Documentation of economy

Documentation is nothing more than keeping the record of every transaction and every activity in the country. In general, people who want to avoid government regulations, habit of utility pilferage, tax evaders and avoiders are part of the undocumented economy. It is not necessary that all the informal activities are undocumented. In certain cases formal sector is also undocumented.

Problem of documentation is not just mere tax collection, but it is core part of good governance. It helps in eradicating the problem of terrorism, for example, having all the records of sim cards issued on respective CNICs.

Furthermore, better documentation helps in better policy formulation such as offering social security benefits to the lay off or unemployed persons can only be effective in the presence of proper documentation.

Avoiding government regulations, sometimes, is inevitable in the presence of higher inflation and lesser purchasing power of the people. People tend to do more jobs than one and hide it from the government. In this way they avoid legal problems as well as they can save more but not paying taxes. Therefore, these kinds of undocumented activities can be mitigated by change in regulations.

Documenting the economy does not imply that our economic activity will increase. There is a good possibility that economic activity is reduced after the documentation and will be unemployed due to high cost of documentation including paying utility bills, paying indirect taxes etc. As well as poverty may also increase after the documentation. This is one of the reasons that every economy has smaller undocumented part, where poor are working for their existence. 

Growth by Spending

Growth is the main target of the policymakers. If growth is inclusive then the benefits of growth are distributed among all the groups of society. However in case of non-inclusive growth the redistribution of benefits will trickle down effect of growth. Nevertheless, the trickle down effect is insignificant in the short run.

Several policies have been made by the government and then affiliated departments support government to achieve that announced level of growth. Among those several departments Federal Board of Revenue has significant importance. Every year an impossible task is given to the FBR which sabotage the reputation of FBR.

Along with taxation, the other significant part is expenditures which everyone wants to do without any restriction. However, everyone faces the income constraint which at macro level comes from the revenues government generated from people and the income from the investment they have made. Unfortunately, government entities are not in habit of earning profits thus subsidized heavily by revenues collected by FBR.

Government invests where markets fails, for example it involves in services industry such as PIA and Railways in our case which provide facilities to the general public because private sector does not invest in non-profitable or lesser profitable ventures. Despite these two sectors, government invest in all those activities which are used by general public or in other words which can be called a public good such as parks, defense, police etc. Public goods are provided without considering the profits to all segments of the society. It is worth to mention that Metro Bus service is a public good, which is subsidized by the government and used by the general public. Although in more technical terms this kind of public good is known as club good since it is not totally free. However, since it is used by few people in the society that is one of the reasons it is highly criticized by the opposition, though the beneficiaries are praising it.

Coming back to the main point that growth is the target agenda of policymakers then why are we following lower inflation (stabilization) and lower fiscal deficit policy (fiscal consolidation) from the last several years. Although several seminars and reports prepared by Institute of Policy Reforms suggested that growth is necessary. Dr Pasha repeatedly said that the stabilization is achieved and now its time to shift to higher gears of growth. But unfortunately IMF’s agenda is above the wail of national economists and think tanks.

A recent paper by PIDE suggested number of things. One of the major findings it has is that fiscal consolidation leads to growth which is in accordance with the IMF agenda. However, how it should be achieved is very interesting.

There are several components through which fiscal consolidation is done. As discussed earlier the two major components are revenues and expenditures. Thus it can be done by increae in revenues or decrease in expenditures. For the last 25 years several ineffective policy measures are taken to increase tax revenues but tax revenues as percentage of GDP had declined from 13 percent in 1990 to less than 10 percent in 2014.

Literature on fiscal consolidation explicitly says that consolidation is only effective when it is done by cutting down expenditures. A noteworthy question is what expenditures? These can be classified into capital/development as well as current expenditures. Capital expenditures or development expenditures are those which will payback in future while current expenditures, although very important but are those those expenditures which do not pay back in future. The definition may be debatable because employee’s salaries are current expenditures. However, if school/college/university teachers are paid then it is also known as investment because government is investing in existing knowledge to produce further knowledge (students) which is the crux of endogenous growth theory of Paul Romer.

