Report: An Empirical Critique of National Tariff Policy 2019-2024

30/10/2024by PRIME Institute PRIME Institute No Comments

Policy Research Institute of Market Economy (PRIME) has released its latest report titled, “An Empirical Critique of National Tariff Policy 2019-24” on 29th October 2024.

The report analyses the tariff structure and its impact on trade contraction in Pakistan. The National Tariff Policy 2019-24 prescribed departing from using tariffs as a revenue collection measure, but that specific policy proposal was not put in practical use. As such, the impact of its lopsided tariff structure—the number of tiers and slabs—proved to impede industrial growth while causing delays and inefficiencies in the promotion of manufacturing exports from Pakistan.

Authored by Dr Nadia Tahir, a PRIME research fellow, and Usama Abdul Rauf, this report offers an examination of the soon-to-be-lapsed policy. For Pakistan’s trade policy to assume a robust framework, the report recommends the simplification and gradual reduction of tariffs. Furthermore, a review every 10 years of the tariff policy is recommended for the tariff policy to remain relevant and effective in achieving its objectives.

During the last 5 years, distortions in tariff policy have increased significantly. It has restricted trade and adversely affected growth in Pakistan. Using petroleum products, chemicals and minerals for revenue collection is a hindrance in becoming a part of global value chains. Frequent changes in tariff structure and rates is another area which needs the attention of our policymakers.

“Empirical evidence proves that a uniform tariff rate is the most efficient way to handle trade policy…Optimizing revenue would be easier at a uniform rate rather than calculating custom duties at different rates. One can calculate the nominal protection rate, but it would be challenging to calculate trade intensity and effective tariff rates,” concludes the report.

Dr Ali Salman, Executive Director at PRIME, speaking at the occasion said that we should stop using custom tariff and import taxation as a revenue tool, and should use this as a tool of industrial policy.

As was observed in the report, Pakistan’s import structure shows that commodities with low tariff rates have higher trade volumes. The government’s imposition of high tariff rates and Non-Tariff Measures (NTMs) on certain products would not completely discourage their consumption. Instead, a preference for under-voicing and smuggling over regular channels will materialise.

Parliamentary Secretary, Dr Zulfiqar Ali Bhatti, who attended the event as Chief Guest, spoke about how aid categorically impedes economic growth, recommending trade volume as an indicator of prosperity.

Pakistan has to sell to the world, for the country to reap the benefits of international trade. In this respect, the cascading principle outlined in the National Tariff Policy 2019-24 insulates the local industry from global market opportunities. Hence, a considerable part of the economy is riding on the next five-year national tariff policy.

For further information, contact our Communications Officer Ms. Sumaira Waseem at sumaira@primeinstitute.org or call +92 300 558 2472.

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Illicit Trade in Pakistan: The Twin Task of Combating Illicit Trade and Boosting Economic Growth

08/05/2024by PRIME Institute PRIME Institute No Comments

Illicit Trade in Pakistan: The Twin Task of Combating Illicit Trade and Boosting Economic Growth

The report investigates the situation of illicit trade across sectors in Pakistan. The convergence of various structural weaknesses in Pakistan’s economy challenges its ability to sustain recent gains in poverty reduction and undermines objectives for long-term growth in GDP. Since these factors also create fertile ground for illicit markets to strengthen, this report investigates the associated impacts and suggests remedies for consideration by Pakistan’s policy leaders. The report highlights that high levels of inflation and tax evasion compound the problems, and urgently calls for a comprehensive and coordinated approach to address them. The report contends that effectively tackling illicit trade will be a crucial ingredient in achieving Pakistan's economic prospect

The report has been published by TRACIT. To access the report, kindly click on the link provided below.

Pakistan Economic Freedom Audit: Sound Money as a Case Study

29/03/2024by PRIME Institute PRIME Institute No Comments

Pakistan Economic Freedom Audit: Sound Money as a Case Study

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Author: Dr Wasim Shahid Malik

This study presents an economic freedom audit of Pakistan, focusing on sound money as a case study. The success of free market capitalism is contingent upon protecting individual property rights. The Fraser Institute's Annual Report on Economic Freedom of the World assesses countries based on their economic freedom index, which comprises five areas, including sound money. This economic freedom audit report aims to evaluate Pakistan's monetary stability and analyze the macroeconomic policies that have shaped its current state. Furthermore, the report critically evaluates the methodology of the sound money sub-index to determine its efficacy in measuring economic freedom.

