Petrol is around Rs 300/litre today, excluding government levy, here's how it can effectively be Rs 30/litre.

People do not consume petrol for its own sake; they use it to travel. The average Pakistani rides a motorbike. A fuel-efficient motorbike can travel about 60 km on one litre. An efficient electric scooter can travel about 30 km per kWh, so it needs only 2 kWh to cover the same 60 km.

What should 2 kWh cost in Pakistan? Pakistan is one of the best places in the world for solar, with an all-in LCOE cost of around 5 cents per kWh. The electricity cost is 10 cents, or Rs 30/litre of distance travelled! The Rs 30/litre calculation remains the same for cars.

The 300-versus-30 gap is the cost of bad policy. It reflects billions of dollars of saving that could instead finance EV infrastructure: charging, distribution, battery swapping, and smart pricing software etc. - boosting much-needed domestic investment.

Since solar is highly modular. You do not need massive scale to get reasonable efficiency. That creates business and employment opportunities for small domestic power producers. Instead, Pakistan leaned into large fossil-fuel plants financed by dollar-denominated borrowing and guaranteed returns.

Local firms face credit constraints, but solar creates a natural collateralizable cash flow through electricity sales to the grid. With the right regulatory framework, this could have unlocked large private domestic investment, and employment.

Battery swapping is another area where small local businesses could have emerged and scaled.

Electricity enables smart pricing. When solar supply is abundant, prices can fall, and poor households and firms can shift usage to cheaper hours - automatic demand stabilization.

Better air quality would mean longer, healthier lives and higher productivity. That is a growth multiplier.

Green technology industries could be developed domestically with the right industrial policy, easing balance-of-payments pressure while raising employment and investment.

Instead, Pakistan chose imported-fuel power plants, protected a backward-looking domestic auto sector, and raised electricity prices by burdening them with the fixed costs of those plants and heavy taxation, slowing EV adoption. Then came the net-metering fiasco, all to keep zombie power plants alive.

Pakistan’s energy policy may be the clearest example of a broken nervous system. I hope someone fixes it, because people are paying the price, 300-versus-30.

Pakistan International Airlines, the country’s flag carrier, has finally been privatized after years of persistent losses. Is this a good deal for the government, and its people? I’ll start with the transaction’s financials - what was sold, what cash changed hands, and what liabilities stayed behind - before turning to the final answer.

What did the government get?

Not all of “legacy PIA” was privatized. Before the sale, the state split the airline into two entities. A holding company absorbed most of the old financial baggage—roughly Rs650bn in net legacy liabilities. The operating airline retained the aircraft, routes, and day-to-day business. It is this airline company that the government sold to private investors; the holding company remains with the state.

The 2024 accounts make the motivation for the carve-out plain. The holding company was designed to absorb enough of PIA’s legacy liabilities so that the operating airline - the entity being sold - generated a modest operating profit in 2024. That was not cosmetic: it was the prerequisite for any serious turnaround.

Privatization only works if the buyer has a credible path to creating value. PIA, as it existed, suffered from a classic debt-overhang problem: even if new management improved performance, much of the incremental cash flow would be swallowed by servicing old obligations. In that world, the rational response is to underinvest, cut corners, and limp along. By separating the legacy balance-sheet burden from the operating airline, the government improved the buyer’s incentives - and, in principle, the odds that operational reforms translate into investable returns.

The government sold 75 per cent of the operating airline under a structure that combined a small cash payment to the state with a much larger capital infusion into the company. Roughly Rs10bn arrives as cash proceeds to the government, while about Rs125bn is injected into the airline as new equity to recapitalize the business. On the implied valuation, the state retains a 25 per cent stake worth about Rs45bn. Taken together, the government’s immediate “value” from the transaction is therefore about Rs55bn - roughly Rs10bn in cash and Rs45bn in equity.

What the government will not get

Some commentators have celebrated the sale as if privatizing PIA automatically stops the fiscal bleeding. It does not. The state still retains the holding company—and with it roughly Rs650bn in legacy net liabilities.

Put differently, the government walks away with about Rs55bn in value from the transaction, but it also keeps roughly Rs650bn of legacy obligations. Netting the two leaves a balance-sheet hole of about –Rs600bn. The minus sign matters. And even at a conservative 10 per cent average cost of capital, servicing that legacy burden implies roughly Rs60bn a year in financing costs. The government will continue to pay for the dysfunctions of the past - privatization or not.

Looking forward

A cynic might look at these numbers and conclude that privatization is just rearranging the deckchairs. But that is too harsh. This deal is a step in the right direction: it removes the debt-overhang problem from the operating airline, and puts it under new management with an incentive to perform.

What about the roughly Rs600bn of liabilities the government is still carrying? The first lesson is to avoid the sunk-cost fallacy: past mistakes should not prevent better choices today. Stripping the airline of legacy debt and letting it operate in a more normal market environment was the right move—even if it does not erase the old bill.

