Dec 102008

THERE can be debate among economists on many issues. It is a discipline that is less rigorous than the physical sciences where laws are established based on logic and experimentation.

That notwithstanding, there is a consensus on certain things. There is no contention about the relationship economists have long postulated between supply, demand and price. If demand exceeds supply, prices go up; the reverse happens if supply outstrips demand.

Another point of agreement is that governments must not overspend and if they do overspend they must not finance the difference between expenditure and government revenues by printing money. If the governments respond to the printing press then the economy will lose its balance, inflation will result, the poor will suffer, income disparity will increase and the rate of growth will slow down.

This chain of events will happen and the government that tolerates it should be held responsible for following the wrong sets of policies. This line of thinking is as close to a set of laws that economics as a discipline can get to. These together constitute the economist’s law of gravity. An economy that expects to produce growth by allowing large fiscal deficits will, sooner or later, come crashing down and hit the ground.

Less well known and appreciated among lay people is the relationship between fiscal deficits and deficits in the balance of payments. Large fiscal deficits increase demand, including that for imported goods. The amount of money spent on imports outstrips that earned from exports. The result is a growing balance of payments deficit which has to be financed. Some governments do this by borrowing from abroad which results in increasing the burden of debt which has severe long-term consequences. Others allow the exchange rate to depreciate, making imports more expensive and thus helping to narrow the trade gap.

Those who have followed Pakistan’s economic developments in recent months will recognise all these principles at work. There is little scope for debate about these. Where there can be a vigorous debate concerns the policies the government should adopt in order to address the serious economic situation the country faces today. This discussion is all the more necessary since much of the rest of the world is working on using various kinds of stimuli to keep economies growing. This approach has been followed most spectacularly by China which has announced plans to pump $586bn into the economy to stop the rate of growth from decreasing significantly.

The Indians are thinking of giving their economy some stimulus as well. In the industrial world plans are being announced almost daily to stimulate economies. Even the IMF has suggested that the world’s rich countries should expand government expenditure by at least two per cent of their GDP to prevent their economies from slipping into serious recession.

The economists who are advising president-elect Barack Obama on managing the US economy are working on a stimulus package that may amount to considerably more than the target suggested by the IMF. A figure of $600bn is being mentioned. This is about three per cent of the American gross domestic product.

There is one interesting feature of the programme being developed by the Obama team. This has relevance for Pakistan. According to one adviser, Obama “feels very strongly that this is not just a short-term fix but a long-term retooling of the American economy”. The stimulus package being developed “will lay the groundwork for long-term sustained economic growth.” It will include programmes aimed at healthcare, improving educational infrastructure and “the greening of the economy”. Obama, in other words, is using the crisis as an opportunity. And that brings me to the case of Pakistan.

For obvious reasons, Pakistan cannot stimulate its economy; it does not have the fiscal space which would allow Islamabad to pump more money into the economic system. On the other hand, it has to increase government revenue and reduce government expenditure in order to narrow the fiscal deficit to a sustainable level of about four per cent of GDP.

However, the government should allow social policy to enter the picture in selecting the areas needing state action. There are three that will need the government’s attention as a part of a strategy that not only deals with the current crisis but also seeks to address a number of problems that have been with us for a long time. Economists call them structural weaknesses. The three I have in mind are tax policy, expenditure policy and policies aimed at building institutions. Today I will deal with the first, saving the other two for discussion in later columns.

Pakistan remains an under-taxed economy; the proportion of tax to GDP has been declining and is now less than 10 per cent, one of the lowest among the world’s major developing economies. This must increase in order to allow the government to spend more on social programmes such as those of education and healthcare. But the increase in revenues must come from the rich not the poor and middle classes.

A lax tax administration that has allowed the rich to escape the tax net should be tightened, the sectors of the economy that are not taxed or are taxed lightly should pay their due, only the poor should be subsidised and all others must pay for the services the government provides, and governments at the sub-national levels should be allowed a much larger role in raising tax and other revenues for the state.

Pakistan has been trying to improve its tax structure and its tax policy for decades but, in spite of the effort that has gone into it, the effort has not produced good results. There are many reasons for failure; perhaps the most important being the lack — and over time loss — of confidence on the part of the people in the working of the government.

Good governance, in other words, is a big part of the solution Pakistan must come up with in order to ease the revenue constraint under which the state operates. Here a democratic government should be able to help since by definition it hears the voice of the people and acts upon it. It is interesting to note that it was the people’s voice that forced the executives of the American car companies from their private planes into using energy-efficient cars as they came begging again from Detroit to Washington.

Daily Dawn, 9th December, 2008


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