This article is an ‘open letter’ of sorts to this group of senior leaders and advisors, urging them to view Pakistan’s economic problems from a perspective that is perhaps different and perhaps more longer term (beyond the election-cycle) than the plans they have made so far for running the economy between now and 2018. The key points are as follows:
— The house is ‘on fire’

The condition of Pakistan’s economy, as opposed to that of many Pakistanis we interact with, is far worse than what even many economists realise. The comforting narrative of ‘resilience’ and ‘a hardy country’ is meeting up with the ugly reality of unchecked population growth, fraying institutions, capital flight, brain drain and declining water tables.

The problem with the ‘we are a resilient nation’ narrative is that it is rooted in a historical, static analysis. It also breeds a sense of complacency we can do without. An examination of the economy’s vital signs in a more dynamic manner reveals a much more worrying picture. (As I said off-the-cuff at the launch of the Institute of Public Policy’s annual report in Lahore two weeks ago, the “plane is falling from the sky, while the first- and business-class passengers are happily sipping their drinks and munching peanuts!”.)

Politicians and Pakistan’s other entrenched special interest groups probably subscribe wholeheartedly to the ‘resilient country’ argument because it demands no action — it implicitly says “the current state of affairs is an aberration, and will largely self-correct”. That is simply not true.

A look beyond annual macro-economic indicators, such as the growth rate or the fiscal deficit for a particular year, and focusing instead on the longer-term trend, reveals a worrying picture of the underlying state of the economy and its decaying foundations.

The indicators of the long-term health of the economy tell us that Pakistan is experiencing: the longest economic slowdown in its history; the lowest investment rates by the private sector in over 50 years; a decline to a trickle in the flow of foreign direct investment into the country; a shrinking formal economy and an expanding informal sector; a near-collapse of the energy sector; and the near-complete destruction of its public sector by whole-scale looting by the previous government

The bottom-line: a significant part of the economy is facing a severe, and, in the case of the manufacturing sector, possibly an existential, challenge. (No serious, credible economist will bring up the stock market performance as one possible counterpoint in this debate, because of its largely fallacious signal on the health of the real economy).
— Growth alone is not sufficient

If the onerous challenges are to be addressed, restoring growth to the economy will be important. However, too many policymakers around the world, and not just in Pakistan, think that generating economic growth will, on its own, resolve all problems. As I have consistently argued, along with eminent economists such as Dr Akmal Hussain and others — but with a slightly differing perspective in our views — how economic growth is generated is equally important.

The importance of the origins and structure of economic growth is basically two-fold: the two factors determine how sustainable, and how poverty-reducing and income equality-enhancing, the growth will prove to be.

Take the case of Greece. Before its dramatic economic collapse, Greece was recording a reasonable rate of GDP growth each year. One year before the start of the global economic crisis in 2007, and the start of the eurozone’s woes, Greece’s GDP growth was 5.5pc. The five-year average rate of economic growth was a reasonably healthy 4.3pc. So what happened? Why did the Greek economy with reasonable rates of growth collapse so dramatically? As I have pointed out repeatedly, most recently in Pathways to growth (May 3, Dawn), a debt-fuelled approach to growth will almost always end in tragedy.

In a cruel, but somewhat delicious, irony, Greece is even equipped with a European Union-financed modern underground transit system in Athens that has been the envy of many other European cities.

Moral of the story: Debt-financed bullet trains — or any number of yellow taxis, green tractors, silver laptops, or any colour-coded placebo — will not fix our problems. They will all lead to only one colour for the budget: deep red. We have to get real —and serious – about the sources of our problems. These are institutional and structural in nature, and will require a response that is commensurate.

The most important reform will be in the area of taxes. Stemming the PPP-left rot in the public sector will alone require a massive amount of fiscal resources — over and above the billions of dollars needed for Pakistan’s looming energy and water infrastructure requirements in the next few years. The other reforms I have alluded to previously, and will be covered in a subsequent piece.

The bottom-line is that with its current electoral mandate, a PML-N government can quite easily afford to take some difficult decisions in its first six months in power. The effects will last around two to three years, with the economic — as well as political — dividends starting to come thereafter.

If it moves with understanding, speed, commitment and clarity of purpose, the PML-N government can achieve what no government has managed so far in Pakistan’s history: a neat alignment of economic reform dividends with the next election cycle.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

Generally, the manifestos are a patchwork of intent and wishes without a coherent framework underpinning the largely unspecified policies. A road map of the institutional and structural reforms required to achieve the stated objectives and goals is also, by and large, missing. While the manifestos are not expected to be detailed policy documents, at least in one area they have left a gaping hole — in not articulating the very real trade-offs and choices that their suggested policies would entail.

One critical area where these trade-offs have inter-generational consequences is in the pursuit of economic growth. To put it simply, the fundamental choice here is whether the policies on economic growth will be debt-fuelled, or will have a stronger and more sustainable foundation built on structural and institutional reform.

While sparking growth via the first approach — a liquidity-driven, debt-accumulating binge — can be relatively easier and, equally appealingly for a political party, can show results quicker depending on the initial conditions, its effects are invariably short-lived and distortionary. It also shifts the burden of adjustment to future generations, and, in the case of higher inflation, to the most vulnerable in society. On both these counts, this approach can be deemed to be unfair.

The second approach, which has broadly come to be referred to as “macro-economic stabilisation” — or loosely as “fiscal austerity” — distributes the burden of adjustment, some would argue, more fairly across society (if done right) and across generations, by undertaking a measure of up-front adjustment.

At its core is an emphasis on fiscal consolidation — reducing the budget deficit by measures to improve revenue collection supplemented by better expenditure management. This approach seeks to first stabilise the public debt, and then to lower it progressively to more manageable levels.