The second lesson is that the state remains, in effect, a shareholder in the broader economy. When firms expand, the government participates through the tax system: higher payrolls, more sales, and—eventually—profits translate into higher revenues. The best case after privatization is therefore not that the Rs600bn vanishes, but that a healthier aviation sector grows fast enough to help pay it off over time.

What worries me

Pakistan has privatized before—banking is the obvious example—yet growth has steadily slowed in the years since. That does not mean privatization “failed,” but it does underscore a harder point: ownership changes are not a substitute for a broader environment that rewards investment, competition, and productivity. Without that ecosystem, privatization becomes a transaction, not a transformation.

The PIA carve-out followed the right logic: separate the legacy bad debts, then privatize the operating business. But why has the same discipline not been applied to the far more consequential energy sector? There, the costs of dysfunction have been socialized—pushed onto households and firms through punishing electricity prices rather than cleaned up transparently on the state’s balance sheet.

PIA’s roughly Rs600bn legacy hole is not just an accounting number; it is the residue of decades of weak governance and a failed institutional nervous system. Will that regime change? That is the real question.

(AI-assisted copy editing was done on the initial draft for improving clarity and flow.)

Those sacrifices add up. Remittances to Pakistan are now about 38 billion dollars a year, roughly 10% of GDP. Pakistan stands out globally for how large these flows are relative to the size of its economy. The chart below plots Pakistan’s remittances-to-GDP ratio over time (green line) against that of a “typical” developing country with similar GDP per capita (black line, estimated via a regression). Pakistan’s remittances have climbed steadily and are now about twice as large as what you’d expect for a country at this income level.

Remittances are free foreign exchange, straight into households, with no debt attached. Surely that must be good? For the families receiving them, absolutely. But for the broader macroeconomy, the story is more complicated - and more interesting. If remittances are not managed properly, they can become a restraint on growth. In fact, the evidence suggests that this is exactly what has happened in Pakistan.

When remittances are as large as they are for Pakistan, their macroeconomic effects cannot be ignored. First, they raise consumption and spending power faster than the economy’s own productive capacity. Second, the steady inflow of dollars tends to appreciate the rupee in real terms, which disproportionately hurts the more productive, export-oriented tradable sector. Together, these forces make the country “more expensive” than its productivity justifies — the classic pattern economists call Dutch disease.

Pakistan’s macro trends strongly suggest that these negative remittance effects have been at play. The export sector has steadily weakened as remittances have become more dominant. The exchange rate has been overvalued for long periods. And Pakistan’s investment-to-GDP ratio is strikingly low—implying an unusually high consumption-to-GDP ratio—compared with other countries at a similar income level.

Remittances don’t have to be a drag on growth. With the right macro policy, they can become a catalyst for financial stability, investment, and long-run development. That requires two key steps. First, when remittances surge, the central bank shouldn’t just let them spill into consumption and an overvalued currency. It can “lean against the wind” by building foreign exchange reserves. Strong reserves anchor financial stability and protect a fragile economy from the damage of an over-heated, over-valued exchange rate.

Second, the government needs a serious foreign direct investment strategy that channels capital into greenfield projects in tradable and other high-productivity, technology-intensive sectors. These inflows must be carefully regulated: short-term speculative portfolio flows, and investment into low-productivity non-tradable sectors like real estate, should be discouraged. Instead, major projects should come with minimum domestic partnership requirements to ensure genuine technology transfer and productivity spillovers.

These two parts of macro policy reinforce each other. A healthy reserve buffer signals to foreign investors that the country can backstop its financial system and honor profit repatriation, which reduces perceived risk, and hence cost of capital. And unlike unsterilized remittance inflows, which can push the currency into overvaluation, FDI into productive sectors expands the supply side of the economy - raising productive capacity and competitiveness rather than eroding it. With better macro-financial management, the same remittances could have underwritten a very different, export-oriented and investment-driven growth path.

Why can the government not have better policies? In my previous post, I discussed how poor policy choices, like the ones highlighted above, have pushed Pakistan into a stagnant economic regime with declining growth over time. I also laid out some of the ingredients needed to design better policies. But is bad policy the result of weak capacity or low competence alone? No, there is another important - and perhaps more sinister - reason: political economy.

Pakistan’s most powerful elites often earn their wealth not through competitive exports, but through protected, rent-seeking sectors such as real estate and the sugar industry. Their interests are better served by an overvalued exchange rate, which allows them to convert domestically generated rents into foreign assets on more favorable terms. The irony is stark here: the remittances of poor workers forced to leave home in search of a livelihood end up helping sustain the external purchasing power of the country’s most privileged groups.

For decades, scientists and engineers have struggled with how to build intelligent systems that can solve hard problems - like recognizing a face. One option was to be completely prescriptive: spell out what a “normal” face looks like, then list every possible variation for every person. That path quickly hit a wall, and modern AI took a very different route. Instead of writing ever more complicated solutions, we built relatively simple systems with one critical property: iterative self-learning. The goal is not to hard-code the answers, but to build a kind of nervous system that figures out the right answers for itself over time.

