The economists’ hour

September 13, 2020

The economic experts at the helm do not seem equal to the tasks that lie ahead of them

Having recently read Benyamin Appelbaum’s The Economists’ Hour, I could not help but mull over the current state of the economy in my own country. Though The book deals in the main with the economic history of the US since WW-II, the parallels between its subject matter and the national economy today are in many ways striking.

The similarity between the economic affairs of two rather dissimilar states seems to stem from the fact that both economies have been brought greatly under the influence of unelected economic ‘experts’. This has been a process which began in the US in the 1970s. It really took hold after the Reagan era in the ’80s. For Pakistan this has been the stark reality ever since the current government, carrying the hopes of multitudes, came into power.

The book is a fascinating read even for the casual dabbler in the subject; its main theme gyrates around how economists belonging to the free market (read neo-liberal) school of thought, have taken hold of policy-making in the US and how they have grossly missed their mark and have dismally failed to deliver the much-touted benefits that they so assertively promised. In many respects, our current government, led by technocrats, appears to be treading along a similar path.

The State Bank’s policy of adhering to an extremely tight-fisted monetary policy in an attempt to curb inflation, sending interest rates sky high in the process, reminds one of Paul Adolph Volcker’s (chairman of the Federal Reserve from 1979 to 1987) ‘war against inflation’. Following Milton Friedman’s advice to severely limit the money supply and raise interest rates to new heights, Volcker did manage to control inflation. However, the victory came at a staggeringly high cost.

With even prime rates beyond the reach of most, business activity and investments collapsed, economic growth stalled, and unemployment soared to levels not experienced since the Great Depression era. Unemployment in the auto industry, for instance, stood at 23 percent. With massive layoffs across various sectors, the demand for cars and housing plummeted (rings any bells?). Auto dealers sent the keys of their unsold cars and home builders sent wooden beams that lay idle to Volcker’s home, and he gained much obloquy amongst the working class for the murder of the American Dream”.

This notion of sacrificing economic growth at the altar of inflation control is a dangerous one. For quite some time now economists, of the kind mentioned here, have been seeking to realise the ‘Goldilocks economy’ characterised by growth coupled with extremely low inflation, but the manner in which it has been pursued has arguably done quite a lot of harm to large segments of society.

The inflation-adjusted median income of a male worker in the US stood at $54, 932 in 1978. In 2017, it stood at $52,146. The US has arguably been the most powerful and prosperous nation over the past century or so. The colossal size of its economy provided it with enough cushion to bear the brunt of the harmful impact of pursuing such lopsided policies without completely buckling under its weight. The question is, how can Pakistan, with its feeble and measly economy, afford to follow a similar path?

The State Bank’s Volkeristic policy of preferring inflation control over economic growth already appears to have inflicted considerable damage to the economy. Given Pakistan’s miserably low per capita income, limited employment opportunities, and the desperate need to find new vents for economic growth, in this trade-off between inflation and growth, the State Bank seems to have been choosing the wrong side.

Other countries have managed growth with high inflation. For example, South Korea’s income per capita grew at an incredible 7 percent per annum in the 1970s despite having an inflation rate hovering around 20 percent. Brazil has managed high growth at even higher rates of inflation.

For the most part of its two years in power, the government has followed a tight monetary policy with exorbitantly high interest rates in tandem with a tight fiscal policy with PSDP funds drastically curtailed. Without either a monetary or a fiscal stimulus and with an almost insurmountable wall of high interest rates obstructing the path of business activities and investments, is it really a surprise that the economy has faltered and nosedived into a recession?

Only with the onslaught of Covid-19 has the State Bank moderately reduced interest rates and the government taken some perfunctory steps to provide a fiscal stimulus to the construction industry. How successful it will be, time will decidedly tell, but it certainly does not appear to be something that will alter the trajectory of long-term economic growth.

To see how policymaking can change the fates of nations we simply need to look east. Japan, after remaining in a state of isolation and stagnation for several centuries, became (after the Meiji Restoration in 1868) the first nation outside the West to rise to the challenges of modernity, breaking free from the shackles of the past holding it back from progress and industrializing with great vigour and virility. In the mid-twentieth century other East Asian countries followed suit, with South Korea and Taiwan experiencing what has been dubbed ‘miracle growth’ from 1950s to around 1990.

Today, we see neighbouring China experiencing similar miraculous growth rates. From an agricultural and rural economies, Japan, South Korea and Taiwan rose to become hubs of manufacturing and technological innovation. What was it that led to this phenomenal growth and prosperity in East Asia?

Given Pakistan’s miserably low per capita income, limited employment opportunities, and the desperate need to find new vents for economic growth, in the trade-off between inflation and growth, the State Bank seems to have been choosing the wrong side.

