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Thursday, 14 May 2020

Economic Dynamics and Resource Envelopes


Karachi amidst lockdown. Photo credit: Wasim Gazdar

Like many other countries, Pakistan continues to debate the trade-off between lives and livelihoods in the midst of the Covid-19 pandemic. Much of this debate, it appears, has had two distinguishing features in Pakistan; (i) that it is static – in the sense that it views immediate losses in comparison to immediate gains in terms of lives and livelihoods, rather than its impact over clearly defined short and medium terms; and (ii) that a muddled narrative is being put out by different stakeholders – the federal and provincial governments, other state agencies, doctors, big business and small traders. That competing interests will pull in different directions is routine but when the political leadership is unable to aggregate this diversity and put forth a coherent perspective in an emergency, it inevitably leads to confusion amongst the public at large and fragmentation at the policy level.
Part of this confusion is also reflected in determining the fiscal response to the pandemic. Granted that it is an evolving situation but some determination of size of the resource envelope that can be brought to bear for ramping up the health infrastructure, the provision of social protection and saving small businesses during the pandemic will help different tiers of government to calibrate their responses in a more focused manner. It will also reduce uncertainty in markets and the public at large. Transparency will not hurt in an emergency. It can only help.
Dynamic Thinking on the Economy
From what we know about epidemics in general and Covid-19 in particular, flattening the curve of the disease requires slowing down the economy. Bringing down the rate of spread (known as R naught in epidemiological lingo) through a lockdown at one or several points in time will impact the economy differently. Therefore, the relevant metric to assess the economic impact in this situation should not be the here and now but an annualized cycle (short-term) and the medium-term future period, say the next 2-4 years.
Historical analysis of the Spanish Flu of 1918 as well as preliminary modelling on the Covid-19 pandemic done by Yale University demonstrates that initial lockdowns reduce the spread of the disease and ease medium-term pressures on labour supply and aggregate demand through reduced rates of fatality and morbidity. By not implementing a lockdown until the R naught declines (or the curve of Covid-19 positive cases starts declining) we will be trading off livelihoods in the immediate term with more cycles of the pandemic in the future. We will thus have more cycles of shortages in labour supply – because of higher rates of death, morbidity, and caregiving for those who are sick – as well as disruptions in supply chains and aggregate demand in the short and medium future. Strict initial lockdowns can result in a V shaped recovery in terms of economic growth, whereas a more ambivalent response will mean the recovery will be U shaped and if the virus is allowed to run riot, then we are staring down an L shaped economic outcome over the next four to five years. Choices made along this spectrum now will determine economic outcomes in the short to medium term future.
It goes without saying that lockdowns hit those without a secure means of livelihood (casual and daily wage workers as well as those in small businesses) the hardest. Lockdowns will also collapse if supply chains for essentials are not kept functional. Thankfully so far, the supply chains have by and large worked relatively smoothly throughout the country. The matter of social protection, however, has left a lot to be desired. The Federal Government is in the process of disbursing Rs. 144 billion amongst 10 million plus women who have been on the BISP register through the Ehsaas Program. While there may be some overlap between those who have specifically lost livelihoods because of the lockdown, these lists are predominantly rural and the pandemic spread so far is mainly in the urban, metropolitan areas. This misspecification in targeting is being addressed now through a separate scheme, losing precious time, which in turn has impacted the legitimacy of lockdowns.
A muddled narrative on the lockdown as well as delay in rolling out appropriate social protection support has given currency to the notion of ‘smart lockdowns.’ These models are based on the observation that both the administrative capacity and legitimacy of a full lockdown is limited and the short-term cost of a full lockdown is too high in terms of livelihoods. Therefore, after widespread testing, there should be a ‘smart’ lockdown of those geographical ‘hotspots’ where there are more Covid-19 cases, while keeping other areas open. This method is premised on proactive (rather than the currently prevalent reactive) testing. This begs the question about the fiscal and administrative capacity to test proactively and to do it fast enough and its data processed swiftly so that a smart lockdown can be implemented. As a result, even after a fortnight of the mantra of smart lockdowns being peddled, it is yet to begin at any level.
The Resource Envelope
Much of the confusion regarding the policy on lockdowns is underpinned by an implicit notion that the State lack resources to provide adequate protection to the poor and simultaneously ramp up the health infrastructure. But how limited is the resource envelope? This debate has not happened yet in Pakistan. Knowledgeable commentators have put estimates in the range of 2.5 to 5% of GDP. Whether it is within this limit or can be more is essentially a function of the subjective assessment of the political leadership on their perception of the pandemic. Another way to think about the resource envelope the nation is willing to roll out is to juxtapose the situation with a war with a visible enemy.
The Covid-19 pandemic has altered the contours of Pakistan’s fiscal space on both sides of the ledger. On the one hand, fiscal space has been created because of aid from donors – the IMF, World Bank, Asian Development Bank, debt deferment from the G-20 – and from a significant reduction in international oil prices and savings on interest payments because of the decline in interest rates. On the other hand, the lockdown has reduced tax revenues (both FBR and provincial revenues). Pakistan’s exports have taken a hit because of the global nature of the pandemic and remittances from overseas Pakistanis are expected to reduce also. Whether or not both sides balance each other out is, however, just one element of fiscal space. The government has room to reallocate resources from the existing allocations, mainly from PSDP expenditures and the defence budget. The federal government also has ample room to borrow domestically and if push comes to shove, the central bank can enhance money supply, even though that will be inflationary. To put it simply, the federal government’s fiscal space has a fair degree of elasticity.
The other issue regarding the resource envelope is distribution of resources across the federal government and the federating units. Because of their constitutional mandate, the bulk of the health expenditure is being borne by the provincial governments. They are also incurring a cost in administering the lockdown and where possible providing social protection as well. They are, however, in a fiscal bind. Because of the reduction in FBR revenues, the provinces will take a hit on their share of divisible pool taxes and their ‘own source’ revenues will also decline because of the lockdown. Additionally, the borrowing capacity of provinces is close to naught.
In this situation, it is the federal government that has a two-fold responsibility. One, to determine the fiscal space that is available and second, to create mechanisms for the provinces to overcome their resource constraints. Will the federal government provide grants to provincial governments, create a special zero interest rate credit line for them through the central bank or deduct it from future shares of their divisible pool allocations? These are important questions that need discussion and resolution. Fortunately, Pakistan’s constitutional architecture allows for these matters to be resolved. The National Economic Council, the Council of Common Interests and the National Finance Commission are forums where these issues can be debated and resolved amicably. As the pandemic peaks and the annual budget season is on the anvil, these matters have to be brought on the front burner.
This article first appeared in the Jinnah Institute’s ‘Lockdown Paradox’ series on 6th May 2020 and is republished here with the author’s consent.

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