—Rajaa Moini

So, what comes after the IMF?

Should we ignore much-needed underlying reforms, we are destined to be stuck in this vicious cycle.
Updated 26 Sep, 2019 03:49pm

It has been a few weeks since we — the collective we, that is — and the International Monetary Fund (IMF) entered into a staff-level agreement, paving the way for a multi-billion dollar bailout, marking the 22nd such occasion.

As it should, the deal has been followed by a vibrant public debate. Primetime news anchors, op-ed columnists and the twitterati have pondered upon the impact of the devalued rupee, higher interest rate, more taxes and lower government spending.

All of these questions are warranted and they should demand our time and attention. However, there are two substantially more critical questions we need to ask ourselves.

First, why do we keep getting into a dire-enough condition that we need an IMF bailout? And second, what can we do so that we’re not in such a position again?

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I have already given my thoughts on the first question, which I hold is fundamentally due to the extractive nature of our country's political institutions that incentivise politicians to grant patronage to firms rather than establish fair competition in the economy and create short time-horizons for politicians because of instability in maintaining a democratic political system.

I continue to believe that we need to redistribute political power more fairly in order to unlock transformative economic change.

That aside, in this article, I make my contribution to the second question and outline a few policy directions and reforms to increase domestic productivity, so that we don’t end up with the IMF again.

Before going forward, I will add a caveat: there is unlikely to be any single answer to such large policy questions; at best we have a variety of answers which we can experiment with, and learn from. That is what good policy-making entails.

At a familiar place

Let’s recap. We were largely in this position not so long ago, and not long before that. So, what did we do to get back into the same position again? The answer lies in our idea of growth. To illustrate, I will rewind to 2013.

We got an IMF loan which did what it was meant to do — averted a balance of payments crisis, stabilised the economy and allowed us to leverage the stability for more borrowed capital. This allowed us to pay for our imports.

We combined it with other loans, particularly domestic ones, so the government could spend more without substantially raising more taxes.

We used the increase in foreign reserves to overvalue the rupee, which essentially meant that we subsidised imports by making them cheaper. It also made our exports more expensive.

This helped boost the consumption of mainly imported goods, which drives up economic growth, measured as increasing gross domestic product (GDP).

In essence, people bought more stuff and the government got capital to spend on some large-ticket infrastructure projects, some on hiring more people and some on subsidies.

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This created a bad set of incentives for firms as they would have found more profit in acquiring import licences rather than investing in capacity to export, or simply moving their investment towards non-tradable sectors.

For example, think about the growth in real estate that lured many textile firms to move investment away from expanding their manufacturing capacity and towards the property market.

But the problem with real estate is that you can’t export it.

This is in no way exclusive to the past five years or so, but a wider reality of our growth story that continues to be dominated by the non-tradable sector — the part of the economy that can neither substitute imports nor produce goods or services that can be exported: real estate, retail and construction.

In 1995, for example, we exported about $11.6 billion of goods and services — that’s about $95 for each Pakistani. By 2017, our exports jumped to just over $21 billion, or $108 for each Pakistani.

In contrast, Bangladesh pushed its per-capita exports from about $20 to about $164 during the same period.

We have been left behind; it is time to change that.

What can we do about it?

If we need to export more, substantially more, then how do we do it?

The answer lies, in my view, on increasing domestic productivity — that is, how much output our economy can produce given a set of inputs.

In other words, how much resources do you need — people, money and materials — to produce a good or provide a service?

For example, if a factory in Faisalabad were to produce a t-shirt and a factory in Dhaka is producing the same type of t-shirt — how much time and resources will each need to produce that product?

So far, our growth model has mainly focused on the accumulation of physical assets, such as building roads and factories, but not the broader investments needed to increase productivity.

No wonder it is estimated that only 11 per cent of our GDP growth between 1998 and 2008 was due to an increase in productivity. It is not that physical assets aren’t important for us — they are — but growth is more than just roads.

Even the agriculture sector has been unable to sustain an increase in productivity. Growth in the sector has been mainly driven by an increase in inputs rather than efficiency in using these inputs.

Domestic productivity is also intrinsically tied with trade. Economists have found evidence that increasing trade raises domestic productivity; when firms trade with foreign firms, the competition forces them to be more productive or die out. On the other hand, you need higher domestic productivity to make your products competitive globally.

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So if we want to increase domestic productivity, how do we do it? Here are a few areas to think about.

First, we desperately need to invest in building the institutional structures conducive to an increase in domestic productivity.

Let’s start with the basics. The rule of law and secure property rights are essential to productive societies and are worthy of significant public investment.

It needs to be made certain that when you, or a firm, make an agreement, the law will make sure it is fulfilled. Or, when you buy a property, it is reasonably protected from theft and can be used by the owner effectively. For this, reforms are needed of our courts, laws and the police force.

Second, there needs to be significant public investment in human capital, an important element in increasing domestic productivity.

