Goodbye, Keynes!

Pakistan’s policy managers need to switch their economic theorist.

KARACHI: Pakistan’s macro-economic policies have usually treaded the well-beaten Keynesian path, as we have repeatedly attempted to jack up economic growth by increasing government expenditures – in particular, development expenditures. It is time we pay attention to John Maynard Keynes’ arch rival and contemporary, the Austrian Friedrich Hayek, who was awarded the Nobel Prize for Economics in 1974 for correctly predicting the Great Depression through his business cycle theory, which rests on the role of monetary expansion.

Hayek’s contributions notwithstanding, it is Keynesians who continue to rule most democratic governments to date. Sadly, the latter also fail in some ways to understand how the economy works.

Keynes believed that intelligent, well-meaning planners manipulating economic aggregates such as demand and employment could ensure a better outcome to business cycles. Hayek, by contrast, insisted that individual decisions and imbalances between specific prices and demand – or interest rates and specific plans for long-term productive projects – are where the real economic action is concentrated.

To illustrate Keynesian influence on mainstream economic thought in Pakistan, consider this excerpt from a recent article by Dr Akmal Hussain – one of the most prominent economists of the country – published in The Express Tribune on June 4. Dr Hussain writes that: “If a budget deficit of even seven percent is caused by productive expenditure that creates employment, incomes and a revenue stream in the future, it ought to be acceptable.” By saying so, he is clearly advocating Keynesian style deficit-financing for economic growth.

Ever since the Planning Commission was taken over by Dr Nadeem-ul-Haque, there is a semblance of a departure from the Keynesian focus on macro-economic modelling. The new growth strategy “pinpoints microeconomic foundations that will lower the cost of doing business and make markets more flexible. This will create incentives for businesses to expand; therefore endogenising the reasons for higher investment.”

This departure from a focus on macro-economic stability to an emphasis on micro-economic reforms represents a paradigm shift in our economic policy making. What is unfortunate is that it has as yet failed to influence the finance ministry. The federal budget 2012-13 presents itself as an evidence of this disconnect between policy and implementation.

Pakistan’s low and volatile growth trajectory can be termed Keynesian in characteristic. The Economic Survey of Pakistan (ESP) 2011-12 informs that the GDP of the country is essentially driven by consumption – specifically, private consumption. Consumption by households and businesses accounts for 75% of our GDP. Add to that 13% in public consumption expenditure, and we realise that we, as a nation, save a mere 12% of what we produce. This growth in private consumption has been attributed to the sustained growth in remittances, which touched an all time high of $13 billion this year.

The ESP also notes that “contribution of fixed investment to economic growth has become negative since 2008-09, as it has decreased to 10.9% of GDP in 2011-12 from 20.5% of GDP in 2007-08. Private investment witnessed a contraction of 7.9% in 2011-12, compared to 15% of GDP in 2007-08.”

In nutshell, the Pakistani nation, with an expanding middle class, has diverted its income to consumption. Therefore, we cannot solely blame the government for its myopic, consumption-friendly policies. Perhaps there is some kind of interaction between the private consumption and public consumption; however, what is worrisome is that while private individuals usually consume their own earning, the state consumes its citizens’ income. This holds true whether the state resorts to printing money to finance expenditure, or borrowing from domestic or international resources: invariably, it is the nation’s money that is systematically debased.

The private propensity to consume, rather than save, is driven by a number of forces. Most notably, this includes the absence of viable business projects, big or small. Such businesses thrive in a predictable environment, where prices of inputs can be rationally projected. In the absence of such a reliable price environment, entrepreneurs, savers and investors shy away from businesses and take comfort in low-risk projects – such as real estate or gold – or simply consume today, fearing a worse future.

The absence of a savings culture holds the key to the riddle of low and volatile growth. Unless the average Pakistani is made ‘savings-savvy’ and enabled to finance risky business projects, growth will remain subject to external cash flows.

It is high time our economic policy makers and managers turn their attention from an inflation inducing, deficit prone and short-sighted Keynesian approach, to an enterprise-centric, free market generated, spontaneous Hayekian order.

That is, if we ever hope to stabilise output in the long run.

The writer is managing partner of Development Pool and is a founding member of the Economic Freedom Network Pakistan.

Published in The Express Tribune, June 11^th, 2012.