One of my favorite examples is DeepMind’s AlphaZero, an AI system that teaches itself to master complex board games and then beats the best human players. Its brilliance lies in its simplicity. You never tell it what a “good” chess move is; you only give it the rules of the game, and it learns the rest on its own. To me, that is what smart policy should aspire to: build a nervous system, grounded in first principles, that keeps learning better policy solutions over time. It is precisely this kind of nervous system that Pakistan lacks.

What would a self-learning nervous system for Pakistan look like? It should have three key ingredients. The first is data. AlphaZero generates its own data through self-play, then uses it to test existing strategies and discover better ones. We already live in an age of data. Interactions between students and teachers, doctors and patients, consumers and producers can all be digitized and “trained on” to improve incentives, learning and health outcomes, boost domestic productivity, and so on. That data is essential for any intelligent system should be obvious - yet Pakistan has failed even to conduct a census on time for decades.

The second key ingredient is an iterative learning-and-feedback mechanism. In AlphaZero, a deep neural network starts with a rough way of playing, then repeatedly improves by playing against itself, using the data from those games to update its internal strategy through backpropagation. Over time, bad ideas are discarded and better ones are reinforced. Pakistan desperately needs institutional capacity that works the same way: using real-world evidence to see what works, what needs fixing, and what is missing. That means building serious technical capacity across universities, think tanks, and government organizations. Instead, after decades of neglect, whatever capacity Pakistan once had has simply withered away.

The third ingredient is the most important one: choosing the human in the loop. As remarkable as AlphaZero is, none of it would exist if Google had not backed someone as capable as Demis Hassabis, a future Nobel laureate, and given him substantial resources and authority. This is where governments have stumbled badly. I have long argued that we must appoint highly competent people at the top of the decision-making chain and then give them the power and resources to get things done. Instead, far too often, outright quacks have been placed in some of the most critical policy roles. Pakistan can do much better. If you want to win the World Cup, you do not select your relative; you find a Wasim Akram, and let him bowl.

Pakistan’s potential is enormous - that is exactly what makes our current state so intolerable. As I argued in my previous post, the stagnant regimes of yesterday and today have run their course; you cannot escape crisis by running the same failed tricks again and again. What Pakistan needs now is a new nervous system - built on real data, genuine learning, and competent people trusted with real authority.

Five-for-fifty is an attainable goal, and Pakistan could do even better in best case scenarios. For example, consider two countries that once had income levels similar to Pakistan’s - South Korea and China. They reached global average income per capita around 1985 and 2020, respectively, on the backs of much higher sustained growth rates. Since growth naturally slows as countries get richer, a natural implication of Five-for-Fifty vision is that Pakistan should have significantly higher growth rate in the first twenty five years. The earlier decades have to do more of the heavy lifting.

The Five-for-Fifty vision would be transformative for a large country like Pakistan with a population of over 250 million. It means that a child born in Pakistan today would reach middle age in a completely different nation, with a global standing in the top echelons. For example, if Pakistan had managed 5/50 over the last half century, it would be one of the world’s top ten economies today, with a global standing comparable to France.

Unfortunately, Pakistan’s economic performance over the last fifty years has fallen far short of the 5/50 vision. Worse, the trajectory has been deteriorating. The figure below plots Pakistan’s GDP per capita (black line) on a log scale, so the slope of the line reflects the growth rate. The green dashed line extends the average per capita growth Pakistan achieved in the 1980s - about 3.1 percent a year, already well below what 5/50 would require. But what is deeply disturbing is that growth has slowed even further since then, to the point of near stagnation in recent years. You can see this visually in the widening gap between the black line and the green dashed line. The situation is grim.

What would it take to turn things around and bring the 5/50 vision within reach? The single most important step is “regime change” - not in political terms necessarily, but in strategic policy. This is one of the important lessons of economic history. An analysis of growth experiences around the world reveals that countries typically fall into two distinct growth regimes. Some are stuck in a stagnation regime: they may enjoy the occasional burst of high growth, but it quickly mean-reverts and they never catch up to the world average. Others manage to build institutions and policies that deliver a sustained high-growth regime: external shocks may slow them for a few years, but they soon return to a strong long-run path.

The figure above makes it clear that Pakistan is stuck in the wrong stagnation regime. Our long-run growth trajectory has been essentially the same whether the country is ruled by the generals, the PPP, PML-N, PTI, or today’s convex combination. What Pakistan needs is a new regime guided by credible, consistent policies grounded in rational rather than whimsical thinking. I have long argued that Pakistan’s strategic nervous system is broken. Rebuilding it will require serious investment, sustained effort, and real resolve.

A few examples of how this broken nervous system keeps us locked in a stagnation regime. The ongoing IMF program was badly needed in for liquidity support, but the program is poorly designed to deliver sustained growth. For example, the program jacked up taxes on electricity, making it among the most expensive in the world in order to plug fiscal holes. This flies in the face of basic public finance 101: you tax where distortions are smallest - land, carbon, retail - not the most important input into production. And you certainly don’t cripple a sector where Pakistan has some of its strongest investment potential in solar and other renewables.