We currently fare poorly. The World Bank’s Human Capital Index, which tries to capture human capital a child born today is expected to gain by the time he or she turns 18, puts us below our regional and income-level average.

This means that, even compared to countries of similar income level, we are failing to invest in our people.

A large part of human capital is schooling, but much of it is beyond that and includes various other types of skills and attributes that allow people to achieve their potential.

This requires Pakistan to continue its investments in basic education while making sure that these years in school are translating into tangible learning outcomes for students.

This should be combined with an increase in the quality and quantity of post-secondary education through investing in both traditional undergraduate programmes and non-traditional programmes that allow people to gain skills faster.

Research and development spending adds on to this, making it an important part of the human capital stock of a country.

Greater human capital also allows people and firms to adapt to new technology, which in itself is an important part of boosting productivity.

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Third, we need to re-evaluate the government's protection of firms, and in some cases entire sectors.

Presently, we run the risk of creating a poor set of incentives for firms as they can rely on subsidies and other forms of state-granted protection to generate profits, rather than increase their productivity.

The sugar industry and automobile sector are the most clear examples of this ‘protection’, but it is not limited to them. Several other firms and sectors also receive special tax breaks (through statutory regulatory orders) or frequent ‘packages’ from the government.

These protections can lead to misallocation of labour and capital. In other words, we are keeping people (and money) in sectors that aren’t productive enough. This misallocation makes all of us worse off by reducing our combined productivity.

Ideally, these poor performing firms should either improve their performance, or die out and allow people and capital to move towards better performing firms.

If our goal with these subsidies is to help the poor, it is hardly the way to do it. Instead, this revenue could be redirected towards targeted social welfare programmes that don’t lead to misallocation in the market.

This is not to say that we shouldn’t have a policy to protect specific industries, but such policies need to be designed carefully and not allow patronage relationships to develop.

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Fourth, we need to make an integrated and coherent move to invest in cities. By creating vibrant cities that bring people and firms together in dense environments, we can unlock significant productivity gains.

Some of these gains will be due to more people moving away from agriculture and into manufacturing and services, which are more productive activities and are primarily undertaken in cities.

The rest will be due to gains from density. This is done by bringing people and firms close to each other; cities allow for sharing of ideas and unlock the ability of people and firms to specialise. Both lead to higher productivity.

However, these gains are going to be untapped if we don’t actively invest in building the institutions and infrastructure cities need not only for the population already living there, but also the people who can move from rural areas.

This requires independent and empowered urban governments who can provide public services and undertake context-specific policy decisions, particularly those that can help build a stock of knowledge through schooling, research and attracting skilled people, and housing them in high-density settlements.

Even though we currently lack many elements of vibrant cities, they are still more productive than rural areas. One measure of this is that our cities, while home to 38pc of our population, count for about 55pc of our GDP.

An added advantage of vibrant and empowered cities is that they are best placed to enforce property taxes. These taxes can be used to discourage speculative investment in this non-tradable sector, which has accumulated significant capital over the past few years.

Looking forward

Should we ignore these underlying reforms, we are destined to continue to be stuck in this vicious cycle which is pushing us from one IMF loan to another.

For this, our policy needs to move away from merely fire fighting. At the risk of oversimplifying, think about this:

If our house bursts into flames every few years, we certainly need to put the fire out, but we also need to ask ourselves what keeps causing this fire and make the necessary changes to prevent it.

Illustration by Rajaa Moini

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Author Image

Shahrukh Wani is an economist at the Blavatnik School of Government, University of Oxford. He tweets at @ShahrukhWani

The views expressed by this writer and commenters below do not necessarily reflect the views and policies of the Dawn Media Group.