The advantage of this strategy is two-fold. First, this approach generally lowers inflation after an initial period of adjustment in administered prices, if required. Second, as government borrowing declines, more space is created for banks to lend to the private sector. Importantly, it is not just the availability of credit to private businesses which improves, but the price of credit as well — both of which can be important channels for growth.

Despite its prolonged use of IMF resources since the 1970s, and its pretence of reform, Pakistan has followed, by and large, a debt-laden or liquidity-driven approach to stimulating growth — with underwhelming results even in the medium term. On the other hand, periods of macroeconomic stability and even limited moves on reform have been followed by a robust growth and investment response.

Two key episodes of economic reform in Pakistan’s recent history — the “big bang” de-regulation and privatisation orchestrated by Sartaj Aziz as finance minister in the early 1990s , and the liberalisation of the financial and telecoms sectors in the mid-2000s — were followed by an upsurge of investment in the economy. Even in the wake of the severe 2008 crisis, the pursuit of stabilisation policy under Shaukat Tarin successfully restored confidence to investors and markets (with the release of a wad of cash by the IMF admittedly a powerful influence as well).

The fact is that given the state of Pakistan’s public finances, the level of its debt, and the weak institutional links and broken “transmission channels” between policies and outcomes, the country does not have the luxury to follow outright expansionary Keynesian policy.

However, contrary to popular misconception, the fact is that macroeconomic stabilisation can be pursued in ways that are not only growth-neutral, but are actually growth-enhancing. Below is a partial framework of policies that can be pursued under the aegis of a plan of macroeconomic stabilisation that will, I believe, lead to not only a rapid return to higher economic growth, but do so in a durable and sustainable manner.

1) Reduce undirected consumption subsidies and partially replace with investment subsidies. Almost the entire subsidy allocation in the budget — barring a miniscule amount — is geared towards supporting consumption. If the overall subsidy burden is reduced, and a part of it reoriented towards new capital investment or new hiring by businesses, or the absorption of new technology, it will be more growth-enhancing than the current regime.

2) Reduce overall government expenditure — but channel more resources to high-priority areas such as overcoming the energy crisis and the water challenge, and enhancing yields in agriculture by spending more on research and extension services.

3) Widen the tax base, and reduce the marginal tax rate.

4) Make provinces more accountable — for revenue mobilisation as well as service delivery. An ‘adjustor’ should be applied to the provinces’ NFC Award transfers for shortfalls in either area. While this measure will not directly lead to economic growth in the short run, it will improve the resource envelope in a substantial manner, and lead to a lower level of fiscal consolidation in future.

I have returned to the theme of fiscal consolidation repeatedly since last year for good reason. It is highly misunderstood, for starters. Equally important, with almost all political parties that could form the next government demonstrating an unrestrained populist impulse in their previous stints in power, it is more than likely that we could see a continuation of Pakistan’s historical pattern of “over-financing and under-adjustment”. Were this to happen, it would be unfortunate and counterproductive as well as outright dangerous.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

With a backdrop of a record budget deficit of around 10 per cent of GDP staring us in the face, the near-collapse of the energy sector as well as of most public-sector enterprises (PSEs), the more-than-doubling of public debt, and the Federal Board of Revenue (FBR) struggling to prevent a meltdown in tax collection, the situation on the public finances front is far grimmer than most people realise.

It is clear that nothing short of deep institutional as well as structural reform is required to correct, where and to the extent possible, the damage done to Pakistan’s economy and finances by successive governments in the recent past. These reform moves would include restructuring the FBR, setting up a permanent tax reforms commission to unify and bring coherence to the tax effort of the centre and the provinces, restructuring the size and performance incentives of government, improving governance of the energy sector, providing a framework for the restructuring of PSEs etc.

Such a sweeping reconstruction of Pakistan’s economy is beyond the scope of the caretaker government. With its limited mandate — and fast-disappearing tenure, especially for a yet-to-be-nominated finance minister — is there any balm that can be applied in the caretaker’s triage?

Mindful of what can and cannot be done by an interim government, I would suggest the following priorities with regard to the economy for the next 36 days:
1. Kill the proposed tax amnesty scheme: Given the developing urgency on the revenue front, and the FBR’s rising desperation, the caretaker government may be convinced into approving a notoriously bad idea. I intend to write separately on why the FBR’s proposed scheme can be a “near-fatal” blow to Pakistan’s tax collection effort, but many of the country’s best tax and legal minds have already made their views known. Broadly, the arguments against the tax amnesty are as follows:
— It “institutionalises” moral hazard i.e. it will encourage behaviour it seeks to avoid.

By raising the white flag of surrender to tax defaulters and delinquents — even with the incredible “goldmine” in its possession in the form of data from the National Database Registration Authority on 3.2 million elite citizens with affluent lifestyles who are not on the tax register — the FBR is reinforcing the perception of a lack of credibility and ability on its part to collect taxes from those who choose to stay outside the tax net.

Amnesties of this nature work best when the threat of subsequent enforcement action is credible. If this is the state of the FBR that there are 3.2 million people outside the tax net operating under its nose, so to speak, that it has identified with addresses, name of spouse(s) and children, bank account details etc., but cannot send a tax notice to and is instead forced to offer a blanket amnesty at the rate of a paltry Rs40,000, why should anyone take it seriously?

And that too when it is unclear if a “business-friendly” elected government may choose to soften, or do away with completely, the penal terms for non-compliance that the FBR has placed in the amnesty proposal.

The FBR’s priorities are misplaced. It should seek to meaningfully and credibly improve its processes, procedures and personnel to enhance tax revenue in a sustainable manner.

— Amnesties have been tried many times before, with no success Starting with Dr Mahbub ul Haq’s somewhat twisted efforts in the 1980s to “whiten” black money through the issuance of bearer bonds, to previous six or seven tax amnesty schemes since the 1990s, Pakistan’s tax problem has grown rather than been resolved. The size of Pakistan’s thriving informal economy and the continued abysmal tax-GDP ratio are testimony to the disastrous failure of short-term gimmickry replacing a serious reform effort.

