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The Repeated Privatization Attempts in Pakistan

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The Many Privatisation Attempts in Pakistan

Introduction

Privatization, a policy shift aimed at rebalancing the roles of the public and private sectors in government policies (Smith & Lipsky, 2009), has been a prominent focus for decades. Auctions, divestitures, tenders, initial public offerings, and global depository receipts are some of the common methods employed for privatization (Qureshi, Iftikhar, & Raza, 2020). Auctions have been the most popular method, accounting for 37.5% of privatization efforts, followed by divestitures at 13.6% and tenders at 15.91%.

The paradigm shift towards privatization gained momentum following the oil price shock and economic crises triggered by state-owned enterprises. This shift led to a widespread endorsement of privatization by international donor agencies, the International Monetary Fund, and the World Bank. In the late 1980s, many countries, including New Zealand, Czechoslovakia, Latin American nations, and sub-Saharan African countries, began to sell off their state-owned enterprises.

However, underdeveloped and emerging economies continue to rely heavily on state-owned enterprises. Globally, there are still 1500 state-owned multinationals with over 86,000 subsidiaries (Karimkhan, 2018). Half of these multinationals are based in emerging economies, while one-third are in Europe. In Pakistan, as of 2018, state-owned enterprises contributed 10% to the GDP and generated 0.5 million jobs. Unfortunately, the losses incurred by these enterprises have placed a significant burden on the budget, consuming nearly Rs 1.3 trillion of taxpayers’ money in total liabilities and debt. The annual average losses of state-owned enterprises have reached Rs 900 billion.

Overview of Pakistan’s Economic Structure and Privatization

Privatization is crucial for discouraging rent-seeking behavior by the government and promoting firms’ profit maximization. However, the government may retain strategic sectors or commodities where social optimality differs from that of private firms (Naqvi & Kemal, 2002). The primary objectives of privatization include reducing the fiscal deficit caused by state-owned enterprise losses, improving production efficiency, increasing employment opportunities, boosting investment and savings, and stimulating economic activity.

Privatization is essential for enhancing market structure, and the goals of small-scale and large-scale privatization differ. The effectiveness of privatization varies depending on the economic conditions, such as unemployment and inflation levels. Small-scale privatization is generally more beneficial in economies with high unemployment and low inflation, while large-scale privatization is more suitable for addressing significant fiscal deficits.

The presence of state-owned enterprises has deterred foreign investors from investing in Pakistan due to the substantial stakes involved. To attract foreign investment, Pakistan needs to create a free and competitive market environment. Mehmood and Faridi (2013) analyzed the minor effects of privatization on Pakistan’s economy, using figures, descriptive statistics, a correlation matrix, and year-wise percentage changes in selected variables due to a lack of data. The government has divested state-owned enterprises through 167 transactions worth Rs 467.421 billion. Their analysis suggests that privatizing state-owned enterprises can benefit the government by increasing revenue. They emphasize the importance of transparency in privatization to achieve the goals of a competitive market and nation-building.

A robust financial system is essential for a country to mobilize domestic savings towards efficient businesses. Khalid (2006) highlights that Pakistan’s financial sector, particularly the banking sector, was nationalized in the early 1970s. In contrast to the 1970s policies, the government reversed its stance and initiated privatization and reforms in the banking sector during the 1990s. By the end of 2002, the public sector’s share in banking had decreased to 41% from 92% in the 1990s.

Khalid (2006) analyzed the impact of liberalization and privatization on the banking sector using the CAMEL framework (capital adequacy, asset quality, management soundness, earning and profitability, liquidity, and sensitivity to market risk). The study concluded that privatization had a positive effect on the banking sector, leading to increased transparency and efficiency in operations.

An empirical study by Qureshi, Iftikhar and Raza (2020) found that the fiscal deficit is a key factor influencing the decision to privatize. They also identified other exogenous variables that influence privatization decisions, such as government will, the influence of international institutions like the World Bank and IMF, and inflation rates. They concluded that privatization tends to increase when inflation rises but can be hindered by increased GDP.

Historical Perspective of Pakistan’s Economic Structure and Privatization

Pakistan has experienced a history of economic ups and downs. Economic challenges have persisted since its independence, with each government adopting different approaches. Understanding the historical context provides valuable insights into Pakistan’s economic journey.

Pakistan in 1947-71: Pakistan’s economy experienced moderate growth during the era of General Ayub Khan (1958-1969), with GDP growth rates exceeding 5%. However, this growth was concentrated in the hands of a few wealthy families, leading to a significant disparity between the rich and poor. The private sector was efficient during this period, despite being controlled by a select group of 22 families.

Pakistan’s Nationalization in 1971-78: The Zulfiqar Ali Bhutto era witnessed a shift towards socialism and the nationalization of key industries. This policy had negative consequences for businesses, industries, and investors, deteriorating the market structure. The transition from a capitalist approach to a partially communist one led to increased tensions between labor unions and the business class. The nationalization program, implemented in three phases, encompassed various industries, including metal, engineering, petrochemicals, cement, and public utilities. However, the nationalization resulted in significant losses for the economy, including inefficient production techniques, bureaucratic involvement, and increased fiscal burdens.

Reversal of Pakistan’s Nationalization in 1978-88: General Zia ul Haq, who became president in 1978, reversed the nationalization policy initiated by Zulfiqar Ali Bhutto. Despite his limited economic expertise, Zia entrusted economic management to a team of technocrats. He successfully denationalized several industries, particularly ginning mills, but faced challenges in privatizing others due to various factors, including lack of private sector interest and conditions set by previous owners.

Pakistan’s Privatization in 1988-90: The Pakistan People’s Party, led by Benazir Bhutto, won the 1988 elections and prioritized privatization. A British advisor, Rothschild, recommended a widespread ownership model involving small savers to enhance the capital market. The government initiated privatization of several key assets, including Habib Bank, Muslim Commercial Bank, PNSC, PIAO, PSO, SSGC, and SNGPL. However, some privatization efforts were abandoned due to a lack of private sector interest.

Pakistan’s Privatization in 1990-93: The Islamic Jamhuri Ittehad (IJI) government, which came to power in 1990, continued the privatization agenda. Their objectives included reducing government expenditure, expanding the private sector, modernizing state-owned enterprises, and creating a liberal and competitive market. They planned to privatize 118 state-owned enterprises through a bidding process, but only managed to privatize 69 units during their tenure.

Pakistan’s Privatization in 1993-95: The Pakistan People’s Party, under Benazir Bhutto, again prioritized privatization upon their return to power in 1993. They established a privatization commission to accelerate economic development and reforms. The commission categorized state-owned enterprises into three groups and implemented three privatization methods: open bidding, stock exchange, and strategic investors. During this period, several major SOEs were privatized, including General Refectories Limited, Harnai Woolen Mills Limited, Lyllpur Chemical and Fertilizer Limited, Republic Motors Limited, Spinning Machinery of Pakistan, and Hazara Fertilizer.

Statistics Relevant to the Period 1988-1995

Privatization was a common theme among all political parties that ruled during the period 1988-1995. The government received Rs 34.531 billion through privatization, but a significant portion, Rs 600 billion, was used to pay off debt. Additionally, Rs 1600 billion was allocated to the Social Action Program (SAP), a public sector development plan.

