Calamities, debt crisis, growth: prospects — II

H istorical precedents show the many ways in which various sectors of the economy do this. As rising debt causes a widening gap between demand and supply, economic agents understand that this gap will be resolved by some combination of means including inflation, higher taxes, rising unemployment, wage suppression, financial repression, capital controls, and currency depreciation.

The point is this: to the extent rising debt must lead to some sort of adjustment in which certain economic sectors will lose purchasing power to equilibrate demand and supply, each sector recognizes the risk and changes its behavior to protect itself from being forced to absorb the cost.

These actions in turn can cause a host of spillover effects. Business owners may generally disinvest or shorten their investment time horizons, real estate developers may cut back on development projects, and factories may postpone expansion plans, and all these actions reinforce similar behavior in other economic sectors.

It is important to note that the government imposed a 10% super tax on banks, cement, iron & steel, sugar, oil and gas, fertilizers, LNG terminals, textile, banking, automobile, cigarettes, beverages, chemicals and airlines. This supertax therefore was imposed mainly by manufacturing, industry, and a few professional services sectors but did not aim to target those in real estate or retail.

But the government did not stop there and soon rumors were rife that they may further impose 5% special income tax on manufacturers to create fiscal space for giving a relief of billions of rupees to the traders, bankers, brokers and real estate players.

This behaviour is especially destructive because it is so highly self-reinforcing: rising levels of debt create increasing uncertainty about how the associated costs will be allocated, which sets off financial distress behavior that undermines growth, further increasing the gap between debt-servicing needs and debt-servicing capacity and driving even more financial distress behavior.

Conclusion:

Unable or unwilling to see deficit spending for the ruinous model it is, the government must not at any cost repeat past mistakes made by many African economies and drive the economy further into economic ruin by accumulating excessive debt (and consequently imposing heavier tax burdens). Excessive debt is detrimental to Pakistan’s economy in eight ways:

Calamities, debt crisis, growth: prospects – I

1. It perpetuates the state-led development approach, which has failed to generate economic prosperity and left the economy in a precarious situation characterized by dependency, poverty, tyranny, corruption, rampant inflation, and deindustrialization.

2. By perpetuating the state-driven development approach, debt-fueled government spending makes poverty worse, consolidates political and economic repression, and thus further delays pro-market reforms that Pakistan’s society urgently needs to truly develop and weather global economic storms.

3. Debt repayments further cripple already crippled economies by diverting increasingly significant portions of government revenue to debt servicing. Worse still, Pakistan pays much higher interest rates (9 to 16 percent) on their Eurobonds than developed countries.

4. Like most government spending, Pakistan’s government spending tends to be mired in corruption, cronyism, embezzlement, rent seeking, overbilling, and wastefulness, which ultimately means it does more harm than good. It leads only to further debt to keep the spending binge going—a vicious cycle that attracts more political and economic opportunists seeking office or to get rich on government spending and favor.

5. It leads to injustice and a broader income and wealth inequality gap, as politicians and their associates (e.g., large businesses and other interest groups) benefit first and most from such money injections through various schemes.

6. Debt-driven government spending also means a heavier (i.e., more oppressive) tax burden in the future. High taxes are one of the main impediments to economic development. Less development means more poverty, more human suffering, and more poverty-related deaths.

7. Moreover, excessive debt leads to a situation where the people, their children, and even the unborn will have to be taxed to pay for today’s largely wasteful and counterproductive government spending, which only makes politicians and associates rich.

8. On top of all that, debt (loans and grants) traps Pakistan in poverty and vassalage to foreign governments (primarily Western states but others too, nowadays).

   Sophisticated 21st century versions of financialized debt must be inevitably repaid by the state either through economic growth or enhanced taxation, hinting at the deep connection between fiscal and financial governance. Developing countries often barely ever repay their debts because they lack a robust economy. Increasing the tax burdens in precarious economies such as Pakistan will only further impoverish an already impoverished society.

Instead of maintaining one of the most oppressive tax regimes globally which target sectors that generate significant economic growth and proactively contribute towards exports, Pakistan should implement tax policies which encourage local capital formation, investment, entrepreneurship, and lasting economic growth The government should therefore look into suggestions by tax policy expert Dr Ikramul Haq who states a paradigm shift is required - the best tax is one which has the lowest possible tax rate on the highest possible tax base.

There is no lack of entrepreneurship in Pakistan. To release this huge potential, the government first needs to do much less. Above all, they must stop trying to micromanage the process of industrialization, whether through trade policy, industrial licensing, or direct control of state-owned enterprises. But they also need to do more. They must strive to keep public borrowing and inflation in check, while investing adequately in physical infrastructure such as bridging the digital divide and nonphysical infrastructure such as human capital.

Copyright Business Recorder, 2022