Structural Problems of Pakistan's Economy: The Way Forward

Published in Hilal English Jan 2014

Written By: Dr Zafar Mehmood

What are the structural problems of an economy? These are essentially the structural imbalances that act as binding constraints to sustained economic growth and development. In case of Pakistan the structural problems include: disproportionately higher involvement of government in economic activities, large informal economy, agriculture remains a major employer of workforce, concentration on cotton-related production activities, policies biased toward import-substituting activities, neglect of services economy in public policies, low rate of savings and consequently inadequate investment to develop human resources and infrastructure, inability of the government to collect enough tax revenues, neglect of small and medium enterprises, ineffective governance and institutional structures, lack of accountability, etc.

Deep rooted economic reforms are thus needed to remove these structural imbalances to increase efficiency, improve competitiveness, stimulate entrepreneurship, and technological progress. It may be noted that when cyclical macroeconomic measures stop producing results then the only way left with economic managers is introduction of fundamental structural reforms. Pakistan is currently at this crossroad.

Pakistani economy is currently trapped in low growth, high inflation and unemployment, falling investment, excessive fiscal deficits, and a deteriorating external balance position. Foreign exchange reserves are steadily dwindling owing to low foreign capital inflows, heavy debt repayments and slow growth in foreign earnings. Currently, Pakistan has foreign reserves to pay only about a month's import bill. These are the outcomes of failure to timely address the structural problems faced by the economy. Failure to deliver 'inclusive' growth in turn is threatening the social stability of the society.

Savings rate in Pakistan is persistently low as compared with the investment requirements. This is one of the main reasons as to why we have to rely on foreign capital. When foreign capital is not available then the investment rate further goes down, which has adverse implications for growth and employment. Main reasons for low private savings in Pakistan are: low or negative real interest rate, unstable income, large family size, low education level, high inflation, lack of culture to save, etc.

Energy crisis being faced by the country is believed to be mainly due to circular debt, untargeted subsidy, distribution problem, and theft. Government provides large subsidy owing to high generation cost compared to the price charged by distribution companies. Why the cost of electricity is high in Pakistan? We often find arguments explaining that it is high because oil price is high and line losses including the theft, are high. But I think there is more than this, and that can be attributed to inefficiency in power generation due to the use of obsolete technology by power generation companies, their wastage and frequent breakdown of plants, and the outdated transmission system. On the demand side, government does not take measures to curtail demand for electricity. Demand side measures must be introduced in Pakistan. In contrast, what we see in Pakistan, as per report of a major international electric appliance company, that its sales increased by 60% in just one year during 2012. What is the policy response to such an uncontrolled demand? Probably none.

Large informal segment of the economy escapes from national laws and regulations. Due to unrecorded nature of the informal economy, it is not covered in official statistics. As a result, most of the official economic indicators present a dismal position. There is a need to document the informal economy.

Besides huge debt servicing, loss-making State-Owned Enterprises (SOEs) are consuming large sums of budgetary resources, which constitute a drag on the public finances as well as on economic growth. Losses of SOEs are mainly due to corruption, inefficiencies, over staffing, and incompetent staff. Government has been providing resources to SOEs to ensure that these enterprises keep running. However, no effective effort is made by SOEs to improve their productivities, efficiencies, etc., to make themselves viable on sustainable basis. Consequently, each year a huge sum is used by the government for the survival of SOEs.

The ill planned tax reforms have failed to deliver the desired results. Tax reforms are introduced in an ad hoc manner, which lack commitment to take hard decision. Frequent introduction of withholding tax itself speaks of lack of government's competence or will to directly collect the taxes. It is hard to imagine why exemptions to certain activities are given in the tax system without any public debate. Why most of the services sector and businesses remain outside the tax net? Why the agricultural income tax is not collected by the Centre like income tax on other sectors? Why the formal sector industries do not fully pay the sales taxes they collect on behalf of the government from consumers? Why amnesty schemes are introduced by every other government with a clear understanding that tax avoiders and evaders will again indulge into such practices? Is this the acceptance of our failure? Answers and solutions to these questions can substantially increase the tax base.

Many of the problems being faced by the economy are due to weak regulatory system. In turn, the lax enforcement of laws and regulations is due to weak institutional capacity. This can be seen especially when it comes to the application of tax laws and competition law. In case of taxes, people evade and avoid taxes with connivance of tax officials and loopholes in the system. Inapplicability of competition law facilitates sellers in general, to not only cheat on price, but on quality as well.

Given its deep rooted structural problems, Pakistan needs to introduce economic reforms. It should introduce strategically planned reforms without haste. While introducing reforms, the government must keep in front social implications of reforms such as unemployment, environmental degradation, and economic dislocation. Reforms should also be designed in such a manner that they do not create any disparity between the provinces. All of this requires a strong political will and consensus between federal and provincial governments.

Introduce structural reforms in the areas of trade, SOEs, and business climate, which in turn will encourage higher investment. Restructuring and privatization of SOEs should aim to ultimately help restore fiscal stability as well as boosting investor confidence in Pakistan's future economic prospects and opportunities, leading to higher growth and job creation. In the area of trade, remove bias in policies against exports, remove commodity concentration, diversify export markets and improve international competitiveness of exports. This will enlarge our export share in global and regional markets.

Business environment should be made friendlier by simplifying start-up procedures, internationalization of companies, education of entrepreneurs, reducing administrative burden, and introducing reward of excellence for promoting entrepreneurship.

Urgent policy actions are needed to place Pakistan on a higher and inclusive growth path including: (i) strengthen public finances through revenue mobilization, cuts in wasteful and low-priority expenditure, and a strengthened fiscal decentralization framework; (ii) reform the energy sector to remove power deficit and untargeted subsidies, (iii) reduce government's involvement in the economy; (iv) implement financial policies to reduce inflation, protect the external position, and safeguard the stability of the financial sector; (v) remove imperfections in the market by strengthening competition law and its enforcement; (vi) remove unnecessary controls so as resources are reallocated in desired direction; and (vii) remove policy bias against the private sector, non-agriculture sectors, and non-textile sectors. An important structural change would be to make the economy less dependent on foreign assistance for sustaining growth. This may take time, but the process must begin now. In this regard, measures should be introduced to induce more savings by all agents of the economy.

Private sector is the engine of economic growth in any economy. Unfortunately, most of the economic policies, especially financial, are biased against the private sector. Consequently, this sector has failed to make desired contributions in the economy. The private sector should be allowed to play the leading role in all economic activities; of course, within a well-functioning regulatory environment. The govern-ment's primary role should be limited to provide social and physical infrastructures, and social protection to poor.

The writer is an HEC Foreign Professor and presently on the faculty of NUST Business School, Islamabad. This email address is being protected from spambots. You need JavaScript enabled to view it.
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