The supposed trade-off between approving the amnesty scheme or levying additional taxes is a false one. The choice before the FBR is to get its act together — and bring non-payers whose details it possesses into the tax net.

2. Book the “losses”: An equally important priority should be to recognise (in the accounting sense) the fiscal and quasi-fiscal costs of the actions taken by the previous government over and above the budget approved by parliament. This would be important for at least two reasons.

One, it will give the incoming government a clear sense of how much it has to “provide for” in subsequent budgets for recapitalisation costs, or for power-sector subsidies, for example. My guesstimate is that these un-booked fiscal and quasi-fiscal costs are substantial, quite possibly in the range of 3pc to 5pc of GDP. As I have noted previously, the exact magnitude can only be unearthed by professional forensic accounting.

Second, it will provide, to an extent, some much-needed operating space to the incoming government by establishing a base-line of the fiscal situation it inherited. This exercise will have greater credibility if conducted by a non-political interim set-up.

Since the caretaker government cannot prepare next year’s budget, as it is not in its remit to establish the fiscal envelope or the expenditure and tax priorities of the next government, or negotiate with the IMF or institute any wide-ranging economic reform, its focus will perforce have to be on fiscal housekeeping — and on stopping a bad piece of legislation in its tracks. If it can achieve these somewhat modest tasks in the stipulated time, it should credit itself with a job well done.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

Contrary to most expectations, and after a delay of years, Pakistan and Iran have finally made significant headway in the Iran-Pakistan (IP) gas pipeline project. Despite strong and consistent opposition from the US, Pakistan has cited the so-called peace pipeline as vital to its energy security and needs, and is committed to seeing gas flow from Iran by December 2014.

The IP pipeline is slated to deliver 750 million cubic feet of gas per day (mmcfd) from the Iranian South Pars gas fields, to the Sui Southern Gas Company’s transmission and distribution network. Currently, Pakistan is facing a natural gas shortfall of nearly 1.5 billion cubic feet per day (bcfpd), which is expected to rise — without countervailing measures — to around 6-8bcfd by 2020.

Pakistan is actively seeking a multitude of diverse sources to meet its rapidly growing energy requirements, including import of liquefied natural gas and liquid petroleum gas, the Tapi project, import of electricity from Central Asia and, possibly, India, and greater exploitation of indigenous hydel, natural gas and coal resources.

The IP gas pipeline is thus one, albeit important, component of Pakistan’s overall energy requirement mix. Pakistan has earmarked the potential gas supply from the IP pipeline exclusively for generation of approximately 4,000 megawatts (MW) of electricity. Currently, the country is facing a power shortfall of approximately 4,000-5,000 MW, which peaked last year at around 7,000 MW.

Thus, the gas from Iran via the IP pipeline can not only wipe clear the power shortfall, but it can do so at a significantly reduced generation cost from the current fuel mix which is skewed towards furnace oil and diesel.

The direct economic cost to Pakistan emanating from the energy crisis amounts annually to around three to four per cent of GDP. The direct cost is mainly in the form of lost output/GDP. However, the broader macroeconomic collateral costs are substantial too, and include a decline in employment levels, lower incomes, lower government revenue, a decline in export orders, drastically lower fixed investment levels, and greater fragility of the banking system.

In addition, the persistent energy shortfall has burdened public finances through the provision of heavy subsidies via the budget, amounting cumulatively in the past five years to approximately Rs1.5 trillion, leading to a diversion of budgetary resources from development projects, and to a rapid build-up of public debt.

The build-up and persistence of the inter-enterprise circular debt in the energy sector has sapped the financial strength of energy companies, severely curtailed their operations and profitability, and drastically reduced new investment in upstream exploration and production activities, and in downstream projects such as installation of new generation capacity. Another important motivation for Pakistan to actively pursue the IP gas pipeline could include a strategic diversification of its energy sources.

Iran is currently under three layers of international sanctions targeting its alleged pursuit of “non-peaceful” nuclear activities — a unilateral sanctions regime imposed by the US in conjunction with the European Union, and a multilateral regime under the framework of the United Nations.

Broadly, US sanctions prohibit US nationals and entities from business and arms dealing with Iran, while also targeting Iran’s financial dealings with the rest of the world.
Its ambit extends to non-US persons, however, in the case of re-export of sensitive US-origin goods, technology or services to Iran or the government of Iran.

The UN sanctions regime embargoes all dealings with Iran and designated Iranian entities that relate to “proliferation-sensitive nuclear and ballistic missiles programmes”. UN sanctions on Iran have been imposed via four binding Security Council resolutions, namely: 1737 (2006), 1747 (2007), 1803 (2008) and 1929 (2010).

Prima facie, transactions with the Iranian oil and gas industry that do not constitute investment in Iran’s energy infrastructure appear to be excluded from the ambit of the sanctions’ regimes of the US, EU and the UN. In addition, the US has provided a waiver to nine countries from its sanctions rules on import of, and processing payments for, Iranian oil.

For this reason, South Korea, Japan, South Africa, China and India continue to purchase crude oil from Iran — though at lower levels than previously — while Turkey continues to be supplied Iranian gas via pipeline. In fact, Iran’s crude oil exports rose 13 per cent in February from January to 1.28 million barrels per day (mbpd) — but down from an average of 1.5mbpd in 2012 and 2.5mbpd in 2011, according to the International Energy Agency.

However, under new US rules that took effect from February this year, the importers of Iranian crude are required to pay in local currencies kept in escrow accounts — or risk being debarred from the US financial system.

The purchase of Iranian natural gas does not appear to be “sanctionable” activity under current rules. However, even if it were met by the US “dialling up the pain” for Pakistan, economically or via other means, cold economic logic dictates that Pakistan should follow through on the pipeline. This is so since the annual cost of the foregone natural gas is around two to three per cent of GDP, at least, while the likely cost of US economic sanctions would be far below this level.

