Pakistan's Unending Debt Enslavement

Dr. Ikramul Haq in The Friday Times

Nearing 76 years of independence, our leaders in power want to celebrate liberation from colonial rule after pushing the country into a deep debt trap. This paradox depicts what Zulfikar Ali Bhutto highlighted in his masterpiece, Myth of Independence. What makes the situation more painful is the fact that every time a new loan is obtained, those in power express jubilation as if an extraordinary goal has been achieved.

The signing of a nine month US$ 3 billion standby arrangement (SBA) with International Monetary Fund (IMF) on June 29, 2023, was commemorated like August 14, 1947 by Premier Shehbaz Sharif and Finance Minister Muhammad Ishaq Dar et al. The same was the practice in all earlier governments and mindset of previous rulers. This indeed is the worst possible manifestation of our subjugated ruling elites—tragically all governments, civil and military alike, have forced the nation to remain incarcerated in the debt prison.

In 2016, I brought up the burning issue of debt enslavement of Pakistan and the callous attitude of our ruling elites. In 2023, the situation is no different, rather worse. All the six budgets presented by the PML- N government from 2013-2018, four by the Pakistan Tehreek-i-Insaf (PTI) from 2018 to 2022 and two by Pakistan Democratic Movement (PDM) from 2022 to 2023 have common characteristics, with the main emphasis on ensuring economic enslavement through burgeoning debts. The PDM with their fourth-time Finance Minister Ishaq Dar heading the economy has finally obeyed all of IMF’s commands in a revised budget 2023-24, as he did when PML-N obtained a US$ 6.6 billion bailout package in 2013.

Our history of IMF programs is old and seemingly never ending. On December 19, 2019, as per a statement issued by IMF, its Executive Board completed the first review of Pakistan’s economic performance under the Extended Fund Facility (EFF). Completion of the review allowed Pakistan to draw Special Drawing Rights (SDR) 328 million (about US$ 452.4 million), bringing total disbursements to SDR 1,044 million (about US$ 1,440 million). It may be remembered that IMF Executive Board approved the 39-month, SDR 4,268 million (about $6 billion at the time of approval of the arrangement, or 210 percent of quota) Extended Fund Facility (EFF) for Pakistan on July 3, 2019. It was later extended to June 30, 2023, but as in the past ended unsuccessfully with new short term 8-month US$ 3 billion SBA for which complete credit is given by Ishaq Dar to Premier Shehbaz Sharif. 

For the coalition government of PTI claiming prior to elections that “we will never beg” obtaining IMF’s US$6 billion bailout was a great “achievement,” though the conditions imposed by the lender of the last resort were the most stringent in our history of getting such packages since 1958.

It is a matter of record that the PTI coalition government secured over US$13 billion in foreign loans in the fiscal year 2019-20 alone! It was the second highest amount in history. Making things more painful was the reality that we started borrowing just “to repay maturing external debt and cushion the shrinking foreign exchange reserves.” During the fiscal year 2017-18, we received gross loans of $13.2 billion from bilateral and multilateral lenders including, IMF and commercial creditors, according to a report, quoting data compiled by the Ministry of Economic Affairs.

Pakistan received $29.2 billion in foreign loans from 2017-2019 that included US$26.2 billion by the PTI government since August 2018. Out of this, US$19.2 billion was used just to repay maturing external debt and the remaining was added to “external public and publicly guaranteed debt.” The resultant increase in debt-servicing as repayments contracted as new foreign loans, increased substantially. For the fiscal year 2020-21, the cost of external debt servicing was estimated at Rs. 315 billion though we had secured over US$300 million or about Rs. 50 billion temporary relief from the G20 group’s moratorium on debt servicing.

In fiscal year 2018-19, Pakistan borrowed US$16 billion, including balance of payments support from Gulf countries, and returned US$9.1 billion worth of loans. In fiscal year 2019-20, gross foreign loans stood at US$13.2 billion and repayments amounted to slightly above US$10 billion. The Ministry of Finance said we did not have any option but “to borrow to repay maturing loans and stabilize foreign currency reserves that dipped below $10 billion in May 2020 after the outflow of hot foreign money of over $3 billion”.

According to a press report, “the withdrawal of hot foreign money, on the one hand, exposed the State Bank of Pakistan’s (SBP) ill planning and on the other highlighted the fragility of foreign exchange reserves that were built on the back of foreign borrowing. The dip in foreign exchange reserves triggered panic borrowing by the economic managers of the PTI government.” Resultantly, the government “started borrowing from the commercial, bilateral and multilateral creditors exceeded the budgetary target due to the dip in SBP’s foreign currency reserves, low inflows under the Saudi oil facility and the decision not to float Eurobonds valuing at $3 billion. The PTI government, like its predecessor, has also been unable to fully capitalize on non-debt creating inflows like exports, remittances and foreign direct investment”, the report added. 

