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December 27, 2020

Macroeconomic dislocation in the depths of debt

Business

December 27, 2020

LAHORE: A strong economy is the only option to ensure that Pakistan holds a respectable place in the community of nations.

We have all essential growth ingredients, but our rulers lack the ability to put their foot down when it comes to political compromises.

An economy simply needs right, and transparent policy instruments to rebuild from the debris, as was done by many Latin American countries. Their economic managers simply pursued universally accepted economic principles, and were able to confront vested interests and political compromises.

The main areas of our economy that need urgent attention of planners include fiscal deficit, tax revenue, interest rates, exchange rates, trade policy, privatisation, and infrastructure projects.

Large and sustained fiscal deficits are a primary source of macroeconomic dislocation in the forms of inflation, payments deficits, and capital flight. In our daily life, we see households curtailing expenses when their monthly incomes do not support spending.

They take loans to the extent of their repayment abilities from expected future incomes. However, if the incomes do not materialise, they sell family silver to pay back their debt and reduce expenses within the limit of their incomes.

They may move from a larger house to a smaller one, reduce transport expenses either by disposing of their luxury cars and buying a smaller version, or they curtail their outings to save fuel.

Pakistan government also needs to adopt this approach.

It is indeed worrisome that the incumbent regime is not worried about the highly unsustainable fiscal deficit. The non-development expenditures must be controlled.

If the going is not sustainable, the government should reduce the perks of its employees and withdraw all official vehicles. It should set a limit to monthly power, gas, and telephone bills of each office by up to 50 percent.

Instead of unnecessary domestic and foreign trips, it should use technology to connect virtually at all levels. This would also improve governance.

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

When a fiscal deficit needs to be reduced, 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) more beneficial to the poor than hospitals in the capital city stuffed with all the latest high-tech medical gadgets.

Increased tax revenues are the alternative to decreased public expenditures as a remedy for a fiscal deficit. An aversion among politicians in matters of tax increases is irresponsible and incomprehensible.

The economic managers should be strict to the principle of increasing 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, a market-determined interest rate may be extremely high. The government would have to find a compromise.

Like interest rates, exchange rates may 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 allows 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.

Free trade ideal was generally 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.

The second qualification concerns timing. A highly protected economy is not expected to dismantle all protection overnight. It should be 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 faced by a manager who either has a direct personal stake in the profits of an enterprise or else is accountable to those who do.