Two years ago, the much touted Western capitalistic model of Laissez Faire economic management came a cropper. In hindsight, one can now say that it was an accident waiting to happen. For nearly a decade before the crash, consumption-based economic growth in the West was funded by Asian trade and Middle Eastern oil surpluses.
The West's consumption splurge was, in turn, enabled not by national savings, but by asset-price inflation, most conspicuously, real estate bets fuelled by trillions of dollars of nil-margin mortgages financed at ridiculously low rates of interest.
It is estimated that real estate asset inflation in OECD countries during this period was of the order of USD 5 trillion, ie roughly equal to the current GDP of Japan or China. Nearly two-thirds of this overpriced real estate is located in the US (disasters of lesser absolute magnitude occurred in Ireland, UK, Spain, Greece, and Portugal). Wall Street's penchant for financial engineering added fuel to the sub-prime mortgage fire.
Dud assets were repackaged as high-yielding collateralized debt obligations (CDOs) and sold to financial institutions and investors world-wide. The icing on the cake was that the yields on these inflated assets were, in turn, insured by AIG, the largest global insurer! It is this phantom wealth that now has to be purged from the West's national balance sheets with several years of marginal growth, high unemployment, and deflation.
The purpose of this article is not to reiterate the consequences of unfettered greed that scuppered the likes of Lehman Brothers (USA), Hypo Real Estate (Germany), and Northern Rock (UK), or to dwell upon the wounded pride of the cream of American Banking (Citi, Morgan Stanley and Bank of America) and Automation (General Motors, Ford, and Chrysler) seeking state intervention. But, to reinforce the principle that if civil order is itself threatened by excesses of the capitalist system, long-cherished fundamentals of economic management do, and should, fall by the wayside.
The US government spent over USD 2 trillion in TARP (troubled asset recovery programme) and purchase of sub-prime mortgage assets from Fannie Mae and Freddie Mac to put a floor under its collapsing financial and real estate markets and to arrest rising unemployment. The EU, Japan, and China have together spent an equal sum in quantitative easing...buying government bonds to ease financial liquidity.
Current interest rates in the developed world are close to zero, unemployment remains high, budget deficits range from 8% to 15% of GDP, debt to GDP hovers around 90% to 200%, and a double-dip recession is a distinct possibility. Meanwhile, in Latin America (Brazil, Argentina), South and Southeast Asia (India, Indonesia, Thailand, Korea, Taiwan, Malaysia, Singapore and China) economic welfare is on a roll with high national savings, persistent productivity growth, and exportable surpluses. For the first time in nearly 200 years, the developed world (mainly North America, EU, and Japan) account for less than 50% of global GDP...a trend that is likely to gather steam in years to come.
Back home, our PKR 15 trillion economy struggles to support our burgeoning 180 million souls using failed WB/IMF recipes of economic management. While American national savings are half our level, and their budget deficit as a percentage of GDP is 50% larger than ours, these Washington institutions are applauding the Congress for its profligacy, while censuring us for living beyond our means.
Keynesian public spending is being advocated in the US while we are being told to cut back on development spending and to raise power tariffs to a level that is 100% higher than that prevailing in the US! The fallacy of our acquiescence to these unjust demands is that if we do not comply, somehow our entire economic fabric will collapse for want of foreign exchange support provided by these institutions. Let us examine the truth of this contention.
The reliance of any country's economy on external funding is a function of:
-- The country's current account balance, ie the balance of trade in goods and services and voluntary capital flows.
-- The government's budgetary deficit.
Tackling the former first, our annual tangible goods trade is in deficit by approx USD 13 billion (USD 32 billion imports against USD 19 billion exports). Services deficit (principally shipping, finance, and insurance) is another USD 3.5 billion, with a like amount in annual debt service on our USD 56 billion of foreign debt. Roughly then, to balance our books, we need to find USD 20 billion of capital inflows each year. Fortunately, workers' remittance takes care of nearly half that number, leaving us with a critical deficit of only USD 10 billion. On our USD 175 billion GDP, that is a significant, but not unmanageable 5.7%.
Given a modicum of will, any government can tackle a trade deficit with either tariff and / or non-tariff measures. There is no fundamental imperative for our imports to exceed exports by a whopping USD 13 billion. Can we not do without Hershey's chocolates and Kellog's fruit loops?
Eighteen years ago, I and my family had occasion to visit India. In the heart of Delhi, while my wife was shopping for Saris in Connaught Place, our kids clamored for Macdonald's. Since they were not available, we made do with local burgers. Even Hunt's ketchup was not available. The burgers came with a watery local substitute! And, of course, instead of Coke, we were served the local "Thumbs Up". In short, for several decades, successive Indian governments had embargoed non-essential consumer imports while building up the country's basic industrial infrastructure in steel, transportation, chemicals, and pharmaceuticals. The addition of info-technology to this list is admittedly a later addition. In all of these industries they now have world-beating business houses...the Mittals, Tatas, Ambanis, et al.
