Why we lack economic freedom?

Excessive govt spending, borrowing and footprint cause economic freedom to fall

ISLAMABAD:

The economic freedom is the freedom available to the private citizens of a country to undertake businesses, and freedom to grow these businesses, including freedom to do trade domestically and internationally.

While apparently we have this freedom (you can register a new business in a single day today, register with the Federal Board of Revenue (FBR) and open a bank account in a week and be in your shop in the second week), we perform rather poorly on the index of economic freedom.

Pakistan is ranked 147th out of 184 countries and it is classified as a "repressed" economy with a score of 49.5, according to the Heritage Index of Economic Freedom issued in 2023.

The other four categories are: mostly unfree, moderately free, mostly free and free. We have been classified as "mostly unfree" for the last 25 years, however, now we are being downgraded to the lowest category called "repressive".

There are various parameters to explain the economic freedom where the Fraser Institute index includes size of the government, legal and property rights, sound money, freedom to trade internationally and business regulations.

The Heritage Index has 12 parameters. These are property rights, government integrity, judicial effectiveness, tax burden, government spending, fiscal health, business freedom, labour freedom, monetary freedom, trade freedom, investment freedom and financial freedom. There are many overlaps in the two indices.

Excessive government spending, borrowing and its ever-expanding footprint collectively cause the economic freedom to fall.

A bloated public sector, loosely defined, needs higher levels of tax and non-tax revenue, which not only takes away economic freedom from the private sector, but also exposes the public sector to greater risk of default. In fact, an insolvent government poses a risk to the national security.

In certain sectors, government companies, including those run by the armed forces or their welfare foundations, dominate market share. Due to their access to the government, these companies can have preferential access to information, if not preferential treatment in terms of taxes and NOCs.

On the other hand, in sectors, where liberalisation has allowed the private sector to operate simultaneously with state-owned enterprises (SOEs), the private sector has outpaced the state units. Commercial air traffic is a good example, where several competitive companies now operate both domestically and internationally and Pakistan International Airlines (PIA) is about to be acquired.

We need to imagine radical changes in the federal government and public sector to make them solvent, otherwise this situation may lead to default. Going forward, I propose five shocks in the economic structure of the federal government.

One is announcement of a simple and harmonised tax policy as already outlined in the PIDE-PRIME Tax Reforms Commission report, and a new smart national tax agency replacing the FBR.

Secondly, all commercial SOEs should be free to declare bankruptcy (if they are reporting continuous losses) and close down their operations, forever. Their land can be sold in commercial market and an endowment or insurance fund can be set up to finance salaries of their employees for a defined tenure.

If SOEs are making profit, then the government should announce immediate privatisation. Instead of offering loss-making units for privatisation, we should offer profit-making units to both domestic and global investors. Necessary amendments in the law should be introduced to reduce timelines.

If there are SOEs related to defence or essential services, they should be de-corporatised and enlisted as government departments.

Thirdly, we should radically restructure the Planning Commission, while recognising its importance in long-term economic growth. Projects can be managed by line ministries and provincial governments.

We should also immediately transfer the income support programme and power subsidies (where it is needed) to provincial governments, which will substantially reduce the burden on federal government. After the 18th amendment, social sector spending is the exclusive domain of provincial governments.

Immediate withdrawal of corporate subsidies, exemptions and privileges will also reduce significant government spending.

A shock reduction in government spending through these measures will immediately relieve the pressure to collect more taxes, which have proven detrimental to economic growth. It will also allow the government to focus on more important matters than running businesses.

Instead of doubling the tax-to-GDP ratio, we should think about slashing the government to half. If the government is currently 20% of GDP, at least in its formal sense, then a government size of 10% of GDP implies that our fiscal deficit will be zero overnight, while maintaining current levels of tax collection.

Once we achieve a growth in collection, which is bound to occur, we can invest in facilities such as high-quality education, healthcare and internet connectivity for all.

This will usher in a new era of economic growth for the nation without burdening the private sector, which is the engine of growth. This will happen largely through two channels: one is the fiscal channel, which will be in the form of reduced tax rates, thus encouraging investment and consumer spending.

Secondly, it will happen through increased credit flow to the private sector as the government appetite to borrow will reduce and commercial banks will chase the private sector to meet their targets.

The writer is the Executive Director of Policy Research Institute of Market Economy (PRIME)