Economy: revisiting the basics

WHILE the tempo of economic growth has been sustained this year, it is losing much of its lustre because of a double-digit food inflation, high unemployment and heavy indirect taxes that affect the common people. According to the Economic Survey 2006-2007 released on Friday, the Consumer Price Index at 7.9 per cent exceeded the estimated GDP (national income) growth rate of seven per cent. Food prices surged despite an impressive 7.5 per cent rise in output of major crops, a robust agricultural growth of five per cent and record foodstuff imports worth $2.3 billion during the first nine months. The price spiral can be attributed to fiscal expansion, heavy government borrowings, rising foreign capital and financial inflows and market abuse. On the eve of the budget, prices of such sensitive items as wheat flour, milk, rice, vegetable ghee, etc rose significantly. Convinced that “food inflation is less responsive to monetary policy”, the State Bank “depends on market dynamics and administrative measures” by the government to take care of the problem. In the event of market failure, the government has intervened on a case-by-case basis, though belatedly, but has so far failed to update the competitive law or set up the proposed competition commission. The decision to allow export of wheat without building up strategic reserves and the supply chain further fuelled inflation. The worst sufferers are the low-income groups, the poor and the vulnerable who have no means to hedge themselves against the effects of inflation. Combined with high interest rates, inflation is also eroding the savings of the middle-income groups, as is evident from a sharp fall of 42 per cent in consumer loans in the 10 months ending April 2007 compared to the same period last year. Now it is investment at a high level of 23 per cent of the GDP (rather than consumption) that is the leading factor contributing to GDP growth. The rise in the per capita income to $925 billion this year has come more from $4-5 billion remittances per annum than from the GDP growth.

While the government claims that it has brought down the unemployment rate to 6.2 per cent, it is actually higher than at the time General Musharraf took over in 1999. According to the Asian Development Bank, joblessness in the last two years was higher than the unemployment rates during 1990-1998. Over the last six years, the share in GDP of agriculture that employs more than 43.4 per cent of the workforce has declined by 3.2 percentage points. This belies the official claim that it has designated agriculture “as the engine of economic growth and poverty reduction”. The capital-intensive large-scale manufacturing (LSM) driven by sophisticated technology grew by 8.8 per cent against 10.7 per cent last year while the overall manufacturing growth was lower at 8.4 per cent. It shows that the growth in labour-intensive small and medium industries continues to lag behind LSM. Employment generated from high growth is not evenly distributed, province-wise or household-wise. The government’s development spending on physical and social infrastructure offers mainly temporary jobs. In these conditions, the trickle-down theory has lost much of its validity. As lifetime employment managed by changing jobs is the preferred choice of a flexible labour policy, the quality of human skills in all fields of economic activity needs to be improved on a war footing so that abundant and idle manpower can be utilised to realise a transforming economy’s full potential. Economic growth has to be socially sustainable. That the gender gap in labour participation ratio is 50 per cent against the average of 35 per cent in South Asia shows how much Pakistan lags behind in developing human resources.

Apart from price stability and a high rate of employment, low tax rates are also an inseparable part of any economic success story. With the present narrow base, taxes remain high and concentrated in the manufacturing sector which contributes well over 60 per cent of the total tax revenue and the bulk of the export earnings. The services and agricultural sectors which account for nearly 80 per cent of the GDP are lightly taxed as in the case of large land holdings, the share market and real estate business. The exemptions on capital gains tax and concessions to various sectors and investors are fast approaching the Rs200 billion mark. Besides, the bulk of the tax revenue comes from indirect taxes that puts a disproportionate burden on the low-income groups. However, one positive development this year has been a healthy growth in direct taxes which more than made up for the weak growth in customs duty and sales tax, resulting in the tax revenues rising by 21.9 per cent to Rs597 billion during July-March 2007.

A gradual increase in tax-to-GDP ratio, achievable by widening the tax net, is required to sustain an accelerated pace of governmental development spending. A record of Rs520 billion public sector development programme will help realise a 7.2 per cent GDP growth targeted for the next year. In the first three quarters of this year, the government’s domestic borrowings of Rs190.5 billion are four times the debt recorded in the same period last year. According to the Economic Survey, the revenue balance (revenue minus current expenditure) has suffered a deficit of 0.3 per cent as against the stipulated surplus of six per cent of the GDP. The primary balance (total revenue minus non-interest total expenditure) turned negative since last year after remaining in surplus for the previous seven years. The sovereign debt of $750 million, raised on the eve of the budget, is expected to be used to retire a part of the domestic debt and to stick to the budget deficit target of 4.2 per cent of the GDP. While the foreign debt-to-GDP ratio has declined sharply over the years because of a high growth over the last four years and rebasing of the national accounts, it has risen faster by $1.6 billion to $38.86 billion this year. The increased debt is a source of concern when GDP growth is driven by domestic demand and the growth in exports of merchandise has plummeted to 3.4 per cent.

