Pakistan Institute of Development Economics


The sky is falling

Publication Year : 2017
Author: Asad Zaman
Explore More : PIDE in Press

When an acorn fell on Chicken Little’s head, the ruckus she raised convinced a crowd of spectators of imminent disaster. Similarly, many writers are describing current economic scenario of Pakistan as one of skyrocketing debt, nosediving exports, leading to doomsday at the IMF’s doorsteps in the near future. This gloom-and-doom contrasts with recently published World Bank Economic Outlook’s projections of accelerating growth for Pakistan, exceeding those of the BRICS countries. How can Pakistan join the Asian Tigers, as projected by some eminently respectable economics experts, when the economy is headed for imminent collapse? Although it appears mysterious to laymen, high budget and BOP deficits, appropriately handled, are actually the drivers and engine of high growth.To understand this paradox, we must revisit the two-gap growth model for development, which was relegated to the sidelines when Chicago Style free market economics, formatted as the Washington Consensus, took over the world. The Chicago model has taken a beating in the past two decades, when capital flow liberalization led to the East Asian Crisis, financial deregulation created the Global Financial Crisis, and privatizations everywhere have led to higher prices at lower quality and increased corporate profits, accompanied by unprecedented inequality in income and assets leading to increasing misery of the bottom 90%. Even John Williamson, the inventor of the Washington Consensus, and the World Bank, which implemented it across the globe, have admitted the failure of these free market policies to produce development. The central idea of “free market fundamentalism,” that if we just stand aside and let the market do its magic, everything will turn out wonderfully, has been thoroughly refuted by growth experiences across the globe.Turning away from the mythical magic of markets, the two-gap model is based on some very simple, common sense, and easy to understand ideas. There can be no doubt that to increase growth, we must invest in our future. Investments cost money, which is in short supply in low income countries. A portion of the needed investment can be financed in rupees; shortfalls in savings required for this purpose leads to the first gap. Another portion of required investment, like energy and high-tech products, requires imports; shortfalls in foreign exchange earnings from exports create the second gap. Low income economies fail to grow at their potential because they cannot fill the two gaps required for investing in their own futures. The solution lies in borrowing to fill these gaps and investing in high return projects that increase production and exports, placing the economy on a long run higher growth trajectory. This theory conforms very well to the current economic scenario in Pakistan, as we will now show.When we say that Pakistan is running a huge deficit, this is not, by itself, a cause for alarm. The question of burning importance is: what is the government doing with the money it borrows? If it finances luxury imports for corrupt officials, or speculation in land and stocks, or other types of non-productive uses, then an expanding deficit can cause great damage. Similarly, drawing down foreign exchange reserves can be extremely beneficial if it is used for imports of energy and capital goods, which is an essential pre-condition for increasing production and exports. It is true that the deficit and the trade gap has increased, but before learning why, and doing some projections of future impact of these twin gaps, it is foolish to raise a ruckus about these matters.Let us have a look at the cause of these twin deficits – what are we buying with what we are borrowing? After all, everyone knows that if your son gets admission into a top university, you must borrow to finance his education, because the returns to graduation will be much higher than the current investment required to finance it. One of the critical bottlenecks for the Pakistan economy has been energy. More than $35 billion is budgeted for a wide variety of energy projects, many of which have already come online; this is reflected in our daily lives, where load-shedding has been significantly reduced. It projected that self-sufficiency in energy will be attained by the end of this year, and substantially greater energy will be available as the multiple power projects under way come on line. About 23% of our imports have been in the energy sector, and these have also seen the highest growth of 35% in the recent past. While this is bad news for current account foreign exchange reserves, it is very good news from the perspective of our projected future energy profile. The increased imports are not due to higher energy prices, but due to higher quantum, and have contributed to the robust GDP growth. An additional good news about energy is that, as our investments in energy projects come on line, our foreign exchange requirements for energy imports will be significantly reduced.Although our weak export performance has been due to multiple causes, energy shortages have been a very significant factor. The availability of additional energy, both domestic and imported, has had a dramatic impact on our economy, which is just starting to be reflected in the statistics. The growth rates in services, industry, and agriculture have hit record highs, and are projected to be at a ten-year peak next year. This broad-based recovery is supported by a large number of factors. The nationwide decline in terrorist activity is reflected in record high domestic tourism figures; people in Pakistan have learned that our country is safe for travel, although the news has yet to reach the foreigners. In particular, the improvements in the security situation in Karachi have had a major