The author is the Director, Poverty and Social Policy Department, World Bank. The views expressed in this article are personal and do not represent those of the World Bank.

 The economic situation of the past several months in Pakistan has elicited two different kinds of responses. There are either those who blame the economic managers of the country for their "ineptness" and mishandling of the situation or a second group that holds the international financial institutions such as the IMF and the World Bank responsible for all our economic woes. This article will attempt to demonstrate that economic policy outcomes in today’s world are more complex than the above simplistic analysis suggests. Most outcomes are determined by the interaction of a host of political, social and economic factors, the cultural milieu in which the institutions work and the external conditions that impinge on them. But the underlying difference between the countries that have been successful in eliciting positive or favorable results for their population and those who have failed to achieve so lies, despite many variations, in the simultaneous adaptation of policies and institutional settings in a consistent and credible manner over a longer period of time. What can we, in Pakistan, learn from the experience of successful countries that have avoided serious economic difficulties and promoted equitable growth and better living standards for their people?

First and foremost is the credibility of policies and the policy makers. There are two components of policy credibility. First, how do the domestic economic agents perceive government policies? Even in cases where the policy content is sub-optimal or less than desirable, economic agents—both domestic and foreign—should be able to make long-term decisions expecting that the current set of parameters will remain in force for the next few years without major surprises, drastic or abrupt changes. In Pakistan, every successive government has followed policies that are unpredictable, impulsive and are of short duration. There have been too frequent changes, sometimes contradictory in nature and at times catering exclusively to special vested interests rather than meeting national economic objectives. The Statutory Regulatory Orders (SROs) are issued practically everyday exempting, withdrawing, imposing, amending, modifying, deleting, superseding, overriding, the earlier orders thereby creating confusion, uncertainty and variance in application. The complex maze of these and similar orders and gazette notifications does not just create opaqueness in interpretation of policies. It confers enormous power of discretion, arbitrariness and harassment to government functionaries of all kinds in a cascading manner along the chain—central governments, provincial governments, district councils, municipalities, public sector corporations, public utilities, etc. The implementation of the policies under these circumstances is not only indifferent but highly variable with connections, sifarish and bribes playing the decisive role in final decision making. Thus the credibility of policies in Pakistan among the investors is close to none and, although the investment regime has become favorable, this lack of policy certainty has remained a serious deterrent. This can be illustrated with a real world example.

Let us assume that an importer of component parts is levied tariff by the Custom official at a lower rate than his competitor because of difference in the interpretation of a particular SRO under which the import was allowed. This lower duty will, therefore, trigger lowering of sales tax or GST, Iqra, or other surcharges in force at that time, octroi duty, the District Council charges and all other similar dues. Another importer of the same components who is forced to pay a higher rate because the custom appraiser draws on a different SRO to assess the tariff rate will consequently pay higher charges all along the line and will, therefore, be put out of business as he cannot compete under these circumstances. Alternatively, he may have to bribe his way out. This source of unevenness in the application of government policy is a bigger threat to the existing and potential investors in any country than a higher rate of duty itself. Lack of credibility, inconsistency, unpredictability and the fear or implicit threat of frequent and unforeseen changes in the government policies are inimical to the expansion of industrial capacity in the country. The Philippines, which until 1985 had lower level of manufactured exports than Pakistan (Pakistan $1.6 billion versus The Philippines $1.2 billion) was able to increase manufactured exports ten times during a decade ($12 billion by 1996) while Pakistan had reached the level of $6.8 billion.

The other part of the credibility is whether the governments stick to the agreements reached with the international financial institutions (IFIs). If there are domestic political constraints in implementing some of the actions proposed under these agreements, these should be sorted out before accepting them. There is not much point in accepting reforms that cannot be realistically implemented and then backtracking and reversing them. This depletes the reservoir of goodwill for the country among the management and the staff of the IFIs.

The wrath against the IMF and the World Bank is highly misplaced. The source of external financing is fast shifting away from official capital flows (except for the poorest countries). In this world dominated by private capital flows, it is the credit rating agencies, the fund managers and the market analysts that are acquiring the power to punish irresponsible and recalcitrant governments. At least with the IMF you can enter into negotiations and present your viewpoints, share your plans and reach an agreement on the actions to be taken. You have a representative on the Executive Board who can informally and formally articulate your viewpoint, defend your position and explain as to why the agreement was breached. But with the highly diffused set of fund managers scattered all over the globe with no single focal point to talk to, it is the policy actions and deeds of borrowing governments that speak for themselves, not the words or the letters of intent. The consequences of the violation of agreements with the IMF, which is an international publicly owned cooperative institution, are unlikely to be as severe as those resulting from a shift in market sentiment and market confidence. The example of Mexico in December 1994 should remain a constant reminder of the wrath of the financial markets.

