Blog – Shahrukh Wani – Personal Website

Cities have turned it around before

In 1975, NYC narrowly averted bankruptcy. In Shakespeare’s London, life expectancy was six years lower than the rest of the country. An 1842 report by Edwin Chadwick noted that a labourer in rural Rutland expected to live over twice as long as a labourer in the city of Liverpool.

These cities built infrastructure backed by new laws such as the UK’s 1848 Public Health Act. NYC built an entire city underneath its city: 438 miles of subway lines, 6,000 miles of sewers, and thousands of miles of gas mains.

It paid off. Today, life expectancy in NYC is higher than the national average — even the poorest live longer than poor elsewhere in the U.S. In London, mean earnings are 1.3 times the U.K. average. While people in Liverpool now live twice as long today.

All I’m saying is that cities have turned it around before. They have contained congestion, crime, and pollution to attract smart people — allowing people to exchange ideas and build better lives.

Feature Image: Credit: © Steve Duncan / Barcroft Media

Making policy decisions under uncertainty

Co-authored with Sir Paul Collier and Victoria Delbridge

The COVID-19 pandemic has exposed policymakers to high levels of uncertainty: governments simply do not have enough information to know what to do. The result is changing policy decisions mid-course: Britain reversed its strategy of building herd immunity when a new estimate put the likely death toll from this strategy at 250,000 people; America’s Centres for Disease Control initially discouraged the wearing of face masks by citizens but has since reversed its course. Policy changes like these have risked policymakers’ credibility, as well as their citizens’ compliance.

The uncertainty is far worse for developing country policymakers. Developed countries have more resources to spare if their decisions do not lead to desired outcomes. Trust in governments tends to be higher, and data is also better. While policymakers in developed countries have benefited from sophisticated analysis based on data shared by large firms, the best bet in developing countries are small surveys, or projections which typically use mortality data from elsewhere and assumptions to provide local estimates. Even core health data, such as the rate of infections, might be significantly understated: across Africa, only 685 tests have been carried out per million people, while Italy has conducted nearly 37,000 per million. If policymakers in developed countries are making decisions in fog, their counterparts in developing countries are doing so in the dark.

For policymakers at the city level, decision making is even harder. While the spread of the pandemic is deeply spatial by nature, local governments often lack the authority to act to contain the virus. For cities that are led by parties in opposition to those at the national level, authority is prone to re-centralisation. When Delhi’s local government attempted to reserve hospital beds exclusively for its residents, the decision was quickly overruled by the central government-appointed governor. Data sharing is also a challenge: even more tricky than sharing between various national government departments is sharing with sub-national tiers.

Making policy decisions under this level of uncertainty requires four key steps:

Distinguish between questions that can be answered without further information and those which cannot.

Some policies make sense no matter what new information comes in — what economist Stefan Dercon calls no-regret policies. As Michael Callen and Edward Glaeser also suggest, encouraging hygiene is one such policy: across sub-Saharan Africa, only a quarter of people have access to basic handwashing facilities including soap and water. These investments are important regardless of the pandemic, but more so given the increased importance of handwashing to limit the spread of the COVID-19 virus.

Other policies involve significant trade-offs — costs and benefits — which are currently poorly measured. For these, the first policy response is to gather information that would enable a decision to be taken, as far as possible. Since capacity is limited, all such efforts should be driven by the specific policy choices that need to be made. For example, through combining easy-to-access administrative datasets with a pre-existing socio-economic survey, policymakers in Pakistan have been able to target cash transfers to the poorest. Cape Town uses live data from funeral homes to quickly identify areas with excessive deaths in the city. Where possible, technology can also help: Medellín asks residents who need financial support to register their vulnerability, as well as their symptoms, online — nearly 90 percent of the residents have.

Some questions cannot be answered at all at present: for example, how long will the virus continue to spread? When will it end? How many people will lose their lives? — all of these can only be known ex-post. Until then, while we may be able to guess, ‘we don’t know’ is the only right answer.

Uncertainty requires experimentation: it is learning from doing.

When ‘we don’t know’ is the only right answer, it is unlikely that our first attempt at solving a problem will be correct. In this case, the most appropriate response is to use the best information available and quickly learn from what is working and what isn’t.

This requires experimentation — varying activities, locations, and time periods. As the costs and benefits of lockdowns is unclear, our understanding of lockdowns can benefit from such localised experimentation. On the one hand, China’s decision to lockdown the city of Wuhan may have reduced the infection rate in other Chinese cities by about 65%. On the other hand, emerging evidence shows that lockdowns in developing countries lead to significant income losses and reduced food consumption. In these cases, targeted lockdowns that impose restrictions based on local risk profiles might work better.

COVID policy response requires experimentation — varying activities, locations, and time periods.
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With experimentation, we need to rapidly monitor, evaluate, and adapt. When Madrid shut down schools and offices and asked people to stay home, many people instead congregated at parks. Only after seeing this did the city adapt and closed its parks. The city of Durban has daily “war room” meetings to undertake and evaluate decisions in the city.

Models can help, but they are no more reliable than the numbers fed into them. The epidemiological model being used by the American government is repeatedly wrong. — Vox has reported that the actual death numbers fell outside the range it predicted 70 percent of the time. While other models have been more accurate, their importance lies in understanding what they can do: provide a range of outcomes likely under certain conditions., their importance lies in understanding what they can do: provide a range of outcomes likely under certain conditions. As more data is collected and fed into models and assumptions are tweaked based on real-world evidence, models become better. Until we have that data, they are best used with caution.

