Policymaking: the wrong choices

Pakistan needs policies like tax rationalisation, free trade and sound money

BRUSSELS:

Economic policy is about choices and the right policy choices make the difference. Pakistan, unfortunately, for the last four decades has been making the wrong ones.

No wonder, we are in a 24th IMF programme, unable to get ourselves out of this vicious cycle of slow growth, higher taxes, unsustainable budget deficits, excessive debt burden and a never-ending balance of payments crisis.

Our myopic politicians and bureaucrats repeatedly succumb to short-term "whack-a-mole" solutions to the economic ills. Unless and until we embark on a comprehensive supply-side economic agenda of accelerated growth, we are unlikely to get out of this quagmire.

Trying to do the same things over and over again and expecting a different outcome is insanity (Einstein's dictum).

What Pakistan needs is a straightforward set of supply-side economic policies: rationalisation of its tax system A-Z free trade, sound money, fiscal restraint, deregulation, privatisation and lastly, debt restructuring.

A supply-side tax policy includes low tax rates on a broad base with no exemptions, deductions and exclusions. There should be few taxes and income should be taxed once.

The dramatic supply-side stimulus from cutting the tax rate has the incentive effect on work, savings and investment and also the disincentive effect to evade, avoid and not report the taxable income.

This pro-growth tax policy is the idea behind "The Laffer Curve"; it demonstrates what happens when the economic and arithmetic effects collide, explaining why a tax increase may reduce the taxed activity and raise less revenue than otherwise predicted, just as a tax cut may increase the taxed activity and raise more revenue than otherwise predicted. This sums up the entire pro-growth world view of supply-side economics.

Free trade benefits all – importers, exporters, consumers, producers and, more importantly, promotes economic growth. Low tariffs lead to gains from trade by increasing the total trade (exports and imports) whereas protected tariffs invite evasion and crime. A tariff is not only a tax on imports but also a tax on exports.

Furthermore, trade is not a zero-sum-game. Trade and protectionist measures are not about trade balance (exports minus imports); it's about total gains by increasing the total trade (exports plus imports). The myth of trade deficit; often said to "worsen" if it grows and "improve" if it shrinks is unfounded.

To understand a trade balance, one needs to see that there is a close relationship between a country's capital surplus (ie, the inflow of capital), its trade deficit and its terms of trade (often called the real exchange rate).

A capital surplus is the difference between what's expended and what's produced. Simply put, a country's capital surplus is the same as its trade deficit. Countries that implement pro-growth policies will experience good trade deficits, in addition to a stable currency, capital flows, economic growth and raising relative asset values.

Fiscal restraint, another important element in the supply-side growth agenda, is essential. Excessive and wasteful government spending, way beyond its ability to collect in tax revenues, is a recipe for disaster.

It not only leads to underperformance and inefficiency at the federal and provincial levels but also keeps one addicted to reckless borrowing. Currently, the bulk of our tax revenues goes towards our ever-increasing debt servicing costs and repayments, leaving no fiscal space for a development-starved Pakistan.

A big government crowds out the private sector in the allocation of precious resources. It's the private sector that creates the nation's wealth and the real growth in any economy, governments don't.

It's the private sector that creates investments, employment and the much-needed foreign exchange reserves including remittances. Sadly, whatever wealth created by the private sector is sucked dry by our irresponsible government to the detriment of our tax-paying citizens. Pakistan is suffocating!

Monetary and fiscal policies are closely aligned. Fiscal discipline is a prerequisite for sound money. There is nothing that has a more pervasive, insidious impact on economic growth than an unstable and weak currency.

Excessive government borrowing and the State Bank of Pakistan's money printing is the primary cause of an unstable rupee.

An ideal monetary policy consists of slow money growth (quantity of money) and low interest rate (price of money) in a single digit. The rupee's volatility and depreciation is a direct assault on market efficiency and economic growth.

A devalued currency sparks inflation and has an extraordinarily damaging effect on businesses, households and government budgets.

Government regulation acts as speed bumps and roadblocks. It raises the cost of doing business, resulting in excessive collateral damage to the economy.

Unnecessary regulations are nothing more than slow strangulation and therefore should be eliminated. The ones that remain should be reviewed, evaluated and justified on a continuous basis to ensure a level playing field for all businesses.

Privatisation of state-owned enterprises (SOEs), no matter how difficult, is a must. SOEs are a huge net drain of fiscal solvency. We currently have about 200 (commercial and non-commercial) white elephants which are bleeding or have bled to death.

We must and should put all of them on sale, a fire sale, and not attempt to reform them nor transfer to provinces. There should be sale by auction to the highest and best bidder in a very transparent manner so as to build trust in order to avoid getting into unforeseen legal jams.

There should be no haggling on price nor diktats. The recent PIA fiasco is an example of a case study how not to privatise.

Last but not the least, it is imperative that Pakistan restructure its international and domestic debt in close collaboration with its lenders, internal and external, so as to avoid a sudden default and consequently a run on the domestic banking sector.

Our current external and domestic debt obligations over the next five years will keep us, as always, on a knife edge, begging for loans and rollovers. We are now paying more to service our external debt than receiving in new external finance (net negative transfers), leaving us no fiscal space whatsoever and further into poverty.

This brings us back to the multimillion-dollar question; why do we keep going back to the IMF? Why do we not learn from our previous mistakes? Why do we not listen and implement the right economic policies that have been extensively researched and covered by our think tanks, academia and countless associations?

Well, the fault lies in Pakistani Kakistocracy!

The writer is a philanthropist and an economist based in Belgium