One of the important conclusions of PIDE’s paper is to reduce interest payments. In the current budget Rs.1328 billion is the estimated budget deficit and Rs.1280 billion is interest payments. If interest payments are zero, which is almost impossible with the high debt and high fiscal deficit, then the total budget deficit comes to Rs.48 billion. In this way government can spend rest of the money to produce further knowledge, i.e. spending on Research and Development, which is low to an embarrassing level. The interest payments can only be curtailed by reducing the overall debt, which is close to impossible, in the current scenario.

It has also been revealed that higher growth episodes are strongly related to the higher capital/development spending. Nonetheless, the trend of capital spending has been declining for the last 2 and half decades. This implies that fiscal consolidation, if it is followed in few years, is done by cutting in development expenditures. This is the worst form of fiscal consolidation. It affects the growth negatively.

It is high time to identify the leakages in the system, which will give us more fiscal space to invest in development projects. Finding an efficient way of doing the mega projects is very necessary. The recent worst example is metro bus system which according to Dr Farrukh Saleem cost us Rs.2 billion per KM. This cost is 8 times of the cost of building Indian Metro and more than double the cost of building Turkish Metro (0.88 billion per KM).

In conclusion we may say that since we are facing huge debt and deficit problems and we are scarce in resources to fund our development projects thus (i) leakages and over spending should be avoided by carefully examining every project, thus we may have more fiscal space to allocate funds on other development projects (ii) prioritize the projects according to the need of public (iii) give importance to Paul Romer’s theory of endogenous growth and allocate sufficient fund for research and development.

Issues not addressed in the Budget 2015-16

Published in The Nation, Jun 13, 2015
http://nation.com.pk/islamabad/13-Jun-2015/issues-that-were-not-addressed-in-the-budget

Budget 2015-16 does not bring happiness in everyone’s life. I call it partly friendly in my previous article. Nevertheless, there are certain problems which are not addressed. Let’s look at the neglected sectors which are not addressed in the budget and forgotten issues.

Services sectors contributed more than 50 percent to GDP but it is totally neglected once again. Services sector is neglected and the major emphasis is on the commodity producing sector, i.e. manufacturing and agriculture. What constitute the services sectors? It includes drivers, road transporters, telecom sector, storage sector, cobbler, barber, electrician, plumbers, tailors, shopkeepers (wholesalers and retailers), Banks and Bankers, insurance agents and other staff, construction workers, Public administration and defense, and social services.  Therefore in nutshell not everyone is working in Industrial sector an in agriculture sector. Furthermore, the neglected sector has maximum share in GDP and 40 percent of employed labor force.

Although the components of services sectors are inter-linked with the production of industry and agriculture thus making policies for commodity producing sector will enhance growth of services sectors as well nonetheless, services sector has its own significance through domestic commerce (at term introduced by Dr nadeem-ul-Haque, former deputy chairman Planning and Development Division and former Vice Chancellor PIDE in 2006 in Pakistan). Increase in domestic commerce leads to more employment opportunities for the people, Local competition in open market will increase which helps in generating innovative ideas; these ideas thus result in expansion in business and eventually increase in exports. These local industries which look for the demand of local buyers are known as organic industries. The domestic commerce will increase the need for space in the market as well as create new cities. Therefore, budget should bring certain reforms which helps domestic commerce to flourish. This would also reduce the income inequality and poverty in the country.

It’s been more than 2 and half decades when Paul Romer wrote an article on endogenous growth. It is among the most quoted article since then. It says that investment in human capital innovation and knowledge are drivers of economic growth not the external forces which are in general known as exogenous factors. Moreover, the outcome of this investment will have spillover affect which results in better economic development. However, the budget makers may not know the importance of investment in innovation and knowledge. This seems to be the only reason that even after twenty years the allocation of budget on research and development in all the sectors is negligible. I am sure that out of thousand billion budget government may allocate few billions to the research and development and grant it to various universities depending on the research projects they are running. It is very much possible that dues to this allocation they may not have to introduce billion rupees incentive structure to the industries.

