State intervention dominates Pakistan’s economy more than ever before

In the early days of the Soviet Union, facing a shortage of nails, central planners introduced a scheme offering bonuses to factories that met specific nail volume targets. In response, factories reduced nail sizes to maximize production, meeting the targets but flooding the government with millions of useless tiny nails. To correct this, the government revised the bonus target to focus on the tonnage of nails produced monthly. As a result, factories shifted to producing larger nails. Once again, they met the target, but the government was left with an excess of useless, oversized nails. This anecdote highlights the unintended consequences of central planning, where the focus on meeting production targets can lead to inefficiencies rather than addressing real consumer needs.

Friedrich Hayek’s concept of the ‘knowledge problem’ offers a compelling critique of central planning’s limitations. He argued that the dispersed and tacit nature of knowledge in society makes it impossible for central planners to efficiently allocate resources. Decision-making is concentrated in the hands of a few, lacking real-time information leads to incentivizing misallocation of resources due to an inability to gauge consumer preferences, technological advancements or supply chain disruptions accurately.

State-directed policies lacking market incentives stifle innovation and entrepreneurship, limiting individuals’ and enterprises’ autonomy to adapt and respond to changing conditions. Behavioral economists Richard Thaler and Daniel Kahneman further highlight the challenges associated with assuming perfect information and rational decision-making by central planners. They emphasize the influence of cognitive biases, heuristics, and social norms on human behavior. Often, the assumptions about human behavior in central planning are overly simplistic and unrealistic, contributing to further inefficiencies and market distortions.

While streamlining investment policies is commendable, the SIFC’s discretionary powers raise concerns about distorting market rules. 

Javed Hassan

Bureaucratic policymakers tend to prioritize stability and predictability over risk-taking and innovation. They are incentivized to maintain control and avoid disruptions to their plans. This risk-averse approach stifles the creative destruction process essential for economic progress, where obsolete industries and practices are replaced by new ones, driving productivity growth and technological advancement.

While Pakistan is not a communist country and claims to aspire to a market-based economy, state intervention permeates almost every sphere of economic activity, leading to suboptimal outcomes similar to the Soviet nail production debacle. For instance, the Independent Power Producer (IPP) agreements, based on take-or-pay payments and high sovereign-guaranteed dollar returns, were negotiated and signed by the state. These generous terms attracted numerous new power plants, resulting in an excess of generating capacity that the country pays for, even when unused. This has led to escalating power tariffs, further suppressing demand and raising prices.

The top-down approach mirrors Pakistan’s energy sector, where state authorities determine prices and guarantee margins or returns to suppliers. State intervention also extends to other sectors, limiting market dynamics and impacting the choices of millions. Central planning has metastasized into a powerful instrument of state capture by large landholders, industrial and banking groups, and real estate developers who wield political influence to control policymaking and extract rents. A much-favored mechanism, popular even among multilateral development banks, is public-private partnerships through which risks are often insured by the state, while the profits are privatized.

In the industrial sector, tax and trade policies have been designed to protect dominant incumbent players. Unlike in other fast-growing developing economies, free trade and global integration policies have not been pursued to protect the interests of local industry and jobs. The prevalence of oligopolistic practices has adversely impacted productivity and export growth. In the agriculture sector, support prices, import restrictions, and direct and indirect subsidies have all contributed to anti-competitive practices and adversely affected consumer interests. Resultant price distortions in food commodity markets have incentivized large landlords toward unsustainable and suboptimal usage of their holdings, leading to sluggish improvement in productivity.

Despite ample evidence of its failures, Pakistan continues to expand state intervention in economic decision-making. In many sectors, state policies interfere with price signalling, distorting market mechanisms that would otherwise spontaneously coordinate complex patterns of productive resource uses. Consequently, market-driven processes, which should motivate maximizing returns and improving efficiency, are not the primary determinants of actions by economic agents.

Similarly, instead of creating an environment to encourage foreign investors to discover and utilize its large and youthful population as a production hub for labor-intensive products that could generate substantial export volumes, reports suggest that generous returns and repatriation privileges are being offered to attract Gulf foreign investments. There appears to be little focus on enhancing manufacturing competitiveness or promoting market-driven decision-making.

The Special Investment Facilitation Council (SIFC), designed to expedite Gulf investments, wields considerable influence over resource allocation and major investments. While streamlining investment policies is commendable, the council’s discretionary powers raise concerns about distorting market rules. This concentration of power in the hands of a few and their influence on critical resource allocation decisions reinforces the impression that state intervention dominates Pakistan’s economy more than ever before.

- Javed Hassan has worked in both the profit and non-profit sectors in London, Hong Kong, and Karachi. He tweets as @javedhassan. The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of Arab News.