THE RIGHT WAY TO REFORM AN AILING ECONOMY

How do you reform an economy reeling from severe balance of payment problems, shortages of foreign exchange and raw material and so on? At this point, these economies are in really, really bad shape.

The next step usually is to bring in the IMF to sort out its woes. The IMF prescribes its usual medicine- devaluation, privatization, deregulation etc.

Unfortunately, what has been observed in most instances is that the ‘bitter’medicine only stabilizes the condition without initiating a full recovery. Criticism then mounts against further reforms.

I have always felt that implementing economic reforms should be a skill and not just textbook work because the programs affect humans.

How should reforms therefore proceed?

Reforms must first start with those that may be most acceptable to the government. Devaluation is sellable and the benefits are swift, primarily an increase in foreign reserves, an increase in government revenue, economic stability and an end to a lot of trade distortions. A devaluation also reduces the relative cost of servicing budget busting State corporations. And anyway, the governments in question in cases have little option.

Apart from these, there are many wrongs that a devaluation will right such as raw material shortages, weak industrial production, misallocation of resources etc.

What is the next step? Privatization of State enterprises? This will be a positive step as privatization will lead to a reduction in government spending thereby improving the fiscal position and will also enhance productivity of hitherto poorly managed companies. Unfortunately, this will prove unpopular both with the government and the masses. It will be unwise to move in this direction due to the mass sackings that follow.

Foisting painful reforms upon reluctant governments has in most cases, proved counter-productive and stall other reforms.

Rather than start a privatization process, focus should be placed on eliminating needless regulations that stifle business. Governments must make it easy to start a business, hire and fire workers, clear goods from ports and the reduction of paperwork in most sectors of the economy. This will help in creating employment and generate revenue which both the populace and government will find beneficial.

Taxes should also be reduced. This is perhaps the most important. A reduction in taxes will lead to both an increase in economic growth and government revenue. When Russia reduced its income and corporation to 13% and 24% respectively, tax collected increased by 40%!

As earlier mentioned, a massive reduction in taxes will spur economic growth.

The reason is not far fetched. Businessmen love low taxes and this spurs investment, both local and foreign. A surge in investments will give the economy a much needed boost that will be sustained in the long term.

A significant reduction in taxes can add an extra 3-4% to yearly economic growth rates which is significant indeed. If care is not taken, it may even result in overheating from the excessive increase in growth over the long term.

For an economy in shambles, it will take a minimum of three years for the positive effects of the tax cuts to become manifest or bear fruit as it takes time for it (the tax cuts) to work its way through the economy.

Further reforms should empower the private sector to enter new industries from which they were previously secluded from especially where private-public sector participation is possible. Examples are the setting up of airports, seaports, roads, power generation and so forth on BOT terms. Enabling legislation should be put in place. We should however note that before this policy yields the desired fruitage, it will take time due to the size of these projects.

With the above mentioned reforms in place, the economy within three years will be growing at a solid rate of 7-8% annually. Such growth is impressive and is capable of creating enough jobs for those entering the job markets yearly.

Once this growth has proven sustainable over a period of five years at least, 'painful' reforms can now be carried out.

At this point, the populace will see reforms as beneficial and that economic growth can be driven by the private sector and no longer government. Also at this junction, the private sector ability to create jobs will have taken hold among the citizenry.

Government can now implement painful reforms. Note that at this stage because public institutions were not privatized and the civil service was not downsized, the budget deficit will most likely be in the red and inflation in low double digits.

Once government begins to privatize and rightsize the civil service, the budget will shrink and may even become a surplus.

You see, at this junction, these 'belated' reforms will not be as painful as they would have been were they had been implemented in the beginning.

The reason is that with a booming economy, job losses are more acceptable to the citizenry than in a collapsing one. The opportunity available to those laid off will have increased considerable and the populace now link the old unreformed system as wasteful and purposeless and new one beneficial. This is most crucial as reforms continously need to be improved upon.

About subsidies, government can at the beginning cut costly subsidies if it believes it has no option i.e. it consumes an obscene percentage of the budget and only benefits in reality a privilege few.

Following this, the next step will be to cut down the foreign debt. This is best achieved through debt forgiveness.

Will foreign governments forgive these debts? Yes, based on the present happenings in the international community. Countries that take reforms seriously have consistently been rewarded not only with debt forgiveness but with increased foreign aid as well.

With the above reforms, there are no reasons why these economies will not become developed within a generation or two.

The next time the IMF or World Bank, rather than force down bookish reforms down the throats of unwilling countries, it will do better by considering these options.