Like the previous PML-N government, the PTI also relied on short-term foreign commercial loans. Against the budgetary estimate of $2 billion, it took $3.4 billion in foreign commercial loans. Commercial loans are always considered expensive due to their short maturity period and relatively higher interest rates compared with the official bilateral and multilateral credit. Two Chinese financial institutions, China Development Bank ($1.7 billion) and Bank of China ($500 million), provided about two-thirds or $2.2 billion of total foreign commercial loans. Dubai Bank extended $564 million, Ajman Bank $300 million, Citibank $148 million, Standard Chartered $27 million and Suisse Bank AG $205 million.

The PTI government also sought US$15 billion in gross foreign loans in 2020-21 for debt servicing and building foreign currency reserves in the absence of non-debt creating inflows. Out of the estimated external borrowing of US$15 billion, nearly US$10 billion, or two-thirds, were used to return the maturing loans, excluding interest payments. The pattern under the PDM has not changed, rather assumed further accentuation.

Decades of dependence of local and foreign debts has made Pakistan a weak and vulnerable state—though every government keeps on harping the mantra of having nukes and an unparallel ‘strategic location.’ Now Ishaq Dar after inking fresh SBA with IMF, while terming it a “great success” proudly claimed: “… the government convinced the IMF that it would be very unfair if $ 2.5 billion balance amount of the concluding program was not given to Pakistan… only potential of the mines sector of the country is six thousand billion dollars. Pakistan possesses substantial assets amounting to $3000 billion… We need to make efforts to free our economy from foreign aid.”

It may be remembered that on concluding talks with IMF in 2018, the PML-N government proudly announced: “this is the first time we have successfully completed the program in 15 years and the sixth in its 58-year relationship with IMF.” The detail story of that sordid subjugation and what happened thereafter was highlighted here in 2019 and more recently on this paper’s pages.

IMF Agreements (1958-2023)

Since 1958, Pakistan has entered into 23 programs with the IMF. On December 8, 1958 the military government signed a one-year Standby Arrangement (SBA), which it terminated prematurely in nine months. The second SBA was signed on March 16, 1965 and concluded on March 15, 1966. Yet another one-year SBA completed on May 17, 1973. The fourth SBA, signed on August 11, 1973, ended on August 10, 1974. The fifth one was on November 11, 1974 and concluded on November 10, 1975. The sixth was signed on March 9, 1977—it was terminated exactly after one year. On November 24, 1980, an Extended Fund Facility (EFF) was concluded which lasted for three years—ended on November 23, 1983. After a gap of five years, two simultaneous programs, Structural Adjustment Facility (SAF) and SBA were signed on December 28, 1988. Both continued beyond the agreed timeframe and ended in 1990 and 1992, respectively.

The ninth program, again a one-year SBA, was signed on September 16, 1993 but was terminated prematurely on February 22, 1994. The 10th program comprised two separate facilities—SAF and EFF—signed on February 22, 1994 for a period of three years. However, both the facilities were terminated much before maturity—on December 13, 1995. The 11th SBA was signed on December 13, 1995. It ended on September 30, 1997. The 12th program was of two separate facilities, the Poverty Reduction Growth Facility (PRGF) and an EFF. Both were signed on October 20, 1997 and continued till October 19, 2000. Under the 13th program, another SBA was signed on November 29, 2000 and continued until September 30, 2001.

The 14th Extended Credit Facility/PRGF was signed on June 12, 2001 and terminated on May 12, 2004. A three-year SBA was signed on November 24, 2008 but was prematurely terminated on September 12, 2010 after Pakistan could not initiate tax and energy reforms. The PML-N signed an agreement in September 2013 and was successfully completed. The PTI government’s US$ 6 billion extended EEF ended unsuccessfully on June 30, 2023. Under the just concluded SBA, the IMF would give US $3 billion dollars within a period of nine months and the first tranche of the US$ 1.1 billion would be released after the IMF board meeting in mid July 2023.

Finding the right path 

Managing a high fiscal deficit coupled with massive debt burden is the toughest challenge faced by our economic managers. The obvious and undisputed solution is substantial increase in resources and drastic reduction in spending, but it is easier said than done. For the last many decades, Pakistan’s fiscal policy has remained under immense pressure owing to perpetual failure of underperformance of Federal Board of Revenue (FBR), continued security related outlays, rise in wasteful expenditure and greater than targeted subsidies, losses of State-owned Enterprises (SOEs) etc. Other alarming elements remained great fiscal deficit, sluggish exports and high imports.

