Inflation – A result of poor economic policies or a part of global economic woes

Inflation – A result of poor economic policies or a part of global economic woes

The following article is written by Syed Muhammad Hamza, a student of Sir Syed Kazim Ali. Moreover, the article is written on the same pattern, taught by Sir to his students, scoring the highest marks in compulsory subjects for years. Sir Kazim has uploaded his students’ solved past paper questions so other thousands of aspirants can understand how to crack a topic or question, how to write relevantly, what coherence is, and how to include and connect ideas, opinions, and suggestions to score the maximum.

Burgeoning inflation, an increase in the price of commodities over a given period, erodes the stability of a state’s economy. With the unprecedented fluctuation in the inflation rate, a country’s economy becomes a point of hesitation for investors and creditors to invest in the country. Nevertheless, Pakistan has been a victim of inflation, or hyperinflation to some academicians, for the last few years. Inflation has hit the country hard with a list of factors behind it. However, among external and internal factors of inflation, poor economic policies stand out as a valid and certain reason behind the record-making inflation of 38 per cent. Although the global economic woes cannot be ignored in the discussion, many countries across the world have been able to secure themselves from the unpredictable rise of inflation because of effective economic policies. On the other hand, import-oriented economies, oil-dependent countries, and poor fiscal policymaking countries have, for sure, found themselves entrapped in the vicious cycle of inflation. For the same reason, Pakistan’s inflation is much attributed to its poor economic policies. Whereas other global factors, such as the disruption of the global supply chain due to covid, combined with the US–China trade war and the breakdown of the Russia–Ukraine war, have further worsened the situation in the case of Pakistan. Therefore, Pakistan must gauge the intensity of the issue and take pragmatic steps like aligning its fiscal policies according to its priorities, attracting FDI by giving rational subsidies and strengthening the taxation system in the country. At last, it is time for Pakistan to take the short–term and long-term steps to combat rampant inflation.

Inflation is an important indicator of an economy. In economics, inflation is defined as the increase in the cost of living due to the persistent increase in the price of goods and services. Moreover, inflation can be bifurcated into two types: Cost–Push Inflation and Demand–Pull Inflation. Cost-Push Inflation refers to the increase in the price of the commodity due to the increase in the cost of making the product. For instance, the increase in the cost of the raw material or the increase in the wages of the labour involved in the production of the product may result in an increase in the price of the finished product. On the other hand, Demand – Pull inflation is caused when too much money is chasing fewer goods. However, inflation may also be categorized on the basis of causes. For instance, if inflation is caused by external or international market factors, it is called Imported inflation, whereas if the contributory factors of inflation involve the internal economic and monetary policies, such a type of inflation is said to be Domestic inflation. However, it is important to note that the essay holds domestic factors more responsible for inflation in Pakistan than external factors.  

Currently, the fiscal stats have been alarming for the dwindling economy of Pakistan. Unfortunately, the annual inflation rate has accelerated to history’s highest-ever level of 38 per cent in May 2023. Moreover, the effect of the inflation in the rural areas has been more detrimental, hitting 42.2 per cent by the end of the fiscal year 2023. To curb the situation, the central bank of Pakistan – The State Bank of Pakistan – has set the interest rate at 21 per cent at the start of the year 2023 but failed to arrest the inflation rate. Though in the fiscal year 2022 – 2023, the government was with a target to halt the inflation of around 11.5 per cent but failed to do because of the drastic floods and poor economic policies. Hence, the current picture of the economy is gloomy.

To begin with, Pakistan’s inefficient taxation system is an enormous reason behind the inflation. The narrow tax base has made the state fall short of wealth to meet its needs. According to the reports of the Federal Board of Revenue, out of the 62 million employed population, only 3 million people are filers. Thus, the tax base is very narrow. In fact, this is reflected in the form of a low tax-to-GDP ratio. Moreover, the tax administration department has a shortage of staff; they fail to manage tax collection. Though after 2016, there has been an increase in the number of hiring in IRS and PC, there still, is a need for about 7000 staff in the tax administration department. Due to the lack of sources of income for Pakistan, the commodities and services in the market go high.