Communicate with citizens so that they can make good choices.

Policymakers need to communicate two big messages:

There are serious risks associated with COVID-19, and that by their own actions, people can reduce these risks to themselves and to others.
Policymakers do not yet have enough evidence, and so may well need to revise policies as they learn more: people should stay alert to further advice on what to do.

The authorities must balance the need to reassure — which is very important to avoid panic — with the need to avoid losing credibility as events unfold in unexpected ways. We know from past shocks, such as from the Ebola epidemic in West Africa, that misinformation can have a disastrous impact on containment efforts. We are seeing some of this play out right now: across cities in Pakistan, rumours and misinformation have fuelled incidents of patients’ families attacking hospital staff.

More worryingly, some countries have outright stopped sharing information with people: Tanzania stopped sharing data on the spread of COVID-19 six weeks ago and has just announced that the country is free of any cases, even though border testing of Tanzanian truck drivers by Uganda indicates otherwise. Countries which have clear and consistent information are doing better. Vietnam stands out: the government communicates protection measures via text messages, and posters across Vietnamese cities highlight the seriousness of the virus — so far, Vietnam has prevented any large-scale community outbreak and the death toll is at zero.

The messenger is as important as the message.

As far as possible, decisions need to be taken close to the communities and people who understand their specific constraints. In South Sudan, researchers note that localised priorities are competing with the threat from coronavirus, and the messaging needs to be tailored to account for these other challenges. In China, devolvement went even further, with some cities actively recruiting their residents into containment measures. Guangzhou alone hired as many as 80,000 of its residents to conduct community patrols to ensure compliance.

Working with local community leaders can also help — as Freetown Mayor Aki-Sawyerr put it, “it is not only the message, but also the messenger”. By working with local allies, policymakers can leverage greater trust in their decisions. During the Ebola epidemic in Liberia, door-to-door community outreach with community leaders was incredibly effective in increasing the uptake of preventative measures. Not working with community leaders can undermine containment efforts: in the Punjab province of Pakistan, nearly half of all urban mosques surveyed still conducted congregational Friday prayers, despite government asking them not to. But when the surveyors provided them with information on the pandemic, around 8 out of 10 mosque leaders said they would consider postponing congregational prayers.

Making policy decisions under this level of uncertainty is not easy. The best we can do is to restructure the way we think about it: recognise the limitation of the available evidence and experiment with different policy decisions, actively learn from the outcome, devolve decisions to local governments who best understand the context, and clearly communicate the information to the people.

Published by the International Growth Center on 23rd June, 2020.

Devolve more power to cities: they will need it more than ever

Co-authored with Astrid Haas.

COVID-19 pandemic started in a city and spread through them. The core benefit of cities — as an enabler of proximity — is also their biggest liability. This is exacerbated when infrastructure and services are scarce. Across sub-Saharan Africa, only a quarter of people have access to necessary handwashing facilities, including soap and water. More than a third of Indian urbanites are packed into a single room or a house without a roof.

Yet some cities were better prepared to respond to this pandemic than even their own national governments. In Colombia, where city leaders have sufficient power to make decisions, many acted quickly and have been able to tailor policy decisions to the situation at hand. Medellín’s mayor began preparing for the virus in late January, far before the national government. Bogotá’s mayor created an 84 km emergency bike network to help essential workers get around safely.

A defining difference in how well cities are responding to COVID-19 is whether city governments actually have the power to respond. Many cities, particularly in developing countries, don’t because national governments have often been reluctant to devolve power to them. This may be for a number of reasons such as politics (cities can be opposition strongholds) — or perhaps due to economics (they are important sources of tax revenue). Yet cities are complex systems, and they need context-specific policies to work effectively.

This reluctance to devolve power affects how well cities can be managed: given the complexity of urban systems, cities need context-specific policies to work effectively. The pandemic is a case in point: the initial response across the globe was to impose blanket national-level lockdowns. However, there is increasing evidence that they are inefficient and economically very costly. Instead, localised containment measures that can be implemented and lifted by responsive authorities are proving to be more flexible, efficient and effective.

But localised containment measures require local leaders who to have adequate control. In Britain, the ongoing stand-off between the national government and the mayor of Greater Manchester is a stark example of how the central government’s desire to impose local containment measures can fail without local leaders willing to lend it legitimacy. As our LSE colleague, Tony Travers, said: “There is a sense that people in Greater Manchester are having things done to them by a distant government.” This might have been avoided if the Mayor was given more control over the city’s pandemic response and resource-raising powers.

For many countries, the power over cities may have been devolved on paper, but very rarely in practice. Some of this is historical: many cities in developing countries inherited centralised urban governance structures and laws from their colonial pasts. These are ill-suited to their current needs. For example, Britain’s Town and Country Planning Acts still cast a long shadow over many African and South Asian cities in the form of stringent height regulations and large, pre-defined plot sizes for land. This encourages sprawling, low-density cities where people struggle to travel between their homes and workplaces.

Reluctance to devolve power has also at times resulted in incomplete and inconsistent outcomes. Cities are often only given partial control over urban policies or have their administrative jurisdiction siloed. In Karachi, Pakistan, the mayor barely has jurisdiction over a third of the city. The rest is split between provincial and federal governments, while three different political parties control each tier.