The burgeoning fiscal deficit and ever-increasing debt burden are not isolated phenomena. These are related to lack of political will to undertake fundamental structural reforms, enforce fiscal discipline, crackdown on parallel economy, increase tax collection, abolish perks and benefits of the ruling elites, eliminate wasteful expenses, dismantle rent-seeking structures, ensure rule of law, and stop reckless borrowing and ruthless spending. The perpetual failure to tap the actual tax potential has forced successive governments to rely more and more on external and internal borrowings, pushing the country into a ‘debt prison.’ In the just ended fiscal year 2023, the FBR failed to meet even the original target of Rs. 7470 billion, what to speak of the revised figure of Rs. 7640 billion even after mini budget, levying additional oppressive taxes of more than Rs. 270 billion through the Finance (Supplementary) Act of 2023 and Tax Laws (Amendment) Act, 2023. 

Collection of below potential revenue of Rs. 7.15 trillion (provisional) by FBR has raised serious questions about the State’s ability to meet its needs, in fact to ensure its economic viability, Collection of Rs. 16 trillion at federal level alone is not possible without restructuring the entire tax system for enhancing revenues to decrease/eliminate the burgeoning fiscal deficit, which is estimated at Rs. 7.5 trillion in the federal budget of 2023-24 . Even in the revised budget of 2023-24 and Finance Act 2023 approved on June 21, 2023, there is nothing to tax the high net-worth rich and mighty sections of society through progressive direct taxation.

Taxes are byproduct of economic growth and the new federal and provincial governments after general elections 2023 should not impose further oppressive taxes even if suggested by IMF. New vistas of non-tax revenues should be explored by making locked assets productive, ending circular debt and losses in SOEs, and drastic cut in wasteful non-development expenditure. Efforts should be made to achieve high economic growth of over 7 percent for a sustainable period of at least one decade.

Are we ready to put our house in order through fundamental structural reforms? Nadeem Ul Haque, Vice-Chancellor of Pakistan Institute of Development Economics (PIDE) has very rightly pointed out: “The IMF or no donor or external friend can help us with putting our house in order. We have to build a modern state and a modern society that is responsible and ready to participate in the global economy of the 21^st century. Without that we will continue to bleed and require the IMF again and again.” 

Let us take the example of Finland, a small country of 5.56 million people with GDP of nearly US$ 300 billion in 2022 (Pakistan with population of 225 million has a GDP of around US$ 350 billion, it was US$ 348.3 billion in 2021). In 2022, Finland’s tax-to-GDP ratio was 43 percent and ours only 10.1 percent.

Unfair taxation is the biggest impediment in the way of economic and industrial growth. What a tragedy that the rich and mighty get VIP facilities, plots, perks and benefits at taxpayers’ expense. They are the beneficiaries of the state’s resources—generated mainly by the poor farmers, suppressed landless tillers and toiling industrial workers. Pakistan is not a poor country—the state’s kitty is empty because of unwillingness of the rich to pay due taxes, the colossal wastage of taxpayers’ money on unproductive expenses and non-exploitation of vital natural and human resources.

Absentee landlords, a list which now include mighty generals who have been allotted State lands under award and rewards, have been resisting proper personal taxation on their enormous income and wealth. This anti-people alliance of military-judicial-civil complex, corrupt and inefficient politicians and greedy businessmen controlling and enjoying at least 90% the State resources contribute less than 2% towards national revenue collection and nobody talks about it.

We can easily generate taxes of Rs. 16 trillion through FBR alone. The dire need in today’s Pakistan is rapid industrialization, especially promoting agro-based industries to provide employment to the poor rural population and ensure fair distribution of resources to reduce inequalities. The IMF or any other donor will not tell us how to achieve these goals. We will have to promote research to find our own solutions to become a modern and dynamic nation as pleaded by Dr. Nadeem Ul Haque and many others.

Resource mobilization should be given priority to build infrastructure, facilitate growth of small and medium sized firms in the industrial sector and small farms in the agricultural sector for an employment intensive and equitable economic growth process. To end economic apartheid, large corporations, especially loss-bearing SOEs, with equity stakes for the poor can be established through public-private partnerships. This would set the stage for a structural change that could help achieve economic growth for the people and by the people, which is presently confined to the elites only.

Economics Essay 85: Consumer and Producer Surplus

Explain how the imposition of a tax on a good or service affects both consumer surplus and producer surplus.

Consumer Surplus: Consumer surplus is the economic benefit or gain that consumers receive when they are able to purchase a good or service at a price lower than the maximum price they are willing to pay. It represents the difference between the price consumers are willing to pay and the actual price they pay in the market.

Producer Surplus: Producer surplus refers to the economic benefit or gain that producers receive when they are able to sell a good or service at a price higher than the minimum price they are willing to accept. It represents the difference between the price producers receive and the actual cost of production.

