By Ishrat Hussain

December 31, 2013

Governments in developing countries are increasingly being accused of policies and practices that favour cronies and party loyalists in allocation of scarce resources. They do this blatantly in the name of market-friendly policies thereby creating mistrust, suspicion and doubts in the minds of the ordinary citizens about the ‘market’.

By Ishrat Hussain

December 31, 2013

Governments in developing countries are increasingly being accused of policies and practices that favour cronies and party loyalists in allocation of scarce resources. They do this blatantly in the name of market-friendly policies thereby creating mistrust, suspicion and doubts in the minds of the ordinary citizens about the ‘market’.

Market-Friendly Or Business-Friendly?
By Ishrat Husain

[This article first appeared in The News on December 26, 2013. The writer is former governor of the State Bank of Pakistan.]

Governments in developing countries are increasingly being accused of policies and practices that favour cronies and party loyalists in allocation of scarce resources. They do this blatantly in the name of market-friendly policies thereby creating mistrust, suspicion and doubts in the minds of the ordinary citizens about the ‘market’.

The scepticism about the market-friendly approach was further intensified by the 2008 financial crisis. The big privately owned banks, financial institutions and auto companies were bailed out by the taxpayers for the excesses, greed and selfish behaviour of executives and shareholders. This raised a fundamental question about the asymmetric distribution of gains and losses. While the upside gains from taking excessive risks were mostly appropriated by private owners and managers, the losses were socialised and borne by the public at large.

The opposition to the privatisation of public enterprises in Pakistan, for example, is no longer limited to the ideologues on the left but is popularly held by large sections of the judiciary, academics, media and civil society. The seminal decision by the Supreme Court overturning the privatisation of the Pakistan Steel Mills reflects this popularly held view despite the fact that according to the Ministry of Finance they have disbursed Rs1.5 trillion or $15 billion on the subsidies and losses incurred by public enterprises in the energy sector alone.

If the losses – implicit or explicit – of other public enterprises – Railways, PIA, irrigation departments, water and sewerage authorities etc – are added the actual outlay may exceed $20 billion. This is a country that is desperately struggling to meet the conditions for the release of $6 billion of IMF money to repay the 2008 loan.

Why is this suspicion and mistrust of the markets so rampant and widespread? The simple fact is that we have confused ‘market-friendly’ policies with ‘business-friendly’ policies.

We have to look back at the history of the private sector in Pakistan to gain insights into this important distinction. In the 1950s, the government granted import licences to traders and businessmen making them rich overnight. As the industrial base was almost non-existent and the market for Indian goods was disrupted, the country badly needed all kinds of imports – fuels, food, clothing, steel, machinery and equipment. In an environment where the demand exceeded the supply, the importers and distributors were able to create artificial scarcity and earn huge premium.

In the second stage, the government industrial units set up by PIDC with taxpayers’ money were sold to private businessmen in a non-transparent manner. Those who had earned huge premium by selling imported goods were also the lucky winners of the government’s disinvestment of PIDC’s industrial assets. In the third stage, the same groups took advantage of high tariff protection, overvalued exchange rate, and subsidised credit to set up industries mostly in textile, leather and agriculture based sectors. These goods displaced imports which became non-competitive because of high customs duty.

Licences for inputs, components, parts, machinery etc were also granted selectively to the same groups. In the fourth stage, banks and insurance companies and large capital goods and intermediate goods industries were nationalised. These banks became a major source of patronage for crony capitalism.

The powers of the State Bank of Pakistan as a regulator and supervisor were assigned to the Pakistan Banking Council under the Ministry of Finance. Presidents of the banks were appointed by the finance minister and each incoming government replaced the appointees of the previous government and brought in their own nominees. This combination of a subservient banking ccouncil and political appointees as presidents did wonders for cronies and loyalists of the ruling parties.

Loans were granted to these individuals and their firms without due diligence, proper credit appraisal, securing of collaterals and securities. These loans soon turned sour as the underlying assets were overvalued and the owners’ equity was also financed out of the bank loans. The unsustainable capital structure was not able to generate adequate returns to service the inflated debt payments.

Another mode of enriching the cronies was the privatisation of some of the public enterprises in the 1990s. Many of the companies were sold to parties with no prior experience of running the business they had acquired. They, therefore, indulged in asset stripping and converted the premises of the industrial unit into commercial or residential real estate. Other unscrupulous buyers made money for themselves but defaulted on their payments to the government.

This type of privatisation naturally infuriated opinion makers since the benefits of privatisation – efficient operations by the private owners adding value, contributing to the tax revenues, making investment through expansion or modernisation – were not allowed in many cases.

Banking and telecommunications privatisation, on the other hand, have brought in substantial benefits to the economy because these were carried out in a transparent manner, notwithstanding the criticism of the detractors of the regime at that time. The more important point is that there was competition and a strong regulatory environment.

The above history shows why the attitude towards ‘market’ in Pakistan is so negative. In a ‘market-friendly’ economy the consumers are the main beneficiaries as the forces are set by competition among many players. If one firm makes excess profits, new firms move in and the profits are lowered. In a ‘business-friendly’ economy, there is no level playing field – new entrants are discouraged and the existing firms are the main beneficiaries making excess profits at the expense of the consumers.

The ‘market’ has been rigged by a small segment of influentials and cronies of the various ruling regimes for self-aggrandisement rather than for the larger public interest. Some of the basic ingredients of market structure are missing ie property rights protection, rule of law, competition, uniform pricing for similar goods and services, non-discriminating taxation and subsidies and a level playing field.

Heavy-handed interventions by governments, slow and cumbersome judicial process for the enforcement of contracts, bureaucratic hassle in grant of permits, licences and no-objection certificates, firm-specific statutory regulatory orders (SROs), exemptions and concessions to some and not to others, bribes and extra payments negate the very concept of ‘market’.

To conclude, it is highly erroneous to term the policies and practices followed in Pakistan as ‘market-friendly’. The term that more aptly describes these policies is ‘business-friendly’ – and that too for a chosen few. Those who resent the ‘market’ should in fact try to work towards nurturing and creating a competitive market structure and demolishing the existing inefficient and rent-seeking apparatus of patronage and pelf that widely prevails in this country. [Courtesy The News]