While the external sector, with its huge capital and financial flows, indicates buoyancy, it is actually not robust, carrying as it does long-term risks to the economy. Of nearly 50 per cent of the six billion dollars estimated in foreign investment, $1.8 billion was portfolio investment or hot money and over one billion dollars came from the sale of two enterprises Paktel and Lakson Tobacco. After the Supreme Court judgment in the Pakistan Steel Mills case, the pace of privatisation has slowed down sharply. In the nine months to March, privatisation proceeds have decreased to $133 million as compared to $919 million in the same period last year. Imports estimated at $30 billion for this year continue to outpace exports, resulting in a record trade deficit projected at $13 billion and a current account deficit at seven billion dollars.

According to an independent economist, many worsening macro-economic factors linked to the GDP growth “are incongruent to their behavioural relationship with the GDP.” Apart from robust agricultural production which has made a seven per cent growth possible, the growth in key sectors is receding, whether large-scale manufacturing, exports or services. Even last year’s buoyant growth of 7.5 per cent in livestock, which contributes nearly 50 per cent of the agricultural output, is down to 4.3 per cent. With mounting macro-economic imbalances, it is time to revisit the basics.

Eight years of missed opportunities

MANY people may have forgotten the fact that Mr Shaukat Aziz is Pakistan’s finance minister, and has been for almost eight years under the same leader, and is now Pakistan’s longest serving finance minister. It is very probable that by this time next year, Pakistan will have a new prime minister and a new finance minister (and many hope, a new president). Hence it is an opportune moment to examine the economic record of the Musharraf regime.

Although we have had a finance and prime minister for some years now, we know that the policy, with regard not just to the economy but more or less everything else that relates to Pakistan, comes from President Pervez Musharraf.

If one were to go by the huge advertisements placed in the press by the government about its achievements, it seems that the last almost eight years, have been Pakistan’s best ever, and that this has been an era of plenty. For those who are old enough to remember, they will recall a similar campaign celebrating the ‘decade of development’ in 1968. They will also remember that the government of Ayub Khan was toppled following mass protests soon after. With so many parallels between 1968 and 2007, one would have hoped that the media campaign managers would have read their history before embarking on this self-congratulatory exercise.

The half-page advertisements of the campaign, ‘When Pakistan prospers … Pakistanis prosper’, or its Urdu version, ‘Kahani naheen, haqiqat’, presents 10 carefully selected indicators related to the economy, all of which make the government look very good. The advertisements show a set of statistics for the year 1998-99 and compare them with figures for 2006-07.

For example, the main advertisement, shows that the size of Pakistan’s economy has almost trebled, exports doubled, remittances gone up five-fold, and so on. On every count, the government looks very good. However, in order to understand the nature and impact of these numbers, one needs to go well beyond a set of carefully chosen, highly favourable set of numbers, and also examine them in a context where some more substantive comparisons can be made. Let us just take a handful of the prosperity data presented by the government.If one looks at exports, for example, the data suggest that exports have risen from $7.5 bn in 1998-99 to $17.5bn in 2006-07, clearly a substantial achievement as depicted in the charts. However, this hides the fact that today, as in 1998-99, the composition of exports has hardly changed and Pakistan still exports around 62 per cent of cotton-related products.

Moreover, the expectations that following the end of trade-related restrictions Pakistan’s textile exports would surge have been proven wrong. Pakistan’s exports continue to stagnate and have not diversified. Besides, any figure showing exports needs to be seen in the light of imports and a country’s trade and balance of payments, and on both counts, Pakistan’s statistics are far worse than they have ever been.

Similarly, the much touted $14bn foreign exchange reserves figure, while the ‘highest ever’, is exposed for its real worth, i.e. its ability to buy imports. In 2002-03, for example, following the 9/11 bonanza which the government received, Pakistan’s foreign exchange reserves were lower than what they are currently but were equivalent to 33 weeks of imports. Today, the record reserves are worth a mere 18 weeks of imports, about the same as in 2001-02. No prosperity on this front.

Exactly the same logic can be used to show that most of the figures being paraded as indicators of prosperity, are false, or hide far more than they reveal. Remittances, for example, while the highest ever at around $5.5bn, are supply driven and governments cannot claim any credit for their increase. Because of the huge rise in the price of oil and surging incomes in the Gulf resulting in an economic boom, there has been more money available to be given to migrant workers, who are remitting it in huge amounts and numbers. This has happened globally over the last five years and Pakistan is no exception.

