Urgent need for revisiting economic policy

Prime Minister Imran Khan generally underscores the need for promoting wealth creation since there had been no meaningful effort by predecessor governments to create pro-business policies. This makes sense, but policy needs to avoid the ‘trickle-down’ economics trap, whereby it should not be assumed that markets alone will ensure that the fruits of such wealth creation will get equitably distributed, for which in some narrow sense, greater regulation and distribution policies will need to be created. It is not that pro-business policies were not previously created, but they were created for a tiny elite class on the back of perpetuation of extractive institutional design by collusion of politico-economic elites.

This leads to a broader question and which has been strongly answered in favour of active role of government, especially in the wake of neoliberal policies of lesser role of government significantly contributing towards Global Financial Crisis of late 2000s, and the reverse in the shape of greater role of government during the pandemic producing positive consequences for growth and welfare. Hence, for government while formulating policy for wealth creation, should understand the fundamental importance of market reform, whereby the government does not just ‘corrects’ market failures, but ‘shapes’ markets – primarily through reducing transaction costs and information asymmetries on the one hand, but playing the role of an ‘entrepreneurial state’ on the other hand to create the innovative basis for the private sector to build on it. Overall, a multi-sectoral and focused policy approach needs to be adopted by the government in the form of a ‘mission’; the same way a focused effort was made, among others, by China to lift around 300 million people out of poverty in a matter of just two decades (the then West Germany achieved a goal on similar lines after the World War II in a relatively shorter period).

In addition, policy here should provide direction to markets, in the shape of a ‘green new deal’ whereby firstly, big players in markets are not allowed to socialize risks, and privatize profits, which would require active regulation, in both the real and financial markets, due to the role of middle-men and collusive practices in the former, and of risky financial instruments catering to the wealth of the few in the latter, and not caring about the larger repercussions of this on overall environment, economy and politics.

Secondly, given the hastening of climate change crisis, and the coming of the pandemic, at the back of markets allowed to follow signals that catered to the short-term gains, and not taking important steps like significantly moving away from the fossil fuel sector over the years, or to reach a coronavirus vaccine, even after the passage of virtually two decades since its first appearance in the shape of SARS (severe acute respiratory syndrome) – rather than, for instance, investment going into producing body creams/lotions – to safeguard long-term interests of society. In Pakistan, for instance, to primarily attract voter attention, over the years infrastructural investments – mostly among them that could be completed during the tenure of a government – and that too in big metropolitans, largely outpaced investments in social sectors; since the latter produced less visible outcomes over the short-term. Here, the environment aspect was also neglected, and also health sector remained underinvested, and little prepared to either actively contribute towards reaching Covid-related vaccines, or for generally better caring for the Covid-infected patients.

Three other areas urgently need policy revision as well. Firstly, notwithstanding the traditional bias of the World Trade Organization (WTO) – in terms of how it allowed developed countries to remain quite protected with regard to their certain sectors like agriculture through subsidies, for instance, while on the other hand, through its own policies and by taking on board multilateral institutions like the International Monetary Fund (IMF), pushed developing countries to liberalize and open up their economic sectors – unlike China and India, among others, Pakistan has not been able to take advantage of the globalization wave over the years. Sadly, this government has also pursued the same course of action, and that is to remain interested in attracting very volatile, ‘hot-money’ or foreign portfolio investment, rather than focusing on institutional reform to enable underlying organizations, and markets work in an environment of much better governance and incentive structures, in an overall effort to attract foreign direct investment (FDI); not to mention the much-needed positive impact it would have had on exports growth.

Both China and India, on the contrary, from the very early stages of the globalization wave of the 1990s clearly indicated to the world that their economies were not in an advanced stage of development to properly deal with the underlying volatility of portfolio investment. Instead, they focused a lot more on creating conditions for attracting greater FDI inflows, which they did successfully over the years, with a significant contribution of this policy in these countries in achieving high economic growth rates for many years.

Secondly, the agriculture sector continues to remain neglected in terms of lack of needed improvement in related public institutions, and underlying organizations and markets. Here, lack of governance and incentive structures has meant lower productivity, and inability to reach correct prices for farmers, retail consumers, and agricultural raw material buying firms – where middle-men and market sellers earning most income – while farmers received much less in terms of prices of their produce, after having little institutional support of government.

At the same time, rather than focusing on imports of many essential products for managing price smoothening of such items in domestic markets, and for meeting local demand needs in the first place, not to mention the burden this has on foreign exchange reserves, the government ought to have come up with a stronger role in addressing these issues in the agricultural sector so that local production is enhanced, and income inequality also reduced here.

