted for $300 million a year in export revenues, about 56% of total export revenues in the 1980s . 90% of these exports went to the Soviet Union to pay for imports and debts; however, as the Soviets retreated the gas fields “were capped to prevent sabotage by the mujahedin” thereby limiting the potential income from natural resources . With licit income sources on the decline, the war economy that developed during the Soviet period not only continued but also expanded. Gas production after the withdrawal of the Soviet Union dropped from a high of 290 million cubic feet (Mmcf) per day in the 1980s to current low of about 22 Mmcf in 2001. DfID reports that the supply routes established during the anti-Soviet resistances, which were used by segments of the international community to provide weapons as well as humanitarian supplies, “laid the foundations for the regionalized war economy that was to emerge in the 1990s”. Profits accumulated by commanders and traders were invested in illicit activities such as drug trafficking and cross-border smuggling. Revenue collection by the warring parties and commanders was achieved through predation and banditry, appropriation of state land, taxation and the illegal regulation of trade.
The war economy was devastatingly informal and highly decentralized. With no central economic authority, provincial capitals and major cities within Afghanistan became integrated into the economies of neighboring countries. Significant changes occurred on emergence of the Taliban in 1994 and their subsequent takeover of Kabul in 1996. Fighting continued between the predominantly Pashtun Taliban and the revolutionaries. Though the Taliban technically controlled most of Afghanistan, they did not have the means to administer and run public services in a centralized fashion; each region was administered by local authorities who acted quite independently. The significant economic relations between the central Asian countries allowed the warlords cross-border trafficking of cars, drugs and weapons. At the same time transnational trade was increasing, state borders were becoming increasingly permeable as the Taliban employed a multinational network. While Afghanistan experienced a decline in licit revenues from natural gas and other sources throughout the 1990s, the Taliban continued to generate income through their control of the main roads, cities, airports and border crossings (where customs are collected). Conrad Schetter of the University of Bonn reports that by charging 6% on each item imported into Afghanistan “the Taliban earned USD 2.1 billion from trade in 1997” alone. Taliban began to form a more stabilized and hierarchical system moving from “Rule of the strong” to a system funded by illicit activities such as narcotic production and trafficking. Opium production and revenue generated by it was the main source of maintaining the rule not considering foreign funds. The greater security provided by the Taliban also improved conditions for the trade in opium, and, in 1998, opium production rose by 9%.  Estimates suggest, however, that revenues earned from transit trade actually exceeded that of the opium trade as border crossings into Pakistan became more accessible. By the year 2000, Afghanistan’s economy still consisted of the transit trade, the drug trade and the gem trade, with service industries stimulated by their growth.
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Economic Development and Recovery:
After the fall of Taliban and an interim Karzai government, Afghanistan heavily depended on foreign aid to stay afloat. Between 2001 and 2006, half of its operating costs were covered by the foreign support. According to the World Bank, Afghanistan’s operating budget for 2005 was $600 million, half of which came from taxes and the other half from foreign donors.
Afghanistan’s economy picked up pace and started growing in a convincing manner. The past few years have shown significant growth in different sectors of Afghanistan. The real GDP growth has seen its share of tumbles but currently remains at a solid 8.4% at the end of FY2010/11, according to the annual reports of the World Bank. Afghanistan’s primary sector plays a major role in the country’s economy, as 70% of the labor force works in this sector. About 30% of the country’s GDP comes from agriculture. Some of the major crops cultivated in Afghanistan are opium, wheat, fruits and nuts, while wool, mutton, sheepskins and lambskins also form a major part of the produce. Afghanistan witnessed a great increase in their GDP in FY2009/10 but it was volatile and unstable thus falling down to an average 8.4% for the year 2010/11 (Figure A).
For the past five years, the service sector has led the way. The sector accounted for almost half of the GDP growth of Afghanistan (Figure B). The subsectors actively participating in the GDP growth have been the Telecommunication sector, transportation, finance and insurance and minimum contribution has been done by retail trade which grew at 5.7%.  Overall, industry grew by 6.3 percent from last year. This was largely due to the expanding mining sector which grew sharply by 43 percent. On the other hand, subsectors such as construction and manufacturing which have larger contribution to GDP growth, showed modest annual growth of 7.7 percent and 3.8 percent respectively. 
Inflation and Price control:
Afghanistan’s inflation has always been fluctuating since being an importing country, it seems normal. According to the World Bank report, Afghanistan witnessed a steep inflation in year 2010 till the early months of 2011. Based on the consumer price index (CPI), inflation rose to 13.3% in the said period of time (Figure 1). This can be explained by the super dependence of Afghanistan on foreign imports. As the prices in the external markets fluctuated, the prices in Afghanistan changed likewise but a strong deflation was seen in the in the late months of 2011 which can be explained by the declining international prices of commodities and by a high degree of food imports substitution made possible by a good domestic harvest.
Every sector has seen good development if not great since the reestablishment of a new government but the critics have not yet been satisfied. Afghanistan has now laid the foundation for a market-based economy. A new economic system, based on the state as a regulator, not a producer, of goods, with a clear segregation between the public and private sectors, stands in place of the centralized economy of the past. An independent central bank, a liberalized foreign exchange system and laws permitting private owners to wholly own factors of production characterize the new economic landscape. But questions still linger, is Afghanistan ready for such a system? Do the different factors effecting Afghanistan let this country move into that direction? Will the psychic of Afghans understand such a system or even if they do, will they be able to adapt it? Substantial challenges remain, many of the problems this economy faces are typical for those rebuilding after war. High prices from an immature system that lacks sufficient private sector competitiveness; resistance to change from a state-controlled system; the shortage of human capital; increased corruption; insecurity to the utmost; and inequalities created by the market system itself are the challenges Afghan government needs to overcome first and later think of alterations in the economic systems. Yes, billions of dollars have been spent on Afghan government but that hasn’t had the expected impact, believed by most of the critics.
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