Nhere are no two opinions that the present government had inherited an economy which was in a shambles. Both fiscal and current account deficits were high, economic growth was slowing, unemployment was rising and both public and external debt were shooting up. The new leadership, while in opposition, had raised expectations of the people that once they are in the government, they will have the capacity to address these multi-dimensional challenges. There is a general consensus among the independent economists that instead of addressing humongous challenges that it inherited, the inexperienced economic team further compounded the difficulties. The government either had no option or was “forced” to go to the IMF for the 22nd IMF Program. In either case, the government went to the IMF for a balance of payments support. It was an interesting coincidence that after 22 years of continuous struggle, Imran Khan became the 22nd Prime Minister of Pakistan and landed up in the 22nd IMF Program.
It is essential for the readers to know the intellectual foundation of the IMF as an institution. The intellectual philosophy of this institution is based on the neo-liberal economic order commonly associated with policies such as economic liberalization, privatization, de-regularization, free market, increasing role of the private sector, reducing the size of the government, austerity or cut in government expenditure, particularly subsidies, and dominant role of monetary policy (that is why, IMF always talks about the “independence” of the Central Bank). The Chicago school led by Milton Friedman, provided intellectual inputs to neo-liberal economic thoughts.
A consensus on a set of economic policies representing the neo-liberal economic order emerged in the early 1980s among the three institutions, namely the IMF, the World Bank and the US Treasury. A British Economist John Williamson, termed the Consensus as Washington Consensus in 1989. The set of policies on which the consensus emerged included i) tight monetary policy; ii) tight fiscal policy; iii) market-based exchange rate (or devaluation), and iv) raising utility (gas, electricity) prices. Whenever a developing country like Pakistan faced a serious balance of payments crisis and knocked the door of the IMF, that country had to implement the afore-mentioned set of policies, commonly known as the Washington Consensus or neo-liberal economic order. The IMF as an institution was made responsible for the implementation of the Washington Consensus /neo-liberal economic order. The IMF, being the implementation agency, derived its intellectual inputs from the Chicago school where every economic ill is a monetary phenomenon, be it the balance of payments crisis or inflation. These economic ills had to be corrected through demand management policies. Ever since the early 1980s, the standard IMF prescription has been geared towards addressing the issue of excessive demand. While the world has changed in the last four decades, the prescription of the IMF Program, as enshrined in Washington Consensus, has remained unchanged.
Like the previous 21 IMF programs which were based on the Washington Consensus, the current program was also based on the same four policy prescriptions. How do these policy prescriptions work to curtail aggregate demand? Firstly, through tightening of monetary policy, that is, raising the discount rate as fast as possible. Since the discount rate serves as a benchmark for all the lending rates, private sector investment declines, which, in turn, reduces import demand. Since developing countries’ economic activity depends principally on imported raw materials, imported capital goods, imported machinery and equipment and imported energy, any decline in imports slows down the economic activity. In other words, demand destruction is achieved by chocking the economic activities of the country.
How else can we discourage imports, promote exports and, hence reduce current account imbalances? Very simple! Go for massive devaluation. Devaluation increases the landed cost of all the imported items, including inputs for the production process. Higher cost of imported items not only discourages its consumption but also increases the cost of production. Hence, lower import slows economic growth. Since devaluation is also inflationary by definition, the Central Bank justifies tightening of monetary policy (i.e., raising discount rate) to contain inflationary pressures. After all, inflation is a monetary phenomenon as propounded by the Chicago school of thought. Interestingly, under the IMF Program, through devaluation, we create inflation and then by raising discount rate we try to control inflation. Isn’t it surprising?
Higher interest rate, on the other hand, increases cost of borrowing of the government to finance fiscal deficit and therefore, increases interest payment. In the absence of commensurate rise in revenue, the overall fiscal deficit increases. Hence, an irrelevant tax target is given under the IMF program to achieve targeted fiscal deficit. The government is also being asked to raise utility prices, supposedly to improve the financial health of the utility companies, but actually it also increases the cost of production.
The writer is Principal and Dean of the School of Social Sciences & Humanities (S3H), NUST, Islamabad. He can be reached at ahkhan@s3h.nust.edu.pk
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