Second, the interrelationship between various economic policies and their full impact—both primary and secondary should be fully examined and the decisions taken after taking into account the costs and benefits of various alternatives. In Pakistan, these relationships are seldom fully analyzed and, if they are analyzed, the trade-offs involved in the adoption of different policies are not fully discussed among the various parts of the Government. There is a tendency to examine each policy in isolation as if its implications do not extend beyond the targeted goal at hand. Let me illustrate this with the example of trade-off between the objective of increased tax revenue and the goal of raising the volume of manufactured exports.

If the instrument for reducing budget deficit is increased tax revenues then, in absence of extended coverage of taxpayers or tax base, the burden will fall on the organized, formal manufacturing and supporting service industry that is already paying taxes of all sorts The businesses in the formal sector can respond to this increased tax burden in any of the following three ways. First, the honest exporting firms will attempt to pass this burden to their customers abroad. But with the international prices given and alternate sources of supply available at that price, the customers will naturally divert their orders to cheaper sources, resulting in the loss for Pakistani exports and a decline in the value of total export receipts. If the level of imports remain unchanged, this decline in export receipts will translate into higher current account deficit which will require external borrowing to meet this increased deficit. The tax policy decision has, therefore, resulted in adverse effects on exports and consequently in an increase in the external debt burden of the country (assuming that the foreign exchange reserve position is not that strong to absorb the deficit). A second way of avoiding tax burden is to switch production and sales from the formal sector to the informal sector. As the incomes in the informal sector remain, by and large, undocumented, unrecorded or recorded at lower values, the total tax liability will either remain unchanged or become reduced. The Government loses tax revenues or at best does not gain any additional revenues by changes in the tax rate. The "unrecorded" income accumulated in this process will add to the liquidity overhang in the economy and not add to the expansion of the productive capacity which can generate employment, tax revenue and exports. Finally, the unscrupulous among the businessmen would get in touch with the tax authorities and minimize the additional tax payment by winning over the assessing officer and his staff in exchange for the right sum of "nazrana." Both the businessman and the tax officer are better off under this arrangement as the businessman pays only a fraction of the tax that he is obligated to pay and the tax officer adds to his private wealth. In this case, the additional tax burden has conferred a gift which is distributed among the businessmen and the tax officials. The economic consequences are, however, the same in all three cases with benefits distributed differently, i.e., the Government’s tax revenues remain unchanged or decline with losses to the country’s export receipts.

It is true that the tax-GDP ratio in Pakistan is fairly low compared to other countries but the right measures are to widen the taxpayer base, eliminate all kinds of discretionary exemptions and loopholes and raise the incentive, recover direct taxation on a progressive basis, tax conspicuous consumption and raise the incentive—pain threshold for tax administration and enforcement.

The third trait of the successful countries is that economic policy making should be highly participatory involving the broadest range of stakeholders—private sector, industrial organizations, professional cadre, farmer associations, trade unions, NGOs, etc. There is increased recognition that the Government alone cannot solve all the development problems and solutions have to be derived from a dynamic exchange of information, experience and resources among the affected stakeholders.

Except for a few key decisions such as exchange rate, interest rate, etc., that need to be made in strict secrecy as they impinge upon market behavior, all long-time development policy decisions should be made in an open mode of consultation, shared analysis, joint action and monitoring by all stakeholders and not by the Government alone. The failure of central economic planning model of the 1960s and 1970s occurred because the governments and their planners did not have complete information as to how changes in the key variables will affect the behavior of the economic agents and how they will respond to these stimuli. Policy implementation is an ongoing, non-linear process in which the ability to be flexible and make changes when required is an important determinant of success. When the affected parties participate in designing these changes after negotiations, consultations and consensus, the chances of that policy being implemented are brighter. This participatory process whereby those affected by the proposed policies are able to aggregate and articulate their needs and interests will help prevent government officials from making errors while the private sector will be more likely to shift their own behavior from gaining privileged access, seeking special favors and other forms of rent-seeking to influencing the overall policy and institutional environment. By dealing directly with the kinds of hidden resentments and disagreements in this process of inclusive and broad-based decision making, the delays, backsliding and obfuscation, which normally characterize the implementation record of policies in Pakistan, will be avoided.

For example, if the representatives of cotton growers, ginners, spinners, weavers, value added manufactures and exporters are brought together with the Ministries of Commerce, Agriculture, Finance, State Bank of Pakistan, CEC, CBR, EPB, the provincial governments, etc., and the cotton textile policy for the country is developed in an open, discursive mode and decisions are made on the basis of a consensus arrived after these discussions, the chances are that the textile policy thus developed will be owned, respected and implemented by all the parties concerned. But if there is a perception—even erroneous—that bilateral deals are being struck behind closed doors to favor particular lobbies or groups or decisions are being made on purely political bargaining considerations, the implementation of the policy will be fraught with grave difficulties. The bickerings, rivalries and strifes between different groups to maximize their own returns cannot be eliminated and one or the other group will remain dissatisfied by the final decision, but the veracity and transparency of the whole process will minimize the risks of reversal of the policy. These policy decisions should be communicated widely and the public fully informed about the content of the policies. In that event, public opinion and the media will condemn those who would like to sabotage the broadly agreed decisions.

