Pakistan3-Three Way Partnership
Previous posts in this sequence about “Policy Implications of MMT for Pakistan” are 1-MMT For Pakistan and 2-Two Sources of Monetary Injections. This post notes that standard approaches to MMT, where the government creates money to finance public projects, are not feasible in current Pakistani context. Instead, a three-way partnership is required to allow private sector creation of credit, government regulations of excesses and evils of private sector credit creation, and community ownership to ensure responsible and beneficial use of funds. This is explained in greater detail below. This sequence of six posts expands upon talk on MMT at SBP delivered on 7th Jan 2020. This 30 minute video talk is linked below:
Even though money creation is necessary for prosperity, political constraints make this virtually impossible for Pakistan. This portion of the talk proposes a complex alternative based on three way partnership between private Islamic finance, communities, and government, which would have the effect of creating money for investment in certain projects for social welfare which have high long run impact on national development.
As a matter of accounting, when firms want to make more money, and households want to increase savings, money must be injected into the economy. It is not possible for everyone to get more money if the money stocks remain the same over time. There are two sources of injections – foreign money earned from exports, or domestic money created by government deficits. While the government MUST run deficits to create prosperity, it is not true that all kinds of deficits will do the job. The money which is created by the government must flow to the right sectors of the economy. If it flows to the wrong sectors, the money creation can cause severe inflation, and financial crises of different sorts:
- Government Deficit spending, DONE WISELY, can MASSIVELY BENEFIT the economy.
- Government Deficit spending, DONE FOOLISHLY, can RUIN the economy.
Next, we consider what it means to spend wisely, and how to differentiate between wise and foolish government deficit spending. In a nutshell, wise spending will enhance production, and the productive capacity of the economy. Foolish spending will not enhance productive capacity and hence will lead to inflation. The money created must be injected into sectors with slack productive capacity, and must not be put into sectors of the economy where capacity cannot be expanded. Also, we must avoid injecting money into financial sector and real estate, where extra money will lead to rising prices and speculative activity, without enhancing productive capacity.
Feasible Policy Options for Pakistan TODAY
What are our options in Pakistan to create money required for profits and savings, given that we are currently caught in an IMF Straitjacket? This enforces on us Austerity, Budget Balancing, and puts severe constraints on our abilities to use Deficit Financing, in order to inject money into the economy. Theoretical aspects of MMT inform us that governments should spend on “self-financing” projects which will generate long run revenues which cover costs. In addition, governments should invest in sectors with unemployed resources, so that spending stimulates production, as well as building of productive capacity. More specifically, it is often the case that private returns differ dramatically from social returns. In particular, whereas the private sector may invest in stocks and real estate, the socially most profitable investments are always in human beings. A recent World Bank study with the title “Where is the Wealth of Nations?” found that human capital is the biggest source of wealth, not natural resources like oil, land, etc. The most profitable social investment is in education and technical training. For a number of complicated reasons, private sector does not find this very lucrative. However, the government can change the rules of the game to make it worthwhile for the private sector to invest in the future of Pakistan. A mission to EDUCATE PAKISTAN will result in massive gains from skilled workforce. Whereas MMT would suggest the use of government deficit financing for this purpose, we can achieve similar effects by shifting the responsibility for credit creation to the private sector, to bypass IMF restrictions.
Three-Way Partnership Models.
Plans for large scale deficit spending, in order to finance investment projects, are not feasible, or advisable, in Pakistan for a number of different reasons. Partly, it is due to IMF constraints. But also important is the limited capacity of the bureaucratic structure to initiate and manage large projects. Concentration of power and authority also increases chances of corruption. The solution to these problems lies in a three-way partnership, where the government plays the role of facilitator and enabler. Funding would by created by private financial sector. In this area, Islamic financing can play a unique and valuable role, rather different from Capitalist interest-based finance.
Instead of government creation of money via deficit financing, we use the MMT insight that money can be created at will. Private sector creation of money is harmful because private sector invests in privately profitable projects, and not in long run social welfare. However, the government is in a strong position to regulate banks and to nudge them in favorable directions. The creation of the 30 year mortgage in the USA revolutionized home financing and put the American dream of home-ownership within reach of large part of the public. Private distaste for long-term loans, which have large levels of risk due to high uncertainty over long horizons, can be overcome by government guarantees. The US government created the Fannie Mae organization which would insure 30 year mortgages with suitable pre-conditions, and that created a huge financial industry. In a similar way, the Pakistan government can incentivize investment in the future of Pakistan by providing suitable incentives and guarantees.
The problem of incentivizing investment in education and training is more complex than housing investment, where there is a natural valuable collateral asset. Islamic Musharka finance is ideally suited for this purpose. There is a large Islamic finance industry, with available capacity for credit creation which remains un-utilized due to lack of suitable Islamic opportunities. A pro-active government program can create channels which would utilize this credit in new direction. The proposals below are uniquely suitable for the particular circumstances currently facing Pakistan, and not generally applicable.
Whereas traditional banking is concerned purely with provision of money, Islamic finance must, by rules of the Sharia, go beyond this. Earning profits on money investments is only permissible if those who advance the loans share in the risks of business. Thus Islamic banks which invest in education and training would be much more closely involved with the creation of the infrastructure, and the entire process. In particular, especially in connection with the risks of finance, Islamic banks should play an active role in monitoring and evaluation, and in making course corrections on investments. As financiers of mass education and training project, they would automatically acquire some authority in directing the course of the investment. Unlike conventional finance, which is extremely averse to any involvement in the real sector, Islamic finance must necessarily be far more actively engaged in partnership with the social welfare investment projects. However, the best management would come from the communities being served by the projects, and this is why a three-way partnership is required for implementation of this idea. Communities can envision and plan projects, and apply for financing from the government. The government acts as a regulator and an intermediary, which would connect suitable Islamic Musharka based finance with the community owned and operated projects. The financiers would monitor and evaluate the projects to ensure smooth operation and fruitful results. They would share partially in the risk of operations, to ensure that they have incentives for monitoring and evaluation. The government would regulate to ensure the profits are not exploitative, and at the same time, partially insure the risks to enable the private sector to undertake social welfare projects. Partial insurance (instead of a complete sovereign guarantee) is necessary to provide incentives for the bank to monitor and evaluate the projects.
This is a complex idea, which requires substantial attention to details to create workable models. The general feasibility of private financing of education is evidenced by the current structure of US higher education, where the financial industry has lent more than a trillion dollars to students for education. Thus projects which involve providing training and education to create workforce skills can easily be self-financing. Current US structures have effectively enslaved the students to the financial lobby, and they will have to spend a significant portion of their lifetime in paying off their loans. This illustrates the need for strong government regulation, which provides enough returns to incentivize investment, while preventing exploitation of the students. The third important component of the program is the community, which is a primary stakeholder and beneficiary, and therefore must be intimately engaged in design and execution of such programs.
Previous Posts – 1-MMT For Pakistan and 2-Two Sources of Monetary Injections
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