(As a relevant aside, fears of an economic “meltdown” in case of US sanctions are grossly exaggerated — and appear to be designed to foster and perpetuate a degree of dependency. “Noopolitik”?)

Pakistan should pursue deeper economic engagement with Iran as part of an expanded effort for regional economic integration which the US purports to support.
Relations with Iran should not be viewed as a “zero-sum” game to any other set of Pakistan’s important bilateral relationships — in line with the US approach to Pakistan and India.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

With the scale of the fresh assault launched on public finances and institutions, and on state-owned enterprises, resembling a blitzkrieg, perhaps the government’s already less-than-ordinary handling of the economy can be described as a “giant leap backward”. (In evolutionary terms, what would that be: Fiscal Homo-Erectus?)

After three years of heading the finance ministry, during which time the average fiscal deficit amounted to 7.9 per cent of GDP (including the projected deficit this year), and the budget gap amounted to a cumulative Rs5 trillion, Mr Hafeez Sheikh has relinquished charge. His resignation came amid rising frustration of his party colleagues that the minister’s inaction would “cost the PPP the election”.

His successor has clearly taken on the mantle of someone who will “deliver” the election by taking pork-barrelling and free-wheeling spending to new heights — from an already dangerously elevated level under Mr Sheikh. (To the Planning Commission’s eternal shame, it has acted as a willing facilitator to the political patronage and pork-barrelling of the last few years).

Measures which the federal as well as provincial governments are trying to rush through in the dying days of their incumbency, include: “regularisation” of the services of hundreds of thousands of contractual employees, stuffing constituents and party loyalists in newly created jobs in the public sector, approving bailout packages amounting to billions of rupees to the likes of PIA; and doling out state land as plots to bureaucrats.

This comes on top of thwarting any independent and transparent investigation of alleged mega-corruption through acts of commission and omission in the case of Ogra, NICL, Haj, allotment of ephedrine quotas, “missing” Isaf containers etc., which collectively have cost the exchequer and taxpayers hundreds of billions of precious rupees through either embezzlement and outright fraud, or via incompetence caused by non-meritorious appointments.

Broadly, a few pages from this playbook of mis-governance and mal-administration encompass the following well-tried and tested methods:

— Non-merit-based appointments, especially at senior decision-making levels — with the appointment by the PPP government of the erstwhile and fugitive Ogra chairman the most egregious example;

— Jobs by the thousands to party loyalists in state-owned institutions ranging from FIA, Nadra, police, to Railways, OGDCL, PSO, PIA and Pakistan Steel Mills;

— The doling out of “development funds” to MNAs and MPAs with no accountability of end use;

— The use of discretionary funds and powers by the prime minister and chief ministers with no oversight and accountability;

— Non-transparent procurement at inflated rates by public-sector companies from “fly-by-night” companies set up by relatives/cronies of those in power;

— Relaxation of PPRA (Public Procurement Regulatory Authority) rules for specific entities or specific transactions in the name of “expediency”;

— Institutionalising gas theft by nearly doubling the “Unaccounted-For Gas” (or UFG) benchmark for the two gas distribution companies;

— Overseeing poor governance in the power sector that is estimated to cause a loss of at least Rs100 billion each year;

— Issuance of tax and customs duty waivers to favoured companies through issuance of SROs;

— Fraudulent tax refunds by FBR, obtained via illegal gratification or under pressure;

— Allowance of mis-declaration on import to escape payment of higher customs tariff;

— Ensuring loans to cronies from banks either under state ownership (Sindh Bank, Bank of Punjab, NBP etc), or under government influence;

— Allocation of licences and quotas, with LPG and ephedrine just two examples;

— Use of government advertising revenue as a source of influence or favour;

— Grant of plots to bureaucrats, journalists and others from state land;

Categorising the actions of the PPP-led government into three groups will make it easier to understand the scale of the institutional carnage that has been let loose, and to begin monetising the potential losses.

Public finances: The direct costs to the exchequer of these actions will come in the form of higher employee-related expenses, higher interest payments on government borrowing undertaken to cover the additional expenditure, and lower tax receipts and dividend income accruing to the government.

In addition, the losses of public-sector enterprises (PSEs) because of bad governance will eventually translate as a charge on the budget when an equity injection or ‘bailout’ by the government takes place. Given the scale of the corruption and mal-administration, the aggregate recapitalisation costs could amount to anywhere between two to five per cent of GDP, as a conservative estimate. On a current basis, this amounts to between Rs400bn to Rs1,032bn, but it will almost certainly be higher in later years given that the GDP base would have increased. The indirect costs occur from the higher inflation burden (or “tax”) on the citizens of Pakistan, and the near-collapse in public service delivery that accompanies this scale of mal-administration.

Another cost is the steep negative impact on the formal sector of the economy, and its consequent spill-over into lower investment and employment.

Public-sector enterprises: The damage done in the past five years to the PSEs can best be gauged by the fact that on-paper profitable PSO cannot pay for its import letters of credit without release of funds from the finance ministry, and the two Sui companies will “become bankrupt by June”, according to none other than the prime minister’s adviser on petroleum. In addition, PIA’s losses had reached Rs28bn during 2011, while its equity stood at Rs86bn (deep in the red). Its auditors have given an unqualified opinion as to its standing as a “going concern” — meaning it’s officially bankrupt.

Railways, the power sector, Pakistan Steel Mills, TCP, Utility Stores Corporation are the other entities suffering huge losses and imposing a mega-burden on public finances.

Public institutions: Political appointments in SBP, OGRA, FIA, ECP, boards of commercial banks and PSEs, are the other manifestation of mal-governance by the PPP government.

