The three Es of political economy

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Economic Updates - Economic Fundamentals

THE large size of Pakistan’s ‘hidden’ or ‘informal’ economy is sometimes cited as an indicator of the country’s resilience and its potential.

But it is also symptomatic of the debilitated structures of a state that has become weak over time with grave consequences.

If all goes well, Pakistanis will go to elections in June this year and elect a new government. The random polls show the PPP is likely to be defeated. If so, it may come down to who wins Punjab between Pakistan Muslim League (PML-N) and Pakistan Tehreek-e-Insaf (PTI).

More than six years ago, writing for these pages about Musharraf-Benazir deal, I had noted, “Power sharing adjustments between military leaders and civilian politicians have taken place before but failed to bring either stability or prosperity to the country. This time, the stakes are even higher.” I find it difficult to be more optimistic than I was then. Here is why.

In 2009, an Organisation for Economic Co-operation and Development (OECD) study concluded that half the workers of the world — close to 1.8 billion people — were working in informal economy, in jobs that were neither registered nor regulated, getting paid in cash, and, most often, avoiding income taxes.

In developing countries informal economy has been expanding in the face of liberalisation and globalisation, and now accounts for between one-half and three quarters of non-agricultural employment.

Informality has also been described as a reflection of mechanisms that exclude large segments of the population from education, health care, and judiciary services; and from economic opportunities through a segmented labour market. This exclusionary process is related to the extremely high and persistent levels of inequality, which are rooted in differences in power and influence; and which seem empirically highly correlated with informality.

A study by Pakistan’s central bank put the size of the country’s black economy at around 30 per cent of GDP (compared to 25 per cent in Greece and 20 per cent in Italy), or around $70 billion a year. It is probably much bigger perhaps closer to 40 per cent given Pakistan’s low tax-to-GDP ratio. Research at Lahore School of Management Sciences has shown that informal sector employs 78 per cent of the non-agricultural labour force or nearly 44 per cent of the country’s total labour force.

Pakistan’s informal economy size appears to be among the highest in the developing countries as a proportion of the total economy. Should we celebrate? Historically, Latin America’s high level of informality was seen as a manifestation of disconnects between the state and citizens, in part as a result of failures of the state in its various roles.

World Bank studies have shown inverse relationship between relative size of informal economy and state effectiveness. The estimates for the proportion of informal economies of Nigeria, Congo, Angola, Ethiopia, and Niger exceed 40 per cent. In Zimbabwe, arguably a political and economic basket case, one estimate of the size of the informal economy puts it at as high as 65 per cent.

While Pakistan’s large informal economy makes it attractive for companies producing consumer goods it may also be an indicator of the growing risk of its failure as a state because high degree of informality is symptomatic of a dysfunctional state which is ineffective, inefficient, and unfair.

It is fashionable and popular to put much of the blame for the State’s dysfunctions on politicians and the two big political parties that have governed for different periods since 1988. While they definitely, in my view, failed to perform up to the expectations, their failures represented much bigger issues in the political economy. Much is talked, discussed and written about what ails Pakistan and what are the biggest obstacles to its progress. They probably can be encapsulated in three Es: establishment, elites, and extremism.

Each of them represents a formidable challenge to the establishment of rule of law and truly representative inclusive political institutions. The authors of the widely acclaimed book, Why Nations Fail: The Origins of Power, Prosperity, and Poverty, Daron Acemoglu and James Robinson argue what distinguishes societies isn’t whether they are centrally planned or capitalist, but whether they are extractive or inclusive.

Acemoglu and Robinson are intellectual heavyweights of the first rank, one a professor of economics at MIT, the other a professor of political science at Harvard. They reject geography and culture as the root causes of poverty or failure of nations.

Their argument is that order without inclusive institutions may enable an economy to escape poverty, but will not permit the full ascent to modern prosperity. Their explanation is that if the institutions of power enable the elite to serve its own interest — a structure they term ‘extractive institutions’ — the interests of the elite come to collide with, and prevail over, those of the mass of the population until and unless the masses are ready to transform them.

In Pakistan, as many analysts might agree, that has been the central issue regardless of whether military or political parties were in power. Moreover, since the 1980s, the military-elites alliance was expanded to officially co-opt the extremist religious forces. The militants were given a virtual licence to carry on all kinds of illicit trade to finance themselves, make illegal encroachments to build mosques and madrassas, to receive money from abroad, etc.

They also used farmers, rural workers, small traders, shop keepers, etc., to expand influence and pose a serious challenge to any government that would try to establish its writ, collect taxes or regulate their activities. Another adverse development is their increasing influence on the society’s attitude towards women — or half the population. Pakistan’ female youth literacy is already abysmally low.

According to the United Nations Educational, Scientific and Cultural Organisation (UNESCO), 71 per cent of the eligible girls did not go to secondary school in 2009. Historic problems of female illiteracy and low labour participation rate have been compounded by the rise of the extremism.

These three powerful forces — establishment, elites, extremists — have little incentive or interest in supporting or developing inclusive political institutions that would try to restrict or curtail their power or influence in a manner that would hurt their rent-seeking activities; their ability to extract economic benefits such as grabbing urban land through legal or illegal means; avoid taxes on income or property, or accept reforms that would require them to abide by the law.

Moreover, the coercive and raw power of state and non-state actors has further complicated this chronic issue. In this context, much has been made of the judicial activism of the recent few years. Judiciary’s failure or reluctance to pursue some of the cases, with any serious vigour, that related to the three Es seems to be indicative of their limited power. It remains far from certain whether the judiciary made any real difference toward strengthening the rule of law other than making news headlines.

The crux of Pakistan’s problems is that not only it has failed to develop inclusive political institutions that would promote and encourage inclusive economic growth, its most powerful forces have every incentive to thwart any attempt or effort to make the institutions more participatory and the growth most inclusive. Whether an electoral change would make any real immediate or long term difference remains to be seen. I am not anymore optimist than I was in the spring of 2007.

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