THOUGH many of economic indicators were showing a healthy trend in 2018, the PTI government thought that she had found the country under a debt crisis. The government attempted to follow the principle of austerity to drive the country out of perceived crisis. Unfortunately, this policy is based on very poor understanding of fundamental of economics and the austerity as a national policy more often leads to economic crisis. In 1929, a severe economic recession started in Wall Street and soon it expanded to many parts of globe. The depression caused world GDP to fall by about 15% and the industrial production by about 40%. In the United States, the unemployment increased by about 5 multiples of the pre-crisis period. The recession lasted more than five years and was the longest recession of twentieth century. This economic recession provided opportunities for evolution of numerous new economic theories and new ways of looking at the economy.
There are many conflicting theories explaining about how the recession started; however, there is a general consensus about the reasons for its intensity and its unusually long tenure. The reasons for deepening of the crisis and its prolonged tenure are the austerity type actions of governments and central banks. Keynes who is recognized as the most influential economists of twentieth century says that the failure of government to spend enough deepened the crisis. Friedman, the father of monetarist school of thought argues that failure of central banks to pump enough money into economy is responsible for deepening of crisis. Unfortunately, the incumbent government is adapting the two policies which were held responsible for the crisis by the two great economists.
The dynamics of macro-economy are very different from the individual level economics. At individual level, you can advise someone to save more as a policy for better economic future. But at the economy level, such an action leads to negative consequences. If a large number of individuals start spending less, the businessmen will find fewer customers and will reduce the staff at their disposal. The factories will find fewer orders and will reduce their production and employment. These unemployed people will have little money to spend which will spark second round of spiral of reduction, and this spiral will continue.
The opposite will happen if people and/or government start spending more. Therefore the Keynes advised that government should run in deficit and should spend excessively during the crisis to come out of the recession. A famous quote referred to Keynes reads as ‘the government should pay the people to dig holes in the ground and then to fill them up’. The quote implies the government should spend even if there is no feasibility of the spending, because it will enable people to purchase, and this purchasing will add to someone’s income that will again be spent in the economy.
Despite high inflation during past two years, the nominal salaries of the government employees are stuck at the level of 2018, which means a reduction in real income by about 20% during past 27 months. The nominal development expenditures are reduced from 1.1 trillion to 0.89 trillion, implying a much larger reduction in real terms. Such reduction in government spending has initiated downward spiral that we are witnessing. On the other hand, the monetary policy is non-accommodative. The government has borrowed about 6 trillion from commercial banks to pay to the central bank. Such a monetary policy is a big hurdle in creating the liquidity needed to maintain the pace of progress. At the time when the central banks around the globe have reduced the interest rate to near zero, Pakistan is having 7% interest rate which is one of the highest in the world. Such actions would only intensify the crisis instead of doing any good for the economy.
The governments all-around the globe have adapted the policy of excessive spending and accommodative monetary environment during the crisis caused by pandemic. There are many countries that spent more than 50% of their normal budget in the Covid-19 financing. The interest rates were reduced drastically and trillion of dollars were pumped into the economy to maintain the pace of growth at pre-Covid trajectory. The same policy needs to be adapted by Pakistan if the government wants to bring back the growth rate of 2017-18, which is needed to accommodate the increasing population of youth. If the government followed the austerity drive to save money for the country, it will only deepen the crisis. We are already behind the regional economies in terms of economic growth and if we followed anti-growth policies, we will remain far behind the regional economies and would be cited as the deprived nation after a decade.
—The writer is Director, Kashmir Institute of Economics, University of Azad Jammu and Kashmir.