Why Pakistan will go to the IMF again, and again and again

 Originally published in Dawn.com on October 16, 2018 here (where it was the third most read article of the day, to my surprise). It was subsequently cross-posted at Scroll.in here. Header image by Dawn.com.

Pakistan’s formula for economic growth is as flawed as it gets: borrow foreign currency-denominated loans, build some large-scale infrastructure, get a minor growth spurt in the process, and wait until this growth spurt fades so we can repeat the process again.

This is what the previous government did. And, the one before that. It could have worked if, while borrowing to build infrastructure, it did not ignore the underlying constraints to growth and productivity.

Because they did not do that, Pakistan has ended up with an increasing level of debt, a balance of payment crises, and a government struggling to keep the growth spurt going.

When these challenges become dire — Pakistan often ends up getting a loan by the International Monetary Fund (IMF).

This time, if we’re successful in persuading them which looks to be the case, will be the 22nd occasion we will be loaned capital by the fund since 1958.

And, if our public discourse and policies remain the same, we will without doubt keep knocking at IMF’s door every few years (or some other lender for that matter).

The logical argument made by analysts in Pakistan here is that the government needs to bring meaningful reforms to our economy.

So, in due course, we are in a fiscally sound enough condition that we not require bailouts like the ones we get from the IMF.

This is a perfectly accurate demand. But, it often masks the politicalcauses to our economic despair.

The problem with talking about the economy divorced from politics is that we end up with superficial reforms.

This is because any meaningful reforms are impossible if the political structure does not allow them.

For this to change, our public discourse needs to take a holistic overview of our institutions. This is a contribution to that end.

Digging deeper

Let me explain. Take the much talked about balance of payment crisis as an example.

The most direct culprits are lack of exports and the increasing cost of imports. Pakistan imports nearly twice as many products and services than it exports.

In turn, there are many causes for low exports, some are macroeconomic determinants. The unsound infatuation of the previous government with an appreciated rupee is an example of this.

Dig deeper, we are exposed to the fact that Pakistan has developed little comparative advantage over the years. Which means that we mostly export basic textiles, cotton and rice and other related products.

Most of them are low-value items in the global value chain, so we earn little revenue from exporting them, and are hence unable to cover our import bill.

Dig further, we find that even in products which we do export, we face structural problems  —  such as lack of capital, whether it is human or financial.

Hence, exporters struggle to grow, move up the value chain, compete with foreign firms, and boost productivity.

But, why is this? Why does Pakistan fail to provide an environment which is conducive to developing globally competitive enterprises?

There are many explanations here — but one persuasive thought is that our institutions do not create the set of incentives needed for the growth of a competitive market.

Instead, they encourage a reliance on state patronage even if it comes at the cost of the larger industrial growth.

Pakistan’s public discourse has been rather good at ignoring these underlying causes. The result of this has been that, whenever Pakistan has found itself in such crises, it has been able to get loans to sail, or crawl, through the crisis.

But, all those reasons why this crisis emerged in the first place will remain — waiting to fuel another crisis down the road.

It is like putting the fire out but not fixing the leaking gas socket in the basement.

What are institutions?

A good place to start is understanding what institutions are, and how they influence our collective behaviour.

Simply put, institutions are the ‘rules of the game’ as Douglas North popularly put it in his 1990 book.

Think about cricket — we have certain rules under which everyone plays the game. There has to be a fixed number of players, they have a number of balls to play with, and everyone has a consensus on how we determine which team wins.

Now, apply the intuition behind this analogy to the broader institutions which shape our daily life.

Like the rules which govern the game of cricket, we have humanly devised rules which govern our lives in a more consequential manner.

They can be formal which are written down, such as the laws of the land often codified in the constitution, or informal ones widely accepted by the population, such as kinship bonds.

These institutions are important because without them, society as we know it would collapse. But, these institutions differ from country to country, and a persuasive strand of economic literature argues that they are the key to understanding our development outcomes.

We can also split them between economic and political institutions. The former directly shape our economic incentives, such as ownership rights of property, and the latter determine the political structure, such as whether we’re a parliamentary democracy or not.