National governments can and should change this. Across history and across the globe, cities have given individuals the quickest route from poverty to prosperity: in Africa, one can earn as much as 23% more in cities than in rural areas. Cities provide opportunities that attract people and create ‘agglomeration’ economies that cluster people and businesses together, which is attractive to the private sector. The outcomes of this proximity can be innovation, economic growth, and development.

But not all cities lead to this outcome: it is only well-managed cities. This requires giving cities control over key areas that shape the path of urbanisation. At a city-level, all these policy areas, such has housing, transport, and planning, complement each other and require context-specific approaches. For example, new transport investments need to consider where people live and work to be most effective.

Devolving control over policy areas also needs to be coupled with increasing the ability of city leaders to raise their own revenues. This is not only important to allow them to deliver local services and infrastructure effectively, it also reduces the burden on national treasuries. Perhaps most importantly, it increases the accountability of city leadership to their citizens.

In 1960, no low-income country had more than one-third of its population living in its cities: now nearly 40% of them do. This trend is projected to continue well into this century, with Africa and South Asia urbanising rapidly. Furthermore, as more people are pushed into poverty due to the pandemic, we are likely to see more rapid urbanisation rates on these continents, as people move towards cities looking for opportunities.

Cities need to not only meet the expectations of the current citizenry, they also need to plan for the people to come. As shocks — health, climate, and others — are likely to increase, city leaders need the power to prepare and respond. Luckily for Bogotá, their mayor has this control and is now planning to add 280 additional kilometers of bike lanes, paving the way for a more resilient city. Other cities in rapidly urbanising countries need more of this local control as well.

Editor’s note: This article first appeared on LSE blog.

The case for taxing landlords in Pakistan

A replica of the Statue of Liberty stands on a hill overlooking the construction of new homes in Bahria Town on the outskirts of Islamabad, Pakistan March 16, 2016. To match Interview PAKISTAN-PROPERTY/TYCOON REUTERS/Caren Firouz

BUY land for they aren’t making it anymore, Mark Twain once advised. Our politicians certainly seem to agree — some have over a dozen parcels of land to their name, according to recent asset declarations published by the Election Commission.

None of this is a surprise. Pakistan’s rich (like the rest of us) like to buy land because it is a tangible and easily definable asset, instead of company stocks or government bonds — you can see land, touch it, build upon it. It gives you social status and helps you keep it. It also tends to go up in value by a lot: on average, Lahore’s residential plot increased its market value by 85 per cent between 2013 and 2018.

Better yet, once you own land, you don’t have to do anything for its value to go up. The majority of the value of properties comes from its land. Once the owner of a piece of land, one benefits from other people’s work: people who run businesses; those whose taxes allow governments to invest in improving infrastructure. All of these people work, and they drive up the value of land around them. Those who own the land benefit without having to lift a finger.

Hence, the fair thing to do is to tax people who own land, so that the landlords pay for the infrastructure they benefit from. It is also the smart thing to do so the government can use this tax revenue and invest in better infrastructure that drives up the value of land and paves the way for more property tax revenue in the long run. The best way to do this is by enforcing an annual tax on property that owners linked to the land’s market value, so as the land value goes up, a portion of it is actively captured to pay for public services.

As most fair and smart things go, we don’t do this well right now. All of Punjab, with its 100 million-plus population, collects less urban property taxes than the city of Chennai, which is home to about 10m people.

All of Punjab, with its 100 million-plus population, collects less urban property taxes than the city of Chennai, which is home to about 10m people.
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This is because our current system allows landlords to pay little regular taxes on their properties. This is by design: the tax method used underestimates property values. An owner of a one-kanal (approximately 500 square metres) house in a posh area in Lahore or Karachi rarely has to worry about an annual tax bill above a few thousand rupees.

By not taxing land enough, we have designed a system in which people buy land to increase their wealth rather than buy land for housing. This is why parts of our cities are left vacant, as landlords wait for their plots to increase in value. Those who aren’t lucky enough to own land have to move to the city’s outskirts to afford a house.

How do we change this? If the government is willing, there is enough technical expertise to design a fairer tax system that actively targets the richest landlords. But landlords are a powerful lobby, especially if they’re the ones who dominate our legislatures. Any such reforms will depend on the reformer’s ability to balance winners (the people at large) and the losers (the landlords).

An excellent way to do this is to link any such expansion of taxation with local service delivery led by independent urban governments. This would help create a clear coalition of beneficiaries from the expansion of property taxes in every city. But currently, we don’t have empowered local governments: Punjab’s decentralisation bill would pave the way for such governments in the province, but elections are repeatedly delayed.

For such local governments to properly tax wealth kept in the form of land, we also need to change the special provisions given to parts of the city — such as the cantonment areas and Defence Housing Authorities where the highest-value land is located and they collect property taxes independently of local and provincial governments. As residents of these areas benefit from the city’s larger economic system, it is only fair that they contribute towards city-wide public investment.

Such reforms are possible. Consider: Freetown’s mayor revamped her city’s property tax system earlier this year. Her message is simple: we need to pay for public services, and it is only fair that the richest landlords pay their fair share. The taxes on the top 20pc of the landlords will triple, while taxes on the poorest will be halved. The city expects its property tax revenue to increase five-fold.

