Political compromises

LAHORE: People talking about the doomsday scenario fail to realise that Pakistan’s economy can still be rebuilt from the debris if the economic managers put their foot down on political compromises.

Many countries in the past faced insurmountable hurdles that threatened their existence, but their economic wizards pursued universally accepted economic principles and were able to confront vested interests and political compromises to restart the growth path.

The main areas of the economy that need urgent attention of Pakistani planners include fiscal deficit, tax revenue, interest rates, exchange rates, trade policy and privatisation. Large and sustained fiscal deficits are a primary source of macroeconomic dislocation in the forms of inflation, payment deficits, and capital flight.

Unless deficit financing is being used to finance productive infrastructure investment, an operational budget deficit in excess of around 1 to 2 percent of GNP1 is prima facie evidence of policy failure.

When a fiscal deficit needs to be cut, a choice arises as to whether this should be accomplished by increasing revenues or by reducing expenditures. Military expenditures are sometimes privately deplored, but in general they are regarded as the ultimate prerogative of sovereign governments and accordingly off limits to international technocrats.

Subsidies, especially indiscriminate subsidies (including subsidies to cover the losses of state enterprises) are regarded as prime candidates for reduction or preferably elimination.

Education and health, in contrast, are regarded as proper objects of government expenditure. They have the character of investment (in human capital) as well as consumption. Moreover, they tend to help the disadvantaged. Primary education is vastly more relevant than university education and primary health care (especially preventive treatment) that is more beneficial to the poor than hospitals in the capital city stuffed with all the latest high-tech medical gadgets.

Politician’s aversion to tax increases is irresponsible and incomprehensible. The economic managers must be strict to the principle of increasing the tax base so that the marginal tax rates should be moderate.

Real interest rates should be positive but moderate, so as to discourage capital flight and increase savings. Under the sort of crisis conditions that Pakistan is currently passing through, the market-determined interest rates may be extremely high. The central bank must find a compromise.

Like interest rates, exchange rates should be determined by market forces, or their appropriateness may be judged on the basis of whether their level seems consistent with macroeconomic objectives.

In the case of Pakistan, the real exchange rate needs to be sufficiently competitive to promote a rate of export growth that will allow the economy to grow at the maximum rate permitted by its supply-side potential, while keeping the current account deficit to a size that can be financed on a sustainable basis.

The exchange rate should not be more competitive than that, because that would produce unnecessary inflationary pressures and also limit the resources available for domestic investment, and hence curb the growth of supply-side potential.

The free trade ideal should be subject to two qualifications. The first concerns infant industries, which may merit substantial but strictly temporary protection.

Furthermore, a moderate general tariff might be accepted as a mechanism to provide a bias toward diversifying the industrial base without threatening serious costs.

A highly protected economy is not expected to dismantle all protection overnight. It should be done in well-planned phases.

The main rationale for privatisation is the belief that private industry is managed more efficiently than state enterprises, because of the more direct incentives that the private owners have.