Conclusion

The three-phase privatization process from 1988 to 1995 faced several challenges, including a lack of consensus among relevant parties. The government’s failure to involve labor unions and social partners in the policy-making process contributed to resistance and opposition. While there is a perception that public enterprises are inefficient, many private enterprises also struggle to meet the requirements of the Privatization Commission of Pakistan.

Common issues associated with privatization include regulatory reforms, job losses, monopolistic behavior by private firms, and the establishment of inadequate regulatory frameworks. It is crucial to implement a comprehensive legal framework and operating mechanism for privatized state-owned enterprises.

Many governments in Pakistan continue to prioritize privatization, but the lack of a long-term implementation program is hindered by political and economic uncertainties.

References

Alam, K. (2016). Bhutto’s economic policies were disastrous for Pakistan. The Express Tribune.

Bellingham, J. (2016). The 1968-9 Pakistan revolution: A students’ and workers’ popular uprising. Marxist Left Review, 12, 2016.

Bokhari, S. (1998). History and evolution of Privatization in Pakistan. National Seminar on Privatization held on Sep,

Burki, S. J. (1988). Pakistan under Zia, 1977-1988. Asian Survey, 28(10), 1082-1100.

Fatima, G., & Rehman, W. (2012). A review of privatization policies in Pakistan. Interdisciplinary Journal of Contemporary Research in Business, 3(9).

Goel, R. K., & Budak, J. (2006). Privatization in transition economies: Privatization scale and country size. Economic Systems, 30(1), 98-110.

Karimkhan. (2018). State-owned enterprises in Pakistan — a drain on the economy. Daily Times.

Khalid, U. (2006). The effect of privatization and liberalization on banking sector performance in Pakistan. SBP Research Bulletin, 2(2), 403-425.

Mehmood, K. A., & Faridi, M. Z. (2013). Effects of privatization on economic performance in Pakistan. Middle-East Journal of Scientific Research, 16(5), 729-743.

Naqvi, S. N. H., & Kemal, A. (2002). Privatization, efficiency and employment in Pakistan. In How Does Privatization Work? (pp. 244-267). Routledge.

Qureshi, A. A., Iftikhar, S. F., & Raza, H. (2020). Macroeconomic Determinants of Privatization in Pakistan. PAKISTAN BUSINESS REVIEW, 385.

Raza, S. R. (1976). Zulfiqar Ali Bhutto The Architect of New Pakistan.

Sajid, M. A., & Chaudhary, A. (1996). Historical Development of Liberalization since 1947 in Pakistan. Pakistan economic and social review, 179-192.

Shafqat, S. (1996). Pakistan under Benazir Bhutto. Asian Survey, 36(7), 655-672.

Smith, S. R., & Lipsky, M. (2009). Nonprofits for hire: The welfare state in the age of contracting. Harvard University Press.

wood, A. (2009). Introduction. In Pakistan’s Other Story: The Revolution of 1968-69. Wellred.

Author: Maaz Khan is currently pursuing his M.Phil. in Economics from PIDE, Islamabad.  

Plans on Cutting Down the Government’s Size

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cutting down government size

Plans on Downsizing the Government

 

cutting down government size

By Dr Khalil Ahmad

At the turn of this century, the economic-intellectual scene in Pakistan was totally dominated by economists, who never gave a thought to the growing size of the government.

Although it is still they who largely define the national economic scenario depending on the ever-increasing size of the government, an alternative economic narrative has emerged that is becoming clearly visible. Now, the government has to acknowledge its bigger and bloated size and do something about it. This dent in the dome of the statist economists has been caused by the slow and steady hammering by a group of classical liberals who, around the year 2000, started questioning the rationale of the unlimited size of the government, the delivery of which was nothing but zero. At present, it has entered the red zone.

As this group, which initially consisted of a handful of persons, gradually won the support of intellectuals and economists from other domains and institutions, their views generated a hum and, finally, their strengthened voice somehow succeeded in resonating in the closed ears of those slumbering in the power corridors.

It was in March this year that the incumbent prime minister, Shehbaz Sharif, formed a committee and tasked it with reducing the federal government’s size and rationalising pension and development expenditures. The main objective of the committee was to suggest institutional reforms and cut the size of the government.

In fact, there have been now and then, a plethora of attempts by various governments at rightsizing and downsizing its body politic, but these have always proved to be merely political fads.

Likewise, as is the case, almost every government fashionably tries to present itself as a frugal one, and thus goes for austerity and cutting expenditures, though no substantial saving comes out of it but a bigger spending somewhere else. It’s all a cycle of penny-wise, pound-foolish optics.

Like a government that is in dire economic straits, the Shehbaz Sharif administration too, who knows, may be acting in earnest or not in earnest, however, apart from any political and such optics, the government has put the issue of the size of the government at least on the table and on its agenda. Not only did the government put it on the agenda, it has set parameters to proceed in this regard. Somehow, that’s a good omen.

Soon after the announcement of 2024-25 budget, the prime minister constituted a high-powered committee on rightsizing the federal government for a detailed review and analysis on the basis of the initial work done by an earlier committee. The committee is going to present its recommendations within 75 days to the prime minister.

The terms of reference of this committee are as follows:

1) Propose an architecture for functions of the federal government that can be undertaken in private mode; ascertain functions requiring public finances that can be performed in private mode; and analyse whether the remaining functions have an appropriate and economical architecture corresponding to them.

2) Determine the functions that are entirely provincial with no international obligation and without affecting the common market principles.

3) Recommend a concrete plan with a clear way forward and methodology, along with ascertainment to safeguard assets, human resources and other ancillary issues.

4) Any other issue relevant to the scope of work assigned to the committee.

Given the historical track record of various governments, one must remain sceptical with a tinge of hope about something to materialise in reality this time around. Notwithstanding the longstanding despair, there is no denying the fact that the issue of the size of the government is finally on the agenda, and future governments will also not be able to ignore it.

originally published in The Express Tribune on August 05, 2024

Reforming without restoring trust

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Reforming without restoring trust

There is sheer absence of governance and long-gone trust between govt and businesses

By Dr Khalil Ahmad

A new narrative of “home-grown solutions” takes the lead. A piece by Dr Ishrat Husain endorsing it appeared in The News on June 8. 

It’s a good omen that the narrative of home-grown solutions is making waves, though not in government circles, and only in the domain of civil society thinking (this thinking takes shape mostly in WhatsApp group chats and published writings). After cursorily enlisting “home-grown solutions” prepared over the last six years, that is, plans, reports, proposals, etc produced locally, Dr Ishrat Husain concludes his piece by proposing a number of measures.

It may be noted here that PIDE VC Dr Nadeemul Haque terms a lot of these home-grown solutions donor-funded. Husain proposals include bringing in 60% of the economy into the tax net, reducing the sales tax rate, privatising the loss-making SOEs, targeted energy subsidies for the poor, expanding the BISP’s scope, restructuring and reducing the size of the government, devolving power and diverting development funds from legislators to the directly elected local governments (LGs). I don’t aim to contest the proposed measures here, though I strongly disagree with a few of them. My concern is the entire political-economic environment within which an attempt to implement these and other reforms can be made. 