The imposition of a tax on a good or service affects both consumer surplus and producer surplus. Here's how:

1. Consumer Surplus: When a tax is imposed on a good or service, the price paid by consumers increases. As a result, consumer surplus decreases. This is because consumers are now paying a higher price than before the tax, reducing the difference between the maximum price they are willing to pay and the actual price they pay. Some consumers may even choose to no longer purchase the good or service at the higher price, leading to a further reduction in consumer surplus.

2. Producer Surplus: On the producer side, the imposition of a tax increases the cost of production for producers. This reduces the producer surplus as they are now receiving a lower price for their product after deducting the tax. If the tax burden is significant, it may even lead to some producers exiting the market if they find it no longer profitable to produce the good or service.

It's important to note that the impact of the tax on consumer surplus and producer surplus may not be equal. The actual distribution of the tax burden between consumers and producers depends on the relative price elasticities of demand and supply. If the demand for the good or service is relatively inelastic (less responsive to price changes), consumers may bear a larger share of the tax burden, resulting in a greater reduction in consumer surplus. Conversely, if the supply is relatively inelastic, producers may bear a larger share of the tax burden, leading to a greater reduction in producer surplus.

Overall, the imposition of a tax on a good or service reduces both consumer surplus and producer surplus. The extent of the reduction depends on the magnitude of the tax, the price elasticities of demand and supply, and the ability of consumers and producers to adjust their behavior in response to the tax.

Fallacies of Capitalism 1: Inevitability of Inequality

How does the 'inevitability of inequality' fallacy ignore the role of social and institutional factors in perpetuating the unequal distribution of wealth and opportunities in a capitalist system?

The "inevitability of inequality" fallacy suggests that inequality is a natural and unavoidable outcome of a capitalist system, implying that it is inherently fair and just. However, this fallacy ignores the significant role of social and institutional factors that contribute to the unequal distribution of wealth and opportunities. Let me break it down with some simple examples:

1. Unequal starting points: In a capitalist system, individuals have different starting points due to factors like family wealth, education, and social connections. These disparities make it harder for those with fewer resources to compete on an equal footing. For instance, imagine two children who want to become doctors. One child comes from a wealthy family with access to the best schools and tutors, while the other child comes from a low-income family and attends underfunded schools. The unequal starting points put the second child at a significant disadvantage, limiting their opportunities for success.

2. Discrimination and bias: Social factors such as discrimination based on race, gender, or socioeconomic status can perpetuate inequality. Discrimination may lead to unequal treatment in hiring practices, education, or access to resources. For example, imagine a qualified job applicant who is denied a position because of their gender or ethnicity, while a less qualified candidate from a privileged background is chosen. Discrimination hinders individuals' ability to succeed and reinforces inequality in society.

3. Power imbalances: Capitalist systems often concentrate power and wealth in the hands of a few individuals or corporations. These powerful entities can influence policies, regulations, and institutions to their advantage, further perpetuating inequality. For instance, consider a large corporation that has significant political influence. They may lobby for policies that favour their interests, such as tax breaks or deregulation, while undermining measures that could reduce inequality, such as progressive taxation or workers' rights.

4. Lack of social mobility: Inequality can persist if social and institutional factors make it difficult for individuals to move up the social ladder. For example, imagine a society where access to quality education is primarily determined by wealth. If children from low-income families are unable to receive a good education, it becomes challenging for them to break the cycle of poverty and improve their economic prospects. This lack of social mobility reinforces existing inequalities over generations.

These examples demonstrate that the "inevitability of inequality" fallacy overlooks the social and institutional factors that contribute to the unequal distribution of wealth and opportunities in a capitalist system. By recognising these factors and working towards creating a more equitable society, we can address and reduce the systemic barriers that perpetuate inequality.

How do governments pay for wars?

Russia’s invasion of Ukraine has led to a sharp rise in defence spending writes John Paul Rathbone in the FT

Next April, for the first time in more than three centuries, Danes will have to work on the holiday of Great Prayer after the government scrapped the religious day off partly to pay for extra defence spending. 

The decision, approved in March, was deeply unpopular: in one poll, 70 per cent of Danes opposed it. But economists have praised Copenhagen for enacting a plan to meet its rising defence bills, unlike many other governments. 

“Nobody wants to pay more taxes. But at the same time, everybody wants better defence and good health services too,” John Llewellyn, a former head of economic forecasting at the OECD, said. “At some point the issue will be forced into the public arena, as nobody is clear how the funds will be raised.” 

Japan, worried by China’s rise and the risk of war in the Indo-Pacific, has not specified how it will fund a planned two-thirds increase in its defence budget by 2027. The UK, spurred by Russia’s war on Ukraine, wants to eventually boost military spending to 2.5 per cent of gross domestic product but only as “fiscal and economic circumstances allow”. 

Germans, unnerved by Russian aggression, want to increase defence spending, but not if it means losing a public holiday. France has not detailed how it will pay for a planned 40 per cent rise in its military budget over the next five years. The same is true for Poland, which aims to almost double its spending to 4 per cent of GDP. 

