Thursday, 27 November 2014

End Austerity Policy

Our macroeconomic policy stance is and has been seriously wrong for a long time. Time we seriously reviewed it.
We have been chasing the chimera of fiscal adjustment most unthinkingly. In the bargain we have killed growth, governance, public service delivery and perhaps even the state. Let us see how?

Consider an economy where economic growth has slowed down and large fiscal deficits have led to a growing debt stock and balance of payments difficulties.  No doubt such an economy needs adjustment. The question is how?

Several options are available.

The best approach is to address the fundamental causes that have caused the slowdown in the economy. Often the source of the economic difficulties is deep-seated structural issues such as a bloated government based on poor expenditure choices and a poorly developed mismanaged public sector enterprise sector, poor market regulation, low quality of governance and regulation that drives up the cost of doing business, and several legal rigidities that prevent flexible movement in resources from low to high return activities. Deep, painstaking and carefully researched reform is necessary in such cases but could require time and resources if it is to be done well.  Moreover, this reform does have its own political costs and benefits. Often the beneficiaries are the masses in the long run. However the beneficiaries of the distorted system (lazy and perk-rich civil servants, public sector enterprise managers unions, monopolists with captured regulators) are more immediate to the government and have the resources and the muscle to delay the reform. As much as possible this path is avoided.
The preferred path is always to take the fastest possible route to debt and fiscal consolidation. To achieve this governments hastily cut expenditures and raise extraordinary taxes that could have negative growth and expenditure consequences.  This set of policies has now come to be known as “austerity”.
As Paul Krugman laments the Keynesian solution that we all learnt in our macroeconomic classes where fiscal policy was supposed to be expansionary in recessionary times and contractionary in good times is now ignored in the keeping with current austerity thinking.

In Pakistan, under the tutelage of the IMF, the approach that MOF has followed has been that of “austerity” at its worst. MOF to impress the tutor always chooses the fastest route to get to a deficit target of 4% of GDP. It hides arrears and expenditures, dries up funds to places where needed (such as education, development, railways services) and fixes overambitious revenue targets never meaning to keep.

MOF has to look after its brethren—the public servants. Their wage bill often with an increase has to be met even when expenditures are cut. And of course no one can be fired even if there is an acute redundancy.

Imagine the police budget being slashed by some percentage and then the whole system being put on slow release by MOF to meet its unrealistic numbers. Of course salaries have to be paid. Well then the operations suffer, as there is no budget for running patrols, doing drills, ammunition etc.

Over time, such “austerity” based policies depreciate capital that has been built up and impede renewal of necessary capital.  For example, necessary equipment for conducting operations becomes obsolete or is in short supply. Like Railways has engines standing but no money to maintain them. Like transmission lines are not maintained on schedule leading to increased line losses.

The important point to remember is that there are systems operating that provide public service. Arbitrary budget cuts as austerity demands erodes those systems with long-term consequences for governance and public service delivery. Eventually these eroded public service delivery show up in increased cost of doing business driving down investment and growth.

The austerity debate has raged in Europe for the last 5 years and even the IMF has now conceded that the pace of fiscal adjustment must bear in mind the cost t the functioning of the state and social contract.

MOF austerity policies have led us into a vicious cycle of incredible, unthinking, and poor quality fiscal adjustment, which in turn erodes governance and public service. Over time this slows down the economy destroying efficiency and even institutions.

Blaming the IMF is useless. Their response is that your government can to choose a better adjustment path. MOF can adopt the path of careful reform (first option) taking on the lobbies and put in process a sensible budgeting approach that will allow departments autonomy and sensible budgeting.

The tragedy is that the austerity policy along with postponed reform has so eroded government capacity that change is vertically impossible. We all know the government lacks the capacity lacks to think, research and develop the kind of policy and reform.

Sadly civil society also worries mostly about poorly determined austerity policy and has little time for debating deeper reform issues. There is much excitement about a missed fiscal number which in any case was projected on a false basis. But little thought us given to how MOF is killing public service delivery through bad budgeting.

Indeed it is time to rethink our economic policy stance.