There are certain truths written on the wall. Nobody, including the politicians, deny them. At the same time, no government dares address them. They are like chronic diseases that have plagued Pakistan from the day one. So much so people, especially businessmen, have learnt to live with them. 

The pivotal one is political instability. Rules of the game are not adhered to by anyone, whether they are political parties, the security establishment, or the judiciary. They all trash some or all the rules and laws now and then, the last two being the habitual reprobates. As a rule, a bit of political instability within a certain limit is tolerable, as can be witnessed in India, the US or elsewhere. Actually, it’s political instability, pure and unmixed.

But in the case of Pakistan, the predominant cause of political instability is the stronger foothold of the security establishment. It is that factor that makes political instability too fatalistic. Differences among various political parties take place on a spectrum, the two ends of which are subsumed under leftist and rightist leanings. And the pendulum continues to oscillate between these two extremes, representing the changing views, economic thinking, and shifting loyalties of the electorate. Moreover, impure political instability gives rise to distorted political economics which, in turn, helps manipulate economic choices in the political domain. Under these circumstances, the political parties safely ignore the need to address the economic problems facing citizens, especially the businesspeople.

They know well that they are not accountable to the people. That explains the sheer absence of any governance and the long-gone trust between the government and businesses, the foundation of which was initially uprooted by the “Awami” nationalisation. Hence, political instability, as the mother of all instabilities, removes any semblance of continuity in the economic framework that sustains economic policies across governments.

There is perennial uncertainty lurching in the environment; nobody knows what’s going to happen the next day. Not only does that disincentivise the spirit of entrepreneurship immeasurably, but that has also made a substantial section of the big business to look to the government for tax exemptions, subsidies, favoured status, etc. A class of rentier businessmen has also emerged. Under this political-economic environment, talking about any such reforms is easier than implementing them. No political consensus exists among various political parties; they too live in uncertainty.

The PPP, a coalition partner of the federal government, opposes the PML-N’s attempt to privatise PIA. And you see how the chatter of a charter of economy has already fizzled out. In trying to address this issue, another forum, SIFC, may accomplish the least of what needs to be done. A reform agenda is not on the table of the SIFC either. At most, they may privatise a few SOEs and bring in a bit of G2G FDI.

If there is any will to do anything worthwhile on the part of the powers that be, they must try to convene a grand dialogue and a Truth and Reconciliation Commission should be an integral part of it. All the real and unreal stakeholders – the security establishment, judiciary and political parties – should participate. Civil society organisations, such as Pildat, Fafen and the media should be there as observers.

Thus, after admitting their unconstitutional acts, they all should sign a pledge to start a new era of constitutional rule. That may bring the crucially required political stability that would beget trust between the government and businessmen, especially, and the people at large. Under this new environment of trust, an agenda of reforms may successfully be implemented. Lesson: Before going for any reforms, create a conducive environment wherein reforms may prove fruitful.

The writer is affiliated with the PRIME institute as a distinguished research fellow

This article was originally published in The Express Tribune on June 24, 2024

Budget must be incentives-free

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Budget must be incentives-free

While people expect some relief, best relief is cut in public spending

By Dr Ali Salman

The federal government will be announcing its annual budget in a matter of days. As happens every year, there is a lot of interest and anticipation in the media about what the budget will entail. 

The private sector and industrial lobbies are making their demands public and want incentives. Business associations have submitted their tax proposals and demand tax reliefs. The public is expecting a relief from the back-breaking inflation and wants prices to come down. 

These expectations from the budget arise from an erroneous understanding: government’s budget and national economy are the same. 

The budget is an exercise of state’s financial management and it cannot encompass the economy as a whole. It’s a document where the state declares its intent and plan to collect taxes and manage its expenditures. 

Beyond a necessary level of tax collection required to run a limited and smart government, the budget exercise does not have the capacity to influence economic direction of the nation. 

To give one parameter, let’s consider jobs creation. Our workforce is 80 million strong. Assuming a 15% rate of unemployment (PBS estimates it to be 8%, PIDE estimates youth employment at 31%), we have around 68 million people employed out of a population of 235 million. 

From these 68 million people employed, the federal and provincial governments employ around 3.2 million people. In other words, the state provides jobs to hardly 5% of the population. 

As 90% of budget resources (tax revenue, non-tax revenue and loans) will be spent on current needs, I make a straightforward inference: budget is essentially a statement of how the state intends to keep its infrastructure running, including work for 3.2 million people and pensions of those who have retired or died. 

Now let’s talk about incentives. Each budget is expected to provide incentives and disincentives to selected industries and products, thus influencing consumer choice by using its financial and legal power.

The state can withdraw exemptions, can offer new subsidies and can raise tax rates on its own will. Obviously, in making these choices, it is influenced by stakeholders such as special interest groups as well as lending agencies and commercial banks. 

In my opinion, the budget should be incentives-free. Instead of opening the possibility of changing the incentive structure, which then opens the door on rent-seeking, if not corruption, the state should close its doors on seeking suggestions and demands from the public and private sectors. 

It should just focus on keeping its own economy – public finance in essence – in a good order. It should not default. 

By making futile attempts to change incentives through budget, the state misallocates scarce resources. Even if it is done with good intentions (which may be a path to hell, if you believe in this idiom), such an exercise is done on a false premise of access to perfect information, which remains dispersed. 

In practical terms, the exclusive focus of budget should be to minimise fiscal deficit while considering balancing budget as the ideal type. We may not be able to achieve the ideal, but we should always keep it as a benchmark. 

While the state should enforce its writ on tax collection and take all legitimate measures to collect due taxes, it must always confine its expenditures to the revenue collected. Parliament should have powers to declare any unfunded expenditure as illegal and unauthorised.

To save itself from the complex exercise of calculating the rates of taxes and tariffs on millions of transactions and products, the government should come up with an average and single number where the current tax revenues are not compromised. 

A single rate of general sales tax (GST) should be the starting point, as understandably we may not be able to achieve the uniform tariff rate instantly. 

We should begin to confine the government to a size which the economy can afford without making unrealistic assumptions about growth. That should lead to an exercise where we may have to close some government departments and almost all commercial state-owned enterprises. 

This should also include the rationalisation of defence budget. By moving in its direction, the state will save itself from default.

While the public anticipates some relief from the budget, the best relief is the reduction in public spending. All government expenditures are either funded by present taxes, present loans, future taxes or inflation taxes. 

To allow this and future generations to earn their own livelihood and minimise the burden on their hard-earned income, the state should reduce its size and should free itself from the burden of allocating budgetary resources to specific sectors. 

We should not view the budget as a substitute of growth strategy and should only view this as a plan to manage state finances.

To foster fair competition, the budget should be incentives-free as such incentives distort the market, create an uneven playing field for businesses and can become a breeding ground for lobbying and corruption. In a system without these distortions, firms compete on the basis of merit and efficiency.

The writer is the founder and executive director of the Policy Research Institute of Market Economy (PRIME)

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This article was originally published in The Express Tribune on June 10, 2024

Biting the hand that feeds you

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Biting the hand that feeds you

If rich are taxed too much, they will flee for favourable pastures and not pay any taxes

By Rizwan Rawji

Cutting tax rates in the highest income tax brackets has the most positive impact on tax revenues and the economic growth. The important point is to recognise that people don’t work to pay taxes; they work to earn what they can after tax.

