Debt Traps from China, Western Stringency, and the Future of South Asian Democracy

Introduction

If one were to look at two events in South Asia – the economic crisis in Sri Lanka and the downfall of the Imran Khan-led Pakistan Tehreek-E-Insaaf (PTI) government in Pakistan, one of the points which clearly emerges is that both the South Asian nations have moved closer to China, and there are pitfalls to being excessively dependent upon Beijing. Both countries have often been accused of becoming excessively reliant upon China and falling into what has been dubbed as a “debt trap,” which leads not only to rising economic dependency — as a result of piling debts — but also to Beijing dictating political choices. 

External debts of Pakistan and Sri Lanka

The International Monetary Fund (IMF), according to estimates in February 2022, had said that Pakistan owe $18.4 billion (or 1/5th) of its external debt to China, while Sri Lanka’s total debt to China is estimated at $8 billion, its total external debt is $45 billion.

In the case of Pakistan, a lot of attention has been focused on Imran Khan’s independent stance on the Ukraine issue, and a possible external hand in his ouster. Yet the Pakistan Democratic Movement (PDM) coalition, led by PML-N Supremo Shahbaz Sharif — which is now in power – has repeatedly pointed to Khan’s mismanagement of the economy and the growing disillusionment of the public as well as erstwhile allies (one of the final blows to Khan’s hopes of staying in power was when the Muttahida Qaumi Movement Pakistan (MQM) pulled out of the PTI alliance) as some of the key reasons for the ouster of the PTI government. While no political party can afford to say it, Pakistan’s dependence upon China has begun to cause concern, especially amongst sections of the business community who are keen to diversify the country’s economic relations.

The dire economic crisis which has hit Sri Lanka has been attributed to multiple factors; economic mismanagement by the government, dip in remittances as well as a fall in tourism as a result of the Covid-19 pandemic and over reliance on China. 

Interestingly, while earlier Sri Lanka had refused to seek assistance from the IMF, it has been compelled to, as it is left with limited options. A Sri Lankan team headed by newly-appointed Finance Minister Ali Sabry is headed to Washington DC for negotiations with the Americans. In an interview to Bloomberg television, the Sri Lankan Finance Minister said “‘We need immediate emergency funding to get Sri Lanka back on track.”

If one were to look at the instance of Pakistan, while Islamabad has become increasingly dependent upon China in recent years — especially as a result of its deterioration of ties with the US, and the $64 billion China Pakistan Economic Corridor (CPEC) project – it has realized that it can not allow its ties with the West to slide further even though close relations with China are imperative. It is not only Western analysts and US policy makers but even ministers in the previous Imran Khan-led PTI government who had actually raised question marks with regard to the economic sustainability of certain CPEC projects. China had expressed its displeasure to Pakistan over the same.

One of the reasons cited for Imran Khan’s differences with the Pakistan army have been his anti-West stance – the former PM accused the US of plotting his downfall and for following an independent foreign policy, pointing to a memo which said that “…if the no-confidence motion passes, Pakistan will be forgiven, if not, there will be consequences.” The US has repeatedly dismissed these charges levelled by Imran Khan.

Khan’s successor, Shahbaz Sharif, has given clear indicators that he will focus on relations with China and Saudi Arabia. He has also hinted at mending ties with the West. US Secretary of State Antony Blinken, in a congratulatory message to the Pakistan PM, said:

The United States congratulates newly elected Pakistani Prime Minister Shahbaz Sharif and we look forward to continuing our long-standing cooperation.

Pakistan is dependent upon the US and EU, since they are important export markets. During his address at the Islamabad Security Dialogue, Pakistan Army Chief Qamar Javed Bajwa, while commenting on Pakistan-US ties, had said: “we share a long and excellent strategic relationship with the US which remains our largest export market.”

Pakistan’s grey list status at Financial Action Task Force (FATF) will also be in review in June 2022. Islamabad would need to mend ties with Western countries if it wants its grey list status to be removed. Pakistan is also likely to resume negotiations with the IMF for the 7th review of the $6 billion loan agreement which was signed with the IMF in 2019. For smooth negotiations with the IMF, a working relationship with Washington DC is essential.

In conclusion, while it is true that Western institutions impose stringent conditions on developing countries and they are compelled to look for different options, excessive dependence upon China has its own pitfalls. It is time for South Asia to look inwards and focus on strengthening regional cooperation and realise that no external player can come up with sustainable solutions for dealing with the region’s economic challenges.

George Halm against Common Wisdom on Currency Boards

Motivated by the recent decision of Argentina’s government to ask for an stand-by loan to the I.M.F., after a run on the peso, the last The Economist’s Bello section gives an account of the history of the relationship between them and makes a remark about the Argentine currency board experience between 1991-2002 that today is almost common wisdom: Since convertibility meant forgoing exchange-rate flexibility and an independent monetary policy, fiscal discipline was all-important for its success.”

But by the time the I.M.F. was being created, that was not an unanimous opinion. We have the example of George N. Halm who, in his book Economics of Money and Banking, stated that every Currency Board must implement a countercyclical policy on reserve requirements to be held by the commercial banks. Thus, the Currency Board could neutralize or mitigate an expansion or contraction of the base money by alternatively increasing or lowering the reserve requirements of the banks. For George Halm, a Currency Board could be almost in full command of monetary policy -and even more with respect to any other system, since it retains its political independence.