Pakistan's rating for monetary stability has been consistently low for the past two decades and has further declined in 2023. Historically, Pakistan has had a sound money rating of less than seven due to restrictions on residents having foreign currency accounts and monetary expansion exceeding real GDP growth. Fluctuations in the sound money rating were driven by recent inflation, its volatility, and monetary growth in the near past, as the score on foreign currency accounts remained stable. Pakistan's historical data reveals that sound money rating has typically risen during economic recessions caused by demand contraction but has fallen during periods of cost-push inflation. Recent assessments reveal that Pakistan's sound money rating for 2023 is 4.60, which is the lowest in history, primarily due to exceptionally high inflation during the year.

Throughout history, the fragility of money has been a persistent concern in Pakistan. The value of money has consistently depreciated over time, with a decline in its purchasing power for goods and services included in the CPI basket by one-tenth from 1974 to 2001 and one-sixty-eighths from 1974 to 2023. The Pakistani rupee (PKR) has also experienced a similar decline in value against foreign currencies. For instance, the value of one US dollar in Pakistani rupees increased from less than 10 in 1974 to 248 in 2023, resulting in a 25-fold cumulative loss.

Monetary fragility can be attributed to excessive monetary growth. The growth rate of broad money (M2) has consistently exceeded that of real GDP by a significant margin and has even surpassed nominal GDP growth. Real GDP has increased ten-fold over the past five decades, while nominal GDP has increased 644-fold. However, monetary growth during this period exceeded 1000 times, indicating inefficiencies in both monetary and fiscal policies that have contributed to this expansion and, ultimately, the devaluation of money. Since its inception, the Pakistani government has heavily relied on borrowing from the State Bank of Pakistan (SBP) to finance its budget, leading to an unsustainable monetary expansion. Although the amended SBP Act has limited the government's ability to issue its debt to the SBP, monetary expansion has continued. The SBP has provided the necessary liquidity to banks, which have, in turn, lent it to the government

Over the last five decades, the monetary value has been fragile and unstable, resulting from the misguided and ineffective implementation of monetary, fiscal, and exchange rate policies. Particularly, the short-term real interest rate has remained marginally negative and has shown poor responsiveness to rising inflation, exacerbating the problem. The State Bank of Pakistan has recently adopted a reactionary stance in response to inflation and currency depreciation. However, this approach proved to be ineffective as well. The interest rate, which serves as the SBP's monetary policy instrument, has yielded little success in controlling inflation and exchange rates. Furthermore, interest rate changes hurt economic activity, particularly in large-scale manufacturing. On the other hand, fiscal slippages emanating from increased spending without matching revenue have led to domestic debt accumulation. At the same time, the overvaluation of the exchange rate has caused a trade deficit, contributing to external debt accumulation. Both of these debts are responsible for the monetary fragility that Pakistan is currently facing.

The methodology used to rate sound money requires revision, particularly for developing countries. The rating scheme awards countries with the highest score for inflation and money growth components if they adhere to a zero inflation or deflationary policy. However, these policies are not preferred by any central bank globally; rather, they aim to maintain positive inflation. Additionally, inflation persistence may exhibit positive or negative trends over brief periods, making the standard deviation of five years’ inflation an inadequate indicator of the solidity of money.

This is because the standard deviation is a measure of variation that applies equally to both rising and declining inflation. Finally, there are limited options available for scores related to restrictions on foreign currency accounts within the country and overseas. For example, the State Bank of Pakistan permits foreign cu rrency bank accounts in Pakistan but restricts the flow of some types of funds into these accounts. Moreover, certain restrictions may sometimes hurt economic freedom, but their imposition can lead to more stable and sound money.While different countries may have varying degrees of restrictions, the current rating scheme fails to assign scores based on the severity of such restrictions.
A comprehensive reform agenda is needed to improve the solidity of money in Pakistan. The rationalization of government size, effective coordination between fiscal and monetary policies, efficient debt management, and establishment of an enabling environment for continuous economic growth, which provides equal opportunities to all, are pivotal requisites. It is crucial to re-evaluate the existing monetary-fiscal policy mix and ascertain the appropriate operating instrument for the State Bank of Pakistan to restrict monetary expansion and exercise its autonomy. Setting the policy rate to contain inflation while expanding the money supply as a response to government borrowing from scheduled banks is unproductive. A suitable monetary-fiscal coordination mechanism can be designed to overcome the high inflation and excessive debt predicament. Fiscal policy must adhere to the Fiscal Responsibility and Debt Limitation Act, and there is a need to put in place an accountability mechanism for the government's non-compliance, which can help limit the budget deficit and financing obligations. The government's economic intrusion must be reduced through reforms while simultaneously rendering tax policy more efficient. An Act of Parliament can restrict the deliberate overvaluation of the exchange rate, for which a suitable indicator needs to be developed

For inquiries, you can reach out to us at info@primeinstitute.org or farhan@primeinstitute. Alternatively, you can also call us at +92 (51) 8 31 43 38.

