WASHINGTON DIARY: Borrow until broke: how to make a nation fail —Dr Manzur Ejaz - Wednesday, December 29, 2010

Source : www.dailytimes.com

The lack of governance, irresponsible spending by the governing elite and non-collection of income taxes are the biggest hurdles. Power shortages, corruption and nepotism are major hurdles for the private sector to increase production. The opportunism of different political parties does not allow any government to devise a rational policy

When Pakistani governing elites go around distributing grants in the name of various programmes — from the Benazir Income Support Programme to flood relief — one wonders where all this money is coming from. Every year salary levels are raised around budget time and money is thrown at various professional groups (like bar councils) without any reference to the source of these funds. The result is that inflation is roaring in Pakistan and necessary goods are becoming too expensive for the common citizen. And yet every political party wants funding for its pet programmes without any clue to the available national resources.

Last week, the Governor of the State Bank, Mr Shahid Hafiz Kardar, let the cat out of the bag by saying that heavy government borrowing was causing the rise of price levels. The Pakistani media is immune to such statements and it was perceived as a minor note compared to the WikiLeaks story. There was nothing new in his statement because it has been said over and over again, and we all know it. But no one takes it seriously enough to make it a national issue and protest in the legislative bodies. On the contrary, almost every political party opposes corrective measures in the name of the “poor masses” without suggesting any workable remedy.

Excessive government borrowing has been the biggest story in Pakistan for many years and many successive governments. This issue is even bigger than fighting the Taliban or Kashmir because it keeps Pakistan’s basic economy unstable and deep in the ditches. It simply means that governments spend money that they do not have.

The government asks the State Bank of Pakistan for a loan. The central bank floats bonds and other financial instruments to raise the funds. In the ultimate analysis, the central bank increases money supply, which is called money printing in common parlance. Because of increased supply, too much money chases goods that are always in limited quantity. Therefore, the price of every good goes up by the strength of the hike in money supply. Therefore, when the government increases salaries or distributes funds, the recipients should know that they are given something by one hand and are having something taken away by the other. Pakistan has been mired in this cycle for decades.

Pakistan’s economic scenario is a typical example of stagflation in which inflation and unemployment rise simultaneously. If the economy is running smoothly then there is a trade off between inflation and the level of unemployment, i.e. to bring unemployment down, inflation is accepted. However, in stagflation this process breaks down and rising inflation does not decrease unemployment, rather it increases it. The US was trapped in stagflation during the 1970s.

In such conditions the government is supposed to decrease its spending, borrow less from the central bank and stop printing money. At the same time, the government undertakes policies to provide incentives to the private sector to increase production and create more employment. During the Reagan administration, the US government tried to bring down spending on social welfare programmes and gave tax cuts to the private sector so that it had more funds to invest. Somehow it worked for a while and the US came out of stagflation. During the Clinton era, not only was the deficit eliminated, the government had a huge surplus fund that the Bush administration squandered.

Pakistan’s case is very different because the government has no tool other than using or misusing the central bank. The idea of tax cuts to the private sector is irrelevant because very few pay taxes anyway. Sales tax is no solution for this problem because the burden is borne by the common citizens. The government will reduce its borrowing from the central bank but the sales tax will create inflationary pressure. Therefore, again the government will be giving something with one hand and taking away with the other. The only way Pakistan can come out of stagflation is by strict austerity and creating a conducive environment for the private sector to boost production.

Presently, the lack of governance, irresponsible spending by the governing elite and non-collection of income taxes are the biggest hurdles. Power shortages, corruption and nepotism are major hurdles for the private sector to increase production. The opportunism of different political parties does not allow any government to devise a rational policy. For example if the MQM or ANP facilitates electricity thieves or the PPP protects its feudal backers, no economic manager can stabilise this economy.

Pakistan’s new economic managers led by Dr Abdul Hafeez Sheikh and Dr Nadeem-ul-Haque may be competent and well meaning but they cannot do much because the root cause of Pakistan’s economic problem is in the political arena. Therefore, unless a competent political force (not military or technocracy) takes the reins in its hands, there will be no end to government borrowing, inflation and impoverishment.

The writer can be reached at manzurejaz@yahoo.com