Capturing the CPEC Opportunity

Without restructuring the domestic economy, Pakistan will struggle to benefit from Chinese assistance.

The early harvest projects under the China-Pakistan Economic Corridor (CPEC) catalyzed sorely needed investments in power projects and large public infrastructure projects. The completion of the projects helped Pakistan end its chronic power generation crisis and developed world-class highway infrastructure.

At the same time, however, these projects were largely responsible for a dramatic spike in Pakistan’s current account deficit, a rise in external debt, and a sustained decline in foreign exchange reserves.

But debt and current account deficits by default are not bad things. Allow me to explain:

• Imagine there are two living versions of you, Version A and Version B.

• Both borrow $250,000.

• Version A borrows the money as part of a graduate student loan program to get their MBA.

• Version B uses a credit card to buy an expensive luxury car.

• It is clearly evident that Version A has borrowed money to invest in their future income - the loans have been taken at low rates to finance a long-term growth in their income generating capacity.

• Version B, meanwhile, has used a short-term, high-rate credit line to finance a high-depreciation, high-maintenance asset. This asset does not boost their long-term income generating capacity.

• While both have borrowed, clearly Version A’s borrowing is justified and should be encourage, while Version B has a spending problem and needs help.

The same goes for countries like Pakistan, who need to invest in development spending to build their long-term economic growth capacity. The early harvest projects under CPEC did exactly that.

But like Version A, who after getting into an MBA program must study hard and make the right choices to maximize the benefit of their education, Pakistan had to embark on structural reforms to maximize the benefits from CPEC.

This is all the more important given that the loans are denominated in US dollars, meaning that the country must find a way to earn US dollars in order to pay back these loans plus interest.

Before going into the details, a short disclaimer: what I am describing does not, in any way, shape, or form, justify the overvalued exchange rate and the poor choices made by the PML-N in managing an overheating economy.

To earn US dollars, Pakistan must eliminate “plotistan.”

To talk about CPEC and its impact on Pakistan’s economy, I recently invited Dr. Tayyab Safdar, a post-doctoral researcher at the University of Virginia, to the podcast.

We talked about a whole bunch of things but one of the most important points we discussed was related to the incentive people have to invest in unproductive asset classes in the country. The most attractive asset within this category are plots.

For investors in Pakistan, it is far more beneficial to operate in this economy, which I call “Plotistan.” You can hide your illicit wealth there. You can speculate and get a quick buck. You don’t have to pay much, if anything, in the form of taxes. And best of all, you can get high returns all while sitting in the comfort of your home.

Meanwhile, those who want to actually do something more have to operated in the real economy where it is simply very, very hard to do business. You have to constantly deal with the tax authorities, who are continually extracting more rupees from those who pay while failing to expand the tax net. You have to deal with poor urban infrastructure, especially if you are in Karachi. And if you are an exporter, you have to deal with a whole host of issues from waiting for refunds to high inflation to hiring and training a poorly-skilled labor force.

All of this means that over time, anyone with excess capital will choose to migrate to Plotistan, because it offers equal if not better returns than the real economy and there is less hassle.

Additionally, the Supreme Court decision setting a precedent that an operative in Plotistan can steal peoples’ lands and be given a clean chit by paying a fine to the state, means that one can now run illegal housing schemes and come out richer and more influential!

Operatives in Plotistan have captured Pakistan.

Effective property tax collection systems that value property on par with market value provide finances to run urban centers all over the world. But given that the state has been captured by elites who benefit from parking their wealth in plots, Pakistan has a weak property tax collection system.

Here is a comparison:

• Pune, a city of ~3.5m people, collects USD 109m per year from property taxes.

• Sindh, a province of ~50m people, collects USD 11m per year from property taxes.

Messed up, isn’t it?

So next time you hear a politician talking about the need for Pakistan to grow its exports and how CPEC will change the destiny of the Pakistani state, ask them what they are doing about reducing the incentives for people to invest in unproductive asset classes, and more specifically, what they are doing to raise property taxes across the country.

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