How to pay for wars is an issue as old as war itself. Cicero, the Roman statesman, said the “sinews of war are infinite money”. In 1694, the Bank of England was founded to help William III finance war with France. Today, even as the world appears increasingly chaotic, spending looks more finite amid an environment of rising interest rates and high government debt burdens. 

Europe is in the middle of its biggest armed conflict since 1945. Geopolitical tensions between China and Taiwan are on the rise. Iran may soon be able to make a nuclear weapon. In addition, global challenges such as climate change and migration may also force governments to spend big. 

The Stockholm International Peace Research Institute (Sipri) calculates that global defence spending rose by 4 per cent to reach a record $2.24tn last year. This year, it is set to continue rising, even as higher rates increase governments’ borrowing costs. 

Economists such as Lawrence Summers, former US Treasury secretary, and Olivier Blanchard, former chief economist at the IMF, have suggested higher defence spending could even contribute to driving interest rates higher. 

“One scenario is that countries which already increased defence spending in 2022 continue to do so, while those that have said they will begin to increase defence spending in 2023 actually start,” said Diego Lopes Da Silva, senior researcher at Sipri’s military expenditure and arms production programme. 

Among the world’s five biggest defence spenders, the numbers are mind-boggling. 

In the US, politicians carved out an exemption in the debt ceiling talks to allow for a 3 per cent rise in military spending to $886bn in 2024. China’s defence budget, which Sipri estimates to be $292bn, is on track this year for its 29th consecutive annual increase. 

Russia, which spent an estimated $86bn on defence last year, has meanwhile said there will be “no funding restrictions” for its war against Ukraine, even as its budget remains classified. India plans to increase its defence budget by 13 per cent this coming year to $73bn, while Saudi Arabia, fearful of a nuclear Iran, now spends 7.5 per cent of GDP on defence, second only to Ukraine. 

In Nato, only seven of its 31 members last year met the alliance’s self imposed defence spending target of 2 per cent of GDP. If they all did, total outlays would rise by over $150bn a year, FT research shows. 

While war was one of “the most expensive and least productive of human activities”, James Grant, a financial historian and editor of the Grant’s Interest Rate Observer, noted that there was “also a tendency for peace to explode periodically in our faces.” 

Grant added: “When that happens, there is often a confluence of promises to pay and money printing.” 

As a general rule, “short, hot wars” that require a sudden surge in spending are financed by extra borrowing, while “long, cold wars” that require sustained defence spending are financed by taxes. 

The Napoleonic and first and second world wars were largely financed by debt. By contrast, during the long decades of the cold war, the west financed its defence spending through higher taxation. In the quarter century that preceded the fall of the Berlin Wall, tax revenues among OECD countries rose on average to more than 32 per cent of GDP from 25 per cent, while debt levels generally fell. 

“For short wars, governments can finance the expenditure by borrowing,” said James Macdonald, author of A Free Nation Deep in Debt, a history of public finance and wars. “But if there is a long war, the more it goes on, the more you have to use other methods, such as taxes.” 

Wars are also often accompanied by higher inflation and the suppression of interest rates. During the second world war, US wholesale prices rose by an average of 8.2 per cent a year, even as interest rates on long-term debt were fixed at 2.5 per cent — a gap that helped Washington inflate away the value of the bonds the US issued. 

“All wars are generally associated with some inflation. Politicians don’t like to put up taxes [to pay for wars], and inflation is a hidden tax,” said Richard Sylla, co-author of A History of Interest Rates. 

Economists suspect rebuilding long-term defence spending, which has dropped by a third across OECD countries since the fall of the Berlin Wall, would require a mix of higher taxes and spending cuts elsewhere. 

“The politics can’t be avoided,” said Llewellyn. “Societies face a series of conundrums and some difficult choices have to be made.”

Externalities and Taxes - What to do when the interests of the individual and society do not coincide?

 From The Economist

LOUD conversation in a train carriage that makes concentration impossible for fellow-passengers. A farmer spraying weedkiller that destroys his neighbour’s crop. Motorists whose idling cars spew fumes into the air, polluting the atmosphere for everyone. Such behaviour might be considered thoughtless, anti-social or even immoral. For economists these spillovers are a problem to be solved.

Markets are supposed to organise activity in a way that leaves everyone better off. But the interests of those directly involved, and of wider society, do not always coincide. Left to their own devices, boors may ignore travellers’ desire for peace and quiet; farmers the impact of weedkiller on the crops of others; motorists the effect of their emissions. In all of these cases, the active parties are doing well, but bystanders are not. Market prices—of rail tickets, weedkiller or petrol—do not take these wider costs, or “externalities”, into account.