The visible costs of mis-governance are usually the tip of the iceberg, as proven by experience the world over as well as in Pakistan during the 1990s. The true scale of the long-term damage caused to the economy will only become clear over a period of years. This is so since balance sheets and income statements can be opaque, and large losses or material risks and contingent liabilities, can remain hidden from public view for years before a “blow up” occurs. Only professional forensic accounting will be able to reveal the true scale of the fiscal mess the PPP-led government is leaving behind after five years in power.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

Indications to this effect have been around for several years. These indicators have included, among others, a rising share of informal jobs in total employment, a static share of output and employment of the formal manufacturing sector, a growing level of cash transactions in the economy, and an increase in estimates of the “tax gap”.

In addition, firm-level behaviour has also provided clues to the underlying trend in the economy. There are fewer listings on the stock exchanges, and some prominent de-listings, while a fairly significant number of previously formal small and medium enterprises have chosen to become Association of Persons over the past few years, according to some tax experts. Finally, according to some reports, the number of firms on the tax register (for income as well as sales tax) has declined in the past five years.

In fact, anecdotal evidence suggests that in the past few years, there have been instances of even large manufacturing units that have either completely or partially “shifted” production to the underground economy. Evidence to this effect has come from the Federal Board of Revenue (FBR) in the case of at least one significant sector of the economy — cigarettes — where a sharp dip in federal excise duty collection in 2009-10 was attributed to this phenomenon.

Reportedly, though unconfirmed, a similar trend has been observed in the case of some of the vegetable ghee and cooking oil units. Given the underlying factors at work, there is no reason why this trend should be restricted to these two sectors alone. Against this backdrop of mounting evidence of rising informality, a 2012 report by Pakistan Institute of Development Economics (PIDE) researchers M. Ali Kemal and Ahmed Waqar Qasim using a more robust approach than previous studies, suggests that the size of the informal economy in 2008 ranged between 74 per cent to 91 per cent of the formal, reported economy.

This is substantially larger than previous estimates of between 30 per cent to 50 per cent (albeit using different methodologies). If correct, this implies that the overall size of Pakistan’s economy, both reported as well as unreported, is around $420 billion, with private consumption at current prices amounting to a whopping $365bn in 2012 (which would explain the consumption “conundrum” I have written about previously).

The trend of rising informality of the economy is no cause for celebration. While a large informal sector acts as an important shock absorber for an economy gripped by a fairly lengthy period of sluggish jobs and income growth, the trend of growing informality — that too from an already elevated starting point, and at the expense of the documented economy — depicts the operation of very serious structural constraints for the country’s formal sector, and for its overall, long-run growth prospects.

While the formal sector may not be as labour-intensive as the generally smaller businesses in the grey economy, it is the driver of large-scale fixed investment, which creates multiplier effects for the informal economy as well. In addition, it is by far the largest source of tax revenue, through which the infrastructure needs of the entire economy — including of the informal sector — are financed.

Foreign direct investment, an important source of not just foreign exchange for the country but of entrepreneurial capital and technology, in addition to potential access to external markets, is invariably attracted by the formal sector of the economy, and hardly ever by the informal one.

The quality of jobs offered by the two segments of the economy also differs greatly. Jobs in the informal sector are almost always less secure and lower paying, and offer fewer opportunities for upward mobility due to a lack of training and employee development.

At a more fundamental level, the fact that economic agents are leaving the “safeguards” and “protection” supposedly offered by the institutional framework provided by the state, and are choosing to organise their economic activities on more informal, less organised “natural state” arrangements is a cause for serious concern. I have alluded to this aspect previously, while other commentators such as Jamil Nasir and Khurram Husain have also written recently on this institutional facet.

In the face of unambiguous and unequivocal evidence on the rising informality of the economy, the central question is: why is this trend taking place at all, and why is it appearing to be gathering pace?

Having set up and run my own small business in the formal sector for the past two years has given me some unparalleled insights. While Jamil Nasir in his article in January (in another newspaper) believes the tax structure is not a big contributor, and the regulatory burden is a bigger factor, my own experience suggests that it is both, the tax and regulatory burden, that are either preventing informal businesses from formalising, or are driving already documented firms into the informal economy.

Here’s how. For starters, a formally registered firm filing an income tax return has a 20 per cent disadvantage compared to an enterprise that is operating in the undocumented sector (the tax arbitrage for informal firms). But this is not the end of it. The direct costs of maintaining books, having the firm’s accounts externally audited by a professional auditor, hiring tax consultants and an accountant etc. are not insignificant.

More annoying from my perspective is the opportunity cost of devoting roughly 10-15 per cent of my management time to tax and SECP-related issues, not least of which are chasing up on tax deduction certificates and acting as a withholding tax agent for the government.

In addition, the number of corporate and tax-related filings that the company has to make each month, every quarter, and then on an annual basis is absurd. To incentivise informal sector players to formalise, both the Federal Board of Revenue (FBR) and the Securities and Exchange Commission of Pakistan (SECP) will have to reduce the number of filings, while the transactional relationship with FBR will need to be converted to “arm’s length” via the use of automation.

Finally, the government should consider a system of tax credits and rebates on investment and hiring by small registered businesses, and an initial lower income tax rate for newly corporatised firms as a powerful incentive.
At the other end of the spectrum, the tax and regulatory burden on large, formal firms also needs to be reduced by a comprehensive broad-basing of the tax regime.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

Each year, the highly-regarded and widely followed annual report of the State Bank of Pakistan attempts to credibly answer the first of the two questions. With a large, competent team of economists at its disposal, and a degree of independence that needs to be protected, it produces a far more credible document than its Ministry of Finance counterpart, the Pakistan Economic Survey. (However, the Ministry of Finance needs to be commended for the occasional forthrightness it does manage to show, given the resources at its disposal and the environment in which it operates.)