 It is the after-tax rate of return on work, after all, that is the incentive that propels output and employment growth. 

Given the data on tax rates and tax revenues from the highest income earners, there is no way anyone can take for granted that higher tax rates mean higher revenues. The highest tax bracket income earners when compared with those people in lower tax brackets are far more capable of avoiding and evading taxes.

Rich people are highly incentivised to keep their money. They are smart and they have money – they can hire lawyers, they can hire accountants, they can hire members of the National Assembly, senators and bureaucrats. 

They are the people who want a favour from the government. Rich people can buy influence. They don’t only have the means to buy influence, but they also have the ways of doing it. This fact is universal and Pakistan is no exception. 

Money is a universal language, but it speaks at different volumes. Rich people can get around taxes. If the government taxes rich people too much, they will flee the jurisdiction for favourable pastures and not pay any taxes. 

The optimal tax system is one where taxpayers recognise their obligations to pay taxes and believe the tax system is fair and equitable. Then rich people will pay taxes willingly.

Pakistan’s tax agenda should be to stop high-income earners from not paying their fair share of income taxes. Given that they hold the majority of the nation’s wealth, they contribute disproportionately in income taxes to the national exchequer.

What’s missing in Pakistan is a simple, straightforward, broad-based, flat rate and predictable tax system. A flat tax system should be with no exemptions, no exclusions, no deductions and no credits.

A flat income tax means that all taxpayers, regardless of their income level, pay the same percentage of their income in taxes. It is fair and creates incentive for better compliance and more tax revenues. 

For example, say the tax code has a flat tax rate of 10%. A taxpayer earning Rs9,000,000 would pay 10% of the income in taxes (Rs900,000), while a taxpayer earning Rs90,000,000 would also pay 10% of the income (Rs9,000,000). So, while the tax percentage stays the same across all income levels, your specific income determines how much you owe in taxes. 

The advantage of flat income tax over complex progressive or graduated rate tax systems is that it is straightforward and takes the same proportion of income from each taxpayer. The simplicity of this model, offering clarity and ease of administration, shouldn’t fool you. It will have massive beneficial consequences. 

In a progressive tax system, the tax rate increases as income levels rise. Higher-income individuals pay a higher percentage of their income in taxes when compared to those with lower incomes. 

Unreasonable high progressive tax rates lead to quixotic tax enforcement, corrupt implementation of rules and regulations, counter-productive behaviour of individuals resorting to avoiding, evading and misrepresenting their true income. 

The rich are particularly sensitive to high income brackets. The elasticity of supply of taxable income is the greatest in the highest income brackets. Tax rate cuts in the highest income tax brackets have the most positive tax revenue and growth impacts. 

The government should incentivise high-net-worth individuals by being a protector, a creator and a friend by bringing them gradually in the tax fold. It will also diminish the “trust deficit” that exists between the high-income earners and the tax collector.

The rich, in return, should recognise their obligation to pay taxes and believe that the tax system is fair and equitable. They should set an example by marketing themselves as patriots who care for all the citizens and want to share a common prosperity for all Pakistanis.

This article was originally published in The Express Tribune on June 3, 2024.

The writer is a philanthropist and an economist based in Belgium

Economic policies: confusion prevails

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Economic policies: confusion prevails

Solution lies not in distorting market with protests, but in pro-market approach

By Bilal Zahid

In the span of just a few days, two seemingly contradictory headlines graced the front pages of Pakistan’s newspapers, shedding light on the perplexing state of the country’s decision-making. 

The first headline, about wheat crisis, detailed how wheat prices had plummeted, leaving farmers unable to secure the guaranteed support price for their produce due to the influx of imports. This led to widespread protests by farmers demanding fair compensation. 

The second headline, highlighting soaring prices of onions and other vegetables due to increased exports, painted a starkly different picture of consumers struggling with inflation and trying to afford basic necessities. 

These ironical headlines encapsulate the confusion and contradictions prevalent in the country’s economic policies and the broader state of affairs. On the one hand, farmers are protesting for higher prices, while on the other hand, consumers are grappling with skyrocketing costs while agricultural exports are bringing in the much-needed foreign exchange. 

If we were to follow this line of reasoning, our approach would entail importing food items from abroad only when they are expensive. Otherwise, such imports would lead to reduced prices locally, adversely affecting the profitability of farmers.

Moreover, exporting any food items should be avoided altogether, as it would drive up prices for consumers domestically. The notion of exporting only surplus food becomes questionable when we consider the millions who suffer from hunger and malnutrition. 

On the surface, the farmers’ grievances seem legitimate. After all, who wouldn’t want a guaranteed income for their hard work? But here’s the rub: the artificially inflated support price for wheat, higher than the market price, makes it more expensive for consumers than it has to be. 

In a country where nearly half the children under the age of five are stunted and half a million people die annually due to malnutrition, this situation borders on criminality, and its impact on poverty cannot be overstated. 

The estimated loss of Rs400 billion to farmers can be seen as a benefit of the same amount to consumers. To put this figure in perspective, it is equivalent to providing a year’s worth of wheat supply to 26 million people at current market prices. 

These contradictory crises reflect a broader systemic issue: centralised control and Soviet-style planning and decision-making.

Almost every year, there are headlines about wheat and sugar shortages or high prices, but nobody remembers the last time there was a rice crisis because government intervention is relatively minimal, with no minimum support price or export subsidy.

The government’s role should be that of a facilitator, not a meddler. Abstaining from price controls, import restrictions, export quotas, and guaranteed minimum prices allows the market to function organically. 

Consumers should have the opportunity to benefit from the productivity of other nations by obtaining wheat and other food items at lower prices. At the same time, farmers should have the flexibility to seek higher prices in the global market.

Imagine a scenario where Pakistan imports food items that are cheaper globally, allowing consumers to enjoy the affordability of these items while enabling farmers to invest in crops that could potentially fetch higher prices, either domestically or internationally. This wouldn’t just put food on more tables but also inject much-needed efficiency into the system. 

The solution lies not in further distorting the market with protests and support prices, but in embracing a pro-market approach. This promises not only greater efficiency and fairness but also a more sustainable solution to the nation’s food security challenges.

Embracing a pro-market approach is not just a choice; it’s a necessity for Pakistan’s economic prosperity and social well-being and can help balance interests of both farmers and consumers.<span style="color: rgb(0, 0, 0); font-family: georgia, sans-serif; font-size: 18px; letter-spacing: normal; white-space-collapse: collapse;"  

"This article was originally published in The Express Tribune on June 3, 2024.

The writer is affiliated with the Policy Research Institute of Market Economy (PRIME) as a fellow

Unshackling Pakistan’s economy

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Unshackling Pakistan’s economy

By Dr Khaqan Hassan Najeeb

Australia taught me a considerable amount of what I know about successful economic deregulation. Australia was a heavily regulated economy post-World War II. Protectionist measures like high tariffs and import controls were well in place. The financial sector was highly regulated. The government exercised price controls through agricultural boards. 

This ambiance hindered competition, created inefficiencies, and restricted productivity potential. A similar story holds back the potential of Pakistan's economy to this very day. 

