“The undocumented economy needs to be left unencumbered,” Dr. Khalid Saeed
Dr. Khalid Saeed is a Professor of Economics and System Dynamics at the Worchester Polytechnic Institute (Massachusetts, US). He is renowned for his work on computer modeling and experimental analysis of developmental, organizational, and governance-related issues. Dr. Khalid obtained his PhD from the MIT in 1981. He has written two books and many articles and book contributions in areas like sustainable economic development, infrastructure planning, political economy, supply chain management, and system dynamics modeling. BR Research recently interviewed Dr. Khalid, who is in Islamabad these days, to understand the contribution of System Dynamics to Economic Development and Public Policy. Selected excerpts are produced below:
BR Research: Economic progress is a non-linear, complex phenomenon. From your vantage point, what lessons from the field of System Dynamics can be applied in Economic Development?
Dr. Khalid Saeed: Economic Development is a multi-disciplinary process; it veers a bit from mainstream economic theory. You will find that macroeconomics textbooks – which address economic cycles that happen in advanced, industrialized economies – are a bit different from development economics textbooks – which address the issue of economic growth. My thinking on economic development is influenced by my mentor, Jay Forrester, who was a pioneer in the field of Urban Dynamics and the problems associated with stagnating cities. I saw parallels between stagnating cities, which Jay Forrester talked about, and the poor countries where economic development has been actively pursued.
I have previously written about how our approach to economic development is misguided. Driven by the concept that developing economies are infant, nascent systems which need to be matured – we have chased growth, and occasionally targeted human development. On the other hand, in urban dynamics, a stagnating city is visualized as an aging system culminating into a low-welfare homeostasis manifest in high unemployment, decaying infrastructure and failing businesses. This homeostasis is reached under a variety of resource constraints and institutional settings. I see urban dynamics as described by Forrester to be highly relevant to developing countries, which are indeed aging and stagnating systems, not infant and nascent economies. The fact is that many developing countries are old civilizations, much older than the Western civilizations.
When curing a low welfare homeostasis of an aging economy is recognized as the starting point for economic development, we need to learn how this stagnation is created and what are the interventions that will pull us out of it. Since the contemporary economic development approach is based on the notion that poor countries lag behind rich countries, economic growth is seen as a remedy. Furthermore, the unstated assumptions of the simple economic growth models are that labor is unlimited and there are no resource or environmental constraints. Furthermore, since economic growth did not alleviate poverty, some economists later argued for ‘structural transformation’ of undocumented, self-employed sectors, which were deemed inefficient. The solution to this problem was surmised as replacement of the inefficient sectors by modern sectors that were capitalist in nature and could provide wage-employment to previously self-employed people.
This wave was followed by some economists making a case for human and social development – but it required very strong state intervention, which in developing countries is not without pitfalls, thanks to somewhat naïve and rent-seeking state officials. Then came some economists who wrote eloquently about freedoms and equality and and exclusionary barriers – however, those economists did not elaborate on how to alleviate those problems, again leaving the task to increasingly interventionist governments.
I have been fascinated by the contribution of Joseph Schumpeter, a well-known Harvard economist who proposed the concept of ‘creative destruction’. Jay Forrester’s Urban Dynamics actually dovetailed into that concept very well. Schumpeter did not see growth, recession, or stagnation as separate phenomena happening at different times – he saw them as multiple manifestations in the same economic system and as a continuum where any innovation leads to over-investment in it, creating a recession that is overcome only when a new innovation and entrepreneurial action can draw idle resources into it, thus creating a path of destruction for the old technology. That is what economic development should be – if we are dealing with stagnation, then we need to try to introduce policies to come out of that situation, by facilitating removal of old, failing infrastructure and institutions to make room for new ones.
BRR: What can be some of those policies to come out of stagnation?
KS: The policies are totally different from what the urban planners have been doing for a long time – let’s create jobs for the poor; let’s help failing firms. The new concept is to help old infrastructure and failing firms meet their end, and let’s help new innovative concepts to replace them. Growth and jobs policies are irrelevant for a stagnating economy, and there is a need to take out obsolete infrastructure to make room for new enterprises. This does not mean sending a bulldozer and destroying old infrastructure – the intervention channels for a government are fiscal, informational and institutional in nature.
BRR: The recent technological transformations brought about by digital electronics – especially computing devices – have changed the face of several economies, particularly in Asia. How do you see the role of these innovations in replacing old modes of production?