The budget, every year, gives us the equation of revenues and expenditures. Expenditure heads are initially decided and then deciding on the magical number of budget deficit, revenue target is set. After the decision of revenue target several possible algorithms are made to achieve the impossible target of total revenues, this year its Rs. 3100 billion. This year tax reform commission has been established which gave several recommendations to the government. Moreover, Dr Pasha has also gave several recommendations to increase the revenues, nevertheless, no major initiative has been taken to improve the tax administration, cover the loopholes, and abolishment of exemption apart from abolishing the SROs issued by FBR.

Apart from these reforms construction sector and agriculture income is still un-taxed. Although agricultural income tax is a provincial matter but people get exemptions by declaring their income coming from agriculture sectors. In general it is seen that agriculture income tax become controversial, nonetheless, it is not. The same rules will be applied on the agriculture income which are applied on the income from other sources. Most of the investment is either going into real estate sector. Prices of the real estate sector are also changing frequently at rapid speed, which implies higher profitability of the investors in the real estate sector. Since mostly it is undocumented sector therefore it is difficult to tax, nonetheless, looking at the profitability it is pretty sure that FBR can raise significant amount of revenues from this sectors. Neglecting both the sectors for revenue collection affects negatively to the revenue collection efforts.

Similar to the real estate sector several informal activities are undocumented and are not paying sales tax especially albeit consumers are paying them sales tax when they use their services. For instance, restaurant, fast foods, bakeries etc. Vague estimates show that FBR is losing close to Rs. 250 billion every year by not collecting taxes from informal sector. 

Budget 2015-16 is Partly Friendly

The article is published in the Nation on 6/6/2015

Budget is nothing more than an estimate of income and expenditures. However, in Pakistan we celebrate it as a major national event. We also have a tendency of estimating our expenditure first and then, according to the budget deficit (which is either dictated by IMF or some imaginary golden number in our minds) we set the tax target. 

This year, the economists, especially, were hoping that since stabilization has been achieved (inflation came down to 4 percent level) so there is a dire need to adopt a set of policies that result in a boost in growth. However a common person’s expectations are something else. Those expectations can generally be never met in any kind of budget, barring a few exceptions. Every year, there are boilerplate statements after a budget is announced. One significant comment is whether the budget was people-friendly or pro-rich. My initial assessment of the budget presented by Finance minister Ishaq Dar yesterday is that 2015-16 budget is a partly people-friendly budget. 

This assessment can be explained in six parts: (i) interest payments issue (ii) PSDP (iii) relief to common person (iv) Employment Generation through public and private sector investment (v) Human Capital and (vi) Taxes.

The estimated budget deficit is Rs. 1328 billion out of which Rs. 1280 billion are interest expenses and Rs. 1512 billion is allocated for PSDP, out of which Rs.700 billion will be spent by Federal government. Therefore, as suggested by few latest research papers at the Pakistan Institute of Development Economics, the interest payments need to be curtailed down because it eats up significant amount of resources.

This year development expenditures need special attention because of two reasons (i) the allocation (ii) the way it will be spend on each project. Lots of money is needed to eradicate the problem of energy shortages and government has allocated Rs.142 billion, to spend on development projects.  It includes projects of Neelum-Jhelum and Diamir and Dasu dams. Moroever, as Dar sb announced they are determined to get rid of electricity shortages by December 2017. Therefore it is necessary to invest in the projects. 

Relief for common person has few dimensions. Budget of BISP is raised to Rs.102 billion and number of beneficiaries will be increased from 41 million to 50 million. However one question remain that what is the total anticipated number of people who should get benefit from BISP program. If it is close to 80 million then we are still short of 30 million. Moreover, Baitul-Maal budget is increased from Rs.2 billion to Rs.4 billion, which implies that it will increase the beneficiaries by significant amount as well as they can start new ventures. Salaried class will get more salaries, which is more than increase in inflation. Minimum wage is increased to Rs.13000 for the informal sector. 