Pakistan’s policy establishment still misunderstands what investment is, repeatedly mistaking inflows of borrowed dollars for growth-generating capital. The latest example is the poorly designed SIFC, but earlier foreign investment deals were similarly ill-structured. For instance, Pakistan could benefit enormously from a well-designed economic partnership with China - built on technology transfer, skills, and higher domestic productivity. Instead, policy leaned on fossil-fuel power plants, often in the wrong places and with high fixed and operating costs in dollars. The result is a zombie power sector, which the government is now trying to rescue by taxing electricity! Growth begets growth; madness begets more madness.

Pakistan continues to lack a serious, rational external-account policy. It should have been clear decades ago that actively maintaining an overvalued exchange rate, while encouraging unproductive dollar-denominated sovereign borrowing, would end badly. But the nervous system was broken. I have outlined elsewhere how macro-financial policy should be designed for a country like Pakistan.

There are many more examples of poor policy choices that have locked Pakistan into a stagnation regime: real-estate–driven elite capture; institutional support for negative-sum games of sectarianism; the much-hyped Naya Housing Scheme that was supposedly going to turn the country around; the list goes on … most recently, the government even appointed a special czar for crypto!

What Pakistan needs is a regime change in thinking - a decisive break from the stagnation regime of the last five decades. Change of this sort is never easy, which helps explain why it has not happened so far. A successful regime shift requires serious investment in the decision-making process: robust data infrastructure, domestic research institutions with independent analytical capacity, and competent technical professionals at the top with real delegated authority. This is, in part, what China did under Deng Xiaoping with the dictum “cross the river by feeling for the stones,” putting in place an iterative, experimental approach to reform. Above all, however, successful regime change requires courage - the courage to break with entrenched, regressive special interests, and the courage to think and act differently.

The numbers tell a different story. Comparing Pakistan’s investment rate before and after CPEC shows no improvement—in fact, it has declined. Why did total investment decline despite tens of billions in CPEC investment? The reason lies in the economics of foreign investment.

Every foreign investment creates a financial liability for the country since the investment is expected to be paid back with profit. This liability can only be paid back in a foreign currency, which a country can only manage by generating an equivalent export surplus. Thus if foreign investment is largely used to fund domestic consumption, as was the case with CPEC, it would generate negative pressure on the country’s balance of payment situation - increasing risk, raising cost of capital, and tightening financial conditions in the process.

Beyond the currency mismatch issue, foreign investment still has to generate sufficient domestic productivity gains. Since every foreign investment is a liability, prudent policy requires that domestic gains from foreign investment must significantly outweigh the liability. For example, prudent policy (as is the custom in countries like Vietnam, China, India etc.) requires that large-scale foreign investment occur through domestic joint ventures to guarantee that skills and technology from the investment passes through to domestic firms.

Even more important is the selection of industries in which to prioritize foreign investment - there’s not much technical content in the production of roads, bridges or legacy power plants. Instead foreign investment should be prioritized in sectors closer to the frontier of global technology, such as chip manufacturing, renewable energy supply chains, space technology etc. Careful consideration should go in embedding such investment through local firms and universities - so knowledge sticks and grows. Again there are many examples to learn from in the region.

On the financing side, the goal should be to minimize the foreign liability, while maximizing domestic gains through strategies outlined above. This can be done by financing a major portion of total investment via domestic debt, and then splitting the equity piece between domestic joint venture companies and the foreign investor. An equally important issue is the valuation of equity - this must be done on market principals - the lower the valuation by the foreigners, the higher will be the implied liability that the country owes going forward.

A terrible way to finance is to borrow both debt and equity entirely from abroad. Even worse would be to do so under sovereign guarantees on both debt and equity! In fact, there is no such thing as “equity” if it comes with a guaranteed rate of return in dollars! But this is how most of foreign investment was financed by Pakistan - another reason i keep saying, the nervous system is broken.

We are now in a position to understand why the 2015 foreign investment deal of around 15% of GDP made zero impact on Pakistan’s total domestic investment. The deal was structured to primarily finance the non-tradable sector. It focused on sectors without much productivity or technology content. It had no significant joint venture content - the entire supply chain, often including labor, was to be imported from China. The entire financing - debt plus equity - was largely foreign based, and denominated in dollars. There was little market discipline, like competitive bidding to avoid over-invoicing for example. With all these negatives, the addition of foreign liability that came with CPEC crowded out domestic investment. The net result is depicted in Pakistan’s total investment numbers before and after.

Pakistan is repeating the same old mistakes in the next round of “game changing” foreign investment in the form of SIFC. Once again, foreign investment is being seen as a silver bullet - without regard to understanding the fundamental issues with the domestic economy. History is likely to repeat itself.

None of this is to say that Pakistan should not target foreign investment - it should. Countries like China and others have a lot to offer. But it must be done as part of a broader macro-financial framework. For example, Pakistan should closely follow the advice I laid out for Bangladesh. Only within such a structure can foreign investment be fruitful.

(This post comes after a bit of delay - I want to write more frequently, but my priority remains research and teaching, which slows down the posts.)