Australia's exceptional journey towards economic deregulation began in the mid-1970s. Since then, it has been an impactful and transformative process – one that has been pursued quite well by successive Australian governments over the decades. Authorities have endogenously conceived and implemented a regulatory overhaul – insourcing economic thinking rather than relying on the outside. A path Pakistan consistently seems to miss.

  Some key deregulation measures included floating the Australian dollar, deregulating financial markets, removing controls on foreign capital flows, decentralizing industrial relations, pushing a competition policy, broadening the tax base, and corporatizing state-owned enterprises. These reforms aimed to enhance economic freedom, reach new international markets, shape competitive behaviour, and better the economy's flexibility. The very story Pakistan needs to craft for itself.

  Important areas of deregulation also included enhancing global trade by lowering trade barriers and tariffs and liberalizing sectors like telecommunication dominated by government entities, by removing prohibitions for new entrants. Government authorities engaged private-sector business development service providers for legal services and training for job seekers. Australia moved away from centralized wage fixing to enterprise bargaining. All worth learning lessons for Pakistan’s decision-makers. 

Authorities responded to Australian-based Industry Commission reports on the payoffs and risks related to the corporatization and privatization of public utilities. The recommendations included administrative reform of public utilities and structural reform of a sector as a whole. The outcome included the introduction of competition into power generation and retail areas, and the privatization of publicly owned generation, transmission, and distribution assets. This is a valuable insight into Pakistan’s crumbling energy sector. The deregulation process gained steam in the energy sector in the early 1990s. Australia made a push to develop a National Electricity Market. The creation of an energy market has been pending in Pakistan for eons. 

Australia's National Competition Policy (NCP) framework cut out regulatory barriers to competition, giving stronger incentives for suppliers to operate efficiently, be price competitive, and pursue innovation. A significant component of the NCP was the Legislation Review Program. This reform assessed whether regulatory restrictions on competition were in the public interest. It covered a large area of the economy including professional licensing, agricultural markets, insurance, and transport, among others. 

A competition framework is a less understood area and a missing link in reforming the Pakistan economy. As a result, most businesses are uneasy operating outside the confines of our borders, protected by generous government concessions, exemptions and subsidies, and barriers to competition. 

It is asserted that deregulation has been largely beneficial for the 26 million Australians. Competition has improved services, created long-term price stability and increased consumer choices. Labour has much higher wages, and citizens have experienced a surge in wealth and living standards. Importantly, the decades of economic growth are driven by private investments, not debt-funded fiscal largesse. Tragically, many of us are still unable to internalize this story for Pakistan. The thinking that foreign-funded projects, niche area investments, and an outsourced thought process can help us out of our morass is probably over-optimism. These actions are only likely to help at the periphery. 

The present regulatory regime in Pakistan is a relic of a bygone era conceived to control and manage rather than facilitate and enable. We are still uncomfortable with market signals and rely on controls in many markets. It is time to recognize that undertaking economic reforms and liberalizing price controls and quotas creates a flexible and resilient economy. By prioritizing deregulatory policies, Pakistan can unlock productivity gains, and begin its journey to competitiveness in the global economy. 

Australia carried out several studies to calculate the compliance costs of the prevalent regulations. These studies also considered the flow of regulation. They then set new guidelines to help reduce the flow. With little supporting evidence, most policymakers in Pakistan cannot relate to the heavy compliance costs that stifle entrepreneurship, create excessive paperwork, linger decisions, and lower the efficiency of the economy. The flow of new regulations and setting up of bodies has continued in Pakistan. 

Australia’s success underscores the value for Pakistan in reducing unnecessary compliance costs, enhancing productivity, and driving economic growth. Deregulation is a potential driver of productivity growth. A step-up in Gross Domestic Product (GDP) growth is possible by freeing up the economy, reducing efficiency costs, and improving competition in several markets where it is currently constrained. The largest gains of a deregulatory effort would come from prioritizing a reduction in compliance costs relating to regulations that apply to large numbers of people and businesses, including an estimated 5.2 million small and medium businesses and their taxation regulation. 

In 2016, I helped author a Doing Business Reform Strategy within the government. The reform agenda focused on smart regulations, simplified procedures, and competitive costs. This was to lay the foundation of a far wider effort to deregulate the economy. Short of a decade down the road, a few attempts have been made by the government through initiatives such as the Pakistan Regulatory Modernization Initiative, SMART, Digital Economy Enhancement Project, and Zero-time to start-up policy of the government of Punjab to signal regulatory reforms; albeit to our chagrin, we are a long way from home. 

Research highlights that regulatory compliance costs across certain sectors can be as high as 40 per cent of GDP in Pakistan. An unnecessary and obsolete regulatory system burdens Pakistan’s investment climate. The economy is strangled at the federal, provincial, and municipal levels by a plethora of agencies. Regulatory overhang distorts markets and hinders economic activity while inflating costs and hurting the ease of doing business. 

Regulatory Guillotine efforts, an approach towards determining the legality, necessity, business friendliness, and associated cost of regulation hangs in balance, as the Asaan Karobar Act, needs to move forward. The much-discussed single window for business and investment, Pakistan Business Portal is yet to be fully functional. 

Brooding over the technically correct noises raised over the past decade regarding regulatory reforms and seeing limited impact on the ground, one feels that a serious action-oriented effort towards doing away with regulations that are no longer considered necessary; streamlining and harmonizing regulations across jurisdictions; and moving towards technology or digitization to ease frictions should be the hallmark of the economy for the next few years.

Sometimes life can be gratifying. The arduous hours of completing a doctorate, my engagement with a research think tank, and my industry work in Australia gave me invaluable insider perspectives into remodeling a well-regulated market economy. One could always feel the sense of this transformation in the air. 

One understands Pakistan’s policymakers' mindset for focusing on visible outcomes. However, simplifying rules and regulations shows the state’s capability of deeper reforms. It is Pakistan's time to realize the depth and breadth of work required to make such a transformation – one sincerely hopes we can nudge the mindset of the nation for hard work to achieve a seriously deregulated competitive economy. God bless Pakistan.

The article was originally published in The News International on May 26 2024.

The writer is former adviser, Ministry of Finance. He tweets @KhaqanNajeeb and can be reached at: khaqanhnajeeb@gmail.com

Propelling the ICT sector via imports of IT products

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Propelling the ICT sector via imports of IT products

As the second most prominent source of exports, easier access to IT products is critical

Author: Dr Aadil Nakhoda


The information, communication and technology (ICT) sector is often hailed as the engine of export growth amongst all the services sectors. The ICT sector generated $2 billion worth of exports in the first eight months of FY24, which is approximately 15% higher than the amount generated in the first eight months of the previous fiscal year. The exports from the ICT sector in FY23 and FY22 was reported at $2.6 billion. If the trend in the current fiscal year is to continue, the current exports can likely close in at $3 billion. This makes it the second most prominent source of exports, after the textile sector. However, as a technology intensive sector, it is likely that the IT firms are heavily dependent on the imports of IT goods. Hence, easier access to IT products becomes ever more critical.

A recent study by the Information Technology and Innovation Fund, titled “How Expanding the Information Technology Agreement to an ‘ITA-3’ Would Bolster Nations’ Economic Growth,” reported that several developing countries could benefit significantly by signing the ITA (Information Technology Agreement) and allowing duty-free imports of the proposed expanded list of ITA products. These countries could benefit by increasing the size of their GDP, increasing the size of the tax revenues and benefit from the improvement in the ICT-related infrastructure as well as from improved digitalisation.