Other than monetary increase in wages and salaries several projects will be started by the government, such as renovation of Islamabad-Lahore Motorway, Lahore-Karachi Motorway, highways which are part of Pak China Projects, canals and dams in Baluchistan and Sindh etc. These projects will definitely generate employment opportunities.

To boost domestic production, industrial tax holiday in KPK, decline in exports financing, reducing the exporter’s risk, and setting up exports development fund and land port authority will increase industrial production as well as exports. Rs.600 billion is allocated for the betterment of agriculture sectors, as well as duty free solar tube wells, will reduce the cost of agriculture production. 

Health and education is a provincial subject, nevertheless, Rs.71.5 billion is allocated for higher education out of which Rs.20.5 billion is allocated for HEC. The government is determined to increase the budget of education to 4 percent of GDP which is close to 2 percent currently. Nonetheless, important thing is not to spend more but how to spend and where to spend is vital for better results. Moreover government has started internship programs for all those graduates who do not get jobs after getting degrees from their institute.

Every year it is debated that poor should be taxed less and rich should be taxed more. Moreover, neglecting the excess burden the debate of regressivity and progressivity is the topic of the town. Considering the hot topic, the announced tax policy is not pro rich apart from decline in corporate tax from 33 percent to 22 percent. 10 percent tax is imposed on all the electricity bills exceeding Rs.75000. This implies that revenue will increase if theft does not increase. Moreover, capital gains tax is increased to 15 percent if the shareholder sells his share within one year, 12.5 percent if he sells between one and two years and 7.5 percent if he sells his shares after two years. Currently, the share of capital gains tax in total tax is 0.3 percent. Therefore, it is a very good initiative to collect taxes from share market. Moreover, tax-non-filers need to pay extra tax, which will increase the compliance rate. Apart from above few taxes, minimum tax rate slab is declined to 2 percent. Vehicle transfer duty is reduced, regulatory duty on mobile phones is decreased but sales tax is doubled, taxes on cigarettes are increased, and more importantly SROs cannot be issued by FBR.

Privatization: Why What and How?

Privatization is a process of change in the ownership of any entity which is owned by the government. It could be done by selling shares in the stock market to the private investors or selling the entire organization to a private sector. It can also be done by selling few departments to private sector while holding the key positions. Another way which is not popular in this region is to give vouchers of books to the citizens which represents share in the state owned enterprises.

One of the potential benefits of privatization mentioned in the literature is increase in efficiency. Moreover, there is a possibility that private owned firm will invest in innovating ideas to enhance their profitability. Therefore, innovation and reduction in cost both lead to higher economic growth. Dr Akhtar Hasan Khan (former secretary Planning) in his book said that only 20 percent of the privatised units become more efficient, which is an alarming number considering the past efforts of privatisation is concerned.

Since the decisions in SOEs are taken considering vested interests, and other rhetoric concerns and not following economic benefits, therefore, apart from the efficiency and innovating ideas privatization may help government in reducing the impact of corruption. Moreover, procedures of accountability in SOEs are not transparent and effective compared to the privately owned companies.

Pakistan has been following privatization policies for the last three decades. However the process is very slow and ineffective according to many studies done. One of the major issues highlighted by Dr. Akhtar Hasan Khan is transparency. For transparency he wrote that proper advertisement, proper reserve price, proper pre-qualification of bidders and payment in short period of time are the important components which are unfortunately not devotedly followed. While giving the example of an advertisement he mentioned that among the major Privatization of HBL the selection of foreign newspapers was not appropriate.

