WANTED – growth strategy for Pakistan without inflation

A strategy for economic growth, full employment, and deficit reduction—all without inflation is a real challenge for a country like Pakistan. Experience and empirical evidence illustrates how to get there. Credible actions that reduce the rapid growth of federal spending and debt will raise economic growth and lower the unemployment rate. Higher private investment, not more government purchases, is the surest way to increase prosperity. Time for a budget game changer has arrived now.

Dispelling myths

Firstly, higher government spending is not associated with lower unemployment. It is the biggest peacetime fiscal expansion in Pakistan financial history. Debt [both international and domestic] stood at record high $61 billion i.e 63 per cent of GDP. The big question is what has been the real impact of Marginal Productivity of Debt to the GDP growth in Pakistan in the last 3-years. Has it made any major impact on the structural economic landscape of Pakistan? The answer is left for Ministry of Finance to respond. In my humble point of view; it’s not positive. Across the globe countries have countered the recession by cutting taxes and by boosting government spending. To the extent that government spending crowds out job-creating private investment, it can actually worsen unemployment. Indeed, extensive government efforts to stimulate the economy and reduce joblessness by spending more have failed to reduce joblessness. In Pakistan, private sector credit growth was 20 per cent and government borrowed 80 per cent which led to sub-par GDP growth in the last fiscal year 2010-2011.

Has expansionary fiscal policy worked in Pakistan?

Strategic analysis illustrates no. We failed to stimulate the economy. Pakistan is a classic case study that proves the evidence of failure of fiscal policy to stimulate the economy and never really worked to get the economy out of stagnation (High inflation, unemployment and low growth) mode. Careful analysis of leading economists globally and Nobel laureate provide some interesting facts. The debate hinges on the scale of the “fiscal multiplier”. This measure captures how effectively tax cuts or increases in government spending stimulate output. A multiplier of one means that a $1 billion increase in government spending will increase a country’s GDP by $1 billion.
The size of the multiplier is bound to vary according to economic conditions. For an economy operating at full capacity, the fiscal multiplier should be zero. Since there are no spare resources, any increase in government demand would just replace spending elsewhere. But in a recession, when workers and factories lie idle (Gas and power shortages, Faisalabad textile sector has collapsed. 1100 units closed), a fiscal boost can increase overall demand. And if the initial stimulus triggers a cascade of expenditure among consumers and businesses, the multiplier can be well above one.
The multiplier is also likely to vary according to the type of fiscal action. Government spending on building a bridge may have a bigger multiplier than a tax cut if consumers save a portion of their tax windfall. A tax cut targeted at poorer people may have a bigger impact on spending than one for the affluent, since poorer folk tend to spend a higher share of their income.

Fiscal multiplier

Crucially, the overall size of the fiscal multiplier also depends on how people react to higher government borrowing. If the government’s actions bolster confidence and revive animal spirits, the multiplier could rise as demand goes up and private investment is “crowded in”. But if interest rates climb in response to government borrowing then some private investment that would otherwise have occurred could get “crowded out”. And if consumers expect higher future taxes (in Pakistan’s case, yes) in order to finance new government borrowing, they could spend less today. All that would reduce the fiscal multiplier, potentially to below zero. There is fear among local investors to invest in Pakistan. Fear is a depreciating asset that has led to capital flight from locals to invest in other countries like Singapore, Bangladesh, Malaysia, Thailand and Indonesia. Sometimes government deliberately avoid raising taxes and cut down its spending as it continues to debase currency by printing money inflation in the economic landscape and decreasing the purchasing power of people. Solution for Pakistan: according to late Milton Friedman-Nobel Laureate from University of Chicago, Booth School of Business, USA once said. “Price inflation can be controlled through monetary deflation”. Will we achieve this solution is a big question mark?
Above all, the GOP needs a credible and transparent budget strategy. It’s time for a game-changer—a budget action that will stop the recent discretionary spending binge before it gets entrenched in government agencies.

