Economy & Manufacturing – Redrawing the Map!

As the economic indicators nose dive, conspiracy theories run galore: On how the Finance Minister’s only agenda is to deliver the IMF program; IMF negotiating with IMF; why Reza Baqir is an ‘economic hit man’ from Washington, etc.! Had I not known Reza personally, maybe I would have also bought into some of these stories.

Anyway, keeping the certificates of patriotism aside for a moment to objectively analyse the current situation: The question, which arises here is that while surely there may not be any easy solutions in the shortterm, but has this government, through its sheer inexperience and incompetence, in any way exacerbated the negative economic fallout facing the nation today? The reality is that this government unfortunately started on the wrong foot with its born-again finance minister, Asad Umar, looking for capitalist solution amidst socialist slogans! Such mixed signals never work.

In a market economy confidence and perception play an important role, lose this and things simply roll out of control. Sadly the prime minister and his coterie of imported advisors and friends didn’t realize that economic governance has different requirements to mere populist street politics. Pakistani economy today faces

uncertainties and pessimism over a series of “black swan” moments like an eroding Rupee (with no end in sight), rising interest rates, looming FATF threat and a diminishing economic activity largely created through this government’s own follies in spreading needless panic and fear amongst the real stakeholders.

Now to counter this or to pull it back will require a sound medium to long-term strategy followed by some serious work on part of the government functionaries – mere rhetoric and blame game will not do.

The problem however is that the government’s resolve to look inwards rather than outwards and its understanding on what really is required to be done seems questionable. The distrust in its competence compounds if we take a cursory look at the past 9 months performance, which shows an over reliance on basic quick fix actions and those too being ordered through external dictates – any home grown vision on how the economy should ultimately evolve or take shame, appears to be unfortunately absent.

The more one listens to our ruling politicians the more it becomes clear that they remain clueless on a clear road map going forward. One hears the same arguments over and over again on how the Rupee was overvalued, thereby hindering exports and encouraging imports; why the utility tariffs need to be abruptly raised; how additional taxes need to be imposed, etc., but not a word on an admission that while these measures may have been necessary owing to some poor previous policies, still these measures in themselves are not desirable policy actions. Instead we hear arguments defending these actions, on how devaluation is good for the country, how arbitrary tariff increases are the only solution to energy sector woes, why additional taxes remain the primary tool to collect more revenues, etc. The trouble is that unless a government’s guilt in unleashing high thresholds of pain on its people – like a devaluing currency or an escalating cost of capital or a shrinking disposable income of an individual - is somehow reflected in its daily public face, it can never go on to take the right decisions even in future nor can it gain its people’s trust. The shameless way in which some of these painful decisions are daily defended on the evening media talk shows is simply appalling.

Make no mistake that devaluations can never be a justification to sustainably address competitiveness or for that matter high interest rates – even if to control inflation – since a double digit discount rate can never be commensurate to achieving sustainable equitable growth and employment generation in an economy. More than eighty years ago, prominent Russian economist, Prof. Nikolai D. Kondratiev described and theoretically substantiated through his K-cycles theory the damage (excessively) high interest rates can cause to the long term prospects of an economy.

His theory, simply put, explains that: Higher the cost of capital the longer it will take the next cycle of growth to arrive. Alarmingly a typical K-cycle puts this length (of an era of meaningful growth to re-arrive) to 45-60 years once interest rates enter into double digits. Ironically, the classic textbook job description of a head of a central bank or Federal Reserve calls for safeguarding national currency and taming inflation while promoting economic activity in the markets, as his/her principal responsibilities! Conceded that the tool of devaluation is sometimes selectively cum mildly used by governments to correct market imbalances or to restore short-term export competitiveness where one’s export markets have continuously worked on lower inflation rate than at home, still the long term solutions always lie in adjusting increased costs against productivity, innovation and value addition.

There exists no credible study or a real time example to prove that currency devaluation does indeed (sustainably) boosts exports – Asian tigers, China, Bangladesh and India, all have managed a surge in their exports during a stable currency period and not through any abrupt devaluation measures. In fact on the contrary, a WTO study (2008) points to a correlation between value addition and a stable currency environment. Amongst many other types of fallout, devaluation is invariably followed by a wave of inflationary pressures - especially in a current-account-deficit economy like Pakistan – and given that Pakistani exports in general are quite low on value addition, one needs to be careful in computing the trade-off between real gains in exports with other likely fall-outs.

So the challenge is not just to re-start the process of industrialization in the country, but (through visionary policymaking) to redraw the future industrial map in a way that a) places reliance on home grown industrial solutions in a competitive manner; b) encourages exports and replaces imports; and c) promotes the SME sector - the engine of growth and employment generation in any economy. Back in the 90s working with Dr. Bentzien of Detmold Institute, I was intrigued to find that how successive German governments consciously ensure funding to seek a minimum level (as high as) of 10% for start-ups every year and to retain an industrial share of around 30% for the Mittelstadt in its manufacturing economy – Mittelstadts, as we know is the primarily family owned SME sector of Germany and its real engine of growth, employment generation and exports since the 1950s – No wonder they succeed since the planning is so clear and precise. Needless to say for us to embark on this clichéd new beginning, the journey will be a slow, tedious and with a delicately timed process that entails due transition.