Pakistan's lost economic freedom

Indices show reform momentum, but taxation, informality weigh on outlook

ISLAMABAD:

The Heritage Institute's Index of Economic Freedom measures 12 economic freedoms: namely, 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.

These 12 institutional and structural pillars can be considered conditions for sustainable economic growth and development in a country. In its 2025 report, the Heritage Institute's Index of Economic Freedom classified Pakistan as a "repressed" economy, ranking it 150th out of 184 economies, with a score of 49.1 out of 100.

The report noted: "The government has demonstrated little commitment to much-needed economic reform. Efforts in key areas have been marginal at best. Measures to strengthen the management of public finance and reform outmoded economic structures have met institutional resistance. A judiciary that is susceptible to political interference and corruption undercuts property rights. Neither the entrepreneurial environment nor private-sector dynamism has been improved to any meaningful degree. The labour market remains stagnant. Much of the workforce is underemployed in the informal sector. High inflation has disrupted monetary stability."

The cut-off date for including data in the 2025 Index was June 2024. Thus, it makes sense to point out problems such as high inflation, which was around 12% at the time and already on a downward trend, or a perceived lack of commitment to reform, when the national debate was focused on avoiding default rather than on structural reforms.

On two accounts, the Heritage Index does not seem to reflect the actual dynamics, which is a fundamental problem and highlights the limitations of all such indices.

The index awarded a rather high score of 88.9% for "government spending" and 78.3% for "tax burden". This is because the index relies on two numbers: government spending and tax collection as a percentage of GDP. Pakistan's government spending is around 20% of GDP, while its tax-to-GDP ratio is 10%.

From an absolute perspective, 20% of GDP does not indicate an excessively large government. However, when one notes that interest payments and defence spending account for almost 70% of total expenditure, and when we consider wasteful spending in other areas, then a high score for public spending becomes largely irrelevant. Similarly, while a 10% tax-to-GDP ratio may sound like a country with a low tax burden and, therefore, high economic freedom, the tax burden on those who actually pay taxes remains very high. Fast forward to the first quarter of 2026. How will the next edition of the Index of Economic Freedom view economic freedom in Pakistan?

Since the last edition of the index was published, the tax burden on taxpayers has increased substantially. Pakistan's top marginal tax rate on individual incomes has risen from 35% to 45%. The super tax, initially introduced as a temporary levy on corporate incomes above a certain threshold to meet the costs associated with internally displaced populations, has recently received judicial cover. This has raised the effective tax burden on large corporations to more than 50%.

It is true that inflation has now been largely tamed, hovering around 5%. It is also easy to establish that the government has made credible commitments to reform, visible in PIA's successful privatisation programme, a new open and trade-oriented tariff policy, and a concerted drive to improve the regulatory environment through the regulatory guillotine process. These developments should help improve Pakistan's score on economic freedom.

On the other hand, as noted earlier, several sobering observations in the 2025 Index of Economic Freedom remain valid today and, in some aspects, we are worse off since 2024, when the data was collected. The unemployment rate has increased, and most of the workforce continues to be underemployed in the informal economy. According to the latest official labour force survey, the informal sector employs 81% of our workforce; in the urban economy, the figure is 71%.

This is an exceptionally high proportion for an economy aspiring to move onto a sustainable development path. It is also significantly higher than what was reported in the previous labour force survey released in 2020-21, when informal employment stood at 72.5%.

The index described Pakistan's judiciary as "susceptible to political interference" and found that "corruption undercuts property rights". These observations were echoed in the IMF's Diagnostic report released recently. Available evidence suggests that political interference in our judicial system has increased. This erodes investor confidence in the dispute resolution process and acts as a deterrent to new investment.

The lack of fresh private-sector investment also remains a challenge to the narrative of macroeconomic stability, as investment-to-GDP has not picked up. Exports during the last six months of 2025 have declined compared to the same period in 2024, although this appears to be partly the result of across-the-board tariff reductions.

These negative developments will either push the score downwards or prevent any meaningful improvement in these areas.

In the final analysis, Pakistan's outlook on economic freedom, as viewed through an institutional lens, presents a mixed picture. If reforms are given higher weightage, our score will improve, but it will be undermined by backward progress in other parameters.

THE WRITER IS FOUNDER AND CEO OF POLICY RESEARCH INSTITUTE OF MARKET ECONOMY, AN INDEPENDENT ECONOMIC POLICY THINK TANK