It is hard to imagine a Halm’s Currency Board that promotes a rapid economic growth which, in turn, could bring any popularity to its implementation. But it is as hard to imagine as the probability that a monetary system as such could end up in a bank run.

The Dangerous Inequality Meme

The inequality of wealth and income has become a meme loaded with danger. A “meme” is an idea that gets propagated like genes in biology. Economic inequality has long been a topic of interest, but during the past few years, and especially during the 2015-2016 American elections, the inequality meme has erupted into a major political issue among those who identify as progressive, liberal, and socialist.

The facts about inequality in the USA are clear. Since 1970, income inequality has increased. As national income has grown, most of the gains have gone to the rich. Average incomes have even dropped since the recession of 2007-2009.

During the 1800s, the first economist to analyze equality and inequality was Henry George. Karl Marx had touched on economic inequality by saying that the surplus from production was due to labor but was captured by the capitalist, the owner of the firm and its tools. Thus, the proletariat, the workers, stay poor and the capitalists get rich, creating inequality. But Marx and his followers focused on the conflict between labor and capital rather than the inequality.

Henry George pointed out that the surplus from production is not in wages, nor in business profits, but in land rent, which is a pure surplus, since land has no cost of production. George showed how land rent captures the gains from economic progress, creating the inequality in wealth and income between workers and the landowners. Competitive firms make normal profits, which has no surplus. Of course monopolies can capture surplus also, but the profits from entrepreneurship are a bonus to society, rather than a social problem, as entrepreneurs drive innovation and economic progress.

Unfortunately, when the classical economics of the 1800s turned into the neoclassical doctrines of the 1900s, both by design (in opposition to the Georgist remedy of taxing land value) and for mathematical convenience, land was dropped as an input factor, and mainstream economics became the two-factor production function Q=f(K,L). It is illogical that land rent gets included in the distribution of income in the return on K, but excluded on the production side, as the models are based only on the two inputs, labor L and capital goods K. This contradiction is not questioned by graduate students in economics, who are too busy learning the calculus of “math econ” to bother asking if the whole system makes sense.

Therefore the inequality meme is now blended with the labor-capital meme, ignoring the real source of economic inequality, unequal land tenure. Politicians exploit the all-too-real economic inequality with a superficial, simplistic, and dangerous remedy: tax the rich and transfer the funds to the poor. Of course governments are doing that already, and that has not reduced inequality, but the welfare-statists insist that government should do more of it.

Conservative opponents of greater redistribution point out, correctly, that higher taxes and takings from the rich will stifle entrepreneurship and savings, reducing the economic growth. But other than eliminating some of the tax deductions and generating more growth by reducing the top tax rates, the conservatives have no effective remedy. Their call to flatten the tax rates play into the political agenda of the redistributionists who call for higher, not lower, tax rates on the rich.

The danger in the inequality meme is the confiscation of the wealth not just of the rich but also of the middle class. A family that spent all its income and now has no wealth would be given welfare aid, while the family with the same income but frugally saved its income for retirement or to provide for their children would have their wealth taken away, not just by ordinary and predictable taxation, but by a sudden taking, as happened in Cyprus in 2013. Government chiefs facing a debt crisis can kill two birds with one stone: confiscate savings and use some of it to pay off debt and the rest to transfer to the poor. Such confiscation has been suggested by the International Monetary Fund, which lends funds to countries bogged down in debt. In its publication Fiscal Monitor Report, the IMF stated (pdf):

The sharp deterioration of the public finances in many countries has revived interest in a “capital levy”— a one-off tax on private wealth—as an exceptional measure to restore debt sustainability. The appeal is that such a tax, if it is implemented before avoidance is possible and there is a belief that it will never be repeated, does not distort behavior (and may be seen by some as fair).” There we have the proposition that such confiscation of wealth can be “fair” (49).

This IMF capital-levy proposition was presented in Forbes with the title, “The International Monetary Fund Lays The Groundwork For Global Wealth Confiscation.” The Wikipedia article on “capital levy” shows that this meme is getting some traction, such as by Germany’s Bundesbank. The concept of a capital levy, confiscation of savings and investment, comes from the meme of economic inequality that looks only at the superficial existence of unequal wealth and not to the source.

It has been well pointed out by British journalist and economist Fred Harrison in his Youtube video “Ricardo’s Law: the Great Tax Clawback Scam” that while the rich pay much in taxes, many of them get the tax back, as a clawback, from government’s public goods, which generate higher rent and land value.

The effective and equitable remedy for economic inequality is not redistribution but the proper initial distribution of income. Wages and capital yields should be kept by the workers and investors, while land rent should be equally distributed either as cash or in public services. Public revenue from land rent would equalize income while promoting growth and raising wages. We need to bring land back into economic discourse, but that requires penetrating the appeal of superficial thinking. That’s what Henry George tried to do, and the Georgist meme had reached up to the heads of state in China, Great Britain, and Russia (after the first revolution with Kerensky), but World War I blasted the impending tax reforms to bits.

The candidates who now rant against inequality, the corporations, and the billionaires, even if they don’t win the election, will influence policy and generate calls for more redistribution and, perhaps in the next financial crisis, a capital levy. While alarmists often exploit impending doom for their own gains, sometimes they are right.

—————————–

This article is also in progress.org under the title “Tyrants Exploit Income Inequality”

[Ed. note: I added tags, categories, and links, and patched up some grammar – BC]