The expanded list of ITA products used in the aforementioned study includes semiconductors, smart appliances, robots, energy efficient storage systems and smart medical instruments. The GDP of Pakistan would increase 2% in the next 10 years if it provided duty-free access on the expanded list of products. ICT products are often labelled as ‘super capital’ as they are not only likely to add to the infrastructure but also help in improving the productivity levels in a country. Adoption of smart technologies can help boost productivity levels significantly as it improves the efficiency levels of several processes and procedures in manufacturing and service industries.

ITA was introduced in 1996 with a purpose to eliminate tariffs on the imports of IT products. Although, the signatories of ITA agreed to reduce their tariffs, several non-signatories also benefit from tariff reduction by the member countries due to the most-favoured nation principle of the World Trade Organisation, which requires members to give favourable treatment to all member countries. Currently, there are over 80 signatories of ITA, who contribute to more than 96% of global trade in ICT related products. Afghanistan, China, India and Vietnam have already signed the ITA, while Pakistan and Bangladesh are yet to do so. ITA-2 was introduced with an expanded list of products. The ITIF report discusses the benefits of ITA-3, which further expands the list of products provided in the ITA-2.

One of the largest exporters of IT products, as listed in the proposed ITA-3, is China. It exported more than $1.5 trillion worth of products on average between 2019 and 2022. Vietnam exported more than $165 billion. Both these countries exported more than they imported, running a trade surplus in this category of products. The South Asian countries reported a trade deficit in IT products, with India importing more than $100 billion and exporting $35 billion. Pakistan exported $1 billion, while it imported $7.2 billion. Bangladesh reported a similar pattern as Pakistan. The largest imports for Pakistan were mobile phones, photosensitive electrical equipment and other communication devices. All of these products are categorised as capital goods as they can be used to add further value in the economy. The main exports were refined copper, listed as an intermediate good, and medical and surgical devices listed as a capital good. The highest tariff rates on the imports of IT products are imposed by Pakistan and Bangladesh, which are significantly higher than those applied by the East Asia countries. The imports of consumer goods into Pakistan face an average tariff rate of more than 10%, while imports of similar goods into China face average tariff of less 5%. On the other hand, Pakistani and Bangladeshi exporters face lower tariff rates on their exports to their export destinations than their counterparts in China and India. Even with such preferences, the exports of IT-related products have not achieved the desired results in Pakistan. The total amount of trade creation, using a methodology based on tariff change and import elasticities, if tariffs are reduced to zero is approximately $2 billion.


Although, the tariff rates on IT products are relatively high, the non-tariff measures (NTMs) are relatively non-existent on the imports of IT products into Pakistan. The East Asian countries, such as China and Vietnam, impose several measures across the products, while they are significantly lower for the South Asian countries. Further, the Pakistan imposed different measures to curtail imports as a response to the rising trade deficit. These included import licensing requirements, internal taxation of imports, import tariffs and trade payment measures. The complex web of government interventions makes the import policies more intricate as businesses face several challenges that result in a less conducive business environment.

In essence, the share of the imports of the IT products in total imports tends to be higher in the richer countries than in the lower countries. IT products are not only likely to boost productive capabilities but can also aid the digitalisation of procedures and processes. For instance, digital products can help improve connectivity and take advantage of new innovations and facilitation tools. It is essential that the government rethinks its policies on the imports of IT products if it is to not only propel the exports of ICT services from Pakistan but also the country into the digital age.

Note: The content was also presented by the author at the 17th Annual Conference on Management of Pakistan Economy held at Lahore School of Economics in April 2024.


WRITER IS THE ASSISTANT PROFESSOR OF ECONOMICS AND RESEARCH FELLOW AT CBER, INSTITUTE OF BUSINESS ADMINISTRATION, KARACHI


THE ARTICLE WAS ORIGINALLY PUBLISHED IN THE EXPRESS TRIBUNE ON MAY 20TH, 2024.

A pro-growth flat tax policy

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A pro-growth flat tax policy

Flat tax plan will dramatically change taxation structure by aligning incentives

Author: Rizwan Rawji

Pakistan can replace all taxes by introducing a flat-rate tax of 10% on personal income, 5% general sales tax (GST), 20% tax on corporate income, 5% customs duty and 3% excise duty. Arguments for a flat tax are cast in a number of ways, with simplicity and efficiency being the two key selling points. These lead to two distinct and complementary paths for tax reform.

One focused on the broadest base and the lowest rate possible. The second focused on the concept of single taxation on the principle that income should be taxed only once (fairness and efficiency).

The broadening of tax base accomplishes, in part, the second objective. With the broader base, there is a less likelihood of double taxation.

To make the tax base as broad as possible and void of substitution effects, virtually all deductions and tax credits for individuals and businesses should be repealed.

Lowering the overall marginal tax rates acts as a ceiling for incentive-based activity. The higher the tax rate, the lower will be the incentive for highly productive individuals to step up their efforts.

With the lower marginal tax rates, economic activity will increase, with the added benefits of lower government entitlement spending and increased revenue generation.

Tax rates have two effects on tax revenues. First, “the arithmetic effect” which shows that when tax rates change, tax revenues per dollar of the tax base also change in the same percentage.

Second, “the economic effect” which shows that when tax rates change, the tax base also changes, but in the opposite direction. The economic effect, thus, always works in the opposite direction from the arithmetic effect. This is the logic behind the Laffer Curve.


Economics is all about incentives and taxes have consequences. Pakistan needs a pro-growth flat-rate broad-based tax system. A flat tax system is inherently equal, as everyone pays the same proportion of their income and treated the same.
Fairness in taxation creates incentive for better compliance, accelerates economic growth and generates more government tax revenues. A paradigm shift is required to restructure the entire tax system to induce more work, savings and investments.

High tax rates, complex tax codes with exceedingly technical and abstruse wording and procedures, weak enforcement, inefficiencies riddled with SROs, exemptions, concessions, amnesties, etc have kept Pakistan struggling with a low tax-to-GDP ratio, high fiscal deficit and sluggish growth.

Pakistan can learn and adopt a pro-growth flat tax experience from a number of flat tax countries in Central and Eastern Europe that were part of the Communist bloc just three decades ago.

The flat tax revolution of the 1990s had put pressure on politicians to lower tax rates and reform their tax systems to attract jobs and capital from the uncompetitive high tax nations. Globalisation had a positive impact on tax policy because governments had to compete and “converge” with wealthier nations.

Leading the flat tax trend were the Baltic states (Estonia, Latvia and Lithuania), then soon followed by the Balkan nations (Macedonia, Montenegro and Albania), Romania, Bulgaria, Georgia and Russia.

Critics such as the International Monetary Fund (IMF) then said that flat tax was unrealistic and that it only works in small jurisdictions and cannot work in large economies.

But when Russia and other large Eastern European countries got on the flat tax bandwagon, opponents began to concede that flat tax regimes were feasible, but reasoned that tax reform worked only in transition economies.

The IMF, in its study in 2006, labelled it as a fad and boldly stated; “looking forward, it is not so much whether more countries will adopt a flat tax as whether those that have will move away from it”.

