The prime minister recently met some leading businessmen to understand ways in which the economy could be put on a growth trajectory, while the government continues to deal with the issue of twin deficit- high percentage of current and fiscal account deficits as a proportion of GDP (Gross Domestic Product; or national income).
This is good in principle to look for economic wisdom from stakeholders, but after one year in office there should have been much better decision-making in effectively dealing with macroeconomic imbalances, and in putting growth on sound footings.
On one hand, the economic team has signed an IMF programme, which is highly imbalanced in terms of overly focusing on squeezing aggregate demand- as these programmes generally are- and that too by over-relying on two policy instruments- market-determined exchange rate, and policy rate- which for a country that is a net importer of oil, where cost of capital matters a lot more for financing investment than employing capital for making consumption, and where both external and domestic debt burden for the government is quite significant, means the sacrifice ratio of growth is abnormally and therefore unconvincingly high.
The economic team should have known better. The PM and the economic team should have listened better to many dissenting voices that continue to try to convince the government to re-think the above stabilization programme, and to re-negotiate at least now the IMF programme. Doing this would mean reining-in a lot on policy rate, and understand that inflation is at least equally a fiscal phenomenon in developing countries like Pakistan.
Secondly, the exchange rate should be devalued to a more economy-friendly level, and managed-floated thereabouts, which allows the economy to keep import bill and shocks- mostly on account of changing oil prices globally, especially at a time of rising mid-east tensions- under some manageable levels. This would also help check the imported component of inflation, which is generally high in the country.
Thirdly, the economic team should understand that a relationship does not exist as such, not only in Pakistan but also globally. And which is that negative correlation between inflation and unemployment (or more technically, the Philips Curve) does not exist, and instead what has been seen to be occurring with persistence, is a situation of stagflation, where both inflation and stagnation in economic growth, and in turn increase in unemployment, is happening. This requires a balanced approach, where both aggregate demand and supply-sided policies are equally focused, so that growth is not compromised while lowering macroeconomic instability.
The above should clarify the path that the PM and the economic team should take. Firstly, they should try to re-negotiate the IMF programme, seeking to lower the emphasis on the two policy instruments (indicated above). Secondly, the imbalance needs to be corrected in terms of bringing more emphasis on the aggregate supply-side. This should happen both in the programme, and the overall policy emphasis of the government.
A wholesome approach is needed here, and one that aims to improve the efficiency of ‘exchanges’ in the economy, both among individuals and among entities. For this the government should immediately task all the ministries and departments to come up with a detailed policy programme on improving governance and incentive structures of organizations and markets within each sector of the economy. In laying out this plan, each ministry/ department should identify the transaction costs and the level of information asymmetry involved within that sector, which feed into the cost of these exchanges and the overall production activity.
The PM has rightly pointed out that it is not the quantity of GDP as such that is important, but its quality that needs to be improved. This means that while incentives and governance structures are being suggested, these should try to channelize the overall composition of consumption demand and supply of investment funds- important components of aggregate demand- to areas that put the economy on sound footings-such an in increasing spending and investment in social sectors like education and health, and in boosting the base, quantity and quality of exports in terms of diversity and value-addition.
This reorientation of aggregate demand components to more meaningful uses, would incentivize aggregate supply to change its course as well into meeting this new demand. In addition, the government could incentivize the financial sector- in one important way by reducing bank borrowing- to make available greater and more cheaper loanable funds- where lowering of policy rate will also help significantly- for investment purposes.
Managing growth with macroeconomic stabilization would therefore, require a) balancing the policy focus by concentrating emphasis on both aggregate demand and supply sides, b) re-orienting the composition of aggregate demand and supply, and c) bringing to power the role of institutions in improving efficiency of economic exchanges by lowering involved transaction costs and information asymmetries, in turn by providing better governance and incentive structures, and d) freeing up finance and lowering its cost.
Improving growth, its quality, and the spread of its fruits would require that PM should formulate a ‘Prices and Wages Commission’ to take stalk of institutional arrangements that need to be rectified to a) lowering market failures, especially in the labour sector that have not allowed average real wages in the economy to grow in line with inflation for a long time now, and b) rationalizing profits to some socially responsible acceptable levels, which would not only check increasing inequality and poverty levels, but also help remove these channels of price increase in the economy.
The PM should ask the concerned committees to come true on reforming the public-sector enterprises and public service in an effective way. Improvement in these two important areas has taken too long, and without this reform it is difficult to see through other reforms efficiently. Moreover, the education sector improvement also needs to be pushed, as the current progress is too slow and lacks much imagination.
Lastly, the PM should remember that institutional reform is not a slow-moving process inherently, since many countries, like China, Asian Tigers, among others, have turned around institutions in a matter of few years.
(The writer holds PhD in Economics degree from the University of Barcelona, and previously worked at International Monetary Fund. He tweets @omerjaved7)
(This news/article originally appeared in Business Recorder on September 6th, 2019)