It is generally argued that privatisation efforts reduce the burden of total debt of the country by using the money earned from privatisation on retiring the debt. Furthermore, it also reduces the expenditures incurred by the government on the loss making companies. By privatising the loss making SOEs has double impact, (i) by less spending on those SOEs and (ii) earning money by privatising and further using it to reduce budget deficit further. Fiscal consolidation by this practice has not been successful in many countries including Greece. In Pakistan debt was not reduced, poverty numbers went up and fiscal deficit was higher in the nineties. One of the problems which were discussed in general is that we have privatised profit making institutions and kept the loss making institutes. Hence expenditures of the government remained the same but revenue had gone down which increased the budget deficit.

The above story is history now. Question is that do we need a policy of privatization? Do we need government owned institutions? Are our privatization policies on the right track? What to privatize and how to privatize? Dr Khan said that we should privatize by selling the shares in the stock market. However, our stock market is not developed and the main objective of selling the shares to many people may not be achieved. Nevertheless, possibility of firing workers from their jobs will be lessened. But can we sell the entire entity by selling the shares in stock market?

One of the major flaw of the privatization policy is that we are not clear that what sector to privatize. This is important because private sector then invests freely in that sector without any hindrance. Government is confused and trying to reform the part of SOEs so that they can make them a profitable organization and sell part to the private sector. However, the attempt of reforming the organization has not been productive apparently until now apart from few smaller success stories.

Monopolistic exploitation could be another reason of the apparent confusion. Although in the presence of Competition Commission (CCP) it is difficult to do. The answer to this simple problem is “regulations” and CCP can act as a regulator. Dr A R Kemal, ex-Chief Economist and Ex-Director PIDE found in his paper that after privatization growth rate of the firms has declined and prices have increased which shows the monopolistic power of the firms. He stressed the importance of regulations that removes the possibility of monopolistic exploitation. Nonetheless, emphasized on the lesser regulations to give them flexibility to make their own decisions. Price caps were one of the suggestions which may regulate the privatized firm better. In UK this practice was adopted to regulate privatized firms.

In several other papers Dr Kemal wrote that competition is necessary to increase the efficiency. Thus, tariff rationalisation, anti-trust laws and control of monopoly are plausible regulatory frameworks that must precede privatization. Automatic systems to check the monopoly powers need to be built into the system so that there should not be any chance of exploitation.

At present few SOEs are not getting billions of rupees in subsidies and intellectuals are advising government to privatize them. However, donors and government want to revamp those organizations such as Railways and PIA. One of the old PDR’s paper witnessed the same issue that privatization in the power sector may not eradicate the problem of inefficiency. Nonetheless, it needs reforms irrespective of whether it is owned by public private or jointly by the two. Therefore, it is good to implement institutional reforms and ADB is helping the government in their reform package.

Privatisation efforts in the last few years are evidently non-objective oriented. It seems that when government wants to increase their spending they privatise some assets. It is quite similar to the situation where a member of a household starts selling their household objects to fulfil their daily needs. If this is true then it’s a mad policy.

From my mentors I learnt two possible actions after the previous privatisation practices were failed. Those are; (1) following neo-libertarians government should not involve in the business venture thus privatise everything, have very few regulations and let the private sector work (2) ask private sector to invest in a particular sector, where government wants to divest in future. As a result efficient workers will move to the private sector. When government does not invest in that sector the SOEs will go further into loss. Wait for the private sector to establish a little and then give golden handshakes to the rest of the employees and close down the enterprise. Other than the above two possibilities government may have the hotchpotch policy which is not clear to them as well as to the others.

From the above discussion the following lessons are learnt

1.      Previous privatisation attempts were not successful

2.      The important components of privatisation were not strictly followed, i.e., proper advertisement procedures, proper reserve price, payment in a short period of time and proper pre-qualification.

3.      The outcome of privatisation is not coherent with the objectives of privatisation

4.      To prevent monopolistic exploitation regulations is necessary

5.      Competition Commission needs to play its role vigorously

6.      Policy of tariff rationalization (cascading with reduction) enhances competition

7.      Current eating out the earning through privatisation is a mad policy