Until we do the same, our legislators-cum-landlords will continue to benefit from unearned profits while accumulating larger landholdings. Aspiring landlords will buy plots in shady housing societies. Our cities will continue to struggle to pay for essential services. As for those who want to buy land to build a house — they will have to wait.

Published in Dawn, November 24th, 2020

Image: Dawn.

How Pakistan’s sugar industry extracts rent

Published in The Express Tribune, May 8^th, 2020.

Co-authored with Dr. Adeel Malik.

While an inquiry on the sugar sector has been made public for the first time, the crisis that necessitated this inquiry is a recurring feature of Pakistan’s sugar industry. Rattled by a controversy every 18 months, why is the sugar industry so prone to crises?

To answer this, we must use a basic principle of political economy: rent-seeking. Imagine this: you want to open a restaurant, but there is a lot of competition. You want to make more money but other restaurants, serving better food at cheaper prices, keep opening up. Along with other restaurants, you lobby the government to require all new restaurants to have a new licence to operate. The government sets up a special committee to issue these licences. You convince them to put you or your friends on this committee and ask them not to issue new restaurant licences. The supply of new restaurants goes down, allowing you and other existing restaurant owners to capture the market. The money you make now isn’t profit, they are rents.

Rents are fundamentally exploitative: it implies that the business is making more money than it would otherwise in a competitive, fair market. They are rigging the game in their favour. This is how our sugar industry works: through administrative actions rather than the standard rules that govern a functioning market. Let’s consider three questions to illustrate this point.

First, who can open a sugar mill? You can’t unless you are politically connected and able to obtain a licence from the government, granted under the provincial Sugar Factories Control and Sugar Licensing Controlling Orders. Punjab has an outright ban on new sugar mills, in effect since 2003. Existing owners have used their political connections to path a way around it: rather than establishing new mills, many existing sugar mills have successfully sought permission to set up their “branches” in other regions.

The result of this has been a high degree of concentration of the industry in the hands of a few — nine families own more than half of the country’s sugar mills. And, six industrial groups control half of the total national production. Three of these six are owned fully or partially by a current (or a former) member of parliament, who sit on all sides of the political divide. One is a member of the current federal cabinet, the second is a member of the cabinet in all but paper.

Second, how are sugar prices determined? Normally, the price would be determined by the interaction of supply and demand i.e. how many people want to buy sugar and how much sugar can be produced in a country. Since the demand for essential food items, such as sugar, is relatively inelastic (large price increases have little effect on demand) and predictable (for example, demand increases during Ramazan), what happens on the supply-side is more important for sugar prices.

One key determining factor in sugar price is the minimum support price that is guaranteed by the government to sugar growers every year to shield them from income and price fluctuations. These support prices have increased by three times during the past decade and are typically negotiated between millers and sugarcane commissioners who are provincial civil servants. The second is the recovery rate or the amount of output that can be recovered from a typical length of sugarcane. These are declared by sugar mills. As indicated by the sugar inquiry report, the recovery rates are typically unverified. Even mills in the same region and using the same variety of sugarcane document different recovery rates.

Another factor that impinges on the supply of sugar is when support prices are announced and when mills start the crushing period. The former determines the incentives of the farmers to grow sugarcane and the latter influences the available sugar stock in the market. Both decisions are routinely delayed in ways that benefit sugar mills. Given greater bargaining power and control over the state’s administrative machinery, the millers exert a disproportionate influence on how sugar prices are determined.

The industry also benefits from a formal lobbying group, the Pakistan Sugar Mills Association (PSMA). When, in 2010, the Competition Commission of Pakistan launched an inquiry into the sugar industry, the PSMA earnestly went to the court and got a stay order, derailing the inquiry. Cleary, the fuel which runs our sugar mills is not competition. It is extraction.

Third, are there any special privileges provided to this sector? There are more than we can count, including high import barriers through tariffs and regulatory duties which restrict competition from foreign producers. But, the clearest privilege is export subsidies: when global sugar prices are surging or there is an excess stock for sugar available, sugar producers not only get permission to export but also get subsidies to do so. This export of sugar is typically followed by a drawing down of the national sugar stock, creating the perfect conditions for a price rise in the domestic market in the following season.

Unproductive rents harm all of us but benefit a few well-placed people who use political connections to restrict competition and extract benefits from the government. How much does it cost all of us? Between 2006 and 2010, calculations done by one of us estimate that Rs585 billion was transferred from the pockets of ordinary people to the sugar industry. This is likely to be much higher when we consider the costs of broader misallocation this creates in our economy. Another implication is that Pakistani farmers are moving away from cotton to growing water-intensive sugarcane. In 2010, this resulted in $1.4 billion in terms of lost exports of cotton.

Over time, this rent-seeking has been institutionalised — whichever party may be in power, the underlying vested interests remain the same. In an efficient economy, firms compete with each other fairly, lowering prices, innovating, and upping quality. Firms which can’t, fail; people who work in them move to other, better-performing firms. Ask yourself this: when did the last sugar mill collapse in Pakistan? Take the protection and subsidies away and see what happens.

What prevents developing countries from taxing more?

Published: International Growth Centre, 12^th Aug 2020.