New Privatisation Policy Framework | Working Paper

17/01/2024by PRIME Institute PRIME Institute No Comments

NEW PRIVATISATION POLICY FRAMEWORK

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1. Introduction

The Policy Research Institute of Market Economy (PRIME), as part of the project titled “Privatisation Acceleration Initiative” has prepared this working paper to contribute to the on-going debate and policy initiatives to support, and accelerate, privatization of commercial State-Owned Enterprises (SOEs). As the government has no policy framework for privatization at the moment, we realize that a discussion and consensus on privatization policy is essential. This paper contains a brief overview of the challenges and a list of recommendations which are based on consultation with the stakeholders. We hope that this can lead to useful deliberations and policy evolution. The scope of this working paper is to develop a framework which can be applied to commercial SOEs and outsourcing of public services to private contractors. We hope that it will make the process of privatization transparent, free it from ad-hocism, minimize the potential of misappropriation and corruption attached with it, shorten the process, improve its sustainability prospects, and take cognizance of labour market sensitivities.

2. Background

The issue of privatization of the SOEs is reflective of the complexity, ambivalence and indecisiveness of the public policy in Pakistan. These three traits are embedded in the process of privatization, on the one hand, and on the other, they demonstrate the inability and incompetence of the state institutions and agencies set up from time to time in order to privatize, as the first step, the commercial SOEs, and in particular, but not limited to loss-making SOEs.

A historical review of the various attempts at privatization of the SOEs reveals a number of issues impeding the process of privatization and it is these impediments that have left us with an economic legacy consisting of a heavier footprint of the state (more than 200 SOEs including 87 commercial SOEs1, and 67% state footprint2 in Pakistan’s economy), that includes from commercial SOEs to non-commercial SOEs.

As the state unavoidably needs to shed its burden of the commercial SOEs (whose assets today value more than 40% of GDP), and as it will no doubt relieve the citizenry also from the ever-increasing tax-burden utilized to sustain most of the SOEs, it is imperative to facilitate and accelerate the process of privatization and at the same time to make it transparent, free from bureaucratic and legal disincentives and regulatory hurdles.

And, as the political and economic stakes are extremely high, privatizing the SOEs successfully requires that the concerns of all the stakeholders and issues related with individual SOEs be addressed in a satisfactory manner.

3. Consultation Exercise

PRIME conducted the “Workshop on Privatisation and SOE Policies of the Federal Government” on the Thursday 6th of December 2023, at the Best Western Premier in Islamabad. The workshop had participants and representation from the Competition Commission of Pakistan (CCP), the Petroleum Division (Energy Ministry), an SOE, Zarai Taraqiati Bank Limited (formerly Agricultural Development Bank of Pakistan), a regulator National Electric Power Regulatory Authority, a think tank, Center for Economic Research in Pakistan, and a multilateral lender Asian Development Bank (ADB).

The session was chaired by the Privatisation Minister Fawad Hasan Fawad, and was conducted by the Executive Director PRIME Ali Salman and Programme Director Syed Ali Ehsan. Political Economist and PRIME Distinguished Fellow Dr Khalil Ahmad facilitated the discussions. The first segment of the workshop contained a presentation by Lahore University of Management Sciences (LUMS) Fellow at PRIME Hassan Abbas, with his focus on facts related to privatisation.

Next was an interactive session with participants exchanging their diagnoses on repeated failures to privatise State-Owned Enterprises (SOEs). This was followed by a discussion session on amendments to the privatisation policy and the SOE Policy. The discussion was held under Chatham House Rules. The Workshop was concluded with comments by the Privatisation Minister followed by a networking exchange over Hi-Tea.

4. Identification of Problems

The first interactive discussion revolved around the identification of recurring systemic patterns hindering past privatisation attempts by various governments.

4.1 Problems Stemming from Human Resource Complexities

A significant number of pressures emanate from the labor force related complexities. These were traced to opposition by unions, over extended job contracts which no new owner would plausibly try to accept.