Strong public protests forced the long-serving Prime Minister of Bangladesh to resign and flee. The natural question is, what comes next? There’s opportunity for positive change, but great risk as well - getting political transition right is never easy.

Bangladesh has shown tremendous promise since independence half a century ago. Arguably its three most noteworthy accomplishments are: (i) impressive improvement in human development indicators such as child mortality, (ii) the development of a vibrant non-profit sector, and (iii) the country’s ability to keep religious extremism out of mainstream politics. The third accomplishment is all the more impressive, given the rising political acceptance of religious extremism in rest of South Asia as both Pakistan and India fall further into religious communalism.

As Bangladesh looks towards the future, one particular area that needs attention is macro-financial policy. Bangladesh did not properly capitalize on its impressive export growth in ready-made garments. Instead of using its export gains to build credibility in currency and financial markets, it squandered the gains through an imprudent policy that favored consumption over investment, among other flaws. This weakness was laid bare when global financial conditions tightened and Bangladesh had to seek help from the IMF. How should Bangladesh design its macro-financial policy, now that it has a fresh start?

First, announce a commitment to building real reserves while maintaining a market-based exchange rate. This can only be done by running moderate current account surpluses for a while. The target should be for Bangladesh to save a significant portion of its 20+ billion dollars of annual remittances.

The commitment to save remittances will send a clear signal for potential exporters that they can expect a favorable exchange rate, and protect the country from Dutch disease. The buildup of reserves also provides a war chest against speculative attacks, and builds confidence in Bangladesh’s domestic financial sector. This will help bring spreads come down and ease financial conditions for domestic investment.

Second, the commitment to build reserves must be accompanied by a sound macro-prudential policy that regulates leverage and international capital flows. In particular, as financial conditions ease due to reserve buildup, foreign capital would want to enter Bangladesh. But this is where Bangladesh must put in place sound rules to guide what kind of capital it prefers.

All capital inflows are not created equal for a country like Bangladesh. Bangladesh should not allow capital account convertibility for speculative “hot money” flows, or flows in non-productive sectors like land and real estate. In general, foreign borrowing for investment in largely non-tradable sectors should be avoided. Instead the focus should be to encourage foreign capital in tradable sectors that comes with technology and managerial talent that Bangladesh otherwise lacks. Joint-ventures should be strongly promoted so the technology and management skills that come with foreign capital ``stick’’ inside Bangladesh and generate positive knock-on effects. The government should stay away from the “original sin” of borrowing in a foreign currency. Bangladesh should learn from India on this front and completely avoid sovereign borrowing in dollars.

Third, the reserve and external macro-prudential policy will create space for independent monetary policy. This is the well-know “trilemma” that developing countries face - they must protect themselves from the whiplashes of global financial markets if they want to have an independent monetary policy. Once Bangladesh has this hard-earned monetary space, it must use it intelligently to manage domestic demand cycles and anchor inflation expectations.

The key to sound monetary policy is having an independent central bank with a strong board and competent leadership. Monetary policy is a technical subject, and must be lead by people with relevant expertise, who are institutionally protected from myopic political pressures. The focus should be squarely on managing cyclical fluctuations and anchoring inflation at a low level. Sound monetary policy provides the comfort and security that private sector needs in order to invest for the long-run.

Fourth, recognize the natural linkages between the policies described above and fiscal policy. Design a tax and spending policy that is supportive of broader macro-stability, encourages long-term investment, and does not promote external imbalances. For example, on the taxation side, institute a market-value based land and property tax system that funds local infrastructure and public good needs. These taxes have the merits of being less distortionary (land is a non-reproducible asset) and also curb excessive unproductive land speculation. Incentivize getting out of fossil fuel dependence by taxing carbon, use congestion pricing, and then take the proceeds to invest in public transport and renewables infrastructure.

Managing public deficits is very important to avoid extremes such as fiscal dominance. However, Bangladesh has large public investment needs as well. If properly done, such public investments create asset value and hence should not be counted against fiscal deficit. Bangladesh should adopt dynamic scoring fiscal rules to promote public investment - but this should only be done after putting in place an independent fiscal scoring body. In general, like I mentioned in the case of monetary policy, Bangladesh should establish strong and independent macro-prudential and fiscal bodies with legal cover to bring long-term credibility to macro policy. I discussed this issue in more detail in my conversation at the IMF in the context of African countries.

I will end on a personal note. My only reason for writing this post was the hope that perhaps it might be of some use to people working in Bangladesh. They of course know a lot more about Bangladesh than I ever can - so I very much welcome their feedback and questions. May Bangladesh continue to prosper!

The first casualty is monetary policy as central bank finds it exceedingly difficult to set interest rates independently. Central bank is “forced” to set interest rates high in order to defend the currency against fiscal solvency concerns and/or limit inflation from money printing. As a result, the country loses monetary independence, which is a huge loss.

The second casualty is the financial sector. A healthy financial sector play a key role in financing private investment. But fiscal dominance burdens the financial sector with high interest rates due to the loss of monetary independence. Fiscal dominance also comes with financial repression, as governments strong-arm the financial sector into holding government bonds. Both the high cost of financing and financial repression restrains the financial sector from financing private investment and hence growth.

