ARTICLE: The part-II of this series highlighted limits of monetary policy and the need for fiscal policy to take the main load of regenerating growth in the economy as the multiplier effect of fiscal policy is larger when the economy is operating below its potential capacity.
What is fiscal policy? According to the Nobel-prize winning American economist, Paul Krugman, "fiscal policy is the use of spending and taxation to influence the economy. It determines not just how much the government taxes and spends, but who pays those taxes and where that government spending is directed". Thus, fiscal policy impacts overall demand in the economy, the business cycle, savings and investment dynamics as well as income and wealth distribution. In 'normal' times, ideal objective of fiscal is to keep a growing labour force (human capital) and the country's stock of public and private physical capital employed at relatively high levels without generating inflation to drive sustainable economic growth.
There is considerable debate among economists about which of the two major strands of fiscal policy are more effective - taxation or government spending. Numerous studies have been presented by supporters of one or the other policy route. This debate has relevance in well-documented developed economies. In developing countries where taxpayers and the tax base are very low, and documentation of the economy in nowhere near where it should be (to provide proper data for objective analysis and policy making), the government spending is a far more effective route for fiscal policy than taxation.
In the early 1990s, swept up in the so-called free-market capitalist revolution, governments in both developed and developing countries effectively abandoned the role of fiscal policy in giving macro direction to the texture and tenor of economic growth. 'Free-market' became the sole decider of the shape or form that economic growth should take. Based on James Buchanan's Public Choice Theory which, in the words of Mariana Mazzucato (The Value of Everything, (c) 2018), argued that government interventions destroyed value as private interests influenced government policy via nepotism, cronyism, corruption or rent-seeking) and Milton Friedman's monetarist ascendency, privatisations and outsourcing of government responsibilities to private parties became mainstream policy thinking. As a result, the role of fiscal policy was greatly diminished and relegated to mostly taxation. And once the market became dominant, profit motive became the primary objective of all economic activity. It espoused unchecked financialization of economies, unfettered globalization and monopolization within and across industries, supported by less and less regulation which is supposed to protect public interest. This model caused intra-country and inter-country economic growth disparities leading to the 'populist' backlash in the second decade of the 2000s. The benefits of globalization in lifting hundreds of million people out of poverty in the developing world have been eclipsed by slow economic growth and rising income and wealth inequalities in the developed world. The backlash has now morphed into nationalism, anti-foreigner sentiments and even ethnic and religious fissures opening up all over the world.
The Covid-19 crisis has brought to fore the realisation that the government ultimately has an important role along with the private sector in determining how the economy benefits not just the few but many. Hence the new tune in favour of fiscal policy, even by previous free-market supporters. As an example, consider the recent comments by the Financial Times Editorial Board. "Over the longer term ... governments should think about how to switch from trying to preserve pre-lockdown economies to a long term strategy for transformation, which could mean building in resilience to infrastructure projects or supporting green transition... Governments have a chance to reshape economies and invest for the next 10 - 15 years, whether through re-training programmes (human capital) or infrastructure spending (physical capital)". Parenthesis added.
While it is now generally accepted that fiscal policy should blend with economic planning, there are many views as to how it should be implemented. In simplest terms, if our objective is to increase the productive capacity of the economy sustainably rather than just look for a short term growth spurt, then the starting point has to be development of physical infrastructure, human capital and applied technology driven by strong support for research and development.
In the infrastructure space, much has been written and Pakistan already has major projects underway in the transport, logistics and power sectors via the CPEC initiative. But beyond the mega national projects there are many areas that can improve productivity of the economy and specific sectors.Some examplesinclude distributed power generation, smart-grid in urban areas, industrial energy efficiency, massive solar-panel installation programme across the country, water-desalination and co-generation plants to address acute water shortage, large-scale solid waste management projects, urban sewerage systems upgrade, inner-city and shanty town rehabilitation, arresting environmental degradation and water conservation, rural uplift schemes focusing on provision of basic necessities, farm to market roads, storage and refrigeration facilities, incentives for value-added agri-products, to name but a few.