Virtually every country in the world taxes their populations. But, some do so more successfully than others. Most developing countries raise tax revenue equivalent to between 10% to 20% of their GDPs, some even less. Rich countries raise much more, on average 34%. If Pakistan distributed all its annual tax revenue equally among its 200 million citizens each would get less than 1% of the country’s legal minimum wage. The result of this is considerable differences between the abilities of governments to fund public services, explaining why India spends $62 per citizen on healthcare, while Germany spends over $4,000.^[1]

Why do developing countries find it so hard to tax? There is no one answer. For starters, developing countries are information-scarce environments – governments typically do not know who owes how much. This is why when developing countries do tax, they focus on taxing consumption and trade instead of labour, as the former are easier to target.^[1]

In most developed countries, this information is largely created by third-party reporting of income. Firms report how much they pay their employees, making it harder for people to cheat. In most developing countries, large informal sectors make this nearly impossible to achieve. Even in China, where formal employment is more widespread, only 28 million people pay direct income taxes, as of 2015. In Pakistan, it is about one million people.

Increasing income taxation is hard without widespread formal employment. In a 2019 working paper, Anders Jensen, of Harvard University, uses data from the United States to show that as people moved away from self-employment to wage labour, this was associated with increased income taxation usage. In a similar vein, research from Denmark shows that tax evasion is significantly higher among people who self-report their income than those whose income is reported by employers.

Some developing countries have made some progress on this front by targeting the small number of people who work in formal firms. This is largely done using withholding taxes, in which businesses deduct the tax before giving paychecks to their employees. But doing so risks pushing the administrative burden on formal private firms — a bad precedent to set, especially when so few exist.

The expansion of value-added taxation (VAT), under which the government levy tax on each firm across a supply chain, is also in part motivated by the desire to create more information. To calculate the value, each firm needs to subtract the difference between its output and its input. By doing so, they create an information trail that can verify the tax liabilities of other firms in that chain. 8 out of 10 countries in sub-Saharan Africa levy the VAT today.

It is ingenious, on paper. In practice, it has led to mixed results. In Chile, third-party reporting due to the VAT has strongly disincentivised tax evasion. While researchers in Uganda have found widespread discrepancies in amounts reported by sellers and buyers, despite the paper trail created by the VAT.

The secret might be how much enforcement capacity a given state has. Firms may eventually realise that the state does not do anything if they do not accurately report their profits. After all, information is worth only if someone acts upon it. But, capacity is a whole other beast: you need the capacity to raise revenue, and revenue to raise capacity.

One way to address this problem is to motivate tax bureaucrats to perform better. When researchers in Pakistan provided property tax collectors with performance pay schemes, revenue jumped by as much as 46%. But, incentives can be tricky to tweak. Some of them can also be costly: in Ghana, one out of five revenue collectors earn a monthly salary that is greater than the revenues they collect, giving them bonuses might not help nor be feasible for the government coffers.

Given all these limitations, developing countries may need to think about a different set of tax policies, such as those we find unwise for developed countries. Economists Adnan Khan and Henrik Kleven term such policies as ‘third-best’.

One policy they consider is taxing full firm revenue instead of profit. Doing so is inefficient because it does not allow firms to deduct the costs of input and may distort a firm’s production decisions. But some inefficiency maybe tolerable if it raises enough revenue. Researchers estimate that in Pakistan’s case this could raise as much as 74% more tax revenue.

There are other factors: less technocrat, more political. An important one is the prevalence of double tax treaties between countries. Signed to prevent taxing the same income twice, they have undermined the tax capacity of several developing countries. Firms can base their operations in one country, usually that has a treaty with another country and very low taxes, evading taxes in the latter because they pay in the former.

In a 2018 paper, IMF Economists Sebastian Beer and Jan Loeprick have used the fact 11 African countries have such treaties with Mauritius, where firms are effectively taxed at a rate of just 3%. They find that these treaties have not only not led to increased foreign investment in countries that sign these treaties with Mauritius but also lead to significant revenue losses. Zambia has just torn up its tax treaty with Mauritius.

The cross broader implications do not end here. The elite in many developing countries evade taxes by moving their wealth abroad, supported by a network of financial and legal firms. African governments collectively lose about $15 billion a year because of offshore wealth, calculations by economist Gabriel Zucman show. It is hard to tax when much of the tax base is signed away, or hidden in Swiss bank accounts.

Published under the title “What is stopping developing countries from taxing more?” on theigc.org as part of IGC’s Ideas Matter campaign to celebrate the launch of the Little Book of Growth.

^[1] This moves the tax burden to lower-income groups. However, in new research, Bachas et al. (2020) argue that consumption taxes might be more progressive in countries with large informal sectors, because people in the bottom decile tend to rely more on informal transactions which are not taxed.

^[1] Data by World Bank’s WDI database. PPP dollars.

Pakistan’s urban transition

Published in Dawn, November 23rd, 2019

VIRTUALLY every country which has economically advanced in modern history has done so while becoming urbanised. Pakistan’s path can be no different; to prosper, we need well-connected, vibrant, and liveable cities that bring people and firms together in dense environments.

But such cities don’t emerge naturally; they are the result of policy actions. New York City functions effectively because of its expansive infrastructure, including an over 10,000 kilometres-long elaborate water supply system.

