The economy of Pakistan has oscillated between boom-bust cycles for the last two decades. But the duration between those cycles has reduced, as structural reforms are shelved and an obsession with consumption-oriented growth through borrowed capital squeezes the country’s fiscal position.
On a structural level, Pakistan’s industries are largely inward-looking, as successive governments have never focused on the development of an export-oriented economy. From pulses to edible oil, and even basic machinery, what’s used and consumed is largely imported.
The country became import-dependent in the last 15 years as it started borrowing dollars to fund its growth. As the world moved away from a zero-interest rate regime, and borrowed dollars started getting expensive, the country found itself in a liquidity crisis. To pay dollars, it needed more dollars, and those were not available. For Pakistan, the quantum of debt is not as big an issue as liquidity is.
Like India, land and labour were its core competitive strengths, but a competitive economy was not developed. It didn’t use land to increase the agricultural output, and thus maintains one of the lowest agri-yields among its peers. In human capital, it didn’t invest in education and skilling its population. When bilateral and multilateral institutions gave loans to improve educational outcomes or other interventions for social welfare, the funds were largely used to finance imports for the elite, such as luxury cars. Resources were reallocated for consumption and not investments.
In Pakistan, 85 per cent of taxes are indirect. Real estate can’t be taxed because certain vested groups with considerable influence hold a significant chunk of it. But the sector along with wholesale and retail segments needs to be taxed directly, and the expanding informal economy to needs to be brought under the tax net. Like India, Pakistan needs demonetisation so that there’s money in the formal financial segment. Currency in circulation as a percentage of GDP is close to 20 per cent, which is at its highest level. The social cost of not demonetising and letting an untaxed informal economy thrive is much higher than the social cost of demonetisation.
In Pakistan, the informal economy readjusts itself and cash keeps flowing. So the domestic economy keeps chugging along, thereby driving demand for imports in the formal economy. There’s no political will to fix the situation because many parliamentarians simply do not pay taxes themselves, and therefore, incentives are misaligned.
The country is endowed with physical, mineral and human capital resources. There is a need to restructure and retool the economy to move away from consumption-driven growth to investment-oriented growth. Pakistan also needs to formalise its capital and reorient it towards export-oriented industries. The demographic and economic dividend that can be unlocked through tactical interventions can enhance economic value generation across the region and beyond.
The writer is a senior non-resident fellow at, South Asia Centre, Atlantic Council