Monday, 15 July 2013

Austerity Pakistan 3: An Economy of Shortages

Austerity Pakistan 3

An Economy of Shortages!

Austerity economics that has prevailed in Pakistan has created an economy of shortages and is choking growth and employment. This is not a matter of well thought out policy but an outcome of inertia in thought and analysis in government, and an inability in our economic profession to keep up with global knowledge. Let me show you what I mean.

Fiscal Arithmetic

Austerity economics has been struggling with the objective of bringing our growing fiscal deficits under control. This approach has been caught up in what I call fiscal arithmetic. These analysts see the budget only as expenditures minus taxation and hence the solution is simple: increase taxes no matter how and reduce expenditures no matter how. Ambitious targets are set with arbitrary taxes (Surcharges, one time levies, excises of all kinds) and expenditure cuts with no thought for impact on the economy (Salary freezes, across the board cuts). The only thing that matters to the proponents of fiscal arithmetic is the dream of reaching a deficit number of 4% of GDP. If this happens with 25% increase in taxes and 20% cut in expenditures, that is fine. Quick and ill-thought out measures are cited to support these cuts. The impact of these measures on economic growth, productivity and employment does not concern the proponents of fiscal arithmetic.

Examine the austerity measures that the Finance Ministry (MOF) proudly proclaimed as an achievement in the last few years. The claim was that all now wage expenditures are not being allowed to grow. In fact MOF was trying to cut such expenditures in real terms they were being cut.

MOF was also caught in a strange dance with the Ministry of Water and Power (W&P) where the former would not pay the full bill of the power sector and the latter lacked the wherewithal to repair the sector. A classic standoff where egoes were at work! MOF thought that mere withholding money would force W&P to solve the problem. The latter knew that enough load shedding would force the hand of MOF. Hence the vicious cycle of load-shedding and circular debt buildup and eventual payoff and once again load-shedding and circular debt.....

This vicious cycle cost the economy a loss of 2-3% on our annual growth rate. Rough estimates would suggest that about 800,000 jobs were lost. No effort was made to understand either the nature of the problem or to address the human and the organizational capital in the power sector. The nation lost in this strategic playoff between 2 large ministries (MOF and W&P) with large egoes and desire for power grabs.

Our energy shortage is partly artificial caused by fiscal arithmetic and partly by a bureaucratic system that lacks capacity and the ability to manage complex systems such as energy.

How easy is it to cut expenditures and what do expenditure cuts mean?

Government incurs expenditures to provide certain public services. In providing those services, governments employ people, develop some assets and agree by policy to provide some activities or groups some subsidies. None of these expenditures can be cut overnight. Cutting wages of the public sector workers and the monies required for maintaining assets that have been created could be counterproductive in the long run as the resulting depletion of human capital and assets will have lasting adverse consequence for economic growth and employment.

Reducing and managing government expenditures must be a carefully done to not erode public governance and policy-making capital as well as to prevent deterioration in public infrastructure assets (such as roads, railways, stadiums, libraries, public spaces etc).

Distorting the incentives of public sector workers who are critical for good governance and good policy through arbitrary expenditure cuts such as wage restraints is not a good idea. When this happened in the past the public sector workers reacted with setting up a plethora of perks and plots as non wage payoffs to themselves. These perks and plots are not only protected from expenditure cuts but as noted in the Framework For Economic Growth they also severely reduce investment in the urban sector. Mere fiscal arithmetic will not capture the intricacy of incentives and economic gamesmanship of bureaucracy.

Most analysts would agree that without a bureaucratic reform, governance will remain flawed, corruption will not be corrected and policy will be poorly made. However reform will require expenditure increase since monetizing perks/plots and giving market relative salaries costs. Yet fiscal arithmetic will stop us from making a reform that has a large payoff in governance improvement and a huge payoff in terms of an investment boom. A Planning Commission study showed that monetizing housing in Islamabad alone would create an investment potential of Rs.10 trillion.

Depreciating Assets

Fiscal arithmetic also talks of across the board cuts since it is too painstaking to pinpoint where cuts should be made. Time is better spent maximizing perks.

Over the years, public sector worker pressure has forced a wage rate increase for them. Under pressure of fiscal arithmetic, the government put in a policy of freezing non-wage expenditures--a policy that was much appreciated by donors.

This meant that an already flawed public service incentive system was rewarded while working capital in government was sharply reduced. Needless to say public service delivery declined as schools were unable to afford books, hospitals medicines and police the tools for their work.

Cash-short systems postpone much needed maintenance of critical assets such as railways, transmission lines, roads, generation companies. Asset depletion adversely affects productivity, long term growth as well as public service delivery. No wonder that our public sector assets (railways, Energy etc) are performing so poorly not having been maintained properly for years and being run by people least interested in productivity (more worried about perks).

Social infrastructure killed off

4 decades ago, Pakistan was developing a system of libraries/community centers called first Bureau of National Reconstruction and later Pakistan National Centers, There was also an attempt to start making movies and educate people on this medium through a National Film Development Corporation. Needless to say these were the first entities that were cut when fiscal arithmetic set in.

Yet the Framework of Economic growth of the Planning Commission argues (following considerable global experience) that for growth such elements of social infrastructure impact long term development of society and hence productivity. But with austerity this would be almost unthinkable. Meanwhile Pakistan society fragments; all global measures of trust and social capital show sharp declines in Pakistan. And generations are growing without libraries when books are very expensive.

How to cut expenditures

Durable cuts in expenditure can only be made through painstaking and detailed reform efforts that ensure quality public service delivery, increasing public sector productivity, improving governance, and well deliberated system of regulation that fosters growth and development. This will only happen through a competent and credible reform system that recruits and motivates professionals into public service and arms them with adequate resources to build assets. While the focus of a public governance system is public service delivery, it must always remain deliberative and thoughtful on the fine balance between the state and market for a growing economy.

This is a tall order and requires patient work and will not happen through quick cuts of fiscal arithmetic.

Fiscal policy is not mere arithmetic but a careful and detailed understanding of the role of government and how best to deliver it. Changes in expenditure and revenue policy must be based on serious reform with adequate time to implement if they are to be durable and if they are expected to happen with improved public service delivery and growth and development. This means moving away from fiscal arithmetic and an austerity focus.

Our policy focus must be growth. Prudent economic management for durable economic growth will force fiscal policy towards stability.