The examples so far are the negative sort of externality. Others are positive. Melodious music could improve everyone’s commute, for example; a new road may benefit communities by more than a private investor would take into account. Still others are more properly known as “internalities”. These are the overlooked costs people inflict on their future selves, such as when they smoke, or scoff so many sugary snacks that their health suffers.

The first to lay out the idea of externalities was Alfred Marshall, a British economist. But it was one of his students at Cambridge University who became famous for his work on the problem. Born in 1877 on the Isle of Wight, Arthur Pigou cut a scruffy figure on campus. He was uncomfortable with strangers, but intellectually brilliant. Marshall championed him and with the older man’s support, Pigou succeeded him to become head of the economics faculty when he was just 30 years old.

In 1920 Pigou published “The Economics of Welfare”, a dense book that outlined his vision of economics as a toolkit for improving the lives of the poor. Externalities, where “self-interest will not…tend to make the national dividend a maximum”, were central to his theme.

Although Pigou sprinkled his analysis with examples that would have appealed to posh students, such as his concern for those whose land might be overrun by rabbits from a neighbouring field, others reflected graver problems. He claimed that chimney smoke in London meant that there was only 12% as much sunlight as was astronomically possible. Such pollution imposed huge “uncharged” costs on communities, in the form of dirty clothes and vegetables, and the need for expensive artificial light. If markets worked properly, people would invest more in smoke-prevention devices, he thought.

Pigou was open to different ways of tackling externalities. Some things should be regulated—he scoffed at the idea that the invisible hand could guide property speculators towards creating a well-planned town. Other activities ought simply to be banned. No amount of “deceptive activity”—adulterating food, for example—could generate economic benefits, he reckoned.

But he saw the most obvious forms of intervention as “bounties and taxes”. These measures would use prices to restore market perfection and avoid strangling people with red tape. Seeing that producers and sellers of “intoxicants” did not have to pay for the prisons and policemen associated with the rowdiness they caused, for example, he recommended a tax on booze. Pricier kegs should deter some drinkers; the others will pay towards the social costs they inflict.

This type of intervention is now known as a Pigouvian tax. The idea is not just ubiquitous in economics courses; it is also a favourite of policymakers. The world is littered with apparently externality-busting taxes. The French government imposes a noise tax on aircraft at its nine busiest airports. Levies on drivers to counterbalance the externalities of congestion and pollution are common in the Western world. Taxes to fix internalities, like those on tobacco, are pervasive, too. Britain will join other governments in imposing a levy on unhealthy sugary drinks starting next year.

Pigouvian taxes are also a big part of the policy debate over global warming. Finland and Denmark have had a carbon tax since the early 1990s; British Columbia, a Canadian province, since 2008; and Chile and Mexico since 2014. By using prices as signals, a tax should encourage people and companies to lower their carbon emissions more efficiently than a regulator could by diktat. If everyone faces the same tax, those who find it easiest to lower their emissions ought to lower them the most.

Such measures do change behaviour. A tax on plastic bags in Ireland, for example, cut their use by over 90% (with some unfortunate side-effects of its own, as thefts of baskets and trolleys rose). Three years after a charge was introduced on driving in central London, congestion inside the zone had fallen by a quarter. British Columbia’s carbon tax reduced fuel consumption and greenhouse-gas emissions by an estimated 5-15%. And experience with tobacco taxes suggests that they discourage smoking, as long as they are high and smuggled substitutes are hard to find.

Champions of Pigouvian taxes say that they generate a “double dividend”. As well as creating social benefits by pricing in harm, they raise revenues that can be used to lower taxes elsewhere. The Finnish carbon tax was part of a move away from taxes on labour, for example; if taxes must discourage something, better that it be pollution than work. In Denmark the tax partly funds pension contributions.

Pigou flies

Even as policymakers have embraced Pigou’s idea, however, its flaws, both theoretical and practical, have been scrutinised. Economists have picked holes in the theory. One major objection is the incompleteness of the framework, since it holds everything else in the economy fixed. The impact of a Pigouvian tax will depend on the level of competition in the market it is affecting, for example. If a monopoly is already using its power to reduce supply of its products, a new tax may not do any extra good. And if a dominant drinks firm absorbs the cost of an alcohol tax rather than passes it on, then it may not influence the rowdy. (A similar criticism applies to the idea of the double dividend: taxes on labour could cause people to work less than they otherwise might, but if an environmental tax raises the cost of things people spend their income on it might also have the effect of deterring work.)

Another assault on Pigou’s idea came from Ronald Coase, an economist at the University of Chicago (whose theory of the firm was the subject of the first brief in this series). Coase considered externalities as a problem of ill-defined property rights. If it were feasible to assign such rights properly, people could be left to bargain their way to a good solution without the need for a heavy-handed tax. Coase used the example of a confectioner, disturbing a quiet doctor working next door with his noisy machinery. Solving the conflict with a tax would make less sense than the two neighbours bargaining their way to a solution. The law could assign the right to be noisy to the sweet-maker, and if worthwhile, the doctor could pay him to be quiet.