The third casualty is a wider loss of confidence and consequently a broader “run” on the economy. Investors and workers do not feel confident about long-term viability of the country’s financial future and flee to other places around the world.

And as they say, three strikes and you are out. So which countries in the world are most crushed under the weight of fiscal dominance today?

The figure below ranks countries according to the share of government revenue that goes into servicing debt - a measure of the extent of fiscal dominance. The latest available year with sufficient coverage of developing countries is 2021. Sri Lanka stands out the most, and its a country that has already declared default since 2021.

The next country facing extreme fiscal dominance is Pakistan (the green dot). Pakistan’s debt service to revenue ratio is significantly higher than all other countries, but even this understates the true extent of Pakistan’s fiscal dominance woes. The orange dot adds the unfunded pension debt service that the government must pay every year. Pakistan’s government has promised pensions to its military and civilian workforce without funding these through contributions. These unfunded pension liabilities thus effectively add to Pakistan’s total debt.

Pakistan’s extremely high debt service ratio makes it susceptible to self-fulfilling runs that I mentioned earlier. This danger came to the surface during the 2022-24 crisis when central bank *had* to raise rates (that is the definition of fiscal dominance). The red dot shows the sharp jump in debt service ratio as a result of this rate rise.

Finally, even the red or orange dots do not fully reflect the true extent of Pakistan’s fiscal dominance challenge. The reason is that in another example of very poorly thought out policy decision, Pakistan chose to essentially bankroll its entire power sector with sovereign guarantees (this is why i say the nervous system is broken). As a result, Pakistan has a zombie power sector that is loaded with bad sovereign debt. It is a bit of a technical issue how to add this debt service in the figure above, but my back of the envelope calculation suggests that it should be of similar magnitude as the country’s unfunded pension liabilities.

The bottom line is that the combination of Pakistan’s domestic debt, external debt, unfunded pension liabilities and zombie power sector has pushed Pakistan into an extreme form of fiscal dominance - hard to think of any other country that is in as bad a shape. The lesson for other countries is: be afraid of fiscal dominance, and put checks in place beforehand to guard fiscal health.

(PS: I am using consolidated government revenue to calculate Pakistan’s debt service to revenue ratio. Since more than half of federal revenue goes to the provinces - and is not used to service the debt, debt service to net federal revenue number is much worse. It would be more than 100% with pensions included.)

To understand why, a bit about the economics of land value. Land is a non-reproducible factor that comes in fixed supply - humans do not create it, it’s just there. The value of land in urban areas, where it is most valuable, comes largely from the economic and social activity that surrounds it. These two facts imply that the value of land is largely “public” in nature - it has less to do with individual effort or investment of the owner. In short, land value (not counting the structures that may be build on it) mostly reflects location rents.

Given the public nature of land value, there is a basic intuition in economics that it is efficient for government to generate revenue through land value. The revenue can then be used to invest back in the city, thus benefitting everyone without creating any tax distortions (because no one creates land). This basic insight is sometimes referred to as the “Henry George theorem” after the American political economist who famously proposed land value tax to replace other forms of taxation.

How can government raise revenue through land value? There are three practical ways of doing so: (i) any public land should be auctioned off in a competitive bidding process with proceeds going to public funds, (ii) the government can price the increase in market value from up-zoning, e.g. converting agricultural to urban land, and send proceeds to fund public expenditure, and (iii) the government can tax a fraction of the market value of land on an annual basis.

When it comes to generating revenue using land value in developing countries, China is the most noteworthy example. It financed a large share of its infrastructure needs via land sales by local governments to the private sector. Naturally, all land was in state hands before China embarked on the liberalization program in late ‘70s. The country chose to gradually auction off land to the private sector and use the proceeds to fund local governments - in effect following the insight of the Henry George Theorem. China has obviously benefitted greatly from this political choice.

Contrast this with Pakistan, where the powerful have focused on pocketing land value through a number of schemes. For example, elaborate off-balance sheet, special purpose vehicles exists with the sole purpose of acquiring land using public resources and transferring it to private hands under various forms of privilege and patronage. Unlike China, almost none of this value goes to the pubic exchequer.

The figure above shows that Pakistan generates one of the lowest revenues from property - both as a share of GDP, and as a share of total tax revenue. Rather than use land to raise much-needed public funds, an elaborate alliance of the powerful has developed over time to convert public land value into private property. This is also the likely reason land value is protected from taxation. For example, despite extreme pressure due to fiscal deficit, the recent budget protected property sales of army personnel and bureau­crats from taxation.

The macroeconomic consequences of rent-seeking via plots of land are bad. First, as mentioned earlier, land value represents “location rents” that are coming from the fruits of other peoples efforts. When the powerful grab these rents so they do not flow back to the public as tax revenue, it distorts the entire economy. For example, Pakistan has high consumption and very low investment rates partly due to this issue. When the unproductive elite grab rents via land value, they generate consumption demand in the economy, without adding to the economy’s productive capacity.