KS: This is exactly what Schumpeter meant. These are new innovative lines of service and manufacturing, and if we encourage them, the old infrastructure will slowly decay and will be out of sight. Take our exports: our major exports are agricultural commodities, including textiles, and a lot of countries are competing for that market at low prices for the value they export. Whereas most of our imports are relatively high-tech, and oftentimes the price we pay is higher than the value we get. The solution is to get out of export of competitive products and focus on ones that can fetch high price. We might need to radically change our agricultural land use to accomplish this.
BRR: As you are aware, export competitiveness is deeply affected by rather frequent boom-bust cycles in Pakistan. In your view, what are the root causes of Pakistan’s economic challenges, which impede its own journey towards economic development?
KS: The fundamental issue is that there is too much state intervention into the part of the economic engine that actually works. I personally think that our economy – comprising about 220 million people – has a lot of promise, and our people are smart and innovative. The challenge is to leave them alone. The government does not know how to help the poor or how to control prices of everyday goods. The more you empower a naïve and rent-seeking bureaucracy, the more problem you create for the public.
Secondly, the whole argument about the undocumented economy being inefficient is totally incorrect – in fact, what is happening is that this economy is what is making the system keep on functioning. The undocumented economy needs to be left unencumbered. The so-called undocumented economy helps increase household income by fueling demand and also the wage rate by increasing the opportunity cost of wage work. The third important thing is the open economy concept, where it needs to be evaluated whether the policy of free imports and exports is relevant to us. The older concept of import substitution might work better for us.
And lastly, an issue that is in the limelight is tax collection. The taxation model we are following is medieval, in which taxes were collected in terms of real commodities and spent on enforcing the power of the sovereign. Now they need to be collected to sponge away excess money supply, whereas public expenditure is met by creating new money tokens. Tax collection system must be reformed in light of what is known as Modern Money Theory that we should talk about in another conversation.
BRR: Let’s move to the question of poverty alleviation, an issue on which you have written extensively. There is a continued debate among economists, with positions taken somewhere on the spectrum of income re-distribution policies on one end and trickle-down mechanism (market finding its own time to solve poverty) on the other end. What are your thoughts?
KS: I have wrestled with this question quite a bit, and I have written a lot about it, too. First of all, if the government promises to send cheques to the poor, or if it makes efforts to reduce prices for the poor through opening discount stores, it cannot do much to alleviate poverty. You don’t take poverty as a given condition and then create a charitable process to help the poor people. The poor people cannot be helped through charity – that’s my starting point.
You need to first understand why people are poor. In that regard, we need to understand how ‘functional income distribution’ is created. This distribution is between capitalists and workers, and also between documented and undocumented sub-economies. Poverty is usually caused through the relationships that transfer value from poor to the rich leading to the income distribution patterns we see around us. And those relationships need to be targeted in our poverty alleviation policies.
The documented economy is capitalist in nature and the undocumented economy is run by workers who are largely self-employed. The prosperity of undocumented economy actually enhances household income, creates alternative employment opportunities, and strengthens wage-bargaining power of workers. What you receive for your labors is actually what you can bargain for. The poverty alleviation policy has to target that bargaining power to change the functional income distribution.
In addition, there is a possibility in the free-market system for the rich to become absentee owners and extract rents or unearned income. The best intervention into this free-market system is creating a process to discourage rents through taxation of unearned income. What will happen is that if I am a rent extractor and my rent income starts getting taxed, then I would want to sell that particular piece of property or asset, and then I would want to invest it into a business or portfolio of investments which are new and which can expand in the market. Not only will this help reduce the incentive to receive rents, it will also create new opportunities for investment as well as more employment. Over time, this will improve functional income distribution and reduce poverty.
BRR: Lastly, let’s talk a bit about public policy. Considering the government’s large economic footprint in Pakistan, what kind of a public policy space is left there to effectively regulate the market?
KS: I would highlight the taxation issue here. My thinking is that leaving the self-employed sector alone is good policy. Taxing the capitalist sector might help because it has become exceedingly rent-extracting while it can also bargain for receiving a good part of the output – proportionally more than what it contributes. The government-run economic bodies, which enjoy tax breaks and influence, also need to pay more tax, so that their market influence can be curbed. If we don’t do that, the so-called undocumented sector will continue to bear that tax burden through rising indirect taxation. The regressivity of indirect taxation can, however, be mitigated by provision of social services like health, education, public transportation, etc., the expenditure on which constitutes a large part of the household incomes of the poor. All this calls for carefully rethinking taxation and public finance processes.