Wednesday September 28, 2022

Reasons for economic insolvency (Part - I)

August 01, 2022

The debate on whether Pakistan is close to a sovereign default on its obligations has been raging for a while now, notwithstanding a staff-level agreement signed a few weeks back for the two last tranches of the 23rd IMF programme.

The financial crisis has further aggravated owing to intensely divisive politics, sharply declining foreign exchange reserves, which are currently below $8.5 billion, the collapse of the stock market, hyperinflation and the massive devaluation of the rupee, making the country most vulnerable to a risk of economic meltdown, which one hopes will be averted with the likely approval of the IMF programme.

Why have Pakistan’s economic conditions continued to deteriorate, necessitating bailouts from a lender of last resort at regular intervals of three to four years, irrespective of changes in governments, which have been receiving advice from top economists and wise counsel from the IMF and other international financial institutions (IFIs)?

There are several interconnected reasons that underpin the poor performance of the economy; they include poor governance, divisive politics, a huge mess in the energy sector, flawed socio-economic policies and poor implementation due to incompetence and lack of accountability.

These issues have often been the subject of debate from time to time, without any workable solutions. One major factor that has eroded Pakistan’s productivity and competitiveness is the prevalent culture of seeking government jobs; this has led to overexpansion of governments with adverse consequences on businesses. This article will discuss the consequences of this culture, and its second part will cover what needs to be done to promote entrepreneurship/business.

Let us briefly discuss why the country is on the brink of a sovereign default. The basic issue is low levels of exports (what our businesses produce and sell to the world) and high amounts of imports (what we consume but do not produce), resulting in a large trade deficit every year. We also receive remittances almost equal to our exports from overseas Pakistanis, but the trade deficit is much larger than these remittances, leaving a major deficit in foreign exchange – current account deficit.

Since this has been happening for decades, we have also acquired a large amount of foreign currency external debt and liabilities, accumulated to over $115 billion. In the past, we closed this gap by taking more external loans from the IMF, IFSs and some friendly countries. The problem this time has compounded owing to a high cost of energy (oil and gas) imports made expensive by the Russian invasion of Ukraine.

Consequently, a significant gap exists between what the IMF and IFIs are willing to give to us and what we require to meet current account deficit and loan repayments that are due. While I am reasonably certain that with some difficult decisions, including placing even greater restrictions on imports (making them more expensive), we should be able to find a temporary solution to finance our gap, the problem is that every time we manage this with the help of an IMF programme, the chronic issue of current account deficit returns after a few years as the external debt continues to rise and our exports remain stagnant or grow much slower than imports.

So the fundamental issue is a large trade deficit as we do not produce, in terms of quantity, value and quality, goods and services that are needed by our own people and for the export to other countries. Goods and services are produced by businesses. The reason our businesses are not generating sufficient goods and services for exports or to substitute imports is due to three major reasons: first, low productivity (we produce less or low quality goods from given resources). Second, lack of innovation, which refers to using technology and processes that enhances productivity, reduces cost, improves quality and customer satisfaction. And, third, we have not yet identified goods and services that we can produce economically with our local resources, and do not have adequate knowledge, technology and talent to do so (what can be described as our inability to identify new opportunities/ideas).

Key factors of production include land, labour, capital, technology and entrepreneurship. We clearly have no dearth of land and labour, and capital can also be mobilized given the opportunities. Our biggest weakness is a lack of a robust business/entrepreneurial ecosystem.

It is common knowledge that except for a few small communities, an overwhelmingly large part of society heavily relies on and seeks jobs. Children from a very young age are told, rather indoctrinated at home and school, that they have to get education, focusing on certificates or degrees primarily to get jobs, especially government jobs, which come with security of service and progression, irrespective of job performance.

As our politicians come from the same society, the key promises made to voters in elections include the provision of government jobs. For decades, all regimes expanded governments at all levels to accommodate their voters’ demand for jobs. Consequently, not only is the government now the biggest employer in the country (it is so in most countries), it also employs the most incompetent segment of society. Owing to job security in the government sector, which is accepted as unalterable gospel and no accountability, there is double jeopardy: high demand for government jobs on the one hand and poor delivery and decision-making of the government on the other; this incurs huge cost for the economy.

One may argue that while this is true for low-level jobs, the bureaucracy comes through merit based on competitive examinations and a rigorous selection process through federal and provincial public-service organizations. While this may be correct to some extent, the quality of civil service recruitment and training has not kept pace with the fast changing world over the years. Also, once bureaucrats get appointed, they work in an environment where performance is not the criteria for their postings and promotion; they have to largely work to meet political interests.

A country and its people progress only when they produce high-quality goods and services efficiently at low cost for both the domestic and global markets, and this is done by businesses not governments. A government’s primary role should be to create jobs in the private sector through promoting businesses and entrepreneurship rather than providing jobs itself by expanding the government.

An excessive number of people in the government has already eroded efficiency and effectiveness of our public sector, besides leading to a huge increase in the cost of the public sector that translates into a big fiscal deficit despite heavy taxation, placing a huge financial burden on the people and businesses in the form of inflation and making our businesses non-competitive.

To be continued

The writer is a former managing partner of a leading professional services firm and has done extensive work on governance in the public and private sectors.

Twitter: @Asad_Ashah


    zahida abro commented 2 months ago

    very good article sir our government must revisit economic policies and make better infrastructure and give suitable law and order to investers.

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