beneficial impact on the economy. It will come as a surprise to the readers, but our exports are recovering, and have shown a healthy increasing trend, catching the global tide of increasing trade. The BOP is deteriorating because the imports have increased much faster. But more than 50% of these imports are intermediate goods like energy, machinery, metals, etc. which increase our productive capacity. Internal projections show that there will be a further decline of reserves of $2 to $3 billion dollars, before we begin to see a favorable turn in the BoP starting in 2019. Given that we have built up a comfortable cushion of reserves in the past few years, it would be folly not to use this money to enhance the productive and export capacity of our economy, moving us onto a higher growth path, when we can easily afford to do so.Even though we have botched many golden opportunities for significant increases in exports in the past, the future potential remains bright. The most recent gaffe occurred recently when Pakistan earned the goodwill of Iran by taking a solitary courageous stand, resisting pressure to join an alliance against Iran and Qatar. The president of Iran chose to honor us with a visit in recognition. The enormous potential payoff in terms of improved trade relations with Iran was sabotaged by front page headlines on the same day, regarding a minor Indian spy captured more than a month ago, which relegated the Iranian visit to the back pages. Our failure to give significance to visit was duly noted, and our relations with Iran became even worse in the aftermath. Nonetheless, a well-designed diplomatic initiative to Iran can yield tremendous benefits in multiple dimensions, including increased trade and growth. Similarly, there is a huge unexploited potential for exports to China, especially when phase 2 of our Free Trade agreement becomes operational. Turning this into reality also require some imagination and skill on our part to realize.In addition to the major energy projects, we are borrowing to pay for a massive transport infrastructure (roads, train tracks, and ports like Gwadar) which will radically transform the landscape of Pakistan. The effects of the early harvest roads constructed are already visible. The road from Gwadar to Kashghar in China has started to carry goods, and the first southbound shipment from Gwadar has already left the port. The desert surrounding the link road from Gwadar to Quetta has started to bloom. The increase in value of the land around the new roads would easily repay the domestic debt, but government has failed to capitalize on this golden opportunity. However, this merely means that the benefits go to the private sector, which has indeed capitalized on the Gwadar real estate bonanza. There is every reason to believe that with efficient management, Gwadar may even overtake prosperous Dubai as the leading seaport in the area. Our current foreign exchange deficits are required to finance the investments in development of a major international seaport which will bring in the foreign exchange required to create the desired improvement in our BOP in the long run. The impact of increased connectivity which will be created within Pakistan by the network of transport infrastructure currently under construction cannot be calculated or measured in terms of billions of dollars alone. This connectivity will transform social structures and ways of living in remote and unserved areas beyond recognition – indeed, the beginnings of the process are already visible. The direct economic benefits of being able to quickly and cheaply bring agricultural produce to major markets and seaports will bring unprecedented prosperity to the agricultural sector, lifting rural areas out of centuries old cycles of poverty.At this point, those who have been taken in by the doom-and-gloom scenarios in popular press may be wondering if this is merely a pie-in-the-sky pipedream, which exists only in the imagination of the author. The newly constructed roads are there on the ground; drive from Gwadar to Quetta to witness the bloom in the desert as ancient communities surrounding the roads prepare for the windfall created by availability of quick transport to major cities. All over Pakistan, power plants in different phases of completion have already added about 2000MW, and many more power projects have been initiated. The Gwadar port is already functional, though much more work is required to bring it up to the standards of Dubai. All over Pakistan, construction is taking place at a fast and furious pace, visible for anyone with open eyes. The ancient Silk Road, which changed the destiny of this region in the distant past, has already been re-constructed, making it possible to take our exports to China by road. While the public may be fooled by pessimistic projections, business confidence as shown both by surveys and by fixed capital investments, is at a record high.The potential that exists is far greater than the tiny portion which has been realized to date. Opportunity is knocking, and requires a broad based and multi-dimensional effort to realize. A few years ago, Mahathir Mohammad said that the key to the transformation that occurred in Malaysia was a change in mindset that created unity. The different parties agreed to cooperate to increase the size of the pie so that even a small share would be much more than what they could get by fighting each other over a shrinking pie. Today, the keys to a transformed Pakistan lie in creating national unity, overcoming sectarian, regional and political divides in order to take advantage of the massive resources in agriculture, energy, raw materials and human resources that God has gifted us with. We need to change our mindset from “The Sky is Falling” to “The Sky is the Limit”, and realize that there is more than enough for everyone, if we work together to build a better Pakistan.