Enhancing public understanding of economic issues is crucial for sustaining the economic reform process. The availability of a broad flow of information is central to this process and also for improving governance. The greatest damage that has been done to good governance in Pakistan has been the indiscriminate use of Official Secrets Act. The unscrupulous officials hide their malpractices and misdeeds behind this Act while the politicians take the refuge of the Act to conceal and mislead the public on the ill-advised decisions they take to advance their personal rather than national interests. This Act has, in fact, diluted the accountability of the public officials and been a major contributing factor to the growing mistrust between the Government and the public-at-large. We should ask ourselves as to why the villagers listen to the BBC and believe it rather than the Radio Pakistan. The sooner this Act is done away, the better off the country will be.

These principles of policy credibility, analysis of trade-offs between various policies, and stakeholder participation in policy formulation and implementation are in fact interwoven and reinforce each other. If there is broad-based participation of the relevant stakeholders in the design of the policies, this will bring in different perspectives and the trade-offs involved will become quite apparent. As the costs and benefits of these trade-offs are analyzed openly, a consensus is reached at a set of policies that achieve maximum benefits to the economy at the least cost. However, the costs and benefits to different stakeholders will vary but the openness and transparent process of decision making will help to mute the losers or ways could be found to compensate the losers in a non-distortionary way. If these policies are owned by the relevant stakeholders, then they will be implemented generating positive results for the economy was a whole. As successful implementation of policies reduces the temptation for backsliding, reversals or failure, the credibility of policies will be established and reinforced over time. This is a path for a win-win situation but getting there is extremely difficult. It will require a change in mind set and attitudes—from being paternalistic or mai bap to allowing more participatory processes, from behaving as an authoritarian to building consensus, from highly centralized decision making to more decentralized authority at the local level, from an arrogant, all knowing posture to that of seeking out and listening to diverse viewpoints and from a culture of intolerance, sycophancy and personal loyalty at all costs to a system where it is the strength of ideas and competence that counts. No doubt, this is a difficult and complex agenda, but in order to restore our credibility, we have no other choice but to move in that direction.

If we had followed these principles scrupulously, then neither the economic managers of the country nor the IFIs will be blamed for our economic difficulties. In the first instance, there would have been no need for approaching the IMF. The IMF and the financial markets would have found our policies credible and despite economic difficulties that do arise from time to time in any economy, we would have been spared the temporary shocks and serious disequilibrium that we now face from time to time. In the absence of a track record of policy credibility and violent digressions, an agreement with the IMF becomes the proxy for such credibility for both external and domestic financial markets. An agreement signals that policy is on the right track and absence of an agreement implies the opposite. The markets, therefore, act in accordance with this signaling mechanism. A total reliance on this signaling device, i.e., agreement with the IMF, has serious consequences for the domestic policy makers. Anytime an agreement is not reached with the IMF, market confidence will be eroded and capital outflow will take place, weakening the foreign reserves position. But the Fund, to retain its reputation in the international financial markets as a vigilant watchdog, would have to insist on tougher measures and up-front actions from the governments that have displayed poor track record in implementing the past programs. These measures may have high political costs domestically. In case of Mexico, it was the international financial markets and not the IMF that penalized the country for the loss of credibility. As the Salinas regime had pre-committed itself to a fixed exchange rate, the decision to devalue by the incoming Zedillo regime was considered as a breach of that commitment. The country had to suffer huge and sudden capital outflows, depreciation of currency, inflation and economic recession. The lesson to be drawn from this evidentiary argument is that the countries should not allow their economies to deteriorate in the first place and then blame the IMF for their economic woes.

The economic managers cannot be blamed either. They inherited an inflexible set of public finance obligations from the past. The privileged minority in the country who have amassed enormous private wealth at the expense of the state are unwilling to give up even a small fraction of this wealth for the common good. There is a cultural milieu in which any course of action has to be navigated within a complex web of social connections and obligations where the boundaries between public interest and private realm are either blurred or do not exist. The constant threat to external and internal security of the country imposes extraordinary fiscal burden.

So who is to be blamed for the current economic situation or what happened three years ago or may again happen in the future? The free ride enjoyed by the country’s powerful elites—1 to 2 percent of the population is the root case of our woes. Unless this comes to an end, the economic situation will not improve in any fundamental way. It is only when the hardworking, honest, dedicated, motivated men and women of Pakistan—poor or rich, educated or illiterate—are able to earn their livelihoods and expand their enterprises and businesses by dint of their own labor, wits, imagination, innovation and investment rather than through connections, political favors, evasion of taxes, non-payment of loans and acts of "hera pheri" or "chakar chalao" that this free ride will end. This is not wishful thinking. That citadel of crony capitalism—The Philippines—which was no better than Pakistan in terms of the stronghold of the elites, has begun to transform remarkably by getting rid of the vested interests under the strong and committed leadership of President Ramos. Why could not the same happen in Pakistan? By the way, Ramos is a popularly elected leader under a democratic system and is neither a hand-picked technocrat nor a military leader.