Published by Dawn.com on 26th Sep, 2019
It has been a few weeks since we — the collective we, that is — and the International Monetary Fund (IMF) entered into a staff-level agreement, paving the way for a multi-billion dollar bailout, marking the 22nd such occasion.
As it should, the deal has been followed by a vibrant public debate. Primetime news anchors, op-ed columnists and the twitterati have pondered upon the impact of the devalued rupee, higher interest rate, more taxes and lower government spending.
All of these questions are warranted and they should demand our time and attention. However, there are two substantially more critical questions we need to ask ourselves.
First, why do we keep getting into a dire-enough condition that we need an IMF bailout? And second, what can we do so that we’re not in such a position again?
I have already given my thoughts on the first question, which I hold is fundamentally due to the extractive nature of our country’s political institutions that incentivise politicians to grant patronage to firms rather than establish fair competition in the economy and create short time-horizons for politicians because of instability in maintaining a democratic political system.
I continue to believe that we need to redistribute political power more fairly in order to unlock transformative economic change.
That aside, in this article, I make my contribution to the second question and outline a few policy directions and reforms to increase domestic productivity, so that we don’t end up with the IMF again.
Before going forward, I will add a caveat: there is unlikely to be any single answer to such large policy questions; at best we have a variety of answers which we can experiment with, and learn from. That is what good policy-making entails.
At a familiar place
Let’s recap. We were largely in this position not so long ago, and not long before that. So, what did we do to get back into the same position again? The answer lies in our idea of growth. To illustrate, I will rewind to 2013.
We got an IMF loan which did what it was meant to do — averted a balance of payments crisis, stabilised the economy and allowed us to leverage the stability for more borrowed capital. This allowed us to pay for our imports.
We combined it with other loans, particularly domestic ones, so the government could spend more without substantially raising more taxes.
We used the increase in foreign reserves to overvalue the rupee, which essentially meant that we subsidised imports by making them cheaper. It also made our exports more expensive.
This helped boost the consumption of mainly imported goods, which drives up economic growth, measured as increasing gross domestic product (GDP).
In essence, people bought more stuff and the government got capital to spend on some large-ticket infrastructure projects, some on hiring more people and some on subsidies.
Everything looks good on paper unless you read it closely — but who really does that?
This created a bad set of incentives for firms as they would have found more profit in acquiring import licences rather than investing in capacity to export, or simply moving their investment towards non-tradable sectors.
For example, think about the growth in real estate that lured many textile firms to move investment away from expanding their manufacturing capacity and towards the property market.
But the problem with real estate is that you can’t export it.
This is in no way exclusive to the past five years or so, but a wider reality of our growth story that continues to be dominated by the non-tradable sector — the part of the economy that can neither substitute imports nor produce goods or services that can be exported: real estate, retail and construction.
In 1995, for example, we exported about $11.6 billion of goods and services — that’s about $95 for each Pakistani. By 2017, our exports jumped to just over $21 billion, or $108 for each Pakistani.
In contrast, Bangladesh pushed its per-capita exports from about $20 to about $164 during the same period.
We have been left behind; it is time to change that.
What can we do about it?
If we need to export more, substantially more, then how do we do it?
The answer lies, in my view, on increasing domestic productivity — that is, how much output our economy can produce given a set of inputs.
In other words, how much resources do you need — people, money and materials — to produce a good or provide a service?
For example, if a factory in Faisalabad were to produce a t-shirt and a factory in Dhaka is producing the same type of t-shirt — how much time and resources will each need to produce that product?
So far, our growth model has mainly focused on the accumulation of physical assets, such as building roads and factories, but not the broader investments needed to increase productivity.
No wonder it is estimated that only 11 per cent of our GDP growth between 1998 and 2008 was due to an increase in productivity. It is not that physical assets aren’t important for us — they are — but growth is more than just roads.
Even the agriculture sector has been unable to sustain an increase in productivity. Growth in the sector has been mainly driven by an increase in inputs rather than efficiency in using these inputs.
