IMF report in nutshell: Pakistan follows statist model

Statist economy, by restricting competition or picking up specific areas, allocates resources to protected sectors

ISLAMABAD:

By this time, many articles and commentaries have been published on the IMF report "Pakistan Governance and Corruption Diagnostic Assessment". As already well understood before this report was issued, we do have systemic corruption and governance weaknesses that suppress investment, distort markets, undermine revenue collection, and perpetuate economic fragility.

We have been advocating that structural reforms, especially along supply side, will unlock significant economic growth for Pakistan. This also resonated in the 5th Pakistan Prosperity Forum, which was themed on "Reforms for Growth". Nevertheless, the report generated a stir. In this article, I will focus on what I believe is the main thrust of this report, building on a brief by the former chief economist, MA Zubair.

Fundamentally, the IMF report has concluded that we are running a statist economic model, which is now exhausted.

A statist economy is characterised by a state-corporate nexus, which thrives on thick protectionism, high tax rates and command and control. A statist economy is not a socialistic economy, rather it benefits a large section of the private sector; as argued by Khalil Ahmad in his thesis on state elite.

A statist economy, by restricting competition or picking up specific sectors for government support, forcefully allocates resources to protected sectors. A large section of the private sector prospers due to their exclusive access to power, thus becoming an element, and financier, of the statist economy.

A statist economy has several tools available in its ammunition. It uses tax policy, tariffs, procurement, public spending, demand for credit, and state-run enterprises. None of these tools can be exercised without involving a private counterpart. Tax exemptions benefit certain sectors and firms; tariff protections provide advantages to a few at the cost of many; government procurement rules limit competition; development spending awards go to contractors; most of the banking credit goes to the federal government; and state-owned enterprises command half of the nation's assets.

The IMF report synthesizes these otherwise well-known characteristics of our economic model in a systematic manner, while providing evidence and data. In a way, this is a continuation of a report that UNDP published in 2021, which quantified 'elite capture' by measuring the cost of tax, privileges and tariff exemptions, while reminding us of the work of Dr Ishrat Husain on elitist state, around 25 years ago.

All exemptions granted, all procurement, and all transactions by state-owned enterprises, have complete legal, legislative and judicial cover. None of these can be considered corruption or illegal in a formal sense. However, it is obvious that these systematic manipulations and intended distortions un-level the playing field, erode opportunities, and retards economic growth. The IMF report also puts a number on it – a potential of 5% to 6% additional growth over the next five years.

Pakistan needs to shift from a statist economy to a market economy, which celebrates wealth creation under a responsible, and limited, state. Under an open political system, this culture will help wealth distribution, as private firms will compete for their market share, without any restrictions.

A market economy is designed by rules and regulations. Voluntary exchange between individuals and firms is fundamentally driven by mutual trust. In the absence of these formal and informal institutions, exchange breaks down and the market ceases to exist.

If you know that a local shop or a brand has deceptively sold you inferior quality goods, you are unlikely to make another purchase. If this information becomes widely known, the business closes down. This fatal discipline of the market keeps a check on producers and other market participants.

In contrast to a statist economy, a market economy, while far from perfection, thrives on economic freedom, but then as Nadeemul Haque asserts, where are these markets? These markets, as we observe today, have a lot of friction and sludge. While we do face macroeconomic problems, these frictions are created by institutions and institutional practices, which keep increasing transaction costs.

Business groups oppose tariff liberalisation, because they rightly see cost disadvantages in the form of high tax rates and high energy costs. They need the government to compensate for these advantages through tariff walls. Now these walls are gone, or they will be – brick by brick – there is a lot of resistance and frustration.

The solution does not lie in reversing tariff reforms, the solution lies in doing all other actions, where the government is seriously lacking. These other actions must be led by tax rates in one big move, especially now that the government is confident about deterrence and enforcement. The second major move must be re-writing the regulatory playbook. There are other actions, such as privatisation and spending cuts, which must be taken too.

The real economic transformation will occur when we begin our journey from statist economy to market economy. But the window is very small and is narrowing down.

The writer is the founder and CEO of Policy Research Institute of Market Economy – an independent economic think tank