Comments (24) Closed

Shahrukh Wani
Jun 10, 2019 07:58pm
@Natarajan, yes it is over-value. It is a typo and will be fixed.
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Jun 10, 2019 08:34pm
That last sentence said it all! Excellent analysis... Applicable I'd say to firms also or even individuals.
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Jun 10, 2019 09:39pm
Brilliant analysis. Yet, often economic solutions are political problems....especially when it conflicts with the interests of people who matter in decision making for Pakistan.
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Jun 10, 2019 09:58pm
It's after a long time I have heard something that's more about using free-market as opposed to socialist control and state providing everything. I sense a more of Hayek and Milton, and less of Keynesian influence.
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Jun 10, 2019 10:40pm
Good analysis. Couple of thoughts. In a region where 70% of the population earns a living through agriculture, increasing productivity can lead to massive unemployment. So any productivity increasing initiative has to go hand-in-hand with re-skilling of the population. Building hard assets like roads and ports are not a bad investment if they are accompanied by investment in manufacturing. Right now these assets are only bringing in goods, not leading to increased exports.
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Muhammad Affan
Jun 10, 2019 10:53pm
I agree with you that Pakistan needs structural reforms to come out of this cycle, but we cannot blame the construction industry because they are the ones that are suffering the most because of foreign investors who had invested in office complex and residential projects were receiving a good amount of money through tenants are now pulling all their investments out of Pakistan because of currency devaluation which has decreased their returns. In such a state of economy where the currency is unstable, no foreign investors would invest in Pakistan. Moreover i would prefer reforms more in the construction industry because they can employ blue collar workers (Construction Labor) and white collar workers (Engineer, Architect,etc) and many other industries such as cement, steel, cables, pipes, electrical equipment are connected. Construction industry is now more valuable than textile with the emergence of companies like WeWork(Unicorn) and we need to do help our industry to attract them.
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Nadir UK
Jun 10, 2019 11:10pm
I am sorry, but most of the article is without substance. For example it talks of loans of $6 billion in 2013 but doesn't point out that $4 billion of that was used to pay off loans due for repayment and the balance was used to provide electricity (without which the economy was suffering) and infrastructure on roads (required to support expansion and efficiency). Those are the facts. The money was not used to support the rupee, and even if some was used, supporting the rupee would keep down inflation and our overall debt profile. Not bad priority targets.
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Jun 10, 2019 11:27pm
Excellent analysis with a common sense way forward. But, will anyone in power listen?
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Jun 11, 2019 12:19am
Before being able to fix this problem and unlock the huge potential, Pakistan and Pakistanis have to address the underlying reasons for such situations.
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Jun 11, 2019 12:45am
A commitment to reform is not possible when the politicians in charge of reforms are not the ones who call the shots.
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Jun 11, 2019 02:33am
Excellent article. The author explains the reason for the misery of the country. It is still too early to say if the present regime will follow the old recipe or will make the bold and right path even if it is painful initially. The previous governments of Bhutto-Zardari and Nawaz Sharifs despite the hue and cries of these miserable souls chose a road that was only beneficial for them and their cronies. A case in point is the sugar industry. Many politicians, including Sharifs and Bhutto-Zardari, own the sugar mills, thus the subsidies. Nawaz Sharif if my memory serves me right even exported the sugar for a lower price and then imported sugar at a higher value.
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Jun 11, 2019 03:15am
Funny question in the title. Question - "What comes after the IMF?" Answer - IMF again. Only with stricter conditions.
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Jun 11, 2019 08:22am
It's a great article that nicely summarizes what we have to do. But I doubt we'll do any of it. It's easier for our rulers to just kow tow to US demands and favours from them. As long as foreign bailouts are easily obtained there is no pressure to engage in any long term reforms.
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Umar Zia Khan
Jun 11, 2019 08:34am
"What comes after and before the next IMF?"
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Jun 11, 2019 10:06am
Clearly Pakistan needs IMF because of a deficit. It spends far more than it's own taxes and aid from donations. It has been locked into a high spend dynamic because it was encouraged to do so by Western Powers who assured it of it's viability gap funding. But over time Pakistan has diverged from their agenda, the aid has stopped, and its strategic stance has now become unsustainable on its small economic base. It has essentially to decide on a viable equilibrium between on its strategic choices vis a vis it's economic base. Hope is not a strategy.
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Jun 11, 2019 10:27am
While reading, i could not resist to agree to each and every sentence. I think solution is there but it will require a big political sacrifice
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Bobby Khan
Jun 11, 2019 10:31am
Simple - squeeze public for more tax.
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Jun 11, 2019 11:15am
I have two questions: 1. Which value added products do Pakistan make and export? 2. Which international brands are Pakistan known for? Can our shameful politicians answer these? Especially those who have been in power for years upon years?
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Kashif Nawaz Shaikh
Jun 11, 2019 11:40am
Good and clear analysis on what problems Pak face. However from my point of view, answers relating to increasing productivity needs more and more solutions which all economist need to think about.
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H Shaikh
Jun 11, 2019 03:43pm
great article! You can boost domestic industries contributions also by documenting the informal economy, creating incentives for firms to formalise, pay taxes etc. Focus should be on manufacturing, that is both export generating and labor intensive. Building malls is not productive investment which are the industrialists are now focusing on. Also our labor is not productive - one of the lowest And that has as much to do with education as with health & nutrition.
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Jun 11, 2019 04:41pm
Author should have given example of India under Manmohan Singh and how India was reformed so that it never had to go to IMF after 1993 and achieved very healthy growth rate..
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K Niaz
Jun 11, 2019 05:23pm
it all reads well.. all the right things said that are theoretically correct. How is that translated into something more tangible, concrete and actionable in Pakistan has always been a big question... Urbanization at the cost of rural development is also very very questionable.. another element the impact of CPEC on local trade and small scale industry is a missing link.
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Dr. Diarrhea, Pate Karab
Jun 11, 2019 07:29pm
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Jun 12, 2019 08:05am
Military run countries are always mediocre if not worse.
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