None of the flat tax nations returned to a discriminatory rate structure and the flat tax seems securely enshrined. The international bureaucracy’s powers of prediction certainly leave much to be desired, because the study was wrong about countries moving in the other direction.

Bulgaria, now a European Union and NATO member, adopted a flat tax regime (10% flat tax on income and corporates and 20% flat tax on value addition) two decades ago and has kept it intact till today. Ironically, Bulgaria also happens to be the country of birth for the current IMF Managing Director Kristalina Georgieva.

However, the flat tax is not a cure-all for every economic ill. To maximise the economic benefits of tax reform, a nation should have the rule of law, property rights, sound money, limited government and low levels of regulations. In such an environment, the flat tax ensures the tax code will not be an obstacle to growth.

A flat tax reform plan would dramatically change the structure of taxation in Pakistan by correctly aligning incentives to promote economic growth, voluntary tax compliance and increase in government revenues.

It will launch Pakistan onto a new trajectory of economic growth and prosperity for all of its citizens.


The writer is a philanthropist and an economist based in Belgium

The article was originally published in The Express Tribune on May 20th, 2024.

Illegal trade: short-term gains, long-term economic decline

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Illegal trade: short-term gains, long-term economic decline

Instead of asking IMF for $6b, govt must aim to plug tax loss hole of Rs1.5-2tr

Author: Dr Ali Salman

When Pakistan’s government imposed restrictions on imports to reduce the country’s trade deficit in 2022, it did not deter the inflow of goods – it encouraged substitutes and possibly smuggling, which is growing at 18% annually.

In particular, the large-scale manufacturing firms and multinational companies were negatively impacted, whereas small-scale firms and commercial importers managed to find alternative routes, often without the knowledge of the government, and at times in connivance with some elements within the state.

Taking account of the impact, Prime Minister Shehbaz Sharif had to recently declare that “illegal trade and smuggling have caused huge losses to the country”.

I present an informed guess to quantify this loss here. First, I qualify that for this article, illicit trade comprises legitimate goods, being produced, sold, and consumed through illegal means including non-documentation and tax evasion.

The illicit trade can be classified into: counterfeit, tax evasion, smuggling, and under-invoicing/misdeclaration.

According to some sources, smuggling through the Afghan Transit Trade (ATT) alone may be responsible for causing at least Rs1,000 billion loss to the national exchequer in terms of foregone import-related tax revenue.

Looking at another dimension of the illegal trade, the government is losing approximately Rs300 billion every year in tobacco taxes, which is rising. If we add another Rs270 billion estimated to be lost due to Iranian oil smuggling into Pakistan, the overall loss is at least Rs1.5 trillion.

These are only estimated numbers and as the nature of illegal trade would dictate, it is impossible to find a reliable number.

Using another source, the Pakistan Business Council estimates the size of grey and shadow economy to the tune of $68 billion. If the tax is assumed to be 10%, this would translate into tax losses of almost Rs1.9 trillion.

Therefore, it is safe to assume that the overall loss to the national exchequer caused by illegal trade, smuggling and tax evasion can be between Rs1.5 trillion and Rs2 trillion, which would be 21% of the current tax target.

This is more than 100% of the total targeted collection of federal excise duty and customs duty, as announced in the budget for 2023-24. This is coincidentally almost equal to the new loan being negotiated with the IMF.

These estimates do not include under-invoicing or misdeclaration as well as losses due to counterfeit products. These also do not include implications for business environment, and in particular, incentives for international investors, who look for a level playing field when it comes to tax policy and its practice.

Clearly, in a country where the government is seemingly focused on extracting taxes only from large-scale and corporate businesses, it provides wrong signals to existing investors, who essentially sends similar messages to future investors.

One should not be surprised that foreign direct investment (FDI) rates in Pakistan have remained abysmally low over the last few years.

According to the Transnational Alliance on Combating Illicit Trade (TRACIT), Pakistan is ranked 72nd out of 84 countries on the “Global Illicit Trade Environment Index”, which is published by the Economist Intelligence Unit. Its parameters are government policy, supply and demand, transparency and trade, and customs environment.

Illegal trade may provide short-term benefits to the economy in terms of cheaper alternatives, but in the long run, it deprives the country of productive investment, innovation, and competitiveness. In some cases, such as spurious medicines or pesticides, this also implies direct threats to public health.

Prime Minister Shehbaz Sharif’s government is rightly concerned about damages being caused by illegal trade activities and tax evasion. The strategy is multi-dimensional: tax compliance, improving enforcement, evaluation of track and trace mechanism and digitalisation of FBR.

It is not the first time that the government has launched such drives. A tax compliance initiative, known as “Tajir Dost Scheme” launched without due homework, is already failing.

It was able to bring only around 200 enterprises on the tax register, out of, well over, three million enterprises. The prime minister has already expressed his dismay over the track and trace system, which was implemented in four sectors in 2020.

Industry sources claim that counterfeit stamps are being produced in tobacco and sugar sectors. This system has met with similar failures in many other countries.

We have borrowed hundreds of millions of dollars for digitalisation of FBR in the last few years, and have found, to the national embarrassment, that FBR was using fake software!

While I hope that recent measures will bear fruit, one should remain wary of over-reliance on technology where policy design is faulty.

As Pakistan remains one of the most protected economies of the world, unless we minimise barriers (as demonstrated in taxes, tariffs, and regulations) to legal trade, the government has no chance of generating enough growth to raise required tax revenues and is set on a clear path towards bankruptcy.

The prime minister has a stark choice: instead of asking the IMF to provide another $6 billion (or Rs1,674 billion) to be disbursed over three years, he can take a different route and aim to plug the hole of tax losses estimated at Rs1.5-2 trillion over the same time period.

The writer is founder and executive director of the Policy Research Institute of Market Economy (PRIME), an independent economic policy think tank based in Islamabad

The article was originally published in The Express Tribune on May 13th, 2024.

Sound money needed for stability

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Sound money needed for stability

Economy is struggling with low growth as it lacks prerequisites for prosperity

Author: Dr Ali Salman & Dr Wasim Shahid

In his 2011 article, Dr Muhammad Yaqub, the former governor of the State Bank of Pakistan (SBP), emphasised the need for controlling money supply to maintain its soundness.

PRIME’s report on Sound Money, which evaluates Pakistan’s monetary stability and analyses macroeconomic policies that have shaped its current state, echoes the same.

Pakistan’s economy is struggling with low growth due to a lack of necessary prerequisites for economic prosperity. The path towards prosperity is determined by the functioning of markets, which requires economic freedom for its agents.

Economic freedom is defined as the degree to which individuals’ property rights are respected in society. Money is a property held by almost all individuals, as market transactions now take place in exchange for money.

To ensure property rights over money, macroeconomic policies must maintain its soundness. In the modern world, a country’s money is sound if its value remains stable against domestic and foreign goods, services, real and other financial assets.

The Fraser Institute of Canada uses the Economic Freedom Index to evaluate and rank countries based on their economic freedom. The index consists of five categories, including sound money.

According to the latest annual report, Pakistan ranks 123rd out of 165 countries with a score of 5.98/10. Unfortunately, Pakistan’s rank for sound money is even worse, standing at 150th out of 165 countries with a score of 6.37/10.