Nonetheless, like its counterpart (but mercifully not to the same extent) the SBP report suffers from one limitation: by virtue of its mandate, it is usually tactical in nature, too focused on the performance of the fiscal year gone by. Hence, despite the overwhelming challenges that Pakistan’s economy faces, the SBP annual report starts with an almost soothing assurance of “modest improvement” and “broad-based” growth in the economy.

While, to SBP’s credit, longer-term issues and challenges are mentioned, such as the trend of declining fixed investment and the water challenge, these are presented as stand-alone sections or one-off fragments of analysis, and are not woven into a single narrative of growing structural weaknesses and institutional decay that are already generating serious ramifications for the well-being of Pakistan’s citizens.

As such, there is virtually no credible narrative that the politicians and other power elites are hearing about with regard to the consequences of inaction on the reforms front, barring occasional newspaper columns or the odd presentation at some forum. (The only formal exceptions were the Nine-point plan for economic revival presented to the cabinet by Shaukat Tarin in 2009, and the similar New Economic Agenda launched by the Pakistan Business Council in 2011; unfortunately, these failed to gain traction.)

This is clear from the business-as-usual approach of all political parties in power. The lack of a credible economic roadmap, and the inability to build a case for reform into the fourth year of his tenure, is an abject failure on the part of the finance minister — and on the part of the Planning Commission, which should have graduated from a third draft of its ‘growth framework’ and produced a more meaningful and usable policy document by now.

As permanent players or stakeholders, politicians have much to lose from an unstable and increasingly difficult-to-govern Pakistan — and much to gain from the opposite. Earning rents from a growing economy where ordinary citizens are experiencing rising per capita income (the so-called Suharto model named after the late Indonesian leader, whose family and friends benefited massively from corruption and cronyism) is a relatively more acceptable alternative to the Pakistan of the 1990s, or of today.

Hence, politicians can be a natural reform constituency, despite their Swiss bank accounts, Spanish villas and Canadian passports, if they act in their own enlightened self-interest that goes beyond the short term. For this to happen, I believe, someone will have to get the message across — in a credible, well-reasoned and non-sensationalist manner — that the house is on fire.

(Unfortunately, even non-politicians have refused to see the writing on the wall. In 2005, I cautioned the then prime minister, Shaukat Aziz, not to dismiss the Failed States Index out of hand, as its methodology was not unsound, and that it did raise the red flag on many fault lines that had been ignored for too long. His tongue-in-cheek response through an interlocutor was amusing as much as disappointing. Similarly, in 2009, Carlos Silvani, an internationally acclaimed expert in reform of national tax collection agencies, and I, tried to impress upon the chairman of the Federal Board of Revenue that the tax situation was an emergency and required a war effort. His response: the “house is not on fire.”)

So what are the most worrying economic trends and long-term challenges that need to be highlighted, not just for parliament but for all stakeholders — including civil society? At the risk of repeating myself from previous columns, here is my list of trends in Pakistan’s economy that should concentrate our minds now:

1. A long-run, secular trend of declining economic growth
While most of the developing world, including sub-Saharan Africa, has increased its rate of economic growth impressively over the past two decades or so, Pakistan’s economy has lost momentum. From a long-run growth rate of around 5.5 per cent that was the envy of developing countries, Pakistan has been averaging 4.5 per cent since 1990 — and close to three per cent for the past five years. The 3.7 per cent rate of GDP growth in 2012 — which the finance minister has celebrated — should be seen in this context: it is 33 per cent lower than what Pakistan had achieved for nearly four decades in the past, and less than half of what is required for labour-absorption.

As a result, per capita income has been expanding at sharply lower rates than in the past. In fact, since 2000, per capita income in developing sub-Saharan Africa (excluding South Africa) has overtaken Pakistan, and was roughly 21 per cent higher by 2011.

2. Investment rates at historic lows
Equally of concern is the fact that fixed investment by the private sector has sunk to its lowest level in Pakistan’s history. This does not portend well for the economy’s ability to grow in a sustainable fashion and create millions of needed new jobs.

3. A growing informal economy and a shrinking formal sector
Mistakenly celebrated by many commentators as a sign of the economy’s ‘resilience’, the growing informality is pointing to perhaps the most worrying of all trends — the near-complete collapse of the institutional framework of the state. If this trend continues, the state will disappear into irrelevance — leaving no policy ‘handle’ to improve the economy.

I have briefly touched upon some of the long-run trends in the economy. In a subsequent piece, I will detail the dire economic challenges Pakistan faces.

The writer is a former economic adviser to the government, and currently heads a macroeconomic consultancy based in Islamabad.

THE early morning mist hangs heavy. Seemingly light and ephemeral, it smothers the ground — and hangs heavy on the soul too. No one knows when it will lift its burden. Perhaps later in the day? Perhaps later in the week?

While Islamabad is unquestioningly making the transition to spring, like the sun, when that spring will emerge is only for fools and pundits to judge. One can be optimistic like Kahlil Gibran that “In the heart of each winter’s day, lies a quivering spring”. But it has taken many winters for that spring to reveal itself. (Then again, the mist may not be a precursor to a sunshine-filled day at all. It could be a metaphor, as in Akira Kurosawa‘s brilliant Throne of Blood, the Japanese celluloid version of Macbeth, for losing our way; losing our moral compass.)

The events of the past few weeks, indeed even longer, have left me melancholic and confused. (Hence, the dark, brooding and disjointed nature of my thoughts in this piece.) Are we on the cusp of a stronger institutional base, with a fiery media, an independent chief justice, and a vibrant, social media-driven civil society strengthening the nation’s foundations? Or are we witnessing the vanquishing of the people, the victory of big money, corruption and entrenched vested interest, with only the outward ‘form’ of change?

What needs to happen for us to make a successful transition to a society based on the ‘rule of law’, where a measure of social justice prevails? Several readers of my previous column, Why nations fail, asked searching questions — questions to which I cannot even pretend to have answers for. The most pertinent was: who will change the system when ‘insiders’ have no incentive to change the status quo?