Moreover, the low tax share of the three enormous sectors of the economy, which include the Agricultural, Industrial, and Service sectors, are also contributing to the exacerbation of inflation in Pakistan. Speaking of the stats, the Agricultural sector contributes less than 2 per cent in tax, whereas its share in the GDP crosses 20 per cent. Similarly, the service sector shares about 20 per cent tax share while the industrial sector shares about 50 per cent of the tax share, the highest tax share of the three. Therefore, the poor land policies and provisions in the agricultural sector push the country to low tax collection. However, to cope with this issue, the words of the former chairman of FBR, Shaukat Zaidi, who once said, ‘’ A proper and effective tax reform is impossible unless the 60% of the politicians, who run the agriculture sector, are in houses,’’ must be not be ignored. Hence, the legislative house has to play a pivotal role in increasing the tax share of the sectors.

Additionally, Pakistan is an undocumented economy. The documented economy has never crossed 350 billion US dollar. Whereas the undocumented economy, which is driven majorly by the livestock sector, shows 2300-billion-dollar trade annually. This hinders Pakistan in a way that the true value of the economy of Pakistan isn’t presented in the international market. Similarly, the majority of the taxes that may become a source of income for Pakistan couldn’t be levied due to the absence of a formal economy. As a result, the state has to increase the prices of commodities to meet the demand. Therefore, the informal economy has been a grieve concern to many economists of Pakistan and a giant factor for inflation.

Similarly, the burden of poor-performing state-owned enterprises is also contributing to inflation in the country. As a matter of fact, in Pakistan, which is already in fiscal deficit, the poor state–owned policies are nothing more than a burden on the state’s current account. Investment in such inefficient industries is not favourable for the country’s economy. In the same manner, according to IMF, Pakistan may save about 600 to 800 million dollars by privatising such state-owned enterprises. Now that these enterprises are acquiring more investments to sustain than what they produce, the country must privatise the enterprises. In fact, the enterprises run by the private sector are more competitive and efficient than those under the public sector.

Other than the above-listed points, poor monetary policies have also added fuel to the fire of inflation. The irrational packages of subsidies and tax rebate have been now an existential threat to te economy in many ways. According to the 2021 – 2022 stats, Pakistan has given tax rebate of about 1700 billion PKR in total. In other words, Pakistan has loss these Rs 1700 billion from being added as a revenue of a state. Though tax rebate is a step to build business environment, the step must then pop out more benefits but this isn’t the case. Similarly, irrational subsidies given by 2018 – 2022 government in Pakistan has led the state stuck more deeper in the vicious cycle of circular debt. Hence, such practices have been an exclusive burden on the economy of Pakistan, making abrupt rise of inflation in the past few years.

Besides, Pakistan has failed to become an export-oriented economy since its inception. The failure to craft such economic policies to become an export-oriented state has pushed it towards inflation. Even in the current wave of global inflation, especially after covid 19, only export-oriented economies have been able to stand against external inflation shocks. The best manifestation is Germany and Switzerland. This is because with the rise of the exchange rate of the dollar causes Pakistan’s Balance of Payment sheet to show a rise in imports compared to export. In response to it, the state starts to ban the import by halting letters of credit. However, it hurts the economy by slowing down the wheel of the economy, thus, affecting the state in both ways. Hence, Pakistan, being an import-oriented economy, is left with no way to deal with inflation either by allowing or banning the imports of the country.  

Similarly, Pakistan’s poor economic policies regarding gathering dividends from the blue economy is also another factor indirectly linked with inflation. Currently, the blue economy of Pakistan contributes about 500 million dollars in the GDP. However, the country’s blue economy has the potential of 100 billion dollar annually combined with the 100 million job opportunities. If not 100 billion dollars, at least the country should have exploited 10 billion from its blue economy rather than 500 million dollars, since the very amount is 10 times more than the IMF bailouts for which Pakistan has been striving for. Hence, the country’s failure to boost its GDP or to generate more revenue just like in the case of blue economy has unleashed rampant inflation in Pakistan.       

