EDITORIAL: Pakistan’s economy is trapped in a vicious loop. There are three faultlines; and all of them are interlinked. The first is the extremely high share of consumption in the GDP. The second is the high reliance of imports to support that consumption and the third is the fact that the major portion of direct and indirect taxes that is collected in the country is at the imported stage.
In a regulatory environment where curbs on imports are placed to balance the current account and check the domestic demand, the casualty is the tax revenue collection. This ultimately leads to fiscal slippages that translate into a widening current account deficit, thereby feeding the loop.
Conversely, if the focus is on increasing the GDP growth rate within the economy that comes about by increased consumption rather than production and leads to increase in imports, the Federal Board of Revenue’s (FBR’s) revenue collection expands but the current account becomes unmanageable. To extricate the economy out of this cul-de-sac, it is imperative that the share of exports in the economic output (GDP) must increase to at least 12 to 15 percent of the GDP and taxes should be collected adequately from the under-taxed sectors. The holy cows must be sacrificed to keep the economy solvent.
It is important to note that manufacturing in the country has always relied mainly on import substitution. Textiles are Pakistan’s major exports and that has been always the case. The rest of industrial development is purely on import substitution.
The value addition has remained fractional and inefficient. Import protection through high tariffs from imports, meanwhile, has kept the local industry afloat. Despite such protection from imports, the development, locally, remains limited. It is rare to find exportable surplus from these industries. This model must change. The country needs to start producing for exports rather than exporting its production surplus. That is the only way to increase efficiency and solve the current account problem. Once the industrial policy is pivoted on efficiency, the FDI (Foreign Direct Investment) may come to the exporting sector. Historically, almost all the FDI has been confined to market-seeking. And now the problem is to arrange dollars for repatriation of profits in the form of dividend on that investment.
The other variable that needs to be fixed is taxation. Some businesses are heavily taxed while others are completely ignored. In the retail and wholesale value chain, income tax is abysmally low. Construction and real estate businesses have an identical story, so to speak.
Disposable income is exaggerated which is fuelling consumption. If these sectors are taxed appropriately, there would be some decline in consumption and increase in government’s savings that may translate into investment into infrastructure which would fuel growth in manufacturing. At the same time, however, the heavy taxation on manufacturing must be rationalised to encourage and promote competitiveness for exports’ growth. Currently, import substitution is substituting exports.
Due to protection, returns are high. The tax structure is woefully lopsided, to say the least. Income tax and sales tax are collected in advance at import stage. In domestic sales, it is priced in. In the case of exports, refunds are warranted but hard to get. The textile sector has adequate lobbying power. This power or clout helps it get refunds with little difficulty while small exports from a new sector however cannot imagine timely refunds. This makes exports uncompetitive and import substitution attractive.
This state of affairs must be corrected. The collection of taxes should be at the appropriate stage and across the board. Not only will this step help solve the low tax collection problem, it will also make manufacturing competitive. Sectors with comparative advantages are required to be explored; these, too, will attract investment. In addition, savings in the formal sector must be encouraged by making capital markets attractive.
Right now, there is little or no documentation or Know Your Customer (KYC) requirements and/or taxes in real estate and gold hoarding trades. People prefer that. On the other hand, however, investments in stocks or stock market are heavily regulated and taxed. This has to change. Plus, higher disclosure requirements of listed companies discourage many growing businesses in real estate, food and retail chains to join the bourse.
Once taxation becomes fairer and more distributed, the businesses that are evading taxes may find reasons to list while consumers can find avenues for savings, compromising, in turn, on today’s consumption for it. In a nutshell, the structure of the economy needs to change where rent seeking and tax evasion are effectively curbed, if not eliminated.
One must contend with the fact this won’t make many happy — the ruling elite, including establishment and big businesses, will resist as the surplus will pass from them on to the masses and help develop the middle class. The question is: Does the Pakistan Democratic Movement (PDM) government have the resolve to fix country’s broken economy without any further loss of time? Unfortunately, this question, like many other such questions, has no easy answer.
Copyright Business Recorder, 2022
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