Last February, I wrote the following lines in my column titled System of spoils:

“It should be obvious that such widespread and pervasive rent-seeking on such brazen display can only thrive in the absence of strong institutions (and the presence of a large public sector). It is not surprising therefore that the ecosystem of weak and atrophying institutions serves the interests of Pakistan’s elites very well.

“…Compounding the sense of pessimism on this front, it is unclear what incentive corrupt ‘insiders’ have to change the status quo when they benefit so directly and so profusely from it. While there are incipient signs of hope in the appearance of a developing ‘middle-class consensus’, and the emergence of an assertive and activist superior judiciary, these successes can prove transient. The party that purports to represent the middle classes (MQM) is already co-opted by the ‘system’ and has been enjoying its forbidden fruits for a decade. …it is said big ‘chiefs’ are compromised to the hilt too.”

The co-option by ‘the system’ of large segments of the population has its unfortunate corollary: the absence of a genuine reform constituency, even in the middle class, and even in the media. The appearance of leading columnists and TV anchors in government-sponsored ads against hefty payments — or the practice of the government doling out plots in Islamabad to journalists — are all brazen examples of influential segments of the media selling their soul for the right price. The competition for public-sector ads, or the influence-peddling by owners of media houses to get special tax exemptions and waivers, are unfortunate evidence of how truly ‘independent’ the media is.

Co-option on such a large scale is prevalent across much of South Asia, with governments in Bangladesh, Sri Lanka and the Maldives all practising the same model of state control to varying degrees. India appears to be an exception, to the extent that its size ensures that such large-scale co-option is not feasible. In addition, it has the most relatively robust institutional framework in South Asia, thanks in large part to the vision of its founding fathers.

While I am no historian, my sense is that the coming to being of the Magna Carta that laid the foundation for eventual parliamentary democracy in the UK, was the result of conflict-resolution among equals — the barons on one side, and the king on the other. It made sense for the king to sue for peace and become less ‘extractive’ because the cost of extraction had risen in proportion to the military strength of the other side. (The other route to strong institutions and the ‘rule of law’ is enlightened self-interest — with few contemporary or historical examples.)

In this context, ‘people’s power’ becomes a valid doctrine, when sham democracies fail to provide for even the most basic of their constituents’ aspirations. While the Philippines under Marcos, Zimbabwe under Mugabe, and more recently Egypt and Tunisia under Mubarak and Ben Ali, have all been ‘democracies’ on paper, to the extent of holding of elections, the capture of the ruling elites of all constitutional mechanisms for their replacement — as well as of all resources — left the people only one choice. Hence, a predatory state ruled by an ‘extractive’ elite, sows the seeds of its own eventual demise by encouraging people’s power to take to the streets, or by making civil war more likely.

Coming to our own display of ‘people’s power’, judging by the bursting girths of the full range of Pakistan’s elected kleptocrats on display in the drama in Islamabad, all beaming and smiling after successfully ‘saving the system’, one can hazard a safe guess as to who is benefiting from democracy at the moment — and it’s not the hungry, unemployed, load-shed masses of Pakistan.

“’And hast thou slain the Jabberwock? / Come to my arms, my beamish boy! O frabjous day! Callooh! Callay!” / He chortled in his joy.’

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

Two relatively recent books deal with a theme I have touched upon extensively since I began writing this column two years ago — of how, without a stronger institutional framework and better “governance”, Pakistan’s economy will remain mired in stagnation.

Despite the fact that the pioneering work in the field of new institutional economics came from economists such as Mancur Olson and the Nobel laureate Douglass North over three decades ago, and has gradually become mainstream in the inquiry into the causes of the divergence in the economic well-being of countries with the work of later economists, the link between “institutions” and “economics” has received scant attention in Pakistan.

The development debate within the country has invariably focused on greater use of factor endowments, and the concomitant “big ticket” infrastructure projects, and only very incrementally has graduated to better use of these endowments, be it natural resources, capital or the population. In the latter, i.e. the improved productivity approach, lie the seeds of the institutional debate — what has prevented Pakistan from fully utilising its vast economic potential, while other economies with poorer factor endowments, and a much later start, have powered ahead?

While the title of this column suggests I will be covering Daron Acemoglu and James A. Robinson’s book of the same title that was released in 2012, and which deals with “the origins of power, prosperity and poverty”, I will actually be referring more to Niall Ferguson’s The Great Degeneration: How Institutions Decay and Economies Die.

Niall Ferguson’s book is based on the BBC Radio 4 Reith Lectures 2012 series, and despite its twist to the institutional view, should be more readable for parliamentarians than the academic work of Acemoglu and Robinson. The twist comes from the fact that Niall Ferguson is more interested in nations — today’s US in particular — that historically have had strong institutions which have led to unprecedented economic well-being, but which are now atrophying at the hands of a self-serving political class and system (and complex regulation brought on by big government).

In a sense this is the exact opposite of what Acemoglu et al are studying, which is why only some nations have developed strong “inclusive” institutions while most others are languishing with “extractive” ones that only benefit a small elite. Nonetheless, both the works converge pretty much at the same powerful point — that “good” institutions matter for widespread, and sustainable, prosperity.

A few illuminating extracts from Niall’s work follow. A passage on ‘The Stationary State’ from Adam Smith’s The Wealth of Nations:

“In a country too, where, though the rich or the owners of large capitals enjoy a good deal of security, the poor or the owners of small capitals enjoy scarce any, but are liable, under the pretence of justice, to be pillaged and plundered at any time by the inferior mandarins … In every different branch, the oppression of the poor must establish the monopoly of the rich, who, by engrossing the whole trade to themselves, will be able to make very large profits.”

