Economic reforms: looking beyond the IMF
After much huffing and puffing, the PTI government seems set to follow the two previous regimes in entering an IMF bailout programme. Finance Minister Asad Umar expects a deal to be signed by this month’s end, after he attends the World Bank-IMF annual spring meetings in Washington, D.C. The proverbial ‘begging bowl’ then remains intact.
As negotiations with the Fund have dragged on since October 2018, Mr Umar has been at pains to point out that this time things are different. He credits as an achievement the loans – at market rates, mind you – secured from Saudi Arabia and UAE to partially cover the external funding gap that first triggered the ongoing crisis. Secondly, the minister claims that it is the IMF that has finally come around to his view of things, and thus any agreement now will not impinge on Pakistan’s policy space. Never mind that key demands have already been met: drastic fiscal and monetary tightening, higher energy prices, and letting the currency depreciate.
Mr Umar calls these measures painful but needed course correction, yet they are merely automatic macroeconomic responses to this latest economic crisis. Any dispensation in PTI’s shoes would have done the same; which is, blamed the previous government for the current predicament. So in 2019 the PTI blames the PML-N, in 2013 the PML-N blamed the PPP, and in 2008 the PPP blamed Musharraf. Looking beyond the political rhetoric, these periodic crises are the result of the Pakistani economy’s unique business cycle shaped by deep structural flaws, and no single party can be entirely blamed for it.
This is how each business cycle works. A new government is faced with large fiscal and current account deficits, forcing it to take IMF loans to prevent the economy from stalling. This is followed by two years of ‘stabilisation’ (i.e. economic slowdown), after which there is a moderate recovery largely fuelled by consumption and import-led growth, pushing both the fiscal and current account deficits up again and bringing the economy back to square one. These cycles repeat themselves and we are currently at the bottom of the previous one that began in 2013 when Pakistan took a US$6.6bn IMF bailout.
What is the reason that the fiscal and current account deficits swell to unsustainable levels in such a predictable manner, necessitating foreign loans? With regard to the former, it is primarily because the Pakistani state does not generate enough tax revenues. The tax-GDP ratio has remained stagnant over the last ten years (2008-18), with the yearly average an abysmal 10.6%. The current account problem is caused by a persistent trade deficit, as our exports are uncompetitive and low-value-added. A key underlying reason for this is that we are a society of consumers who hardly save anything, and therefore do not invest enough. Indeed, the average annual gross fixed investment-GDP ratio over the last ten years was a paltry 15%; compare this with regional peers India and Bangladesh where it was twice that of Pakistan at 30% each in 2017.
The worrying thing is that although Prime Minister Imran Khan claims that this IMF bailout will be the country’s last, his economic team has not come up with any concrete reform policies to increase revenue collection and domestic investment. It is understandable that Asad Umar has so far been preoccupied with fire-fighting to resolve the ongoing external sector crisis, yet it will all be for nought if these two vital issues are not given the priority they deserve. Combining an experimental approach based on the latest research with a review of successful growth strategies adopted by developing countries in the past can yield fresh ideas.
With respect to tax policy, the emerging field of behavioural economics can offer useful insights. Behavioural economics, founded by the Nobel Prize-winning psychologist Daniel Kahneman, challenges the fundamental assumptions of orthodox economics that humans are rational, self-interested agents always acting to maximise their utility. Instead, it acknowledges that our emotions and mental biases guide our decisions much more frequently than standard economics textbooks would admit.
One implication of this for fiscal policy is that the tax rate may not be as important as how individuals perceive taxes. In particular, the concept of ‘benefit taxes’ posits that linking a specific tax to the public benefits it funds can yield positive results. In Pakistan, as opposed to tried-and-failed punitive measures such as higher tax rates on bank transactions of non-filers (with the deleterious effect of encouraging the informal, undocumented economy), the benefit taxes approach could be tested. For example, a special tax could be levied for public projects such as the Diamer-Bhasha dam or the Benazir Income Support Programme. Emphasising benefits accruing to the community in this way could raise greater revenue than vague appeals to charity, something that the former Chief Justice Saqib Nisar erroneously pushed for. If successful, this experiment could be expanded by sending notices to individuals disaggregating the proportion of their tax money being spent on different sectors, projects, initiatives, etc.
The other key issue is promoting domestic investment. In devising policies for this purpose, it makes sense to start with a focus on exports as it helps the government solve the information problem: support for firms can be targeted by type of activity. Exporting firms are also likely to be more efficient compared to domestic-focused ones since they have to compete globally, hence the argument that the former may be more deserving of state support. However, in Pakistan, this logic has been abused by giving wasteful subsidies to ‘zero-rated’ export industries without any results. Over the last ten years, merchandise trade exports have remained virtually stagnant, with a yearly average of about US$23bn, while the corresponding average for imports is US$40bn. With the PTI government continuing the same policy, there is no reason to expect a different outcome.
A better alternative would be to learn from the astonishing success of the East Asian ‘tiger’ economies. Countries like Japan and South Korea for example, made government support to exporters – primarily in the form of preferential access to capital and foreign exchange – conditional on past export performance. Essentially, this was a ‘quid pro quo’ rather than the no-strings-attached handouts we continue to give Pakistani exporters.
Leadership demands acting simultaneously to resolve immediate difficulties and move towards a long-term vision. This requires a trade-off, giving up some political capital now for larger societal gains in the future. The fact that the PTI government is engaged with putting out an immediate fire is no justification for its lack of planning to address the real structural issues plaguing Pakistan’s economy. Contrary to Mr Umar’s public statements, the hard decisions are yet to be made.
By Waqas Aslam Rana