I am not advocating a ban on all consumer imports, only a restriction on luxuries and non-essentials. Such an initiative can easily conserve USD 5 billion per annum, thereby halving our current account deficit to a manageable 2.5-3% of GDP. The national quality of life will not be unduly dented without Kellog's corn flakes at breakfast and BMW 7 series cars to transport our elite. Why cannot this "People's Government" evince this minimal requisite will?
Our persistent budgetary deficit, however, needs greater focus. On our PKR 15 trillion GDP, any respectable government should be able to collect 20% in annual tax revenues, ie PKR 3 trillion. Unfortunately, last fiscal year (July-June 2009-10) our Federal Board of Revenue (FBR) barely managed to collect PKR 1.3 trillion. Although this figure was supplemented by another PKR 300 billion in non-tax revenues (mainly petroleum surcharges, State Bank profits and local taxes), it fell short by PKR 900 billion of minimal expenditure needs of PKR 2.5 trillion...needs that have been budgeted at over PKR 3 trillion for fiscal 2010-11.
The government will conveniently blame havoc wreaked by floods to justify its inability to do any better on the tax collection front this year. The resultant deficit will be even larger, perhaps, of the order of PKR 1.2 trillion, ie nearly equal to last year's total tax revenues or approximately 8% of projected GDP. How will this wayward expenditure be financed?
Most likely by borrowing another USD 7 billion (PKR 600 billion)...assuming forbearance on the part of WB/IMF... with the balance made good through resort to the printing press. Yes, get ready for inflation to hit 20 % before the current fiscal year closes in June 2011! And forget about any GDP growth for the foreseeable future. We will be lucky to close this fiscal with a big fat ZERO against the current Ministry of Finance's heroic assumption of 2.5% growth.
On realistic assumption of the current government remaining clueless as to its available options, come June 2011, we are likely to register foreign debt at USD 62 billion along with a somewhat larger domestic debt of PKR 5.7 trillion, ie a total public debt of PKR 11 trillion. The question is, "Is this a crippling level of Public Indebtedness?" Surprisingly, the answer is "No". It amounts to merely 73% of GDP, much lower than nearly 100% ten years ago.
We have already observed that many economies in the developed world have public debt well in excess of 100%. In fact, if we factor in private and corporate debt, overall indebtedness of many of these countries ranges between 200-250% of GDP. Members of this club include the US, Japan, and Mediterranean Europe. Fortunately, consumer finance in Pakistan (despite its splurge during the Shaukat Aziz era) remains subdued. With our total consumer and corporate finance today restricted to approximately PKR 4.5 trillion, our index of total indebtedness is still under 100% of GDP.
I hope, dear reader, that what has been stated above amply demonstrates nothing is sacrosanct when it comes to national interest. Whatever the polity, capitalist or socialist, and whatever the fiscal or monetary remedies propounded for national ills, what is the sauce for the goose is sauce for the gander. In other words, as a nation we should not automatically accept any fiscal or monetary constraints just because they are proposed by institutions such as the World Bank and IMF because it suits the foreign policies of their principal constituents and because our government does not have the political will to live within its means.
It is my contention that the "Means" are all there and can quite easily be accessed without rioting on the streets. Till the FBR gets its act together and raises our national tax to GDP ratio to a respectable 18-20%, till the civilian dispensation is able to stare down the military establishment to freeze its share of our annual budget at current levels (approx PKR 600 billion in 2009-10 including military pensions and "war on terror" outlays), till civilian administration expenditures (the scores of overlapping ministries, hundreds of ministers, and the perks and privileges of the PM and President) can be rationalised, and till the government gathers the political will to curb conspicuous consumption imports noted above, we may well be into year 2015. For the interim, we shall have to generate funds equivalent to at least 2/3rd of the 8% of GDP budget deficit that stares us in the face as mentioned above, ie PKR 1-1.5 trillion per annum for the next 4-5 years.
Here's how it can be done with minimal pain and effort:
Non-funded public borrowing (National Savings Schemes): These are a great source of public finance. Especially so in inflationary times when such borrowings can be raised at practically Zero effective rates of interest. For instance, the best current NSS rate is the one being offered to pensioners. It is approximately 14% p.a. Given that our inflation rate is likely to exceed 15% p.a. for the foreseeable future, the government should aggressively solicit consumer savings at rates of around 15-17% p.a., ie borrow from its own citizens at 0-2% real rates of interest. The current level of this national debt is around PKR 1.8 trillion. For fiscal 2010-11, the government can easily borrow an additional PKR 500 billion from this source.
