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Now that the PTI government is on the verge of entering, it is worthwhile to recall what their economic vision comprises, and what might be the biggest stumbling block they will face. I see one principal trade-off that they will have to face in implementing the agenda laid out in their manifesto: the trade-off between economic growth and good governance.
This might sound counter-intuitive to many, but the recent economic history of Pakistan shows that there is a powerful political current that pushes incumbent parties to gun for a rapid burst of economic growth, just like there is a strong built-in incentive to lavish resources on high-visibility prestige projects in the name of ‘development’. And the same recent economic history also demonstrates that in order to get this growth one has to break the rules in a few places, and perhaps risk a little economic disorder. Let me explain.
Here’s how I see it. Whether we like it or not, the market plays a substantial role in Pakistan’s economy, and the market has certain self-correcting mechanisms that constrain options for a policymaker. For example, if you print too much money you will have inflation and the value of that money will decline correspondingly. Or if you borrow from abroad and spend the proceeds on imports, soon your exchange rate will adjust to make foreign borrowing and imports more expensive. If you use tax breaks as a way to compensate for the erosion of productivity, your fiscal deficit will rise, forcing more domestic borrowing by government, which will crowd out the same industry.
How do you suspend the rules? Successive governments have done this by placing pliant individuals in key leadership slots.
These are just a few examples, and they might well be taken out of a textbook, were it not for the fact that in our own recent past, governments have discovered these rules the hard way. The rules are immutable, and they work in such a way as to kill off any short-term growth spurt that is not supported by fundamentals: rising productivity, revenue buoyancy, rising investment and so on.
The only way to prevent this from happening is to temporarily suspend the rules. The government has some power to do this, but only for a limited time. What’s more, the power to suspend any of these rules comes at a great cost, usually served up a few years later.
But how do you suspend the rules? Successive governments have done this by placing pliant individuals in key leadership slots, then asking them to get the institution under their control to swim against the market’s tide. For example, in the time of Gen Musharraf, they used monetary policy to gun for growth, meaning they dropped interest rates so low that they were below the inflation rate (a state of affairs called ‘negative real interest rates’) for a few years.
This resulted in sharp growth of the money supply, and within the State Bank there was intense concern that it would lead to inflation very quickly. But the then governor of the State Bank did not share this concern. He felt that inflation is not a bigger problem than stagnant output, and insisted on keeping interest rates low and the spigot of the money supply open, for a prolonged period of time.
This created a short, sharp and intense spurt of growth that the regime lost no opportunity to tout. Growth rates hit a historic high of nine per cent in 2004, the year of the Musharraf peak. However, inflation too began to climb that year, reaching a historic high of 25 per cent by 2007, and leading to a crash so intense it nearly shut down our whole financial system.
The PML-N did the same thing, but in slightly different form. They suspended the rules on the exchange rate, so the State Bank was instructed to use its leverage over the banks to tell them at what level all dollar buying should cease. With this control over the ‘wholesale’ market of dollars, if you think of the interbank market in those terms, they were able to set the price of the rupee without any active intervention that might violate an agreement with the IMF.
But it didn’t last. With the exchange rate artificially overvalued, supplies ran low, banks resorted to short-term cross-border borrowing in foreign currency to replenish supplies (this borrowing has now reached close to $1 billion), and soon the State Bank’s ability to control the price of the rupee in the open market began to erode, creating wild swings and differentials between the two markets (interbank and kerb, or wholesale and retail if you prefer).
There are other examples one can give too, from the stock market, property bubble and so on. But in order to get a growth spurt, each government had to swim against the tide. A strong and independent-minded governor of the central bank, who valued his or her own assignment as much if not more than priorities communicated from Islamabad, would not have allowed either of these courses of action. In fact, good governance would not have allowed it. But then, there would never have been a growth spurt either.
That is the big problem the PTI could face in its economic performance. In its manifesto, it promises to keep growth at 6pc, just as the PML-N did. But it also promises to ‘revamp institutions’ and bring in ‘good governance’. In the administration of justice, or law and order, there may well be no trade-off between governance and outcomes. But in economic management there is.
If they want to respect the rules of the game, the same rules will constrain the pursuit of growth. Unless some sort of transformational event happens that nullifies all this. His fans think Imran Khan’s election is that transformative event, but it isn’t. For years the PML-N told us that CPEC is such an event. But now that those who told us this are gone, how convincing is that line?
The writer is a member of staff.
Twitter: @khurramhusain
Published in Dawn, August 16th, 2018
