By:Dr Kamal Monnoo
The economic profession in Pakistan has not, to say the least, covered itself in glory these past seven years. Hardly any of our economists have come up with fresh recipes (for the government of Pakistan) that defy mainstream solutions or tend to be significantly different from what the western minds choose for us to be the best way forward in our ‘times of consistent adversity’. When lenders like IMF and World Bank talk, compulsive borrowers like us listen – Not realizing that we perhaps in the first place happen to be in this quagmire because of them! Ironically, even now a fresh perspective on what appears to bear a lot of traction with the kind of economic policies that we should be following – but do not – instead comes from an American economist, Jeff Madrick, through his latest book, “Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World.”
So what are some of these global bad ideas, which in fact also come across as being quite relevant in the context of continuous wrong policy directions that our economic managers in Pakistan have been steering in recent years? In particular, bad idea No. 1 – “The Invisible Hand” – is pretty hard to distinguish from bad idea No. 3, “Milton Friedman’s case against government intervention”, and it segues fairly seamlessly into bad idea No. 7, “globalization that is always good.” As an aside, this sometimes makes Mr. Madrick’s argument more disjointed with key propositions spread across nonconsecutive chapters; however, he is actually trying to make an important point here: Adam Smith used the phrase “invisible hand” only once in “The Wealth of Nations,” and he probably didn’t mean to say what most people now think he said. Today the phrase is almost always used to mean the proposition that market economies can be trusted to get everything, or almost everything, right without more than marginal government intervention. Is this belief well grounded in theory and evidence? No.
As Mr. Madrick makes clear, many economists have, consciously or unconsciously, engaged in a game of bait and switch. On one side, we have elegant mathematical models showing that under certain conditions, an unregulated free-market economy will produce an efficient “general equilibrium,” in the sense that nobody could be made better off without making anyone worse off. Yet, as he says, these assumed conditions – including the assumption that people “are rational decision makers, and that they have all the price and product information they need” – are manifestly not met in practice. Further, he contends that in the real world and especially in the ‘developing’ world where economic governance structures tend to weak the reliance on the sheer competence of the economic leadership of the day tends to be even more critical than otherwise – Pakistan certainly falls in this category.
Matters are even worse when it comes to the performance of financial markets. Here the proposition that markets should get it right – that major speculative bubbles can’t happen (bad idea No. 5) – doesn’t just depend on conditions that clearly don’t hold in practice, but is directly contradicted by evidence on herd behavior and excess volatility. Yet “efficient markets theory” has maintained its academic dominance.
And this takes us back to bad idea No.2 on Mr. Madrick’s list, the Say’s Law, which states that savings are automatically invested, so that there cannot be an overall shortfall in demand. A further implication of Say’s Law is that government stimulus can never do any good, because deficit spending by the public sector will always crowd out an equal amount of private spending. However, as we have time and again seen in the case of Pakistan, these assumptions are not necessarily true. Given a wide range of other unfavorable factors on investments: savings do not necessarily get translated into investments; certain types and areas of investments invariably fall into the lap of the government since the respective private sector does not either have the required tools or the risk appetite to venture there; mass unemployment cannot be tackled without direct government intervention cum support; and last but not least an artificially high currency parity can serve as an impediment to competitiveness which only the government can redress.
Finally, what Mr. Madrick emphasizes upon is that while expanding global markets is a worthy goal, history offers lessons that can lead to more constructive trade, capital and currency policies. The first lesson being that gradual reform is more effective than a sudden turn to free markets, deregulation and privatization. Shock therapy in Russia was a failure, and nations from Argentina to Thailand paid a dear price for liberalizing capital markets too quickly. The historical models of sustained growth are clear: gradual development of ‘home-based’ core industries; economic diversification; improvement in literacy and education, especially for women; only gradual opening of capital markets; and a focus on self-sufficiency on power and energy at competitive rates as the top national industrial priority. Second lesson being, that developing nations when negotiating with their respective financial lenders must ensure that they retain space for themselves to be able to experiment for home grown recipes and their realities on ground. Third, models of growth that indefinitely depend on exports are not sustainable.
Lastly, every free trade initiative or agreement should come with a plan to simultaneously strengthen the social safety net at home, and a working that the endeavor is not at the cost of the home industry and domestic employment generation – Now one is not sure that this principle is being applied in our current trade calculations with China and India!