The writer is a former caretaker finance minister and served as vice-president at the World Bank
Finance Minister Ishaq Dar’s budget speech on June 12 laid out what can be described as the economic development model the new government headed by Prime Minister Nawaz Sharif would like to follow. Implicit in the revealed strategy is a two-track approach. The government will first save the economy and then the task of reviving the economy will be undertaken.
The economy will be pulled back from impending disaster by undertaking massive public sector investments. The sector of energy will receive the government’s immediate attention. The first task will be to clear the circular debt that has reduced the generation of power since a number of independent power producers have reduced their output, because they were not appropriately compensated for the electricity they had already fed into the national grid. The only quick way of dealing with this problem is for the government to liquidate this debt and increasing government expenditure over the short term. This would be a one-shot injection of public money. Over the long run, the government indicated that it will put in place a system that would ensure that all consumers pay for the power they use.
Some have been critical of the decision to increase the fiscal deficit in order to tackle the problem created for the economy by serious power shortage. This approach will also make it difficult for Islamabad to sign another programme with the IMF, which does not like large deficits. For Pakistan, it would be irresponsible for the policymakers to opt for austerity at a period of extreme economic stress. By not mentioning the Fund even once in his speech, Minister Dar has indicated that he is prepared to postpone the inevitable approach to the Fund. That is the right approach to adopt.
The implied growth model travels a well-trodden theoretical path. This raises three important questions. Were the theoretical underpinnings of the model deliberately adopted by the new finance minister? Will this path take the new policymakers to the destination they hope to reach? Should they break loose from that path in order to ensure that they get to the goal they have set for themselves and the country? To answer these questions, we should go into the theory that is behind the offered approach.
It started with what came to be called the Harrod-Domar model of economic growth. According to this, the rate of economic growth was constrained by the amount of savings available to the economy. The rate of savings divided by a constant called the incremental capital output ratio (ICOR) yielded the rate of growth in GDP. The ICOR signified the efficiency with which the economy deployed resources that became available for investment. A low ratio signified an efficient economy. A high ratio suggested the opposite.
This was the basic model but with one twist that was behind the thinking that gave Pakistan the highly successful Second Five Year Development Plan (1960-65). The twist was that it added external capital flows to domestic savings to define the total amount of resources available to the economy. Capital from the outside came in the form of official development assistance. According to this, domestic savings constraint could be relaxed by relying on external assistance. Much of official thinking about development was based on this expanded version of the Harrod-Domar model. The Planning Commission in the latter part of the Zardari administration sought to move away from this approach by issuing the Framework for Economic Growth.
To this basic growth model was added another component by the economist Hollis Chenery. According to him, developing economy faced not one but two constraints — or gaps. In addition to the rate of savings, trade deficit also served as an obstacle. Still later, the Brazilian economist Edmar Bacha added a “three gap” model. According to him, fiscal deficits could also constrain growth. Budgetary deficits limit the availability of resources to finance public investments needed to grow an economy. How would the adoption of this approach by Minister Dar affect the Pakistani economy? I will come to this question next week.
Published in The Express Tribune, June 24th, 2013.
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And in the sweet by and by, 1 simple suggestion. It goes like this, public procurement act has to be revamped and it can yield in significant savings for the exchequer. Presently our public procurement as is a set of outlined procedures only, basically its only breaurcratic rigmorale. Anyway i have seen procurement of 3600 MT of chickpeas procured at rate of 16 rupees per KG above market rate to a total loss of 56 million to national kitty. Such a waste cannot go on forever. And it happens. Day in & Day out. Such leakages of income have to be plugged. @ Proletariat: You are rite. FDI is not after all anything diffrent that selling your chicks that lay golden eggs. However, history of PSE have been too bad to keep trying them again & again. A middle ground can be reached in this regard. CAP on R.O.I (Return on investment & definately with airtight and preagreed accounting policies for ssigning of overheads to total cost of service delivery) & Repatrition can yield in transfer of benefits to masses.
One principle holds only in the long run: If u keep spending more than you are earning, it is not sustainable. And that gap has to be bridged somehow. The ways and means to do so are: 1. Weath based taxation 2. Blanket taxation/austerity drives (Opted by PML-N) Well said Karachiite about PML-N coming through on protecting the interests of well placed groups, lobbies & trader class and middle men. However, either this approach has to go, or we are gone anyway. About electricity, the thing is we are between a rock and a hard place. IPP agreements in 90's were so ridiculously high that people actually cannot pay that much to afford power. If you withdraw the subsidies, we get the riots, if u dont repeal the subsidies IMF is gonna bite your tail. And besides in 90's we have had lot of money rolling in on the whole in shape of SAP (Social action program) to go around for all. However, it isnt the case anymore, neither will be unless a need for stretegic alignment (Irony) arise in near future and it is attained by a well timed military coop in pakistan ;-).
This is just fancy-pants economic mumbo-jumbo that apologists for capitalistism like to use. You could simply have said that in 1960-65 Pakistan's strong economic growth was due to is near total reliance on forign aid rather than public savings. What any country's needs to avoid recurring crisis is cash-in-hand, which only comes from taxes on income and from the profits made by state-owed assets. The state must create a culture of merit,it must improve and expand it's SOEs instead of privitizing them and it should tax the rich instead of putting all the burden on the middle class and use that money to educate and uplift the poor to the level of the middle class.
I respect Shahid Javed Burki for his strong grip on economic theory however the assertion made in this article are very well exaggerated. First of all, there is no mention of key assumptions in Harrod-Domar model. First of all the model assumes that relative price of labor and capital is fixed and that they are used in equal proportions. That is not the case with current rising prices, and underemployed labor force. Second, it also assumes that investors response is affected by output. This again has been widely proven false by economists (see accelerator principle). Now you also mentioned three gaps namely rate of saving, trade deficit and fiscal deficit that can limit outcomes predicted by the proposed model. I am surprised that as a well read economist, you are predicting outcomes based a model drawn on paper full of assumptions. I suggest that government should develop policies using lean methodology, testing each and every assumption with real consumers and validating their policies throughout the process. It is sheer irony that we have mass amount of knowledge at our disposal in 2013 but Mr. Ishaq Dar wants to use a well forgotten model that he studied somewhere as appropriate to fix economic crisis. Most problems are actually very simple but they require out of the box thinking. I encourage more entrepreneurial approach if one has to solve problems of Pakistan.
Burki sahab seems like you are apologizing for Ishaq Dar's approach of bringing more indirect taxation in order to revive economy. N league did not take difficult decisions to generate revenue. Frankly I did not expect N league to hit the vested interests and they came through on that expectation. However did not expect you to support N league on this.
How will you educate 99.99% people of Pakistan who don't even understand economic terms. Every economist know and appreciate that you are competent and have ability to implicate economic theories with govt. budgets or policies but what is the need? The need is to come up with a concrete and layman approach towards underlying economic theories in budget. I hope you will not come or come with more concrete and layman terminologies with/in your next piece.