On the ‘Rule of Law’, Ferguson quotes from the late Lord Chief Justice Tom Bingham’s book of the same name, in which seven criteria have been specified by which a legal system can be assessed, namely:

— The law must be accessible and so far as possible intelligible, clear and predictable;

— Questions of legal right and liability should ordinarily be resolved by application of the law and not by the exercise of discretion;

— The laws of the land should apply equally to all;

— Ministers and public officers at all levels must exercise the powers conferred on them in good faith, fairly, for the purpose for which the powers were conferred, without exceeding the limits of such powers;

— The law must afford adequate protection of fundamental human rights;

— Means must be provided for resolving, without prohibitive cost or inordinate delay, bona fide civil disputes which the parties themselves are unable to resolve; and — Adjudicative procedures provided by the state should be fair.

Most importantly from our perspective, the rule of law for elites is considered the first of three “doorstep conditions” to move from a basic natural state to a “mature” one which represents an “open access pattern” characterised by a fast-growing economy, decentralised government and a vibrant civil society (North et al).

What are the implications for Pakistan? First and foremost, that the elites will have to be subjected to the rule of law. They will have to be moved from a state of perpetuation and protection of their privileges, to the enforcement of their responsibilities. To do this, we have to lay the groundwork for an interlocking set of institutions that provide for political as well as economic governance. (Olson described a society’s transition in terms of moving from “roving bandits” to “stationary bandits”, i.e. autocratic, and perhaps dynastic, rule).

The precondition for economic development (and not just economic growth) is strong institutions. The precondition for democracy to work is the application of the rule of law, both prior to elections — in filtering those who can stand for public office from those who are ineligible under the law — as well as afterwards, in enforcing rules and boundaries on the behaviour and actions of those in power.

If Pakistan can make the transition to the rule of law, it will have virtually guaranteed a stronger economy and a better quality of life for its citizens.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

The good general and the dear reader are echoing a fairly popular sentiment that has reared its head at the end of each debt-accumulation binge Pakistan has undertaken after yet another round of mismanaging the economy. When the time comes to repay, talk of repudiating our obligations and liabilities becomes the vogue. (Somewhat surprisingly, this gains traction in conservative circles where one would imagine running away from an obligation is considered even more so an act of dishonour.)

So instead of devoting this week’s column to the wretched tax amnesty scheme — which will sink Pakistan’s tax effort once and for all, unless by some stroke of luck or divine intervention it is stopped by parliament — I will lay out my position on Pakistan’s “odious” foreign debt.

Firstly, it is a common misconception that all of Pakistan’s debt has been poured down the drain, or used to line pockets. Almost the entire infrastructure of Pakistan — from Tarbela and Mangla dams, the irrigation network and waterworks, the national highways network (including the motorways), electricity and gas transmission and distribution infrastructure, to the ports and airports — has been funded by loans from the Bretton Woods Institutions (BWIs) and Pakistan’s bilateral creditors.

At the same time, there has been an egregiously poor use of many loans too — in building garrison golf courses or stables for polo horses in the presidency, purchasing 7-series BMWs for the military top brass or planes for chief ministers, etc. And corruption has been a large factor too in reducing the efficacy of the loans and making repayment ever more onerous.

However, the fundamental point is that the recourse to borrowing — whether domestic or external — on such a scale and with such persistence, largely represents a massive failure on our part to manage the economy in a responsible manner. Pakistan is a global laggard not just in collecting tax revenue from its own citizens, but also in terms of expanding its exports (or displacing a portion of its imports).

Hence, while Bangladesh has managed to increase its exports four-fold since 2000 (from $6 billion to $24bn), and Vietnam over five-fold (from $14bn to over $72bn), Pakistan’s exports have risen from $9bn to $24bn in the same period. India’s exports have grown from $42bn to $305bn since 2000.

On the import front, better management of our indigenous resources, be it the river system Pakistan is endowed with or its fertile soil and natural eco-systems, can significantly reduce dependence on imports of energy and food commodities.

Combined, imports under these two heads amounted to $20.3bn in 2011-12 (nearly half of Pakistan’s total imports for the year).

But it is the apathy towards taxing Pakistan’s elites, combined with unchecked expenditure that mostly favours the same cohort, which is the biggest cause of our public debt build-up — and the fairly frequent crises the country has experienced on the debt front.

As I have written before, a rough calculation suggests that if we had managed to raise our tax-GDP ratio to around 13 per cent in 2005, instead of the nine per cent it had sunk to, and sustained this level, Pakistan’s public debt could have been lower by around 15 per cent of GDP today. In monetary terms, this would translate into a public debt stock that would be at least Rs3.1 trillion lower, if not more under favourable conditions. In terms of annual saving on interest payments, it would translate into roughly Rs300bn per annum — or 27 per cent of the current budgeted debt servicing, and nearly 10 per cent of the entire budgeted outlay.

Pakistan needs to buckle down and adopt a ‘back-to-basics’ approach. Self-serving gimmicks like tax amnesty schemes or waiver of capital gains on equities are not going to release it from the clutches of a debt trap. On the contrary, these policies will only intensify the pressure.

The bottom-line is that Pakistan is not a poor ‘Third World’ country that has been forced to accept “odious” loans by the BWIs or other institutional creditors. Its power elites have consciously sought and taken these loans — and partly used them well, and to a not insignificant extent used them poorly too.

The corruption and mismanagement of our own people is the root cause of our frequent debt crises. It is morally wrong to make the savers and taxpayers of other countries pay for our mistakes and “sins”. Their governments and their institutions have lent the money to countries like Pakistan in good faith — it is an ‘amanat’ and should be treated as such. (It is inconceivable that there is any tenet of Islam or the Sunnah of the Prophet [PBUH] that supports a repudiation of any obligation, even a non-contractual one).

Running away from our debt obligations is irresponsible, unethical, and in my book, immoral. We should grow up and start acting like a responsible and mature nation. We should also learn a lesson from the pain we have inflicted upon ourselves — and start managing our affairs better.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.