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Fail and Repeat

Published in Jul-Aug 2023

What is it that prevents Pakistan from moving forward economically?

Although Pakistan has received the much-anticipated IMF bailout, it is clear from the report on the standby arrangement that we are not out of the woods. Based on projections by the IMF, Asian Development Bank and the World Bank, real GDP growth is set to be at two to 2.5% in FY ‘24, which is far below South Asia’s 5.9% (source: Word Bank), and it is projected to rise to 3.6% in FY ’25 and 4.6% in FY ’26 (source: IMF). Furthermore, a tight monetary policy to contain high inflation, combined with import restrictions (due to low foreign reserves) is expected to curtail growth in the near term. Inflation is expected to remain above 25% in FY ’24 followed by 11.6% in FY ’25 and 7.4% in FY ’26. The gradual recovery will be dependent on strong policy implementation of the framework and timely external financing.

In the near term, there seems to be a limited upside in GDP growth (exceeding projections); however, there are significant downside risks that need to be managed.

• A tense political environment leading up to elections and policy slippages due to social pressures.

• The delays in the disbursement of planned external financing; tighter global financial conditions continue to put pressure on the exchange rate and external stability. Any increase in near-term domestic financing requirements may overburden the financial sector and cause disruption.

• Volatility in food and fuel prices due to the Russia-Ukraine conflict. A case in point is the recent withdrawal of Russia from the Black Sea grain deal that was facilitating the export of millions of tons of grain from Ukrainian ports. As a result, grain prices have been fluctuating, sparking concerns in food-insecure countries.

• Delays in structural reforms, including increasing the tax base, managing spiralling circular debt, and improving public financial management, particularly of State Owned Enterprises.

• Mounting risks from climate change with impact on rural and urban areas. This is one of the biggest challenges requiring immediate attention.

Barring a few minor changes, the policy recommendations, the need for structural reforms, and the downside risks have been similar over the years.

So why don’t things change? Why is the country stuck? Economic policies typically assume humans behave rationally and focus on incentives to change outcomes. Is there something in the Pakistani psyche or mindset that is preventing progress? Are there mental models that have been shaped over decades that cause people to think and behave in a manner contrary to the assumptions behind policy development? Or as Einstein warned, “No problem can be solved from the same level of consciousness that created it.”

The 2015 World Development Report Mind, Society and Behaviour, based on hundreds of studies demonstrates that a more realistic understanding of choice and behaviour can make development interventions much more effective. The report creates a framework of human thinking centred on three principles:

• People think fast and often automatically rather than carefully and deliberately. Automatic thinking allows for rapid and pragmatic decision-making, but can also lead to systematic errors in judgement. Even seemingly insignificant details in the presentation of a situation can influence our perceptions as we often tend to make quick assumptions based on limited information.

• Humans are inherently social. When making decisions, we are frequently influenced by the thoughts, actions and expectations of others. The influence of others can lead us towards specific perspectives and collective behavioural patterns. For example, certain segments who collectively believe they should not be paying taxes.

• Thinking with mental models. When individuals engage in thinking, they typically do not rely on the concepts they have personally created. Instead, they draw upon concepts, categories, identities, stereotypes, narratives and worldviews that are shaped by their communities. Rather than responding directly to objective experiences, individuals react to their mental representations of those experiences.

Taking a behavioural view, the mindset in Pakistan tends to favour short-term, easy fixes versus analytically driven, longer-term solutions. Perhaps it is driven by the need to survive today, not knowing what tomorrow will bring. Policies that are driven by short-term populist goals tend to follow a similar train of thought, perpetuating a cycle and making it more ingrained in the psyche of the country. A case in point is the recent effort to increase tax revenue by slapping an additional 2.5% tax on salaried people earning over Rs 200,000 a month/2.4 million a year, plus a one percent increase in withholding tax (WHT) on companies selling goods and services, both of which are already taxpayers.

Let’s analyse the impact in 2023 on a fictitious small to medium size company categorised in other services paying WHT of eight percent. We will call the company XYZ. The global benchmark for strong operating margins of a service-based company is between 15% and 25%. In Table A, the assumption is that XYZ had a 20% margin in 2023.

Even at eight percent, the calculation clearly shows that the company was paying more advance tax (eight rupees) than its liability, calculated on a corporate tax of 29% (Rs 5.8).

Now let’s look at what the numbers in Table B for XYZ could be in 2024, incorporating a sluggish five percent growth due to a slow economy, a 20% increase in cost due to inflationary pressures and an increase of one percent in WHT, making it nine percent.

Table B shows the impact where operating margins are cut in half but more importantly, the nine percent WHT nearly wipes out the profit as the advance tax paid (Rs 9.5) is more than the operating profit (Rs 6.4). In what context would this increase in WHT be considered acceptable? The company is under pressure to cut costs, most likely to the detriment of employee growth, which makes talent retention difficult. It undermines business confidence and reduces any incentive for new investment and makes those paying taxes resentful. It also disincentivises people who are not paying taxes to become filers.

Over time, short-sighted policy decisions lead to mistrust between the state and its citizens. There is merit in Einstein’s quote, “If I had an hour to solve a problem, I would spend 55 minutes thinking about the problem and five minutes thinking about solutions.” The point he makes is important: preparation has great value in problem-solving.

The survival mindset, if not driven by purpose or goals, can have another side effect – creating opportunists versus builders. Countries that experience frequent black swan events, and where there is a lack of information and transparency, tend to encourage speculative and ad hoc decision-making. Rumours become ‘facts’, which opportunists exploit and manipulate to make an extraordinary windfall, usually at the expense of others. Yet, evolving a common sense of purpose and being driven by an ethical belief system, can shift the mindset from individual opportunists to collective builders.

While survival instincts were probably advantageous in the early years of Pakistan, after 75 years of existence, the expectation is of stable growth. Like start-ups, where investors begin to lose interest in companies that constantly pivot, frequent changes in leadership, high cash burn and inability to scale up are leading lenders to Pakistan, who have witnessed decades of unaddressed structural issues (causing low growth with high spends), to lose interest as promises remain unfulfilled.

Pakistan needs to evolve from an early-stage start-up survival mentality to a disciplined growth one. It needs to shift from making do with a bare minimum ‘chale ga’ attitude to an obsession with producing the best quality output. Policies need to be framed and instituted to help the country graduate from a minimum viable product to a unicorn. Change can only come from a strong leadership team that can articulate a credible vision and inspire trust and confidence in people to follow and help execute.

“The world as we have created it is a process of our thinking. It cannot be changed without changing our thinking.” – Albert Einstein.

Amin Rammal is a marketing technology enthusiast and Director, Asiatic Public Relations.