Wealth creation: back to basics

December 24, 2018


PRIME Minster Imran Khan’s pledge to promote ‘wealth creation’ and incentivise investment sends a positive signal to both local and foreign investors.

Wealth creation is a generic issue irrespective of the nature of any social system — capitalism or socialism — because no fresh investment can take place without enough capital accumulation to replace worn out machinery or for future economic and social progress. It is the professed approach to support egalitarian causes that sets the two social systems apart.

According to State Bank data, gross fixed investment in the private sector dropped over a year from 10 per cent to 9.8pc of GDP in FY2018, simultaneously gross capital formation plunged from 4.19pc to 1.08pc of GDP. With the trend persisting, Foreign Direct Investment (FDI) fell by 46pc in the first four months of the current fiscal year compared to a year ago.

There has to be an equilibrium between concentration and distribution of income and assets because over-concentration of wealth results in economic downturn and recession

While chairing a high-level meeting in Islamabad to review progress on improving ease of doing business, the prime minister was informed of the problems facing the business community including taxation, access to finance, regulation and policy issues.

However, the premier’s observations deviate from Finance Minister Asad Umar’s interview to Bloomberg in August in which he said he would reduce taxes on energy supply for industry and agriculture and recover revenue losses by re-introducing the abolished wealth tax. The declining investment may be persuading the PTI leadership to review its original stance on the wealth tax.

In the mini-budget to be presented, Mr Umar informed the parliamentary panel on Dec 19 that while certain taxes would be increased, others would be reduced so that ‘the wheels of the economy also start moving.’

On the same day, the Policy Board of the Securities and Exchange Commission of Pakistan (SECP) which met under its new chairman Khalid Mirza decided to ‘get rid of the unnecessary regulations’ but pledged as a watchdog to be tough ‘across the board, and fair.’ Mr Mirza recognised that stock market was suffering from overregulation.

Discouraged by over-regulatory compliance costs and hassles, nearly 90pc of the firms register with the SECP as private limited companies and very few investors go for public limited companies and rarely for listing at the bourse.

Small investors do not have much choice in the limited number of scrips which spurs speculative trading activity. Not long ago, higher tax paying private limited companies were encouraged to go for listing on the bourse by a lower tax rate on listed public limited companies. This has been done away with.

But for some big groups which prefer to expand their businesses through inter-corporate financing, bank borrowing is the preferred choice for other organised businesses.

Small businesses are run on self-financing or through money borrowed from family members and friends because of lack of easy access to bank financing. The virtual absence of economies of scale keeps productivity low and the economy uncompetitive.

In a difficult domestic and external environment, capital formation is slow and dispersal of funds much faster. There is excess wealth in cash and financial assets engaged in speculative trading as these funds do not find easy access to productive channels.

To escape the hassle of the organised sector, small businesses operate in the informal sector, unable to grow and achieve economies of scale for want of financial resources.

Investment is stated to be hamstrung by extractive tax policies, shortage of skilled human resource and energy at affordable prices and depleted physical infrastructure.

The lag in domestic capital formation results in low direct tax- to- GDP ratio that increases dependence on foreign capital and financial inflows. Bulk of the tax burden is on the manufacturing sector needed to create self-sufficiency. The mini-budget may incentivise industrial investment by reducing custom duties on imported raw materials and other inputs.

In times of intense anti-business sentiments and policy decisions, the country has seen flight of domestic capital abroad and drying up of FDI inflows.

Many of the small businesses (clubbed together with medium-sized industries in the category of SMEs) operate in the informal sector. “You cannot get a company registered, for example for paying sales tax to the government without paying the facilitation fee,” says a businessman from his personal experience.

The SMEs also need to be incentivised to grow and enter into the formal sector. The three sectors — SMEs, agriculture and housing are underserved by the banking system despite the priority for financing accorded to them recently by the State Bank of Pakistan.

Earnings, savings and investments have to be encouraged. One of the areas where savings of the lower middle class can be mobilised is housing sector development.

In the low cost housing project, the government proposes to mobilise Rs0.6 million advance payments from each allottee for a housing unit estimated to cost Rs1.2-1.3m.

In the agriculture sector small farmers need to be encouraged to join corporate farming with each individual’s shareholding being equivalent to the worth of their landholding. Large-scale operations are necessary to boost productivity of crop and dairy farming.

However, Mr Khan’s observation that ‘if an investor earns money, its trickledown effect will reach the grassroots level’ is out of place in the growing disconnect between economic growth and employment. The trend has gained further momentum since the global financial crisis and the Great Recession of 2007-08 and the start of the digital era.

Employment can be better managed in selective labour-intensive economic activities. China has been able to reduce massive poverty through what it labelled as a ‘socialist market economy’.

In Pakistan the unemployment rate was last officially recorded at 5.9pc for FY2017 and unofficial estimates are far higher despite moderate economic growth. There has to be equilibrium between concentration and distribution of income and assets because over-concentration of wealth results in economic downturn and recession. n


Published in Dawn, The Business and Finance Weekly, December 24th, 2018