Moreover, the presence of cartels should be managed through greater governance-related initiatives in an institutional way, rather than opening the sector to virtual unbounded import restrictions. For instance, to break the sugar cartel, the solution is not to take the route of importing sugar in a virtually unlimited way, because that may destroy the cartel, but at a big cost of reliance on supply from international markets, and the price and supply volatility that it may bring, not to mention the supply shortage it may cause due to both situation of demand and supply in international markets, and in times of difficult balance of payments conditions; for instance, due to practice of ‘food nationalism’ during the pandemic, many traditionally big agricultural commodities exporting countries have been reportedly hoarding these commodities, which has also meant greater price hike of many commodities in the last six months or so.

Similar is the case of even more essential commodities like wheat, where strong cartels have operated traditionally, and taking the route of imports would run the danger of seriously damaging domestic sugarcane, and wheat sectors respectively, for instance. In the wake of lifting restrictions on imports would push factory/mill owners to demand similar loosening of restriction on exports, so as to capture meaningful demand for their respective products – sugar and flour – from international buyers to reap greater profits; running in turn the risk of unmet domestic demand, and shortages here would once again generate greater demands on foreign exchange reserves.

This, in turn, would also mean that international market dynamics would determine demand for domestic crops, and in case of farmers left with surplus in some or many years, would pressurize their already narrow fiscal space for continuous farming. Even if the government buys surplus and stores, would generate greater demands on government expenditure, and possibly pressures on generally existing higher levels of fiscal deficits. Hence, opening up economy with regard to agriculture sector, which is the backbone of developing economies, and just for tackling underlying cartels, would bring too much volatility for farmers, and in terms of country’s food security, not to mention the livelihood of this big economic sector, especially when the solution for dealing with cartels basically lies in providing better governance, and through greater role of government overall.

Thirdly, policy needs to give greater role to fiscal/governance related policy in dealing with inflationary pressures, unlike the traditional practice to give unduly higher role to monetary policy for not just targeting inflation, but with the attached goal to attracting higher levels of foreign portfolio investment, which needs to be avoided given the volatile nature of this ‘hot money’, but also and primarily due to highly unnecessary economic growth sacrifice that this overuse of monetary policy has mostly produced. One of the main lessons coming out of the pandemic is the active use of fiscal policy by developed countries to deal with both building-up inflationary pressures – under the recognition that monetary policy only goes that far in dealing with inflation and deflation – and recession, and the positive impact this have had in terms of growth and welfare consequences.

Robert Skidelsky, in a recent article ‘The silent revolution in economic policy’, highlights the importance of fiscal policy, where although he is writing about actively using fiscal policy to contain inflation with regard to developed countries, the same is even more applicable for developing countries, due to their traditionally lesser developed financial sector and markets, and the relatively lower impact of monetary policy, as traditionally experienced by developing countries like Pakistan, and also because of the rising stimulus needs in the wake of the pandemic-caused recession.

He points out in the article: ‘Before the 2008-09 crash, many believed that macroeconomic stabilization was entirely a matter for monetary policymakers, and should be carried out by independent central banks targeting a mandated inflation rate by means of interest-rate policy. This followed from the orthodox belief that economies were cyclically stable, provided that inflation was controlled. Fiscal policy should be passive, or even contractionary if spending cuts would boost market confidence. The belief in the superiority of monetary policy survived even the savage 2008-09 downturn. … Although the combination of monetary expansion and fiscal contraction failed to bring about the expected recovery, belief in monetary therapy was still strong when the COVID-19 pandemic struck in 2020. … In fact, the outstanding feature of Western governments’ responses to the pandemic was their untargeted character. … In the absence of stimulus, the post-COVID European and US economies are expected to have shrunk in 2020 at the highest rate since World War II, with a concomitant rise in unemployment.’

In the case of Pakistan, where like many other developing countries inflation is at least equally a fiscal phenomenon, it would make sense to adopt better fiscal/governance- related policies in general, but also in the time of triple nationalism – vaccine, food, and oil – building up inflationary pressures, through the channel of exchange rate pass-through, to curtail inflation without incurring unnecessary growth sacrifice, especially during the pandemic-induced recession. In this regard, not much using policy rate instrument, therefore, would also help not build up already high domestic debt-related interest payments for the government; not to mention the much-needed positive impact it is likely to have in boosting domestic business through availability of relatively cheaper finance. Moreover, given Pakistan is currently in an IMF programme, therefore, it is indeed important that the programme is revised to enable significantly more accommodation in it for using fiscal/governance-related policies for dealing with inflation.

(The writer holds PhD in Economics from the University of Barcelona; he previously worked at International Monetary Fund)

He tweets@omerjaved7

Copyright Business Recorder, 2021