Incentivizing provinces

Having been caught in the vicious boom-bust cycle, Pakistan’s economic managers have long been focusing on matters that require immediate attention: the crises of twin deficits. The story is quite well known. But here is a strand of thought that the country’s economics community ought to consider.

The notion that short-cut economics will not work is increasingly becoming obvious, even to those who are not well versed with economics 101. For instance, the WHT-isation of taxation, and other means of the collection of direct tax in indirect mode has been a failure. So has been package-based economic management by successive governments.

Subsidy on production inputs, relief on import duties, subsidy on borrowings, tax rebates on new investments and other such offerings that can called ‘price signals’ or ‘clutches’ have either worked for as long as those signals were turned on, or not worked at all. The question is whether such government-led price signals work in an economy where structural distortions ensure that the real torch bearer of price signals – the market – is not giving proper signals at all.

BR Research has previously flagged how a host of economic sectors “have been or still are a victim of a governance mindset that aims to protect the poor in a manner that is irrational and therefore wholly or partially prevents economic growth in those respective sectors”. (See Failed governance mindset, December 5, 2018)

Consider that for all these years, the textile sector has been carrying the torch of exports thanks in huge part to wide variety of government endowments. Yet name one sought-after textile training institute in the country. Budding business graduates are also encouraged to peruse the balance sheets of textile sector companies – the so-called biggest non-farm employers and biggest dollar earners – and analyse how much have these companies spent on research & development.

Anyhow! With the responsibility of key economic sectors now resting with provinces, there is little that the federal government can achieve. The likes of education, health, farming value added, livestock, seafood, vocational skills, housing, tourism, and so forth are the responsibility of the provinces that are supposed to restructure reform and kick start growth and development in these areas through both policy and action.

The centre can perhaps only offer some price signals, such as X percent relief on import duty on say import of livestock farming equipment, or provide some land for housing, or income tax relief on vocational training sector. But in the absence of efficient cogs of policy and governance in these sectors that are to be provided by the provincial government, such price signals will again achieve little, if any at all, as a result of which growth and development in these sectors will remain below potential.

A better way would be to give some incentives to the provinces to foster economic growth and development in the sectors that lie squarely in provincial domain. One potential solution is to give provinces an additional share in income tax, customs and GST on goods collected from new economic sectors.

At present, in ballpark terms, provinces have a combined share of 57.5 percent in the divisible pool. What if – and granted it is a big if - the centre first disaggregates the divisible pool across the various economic sectors it is collected from. And then, it offers provinces an additional share in income tax, customs and GST on goods collected from some of the sectors that lie in provincial domain provided the collections from these sectors increase above a pre-defined threshold as a result of specific sectoral reforms taken by the provincial governments.

The problem with this solution, however, is that there will be problems in calculating the horizontal share since not every province would have the same preference for, or revenue potential in each of those sectors. This is why they would resist any disaggregation of and splitting of divisible pool into taxes that come from conventional sectors and those that come from new provinces-driven sectors.

Regardless, there is still a case to be made that the federal government needs to think how to incentivise provinces to kick start growth in the sectors that are in provincial domain. This discussion should be one of the items of the recently initiated NFC talks.

Another potential way to push provinces into fostering growth in their respective economic sectorsis to create economic incentives for the media so that both the media in particular and the civil society in general starts mediating between the provincial government and the citizens – a problem already flagged in BR Research’s piece Role of media in curbing corruption, September 28,2018. At the very least, the current government in Islamabad and whosever takes up the slot next ought to increase awareness amongst the populace that since the devolution, their fate lies with the provinces. Just as the recently announced water policy, the national fishing policy currently in the works by Islamabad will achieve little fruits if the provincial leaders haven’t made it, owned it and have any political incentives to deliver on it. After all politics is a game of incentives, isn’t it!