Prosperity: criticality of private sector

“The difficulty lies, not in the new ideas, but in escaping from the old ones.” - John Maynard Keynes

Innovation is critical for Pakistan - not only for growth and competitive advantage, but also to ensure its future development remains sustainable and inclusive. The country faces a range of unmet needs related to critical areas such as health, education, agriculture, energy and skills.

It also faces immense challenges related to demography, with 114 million Pakistanis under the age of 30 for whom opportunities must be provided; with the urgent need to lift millions of citizens out of poverty.

Without innovation this would not be possible. The Harvard economist, Elhanan Helpman, notes in his book, The Mystery of Economic Growth, recent “new growth” economics research has shown that capital accumulation (including more capital equipment and higher levels of education) is not the principal factor driving growth.

Helpman cites compelling evidence that innovation (organizing equipment and workers in new ways and using new technologies) is a major driver of productivity, which in turn explains significant cross-country variations in per capita income.

He cites that differences in productivity accounts for 90% of the variation in cross-country differences in the growth rate of income per worker.

This is particularly true in the context of Pakistan. According to a World Bank report, nearly 75 percent of Pakistan’s GDP per capita gap with the United States is explained by its gap in total factor productivity (TFP).

At first, this may seem surprising, since Pakistan’s rate of investment is also markedly low, and there should be much scope for catching up with the United States simply through greater accumulation of physical and human capital.

But while the capital gap undoubtedly needs closing, Pakistan’s TFP gap with the United States is also very high. At such low TFP levels, the returns from capital accumulation will soon start diminishing unless TFP rises.

The problem is that economists have traditionally looked at growth through the lens of productivity: aggregating all the assets in an economy and multiplying that by a production (or an innovation) function.

While mathematically valid, thinking about growth through the benchmark of productivity is less helpful when thinking about policies and programs for economies that are made of people with varying capabilities and cultures, and living in different contexts.

In the context of South Asia, if we learn from Bangladesh and India, it must be understood that innovation and productivity are primarily not driven by the state but by the private sector.

A successful economic development strategy therefore must focus on improving the skills of the area’s workforce, reducing the cost of doing business and making available the resources business needs to compete and thrive in today’s global economy.

So how might the Government of Pakistan go about this task? The way to get a maximum rate of ‘economic growth’ assuming this to be our aim - is to give maximum encouragement to production, employment, saving, and investment. And the way to do this is to maintain a free market and a sound currency.

In the context of Pakistan, there is a 6-point reform program that we at Prime Institute argue the state must focus on to build an economic development strategy to boost entrepreneurship, innovation, productivity and growth.

Firstly, the government should focus on creating a business-enabling environment in the country and reduce its footprint in the economy to create space for the businesses to compete. Excessive regulations only create obstacles for the businesses to operate.

Secondly, multiple taxes and high tax rates promote defiance among the people. High tax rates push people to evade taxes and stay out of the tax net. Overhauling the taxation system requires moving towards flat-low rate and broad-based taxes for promoting businesses in the country.

Third, trade restrictions eliminate competition in the economy and also hinder the transfer of knowledge and technology. Tariffs should be reduced to promote ease of doing business and facilitate competition.

Fourth, the government needs to ensure efficient allocation of public resources to most productive avenues. The trend of untargeted subsidies and exemptions create distortions in the economy and do more damage than any good.

A fifth important factor is the importance of sound money and its importance for growth.

Policy of fixing exchange rate has proved ineffective in the past and led to depletion of reserves. Exchange rate should be left to market forces to create stability and ease pressure on the foreign exchange reserves.

Finally, privatization is the need of the hour as the government cannot continue to bear the burden of loss making state owned enterprises just to keep them operational. Privatization will ease pressure on the public finance and the government can divert resources to improve its efficiency.

History in Pakistan has shown whenever the government— in pursuit of good intentions tries to rearrange the economy, legislate morality, or helps special interests, the cost comes in inefficiency, lack of motivation, and loss of freedom.

The government must understand that countries don’t create economies. It is entrepreneurs and companies that create and revitalize economies.

The role of the governments should be of a referee who creates a nourishing environment for entrepreneurs and companies to flourish, not to get in the way of economic development.

Copyright Business Recorder, 2023