Second, taxing productive sectors (e.g. manufacturing) but not real estate sets in wrong incentives for investors. Why invest in risky manufacturing and pay taxes, when there is an easier way to invest in land? Third, low taxation makes land unaffordable for those young and productive professionals who do not have generational wealth. Proper land taxation helps to bring down the value of land relative to wages, and allocates it more efficiently toward those who are more productive in the economy.

Ultimately, the nexus between power and plots reveals why the political economy of bringing about change is so difficult. The macroeconomic costs of this nexus might be obvious, but who will bell the cat? Perhaps a similar predicament made Faiz - and now I am talking about the much more enlightened Faiz-the-poet - pen these words,

بنے ہیں اہل ہوس مدعی بھی منصف بھی
کسے وکیل کریں کس سے منصفی چاہیں

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Zombie firms are firms that are fundamentally insolvent but are kept alive through subsidies from others. In simpler words, the cost of running these firms far exceeds what these firms can generate as revenue from fair market - yet they are kept alive through artificial life support. Zombie firms come straight from a horror movie - they stay alive by sucking the blood of healthy firms in the economy, killing more firms in the process.

Pakistan’s entire power sector has become a zombie sector - and it is sucking the blood out of the rest of the economy. The proof is simple: Pakistan is selling electricity at one of the highest prices in the world, about 21 cents per kWh (with taxes), and yet the sector as a whole runs in a loss. The true market price of electricity should not be more than 8-9 cents per kWh (just look at neighboring India), but the government is charging an exorbitant price in order to keep the zombie alive.

In essence, Pakistan’s government refuses to recognize that its power sector is bankrupt - itself the the result of a broken nervous system over the past three decades. The government is keeping this bankrupt zombie sector alive by passing on its extremely high cost to ordinary citizens. Since energy is a fundamental input to practically every other sector of the economy, passing on the buck through higher electricity prices ends up seriously damaging the rest of the economy as well.

In an ideal world, these zombie power companies would be declared bankrupt and forced to go through a corporate reorganization, writing down the value of bad debt until the total value of these power companies reflects their true market value. Unfortunately, this cannot be done that easily because governments of the past, in their infinite wisdom, gave sovereign guarantees to these bloated private companies (that’s why I keep saying that Pakistan’s nervous system is broken). I will perhaps write separately someday on how non-sensical the design of these power contracts has been since 1994.

For now, let’s take these sins of the past as given, and ask the question: what should be done with this zombie sector that is currently unsustainable? The answer is the same we teach students in econ 101, do not fall for sunk cost fallacy. Price electricity at its fair efficient market price so you do not distort the rest of the economy. Separate the power sector into good assets that can be sustained at fair price, and bad assets that either have to be restructured through a legal process, privatized or their losses put on general government balance sheet.

Think about more efficient ways to pay for the losses of the bad assets, rather than adding them as additional cost per kWh. For example, cut government expenditure, ask provinces to run a larger surplus (rather than give away free solar panels which makes the zombie problem worse), remove tax subsidies for military and civilian officers on property sales, etc. Even adding to petroleum levy to pay for the bad assets would be more sensible - it would hasten the renewable electrification transition that is the only viable future for Pakistan. And of course change the power sector policies that lead Pakistan to this zombie apocalypse in the first place.

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I mentioned earlier that poor countries have a natural advantage in growing fast - a force economists refer to as “convergence”. However, the promise of fast growth cannot be taken for granted. It has to be harnessed by putting in place the right environment - education, rule of law and broader protection of fundamental rights being the most important ingredients.

The promise of convergence is hence “conditional” - and there is strong empirical support for this idea. Pakistan also offers a clear example of the importance of conditional convergence. The country has failed to harness the natural growth advantage of convergence because it did not put it place the conditions necessary for fast growth. In other words, the structural roots of development have been missing.

This can most clearly be seen in the plot below that shows how Pakistan fares on four structural determinants of growth: investment, infant mortality, education and female labor force participation. The blue line plots how these four metrics vary by GDP per capita across the world. For example, as one would expect, under-5 mortality drops as countries become richer. The green dot represents Pakistan, and the vertical distance to the blue line represents the difference between Pakistan and other developing countries at similar level of GDP per capita.

What stands out in the figure above is that Pakistan is not a typical developing country. It differs systematically from countries at similar levels of income per capita. Pakistan invests a third less than the average country at its income per capita. Pakistan’s child mortality rate is way higher, and literacy rate significantly lower. Its female labor force participation rate is less than half that of developing countries at similar income level.

The net impact of these structural differences is staggering. 114,000 more children die every year in Pakistan - children who would not have died had they lived in another country with similar income level like Bangladesh. There are 17.3 million additional illiterate adults living in Pakistan - individuals who would have been literate if they had lived in another equally poor country. There should have been 16.6 million more women in the labor force if Pakistan had the average female labor force participation for its level of income.

Economic theory and history tell us that with such systematic differences with its peer group, Pakistan should have a very hard time growing - or “converging”. And this is exactly what the data shows.

