Reviving the economy

Attempts to revive economy has to begin with macroeconomic, fiscal policy framework explicitly favouring industry.

The government’s admission of a rise in poverty along with a worsening employment situation and the rupee’s creeping depreciation are indicative of the fact that the economy is stagnating.  The situation demands an innovative big push and a series of fiscal and administrative measures to jump start the economy. And the sector that cries out for attention is manufacturing, which is the engine that drives the economy and creates income, jobs and surpluses for export.

Unfortunately, however, industry has been rendered uncompetitive over the last quarter of a century by the fact that the rate of increase of manufacturing input cost has been about 15 per cent higher than that of the output price. Furthermore, over the last two decades, a macroeconomic regime has emerged that unduly favours non-commodity producing sectors and which competes with industry for investment funds. These sectors are import trade, land market and the stock market, in ascending order of importance.

Thus, any attempt to revive the economy will have to begin with a macroeconomic and fiscal policy framework that explicitly favours industry vis-a-vis non-commodity producing sectors. A range of measures are in order, beginning with reforming the tax regime. Currently, almost two-thirds of indirect tax revenues are contributed by the manufacturing sector. This undue burden will have to be reduced and the tax regime will instead have to become biased against sectors competing with industry. Consideration may be given to tax goods at half the rate that is levied on services and trade.

Import trading suffers from pervasive under-invoicing and ‘out-prices’ locally-manufactured products. One relatively simple administrative measure can, perhaps, provide the necessary protection to local industry from unfair competition from imports. And that is to introduce the principle of ‘right of first purchase’ on imported goods to enable any private party to have the first right of purchase of an imported consignment at a premium of, say, 25 per cent over and above the CIF (cost, insurance and freight) value of the imported goods.

For this purpose, all letters of credit or bills of lading should mandatorily be placed on a website for a period of, say, 10 working days to enable any interested party to bid for the consignment.  No consignment should be allowed to be released from the port or airport until after the expiry of this period. This measure is likely to minimise the extent of under-invoicing, as importers who under-invoice heavily are liable to have to sell the consignment below cost, i.e., at lower than the import value.

Real estate trading has emerged as a major competitor to industry for investment funds, given that profitability from real estate generally exceeds that from manufacturing. In fact, land and property cost is now the single-largest item in fixed capital cost in many cases. However, investment in real estate does not accrue gains for the economy or society. This is because land is a finite commodity and increase in land prices does not imply wealth creation. Real estate purchase is an investment for an individual, but not for the economy, since there is only a change of hands.

The key to real estate speculation is cornering of plots by dealers, which is facilitated by under-valuation of the value of the real estate when registering a sale. This malpractice can likely be checked through two relatively simple administrative measures. The first is to introduce the principle of ‘right of first purchase’ on any land and property that is put up for sale to enable any private party to have the first right of purchase of the real estate in question at a premium of, say, 15 per cent over and above the value at which it is being registered for sale.

For this purpose, all real estate sales agreements should mandatorily be placed on a website for a period of, say, 10 working days to enable any interested party to bid for it. No sale should be registered until after the expiry of this period. The second measure is to introduce a capital gains tax on property sales if the sale occurs within three years of its purchase. The combination of the two measures is likely to minimise the practice of undervaluation, as sellers who undervalue heavily are liable to have to sell the real estate at lower than the actual sale value.

The stock market is the third, and perhaps the largest, competitor to industry for investment funds. In theory, the stock market is supposed to mobilise capital for industry and other gainful economic activities. The reality in Pakistan is different. Here, the stock market is a speculative trading house and largely trades in the same shares of companies that are listed on the stock exchange. Empirical evidence shows that there is little functional relationship between the performance of the stock market and economic variables like GDP, exports, etc., and in many cases, even with company profitability. Capital gains tax is designed to discourage speculative trading and encourage genuine investors.

The measures relating to taxation of industry and to trading in imported goods, real estate and stock market are likely to raise relative profitability in manufacturing and reduce relative profitability in competing sectors. And manufacturing growth is likely to spur jobs, incomes, exports and government revenues.

Published in The Express Tribune, December 22^nd, 2012.