As the poor economic factors of inflation have been discussed in detail, it is now important to shed light on the ways to control exacerbating inflation. First, Pakistan must draft policies to make its basket export oriented rather than import oriented. It goes without denying, import – oriented economies don’t have much ways to tackle inflation. Therefore, to boost the revenue of the state, it is important that Pakistan adds value – added items in the export list along with the finished products. Moreover, putting ban on the import of the luxury items is also a crucial step to conserve dollar for the country.

Second, fiscal policies such as increasing the withholding tax on the non – filers can help Pakistan to channelize its informal economy. After all, informal economy – which is approximately 2000 billion dollars – can play a crucial role in increasing the revenue of the state. moreover, attractive monetary policies may also push the informal sectors to come under tax net. As a matter fact, it has been reported that if Pakistan’s taxation system world efficiently and transparently, it has the potential to collect 12000 billion PKR from the market. Hence, more and more vibrant and pragmatic fiscal and monetary policies are required to increase the tax base, which will eventually lower the inflation.

Moreover, when it comes to crisis regarding economy, irrespective of any form, the ever-green solution is to reduce the government spending. In the case of Pakistan, the government can put cuts on the budget of defence sector or save dollars by privatising the poor performing state owned enterprises. The former measure seems difficult since Pakistan is a security state with its hostile neighbourhood. Therefore, the only best option left is to privatise poorly performing state-owned industries. Consequently, the country may safe about 500 million dollars.

Similarly, Pakistan must also stress on the knowledge-based economy. Today, Pakistan has the potential to become world’s 10th largest knowledge-based economy. Utilising the youth by inculcating skills and cognitive skills can surely the most significant step in the way of betterment. Hence, the above discussed steps may help Pakistan to leap out from the malicious trap of inflation.

Hence, it is important to comprehend that Pakistan needs to revamp its economic policies so that it may control inflation. Though the country has faced inflation due to external or global inflation shocks, however, countries like Vietnam, Malaysia, Chile, Singapore and South Korea, which are also third world countries like Pakistan are secure from the implications of global economic woes. It is because their prudent economic policies are effective and responsive to the changing environment of the international market.  The following two paragraphs discusses the case studies of Singapore and South Korea in detail.

Singapore, a country, which stood at 2 billion GDP in 1971, today owns a GDP of more than 600 billion dollars. Fortunately, it made its way by prioritising human resource development. Although unavailability of natural resources costs Singapore million dollars import, the attractive and conducive environment of business has fetched several foreign direct investment projects. Moreover, it also possesses stable political environment, which has been a day – dream for Pakistan. Hence, Pakistan must learn the value of stable political system is essential for the stable economy – a guarantee of controlled inflation.

Another best example in the context stands of South Korea. The country, after separation from North Korea, has faced lots of economic challenges. However, flexible and timely economic measures enabled it to establish a stable economy with no disturbing factor of inflation. Being an agrarian country at the beginning, they transformed into industrial hub by enforcing land reforms. Not only it made them the powerhouse of the globe but also it pumped their per capita income from 100 dollars to 35000 dollars, keeping country safe from getting trapped in inflations or excessive external debts.

Critically, the above powerful diagnosis proves that poor economic policies are more responsible for inflation in Pakistan than global economic woes. Nevertheless, Pakistan, like other countries: Vietnam, Singapore, and Malaysia, could have secured itself from abrupt and exacerbating trend of inflation if its internal economic policies were on the track of economic development. It is important to note, lending dollars from IMF or friendly countries isn’t an enigma unless used for the economic development purpose. Sustainable economic growth, a patron of stable economy, needs to be established by taking flawless fiscal measures.

To conclude, Pakistan is going through rampant inflation because of its inefficient and unsustainable economic policies. Narrow tax base, huge chunk of informal economy, low tax share of the major sectors of GDP, and poor monetary policies results in less generation of revenue. Consequently, the country runs short of finance, causing demand pull inflation and cost push inflation. Nonetheless, the country has been affected by global wave of inflation as well but the failure to control it is because of its poor economic policies. Hence, Pakistan must come up with efficient and stable economic policies.

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