4.2 Political Resistance by employee unions

The participants raised the matter of employee unions blocking privatisation attempts through political resistance and legal measures. Employee unions in many commercial SOEs have direct affiliation with political parties. As large, organized voter segment, employee unions can exert significant pressure on political representatives to oppose privatisation

4.3 Legal Resistance by Unions and Special Interests

Another mechanism that has blocked privatisation efforts has been the invocation of courts by special interests. Unions as well as ex-servicemen communities, and even Public Interest Litigation lawyers are able to obtain legal stay orders at different levels of a privatisation process to completely paralyze the process.

4.4 Unsuitable Human Resource and Rigid Ecosystem

Private investors seeking to turnaround SOEs are unable to relocate, dismiss or terminate the employment contracts of unsuitable HR due to internal organizational rules, or legal protections contained within past legal precedent established by the judicial courts.

Many SOEs contain specialized positions which would otherwise not exist in the private sector. Mostly, these employees cannot be utilized under a new management plan 3 brought in by the private investor. At the same time, the courts have generally protected the positions and financial compensation of such employees, adding a layer of management complexity, and an additional cost burden without value addition.

4.5 Conflicting Interests of Management

Amongst the identified issues were uncertainties caused by conflicting legislation. New laws conflict with older laws, creating ambiguity in what should be well-established processes. This coupled with a broad culture of judicial activism creates a negative environment for privatisation of PSEs. Significantly, G2G transactions are not dealt with clearly under the law.

4.6 Legislative and Judicial Uncertainties

Amongst the identified issues were uncertainties caused by conflicting legislation. New laws conflict with older laws, creating ambiguity in what should be a well-established process. This coupled with a broad culture of judicial activism creates a negative environment for privatisation of SOEs. Significantly, G2G (Government-to-Government) transactions are not dealt with clearly under the law.

5. Recommendations

After the identification of problems, the participants engaged in a discussion around remedies to eliminating failure in privatisation attempts. These were shared as follows:

5.1 No court other than a specialized Privatisation Appellate Tribunal should be allowed to adjudicate civil or criminal cases related to any privatisation transaction. In the past, even government entities have gone into litigations against the federal government.

5.2 Major modifications must be made in the Privatisation Commission ordinance as well as the regulations to modernize the privatisation framework, and to incorporate international best practices.

5.3 Contradictory and conflicting legislation/statutes which create procedural uncertainties must be reviewed and synchronized to eliminate procedural ambiguities in the privatisation process.

5.4 Political parties should clarify their position on the privatisation of SOEs, and specify their plans to a certain degree, so that political uncertainty around the issue can be mitigated.

5.5 A System of reward and punishment be adopted for the bureaucracy overseeing the privatisation process, and regular performance appraisal of the management overseeing the privatisation must be arranged periodically to ensure process continuity, and management effectiveness. Line Ministries managing SOEs must have answerable/accountable bureaucracies.

5.6 Parliamentary Committees in the National Assembly and Senate overseeing privatisation matters and SOE performance issues must play a more active roleand provide more effective oversight and ownership to keep stakeholders accountable to privatisation goals.

5.7 Bundling of SOE verticals may be done after discussions with investor groups. If investors feel that they would draw greater benefit from purchasing a bundle of verticals together, and if Privatisation Commission deems greater value in terms of incoming receipts, then the organizational management can organize assets accordingly.

5.8 Use Special Purpose Entities (SPEs) as an off-balance sheet tool to park the liabilities of Commercial SOEs, whose compromised balance sheet may be the single biggest hinderance in their privatisation. An SPE holding company can be created to manage all these liabilities arising privatisation in one place. An SPE may not come into existence legally until a deal has been reached and finalized.

5.9 Commercial SOEs should be exempted from the conventional rules of the Public Procurement Regulatory Authority (PPRA) to improve their responsiveness to market forces responsiveness and operational environmental threats. Instead PPRA may work on a separate framework for procurement compliance for Commercial SOEs.

5.10 The Central Monitoring Unit of the Finance Division should be given time bound objectives regarding the management of SOEs and those Commercial SOEs which are on the active privatisation list.

5.11 A periodical report on the financial performance of state-owned enterprises comparing them with their private sector counterparts should be prepared and published.

5.12 All SOEs should maintain an accurate Asset & Liability Register (Balance Sheet) and such statements need to be verified by credible and approved external auditors.

