In 2022, Pakistan experienced great stagflation where the average inflation was around 25 percent, meanwhile, the GDP growth is expected to remain low in FY2023. The Covid-19 pandemic triggered a sharp decline in the country’s productivity which has further been exacerbated by the unprecedented monsoon flooding. While this was the situation from 2020 onwards, Pakistan has been a victim of stagnant productivity during the past decade with the situation not improving any time soon.
Amid this backdrop, the World Bank in its October 2022 report titled “From Swimming in Sand to High and Sustainable Growth: A roadmap to reduce distortions in the allocation of resources and talent in the Pakistani economy” noted that Pakistan’s growth is stunted by its inability to allocate all of its talent and resources to the most productive uses.
The report, which was prepared under the guidance of the World Bank Country Director in Pakistan, Najy Benhassine, identified many distortions in the Pakistan growth model, either introduced by policy decisions or ignored by it.
Pakistan’s economic vulnerabilities
Distortions can take many forms. Some examples are taxes, subsidies, size-dependent industrial policies, trade restrictions, or gender norms. Together, these distortions create powerful incentives for firms and households to allocate resources in ways that are socially suboptimal, while also discouraging innovation and productivity in the country.
In agriculture, these are large landowners that benefit from subsidy schemes or underpriced inputs for a narrow set of crops (e.g.: sugar or wheat). In domestic-oriented manufacturing, these are large businesses that secure import protection, often at effective rates above 100 percent.
In export-oriented manufacturing, these are large exporters of well-established products, such as textiles and apparel that receive a disproportionate share of export subsidies. In services, these are financial institutions that finance large portions of relatively low-risk government debt, or real estate-related sectors that face a reduced tax burden relative to other sectors of the economy.
The World Bank report also acknowledges that Pakistan did witness brief periods of relatively fast growth of per capita GDP, however, growth has been low over the past two decades.
“Periods of relatively fast growth have been interrupted by the accumulation of external vulnerabilities that tend to result in the balance of payments crises, leading to abrupt halts of growth,” the World Bank report said.
Part of the decline in productivity is associated with low investment rates, particularly in tradable and productive sectors, which leads to limited growth of firms. Firms also do not grow because their is coordination failure that is sometimes also associated with gender norm and unadressed policies.
Saving Pakistan’s economy: The way forward
After highlighting the distortions that have stunted Pakistan’s growth and its ability to allocate its talents and resources to the most productive uses, the World Bank report also recommended solutions for Pakistan so that it can achieve a higher and sustained economic growth. To become an upper middle income country by its centenary in 2047, Pakistan needs to accelerate and sustain growth at 6 to 8 percent per year.
The World Bank report proposed a three-step approach to remove the distortion or at least reduce them. This requires strong contributions from political leadership and civil society. The first step to removing distortions in a bid to improve aggregate productivity is through a better allocation of resources by focusing on tax policy, trade policy, export schemes, size-dependent policies, agriculture subsidies, and better working conditions for women which includes safe transport.
The second step is to ensure the maximum positive impact of the alleviation of distortions. Fiscal spaces need to be improved by encouraging private investment in Pakistan to reduce the borrowing needs of the government thus allowing the release of resources for the private sector to grow. The overall business climate needs to be more harmonized to reduce the cost of doing business and more foreign direct investment can be attracted. The regulatory complexity should also be reduced.
Lastly, there needs to be a rigorous framework that entails the use of public funds to impact evaluations, and create a dynamic loop from evidence to policy making. It should be mandated by law that all tax expenditure, subsidy proposals, public sector development programs are properly costed and the results should be made public, especially any substantial expenditures incurrred. For this, the public sector needs to enage the academia to make data on direct support to firms or individuals as transparent as possible.
“Start by building capacity in this area within the Pakistan Institute of Development Economics, while expanding the network of linkages to other universities and think tanks across the country,” the World Bank report recommended on creating a strong link between the academia and public sector.