Before 1868, Japan was a highly oligarchic feudal society that seemed destined to indefinitely continue in its politically archaic, economically backward and militarily weak state under the yoke of the Tokugawa shogunate. In 1960, Taiwan had a literacy rate of 54 percent compared to Philippines’ 72 percent and Argentina’s impressive 91 percent. In 1965, as per the World Bank’s data, South Korea’s nominal GDP per capita stood at a paltry $108, compared to Pakistan’s $116, Philippine’s $187, and Argentina’s $1,279.

The point is that neither of these countries was especially well-endowed in terms of either human capital or any great resource base. From rudimentary beginnings they managed to occasion the transition towards sustained growth and development. Today South Korea’s GDP per capita (~$31,000) is nearly three times that of Argentina, ten times that of Philippines and more than twenty-two times that of Pakistan. Taiwan similarly has a per capita income several folds greater than the countries mentioned above, and Japan has a standard of living at par and in some respects superior to that of Western nations.

What has been the common factor in these East Asian nations is, as the South Korean economist and Cambridge professor, Ha-Joon Chang, has repeatedly mentioned in his various works, that the state played an extremely proactive role in helping set in motion the wheels of economic growth, rather than letting market forces sway the economy.

The governments of these nations channeled great efforts and large sums of money to kick-start the process of industrialisation.

Determined not to be dominated and colonised by the West, the Japanese, set about to overhaul their state politically, economically, and militarily. In a relentless zeal to realise the national slogan of ‘fukoku kyohei’ (rich country, with strong army), the state proceeded with a dirigisme on a hitherto unparalleled scale.

The Battle of Tsushima and the Battle of Mukden in the Russo-Japanese war of 1905 are powerful reminders of how quickly and effectively the Japanese succeeded in their endeavour, and how rapidly they rose in status and power becoming a major player in the international politics of the day.

The South Korean state under the leadership of General Park Chung Hee played a similar role in transforming the nation. It set up of the Pohang Iron and Steel Company (POSCO) under the supervision of former Maj Gen Park Tae Joon in 1968. Privatized in 2001, it is currently the fourth largest producer of steel in the world. In the 1960s the state banned LG from setting foot in the textile industry and forced it instead to enter the electronics industry; the rest, as they say, is history. In a similar vein it put enormous pressure on Chung Ju Yung, founder of the Hyundai Group, to start a shipbuilding company.

To make private companies comply and invest according to what the state planners had in mind and to protect the infant industries from foreign competition, the government used massive subsidies, tariff protection and access to easy loans from state controlled central banks. These carrots were turned into sticks by being denied to non-complying or underperforming companies. In some cases, even direct threats were also used by the state to strong-arm firms into behaving in ways conducive to the long-term benefit of the nation. These state-led measures ignited the process of industrialisation and wealth creation which in turn have immutably altered the social and economic fabric of South Korea.

The transformation in Taiwan took place after Chiang Kai Shek crossed the straits from mainland China and established the rule of the Kuomintang government in the island. In a stroke of genius, the Taiwanese government redistributed excess land to the landless and compensated former owners with shares in sate owned enterprises set up by the government (Redistribution of land also took place in Japan and South Korea). This had a two-fold effect on the economy.

First, it created a broad base of consumers laying the foundations of an egalitarian society and engendering a steady demand for consumer goods. Second, the land reforms effectively transferred the wealth and the interests of the elite from land to industry. The industrialization that consequently occurred took place under the supervision of a government official, KY Yin, who personally travelled to Japan to study the history of the Meiji Restoration and the consequent transformation of the Japanese economy.

Later, Sun Yun-suan, the minister of economic affairs in the 1970s set up the Industrial Technology Research Institute (ITRI) which has been a major driver of economic growth in Taiwan ever since its inception. Through the ITRI, Sun helped Taiwan licence the technology for production of semiconductors from the American firm RCA. Today, semiconductors lie at centre of the Taiwanese economy.

Like its East Asian counterparts, Taiwan also used enormous sticks and carrots to mould and set the direction of the economy. Textile firms were, for instance, ordered to export 60 percent of their produce or face fines, while companies which chose to use Taiwanese-made semiconductors were given tax breaks and easy access to loans.

East Asia picked up the gauntlet and successfully rose to the challenges of the modern world, but South Asia is still floundering to find a firm footing for sustained economic growth and prosperity. Many had pinned great hopes on our present government, but it seems to have no economic roadmap for the socioeconomic development of the nation.

The economists’ hour is upon us and the economic experts at the helm do not seem equal to the tasks that lie ahead of them. Gen Park Chung Hee or KY Yin were certainly no experts in the technical sense, but they successfully managed to lay the foundations that led to the transmogrification of their nations within a few decades from rudimentary agricultural states into the economic powerhouses that they are today. We still await such a transformation, and currently it is nowhere in sight.

The writer is a graduate in economics and finance from Warwick Business School. He has worked on various development projects with the provincial and federal government. He can be reached at [email protected]

The economists’ hour