Tuesday, September 2, 2008

We will all be dead in the long run!

Our Finance Minister Mr. Naveed Qamar is a nice, optimistic and overly hopeful person. I have been reading and hearing him speak on media about his policies. The thrust of his policies is that in the short term there will be tightening of the monetary and fiscal policies. He is asking the nation to make sacrifices in the short term and the fruits will somehow follow in the long term!

The basic premise of the Finance Minister's approach is that in the long run, everything will even out and therefore government does not need to anything to rectify the short term problems in the economy and should concentrate on the long run.

I would just like to remind our Finance Minister of John Maynard Keynes' famous remark 'in the long run, we are all dead'.

Our Finance Minister should aggressively push to rectify economic problems being faced by Pakistanis (preferably within our lifetimes), rather than letting everything work itself out. The market forces have been noted, in recent times, to be not doing what many free market economists expect them to. The recent financial crisis in the USA is an example of laissez-faire policies. And, the biggest advocate of the free market economy has been forced to intervention in the market by the government! Perhaps it is time for our own minister to think afresh about the merits of the free market economics in the current times.

I am not sure if the tightening of monetary policy is a wise idea. The rationale behind increasing the interest rate is that it will some how restrain the inflation. The problems with such approach are many:

(1) one is that you encourage the people from putting their money in the banks and earn interest rather than investing in the real productive ventures;

(2) another is that you make the capital expensive and thus difficult for businesses to carry on, discourage the local entrepreneurs from expanding their businesses or starting new ones thus increasing unemployment; and

(3) another related issue is that by making the local capital expensive you leave the market open to foreign investors who have access to cheaper capital. These investors may invest but then they will take away their capital and earnings abroad in foreign currency putting pressure on the exchange rate of the local currency.

On the fiscal front, our finance minister wants to cut the government spending and thus reduce the fiscal deficit! The lack of investment and demand thus created is sought to be overcome by foreign and local investment! However, by making the local capital expensive (due to high interest rates), you basically shut out the local investment. Thus practically these policies are only encouraging foreign investment. This is a recipe for disaster.

In my opinion, foreign investment with our current policies of allowing full repatriation of the profits and the capital in the form of foreign exchange is worst than the biggest of the deficits that our government can have. If you look at it practically, there is no difference between fiscal deficits and foreign investment. Both need to be repaid and in the case of the latter it has to be in foreign exchange thus dwindling your foreign exchange reserves and leaving your economy's survival on the whims of few CEOs.

The point is that if our economy is not at the optimum level of employment and resource utilisation then fiscal deficit and cheaper domestic capital are much better policy options than sole reliance on foreign investment.

Our government needs to seek out of the box solutions to the current economic crisis. High interest rates and lowering government spending in these critical times will surely lead to an economic catastrophe.

The government needs to reduce the interest rate to a maximum of five percent and increase government spending albeit by printing notes to make up for the lack of investment by the private sector.