5.13 Financial review of SOEs should report any losses which the government might have parked or re-assigned for accounting purpose under any other name or entity.

5.14 A public service campaign to build a favourable public opinion for privatisation should be designed and implemented. It should be backed by research and case studies.

5.15 Training should be conducted by the Privatisation Commission for the benefit of any new organizational management team undertaking privatisation. This training should be compulsory for any management team as soon as their SOE has been added to the active privatisation list.

5.16 A conflict-of-interest policy needs to be introduced and implemented in the board meetings to ensure that those who are present at the board meeting do not have a commercial interest in the transactions. Disclosure rules may be reexamined and incorporated into organizational rules to minimize the possibility of board members’ interests conflicting with transparency and efficacy of the privatisation process

For inquiries, please write to us at info@primeinstitute.org

STICK-IN-THE-MUD: WHY PAKISTAN IS FALLING BEHIND? A Case of Missing Transformation

11/01/2024by PRIME Institute PRIME Institute No Comments

STICK-IN-THE-MUD: WHY PAKISTAN IS FALLING BEHIND?
A Case of Missing Transformation

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Author: Ahmed Jamal Pirzada | Dr. Aadil Nakhoda
Saihan Mohammad | Sarah Javaid

Why is Pakistan falling behind? What is the role of dismal labour productivity growth in hindering meaningful transformation? Can overallocation of resources in some sectors at the expense of others due to political economy reasons explain Pakistan’s poor economic performance? This report attempts to answers these questions through the lens of structural transformation.

The report starts with documenting the phenomenon of missing structural transformation in the case of Pakistan. Specifically, unlike regional peers, agriculture’s share in both total employment and value added has decreased by significantly less over the past several decades. Moreover, changes in the composition of both the export and the import baskets also point to limited economic transformation. We also find that the limited transformation Pakistan has undergone has been towards sectors with low productivity growth thus undermining the country’s future growth prospects. One of the key reasons behind the lack of transformation is that labour productivity in both the overall economy and the agriculture sector has increased by the least in the case of Pakistan relative to the regional economies. As a result, unlike in most other countries, there is limited incentive for labour to move from agriculture to non agricultural sector.

But what is behind the dismal increase in labour productivity? We find that, contrary to popular belief, a critical reason for this is the lack of capital deepening. In fact, capital-to-output ratio has been declining since late 1970s such that today Pakistan has one of the lowest levels of capital-to-output ratio across the list of 183 countries included in the PWT dataset. We think that high macroeconomic uncertainty due to irresponsible macroeconomic policies, including low foreign reserve buffers, are critical for understanding the persistent decline in capital-to-output ratio and, as a result, low growth in labour productivity.

The second half of the report starts with documenting differences in labour productivity across sectors. This is important since it has the potential to open doors for policymakers where reallocating resources from less productive to more productive sectors can increase overall productivity in the economy. Consistent with the rest of the literature, we find that the agriculture sector has one of the lowest labour productivity in Pakistan. Labour productivity in the agriculture sector is 47% that of the non-agriculture sector. We consider if differences in wages and production technology across the agriculture and the non-agriculture sectors can explain the difference in labour productivity between the two. However, we find that these factors cannot explain the observed differences, pointing to an overallocation of resources in the agriculture sector due to reasons which are related to government policies and market failures such as frictions in the credit markets.

Since an increase in labour productivity is critical for meaningful transformation, the report goes on to explore how an increase in integration in the Global Value Chains can help increase overall productivity in the economy. We document that the level of participation in the GVCs is one of the lowest for Pakistan. Surprisingly, and contrary to what we find for other fast-growing economies, the GVC participation in Pakistan is lower for the export sector than it is for the non-export sectors. We conclude the discussion with showing that an increase in GVC participation can go a long way towards increasing the productivity growth and, as a result, facilitate the transformation process.

The discussion in this report centres around the allocation of resources across the economy. However, we note that the challenge of resource misallocation as in the case of Pakistan is not just a challenge of technical knowledge and administrative expertise but also has power-relations between the ruling elites and the effectively disenfranchised masses at the core of it. What is considered economically inefficient could very well be maximising the economic rents for the elites. Therefore, we are unlikely to achieve meaningful progress without bringing these power-relations to the forefront of any discourse on reforms

For inquiries, you can reach out to us at info@primeinstitute.org or farhan@primeinstitute. Alternatively, you can also call us at +92 (51) 8 31 43 38.