Why Investment Alone Won’t Save Pakistan’s Economy

There has always been a simple formula of economic policy in the case of emerging markets over the decades, which provides, increase investment and the growth will follow. The creation of jobs, productivity, and exports was anticipated to happen virtually overnight with the creation of roads, power plants, industrial zones, and tax incentives. That assumption is now disintegrating–and a classic example of why is Pakistan.

According to a recent post, Dr. Sami Ben Naceur, a Director in the Middle East Center of Economics and Finance at the IMF, has emphasized recent World Bank research that indicated a structural change in emerging and developing economies (EMDEs). The level of growth is no longer being achieved through investment like before. The growth of investment has become markedly lower since the 2000s and the type of sustained accelerations in investment that propelled productivity and employment before is now unusual.

This is a sobering but clear message that the volume of investments cannot be relied on any longer. Capital formation does not result in sustained growth without plausible macroeconomic structures, good institutions and reliable rules.

In the past, high investment was a sure way of getting high growth. Today, that link has weakened. The dividends of state investment can only be created in a situation where the governance is robust and fiscal space is credible. The reaction of private investment does not react to the singular incentive, but to confidence it has in macro stability, the consistency of policy, the enforcement of contracts, and the lack of unfair competition.

It is not some abstract academic thing. It gives the reason why most nations have invested heavily in infrastructure and incentives, but are languishing in low-growth equilibria. Uncredible capital brings about assets rather than productivity.

The economic policy of Pakistan has been collapsing more on investment-led growth- especially utilizing government spending on infrastructure development, incentives on taxes and in terms of incentives on specific sectors. However, the results have always been wanting. Growth spurts are soon replaced, exports level off and the balance-of-payments pressure comes back.

The international experience is painful but inevitable, Pakistan lacks projects, it lacks credibility.

Investment in an environment of fiscal pressure, policy reversals, lax regulation and slow dispute resolution cannot recoup its economic benefits. With inefficient logistics, roads cannot create competitiveness. The global firms are not attracted to industrial zones when there is uncertainty in the enforcement of contracts. Even incentives fail to mobilize the capital in the hands of the private as long as the returns remain unpredictable due to macro instability.

The world Bank’s study mentioned by Dr. Naceur helps to validate one of the core arguments of Pakistan: macroeconomic stability is not the by-product–it is the key.

Constant inflation, huge fiscal debt, recurrent exchange-rate crises and stop-go stabilization cycles are a blowback to investor confidence. Credibility signals are very sensitive to the private investors, especially. Capital will be short-term, defensive or not existing whenever policies vary often, fiscal anchors are ambiguous and external funding is threatened.

Even well-conceived investment programmes cannot pick up without plausible medium-term archetypes of debt sustainability, taxation and monetary policy.

The diminishing investment-growth relationship in the world indicates a more general fact: the institutions are the medium between expenditure and results.

The productivity of both public and privately funded investments is watered down in Pakistan by low contract enforcement, unpredictability of many regulations, bureaucratic delays, and governance failures. These risks are directly associated with the decisions of investors, who require more returns, restrict the scale of their interests, or shun the market completely.

It is due to this that investment quality is better than investment quantity. Much of the poor institutional environment can be carried out by a smaller amount of well-controlled, effectively executed investment than can a much larger amount.

The policy discourses in Pakistan are full of exaggerations on the strength of tax holidays, subsidies, and sectoral packages. International experience indicates that these tools can only be effective when incorporated into a larger reform ecosystem.

Systems that are sensitive to the private investment include predictable regulation, competition policy, financial depth, corporate governance, and availability of justice. Without them, incentives only redistribute the capital in the sectors which do not increase the aggregate productivity.

In the case of Pakistan, this would entail replacing transactional policymaking with more of systemic reform, to reduce informality, reinforce financial intermediation, reinforce competition laws and regulations and focus incentives and incentives on long-term value creation as opposed to short-term rent-seeking.

The most notable outcome of the findings of the World Bank is that investment is effective only in the presence of reforms. The successful countries integrate both capital formation and increasing institutional strength, integration of trade, development of skills and reform of governance.

In the case of Pakistan, this means that promotion of investment is not independent of export, human capital, labor market reforms as well as public administration reforms. Existing structural constraints are binding constraints; low productivity, poor institutions, limited export base. Disregarding them will guarantee poor performance in investment.

It does not mean that Pakistan should invest less, but it should invest differently, and in the same time, it should reform.

Investment is not a budget line or a political announcement to be treated as such. The reinforcement of institutions, macro credibility, regulation and uncertainty reduction are not peripheral issues; these are the pre-conditions of growth.

The evidence of the world has now been congruent with the experience of Pakistan: it is not only capital that generates prosperity. Systems do.

As long as Pakistan does not internalize such a change, that is, moving towards an investment numbers drive, rather than creating credible, predictable, and rules-based economic underpinnings, every new investment drive will provide decreasing returns. The age of effortless growth driven by investments is approaching. It is only left to do the more difficult, yet inevitable, work of systemic reform.