As a society, we decide which economic and political institutions to adopt, and these institutions shape much of our behaviour through shaping our incentives.

Incentives, any economist can tell you, are fundamental to understanding any society’s prosperity or lack thereof.

It’s not economics, stupid. It’s politics

The political institutions, I’d argue, are more important in determining our prosperity. As Acemoglu and Robinson argue, those who control the political power determine economic institutions.

So, if political power (which in turn determines the political institutions) is controlled by a small, extractive elite, they will set up economic institutions which benefit them, not the majority.

If the elite benefit from an economy underpinned by clientelism and patronage rather than a well-functioning competitive economy, they will choose the former.

It is important to remember that there is plenty of profit in poverty. It just happens to be controlled by few.

Now, look at Pakistan. Our political economy is defined by an embedded culture of rent-seeking and patronage.

This means we have a system which grants profits to certain players in our economy unfairly, hence undermining the central principle of efficient market allocation — fair competition — and creating a wrong set of incentives for businesses.

Our manufacturing sector is rife with examples of rent-seeking practices. For example, Pakistan’s automobile sector is dominated by a handful of Japanese manufacturers known for selling low-value cars while making a considerable profit.

Despite this, Pakistan provides them with extensive trade barriers to protect them from foreign competition. The recent finance bill (since amended) further shows the extent of their political patronage.

This is not by accident. Because Pakistan’s political power is controlled by an extractive elite, it has allowed for such political institutions to emerge which permit its government to provide these rents to certain car manufactures with immunity, even if this negatively impacts our shared prosperity.

Direct evidence of our political structure influencing economic outcomes comes from a paper by Asim Ijaz Khwaja and Atif Mian.

They show that politically connected firms in Pakistan receive loans from government banks in Pakistan at lower rates despite defaulting more than non-politically connected firms.

This is evidence of unaccountable political power translating into inefficient economic allocation.

Look at this from another angle. A large amount of economic history literature argues that one of the many reasons why some East Asian countries prospered in the second half of the 20th century was because of land reforms.

By undertaking substantial land reforms, these countries were not only to increase agricultural output but also raise living standards for their surplus labour, which, in the long run, subsidised their move towards industrialisation.

If land reforms are important for growth, would Pakistan ever adopt them in any meaningful way?

Despite attempts to do so, Pakistan has not gone through significant land reforms and over 10 million acres of land still remains under tenancy, while one estimate puts the average farm size in Pakistan at about six acres.

In South Korea, despite a significant increase in average farm size over the recent past, it still averages at about 3.5 acres (as of 2005).

Without making a deep dive into the history or merits of land reforms, if we agree for the sake of argument that more radical land reforms are needed in Pakistan — can we undertake such reforms when political power and institutions are so highly influenced by those who control large farm holdings?

In other words, if feudal lords control the political institutions, it shouldn’t be a surprise that economic outcomes will favour them.

To fix the economy, focus on the political discourse

What may seem to a passerby as a country which continues to choose poorly thought-out economic policies, sees rampant corruption and a failure to establish a productive industrial base, are in fact symptoms of the political institutional structure which benefits a narrow extractive governing elite at the cost of everyone else.

Our economic failure is a symptom of our collective political choices. Once we can allocate political power more fairly, we can make better economic outcomes.

Tweaking institutions at the margins does have some impact. Hence, the IMF’s stabilisation programme will provide some macroeconomic stability.

The stock market might recover, the fiscal deficit might get narrower. Taxes might increase a bit, so will inflation.

And, in due course, we will issue a statement saying goodbye to the IMF for few years. Before repeating the process again and again.

But, if the new government wants to break this cycle and make a sincere attempt at reforming Pakistan into some sort of an egalitarian, prosperous nation, it needs to start by looking at political power and the political institutions which rise from them, as they are the real constraints to our growth.

Even if it can make marginal changes on the economic front, they would not unlock the kind of transformative shift we need for widespread prosperity.

By Shahrukh Wani

Economist at International Growth Centre, University of Oxford.

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