Choosing battles wisely, the gaps in PTI’s economic policy

LONDON:

The Pakistan Tehreek-i-Insaf (PTI’s) announcement of its economic plan is a welcome development and indicates increasing maturity of Pakistan’s political space. It has opened up discourse on a mainstream party’s thinking on issues that really matter to the common man.

Delving into the details of the plan, it is not surprising to find a strong liberal agenda at its core. There are, nevertheless, important gaps in the PTI’s policy from a centrist’s viewpoint. Its key weakness is the lack of attention paid by the PTI’s economic think-tank to actual policy details and their implications.

For instance, under the fiscal balance rule – which implies that the government budget deficit remains constant at the current level – every additional rupee spent has to be matched by incoming revenue. Even if we assume that the tax-to-GDP ratio can be increased to 15% of GDP from less than 10% currently, the extra government spending envisaged under PTI’s welfare program implies that the currently precarious fiscal situation will not improve at all.

This implies that clear spending priorities have to be laid out; ie, which part of government expenditures will be cut to finance the difference. This is an important point, in my view, which has been totally ignored. Indeed, this is even more relevant if the promise of reducing the fiscal deficit to 4.5%, from more than 8% currently, is to be achieved. Such a target, if set out over five years, implies a minimum drag of 1.5 percentage points of GDP per year, assuming a very low fiscal multiplier.

Moreover, the more populist measures, such as demolition of Prime Minister houses, etc, will do little to improve the fiscal situation. Indeed, a better idea would be to utilise them as hospitals or schools, thus avoiding destruction of useful capacity. On this front, usefulness of productive office space for government officials needs to be recognised as well, before promising a largely populist measure with no genuine economic benefit.

Another important point is the lack of details on the level and nature of taxes envisaged under the revenue generation plan. Bringing the agricultural sector in the tax loop is key, and so is reduction of indirect taxation and its replacement with direct sources to reduce economic distortions. However, studies around the world show that implementation of tax policies is often a tricky issue, and here the solutions proposed by PTI are very likely to run into institutional constraints.

In this area, further details on implementation, in order to show credible political willingness to carry out taxation reforms, are more important than reiterating the principle itself.

Expansion of the welfare state; with associated negative implications for the fiscal balance and, in turn, public sector debt; and rising investment spending are inherently inconsistent over the short-term. This will do little to reverse the crowding-out of the private sector, which is occurring in the economy currently.

Moreover, the deteriorating law and order situation and a very weak infrastructure base are clear constraints on the supply side, and will again need detailed policy actions rather than just headline comments. Specifically, there is a strong role for the private sector to play on the infrastructure side, and a very liberal agenda is a potential hindrance here. Looking at the experience of other emerging economies, a sharp rise in investment ratios has often come alongside liberalisation of the financial sector and enhanced credit provision; which, as we know now, can lead to asset bubbles with devastating consequences for future growth if not handled properly. The projected investment boom requires careful policy calibration, with a focus on efficient allocation of resources preferably via the capital markets – therefore, the plan looks overly optimistic and lacking details on plausible drivers.

More broadly, generating an investment boom in Pakistan would require significant strengthening of institutions and the deregulation of key sectors. However, looking at other aspects of the economic plan, these pro-investment conditions are, to a certain extent, internally inconsistent with PTI’s view on probing potentially confidence-sapping scandals and corruption cases. For instance, consider India’s struggle with the Coalgate scandal, which led to capital flight from the country.

Experiences of other countries show that political instability tends to be highly correlated with inferior economic outcomes. Here, the PTI will soon need to prioritise the battles it wants to pick once it comes to power. As such, PTI’s strong emphasis on accountability of legacy corruption appears irrelevant (and highly populist) when judged against the greater goal of securing a brighter economic future, given the distraction and negative confidence contagion it will generate.

It must be noted that current changes in the global landscape have opened up a golden opportunity for Pakistan in the external trade sector. The sharp rise in Chinese labour costs is increasingly making Chinese products uncompetitive, thus opening space for Pakistani exporters. Increasing exports has been a broad policy mantra of all regimes: however, the sad fact is that Pakistan has made little progress on this front – despite the existence of excess labour. It is reasonable in this context to question PTI’s headline target. In this area, a detailed plan of incentives needs to be articulated in order to reconnect Pakistan’s export sector with the world.

Strengthening of the regulatory framework, however, needs to be appreciated. Nonetheless, a balance will be required so as not to depress genuine activity. Stronger implementation of common sense rules will require a combination of strong legislative frameworks and robust implementation regimes. Here, a purely ‘moral high ground’ driven approach is unlikely to be enough and will need specific designing of incentives and punishments to ensure adequate compliance in light of spending plans.

The plan is a step in the right direction, but needs further thinking on several important fronts. A number of emerging countries have managed to engineer sharp increases in their growth rates over the last 12 years, despite having no tangible resource export base. In most instances, the drivers of such sustained growth trajectories have been strong institutions, pro-reform governments, enhanced productivity of the labour force and supportive demographics.

There is no reason why Pakistan cannot do the same.

THE WRITER IS HEAD OF GLOBAL MACROECONOMICS FOR EDF TRADING (ONE OF EUROPE’S LARGEST COMMODITY MERCHANTS). PREVIOUSLY, HE HAS WORKED AS A GLOBAL MACROECONOMIST FOR GOLDMAN SACHS INTERNATIONAL

Published in The Express Tribune, September 17^th, 2012.