Domestic productivity is also intrinsically tied with trade. Economists have found evidence that increasing trade raises domestic productivity; when firms trade with foreign firms, the competition forces them to be more productive or die out. On the other hand, you need higher domestic productivity to make your products competitive globally.
So if we want to increase domestic productivity, how do we do it? Here are a few areas to think about.
First, we desperately need to invest in building the institutional structures conducive to an increase in domestic productivity.
Let’s start with the basics. The rule of law and secure property rights are essential to productive societies and are worthy of significant public investment.
It needs to be made certain that when you, or a firm, make an agreement, the law will make sure it is fulfilled. Or, when you buy a property, it is reasonably protected from theft and can be used by the owner effectively. For this, reforms are needed of our courts, laws and the police force.
Second, there needs to be significant public investment in human capital, an important element in increasing domestic productivity.
We currently fare poorly. The World Bank’s Human Capital Index, which tries to capture human capital a child born today is expected to gain by the time he or she turns 18, puts us below our regional and income-level average.
This means that, even compared to countries of similar income level, we are failing to invest in our people.
A large part of human capital is schooling, but much of it is beyond that and includes various other types of skills and attributes that allow people to achieve their potential.
This requires Pakistan to continue its investments in basic education while making sure that these years in school are translating into tangible learning outcomes for students.
This should be combined with an increase in the quality and quantity of post-secondary education through investing in both traditional undergraduate programmes and non-traditional programmes that allow people to gain skills faster.
Research and development spending adds on to this, making it an important part of the human capital stock of a country.
Greater human capital also allows people and firms to adapt to new technology, which in itself is an important part of boosting productivity.
Third, we need to re-evaluate the government’s protection of firms, and in some cases entire sectors.
Presently, we run the risk of creating a poor set of incentives for firms as they can rely on subsidies and other forms of state-granted protection to generate profits, rather than increase their productivity.
The sugar industry and automobile sector are the most clear examples of this ‘protection’, but it is not limited to them. Several other firms and sectors also receive special tax breaks (through statutory regulatory orders) or frequent ‘packages’ from the government.
These protections can lead to misallocation of labour and capital. In other words, we are keeping people (and money) in sectors that aren’t productive enough. This misallocation makes all of us worse off by reducing our combined productivity.
Ideally, these poor performing firms should either improve their performance, or die out and allow people and capital to move towards better performing firms.
If our goal with these subsidies is to help the poor, it is hardly the way to do it. Instead, this revenue could be redirected towards targeted social welfare programmes that don’t lead to misallocation in the market.
This is not to say that we shouldn’t have a policy to protect specific industries, but such policies need to be designed carefully and not allow patronage relationships to develop.
Fourth, we need to make an integrated and coherent move to invest in cities. By creating vibrant cities that bring people and firms together in dense environments, we can unlock significant productivity gains.
Some of these gains will be due to more people moving away from agriculture and into manufacturing and services, which are more productive activities and are primarily undertaken in cities.
The rest will be due to gains from density. This is done by bringing people and firms close to each other; cities allow for sharing of ideas and unlock the ability of people and firms to specialise. Both lead to higher productivity.
However, these gains are going to be untapped if we don’t actively invest in building the institutions and infrastructure cities need not only for the population already living there, but also the people who can move from rural areas.
This requires independent and empowered urban governments who can provide public services and undertake context-specific policy decisions, particularly those that can help build a stock of knowledge through schooling, research and attracting skilled people, and housing them in high-density settlements.
Even though we currently lack many elements of vibrant cities, they are still more productive than rural areas. One measure of this is that our cities, while home to 38pc of our population, count for about 55pc of our GDP.
An added advantage of vibrant and empowered cities is that they are best placed to enforce property taxes. These taxes can be used to discourage speculative investment in this non-tradable sector, which has accumulated significant capital over the past few years.
Should we ignore these underlying reforms, we are destined to continue to be stuck in this vicious cycle which is pushing us from one IMF loan to another.
For this, our policy needs to move away from merely fire fighting. At the risk of oversimplifying, think about this:
If our house bursts into flames every few years, we certainly need to put the fire out, but we also need to ask ourselves what keeps causing this fire and make the necessary changes to prevent it.
Illustration by Rajaa Moini