Building and maintaining such infrastructure isn’t possible without effective governance

structures. Take New York mayor Fiorello La Guardia’s example. In the 1930s, he created a cross-partisan coalition to replace a corrupt network which had controlled the city for nearly eight decades. Over his three terms, he expanded the use of competitive exams to recruit public officials, adopted new administrative practices such as centralised purchasing to reduce corruption, and help set up a public agency to provide urban housing.

If La Guardia and others like him hadn’t taken measures to modernise city governance, New York would look very different today. Such investments have paid off, as demonstrated by the fact that the city has a per capita income that is 172 per cent higher than the national figure.

Pakistani policymakers have failed to understand this importance of cities. Small wonder the people who move to cities in search of prosperity face poor living conditions.

If Pakistan reverses this and manages its urban transition effectively, it can unlock significant economic gains. By bringing people and firms closer, cities provide a dense market for products and workers, where both can focus on interdependent activities. Because of this inter-dependence, cities allow people and firms to learn from each other, fostering creativity.

Think about it this way: if you’re in a city big enough, you can specialise in a narrow but effective set of skills and find a firm interested in hiring those skills. After work, social interaction at cafes or restaurants allows you to learn from others. If you change your job (which is easier in a big city), you take your skills to your new employer, enabling firms to learn from each other.

On a national scale, Pakistan can transform its economic structure by moving people from agriculture, which is generally less productive as it requires more people to produce relatively little output, to manufacturing and services, which are primarily undertaken in cities. But simply moving people to cities is not a condition that unlocks prosperity; people could still move to cities and find themselves in unstable, informal jobs, unable to benefit from density. Some katchi abadis in Karachi have housed people for generations, but they remain poor. Nationally, one in eight urban residents lives in poverty.

This is where effective public policy comes in. To benefit from urbanisation, policy needs to expand the good things about urbanisation such as density and connectivity; and reduce the downsides of urbanisation: crime, pollution, and congestion. New York’s Mayor La Guardia understood this. Backed by federal assistance, his administration oversaw the rapid construction of bridges, highways, parks, and houses, transforming the city’s physical infrastructure.

We’re several steps behind 1930s New York; instead, Pakistan needs to first focus on building three first-order conditions:

First, build local urban governments which are accountable downwards to the people, not upwards towards provincial or federal governments. Pakistan’s record on this is abysmal: when such governments have existed, their purpose has not been to decentralise control. Take Karachi where the reverse has happened; more power has been taken away from the local government and fragmented between various provincial agencies, making accountability impossible.

Punjab doesn’t do much better. In Lahore, provincial agencies provide vital services like water and sanitation. The 2019 local government law might change this but it’s anybody’s guess when elections will be held and how much the law will be implemented by the provincial government, which stands to lose power. There is the possibility of a repeat of what we’re seeing in Islamabad, where the elected Metropolitan Corporation has been in a tug of war with the unelected Capital Development Authority over the control of the city — a battle which now has now gone to the courts.

Ideally, urban areas need to have a single elected urban government with clear authority to provide services like housing, water and sanitation, and local transport.

Second, to pay for our urban transition, we need a robust urban finance base. This can be done by allowing local governments to raise taxes, mainly from land and property (as land cannot be moved between cities). Over time, if these taxes can be tied to visible service delivery, accountability will improve.

Currently, Pakistan is using this revenue source ineffectively. Provinces have their immovable property tax acts but their application is far from effective. For starters, they are often based on outdated valuation measures or proxies. Such is the case in Punjab, where a rigid annual rental value is used to levy this tax. Only now, with help from the World Bank, is the Sindh government planning to revaluate properties.

This leads to the third point, improving urban land rights. Land is a critical feature of urbanisation: people need land to build houses, firms need to locate themselves where they can get customers, and the government can use appreciation of its value to finance public investments.

Ideally, land rights need to be transparent and secure, so everyone knows who owns what. Unfortunately, land in urban Pakistan is regularly exposed to competing claims. Think how many times you have heard of people investing in real estate only to land into uncertainty. In Karachi, as Arif Hasan has argued, land is used as a political tool. This is not what efficient land markets look like.

These are some fundamental policy directions. Our urban transition is already well under way and will occur regardless of what the government does or doesn’t do; official statistics claim that 36pc of Pakistanis live in ‘urban’ areas, but the World Bank puts this at around 55pc. Whether it is 36pc or 55pc, we’re ignoring the proactive public policy needed to manage this transition properly, the consequence of which will be felt for generations to come.

What Pakistan needs to do to break the vicious cycle of IMF bailouts

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.

Looking forward

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

Review of Punjab Local Government Bill 2019

This was published under a different tittle by Dawn.com 21st Aug 2019 here.

There is no path to prosperity which does not pass through cities. Absolutely none. Every country which we today call an advanced economy — like Britain, the United States or Japan — has urbanised as part of their path towards economic prosperity.

This usually meant that these countries experienced rapid economic growth mainly driven by higher productivity unlocked by industrialisation, and during that, more and more of their citizens moved to cities. So for a long time, economists thought that urbanisation happened alongside rising per capita income.

And perhaps that trend made managing these cities more feasible, because growth meant governments had more ability to raise revenue and invest that revenue in infrastructure which cities desperately need to run effectively. London was able to invest in an underground rail system; New York built an elaborate system to deliver water to its residents “that goes as deep as the Chrysler Building is high”, as David Grann once put it.

But increasingly, urbanisation no longer guarantees prosperity in itself. This is due to the trend experienced by many postcolonial countries, where urban populations have grown — and continue to do so — without being accompanied by the rise in per capita income. Urbanisation without significant growth, you might say.

