According to the federal finance minister, the new budget would be growth and investment-oriented offering broad tax incentives and refund measures. There are several questions that arise in this context.
To what extent did the recent decline in interest rates increase investment demand? Is inability of monetary policy to increase investment demand significantly now going to be coupled with an easier fiscal policy to provide twin pull to investment demand?
While fiscal measures are welcome regardless and especially if they impel investment and growth to make a direct impact on unemployment and deprivation levels, it is important to study why conventional policy levers have thus far been not-too-effective in either impacting investment demand in general and/or unemployment and deprivation levels in particular.
There are, therefore, two major assumptions in the above policy direction from the finance ministry that require closer examination. First assumption is that conventional fiscal measures will spur investment demand.
Second assumption is that increased investment demand would make a dent in the country's levels of unemployment and poverty if not now then in the near future. The economy will then enter a virtuous cycle of growth and development according to the above assumptions.
Tax cuts were provided in 1997 also by the then exuberant policy makers of the then PML(N) government but the response was lacklustre. The examples they had quoted were from the tax cuts of Reagan's era which led to fiscal deficits instead of increased tax revenues as the US economy at that time was on the left-hand-side of the Laffer curve instead of on its right that the Reagan's policy makers had assumed erroneously. At this point in time, tax cuts given by the Bush administration in 2003 worked to offset the recession but these could have interacted with a consumer spending sentiment that looked up after the end of the war on Iraq.
Also, the Fed's monetary policy has remained easy in the absence of an inflationary threat from an economy in recession. While conventional fiscal and monetary policy levers work better in developed democracies, there are occasions there as well when either an appropriate fiscal-monetary mix is required and/or an interaction with other variables to produce the desired macroeconomic results.
Many other factors, however, remain unchanged or supportive which makes the policy environment work. As for Pakistan, while the corporate and banking tax rates are high that need to be brought down because they are high, it needs to be ascertained whether a whole lot of other macroeconomic hopes should be pinned on to these and related fiscal measures that need to be taken primarily to rationalize and to set certain wrongs right.
We have seen that the inverse relationship between interest rates and investment demand is strictly bivariate that assumes everything else constant. If other factors vary, the above bivariate relationship will not work to the extent desired no matter how much the interest rates are reduced. So, while domestic investment responded to some extent to the recent decline in interest rates, foreign direct investment (FDI) did not.
What then are the factors that keep investment demand depressed overall despite all the central bank's efforts to lower the rates of interest? If there are other factors influencing investment demand more than the rates of interest, will these factors not also offset the impact of the easier fiscal policy contemplated for the new budget, the need for tax rates' rationalization notwithstanding?
As is said by all, other factors feeding into the demand for investment include the country's law and order situation emanating from the combined convoluted impact of the political strife, the ability or the lack of it to combat terrorism and sectarianism, an emphasis on some foreign policy issues that may at times override issues of prime domestic concern, mal administration and the consequent inability to deal with either ordinary crime or crime emanating from above factors, and crime of collars of all shades emanating from mal development. How mal development leads to depressed investment demand is an aspect that requires further exploration?
In addition to being a function of fiscal-monetary mix, investment demand is a function of consumer demand which if remains low will not encourage investors to come forth as they will not know who to invest and produce for if there are not enough buyers in the market place.
The markets in populous countries, therefore, shrink to the size of purchasing power in the country. In countries with high poverty levels with a significant portion around it, inadequate consumer demand is thrown up to attract fixed investment.
This is a key depressant on investment demand which our top-down policy making approach tends to ignore when they make the second assumption mentioned above about investment making an impact on unemployment and poverty.
For them, all that is needed is to create investment demand from above that will flow down to address unemployment and poverty and if it will not "flow" down, it will "trickle" down even if that trickle is most inadequate for demand to trickle or flow back up from consumers to investors.
If they were in the business of making rain, they would be focusing only on generating clouds autonomously without realizing the natural process that leads to the formation of clouds. Similarly, the natural process of generating investment demand is little appreciated as a two-way natural process flowing up from adequate consumer demand.
While this is notwithstanding the need for external stimuli, it is not possible to generate the desired levels of investment demand merely through the stimulus of fiscal-monetary mix if the natural process is not likely to be set in motion for various reasons mentioned above out of which the current focus is on mal development.
The country's policy makers then tend to address this issue too from above by emphasizing that unemployment and poverty will be taken care of through fixed investment which they will boost through their fiscal-monetary mix. How this will be done in a significant enough manner remains a big question mark as fixed investments in industry nowadays are capital- and technology-intensive that is labour-saving.
It is, therefore, not possible to generate employment through the above kind of industrial investment at a rate equal to or faster than the labour force growth rate.
The issues of unemployment and poverty are only likely to grow for which they have micro credit kind of solutions whose outreach and depth will remain too limited to influence consumer demand in a manner big enough to in turn influence investment demand.
Against the above socio-economic milieu, fixation on growth- and investment-oriented policies may appear like all that the finance ministry can possibly do or is inclined to do under the given circumstances.
The situation could then be better portrayed if realism is reflected in the statements of the economic policy makers instead of unrealistic claims and commitments about a transformation not possible through their incremental play-safe approach.
For, a candid and intrepid approach would at least necessitate a realistic statement of the issues even if they are beyond their purview or scope of action at the moment.
The least they could do is to identify the core issue or problem without whose resolution the economy cannot sprint towards the transformation they think they can achieve through their growth- and investment-oriented outlook.
Absence of consumer demand due to low purchasing power in the country keeps investment prospects dismal which circle can be broken only through transformational redistributional policy measures revolving around land and assets ownership and incomes generated from them.
These in turn generate anti-developmental attitudes of avarice, unduly high profit expectations with a tendency towards profiteering instead of healthy profit-making, capital flight, short-cuts, dishonesty, obfuscation of goals and mission, and public/private corruption all of which together clog the wheels of the economy and tend to depress investment demand further.
The highest levels of policy makers are expected to at least begin to identify the issues that impinge on investment demand instead of assuming full responsibility for a variable they cannot possibly influence satisfactorily in their individual capacity.