Flood relief lotteries: For centuries now, governments all over the world have resorted to public lotteries to raise funds for special projects and causes. Our current tragedy certainly qualifies. It is highly recommended that both Federal and provincial governments fund a bulk of their relief operations via transparently conducted lotteries. To forestall religious objections, let me say that we already have such lotteries by way of the National Prize Bond schemes. Only, this time around, there will be nil addition to public debt. So, let the Federal and provincial legislatures pass requisite Bills sanctioning these lotteries for resettlement of the 20 million uprooted souls. Gathering PKR 200 billion should be a breeze. In fact, services of internationally acclaimed lottery companies can be solicited for this purpose.
Wealth taxes: In a population of over 180 million, we barely have 2.5 million taxpayers. The landed aristocracy pays no taxes because it has legislated itself the requisite exemption. And then, practically our entire services sector that accounts for over 50% of our GDP pays no taxes. All the shopkeepers in the land put together pay less than PKR 1 billion in annual taxes! The typical vehicles of wealth storage are residential houses, commercial buildings (the so-called "shopping plazas and arcades"), residential and agricultural land, and expensive private transports. Your scribe proposes that targeted wealth taxes be designed for all these wealth pools.
Let's start with agricultural land holdings. Income from them is exempt from taxes. However, their inherent wealth has not been legislated any exemption! Pakistan has 55 million acres of arable land under cultivation. Each and every acre of this land is registered in our revenue records with designated commercial value. To be conservative, let's say that the average acre has a market value of 200,000 rupees. That means the total agricultural land is worth PKR 11 trillion. Of this, 80% is held by individuals, who own more than 12.5 acres (the level we deem wealth tax exempt). In other words, the taxable pool amounts to PKR 8.8 trillion. A nominal ONE percent annual wealth tax (or PKR 2,000 per acre) can generate PKR 88 billion. This is hardly an onerous rate of tax, and yet the total sum likely to be generated is very significant.
Moving on to residential houses, let the legislature generously exempt houses built on lots smaller than 500 square yards. Furthermore, for starters let the legislature focus on only major cities like Karachi, Lahore, Hyderabad, Faisalabad, Pindi-Inslamabad, Multan, Gujranwala, Peshawar and Quetta. It is my contention that the total number of these houses is no less than ONE million of which at least 10% are built on land lots larger than 500 square yards. Again, if we estimate the average value of a typical house in this category, it can not be less than PKR 10 million. The total value of wealth in this shape works out to PKR 12 trillion. Again, a ONE percent annual wealth tax can generate a decent PKR 120 billion.
Allied to the foregoing source of wealth tax is the business of keeping wealth in the shape of residential and commercial plots. Although there is no reliable data extant on it, one can easily estimate that once documented, its worth may easily be a quarter, if not more, of the housing wealth estimated above. In other words, that is another potential PKR 30 billion in annual wealth tax revenues.
Now give some thought to the other "landlord" class, the owners of those sky-rises and plazas, whether individual or corporate. Yes, their owners (at least those that are too large and conspicuous) pay taxes on rental incomes. However, they are not assessed for wealth tax. In the absence of an adequate survey, one can comfortably estimate that the wealth held in this form is not likely to be less than the wealth represented by houses, ie PKR 12 trillion. And on the same reckoning, a source of wealth tax worth PKR 120 billion per annum.
Lastly, let's talk of our super-rich, and our VIPs, who feel it beneath their dignity to travel in vehicles powered by engines smaller than 1300 CCs. My estimate is that there are at least one million vehicles in this category with average price tag of PKR 2.5 million. In other words, we are looking at mobile wealth of PKR 2.5 trillion. Again, on the one percent of value formula used above, we could generate PKR 25 billion per annum.
If you care to total potential revenue from all the aforementioned sources, you'll find that it exceeds PKR 1 trillion. All that is needed is a modicum of common sense and determination to break the begging bowl.
For an anecdotal epilogue, one hears that earlier this month our high powered fiscal and monetary team visited Washington to parley the terms of its bondage with WB/IMF. They had evidently done their homework and were in the middle of explaining their fiscal and monetary status and strategy (inflation of 12.5%, budget deficit 6.5%, GDP growth 2.5%, etc), when their hosts interrupted the proceedings to take an urgent call from Pakistan. The gent, on the other end of the line proclaimed that he was the Financial Advisor to the Prime Minister. He was calling to say that the government could not vouch for the veracity of the data being presented by the Pakistani delegation...specifically, that inflation was likely to hit 20%, budget deficit would match that of the US, and that GDP growth for the coming year would be Zero at best. The hosts turned around and asked our official delegates, "Gentlemen, please tell us who to believe!"
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