This means that more and more people are living in cities but, increasingly, cities don’t have the resources to build the institutions and infrastructure people need to benefit from urbanisation — turning urbanisation, a potential, into a challenge.

Pakistan is a case in point. Our cities are growing, but we have consistently failed to allow them to govern themselves properly. And here lies the tragedy. If we can govern our cities effectively, they can unlock the kind of prosperity we have never experienced.

The opposing forces in which cities exist

Cities are subject to two kinds of opposing forces. Understanding these can allow us to comprehend the challenge of governing cities better.

The first is a good force, which makes cities worth living in. They’re mainly driven by what economists call the benefits of agglomeration economies. The term makes it sound more complicated than it is: it merely refers to the benefits of people and firms being close to each other.

Think about them in this way: when people are located close to each other, it allows the unlocking of two interconnected forces.

The first is the ability to specialise, allowing people to build their careers on a narrow set of skills thanks to the size of the city. You can be a lawyer focusing simply on mergers of firms and, because you live in a city large enough, you can work in a firm which demands that skill.

At mass, specialisation allows people to have better matching of skills with firms, with people able to invest in narrower — but more effective — skills which can reap considerable returns.

The second is knowledge spillovers, something which comes out of scale and specialisation. When people are close to each other, it allows them to share ideas and information. In cities, people move from one firm to another, taking their skills with them and sharing them with others. They meet at cafés and talk about new ideas and might even start new firms.

Silicon Valley is a good example of this. If there is one industry you would expect to work without clustering its employees in a single office, surely it is one which works on producing technology.

But technology firms still cluster a large number of their employees in Silicon Valley, and many people who want to work in the technology sector want to move there. This is because firms benefit from having a large workforce with specialised accumulated knowledge, and people benefit from being able to leverage their skills for jobs they want and learn new skills from other people.

Clearly, they benefit from being close to each other.

But there is also a bad force, which makes cities less than great. If people are close enough to give you a new idea, they are close enough to make you sick, stab you or just come in your way and make your life unbearable. (Edward Glaeser wrote something to this effect in the Triumph of the City).

This is mostly due to two reasons. First, congestion. When cities don’t have the infrastructure necessary to connect a large number of people, congestion occurs. Cars are stuck in traffic and people are unable to move smoothly due to lack of public transport. This disconnects people from each other and undermines those good forces.

Second, affordability. Cities are usually more expensive than the countryside everywhere. This is because, in the best of cities, people have higher incomes which drive up the cost of housing, food and other goods and services.

But in developing countries like Pakistan, the problem is made worse by lack of infrastructure which forces people to spend more on moving around, for traders to bring in food and for people to pay for housing, which there is often a deficit of.

Pakistan’s urban landscape

With this largely theoretical background, let’s come to Pakistan. Here, I want to make a few points which embody much of our urbanisation experience, although this is hardly exhaustive.

Let’s start by recognising that we’re an urban country. Let’s not kid ourselves anymore. Official statistics claim that about 36 per cent of Pakistanis live in urban areas, but the World Bank estimates that a majority — about 55pc — of the population lives in areas with urban characteristics.

This is in part because we need to understand that, when we say cities, we really mean metropolitan areas.

These metropolitan areas are part of the larger trend of our urbanisation which is incredibly low-density. Our cities don’t resemble the high-density ones in the advanced countries. Instead, people live in sprawling metropolitan areas which are costly for people to move around in.

This, as the World Bank rightly says, makes our urbanisation hidden: people are increasing living in peripheries of major cities. Some of these metropolitan areas are joining together, forming mega-metros. This is the case in Punjab, where there is a continuous belt of people living in a large swath of area connecting Lahore, Sahiwal, Faisalabad and Gujrat into a single mega-metro.

This also feeds into unequal delivery of services. People who live in the core of the city or wealthy suburbs might benefit from better provision of services like policing and transport networks — and those who live in peripheries don’t.

Despite this, our cities are already incredibly important to our economy. They generate about 78pc of the national GDP and 10 of our largest cities produce 95pc of federal government revenue (Karachi alone accounts for the majority of this). They’re already the engines of our economy.

The law and the Institutional architecture for effective cities

So, what do we do to unlock this urban potential? We need an overall institutional architecture which embodies three principles.

First, the institutional architecture needs to allow for the independence of urban governments. Cities are complex and higher complexity makes it harder to undertake policy decisions away from the context of the city. Because of this, we should benefit from an independent layer of government at the city-level.

While there will always be some coordination and interdependence required by each layer of government, by independence I mean where accountability runs downwards to the residents of the city, not upwards towards provincial or federal governments.

We have often done the opposite. Motivated by the desire to undermine the national political elite, Musharraf introduced this layer, but it was marred with various problems.

For one, it excluded political parties, which allow easier collective action and without which the costs of cooperation — theoretically — rise. As Jean-Paul Faguet and Mahvish Shami put it: “it is notable that local government died a quiet death in Pakistan, in full view, lamented by no one.”

Politicians who have followed Musharraf didn’t want to decentralise power, or if they did, they did an excellent job at hiding the fact.

But Punjab might have made a departure from this trend by adopting a Musharraf-like model in the Punjab Local Government Bill 2019, with some significant changes. Punjab has established nine metropolitan corporations in the province for almost all major cities. (I’m specifically restricting the analyses to metropolitan corporations here.)