Human capital - education
The next plank of productivity enhancement relates to human capital. Again, much has been written about education reform to improve its reach across the country, its quality and applicability to real world needs. There is no doubt that an educated citizenry and workforce significantly increases the productive capacity of the economy. The question is where fiscal policy focus should be to have the greatest long-term impact on human capital given the funding constraints that the government faces. One area that has demonstrated impact on productivity is higher education and applied research customized to local issues and problems. During this writer's university days in London in late 1970s, there was an unusually large cohort of Malaysian students in both undergraduate and graduate levels. When he inquired how come, it came to light that every year over a thousand Malaysian students were provided scholarships by their government to study and train in higher education institutions of the UK. Over a twenty-year period that amounts to 20,000 foreign educated/trained young Malaysians. Upon returning back they were guaranteed positions and jobs with competitive compensation packages. This young cohort formed the backbone of Malaysia's civil service, private sector management and various public sector institutions. Of course, Malaysia has had the good fortune of having a visionary leader such as Mahathir bin Mohammad who personally oversaw the development of human capital in that country. But we can also learn from their experience.
There are multiple channels to foster the development of human capital. A brief look back a few hundred years in history of both the occident and the orient shows that there were no educated 'masses' who transformed their societies and economies. It was the small percentage of deep thinkers, researchers and doers in their respective fields whose courage, insights and creativity opened the doors to moral, scientific, social, economic and political progress of societies. It is therefore worthwhile for today's political leadership to consider creating centres of excellence in higher education which are world class and where there is both transference of knowledge and ideas from all over the world, as well as groundbreaking local research in major bodies of knowledge. At the same time, re-skilling the existing workforce to increase their productivity in various industries and sectors to meet future needs in a digitizing world is where the government can provide the lead. This may be via fiscal incentives, co-sponsored training initiatives in various sectors and industries, quality control and recognition of certification programmes. As the private sector is the largest user of human capital there are opportunities of public-private partnerships in accelerating the development and larger scale roll-out of such initiatives.
Human capital - health
Poor health of the population is a major drag on the economy's productivity and its macro impact is not well documented for Pakistan. This is one of the areas where current emergency measures can be blended with longer term strategic focus on vastly improving the capacity of the healthcare system in the country via fiscal policy through government funding for healthcare infrastructure, personnel training, domestic pharma manufacturing, quality control, health insurance and awareness campaigns.
Technology was not given its proper recognition and weight in traditional economic discourse on productivity. However, it has been recognised now as one of the key components of total factor productivity. Fiscal policy has been used successfully in most developed economies (and increasingly in rapidly developing countries) to support technology research, development and innovation on a continuing basis. Today's information technology revolution owes much of its origin to government support. Examples range from the Internet, smart phones and mobile technology, to robotics, quantum computing and artificial intelligence. These involved high risk investments and the private sector on its own did not initiate these. Only when specific government-funded programmes reached a commercially viable threshold did the private sector come into play. In the case of Pakistan, it is worth considering a private equity type technology fund with an independent board (having public and private sector directors) where the government puts in an initial large equity injection. Once, say over a five to seven year period, a portfolio of socially and/or commercially viable usage and applications has been created, the government can sell the technologies or the incubated companies via auction or through listing on the stock exchange but retain a significant equity stake (say 30-40%) for another ten years to continue guiding these entities as they evolve and mature as value-adding enterprises.
Key drivers of a successfully targeted fiscal policy
In order for fiscal policy to succeed in raising long-term productivity of the economy, its core objectives have to be clearly spelt out and well publicised. The starting point, in this writer's view, is proper and extensive documentation of the economy and its various sub-sectors through full use of digitization. Only then will data integrity improve and be useful for policy making purposes. Next, the implementation process has to be transparent and accessible to citizens via project websites that are constantly updated and highlight project specifications, cost-benefit analyses (both social and economic), expenditure break-up and ongoing budgetary allocations. In order to have credibility, there needs to be open and continuous inspection and implementation monitoring which should also be made public. These measures can go a long way in avoiding the downsides and mistakes of fiscal policy implementation seen in the more interventionist period of the 1950s to 1980s. In a representative democratic society, an informed citizenry is the best guard against government excesses, waste and poor governance. Today, information technology platforms allow the ability to inform, engage and co-opt citizens in the critical process of raising the productive capacity of the economy through fiscal policy.