Pakistan has maintained an average score of 6.22 for sound money from 2001 to 2023, with the highest score of 6.83 observed in 2002 and the lowest score of 4.60 in 2023.

From 1974 to 2023, the purchasing power of money for the goods and services included in the Consumer Price Index (CPI) basket decreased by a factor of 68. Similarly, the value of one US dollar went up from less than Rs10 in 1974 to Rs248 in 2023, leading to a 25-fold loss in the rupee value.

This monetary fragility can be attributed to excessive monetary growth, where broad money (M2) has grown significantly faster than the real and nominal gross domestic product (GDP).

Over the past 50 years, the real GDP increased by 10 times and the nominal GDP increased by 644 times, while money supply expanded by over 1,000 times.

The report reveals that the government is mainly responsible for the unsoundness of money due to the inefficient mix of monetary, fiscal, and exchange rate policies. Specifically, the rate of monetary expansion has been out of sync with economic fundamentals.

Pakistani government has historically relied heavily on borrowing from the SBP to finance its budget, leading to an unsustainable monetary expansion. Although the amended SBP Act has limited the government’s ability to issue debt to the central bank, monetary expansion has continued.

The SBP has attempted to control inflation and currency depreciation through a reactionary approach, using interest rate as its policy instrument. However, this approach has been unsuccessful, as keeping market interest rates close to the SBP policy rate makes it difficult to control money supply.

If the government, the lead borrower in the market, does not reduce its demand for funds in response to interest rate hikes, achieving the interest rate target becomes challenging. The SBP has to provide necessary liquidity to the market to achieve short-term interest rate targets, making it impossible to control monetary expansion.

The government’s fiscal branch is often held responsible for monetary expansion, resulting from increased spending without the matching revenue. While this argument holds, the federal government is currently caught in a cycle of debt accumulation.

The seventh NFC Award increased the share of provinces compared to the federation, which may be desirable but has made the federal government vulnerable to shocks. The delay in implementing reforms to reduce the size of the federal government in accordance with the 18th Constitutional Amendment exacerbated the problem.

After paying the provinces their due share, the federal government is left with limited resources that are hardly sufficient to service its debt. Debt servicing being charged expenditure is paid first, leaving the government with no room to provide public goods.

Moreover, the government has to borrow more to service its debt when the SBP raises interest rates to control inflation. This borrowing strains the market for loanable funds, prompting the SBP to inject liquidity. Hence, the money supply expands despite the government being barred from directly borrowing from the SBP.

A comprehensive reform agenda is required to improve Pakistan’s money stability. This includes reducing the size of the government, coordinating fiscal and monetary policies more effectively, managing debt efficiently, and creating an environment that promotes sustained and inclusive economic growth.

Reviewing the current monetary-fiscal policy mix and determining an appropriate operating instrument for the State Bank to limit monetary expansion and maintain its autonomy is crucial.

The practice of expanding money supply in response to government borrowing from scheduled banks while setting the policy rate to contain inflation is not productive.

The government has to comply with the Fiscal Responsibility and Debt Limitation Act, and an accountability mechanism should be in place for non-compliance..

Dr Ali Salman is the Executive Director of PRIME and Dr Wasim Shahid Malik is a PRIME fellow. He is the author of the report “Pakistan Economic Freedom Audit: Sound Money as a Case Study”

The article was originally published in "The Express Tribune" on April 15, 2024.

Same old govt, new economic path?

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Same old govt, new economic path?

Proposing four key reforms to transform the nation’s economic landscape

Author: Zeeshan Hashim

Pakistan held a general election on February 8th, 2024, and the Pakistan Muslim League-Nawaz (PML-N) formed its government on March 4th, 2024. Mian Shehbaz Sharif, who led the previous government under the Pakistan Democratic Movement (PDM) coalition, is the current prime minister.

However, according to major macroeconomic indicators like inflation, growth rate, and unemployment, the performance of the PDM government hasn’t been impressive.

When PDM assumed office in April 2022, the economy was not functioning well. Rather than pursuing structural reforms that could bring long-term gains, the government decided to maintain the status quo and stabilise the economy using conventional tools that have a long history of failure. As a result, almost two years have passed, and the economic situation remains dire.

The new government may repeat past mistakes, but good hope remains for economic reforms. In this article, I propose four major reforms that can benefit the economy in the long run.

Firstly, rationalising the current economic model is a complex but necessary task. The model has failed and will only produce the same results if it remains in its present form. It has weak institutions, relies on debts and remittances, has an uncompetitive industrial structure, declining exports, brain drain, a lower tax base, economic uncertainty, regulatory burden, and a large government size.

To survive, the government is raising taxes at the cost of savings, consumption, and citizens’ welfare.

It is necessary to audit the entire economic structure, analysing what works and what does not, and removing all inefficiencies.

Without it, no policy is effective since these inefficiencies are deeply embedded in the present model. This long, continuous process needs improvement at each stage but must be done as soon as possible.

Secondly, creating state institutions that ensure the rule of law and accountability.

It also requires a strong political commitment despite high political costs to the dominant state institutions that maintain the status quo. They may prefer to keep their present position. But if they are concerned about the country’s development, they must not create barriers to institutional reforms.

Thirdly, we require market-led reforms that facilitate the growth of the private sector in the market. The private sector is the main driving force behind economic development, job creation, tax revenue, lower inflation, and an improved standard of living for the citizens. A stronger market paves the way for a stronger economy.

Unfortunately, doing business in Pakistan is not easy due to various factors. Some are institutional, such as corruption and regulatory burdens, while others are structural, such as a lower comparative advantage in the competitive market. To address these issues, we need institutional reforms to tackle the former and industrial policy to address the latter.

My fourth suggestion is about industrial policy. It doesn’t involve creating a further government footprint in the market while eliminating some. Its economic justification is simple: internalising externalities to capture learning and innovation and offsetting those externalities that cause market failure. Its objective is to promote industrial development to improve productive capacity and diversification in the economy and to facilitate some industries to gain a comparative advantage in the local and international markets. It will ultimately increase the market size and boost the export sector.

Regarding industrial policy, the most influential economist, Dani Rodrik, warns, “The kind of discipline that’s required is the discipline of monitoring, figuring out whether what you’re doing is working, and being able to move away from mistakes when things aren’t working. Successful industrial policy is not about picking winners; it’s about letting the losers go. Some of the worst cases of industrial policy are when you keep putting good money after bad.”

Therefore, before starting the industrial policy, Pakistan must ensure its policymakers and political economy are efficient enough to maintain that discipline Rodrik advises. Otherwise, a new industrial policy will create new evils.

Almost all industrialised countries, including East Asian economies, have achieved economic success due to the abovementioned factors. These are not easy to implement and require strong political commitment, which is why not all countries are successful economically.

However, the evidence confirms that these policies work and have contributed to the economic success of many countries.

THE WRITER IS A RESEARCH SCHOLAR AT THE PRIME INSTITUTE, A DOCTORAL RESEARCHER AT BRUNEL UNIVERSITY AND A LECTURER OF ECONOMICS AT THE UNIVERSITY OF BEDFORDSHIRE

The article was originally published in 'The Express Tribune' on March 18, 2024