Our economic potential – Journal
“Lord, we know what we are, but we do not know what we can be. Shakespeare alludes to human potential which is always superior to its present condition.
Allama Iqbal elaborated on this idea in his famous verse which translates to “raise yourself so high that even God, before issuing every decree of fate, should ask you: Tell me, what is your intention? Iqbal wanted each person to develop their “self” to realize their individual and collective potential. If only they could invest their time and energies to elevate themselves through continuous struggle.
As a nation of 75, we know how weak our economy is, but we are unsure of our economic future. We know that by devoting our collective energies, time and available resources to investment, our economy can be progressively strengthened. But we have not been able to overcome our weakness and it seems pointless after 75 years to even talk of reaching our economic potential.
Lily: Pakistan’s economic potential
Is our economy afflicted by the madness of Shakespeare’s Ophelia? No of course not. Ophelia was suicidal, but our elite is not. Yet we are afflicted by the madness of our elites, driven as it is by high and borrowed consumption that leads to low savings and low investment. While our elite, both political and apolitical, is not suicidal, it is destructive to non-elites, i.e. the economy as a whole.
In 1965 we reached our highest gross fixed capital formation as a share of GDP at 21.5%. Since then, it has been on a downward trend. Some of our peer countries, including our neighbors, had comparable ratios: China (20.6), Egypt (15.8), Indonesia (6.7), India (17.1) , Iran (31.3), Morocco (10.6), Malaysia (18.4) and Sri Lanka (12.9). In 2021, almost 56 years after 1965, mainly due to our bad and destructive policies, our GFCF/GDP ratio was only 12.8%, compared to Bangladesh (31.0), China (42 .5), Egypt (12.0), Indonesia (30.8). ), India (28.3), Iran (28.2), Morocco (27.1), Malaysia (19.3) and Sri Lanka (26.0).
There is no method to our political madness.
Why did we see rising levels of investment until 1965 that became increasingly insufficient to sustain economic growth at appropriate levels later? This simple question is actually complex, but demands answers nonetheless. There is only one major macroeconomic cause of our downward investment trend, several microeconomic causes (encompassing legal and institutional constraints) and one overall political cause.
We are afflicted by the madness of our elites, driven as they are by high and borrowed consumption.
Let us describe the first macroeconomic cause. It’s the most obvious. It is the inability of our policymakers to maintain macroeconomic stability, which, in turn, depends on many factors. The most important of these factors is the inability to mobilize resources through taxation. Successive budgets have failed to produce convincing tax plans, leading to lower tax-to-GDP ratios. From FY76 to FY20, our tax-to-GDP ratio fluctuated between just 9.1% and 14.5%.
The inability to mobilize our resources in rupees, together with the consumption of resources higher than available by the government, has led to increased domestic and external borrowing. The domestic source consisted of borrowings from the State Bank, commercial banks and other non-bank sources such as national savings schemes. Dependence on the central bank not only limited the development of savings, but also fueled inflation and its expectations. This not only boosted government domestic consumption, but also promoted public and private imported consumption. Savings were therefore thwarted, leading to an increase in internal and external debt.
The original sin of the government eating unbanned apples with borrowed money has led to increasing external account deficits such as trade and current account deficits. The havoc wrought by the overvalued Pak Rupee for most of our 75 year history on our imports should be evident. Our consumption in FY22 was nearly 100% of GDP. Since GDP is the sum of consumption, investment and net exports (i.e. exports minus imports), the impact of our investment to GDP ratio of 15.1 pc is completely offset by the negative gap between exports and imports in the national income accounts!
The microeconomic causes of the investments include several legal and institutional impediments which have been described in detail in a special section of the State Bank’s 2019 fiscal year annual report; they make for heartbreaking reading and are almost impossible to summarize. This report indicates that the investment policies read like an “attraction document”.
Lily: Compare economic performance
When investors want to invest, they find that laws governing investment are different from policy documents. For example, the Investment Policy 2013 differs in its scope, including various rights, requirements, dispute resolution and expropriation, from what is legally available to investors in the Foreign Private Investment Act 1976 and the Economic Reform Protection Act 1992. not only does the actual investment environment fall short of the promises made in the policy document, but “successful” investors must brave a myriad of operational hurdles. This applies to both domestic and international investors.
In the case of foreign direct investment, bilateral treaties form a crucial agreement that establishes the terms and conditions of the investment. These treaties are also not fully consistent with national laws and regulations. The result is that the dispute settlement mechanism is weak and the risk of expropriation, monetary inconvertibility and political violence is the highest in Pakistan among Bangladesh, India, Sri Lanka, Malaysia and the Vietnam. A few high-profile cases of international investment disputes before the London Court of International Arbitration have made the environment in Pakistan less conducive to FDI.
This is just an overview of the various obstacles to investment, as well as political uncertainty, described in detail in the cited report. The main constraint to investment is the complex political environment of our country, fluctuating between pseudo-democracy and dictatorships.
Pseudo-democracies are democracies known to be tainted by the establishment, making it difficult to establish who is really in charge of government. In this regard, it can be argued that pseudo-democracies are inferior to dictatorships. In this political scenario, the priorities are unlikely to be conducive to investment, growth and development. However, any configuration can easily bring national laws, investment policies and bilateral treaties into compliance. Doing just that will go a long way to increasing our investments and our economic potential.
The author is a former Deputy Governor of the State Bank of Pakistan.
Posted in Dawn, September 8, 2022