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Monday May 20, 2024

Setting the economy right

By Husain Haqqani
September 21, 2023

Pakistan’s economy is a mess and badly needs restructuring. The country needs to return to fiscal soundness and bring back private investors. These long-term goals can only be fulfilled through a policy framework that lasts beyond the term of a single individual or political party. For many years, experts have called for reforms in the energy and power sector, tax reforms, and improvements in fiscal and monetary policy management.

Although the vision of economists is sometimes at variance with that of politicians, no economic strategy can succeed if it is politically difficult to implement. But in Pakistan, politicians and other leaders seem to forever postpone inevitable economic decisions by citing political difficulties or popular reaction.

Pakistan’s tax-to-GDP ratio, which hovers around 10.3 per cent, needs to rise to around 15 per cent. Pakistan also needs to attract investment. There have been periodic calls for unburdening the government of state-owned enterprises (SOEs) going back to the 1990s, but the process has moved in fits and starts. These businesses could be run more efficiently in the private sector and foreign buyers will gladly acquire many of them, bringing in much needed foreign exchange.

Some SOEs have run losses for years and are unlikely to become productive under state management even in the distant future. Others need to be simply shut down and their assets stripped and put to other, more productive, uses. Other countries have successfully managed privatization. Why should Pakistan continue to fail or lag behind in doing so?

Fuel prices in most countries are market driven and Pakistan should not be an exception. When international fuel prices rise, consumers should pay higher prices, just as they should benefit from lower costs when prices drop. The current practice is that the government fixes energy prices. It tries to make up for its chronic revenue deficits through surcharges when world oil and gas prices fall and subsidizes consumers when these prices rise.

Government leaders believe that lower oil, gas, and electricity prices make them popular, while higher bills result in public protests. But keeping prices artificially low involves subsidies, which create more problems in running the economy. It might be better for everyone if the government got most of its revenue from direct taxes, took away the surcharges currently burdening consumers, and allowed fuel and electricity prices to be determined by the market.

Pakistan also cannot keep covering its budgetary shortfall by printing more money, which always leads to high inflation. The federal government and the provinces need to agree on mechanisms which would ensure enforcement of commitments of fiscal responsibility. The national fiscal situation needs to become more predictable than it has often been.

A concerted effort is needed to expand exports. A 1960s textbook will tell you that Pakistan is an exporter of cotton products, rice, leather goods, surgical instruments, and sporting equipment. Meanwhile, our neighbour India, which had a similar export profile fifty years ago, now exports refined petroleum, polished diamonds, packaged medicaments, computer software, and jewellery as well.

Clearly, Pakistan’s business community has not found it in their self-interest to find new products to export. Only economic incentives, not admonishments and sermons, can change that. For instance, Pakistan’s textile sector must be incentivized to move into value added garments, like Bangladesh.

Adam Smith, who is considered the father of economics, identified three fundamental laws of economics. These are: the law of self-interest, the law of competition, and the law of supply and demand. Based on these, it must be understood that investment and business decisions will be made on the basis of the self-interest of investors, fair competition will make the economy more efficient, and prices of goods and services will be determined by supply and demand.

The government’s role should not be to lecture business owners on how it is their patriotic duty to invest or pay taxes. It should be to create an environment in which the self interest of investors and business owners would be best served by investing in Pakistan and in paying taxes. Similarly, enabling competition without over-regulation and allowing market mechanisms to work without unfair manipulation would ensure better functioning of the economy.

Currently the powers-that-be are focusing on administrative measures, such as cracking down on smuggling (which results in revenue loss), hoarding of essential commodities (which artificially limits supply and drives prices up), and corruption (which depresses investment, limits economic growth, and has a detrimental impact on competition as well as the composition of government spending). These steps are not without their usefulness, but it is important to remember their limitations.

Soon after imposing Pakistan’s first martial law in October 1958, Field Marshal Ayub Khan also initiated similar measures to cleanse the country of corrupt elements. Ten years later, in his autobiography ‘Friends Not Masters,’ he explained why the crackdown did not transform the economy. The Field Marshal’s observations (on page 78 of ‘Friends Not Masters) would be useful to remember even in today’s environment.

According to Ayub Khan, “What army officers did not understand was that civil action was subject to the limitations of the law and had to take into account currents and crosscurrents of public opinion. I would tell them of the results of two quick actions which were taken by us during the first days of the revolution. We produced two martial law regulations: one made the adulteration of foodstuffs a criminal offence and the other made black-marketing subject to heavy punishment.”

The result of these measures, he continued, “was that sweetmeats started selling at Rs 150 a seer [equal to 1.25 kg] and adulteration of foodstuffs was completely checked. But within a fortnight all the stocks were exhausted, and business came to a standstill. There was great initial enthusiasm for price controls too, and everybody started buying crockery, cutlery, and watches at very reasonable prices. But once the stocks were sold there was nothing to replace them. The businessman had no incentive to re-invest.”

The writer, former ambassador of Pakistan to the US, is Diplomat-in-Residence at the Anwar Gargash Diplomatic Academy in Abu Dhabi and Senior Fellow at the Hudson Institute in Washington DC.