In most cases, the sheer hassle of haggling would render this unrealistic, a problem that Coase was the first to admit. But his deeper point stands. Before charging in with a corrective tax, first think about which institutions and laws currently in place could fix things. Coase pointed out that laws against nuisance could help fix the problem of rabbits ravaging the land; quiet carriages today assign passengers to places according to their noise preferences.

Others reject Pigou’s approach on moral grounds. Michael Sandel, a political philosopher at Harvard University, has worried that relying on prices and markets to fix the world’s problems can end up legitimising bad behaviour. When in 1998 one school in Haifa tried to encourage parents to pick their children up on time by fining them, tardy pickups increased. It turned out that parental guilt was a more effective deterrent than cash; making payments seems to have assuaged the guilt.

Besides these more theoretical qualms about Pigouvian taxes, policymakers encounter all manner of practical ones. Pigou himself admitted that his prescriptions were vague; in “The Economics of Welfare”, though he believed taxes on damaging industries could benefit society, he did not say which ones. Nor did he spell out in much detail how to set the level of the tax.

Prices in the real world are no help; their failure to incorporate social costs is the problem that needs to be solved. Getting people to reveal the precise cost to them of something like clogged roads is asking a lot. In areas like these, policymakers have had to settle on a mixture of pragmatism and public acceptability. London’s initial £5 ($8) fee for driving into its city centre was suspiciously round for a sum meant to reflect the social cost of a trip.

Inevitably, a desire to raise revenue also plays a role. It would be nice to believe that politicians set Pigouvian taxes merely in order to price in an externality, but the evidence, and common sense, suggests otherwise. Research may have guided the initial level of a British landfill tax, at £7 a tonne in 1996. But other considerations may have boosted it to £40 a tonne in 2009, and thence to £80 a tonne in 2014.

Things become even harder when it comes to divining the social cost of carbon emissions. Economists have diligently poked gigantic models of the global economy to calculate the relationship between temperature and GDP. But such exercises inevitably rely on heroic assumptions. And putting a dollar number on environmental Armageddon is an ethical question, as well as a technical one, relying as it does on such judgments as how to value unborn generations. The span of estimates of the economic loss to humanity from carbon emissions is unhelpfully wide as a result, ranging from around $30 to $400 a tonne.

It’s the politics, stupid

The question of where Pigouvian taxes fall is also tricky. A common gripe is that they are regressive, punishing poorer people, who, for example, smoke more and are less able to cope with rises in heating costs. An economist might shrug: the whole point is to raise the price for whoever is generating the externality. A politician cannot afford to be so hard-hearted. When Australia introduced a version of a carbon tax in 2012, more than half of the money ended up being given back to pensioners and poorer households to help with energy costs. The tax still sharpened incentives, the handouts softened the pain.

A tax is also hard to direct very precisely at the worst offenders. Binge-drinking accounts for 77% of the costs of excessive alcohol use, as measured by lost workplace productivity and extra health-care costs, for example, but less than a fifth of Americans report drinking to excess in any one month. Economists might like to charge someone’s 12th pint of beer at a higher rate than their first, but implementing that would be a nightmare.

Globalisation piles on complications. A domestic carbon tax could encourage people to switch towards imports, or hurt the competitiveness of companies’ exports, possibly even encouraging them to relocate. One solution would be to apply a tax on the carbon content of imports and refund the tax to companies on their exports, as the European Union is doing for cement. But this would be fiendishly complicated to implement across the economy. A global harmonised tax on carbon is the stuff of economists’ dreams, and set to remain so.

So, Pigou handed economists a problem and a solution, elegant in theory but tricky in practice. Politics and policymaking are both harder than the blackboard scribblings of theoreticians. He was sure, however, that the effort was worthwhile. Economics, he said, was an instrument “for the bettering of human life.”

The secret of Dubai

 

Imran Khan alone is not to blame

Pervez Hoodbhoy in The Dawn

PAKISTAN’S mad rush towards the cliff edge and its evident proclivity for collective suicide deserves a diagnosis, followed by therapy. Contrary to what some may want to believe, this pathological condition is not one man’s fault and it didn’t develop suddenly. To help comprehend this, for a moment imagine the state as a vehicle with passengers. It is equipped with a steering mechanism, outer body, wheels, engine and fuel tank.

Politics is the steering mechanism. Whoever sits behind the wheel can choose the destination, speed up, or slow down. Choosing a driver from among the occupants requires civility, particularly when traveling along a dangerous ravine’s edge. If the language turns foul, and respect is replaced with anger and venom, animal emotions take over.