The green line is Pakistan’s actual GDP per capita since 1995. The black line is what would have been Pakistan’s GDP per capita if it had grown at the average pace of other countries at similar income level. The red and orange lines represent Pakistan’s income per capita if it had grown at the same pace as Bangladesh and India respectively. The verdict is clear: Pakistan is diverging from, rather than converging to, the rest of the world.

The core reason for Pakistan’s divergence from rest of the world is that its leaders have not focused on the structural conditions necessary for growth. The focus instead has been on foreign borrowing, or some other half-baked idea driven by a broken nervous system. Unless there is structural change in the decision making process that focuses on the fundamentals, growth is unlikely to happen.

The world is a complicated place - even proper disease diagnosis for a patient requires a team of competent physicians, labs and technicians to work together. Leave the same job to a bunch of quacks who don’t believe in science, and you can imagine the rest. The same is true for economic policy. As an example, consider Pakistan’s energy policy.

A little less than a decade ago, the government of Pakistan announced a $33 billion dollar (over 10% of then GDP) new energy policy. Pakistan would borrow this amount in dollars, with sovereign guarantees, to get (mostly) fossil-fuel based power plants built. I was quite concerned when I heard about the scale and manner in which these power plants were to be built. Yes, Pakistan needed electricity for its growing domestic needs, but could it afford to do so in the manner it was being proposed?

If Pakistan had a well-functioning nervous system, some simple diagnostics should have been run before embarking on a project of this magnitude. How will the country pay back the principal plus profit in dollars when electricity revenue would be largely rupee based? What if the price of oil goes up, or there is external balance of payment pressure? Wouldn’t the additional external debt burden make such “sudden stop” scenarios more likely? Wouldn’t that crowd out private investment, and lower GDP growth? What if GDP projections are off, wouldn’t the fixed capacity payments make the whole pricing system unsustainable? What about alternative ways of designing an energy policy that harnesses domestic resources and builds domestic value chains for renewables?

I inquired around, but to my dismay could find no evidence of any reasonable, or even half-decent, analysis. No one had done a simple macro risk analysis. For example, rudimentary monte carlo simulations of possible scenarios, estimating demand elasticities to make sure pricing is sustainable etc. It is not just that the analysis was missing, no one was even looking for it. As my African friend would say, “they did not even know, what they know not”.

Today Pakistan is under extreme financial pressure, and it has one of the highest cost of electricity in the world. Households are paying about 21 cents per Kwh - in neighboring India the price is about 9 cents. Even at 21 cents per Kwh, the energy sector is barely financial sustainable1, as the country struggles with circular debt. There are about two billion dollars of delayed dividend payments owed to foreign power plant investors. In fact, at such high cost, a kind of doom-loop has set in, the higher the price, the lower the demand, which further raises average cost per unit given the fixed capacity payments promised to power producers. Then as the country struggles to pay dividends abroad, exchange rate devalues, which only makes the problem worse.

The sad reality of Pakistan’s energy woes is that the system was designed to fail. It’s fashionable these days to talk about capacity payments and the like. But all the major faults should have been visible a decade ago when such decisions were being made. Unfortunately, Pakistan did not have a nervous system to make the right decisions - for things to change, the country must build a functioning nervous system.

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Poverty is a terrible thing - but it always comes with a silver lining. Poor people are willing to work for less, and knowledge they can use to be more productive is already out there. If only a government can help harness this natural advantage, growth and prosperity follows, as countries like Vietnam and Korea have shown.

To put it differently, it takes effort to suppress growth for long periods of time. But some countries manage to do so through their collective decisions, and remain stuck in what economists refer to as a “poverty trap”. There is increasing evidence that Pakistan is stuck in such a trap due to decades of malpractice.

The black line below plots Pakistan’s GDP since 1980. It’s log-scale, meaning a straight line reflects constant growth rate. The straight red line depicts Pakistan’s growth rate during the 1980’s. The increasing separation of black line from red shows that Pakistan’s growth rate has progressively declined since the 80’s. In fact, the black line is almost flattening in recent years, depicting a stagnating economy - Pakistan is stuck in a poverty trap.

The last two years have been the worse in Pakistan’s economic history. I plot annual inflation and per-capita GDP growth for each year since 1980 below. 2023 and 2024 stand-out - never has inflation been this high and growth this low. The closest years are global crises of 2009 and 2020, but the recent two years are purely the country’s own making.

Is this just statistics? I have personally never seen as much hopelessness on the streets of Pakistan as now - it seems that anyone who can, wants to leave the country. There is some credence to this perception of mine. The chart below plots how frequently Pakistanis search for the word “visa” on google relative to the rest of the world. The number of people searching for visas abroad has skyrocketed.

The thing about poverty traps is that they are “traps” - meaning incremental change cannot take you out of your misery. The only way out of poverty traps is through a big policy change - a change that is coordinated and credible over a sustained period of time. I’ll talk about what this means in the future.

For now, it’s business as usual in Pakistan. And that is terrible news for its people.

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