Monday May 29, 2023

Economic malaise

April 01, 2023

LAHORE: Inability to control spiraling inflation has forced Pakistani planners to raise interest rates to reduce money supply, but the dilemma is that higher interest rates do not suit businesses that are already operating under stress.

In normal times, high inflation occurs during high growth periods. Pakistan’s economy is in a deep recession where economists recommend lowering of interest rates. Economic indicators have gone out of control.

Pakistani planners are facing a dilemma as the normal recipe to arrest inflation is to raise interest rates; just as economists prescribe lowering of interest rates in economic downturn. Their dilemma is that Pakistan is facing both high inflation and economic recession.

Inflation has stubbornly remained in double digits for the last four years and has crossed the 40 percent barrier for the first time in the last five decades. Unemployment is also at a historic high level and is increasing.

There has been no net job growth in the private sector in the last four years. Real estate that until recently was the only avenue for investment is also facing stagnation.

Current situation is because of special-interest pressure, populist politics, bad economics, and sheer incompetence of the economic planners. Market failures come only in macro doses, in the form of the recessions and depressions that have periodically plagued all capitalist economies. These doses caused a number of inefficiencies in the systems that are difficult to assess.

New populist rhetoric of —persuading taxpayers that ordinary people always know how to spend money better than the government does, and promising a new world without budget constraints has added to our economic woes. Special interests remained beneficiaries of numerous subsidies on the strength of populism.

As far as growth and inflation control are concerned, they can yield contradictory results. The sad truth is that we have reached the limits of monetary policy. Lowering interest rates will not stimulate the economy. The banks are not going to be willing to lend to distressed consumers, and consumers also might not have the desire to borrow.

To come out of the current mess, a careful balancing is required. Turnaround would not be immediate; it would take some time. Some decisions, painful for rent seekers and elite, taken now could shorten the length of the downturn and reduce its magnitude.

If at the same time we think about what would be good for the economy in the long run, we can build a durable foundation for economic health. The tax policies need to be changed. There is something deeply peculiar about having rich individuals who make their money speculating on real estate or stocks paying lower taxes than middle-class Pakistanis, whose income is derived from wages and salaries.

It is also offensive that those whose income is derived from inherited stocks pay lower taxes than those who put in a 50-hour workweek. The vested interests and rent seekers talk about the miracles of free market, but they are not averse to accepting government bailouts against the fundamentals of a free market economy. In fact they always demand subsidies warning that unless they get what they want the whole system may crash.

Confidence in the economy won’t be restored as long as growth is low, and growth will be low if investment is anemic, consumption weak, and public spending on the wane. Under these circumstances, to mindlessly reduce government development expenditures would be a folly.

Spending money on needed investments on infrastructure, education, health and technology will yield double dividends. It will increase incomes today, while laying the foundations for future employment and economic growth.