The new law, if implemented, would pave the way for a directly-elected head of metropolitan corporations, supported by a cabinet and checked by a locally-elected council. The council members would be elected through proportional representation lists which, unlike the Musharraf system, empower political parties at an unprecedented scale.

But true independence of this layer is going to depend on various factors, including the degree of interventions made by the provincial government into the areas which have been decentralised to these corporations, especially as the law provides the provincial government enough wiggle room to interfere into local affairs.

For example, the provincial government can give policy directions and fix objectives for the areas decentralised to the local government. This could be used to undermine the urban government’s independence.

Another source which could possibly undermine this independence is the role of chief officer, a bureaucrat who will be appointed by the provincial government and has been assigned significant administrative powers in the local government under this law.

Second, we need an institutional architecture which empowers urban governments by providing sufficient control over key local policies and the ability to raise sufficient local revenue.

Generally, policies over local transport, waste management, land use and housing need to be decentralised to cities. Punjab’s new law does decentralise power over these areas to the metropolitan governments (with the exception of housing).

But how effective this empowerment is in practice will come down to the province’s willingness to radically restructure the bureaucratic apparatus it has built over the decades. This is correctly pointed out by Umair Javed as a litmus test for the success of this law.

Another dimension to this is money. Control means little if the urban government isn’t able to pay for it.

Some of the revenue will come through the provincial or federal governments and these fiscal transfers need to be stable over time. The new law, for example, provides this stability by setting a floor of minimum transfers (about 26pc of the province’s general revenue receipts, to begin with) and mandates a formula to be set up by a finance commission to divide this pool for every four years.

However, a significant proportion of the revenue can be raised by the cities themselves. This is mainly through what urban economists call land-value capture.

As the work done by the International Growth Centre’s Cities that Work initiative shows, when cities grow, the value of land and properties often increases significantly. This provides an opportunity for urban governments to capture some of this value — for example, through taxes — and invest it in the infrastructure they need.

Punjab’s new law provides, in my view, ample mandate over raising revenue locally, including the tax on urban immovable property.

It goes further and stipulates that the province consider the financial capacity of the local government while making the transfer. It is unclear as to how this is will be translated into exact policy, which will depend on the specific formula adopted. But if the province is able to incentivise cities to invest in their independent financial capacity, it would go quite far to empower urban governments in Punjab.

Third, we need institutional architecture that makes cooperation between various urban governments conducive. This goes to my earlier point of urban populations expanding beyond jurisdictions of a single overreaching local government.

Decentralising power often requires cities to coordinate policies among various their neighbouring governments or with lower-tier bodies, such as neighbourhood councils — like joint provision of transport services for allowing people to move around the metropolitan area, but only the legal jurisdictions.

Punjab’s new law makes extraordinary provisions for this. An entire chapter is dedicated to cooperation between local governments (Chapter VII to be particular) which allows joint authorities to be set up for the provision of one or more of such public services.

Going forward

On all these three fronts, Punjab’s new law does a decent job in establishing an institutional framework for better cities.

But there are various factors which will determine if cities can leverage this framework, particularly whether there is enough political commitment to maintain this framework and power is distributed accordingly by the provincial political and bureaucratic apparatus.

We need to keep our eye on the ball. Cities which are operated by independent and empowered local governments, who can cooperate with each other, can provide context-specific, pragmatic policy solutions.

Going forward, the metropolitan corporations will need to build local capacity and institutions which make them genuinely responsive to the jurisdictions they govern.

Pakistan’s Growth Story, Simplified

The story is now as Pakistani as it gets. We go to the IMF, get a few billion dollars, we use it to finance an import-led growth bubble which increases domestic consumption. It’s all good so far.

We say goodbye to the IMF. Consumption allows us to proclaim that we’re growing. The GDP is growing, after all. We make some speeches. We also take loans from the Chinese. We don’t tell you on what terms, though, we promise they love us (sweeter than honey, we proclaim).

People buy more stuff, the government spends some on infrastructure, others to hire more people, some on subsidies for those good-old industrialists. Our currency is overvalued because we have made the value of rupee somehow part of our pride.

All is jolly good. Then we import more to consume, but something is going wrong. We aren’t exporting enough. Why? We wonder. But who really cares. Oh, we do now, because we need to pay some of the loans we took back.

We also need to pay for all this imported stuff to keep this consumption-driven bubble going. Oh God, we’re running out of dollars. Maybe, we borrow some more, but for how long? Turns out not long enough.

Let’s try to crowdsource it from the diaspora. Jeez, patriotism goes out of the window when we ask them for dollars. Let’s try to ask the Saudis, oh, that is not enough. The Malaysians, maybe? They aren’t rich enough.

The growth bubble has burst. What do we do now? Devalue the rupee. Screw pride. Oh, that isn’t working. Why aren’t other countries buying our goods? Foreign conspiracy, maybe.

Let’s just print money. Damn, why are things becoming so expensive? Oh, that is why countries don’t print money. Wait. Can’t we pay for our imports or loans with rupees? We forgot we need dollars.

Who has dollars? Let’s call the IMF; hey can you bail us out? We promise this time will be different.

(this is a simplified version of real events which took place between 2013 and 2019 in Pakistan; I tweeted is here)