Evolving strategies

Second, we need to lay out a path for total federal government spending growth for the next 2-years that will gradually bring spending into balance with the amount of tax revenues generated in later years by the current tax system approximately Rs1.95 trillion. Our government has yet to position its strategy of VAT or RGST or new VAT. Assurance that the current tax system will remain in place—pending genuine reform in corporate and individual income taxes—will be an immediate stimulus. Agriculture and services sectors need to be taxed. Just imagine untaxed farm income stands at Rs3.6 trillion today and I can safely predict that this income would touch Rs5-6 trillion in the next 2-3 years with increase in agriculture prices globally.
All this must be accompanied by an accurate and simple explanation of how the strategy will increase economic growth, an explanation that will counteract scare stories and also allow
people outside of government to start making plans, including business plans, to invest and hire. In this respect the budget strategy should be seen in the context of a larger pro-growth, pro-employment government reform strategy.
Control of federal spending and a strategy for ending the deficit will provide assurance that tax rates will not rise—pending tax reform—and that uncontrolled deficits will not recur. This assurance must be the foundation of strategy for a healthy economy. GoP needs to focus on Monetary Policy to stimulate the economy. Intervention in the market should be stopped and the market should be allowed to function themselves. Unwanted subsidies should be abolished to create a level playing field for all players to eschew inefficiencies and deadweight loss for the economy.

Encouraging SMEs

Thirdly, SME sector is one area that can really boost teconomic growth not only in the short run but also in the long run. It can alleviate poverty, provide employment opportunities and above all increase the productivity of labour in this industry which would benefit the sustainable growth of GDP going forward. Government needs to focus and revisit its strategy that was adopted in the 1960’s to build SME base in the country which was implemented by other countries including South Korea and Malaysia.
Today SME stands as the backbone of all the emerging economies including Brazil, Chile, China, India, Argentina, Malaysia, Singapore and Poland. . However, in Pakistan it’s a different story. Ministry of finance has imposed harsh taxation whereby SME family units have not been given any tax exemptions and are liable to pay income tax at 25 per cent from the first rupee they earn.
Furthermore, the import of raw material and packing material has become expensive due to the depreciation of the rupee and since the duty is charged on the converted rupee value the landed cost increases and on top of it the duties and sales tax make it unaffordable ruining the overall growth potential of the industry.
Government should focus on building institutions like SME Export Bureau, SME Institute of Technology, SME Credit Guarantee and Venture Capital Fund to enhance capacity of SME’s which were supposed to be established for the benefit of the small and medium enterprises but in due course have been over looked completely.
Government should introduce financing and farmers protection insurance scheme in line with IFC and World Bank strategic initiative. Banks and insurance companies can provide colossal impetus in this drive thus bolstering government effort in economic growth and development. Insurance cover would provide protection to the small farmers in case of drought and price volatility which is happening in commodities globally.

Revolutionising agriculture

In addition to this, government needs to guarantee adoption of newer varieties of crop in order to integrate small farmers into modern value chains, existing barriers – such as low education, missing infrastructure, lack of credit and insurance markets – and insecure property rights have to be addressed.
And new ways of information dissemination and learning methods, such as the use of communications technology (Mobile Phone) in extension services, can foster adoption and profitable cultivation among farmers. Increasing productivity among smallholders in developing countries is also an instrument to guarantee food security in the long-run.
In East Asia economies have benefited with increased use of technology by the farmers which led to higher yield, improving productivity growth and above all enhancing the standard of living in the APAC region. World Bank and international donor agencies have goaded successive governments in Pakistan to focus on agriculture to bring about a change in the living standards of the people and GDP growth.

Shan Saeed is a financial economist and commodity expert. He has 12 years of financial market experience. Graduated from the University of Chicago, Booth School of Business, USA & IBA Karachi. Attended Islamic Banking group discussion at Harvard Business School. Can be reached at [email protected] Blogs at www.economistshan.blogspot.com