Imran Khan started the rot in 2014 when, perched atop his container, he hurled loaded abuse upon his political opponents. Following the Panama exposé of 2016, he accused them — quite plausibly in my opinion — of using their official positions for self-enrichment. How else could they explain their immense wealth? For years, he has had no names for them except chor and daku.

But the shoe is now on the other foot and Khan’s enemies have turned out no less vindictive, abusive and unprincipled. They have recorded and made public his recent intimate conversations with a young female, dragged in the matter of his out-of-wedlock daughter, and exposed the shenanigans of his close supporters.

More seriously, they have presented plausible evidence that Mr Clean swindled billions in the Al Qadir and Toshakhana cases. Which is blacker: the pot or the kettle? Take your pick.

Everyone knows politics is dirty business everywhere. Just look at the antics of Silvio Berlusconi, Italy’s corrupt former prime minister. But if a vehicle’s occupants include calm, trustworthy adjudicators, the worst is still avoidable. Sadly Pakistan is not so blessed; its higher judiciary has split along partisan lines.

The outer body is the army, made for shielding occupants from what lies outside. But it has repeatedly intruded into the vehicle’s interior, seeking to pick the driver. Free-and-fair elections are not acceptable. Last November, months after the Army-Khan romance soured, outgoing army chief General Qamar Javed Bajwa confessed that for seven decades the army had “unconstitutionally interfered in politics”.

But a simple mea culpa isn’t enough. Running the economy or making DHAs is also not the army’s job. Officers are not trained for running airlines, sugar mills, fertiliser factories, or insurance and advertising companies. Special exemptions and loopholes have legalised tax evasion and put civilian competitors at a disadvantage.

A decisive role in national politics, whether covert or overt, was sought for personal enrichment of individuals. It had nothing to do with national security.

While Khan has focused solely on the army’s efforts to dislodge him, his violent supporters supplement these accusations by disputing its unearned privileges. When they stormed the GHQ in Rawalpindi, attacked an ISI facility in Pindi, and set ablaze the corps commander’s house in Lahore, they did the unimaginable. But, piquing everyone’s curiosity, no tanks confronted the enraged mobs. No self-defence was visible on social media videos. The bemused Baloch ask, ‘What if an army facility had been attacked in Quetta or Gwadar?’ Would there be carpet bombing? Artillery barrages?

The wheels that keep any economy going are business and trade. Pakistanis are generally very good at this. Their keen sense for profits leads them to excel in real-estate development, mining, retailing, hoteliering, and franchising fast-food chains. But this cleverness carries over to evading taxes, and so Pakistan has the lowest tax-to-GDP ratio among South Asian countries.

The law appears powerless to change this. When a trader routinely falsifies his income tax return, all guilt is quickly expiated by donating a dollop of cash to a madressah, mosque, or hospital. In February, the pious men of Markazi Tanzeem Tajiran (Central Organisation of Traders) threatened a countrywide protest movement to forestall any attempt to collect taxes. The government backed off.

The engine, of course, is what makes the wheels of an economy turn. Developing countries use available technologies for import substitution and for producing some exportables. A strong engine can climb mountains, pull through natural disasters such as the 2022 monster flood, or survive Covid-19 and events like the Ukraine war. A weak one relies on friends in the neighbourhood — China, Saudi Arabia, and UAE — to push it up the hill. By dialling three letters — I/M/F — it can summon a tow-truck company.

The weakness of the Pakistani engine is normally explained away by various excuses — inadequate infrastructure, insufficient investment, state-heavy enterprises, excessive bureaucracy, fiscal mismanagement, or whatever. But if truth be told, the poverty of our human resources is what really matters.

For proof, look at China in the 1980s, which had more problems than Pakistan but which had an educated, hard-working citizenry. Economists say that these qualities, especially within the Chinese diaspora of the 1990s, fuelled the Chinese miracle.

The fuel, finally, is the human brain. When appropriately educated and trained, it is voraciously consumed by every economic engine. Pakistan is at its very weakest here. Small resource allocation for education is just a tenth of the problem.

More importantly, draconian social control through schools and an ideology-centred curriculum cripples young minds at the very outset, crushing independent thought and reasoning abilities. Leaders of both PTI and PDM agree that this must never change. Hence Pakistani children have — and will continue to have — inferior skills and poorer learning attitudes compared to kids in China, Korea, or even India.

The prognosis: it is hard to see much good coming out of a screeching catfight between rapacious rivals thirsting for power and revenge. None have a positive agenda for the country.

While the much-feared second breakup of Pakistan is not going to happen, the downward descent will accelerate as the poor starve, cities become increasingly unlivable, and the rich flee westwards. Whether or not elections happen in October and Khan rises from the ashes doesn’t matter. To fix what has gone wrong over 75 years is what’s important.