Jun 242008

THE budget presented by the new government on June 11 missed an opportunity to prevent the economy from completely going off the track.

As previous administrations have done during periods of economic stress, Islamabad’s policymakers have once again chosen the easy approach. Rather than opt for changing the structure of the economy so that it will not go through crises every few years, Islamabad has papered over the problems it has to deal with.

The solutions I am proposing will be politically difficult since they will impose some burden on powerful constituencies. It is the job of the politicians to resolve these political conflicts; if they walk away from them, they are not earning their living.

The present crisis is the result of the faulty policies pursued in the five-year period between 2002 and 2007 when the economy was allowed to expand without any worry about the stresses that the expansion may produce. The consequence of this misguided approach was the neglect of some of the sectors that should have produced the supplies needed by the expanding economy.

This is precisely what happened to the sectors of agriculture and energy. For some inexplicable reason, the previous administration did not invest in electric power generation or on increasing the supply of natural gas. At the same time it encouraged village electrification and added more areas to the gas grids. The demand for these two essential commodities increased while their supply remained severely constrained.

The process of adjustment that has been forced upon the current administration will have to take place when the global economy itself is under great strain. Having given up development planning, the annual budget exercise is the only occasion when the government takes a careful look at the economy and lays down the policy framework for developing it.

The amount of economic power that was captured by the finance ministry since 1999 has meant that the Planning Commission lost the role it used to play. While the ‘Q’ block captured power, it did not acquire the capacity to do serious analytical work. During the latter part of the Musharraf period, policymaking led by finance, was ad-hoc and opportunistic.

Given the difficult economic situation that confronts the country today, it must develop a coherent strategy aimed at both reviving the economy and placing it on a high growth strategy. In addition the model of development should include two additional objectives – reducing the incidence of poverty and narrowing the inter-personal and inter-regional income distribution gaps. I will today focus on two aspects of the strategy that needs to be formulated: to develop the sectors whose development needs immediate attention, and to reduce macroeconomic deficits.

In this context, the policymaker must ask and then find answers to the following four questions. One, what to do with domestic prices when most experts agree that we are witnessing a paradigm shift in the prices of agricultural commodities? Two, what should be the response to the increase in the price of oil, an important item of import for the country? Three, how should the government’s finances be improved to narrow the fiscal deficit so that it does not go beyond five per cent of GDP, which, in Pakistan’s conditions, is a sustainable level. And, four, what should be done to narrow the current account deficit and also bring it to a sustainable level of around four per cent of GDP?

In so far as the energy sector is concerned, the government should pass on the prevailing international prices to the consumers. Subsidising the consumption of petroleum products and natural gas places intolerable burden on the national exchequer. It also skews the pattern of demand which is not efficient for the economy. In fact, the price of petroleum products that are consumed by the well-to-do should not only reflect international prices. The government should also impose an additional levy from which some subsidies should be given on the products that are consumed by the poor.

The second area for policy attention is the sector of agriculture and, related to it, the prices of food gains for the poor consumers. Pakistan should take full advantage of the changes in agriculture’s terms of trade. This is the first time that agricultural prices have moved higher than the prices of manufactures and services. Allowed to be passed on to the producers, there should be a fairly quick supply response.

Subsidising the prices of food grains, limiting their movement or preventing their export are all akin to levying tax on agriculture and passing the revenue to the urban areas. Such an approach will keep the sector of agriculture under-developed. It will also keep millions of people poor who depend on agriculture for employment.

The third area of concern is the growing fiscal deficit. This ripples through the economy, affecting the level of prices, private sector investments and balance of payments. Pakistan has one of the lowest tax-to-GDP ratios of any major developing country. It barely acceded 10 per cent at the end of the Musharraf period. The total government expenditure approached one-fifth of the GDP. These ratios suggest a tax and expenditure regimes that need a total overhaul. The government should have a careful look at the tax policy, closing the loop-holes the rich have exploited to avoid paying their due share.

The share of the well-to-do in the taxes collected by the government needs to significantly increase; sub-national governments should play a larger role in mobilising tax revenues; incomes from all sources, including agriculture, should be taxed; speculative activities in real estate and stock markets should be discouraged by levying capital gains tax. On the expenditure side, duplication of work between national and provincial governments should be eliminated by transferring more functions to the governments at the sub-national levels.

The fourth area that needs government attention concerns trade. The only time Pakistan aggressively pursued export expansion was in the 1960s when the Ayub Khan government introduced the Export Bonus Voucher Scheme. The scheme allowed the exporters to earn large premiums financed by the importers. The country then had a dual exchange rate, one for exports and the other for imports.

In sum, considerable amount of analytical work needs to be done to reshape the Pakistani economy by devising the right kinds of public policy. The donor community could nudge the government by supporting a programme of deep structural change.

Source: Daily Dawn, 24/6/2008

 Posted by at 7:25 pm

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