Moreover, the more interesting question worth asking the ministry of finance is, what has happened to the nearly $23bn remitted to Pakistan since 2002? Why have foreign exchange reserves risen by a mere three billion dollars in the last four years? These questions lead on to the missed opportunities which would really have made Pakistan prosper.

In terms of economic possibilities, no government could have had it as good as General Pervez Musharraf’s following 9/11. With the economy’s biggest problem throughout the 1990s – that of its huge debt – being dealt with by it being rescheduled and partly written off a few days after 9/11, no government could have hoped for a greater windfall.

Debt repayments had been the biggest constraint on the economy in the previous decade and were the main reason for the economy performing poorly in the 1990s. Following 9/11 sanctions, too, were lifted or relaxed, and aid, which had been curtailed during the 1990s, came back in unprecedented amounts. Moreover, on account of 9/11 and due to the boom in the Gulf, remittances touched astronomical proportions easing the pressure on Pakistan’s current account deficit. If only previous governments had been so fortunate.

It is this embarrassment of riches in a flawed policy framework, by a government which, until very recently, has been in full control for more than seven years, that makes one suggest that much ‘prosperity’ that has taken place has been due to fortuitous circumstances, rather than to active engagement with key problems in the economy. In fact, by avoiding serious and urgent issues, this government has ridden its luck, passing the buck on to the next government.

Key failures, and there are many, include the inability to expand the tax base, despite growth in incomes, in terms of numbers, revenue collected, and more importantly, by not being able to diversify the tax base. It is difficult to believe that even now, highly lucrative forms of earning wealth – such as the stock market – are exempt from substantive taxes, as is agricultural income. Health expenditure is still a mere 0.7 per cent of GDP, and education spending continues to be the lowest in South Asia. This despite unprecedented fiscal space created after 9/11. Regarding the power sector, all there has been is talk, and no urgent measures have been taken, the absence of which is beginning to undermine the ‘prosperity’ of recent years.

Perhaps the government’s biggest failure on the economic front has been its blindness to address questions of growing disparity, both in terms of incomes and regions. While its advertisements show that per capita income may have risen to $926 per capita, they hide the fact that this prosperity has been unequal and uneven. Some regions and individuals may have prospered, but all research shows that the differences between individuals and regions have grown markedly. Inflation too, is at its highest in many years.

These are exactly the same truths which were hidden in the advertisements when the government was celebrating its decade of development in 1968, at a time when a popular movement was gaining momentum. Are we on the cusp of a repeat performance?

A new front

"TEN out of ten." That was how Bob Geldof rated the G-8's 2005 deal on aid for Africa, a declaration which rings hollow now that several members of this club of the powerful have reneged on their promises. The German chancellor, Angela Merkel, sounded almost as triumphant on Thursday as she announced that she had brokered another G-8 agreement, this time aimed at reducing carbon emissions. The question now is whether her judgment will stand the test of time better than that of Mr Geldof.

There are reasons to hope that it might. The strongest is that the statement represented a shift in the US position which would not be easy to reverse. Since the flooding of New Orleans, climate change has climbed up America's domestic agenda. Individual states such as California, as well as businesses such as General Motors, have responded to the definitive scientific warnings by committing themselves to carbon reductions, helping to create a political tide against which even President Bush can no longer swim.

On Thursday he not only accepted the goal of a post-Kyoto treaty, but also, more specifically, he accepted that this should be agreed by 2009 and through the United Nations. The nod towards multilaterism is especially welcome, given that Mr Bush was making proposals for an American-led approach only last week.

The devil, however, is in the absence of detail. Despite Ms Merkel's best efforts, there was no agreement on even an indicative target for reduction: the US is committed only to "consider" a 50 per cent reduction by 2050, a figure which is too small given the latest science and the need for the heaviest polluters to lead the way. Worse still, there is silence on what it is that might be cut by half.

The baseline year for Kyoto is 1990; emissions have, however, risen sharply since, which is why Mr Bush sees advantage in a later date that would make any given percentage reduction compatible with more pollution. Such sleight of hand is worse than futile – it hardly needs saying that global temperatures will respond to actual emissions, not headline figures. And then there was the loaded "invitation" to India and China to do their bit, intended as a signal that the US retains the right to walk away unless these much poorer countries are prepared to share the pain.

These are not quibbles but serious sticking points - any one of which could delay or even derail the progress that is so urgently required.

––The Guardian, London